** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-K**

 
| **(Mark One)**                                                                                                                                                                                                                        |       |                                                                                                |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                            |       |                                                                                                |
| ý                                                                                                                                                                                                                                |       | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**     |
|                                                                                                                                                                                                                                  |
| **For fiscal year ended December 31, 2004**                                                                                                                                                                                      |
|                                                                                                                                                                                                                                  |
| **OR**                                                                                                                                                                                                                                |
| ** **                                                                                                                                                                                                                            |
| o                                                                                                                                                                                                                                     |       | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
| ** **                                                                                                                                                                                                                            | ** ** |                                                                                                |
| **For the transition period  from                to                ** |

** **

**Commissionfile 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 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 (Section 229.405 ofthis chapter) is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Exchange Act Rule 12b-2). Yes ý    No o

 

The aggregate market value of the voting andnon-voting common equity held by non-affiliates of the registrant as of June30, 2004 was approximately $270,873,536.

 

As of March 28, 2005, 21,704,790 shares of our commonstock were outstanding.

 

**DOCUMENTSINCORPORATED BY REFERENCE**[None]

 

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**FORM 10-K**

 

**For theYear Ended December 31, 2004**

 

**TABLE OFCONTENTS**

 
| **PART  I**  |
|--------------|
|         |   |   |
| ITEM 1:      | Business |   |
| ITEM  2:     | Properties |   |
| ITEM  3:     | Legal  Proceedings |   |
| ITEM  4:     | Submission  of Matters to a Vote of Security Holders |   |
| **PART II**  |
| ITEM  5:     | Market  For Company’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  Accounting 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 toeCollege.com and 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 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 the Management’sDiscussion and Analysis of Financial Condition and Results of Operations, RiskFactors and elsewhere in this report, and in the Company’s filings with theSecurities and Exchange Commission (the “SEC”). We advise readers not to placeundue reliance on the forward-looking statements contained in this report,which reflect our beliefs and expectations only as of the date of this report. Weundertake no obligation to update or revise these forward-looking statements toreflect new events or circumstances or any changes in our beliefs orexpectations, other than as required by law.

 

**ITEM 1:****    BUSINESS**

 

**General**

 

eCollege is anoutsource provider of value added information services to the post-secondaryeducation industry.  Our eLearning division provides technology, productsand services that enable colleges, universities and high schools (“K-12 schools”)to offer online distance and hybrid educational programs as well as on-campuscourses.

 

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Datamark, our Enrollmentdivision, provides integrated enrollment marketing services to the proprietarypost-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 very beginning of the decision togo (back) to school, throughout the completion of courses and programs, all theway to graduation and career placement/progression.  Our goal is toprovide our customer institutions with value-added solutions along this chain.

 

Thefour principal components of the Company’s growth strategy include:

 

***Continue fueling the profitable growth ofour current customers and in so doing drive our own revenue growth:*****As our solutions in both the eLearningdivision and the Enrollment division successfully help our clients attract,retain and educate a growing pool of students, our own revenue increases. In eLearning, our price structure is tied directly to the number of courseenrollments on our platform.  In Enrollment, as our products and serviceshelp drive enrollment revenue at a customer, there is an increasing opportunityfor our revenues to grow along with the client’s increasing marketing budget.

 

***Up-sell and cross-sell to current customers*****:**  Up-selling involves selling additionalproducts and services to current customers within the eLearning and Enrollmentdivisions.  Cross-selling focuses on selling products of one operatingdivision to appropriate customers of the other division.  Our initialexperience with cross-selling was highly targeted to the biggest opportunitiesand customers most resembling current institutions within each division. We intend to expand on this in the future to package Enrollment solutionsappropriately across various segments of customers within eLearning.

 

***Add additional customers***:  We expect to continue to increase ourcustomer base by targeting sales efforts at entrepreneurially-mindedinstitutions who are committed to achieving enrollment growth in both onlineand on-campus programs.  Additionally, we will look for resellerrelationships where appropriate to drive sales of certain products and servicesto market segments outside the normal focus of our current businesses. For example, we recently entered into a reselling relationship with a courseevaluation vendor to facilitate sales of our online survey applications.

 

***Add new products and services along thestudent life cycle that leverage both businesses in bringing additional valueto the target market*****:** Thisinvolves gaining market acceptance of recent and planned product introductionswithin divisions, planning the development and integration of new productopportunities across the divisions, and analyzing other solution providers inthe industry for potential acquisitions to provide additional products andservices that are complementary to our core businesses. As part of ourcommitment to operational excellence in our new products, we recently expandedthe role of the Product Engineering & Technology organization, originallypart of eCollege’s eLearning business, to also support product innovation inthe Enrollment business.

 

**Segment Information**

 

eCollege has two businesssegments, eLearning and Enrollment. A summary of our net revenue, income (loss)from operations, and assets for each of our business segments may be found inItem 7 of this Annual Report on Form 10-K.

 

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**Our Solution**

 

**eLearning**

 

Our eLearning technology,products and services are designed to be comprehensive, powerful and flexibleto drive the success and growth of the online educational programs of ourtarget market. As an application service provider (“ASP”), we provide ourcustomers access to our software products, consisting of online campuses,courses, reporting, content management and administration solutions, throughhosting 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 proprietaryservices and software that create and support the operational and academicneeds of our customers for their online programs and includes: eCollegeTeaching SolutionsSM, 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. In addition, we recently released eCollege Content Manager, which isdesigned to help customers efficiently manage Web-based content items.TheeCollege 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.

 

**Content Manager. **The eCollege Content Manager helps ourcustomers centrally manage, standardize and reuse content across multipleprograms, courses, sections and other applications. Content Manager is tightlyintegrated into eCollege’s course management system so users do not have to gooutside of a course to create, edit, search for or add content to a course orcourse 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 can 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 the customer to gather datafrom

 

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studentsand faculty online, and then aggregate the data into reports to help monitorcourse and program quality and instructor effectiveness.

 

*eCollegeServices. *In addition to itscore products and services, eCollege offers a suite of professional servicesthat complement its Teaching and Program Administration Solutions. Theseofferings include:

 

**Help Desk.**    eCollege provides assistance to students,faculty and administrators 24 hours a day, 365 days a year. We arestaffed to ensure that technical questions related to the eCollege System areresolved 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 for 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 ASP, we host our software for ourcustomers in a highly reliable and scalable hosting environment, allowingcustomers to provide their online programs through a standard Web browser. Wehave two commercial data centers and have built redundancy into every criticalarea of the eCollege System, including security, switches, communicationservers, network management, Web servers, application servers, database serversand data storage. This redundancy enabled us to achieve 99.99% internal systemavailability to our customers during the 2003-2004 academic year and we havecontinued to achieve that level of availability thus far in the currentacademic year.

 

**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 ASP model, whenever we release an upgradeor enhancement to our Teaching Solutions or Program Administration Solutions,all of our customers have immediate access to the benefits of the new productoffering.

 

**Enrollment**

 

OurEnrollment products and services are focused on three stages of the studentlife cycle: recruiting (lead generation), enrollment (lead conversion), andstudent retention. Our lead generation products primarily consist of directmail, media placement and interactive marketing solutions that are designed toattract the interest of the most

 

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likely candidates forenrollment at our customers’ institutions. We provide sophisticated leadresponse tracking and utilize that tracking to optimize the media mix forcustomers 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. Our LeadBoostservice is a customized lead contact strategy that uses a tailored mix of mail,interactive and telephonic media to keep interested prospects engaged.

 

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. The targeted lists helpto ensure that mailings are received by qualified sales leads and enable ourcustomers to reach potential students at lower costs. Datamark also providescustomized response modeling and list development. In addition, our customsoftware and database systems enable us to streamline the direct mailproduction process and ensure accurate and efficient targeting of prospectivestudents. We provide responsive and efficient turnaround times for directmailings, generally finishing an entire campaign within three weeks.

 

**MediaPlacement.**    Weprovide comprehensive media buying for both broadcast and print advertising media.Our MediamaxSM system provides tracking technology for complete,accurate and real-time information on media-generated leads. Through Mediamax,we are able to provide a systematic and measurable media placement offering.Using Mediamax, our customers can identify which advertisements generated themost sales leads because prospects responding to advertisements dial toll-freenumbers unique to the region, time, and media placement, thereby enhancingtracking accuracy. We also have a strategic alliance with a leading architectof telemarketing solutions, which allows our Mediamax product to connect with atelemarketing service in order to track and route advertising response calls.

 

**InteractiveMarketing.**    Weoffer interactive products based on managing and buying media mixes for leadgeneration on behalf of our customers. Our eMaxSM product createscustomer leads through Web marketing, such as strategic placement of schoolwebsite links, and is sold on a prescribed cost-per-lead basis. We also offerservices such as research and competitive analysis, search engine optimizationand web site review, consultation, design, and development. Additionally, weoffer an Internet marketing solution called eOptSM to smallerschools. eOpt allows us to group smaller schools together, so we can make mediapurchases for the group as a whole to get more efficient rates. eOpt is alsosold on a cost-per-lead basis. Our database driven lead management systemprovides a complete lead verification process that minimizes the number ofinvalid leads sent to our customers. In addition, the lead management systemprovides real-time reporting via the Internet on all critical aspects of acustomer’s media buy. Our lead management services are included in eMax andeOpt and are also available to customers on a cost-per-lead or flat fee basis.

 

**StudentRetention.**    OurPath FinderTM solution provides a targeted and prescriptivecustom-designed retention solution for our customers that can be implemented inas few as six weeks. This program helps record and mine data comprised ofstudent success guides, course evaluation surveys, student satisfactionsurveys, faculty and staff surveys and exit surveys. While the program isdesigned to help all students succeed, it particularly identifies and focuseson students most susceptible to attrition and utilizes specialized tools andtechnologies to motivate and keep them in school. This enhanced monitoring ofstudent satisfaction allows our customers to proactively address student issuesand increase graduation rates.

 

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**Other Products***.* Other Datamark products include customresearch and admissions training. Our custom research includes services such asfocus groups, surveys, curriculum mix, site location and other marketingstudies. We also offer training to our customers’ admissions staffs to improvetheir conversion rate of leads into enrollments. These solutions are supportedby an infrastructure that uses specialized database technology and research andoptimization methods. We can provide research capabilities to customers beforea campaign or even when a customer is looking for a new school location.Further, a tight results tracking and targeting adjustment cycle helps optimizethe campaign’s effectiveness, thereby improving the return on investment forour customer.

 

**Customers**

 

TheCompany’s definition of a customer is determined based on which entity withinan organization makes budgetary decisions and enters into a sales agreementwith eCollege or Datamark. Online distance education purchasing decisions aregenerally made at the consolidated school group level, while enrollmentmarketing purchasing decisions are more often made at the individual school orcampus level. Therefore one school group could potentially include more thanone customer if the organization does not centralize purchasing decisions.

 

As of December 31, 2004, our eLearning divisionhad customers located primarily in the United States and Canada. Such customersinclude some of the fastest growing and largest programs for online degrees,certification, and professional development. The eLearning division servesfor-profit education companies and post-secondary schools, public and privateuniversities, community colleges, career commuter colleges, state departmentsof education and K-12 school districts. In addition, we have contracts withseveral providers of continuing education and corporate training. For the yearended December 31, 2004, our 30 largest eLearning customers accounted for71% of our eLearning revenue.

 

Our Enrollment divisionoperates in three key customer sectors within the post-secondary marketincluding proprietary, continuing education and community colleges, with themajority of customers in the proprietary sector. Our Enrollment divisioncurrently has more than 190 customers. These customers are located throughoutthe United States and Canada. For the year ended December 31, 2004, our 30largest Enrollment customers accounted for approximately 93% of our Enrollmentdivision revenue.

 

For the year ended December 31, 2004,Corinthian Colleges, a customer of both the eLearning and Enrollment divisionsaccounted for approximately 16% of our consolidated revenue, Career EducationCorporation, a customer of the Enrollment division, accounted for approximately14% of our consolidated revenue and 15% of our consolidated accounts receivablebalance at December 31, 2004.

 

**Sales and Marketing**

 

**eLearning**

 

We target prospectivecustomers in the United States and Canada. We have a dedicated eLearning salesforce, most of whom have a background in education and/or technology, who aresolely responsible for new business development. We compensate our sales forcewith a combination of salary and commissions. We divide our sales force intotwo groups: higher education and K-12, each managed by a vice president who isresponsible for regional directors who are located within the geographicterritories they serve. Our regional directors focus exclusively on selling toinstitutions with large distance programs or with the potential for a largedistance program within a clearly defined target account list for eachgeographic region.

 

Once a customer contractswith us, the account is assigned to our Account Management department, which isresponsible for partnering with our customers to build new online programs fornew schools or departments within customers’ institutions. The AccountManagement department also promotes and sells additional products and serviceofferings to our customers for their existing programs and provides assistanceto program administrators to ensure that customers’ communications andreporting needs are met. We compensate our Account Managers with a combinationof salary and commissions based on existing customer revenue goals.

 

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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.

 

We market our eLearningtechnology and services through online media advertising, trade shows,eCollege-sponsored symposiums, speaking engagements and direct marketing. OureCollege.com website includes a demonstration and trial of the eCollege Systemand provides information on industry news, trends and important events inonline learning. We use press releases and communications to the news and trademedia to promote online learning and our customers’ programs in order toincrease online student enrollments. We are currently focusing our marketingactivities to include more direct marketing to decision-makers in our targetmarkets and continuing to strengthen our brand identity by participating intrade shows, conferences and executive speaking engagements.

 

**Enrollment**

 

Our Enrollment divisionemploys an experienced direct sales force, which is compensated for drivingsales to existing and new customers. Incentive compensation plans for our salesexecutives include a base salary plus commission on gross sales of direct mail,interactive, research, training and retention services and on net sales ofmedia placement. We also reward account executives with an incrementalcommission for the first 12 months of new business revenue in an effort to motivatesalespeople to generate new sales opportunities.

 

In order to effectively sellour enrollment marketing solutions to existing customers, we have divided ourcustomer base into different segments based on revenue size. Senior managementspends the majority of its time focusing on the customers with the greatestrevenue potential. We have also developed an integration strategy which weestablish multiple Datamark contacts with a customer at different levels of thecustomer organization. In addition, our account managers and account servicespecialists oversee each customer job to ensure quality customer service.

 

The Enrollment division ispursuing several growth initiatives to leverage its core competencies, businessmodel, and customer base. The division’s near-term growth areas include furtherpenetrating its core market and broadening its services offerings. We areactively working with our large customers to integrate additional serviceofferings to support enrollment and retention objectives. While Datamark’scustomers continue to purchase marketing services primarily to drive on-campusenrollments demand for Datamark’s marketing solutions for online programs isgrowing quickly.

 

We primarily market ourEnrollment division solutions through the sales efforts of our accountexecutives. We also participate in industry trade shows, sponsorships, e-mailcampaigns, and newsletters. In addition, we rely on our Datamark website andplace advertisements in major trade magazines.

 

**Competition**

 

**eLearning**

 

The online learning markethas evolved quickly over the past ten years and is subject to technologicalchange.   Some colleges and universities construct online learning systemsutilizing in-house personnel and create their own software or purchase softwarecomponents from a vendor. Therefore, we face significant competition from avariety of entities including software companies with specific products for thecollege and university market, and service companies that specialize inconsulting, system integration, and support in the eLearning industry. Othercompetitors in this market include a wide range of education and trainingproviders using video, mail correspondence, CD-ROM, and live online training. Webelieve that the market has recently begun to consolidate. Our principalcompetitors include Blackboard, Inc., WebCT, Inc., Desire2Learn Inc. and ANGELLearning, Inc.

 

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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;

 

•                         Reliability, with up-time and degradation freeusage being the significant measures;

 

•                         Scaleability, security and systemperformance;

 

•                         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 customer support and satisfaction

 

•                         Vendor financial viability and companyreputation;

 

•                         Competitive pricing; and

 

•                         The quality of implementation and ongoingsupport teams.

 

Webelieve we compete favorably on the basis of these factors.

 

**Enrollment**

 

The primary source ofcompetition for our Enrollment division comes from large educationalinstitutions that perform a significant portion of their marketing functionin-house and from local advertising agencies, media companies and printingservices companies who compete for our accounts. There are a few outsourcedmarketing service providers that we believe are our primary competitors, but webelieve that few, if any, of these companies offer as comprehensive a selectionof integrated marketing solutions as we do. We believe that the principalcompetitive factors in our market include:

 

•                         The ability to deliver an industry specificsolution;

 

•                         The ability to provide a comprehensive solution for student enrollmentand 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 return on their marketing investments.

 

Webelieve that we compete favorably on the basis of these factors.

 

**Technology**

 

In 2004, we consolidated the technologyorganizations for eLearning and Enrollment under a single management team. Followingis a discussion of the technology we employ in each of our operating divisions:

 

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**eLearning**

 

Our technology strategy forthe eLearning division is to employ the best available software on stable andscalable platforms. All of our solutions contain our proprietary software andinclude access to certain widely-available software products we license fromthird parties. To create the custom components of our software, we employMicrosoft’s most current and commonly used Internet programming technologies,allowing applications to communicate and share data over the Internet.

 

Because our current businessdepends on our ability to host Web-based software applications for ourcustomers, one of our primary technical goals is to provide a highly reliable,fault tolerant system. To do so, we have made substantial investments insystems monitoring, fault handling, technology redundancy and other systemup-time enhancements. For example, we continuously monitor our customers’online campuses and our own core systems for availability. All of our primaryservers contain fault-tolerant disk storage technology, backup network cardsand power supplies, which reduce the possibility of a single point of failurein our servers and reduce downtime. Our database servers contain the latestclustering technology, which uses a combination of scalable hardware andMicrosoft software technologies. We maintain sophisticated “firewall”technology to prevent access by unauthorized users and to minimize known vulnerabilitiesto system security. We also have Intrusion Detection Systems and offer SSL(Secure Socket Layer) encryption for sensitive data, and VPN (Virtual PrivateNetwork) access to safely transfer data.

 

Our products are deliveredto our customers from a network of centralized Web servers. Our Web servers arelocated in two data centers, commonly known as Web “server farms,” whichprovide us with scalable, high bandwidth Internet connections. Our primaryfacility is co-located at ViaWest Internet Services, Inc. in Denver,Colorado, and our back-up facilities are located at our eLearning divisionheadquarters in Denver. Having multiple data centers provides us with thecapability to provide backup in the case of failure of a data center, therebymitigating or eliminating customer downtime. Our investment in our technologyhas enabled us to deliver 99.99% internal system availability to our customersduring the 2003-2004 academic year and thus far in the current academic year.

 

**Enrollment**

 

Our technology strategy forthe Enrollment division is to employ the best available software and systems toprovide our customers with the highest return on their investments. Thisstrategy 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 services such as Internetsearch engine optimization and web site review, consultation, design, anddevelopment.

 

To create the customcomponents of our software, we employ Microsoft’s most current and commonlyused programming technologies, as well as open source software such as Linux,PHP and MySQL.

 

The Enrollment division usesstate-of-the-art equipment in its direct mail production facility. Usingdirect-to-plate technology, which reduces turnaround times and increasesquality, our production facility is easily scalable and is designedspecifically for short-run, highly personalized direct mail campaigns. Thefacility has several printing presses, folding machines, inserting machines andsorting machines. Our high volume laser printers provide us with astate-of-the-industry solution for personalizing direct mail pieces. Inaddition, we have purchased equipment that enables us to create new kinds ofdirect mail products such as matched mailings.

 

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**Research and Development**

 

The Company’s product development activities aremanaged from Denver, Colorado. Although we have primarily developed productsinternally in previous years, in January 2004 we decided, based on timingand cost considerations, to supplement our development efforts by committingresources to offshore development in Sri Lanka. eCollege entered into anagreement with a third party vendor to provide supplemental softwaredevelopment for our development projects. Effective in 2007, we will have theoption of hiring the third party’s staff and establishing our own facility inSri Lanka. Minimum commitments under this contract aggregated $3.3 million atDecember 31, 2004. If we elect to terminate the agreement before April 2007, wewill have to pay a termination penalty equal to six months expense at the thencurrent minimum staffing level. In 2004, we integrated technology operationsand software development to ensure common architectural standards and processesthroughout the Company. Both onshore and offshore resources are used to supportresearch and development for the eLearning and Enrollment divisions.

 

eCollege’s total expenditures for research anddevelopment were $6.6 million in 2004 (of which $0.9 million related todevelopment in Sri Lanka) and $5.7 million (all in the United States) inboth 2003 and 2002. We capitalized $1.8 million in costs for internallydeveloped software in 2004, which reduced research and development expense by acorresponding amount. In 2003, we capitalized $304,000 in costs for internallydeveloped software. No such costs were capitalized in 2002. We anticipate thatwe will continue to have significant research and development expenditures inthe future as we continue to develop and provide innovative, high-qualityproducts and services to maintain and enhance our competitive position.

 

**Seasonality**

 

Because the majority of oureLearning revenue is derived from the number of students our customers haveenrolled in online courses delivered on our CMS, our results of operations areimpacted somewhat by the seasonality inherent in the traditional academiccalendar. However, in 2004, we continued to see our customers offer morenon-traditional course terms (i.e. quarterly, monthly and bi-monthly), whichhas somewhat mitigated the seasonality of our results. We expect this trend tocontinue in the future. There is also a certain degree of seasonality in ourEnrollment division. The seasonality is primarily driven by our customers’direct mail campaigns, which tend to be weighted toward the second half of thecalendar 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 rights. InOctober 2002, we received notice of registration patent number 6,470,171and in January 2004, we received notice of registration of patent numbers6,674,992, 6,678,500 and 6,684,053, with the United States Patent and TrademarkOffice (“USPTO”) covering certain key features of the eCollege System. eCollegehas additional patent applications filed with the USPTO covering other keyfeatures of our software.

 

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

 

**Employees**

 

As of December 31, 2004we employed 443 people. None of our employees are subject to collectivebargaining agreements, and we consider our relations with our employees to begood.

 

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**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 electronically filing or furnishing such materialto the SEC. You can download and read our Annual Report on Form 10-K by goingto the Investor Relations section of our website and clicking on the “AnnualReport” link. You can obtain access to our other SEC filings from the InvestorRelations section via a hyperlink to a third-party SC Filings website. Theinformation found on our website is not part of this or any other report wefile or furnish to the SEC.

 

**ITEM2.    PROPERTIES**

 

The Company recentlyrelocated its principal executive office to Chicago, Illinois. The Chicagooffice houses the Chief Executive Officer, Chief Financial Officer and GeneralCounsel as well as certain accounting, finance and administrative employees.The office comprises approximately 6,178 square feet and is held under a leasethat expires in January 2010, with an option to extend for one additional fiveyear period.

 

Our other corporateexecutives and our eLearning division continue to be located in Denver,Colorado. The Denver facility encompasses approximately 47,600 square feet andis held under a lease that expires on September 30, 2007. We have theoption to extend this lease for two additional periods of three years each.

 

Our Enrollment division islocated in Salt Lake City, Utah in leased office space that is attached to itsproduction facility. The production facility is approximately 22,000 squarefeet and the office space is approximately 28,000 square feet. The Enrollmentdivision also has office facilities consisting of approximately 5,000 squarefeet in Spokane Washington; 1,100 square feet in Kansas City, Kansas; and 850square feet in St. Louis, Missouri. The office in Spokane serves as the mediaplacement center and the offices in Kansas City and St. Louis are salesoffices. The lease on our Salt Lake City facilities expires in June 2012and the leases on our Spokane, Kansas City and St. Louis facilities expire onvarious dates from 2005 through 2007.

 

We believe that our currentfacilities are adequate for our current needs and that suitable additional oralternative space will be available in the future on commercially reasonableterms as needed.

 

**ITEM 3.    LEGAL PROCEEDINGS**

 

In December 2002, theCompany was named as a defendant in the lawsuit captioned IP Innovation, LLC,Plaintiff vs. Thomson Learning, Inc., eCollege.com,Digitalthink, Inc., Docent, Inc., Blackboard, Inc., GlobalKnowledge Network, Inc., and The Princeton Review, Inc., Defendants,Case No. H-02-2031, In the United States District Court for the SouthernDistrict of Texas, Houston Division. The lawsuit was originally captioned IPInnovation, LLC, Plaintiff vs. WebCT, Inc., and Thomson Learning, Inc,Defendants, Case No. H-02-2031, In the United States District Court forthe Southern District of Texas, Houston Division. The case involves claims ofpatent infringement. In April 2004, the Company filed a motion for summaryjudgment, and on July 1, 2004, the court entered final judgment in ourfavor, finding that the Company’s programs do not directly or indirectlyinfringe on plaintiff’s patents.  In August 2004, the plaintiff fileda notice of appeal in the United States Court of Appeals for the FederalCircuit. The Company intends to continue to vigorously defend the lawsuit.Although no assurances can be given that this matter will be resolved in theCompany’s favor, we believe that the case is without merit, and that theultimate resolution of the lawsuit will not have a material adverse effect onthe operating results or the financial position of the Company.

 

The Utah State Tax Commission conducted a sales taxaudit of Datamark for the period April 1, 2002 through December 31, 2002. Uponcompletion of the audit in November 2003 the Tax Commission claimed thatDatamark owed $530,209 in sales tax plus continuing interest for a totalassessment of approximately $590,000.

 

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Datamark subsequently paid$52,000 to the Tax Commission. In February 2004, Datamark appealed theassessment in an administrative proceeding before the Tax Commission captionedDatamark, Inc. v. Auditing Division, Utah State Tax Commission, Appeal No.03-1679, Account No.E76142. Datamark vigorously disputes the Tax Commission’sclaims and is vigorously prosecuting its appeal. The former stockholders ofDatamark have agreed to indemnify the Company for any liability arising fromthis matter to the extent that such liability relates to periods ending priorto October 31, 2003. Although we cannot predict with certainty the outcome ofthis dispute, we believe that its ultimate resolution will not have a materialadverse effect on the operating results or financial position of the Company.

 

**ITEM 4.    SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

During the fourth quarter of2004, the Company did not submit any matters to a vote of the Company’sstockholders.

 

**PART II**

 

**ITEM 5.    MARKET FOR COMPANY’S COMMONEQUITY AND RELATED STOCKHOLDER MATTERS**

 

eCollege’s common stock hasbeen traded on the NASDAQ National Market System (“Nasdaq NMS”) under thesymbol “ECLG” since December 15, 1999. The following table sets forth thehigh and low sales prices of the Company’s common stock for the periodsindicated as reported on the Nasdaq NMS.

 

| ** **                       | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------------------------|------------|----------|------------|---------|------------|
| **Year ended December 31, 2003** |       |     |       |    |       |
| 1st Quarter                      |       | $        | 4.70       |    | $          | 3.45 |   |
| 2nd Quarter                      |       | $        | 12.03      |    | $          | 3.88 |   |
| 3rd Quarter                      |       | $        | 23.14      |    | $          | 10.80 |   |
| 4th Quarter                      |       | $        | 26.71      |    | $          | 15.62 |   |
|                             |       |     |       |    |       |
| **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 |   |

 

The closing price on March28, 2005 was $12.70.

 

As of March 28, 2005 therewere approximately 102 holders of record of our common stock.

 

The Company has never paidcash dividends on its stock, and is currently precluded from doing so under itsborrowing agreements.

 

**ITEM 6.    SELECTED FINANCIAL DATA**

 

The following table setsforth our summary consolidated financial data for each of the past five years.Data for 2004 and 2003 include Datamark’s results of operations fromOctober 31, 2003, the acquisition date. You should read this informationtogether with the Consolidated Financial Statements and the Notes to thosestatements included in Item 8 of this Annual Report on Form 10-K and theinformation set forth under the caption

 

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“Management’s Discussion and Analysis of FinancialCondition and Results of Operations” in Item 7 of this Annual Report onForm 10-K.

 

**Statement of Operations Data:**

** **
| ** **                                                                                           | ** ** | **Years Ended December 31,**              | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2004 (1)**                              | ** ** | **2003(1)** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                                           | ** ** | **(In thousands, except per share data)** | ** ** |
| Revenue:                                                                                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Student fees                                                                                         |       | $                                         | 31,154     |   | $ | 24,971 |   | $ | 18,058 |   | $ | 13,054 |   | $ | 7,037 |   |
| Direct mail enrollment marketing                                                                     |       | 38,347                                    |       | 6,277 |   | — |   | — |   | — |   |
| Interactive enrollment marketing                                                                     |       | 11,079                                    |       | 790 |   | — |   | — |   | — |   |
| Other                                                                                                |       | 8,687                                     |       | 4,822 |   | 5,634 |   | 6,793 |   | 5,502 |   |
| Total revenue                                                                                        |       | 89,267                                    |       | 36,860 |   | 23,692 |   | 19,847 |   | 12,539 |   |
| Cost of revenue                                                                                      |       | 46,780                                    |       | 16,183 |   | 11,663 |   | 13,840 |   | 12,650 |   |
|                                                                                                 |       |                                      |       |   |   |   |   |   |   |   |   |
| Gross profit (loss)                                                                                  |       | 42,487                                    |       | 20,677 |   | 12,029 |   | 6,007 |   | (111 | ) |
| Operating expenses:                                                                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Product development                                                                                  |       | 6,635                                     |       | 5,723 |   | 5,658 |   | 4,810 |   | 7,133 |   |
| Selling and marketing                                                                                |       | 9,878                                     |       | 5,843 |   | 5,613 |   | 7,147 |   | 10,587 |   |
| General and administrative                                                                           |       | 16,213                                    |       | 7,140 |   | 5,621 |   | 6,718 |   | 9,435 |   |
| Other general and administrative expense  (2)                                                        |       | 1,492                                     |       | 249 |   | — |   | — |   | 2,570 |   |
|                                                                                                 |       |                                      |       |   |   |   |   |   |   |   |   |
| Total operating expenses                                                                             |       | 34,218                                    |       | 18,955 |   | 16,892 |   | 18,675 |   | 29,725 |   |
|                                                                                                 |       |                                      |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations                                                                        |       | 8,269                                     |       | 1,722 |   | (4,863 | ) | (12,668 | ) | (29,836 | ) |
| Interest income (expense), loss from early  repayment of debt and other, net (3)                     |       | (7,406                                    | )          | (1,154 | ) | (58 | ) | 331 |   | 2,154 |   |
|                                                                                                 |       |                                      |       |   |   |   |   |   |   |   |   |
| Income (loss) before income taxes                                                                    |       | 863                                       |       | 568 |   | (4,921 | ) | (12,337 | ) | (27,682 | ) |
|                                                                                                 |       |                                      |       |   |   |   |   |   |   |   |   |
| Income tax benefit (4)                                                                               |       | 18,497                                    |       | — |   | — |   | — |   | — |   |
| Income (loss) before cumulative effect of  change in accounting principle                            |       | 19,360                                    |       | 568 |   | (4,921 | ) | (12,337 | ) | (27,682 | ) |
| Cumulative effect of change in accounting  principle (5)                                             |       | —                                    |       | — |   | — |   | — |   | (1,205 | ) |
|                                                                                                 |       |                                      |       |   |   |   |   |   |   |   |   |
| Net income (loss)                                                                                    |       | $                                         | 19,360     |   | $ | 568 |   | $ | (4,921 | ) | $ | (12,337 | ) | $ | (28,887 | ) |
|                                                                                                 |       |                                      |       |   |   |   |   |   |   |   |   |
| Net income (loss) applicable to common  shareholders                                                 |       | $                                         | 19,360     |   | $ | 568 |   | $ | (4,921 | ) | (12,337 | ) | $ | (28,887 | ) |
|                                                                                                 |       |                                      |       |   |   |   |   |   |   |   |   |
| Basic net income (loss) per common share  before cumulative effect of change in accounting principle |       | 0.95                                      |       | 0.03 |   | $ | (0.30 | ) | $ | (0.76 | ) | $ | (1.76 | ) |
| Cumulative effect of change in accounting  principle (5)                                             |       | —                                    |       | — |   | — |   | — |   | (0.07 | ) |
| Basic net income (loss) per share                                                                    |       | $                                         | 0.95       |   | $ | 0.03 |   | $ | (0.30 | ) | $ | (0.76 | ) | $ | (1.83 | ) |
| Diluted net income (loss) per share                                                                  |       | $                                         | 0.88       |   | $ | 0.03 |   | $ | (0.30 | ) | $ | (0.76 | ) | $ | (1.83 | ) |
| Weighted average shares outstanding – basic                                                     |       | 20,358                                    |       | 17,758 |   | 16,329 |   | 16,219 |   | 15,743 |   |
| Weighted average shares outstanding –  diluted                                                  |       | 21,996                                    |       | 19,578 |   | 16,329 |   | 16,219 |   | 15,743 |   |

 

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(1)          Noteon adoption of Statement of Financial Accounting Standards (“SFAS”)No. 123 “Accounting for Stock-Based Compensation”: The Company adoptedSFAS No. 123 effective January 1, 2003 for its financial statements,using the prospective method as described in SFAS No. 148 “Accounting forStock-Based Compensation-Transition and Disclosure, an amendment ofSFAS 123.” The Company’s use of the prospective method of adoption meansthat the fair value for stock-based compensation required by SFAS No. 123was applied only to stock-based compensation awards granted, modified, orsettled subsequent to January 1, 2003. Accordingly, the results for 2003 and2004 are not directly comparable to results of prior years in this regard. TheCompany recorded $3.8 million and $1.0 million of total stock-basedcompensation expense in 2004 and 2003, respectively.

 

(2)          OtherGeneral and Administrative Expense: In 2004 other general and administrativeexpense consisted of amortization of intangible assets acquired in the Datamarkacquisition of $1.5 million. In 2003 other general and administrative expenseconsists of two months of amortization expense for our intangible assetsacquired in the Datamark acquisition. In 2000, other general and administrativeexpense relates to compensation expense for non-employee options granted to aninvestment fund affiliated with the Chief Executive Officer of the Company. Theoptions were granted in lieu of salary, benefits and other compensation andwere valued based on an independent valuation.

 

(3)          OtherIncome (Expense), net: In 2004 and 2003, this expense consists primarily ofinterest expense associated with our various debt obligations, net of interestincome. In 2004 this also includes a loss from early repayment of debt in theamount of $2.5 million. Income in 2002, 2001 and 2000 is primarily interestincome on our invested cash and cash equivalents, net of interest expense ondebt and capital leases.

 

(4)          Werecorded an income tax benefit for the year ended December 31, 2004 from thereversal of the valuation allowance we had previously recorded against ourdeferred tax asset as well as from the recognition of changes in othertemporary differences.

 

(5)          Noteon Change in Accounting Principle: Effective January 1, 2000, we adopted theSecurities and Exchange Commission’s Staff Accounting Bulletin No. 101 (“SAB101”), “Revenue Recognition in Financial Statements,” which provides guidanceon revenue recognition for public companies. Under SAB 101, online campusdevelopment fees are recognized from the campus launch date through the end ofthe contract period or the expected life of the customer relationship,whichever is greater. Course development fees for building individual onlinecourses are recognized on a straight-line basis over the approximate length oftime which we complete our obligations to our customers, currently estimated asnine months on average. We have accounted for the implementation of theguidelines of SAB 101 as a change in accounting principle effective January 1,2000.

 

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**Balance Sheet Data:**

 
| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                         | ** ** | **(In thousands)**    | ** ** |
| Cash, cash equivalents and short-term  investments |       | $                     | 8,223      |   | $ | 15,974 |   | $ | 13,633 |   | $ | 16,626 |   | $ | 28,415 |   |
| Working capital                                    |       | 4,495                 |       | 4,437 |   | 6,624 |   | 8,677 |   | 17,648 |   |
| Total assets                                       |       | 117,815               |       | 102,023 |   | 22,567 |   | 27,240 |   | 44,748 |   |
| Line of credit                                     |       | —                |       | 9,365 |   | 2,938 |   | 2,500 |   | 2,000 |   |
| Current portion of debt                            |       | 1,000                 |       | 1,000 |   | — |   | — |   | — |   |
| Long-term portion of debt                          |       | 20,023                |       | 27,785 |   | 706 |   | 946 |   | 1,389 |   |
| Total liabilities                                  |       | 39,899                |       | 51,590 |   | 12,163 |   | 12,242 |   | 18,461 |   |
| Total stockholders’ equity                    |       | 77,916                |       | 50,433 |   | 10,404 |   | 14,998 |   | 26,287 |   |
|                                                    |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**ITEM 7.    MANAGEMENT’S DISCUSSION****AND ANALYSIS OF FINANCIALCONDITION 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. These policies have been discussed with, and areevaluated by, our Audit Committee and are substantially consistent with thepolicies in effect during 2003. Each of these policies is discussed in detailbelow, as well as in the Notes to Consolidated Financial Statements included inItem 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 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 EITF00-21, “Accounting for Revenue Arrangements with Multiple Deliverables”, toidentify units of accounting in revenue arrangements with multipledeliverables.

 

*eLearning*

 

We enter into contracts withour customers to provide our online learning products and services. Ourcontracts typically have initial terms of one to five years, with an averageterm of approximately three years. Each contract specifies the type and priceof the online campus purchased and the number and price of online coursespurchased, as well as the fees for student enrollments and any other productsor services purchased. Since our customer contracts are generally applicablecampus-wide, colleges and universities can add new online programs and schoolswithout the need to negotiate new contract terms.

 

The majority of oureLearning division revenue is earned by charging a per-enrollment studenttechnology service fee to our customers for access to their eCourses and ourhelp desk. We also offer a pricing model for our eCompanion product under whichwe charge an annual license fee for up to a predetermined number of users. For

 

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our Program Administration Solutions, wegenerally charge a one time set-up and design fee to implement an onlinecampus, and an annual license, hosting, and maintenance fee for access to oursoftware. We generally sell our course development services on a per-coursebasis, although we also offer customers the option to purchase blocks of coursedevelopment service hours with pricing based on our standard hourly rates. Feesfor other professional consulting services are based on our standard hourlyrates.

 

Student fees are recognizedon a per enrollment basis over each course’s specific academic term or over thelength of the student fee license purchased by the customer, depending uponcontract terms. No billing occurs, and no revenue is recognized, for cancelledclasses and student withdrawals or drops that occur before the agreed-uponenrollment census date that is the basis for amounts billed. Campus license,hosting, and maintenance fees, including the design and development of acustomer’s campus, are recognized on a straight-line basis from the campus launchdate through the end of the relevant contract period or the expected life ofthe customer relationship, whichever is greater. The average recognition periodfor these campus fees is approximately three years.

 

Course development fees arerecognized on a straight-line basis over the approximate period over which ourservices are provided and our obligation to the customer is fulfilled. If acustomer has purchased a block of course design and development consultinghours, we recognize such hourly fees as the work is performed. If a customerhas contracted with us to build a unique online course, we generally recognizesuch fees over a period of nine months, which approximates the length of timeover which we complete our work and fulfill our obligations to the customer.The period over which we perform the services and therefore recognize therevenue may change in the future as our actual experience in completingdevelopment obligations continues to evolve. Changes in our contract terms andexpected customer life may also affect the period over which campus and coursedevelopment fees are recognized in the future.

 

All other revenue sourcesare recognized at the time of the performance of the service (e.g., training,instructional design, and technical consulting) or over the length of theservice period (e.g., annual Evaluation Solutions license fees).

 

*Enrollment*

 

Our Enrollment divisionrevenues are primarily generated from the sale of direct mail, interactivemarketing, and media placement services. We also derive revenue from researchservices, admissions training, and retention services.

 

It is our practice toexecute contracts or work orders of various lengths, typically up to threemonths for one project, for direct mail advertising campaigns. Individualdirect mail projects typically take 10 to 18 business days to complete withpayments due two days before marketing materials are mailed in most cases. Feesare determined based on the number of pieces mailed and the associated revenueis recognized when the marketing materials are mailed. Our pricing and revenuefor direct mailings include all applicable postage costs.

 

Interactive mediaarrangements usually last from three months to one year. Our pricing is basedon a fee-per-lead generated model, with an up front payment or deposit due atthe time the customer’s agreement is signed and monthly invoices thereafterbased on the number of leads generated. Payments received are recorded ascustomer advances (a liability) until the leads are generated, at which pointthe revenue is recognized.

 

We generally enter intomaster services agreements with clients for whom we provide media buyingservices. We also execute an agency of record letter which identifies Datamarkas the agent authorized to make media placements on behalf of the customer.Smaller clients may not be required to execute master service agreements butare required to sign the agency of record letter. We charge our customer forthe cost of the advertisement placed with the third-party media supplier (e.g.newspaper, television, radio station, etc.) as well as a commission, typicallyin the amount of 15%. Revenue is recognized when the media advertisements arerun by the third-party media supplier. Revenue is recorded on a net basis,meaning that we only include in our consolidated revenue the commission portionof the amount we charge, not the gross amount of fees charged to, and collectedfrom, our customers. Accordingly, we also exclude the direct cost of theadvertisement charged by the media supplier from our

 

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cost of revenue in our consolidatedstatements of operations. We determined that media revenue should be recordedon a net basis, in accordance with EITF 99-19, “Reporting Revenue Gross as aPrincipal versus Net as an Agent,” based on the fact that the third-party mediasupplier (and not Datamark) is responsible for ultimate fulfillment, includingthe acceptability of the products or services purchased by a customer, andtherefore Datamark does not have risks and rewards as principal in the mediaplacement transactions. Furthermore, the fact that we earn a stated percentageof the amount billed to a customer is an indication that Datamark is acting asan agent only.

 

Other enrollment marketingrevenue sources include retention services, admissions training and researchservices. Contracts for student retention services agreements have a length ofnot less than 6 months and typically are for a period of one year. Wecharge a fee based on the number of students actively enrolled in a particularmonth. We also charge a one-time fee for implementation of our retentionproduct that is recognized as revenue over the contract period. Contracts foradmissions training and research services are negotiated based on scope ofwork. These services are provided on an hourly rate and are recognized at thetime of the performance of the service or over the length of the serviceperiod.

 

**Stock-Based Compensation**

 

Stock-based compensation isa critical accounting policy for our Company due primarily to the significantjudgment required when estimating the fair value of the stock-basedcompensation 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 of the awards). Prior toJanuary 1, 2003, we accounted for stock options granted to employees anddirectors and other stock-based employee compensation plans using the intrinsicvalue method of accounting in accordance with APB No. 25 and relatedinterpretations. Under APB No. 25, we generally did not record anystock-based compensation expense for options granted to employees, provided theoptions had an exercise price equal to or above the market price of our commonstock and the ultimate number of shares to be issued upon exercise was fixed onthe day the option was granted. As such, we recognized compensation expense forstock options only if the quoted market value of the Company’s common stockexceeded the exercise price of the option on the grant date.

 

During the fourth quarter of2003, we adopted SFAS No. 123 effective January 1, 2003 for ouremployee stock option plans and other employee stock-based compensationarrangements using the prospective method under SFAS No. 148. This methodapplies the provisions of SFAS No. 123 to all employee stock awardsgranted, modified or settled after January 1, 2003, and accordingly, wehave recognized compensation expense for such awards made under our stock-basedemployee compensation plans. The fair values of restricted share rights aredetermined using the closing price of our common stock on the date of grant,while stock options and stock purchase awards are estimated at the date ofgrant using the Black-Scholes option-pricing model. The fair values of stockappreciation rights are estimated at the date of grant using a Monte Carlosimulation for an Asian type award. The estimated fair values of awards arebeing amortized over the vesting period of the applicable award, generally3 to 5 years.

 

The Company recorded $3.8million of stock-based compensation expense in 2004 and $1.0 million ofstock-based compensation expense in 2003, as compared to $153,000 in 2002 priorto the adoption of SFAS No. 123. For stock awards granted prior toJanuary 1, 2003, compensation expense has not been recognized under SFASNo. 123, in accordance with the prospective method of adoption allowed forunder SFAS No. 148. Accordingly, 2004 and 2003 results are not directlycomparable to prior years’ results in this regard. However, as required by SFASNo. 123, we do present pro forma disclosures of our net income (loss)using the fair value-based accounting model for awards granted prior toJanuary 1, 2003, as shown in Note 2 to the Consolidated FinancialStatements include in Item 8 of this Annual Report.

 

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. Therights will be settled in stock. Each grant is separated into five differentlevels of base prices to reflect minimum required levels of stockholder returnover 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

 

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distribution with respect to the shares ofcommon stock in each grant level only if the average closing price of ourcommon stock for the last quarter in the five year term exceeds the base pricefor such shares. Each participant may elect to receive a distribution withrespect to 10% of the rights he or she was granted after the third anniversaryof the grant and with respect to an additional 10% after the fourthanniversary. In the event of a change in control, participants will be entitledto receive 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 stockappreciation right was estimated on the date of grant using a Monte Carlosimulation for an Asian type award. On March 23, 2005, the Company grantedsubstantially the same recipients additional stock appreciation rights withrespect to 1.1 million shares of common stock. Such grants have the same termsas the 2004 grants except that they have different base prices and a newfive-year performance period beginning on the grant date. In addition, theCompany may grant stock appreciation rights to new hires and in connection withpromotions and other special circumstances. Compensation expense is recognizedratably over the five year vesting period.

 

Effective November 1, 2004, the Company amended its1999 Employee Stock Purchase Plan to revise certain features. The current twoyear offering period under the Plan ends April 30, 2005. Effective with the purchaseinterval that began on November 1, 2004 the ability of plan participants toincrease contributions during an offering period has been eliminated as a resetfeature that established a new offering period if the fair market value of theCompany’s stock on any purchase date within an offering period was less thanthe fair market value at the beginning of the offering period. Effective May 1,2005, the length of an offering period will be reduced from two years to oneyear and the length of each purchase interval will be increased from six monthsto one year. The Employee Stock Purchase Plan has been and continues to beaccounted for under the fair value method in accordance with SFAS No. 123,which requires that compensation expense be recognized for the fair value ofawards.

 

**Debt Obligations**

 

In October 2003, theCompany financed a portion of the purchase of Datamark with $20.0 million(face value) senior subordinated secured notes (“Senior Subordinated Notes”)issued to a lender and $12.0 million (face value) subordinated sellernotes (“Seller Notes”). The Senior Subordinated Notes have principal paymentsdue in $5.0 million quarterly increments beginning on December 31,2007, with interest payments due quarterly beginning on December 31, 2003,at a nominal rate of 12.5% per annum. The Seller Notes, with interest andprincipal due in 2008, initially consisted of a series of notes aggregating$7.0 million, with a stated interest rate of 10.0% per annum, simpleinterest, and another series of notes aggregating $5.0 million, with aninterest rate of 10.0%, interest compounded annually.

 

In accordance with generally accepted accountingprinciples, the Company estimated the fair value of the Senior SubordinatedNotes and the Seller Notes. The initial fair value of the Senior SubordinatedNotes reflected a fair value adjustment to the notes for the estimated fairvalue of the warrants issued in connection with this debt (see Note 5 tothe Consolidated Financial Statements included in Item 8 of this Annual Reporton Form 10-K for additional information concerning the warrants). A significantamount of judgment was involved in management’s estimate of the fair value ofthe warrants (e.g. using the Black-Scholes valuation model, estimatedvolatility and an expected life of the warrants). The estimated fair value ofthe warrants at the date of issuance was $3.3 million, and was recorded asa debt 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 $17.3 million at December 31, 2004, whichincludes amortization of warrant costs.

 

Theinitial fair value of the Seller Notes was determined by a third party whoconsidered, among other factors, the effective interest rate of our SeniorSubordinated Notes, and other comparable debt securities. The effective interestrate on this debt is 14.9%. In December 2004 the Company repaid all of the $7.0million (face value) of simple interest notes and $3.0 million (face value) ofthe annually compounding notes. The carrying value of the repaid Notes was $7.5million and the repayment resulted in a $2.5 million charge for the write-offof the unamortized discount on these notes. The carrying value of the remainingSeller Notes was $1.8 million at

 

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December 31,2004, which includes amortization of the original discount recorded and accruedinterest payable. Interest will accrue on the remaining notes until they arepaid.

 

Due to the discounts recorded when the SeniorSubordinated Notes and Seller Notes were issued, any further pre-payments ofthese debt obligations prior to their maturity would again result in asignificant amount of interest expense, since cash paid would exceed thediscounted carrying amount.

 

**Goodwill and Other Intangible Assets**

 

Withthe acquisition of Datamark in October 2003, we recorded $68.0 million of theapproximate $70.3 million purchase price as goodwill and intangible assets. Significantjudgment is required in establishing the fair value, determining appropriateamortization periods and assessing such intangibles, including goodwill, forimpairment in the future. It is possible that our review of such intangibleassets in the future could determine that they are impaired and the amount ofsuch impairment could be significant.

 

Goodwillrepresents the excess of the acquisition costs over the net of the fair valueof the identifiable tangible and intangible assets acquired and the fair valueof liabilities assumed in acquisitions. The Company applied SFAS No. 142 “Goodwilland Other Intangible Assets” in October 2003 and, in accordance with SFAS No.142, there is no amortization of goodwill and intangible assets that haveindefinite lives. However, such assets are tested for impairment annually.

 

Thefair values of the intangible assets were recorded based upon valuationsdetermined by a third party using the income and cost methods at the date ofthe acquisition. The income method determines a value based upon estimatedfuture cash flows and the cost method determines value based on what it would costto replace the asset less depreciation and functional obsolescence.

 

Basedupon the nature of Datamark’s assets, the income approach was utilized to valuethe customer relationship intangible asset. In performing the allocation, theassets were analyzed within the context of the Datamark business enterprise. TheCompany considered this context to be representative of assumptions marketplaceparticipants would use in analyzing the assets acquired. In establishing theamortization period for the customer relationship intangible asset, the Companyconsidered the relative weighting of customer revenues and customer lives anddetermined that while certain customer relationships are expected to span aslong as 16 years, the economic benefit attributable to these customersgenerally declines in the final eight years as compared to the first eightyears. Therefore, the Company used an eight year period (weighted average) fordetermining 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 hasdetermined that a straight-line amortization method over eight years isappropriate and representative of the economic benefits of the intangibleasset.

 

Indetermining the value of the Datamark trade name, the Company utilized therelief-from-royalty method – using a royalty rate applied to projected Datamarksales streams. In determining that the trade name intangible asset had anindefinite life, the Company considered the following factors: the ongoingactive useful life of the trade name, the lack of any legal, regulatory, orcontractual provisions that may limit the useful life of the trade name, thelack of any substantial costs to maintain the asset, the positive impact on thetrade name generated by Datamark’s other ongoing business activities, andDatamark’s commitment to products being branded with its trade name over itscorporate history. The Datamark trade name has significant market recognitionand the Company expects to derive benefits from the use of this asset beyondthe foreseeable future. However, should the Company discontinue use of orotherwise determine that the value of the trade name is diminished, the Companymay be required to impair all or a significant portion of this asset.

 

Pursuantto the Datamark transaction, eight Datamark employees signed agreements thatlegally restrict them from competing with eCollege during the employment periodand for two years after the last date of employment;

 

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provided that the total restricted period maynot exceed five years. In determining the value of the non-compete agreements,the Company estimated the incremental sales associated with having thenon-compete agreements in place versus not having them in place. The Company isamortizing the fair value of the non-compete agreements over five years. 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.On March 25, 2005, the Company announced that Arthur Benjamin, the Chief ExecutiveOfficer of the Enrollment Division, had resigned from the Company, as well asfrom Datamark Board of Directors. The amortization of the fair value of Mr.Benjamin’s non-compete agreement will be accelerated beginning in 2005 tocorrespond with the resulting decrease in the term of the non-compete.

 

Goodwill and the identified intangible assets withindefinite and finite useful lives were not impaired at December 31, 2004.

 

**Software Development Costs**

 

The Company’s activitiesinclude ongoing development of internal-use software used in connection withdelivery of services via its proprietary software platform and network.Pursuant to the provisions of the AICPA’s Statement of Position 98-1, “Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use,”costs incurred during the application development stage are capitalized andcosts incurred during the preliminary project and post-implementation stagesare expensed as incurred. Capitalized software development costs are amortizedusing the straight-line method over their estimated useful lives, generallythree years. Amortization begins when the products are ready for their intendeduse.  Amortization expense for the years ended December 31, 2004,2003 and 2002 was $0.3 million, $1.3 million and $1.3 million,respectively. If the internal-use software developed is determined to have areduced life or is otherwise abandoned or impaired, amortization could beaccelerated.

 

**Income Taxes**

 

Income taxes consist offederal, state and local taxes. Accounting for income taxes and any relatedvaluation allowance requires the application of significant judgment andestimates. We incurred significant losses from our inception throughDecember 31, 2002 resulting in approximately $66 million of netoperating loss carryforwards, which expire in varying amounts beginning in2011. However, utilization of such prospective net operating loss carryforwardsmay be subject to certain limitations, such as limitations resulting fromsignificant changes in ownership. In addition, income taxes may be payableduring this time, due to operating income in certain tax jurisdictions whichcannot be offset by operating loss carryforwards. If we have taxable income andthe net operating loss carryforwards are not available, because they have beenlimited by tax law, have been exhausted or have expired, we may be liable forsignificant taxes payable.

 

In assessing therealizability of deferred tax assets, management considers whether it is morelikely than not that some portion or all of the deferred tax assets will not berealized. The realization of deferred tax assets is dependent upon thegeneration of future taxable income during the periods in which temporarydifferences, as determined pursuant to Statement of Financial AccountingStandards (“SFAS”) No. 109, “Accounting for Income Taxes,” becomedeductible. Management considers the reversal of deferred tax liabilities,projected future taxable income, and tax planning strategies in making thisassessment. Management’s evaluation of the realizability of deferred tax assetsmust consider both positive and negative evidence, and the weight given to thepotential effects of positive and negative evidence is based on the extent towhich it can be objectively verified. Prior to the fourth quarter of 2004, wehad provided a full valuation allowance for the potential benefits of theaforementioned net operating loss carryforwards as we believed it was morelikely 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 we believeit is now more likely than not that we will be able to use the assets to reducefuture tax liabilities. Approximately $591,000 in valuation reserves associatedwith state net operating loss carryforwards were not reversed as it is morelikely than not that the benefits of such carryforwards

 

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will not be realized. The reversal resultedin recognition of an income tax benefit of $18.5 million in 2004 and anincrease in the deferred tax asset on the consolidated balance sheet. Thereversal also resulted in an increase of $1.9 million to additional paid incapital associated with tax benefits from stock-based compensation, and anincrease of $900,000 to goodwill associated with certain tax benefits relatedto the Datamark acquisition. In future years, we expect to record income taxexpense in relation to our pretax income.

 

**Description of Significant Components of ourConsolidated Statement of Operations**

 

**Revenue**

 

Our revenue in 2004primarily consisted of eLearning student technology fees for students enrolledin online courses and online course supplements and revenues generated bydirect mail and interactive marketing products and services provided by ourEnrollment division. We also recognized a smaller portion of revenue fromeLearning online campus and course design and development services (includinglicensing and hosting services fees for online campuses), and other eLearningprofessional services as well as Enrollment division media placement services,custom research, admissions training and student retention services.

 

**Cost of Revenue**

 

Cost of revenue for oureLearning division consists primarily of employee compensation and benefits forour account management, online campus development, course design, technicalpersonnel, and help desk departments as well as sales commissions. Our cost of revenuealso includes software, hardware, and other direct costs associated withmaintaining our data center operations, and our network infrastructure.Amortization of capitalized software development costs is also included in costof revenue.

 

Cost of revenue for ourEnrollment division includes postage costs, raw material costs, including paperand ink, costs for interactive marketing leads as well as all costs associatedwith the purchase/license of mailing lists. It also includes direct laborcosts, allocable indirect labor and overhead and contract production costs.

 

**Gross Profit**

 

As our product mix continuesto change and diversify, the mix of our cost of revenue will changeaccordingly. In 2004, our revenue increased and our cost of revenue also increasedas a percent of revenue, due to the inclusion of a full year of our Enrollmentdivision’s operations. Datamark’s gross margins have historically been lowerthan those of our eLearning division.

 

**Product Development**

 

Product development includescosts of maintaining, developing, creating and improving our online solutionsand software products. These costs consist primarily of employee compensationand benefits, consulting fees, occupancy costs, and depreciation expenses.Product development costs in the future may be reduced by any softwaredevelopment costs that are capitalized in accordance with relevant accountingstandards.

 

**Selling and Marketing**

 

The principal components ofour selling and marketing expenses in both divisions are employee compensationand benefits, advertising, industry conferences, and travel. Other significantcomponents include marketing collaterals and direct mailings, consulting fees,occupancy costs, and depreciation expenses.

 

**General and Administrative**

 

We include costs from bothdivisions as well as unallocated corporate expenses in general andadministrative expense. These costs include executives, human resources,corporate facilities, corporate and divisional accounting

 

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

 

**Amortization of Intangible Assets**

 

Our amortization ofintangible assets consists entirely of the amortization of identifiedintangible assets that we recorded in connection with the Datamark acquisition.Specifically, customer relationships are amortized over their estimated usefullives of eight years and non-compete agreements are being amortized over theirestimated useful lives of five years. On March 25, 2005, the Company announcedthat Arthur Benjamin, the Chief Executive Officer of the Enrollment Division,had resigned from the Company, as well as from Datamark's Board of Directors. Theamortization of the fair value of the related non-compete agreement will beaccelerated to correspond with the resulting decrease in the term of thenon-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), netconsists primarily of interest expense associated with our various debtobligations. It also includes interest income from invested cash and cashequivalents.

 

**Results of Operations**

 

The following discussioncompares the historical results of operations for the years endedDecember 31, 2004, 2003, and 2002. The results for 2003 include theEnrollment division’s results of operations from October 31, 2003, thedate on which we acquired all of the outstanding stock of Datamark, Inc.The inclusion of the Enrollment division’s results for 2004 and the two monthsended December 31, 2003 caused significant fluctuations in the operatingresults of eCollege for the years shown.

 

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

 

*Revenue.*    Revenue increased$52.4 million, or 142% to $89.3 million for the year endedDecember 31, 2004 from $36.9 million for the year endedDecember 31, 2003. The Enrollment division was responsible for$46.8 million of this increase, primarily from inclusion of a full year’soperating results, as compared to two months in 2003. The remaining $5.6million of the increase in revenue is primarily due to $6.2 million increasein student fees from online courses partially offset by a $0.6 million decreasein other eLearning revenue.

 

Student fees represented $31.2 million and$25.0 million of total revenue for the years ended December 31, 2004and 2003, respectively, an increase of 25%. Our eLearning customers benefitfrom volume discounts on their student technology fees based on the success oftheir distance programs. In addition, they often guarantee a minimum amount ofstudent technology fees for each year they are under contract with us, forwhich 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. We expect the trend of enrollment growth outpacing revenuegrowth to continue in 2005.

 

Revenue from direct mail marketing activities at ourEnrollment division was $38.3 million for the year ended December 31, 2004, anincrease of $32.1 million from the two months of Enrollment division operationsincluded in 2003. Direct mail accounted for 70% of total Enrollment divisionrevenue we recognized in 2004 compared to 81% of Enrollment division revenue inthe two months included in operations in 2003.

 

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Revenue from interactive marketing servicesincreased to $11.1 million in 2004 from $790,000 in the two months ofoperations included in the year ended December 31, 2003. This increase ininteractive marketing revenue was the primary reason for the decrease in directmail revenue as a percentage of Enrollment division total revenue, asinteractive marketing revenue growth exceeded direct mail revenue growth in2004.

 

Campus and course development fees represented$1.8 million and $2.6 million of total revenue for the years endedDecember 31, 2004 and 2003, respectively, a decrease of $0.8 millionor 31%. We recognized revenue from developing, licensing, and hosting onlinecampuses for 152 customers during 2004, down from the 198 customers that hadonline campuses in 2003. The decrease results from an increasing number ofcustomers taking advantage of our tools by self-designing and developing theirown courses.

 

Other revenue included eLearning technical andinstructional design consulting revenue of $1.9 million and $986,000 for theyears ended December 31, 2004 and 2003, respectively. It also included$3.1 million from media placement activities from our Enrollment division inthe year ended December 31, 2004 compared to $448,000 in 2003.

 

*Cost of Revenue.*    Costof revenue for the year ended December 31, 2004 increased by $30.6million, or 189%, to $46.8 million from $16.2 million for the yearended December 31, 2003. The Enrollment division’s direct mail and othercost of revenue was $36.4 million in 2004, an increase of $31.4 millionfrom $5.0 million for the two months of operations included in 2003. eLearningdivision cost of revenue decreased by $1.0 million, or 8%, to$10.3 million for the year ended December 31, 2004 from $11.3 millionin 2003. This decrease is attributable to a $1.0 million decrease inamortization expense related to our capitalized software costs.

 

*Gross Profit.*    We realized grossprofit of $42.5 million for the year ended December 31, 2004, resulting ina 105% or $21.8 million increase compared to the $20.7 million werealized in 2003. The Enrollment division contributed $18.1 million to ourgross profit for 2004, up from $2.7 million in 2003, while the eLearningdivision contributed $24.4 million for 2004, up from $18.0 million in 2003.The increase of $15.4 million related to the Enrollment Division was primarilydue to the inclusion of a full year of operations in 2004 as compared to twomonths in 2003, while the $6.4 million increase related to the eLearningdivision was primarily due to the increase in our higher margin student feerevenue.

 

*Product Development.*    Product developmentexpenses increased to $6.6 million for the year ended December 31, 2004 from$5.7 million for the year ended December 31, 2003, an increase of$0.9 million or 16%. The increase was primarily attributable to increasedstaffing (including offshore developers) and travel expenses related to our SriLanka development facility. We capitalized $1.8 million in costs for internallydeveloped software in 2004, which reduced research and development expense by acorresponding amount. In 2003, we capitalized $304,000 in costs for internallydeveloped software. No such costs were capitalized in 2002.

 

*Selling and Marketing.*    Selling and marketingexpenses increased by $4.1 million or 71% to $9.9 million for the yearended December 31, 2004 from $5.8 million for 2003. The Enrollmentdivision recorded $5.1 million of selling and marketing expenses during 2004,an increase of $4.5 million from 2003, reflecting a full year of expense in2004 as compared to two months in 2003. The eLearning division had $4.8 millionof selling and marketing expenses in 2004, a decrease of $400,000 from 2003,primarily due to a decrease in the number of sales and marketing personnel in2004 and the expiration of a prepaid marketing contract.

 

*General and Administrative.*    General andadministrative expenses increased by $9.1 million, or 127%, to$16.2 million for the year ended December 31, 2004 from $7.1 millionfor the year ended December 31, 2003. Of this increase, $5.0 million related toa full year of operations for the Enrollment division in 2004 ($5.6 million),as compared to two months in 2003 ($644,000). Other factors contributing to theincrease in 2004 from 2003 included increases in general corporate expensessuch as bonuses ($1.4 million), Sarbanes-Oxley compliance ($1.3 million), auditfees and higher stock-based compensation. These increased costs were offsetsomewhat by a decrease in information systems costs.

 

Werecord non-cash stock-based compensation in connection with the grant of stockoptions, stock awards under our Employee Stock Purchase Plan, stockappreciation rights and restricted share rights to employees, officers, anddirectors in accordance with SFAS 123 which we adopted using the prospectivemethod, effective

 

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January 1, 2003. The deferred charges arebeing amortized over the relevant vesting periods of such options or restrictedshare rights, which range from one to five years. We recorded$3.8 million of stock-based compensation in the year endedDecember 31, 2004. A portion of such compensation expense was allocated tocost of revenue, selling and marketing expense, and product developmentexpense, as appropriate, based on the recipients of the awards; however themajority of the stock-based compensation expense relates to our executive teamand was therefore included in general and administrative expense.

 

*Amortization of Intangible Assets.*    Amortization ofintangible assets for the year ended December 31, 2004 was $1.5 millioncompared to $0.3 million in 2003. The increase was due to twelve months ofamortization in 2004 compared to two months in 2003. Amortization of intangibleassets consists entirely of the amortization of identified intangible assetswhich we recorded in connection with the Datamark acquisition. Specifically,customer relationships with an estimated value of $8.1 million are beingamortized over their estimated useful lives of eight years, andnon-compete agreements valued at $2.4 million are being amortized overtheir estimated useful lives of five years. On March 25, 2005, the Companyannounced that Arthur Benjamin, the Chief Executive Officer of the EnrollmentDivision, had resigned from the Company as well as from Datamark's Board ofDirectors. The amortization of the fair value of the related non-competeagreement will be accelerated to corespond with the resulting decrease in the termof the non-compete.

 

*Other Income (Expense).*    Interest expenseincreased by $6.1 million, or 483%, to $7.4 million for the year endedDecember 31, 2004 from $1.3 million for the year ended December 31, 2003. Themajority of the increase is related to a full year of interest expense on thedebt obligations incurred to fund the acquisition of Datamark in October, 2003.Included in interest expense for the year ended December 31, 2004 was $2.5million in expense from early repayment of $7.5 million ($10.0 million facevalue) in Seller Notes issued as a part of the Datamark acquisition. Includedin interest expense for the year ended December 31, 2003 was approximately$353,000 of foregone debt issuance costs incurred in September, 2003 toestablish a financing commitment to fund the Datamark acquisition. Prior to theconsummation of the Datamark acquisition, we were able to negotiate debt onmore favorable terms with different lenders; therefore all of these costs wereexpensed during 2003.

 

*Income taxes.*    We recorded an incometax benefit of $18.5 million for the year ended December 31, 2004 due to thereversal of the valuation allowance we had previously recorded against ourdeferred tax asset as well as from the recognition of changes in othertemporary differences. We had $115,000 in cash expenditures for income taxes in2004. We determined in 2004 that it is more likely than not that we will beable to realize the tax benefits of our approximately $66 million in netoperating losses as a carryforward against future taxable income. We had noincome tax expense or benefit in 2003.

 

*Net income.*    Our net incomeincreased to $19.4 million or $0.95 per basic and $0.88 per diluted share forthe year ended December 31, 2004, from a net income of $568,000 or $0.03per basic and diluted share in 2003.

 

**Years Ended December 31, 2003and 2002**

 

*Revenue.*    Revenue increased $13.2 million, or 56% to$36.9 million for the year ended December 31, 2003 from$23.7 million for the year ended December 31, 2002. The newEnrollment division was responsible for $7.7 million of this increase,primarily from the direct mail marketing services completed in November andDecember which accounted for $6.3 million. The remaining $5.4 millionof the increase in revenue is primarily due to $6.9 million increase instudent fees from online courses and an increase in other revenue of$1.6 million, offset by decline in campus and course fees of$3.0 million.

 

Totalstudent fees represented $25.0 million and $18.1 million of totalrevenue for the years ended December 31, 2003 and 2002, respectively, anincrease of 38%. 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 38% increase in our student feerevenue was not directly proportional to the increase in our customers’ onlinestudent enrollments in 2003. Student enrollments in eCourses increased 47% to327,308 in 2003 from 222,087 in the prior year, while the corresponding revenueearned from distance enrollments increased 36% to $23.2 million in 2003from $17.1 million in 2002.  Student enrollments in our lower pricedeCompanion course supplements increased 126% to 299,808 in 2003 from 132,398 inthe prior

 

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year while total revenuerecognized from such supplements increased 70% during 2003 to $1.7 millionfrom $1.0 million in 2002, due primarily to our pricing strategy.

 

Campus and course fees represented $2.6 millionand $4.0 million of total revenue for the years ended December 31,2003 and 2002, respectively, a decrease of $1.4 million or 35%. Werecognized revenue from developing, licensing, and hosting online campuses for198 different customers during 2003, down from the 217 customers that hadonline campuses in 2002. The decrease results from an increasing number ofcustomers taking advantage of our tools by self-designing and developing theirown courses.

 

Other revenue includes eLearning technical and instructionaldesign consulting revenue of $986,000 and $1.1 million for the years endedDecember 31, 2003 and 2002, respectively. It also includes$1.4 million of other revenue from our Enrollment division, including$790,000 from interactive marketing services and $448,000 from media placementactivities.

 

*Cost of Revenue.*    Cost of revenue forthe year ended December 31, 2003 increased by 39% to $16.2 millioncompared to $11.7 million for the year ended December 31, 2002. Thenewly acquired Enrollment division increased direct mail and other cost ofrevenue in 2003 by $5.0 million. Student fees, campus and course fees andother cost of revenue decreased by $456,000 or 4% to $11.2 million for theyear ended December 31, 2003. This decrease is mainly attributable to asavings of $849,000 of depreciation expense primarily related to our internaltechnology cost of sales departments, commission expense of $185,000, anddecreased NIST costs of $262,000. Offsetting these savings were increasedsalaries and related benefits of $350,000 and increased system costs of$125,000. Amortization expense related to our capitalized software costs forboth of the years ended December 31, 2003 and 2002 was $1.3 million.

 

*Gross Profit.*    We realized grossprofit of $20.7 million, resulting in a 72% or $8.7 million increasefor the year ended December 31, 2003 compared to the $12.0 million werealized in 2002. The new Enrollment division contributed $2.7 million toour gross profit for 2003, while the eLearning division contributed $18.0. Thefavorable increase of $6.0 million related to the eLearning division wasprimarily due to the increase in our student fees, which have a relativelyhigher contribution margin than most of our other revenue sources due to therealization of operating leverage on the generally fixed nature of our datacenter expenses.

 

*Product Development.*    Product developmentexpenses remained flat at $5.7 million for both the years endedDecember 31, 2003 and 2002. The Enrollment division did not incur expensesrelated to product development during the period of our ownership in 2003. TheeLearning division recognized savings in rent, consulting, maintenance anddepreciation expenses of approximately $170,000. Savings related to severancepayments made to an executive during 2002 offset increases to salaries andbenefits related to additional staff personnel, netting to a savings of$46,000. Offsetting these savings were increases in travel and office expensesof $72,000.

 

*Selling and Marketing.*    Selling and marketingexpenses increased by $230,000 or 4% to $5.8 million for the year endedDecember 31, 2003 from $5.6 million for 2002. The Enrollment divisionrecorded $673,000 of selling and marketing expenses during the two months endedDecember 31, 2003, therefore accounting for the entire increase on aconsolidated basis. For the eLearning division, selling and marketing expensesdecreased to $5.2 million in 2003. The decrease was partially due toreduced expenses related to conferences, advertising, and promotion costs of$370,000, which were somewhat offset by increased collateral costs of $82,000,as we focused on more activities directed at key decision makers within ourtarget markets.

 

Our eLearning division marketing personnel costsremained consistent during 2003 and 2002. We had decreases in rent anddepreciation expense associated with our sales and marketing groups of $179,000from the same period last year.

 

*General and Administrative.*    General andadministrative expenses increased $1.5 million or 27% to $7.1 millionin 2003 from $5.6 million in 2002. $644,000 of the increase related to thenewly acquired Enrollment division. Additional factors contributing to theincrease during 2003 included increases in general corporate expenses such asfranchise and personal property taxes, tax consulting, audit, and legalexpenses of $589,000, as

 

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well as higher costs relatedto executive compensation and benefits including stock-based compensation. Wealso incurred approximately $375,000 of expenses specifically associated withthe Datamark acquisition. These increased costs were offset somewhat bydecreases in travel and depreciation expenses of $340,000. Our facilities costsdecreased in 2003 since we incurred $208,000 of one time expenses related toour corporate headquarters move during the year ended December 31, 2002.

 

Werecord stock-based compensation in connection with the grant of stock options,stock awards under our Employee Stock Purchase Plan and restricted share rightsto employees, officers, and directors in accordance with SFAS No. 123, which weadopted using the prospective method effective January 1, 2003. The deferredcharge is being amortized over the relevant vesting periods of such options orrestricted share rights, which range from 1 to 5 years. We recorded$1.0 million of stock-based compensation in the year endedDecember 31, 2003, of whichapproximately $677,000 was directly related to our adoption of SFAS No. 123using the prospective method. Since we had previously accounted for ouremployee stock-based awards in accordance with APB No. 25, only $153,000of stock-based compensation was recorded in the year ended December 31,2002. A portion of such 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.*    Our amortization ofintangible assets of $1.5 million consists entirely of the amortization of ouridentified intangible assets which we recorded in connection with the Datamarkacquisition. Specifically, customer relationships with an estimated value of$8.1 million are being amortized over their estimated useful lives of8 years, and non-compete agreements valued at $2.4 million are beingamortized over their estimated useful life of 5 years. On March 25, 2005,the Company announced that Arthur Benjamin, the Chief Executive Officer of theEnrollment Division, had resigned from the Company, as well as from Datamark'sBoard of Directors. The amortization of the fair value of the relatednon-compete agreement will be accelerated to correspond with the resultingdecrease in the term of the non-compete.

 

*Other Income (Expense).*    Our interest andother income, which consists primarily of interest earnings on our cash andcash equivalents and short-term investments decreased by $74,000 to $111,000for the year ended December 31, 2003. Interest expense increased by$1.0 million, the majority of which related to the debt obligationsincurred to fund the acquisition of Datamark, on October 31, 2003.Included in interest expense for the year ended December 31, 2003 wasapproximately $353,000 of foregone debt issuance costs that were incurred inSeptember, 2003. These costs were originally incurred to establish a financingcommitment from a lender to fund the Datamark acquisition. However, prior tothe consummation of the Datamark acquisition, we were able to negotiate debt onmore favorable terms with different lenders, therefore all of these costs wereexpensed during 2003.

 

*Income taxes.*    We recorded noprovision or benefit for federal or state income taxes during the year endedDecember 31, 2003 as we believe any tax liability incurred during this periodwould be offset by the benefit of our net operating loss carryforwards and wehad not yet determined that it was more likely than not that the deferred taxasset associated with the net operating loss carryforwards would be realizable.

 

*Net income.*    Our net incomeincreased to $568,000 or $0.03 per basic and diluted share for the year endedDecember 31, 2003 from a net loss of $4.9 million or $0.30 per basicand diluted share in 2002

 

**Segment Information**

 

The two reportable segmentsdisclosed in this document are based on our management organizational structureas of December 31, 2004. A detailed description of the products andservices, as well as financial data, for each segment can be found inNote 10 to the Consolidated Financial Statements included in Item 8 ofthis Annual Report on Form 10-K. Please note that based on the way in which ourmanagement team reviews and evaluates segment performance, the segmentoperating results shown below for 2004, 2003 and 2002 do not includeamortization of intangible assets, interest income, interest expense and otherincome/(expense). In addition, the segment operating results for 2004 do notinclude non-allocated corporate expenses. Such items are only considered whenevaluating

 

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the results of the consolidated company.Future changes to this organizational structure may result in changes to thereportable segments disclosed.

 

**Historical Results**

 

The historical results anddiscussions below include the historical results of each of eCollege’s segmentsin fiscal 2004, 2003, and 2002, including Datamark’s results of operations fromOctober 31, 2003 (the acquisition date).

 

**eLearning Division**

** **
| ** **                                                    | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|---------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenue                                                   |       | $          | 34,781     |       | $          | 29,135     |       | $ | 23,692 |   |
| Income (loss) from operations                                 |       | $          | 9,402      |       | $          | 539        |       | $ | (4,863 | ) |
| Income (loss) from operations as a  percentage of net revenue |       | 27         | %          | 2          | %          | (21        | )%         |

 

eLearning revenue grew 20%in 2004 and 23% in 2003 from the prior year. The increase in revenue for bothyears is primarily due to an increase in the number of student enrollments inonline courses. From our inception through December 31, 1998, the majorityof our revenue was generated by development and design services fees forbuilding online campuses and courses, and, to a lesser extent, student fees.However, student fees represented $31.2 million, $25.0 million, and$18.1 million of total revenue for the years ended December 31, 2004,2003 and 2002, respectively, which translates into increases of 25% in 2004 and38% in 2003. Student fees have become the majority of our total eLearning revenueas the number of online courses offered by our customers and the number ofstudents enrolled in those courses delivered on our course management platformcontinues to increase while the revenue generated by our online campus andcourse development services has declined. As previously mentioned, our studentfee revenue growth has been outpaced by the growth in enrollments on theeCollege System due to various pricing programs that we offer to benefitcustomers with large online distance programs. We expect these trends in ourrevenue mix and growth to continue in 2005.

 

Our customers offertraditional, as well as quarterly, bi-monthly and monthly course terms to theirstudents and we typically host more courses during the spring academic termthan in the summer or fall terms. As a result, consecutive academic termenrollment results are not directly comparable. The following table presentsthe number of student enrollments our customers had start in distance coursesduring the 2004, 2003, and 2002 spring, summer, and fall academic terms.

 

| ** **                                    | ** ** | **Distance Course Enrollments** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **2004**                        | ** ** | **2003** | ** ** | **2002** | ** ** |
| ACADEMIC TERM:                                |       |                            |       |   |   |   |   |
| Spring (January 1 - May 15)    |       | 220,126                         |       | 138,630 |   | 89,660 |   |
| Summer (May 16 - August 15)    |       | 105,072                         |       | 70,129 |   | 52,305 |   |
| Fall (August 16 - December 31) |       | 174,291                         |       | 118,549 |   | 80,122 |   |
| Total student enrollments                     |       | 499,489                         |       | 327,308 |   | 222,087 |   |

 

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For a more detailedexplanation of revenue components and the growth trends of the eLearningdivision revenue, please see the information under the caption “Results ofOperations” earlier in this Item 7.

 

Income (loss) fromoperations increased by $14.3 million between 2002 and 2004. The favorableincrease was primarily due to an increase in our eLearning student fees, whichhave a relatively higher contribution margin than most of our other revenuesources and by the exclusion of non-allocable corporate general andadministrative expenses from segment results in 2004. In 2002 and 2003,eLearning results include these corporate expenses, as the eLearning divisionwas the only reporting segment for eCollege in 2002 and the Enrollment divisionhad only two months of operations in 2003.

 

**Enrollment Division**

 

| ** **                                                    | ** ** | **Year Ended December 31,**           | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                    | ** ** | **(in thousands, except percentage)** | ** ** |
| Net revenue                                                   |       | $                                     | 54,486     |   | $ | 7,725 |   | $ | — |   |
| Income (loss) from operations                                 |       | $                                     | 7,256      |   | $ | 1,432 |   | $ | — |   |
| Income (loss) from operations as a  percentage of net revenue |       | 13                                    | %          | 19 | % | — | % |
|                                                               |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

 

As Datamark was acquired onOctober 31, 2003, the preceding results only show activity for the fullyear of 2004 and the last two months of 2003. During the ten months endedOctober 31, 2003 (prior to our acquisition of Datamark), Datamark’srevenue was $35.6 million and income from operations was $3.8 million.Therefore, on a pro forma basis for the entire year of 2003, Datamark’s revenuewas $43.3 million and income from operations was $5.4 million (12% ofnet revenue).

 

For a more detailedexplanation of revenue components and operating results of the Enrollmentdivision, please see the information under the caption “Results of Operations”earlier in this Item 7.

 

**Liquidity and Capital Resources**

 

The Company’s cash and cashequivalents decreased by $7.8 million from $16.0 million atDecember 31, 2003, to $8.2 million at December 31, 2004. Balances atDecember 31, 2003 reflect cash from draws on our line of credit of$9.4 million. Such draws were made to demonstrate the availability of thefunds in 2003 and were repaid in January of 2004. The decrease in total cashand cash equivalents from December 31, 2003 to December 31, 2004 wasprimarily due to cash provided by operating activities of $15.2 million offsetby cash used in financing activities of $17.5 million and net cash used ininvesting activities of $5.4 million. Major cash uses for financingactivities included repayment of the $9.4 million in draws against our Revolveroutstanding at December 31, 2003, repayment of $7.5 million ($10.0 million facevalue) in Seller Notes and repayment of $1.0 million of principal on our TermLoan. These uses were partially offset by proceeds from option exercises in theamount of $2.6 million. Cash used in investing activities for the year endedDecember 31, 2004 included purchases of property and equipment of $2.8 millionand capitalized internal use software costs of $1.8 million. Included in thecash provided by operations for

 

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the year ended December 31, 2004 wereadjustments to net income of $2.4 million for depreciation and$1.8 million for amortization expenses of capitalized software andintangible assets.

 

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 and the former Datamarkstockholders reached agreement concerning the purchase price. Under the termsof the agreement, the Company was entitled to receive the $1 million in escrowas well as $157,000 of the $208,000 owed by the former Datamark stockholders. Theremaining $51,000 was recorded during 2004 as an increase to goodwill. Underthe terms of the agreement, the Company agreed to pay the former Datamarkstockholders $959,000 in federal and state tax refunds associated with returnsfiled subsequent to the acquisition. As of December 31, 2004, $444,000 of thisliability remains to be paid as the related refunds had not yet been received.

 

Pursuant to the stock purchase agreement, Datamark’sformer stockholders were required to indemnify eCollege. As security for theindemnification obligations, $5.0 million of the cash paid in the acquisitionwas placed in escrow. In addition, eCollege has the right to offset theremaining balance owed under the Seller notes for indemnified claims. In 2004,eCollege received $44,000 from the indemnification escrow in satisfaction ofvarious claims. eCollege has also submitted a claim for liabilities, if any,arising in connection with the Utah sales and use tax dispute described in Item3 of this Annual Report of Form 10-K.

 

**Issuance of equity securities**

 

We have financed themajority of our operations through the issuance of equity securities. We usedthe net proceeds from equity financings for funding capital expenditures,supporting sales, marketing and product development activities; expanding ourdata centers; enhancing financial information systems; and funding otherexpenses associated with our growth, including partial funding of the Datamarkacquisition in 2003.

 

**Borrowings**

 

The Company obtained a$3.0 million term loan (“Term Loan”) with a bank in October 2003. TheTerm Loan refinanced a previous term loan and the outstanding debt on anequipment financing facility. The Term Loan has an interest rate of 7.0% perannum and is being repaid in 36 equal installments which began in November2003. At December 31, 2004, the Company had $1.9 million outstandingunder this loan. The Company incurred approximately $56,000 in debt issuancecosts in connection with obtaining this loan. These debt issuance costs weredeferred and are being amortized as interest expense over the three-year termof the loan. The Term Loan contains certain financial covenants, includingrequirements that the Company maintain a specified minimum ratio of quickassets to current liabilities, minimum tangible net worth, minimum debt servicecoverage and Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”).The Term Loan is secured by all the Company’s assets. We were in compliancewith all financial covenants contained in the Term Loan as of December 31,2004. The Term Loan was repaid in full during March, 2005.

 

As a part of the master debt agreement with the bankthat provided the Term Loan, the Company also obtained a $10.0 millionrevolving line of credit, (the “Revolver”) which will mature onOctober 31, 2005, and which replaced a previous revolving line of credit.The interest rate on the Revolver is equal to the bank’s prime rate, which was5.25% at December 31, 2004, plus 1.25%, but at no time will it be lessthan 5.25%. The Revolver contains the same covenants as the Term Loan and issecured by all of the Company’s assets. The Revolver contains a cross defaultprovision with the Term Loan. Maximum amounts outstanding under the Revolverare limited to the Company’s borrowing base, which is calculated primarilybased on aged accounts receivable. We were in compliance with all financialcovenants of the Revolver as of December 31, 2004.

 

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The Company drew $9.4 million from itsrevolving line of credit in December, 2003 and $9.7 million in each ofMarch, June and September, 2004 under the Revolver. Each draw was repaid in themonth following the draw.

 

In October 2003, 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 minimumquick ratio, minimum tangible net worth, minimum debt service coverage, andminimum EBITDA, and are secured by all the Company’s assets. The SeniorSubordinated Notes also contain a cross default provision with the Company’sbank debt. We were in compliance with all financial covenants of the SeniorSubordinated Notes as of December 31, 2004.

 

In connection with the issuance of the SeniorSubordinated Notes, the Company issued warrants to the lender to purchase200,000 shares of common stock at a price of $13.00 per share. However, if atthe time of exercise of all or any portion of the warrants, the trading priceof the Company’s common stock is less than $13.00 per share for the thirtytrading days immediately preceding the date of such exercise, then the exerciseprice shall be automatically adjusted such that the exercise price will beequal to $10.00 per share with respect to such exercise. As of December 31,2004 the exercise price had adjusted to $10.00 per share. The warrants expireon October 31, 2008.

 

The net proceeds received inconnection with the issuance of the Senior Subordinated Notes totaled$20.0 million, which was allocated to the Senior Subordinated Notes andthe warrants. The Company allocated $3.3 million 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 five years (thecontractual life). The remaining $16.7 million was allocated to the SeniorSubordinated Notes. The debt discount attributable to the value of the warrantsis being amortized as interest expense over the five-year term of the SeniorSubordinated Notes using the interest method. The Company also incurredapproximately $1.0 million in debt issuance costs in connection with theSenior Subordinated 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 theacquisition of Datamark in October 2003, the Company issued Seller Notestotaling $12.0 million to the selling stockholders. The Seller Notes, withinterest and principal due in 2008, were comprised of a series of notes issuedto the selling stockholders, aggregating to $7.0 million (face amount),which bear simple interest at a rate of 10.0% per annum and another series ofnotes, aggregating to $5.0 million (face amount), which bear simpleinterest 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 noteswere repaid in 2004. The Company recorded $8.9 million for the Sellernotes at the time of their issuance based upon their estimated fair value,resulting in a discount in the original amount of $3.1 million, which isbeing amortized over the term of the debt using the interest method. Theeffective interest rate on these notes, including the amortization of therecorded discount, is 14.9%. The fair value of the Seller Notes was determinedby a third party who considered, among other factors, the effective interestrate of the Senior Subordinated Notes, and other comparable debt securities.Due to the discounts on the Senior Subordinated Notes and Seller Notes, anypayment of these debt obligations prior to their maturity results in additionalinterest expense due to the realization of the unamortized portions of thecosts and discounts recorded. The early repayment of $7.5 million carryingvalue ($10.0 million face value) of Seller Notes during the fourth quarter of2004 resulted in an additional $2.5 million interest charge. The remainingbalance of the Seller Notes was $1.8 million at December 31, 2004, with anunamortized discount of $411,000 and accrued interest payable of $238,000.

 

We expect our current cash,cash equivalents, and short-term investments, together with cash generated fromoperations, to meet our working capital and capital expenditure requirementsfor at least the next twelve months.

 

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**Contractual Obligations**

 

The following tablesummarizes, as of December 31, 2004, our obligations to make future paymentsunder current contracts (in thousands):

 
| ** **                                    | ** ** | **Total** | ** ** | **Less than 1 Year** | ** ** | **1 - 3 Years** | ** ** | **4 - 5 Years** | ** ** | **More than 5 Years** | ** ** |
|-----------------------------------------------|------------|-----------|------------|---------------------------|------------|----------------------|------------|----------------------|------------|----------------------------|------------|
| Long term debt including current portion  (1) |       | $         | 33,881     |                      | $          | 3,638                |       | $                    | 11,019     |                       | $          | 19,224 |   | $ | — |   |
| Capital lease obligations                     |       | 284       |       | 136                       |       | 148                  |       | —               |       | —                     |       |
| Operating lease obligations (2)               |       | 5,234     |       | 1,780                     |       | 2,961                |       | 493                  |       | —                     |       |
| Purchase commitments (3)                      |       | 3,348     |       | 768                       |       | 2,580                |       | —               |       | —                     |       |
| Consulting agreement (4)                      |       | 800       |       | 200                       |       | 400                  |       | 200                  |       | —                     |       |
| Total                                         |       | $         | 43,547     |                      | $          | 6,522                |       | $                    | 17,108     |                       | $          | 19,917 |   | $ | — |   |
|                                               |            |           |            |                           |            |                      |            |                      |            |                            |            |  |  |  |  |  |  |  |

 

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(1)          Amounts represent the expected cash payments of the stated face valueof principal on our debt as well as interest payments.

 

(2)          The Company leases office space and equipment under variousnon-cancelable operating leases.

 

(3)          eCollege entered into an agreement with a third party vendor inJanuary, 2004 to provide supplemental software development for our developmentprojects. Minimum commitments under this contract aggregated $3.3 million atDecember 31, 2004. If eCollege terminates the agreement prior to April, 2007,it will be required to pay a termination penalty equal to six months expense atthe then-current minimum staffing level.

 

(4)          In conjunction with the Datamark acquisition, we entered into a fiveyear consulting agreement with Leeds Equity Advisors Inc., of whichJonathan Newcomb, a former director, was a principal. Payments under thisagreement aggregate $200,000 per year, plus expenses. The agreement continuesfor four additional years at $200,000 per year, plus expenses.

 

Rent expensefor the years ended December 31, 2004, 2003, and 2002 was $1.9 million,$1.1 million, and $1.3 million, respectively.

 

**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) is similarto the approach described in SFAS 123. However, SFAS 123(R) requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the statement of operations based on their fairvalues. Pro forma disclosure is no longer an alternative following the adoptionof SFAS 123(R). The Company is in the process of evaluating the impact ofSFAS 123(R) on its consolidated financial statements.

 

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SFAS 123(R) must be adopted no later thanJuly 1, 2005. Early adoption will be permitted in periods in whichfinancial statements have not yet been issued. The Company plans to adoptSFAS 123(R) using the modified prospective method on July 1, 2005.

 

**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 financial strength,thereby causing our stock price to decline. The risks and uncertaintiesdescribed below are not the only ones we face. Additional risks not presentlyknown to us or other factors not perceived by us to present significant risksto our business at this time also may have a negative impact on our business.

 

**We Face Significant Competition in our Markets.**

 

The online learning markethas evolved quickly over the past ten years and is subject to technologicalchange. Some colleges and universities construct online learning systems usingin-house personnel and create their own software or purchase softwarecomponents from a vendor. Therefore we face significant competition from avariety of entities including software companies with specific products for thecollege and university market and service companies that specialize inconsulting, system integration and support in the eLearning industry. Othercompetitors in this market include a wide range of education and trainingproviders using video, mail correspondence, CD-ROM, and live online training.We also face significant competition in the market for enrollment marketingservices to the post-secondary education industry. Competition is most intensefrom colleges and universities that perform their own enrollment marketingservices in-house. Datamark also faces competition from other enrollmentmarketing companies, direct marketing companies, media placement agencies andonline marketing companies.

 

Some of our current andpotential competitors have longer operating histories, larger customer bases,greater brand recognition and significantly greater financial, marketing andother resources than we do. Certain competitors may be able to secure allianceswith customers and affiliates on more favorable terms, devote greater resourcesto marketing and promotional campaigns and devote substantially more resourcesto systems development than we can. In addition, it is possible that certaincompetitors, or potential competitors, could reduce their pricing to levelsthat would make it difficult for us to compete. Increased competition mayresult in reduced operating margins, as well as loss of market share and brandrecognition.

 

In addition, in order tocompete effectively in our markets, we may need to change our business insignificant ways. For example, we may change our pricing, product, or serviceofferings, make key decisions about technology directions or marketing strategies,or acquire additional businesses or technologies. Any of these actions couldhurt our business, results of operations, and financial condition.

 

**Recent Rapid Growth in Our Markets May Not Continueand 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 are subject to frequent change for a variety of reasons.

 

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**A Significant Portion of Our Revenue Is Generated Froma 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, 2004, our30 largest eLearning customers accounted for 71% of eLearning division revenueand the 30 largest customers of the Enrollment division accounted for 93% ofEnrollment division revenue. One institution (Corinthian Colleges) that is acustomer of both the eLearning and Enrollment divisions accounted forapproximately 16% of consolidated revenue in 2004, and one other customer ofthe Enrollment division (Career Education Corporation) accounted forapproximately 14% of our consolidated revenue in 2004. Any cancellation,deferral, or significant reduction in work performed for these principalcustomers, or failure to collect accounts receivable from these principalcustomers, could have a material adverse effect on our business, financialcondition, and results of operations.

 

**Our Network Infrastructure and Computer Systems MayFail.**

 

The continuing anduninterrupted performance of our network infrastructure and computer systems iscritical to our success. Any system failure that causes interruptions in ourability to provide services could reduce customer satisfaction and, ifsustained or repeated, would reduce the attractiveness of our technology andservices to our customers and their students and prospective customers.

 

Because our services involve the storage andtransmission of proprietary and confidential customer and student informationour success depends on our ability to provide superior network securityprotection and the confidence of our customers in that ability. Unauthorizeddisclosure of such information could subject us to liability and have anegative 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 amaterial adverse 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 theMicrosoft platform, security flaws in Microsoft software, and/or potentialprice increases or licensing changes by Microsoft.

 

**We Have Incurred Debt, Which Could Adversely AffectOur Financial Health and Our Ability to Obtain Financing in the Future andReact to Changes in Our Business.**

 

As of December 31, 2004, theCompany’s principal debt obligations totaled approximately $21.0 million($23.9 million face value). Of this amount, $19.0 million ($21.9 million facevalue) is secured by all of our assets. Our debt could have importantconsequences 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

 

•                       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

 

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orbe unable to carry out capital spending that is necessary or important to ourgrowth strategy and productivity improvement programs.

 

The breach of any of the covenants or restrictionscontained in our Term Loan, Senior Subordinated Notes, Seller Notes or Revolvercould result in a cross default under the applicable agreements which wouldpermit the applicable lenders to declare all amounts then outstanding to be dueand payable, together with accrued and unpaid interest, and, in the case of theTerm Loan, Senior Subordinated Notes and Revolver, to foreclose on our assets.In any such case, we may be unable to make any borrowings under our Revolverand may not be able to repay the amounts due under our Term Loan, SeniorSubordinated Notes, or Seller Notes. This could have serious consequences toour financial condition and results of operations and could cause us to becomebankrupt or insolvent.

 

**Our Stock Price Is Likely to be Volatile.**

 

The market price of ourcommon stock has been and is likely to continue to be volatile and could besubject to significant fluctuations in response to factors such as thefollowing, some of which are beyond 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 sales of our common stock;

 

•                       Stock market price and volume fluctuations;

 

•                       General political and economic conditions,such as a recession, war or terrorist attacks or interest rate or currency ratefluctuations; 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.

 

**If We Undertake Future Acquisitions, We May NotEffectively Manage their Integration into eCollege.**

 

A key element of our growth strategy is to pursueacquisitions. If we make an acquisition, we may have difficulty integrating theacquired business into eCollege. Our ability to realize the expected benefitsof any acquisition will require, among other things, the following:

 

•                       Retention and relationship management ofexisting customers of both companies;

 

•                       Retention of strategic partners of eachcompany;

 

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•                       Minimization of disruption of each company’songoing business and distraction of its management;

 

•                       Integration of the two companies’ informationand software systems and other operations;

 

•                       Developing and maintaining uniform standards,controls, procedures, and policies, including internal controls; and

 

•                       Limiting expenses related to integration.

 

Wemay not succeed in addressing these integration risks or other problems orliabilities that we may encounter in connection with an acquisition, including:the creation of a variety of accounting charges which could increase ourreported expenses, including impairment of goodwill and the write off ofacquired intangible assets; diminishing the value of our brands or reputationif an acquired company turns out to be a poor performer; and the assumption ofmost or all of the liabilities of the acquired companies, some of which may behidden, significant, or otherwise not reflected in the final acquisition price.If the benefits of the acquisition do not exceed the associated costs,including costs associated with integrating the two companies, our financialresults, including earnings per share and stock price, could be materiallyadversely affected.

 

**Certain Aspects Of The Datamark Acquisition Could NegativelyImpact Our Financial Results.**

 

Certain aspects of the Datamark acquisition couldnegatively impact our financial results. We recorded a significant portion ofthe approximate $70.3 million purchase price as goodwill and identifiableintangible assets. Intangible assets resulting from acquisitions requiresignificant judgment in terms of establishing their fair value, determiningappropriate amortization periods, and assessing such intangibles, includinggoodwill, for impairment in the future. It is possible that our review of suchintangible assets in the future could determine that they are impaired and theamount of such impairment could be significant. We recorded approximately$10.5 million of the purchase price as identifiable intangible assets,which will cause us to record additional non-cash amortization expense in thefuture and which will also be reviewed periodically for impairment in thefuture. An impairment charge could be material, if it is determined that animpairment of the assets has occurred. We are also incurring interest expenserelated to the fair value of the warrants issued in connection with the SeniorSubordinated Notes and the discount to fair value of the Seller Notes. We alsohave increased cash interest expense due to the debt we incurred to finance theacquisition, and will be required to repay the face amount of these debtinstruments ($22.0 million as of December 31, 2004) upon their maturity.All of these additional expenses and cash outflows could negatively impact ourfinancial results, financial position, and liquidity.

 

**We May Desire or Need to Raise Additional Capital InThe Future And It May Not Be Available On Acceptable Terms.**

 

We may desire or need to raise additional capitalthrough public or private financing, strategic relationships, or otherarrangements in the future. In the event that we desire or need to raiseadditional capital, we cannot assure that additional funds will be available orthat funds will be available on terms favorable to us. Furthermore, we may haveto sell stock at prices lower than those paid by existing stockholders, whichwould result in dilution to those stockholders, or we may have to sell stock orbonds with rights superior to rights of holders of common stock. Any debtfinancing might involve restrictive covenants that could limit our operatingflexibility. If adequate funds are not available on acceptable terms, we may beunable to develop or enhance our services and products, take advantage of futureopportunities, or respond to competitive pressures, which could have an adverseeffect on our business and our financial position. Any future need to raiseadditional funds could also directly and adversely affect our stockholders’investment in our common stock.

 

**We Depend On Our Customers and Third Parties to MarketStudent 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

 

37

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our customers’ courses andtherefore have little influence on the number of students that enroll. We aretherefore dependent on the institutions and organizations that purchase ourproducts and services to market to individual students. The failure of thesethird parties to effectively attract, maintain, and increase studentenrollments could affect our revenue growth and have a material adverse effecton our business and financial results. Although Datamark provides enrollmentmarketing services for its customers, the majority of Datamark’s customers arenot customers of our eLearning division, and there can be no assurance that theywill become customers of our eLearning division.

 

**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.

 

Key personnel have left the Company over the years,and there may be additional departures of key personnel from time to time. OnMarch 25, 2005, Arthur Benjamin resigned as Executive Vice President ofeCollege and Chairman and Chief Executive Officer of the Enrollment division. Duringhis tenure at Datamark, Mr. Benjamin developed significant customerrelationships, and eCollege intends to maintain those relationships in thefuture. There can be no assurance, however, that Mr. Benjamin’s departure willnot have a material adverse effect on our business, financial condition andresults of operations.

 

Our future success and our ability to pursue ourgrowth strategy will depend to a significant extent on the continued service ofour senior management personnel. Although we have employment agreements withour executive officers, these agreements do not obligate them to remainemployed by us. The loss of services of any senior management personnel couldmake it more difficult for us to successfully pursue our business goals.

 

**We May be Unable to Sustain Profitability.**

 

Although we have reported net income for each of theprevious seven fiscal quarters ending December 31, 2004, and Datamark, underits previous 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 over Financial Reporting May NotBe Considered Effective, which Could Result in Possible Regulatory Sanctionsand a Decline in our Stock Price.**

 

Section 404 of the Sarbanes-Oxley Act of 2002requires us to furnish annually a report on our internal control over financialreporting, beginning with this Annual Report on Form 10-K. The internal controlreport must contain an assessment by our management of the effectiveness of ourinternal control over financial reporting (including the disclosure of anymaterial weakness) and a statement that our independent auditors have attestedto and reported on management’s evaluation of such internal controls. TheSarbanes-Oxley Act requires, among other things, that we maintain effectivedisclosure controls and procedures and internal control over financialreporting. In order for management to evaluate our internal controls, we mustregularly review and document our internal control processes and procedures andtest such controls. Ultimately, we or our independent auditors could concludethat our internal control over financial reporting may not be effective if,among other things:

 

•                  Any material weakness in our internal controlover financial reporting exists; or

 

38

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•                  We fail to remediate assessed deficiencies.

 

As of the date hereof, we have identified severalinternal control deficiencies that existed as of December 31, 2004 and that webelieve will be considered material weaknesses in our internal control overfinancial reporting. As a result, we believe that, when assessing our internalcontrol over financial reporting, neither management nor our independentauditors will be able to conclude that our internal control over financialreporting was effective within the meaning of Section 404 of Sarbanes-Oxley asof December 31, 2004. For further discussion of these internal controldeficiencies and our remediation efforts, see Item 9A “Controls and Procedures.”

 

If we are unable to assert that our internal controlover financial reporting is effective as of December 31, 2004, we could besubject to regulatory sanctions or lose investor confidence in the accuracy andcompleteness of our financial reports, either of which could have an adverseeffect on the market price for our securities.

 

**We May Not be Able to Protect Our IntellectualProperty and Proprietary Rights and We May be Subject to Claims of Infringementby 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.

 

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 our business.In addition, our agreements with our customers require us to indemnify ourcustomers in the event they are sued by a third party claiming that ourproducts and services infringe a third party’s intellectual property rights. Inthe event of such a lawsuit against our customers, our performance of theseindemnification obligations could have a material adverse effect on ourbusiness, financial condition and results of operations.

 

**Government Regulation May Adversely Affect Our FutureOperating 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. Ourviolation of any state statutes, laws or other regulations could have amaterial adverse effect on our business and financial results. We cannotpredict the impact, if any, that future regulation or regulatory changes mayhave on our business.

 

39

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**Our Operating Results May Fluctuate Significantly andMay Be Below the Expectations of Analysts and Investors.**

 

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 revenuerecognition could 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. Additionally, our operating expenses may fluctuatedue to changes in accounting standards and/or our elected accounting policies.Further, any such variations could cause our operating results to fall belowthe expectations of securities analysts and investors. In such an event, thetrading price of our stock would likely fall and investors might sue theCompany, causing increased litigation expenses and, possibly, the payment oflarge damages or settlement fees.

 

**Datamark Does Not Have Long-Term Agreements With ItsCustomers And May Be Unable To Retain Customers, Attract New Customers OrReplace Departing Customers With Customers That Can Provide ComparableRevenues.**

 

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 to Receive our CurrentLevel of Access to and Costs for Mailing Lists, Our Competitive Advantage CouldBe 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 an efficient format. If we were unable to continue to obtainthese mailing lists at our current pricing levels, and in the format in whichwe historically have received these lists, it could reduce our competitiveadvantage and have a material adverse effect on our business.

 

**Increases in Costs of Revenue Could Harm Datamark’sBusiness.**

 

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, especiallyincreases that are imposed without sufficient advance notice to allowadjustments to be made to marketing budgets. With regards to Datamark’sinteractive marketing services, rising demand for online advertising has in thepast and may in the future cause Internet media prices to increases. BecauseDatamark is generally obligated under its contracts to deliver a specifiednumber of leads at a specified price, Datamark may be unable to adjust itspricing to reflect increased Internet lead costs until contracts expire and arerenegotiated. Any of these occurrences could materially and adversely affectthe business, financial condition and results of operations of Datamark andeCollege as a whole.

 

**Our Operating Margins May Suffer if our Enrollment Marketing RevenuesIncrease as a Percentage of Total Revenues Because our Enrollment MarketingRevenues Have Lower Margins.**

 

Because our Enrollment division revenues typicallyhave lower margins than the revenues from our eLearning division, an increasein the percentage of total revenues represented by Enrollment marketingrevenues could have a detrimental impact on our overall margins and couldadversely affect our operating results.

 

40

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**Our Business and Future Operating Results Are Subjectto a Broad Range of Uncertainties Arising Out of Terrorist Attacks on theUnited 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 the potential worsening or extension of the globaleconomic slowdown and the economic consequences of military action oradditional terrorist activities. While terrorist attacks have not had amaterial impact on our financial position or results of operations to date, anyfuture attacks or events arising as a result of the attacks, such asinterruptions to the international telecommunications network or the Internet,could have a material impact on our business.

 

**ITEM 7A.    QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT 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, 2004, we have notused derivative instruments or engaged in hedging activities.

 

Additionally, the Company does not have significantexposure to changing interest rates on invested cash, which was$8.2 million at December 31, 2004. Historically we have investedavailable cash in money market accounts, certificates of deposit, andinvestment grade commercial paper that generally had maturities of three monthsor less, as well as debt securities of United States government agencies andcorporate bonds. Our short-term investment portfolio is managed in accordancewith our investment policy. The Company’s investment policy requires that itsinvestment portfolio be limited to investment securities of less than one yearin maturity. Furthermore, as a result of a change in the Company’s investmentstrategy during the third quarter of 2001 to limit risk exposure, all of ourinvested cash has been in money market accounts since October 2001. As aresult, the interest rate market risk implicit in these investments atDecember 31, 2004, 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 equivalents nor would it materiallyimpact the earnings or cash flow associated with our cash investments. SeeNote 2 to the Consolidated Financial Statements for further information onthe fair value of the Company’s financial instruments. Although our revolvingline of credit bears interest at an adjustable rate of prime plus 1.25%, ahypothetical ten percent change in the market rates as of December 31,2004 would not have a material effect on our earnings and cash flows in 2005,because we anticipate drawing on our line of credit only for short-term workingcapital needs during 2005.

 

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**ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARYDATA**

 

**ECOLLEGE.COM AND SUBSIDIARIES**

** **

**INDEX TO FINANCIAL STATEMENTS**

 

**FinancialStatements**

 
|   | Report  of Independent Registered Public Accounting Firm                                                                     |   |
|--------|------------------------------------------------------------------------------------------------------------------------------|--------|
|   |                                                                                                                         |   |
|   | Consolidated Balance Sheets  as of December 31, 2004 and 2003                                                                |   |
|   |                                                                                                                         |   |
|   | Consolidated  Statements of Operations and Comprehensive Income (Loss) for the years ended  December 31, 2004, 2003 and 2002 |   |
|   |                                                                                                                         |   |
|   | Consolidated Statements  of Stockholders’ Equity for the years ended December 31, 2004, 2003 and 2002                   |   |
|   |                                                                                                                         |   |
|   | Consolidated  Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002                                  |   |
|   |                                                                                                                         |   |
|   | Notes to Consolidated Financial Statements                                                                                   |   |

 

42

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**Reportof Independent Registered Public Accounting Firm**

** **

The Board of Directors and StockholderseCollege.com:

 

Wehave audited the accompanying consolidated balance sheets of eCollege.com andsubsidiaries as of December 31, 2004 and 2003, and the relatedconsolidated statements of operations and comprehensive income (loss),stockholders’ equity and cash flows for each of the years in the three-yearperiod ended December 31, 2004. These consolidated financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudits.

 

Weconducted our audits 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 whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of eCollege.com andsubsidiaries as of December 31, 2004 and 2003, and the results of theiroperations and their cash flows for each of the years in the three-year periodended December 31, 2004, in conformity with U.S. generally acceptedaccounting principles.

 

Asdiscussed in note 2, effective January 1, 2003, the Company changed its methodof accounting for stock-based employee compensation by adopting the fair valuemethod prospectively from that date.

 

 
|   | **/s/ KPMG LLP** |   |
|--------|------------------|--------|

 

Denver, Colorado

March31, 2005

 

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**eCollege.comCONSOLIDATED BALANCE SHEETS(in thousands except per share data)**

 
| ** **                                                                                                                                                       | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                       | ** ** | **2004**              | ** ** | **2003** | ** ** |
| **ASSETS**                                                                                                                                                       |       |                  |       |   |   |
| CURRENT ASSETS:                                                                                                                                                  |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                        |       | $                     | 8,223      |   | $ | 15,974 |   |
| Accounts receivable, net of allowances of  $155 and $188, respectively                                                                                           |       | 12,166                |       | 8,722 |   |
| Accrued revenue receivable                                                                                                                                       |       | 250                   |       | 141 |   |
| Due from former Datamark stockholders,  including $1,000 in escrow at December 31, 2003                                                                          |       | —                |       | 1,208 |   |
| Deferred income taxes                                                                                                                                            |       | 1,927                 |       | — |   |
| Other current assets                                                                                                                                             |       | 1,195                 |       | 1,623 |   |
| Total current assets                                                                                                                                             |       | 23,761                |       | 27,668 |   |
|                                                                                                                                                             |       |                  |       |   |   |
| Property and equipment, net                                                                                                                                      |       | 5,265                 |       | 4,962 |   |
| Software development costs, net                                                                                                                                  |       | 2,103                 |       | 620 |   |
| Other assets                                                                                                                                                     |       | 1,384                 |       | 1,125 |   |
| Deferred income taxes                                                                                                                                            |       | 19,846                |       | — |   |
| Intangible assets, net                                                                                                                                           |       | 10,359                |       | 11,851 |   |
| Goodwill                                                                                                                                                         |       | 55,097                |       | 55,797 |   |
| TOTAL ASSETS                                                                                                                                                     |       | $                     | 117,815    |   | $ | 102,023 |   |
| ** **                                                                                                                                                       |       |                  |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                   |       |                  |       |   |   |
| CURRENT LIABILITIES:                                                                                                                                             |       |                  |       |   |   |
| Accounts payable                                                                                                                                                 |       | $                     | 8,215      |   | $ | 4,643 |   |
| Other accrued liabilities                                                                                                                                        |       | 5,820                 |       | 5,724 |   |
| Customer advances                                                                                                                                                |       | 1,493                 |       | 753 |   |
| Deferred revenue, current portion                                                                                                                                |       | 2,297                 |       | 1,746 |   |
| Current income taxes                                                                                                                                             |       | 305                   |       | — |   |
| Line of credit                                                                                                                                                   |       | —                |       | 9,365 |   |
| Current portion of long-term debt                                                                                                                                |       | 1,000                 |       | 1,000 |   |
| Current portion of capital lease  obligations                                                                                                                    |       | 136                   |       | — |   |
| Total current liabilities                                                                                                                                        |       | 19,266                |       | 23,231 |   |
|                                                                                                                                                             |       |                  |       |   |   |
| LONG-TERM LIABILITIES:                                                                                                                                           |       |                  |       |   |   |
| Deferred revenue, net of current portion                                                                                                                         |       | 67                    |       | 97 |   |
| Other liabilities                                                                                                                                                |       | 395                   |       | 477 |   |
| Long-term debt, net of current portion                                                                                                                           |       | 20,023                |       | 27,785 |   |
| Capital lease obligations, net of current  portion                                                                                                               |       | 148                   |       | — |   |
| Total long-term liabilities                                                                                                                                      |       | 20,633                |       | 28,359 |   |
| Total liabilities                                                                                                                                                |       | 39,899                |       | 51,590 |   |
|                                                                                                                                                             |       |                  |       |   |   |
| 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, 20,719 and 20,119 shares issued, respectively, and 20,704  and 20,108 shares outstanding, respectively |       | 207                   |       | 201 |   |
| Additional paid-in capital                                                                                                                                       |       | 127,739               |       | 121,301 |   |
| Treasury stock at cost, 15 and 11 shares,  respectively                                                                                                          |       | (148                  | )          | (81 | ) |
| Warrants, restricted stock rights, and  options for common stock                                                                                                 |       | 8,601                 |       | 6,880 |   |
| Deferred compensation                                                                                                                                            |       | (4                    | )          | (29 | ) |
| Accumulated deficit                                                                                                                                              |       | (58,479               | )          | (77,839 | ) |
|                                                                                                                                                             |       |                  |       |   |   |
| Total stockholders’ equity                                                                                                                                  |       | 77,916                |       | 50,433 |   |
| **TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                              |       | $                     | 117,815    |   | $ | 102,023 |   |

 

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

 

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**eCollege.com**

 

**CONSOLIDATED STATEMENTS OF OPERA****TIONS AND COMPREHENSIVEINCOME (LOSS) (in thousands, except per share data)**

 
| ** **                                                       | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                       | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| REVENUE:                                                         |       |                         |       |   |   |   |   |
| Student fees                                                     |       | $                            | 31,154     |   | $ | 24,971 |   | $ | 18,058 |   |
| Direct mail enrollment marketing                                 |       | 38,347                       |       | 6,277 |   | — |   |
| Interactive enrollment marketing                                 |       | 11,079                       |       | 790 |   | — |   |
| Campus and course fees                                           |       | 1,761                        |       | 2,593 |   | 3,969 |   |
| Other                                                            |       | 6,926                        |       | 2,229 |   | 1,665 |   |
| Total revenue                                                    |       | 89,267                       |       | 36,860 |   | 23,692 |   |
|                                                             |       |                         |       |   |   |   |   |
| COST OF REVENUE:                                                 |       |                         |       |   |   |   |   |
| Student fees, campus and course fees, and  other cost of revenue |       | 10,345                       |       | 11,207 |   | 11,663 |   |
| Direct mail, Interactive and other cost of  revenue              |       | 36,435                       |       | 4,976 |   | — |   |
| Total cost of revenue                                            |       | 46,780                       |       | 16,183 |   | 11,663 |   |
|                                                             |       |                         |       |   |   |   |   |
| Gross profit                                                     |       | 42,487                       |       | 20,677 |   | 12,029 |   |
|                                                             |       |                         |       |   |   |   |   |
| OPERATING EXPENSES:                                              |       |                         |       |   |   |   |   |
| Product development                                              |       | 6,635                        |       | 5,723 |   | 5,658 |   |
| Selling and marketing                                            |       | 9,878                        |       | 5,843 |   | 5,613 |   |
| General and administrative                                       |       | 16,213                       |       | 7,140 |   | 5,621 |   |
| Amortization of intangible assets                                |       | 1,492                        |       | 249 |   | — |   |
| Total operating expenses                                         |       | 34,218                       |       | 18,955 |   | 16,892 |   |
| INCOME (LOSS) FROM OPERATIONS                                    |       | 8,269                        |       | 1,722 |   | (4,863 | ) |
|                                                             |       |                         |       |   |   |   |   |
| OTHER INCOME (EXPENSE):                                          |       |                         |       |   |   |   |   |
| Interest income and other income (expense)                       |       | (35                          | )          | 111 |   | 185 |   |
| Interest expense                                                 |       | (4,892                       | )          | (1,265 | ) | (243 | ) |
| Loss on early repayment of debt                                  |       | (2,479                       | )          | — |   | — |   |
| Income (loss) before income taxes                                |       | 863                          |       | 568 |   | (4,921 | ) |
| Income tax benefit                                               |       | 18,497                       |       | — |   | — |   |
| NET INCOME (LOSS)                                                |       | 19,360                       |       | 568 |   | (4,921 | ) |
| COMPREHENSIVE INCOME (LOSS)                                      |       | $                            | 19,360     |   | $ | 568 |   | $ | (4,921 | ) |
|                                                             |       |                         |       |   |   |   |   |   |   |   |
| BASIC NET INCOME (LOSS) PER SHARE                                |       | $                            | 0.95       |   | $ | 0.03 |   | $ | (0.30 | ) |
| DILUTED NET INCOME (LOSS) PER SHARE                              |       | $                            | 0.88       |   | $ | 0.03 |   | $ | (0.30 | ) |
| WEIGHTED AVERAGE SHARES OUTSTANDING—BASIC                   |       | 20,358                       |       | 17,758 |   | 16,329 |   |
| WEIGHTED AVERAGE SHARES OUTSTANDING—DILUTED                 |       | 21,996                       |       | 19,578 |   | 16,329 |   |

 

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

 

45

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**eCollege.com**

 

**CONSOLIDATED STATEMENTS OFSTOC****KHOLDERS’EQUITY**

 

**(in thousands)**

 
| ** **                                                                         | ** ** | ** **        | ** ** | ** **     | ** ** | ** **          | ** ** | ** **     | ** ** | ** **   | ** ** | **Accumulated**               | ** ** | ** **       | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------|------------|----------------|------------|---------------------|------------|----------------|------------|--------------|------------|-------------------------------|------------|------------------|------------|------------|------------|
| ** **                                                                         | ** ** | ** **        | ** ** | ** **     | ** ** | **Additional**      | ** ** | ** **     | ** ** | ** **   | ** ** | **Warrants,**                 | ** ** | ** **       | ** ** | **Other**  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                         | ** ** | **Common  Stock** | ** ** | **Paid-in**    | ** ** | **Treasury  Stock** | ** ** | **Restricted** | ** ** | **Deferred** | ** ** | **Comprehensive**             | ** ** | **Accumulated**  | ** ** | ** ** | ** ** |
| ** **                                                                         | ** ** | **Shares**        | ** ** | **Par  Value** | ** ** | **Capital**         | ** ** | **Shares**     | ** ** | **Amount**   | ** ** | **Stock  Rights And Options** | ** ** | **Compensation** | ** ** | **Loss**   | ** ** | **Deficit** | ** ** | **Total** | ** ** |
| ** **                                                                         | ** ** | ** **        | ** ** | ** **     | ** ** | ** **          | ** ** | ** **     | ** ** | ** **   | ** ** | ** **                    | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| BALANCES, January  1, 2002                                                         |       | 16,345            |       | $              | 163        |                | $          | 84,887         |       | —       |       | $                             | —     |             | $          | 3,657      |       | $ | (224 | ) | — |   | $ | (73,486 | ) | $ | 14,997 |   |
| Issuance of  common stock-employee stock purchase plan                             |       | 103               |       | 1              |       | 251                 |       | —         |       | —       |       | —                        |       | —           |       | —     |       | — |   | 252 |   |
| Issuance of  common stock upon exercise of options                                 |       | 23                |       | —         |       | 63                  |       | —         |       | —       |       | —                        |       | —           |       | —     |       | — |   | 63 |   |
| Issuance of  options for common stock to board member                              |       | —            |       | —         |       | —              |       | —         |       | —       |       | 9                             |       | (9               | )          | —     |       | — |   | — |   |
| Forfeited options                                                                  |       | —            |       | —         |       | 179                 |       | —         |       | —       |       | (181                          | )          | 2                |       | —     |       | — |   | — |   |
| Retirement of  common stock in exchange for reduction of note receivable           |       | (39               | )          | —         |       | (118                | )          | —         |       | —       |       | —                        |       | —           |       | —     |       | — |   | (118 | ) |
| Expiration of  warrants                                                            |       | —            |       | —         |       | 172                 |       | —         |       | —       |       | (172                          | )          | —           |       | —     |       | — |   | — |   |
| Amortization of  deferred compensation                                             |       | —            |       | —         |       | —              |       | —         |       | —       |       | —                        |       | 153              |       | —     |       | — |   | 153 |   |
| Acquisition of  treasury stock at cost                                             |       | —            |       | —         |       | —              |       | (6             | )          | (22          | )          | —                        |       | —           |       | —     |       | — |   | (22 | ) |
| Net loss                                                                           |       | —            |       | —         |       | —              |       | —         |       | —       |       | —                        |       | —           |       | —     |       | (4,921 | ) | (4,921 | ) |
|                                                                               |       |              |       |           |       |                |       |           |       |         |       |                          |       |             |       |       |       |   |   |   |   |
| BALANCES,  DECEMBER 31, 2002                                                  |       | 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 |   |
|                                                                                    |            |                   |            |                |            |                     |            |                |            |              |            |                               |            |                  |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

46

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**eCollege.comCONSOLIDATED STATEMENTS OFCASH FLOWS (in thousands)**

 
| ** **                                                                                               | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                    |       |                                      |       |   |   |   |   |
|                                                                                                     |       |                                      |       |   |   |   |   |   |   |   |
| Net income (loss)                                                                                        |       | $                                         | 19, 360    |   | $ | 568 |   | $ | (4,921 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities— |       |                                      |       |   |   |   |   |
| Depreciation                                                                                             |       | 2,438                                     |       | 1,996 |   | 3,205 |   |
| Loss on dispositions of assets                                                                           |       | 73                                        |       | 17 |   | 75 |   |
| Accrued interest                                                                                         |       | 37                                        |       | — |   | — |   |
| Provision for doubtful accounts                                                                          |       | 60                                        |       | — |   | — |   |
| Amortization of capitalized internal-use  software development costs                                     |       | 325                                       |       | 1,255 |   | 1,254 |   |
| Amortization of intangible assets                                                                        |       | 1,492                                     |       | 249 |   | — |   |
| Amortization of debt issuance costs and  discounts on debt                                               |       | 890                                       |       | 505 |   | — |   |
| Loss on early repayment of debt                                                                          |       | 2,479                                     |       | — |   | — |   |
| Stock-based compensation                                                                                 |       | 3,820                                     |       | 1,029 |   | 153 |   |
| Deferred income taxes                                                                                    |       | (18,716                                   | )          | — |   | — |   |
| Changes in—                                                                                         |       |                                      |       |   |   |   |   |
| Accounts receivable and accrued revenue  receivables                                                     |       | (3,613                                    | )          | (208 | ) | (1,087 | ) |
| Other current assets                                                                                     |       | 1,584                                     |       | (102 | ) | 129 |   |
| Other assets                                                                                             |       | 88                                        |       | 164 |   | 164 |   |
| Accounts payable and accrued liabilities                                                                 |       | 3,668                                     |       | (1,125 | ) | 674 |   |
| Deferred revenue and customer advances                                                                   |       | 1,261                                     |       | (1,335 | ) | 80 |   |
| Grant liabilities                                                                                        |       | —                                    |       | (354 | ) | (2,140 | ) |
| Other liabilities                                                                                        |       | (82                                       | )          | 157 |   | 243 |   |
| Net cash provided by (used in) operating  activities                                                     |       | 15,164                                    |       | 2,816 |   | (2,171 | ) |
|                                                                                                     |       |                                      |       |   |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                    |       |                                      |       |   |   |   |   |
| Purchases of property and equipment                                                                      |       | (2,848                                    | )          | (930 | ) | (1,638 | ) |
| Proceeds from disposition of property and  equipment                                                     |       | 6                                         |       | 7 |   | 13 |   |
| Capitalized internal-use software  development costs                                                     |       | (1,809                                    | )          | (304 | ) | — |   |
| Net cash paid for business acquisition, net  of cash acquired, including acquisition costs               |       | (208                                      | )          | (57,552 | ) | — |   |
| Restricted cash to investments                                                                           |       | (516                                      | )          | — |   | — |   |
| Net cash (used in) investing activities                                                                  |       | (5,375                                    | )          | (58,779 | ) | (1,625 | ) |
|                                                                                                     |       |                                      |       |   |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                    |       |                                      |       |   |   |   |   |
| Proceeds from issuance of common stock                                                                   |       | 2,551                                     |       | 33,962 |   | 315 |   |
| Payment of stock issuance costs                                                                          |       | (10                                       | )          | (1,750 | ) | — |   |
| Proceeds from sale-leaseback arrangements                                                                |       | 409                                       |       | 649 |   | 1,045 |   |
| Payments on sale-leaseback arrangements                                                                  |       | (125                                      | )          | (525 | ) | (995 | ) |
| Payments on line of credit, net                                                                          |       | (9,365                                    | )          | 6,427 |   | 438 |   |
| Proceeds from term loan                                                                                  |       | —                                    |       | 1,207 |   | — |   |
| Payments on term loan                                                                                    |       | (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                                                     |       | (17,540                                   | )          | 58,304 |   | 803 |   |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                                                    |       | (7,751                                    | )          | 2,341 |   | (2,993 | ) |
| CASH AND CASH EQUIVALENTS, beginning of  year                                                            |       | 15,974                                    |       | 13,633 |   | 16,626 |   |
| CASH AND CASH EQUIVALENTS, end of year                                                                   |       | $                                         | 8,223      |   | $ | 15,974 |   | $ | 13,633 |   |
|                                                                                                     |       |                                      |       |   |   |   |   |   |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:                                                       |       |                                      |       |   |   |   |   |
| Cash paid for interest                                                                                   |       | $                                         | 4,146      |   | $ | 243 |   | $ | 243 |   |
| Cash paid for income taxes                                                                               |       | 115                                       |       | — |   | — |   |
|                                                                                                     |       |                                      |       |   |   |   |   |
| SCHEDULE OF NON-CASH INVESTING AND  FINANCING ACTIVITIES:                                                |       |                                      |       |   |   |   |   |
| 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                                                                              |       | $                                         | —     |   | $ | 19 |   | $ | 555 |   |
| Acquisition of treasury stock included in  accrued liabilities                                           |       | $                                         | 67         |   | $ | 59 |   | $ | 22 |   |

 

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

 

47

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**eCollege.comNOTES TO CONSOLIDATEDFINANCIAL 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 technology and services thatenable colleges, universities, and K-12 schools to offer online, distance andhybrid educational programs as well as on-campus courses. Datamark, the Company’sEnrollment division, is an outsource provider of integrated enrollmentmarketing services to the proprietary post-secondary market.

 

**(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 that management uses significant estimates andassumptions are in the valuation of goodwill and identified intangible assets,in establishing reserves for uncollectible accounts receivable, in establishingestimated useful lives for long-lived assets, in revenue recognition, in accounting for the issuance of debtobligations, in establishing the valuation reserve for deferred tax assetsrelated to net operating loss carryforwards, and in estimating the fair valueof stock options, stock appreciation 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.

 

 

48

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**Accounts Receivable**

 

The Company maintains an allowance for doubtfulaccounts based upon the expected collection of accounts receivable. AtDecember 31, 2004 and 2003, the allowance for doubtful accounts was$155,000 and $188,000, respectively. One customer accounted for 15% of theconsolidated gross accounts receivable balance at December 31, 2004.  One customer accounted for 13% of theconsolidated gross accounts receivable balance at December 31, 2003. Salesto two customers represented 16% and 14%, respectively, of the Company’s totalrevenue in 2004 and one customer represented 11% of the Company’s total revenuefor 2003. No customers represented 10% or more of the Company’s revenue for2002.

 

**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 exchange contracts, optioncontracts or other foreign currency hedging arrangements. The Company maintainsits cash balances in the form of bank demand deposits and money market accountswith financial institutions that management believes are credit worthy.Accounts receivable are typically unsecured and are derived from transactionswith and from educational institutions primarily located in the United States.Accordingly, the Company may be exposed to credit risk generally associatedwith educational institutions. The Company performs ongoing credit evaluationsof its customers and maintains reserves for estimated credit losses. TheCompany historically has not had significant write-offs of accounts receivable.

 

**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,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Computer equipment (3 - 5 years)              |       | $                     | 10,903     |   | $ | 10,003 |   |
| Purchased software (3 - 5 years)              |       | 3,663                 |       | 3,314 |   |
| Office furniture and equipment (3 -  7 years) |       | 2,094                 |       | 1,843 |   |
| Machinery and production equipment  (7 years) |       | 781                   |       | 718 |   |
| Leasehold improvements (2 - 7 years)               |       | 1,093                 |       | 1,075 |   |
|                                               |       | 18,534                |       | 16,953 |   |
| Less: accumulated depreciation and  amortization   |       | (13,269               | )          | (11,991 | ) |
|                                               |       | $                     | 5,265      |   | $ | 4,962 |   |
|                                                    |            |                       |            |  |  |  |  |  |

 

 

50

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Depreciation expense for the years endedDecember 31, 2004, 2003, and 2002 was $2.4 million, $2.0 million, and$3.2 million, respectively.  Fixedasset balances at December 31, 2003 have been reclassified to conform to theDecember 31, 2004 presentation.

 

**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 impairment review is performed using a two-stepimpairment test. The first phase screens for impairment; while the second phase(if necessary), measures the impairment. For purposes of this test we haveidentified two reporting units, which are the same as our reportable segments(see Note 10). In the first step, the Company compares the fair value of areporting unit to its carrying value. In the second step, the Company comparesthe carrying value to the implied fair value of the goodwill and non-amortizedintangible asset under a theoretical purchase allocation scenario. eCollegecompleted the first phase impairment analysis in the three months endedDecember 31, 2004 and found no instance of impairment of our recordedgoodwill and indefinite-lived intangibles. Accordingly, the second testingphase was not necessary.

 

**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 5 to 8 years. The Company reviews long-lived assets to beheld and used for impairment whenever there is an indication that the carryingamount may not be recoverable from future estimated cash flows. On March 25,2005, the Company announced that Arthur Benjamin, the Chief Executive Officerof the Enrollment Division, had resigned from the Company as well as from theCompany’s Board of Directors.   Theamortization of the fair value of the related non-compete agreement will beaccelerated to correspond with the resulting decrease in the term of thenon-compete.  Through December 31,2004, the Company’s management believes that there have been no indications ofimpairment 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 the Costs of ComputerSoftware Developed or Obtained for Internal Use,” costs incurred during theapplication development stage are capitalized and costs incurred during thepreliminary project and the post-implementation stages are expensed asincurred. Capitalized software development costs are amortized using thestraight-line method over their estimated useful lives, generally three years.Amortization begins when the products are ready for their intended use.

 

The Company recorded $0.3 million,$1.3 million, and $1.3 million of amortization expense for the years endedDecember 31, 2004, 2003, and 2002, 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,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Accrued compensation and related taxes |       | $                     | 3,617      |   | $ | 4,178 |   |
| Other accruals                         |       | 2,203                 |       | 1,546 |   |
| Total other accrued liabilities        |       | $                     | 5,820      |   | $ | 5,724 |   |

 

51

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**Stock-Based Compensation**

 

Currently, generally accepted accounting principlesprovide two methods for accounting for employee stock option plans and otheremployee stock-based compensation arrangements. Companies may recognizestock-based compensation expense under the intrinsic value-based methodprescribed by APB Opinion No. 25, “Accounting for Stock Issued toEmployees” and related interpretations or under a fair value-based methodprescribed by SFAS No. 123, “Accounting for Stock-Based Compensation” andrelated interpretations. Prior to January 1, 2003, the Company accountedfor stock options granted to employees and directors and other stock-basedemployee compensation plans using the intrinsic value method of accounting inaccordance with APB No. 25 and related interpretations. Under APBNo. 25, the Company generally did not record any stock-based compensationexpense for options granted to employees, provided the options had an exerciseprice equal to or above the market price of eCollege’s common stock and theultimate number of shares to be issued upon exercise was fixed on the day theoption was granted. As such, the Company recognized compensation expense forfixed stock options only if the quoted market value of the Company’s commonstock exceeded the exercise price of the option on the grant date.

 

During the fourth quarter of 2003, the Companyadopted SFAS No. 123 effective January 1, 2003 for the Company’semployee stock option plans and other employee stock-based compensationarrangements using the prospective method under SFAS No. 148. This methodapplies the provisions of SFAS No. 123 to all employee stock awardsgranted, modified, or settled after January 1, 2003 and accordingly,eCollege recognized compensation expense for such awards made under itsstock-based employee compensation plans. The fair values of restricted sharerights were determined using the closing price of its common stock on the dateof grant, while stock options were estimated at the date of grant using theBlack-Scholes option-pricing model. The fair value of stock appreciation rightsare estimated on the date of grant using a Monte Carlo simulation for an Asiantype award.  The estimated fair values ofawards are being amortized over the vesting period of the applicable award,generally 3 to 5 years.

 

For stock awards granted prior to January 1,2003, compensation expense has not been recognized under SFAS No. 123, inaccordance with the prospective method of adoption allowed for under SFASNo. 148. The Company’s use of the prospective method of adoption meansthat the fair value for stock-based compensation required by SFAS No. 123was applied only to stock-based compensation awards granted, modified, orsettled in 2003. Accordingly, 2004 results are not directly comparable to prioryears’ results in this regard.

 

As required by SFAS No. 123, the Companypresents pro forma disclosures of its net income (loss) using the fairvalue-based accounting model for awards granted prior to January 1, 2003,as shown below (in thousands, except per share data).  Cumulative compensation cost recognized inactual and pro forma net income or loss with respect to options that areforfeited prior to vesting is adjusted as a reduction of pro forma compensationexpense in the period of forfeiture:

 
| ** **                                                 | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income (loss):                                         |       |     |       |     |       |     |       |
| As reported                                                |       | $        | 19,360     |     | $          | 568      |       | $ | (4,921 | ) |
| Stock-based compensation expense, as  reported, net of tax |       | 2,349    |       | 1,029    |       | 153      |       |
| Stock-based compensation expense, pro  forma, net of tax   |       | (2,486   | )          | (1,720   | )          | (2,452   | )          |
| Pro forma income (loss)                                    |       | $        | 19,223     |     | $          | (123     | )          | $ | (7,220 | ) |
|                                                       |       |     |       |     |       |     |       |
| Basic net income (loss) per share:                         |       |     |       |     |       |     |       |
| As reported                                                |       | $        | 0.95       |     | $          | 0.03     |       | $ | (0.30 | ) |
| Pro forma                                                  |       | $        | 0.94       |     | $          | (0.01    | )          | $ | (0.44 | ) |
|                                                       |       |     |       |     |       |     |       |
| Diluted net income (loss) per share:                       |       |     |       |     |       |     |       |
| As reported                                                |       | $        | 0.88       |     | $          | 0.03     |       | $ | (0.30 | ) |
| Pro forma                                                  |       | $        | 0.87       |     | $          | (0.01    | )          | $ | (0.44 | ) |

 

**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 $315,000, $293,000, and $349,000 forthe years ended December 31, 2004, 2003, and 2002, respectively.

 

During 1999, the Company paid $822,000 to a thirdparty to provide the Company advertising and other services. The Companydeferred the $822,000 payment and expensed the cost as services were providedover the five-year term of the agreement. As of December 31, 2004 thisprepaid amount had been expensed. $137,000, $164,000 and $164,000 was expensedin the years ended December 31, 2004, 2003, and 2002, respectively.

 

**Net Income (Loss) Per Share**

 

Basic net income (loss) per share is computed bydividing net income (loss) for the period by the weighted average number ofcommon shares outstanding for the period. Diluted net income (loss) per shareis computed by (i) adjusting net income (loss) for the effects, if any, ofassuming the conversion of certain convertible securities, and(ii) adjusting the weighted average number of shares outstanding for theeffects, if any, of common shares issuable upon the conversion or exercise ofcertain securities such as warrants and options for common stock outstandingduring the period, if the effect of such adjustments is dilutive. Certainoptions,  warrants and other common stockequivalents were dilutive as of December 31, 2004 and, using the treasurystock method, resulted in an additional 1.6 million weighted-average commonshares outstanding for the computation of diluted net income per share for theyear ended December 31, 2004. There were no adjustments to net income inthe determination of dilutive net income per share for the year endedDecember 31, 2004. As a result of the Company’s net loss for the yearended December 31, 2002, all potentially dilutive securities areanti-dilutive and are excluded from the computation of diluted loss per sharefor that year.

 

 

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The following table provides a reconciliation of the denominators usedin computing basic and diluted net (loss) income attributable to commonstockholders per common share.  Therewere no adjustments to the numerator.

 
| ** **                                             | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                             | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                             | ** ** | **(In thousands,**               | ** ** |
| ** **                                             | ** ** | **except per share amounts)**    | ** ** |
|                                                   |       |                             |       |   |   |   |   |
| Net income (loss) per share                            |       | $                                | 19,360     |   | $ | 568 |   | $ | (4,921 | ) |
|                                                   |       |                             |       |   |   |   |   |
| Weighted average shares outstanding - basic            |       | 20,358                           |       | 17,758 |   | 16,329 |   |
|                                                   |       |                             |       |   |   |   |   |
| Basic net income (loss) share                          |       | $                                | 0.95       |   | $ | 0.03 |   | $ | (0.30 | ) |
|                                                   |       |                             |       |   |   |   |   |
| Diluted net income (loss) per share:                   |       |                             |       |   |   |   |   |
| Net income (loss) per share                            |       | $                                | 19,360     |   | $ | 568 |   | $ | (4,921 | ) |
|                                                   |       |                             |       |   |   |   |   |
| Weighted average number of basic shares  outstanding   |       | 20,358                           |       | 17,758 |   | 16,329 |   |
| Dilutive effect of:                                    |       |                             |       |   |   |   |   |
| Stock options related to the purchase of  common stock |       | 1,546                            |       | 1,801 |   | — |   |
| Restricted stock units                                 |       | 15                               |       | 19 |   | — |   |
| Employee stock purchase plan                           |       | 15                               |       | — |   | — |   |
| Warrants related to the purchase of common  stock      |       | 62                               |       | — |   | — |   |
|                                                   |       |                             |       |   |   |   |   |
| Diluted shares outstanding                             |       | 21,996                           |       | 19,578 |   | 16,329 |   |
|                                                   |       |                             |       |   |   |   |   |
| Diluted net (loss) income per share                    |       | $                                | 0.88       |   | $ | 0.03 |   | $ | (0.30 | ) |

 

On February 1, 2005, 955,760 of 1,000,000 optionsheld by Blumenstein/Thorne Information Partners I, L.P, an investment fundaffiliated with the Company’s Chief Executive Officer, were exercised at aprice of $3.875.  An additional 16,575options were exercised on March 23, 2005 at the same exercise price.

 

The Company has never paid cash dividends on itsstock, and is currently precluded from doing so under its borrowing agreements.

 

The table below summarizes common stock equivalentsfor 2004, 2003 and 2002 which would have been included except for theiranti-dilutive effect (in thousands):

 
| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Stock options                            |       | 2                     |       | 5 |   | 3,185 |   |
| Employee Stock Purchase Plan             |       | 10                    |       | 197 |   | 70 |   |
| Warrants                                 |       | —                |       | 200 |   | 7 |   |
| Stock appreciation rights                |       | 224                   |       | — |   | — |   |
| Restricted share rights and common stock |       | 52                    |       | 198 |   | 25 |   |
| Total                                    |       | 288                   |       | 600 |   | 3,287 |   |

 

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**Comprehensive Income (Loss)**

 

Comprehensive income (loss) includes all changes instockholders’ equity from non-owner sources. There were no adjustments to netincome (loss) to arrive at comprehensive income (loss) for the years endedDecember 31, 2004, 2003 and 2002, respectively.

 

**Treasury Stock**

 

The Company accounts for treasury stock purchases atcost. In 2004, 2003 and 2002, the Company withheld 4,000, 5,000 and 6,000shares of common stock with a cost of $67,000, $59,000 and $22,000,respectively, in satisfaction of statutory tax withholding requirements uponthe vesting of restricted share rights held by an officer of the Company (SeeNote 8). These shares are presented as treasury stock in the consolidatedbalance sheet.

 

**Reclassifications**

 

Certain prior year amounts have been reclassified toconform to the current year presentation.

 

**(3)    Acquisition of 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 and two daysafter the signing of the definitive purchase agreement on September 15,2003). The $58.0 million in cash consideration was funded by cash on hand,proceeds from a $3.0 million term loan, and proceeds from$20.0 million in senior subordinated notes. The total purchase priceallocated to the acquired assets and assumed liabilities included $1.7 millionin capitalized acquisition costs. Acquisition costs primarily consisted ofinvestment 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 agreementregarding the purchase price with the former Datamark shareholders.  Under the terms of the agreement, the formerDatamark stockholders agreed that the Company was entitled to receive the $1million in escrow as well as $157,000 of the $208,000 owed by the formerDatamark stockholders.  The Companyagreed to pay the former Datamark stockholders $51,000 of the $208,000 owed bythem to the Company at December 31, 2003. The $51,000 was recorded during 2004 as an increase to goodwill.  Under the terms of the settlement, theCompany also agreed to pay the former Datamark shareholders $959,000 in federaland state tax refunds associated with returns filed subsequent to theacquisition of Datamark, of which $444,000 of this liability remains to be paidat December 31, 2004 as the related refunds 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

 

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was placed in escrow andeCollege has the right to offset up to the balance owed under the Seller Notesfor indemnified claims. However, the former stockholders of Datamark are liableto eCollege for indemnification  if andonly to the extent that the aggregate indemnifiable damages incurred byeCollege exceed the sum of $500,000. This limitation on indemnification doesnot apply to claims involving certain disputes known at the time of theacquisition or to certain breaches of the representations of the sellingstockholders under the stock purchase agreement, including indemnification fordamages incurred by eCollege associated with any unpaid or unrecordedliabilities for taxes related to periods prior to October 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

 

55

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deferred tax liabilities. Asa result, 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 twelve months ended December 31, 2004,the total purchase price allocated to the acquired assets and assumedliabilities decreased by $0.7 million due to reversal of the valuation reserveagainst deferred tax assets associated with certain tax benefits related to theDatamark acquisition, offset by additional capitalized acquisition costs forlegal and other expenses.

 

*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.

 

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.  On March 25,2005, the Company announced that Arthur Benjamin, the Chief Executive Officerof the Enrollment Division, had resigned from the Company, as well as from Datamark'sBoard of Directors.   The amortization ofthe fair value of the related non-compete agreement will be accelerated in 2005to correspond with the resulting decrease in the term of the non-compete.

 

*Goodwill and intangible asset with an indefinite life*

 

The Company recorded $55.1 million of goodwillas a result of the Datamark acquisition. This amount reflects unique synergieswith eCollege not associated with the assets acquired. The Company paid apremium for Datamark because eCollege believes that the acquisition will enableeCollege to strengthen its position in the for-profit-post-secondary education market and increase its serviceofferings along the student life cycle. Operationally, the Company believes theacquisition is valuable in that it offers the potential to cross-sell to eachcompany’s customer base and the ability to offer new integrated products andservices.  All of the goodwill has beenallocated to the Enrollment division as of December 31, 2004.  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

 

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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 its trade name generated by its other ongoing business activities;and the Company’s commitment to products being branded with its trade name overits corporate history.  The acquiredtrade name has significant market recognition and the Company expects to derivebenefits from the 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, 2004, are as follows (inthousands):

 

| ** **                                     | ** ** | **Gross** | ** ** | **December 31, 2004  Accumulated  Amortization** | ** ** | **Net** | ** ** |
|------------------------------------------------|------------|-----------|------------|--------------------------------------------------|------------|---------|------------|
| Customer Relationships (8 years)          |       | $         | 8,100      |                                             | $          | 1,181   |       | $ | 6,919 |   |
| Non-compete agreements (5 years)          |       | 2,400     |       | 560                                              |       | 1,840   |       |
| Total amortizable purchased intangible  assets |       | 10,500    |       | 1,741                                            |       | 8,759   |       |
| Datamark trade name                            |       | 1,600     |       |                                             |       | 1,600   |       |
| Total purchased intangible assets              |       | $         | 12,100     |                                             | $          | 1,741   |       | $ | 10,359 |   |

 

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

 

Estimated future amortization expense related topurchased intangible assets by year at December 31, 2004 is as follows (inthousands):

 

| **Year ending December 31,** | ** ** | **Amortization** | ** ** |
|-----------------------------------|------------|------------------|------------|
| 2005                              |       | $                | 1,493      |   |
| 2006                              |       | 1,493            |       |
| 2007                              |       | 1,493            |       |
| 2008                              |       | 1,413            |       |
| 2009                              |       | 1,013            |       |
| Thereafter                        |       | 1,856            |       |
|                                   |            |                  |            |  |

* *

*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, 2002.  Adjustments of $5.4 million in 2003 and$4.5 million in 2002 were made to the combined results of operations,reflecting amortization of purchased intangible assets, stock compensationexpense, interest expense, and related financing costs, net of tax that wouldhave been recorded if the acquisition had occurred at the beginning of 2002.The unaudited pro forma financial information is not intended to represent orbe indicative of the consolidated results of operations of eCollege that wouldhave been reported had the acquisition been completed as of the beginning ofthe periods presented, and should not be taken as representative of the futureconsolidated results or operations of financial condition of eCollege. Proforma results were as follows for the years ended December 31, 2003 and2002 (in thousands, except per share amounts):

 

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| ** **                           | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------|------------|------------------------------|------------|
| ** **                           | ** ** | **2003**                     | ** ** | **2002** | ** ** |
| Revenue                              |       | $                            | 72,446     |   | $ | 56,175 |   |
| Cost of revenue                      |       | 38,408                       |       | 31,962 |   |
| Gross profit                         |       | 34,038                       |       | 24,213 |   |
| Operating expenses:                  |       |                         |       |   |   |
| Product development                  |       | 5,723                        |       | 5,658 |   |
| Selling and marketing                |       | 11,034                       |       | 9,436 |   |
| General and administrative           |       | 11,013                       |       | 10,067 |   |
| Amortization of intangible assets    |       | 1,493                        |       | 1,493 |   |
| Total operating expenses             |       | 29,263                       |       | 26,654 |   |
| Income (loss) from operations        |       | 4,775                        |       | (2,441 | ) |
| Other income (expense), net          |       | (4,855                       | )          | (4,802 | ) |
| Net loss                             |       | $                            | (80        | ) | $ | (7,243 | ) |
| Basic and diluted net loss per share |       | $                            | (0.00      | )  | $ | (0.44 | ) |
|                                      |            |                              |            |  |  |  |  |  |  |

 

**(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-campus courses;services fees for the design, development, licensing and hosting of onlinedigital campuses; and services fees for the design and development of onlinecourses. With the acquisition of Datamark on October 31, 2003, the Companystarted 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.

 

*eLearning Division*

 

The Company enters into contracts with customers toprovide online learning products and services. The contracts typically have initial terms of one to five years, withthe average being approximately three years. Each contract specifies the typeand price of the online campus purchased and the number and price of onlinecourses purchased, as well as the fees for student enrollments and any otherproducts or services purchased. Since customer

 

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contracts are generallyapplicable campus-wide, colleges and universities can add new online programsand schools without the need to negotiate new contract terms.

 

The majority of eLearning division revenue is earnedby charging a per-enrollment student technology service fee to customers foraccess to their eCourses and our help desk. We also offer a pricing model forthe eCompanion product under which an annual license fee is charged for up to apredetermined number of users. For Program Administrative Solutions, theCompany generally charges: 1) a one time set-up and design fee to implementan online campus, and 2) an annual license, hosting, and maintenance feefor access to software. Course development services are sold on a per-coursebasis while other professional consulting services are based on standard hourlyrates.  The Company also offers customersthe option to purchase blocks of course development service hours, based onstandard hourly rates.

 

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.No billing occurs, and no revenue is recognized, for cancelled classes andstudent withdrawals or drops that occur before the agreed-upon enrollmentcensus date that is the basis for amounts billed. Campus license, hosting, andmaintenance fees, including the design and development of a customer’s campus,are recognized on a straight-line basis from the campus launch date through theend of the relevant contract period or the expected life of the customerrelationship, whichever is greater. The average recognition period for thesecampus fees is approximately three years.

 

Course development fees are recognized on astraight-line basis over the approximate period over which services areprovided and the obligation to the customer is fulfilled.  If a customer has purchased a block of coursedesign and development consulting hours, the Company recognizes such hourlyfees as the work is performed. If a customer has contracted to build a uniqueonline course, in general, such fees are recognized over a period of ninemonths, which approximates the length of time over which work is completed andobligations are fulfilled to the customer. The period over which the servicesare performed and revenue recognized may change in the future as actualexperience in completing development obligations continues to evolve. Changesin contract terms and expected customer life may also affect the period overwhich campus and course development fees are recognized in the future.

 

All other revenue sources are recognized at the timeof the performance of the service (e.g., training, instructional design, andtechnical consulting) or over the length of the service period (e.g., annualEvaluation Solutions license fees).

 

*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,and retention services.

 

It is the Company’s practice to execute contracts orwork orders of various lengths, typically up to three months for one project,for direct mail advertising campaigns. Individual direct mail projectstypically take ten to eighteen business days to complete with payments due twodays before marketing materials are mailed in most cases. Fees are determinedbased on number of pieces mailed and the associated revenue is recognized whenthe marketing materials are mailed. The pricing includes all applicable postagecosts.

 

Interactive media arrangements are usually fromthree months to one year in length. Pricing is based on afee-per-lead-generated model, with an initial up front payment due at the timethe customer’s agreement is signed and then the customer is invoiced monthlythereafter based on the number of leads generated. Payments received arerecorded as customer advances (liability) until the leads are generated atwhich point the revenue is recognized.

 

It is generally the Company’s practice to executewritten master services agreements, signed by both the customer and Datamark,for customers buying media placement services. The Company also executes anagency of record letter, which identifies Datamark as the agent authorized tomake media placements on behalf of the

 

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customer. Smaller customersare not required to execute master service agreements but are required to signthe agency of record letter. Datamark charges customers for the cost of the advertisementplaced with the third-party media supplier (i.e. newspaper, television, radiostation, etc.) which generally includes a 15% commission. Revenue is recognizedwhen the media advertisements are run by the third-party media supplier.Revenue is recorded on a net basis, meaning that the Company only includes the15% commission portion of the amount it charges in consolidated revenue, notthe gross amount of fees charged to, and collected from customers. Accordingly,the Company also excludes the direct cost of the advertisement charged by themedia supplier from cost of revenue in the consolidated statements ofoperations. Management determined that revenue should be recorded on a netbasis based on the fact that the third-party media supplier (and not Datamark)is responsible for ultimate fulfillment, including the acceptability of theproducts or services purchased by a customer, and therefore Datamark does nothave risks and rewards as principal in the media placement transactions.Furthermore, the fact that the Company earns a stated percentage of the amountbilled to a customer is a further indication that Datamark is acting as anagent.

 

Other enrollment marketing revenue sources includeretention services, admissions training, and research services. Studentretention services agreements are contracted for a period of not less than sixmonths and typically for a period of one year. Datamark charges a fee based onthe number of students actively enrolled in a particular month. There is also aone-time fee for implementation of the retention product that is recognized asrevenue over the contract period. Contracts for admissions training andresearch services are negotiated based on scope of work. These services areprovided on an hourly rate and are recognized at the time of the performance ofthe service or over the length of the service period.

 

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 2003, the Company entered into anagreement with a bank to obtain a $10.0 million revolving line of credit,(the “Revolver”) that matures on October 31, 2005, and which replaced theprevious revolving line of credit. The interest rate on the Revolver is equalto the bank’s prime rate, which was 4.00% at December 31, 2003, plus1.25%, but at no time will be less than 5.25%. The Revolver contains certainfinancial covenants, including requirements that the Company maintain aspecified minimum ratio of quick assets to current liabilities, minimumtangible net worth, minimum debt service coverage and Earnings before Interest,Taxes, Depreciation and Amortization (“EBITDA”). The Revolver is secured by allof the Company’s assets and contains a cross default provision with the Company’s$3.0 million term loan. In December 2003, the Company drew$9.4 million from the Revolver. The entire amount was subsequently repaidin January 2004. The Company was in compliance with all financialcovenants as of December 31, 2004. The Company drew and repaid$9.7 million from its revolving line of credit at three different pointsduring the year ending December 31, 2004.    The Company maintains a letter of creditwith the bank in the amount of $300,000 under which the vendor of the Company’sback-up computer systems is the beneficiary. The letter of credit effectively reduces the borrowing ability under theline of credit by $300,000.

 

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**Long-Term Debt**

 

*Term Loan*

 

The Company obtained a $3.0 million term loan (“TermLoan”) with a bank in October 2003. The Term Loan refinanced the existingterm loan and the outstanding debt on the equipment lease facility describedbelow. The Term Loan has an interest rate of 7.0% per annum. The Term Loan is beingrepaid in 36 equal installments.  AtDecember 31, 2004, the Company had $1.9 million outstanding under theTerm Loan. The Company also incurred approximately $56,000 in debt issuancecosts in connection with the Term Loan. These debt issuance costs were deferredand are being amortized as interest expense over the three-year term of theloan. The Term Loan contains certain financial covenants, includingrequirements that the Company maintain a specified minimum ratio of quickassets to current liabilities, minimum tangible net worth, minimum debt servicecoverage and Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”).The Term Loan is secured by all the Company’s assets. The Company was incompliance with all financial covenants as of December 31, 2004. The TermLoan was repaid in full in March, 2005. The Company maintains a letter of credit in the amount of $472,949 withColorado Business Bank under which Silicon Valley Bank is the beneficiary.  The letter of credit is secured by acertificate of deposit in the amount of $516,000 at Colorado BusinessBank.   The letter of credit expires May5, 2005 unless automatically renewed for an additional year.

 

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%).

 

The Company entered into a capital lease agreementto acquire certain 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, 2004, $284,000was outstanding on this lease.

 

*Subordinated Notes*

 

In October 2003, the Company issued$20.0 million in senior subordinated secured notes (“Senior SubordinatedNotes”) to a lender. The Senior Subordinated Notes have principal payments duein $5.0 million quarterly increments beginning on December 31, 2007,with interest payments due quarterly beginning on December 31, 2003, at arate of 12.5% per annum. The Senior Subordinated Notes are secured by all ofthe Company’s assets. In connection with the issuance of the SeniorSubordinated Notes, the Company issued warrants to the lender to purchase200,000 shares of common stock at a price of $13.00 per share. However, if atthe time of exercise of all or any portion of the warrants, the trading priceof the Company’s common stock is less than $13.00 per share for the 30 tradingdays immediately preceding the date of such exercise, then the exercise priceshall be automatically adjusted such that the exercise price will be equal to$10.00 per share with respect to such exercise. The warrants expire onOctober 31, 2008. The net proceeds received in connection with theissuance of the Senior Subordinated Notes totaled $20.0 million, whichwere allocated 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 5 years (the contractual life). The remaining$16.7 million was allocated to the Senior Subordinated Notes. The discountattributable to the value of the warrants will be amortized as interest expenseover the five-year term of the Senior Subordinated Notes using the interestmethod. The Company also incurred approximately $1.0 million in debtissuance costs in connection with the Senior Subordinated Notes. The debtissuance costs were deferred and are being amortized as interest expense overthe five-year term of the Senior Subordinated Notes. The Senior SubordinatedNotes contain certain financial covenants, including minimum quick ratio,minimum tangible net worth, minimum debt service coverage, and minimum EBITDA,and are secured by all the Company’s assets. The Senior Subordinated Notes have a cross default provision with theCompany’s other bank debt. The Company was in compliance with all financialcovenants as of December 31, 2004.

 

The Senior Subordinated Notes also contain aprovision that provides for the acceleration of all interest payments duethrough October 31, 2006 upon early extinguishment 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 to the selling stockholders. The Seller Notes, with interest and principal due in 2008, werecomprised of a series of notes issued to the selling stockholders, aggregatingto $7.0 million (face amount), which

 

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bear simple interest at arate of 10.0% per annum and another series of notes, aggregating to$5.0 million (face amount), which bear simple interest at a rate of 10.0%,compounded annually. All of the simple interest notes, as well as $3.0 million(face amount) of the annually compounding notes were repaid in 2004.  The Company recorded $8.9 million forthe Seller notes at the time of their issuance based upon their estimated fairvalue, resulting in a discount in the original amount of $3.1 million,which is being amortized over the term of the debt using the interestmethod.  The effective interest rate onthese 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 $1.8million at December 31, 2004, with an unamortized discount of $411,000 andaccrued interest payable of $238,000.

 

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

 

The following is a summary of the Company’slong-term debt and capital lease obligations as of December 31, 2004 and2003, respectively (in thousands):

 

| ** **                                                                                                                                                                                              | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Term loan, 7% interest rate, due through  November 2006                                                                                                                                                 |       | $                           | 1,917      |                        | $          | 2,917 |   |
| Seller notes, 10% face interest rate, 15%  effective interest rate, interest and principal due November 2008, face  amounts of $2.0 million and $12.0 million, respectively                        |       | 1,827                       |       | 8,871                       |       |
| Senior subordinated notes, 12.5% face  interest rate, 19.7% effective interest rate, $5.0 million quarterly  payments starting December 2007, due September 2008, principal of  $20.0 million |       | 17,279                      |       | 16,797                      |       |
| Capital lease obligation, 8.4% imputed  interest rate, 36 monthly payments beginning January, 2004                                                                                                      |       | 284                         |       | —                      |       |
| Total                                                                                                                                                                                                   |       | 21,307                      |       | 28,585                      |       |
| Less current portion                                                                                                                                                                                    |       | (1,136                      | )          | (1,000                      | )          |
| Long-term portion                                                                                                                                                                                       |       | $                           | 20,171     |                        | $          | 27,585 |   |

 

 

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The following is a schedule by year of futureprincipal debt payments, as of December 31, 2004. 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** | ** ** |
|------------------------------|------------|---------------|------------|---------------------------------|------------|------------------|------------|--------------------|------------|-----------|------------|
| 2005                         |       | $             | 1,000      |                            | $          | —           |       | —             |       | $         | 136        |   | $ | 1,136 |   |
| 2006                         |       | 917           |       | —                          |       | —           |       | 148                |       | 1,065     |       |
| 2007                         |       | —        |       | 5,000                           |       | —           |       | —             |       | 5,000     |       |
| 2008                         |       | —        |       | 15,000                          |       | 2,000            |       | —             |       | 17,000    |       |
| 2009                         |       | —        |       | —                          |       | —           |       | —             |       | —    |       |
|                         |       |          |       |                            |       |             |       |               |       |      |       |
| Total principal              |       | $             | 1,917      |                            | $          | 20,000           |       | $                  | 2,000      |      | $          | 284 |   | $ | 24,201 |   |
|                              |            |               |            |                                 |            |                  |            |                    |            |           |            |  |  |  |  |  |

** **

**(6)    Commitments andContingencies**

 

**Operating Lease Obligations**

 

The Company leases office space and equipment undervarious non-cancelable operating leases. At December 31, 2004 theaggregate future minimum lease commitments were as follows (in thousands):

 

| **Year ending December 31,** | ** ** | ** ** | ** ** |
|-----------------------------------|------------|------------|------------|
| 2005                              |       | $          | 1,780      |   |
| 2006                              |       | 1,610      |       |
| 2007                              |       | 1,351      |       |
| 2008                              |       | 323        |       |
| 2009                              |       | 136        |       |
| Thereafter                        |       | 34         |       |
|                              |       | $          | 5,234      |   |

 

Rent expense for the years ended December 31,2004, 2003, and 2002 was $1.9 million, $1.1 million, and$1.3 million, respectively. In connection with the lease on the corporateheadquarters building, the Company has recognized $395,000 in a deferred rentliability as of December 31, 2004, as the amount of the monthly cashrental payments increases over the lease term.

 

**Offshore Development Commitment**

 

In January 2004, the Company entered into a contractwith a third party to establish an offshore development facility in SriLanka.  Minimum commitments under thiscontract aggregated $3.3 million at December 31, 2004.  If the Company terminates the agreement priorto April, 2007, it will be required to pay a termination penalty equal to sixmonths 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 up to 15% of their annual compensation. In addition,the Company may make discretionary and/or matching contributions on behalf ofparticipating employees. No such contributions were made in 2004, 2003, or2002. With the acquisition of Datamark, the Company has continued to useDatamark’s 401(k) plan for the Enrollment division. Datamark’s 401(k) featuresa discretionary matching provision in which the Board determines matchinglevels yearly.  During 2004, the Companymade a discretionary matching contribution of $37,954.

 

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**Legal Matters**

 

In December 2002, the Company was named as adefendant in the lawsuit captioned IP Innovation, LLC, Plaintiff vs. ThomsonLearning, Inc., eCollege.com, Digitalthink, Inc., Docent, Inc.,Blackboard, Inc., Global Knowledge Network, Inc., and The PrincetonReview, Inc., Defendants, Case No. H-02-2031, In the United StatesDistrict Court for the Southern District of Texas, Houston Division. Thelawsuit was originally captioned IP Innovation, LLC, Plaintiff vs.WebCT, Inc., and Thomson Learning, Inc, Defendants, CaseNo. H-02-2031, In the United States District Court for the SouthernDistrict of Texas, Houston Division. The case involves claims of patentinfringement. In April 2004, the Company filed a motion for summaryjudgment, and on July 1, 2004, the court entered final judgment in ourfavor, finding that the Company’s programs do not directly or indirectlyinfringe on plaintiff’s patents.  In August 2004, the plaintiff fileda notice of appeal in the United States Court of Appeals for the FederalCircuit. The Company intends to continue to vigorously defend the lawsuit.Although no assurances can be given that this matter will be resolved in theCompany’s favor, management believes that the case is without merit, and thatthe ultimate resolution of the lawsuit will not have a material adverse effecton the operating results or the financial position of the Company.

 

**Contingency**

 

The Utah State Tax Commission conducted a sales taxaudit of Datamark for the period April 1, 2002 through December 31, 2002. Uponcompletion of the audit in November 2003 the Tax Commission claimed thatDatamark owed $530,209 in sales tax plus continuing interest for a totalassessment of approximately $590,000. Datamark subsequently paid $52,000 to the Tax Commission. In February2004, Datamark appealed the assessment in an administrative proceeding beforethe Tax Commission captioned Datamark, Inc. v. Auditing Division, Utah StateTax Commission, Appeal No. 03-1679, Account No.E76142. Datamark vigorouslydisputes the Tax Commission’s claims and is vigorously prosecuting itsappeal.  The former stockholders ofDatamark have agreed to indemnify the Company for any liability arising fromthis matter to the extent that such liability relates to periods ending priorto October 31, 2003. Although the Company cannot predict with certainty theoutcome of this dispute, management believes that its ultimate resolution willnot have a material adverse effect on the operating results or financialposition of the Company.

 

**City ofDenver Sales, Use and Occupational Privilege Tax Audit**

 

The Company has been issueda preliminary notice of a sales, use and occupational privilege tax liabilityby the City of Denver for the period of July 1, 2001 through June 30, 2004, inthe amount of $242,000 with interest and penalties of $71,000 for a totalamount of $313,000. The Company is currently disputing this amount and hasengaged outside experts to assist in the evaluation.  Based on this analysis, the Company hasestimated the likely liability to be $150,000 and accrued this amount.  The Company believes that the ultimateresolution of this matter will not have a material adverse effect on theoperating results or the financial position of the Company.

 

**State ofColorado Sales and Use Tax Audit**

 

The Company is in theprocess of a sales and use tax audit by the State of Colorado for the period ofOctober 1, 2001 through September 30, 2004. Preliminary audit workpapersprovided to the Company estimate the potential liability in the range of$223,000 with estimated interest and penalties of $63,000 for a total amount of$286,000. The Company is currently providing additional information for certainitems and disputing others included in these calculations and has engagedoutside experts to assist in the evaluation. Based on its analysis, the Company has estimated the likely liability tobe $50,000 and accrued this amount.  TheCompany believes that the ultimate resolution of this matter will not have amaterial adverse effect on the operating results or the financial position ofthe Company.

 

**Datamark AcquisitionIndemnification**

 

The Datamark stock purchase agreement provides forcertain indemnification of eCollege by the selling stockholders, severally andnot jointly. To satisfy, in part, these indemnification obligations,$5.0 million of the

 

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purchase price was placed inescrow and eCollege has the right to offset up to the balance owed under theSeller Notes for indemnified claims. However, the former stockholders ofDatamark are liable to eCollege for indemnification if and only to the extentthat the aggregate indemnifiable damages incurred by eCollege exceed the sum of$500,000. This limitation on indemnification does not apply to claims involvingcertain disputes known at the time of the acquisition or to certain breaches ofthe representations of the selling stockholders under the stock purchaseagreement, including indemnification for damages incurred by eCollegeassociated with any unpaid or unrecorded liabilities for taxes related toperiods 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 Chief Technology Officer is a board memberof, and holds a minority ownership interest in the vendor. The Company believesthat payments for such services were negotiated on an arms-length basis and inthe ordinary course of business.

 

During the year ended December 31, 2004Datamark provided services to ATI and received payments of $454,823 for suchservices. Arthur Benjamin, who served as Chairman and Chief Executive Officerof the Enrollment division from October 31, 2003 until March 25, 2005, is amember of the Board of Directors of ATI. The Company believes that the arrangementbetween Datamark and ATI was negotiated on an arms-length basis and in theordinary course of business.

 

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 theCompany paid Leeds Equity Advisors, Inc. the sum of $200,000 plusexpenses. The agreement continues for four additional years at $200,000 peryear, plus expenses.

 

**(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 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, 2004, the Company had reserved 666,667shares of common stock for issuance under the Purchase Plan, of which 59,250shares remained available for purchase.  Eligible employees are individuals scheduled towork more than 20 hours per week for more than five calendar months peryear. Under the Purchase Plan, eligible employees may contribute up to 15%of their cash earnings through payroll deductions, and the accumulateddeductions will be applied to the purchase of shares on each purchase date. Thepurchase price per share will be equal to 85% of the fair value per share ofthe Company’s common stock on the participant’s entry date into the offeringperiod or, if lower, 85% of the fair value per share on the purchase date. Inno event, however, may any participant purchase more than 1,000 shares (2,000shares after May 1, 2005) on any purchase date, and not more than 166,667shares (333,334 shares after May 1, 2005) may be purchased in total by allparticipants on any purchase date.

 

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Since its inception, the Purchase Plan has had aseries of successive offering periods, each with a maximum duration of 24months and each comprised of successive six-month purchase intervals.  The current two year offering period underthe Purchase Plan ends April 30, 2005.

 

Effective November 1, 2004, the Company amended thePurchase Plan to revise certain features. Effective with the purchase interval that began on November 1, 2004 theability of plan participants to increase contributions during an offeringperiod has been eliminated as has a reset feature that established a newoffering period if the fair value of the Company’s stock on any purchase datewithin an offering period was less than the fair value at the beginning of suchperiod.  Effective May 1, 2005, thelength of an offering period will be reduced from two years to one year and thelength of each purchase interval will be increased from six months to one year.

 

During 2004 and 2003, the Company recognized $1.7million and $582,000, respectively, of compensation expense for employee stockpurchases under the Purchase Plan.  In2004, the Company issued 163,000 shares of common stock at an average per shareprice of $5.75. The Company issued 81,896 shares of common stock in 2003 at anaverage per share price of $3.45 per share. In 2002, the Company issued 102,947shares of common stock at an average price of $2.44 per share.

 

**Employee Stock Option Grants**

 

The Company’s 1999 Stock Incentive Plan (the “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, 2002 throughDecember 31, 2004, includes options issued under the 1999 Plan and the1997 Plan (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, 2004, 4.6 million shares wereauthorized for issuance under the Plans, of which 351,000 shares remainedavailable for grant.

 

The following table summarizes the employee stockoption activity during the years ended December 31, 2004, 2003, and 2002,respectively (in thousands, expect per share data).

 

| ** **                     | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|--------------------------------|------------|------------|------------|----------------------------------------|------------|
| Outstanding, December 31, 2001 |       | 1,720      |       | $                                      | 5.49       |   |
| Granted                        |       | 755        |       | 3.77                                   |       |
| Forfeited or canceled          |       | (346       | )          | 5.80                                   |       |
| Exercised                      |       | (23        | )          | 2.74                                   |       |
| Outstanding, December 31, 2002 |       | 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       |   |

 

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As of December 31, 2004, 2003 and 2002, 1.0million, 1.2 million and 1.2 million of the above options wereexercisable, respectively, with weighted average exercise prices of $5.35,$5.19, and $5.73, respectively.

 

The following table summarizes the weighted averageexercise prices of options granted during the years ended December 31,2004, 2003, and 2002. 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,** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Exercise price-less than fair value:   |       |                              |       |   |   |   |   |
| Number of options                      |       | —                            |       | — |   | 51 |   |
| Weighted average exercise price        |       | $                                 | —     |   | $ | — |   | $ | 2.95 |   |
| Weighted average fair value of options |       | $                                 | —     |   | $ | — |   | $ | 3.02 |   |
|                                   |       |                              |       |   |   |   |   |   |   |   |
| Equal to fair value:                   |       |                              |       |   |   |   |   |
| Number of options                      |       | 3                                 |       | 72 |   | 704 |   |
| Weighted average exercise price        |       | $                                 | 18.38      |   | $ | 4.75 |   | $ | 3.83 |   |
| Weighted average fair value of options |       | $                                 | 12.61      |   | $ | 2.46 |   | $ | 2.40 |   |
|                                   |       |                              |       |   |   |   |   |   |   |   |
| Greater than fair value:               |       |                              |       |   |   |   |   |
| Number of options                      |       | —                            |       | — |   | — |   |
| Weighted average exercise price        |       | $                                 | —     |   | $ | — |   | $ | — |   |
| Weighted average fair value of options |       | $                                 | —     |   | $ | — |   | $ | — |   |
|                                        |            |                                   |            |  |  |  |  |  |  |  |  |

 

The status of stock options outstanding and exercisableunder the Plans as of December 31, 2004 is as follows (in thousands exceptper 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 -  $1.35               |       | 11                            |       | 5.8                                                 |       | $ | 1.32 |   | 11 |   | $ | 1.32 |   |
| $2.14 -  $3.04          |       | 235                           |       | 5.5                                                 |       | $ | 2.86 |   | 213 |   | $ | 2.85 |   |
| $3.08 -  $4.44          |       | 529                           |       | 5.9                                                 |       | $ | 3.76 |   | 403 |   | $ | 3.73 |   |
| $4.88 -  $6.63          |       | 99                            |       | 5.6                                                 |       | $ | 6.13 |   | 99 |   | $ | 6.13 |   |
| $7.00 -  $9.00          |       | 305                           |       | 4.8                                                 |       | $ | 8.96 |   | 305 |   | $ | 8.96 |   |
| $11.36 -  $18.38        |       | 7                             |       | 6.9                                                 |       | $ | 15.44 |   | 5 |   | $ | 16.33 |   |
|                         |       | 1,186                         |       | 5.5                                                 |       | $ | 4.58 |   | 1,036 |   | $ | 5.35 |   |

 

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**Option and Restricted Stock Grants to Officers**

 

As of April 23, 2002, the Company entered intoan employment agreement with  Oakleigh Thorne, the Company’s Chairman andChief Executive Officer. As part of the agreement, in lieu of an annual salary,on April 23, 2002 Mr. Thorne was granted an option to purchase up to101,000 shares of common stock at an exercise price of $4.49 per share, theclosing price of the Company’s common stock on the grant date. This option hasa 10-year term and vested monthly in twelve equal installments beginningJanuary 1, 2002. In addition, on April 23, 2002, Mr. Thorne wasgranted a Performance Option with a 10-year term to purchase up to 101,000shares of common stock at an exercise price of $4.49 per share. The PerformanceOption vested, if at all, partially on June 30, 2002 and onDecember 31, 2002, based on the Company meeting the targets set in the2002 corporate bonus plan. On June 30, 2002, the Performance Option vestedwith respect to 20,000 shares as a result of the Company meeting interimtargets. On December 31, 2002, the Performance Option vested with respectto an additional 55,000 shares as a result of the Company meeting a portion ofthe year end financial targets. The remaining 26,000 shares of the PerformanceOption did not vest pursuant to the corporate bonus plan and were forfeited asof December 31, 2002.

 

No compensation expense was recorded upon theissuance of the options to Mr. Thorne due to the fact that the exercise priceswere equal to the closing prices of the common stock on the grant dates.  However, the Performance Option was subjectto variable accounting due to its performance-based terms. As a result, theCompany was required to re-measure compensation expense at each reporting dateuntil each portion of the Performance Option vested or was terminated. Sincethe closing price of the Company’s common stock on both the interim and finalcompensation measurement dates was less than the exercise price of $4.49, theamount of compensation expense was determined to be zero, and the Company didnot record any stock-based compensation expense for these options during theyear ended December 31, 2002.

 

On June 21, 2001, the Company’s Board ofDirectors’ Compensation Committee awarded Mr. Douglas Kelsall, thenExecutive Vice President and Chief Financial Officer, 50,000 shares of theCompany’s common stock under the 1999 Plan, as consideration for Mr. Kelsall’s services to the Companyand his consent to terminate a previous option grant issued in 1999. One thirdof the shares vested on June 21, 2002, the one year anniversary of theaward, and the balance vested in 24 successive equal monthly installmentsbeginning in July 2002 and ending in June 2004. The Company recordedstock-based deferred compensation cost of $143,000 in connection with thisgrant, which amount equaled to the fair market value of the restricted commonstock on June 21, 2001. The deferred compensation cost was amortized on astraight-line basis through July 2, 2004. During the years endedDecember 31, 2004, 2003, and 2002, the Company recorded $24,000, $47,000,and $47,000 of compensation expense, respectively, in connection with thisgrant. There were no remaining restricted shares outstanding under this grantat December 31, 2004. The Company withheld 4,000, 5,000 and 6,000 sharesof stock during 2004, 2003 and 2002, respectively, from Mr. Kelsall’svested shares to cover minimum tax withholding requirements. These shares arereflected as treasury stock in the accompanying consolidated balance sheet asof December 31, 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 2004 and 2003, respectively, theCompany awarded 116,236 and 55,487 restricted share rights to employees. Theserights vest over three to four years. The value of these restricted sharerights awards was $1,748,000 in 2004 and $686,000 in 2003 based on the closingprices of the common stock on the dates of the grants. On October 31,2003, the Company awarded 195,000 restricted share rights, vesting over fouryears, to certain Datamark employees. The value of these restricted sharerights was $4.2 million based on the closing price of the common stock onOctober 31, 2003. The Company recognizes the issuance of the sharesrelated to these stock-based compensation awards and the related compensationexpense on a straight-line basis over the vesting period. The Company recorded$1,727,000 of stock-

 

68

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based compensation expenserelated to the restricted share rights awarded for the year endedDecember 31, 2004 and $275,000 for the year ended December 31, 2003. Theremaining $4.6 million will be recognized over the remaining vestingperiods.

 

**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 stock.  Each grant is separated into five differentlevels of base prices to reflect minimum required levels of stockholder returnover a five-year performance period.  Thebase price for the first level is 10% higher than the grant date stock price,and the base price for each successive level is 10% higher than the previouslevel. Except in the case of a change in control of the Company, as describedbelow, a participant will receive a distribution with respect to the shares ofcommon stock in each grant level only if the average closing price of ourcommon stock for the last quarter in the five year term exceeds the base pricefor such shares.  Each participant mayelect to receive a distribution with respect to 10% of the rights he or she wasgranted after the third anniversary of the grant and with respect to anadditional 10% after the fourth anniversary. In the event of a change incontrol, participants will be entitled to receive a distribution with respectto a specified percentage of the shares granted (50% if the change in controloccurs on September 13, 2004, increasing by 1/36 each month to 100% onSeptember 13, 2007), and will forfeit the right to receive a distribution withrespect to the unvested portion of the shares. The number of shares of commonstock issued following a change in control will be based on the differencebetween the base prices and the share price as of the date the change incontrol occurs.  The fair value of eachstock appreciation right was estimated on the date of grant using a Monte Carlosimulation for an Asian 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.   Suchgrants have the same terms as the 2004 grants except that they have differentbase prices and a new five-year performance period beginning on the grantdate.  In addition, the Company may grantstock appreciation rights to new hires and in connection with promotions andother special circumstances. Compensation expense is recognized ratably over the five year vestingperiod.

 

**Warrants**

 

In connection with the Senior Subordinated Notesissued in 2003, the Company issued warrants to the lender to purchase 200,000shares of common stock at a price of $13.00 per share.  However, if at the time of exercise of all orany portion of the warrants, the trading price of the Company’s common stock isless than $13.00 per share for the thirty trading days immediately precedingthe date of such exercise, then the exercise price shall be automaticallyadjusted such that the exercise price will be equal to $10.00 per share withrespect to such exercise.  The warrantswere immediately exercisable at the grant date and expire October 31, 2008(See Note 5). The value of the warrants at the date of issuance was$3.3 million, which resulted in a discount on the Senior SubordinatedNotes that is being amortized as interest expense over the five-year term ofthe Senior Subordinated Notes.  As ofDecember 31, 2004 the exercise price had adjusted to $10.00 per share.

 

**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:

 

69

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| ** **                                                          | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                          | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                |       |                        |       |   |   |   |   |
| Stock options granted to employees and  non-employee board members: |       |                        |       |   |   |   |   |
| Expected lives outstanding                                          |       | 5 years                     |       | 3 years |   | 5 years |   |
| Expected volatility                                                 |       | 85                          | %          | 85 | % | 83 | % |
| Risk-free interest rates                                            |       | 3.4                         | %          | 3.0 | % | 3.3 | % |
| Expected dividend yield                                             |       | 0                           | %          | 0 | % | 0 | % |
|                                                                |       |                        |       |   |   |   |   |
| Employee stock purchase plan:                                       |       |                        |       |   |   |   |   |
| Expected lives outstanding                                          |       | 9 months                    |       | 1 year |   | 1 year |   |
| Expected volatility                                                 |       | 68                          | %          | 70 | % | 80 | % |
| Risk-free interest rates                                            |       | 1.6                         | %          | 1.3 | % | 3.0 | % |
| Expected dividend yield                                             |       | 0                           | %          | 0 | % | 0 | % |
|                                                                |       |                        |       |   |   |   |   |
| Stock Appreciation Rights granted to  employees:                    |       |                        |       |   |   |   |   |
| Expected lives outstanding                                          |       | 4.7 years                   |       | — |   | — |   |
| Expected volatility                                                 |       | 77                          | %          | — |   | — |   |
| Risk-free interest rates                                            |       | 3.2                         | %          | — |   | — |   |
| Expected dividend yield                                             |       | 0                           | %          | — |   | — |   |

 

The total stock-based compensation recorded was $3.8million, $1.0 million and $153,000, respectively, for the years endedDecember 31, 2004, 2003 and 2002. Stock-based compensation recorded in 2004 included $65,000 for options,$1.7 million for grants under the Purchase Plan, $1.7 million for restrictedshare rights, $260,000 for stock appreciation rights and $25,000 of deferredcompensation from awards granted prior to 2003.

 

**(9)    Income Taxes**

 

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

 

| ** **                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Current benefit:                  |       |                        |       |   |   |   |   |
| Federal                           |       | $                           | 110        |   | $ | — |   | $ | — |   |
| State                             |       | 53                          |       | — |   | — |   |
| Total                             |       | 163                         |       | — |   | — |   |
| Deferred expense benefit:         |       |                        |       |   |   |   |   |
| Federal                           |       | 2,418                       |       | 339 |   | (1,570 | ) |
| State                             |       | 269                         |       | 62 |   | (286 | ) |
| Total                             |       | 2,687                       |       | 401 |   | (1,856 | ) |
| Total gross tax expense (benefit) |       | 2,850                       |       | 401 |   | (1,856 | ) |
| Valuation allowance               |       | (21,347                     | )          | (401 | ) | 1,856 |   |
| Net income tax benefit            |       | $                           | (18,497    | ) | $ | — |   | $ | — |   |

 

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

 

70

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| ** **                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Federal income tax rate                   |       | 35.0                        | %          | 35.0 | % | 35.0 | % |
| Increase (decrease) as a result of—  |       |                        |       |   |   |   |   |
| State income taxes net of federal benefit |       | 4.0                         | %          | 3.9 | % | 3.9 | % |
| Stock based compensation                  |       | 82.5                        | %          | 28.8 | % | (1.2 | )% |
| Other                                     |       | 8.2                         | %          | 2.9 | % | (0.1 | )% |
| Change in valuation allowance             |       | (2,271.6                    | )%         | (70.6 | )% | (37.7 | )% |
| Effective income tax rate                 |       | (2,141.9                    | )%         | — | % | — | % |

 

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

 

| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Deferred tax assets—                        |       |                  |       |   |   |
| Current:                                         |       |                  |       |   |   |
| Accrued liabilities and other                    |       | $                     | 701        |   | $ | 586 |   |
| Deferred revenue                                 |       | 1,462                 |       | 308 |   |
| Non-current:                                     |       |                  |       |   |   |
| Depreciation on property and equipment           |       | 320                   |       | 151 |   |
| Stock-based compensation                         |       | 780                   |       | 236 |   |
| Intangibles                                      |       | 1,891                 |       | — |   |
| Net operating loss carryforward                  |       | 21,606                |       | 25,340 |   |
| Other                                            |       | 525                   |       | 225 |   |
| Total deferred tax assets                        |       | 27,285                |       | 26.846 |   |
| Valuation allowance                              |       | (591                  | )          | (21,922 | ) |
| Deferred tax assets, net of valuation  allowance |       | 26,694                |       | 4,924 |   |
| Deferred tax liabilities—                   |       |                  |       |   |   |
| Acquired intangible assets                       |       | (4,271                | )          | (4,610 | ) |
| Capitalized software costs                       |       | (467                  | )          | (122 | ) |
| Other                                            |       | (183                  | )          | (192 | ) |
| Total deferred tax liabilities                   |       | (4,921                | )          | (4,924 | ) |
| Net deferred tax assets and liabilities          |       | $                     | 21,773     |   | $ | — |   |
|                                                  |            |                       |            |  |  |  |  |  |  |

 

71

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Through 2002, the Company generated lossesfor both financial reporting and tax purposes. As a result, for income taxreporting purposes, the Company may utilize approximately $66 million of netoperating loss carryforwards, which begin to expire in 2011 and are availableas late as 2022. The Tax Reform Act of 1986 contains provisions which may limitthe net operating loss carryforwards available to be used in any given year ifcertain events occur, including significant changes in ownership interests.  Of the $66 million in available netoperating loss carryforwards, approximately $10 million will be availableto offset taxable income in 2004 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 $15 million in 2005 and $20 million in 2006.  Any net operating loss carryforwards that arelimited due to the Section 382 limit can be carried forward.

 

The following table details the timing of theexpiration of net operating loss carryforwards:

 
| **Year of expiration**   | ** ** | **Net  operating loss  carryforwards** | ** ** |
|--------------------------|------------|----------------------------------------|------------|
| Prior to  2010           |       | $                                      | —     |   |
| 2011                     |       | 365                                    |       |
| 2012                     |       | 2,241                                  |       |
| 2013                     |       | —                                 |       |
| 2014                     |       | —                                 |       |
| Thereafter  through 2023 |       | 63,310                                 |       |
|                     |       |                                   |       |
|                     |       | $                                      | 65,916     |   |

 

Prior to the fourth quarter of 2004, theCompany  had fully provided a valuationallowance for the potential benefits of the aforementioned net operating losscarryforwards in excess of deferred tax liabilities 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 valuationallowance related to the net operating loss carryforwards and other temporaryitems as management believes it is now more likely than not that the Companywill be able to use the benefit to reduce future tax liabilities. 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.  The reversalresulted 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 future years, the Company expects torecord income tax expense related to our pretax income.

 

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**(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 is basedon 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 and admissions training. These solutions are used by higher educationinstitutions to increase student enrollment leads, conversion rates, andretention 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, certain corporate finance and legal salaries and benefits, audit,consulting, and legal costs incurred on a corporate level, rent and occupancycosts of the Company’s Chicago office, amortization of intangibles, incometaxes and debt costs. There was no intersegment revenue for the year ending December 31,2004.

 

Selected financial information for each reportable segment was as follows for the years ended December 31,2004, 2003, and 2002 (in thousands):

 
| ** **             | ** ** | **eLearning** | ** ** | **Enrollment(1)** | ** ** | **Total** | ** ** |
|------------------------|------------|---------------|------------|-------------------|------------|-----------|------------|
| **2004:**              |       |          |       |              |       |      |       |
| Total net revenue      |       | $             | 34,781     |              | $          | 54,486    |       | $ | 89,267 |   |
| Income from operations |       | 9,402         |       | 7,256             |       | 16,658    |       |
| **2003:**              |       |          |       |              |       |      |       |
| Total net revenue      |       | $             | 29,135     |              | 7,725      |      | $          | 36,860 |   |
| Income from operations |       | 539           |       | 1,432             |       | 1,971     |       |
| **2002:**              |       |          |       |              |       |      |       |
| Total net revenue      |       | $             | 23,692     |              | n/a        |      | $          | 23,692 |   |
| Loss from operations   |       | (4,863        | )          | n/a               |       | (4,863    | )          |
|                        |            |               |            |                   |            |           |            |  |  |  |

 

----

(1)               The Enrollment division was acquired October 31,2003.

 

 

73

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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,** | ** ** |
|---------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                        | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net segment revenue                               |       | $                                 | 89,267     |   | $ | 36,860 |   | $ | 23,692 |   |
| Income (loss) from operations:                    |       |                              |       |   |   |   |   |
| Total segment earnings  from operations           |       | 16,658                            |       | 1,971 |   | (4,863 | ) |
| Unallocated corporate  costs                      |       | (14,303                           | )          | — |   | — |   |
| Amortization of purchased  intangible assets      |       | (1,492                            | )          | (249 | ) | — |   |
| Income tax benefit                                |       | 18,497                            |       | — |   | — |   |
|                                              |       |                              |       |   |   |   |   |
| Total consolidated income  (loss) from operations |       | $                                 | 19,360     |   | $ | 1,722 |   | $ | (4,863 | ) |

 

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, 2004 and 2003 (in thousands) is asfollows:

 
| ** **                      | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------|------------|-----------------------------------|------------|
| ** **                      | ** ** | **2004**                          | ** ** | **2003** | ** ** |
| eLearning                       |       | $                                 | 11,139     |   | $ | 11,845 |   |
| Enrollment                      |       | 17,166                            |       | 11,288 |   |
| Goodwill and intangible  assets |       | 65,455                            |       | 68,318 |   |
| Corporate                       |       | 24,055                            |       | 10,572 |   |
|                            |       |                              |       |   |   |
|                            |       | $                                 | 117,815    |   | $ | 102,023 |   |

 

One customer represented 12% of eLearning revenueand three customers represented 23%, 21% and 11%, respectively, of Enrollmentrevenue for the year ending 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 accounted for 27% each of Enrollmentdivision revenue for the year ending December 31, 2003  No customer represented 10% or more ofeLearning revenue for the year ending December 31, 2002. One customerindividually accounted for 25% of eLearning division accounts receivable as of December 31,2003 and one customer individually accounted for 13% of Enrollment divisionaccounts 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.

 

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**(11)    Valuationand Qualifying Accounts**

 
| ** **                           | ** ** | **Balance at  beginning  of period** | ** ** | **Additions** | ** ** | **Deductions** | ** ** | **Balance  at end of  period** | ** ** |
|--------------------------------------|------------|--------------------------------------|------------|---------------|------------|----------------|------------|--------------------------------|------------|
| 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                         |       |
|                                 |       |                                 |       |          |       |           |       |                           |       |
| Year ended December 31,  2002   |       |                                 |       |          |       |           |       |                           |       |
| Allowance for doubtful  accounts     |       | 173                                  |       | —        |       | (7             | )          | 166                            |       |
| Allowance for deferred  income taxes |       | 25,240                               |       | 1,856         |       | —         |       | 27,096                         |       |
|                                      |            |                                      |            |               |            |                |            |                                |            |  |  |  |  |

 

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

 

The following summarizes selected quarterlyinformation with respect to the Company’s operations for the last eight fiscalquarters, which include Datamark’s results of operations from October 31,2003 (the acquisition date).

 
| ** **                           | ** ** | **2004 Quarter Ended** | ** ** | **2003 Quarter Ended** | ** ** |
|--------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                           | ** ** | **Dec. 31**       | ** ** | **Sept. 30**      | ** ** | **June 30** | ** ** | **Mar. 31** | ** ** | **Dec. 31** | ** ** | **Sept. 30** | ** ** | **June 30** | ** ** | **Mar. 31** | ** ** |
| Total revenue                        |       | $                      | 24,429     |                   | $          | 24,291 |   | $ | 20,940 |   | $ | 19,606 |   | $ | 15,237 |   | $ | 7,601 |   | $ | 7,323 |   | $ | 6,699 |   |
|                                 |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross profit                         |       | 11,355                 |       | 11,404                 |       | 10,140 |   | 9,587 |   | 7,450 |   | 4,913 |   | 4,540 |   | 3,774 |   |
| Net income (loss) (1)                |       | 17,534                 |       | 1,108                  |       | 654 |   | 64 |   | 58 |   | 671 |   | 275 |   | (436 | ) |
| Diluted net income (loss)  per share |       | 0.80                   |       | 0.05                   |       | 0.03 |   | 0.00 |   | 0.00 |   | 0.03 |   | 0.02 |   | (0.03 | ) |
|                                      |            |                        |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)               The Company recorded an income tax benefitfor the year ended December 31, 2004 from the reversal of the valuationallowance previously recorded against deferred tax assets as well as from therecognition of changes in other temporary differences.

 

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

 

None.

 

**ITEM 9A****. Controls and Procedures**

 

**Evaluation of Disclosure Controls and Procedures**

 

The Company maintains a Disclosure Committee,comprised of the Chief Executive Officer, President and Chief OperatingOfficer, Chief Financial Officer, Executive Vice President of eCollege andChairman and Chief Executive Officer of Datamark, Senior Vice President ofStrategy, Chief Technology Officer, Executive Vice President / General Managerof eLearning Division, President and Chief Operating Officer of Datamark,General

 

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Counseland Director of Corporate Accounting. The Company is required to maintain disclosure controls and procedures(as such term is defined in Rules 13a-15(e) or 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”), that aredesigned to ensure that information required to be disclosed by the Company inthe reports it files or submits under the Exchange Act is recorded, processed,summarized and reported on a timely basis and that such information isaccumulated and communicated to the Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure. Based on that evaluation, and because of the material weaknessesdiscussed below, the Chief Executive Office and Chief Financial Officerconcluded that as of December 31, 2004, the Company’s disclosure controls andprocedures were not effective to ensure that information required to bedisclosed by us in the reports we file or submit under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the SEC’s rules and forms.

 

**Evaluation of Internal Control over Financial Reporting**

 

The Company is undertaking a thorough review of itsinternal controls as part of the Company’s compliance with the requirements of Section 404of the Sarbanes-Oxley Act of 2002.  Aspart of this effort, the Company’s management is assessing the effectiveness ofits internal control over financial reporting as of December 31, 2004using the criteria set forth by the Committee of Sponsoring Organizations ofthe Treadway Commission  (“COSO”)’s  “Internal Control-Integrated Framework.”  The Company is required to include in itsAnnual Report on Form 10-K management’s report on the effectivenessof the Company’s internal controls over financial reporting, and ourindependent registered public accountants are required to attest to this reportand to report on the effectiveness of the internal control over financialreporting.  On November 30, 2004,the SEC issued Release No. 50754 providing a 45-day extension forthe filing of both management’s and the independent registered publicaccounting firm’s reports on the Company’s internal control over financialreporting for eligible companies.  TheCompany has determined that it is eligible and has elected to utilize this 45-dayextension; therefore, this filing does not include these reports.  These reports will be included in an amended Form 10-Kexpected to be filed within the 45-day extension period.

 

Prior to the issuance of the Company’s June 30,2004 interim financial statements, we identified an error in the accounting forthe Company’s Employee Stock Purchase Plan under SFAS No. 123, which theCompany voluntarily adopted in 2003.   Inlate August 2004 the Company completed the analysis necessary to verifyand quantify the error and prepared a restatement to correct the errors, whichrestatement was reflected in the Annual Report on Form 10-K/A for2003 and the Quarterly Report on Form 10-Q/A for the quarter ended March 31,2004.  Both such reports were filed withthe SEC on August 24, 2004 and should be referred to for additionalinformation regarding the restatement.

 

The Company believes that the error that led to therestatement was attributable to a material weakness in internal control overfinancial reporting relating to the impact on the Company’s reported financialresults of new accounting pronouncements. The Company has taken a number ofactions intended to remediate this material weakness as described below underthe caption “Remediation Efforts.”

 

In addition to the material weakness previouslyidentified related to a new accounting pronouncement, as discussed above, theCompany has identified the following internal control deficiencies that existedas of December 31, 2004 and that the Company considers to be material weaknessesbased on the Public Company Accounting Oversight Board’s (PCAOB) AuditingStandard No. 2, “An Audit of Internal Controls Over Financial ReportingPerformed in Conjunction with an Audit of Financial Statements”.  A material weakness is a significantdeficiency (within the meaning of the PCAOB’s Auditing Standard No.2), orcombination of significant deficiencies, that results in there being more thana remote likelihood that a material misstatement of the annual or interimfinancial statements will not be prevented or detected on a timely basis byemployees in the normal course of their assigned functions.

 

The Company believes that when making its assessmentof internal control over financial reporting using the criteria issued by COSO’s“Internal Control – Intergrated Framework”, because of the previously disclosedmaterial weakness as well as the additional material weaknesses identifiedbelow, neither management nor the Company’s independent registered publicaccounting firm will be able to conclude in their respective reports that theCompany’s

 

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internalcontrol over financial reporting was effective as of December 31,2004.  As the Company and its independentregistered public accounting firm are still evaluating the effectiveness of theCompany’s internal control over financial reporting, there can be no assurancethat additional deficiencies will not be identified, and that any suchdeficiencies, either alone or in combination with others, will not beconsidered additional material weaknesses.

 

*Material Weaknesses*

 

The Company has identified material weaknesses in thefollowing areas:

 

Financial Reporting Process – including (a) inadequatestaffing at our eLearning accounting function, exacerbated by recent high staffturnover, (b) inadequate training, specifically in technical accountingareas, (c) inadequate documentation of accounting policies and procedures,and (d) inadequate documentation of accounting entries and approval ofaccounting entries and related reports.

 

•      Segregationof Duties – including inadequate segregation of duties in our eLearningdivision accounting group.

 

•      Salesand Use Tax Accounting Procedures – including controls over transactionsimpacting state and city sales and use taxes.

 

•      FinancialClose and Consolidation – including (a) lack of complete documentation offinancial close and appropriate back-up and (b) lack of evidence of reviewand approval of accounting entries, account reconciliations and consolidationcalculations.

 

•      AnalyzingComplex Accounting Matters or Transactions – including income taxes, earningsper share calculations, and other technical accounting matters.

 

*Remediation Efforts*

 

As disclosed in previous public filings, the Companyhas taken a number of actions intended to remediate the material weaknessrelated to internal control over financial reporting in connection with theimpact on the Company’s reported financial results of new accountingpronouncements.  These actions included:

 

•                  Abroad evaluation of the structure and staffing of accounting operationsthroughout the Company.

•                  Thecreation of a separate corporate accounting function at the corporateheadquarters in Chicago, Illinois.  Thisfunction includes a new position, Director of Corporate Accounting, which wasfilled in August 2004, as well as the position of Manager of CorporateAccounting, which is currently being recruited.

•                  Thehiring of key accounting positions at the eLearning division accountingoperations in Denver, Colorado.

•                  Theaddition of accounting staff at the Enrollment division accounting operationsin Salt Lake City, Utah.

•                  Implementationof new procedures for the review of accounting pronouncements that impact theCompany’s financial statements, including the creation of “white papers”documenting the analysis and checklists to ensure that accounting staff arefamiliar with the accounting requirements for their areas of focus.

•                  Increasingthe number and scope of meetings with the Company’s external auditors.

•                  Broadeningrelationships with other outside advisors, such as tax consultants.

•                  Evaluatingthe adequacy of training received by accounting personnel as it relates to theadoption and implementation of new accounting pronouncements.

 

A number of these remediation activities addressother material weaknesses identified above, specifically, the financialreporting process, sales and use tax accounting procedures, and financial closeand consolidation.

 

The Company is undertaking additional remediationefforts. These include:

 

•                  Upgradingcertain accounting positions in the eLearning accounting staff.

 

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•                  Implementing detailed financial closeprocedures and checklists.

 

•                  Realignment of functional responsibilities toaddress segregation of duty control issues.

 

•                  Recruiting for an internal audit position toassist the Company in its ongoing evaluation and monitoring of entity levelcontrols.

 

•                  Moving the Enrollment division accounting tothe Company’s common accounting platform.

 

Whileremediation efforts are underway, these concerns will not be consideredremediated until new staffing arrangements and processes are fully implemented,operate for a period of time and are tested and the Company concludes that theyare operating effectively. We anticipate that we will report in our QuarterlyReport on Form 10-Q for the first quarter of 2005 that material weaknesses  in our internal controls continue to exist.

 

***Changes in Internal Control over Financial Reporting***

 

Exceptfor the remediation efforts described above, which were initiated during thesecond half of 2004 and continue to date, there have been no other changes inthe Company’s internal control over financial reporting during the fourthquarter of 2004 which have materially affected, or are reasonably likely tomaterially affect, such internal control over financial reporting.

 

**ITEM 9B.****     OTHER INFORMATION**

 

None.

 

**PART III.**

 

**ITEM10. ****   DIRECTORS AND EXECUTIVE OFFICERS OF THECOMPANY**

 

The directors and executive officers of eCollege asof March 28, 2005 are as follows:

 
| **Name**                         | ** ** | **Age**    | ** ** | **Position**                                                           | ** ** |
|----------------------------------|------------|------------|------------|------------------------------------------------------------------------|------------|
| ** **                       | ** ** | ** ** | ** ** | ** **                                                             | ** ** |
| Directors and Executive Officers |       |       |       |                                                                   |       |
| Oakleigh Thorne                  |       | 47         |       | Chief  Executive Officer and Chairman of the Board                     |       |
| Douglas H. Kelsall               |       | 51         |       | President,  Chief Operating Officer and Director                       |       |
| Reid E. Simpson                  |       | 48         |       | Chief  Financial Officer                                               |       |
| Marguerite M. Elias              |       | 50         |       | Senior Vice  President, General Counsel and Secretary                  |       |
| Robert S. Haimes                 |       | 44         |       | Senior Vice  President; Chief Operating Officer of Enrollment Division |       |
| Mark A. Resmer                   |       | 50         |       | Senior Vice  President and Chief Technology Officer                    |       |
| Thomas L. Dearden                |       | 48         |       | Chief  Executive Officer of Enrollment Division                        |       |
| Matthew T. Schnittman            |       | 33         |       | Executive  Vice President/General Manager of eLearning Division        |       |
| Jack W. Blumenstein(3)           |       | 61         |       | Director                                                               |       |
| Christopher E. Girgenti(1)(2)    |       | 41         |       | Director                                                               |       |
| Jeri L. Korshak(1)(2)            |       | 50         |       | Director                                                               |       |
| Robert H. Mundheim(1)(2)(3)      |       | 72         |       | 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 Officer since May 30, 2000 andas a member of our Board of Directors since February 1998. Mr. Thorneis responsible for developing the corporate mission and strategic

 

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objectives of the Company,and overseeing New Business Development, Strategy, Product Development andMarketing. Mr. Thorne has been the co-President of Blumenstein/ThorneInformation Partners, L.L.C. since October 1996, and is a co-founder ofthis private equity investment firm. From September 1986 toAugust 1996, Mr. Thorne served in various management positions,including most recently as President and Chief Executive Officer, of CCHIncorporated, a leading provider of tax and business law information, software,and services. Mr. Thorne holds a Bachelor of Science degree in Journalismfrom Boston University and a Master of Business Administration degree fromColumbia University. Mr. Thorne serves on the boards of directors ofShopperTrak, Inc. and AirCell, Inc. Mr. Thorne is also a member of various charitable boards, includingthe Art Institute of Chicago and the Lake Forest Open Lands Association.

 

*Douglas H. Kelsall* was named the Company’s President and ChiefOperating Officer in November 2003. Mr. Kelsall also has served as our Executive Vice President fromNovember 2000 to November 2003, as Chief Financial Officer and Treasurer fromSeptember 1999 to May 2004 and as Secretary from November 2000 to July 2004 andwas elected to the Board of Directors in August 2002. Mr. Kelsalloversees all of the Company’s internal operations, including its operatingdivisions and the Product Engineering and Technology organization. FromJuly 1997 to August 1999, Mr. Kelsall served as Chief FinancialOfficer of TAVA Technologies, Inc.; from December 1995 toJune 1997, he served as Chief Financial Officer of EvolvingSystems, Inc.; and from June 1993 to December 1995, he served asPresident of Caribou Capital Corporation. Prior to that time, Mr. Kelsallserved in various management and vice president positions at Colorado NationalBank. Mr. Kelsall holds a Bachelor of Arts degree from the University ofColorado and a Master of Business Administration degree from the University ofDenver. Mr. Kelsall presently serves on the boards of directors of CaribouCapital Corporation and the Colorado Institute of Technology.

 

*Reid E. Simpson* was named Chief FinancialOfficer in May 2004.  Mr. Simpson oversees all financial and treasury affairsof the Company, including investor relations. From September 1999 to April2004, Mr. Simpson served as executive vice president and CFO of CCCInformation Services (CCC), a publicly held company providing software andservices to the automobile claims industry. While at CCC, Mr. Simpsonplayed a key role in streamlining the company’s business and cost structure andincreasing the financial market’s awareness of CCC.  Prior to CCC, Mr. Simpson held CFOpositions at The Signature Group and Delphi Information Systems. Additionally,Mr. Simpson spent 16 years with the Dun & Bradstreet Corporation where heheld a number of senior finance positions, including CFO for three of thecorporation’s businesses: Dun & Bradstreet Plan Services, Nielsen MarketingResearch and DonTech. Mr. Simpson holds a Bachelor of Science in Accountingfrom Michigan State University.

 

*Marguerite M. Elias* joined the Company in July 2004 as Senior Vice President, GeneralCounsel and Secretary.  Ms. Elias isresponsible for overseeing all legal affairs and human resource matters for theCompany.  From January 2004 until joiningeCollege, Ms. Elias was a partner in the law firm of Hogan Marren,Ltd.   From April 2001 to December 2003,Ms. Elias served as senior vice president and general counsel ofCenterprise Advisors, Inc., a national professional services firm.  Prior to that time, Ms. Elias was inprivate practice focusing on securities and corporate law.  She was a partner in Katten Muchin ZavisRosenman from August 1995 to April 2001 and an associate at Skadden Arps SlateMeagher and Flom from September 1986 to July 1995.  Ms. Elias received a Bachelor of Artsdegree in Economics from Northwestern University and a Juris Doctor degree fromLoyola University of Chicago School of Law.

 

*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 Vice Presidentof Marketing from November 1999 through August 2001.  From 1996 to 1999, he served as the BrandMarketing Director and the Director of Market Development for Coors BrewingCompany. In 1995 and 1996, Mr. Haimes was Director of New Products and NewBusiness Development at Boston Chicken, Inc. Prior to September of 1995,Mr. Haimes held positions in brand management, new business development,and operations management at Procter and Gamble. He played a key role in hiseleven years at Procter and Gamble, managing marketing campaigns to consumersand professionals in a highly competitive industry. Mr. Haimes holds aBachelor of Science degree in Mechanical Engineering from the University ofCincinnati and a Master of Business Administration degree from Xavier University.

 

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*Mark A. Resmer* has served as our Chief Technology Officerand a Senior Vice President since April 2002. Mr. Resmer isresponsible for overseeing and directing our Product Engineering and Technologydivision, including all information technology and product development, from atechnical perspective. Mr. Resmer has an extensive background both inacademia and the broader IT industry. Most recently, Mr. Resmer led thetechnology direction for Prometheus at The George Washington University fromSeptember 2001 through January 2002 where he steered efforts to putmore control of eLearning applications in the hands of institutions’ ITdepartments. Prior to this role, he served as the Chief Technology Officer foriUniverse from May 2000 to September 2001. From April 1988 toApril 2000, Mr. Resmer was with California State University and alsofrom 1997 to 1999 he helped to found and directed the IMS project to promotestandardization and growth of the distributed learning marketplace. Hisexperience in academia also includes a technology leadership role at VassarCollege from 1980 to 1988. Additionally, Mr. Resmer has held positions asthe chair of the California State University System-wide Academic Information ResourceCouncil, chair of the Syllabus Conference Board, and treasurer of the HigherEducation Knowledge & Technology Exchange (HEKATE). Mr. Resmerearned his Bachelor’s of Arts in Computer Science from Vassar College, andLicentiate in Music from Trinity College in London. Mr. Resmer is a memberof the board of directors of TextCentric, Inc.

 

*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. Dearden joined Datamark in 1989 as theoriginal member of its creative staff. Before joining Datamark, Mr. Dearden wasa founder of and senior partner in Bennett/Allen Associates, a Salt LakeCity-based advertising agency. Mr. Dearden serves as the Industry Co-Chairof the Utah Postal Customer Council. Mr. Dearden holds a Bachelor of FineArts degree from the University of Utah.

 

*Matthew T. Schnittman* has served as Executive VicePresident/General Manager of the eLearning Division since November 2003and is responsible for ensuring customer satisfaction, overseeing the areas ofClient Services, Account Management, Help Desk and Evaluation Solutions.  Mr. Schnittman also has served as Senior VicePresident of Account Management from January 2003 to November 2003and as Vice President of Professional Services from July 2001 toJanuary 2003. Mr. Schnittman served as our Director of StrategicPlanning and Analysis from July 1999 to June 2001.  Before joining eCollege, Mr. Schnittmanworked at PricewaterhouseCoopers from June 1998 to June 1999 in theManagement Consulting Strategy group, where he provided strategic consultingservices to Fortune 1000 companies. From January 1995 to June 1997,Mr. Schnittman was with CCD, LLP, a consulting boutique focused onconsumer product strategy. Mr. Schnittman holds a Bachelor of Sciencedegree in Business and Public Administration in Marketing from the Universityof Arizona, and a Master of Business Administration degree in Management andStrategy, Finance and Marketing from JL Kellogg 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 of Blumenstein/ThorneInformation Partners, L.L.C. since October 1996, and is a co-founder ofthis 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 jointventure of Motorola and IBM, and has held various senior management positions inproduct development 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.

 

*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 has held various corporate finance positions with KemperSecurities, Inc. and KPMG Peat Marwick (now KPMG LLP) . Mr. Girgentiis a Chartered Financial Analyst. Mr. Girgenti presently serves on the

 

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advisoryboard of Illinois Technology Enterprise Corporation—Evanston and also serves onthe boards of directors of Tavve Software Company, Sportvision, Inc., andKatalyst, LLC.

 

*Jeri L. Korshak* has served as a member of our Board ofDirectors since February 1999, and is currently a member of our Audit  and Compensation Ccommittees.Ms. Korshak has over twenty years of experience in marketing and businessdevelopment. Since 2001, Ms. Korshak has been an independent consultant. Priorto that time, Ms. Korshak served as Senior Vice President of Marketing andBusiness Development for AuraServ Communications from June 2000 toMarch 2001 and Vice President of Strategy for MediaOne Group fromJune 1998 to June 2000. Ms. Korshak was Vice President andGeneral 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.

 

*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 and President of the American Academy in Berlin, atrustee of the New School University and a member of the Council of theAmerican Law Institute, and President of the Appleseed Foundation. Mr. Mundheimalso serves on the supervisory board of Hypo Real Estate Holding AG and the boardof directors 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 areelected by the Board of Directors to serve in their respective capacities untiltheir successors are elected and qualified or until their earlier resignationor 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 requires theCompany’s officers and directors, and persons who own more than ten percent ofa registered class of the Company’s equity securities, to file with the SEC andthe Nasdaq National Market reports of ownership of Company securities andchanges in reported ownership. Officers, directors and greater than ten percentshareholders are required by SEC rules to furnish the Company with copies ofall Section 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, 2004, the Company’s officers, directors andgreater than ten percent owners timely filed all reports they were required tofile under Section 16(a); except that one report was filed late asdescribed below.  A Form 4

 

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forLee Spiegler, former General Counsel, was filed February 6, 2004 for theissuance of a Share Rights Award granted on January 5, 2004.

 

**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.  TheCompany encourages all employees and directors to properly report any violationof the Code of Ethics to the appropriate persons identified in the Code.

 

**ITEM 11.    EXECUTIVE COMPENSATION**

 

The following table setsforth information with respect to compensation earned by the Company’s ChiefExecutive Officer and the next four mostly highly compensated executiveofficers who were serving as executive officers at the end of 2004(collectively, the “Named Executive Officers”). The positions shown in thetable are those in which the Named Executive Officers served in 2004.  See the footnotes to the table forinformation concerning other positions held by these individuals at present andin prior periods shown.

 

**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                          |       | 2004       |       | $                        | 373,958       |           | —     |                                 | $          | 25,417 | (3) | — |   | 210,000 | (4) | — |   |
| Chief Executive  Officer                 |       | 2003       |       | $                        | 350,000       |           | $          | 295,560                              | (2)        | $ | 28,924 | (3) | $ | 402,289 | (2) | — |   | — |   |
|                                     |       | 2002       |       |                     | (1)           | —         |       | $                                    | 32,258     | (3) | — |   | 211,011 | (1) | — |   |
|                                     |       |       |       |                     |          |           |       |                                 |       |   |   |   |   |   |   |
| Douglas H.  Kelsall                      |       | 2004       |       | $                        | 285,416       |           | —     |                                 | —     |   | — |   | 150,000 | (4) | — |   |
| President and  Chief Operating Officer   |       | 2003       |       | $                        | 250,000       |           | $          | 174,671                              | (5)        | — |   | $ | 232,389 | (5) | — |   | — |   |
|                                     |       | 2002       |       | $                        | 199,167       |           | $          | 75,850                               |       | — |   | — |   | 30,000 |   | — |   |
|                                     |       |       |       |                     |          |           |       |                                 |       |   |   |   |   |   |   |
| Arthur E.  Benjamin                      |       | 2004       |       | $                        | 240,295       |           | $          | 89,295                               |       | — |   | — |   | 75,000 | (4) | — |   |
| Executive Vice  President of eCollege,   |       | 2003       |       | $                        | 37,653        | (6)            | $          | 55,590                               |       | $ | 402,840 | (7) | $ | 1,626,750 | (6) | — |   | — |   |
| Chairman and CEO  of Enrollment Division |       | 2002       |       | —                   |          | —         |       | —                               |       | — |   | — |   | — |   |
|                                     |       |       |       |                     |          |           |       |                                 |       |   |   |   |   |   |   |
| Robert S. Haimes                         |       | 2004       |       | $                        | 203,350  |           | $          | 42,050                               |       | — |   | — |   | 60,000 | (4) | — |   |
| Senior Vice  President of Strategy       |       | 2003       |       | $                        | 187,200       |           | $          | 82,219                               | (8)        | — |   | $ | 71,855 | (8) | — |   | — |   |
|                                     |       | 2002       |       | $                        | 185,100       |           | $          | 55,411                               |       | — |   | — |   | 7,500 |   | — |   |
|                                     |       |       |       |                     |          |           |       |                                 |       |   |   |   |   |   |   |
| Matthew  Schnittman                      |       | 2004       |       | $                        | 191,243       |           | $          | 65,654                               |       | — |   | $ | 99,992 | (10) | 60,000 | (4) | — |   |
| Executive Vice  President/ General       |       | 2003       |       | $                        | 170,000       |           | $          | 68,320                               | (9)        | — |   | $ | 61,855 | (9) | — |   | — |   |
| Manager of  eLearning Division           |       | 2002       |       | $                        | 140,083       |           | $          | 11,000                               |       | — |   | — |   | 10,000 |   | — |   |

 

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(1)          OakleighThorne has served as our Chief Executive Officer since May 30, 2000.  In lieu of an annual salary in 2002,Mr. Thorne was granted an option to purchase up to 101,156 shares ofcommon stock at an exercise price of $4.49 per share. These options vestedmonthly in twelve equal installments beginning January 1, 2002 and werefully vested as of December 31, 2002. In addition, Mr. Thorne wasgranted an additional option to purchase up to 101,156 shares of common stockat an exercise price of $4.49 per share, of which options to purchase 74,855shares were vested as of December 31, 2002 based on the Company meetingcertain targets in its Corporate Bonus Plan for 2002. The remaining optionshares were forfeited. On July 19, 2002, Mr. Thorne

 

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wasgranted an option to purchase 35,000 shares of common stock at an exerciseprice of $3.85 per share. One third of the options vested on August 1,2003 and the balance vest in 24 equal monthly installments beginningSeptember 1, 2003, provided Mr. Thorne continues in employment withthe Company.

 

(2)          Pursuantto his employment agreement for 2003, on August 13, 2003 Mr. Thornewas granted a Share Rights Award of 24,129 shares of the Company’s common stockunder the Company’s 1999 Stock Incentive Plan in consideration for his servicesto the Company. One third of the shares vested on July 1, 2004 and thebalance will vest in 8 successive equal quarterly installments beginningOctober 2004, provided Mr. Thorne continues in employment with theCompany. The value of the Share Right Award as of December 31, 2004 was$274,105. Mr. Thorne received an additional bonus of $225,000, one half ofwhich was paid in cash and the remaining half was paid in the form of 5,594share rights the value of which is $63,547 as of December 31, 2004. Theseshare rights vest 100% on January 27, 2006, provided Mr. Thornecontinues in employment with the Company.

 

(3)          In2004, the Company paid $13,403 of Mr. Thorne’s personal travel expenses,pursuant to his employment agreement. In addition, the Company paid certainliving expenses for Mr. Thorne, which totaled $12,014 in 2004, $14,040 in2003 and $13,748 in 2002.

 

(4)          Stockappreciation rights were granted to the Named Executive Officers on September13, 2004 and are exercisable on September 13, 2009.  At such time, if the average fair marketvalue per share of common stock (the “Performance Price”) for the three monthperiod preceding the exercise date (the “Performance Period”) exceeds the baseprice for a stock appreciation right, then the recipient will be entitled toreceive a distribution of shares of common stock with a value calculated bydividing the excess of the Performance Price over the base price per stockappreciation right by the Performance Price. The recipient may elect to receive 10% of his or her distribution oneach of September 13, 2007 and September 13, 2008.  Subject to vesting provisions, thedistribution will accelerate upon the occurrence of a change in control.

 

(5)          DouglasH. Kelsall has served as the Company’s President and Chief Operating Officersince November 2003. Mr. Kelsall also served as the Company’s ExecutiveVice President from November 2000 to November 2003, as Chief Financial Officerand Treasurer from September 1999 to May 2004 and as Secretary from November2000 to July 2004.  As a portion of hiscompensation for 2003, on August 13, 2003 Mr. Kelsall was granted aShare Rights Award of 12,064 shares of the Company’s common stock under theCompany’s 1999 Stock Incentive Plan in consideration for his services to theCompany. One third of the shares vested on July 1, 2004 and the balancewill vest in 8 successive equal quarterly installments beginningOctober 2004, provided Mr. Kelsall continues in employment with theCompany. The value of the Share Right Award as of December 31, 2004 was$137,047. Mr. Kelsall received an additional bonus of $175,000, one halfof which was paid in cash and the remaining half was paid in the form of 4,351share rights, the value of which was $49,427 as of December 31, 2004.These share rights vest 100% on January 27, 2006, providedMr. Kelsall continues in employment with the Company.

 

(6)          OnMarch 25, 2005, Mr. Benjamin resigned from the Company. He served as theCompany’s Executive Vice President and as Chairman and Chief Executive Officerof the Enrollment division from October 31, 2003 until his resignation.Mr. Benjamin’s salary and bonus for 2003 represents partial yearcompensation which on an annual basis would have been $255,918 and $55,590,respectively. Pursuant to his employment agreement with the Company, onOctober 31, 2003 Mr. Benjamin was granted a Share Rights Award of75,000 shares of the Company’s common stock under the Company’s 1999 StockIncentive Plan.

 

(7)          Inconjunction with the Datamark acquisition, Mr. Benjamin purchased, in aprivate placement, 36,000 unregistered shares of eCollege common stock at aprice of $10.50 per share. The market value of the eCollege common stock on thedate of purchase was $21.69 per share.

 

(8)          Mr.Haimes was named Chief Operating Officer of the Enrollment division on March25, 2005 and continues to hold the position of Senior Vice President ofeCollege. Mr. Haimes served as the Company’s Senior Vice President of StrategyJanuary of 2004 to March 25, 2005, as Senior Vice President of Strategy andMarket Communication from January 2003 to January 2004 and as Senior VicePresident of Market and Product Management from August 2001 to January2003.  On August 13, 2003Mr. Haimes was granted a Share Rights Award of 3,485 shares of the Company’scommon stock under the Company’s 1999 Stock Incentive Plan in

 

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considerationfor his services to the Company. One third of the shares vest on July 1,2004 and 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 31,2004 was $39,589. 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 $16,937 as of December 31,2004. These share rights vest 100% on January 27, 2006, providedMr. Haimes continues in employment with the Company.

 

(9)          MatthewSchnittman has served as Executive Vice President and General Manager of theeLearning Division since November 2003 and previously served as Senior VicePresident of Account Management from January 2003 to November 2003 and as VicePresident of Professional Services from July 2001 to January 2003.  On August 13, 2003 Mr. Schnittman was granteda Share Rights Award of 3,485 shares of the Company’s common stock under theCompany’s 1999 Stock Incentive Plan in consideration for his services to theCompany.  One third of the shares vestedon July 1, 2004 and the balance will vest in 8 successive equal quarterlyinstallments beginning October 2004, provided Mr. Schnittman continues inemployment with the Company.  The valueof the Share Right Award as of December 31, 2004 was $39,589.  Mr. Schnittman received an additional bonusof $40,000, one half of which was paid in cash and the remaining half was paidin the form of 994 share rights, the value of which was $11,291 as of December31, 2004. These share rights vest 100% on January 27, 2006, provided Mr.Schnittman continues in employment with the Company.

 

(10)    On April 7,2004, Mr. Schnittman was granted a Share Rights Award of 4,570 shares of theCompany’s common stock under the Company’s 1999 Stock Incentive Plan.  One third of the shares vest on April 7, 2005and the balance will vest in 8 successive equal quarterly installmentsbeginning July 2005, provided Mr. Schnittman continues in employment with theCompany.  The value of the Share RightAward as of December 31, 2004 was $51,915.

 

**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 31,2004.  All rights were granted under theCompany’s 1999 Stock Incentive Plan. As discussed in Item 7 of this AnnualReport on Form 10-K, the Named Executive Officers were granted additional stockappreciation rights in March 2005. Absent promotions or other specialcircumstances, the Company does not intend to grant additional equity to theseindividuals during the next five years. No option grants were made to the NamedExecutive Officers during the 2004 fiscal year.

 
| ** **            | ** ** | **Individual Grants**                      | ** ** | ** **                                     | ** ** | **Potential Realizable Value** | ** ** |
|-----------------------|------------|--------------------------------------------|------------|------------------------------------------------|------------|--------------------------------|------------|
| ** **            | ** ** | **Number of  Securities  Underlying  SAR** | ** ** | **% of Total  SARs  Granted to  Employees in** | ** ** | **Exercise  Price**            | ** ** | **Expiration** | ** ** | **at Assumed Annual Rates  of Stock Price  Appreciation for  SAR Term(1)** | ** ** |
| **Name**              | ** ** | **Granted($)**                             | ** ** | **Fiscal Year**                                | ** ** | **($/Sh)**                     | ** ** | **Date** | ** ** | **5% ($)** | ** ** | **10% ($)** | ** ** |
| Oakleigh Thorne.      |       | 210,000                                    |       | 19.1                                           |       | (1                             | )          | 9/13/09 |   | 90,059 |   | 496,379 |   |
| Douglas H. Kelsall.   |       | 150,000                                    |       | 13.6                                           |       | (1                             | )          | 9/13/09 |   | 64,328 |   | 354,556 |   |
| Arthur E. Benjamin    |       | 75,000                                     |       | 6.8                                            |       | (1                             | )          | 9/13/09 |   | 32,164 |   | 177,278 |   |
| Robert S. Haimes      |       | 60,000                                     |       | 5.5                                            |       | (1                             | )          | 9/13/09 |   | 25,731 |   | 141,823 |   |
| Matthew T. Schnittman |       | 60,000                                     |       | 5.5                                            |       | (1                             | )          | 9/13/09 |   | 25,731 |   | 141,823 |   |

 

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(1)          Thesestock appreciation rights were granted on September 13, 2004 and areexercisable on September 13, 2009.  Atsuch time, the recipient will be entitled to receive a distribution of sharesof common stock with a value calculated by dividing (x) the excess of (A) thePerformance Price over (B) the base price per stock appreciation right, by (y)the Performance Price.   Each stock appreciationright is divided into five (5) equal levels with an assigned base price to eachlevel as follows:  Level 1 - $9.72, Level2 - $10.70, Level 3 - $11.77, Level 4 - $12.94 and Level 5 - $14.24.  The recipient person may elect to receive 10%of his or her distribution on each of September 13, 2007 and September 13,2008.  Subject to vesting provisions, thedistribution will accelerate upon the occurrence of a change in control.

 

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(2)          There can be no assurance provided to any executive officer or otherholder of the Company’s securities that the actual stock price appreciationover the stock appreciation rights term will be at the 5% and 10% levels or atany other level.  Unless the market priceof the Common Stock appreciates so that the Performance Price is higher thanthe base price, no value will be realized from these grants.

 

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

 

The following table provides information as tooptions and stock appreciation rights exercised and the value of outstandingoptions and stock appreciation rights held by the Named Executive Officers atDecember 31, 2004.

 

**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, 2004** | ** ** | **Value of  Unexercised In-the-  Money Options/SARs at  December 31, 2004(1)** | ** **    |
|------------------------|------------|----------------------|------------|--------------|------------|--------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|---------------|
| **Name**               | ** ** | **on  Exercise**     | ** ** | **Realized** | ** ** | **Exercisable**                                                                            | ** ** | **Unexercisable**                                                                   | ** **    | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Oakleigh Thorne        |       | —               |       | —       |       | 1,000,000                                                                                  | (2)        | 0                                                                                   |          | $ | 7,485,000 |   | $ | 0 |   |
|                   |       | 200,316              |       | $            | 640,541    |                                                                                       | 2,917      |                                                                                | 7,778/210,000 |   | $ | 21,907 |   | $ | 58,413/96,600 |   |
| Douglas H.  Kelsall    |       | 40,277               |       | $            | 511,317    |                                                                                       | 280,277    |                                                                                | 6,667/150,000 |   | $ | 1,131,605 |   | $ | 50,736/69,000 |   |
| Arthur E. Benjamin     |       | —               |       | —       |       | —                                                                                     |       | /75,000                                                                             |          | $ | — |   | $ | /34,500 |   |
| Robert S. Haimes       |       | —               |       | —       |       | 126,833                                                                                    |       | 1,667/60,000                                                                        |          | $ | 520,224 |   | $ | 12,686/27,600 |   |
| Matthew T.  Schnittman |       | —               |       | —       |       | 62,777                                                                                     |       | 2,223/60,000                                                                        |          | $ | 446,608 |   | $ | 16,917/27,600 |   |

 

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1)                                      Whether an option/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, 2004 ($11.36). If the amount is greater than zero, theoption (or SAR) is “in-the-money.”

2)                                      Fully vested options granted toBlumenstein/Thorne Information Partners I, L.P. (“BTIP”), an investment fundaffiliated with Mr. Thorne, in lieu of salary, benefits and othercompensation to Mr. Thorne in 2000 and 2001. The Compensation Committee awarded this stock option grant to BTIP toprovide the limited partners of BTIP with a significant equity incentive tocontribute Mr. Thorne’s services to the financial success of the Company and toalign his interests with those of the Company’s stockholders. Of these optionsfor 1,000,000 shares, options for 200,000 shares have an exercise price of$3.875, the fair market value of the Company’s common stock on date of grant;options for the remaining 800,000 shares have an exercise price of $3.875 basedon the Company having met certain stock price performance criteria.  Options for 955,760 of such shares wereexercised on February 1, 2005 and options for 16,575 of such shares wereexercised on March 23, 2005.

 

**Director Compensation**

 

All non-employee directors are reimbursed for theirreasonable travel expenses incurred in connection with attending the Company’smeetings. No cash payments for Board or committee service were made to anydirector during fiscal year 2003.

 

On February 15, 2005, the Board of Directors approved a newcompensation plan for outside directors as described below, which plan tookeffect on January 1, 2005. Pursuant to the Automatic Award Program establishedunder the 1999 Stock Incentive Plan as previously in effect, each non-employeeBoard member elected as a non-employee director at the 2002 Annual StockholdersMeeting (other than Mr. Mundheim and Jonathan Newcomb, a former director), orfirst elected or appointed at any time after such meeting, received a one-timegrant of a non-statutory option valued at $125,000 as of the date of grant (the“Initial Director Option”).  The sharessubject to the Initial Director Option vest in equal monthly installments overa five-year period commencing on the grant date.  Each such option has an exercise price equalto the fair market value of the common stock on the date of grant and a term ofsix years, subject to earlier termination if the optionee ceases to be adirector.  On August 14, 2002, the Companygranted an Initial Director Option to purchase 41,684 shares of common stock,at an exercise price of $4.00 per share, to each of Messrs. Blumenstein andGirgenti.  The grant date of Ms. Korshak’sInitial Director Option to purchase 50,927 shares was deemed to be January 2,2002, for purposes of setting the exercise price of

 

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$2.95 pershare and establishing the vesting scheudle for the option, based on heragreement to waive her 2002 option grant, pursuant to a previously-existingprogram, and her 2002 annual retainer fee for service on the Board of Directorsand the Audit and Compensation Committees.

 

Mr. Mundheim did not receive anInitial Director Option, due to a previous one-time option grant on April 23,2001 to purchase 95,000 shares of common stock as compensation for his serviceas a director.  The option is exercisablein sixty successive equal monthly installments upon Mr. Mundheim’s completionof each month of Board service.  Theoption was granted with an exercise price of $3.85, the fair market value onthe date of grant.  The option is subjectto a special acceleration event if all three of the following events occur: i)Oakleigh Thorne no longer serves as Chairman of the Board, *and* ii) Oakleigh Thorne no longer servesas Chief Executive Officer of the Company, *and*iii)  Oakleigh Thorne’s replacement orreplacements are not acceptable to Mr. Mundheim in his sole discretion (“Special Acceleration Event”).  If the Special Acceleration Event occurs then100% of the shares subject to the option held by Mr. Mundheim automaticallyvest so that such option shares will become fully vested and exercisable.

 

Also pursuant to the 1999 StockIncentive Plan as previously in effect, on the first business day in January ofeach year beginning in 2003, each non-employee member of a committee of theBoard received, for each committee on which he or she served, a non-statutoryoption valued at $5,000 as of the date of grant. In addition,each non-employeecommittee chair received, for each committee he or she chaired, a non-statutoryoption valued at $5,000 as of the date of grant.  The shares subject to these options vest inequal monthly installments over the one-year period beginning on the grantdate.  Each such option has an exerciseprice equal to the fair market value of the common stock on the date of grantand a term of six years, subject to earlier termination if the optionee ceasesto be a director.  On January 2, 2003,Directors Girgenti, Korshak and Mundheim were granted options to purchase7,614, 5,076 and 7,614 shares of common stock, respectively, in considerationof their committee service.  Such optionshave an exercise price of $3.50 per share. On January 2, 2004, DirectorsGirgenti, Korshak and Mundheim were granted options to purchase 1,224, 816 and1,224 shares, respectively, in consideration of their committee service. Suchoptions have an exercise price of $18.38 per share.

 

Jonathan Newcomb served on theBoard from January 26, 2004 until October 11, 2004 pursuant to a ConsultingAgreement between the Company and Leeds Equity Advisers, Inc., of which Mr.Newcomb was a principal.  Under thisConsulting Agreement, which was executed in connection with the Company’sacquistion of Datamark, Leeds is entitled to receive $200,000 per year for aperiod of five years, plus expenses for Mr. Newcomb’s service on the Company’sBoard. Suchpayments were in lieu of any director compensation to Mr. Newcomb,including but not limited to the Initial Director Option and options issued inconnection with committee service. TheCompany paid Leeds $200,000 plus expenses of $6,145 in 2004 pursuant to theConsulting Agreement

 

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 Directors Compensation Plan also providesfor the payment, beginning in 2005, of an annual cash retainer to eachnon-employee director for each committee of the Board of Directors on which heor 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 IncentivePlan.   The number of deferred stockunits credited to a non-employee director’s stock account will equal the amountof compensation he or she has deferred divided by the fair market value of ashare of Common Stock on the day the compensation would otherwise have beenpaid to the non-employee director.

 

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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 on the first business daycoinciding with or immediately following the date his or her service on theBoard of Directors commences.   TheCompany’s current non-employee directors will not receive such grants.  The Directors Compensation Plan also providesthat on the first business day in January of each year, each non-employee directorwill receive a grant (an “Annual Grant”) of 2,000 deferred stock units. Withrespect to the Company’s current non-employee directors, Mr. Mundheim willbegin to receive Annual Grants in 2006 and Messrs. Blumenstein and Girgenti andMs. Korshak will begin to receive Annual Grants in 2007. Individuals who becomeoutside directors after January 1, 2005 will receive Annual Grants beginning inthe year after the year in which service as a member of the Board of Directorscommenced.   Initial Grants vest inmonthly increments over a three-year period, subject to acceleration upon achange in control of the Company, and Annual Grants vest immediately upongrant.

 

**Employment Agreements**

 

TheCompany has entered into employment agreements with the Named ExecutiveOfficers. On August 10, 2004, the Company entered into new agreements withMessrs. Thorne and Kelsall. Mr. Thorne’s agreement provides for an annualsalary of $375,000 and bonus potential of 90% of base salary or $337,500. Mr.Kelsall’s agreement provides for an annual salary of $300,000 and bonuspotential of 75% of base salary or $225,000. Each agreement also provides thatthe employee is entitled to receive long-term equity compensation. For 2004,the agreements state that each of Mr. Thorne and Mr. Kelsall will be entitledto receive a specified percentage of the equity pool established under a newlong-term equity plan as approved by the Compensation Committee. TheCompensation Committee subsequently approved a long-term stock incentive planpursuant to which Mr. Thorne, Mr. Kelsall and the other Named ExecutiveOfficers received stock appreciation rights as described in footnote (4) to theSummary Compensation 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 Mr. Thorne orMr. Kelsall for good reason, Messrs. Thorne and Kelsall will receive severancepayments equal to one year’s salary, plus pro rata target bonus through thedate of termination (assuming satisfaction of pro-rated performanceobjectives), plus one year’s target bonus. In addition to severance, Messrs.Thorne and Kelsall will vest immediately in any equity incentives outstandingon the contract date that would otherwise vest within one year of thetermination date.  In the event of atermination without cause or for good reason within two years following achange in control, Messrs. Thorne and Kelsall will receive the severancedescribed above plus an additional year of salary. The agreements provide thatupon a change in control, all equity incentives held by Messrs. Thorne andKelsall (other than stock appreciation rights) will vest, and all restrictionson their stock will lapse.

 

Uponthe closing of the Datamark acquisition, the Company entered into an employmentagreement with Mr. Benjamin dated September 15, 2003.  On March 25, 2005, Mr. Benjamin resigned fromthe Company. Mr. Benjamin’s agreement provided for an annual salary of $225,000,a target bonus of 50% of base salary and additional potential up to 125% of 50%of base salary if targets are exceeded. During 2004 only, Mr. Benjamin waseligible for a “bridge bonus” of 50% of base salary if targets based on (i)2004 financial results for the Enrollment Division and (ii) certain eCollegeobjectives set for the Enrollment Division were met; the bridge bonus couldequal up to 125% of 50% of base salary if these targets were exceeded. Inaddition, Mr. Benjamin received 75,000 share rights. If Mr. Benjamin isterminated without cause or for good reason, he will receive severance equal toone year’s salary plus his pro rata annual bonus through the date oftermination, and vesting of his share rights will accelerate.

 

OnSeptember 6, 2002, the Company entered into an employment agreement with Mr.Haimes. The agreement provides for an annual salary (currently $210,000) andbonus potential of 40% of base salary or $84,000. 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.

 

OnJuly 31, 2002, the Company entered into an employment agreement with Mr.Schnittman. The agreement provides for an annual salary (currently $200,000)and bonus potential of 60% of base salary or $120,000. The agreement alsoprovides that Mr. Schnittman may receive equity compensation from time to time asdetermined by the Compensation Committee. In the event of a termination withoutcause, Mr. Schnittman will receive six months’ salary as severance.

 

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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.

 

**ITEM 12.****    SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

 

Thefollowing table sets forth certain information known to the Company withrespect to the beneficial ownership of its common stock as of March 28, 2005(unless otherwise stated in the footnotes) by (i) each stockholder thatthe Company knows is the beneficial owner of more than 5% of the common stock,(ii) each director, (iii) each of the Named Executive Officers and(iv) all executive officers and directors as a group. Unless otherwiseindicated, each of the security holders has sole voting and investment powerwith respect to the shares beneficially owned, subject to community propertylaws, 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                                               |       | 3,883,029                                       | (1)        | 17.9                             | %          |
| Douglas H. Kelsall                                            |       | 375,206                                         | (2)        | 1.7                              | %          |
| Arthur E. Banjamin                                            |       | 66,773                                          | (3)        |                             |       |
| Robert S. Haimes                                              |       | 136,836                                         | (4)        |                             | *          |
| Matthew T. Schnittman                                         |       | 71,249                                          | (5)        |                             | *          |
| Blumenstein/Thorne Information Partners I,  L.P.              |       | 2,622,975                                       | (6)        | 12.1                             | %          |
| Jack W. Blumenstein                                           |       | 2,649,401                                       | (7)        | 12.2                             | %          |
| Christopher E. Girgenti                                       |       | 31,764                                          | (8)        |                             | *          |
| Jeri L. Korshak                                               |       | 52,204                                          | (9)        |                             | *          |
| Robert H. Mundheim                                            |       | 80,588                                          | (10)       |                             | *          |
| Chilton Investment Company                                    |       | 2,407,220                                       | (11)       | 11.1                             | %          |
| Gilder, Gagnon, Howe & Co.                                |       | 1,435,981                                       | (12)       | 6.6                              | %          |
| Federated Investors, Inc.                                     |       | 1,408,215                                       | (13)       | 6.5                              | %          |
| Tiger Technology Management LLC                               |       | 1,800,000                                       | (14)       | 8.3                              | %          |
| Oakleigh B.  Thorne                                           |       | 722,222                                         | (15)       | 3.3                              | %          |
| All executive officers and directors as a  group (13 persons) |       | 4,831,099                                       | (16)       | 21.5                             | %          |

 

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*              Less than one percent.

(1)                                  Includes options topurchase 7,778 shares of the Company’s common stock exercisable within60 days of March 28, 2005; 2,011 shares of the Company’s common stockissuable pursuant to a share right award; and an option grant toBlumenstein/Thorne Information Partners I, L.P., to purchase up to 27,665shares of the Company’s common stock at an exercise price of $3.875 per share.Also includes 2,595,310 shares beneficially owned by Blumenstein/ThorneInformation Partners I, L.P., 75,955 shares owned by the Oakleigh ThorneIrrevocable GST Trust, 204,000 shares owned by the Oakleigh L. Thorne Trust U/Adated December 15, 1976, and 68,500 shares owned by the Oakleigh

 

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Thorne GST Trust III. Mr. Thorne is a co-President ofBlumenstein/Thorne Information Partners L.L.C, the general partner ofBlumenstein/Thorne Information Partners I, L.P. Mr. Thorne disclaimsbeneficial ownership of such shares, except to the extent of his pecuniaryinterest, if any. The address for Mr. Thorne is One N. LaSalle St.,, Suite1800, Chicago, IL 60602.

(2)                                  Includes options topurchase 284,443 shares of the Company’s common stock exercisable within60 days of March 28, 2005 and 1,005 shares of the Company’s common stockissuable pursuant to a share rights award. Also includes 4,500 shares held byMr. Kelsall’s spouse and 1,500 shares held by Mr. Kelsall’s children.The address for Mr. Kelsall is 4900 South Monaco Street, Denver, Colorado80237.

(3)           Includes7,076 shares owned by the Gail L. and Arthur E. Benjamin Foundation. Mr.Benjamin disclaims any beneficial ownership of such shares, except to theextent of this pecuniary interest, if any. The address for Mr. Benjamin is 2305Presidents Drive, Salt lake City, Utah 84120.

(3)                                  Includes options topurchase 127,874 shares of the Company’s common stock exercisable within60 days of March 28, 2005 and 290 shares of the Company’s common stockissuable pursuant to a share right award. The address for Mr. Haimes is4900 South Monaco Street, Denver, Colorado 80237.

(4)                                  Includes options topurchase 64,166 shares of the Company’s common stock exercisable within60 days of March 28, 2005 and 1,813 shares of the Company’s common stockissuable pursuant to a share right award. The address for Mr. Schnittmanis 4900 South Monaco Street, Denver, Colorado 80237.

(5)                                  Includes a fullyvested option to purchase up to 27,665 shares of the Company’s common stock atan 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.

(6)                                  Consists of optionsto purchase 22,926 shares of the Company’s common stock exercisable within60 days of March 28, 2005 and a fully vested option granted toBlumenstein/Thorne Information Partners I, L.P. to purchase up to 27,665 sharesof the Company’s common stock at an exercise price of $3.875 per share. Alsoconsists of 2,595,310 shares beneficially owned by Blumenstein/ThorneInformation Partners I, L.P. and 3,500 shares owned by the Jack WrayBlumenstein Contributory IRA. Mr. Blumenstein is a co-President of Blumenstein/ThorneInformation Partners L.L.C., the general partner of Blumenstein/ThorneInformation Partners I, L.P. Mr. Blumenstein disclaims beneficialownership of such shares, except to the extent of his pecuniary interest, ifany. The address for Mr. Blumenstein is P.O. Box 871, Lake Forest,Illinois 60045.

(7)                                  Consists of optionsto purchase 31,764 shares of the Company’s common stock exercisable within60 days of March 28, 2005. The address for Mr. Girgenti is 1603Orrington Avenue, Suite 1600, Evanston, Illinois 60201.

(8)                                  Includes options topurchase 51,204 shares of the Company’s common stock exercisable within60 days of March 28, 2005. The address for Ms. Korshak is c/oeCollege, 4900 South Monaco Street, Denver, Colorado 80237.

(9)                                  Includes options topurchase 39,588 shares of the Company’s common stock exercisable within60 days of March 28, 2005. The address for Mr. Mundheim is 599Lexington Avenue, Room 1640, New York, New York 10022.

(10)                            The address for ChiltonInvestment Company, Inc. is 1266 East Main Street, 7th floor, Stamford,Connecticut 06902-3550.

(11)                            The address for Gilder,Gagnon, Howe & Company is 1775 Broadway, 26th floor, New York, New York10019.

(12)                            The address for FederatedInvestors, Inc. is 1001 Liberty Avenue, Pittsburgh, Pennsylvania 15222-3779.

(13)                            The address for TigerTechnology Management LLC is 101 Park Avenue, 48th floor, New York, New York10178-4700.

(14)                            Excludes sharesbeneficially owned by Blumenstein/Thorne Information Partners I, L.P.Mr. Oakleigh B. Thorne is the beneficiary of a trust that is a limitedpartner in Blumenstein/Thorne Information Partners I, L.P. Mr. Oakleigh B.Thorne is the father of Oakleigh Thorne, the Company’s Chief Executive Officer.

(15)                            Includes 720,157 sharesissuable upon the exercise of options exercisable within 60 days of March28, 2005 and 8,636 shares of the Company’s common stock issuable pursuant toshare rights awards.

** **

**Equity Compensation Plans**

 

The following table summarizes the status of theCompany’s equity compensation plans as of December 31, 2004:

 
| **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:     |       | 2,601,935                                                                                             |       | $                                                                                  | 4.46       |                                                                                                                                                    | 410,255    |   |
|                                                         |       |                                                                                                  |       |                                                                               |       |                                                                                                                                                    |       |
| Equity Compensation Plans not approved by  security holders: |       | 1,005,806                                                                                             | (1)        | $                                                                                  | 3.86       |                                                                                                                                                    | —     |   |
|                                                         |       |                                                                                                  |       |                                                                               |       |                                                                                                                                                    |       |
| **Total**                                                    |       | 3,607,741                                                                                             |       |                                                                               |       | 410,255                                                                                                                                                 |       |

 

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(1)  Includes:  (i) Options to purchase up to 1,000,000 shares of the Company’scommon stock granted to Blumenstein/Thorne Information Partners I, L.P., aninvestment fund affiliated with Oakleigh Thorne.  Options for 200,000 of these shares have anexercise price of $3.875, the fair market value of the Company’s common stockon the date of grant; options for the remaining 800,000 shares have an exerciseprice of $3.875 based on the Company having met certain stock price performancecriteria.  Options for 955,760 shareswere exercised on February 1, 2005 and options for 16,575 shares were exercisedon March 23, 2005; and

 

(ii) Optionsto purchase up to 5,806 shares of the Company’s common stock granted to JeriL. Korshak, for services rendered as a director of the Company fromJanuary 1, 2000 through December 31, 2000.

 

**ITEM 13.****    CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

In conjunction with the Datamark acquisition, weentered into a consulting agreement with Leeds Equity Advisors Inc., ofwhich Jonathan Newcomb, a former director, was a principal. Under the terms ofthe consulting agreement, in 2004, we paid Leeds Equity Advisors, Inc. thesum of $200,000 plus expenses.   We have entered intoindemnification agreements with our non-employee directors,Messrs. Blumenstein, Girgenti and Mundheim and Ms. Korshak.

 

87

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**ITEM 14.****    PRINCIPALACCOUNTING FEES AND SERVICES**

 

The following table shows the fees billed for thelast two fiscal years for audit and other services provided to the Company byKPMG LLP (in thousands).

 
| ** **         | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------|------------|----------|------------|----------|------------|
| Audit Fees         |       | $        | 530        |     | $          | 135 |   |
| Audit-Related Fees |       | $        | —     |     | $          | 13 |   |
| Tax Fees           |       | $        | —     |     | $          | 30 |   |
| All Other Fees     |       | $        | —     |     | $          | 23 |   |
| Total              |       | $        | 530        |     | $          | 201 |   |

 

 

88

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*Audit Fees.*    This categoryincludes the audit of the Company’s annual financial statements, review offinancial statements included in the Company’s Form 10-Q QuarterlyReports, audit of controls over financial reporting and services that arenormally provided by the independent auditors in connection with statutory andregulatory filings or engagements for those fiscal years. This category alsoincludes advice on audit and accounting matters that arose during, or as aresult of, the audit or the review of interim financial statements, and thepreparation of an annual “management letter” 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.” The servicesfor the fees disclosed under this category include benefit plan audits,consultation on other accounting matters not reported in the “Audit Fees”category, due diligence pertaining to potential business combinations, andevaluating the effect of various accounting issues and changes in professionalstandards.

 

*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 lossstudy, 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;

 

•             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 2004, all of the audit and permitted non-auditservices rendered by the Company’s independent accountants were approved by theAudit Committee.

 

89

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**PART IV****.**

 

**ITEM 15.****    EXHIBITSAND FINANCIAL STATEMENT SCHEDULES**

 
| (a)                                                                                | 1)                                                                                                                                                                                           | Financial  Statements.                                                                                      |
|------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------|
|                                                                               |                                                                                                                                                                                         | The  consolidated financial statements are listed under Item 8 of this report.                              |
|                                                                               |                                                                                                                                                                                         |                                                                                                        |
|                                                                               | 2)                                                                                                                                                                                           | Financial  Statement Schedules.                                                                             |
|                                                                               |                                                                                                                                                                                         | None                                                                                                        |
|                                                                               |                                                                                                                                                                                         |                                                                                                        |
|                                                                               | 3)                                                                                                                                                                                           | Exhibits.                                                                                                   |
|                                                                               |                                                                                                                                                                                         |                                                                                                        |
|                                                                               |                                                                                                                                                                                         | 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. |

 

90

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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 30, 2005                        |

 

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 30, 2005              |                                  |
|   |                               |                                  |
| By:    | /s/  REID SIMPSON             |                                  |
|   | Name:  Reid Simpson                |                                  |
|   | Title:                             | Chief  Financial Officer              |   |
|   |                               | (principal  financial officer)        |   |
|   | Date:  March 30, 2005              |                                  |
|   |                               |                                  |
| By:    | /s/  DAVID REIS               |                                  |
|   | David  Reis                        |                                  |
|   | Title:                             | Director  of Corporate Accounting     |   |
|   |                               | (principal  accounting officer)       |   |
|   | Date:  March 30, 2005              |                                  |
|   |                               |                                  |
| By:    | /s/  JACK W. BLUMENSTEIN      |                                  |
|   | Name:  Jack W. Blumenstein         |                                  |
|   | Title:                             | Director                              |   |
|   | Date:  March 30, 2005              |                                  |
|   |                               |                                  |
| By:    | /s/  CHRISTOPHER E. GIRGENTI  |                                  |
|   | Name:  Christopher E. Girgenti     |                                  |
|   | Title:  Director                   |                                  |
|   | Date:  March 30, 2005              |                                  |
|   |                               |                                  |
| By:    | /s/  DOUGLAS H. KELSALL       |                                  |
|   | Name:  Douglas H. Kelsall          |                                  |
|   | Title:                             | Director                              |   |
|   | Date:  March 30, 2005              |                                  |
|   |                               |                                  |
| By:    | /s/  JERI L. KORSHAK          |                                  |
|   | Name:  Jeri L. Korshak             |                                  |
|   | Title:                             | Director                              |   |
|   | Date:  March 30, 2005              |                                  |
|   |                               |                                  |
| By:    | /s/  ROBERT H. MUNDHEIM       |                                  |
|   | Name:  Robert H. Mundheim          |                                  |
|   | Title:  Director                   |                                  |
|   | Date:  March 30, 2005              |                                  |

 

91

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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                                                                                                                                    |

 

 

92

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|      |   | 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.                                                                                                                                                                            |
| 10.5(4)   |   | Employment  Agreement dated as of March 1, 2002 between Mark Resmer 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.                                                                                                                                                         |
| 10.11(10) |   | Employment  Agreement dated as of September 15, 2003 between Datamark Inc. and  Arthur Benjamin.                                                                                                                                                                            |
| 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.                                                                                                                                                    |
| 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     |   | Lease  Agreement dated December 14, 2004 between One North LaSalle Properties LLC  and eCollege.com.                                                                                                                                                                                  |
| 10.21     |   | 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     |   | 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     |   | Loan  Modification Agreement dated April 1, 2004 between Silicon Valley Bank,  eCollege.com and Datamark, Inc.                                                                                                                                                                        |
| 10.24     |   | Loan  Modification Agreement dated December 28, 2004 between Silicon Valley Bank,  eCollege.com and Datamark, Inc.                                                                                                                                                                    |
| 10.25     |   | First  Amendment to the Employee Stock Purchase Plan dated October 15, 2004.                                                                                                                                                                                                          |
| 14.1      |   | Code  of Ethics.                                                                                                                                                                                                                                                                      |
| 21.1      |   | Subsidiaries  of Registrant.                                                                                                                                                                                                                                                          |

 

93

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| 23.1     |   | 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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(1)                                  Incorporated by reference from the Company’sRegistration Statement on Form S-1 (File No. 333-78365).

 

(2)                                  Incorporated byreference from the Company’s Quarterly Report on Form 10-Q filed with theSecurities and Exchange Commission on November 14, 2000.

 

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

 

(4)                                  Incorporated byreference from the Company’s Quarterly Report on Form 10-Q filed with theSecurities and Exchange Commission on May 15, 2002.

 

(5)                                  Incorporated byreference from the Company’s Quarterly Report on Form 10-Q filed with theSecurities and Exchange Commission on November 13, 2002.

 

(6)                                  Filed as part ofCurrent Report on 8-K filed with the Securities and Exchange Commission onJuly 1, 2002.

 

(7)                                  Incorporated byreference from the Company’s Quarterly Report on Form 10-Q filed with theSecurities and Exchange Commission on August 12, 2003.

 

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

 

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

 

(10)                            Incorporated by referencefrom the Company’s 8-K/A filed with the Securities and Exchange Commission onDecember 2, 2003.

 

(11)                            Incorporated by referencefrom the Company’s Annual Report on Form 10-K filed with the Securities andExchange Commission on March 15, 2004.

 

(12)                            Incorporated by referencefrom the Company’s Quarterly Report on Form 10-Q filed with the Securities andExchange Commission on August 16, 2004.

 

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