-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, K+fl5SeDvgO22bws6dB2t3xyJ+CViYogsaWOul4osQgiHvfxjCTJVld5B0IIaubG TecUSqC0soguDOvI97Et4w== 0001047469-99-002632.txt : 19990201 0001047469-99-002632.hdr.sgml : 19990201 ACCESSION NUMBER: 0001047469-99-002632 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19981031 FILED AS OF DATE: 19990129 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TRO LEARNING INC CENTRAL INDEX KEY: 0000893965 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS PUBLISHING [2741] IRS NUMBER: 363660532 STATE OF INCORPORATION: DE FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-20842 FILM NUMBER: 99516095 BUSINESS ADDRESS: STREET 1: POPLAR CREEK OFFICE PLAZA STREET 2: 1721 MOON LAKE BOULEVARD CITY: HOFFMAN ESTATES STATE: IL ZIP: 60194 BUSINESS PHONE: 8477817800 MAIL ADDRESS: STREET 1: 1721 MOON LAKE BLVD SUITE 555 CITY: HOOFMAN ESGTATES STATE: IL ZIP: 60194 10-K 1 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE - --- ACT OF 1934 FOR THE FISCAL YEAR ENDED OCTOBER 31, 1998 or ____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ COMMISSION FILE NUMBER 0-20842 ------- TRO LEARNING, INC. ------------------ (Exact name of Registrant as specified in its charter) Delaware 36-3660532 - -------- ---------- (State or other jurisdiction of incorporation or organization) (IRS Employer Identification Number) 1721 Moon Lake Blvd., Suite 555 Hoffman Estates, IL 60194 - ---------------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (847) 781-7800 -------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $.01 Per Share -------------------------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ---- The number of shares of the Registrant's common stock, par value $.01 per share, outstanding as of December 15, 1998 was: 6,446,511 shares. The aggregate market value of common stock (based on the closing price on December 15, 1998) held by non-affiliates of the Registrant was approximately $38,640,000. Index for exhibits is located on page 50. This document contains 52 pages. 1 DOCUMENTS INCORPORATED BY REFERENCE Certain information in the Proxy Statement for the Company's Annual Meeting of Stockholders to be held on April 6, 1999 (the "1999 Proxy Statement") is incorporated herein by reference in Part III of this Form 10-K. Pursuant to Regulation 14A under the Securities Exchange Act of 1934, the 1999 Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the close of the Company's fiscal year. NOTE REGARDING FORWARD LOOKING INFORMATION This Form 10-K contains forward-looking statements identified by the use of "believes", "expects", "anticipates", and similar expressions. Such statements are subject to risk and uncertainties that could cause actual results to differ from those contemplated by the forward-looking statement. Such risks and uncertainties include any change in the market acceptance of the Company's products and services, the risk of failure of the Company's technology to remain at market standards, the risk of the Company being able to finance its business operations, and other similar business and market risks. Readers are cautioned not to place undue reliance on such forward-looking statements. 2 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1998 - ------------------------------------------------------------------------------- TABLE OF CONTENTS -----------------
Page ---- PART I Item 1. Business...................................................................4 Item 2. Facilities................................................................14 Item 3. Legal Proceedings.........................................................14 Item 4. Submission of Matters to Vote of Security Holders.........................15 Item 4A. Executive Officers of the Registrant......................................15 PART II Item 5. Market for Registrant's Common Stock and Related Stockholder Matters......18 Item 6. Selected Consolidated Financial Data......................................19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................20 Item 8. Financial Statements and Supplementary Data...............................29 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...................................49 PART III Item 10. Directors and Executive Officers of the Registrant........................49 Item 11. Executive Compensation....................................................49 Item 12. Security Ownership of Certain Beneficial Owners and Management............49 Item 13. Certain Relationships and Related Transactions............................49 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..........50 Signatures ..........................................................................52
3 TRO LEARNING, INC. FORM 10-K FISCAL YEAR ENDED OCTOBER 31, 1998 PART I - ------------------------------------------------------------------------------- ITEM 1. BUSINESS OVERVIEW: TRO Learning, Inc. (the Company) is a leading developer and marketer of PC-based, interactive, self-paced instructional systems. Offering more than 2,000 hours of comprehensive academic and applied skills courseware designed for adolescents and adults, the Company's PLATO-Registered Trademark- Learning Systems are marketed to middle schools and high schools, colleges, job training programs, correctional institutions, military education programs, and corporations. The PLATO Learning System is delivered via local area networks, CD-ROM, the Internet and private Intranets. The Company's wholly-owned operating subsidiary is The Roach Organization, Inc. (TRO). TRO has two wholly owned subsidiaries, one in Canada, TRO Learning (Canada), Inc., and one in the United Kingdom, TRO Learning (UK) Ltd. COMPANY HISTORY: The Company was incorporated in 1989 when an investor group acquired the principal business of the Training and Education Group of Control Data Corporation. In December 1992, the Company became publicly held and is traded on the NASDAQ-NMS exchange under the symbol TUTR. During fiscal 1992, the Company discontinued two businesses, the NASD testing center business and the end user computer training distribution business. In addition, in September 1993, the Company entered into a Certification and Testing Services Agreement with Sylvan Learning Systems (SLS), whereby SLS agreed to assume and perform the Company's rights and obligations under its Certification and Testing Services contracts. In September 1998, the Company announced the sale of its Aviation Training business (which marketed PC-based instructional systems to airlines worldwide for use by commercial airline pilots, maintenance crews, and cabin personnel) and will focus exclusively on its PLATO-Registered Trademark- brand going forward. PRODUCTS AND SERVICES: The Company's products offer educators and trainers an effective supplement or alternative to traditional, instructor-led education. PLATO-Registered Trademark- is a computer-based instructional system designed to enhance the learning process and help adolescent and adult learners reach their fullest potential. PLATO provides interactive, individualized instruction in a broad range of subjects. PLATO courseware has proven effective in a variety of learning settings, including alternative education programs, graduation standards prep labs, school-to-work programs, adult basic education, GED preparation, developmental studies, employment preparation and workplace training programs. 4 Whether used for distance learning, as a supplement to a traditional program, or as an advanced course offering, PLATO's courseware motivates and engages a wide range of learners. The PLATO Learning System is comprised of PLATO courseware, the PLATO-Registered Trademark- Pathways instructional management software, multiple courseware delivery systems, and PLATO Professional Services. A variety of third-party courseware can also be incorporated to meet specific learning objectives. PLATO COURSEWARE AND SOFTWARE: The comprehensive PLATO courseware library includes over 2,000 hours of mastery-based instruction in the subject areas of reading, writing and language arts, mathematics, science, social studies, life and job skills, technology and applied skills for the workplace. The consistent instructional strategy and design, and modular structure of PLATO courseware provides maximum flexibility to design customized programs to meet both individual learner needs and specific program objectives. PLATO courseware can integrate into an educational program as follows: - as a complement to classroom learning, addressing individual learner needs through enrichment and remediation; - as a supplement to classroom learning, providing additional instruction and practice; and, - as a primary resource, allowing the instructor to become a coach, counselor, and manager. The Company provides state-of-the-art education and training solutions to its clients. The Company regularly updates its courseware library and develops new products to extend and enhance it. In October 1998, the Company announced that it was in the final stages of converting the 2,000-hour PLATO courseware library to run as a native 32-bit application under the Windows operating system. Windows-based PLATO problem-solving courses employ sophisticated interactive simulations, online coaching, and advanced multimedia and graphics to create an exciting learning environment that fosters critical-thinking skills. New courses recently released include Math Problem Solving, The Employment Partnership, Advanced Reading Strategies, Technology 5 Fundamentals, and the PLATO WordBank Editor. Another course, Practical Problem Solving, is currently in development and is scheduled for release in the fall of 1999. Math Problem Solving has been selected for inclusion on the Children's Software Review (CSR) "All Star Software" list with a rating of 4.5 out of 5 stars. CSR's All Star Software List is an ongoing collection of highly recommended software titles that is updated on a bimonthly basis. In addition, WordBank Editor has been selected as a top five finalist for the 1999 Codie Award for Best New Education Software Program sponsored by the Software Publishers Association. Earning the status of a Codie Award finalist is significant, particularly since PLATO WordBank Editor was selected from a pool of more than 900 nominations. The following table summarizes PLATO courseware and software offerings: PLATO COURSEWARE: - ----------------- COMMUNICATION SCIENCE/TECHNOLOGY Reading 1 and 2 Science Fundamentals Advanced Reading Strategies Chemistry 1 and 2 Reading for Information Physics 1 and 2 Writing Series Technology Fundamentals Writing in the Workplace Communication SOCIAL STUDIES WordBank Editor Social Studies MATHEMATICS LIFE SKILLS Math Fundamentals Life and Job Skills Math Fundamentals (Spanish Edition) Parenting Skills Math Problem Solving Data Skills WORKSKILLS/SCHOOL-TO-WORK Pre-Algebra Quality Fundamentals Beginning, Intermediate and Advanced Algebra Reading for Information Beginning and Intermediate Algebra (Spanish Edition) Communication Geometry and Measurement 1 and 2 Writing in the Workplace Trigonometry Data Skills Calculus 1 and 2 The Employment Partnership
6 THIRD PARTY COURSEWARE: - ----------------------- Reading Horizons Business Software Training Series Mindplay Writing Series Substances Abuse Series English Discoveries (ESL) Blueprint Reading Rediscover Science 6-9 and 9-12 Mastering Geometric Dimensioning and Tolerancing Toward Algebra Ultrakey Keyboarding PLATO SOFTWARE PRODUCTS: - ------------------------ PLATO Curriculum Manager PLATO Records Transfer and Consolidation Utility PLATO Pathways-Registered Trademark- PCD3 Authoring System Instructional Management PLATO S.T.A.R. System for Windows-Registered Trademark- PLATO on the Internet PLATO Remote Administration
PLATO courseware is objective-based and can be aligned to help learners meet specific program, local, state and provincial learning objectives and tests. PLATO courseware can also be aligned to national standardized tests and curriculum standards including: - ABLE (Adult Basic Literacy Exam) - ACT (American College Test) - CAT (California Achievement Test) - CAAT (Canadian Adult Achievement Test) - CASAS (Comprehensive Adult Student Assessment System) - GED (General Education Development) Exam - NCTM (National Council of Teachers of Mathematics) Standards - SAT (Scholastic Aptitude Test) - SCAN'S (Secretary's Commission on Achieving Necessary Skills) Competencies - Standard Achievement Tests - TABE (Test of Adult Basic Education) - ACT Work Keys-TM- INSTRUCTIONAL MANAGEMENT SOFTWARE: Instructional management is at the core of any learning environment. PLATO-Registered Trademark- Pathways is an easy to use Windows-based software program that seamlessly integrates assessment, instruction and management - giving instructors a versatile educational tool. This instructional management system diagnoses strengths and weaknesses and adaptively prescribes individualized learner menus - ensuring targeted, personalized instruction keyed to program goals. It can incorporate offline, online, and Web-based resources to enrich the learning experience. It also tracks learner progress 7 and offers an extensive array of reports which provide administrators, teachers, learners, and parents with highly meaningful information that documents accountability and performance. PLATO-Registered Trademark- Pathways is compatible with Windows-Registered Trademark- 95, Windows-Registered Trademark- 98, and NT-Registered Trademark-Workstation, and can manage both Windows And MS-DOS-Registered Trademark- applications. Pathways is also compatible with Apple-Registered Trademark- iMac and G3 workstations running Virtual PC Windows emulation software. DELIVERY SYSTEMS: The PLATO Learning System is configured to use PC's running MS-DOS-Registered Trademark- or Windows or Apple-Registered Trademark- iMac or G3 with Windows emulation software. With PLATO's multiple delivery systems, learning is no longer confined to a lab or classroom. - Desktop Launch - with the desktop launch, individual PLATO courses can be delivered directly on a PC without a management system. Individual student sign-on, bookmarking and recordkeeping are available. - Local Area Networks (LAN) - with a LAN configuration, all courseware, management software, student records, and files are centralized and can be accessed by any learner, at any learning station, using a PLATO sign-on and private password. The Company offers LAN configurations utilizing either Microsoft Windows NT or Novell-Registered Trademark- NetWare. - CD-ROM Stand Alone - CD-ROM delivery allows a single PC workstation to deliver PLATO and complementary courseware using PLATO-Registered Trademark- Pathways. - Internet/Distance Learning - remote learners with Internet or Intranet access can study PLATO lessons, test for mastery, and progress through lesson sequences just as if they were onsite in the lab or classroom -using PLATO-Registered Trademark- on the Internet. Records and courseware are kept on an Internet Server and are accessed by learners on demand, from any location, using a private PLATO identifier and password. To enhance speed and reliability, modules are downloaded to the local PC at the time they are selected, so a continuous connection is not required. Learners can monitor their progress via menus and a learner progress report. To create a community of learners, PLATO on the Internet also features a suite of Web-based tools that facilitate discussion groups and links to education Web sites that complement and enrich instruction. 8 PROFESSIONAL SERVICES: PLATO Professional Services was created to ensure that clients receive the necessary support services for the success of their PLATO programs and ongoing personal development. - Training Services - Customized education and training solutions include implementation planning, professional development workshops, and ongoing training, evaluation and support - provided by the Company's experienced Education Consultants. - Technical Support - On-site installation and specialized technical consulting provided by PLATO Field Engineers and Technicians. - Software Support - Available via the Company's toll-free number, Internet e-mail or the PLATO Support Web Page, clients can access a staff of PLATO specialists and software analysts, to answer questions or solve problems with their PLATO system. PLATO clients also receive updates and enhancements to PLATO-Registered Trademark- Pathways management system and to PLATO courseware. SALES AND MARKETING: The Company's sales and marketing efforts are designed to increase market penetration and reinforce the Company's reputation for product quality, customer satisfaction, and service. The Company targets potentially large and high growth market niches to which the Company's existing and future products can be effectively sold. The Company uses a direct sales force in North America and the United Kingdom. The Company has established exclusive distribution agreements with distributors experienced in education product distribution in the following countries: Singapore, Malaysia, Puerto Rico, the United Arab Emirates, and South Africa. As of October 31, 1998, fifty-nine account managers are responsible for sales of PLATO Learning Systems and for maintaining active relationships with both current and potential clients. Forty-nine education consultants are responsible for implementing PLATO Learning Systems and providing customized training solutions for clients. The Company reaches potential clients and reinforces its market image by attending and making presentations at national, regional and state educational conventions and conferences, sponsoring instructional and teaching seminars, and publicity in trade journals. It conducts extensive direct mail and telemarketing campaigns to targeted prospects within each market segment to secure leads and promote increased awareness of the Company and the PLATO Learning System. In addition, 9 the Company maintains comprehensive web sites on the Internet's World Wide Web (www.tro.com and www.plato.com) with news and information about the Company's products, services, and clients. The Company has relationships with many industry associations, such as the American Association of Community Colleges, the National Alliance of Business, the National Association of Black School Administrators, the American Association of School Administrators, the League of Innovation, and the Corrections Education Association. Additional marketing activities to promote the effectiveness of PLATO products to potential clients include the publication of formal evaluation data, program and application reports, and the distribution of press/news releases to appropriate sources. COMPETITION: In all of its markets, the Company competes primarily against more traditional methods of education and training, principally live classroom instruction. The Company has seen increased acceptance of effective multimedia-based, computer-aided methods of training and education due to, among other reasons, their flexibility, cost-efficiency, and demonstrated effectiveness. The Company competes primarily on the basis of the depth and recognized quality of its courseware and its ability to deliver a flexible, timely, cost-effective, and customized solution to a client's education and training needs. Based on recent competitive situations in which it has participated, the Company believes that product depth, quality, and effectiveness are more important competitive factors than price. Within the academic computer-based education market, the Company competes most directly with other learning system providers, including divisions within Pearson PLC and McGraw-Hill McMillan. While these companies are focused primarily on the elementary school market, they compete to some degree with the Company in the secondary and post-secondary and young adult market. Although these companies are significantly larger than the Company, PLATO courseware offers a comprehensive curriculum developed specifically for adult and young adult learners. In the post-secondary education and training markets there are many regional and specialized competitors. PRODUCT DEVELOPMENT AND CUSTOMER SUPPORT: The Company's product development group develops, enhances, and maintains the PLATO courseware, instructional management software, and delivery system platforms. This group 10 employs a rigorous multi-phased product development methodology and process management system. Based on both classical instructional design concepts and models, as well as systems development management techniques, the Company's product development methodology has been constructed to specifically address the creation of individualized, learner-controlled, interactive instruction using the full multimedia capabilities of today's personal computing and other related technologies. The Company's rigorous instructional design and development methodology assures the instructional effectiveness and content integrity of the resulting product. These procedures ensure that the most appropriate and highest quality production values are achieved in the development of all software graphics, audio, video, and text. Moreover, the Company's innovative product architectures and advanced group-based rapid prototyping technologies shorten time-to-market and development costs. Central to the courseware development process are four proprietary software tools: PLATO-Registered Trademark- PATHWAYS - the PLATO instructional management system designed for system control, tracking and reporting of student performance, and administration; MICRO PLATO AUTHORING SYSTEM (MPAS) - software used in the enhancement and maintenance of existing PLATO courseware; PLATO CURRICULUM DESIGN, DEVELOPMENT AND DELIVERY (PCD3) SYSTEM - a proprietary, flexible courseware development tool; and WIN PLATO - a proprietary courseware authoring framework for writing Windows courseware. The Company's technical support group provides a full range of support services to ensure client satisfaction. Full-time professionals, with general technical expertise and extensive operational knowledge of the Company's products, provide pre-sales technical consultation and support to the Company's field sales organization and are responsible for the final technical review and approval of all proposed delivery platforms and installation configurations. These professionals consult and coordinate with the client, account manager, and installation team regarding site preparation and system installation. They also confirm full client acceptance and monitor client satisfaction and support requirements. In fiscal 1997, the Company began offering a new service and support program to new, as well as renewal, clients. As part of this program, the Company started charging for support services including training, installation and technical support for the PLATO products. The Company integrates its products by purchasing component parts from a network of external suppliers under a just-in-time inventory system. The integration and distribution function has the responsibility to integrate computer systems and ship software and courseware to clients. The Company does not use raw materials and maintains minimal inventory. 11 All manufacturers' warranties are passed through to the Company's clients. After the warranty periods are over, the Company offers maintenance contracts through third-party service organizations. The Company contracts with outside vendors, primarily BancTec Services Corp., for hardware installation and maintenance services for its client sites. In addition, the Company distributes a limited amount of third-party courseware and also purchases off-the-shelf software and hardware products from Novell, Microsoft, and other vendors. The Company has supplier relationships with several hardware and software vendors. Although these relationships are important to the Company, management believes that, in the event that such products or services were to cease to be available, alternative sources could be found on terms acceptable to the Company. PROPRIETARY RIGHTS: The Company regards its courseware and software as proprietary and relies primarily on a combination of statutory and common law copyright, trademark, trade secret laws, license and distribution agreements, employee and third-party non-disclosure agreements, and other methods to protect its proprietary rights. The Company owns the federal registration of the PLATO trademark. In addition, in 1989 Control Data assigned to the Company federally registered copyrights in the PLATO courseware. The Company has not recorded the assignment of these copyrights because it believes the additional statutory rights resulting from recordation are not necessary for the protection of the Company's rights therein. The Company has federal copyrights on all PLATO courseware produced since 1989. The Company has not applied for trademark registration at the state level, but has instead relied on its federal registrations and state common law rights to protect its proprietary information. The Company has registered trademarks in the United States and overseas for PLATO. The Company regards these registrations as material to its business. The Company licenses some courseware and software from third-party developers and incorporates them into the Company's courseware offerings and integrated learning systems. Pursuant to a settlement agreement entered into in October 1992, the Company has granted certain limited courseware and software licenses to Drake and Control Data Systems, Inc. (CDSI). The licenses will permit Drake and CDSI to market certain earlier versions of portions of the PLATO courseware in certain specified situations. The Company believes that the limited licenses granted to Drake and CDSI will have no material adverse impact on its future business. 12 BACKLOG: The Company's backlog consists of orders for the delivery of goods and services in future periods. The backlog for PLATO Education was $6.8 million and $8.5 million, respectively, at October 31, 1998 and 1997. From time to time, the Company may have longer-term contracts in its backlog for the delivery of PLATO Learning Systems. At October 31, 1998, approximately $0.6 million of such orders (included in the foregoing backlog figure) are expected to be delivered subsequent to fiscal 1999. CYCLICALITY: The Company's quarterly operating results fluctuate as a result of a number of factors including the business and sales cycle, the amount and timing of new product introductions by the Company, product shipments, client funding issues, marketing expenditures, product development expenditures, and promotional programs. In addition, certain of the Company's PLATO Education clients experience cyclical variations in funding which can impact the Company's revenue patterns. The Company's quarterly revenues can also fluctuate based upon spending patterns, budget cycles, and the fiscal year ends of these clients. The Company historically has experienced higher levels of revenues in its fourth fiscal quarter. EMPLOYEES: As of October 31, 1998, the Company employed 304 people on a full-time basis, including 170 in sales and marketing, 75 in product development and operations, 35 in support services, and 24 in finance and administration. 13 ITEM 2. FACILITIES The Company leases approximately 50,000 square feet of office and warehouse space in Edina and Bloomington, Minnesota for its corporate headquarters and 5,400 square feet of office space for its executive offices in Hoffman Estates, Illinois. The Company maintains sales offices in Dallas, Houston, San Antonio and Texarkana, Texas; Skippack, Pennsylvania; Huntington Beach, California; Ft. Lauderdale, Florida; Westport, Connecticut; Lenexa, Kansas; Chicago, Illinois; Nashville, Tennessee; and Cary, North Carolina. The Company's Canadian subsidiary leases 525 square feet for its principal offices in Vancouver and maintains sales offices in Don Mills, Ontario; Winnipeg, Manitoba; and Moncton, New Brunswick. The United Kingdom subsidiary maintains an office in Berkshire, England. The leases for the Company's offices in Edina and Bloomington, Minnesota expire March 31, 2000 and March 31, 2001, respectively and the lease for the executive offices in Hoffman Estates, Illinois expires August 31, 2000. See Note 7 of Notes to Consolidated Financial Statements. The Company's leased facilities are adequate to meet its business requirements. ITEM 3. LEGAL PROCEEDINGS On December 15, 1997, a securities fraud class action was filed in the United States District Court for the Northern District of Illinois against the Company and two of its current and former executive officers. The purported class action was filed on behalf of all persons who purchased common stock of the Company during the period December 7, 1995 through June 10, 1997, seeking damages for alleged violations of the federal securities laws. On May 19, 1998, the United States District Court for the Northern District of Illinois dismissed the complaint with prejudice. 14 ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter ended October 31, 1998. ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT The Executive Officers of the Company are as follows: William R. Roach Chairman of the Board, President and Chief Executive Officer John Murray Executive Vice President and Chief Financial Officer G. Thomas Ahern Senior Vice President, PLATO Education Sales and Marketing Wellesley R. Foshay Vice President, Instructional Design and Cognitive Learning David H. LePage Vice President, PLATO Support Services and Distribution Mary Jo Murphy Vice President, Corporate Controller and Chief Accounting Officer Frank Preese Vice President, Product Development Steven R. Schuster Vice President and Treasurer John C. Super Vice President, Marketing Patricia A. Hlavacek Corporate Secretary
Executive officers are appointed by, and serve at the discretion of, the Board of Directors. William R. Roach, age 58, has been Chairman of the Board of Directors, President and Chief Executive Officer of the Company since its founding in 1989. Prior to founding the Company, from 1987 to 1988, Mr. Roach was President and Chief Executive Officer of Applied Learning International, Inc. (ALI), a training and education company and successor to Advanced Systems, Inc. (ASI), and a Director and Senior Vice President of ALI's parent, National Education Corporation (NEC). From 1981 to 1987, Mr. Roach was the Chief Executive Officer of ASI, a New York Stock Exchange listed training and education company which was acquired by NEC in 1987. After leaving ALI in 1988, Mr. Roach led a group of investors in pursuing an acquisition in the field of training and education. John Murray, age 43, joined the Company in 1989 as Managing Director of the United Kingdom subsidiary. In October 1998 he was promoted to his current position, Executive Vice President and Chief Financial Officer. From October 1997 until October 1998 he served as Senior Vice President, Operations. From April 1996 to October 1997 he held the position of Vice President, 15 Product Development. From November 1994 to March 1996, Mr. Murray was Vice President, Aviation Sales and Operations. He served as Vice President, Eastern Aviation Sales and Operations, from 1991 to 1994. From 1986 to 1989, Mr. Murray was Manager of Training Systems Group for Control Data Limited. G. Thomas Ahern, age 40, was promoted to Senior Vice President, PLATO Education Sales and Marketing in October 1997. From January to October 1997, he was Vice President, PLATO Education Sales, North America, and from December 1992 to October 1997 he served as Vice President, U.S. Sales, PLATO Education. Previously, he was Regional Vice President, Sales for the Company since its founding in 1989. From January 1989 to September 1989, Mr. Ahern was National Sales Manager for the training and education group of Control Data Corporation, a computer hardware, software and data services company. Wellesley R. Foshay, Ph.D., age 51, has served as Vice President, Instructional Design and Cognitive Learning since the Company's founding in 1989. From 1987 to 1989, Dr. Foshay was Senior Director, Quality Assurance, Standards and Training for ALI. David H. LePage, age 52, has served in his present capacity, Vice President, PLATO Support Services and Distribution since 1997. From the Company's founding in 1989 until 1997, he served as Vice President, Systems Development, Client Support and Operations. From 1972 to 1989, Mr. LePage was General Manager, Systems Development and Technical Support for the training and education group of Control Data Corporation. Mary Jo Murphy, age 42, joined the Company in August 1993 as Vice President, Corporate Controller and Chief Accounting Officer. From 1986 to 1992, she was Corporate Controller for Krelitz Industries, Inc., a drug distribution company. Ms. Murphy, a Certified Public Accountant, was formerly an Audit Supervisor for Coopers & Lybrand. Frank Preese, age 51, joined the Company in 1994 as Director of Curriculum Development. He has served in his present capacity as Vice President, Product Development since November 1997. From 1996 through 1997 he served as Assistant Vice President, Curriculum Development and during 1995 as Senior Director of Curriculum Development. Prior to joining the Company, Mr. Preese served as Vice President of Computer Services with Golle & Holmes Corporation, a training consultancy to Fortune 500 companies. Steven R. Schuster, age 38, joined the Company in December 1996 as Vice President and Assistant Treasurer. In October 1998, he was promoted to Vice President and Treasurer. From 1993 to 1996, he was Vice President for Norwest Bank, a financial services company. Mr. Schuster was formerly the Assistant Treasurer of St. Jude Medical, Inc. 16 John C. Super, age 51, joined the Company in 1990 as a Workplace Account Manager. He has served in his present capacity as Vice President, Marketing, since February 1997. From 1992 through 1996 he served as Vice President, Strategic Sales and during 1991 as Vice President Sales, Eastern Region. Prior to joining the Company, Mr. Super served in sales and management capacities with Wicat Systems and Computer Curriculum Corporation. Patricia A. Hlavacek, age 52, joined the Company in September 1989 as Administrative Assistant to the Corporate Counsel. From 1993 to the present, she has served in various capacities including Assistant Secretary, Stock Option Plan Administrator, and performed the duties of Compliance Officer in matters involving the Securities and Exchange Commission. In October 1998, she was appointed as Corporate Secretary. Prior to joining the Company, Ms. Hlavacek was employed with ALI. 17 PART II - ----------------------------------------------------------------------------- ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION: The Company's common stock is publicly traded on the NASDAQ National Market System under the symbol, TUTR. The following table presents the high and low closing prices for the Company's common stock as reported by NASDAQ for each quarter during the years ended October 31, 1998 and 1997:
FISCAL 1998 ------------------------------------------------------------------- FIRST SECOND THIRD FOURTH ---------------- -------------- -------------- -------------- High $ 7.50 $ 11.38 $ 10.31 $ 9.50 Low 4.88 6.75 8.00 6.63 FISCAL 1997 ------------------------------------------------------------------- FIRST SECOND THIRD FOURTH ---------------- -------------- -------------- -------------- High $ 21.88 $ 11.50 $ 12.13 $ 11.00 Low 10.00 7.06 7.00 7.25
HOLDERS: There were approximately 3,400 stockholders of record as of December 15, 1998 (includes individual participants in security position listings). DIVIDENDS: The Company has not declared or paid dividends on its common stock. The Company's ability to pay dividends is restricted by its revolving loan agreement (see Note 3 of Notes to Consolidated Financial Statements). While future dividend payments are at the discretion of the Board of Directors, the Company is growth-oriented and there is no present intention to pay a cash dividend on its common stock. 18 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (In thousands, except per share data)
1998 1997 1996 1995 1994 -------------- -------------- ------------- --------------- --------------- INCOME STATEMENT DATA: Revenues by product line: PLATO Education.................. $ 39,385 $ 33,265 $ 36,980 $ 30,613 $ 22,591 Aviation Training................ 3,893 3,694 4,425 6,724 5,774 -------------- -------------- ------------- --------------- --------------- Total revenues .................. 43,278 36,959 41,405 37,337 28,365 Gross profit......................... 38,269 30,484 35,192 29,669 22,587 Selling, general and administrative expense.......................... 25,408 36,988 27,537 19,027 15,494 Product development and customer support.......................... 7,341 8,036 5,307 4,487 7,515 Operating income (loss).............. 5,520 (14,540) 2,348 6,155 (1,222) Interest expense..................... 2,217 1,480 856 300 344 Provision (credit) for income taxes.. --- 4,061 564 2,157 (533) Income (loss) from continuing operations....................... 3,068 (20,217) 982 3,752 (889) Income (loss) from discontinued operations....................... --- --- --- --- (1,250) PER SHARE OF COMMON STOCK (diluted): Income (loss) from continuing operations....................... 0.47 (3.24) 0.15 0.60 (0.15) Loss from discontinued operations.... --- --- --- --- (0.21) Net income (loss).................... 0.47 (3.24) 0.15 0.60 0.55 BALANCE SHEET DATA: Total assets......................... 27,407 29,088 42,327 33,660 26,931 Total liabilities.................... 23,738 28,341 21,515 14,158 10,990 Stockholders' equity................. 3,669 747 20,812 19,502 15,941
19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW: The Company is a leading developer and marketer of microcomputer-based, interactive, self-paced instructional systems. Offering more than 2,000 hours of comprehensive academic and applied skills courseware designed for adolescents and adults, the Company's PLATO-Registered Trademark- Learning Systems are marketed to middle schools and high schools, colleges, job training programs, correctional institutions, military education programs and corporations. The PLATO Learning System is delivered via networks, CD-ROM, the Internet and private Intranets. In September 1998, the Company announced the sale of its Aviation Training business (which marketed PC-based instructional systems to airlines worldwide for use by commercial airline pilots, maintenance crews and cabin personnel) and will focus exclusively on its PLATO brand going forward. FISCAL 1998 COMPARED TO FISCAL 1997: REVENUES: Total revenues of $43,278,000 for 1998 increased by $6,319,000 or 17% as compared to $36,959,000 for 1997. The following table highlights revenues by product line (in 000's):
PLATO EDUCATION AVIATION TRAINING TOTAL ----------------------- ---------------------- ----------------------- 1998 1997 1998 1997 1998 1997 ----------- ----------- ----------- ---------- ----------- ----------- Courseware and professional services...... $ 35,694 $ 28,083 $ 3,840 $ 3,390 $ 39,534 $ 31,473 Hardware, third party courseware and other 3,691 5,182 53 304 3,744 5,486 ----------- ---------- ----------- ---------- ---------- ----------- Total revenues....................... $ 39,385 $ 33,265 $ 3,893 $ 3,694 $ 43,278 $ 36,959 =========== ========== =========== ========== ========== ===========
As summarized in the above table, PLATO Education courseware and professional services revenue of $35,694,000 for 1998 increased by $7,611,000 or 27% as compared to 1997. The growth was achieved primarily by expanding the Company's current markets for PLATO products. Aviation Training revenues of $3,893,000 increased by $199,000 or 5% from the prior year. In September 1998, the Company announced the sale of its Aviation Training business and will focus exclusively on its PLATO brand going forward. The Company's quarterly operating results fluctuate as a result of a number of factors including the business and sales cycle, the amount and timing of new product introductions by the Company, product shipments, client funding issues, marketing expenditures, product development 20 expenditures and promotional programs. The Company historically has experienced higher levels of revenues in its fourth fiscal quarter. GROSS PROFIT: Gross profit for 1998 increased by $7,785,000 or 26% to $38,269,000 as compared to $30,484,000 for 1997. This increase was due to the increase in PLATO Education courseware and professional services revenue as well as a higher mix of PLATO courseware revenues. The Company's gross margin was 88% for 1998 as compared to 82% for 1997. PLATO Education gross margin for 1998 was 89% compared to 83% for 1997. Aviation Training gross margin was 81% for both 1998 and 1997. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE: Selling, general, and administrative expense for 1998 decreased by $11,580,000 or 31% to $25,408,000 as compared to $36,988,000 for 1997. This decrease was principally due to the reduction in PLATO Education selling expenses of $4,468,000, resulting primarily from the restructuring of operations initiated in late fiscal 1997, and the decrease in the provision for doubtful accounts of $6,438,000. PRODUCT DEVELOPMENT AND CUSTOMER SUPPORT: Product development and customer support expense for 1998 decreased by $695,000 or 9% to $7,341,000 as compared to $8,036,000 for 1997. PLATO Education product development expense decreased $323,000, due primarily to reduced spending and increased capitalization of costs, slightly offset by increased amortization, as compared to 1997. OPERATING INCOME (LOSS): Operating income for 1998 was $5,520,000 as compared to an operating loss of $(14,540,000) for 1997. This improvement in operating results is due principally to the increase in courseware and professional services revenue and the positive impact of the restructuring of operations initiated in late fiscal 1997. 21 INTEREST EXPENSE: Interest expense was $2,217,000 for 1998 as compared to $1,480,000 for 1997. This increase was due to increased borrowings, resulting in additional expense of $414,000, as well as one-time settlements of interest totaling $323,000 with vendors for past due amounts. PROVISION FOR INCOME TAXES: In line with the Company's decision to fully reserve its deferred tax asset at the end of 1997, no income taxes have been recorded in 1998. FISCAL 1997 COMPARED TO FISCAL 1996: REVENUES: Total revenues of $36,959,000 for 1997 decreased by $4,446,000 or 11% as compared to $41,405,000 for 1996. The following table highlights revenues by product line (in 000's):
PLATO EDUCATION AVIATION TRAINING TOTAL ----------------------- ----------------------- ----------------------- 1997 1996 1997 1996 1997 1996 ----------- ----------- ------------ ---------- ----------- ----------- Courseware and professional services...... $ 28,083 $ 31,252 $ 3,390 $ 4,183 $ 31,473 $ 35,435 Hardware, third party courseware and other 5,182 5,728 304 242 5,486 5,970 ----------- ----------- ------------ ---------- ----------- ----------- Total revenues....................... $ 33,265 $ 36,980 $ 3,694 $ 4,425 $ 36,959 $ 41,405 =========== =========== ============ ========== =========== ===========
As summarized in the above table, PLATO Education courseware and professional services revenue of $28,083,000 for 1997 decreased by $3,169,000 or 10% as compared to 1996. The majority of this decrease occurred in the fourth quarter of 1997 as compared to 1996. Aviation Training revenues of $3,694,000 decreased by $731,000 or 17% from the prior year, reflecting a general weakness in the aviation industry. The Company's quarterly operating results fluctuate as a result of a number of factors including the business and sales cycle, the amount and timing of new product introductions by the Company, product shipments, client funding issues, marketing expenditures, product development expenditures and promotional programs. The Company historically has experienced higher levels of revenues in its fourth fiscal quarter. 22 GROSS PROFIT: Gross profit for 1997 decreased by $4,708,000 or 13% to $30,484,000 as compared to $35,192,000 for 1996. This decrease was due principally to the decline in PLATO Education courseware revenues. The Company's gross margin was 82% for 1997 as compared to 85% for 1996, reflecting the decline in courseware revenues. PLATO Education gross margin for 1997 was 83% compared to 86% for 1996. Aviation Training gross margin was 81% for 1997 compared to 76% for 1996. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE: Selling, general, and administrative expense for 1997 increased by $9,451,000 or 34% to $36,988,000 as compared to $27,537,000 for 1996. This increase was principally due to the additional provision for doubtful accounts of approximately $5,132,000 recorded in 1997, when it was determined that payment for numerous sales contracts would not be received. The majority of these sales were to customers, which are dependent upon various government funding sources, and therefore subject to standard non-appropriation of funds In addition, PLATO Education selling expense increased by approximately $2,736,000, primarily for salaries, fringe benefits and travel due to the expansion of the sales and service organization. In late fiscal 1997, the Company initiated plans to restructure its operations to achieve significant cost reductions and improve operating efficiencies. PRODUCT DEVELOPMENT AND CUSTOMER SUPPORT: Product development and customer support expense for 1997 increased by $2,729,000 or 51% to $8,036,000 as compared to $5,307,000 for 1996. While PLATO Education product development spending was comparable for 1997 as compared to 1996, product development expense increased principally as a result of decreased capitalization and the increased effect of amortization of previously capitalized costs. 23 OPERATING INCOME (LOSS): Operating loss for 1997 was $(14,540,000) as compared to operating income of $2,348,000 for 1996. This decline was due primarily to the decrease in PLATO Education revenues and gross profit, and the increase in PLATO Education selling, bad debt and product development expenses. INTEREST EXPENSE: Interest expense was $1,480,000 for 1997 as compared to $856,000 for 1996. Interest expense increased due to the Company's long term debt incurred during 1997. PROVISION FOR INCOME TAXES: The Company took a non-cash tax charge of $4,061,000 in 1997 to record a valuation allowance against the deferred tax asset. Such valuation allowance has been provided based on the inherent uncertainty of predicting the sufficiency of the future taxable income necessary to realize the benefit of the net deferred tax asset in light of the Company's recent loss history and the competitive nature of the industry in which the Company operates. LIQUIDITY AND CAPITAL RESOURCES: As of October 31, 1998, the Company's principal sources of liquidity included cash and cash equivalents of $466,000, net accounts receivable of $16,427,000 and its line of credit. The Company has total installment receivables of $11,071,000 at October 31, 1998, of which $10,496,000 are due within one year and are included in net accounts receivable. Net cash provided by the Company's operating activities was $1,988,000 in 1998 as compared to net cash used in operating activities of $5,873,000 in 1997 and $4,243,000 in 1996. Cash flows from operations were used principally to fund the Company's working capital requirements. In addition to cash flows from operations, the Company has resources available under its revolving loan agreement to provide borrowings up to a maximum of $18,000,000 through February 28, 1999 (see Note 3 of Notes to Consolidated Financial Statements). At October 31, 1998, borrowings of $6,880,000 were outstanding at a weighted average interest rate of 9.5%. The agreement provides for financial covenants requiring a minimum level of operating profit. The Company was in compliance with all financial covenants for the period ended October 31, 1998. 24 The Company's net cash provided by investing activities was $632,000 in 1998, which included proceeds of $1,414,000 from the disposal of the Aviation Training division offset by capital expenditures. Net cash used in investing activities was $762,000 in 1997 and $1,020,000 in 1996, principally for capital expenditures. The Company's capital expenditures totaled $782,000, $762,000 and $1,033,000 in 1998, 1997 and 1996, respectively. At October 31, 1998, the Company had no material commitments for capital expenditures. The Company's net cash used in financing activities was $2,379,000 in 1998, principally for repayments of debt. Net cash provided by financing activities was $6,723,000 in 1997, principally from long term debt issued, and $5,449,000 in 1996, principally from borrowings under the line of credit. The Company took a non-cash tax charge of $4,061,000 in 1997 to record a valuation allowance against the deferred tax asset. Such valuation allowance has been provided based on the inherent uncertainty of predicting the sufficiency of the future taxable income necessary to realize the benefit of the net deferred tax asset in light of the Company's recent loss history and the competitive nature of the industry in which the Company operates. In prior years the primary differences between pretax earnings for financial reporting purposes and taxable income for income tax purposes included revenue recognition, the capitalization of product development costs and various reserves. The Company has net operating loss carryforwards of approximately $33 million which begin to expire in 2004. From time to time, the Company evaluates making acquisitions of products or businesses that complement the Company's core business. The Company has no present understandings, commitments, or agreements with respect to any material acquisitions of other businesses, products, or technologies. However, the Company may consider and acquire other complementary businesses, products, or technologies in the future. On January 13, 1999, the Company announced the completion of a $5 million private placement of convertible preferred stock. The preferred stock is convertible into shares of the Company's common stock, at the option of the holder, up to two years from the issue date. Conversion is mandatory for securities still outstanding two years from the issue date. The conversion price is based on the average market price of the Company's common stock prior to conversion, as defined, and is adjusted over time to provide an 8% annual return to the holders. The conversion price is also subject to ceiling and floor limitations, which may be adjusted based on the Company's financial performance. Concurrent with this issuance, the Company issued 125,000 warrants to purchase the Company's common stock at $9.51 per share. These warrants expire five years from 25 the issue date. The net proceeds received from the convertible preferred stock issuance were approximately $4.6 million and were used to pay down existing borrowings. In order to maintain adequate cash reserves and credit facilities to meet its anticipated working capital, capital expenditure, and business investment requirements, the Company is currently reviewing several new proposals to replace its existing revolving loan agreement. Completion of this transaction, which will offer a longer-term banking relationship with more advantageous terms and conditions, is expected early in the second quarter of 1999. YEAR 2000: Many existing computer systems use only the last two digits to identify a year. Consequently, as the year 2000 approaches, many systems do not yet recognize the difference between the years 1900 and 2000. This, as well as other date-related processing issues, may cause systems to fail or malfunction. As a result, the Year 2000 (Y2K) issue may affect the Company's products and normal business activities. The Company began addressing the Y2K issue in early 1998 and has assembled a Y2K evaluation team that is endorsed by, and includes members of, senior management. A budget has been prepared for Y2K costs and progress reports are presented to senior management on a regular basis. The Y2K evaluation team has developed and implemented a comprehensive Y2K readiness plan for the Company's products and operations. The objectives of the Y2K evaluation team are as follows: - Develop a Y2K compliance standard for the Company's PLATO courseware and software products and determine compliance with that standard; - Advise on compliance of third party courseware, operating system, and hardware products based on representations by vendors of these products; - Determine compliance for the Company's internal systems (including information technology (IT) systems, such as financial and order entry systems, and non-IT systems, such as telephones and other office equipment); - Determine the Y2K readiness of key business partners that the Company relies on for normal business operations. 26 The Company has developed a compliance standard based on common testing methodology. Existing PLATO courseware and software products are currently being reviewed to determine compliance with that standard. The most current compliance and remediation information is maintained on the Company's Internet web site. PLATO products currently under development are being designed to be Y2K compliant. The Company also sells various third party courseware, operating system, and hardware products. Y2K compliance information has been received from key vendors of third party courseware products and this information is maintained on the Company's Internet web site. Web links to key vendors of third party operating system and hardware products are also provided. The Company has been taking, and will continue to take, actions necessary to resolve Y2K issues with its internal IT and non-IT systems, including planned replacements and upgrades. Major computers, applications, and related equipment have been reviewed and are either compliant or software upgrades have been ordered and will be installed in 1999. The Company's accounting and data processing system was not Y2K compliant and was recently upgraded to a version that the vendor has indicated is Y2K compliant. The Company relies on key business partners for its normal business operations and has contacted them regarding Y2K readiness. While the Company is confident these partners are preparing for the year 2000, it has no control over their preparations and there is no assurance that they will be successful in addressing all Y2K issues. While the Company's Y2K costs incurred to date have not been material, additional costs will be incurred as Y2K readiness is completed in mid-1999. Based on information currently available, management expects these additional costs to be immaterial as well. While the Company is dedicating existing internal resources toward attaining Y2K readiness, there is no assurance that it will be successful in addressing all Y2K issues. If the Company does not achieve Y2K readiness, there could be significant adverse effects on its results of operations, liquidity, and financial condition. For example: - If the Company's PLATO products are not Y2K compliant, it could suffer increased costs, lost sales or other negative consequences resulting from customer dissatisfaction, including litigation. 27 - If the Company's internal systems are not Y2K compliant, financial and customer information, orders and product shipments could be delayed and customer support could be interrupted. - If the Company's customers do not achieve Y2K readiness, sales and cash receipts may be delayed. - If the Company's key business partners and other third parties do not achieve Y2K readiness, its ability to receive supplies, ship products, process cash receipts, and conduct other ongoing business activities may be affected. Based on the progress the Company has made to date in addressing Y2K issues, management does not expect significant risks with its Y2K compliance at this time. As the Company's plan is to address its major Y2K issues prior to being affected by them, it has not developed comprehensive Y2K-related contingency plans. If progress deviates from plan or significant risks are identified, the Company will consider contingency plans as deemed necessary. This Y2K discussion is based on the Company's best estimates using the information that is currently available, and is subject to change. Actual results may differ materially from these estimates. 28 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page ---- (a) (1) Consolidated Financial Statements: Report of Independent Accountants.......................................30 Consolidated Balance Sheets as of October 31, 1998 and 1997.............31 Consolidated Statements of Income for the years ended October 31, 1998, 1997 and 1996.........................................32 Consolidated Statements of Stockholders' Equity for the years ended October 31, 1998, 1997 and 1996.........................................33 Consolidated Statements of Cash Flows for the years ended October 31, 1998, 1997 and 1996.........................................34 Notes to Consolidated Financial Statements..............................35 (2) Consolidated Financial Statement Schedule for the years ended October 31, 1998, 1997 and 1996: Report of Independent Accountants on Consolidated Financial Statement Schedule......................................................47 Schedule II. Valuation and Qualifying Accounts and Reserves............48
All other schedules called for under Regulation S-X are not submitted because they are not applicable, or because the required information is not material or is included in the consolidated financial statements or notes thereto. 29 REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders and Board of Directors of TRO Learning, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, stockholders' equity and of cash flows present fairly, in all material respects, the financial position of TRO Learning, Inc. and its subsidiaries at October 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICEWATERHOUSECOOPERS LLP Chicago, Illinois December 3, 1998 30 TRO LEARNING, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA)
OCTOBER 31, --------------------------- 1998 1997 ----------- ------------ ASSETS Current assets: Cash and cash equivalents........................................................ $ 466 $ 537 Accounts receivable, less allowances of $920 and $7,020, respectively............ 16,427 18,305 Inventories...................................................................... 648 990 Prepaid expenses and other current assets........................................ 1,121 688 ----------- ------------ Total current assets......................................................... 18,662 20,520 Equipment and leasehold improvements, less accumulated depreciation of $3,204 and $4,092, respectively............................................... 1,073 1,271 Product development costs, less accumulated amortization of $4,768 and $2,562, respectively..................................................................... 6,380 5,989 Other assets........................................................................ 1,292 1,308 ----------- ------------ $ 27,407 $ 29,088 =========== ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable................................................................. $ 2,895 $ 3,472 Accrued employee salaries and benefits........................................... 2,647 3,199 Accrued liabilities.............................................................. 2,130 4,072 Revolving loan................................................................... 9,321 11,908 Deferred revenue................................................................. 3,290 1,949 ----------- ------------ Total current liabilities.................................................... 20,283 24,600 Long term debt...................................................................... 3,050 3,050 Deferred revenue, less current portion.............................................. 405 519 Other liabilities................................................................... --- 172 Stockholders' equity: Common stock, $.01 par value, 25,000 shares authorized; 6,535 shares issued and 6,415 shares outstanding in 1998; 6,450 shares issued and 6,405 shares outstanding in 1997....................... 64 64 Paid in capital.................................................................. 22,956 22,074 Treasury stock at cost, 120 and 45 shares, respectively.......................... (1,176) (469) Accumulated deficit.............................................................. (17,592) (20,660) Foreign currency translation adjustment.......................................... (583) (262) ----------- ------------ Total stockholders' equity................................................... 3,669 747 ----------- ------------ $ 27,407 $ 29,088 =========== ============
See Notes to Consolidated Financial Statements 31 TRO LEARNING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED OCTOBER 31, --------------------------------------------- 1998 1997 1996 ------------ ------------- ------------ Revenues by product line: PLATO Education................................................. $ 39,385 $ 33,265 $ 36,980 Aviation Training............................................... 3,893 3,694 4,425 ------------ ------------- ------------ Total revenues............................................... 43,278 36,959 41,405 Cost of revenues.................................................. 5,009 6,475 6,213 ------------ ------------- ------------ Gross profit................................................. 38,269 30,484 35,192 ------------ ------------- ------------ Operating expenses: Selling, general and administrative expense..................... 25,408 36,988 27,537 Product development and customer support........................ 7,341 8,036 5,307 ------------ ------------- ------------ Total operating expenses..................................... 32,749 45,024 32,844 ------------ ------------- ------------ Operating income (loss).................................... 5,520 (14,540) 2,348 Interest expense.................................................. 2,217 1,480 856 Interest income and other expense, net............................ 235 136 (54) ------------ ------------- ------------ Income (loss) before income taxes.......................... 3,068 (16,156) 1,546 Provision for income taxes........................................ --- 4,061 564 ------------ ------------- ------------ Net income (loss).......................................... $ 3,068 $ (20,217) $ 982 ============ ============= ============ Earnings per share: Basic........................................................ $ 0.48 $ (3.24) $ 0.16 ============ ============= ============ Diluted...................................................... 0.47 $ (3.24) $ 0.15 ============ ============= ============ Weighted average common shares outstanding: Basic........................................................ 6,409 6,233 6,120 ============ ============= ============ Diluted...................................................... 6,504 6,233 6,643 ============ ============= ============
See Notes to Consolidated Financial Statements 32 TRO LEARNING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
COMMON STOCK -------------------------------------------- FOREIGN CURRENCY TOTAL PAID IN TREASURY ACCUMULATED TRANSLATION STOCKHOLDERS' SHARES AMOUNT CAPITAL STOCK DEFICIT ADJUSTMENT EQUITY --------- --------- ---------- --------- ------------ ------------ -------------- Balances, November 1, 1995 .... 6,072 $61 $21,345 $ (183) $ (1,425) $(296) $ 19,502 Net income ............... -- -- -- -- 982 -- 982 Exercise of stock options and shares issued under employee stock purchase plan ..................... 99 1 289 50 -- -- 340 Repurchase of shares ....... (4) -- -- (75) -- -- (75) Changes in exchange rates .. -- -- -- -- -- 63 63 --------- --------- ---------- --------- ------------ ------------ -------------- Balances, October 31, 1996 ...... 6,167 62 21,634 (208) (443) (233) 20,812 Net loss ................... -- -- -- -- (20,217) -- (20,217) Exercise of options, stock grants and shares issued under employee stock purchase plan ............ 259 2 440 -- -- -- 442 Repurchase of shares ....... (21) -- -- (261) -- -- (261) Changes in exchange rates .. -- -- -- -- -- (29) (29) --------- --------- ---------- --------- ------------ ------------ -------------- Balances, October 31, 1997 ...... 6,405 64 22,074 (469) (20,660) (262) 747 Net income ................. -- -- -- -- 3,068 -- 3,068 Exercise of stock options and shares issued under employee stock purchase plan...................... 85 1 882 -- -- -- 883 Repurchase of shares ....... (75) (1) -- (707) -- -- (708) Changes in exchange rates .. -- -- -- -- -- (321) (321) --------- --------- ---------- --------- ------------ ------------ -------------- Balances, October 31, 1998 ...... 6,415 $64 $22,956 $(1,176) $(17,592) $(583) $ 3,669 ========= ========= ========== ========= ============ ============ ==============
See Notes to Consolidated Financial Statements 33 TRO LEARNING, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED OCTOBER 31, ------------------------------------------ 1998 1997 1996 ----------- ---------- ------------ Cash flows from operating activities: Net income (loss).................................................. $ 3,068 $ (20,217) $ 982 ----------- ---------- ------------ Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Deferred income taxes........................................... --- 4,061 564 Depreciation and amortization................................... 2,928 2,644 1,466 Provision for doubtful accounts................................. 814 7,252 2,120 Loss on disposal of Aviation Training division.................. 266 --- --- Loss on disposal of fixed assets ............................... 2 2 180 Changes in assets and liabilities: Increase in accounts receivable............................... (1,488) (1,394) (8,680) (Increase) decrease in inventories............................ 239 107 (52) (Increase) decrease in prepaid expenses and other current and noncurrent assets....................................... (479) 1,794 1,255 Increase in product development costs......................... (2,597) (2,251) (3,356) Increase (decrease) in accounts payable....................... (415) 884 341 Increase (decrease) in accrued liabilities, accrued employee Salaries and benefits and other liabilities................. (1,828) 210 722 Increase in deferred revenue.................................. 1,478 1,035 215 ----------- ---------- ------------ Total adjustments........................................... (1,080) 14,344 (5,225) ----------- ---------- ------------ Net cash provided by (used in) operating activities......... 1,988 (5,873) (4,243) ----------- ---------- ------------ Cash flows from investing activities: Capital expenditures............................................ (782) (762) (1,033) Proceeds from disposal of Aviation Training division............ 1,414 --- --- Proceeds from disposal of fixed assets.......................... --- --- 13 ----------- ---------- ------------ Net cash provided by (used in) investing activities.......... 632 (762) (1,020) ----------- ---------- ------------ Cash flows from financing activities: Proceeds from issuance of long-term debt........................ --- 6,050 --- Net proceeds from (repayments of) short term borrowings......... (2,028) 296 5,164 Repayment of long term debt..................................... (559) --- --- Net proceeds from the issuance of common stock.................. 208 377 285 ----------- ---------- ------------ Net cash provided by (used in) financing activities........... (2,379) 6,723 5,449 ----------- ---------- ------------ Effect of foreign currency on cash................................. (312) (26) 58 ----------- ---------- ------------ Net increase (decrease) in cash and cash equivalents............... (71) 62 244 Cash and cash equivalents at beginning of year..................... 537 475 231 ----------- ---------- ------------ Cash and cash equivalents at end of year........................... $ 466 $ 537 $ 475 =========== ========== ============ Cash paid for interest expense..................................... $ 2,191 $ 1,379 $ 854 =========== ========== ============
See Notes to Consolidated Financial Statements 34 TRO LEARNING, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: NATURE OF BUSINESS: TRO Learning, Inc. and its subsidiaries (the Company) develop and market microcomputer-based, interactive, self-paced instructional systems. Offering more than 2,000 hours of comprehensive academic and applied skills courseware designed for adolescents and adults. The Company's PLATO Learning Systems are marketed to middle and high schools, colleges, job training programs, correctional institutions, military education programs, and corporations. The PLATO Learning System is delivered via networks, CD-ROM, the Internet, and private intranets. The Company's fiscal year is from November 1 to October 31. Unless otherwise stated, references to the years 1998, 1997 and 1996 relate to the fiscal years ended October 31, 1998, 1997 and 1996, respectively. PRINCIPLES OF CONSOLIDATION: The accompanying consolidated financial statements include the accounts of TRO Learning, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CONCENTRATION OF CREDIT RISK: Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of accounts receivable. Credit risk is minimized as a result of the large number of the Company's customers. The Company performs evaluations of its customers' credit worthiness and generally requires no collateral from its customers. Although many of the Company's educational customers are dependent upon various government funding sources, and are subject to non-appropriation of funds, the Company does not believe there is a significant concentration of risk associated with any specific governmental program or funding source. As of October 31, 1998, the Company had no significant concentrations of credit risk. 35 CASH EQUIVALENTS: The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Such investments are carried at cost, which approximates fair value. INVENTORIES: Inventories, which consist principally of goods purchased for resale, are stated at the lower of cost (first in, first out) or market. EQUIPMENT AND LEASEHOLD IMPROVEMENTS: Equipment and leasehold improvements are stated at cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Upon retirement or disposition, cost and related accumulated depreciation are removed from the accounts, and any gain or loss is included in the results of operations. Maintenance and repairs are expensed as incurred. OTHER ASSETS: Other assets include principally intangible assets and installment receivables with terms greater than one year. FAIR VALUE OF FINANCIAL INSTRUMENTS: The fair value of the Company's debt is estimated to approximate the carrying value of these liabilities based upon borrowing rates currently available to the Company for borrowings with similar terms. REVENUE RECOGNITION: Revenue from the sale of education and training courseware licenses, computer hardware and related support services, is recognized when the courseware, hardware, and related services are delivered. Upon delivery, future service costs, if any, are accrued. Future service costs represent the Company's problem resolution and support "hotline" service for a one-year period. Deferred revenue represents the portion of billings made or payments received in advance of services being performed or products being delivered. 36 PRODUCT DEVELOPMENT, ENHANCEMENT, AND MAINTENANCE COSTS: The Company develops education and training products, referred to hereafter as courseware products. Costs incurred in the development of the Company's current generation courseware products and related enhancements and routine maintenance thereof are expensed as incurred. All costs incurred by the Company in establishing the technical feasibility of new courseware products to be sold, leased, or otherwise marketed are expensed as incurred. Once technical feasibility has been established, costs incurred in the development of new generation courseware products are capitalized. Amortization is provided over the estimated useful life of the new courseware products, generally three years, using the straight-line method. Amortization begins when the product is available for general release to customers. Unamortized capitalized costs determined to be in excess of the net realizable value of the product are expensed at the date of such determination. INCOME TAXES: The Company accounts for income taxes as required using the liability method, which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities, and income tax carryforwards, using enacted tax rates in effect for the year in which the differences are expected to reverse. In addition, the amount of any future tax benefits are reduced by a valuation allowance to the extent the realization of such benefits is unlikely. EARNINGS PER SHARE: The Company has adopted Statement of Financial Accounting Standards 128 (SFAS 128), "Earnings Per Share", as required, effective November 1, 1997. SFAS 128 requires presentation of basic and diluted earnings per share, including a restatement of all prior periods presented. Basic earnings per share is calculated based only upon the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated based upon the weighted average number of common and, where dilutive, potential common shares outstanding during the period. Potential common shares include options, warrants and convertible securities. 37 FOREIGN CURRENCY TRANSLATION: Results of operations for foreign entities are translated using the average exchange rates during the period. Assets and liabilities are translated using the exchange rate in effect at the balance sheet date. Resulting translation adjustments are recorded as a separate component of stockholders' equity. RECLASSIFICATIONS: Certain prior year amounts have been reclassified in the consolidated financial statements to conform to the current year presentation. NEW ACCOUNTING STANDARDS: In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards 130, "Reporting Comprehensive Income" (SFAS 130). Under SFAS 130, companies are required to report comprehensive income as a measure of overall performance. Comprehensive income includes all changes in equity during a reporting period, except those resulting from investments by owners and distributions to owners. The Company will adopt SFAS 130 in 1999. In June 1997, the FASB issued Statement of Financial Accounting Standards 131, "Disclosure About Segments of an Enterprise and Related Information" (SFAS 131). SFAS 131 redefines how operating segments are determined and requires expanded quantitative and qualitative disclosures relating to an entity's operating segments. The Company will adopt SFAS 131 in 1999. The American Institute of Certified Public Accountants has issued Statement of Position (SOP) 97-2 "Software Revenue Recognition". SOP 97-2 provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions. The Company does not expect the application of the SOP to have a material impact on the Company's financial condition or results of operations. The Company will adopt SOP 97-2 in 1999. 2. ACCOUNTS RECEIVABLE: Accounts receivable include net installment receivables of $10,496,000 and $6,264,000 at October 31, 1998 and 1997, respectively. Installment receivables with terms greater than one year were $575,000 and $565,000 at October 31, 1998 and 1997, respectively, and are included in other assets on the consolidated balance sheets. The provision for doubtful accounts, included in selling, general and administrative expenses on 38 the consolidated statements of income, was $814,000, $7,252,000 and $2,120,000 for 1998, 1997 and 1996, respectively. During 1996, the Company sold certain installment receivables, on a non-recourse basis, to financial institutions. Approximately $735,000 of receivables were sold at their discounted present value of approximately $599,000 at an effective rate of 8.6%. The difference between the gross receivable amount and the proceeds has been recorded as interest expense in the consolidated statements of income. 3. DEBT: The components of debt at October 31 are as follows (in thousands):
1998 1997 ---------------- --------------- Current: Revolving loan............................... $ 6,880 $ 8,908 15% term loan................................ 2,441 3,000 ---------------- --------------- Total current debt......................... $ 9,321 $ 11,908 ================ =============== Long term: 10% subordinated convertible debentures...... $ 3,050 $ 3,050 ================ ===============
The weighted average interest rate of borrowings outstanding under the revolving loan was 9.5% and 10% at October 31,1998 and 1997, respectively. The Company's revolving loan agreement, as amended, provides for a maximum $18 million line of credit through February 28, 1999. The agreement also provides for additional line of credit borrowings up to a maximum $4,500,000 from time to time during certain periods of the remaining term of the agreement. Substantially all of the Company's assets are pledged as collateral under the agreement. Borrowings under the line are limited by the available borrowing base, as defined, consisting primarily of certain accounts receivable and inventory, and bear interest at the prime rate plus 1.5% to 2%, as defined. A commitment fee is payable based on the unused portion of the line of credit. The agreement provides for restrictions on dividends, investments, additional indebtedness, and the sale of assets, as defined, and for financial covenants requiring a minimum level of operating profit. In addition, the revolving loan agreement provides for a $3 million term loan at an annual interest rate of 15%. The term loan is subject to monthly prepayments of $50,000 and a mandatory prepayment of $1,000,000 on or before November 30, 1998. In March 1997, the Company issued $3,050,000 of 10% subordinated convertible debentures with interest payable semiannually. At the option of the holder, the debentures are convertible into the 39 Company's common stock at $9.60 per share. The Company may redeem the debentures at 101% of principal, plus interest, subject to certain terms and conditions. The debentures have a scheduled maturity in 2004 and are subject to mandatory redemption at 25% of principal annually beginning in 2001. Scheduled maturities of long term debt are as follows (in thousands):
2001...................................... $ 763 2002...................................... 763 2003...................................... 762 Thereafter................................ 762 ---------------- $ 3,050 ================
4. STOCKHOLDERS' EQUITY: STOCK INCENTIVE AND STOCK OPTION PLANS: The Company has adopted various stock incentive and stock option plans that authorize the granting of stock options, stock appreciation rights, and stock awards to directors, officers and key employees, subject to certain conditions, including continued employment. Under these plans, 1,953,540 shares are reserved for granting. Stock options are granted with an exercise price equal to the fair market value of the Company's common stock on the date of grant. All options become exercisable ratably over three years and expire ten years from the grant date. Information regarding stock option plans is as follows (in thousands):
1998 1997 1996 ----------------- ----------------- ----------------- Options at beginning of year 952 1,016 937 Options granted 305 151 196 Options exercised (100) (148) (96) Options forfeited (47) (67) (21) ----------------- ----------------- ----------------- Options outstanding at end of year 1,110 952 1,016 ================= ================= ================= Options exercisable at end of year 678 646 623 ================= ================= ================= Weighted average option prices: Outstanding at beginning of year $ 8.53 $ 7.77 $ 6.12 Granted 7.48 9.85 13.19 Exercised 7.48 2.68 2.89 Forfeited 11.21 12.88 6.81 Outstanding at end of year 8.22 8.53 7.77 Exercisable at end of year 8.10 7.76 6.25
40 Pursuant to the Company's various stock incentive and stock option plans, participants may elect to exercise stock options through a noncash transaction. Upon exercise, the Company immediately repurchases shares, at the current market price, equal to the participants aggregate exercise price and tax liability. The acquired shares are recorded as treasury stock at cost. The Company acquired 75,000, 21,000 and 4,000 shares totaling $707,000, $261,000 and $75,000 through noncash exercise transactions in 1998, 1997 and 1996, respectively. In September 1997, stock awards totaling 101,000 shares of the Company's common stock were granted to certain key employees for the purchase price of $1.00 per share. These shares vest over a five-year period and they may not be sold or transferred. The Company has adopted the disclosure only provisions of SFAS 123, "Accounting for Stock-Based Compensation". All stock options are granted at an exercise price equal to the fair market value on the grant date and, accordingly, no compensation expense has been recognized in the accompanying consolidated financial statements. Had compensation expense been recognized based on the fair value of options granted, consistent with the provisions of SFAS 123, the Company's net income (loss) and earnings per share would have been changed to the following pro forma amounts (in thousands, except per share amounts):
AS REPORTED PRO FORMA ----------------- ------------------ Net income (loss): 1998 $ 3,068 $ 1,672 1997 (20,217) (20,816) 1996 982 (40) Diluted earnings per share: 1998 $ 0.47 $ 0.26 1997 (3.24) (3.34) 1996 0.15 (0.01)
The fair value of these options was estimated using the Black-Scholes option pricing model with the following weighted average assumptions:
Expected life: 5 years Interest rate: 4.7 to 6.7% Volatility: 69% to 73% Dividend yield: None
41 STOCK WARRANTS AND CONVERTIBLE SECURITIES: In March 1997, the Company issued subordinated debentures which are convertible into shares of common stock at $9.60 per share (see Note 3). Concurrent with this issuance, the Company issued approximately 51,000 warrants to purchase common stock at $9.60 per share. The warrants expire from 2002 to 2007. 5. INCOME TAXES: The components of income (loss) before provision for income taxes are as follows (in thousands):
1998 1997 1996 ---------------- ---------------- ---------------- United States............................. $ 2,335 $ (13,432) $ 2,066 Foreign................................... 733 (2,724) (520) ---------------- ---------------- ---------------- $ 3,068 $ (16,156) $ 1,546 ================ ================ ================
The components of the provision for income taxes are as follows (in thousands):
1998 1997 1996 ---------------- ---------------- ---------------- Federal................................... $ -- $ 3,397 $ 703 Foreign................................... -- 408 (178) State and local........................... -- 256 39 ---------------- ---------------- ---------------- $ -- $ 4,061 $ 564 ================ ================ ================
The provision for income taxes differs from the amount computed by applying the U.S. federal statutory income tax rate to income (loss) before income taxes. The principal reasons for the differences are as follows (in thousands):
1998 1997 1996 -------------- ---------------- ---------------- U.S. federal statutory rate at 34%........ $ 1,043 $ (5,493) $ 525 State taxes, net of U.S. federal Income tax ............................ -- (565) 52 Previously unrecognized benefit from utilizing tax loss carryforwards....... (1,043) -- -- Other..................................... -- 10,119 (13) -------------- ---------------- ---------------- $ -- $ 4,061 $ 564 ============== ================ ================
42 The components of the deferred tax asset at October 31 are as follows (in thousands):
1998 1997 ------------------------------- ----------------------------- TEMPORARY TEMPORARY DIFFERENCE TAX EFFECTED DIFFERENCE TAX EFFECTED -------------- -------------- -------------- ------------- Current: Revenue recognition.................... $ (3,619) $ (1,339) $ (3,793) $ (1,385) Accrued liabilities and reserves....... 3,130 1,158 7,701 2,811 -------------- -------------- -------------- ------------- Total current deferred tax asset (liability)........................ (489) (181) 3,908 1,426 -------------- -------------- -------------- ------------- Long-term: Net operating loss carryforwards....... 28,497 10,544 26,498 9,673 Product development expense recognition.......................... -- -- (3,133) (1,144) Discontinued operations reserve........ -- -- 500 183 Equipment basis difference............. 465 172 812 296 Revenue recognition.................... (494) (183) (517) (189) Other.................................. 38 14 (345) (126) -------------- -------------- -------------- ------------- Total long-term deferred tax asset... 28,506 10,547 23,815 8,693 -------------- -------------- -------------- ------------- $ 28,017 $ 10,366 $ 27,723 $ 10,119 ============== ============== Less valuation allowance (10,366) (10,119) -------------- ------------- $ -- $ -- ============== =============
In line with the Company's decision to fully reserve its deferred tax asset at the end of 1997, no income taxes have been recorded in 1998. The Company took a non-cash charge of $4,061,000 in 1997 to record a valuation allowance against the deferred tax asset. Such valuation allowance has been provided based on the inherent uncertainty of predicting the sufficiency of the future taxable income necessary to realize the benefit of the net deferred tax asset in light of the Company's recent loss history and the competitive nature of the industry in which the Company operates. At October 31, 1998, the Company had a federal net operating loss carryforward of approximately $28 million and a foreign net operating loss carryforward of approximately $5 million. These net operating loss carryforwards begin to expire in 2004. 43 6. EARNINGS PER SHARE The components of the earnings per share calculation are as follows (in thousands, except per share data:
1998 1997 1996 ------------- ------------- ------------- Numerator: Net income (loss) for basic earnings per share $ 3,068 $(20,217) $ 982 Effect of convertible debentures -- -- -- ----------- -------- -------- Net income (loss) for diluted earnings per share $ 3,068 $(20,217) $ 982 =========== ======== ======== Denominator: Weighted average common shares for basic earnings per share 6,409 6,233 6,120 Potential common shares: Stock options and warrants 95 -- 523 Convertible debentures -- -- -- ----------- -------- -------- Weighted average common and potential common shares outstanding for diluted earnings per share 6,504 6,233 6,643 =========== ======== ======== Basic Earnings Per Share $ 0.48 $ (3.24) $ 0.16 =========== ======== ======== Diluted Earnings Per Share $ 0.47 $ (3.24) $ 0.15 =========== ======== ========
In 1998, the effect of the convertible debentures is antidilutive and the related number of shares and interest expense are excluded from the calculation. Since the Company incurred a net loss in 1997, the effect of all potential common shares is antidilutive and the related amounts are excluded from the calculation. 7. COMMITMENTS: The Company leases its warehouse, sales and administration facilities. Certain of these leases contain renewal options, escalation clauses and requirements that the Company pay taxes, insurance and maintenance costs. Commitments for future minimum rental payments under noncancelable leases for the next five years ending October 31 are as follows (in thousands): 1999....................................$1,286 2000.......................................651 2001.......................................125 2002.........................................8 2003........................................--
Rent expense was $1,692,000, $1,616,000 and $1,413,000 for 1998, 1997, and 1996, respectively. 44 8. INDUSTRY SEGMENT AND GEOGRAPHIC AREA INFORMATION: The Company operates in one industry segment, namely education and training. Information about the Company's operations in different geographic areas is as follows (in thousands):
YEAR ENDED OCTOBER 31 ---------------------------------------------------- 1998 1997 1996 -------------- --------------- --------------- Revenues from unaffiliated customers: United States............................. $ 35,401 $ 30,779 $ 33,217 Canada.................................... 1,411 1,644 2,955 United Kingdom............................ 6,466 4,536 5,233 -------------- --------------- --------------- $ 43,278 $ 36,959 $ 41,405 ============== =============== =============== Operating income (loss): United States............................. $ 4,755 $ (11,856) $ 3,006 Canada.................................... (51) (1,444) (528) United Kingdom............................ 816 (1,240) (130) -------------- --------------- --------------- $ 5,520 $ (14,540) $ 2,348 ============== =============== =============== Total assets: United States............................. $ 24,945 $ 23,398 $ 35,497 Canada.................................... 1,055 1,026 2,322 United Kingdom............................ 1,407 4,664 4,508 -------------- --------------- --------------- $ 27,407 $ 29,088 $ 42,327 ============== =============== ===============
Revenues from affiliates, while not significant, are recorded at established intercompany selling prices which are based upon cost plus mark-up. 45 9. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED): (In thousands, except per share data)
JAN 31 APR 30 JUL 31 OCT 31 TOTAL ------------- ------------- ------------- ------------- ------------- 1998: - ---- Revenues by product line: PLATO Education.......... $ 6,043 $ 8,391 $ 10,601 $ 14,350 $ 39,385 Aviation Training........ 1,160 1,222 1,464 47 3,893 ------------- ------------- ------------- ------------- ------------- Total revenues........... 7,203 9,613 12,065 14,397 43,278 Gross profit................ 5,613 8,266 10,650 13,740 38,269 Net income (loss)........... (2,901) (516) 1,586 4,899 3,068 Earnings per share: Basic.................... (0.45) (0.08) 0.25 0.76 0.48 Diluted.................. (0.45) (0.08) 0.23 0.73 0.47 1997: - ---- Revenues by product line: PLATO Education.......... $ 4,265 $ 6,224 $ 10,674 $ 12,102 $ 33,265 Aviation Training........ 822 1,376 669 827 3,694 ------------- ------------- ------------- ------------- ------------- Total revenues........... 5,087 7,600 11,343 12,929 36,959 Gross profit................ 4,307 6,249 9,582 10,346 30,484 Net income (loss)........... (2,315) (2,281) (1,080) (14,541) (20,217) Basic and diluted earnings per share................ (0.37) (0.37) (0.17) (2.31) (3.24)
10. SUBSEQUENT EVENT (UNAUDITED): On January 13, 1999, the Company announced the completion of a $5 million private placement of convertible preferred stock. The preferred stock is convertible into shares of the Company's common stock, at the option of the holder, up to two years from the issue date. Conversion is mandatory for securities still outstanding two years from the issue date. The conversion price is based on the average market price of the Company's common stock prior to conversion, as defined, and is adjusted over time to provide an 8% annual return to the holders. The conversion price is also subject to ceiling and floor limitations, which may be adjusted based on the Company's financial performance. Concurrent with this issuance, the Company issued 125,000 warrants to purchase the Company's common stock at $9.51 per share. These warrants expire five years from the issue date. The net proceeds received from the convertible preferred stock issuance were approximately $4.6 million and were used to pay down existing borrowings. 46 REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders and Board of Directors of TRO Learning, Inc. Our report on the consolidated financial statements of TRO Learning, Inc. and Subsidiaries is included on page 30 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page 29 of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. PRICEWATERHOUSECOOPERS LLP Chicago, Illinois December 3, 1998 47 TRO LEARNING, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED OCTOBER 31, 1996, 1997 AND 1998 (IN THOUSANDS)
--------------------------------------------------------------------------------------------------------------------- ADDITIONS ------------------------------- CHARGED TO BALANCE AT CHARGED TO OTHER BEGINNING COSTS AND ACCOUNTS DEDUCTIONS BALANCE AT DESCRIPTION OF PERIOD EXPENSES (DESCRIBE) (DESCRIBE) END OF PERIOD ---------------------------- -------------- -------------- ------------- -------------- ----------------- Deducted in the balance sheets from the assets to which they apply: Allowance for doubtful accounts: For the year ended 584 2,120 264 (b) (2,458)(a) 510 October 31, 1996 For the year ended 510 7,252 --- (742)(a) 7,020 October 31, 1997 For the year ended 7,020 814 367 (b) (7,281)(a) 920 October 31, 1998 Allowance for inventory obsolescence: For the year ended 491 150 --- (185)(a) 456 October 31, 1996 For the year ended 456 --- --- (140)(a) 316 October 31, 1997 For the year ended 316 --- --- (41)(a) 275 October 31, 1998
(a) Amounts written off, net of recoveries. (b) Amounts reclassified. 48 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III - ------------------------------------------------------------------------------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT See the information with respect to the Directors of the Registrant which is set forth in the section entitled "Election of Directors" of the Company's 1999 Proxy Statement, which is incorporated herein by reference. See the information set forth in the section entitled "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the 1999 Proxy Statement, which is incorporated herein by reference. The 1999 Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the close of the Company's fiscal year. For information regarding Executive Officers of the Registrant, see Item 4A of this Report, which is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION See the information set forth in the sections entitled "Director Compensation", "Executive Compensation", and "Compensation Committee Interlocks and Insider Participation" in the 1999 Proxy Statement, which is incorporated herein by reference. Such incorporation by reference shall not be deemed to specifically incorporate by reference the information referred to in Item 402(a)(8) of Regulation S-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT See the information set forth in the section entitled "Security Ownership of Certain Beneficial Owners and Management" in the 1999 Proxy Statement, which is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS See the information set forth in the section entitled "Certain Relationships and Transactions" in the 1999 Proxy Statement, which is incorporated herein by reference. 49 PART IV - ------------------------------------------------------------------------------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents filed as a part of this report: 1. Financial Statements - see index on page 29. 2. Financial Statement Schedules - see index on page 29. (b) Reports on Form 8-K: No Reports on Form 8-K were filed for the quarter ended October 31, 1998. (c) Exhibits: The following documents are filed herewith or incorporated herein by reference and made a part of this Form 10-K.
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT -------------- ----------------------- 3.01 Certificate of Incorporation of the Company (1) 3.02 Certificate of Designations for Series C Convertible Preferred Stock 3.03 Bylaws of the Company (1) 4.01 Form of stock certificate of the Company (1) 10.01 Amended and Restated Revolving Loan and Security Agreement between Sanwa Business Credit Corporation and The Roach Organization, Inc. and TRO Learning (Canada), Inc. dated March 5, 1997 (7) 10.04 1993 Outside Director Stock Option Plan+ (3) 10.08 Lease for Edina, Minnesota office (4) 10.14 1993 Stock Option Plan + (2) 10.15 Severance and Non Competition Agreement with William R. Roach + (3) 10.17 First Amendment to Amended and Restated Revolving Loan and Security Agreement between Sanwa Business Credit Corporation and The Roach Organization, Inc. and TRO Learning (Canada), Inc. dated March 18, 1997 (7) 10.18 Form of Series 1997 10% Subordinated Convertible Debentures due March 27, 2004 (7) 10.19 Form of Common Stock Warrants dated March 27, 1997 (7) 10.20 Second Amendment to Amended and Restated Revolving Loan and Security Agreement between Sanwa Business Credit Corporation and The Roach Organization, Inc. and TRO Learning (Canada), Inc. dated December 8, 1997 (7) 10.21 1997 Stock Incentive Plan + (5) 10.22 1997 Non-Employee Directors Stock Option Plan + (6) 10.23 Preferred Stock Purchase Agreement 10.24 Form of 1999 Warrants 10.25 Registration Rights Agreement
50 10.26 Form of Series C Convertible Preferred Stock 10.27 First Amendment to Subordinated Convertible Debentures due March 27, 2004 21.01 Subsidiaries of the Registrant (1) 23.01 Consent of PricewaterhouseCoopers LLP with respect to Registration Statements on Form S-8 24.01 Powers of Attorney 27.00 Financial Data Schedule
(1) Incorporated by reference to the corresponding exhibit to the Company's Registration Statement on Form S-1 (File No. 33-54296). (2) Incorporated by reference to Exhibit A to the Company's 1994 Proxy Statement (File Number 0-20842). (3) Incorporated by reference to the corresponding exhibit on the Company's Annual Report on Form 10-K for the year ended October 31, 1994 (File Number 0-20842). (4) Incorporated by reference to the corresponding exhibit on the Company's Annual Report on Form 10-K for the year ended October 31, 1995 (File Number 0-20842). (5) Incorporated by reference to Appendix A to the Company's 1997 Proxy Statement (File Number 0-20842). (6) Incorporated by reference to Appendix B to the Company's 1997 Proxy Statement (File Number 0-20842). (7) Incorporated by reference to the corresponding exhibit on the Company's Annual Report on Form 10-K for the year ended October 31, 1997 (File Number 0-20842). + Management contract or compensatory plan, contract or arrangement. 51 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on January 22, 1999. TRO LEARNING, INC. By /s/William R. Roach --------------------------------------- William R. Roach Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on January 22, 1999.
Signature: Title: /s/ William R. Roach Chairman of the Board, President and Chief - --------------------------- Executive Officer (principal executive officer) William R. Roach /s/ John Murray Executive Vice President and Chief Financial - --------------------------- Officer (principal financial officer) John Murray /s/ Mary Jo Murphy Vice President, Corporate Controller and Chief - --------------------------- Accounting Officer (principal accounting officer) Mary Jo Murphy * - --------------------------- Jack R. Borsting Director * - --------------------------- Tony J. Christianson Director * - --------------------------- John L. Krakauer Director * - --------------------------- Vernon B. Lewis Director * - --------------------------- John Patience Director * By /s/ Mary Jo Murphy ---------------------- Mary Jo Murphy Attorney-in Fact
52 EX-3.02 2 EX-3.02 CERTIFICATE OF DESIGNATIONS OF SERIES C CONVERTIBLE PREFERRED STOCK OF TRO LEARNING, INC. I, Patricia Hlavacek, duly elected Secretary of TRO LEARNING, INC., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, do hereby certify that: The Board of Directors of said corporation, at a meeting held on December 10, 1998, duly approved and adopted resolutions providing for the creation of Five Hundred Forty (540) shares of Series C Convertible Preferred Stock: SEE ATTACHED EXHIBIT A IN WITNESS WHEREOF, I have signed this Certificate on this 11th day of January, 1999. By: /s/ Patricia Hlavacek ------------------------ Patricia Hlavacek Secretary EXHIBIT A FURTHER RESOLVED, that for purposes of the Offering the Directors approve and authorize the issuance of Five Hundred Forty (540) shares of Series C Convertible Preferred Stock in the form approved by the officers of the Corporation, and approve and authorize the issuance of the Warrants; APPROVAL OF DOCUMENTS FURTHER RESOLVED, in furtherance of the foregoing resolutions, that the officers of the Corporation be, and they hereby are, authorized, empowered and directed to execute, deliver, and file with the appropriate office, if necessary, the following agreements in connection with the Offering: 1. Series C Convertible Preferred Stock issued by the Corporation to the Purchasers; 2. Warrants issued by the Corporation to the Purchasers; 3. Convertible Preferred Stock Purchase Agreement; 4. Registration Rights Agreement; 5. Certificate of Designations providing the terms of the Preferred Stock as provided in Exhibit A to the Convertible Preferred Stock Purchase Agreement; FURTHER RESOLVED, that each of the foregoing documents shall be in such form as the officers of the Corporation executing such agreements may deem appropriate or advisable and may approve, such approval to be conclusively evidenced by the execution and delivery of any such agreement by such officer. CERTIFICATE OF DESIGNATIONS FOR SERIES C CONVERTIBLE PREFERRED STOCK OF TRO LEARNING, INC. TERMS OF SERIES C CONVERTIBLE PREFERRED STOCK Section 1. DESIGNATION, AMOUNT AND PAR VALUE. The series of preferred stock shall be designated as Series C Convertible Preferred Stock (the "PREFERRED STOCK") and the number of shares so designated shall be 540 (which shall not be subject to increase without the consent of the holders of the Preferred Stock (each, a "HOLDER" and collectively, the "HOLDERS")); Each share of Preferred Stock shall have a par value of $.01 and a stated value of $10,000 (the "STATED VALUE"). Notwithstanding anything to the contrary in the Certificate of Incorporation of TRO Learning, Inc. (the "Company"), this Certificate of Designation for the Series C Preferred Stock of the Company constitutes the full and complete description of the rights and preferences of the Series C Preferred Stock of the Company and Section 2 of Article 4 of the Company's Certificate of Incorporation is inapplicable pursuant to Part 15 of Section 2 of Article 4. Section 2. DIVIDENDS. Holders shall not be entitled to receive any dividends on the Preferred Stock. Section 3. VOTING RIGHTS. Except as otherwise provided herein and as otherwise required by law, the Preferred Stock shall have no voting rights. However, so long as any shares of Preferred Stock are outstanding, the Company shall not and shall cause its subsidiaries not to, without the affirmative vote of the Holders of all of the shares of the Preferred Stock then outstanding, (a) alter or change adversely the powers, preferences or rights given to the Preferred Stock, (b) alter or amend this Certificate of Designation, (c) authorize or create any class of stock ranking as to dividends or distribution of assets upon a Liquidation (as defined in Section 4) senior to or otherwise pari passu with or senior to the Preferred Stock, (d) amend its Certificate of Incorporation, bylaws or other charter documents so as to affect adversely any rights of any Holders, (e) increase the authorized number of shares of Preferred Stock, or (f) enter into any agreement with respect to the foregoing. Section 4. LIQUIDATION. Upon any liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary (a "LIQUIDATION"), the Holders shall be entitled to receive out of the assets of the Company, whether such assets are capital or surplus, for each share of Preferred Stock an amount equal to the Stated Value, before any distribution or payment shall be made to the holders of any Junior Securities, and if the assets of the Company shall be insufficient to pay in full such amounts, then the entire assets to be distributed to the Holders shall be distributed among the Holders ratably in accordance with the respective amounts that would be payable on such shares if all amounts payable thereon were paid in full. A sale, conveyance or disposition of all or substantially all of the assets of the Company or the effectuation by the Company of a transaction or series of related transactions in which more than 33% of the voting power of the Company is disposed of, or a consolidation or merger of the Company with or into any other company or companies shall not be treated as a Liquidation, but instead shall be subject to the provisions of Section 5. The Company shall mail written notice of any such Liquidation, not less than 45 days prior to the payment date stated therein, to each record Holder. Section 5. CONVERSION. (a)(i) CONVERSIONS AT OPTION OF HOLDER. Each share of Preferred Stock shall be convertible into shares of Common Stock (subject to the limitations set forth in Section 5(a)(iii) hereof) at the Conversion Ratio (as defined in Section 8), at the option of the Holder, at any time and from time to time, from and after the earlier to occur of (i) the date the Registration Statement is declared effective by the Commission or (ii) the 90th day following the Original Issue Date, the ("INITIAL CONVERSION DATE"). Holders shall effect conversions by surrendering the certificate or certificates representing the shares of Preferred Stock to be converted to the Company, together with the form of conversion notice attached hereto as EXHIBIT A (a "CONVERSION NOTICE"). Each Conversion Notice shall specify the number of shares of Preferred Stock to be converted and the date on which such conversion is to be effected, which date may not be prior to the date the Holder delivers such Conversion Notice by facsimile (the "CONVERSION DATE"). If no Conversion Date is specified in a Conversion Notice, the Conversion Date shall be the date that the Conversion Notice is deemed delivered hereunder. If the Holder is converting less than all shares of Preferred Stock represented by the certificate or certificates tendered by the Holder with the Conversion Notice, or if a conversion hereunder cannot be effected in full for any reason, the Company shall promptly deliver to such Holder (in the manner and within the time set forth in Section 5(b)) a certificate for such number of shares as have not been converted. (ii) AUTOMATIC CONVERSION. Subject to the provisions in this paragraph, all outstanding shares of Preferred Stock for which conversion notices have not previously been received or for which redemption has not been made or required hereunder shall be automatically converted on January 13, 2001 (such date the "AUTOMATIC CONVERSION DATE"), at the Conversion Price on the Automatic Conversion Date. The conversion contemplated by this paragraph shall not occur if (a) either (1) an Underlying Securities Registration Statement is not then effective or (2) the Holder is not permitted to resell Underlying Shares pursuant to Rule 144(k) promulgated under the Securities Act of 1933, as amended (the "SECURITIES ACT"), without volume restrictions; (b) there are not sufficient shares of Common Stock authorized and reserved for issuance upon such conversion; or (c) the Company shall have defaulted on its covenants and obligations hereunder or under the Purchase Agreement or Registration Rights Agreement. Notwithstanding the foregoing, the period for conversion under this Section shall be extended (on a day-for-day basis) and therefore the Automatic Conversion Date shall be deemed to be the date which is the number of Trading Days that the Purchaser is unable to resell Underlying Shares under an Underlying Securities Registration Statement due to (a) the Common Stock not being listed for trading on the Nasdaq National Market ("NASDAQ") or on the New York Stock Exchange, American Stock Exchange, or the Nasdaq SmallCap Market (each, a "SUBSEQUENT MARKET"), (b) the failure of an Underlying Securities Registration Statement to be declared effective by the Securities and Exchange Commission (the -2- "COMMISSION") by the Effectiveness Date (as defined in the Registration Rights Agreement), or (c) if an Underlying Securities Registration Statement shall have been declared effective by the Commission, (x) the failure of such Underlying Securities Registration Statement to remain effective at all times thereafter as to all Underlying Shares, or (y) the suspension of the Holder's ability to resell Underlying Shares thereunder after the Automatic Conversion Date originally noted above. (iii) CERTAIN CONVERSION RESTRICTIONS. (A) The Holder agrees not to convert shares of Preferred Stock to the extent such conversion would result in the Holder beneficially owning (as determined in accordance with Section 13(d) of the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT") and the rules thereunder) in excess of 4.999% of the then issued and outstanding shares of Common Stock, including shares issuable upon conversion of the shares of Preferred Stock held by such Holder after application of this Section. To the extent that the limitation contained in this Section applies, the determination of whether shares of Preferred Stock are convertible (in relation to other securities owned by a Holder) and of which shares of Preferred Stock are convertible shall be in the sole discretion of the Holder, and the submission of shares of Preferred Stock for conversion shall be deemed to be the Holder's determination of whether such shares of Preferred Stock are convertible (in relation to other securities owned by the Holder) and of which portion of such shares of Preferred Stock are convertible, in each case subject to such aggregate percentage limitation, and the Company shall have no obligation to verify or confirm the accuracy of such determination. Nothing contained herein shall be deemed to restrict the right of the Holder to convert shares of Preferred Stock at such time as such conversion will not violate the provisions of this Section. The provisions of this Section will not apply to any conversion pursuant to Section 5 (a)(ii) hereof, and may be waived by a Holder (but only as to itself and not to any other Holder) upon not less than 75 days prior notice to the Company (in which case, the Holder shall make such filings with the Commission as are required by applicable law), and the provisions of this Section shall continue to apply until such 75th day (or later, if stated in the notice of waiver). Other Holders shall be unaffected by any such waiver. (B) The Holder agrees not to convert shares of Preferred Stock to the extent such conversion would result in the Holder beneficially owning (as determined in accordance with Section 13(d) of the Exchange Act and the rules thereunder) in excess of 9.999% of the then issued and outstanding shares of Common Stock, including shares issuable upon conversion of the shares of Preferred Stock held by such Holder after application of this Section. To the extent that the limitation contained in this Section applies, the determination of whether shares of Preferred Stock are convertible (in relation to other securities owned by a Holder) and of which shares of Preferred Stock are convertible shall be in the sole discretion of the Holder, and the submission of shares of Preferred Stock for conversion shall be deemed to be the Holder's determination of whether such shares of Preferred Stock are convertible (in relation to other securities owned by the Holder) and of which portion of such shares of Preferred Stock are convertible, in each case subject to such aggregate percentage limitation, and the Company shall have no obligation to verify or confirm the accuracy of such determination. Nothing contained herein shall be deemed to restrict the right of the Holder to convert shares of Preferred Stock at such time as such conversion will not -3- violate the provisions of this Section. The provisions of this Section will not apply to any conversion pursuant to Section 5 (a)(ii) hereof, and may be waived by a Holder (but only as to itself and not to any other Holder) upon not less than 75 days prior notice to the Company (in which case, the Holder shall make such filings with the Commission as are required by applicable law), and the provisions of this Section shall continue to apply until such 75th day (or later, if stated in the notice of waiver). Other Holders shall be unaffected by any such waiver. (C) Notwithstanding anything to the contrary set forth herein, the Company shall not be obligated to issue in excess of 1,151,525 shares of Common Stock upon conversion of Preferred Stock (the "MAXIMUM SHARE AMOUNT"), which number shall be subject to adjustment pursuant to Section 5, PROVIDED, however that in the event that the 1999 fiscal year end pre-tax earnings are (i) less than $3,068,000.00, then the Maximum Share Amount shall be 1,703,470 shares of Common Stock or (ii) equal to or greater than $3,068,000.00 but less than $4,763,000.00, then the Maximum Share Amount shall be 1,362,776 shares of Common Stock. In accordance with the Purchase Agreement such number of shares of Common Stock shall be available on a pro rata basis based upon the pro rata purchase price for the Preferred Stock paid by the original Holders of Preferred Stock. Shares of Common Stock issued on the Automatic Conversion Date pursuant to Section 5(a)(ii) and in respect of penalties and liquidated damages hereunder shall not count towards the Maximum Share Amount referenced in this paragraph and penalties and liquidated damages shall be paid in cash unless otherwise agreed to by the Holder. (D) If on any Conversion Date (A) the Common Stock is listed for trading on NASDAQ or the Nasdaq SmallCap Market, (B) the Conversion Price then in effect is such that the aggregate number of shares of Common Stock that would then be issuable upon conversion in full of all then outstanding shares of Preferred Stock, together with any shares of Common Stock previously issued upon conversion of shares of Preferred Stock, would equal or exceed 20% of the number of shares of Common Stock outstanding on the Original Issue Date (such number of shares as would not equal or exceed such 20% limit, the "ISSUABLE MAXIMUM"), and (C) the Company shall not have previously obtained the vote of shareholders (the "SHAREHOLDER APPROVAL"), if any, as may be required by the applicable rules and regulations of The Nasdaq Stock Market (or any successor entity) applicable to approve the issuance of shares of Common Stock in excess of the Issuable Maximum in a private placement whereby shares of Common Stock are deemed to have been issued at a price that is less than the greater of book or fair market value of the Common Stock, then the Company shall issue to the Holder so requesting a conversion a number of shares of Common Stock equals such Holder's pro rata portion of the Issuable Maximum and, with respect to the remainder of the shares of Preferred Stock then held by such Holder for which a conversion in accordance with the Conversion Price would result in an issuance of Common Stock in excess of such Holder's pro rata portion of the Issuable Maximum (the "EXCESS PRINCIPAL"), the converting Holder shall have the option to require the Company to either (1) use its best efforts to obtain the Shareholder Approval applicable to such issuance as soon as is possible, but in any event not later than the 60th day after such request, or (2)(i) issue and deliver to such Holder a number of shares of Common Stock as equals (x) the Excess Principal divided by (y) the Conversion Price, and (ii) cash in an amount equal to the product of (x) the Per Share Market Value on the Conversion Date and (y) a number of shares of Common Stock as equals the Excess Principal divided by the Conversion Price (such amount of -4- cash being hereinafter referred to as the "DISCOUNT EQUIVALENT"), or (3) pay cash to the converting Holder in an amount equal to the Mandatory Redemption Amount for the shares of Common Stock otherwise issuable on account of the Excess Principal. If the Company fails to pay the Discount Equivalent or the Mandatory Redemption Amount, as the case may be, in full pursuant to this Section within seven (7) days after the date payable, the Company will pay interest thereon at a rate of 18% per annum to the converting Holder, accruing daily from the Conversion Date until such amount, plus all such interest thereon, is paid in full. (b) (i) Not later than three (3) Trading Days after any Conversion Date, the Company will deliver to the Holder (i) a certificate or certificates which shall be free of restrictive legends and trading restrictions (other than those required by Section 3.1(b) of the Purchase Agreement) representing the number of shares of Common Stock being acquired upon the conversion of shares of Preferred Stock (subject to the limitations set forth in Section 5(a)(iii) hereof), and (ii) one or more certificates representing the number of shares of Preferred Stock not converted, certificates, which shall be free of restrictive legends and trading restrictions (other than those required by Section 3.1 (b) of the Purchase Agreement), representing such shares of Common Stock; PROVIDED, HOWEVER, that the Company shall not be obligated to issue certificates evidencing the shares of Common Stock issuable upon conversion of any shares of Preferred Stock until certificates evidencing such shares of Preferred Stock are either delivered for conversion to the Company or any transfer agent for the Preferred Stock or Common Stock, or the Holder of such Preferred Stock notifies the Company that such certificates have been lost, stolen or destroyed and provides a bond (or other adequate security) reasonably satisfactory to the Company to indemnify the Company from any loss incurred by it in connection therewith. The Company shall, upon request of the Holder, if available, use its best efforts to deliver any certificate or certificates required to be delivered by the Company under this Section electronically through the Depository Trust Corporation or another established clearing corporation performing similar functions. If in the case of any Conversion Notice such certificate or certificates, are not delivered to or as directed by the applicable Holder by the third (3rd) Trading Day after the Conversion Date, the Holder shall be entitled by written notice to the Company at any time on or before its receipt of such certificate or certificates thereafter, to rescind such conversion, in which event the Company shall immediately return the certificates representing the shares of Preferred Stock tendered for conversion. (ii) If the Company fails to deliver to the Holder such certificate or certificates pursuant to Section 5(b)(i), by the third (3rd) Trading Day after the Conversion Date, the Company shall pay to such Holder, in cash, as liquidated damages and not as a penalty, $3,500 for each day after such third (3rd) Trading Day until such certificates are delivered. Nothing herein shall limit a Holder's right to pursue actual damages for the Company's failure to deliver certificates representing shares of Common Stock upon conversion within the period specified herein and such Holder shall have the right to pursue all remedies available to it at law or in equity including, without limitation, a decree of specific performance and/or injunctive relief. The exercise of any such rights shall not prohibit the Holders from seeking to enforce damages pursuant to any other Section hereof or under applicable law. Further, if the Company shall not have delivered any cash due in respect of conversions of Preferred Stock by the third (3rd) Trading Day after the Conversion Date, the Holder may, by notice to the Company, require the Company to issue Underlying Shares pursuant -5- to Section 5(c), except that for such purpose the Conversion Price applicable thereto shall be the lesser of the Conversion Price on the Conversion Date and the Conversion Price on the date of such Holder demand. Any such Underlying Shares will be subject to the provision of this Section. (iii) In addition to any other rights available to the Holder, if the Company fails to deliver to the Holder such certificate or certificates pursuant to Section 5(b)(i) by the third (3rd) Trading Day after the Conversion Date, and if after such third (3rd) Trading Day the Holder purchases (in an open market transaction or otherwise) shares of Common Stock to deliver in satisfaction of a sale by such Holder of the Underlying Shares which the Holder anticipated receiving upon such conversion (a "BUY-IN"), then the Company shall pay in cash to the Holder (in addition to any remedies available to or elected by the Holder) the amount by which (x) the Holder's total purchase price (including brokerage commissions, if any) for the shares of Common Stock so purchased exceeds (y) the aggregate stated value of the shares of Preferred Stock for which such conversion was not timely honored. For example, if the Holder purchases shares of Common Stock having a total purchase price of $11,000 to cover a Buy-In with respect to an attempted conversion of $10,000 aggregate stated value of the shares of Preferred Stock, the Company shall be required to pay the Holder $1,000. The Holder shall provide the Company written notice indicating the amounts payable to the Holder in respect of the Buy-In. (c) (i)(A) The conversion price (the "CONVERSION PRICE") in effect on any Conversion Date shall be the lesser of (1) $9.51 or (2) the Applicable Percentage (as defined in Section 8) of the average of the lowest three (3) Per Share Market Values during the thirty (30) Trading Days immediately preceding such Conversion Date. (B) If: (a) an Underlying Securities Registration Statement is not filed on or prior to the Filing Date (as defined in the Registration Rights Agreement) (if the Company files such Underlying Securities Registration Statement without affording the Holder the opportunity to review and comment on the same as required by Section 3(a) of the Registration Rights Agreement, the Company shall not be deemed to have satisfied this clause (a)), or (b) the Company fails to file with the Commission a request for acceleration in accordance with Rule 12d1-2 promulgated under the Exchange Act, within five (5) Trading Days of the date that the Company is notified (orally or in writing, whichever is earlier) by the Commission that an Underlying Securities Registration Statement will not be "reviewed," or not subject to further review, or (c) the Underlying Securities Registration Statement is not declared effective by the Commission on or prior to the Effectiveness Date (as defined in the Registration Rights Agreement), provided, however that the Effectiveness Date shall be extended for fifteen (15) days in the event that the Company is using its best efforts to cause the Registration Statement to be declared effective by the Commission within ninety (90) days of the Original Issue Date, or (d) such Underlying Securities Registration Statement is filed with and declared effective by the Commission but thereafter ceases to be effective as to all Registrable Securities (as defined in the Registration Rights Agreement) at any time prior to the expiration of the "Effectiveness Period" (as defined in the Registration Rights Agreement), without being succeeded within ten (10) Trading Days by an amendment to such Underlying Securities Registration Statement or a subsequent Underlying Securities Registration Statement filed with and declared effective by the Commission, or (e) trading in the Common Stock shall be suspended from -6- the NASDAQ or a Subsequent Market for more than three (3) Business Days (which need not be consecutive Business Days), (f) the conversion rights of the Holders are suspended for any reason or (g) an amendment to the Underlying Securities Registration Statement is not filed by the Company with the Commission within ten (10) Trading Days of the Commission's notifying the Company that such amendment is required in order for the Underlying Securities Registration Statement to be declared effective (any such failure or breach being referred to as an "EVENT," and for purposes of clauses (a), (c), (f) the date on which such Event occurs, or for purposes of clause (b) the date on which such five (5) Trading Day period is exceeded, or for purposes of clauses (d) and (g) the date which such 10 Trading Day period is exceeded, or for purposes of clause (e) the date on which such three (3) Business Day-period is exceeded, being referred to as "EVENT DATE"), then the Company shall, on the first day of each monthly anniversary of the Event Date and until the earlier to occur of the third monthly anniversary of the Event Date or such time as the applicable Event is cured, pay to the Holder $40,000 in cash, as liquidated damages and not as a penalty. Commencing the third month anniversary after the Event Date and on each monthly anniversary thereafter until such time as the applicable Event is cured, the Company shall pay to the Holder $120,000 in cash, as liquidated damages and not as a penalty. The provisions of this Section are not exclusive and shall in no way limit the Company's obligations under the Registration Rights Agreement. (ii) If the Company, at any time while any shares of Preferred Stock are outstanding, shall (a) pay a stock dividend or otherwise make a distribution or distributions on shares of its Junior Securities or pari passu securities payable in shares of Common Stock, (b) subdivide outstanding shares of Common Stock into a larger number of shares, (c) combine outstanding shares of Common Stock into a smaller number of shares, or (d) issue by reclassification of shares of Common Stock any shares of capital stock of the Company, the Conversion Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock outstanding before such event and of which the denominator shall be the number of shares of Common Stock outstanding after such event. Any adjustment made pursuant to this Section 5(c)(ii) shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or re-classification. (iii) If the Company, at any time while any shares of Preferred Stock are outstanding, shall issue rights, warrants or options to all holders of Common Stock entitling them to subscribe for or purchase shares of Common Stock at a price per share less than the Per Share Market Value at the record date mentioned below, then the Conversion Price shall be multiplied by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to the issuance of such rights, warrants or options, plus the number of shares of Common Stock which the aggregate offering price of the total number of shares so offered would purchase at such Per Share Market Value, and the denominator of which shall be the sum of the number of shares of Common Stock outstanding immediately prior to such issuance plus the number of shares of Common Stock offered for subscription or purchase. Such adjustment shall be made whenever such rights or warrants are issued, and shall become effective immediately after the record date for the determination of stockholders entitled to receive such rights or warrants. However, upon -7- the expiration of any right, warrant or option to purchase shares of Common Stock the issuance of which resulted in an adjustment in the Conversion Price pursuant to this Section 5(c)(iii), if any such right, warrant or option shall expire and shall not have been exercised, the Conversion Price shall immediately upon such expiration shall be recomputed and effective immediately upon such expiration shall be increased to the price which it would have been (but reflecting any other adjustments in the Conversion Price made pursuant to the provisions of this Section 5 upon the issuance of other rights or warrants) had the adjustment of the Conversion Price made upon the issuance of such rights, warrants, or options been made on the basis of offering for subscription or purchase only that number of shares of Common Stock actually purchased upon the exercise of such rights, warrants or options actually exercised. (iv) Except as contemplated by Schedule 2.1(a) to the Purchase Agreement, if the Company or any subsidiary thereof, as applicable with respect to Common Stock Equivalents (as defined below), at any time while any shares of Preferred Stock are outstanding, shall, issue shares of Common Stock or rights, warrants, options or other securities or debt that is convertible into or exchangeable for shares of Common Stock ("COMMON STOCK EQUIVALENTS") entitling any Person to acquire shares of Common Stock at a price per share less than the Conversion Price, then the Conversion Price shall be multiplied by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to the issuance of shares of Common Stock or such Common Stock Equivalents plus the number of shares of Common Stock which the offering price for such shares of Common Stock or Common Stock Equivalents would purchase at the Conversion Price, and the denominator of which shall be the sum of the number of shares of Common Stock outstanding immediately prior to such issuance plus the number of shares of Common Stock so issued or issuable, provided, that for purposes hereof, all shares of Common Stock that are issuable upon exercise or exchange of Common Stock Equivalents shall be deemed outstanding immediately after the issuance of such Common Stock Equivalents. Such adjustment shall be made whenever such shares of Common Stock or Common Stock Equivalents are issued; provided, however, that no such adjustments shall be made for Common Stock Equivalents issued pursuant to the Company's Management Stock Incentive Plan, 1993 Stock Option Plan, 1997 Stock Incentive Plan, 1993 Outside Director Stock Option Plan, TRO 1994 and 1995 Outside Director Stock Option Plan and 1997 Non-Employee Directors Stock Option Plan. (v) If the Company, at any time while shares of Preferred Stock are outstanding, shall distribute to all holders of Common Stock (and not to Holders) evidences of its indebtedness or assets or rights or warrants to subscribe for or purchase any security (excluding those referred to in Sections 5(c)(ii)-(iv) above), then in each such case the Conversion Price at which each share of Preferred Stock shall thereafter be convertible shall be determined by multiplying the Conversion Price in effect immediately prior to the record date fixed for determination of stockholders entitled to receive such distribution by a fraction of which the denominator shall be the Per Share Market Value of Common Stock determined as of the record date mentioned above, and of which the numerator shall be such Per Share Market Value of the Common Stock on such record date less the then fair market value at such record date of the portion of such assets or evidence of indebtedness so distributed applicable to one outstanding share of Common Stock as determined by the Board of Directors in good faith; PROVIDED, HOWEVER, that in the event of a distribution exceeding -8- ten percent (10%) of the net assets of the Company, if the Holders of a majority in interest of the Preferred Stock dispute such valuation, such fair market value shall be determined by a nationally recognized or major regional investment banking firm or firm of independent certified public accountants of recognized standing (which may be the firm that regularly examines the financial statements of the Company) (an "APPRAISER") selected in good faith by the Company, subject to approval by the Holders of a majority in interest of the shares of Preferred Stock then outstanding whose approval shall not be unreasonably withheld or delayed. The adjustments shall be described in a statement provided to the Holders of the portion of assets or evidences of indebtedness so distributed or such subscription rights applicable to one share of Common Stock. Such adjustment shall be made whenever any such distribution is made and shall become effective immediately after the record date mentioned above. (vi) All calculations under this Section 5 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. (vii) Whenever the Conversion Price is adjusted pursuant to Section 5(c)(ii),(iii),(iv), or (v) the Company shall promptly mail to each Holder, a notice setting forth the Conversion Price after such adjustment and setting forth a brief statement of the facts requiring such adjustment. (viii) In case of any reclassification of the Common Stock, or any compulsory share exchange pursuant to which the Common Stock is converted into other securities, cash or property (other than compulsory share exchanges which constitute Change of Control Transactions), the Holders of the Preferred Stock then outstanding shall have the right thereafter to convert such shares only into the shares of stock and other securities, cash and property receivable upon or deemed to be held by holders of Common Stock following such reclassification or share exchange, and the Holders of the Preferred Stock shall be entitled upon such event to receive such amount of securities, cash or property as a holder of the number of shares of the Common Stock of the Company into which such shares of Preferred Stock could have been converted immediately prior to such reclassification or share exchange would have been entitled. This provision shall similarly apply to successive reclassifications or share exchanges. (ix) If (a) the Company shall declare a dividend (or any other distribution) on its Common Stock, (b) the Company shall declare a special nonrecurring cash dividend on or a redemption of its Common Stock, (c) the Company shall authorize the granting to all holders of the Common Stock rights or warrants to subscribe for or purchase any shares of capital stock of any class or of any rights, (d) the approval of any stockholders of the Company shall be required in connection with any reclassification of the Common Stock of the Company, any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, of any compulsory share of exchange whereby the Common Stock is converted into other securities, cash or property, or (e) the Company shall authorize the voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Company; then the Company shall cause to be filed at each office or agency maintained for the purpose of conversion of Preferred Stock, and shall cause to be mailed to the Holders at their last addresses as they shall -9- appear upon the stock books of the Company, at least 20 calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer or share exchange is expected to become effective or close, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer or share exchange; PROVIDED, HOWEVER, that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. Holders are entitled to convert shares of Preferred Stock during the 20-day period commencing the date of such notice to the effective date of the event triggering such notice. (d) The Company covenants that it will at all times reserve and keep available out of its authorized and unissued Common Stock solely for the purpose of issuance upon conversion of Preferred Stock, each as herein provided, free from preemptive rights or any other actual contingent purchase rights of persons other than the Holders, not less than such number of shares of Common Stock as shall (subject to any additional requirements of the Company as to reservation of such shares set forth in the Purchase Agreement) be issuable (taking into account the adjustments and restrictions of Section 5(a) and Section 5(c)) upon the conversion of all outstanding shares of Preferred Stock. The Company covenants that all shares of Common Stock that shall be so issuable shall, upon issue, be duly and validly authorized, issued and fully paid, nonassessable and freely tradeable, subject to the legend requirements of Section 3.1 (b) of the Purchase Agreement. (e) Upon a conversion hereunder the Company shall not be required to issue stock certificates representing fractions of shares of Common Stock, but may if otherwise permitted, make a cash payment in respect of any final fraction of a share based on the Per Share Market Value at such time. If the Company elects not, or is unable, to make such a cash payment, the Holder of a share of Preferred Stock shall be entitled to receive, in lieu of the final fraction of a share, one whole share of Common Stock. (f) The issuance of certificates for shares of Common Stock on conversion of Preferred Stock shall be made without charge to the Holders thereof for any documentary stamp or similar taxes that may be payable in respect of the issue or delivery of such certificate, provided that the Company shall not be required to pay any tax that may be payable in respect of any transfer involved in the issuance and delivery of any such certificate upon conversion in a name other than that of the Holder of such shares of Preferred Stock so converted and the Company shall not be required to issue or deliver such certificates unless or until the person or persons requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the satisfaction of the Company that such tax has been paid. (g) Shares of Preferred Stock converted into Common Stock shall be canceled. The Company may not reissue any shares of Preferred Stock. -10- (h) Any and all notices or other communications or deliveries to be provided by the Holders of the Preferred Stock hereunder, including, without limitation, any Conversion Notice, shall be in writing and delivered personally, by facsimile or sent by a nationally recognized overnight courier service, addressed to the attention of the Chief Executive Officer of the Company at the facsimile telephone number or address of the principal place of business of the Company as set forth in the Purchase Agreement. Any and all notices or other communications or deliveries to be provided by the Company hereunder shall be in writing and delivered personally, by facsimile or sent by a nationally recognized overnight courier service, addressed to each Holder at the facsimile telephone number or address of such Holder appearing on the books of the Company, or if no such facsimile telephone number or address appears, at the principal place of business of the Holder. Any notice or other communication or deliveries hereunder shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section prior to 8:00 p.m. (Minnetonka time), (ii) the date after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section later than 8:00 p.m. (Minnetonka time) on any date and earlier than 11:59 p.m. (Minnetonka time) on such date, (iii) upon receipt, if sent by a nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. Section 6. REDEMPTION UPON TRIGGERING EVENTS. (a) Upon the occurrence of a Triggering Event, each Holder shall (in addition to all other rights it may have hereunder or under applicable law), has the right, exercisable at the sole option of such Holder, to require the Company to redeem all or a portion of the Preferred Stock then held by such Holder for a redemption price, in cash, equal to the sum of (i) the Mandatory Redemption Amount plus (ii) the product of (A) the number of Underlying Shares issued in respect of conversions hereunder and then held by the Holder and (B) the Per Share Market Value on the date such redemption is demanded or the date the redemption price hereunder is paid in full, whichever is greater. If the Company fails to pay the redemption price hereunder in full pursuant to this Section within seven (7) days after the date of a demand therefor, the Company will pay interest thereon at a rate of 18% per annum, accruing daily from such seventh day until the redemption price, plus all such interest thereon, is paid in full. For purposes of this Section, a share of Preferred Stock is outstanding until such date as the Holder shall have received Underlying Shares upon a conversion (or attempted conversion) thereof. A "Triggering Event" means any one or more of the following events (whatever the reason and whether it shall be voluntary or involuntary or effected by operation of law or pursuant to any judgement, decree or order of any court, or any order, rule or regulation of any administrative or governmental body): (i) the failure of an Underlying Securities Registration Statement to be declared effective by the Commission on or prior to the 180th day after the Original Issue Date; -11- (ii) if, during the Effectiveness Period, the effectiveness of the Underlying Securities Registration Statement lapses for five (5) consecutive Trading Days for any reason, or the Holder shall not be permitted to resell Registrable Securities under the Underlying Securities Registration Statement for five (5) consecutive Trading Days; (iii) the failure of the Common Stock to be listed for trading on NASDAQ or on a Subsequent Market or the suspension of the Common Stock from trading on NASDAQ or on a Subsequent Market, in either case, for more than five (5) Trading Days (which need not be consecutive Trading Days); (iv) the Company shall fail for any reason to deliver certificates representing Underlying Shares issuable upon a conversion hereunder that comply with the provisions hereof prior to the 12th day after the Conversion Date or the Company shall provide notice to any Holder, including by way of public announcement, at any time, of its intention not to comply with requests for conversion of any Preferred Stock in accordance with the terms hereof; (v) the Company shall be a party to any Change of Control Transaction, shall agree to sell (in one or a series of related transactions) all or substantially all or in excess of 50% of its assets in one or more transaction (whether or not such sale would constitute a Change of Control Transaction) or shall redeem more than a de minimis number of shares of Common Stock or other Junior Securities (other than redemptions of Underlying Shares); (vi) an Event shall not have been cured to the satisfaction of the Holder prior to the expiration of thirty (30) days from the Event Date relating thereto (other than an Event resulting from a failure of an Underlying Securities Registration Statement to be declared effective by the Commission on or prior to the Effectiveness Date); (vii) the Company shall fail for any reason to deliver the certificate or certificates required pursuant to Section 5(b)(iii) or the cash pursuant to a Buy-In within ten (10) days after notice is deemed delivered hereunder; or (viii) the Company shall fail to have available a sufficient number of authorized and unreserved shares of Common Stock to issue to such Holder upon a conversion hereunder. Section 7. OPTIONAL REDEMPTION. (a) The Company shall have the right, exercisable at any time upon 30 days' notice (an "OPTIONAL REDEMPTION NOTICE") to the Holders of the Preferred Stock given at any time after the Optional Redemption Date (as defined in Section 8) to redeem all or any portion of the shares of Preferred Stock which have not previously been converted or redeemed, at a price equal to the Optional Redemption Price (as defined below), PROVIDED, that the Company shall not be entitled to deliver an Optional Redemption Notice to the Holders if: (i) the number of shares of Common Stock at the time authorized, unissued and unreserved for all purposes is insufficient to -12- satisfy the Company's conversion obligations of all shares of Preferred Stock then outstanding, (ii) the Underlying Shares then outstanding are not registered for resale pursuant to an effective Underlying Securities Registration Statement and may not be sold without volume restrictions pursuant to Rule 144 promulgated under the Securities Act, (iii) the Common Stock is not then listed for trading on NASDAQ or a Subsequent Market, or (iv) the average of the Per Share Market Values for twenty (20) consecutive Trading Days immediately preceding the date of the Optional Redemption Notice is not greater than $15.85. The entire Optional Redemption Price shall be paid in cash. Holders may convert (and the Company shall honor such conversions in accordance with the terms hereof) any shares of Preferred Stock, including shares subject to an Optional Redemption Notice, during the period from the date thereof through the 30th day after the receipt of an Optional Redemption Notice. (b) If any portion of the Optional Redemption Price shall not be paid by the Company by the 30th day after the delivery of an Optional Redemption Notice, interest shall accrue thereon at the rate of 18% per annum until the Optional Redemption Price plus all such interest is paid in full. In addition, if any portion of the Optional Redemption Price remains unpaid after the date due, the Holder of the Preferred Stock subject to such redemption may elect, by written notice to the Company given at any time thereafter, to either (i) demand conversion of all or any portion of the shares of Preferred Stock for which such Optional Redemption Price, plus interest thereof, has not been paid in full (the "UNPAID REDEMPTION SHARES"), in which event the Per Share Market Value for such shares shall be the lower of the Per Share Market Value calculated on the date the Optional Redemption Price was originally due and the Per Share Market Value as of the Holder's written demand for conversion, or (ii) invalidate AB INITIO such redemption, notwithstanding anything herein contained to the contrary. If the Holder elects option (i) above, the Company shall within three (3) Trading Days of its receipt of such election deliver to the Holder the shares of Common Stock issuable upon conversion of the Unpaid Redemption Shares subject to such Holder conversion demand and otherwise perform its obligations hereunder with respect thereto; or, if the Holder elects option (ii) above, the Company shall promptly, and in any event not later than three (3) Trading Days from receipt of Holder's notice of such election, return to the Holder all of the Unpaid Redemption Shares. (c) The "OPTIONAL REDEMPTION PRICE" shall equal the sum of (i) the product of (A) the number of shares of Preferred Stock to be redeemed and (B) the product of (1) a) at any time prior to the first anniversary of the Original Issued Date, 125% or b) at any time thereafter, 156%, of the average Per Share Market Value for the five (5) Trading Days immediately preceding (x) the date of the Optional Redemption Notice or (y) the date of payment in full by the Company of the Optional Redemption Price, whichever is greater, and (2) the Conversion Ratio calculated on the date of the Optional Redemption Notice, and (ii) all other amounts, costs, expenses and liquidated damages due in respect of such shares of Preferred Stock. Section 8. DEFINITIONS. For the purposes hereof, the following terms shall have the following meanings: -13- "APPLICABLE PERCENTAGE" means (i) 90% if the Conversion Date or any redemption or repurchase date, if applicable, occurs on or prior to the 360th day after the Original Issue Date, (ii) 88% if the Conversion Date or any redemption or repurchase date, if applicable, occurs on or after the 361st and before the 450th day after the Original Issue Date, (iii) 86% if the Conversion Date or any redemption or repurchase date, if applicable, is on or after the 451st and before the 540th day after the Original Issue Date, (iv) 84% if the Conversion Date or any redemption or repurchase date, if applicable, occurs on or after the 541st and before the 630th day after the Original Issue Date, and (v) 82% if the Conversion Date or any redemption or repurchase date, if applicable, is more than 631 days after the Original Issue Date. "CHANGE OF CONTROL TRANSACTION" means the occurrence of any of (i) an acquisition after the date hereof by an individual or legal entity or "group" (as described in Rule 13d-5(b)(1) promulgated under the Exchange Act) of in excess of 33% of the voting securities of the Company, (ii) a replacement of more than one-half of the members of the Company's board of directors which is not approved by those individuals who are members of the board of directors on the date hereof in one or a series of related transactions, (iii) the merger of the Company with or into another entity, consolidation or sale of all or substantially all of the assets of the Company in one or a series of related transactions, unless following such transaction, the holders of the Company's securities continue to hold at least 66% of such securities following such transaction or (iv) the execution by the Company of an agreement to which the Company is a party or by which it is bound, providing for any of the events set forth above in (i), (ii) or (iii). "COMMON STOCK" means the Company's common stock, par value $.01 per share, and stock of any other class into which such shares may hereafter have been reclassified or changed. "CONVERSION RATIO" means, at any time, a fraction, the numerator of which is Stated Value (including any accrued but unpaid late fees thereon), and the denominator of which is the Conversion Price at such time. "JUNIOR SECURITIES" means the Common Stock and all other equity securities of the Company which are junior in rights and liquidation preference to the Preferred Stock. "MANDATORY REDEMPTION AMOUNT" for each share of Preferred Stock means the sum of (i) the greater of (A) 115% of the Stated Value, and (B) the product of (a) the Per Share Market Value on the Trading Day immediately preceding (x) the date of the Triggering Event or the Conversion Date, as the case may be, or (y) the date of payment in full by the Company of the applicable redemption price, whichever is greater, and (b) the Conversion Ratio calculated on the date of the Triggering Event, or the Conversion Date, as the case may be, and (ii) all other amounts, costs, expenses and liquidated damages due in respect of such shares of Preferred Stock. "OPTIONAL REDEMPTION DATE" shall mean the date which is thirty (30) days following the date the Underlying Shares are registered for resale pursuant to an effective Underlying Securities Registration Statement. -14- "ORIGINAL ISSUE DATE" shall mean the date of the first issuance of any shares of the Preferred Stock regardless of the number of transfers of any particular shares of Preferred Stock and regardless of the number of certificates which may be issued to evidence such Preferred Stock. "PER SHARE MARKET VALUE" means on any particular date (a) the closing bid price per share of the Common Stock on such date on the NASDAQ or on such Subsequent Market on which the Common Stock is then listed or quoted, or if there is no such price on such date, then the closing bid price on the NASDAQ or on such Subsequent Market on which the Common Stock is then listed or quoted on the date nearest preceding such date, or (b) if the Common Stock is not then listed or quoted on the NASDAQ or on a Subsequent Market, the closing bid price for a share of Common Stock in the over-the-counter market, as reported by the National Quotation Bureau Incorporated or similar organization or agency succeeding to its functions of reporting prices) at the close of business on such date, or (c) if the Common Stock is not then reported by the National Quotation Bureau Incorporated (or similar organization or agency succeeding to its functions of reporting prices), then the average of the "Pink Sheet" quotes for the relevant conversion period, as determined in good faith by the Holder, or (d) if the Common Stock is not then publicly traded the fair market value of a share of Common Stock as determined by an Appraiser selected in good faith by the Holders of a majority of the shares of the Preferred Stock. "PERSON" means a corporation, an association, a partnership, organization, a business, an individual, a government or political subdivision thereof or a governmental agency. "PURCHASE AGREEMENT" means the Convertible Preferred Stock Purchase Agreement, dated as January 13, 1999, between the Company and the original Holder of the Preferred Stock. "REGISTRATION RIGHTS AGREEMENT" means the Registration Rights Agreement, dated as of January 13, 1999, between the Company and the original Holder of the Preferred Stock. "TRADING DAY" means (a) a day on which the Common Stock is traded on the NASDAQ or on such Subsequent Market on which the Common Stock is then listed or quoted, or (b) if the Common Stock is not listed on NASDAQ or on a Subsequent Market, a day on which the Common Stock is traded in the over-the-counter market, as reported by the OTC Bulletin Board, or (c) if the Common Stock is not quoted on the OTC Bulletin Board, a day on which the Common Stock is quoted in the over-the-counter market as reported by the National Quotation Bureau Incorporated (or any similar organization or agency succeeding its functions of reporting prices); PROVIDED, HOWEVER, that in the event that the Common Stock is not listed or quoted as set forth in (a), (b) and (c) hereof, then Trading Day shall mean any day except Saturday, Sunday and any day which shall be a legal holiday or a day on which banking institutions in the State of New York are authorized or required by law or other government action to close. "UNDERLYING SECURITIES REGISTRATION STATEMENT" means a registration statement that meets the requirement of the Registration Rights Agreement and registers the resale of all Underlying Shares by the recipient thereof, who shall be named as a "selling stockholder" thereunder. -15- "UNDERLYING SHARES" means, collectively, the shares of Common Stock into which the Shares are convertible in accordance with the terms hereof. Section 9. CANCELLATION. If at any time all of the outstanding Series C Preferred Stock shall cease to be outstanding for any reason, the provisions of this Certificate of Designation shall become null and void without any further action on behalf of the board of directors or stockholders of the Company. -16- EXHIBIT A NOTICE OF CONVERSION (To be Executed by the Registered Holder in order to Convert shares of Preferred Stock) The undersigned hereby elects to convert the number of shares of Series C Convertible Preferred Stock indicated below, into shares of Common Stock, par value $.01 per share (the "COMMON STOCK"), of TRO Learning, Inc. (the "COMPANY") according to the conditions hereof, as of the date written below. If shares are to be issued in the name of a person other than undersigned, the undersigned will pay all transfer taxes payable with respect thereto and is delivering herewith such certificates and opinions as reasonably requested by the Company in accordance therewith. No fee will be charged to the Holder for any conversion, except for such transfer taxes, if any. Conversion calculations: _______________________________________________ Date to Effect Conversion _______________________________________________ Number of shares of Preferred Stock to be Converted _______________________________________________ Number of shares of Common Stock to be Issued _______________________________________________ Applicable Conversion Price _______________________________________________ Signature _______________________________________________ Name _______________________________________________ Address EX-10.23 3 EX-10.23 CONVERTIBLE PREFERRED STOCK PURCHASE AGREEMENT (this "AGREEMENT"), dated as of January 13, 1999, among TRO Learning, Inc., a Delaware corporation (the "COMPANY"), KA Investments LDC ("KA"), Gary S. Kohler ("KOHLER"), First Trust National Association TTEE FBO Gary Kohler IRA ("KOHLER IRA"), Industricorp & Co., Inc. FBO Twin City Carpenters Pension Plan and ("TWIN CITY"), Stark International ("STARK", and together with KA, Kohler, Kohler IRA and Twin City, the "PURCHASERS"). WHEREAS, subject to the terms and conditions set forth in this Agreement, the Company desires to issue and sell to the Purchasers and the Purchasers desire to purchase from the Company, shares of the Company's Series C Convertible Preferred Stock, par value $.01 per share (the "PREFERRED STOCK"), which are convertible into shares of the Company's common stock, par value $.01 per share (the "COMMON STOCK"). IN CONSIDERATION of the mutual covenants contained in this Agreement, and for other good and valuable consideration the receipt and adequacy are hereby acknowledged, the Company and the Purchasers agree as follows: ARTICLE I PURCHASE AND SALE 1.1 THE CLOSING. (a) THE CLOSING. (i) Subject to the terms and conditions set forth in this Agreement, the Company shall issue and sell to the Purchasers and the Purchasers shall purchase 540 shares of Preferred Stock (the "SHARES") for an aggregate purchase price of $5,000,000. The closing of the purchase and sale of the Shares (the "CLOSING") shall take place at the offices of Robinson Silverman Pearce Aronsohn & Berman LLP ("ROBINSON SILVERMAN"), 1290 Avenue of the Americas, New York, New York 10104, immediately following the execution hereof or such later date as the parties shall agree. The date of the Closing is hereinafter referred to as the "CLOSING DATE." (ii) Prior to the Closing Date, the parties shall deliver or shall cause to be delivered the following: (A) the Company shall deliver (1) to KA (a) stock certificates representing 399.6 Shares, registered in the name of KA, (b) a Common Stock purchase warrant, in the form of EXHIBIT D, registered in the name of KA, pursuant to which KA shall have the right at any time and from time to time thereafter through the fifth anniversary of the Closing Date to acquire 92,500 shares of Common Stock at an exercise price per share (subject to adjustment as provided therein) of $9.51 (the "KA WARRANT"), (c) the legal opinion of Winston & Strawn, outside counsel to the Company, substantially in the form of EXHIBIT C, and (d) all other documents, instruments and writings required to have been delivered at or prior to the Closing Date by the Company pursuant to this Agreement, including an executed Registration Rights Agreement, dated the date hereof, between the Company and the Purchasers, in the form of EXHIBIT B (the "REGISTRATION RIGHTS AGREEMENT"), and the Irrevocable Transfer Agent Instructions, in the form of EXHIBIT E, delivered to and acknowledged by the Company's transfer agent (the "TRANSFER AGENT INSTRUCTIONS"), (2) to Kohler (a) stock certificates representing 8.1 Shares, registered in the name of Kohler, (b) a Common Stock purchase warrant, in the form of EXHIBIT D, registered in the name of Kohler, pursuant to which Kohler shall have the right at any time and from time to time thereafter through the fifth anniversary of the Closing Date to acquire 1,875 shares of Common Stock at an exercise price per share (subject to adjustment as provided therein) of $9.51 (the "KOHLER WARRANT"), (c) the legal opinion of Winston & Strawn, outside counsel to the Company, substantially in the form of EXHIBIT C, and (d) all other documents, instruments and writings required to have been delivered at or prior to the Closing Date by the Company pursuant to this Agreement, including an executed Registration Rights Agreement, and the Transfer Agent Instructions, (3) to Kohler IRA (a) stock certificates representing 8.1 Shares, registered in the name of Kohler IRA, (b) a Common Stock purchase warrant, in the form of EXHIBIT D, registered in the name of Kohler IRA, pursuant to which Kohler IRA shall have the right at any time and from time to time thereafter through the fifth anniversary of the Closing Date to acquire 1,875 shares of Common Stock at an exercise price per share (subject to adjustment as provided therein) of $9.51 (the "KOHLER IRA WARRANT"), (c) the legal opinion of Winston & Strawn, outside counsel to the Company, substantially in the form of EXHIBIT C, and (d) all other documents, instruments and writings required to have been delivered at or prior to the Closing Date by the Company pursuant to this Agreement, including an executed Registration Rights Agreement, and the Transfer Agent Instructions, (4) to Twin City (a) stock certificates representing 16.2 Shares, registered in the name of Twin City, (b) a Common Stock purchase warrant, in the form of EXHIBIT D, registered in the name of Twin City, pursuant to which Twin City shall have the right at any time and from time to time thereafter through the fifth anniversary of the Closing Date to acquire 3,750 shares of Common Stock at an exercise price per share (subject to adjustment as provided therein) of $9.51 (the "TWIN CITY WARRANT"), and (5) to Stark (a) stock certificates representing 108 Shares, registered in the name of Stark, (b) a Common Stock purchase warrant, in the form of EXHIBIT D, registered in the name of Stark, pursuant to which Stark shall have the right at any time and from time to time thereafter through the fifth anniversary of the Closing Date to acquire 25,000 shares of Common Stock at an exercise price per share (subject to adjustment as provided therein) of $9.51 (the "STARK WARRANT" and collectively with the KA Warrant, the Kohler Warrant, the Kohler IRA Warrant, and the Twin City Warrant, the "WARRANTS"), (c) the legal opinion of Winston & Strawn, outside counsel to the Company, substantially in the form of EXHIBIT C, and (d) all other documents, instruments and writings required to have been delivered at or prior to the Closing Date by the Company pursuant to this Agreement, including an executed Registration Rights Agreement, and the Transfer Agent Instructions; and (B) the Purchasers shall deliver (1) $5,000,000 in United States dollars in immediately available funds by wire transfer to an account designated in writing by the Company for such purpose, and (2) all documents, instruments and writings required to have been delivered at or prior to the Closing Date by the Purchasers pursuant to this Agreement, including, without limitation, an executed Registration Rights Agreement. 1.2 FORM OF PREFERRED STOCK. The Preferred Stock shall have the rights preferences and privileges set forth in EXHIBIT A, and shall be incorporated into a Certificate of Designation (the "CERTIFICATE OF DESIGNATION"), which shall be filed on or prior to the Closing Date by the Company with the Secretary of State of the State of Delaware, in form and substance mutually agreed to by the parties. -2- For purposes of this Agreement, "CONVERSION PRICE," "ORIGINAL ISSUE DATE" and "TRADING DAY" shall have the meanings set forth in EXHIBIT A; "BUSINESS DAY" shall mean any day except Saturday, Sunday and any day which shall be a federal legal holiday or a day on which banking institutions in the States of New York, Illinois or Minnesota are authorized or required by law or other governmental action to close. ARTICLE II REPRESENTATIONS AND WARRANTIES 2.1 REPRESENTATIONS, WARRANTIES AND AGREEMENTS OF THE COMPANY. The Company hereby makes the following representations and warranties to the Purchasers: (a) ORGANIZATION AND QUALIFICATION. The Company is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Delaware, with the requisite corporate power and authority to own and use its properties and assets and to carry on its business as currently conducted. The Company has no subsidiaries other than as set forth in SCHEDULE 2.1(a) (collectively the "SUBSIDIARIES"). Each of the Subsidiaries is an entity, duly incorporated or otherwise organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or organization (as applicable), with the full power and authority to own and use its properties and assets and to carry on its business as currently conducted. Each of the Company and the Subsidiaries is duly qualified to do business and is in good standing as a foreign corporation in each jurisdiction in which the nature of the business conducted or property owned by it makes such qualification necessary, except where the failure to be so qualified or in good standing, as the case may be, could not, individually or in the aggregate, (x) adversely affect the legality, validity or enforceability of the Securities (as defined below) or any of this Agreement, the Certificate of Designation, the Registration Rights Agreement and the Warrants (collectively, the "TRANSACTION DOCUMENTS"), (y) have or result in a material adverse effect on the results of operations, assets, prospects, or condition (financial or otherwise) of the Company and the Subsidiaries, taken as a whole, or (z) adversely impair the Company's ability to perform fully on a timely basis its obligations under any of the Transaction Documents (any of (x), (y) or (z), a "MATERIAL ADVERSE EFFECT"). (b) AUTHORIZATION; ENFORCEMENT. The Company has the requisite corporate power and authority to enter into and to consummate the transactions contemplated by each of the Transaction Documents and otherwise to carry out its obligations thereunder. The execution and delivery of each of the Transaction Documents by the Company and the consummation by it of the transactions contemplated thereby have been duly authorized by all necessary action on the part of the Company and no further action is required by the Company. Each of the Transaction Documents has been duly executed by the Company and, when delivered (or filed, as the case may be) in accordance with the terms hereof, will constitute the valid and binding obligation of the Company enforceable against the Company in accordance with its terms. Neither the Company nor any Subsidiary is in violation of any of the provisions of its respective certificate of incorporation, by-laws or other charter documents. -3- (c) CAPITALIZATION. The number of authorized, issued and outstanding capital stock of the Company is set forth in SCHEDULE 2.1(c). No shares of Common Stock are entitled to preemptive or similar rights, nor is any holder of the Common Stock entitled to preemptive or similar rights arising out of any agreement or understanding with the Company by virtue of any of the Transaction Documents. Except as a result of the purchase and sale of the Shares and the Warrants and except as disclosed in SCHEDULE 2.1(c), there are no outstanding options, warrants, script rights to subscribe to, calls or commitments of any character whatsoever relating to, or securities, rights or obligations convertible into or exchangeable for, or giving any Person any right to subscribe for or acquire, any shares of Common Stock, or contracts, commitments, understandings, or arrangements by which the Company or any Subsidiary is or may become bound to issue additional shares of Common Stock, or securities or rights convertible or exchangeable into shares of Common Stock. To the knowledge of the Company, except as specifically disclosed in the SEC Documents (as defined below) or SCHEDULE 2.1(c), no Person or group of related Persons beneficially owns (as determined pursuant to Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT")), or has the right to acquire by agreement with or by obligation binding upon the Company, in excess of 5% of the Common Stock. A "PERSON" means an individual or corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or subdivision thereof) or other entity of any kind. (d) ISSUANCE OF THE SHARES AND THE WARRANTS. The Shares and the Warrants are duly authorized and, when issued and paid for in accordance with the terms hereof, shall have been duly and validly issued, fully paid and nonassessable, free and clear of all liens, encumbrances and rights of first refusal of any kind (collectively, "LIENS"). The Company has on the date hereof and will, at all times while the Shares and the Warrants are outstanding, maintain an adequate reserve of duly authorized shares of Common Stock, reserved for issuance to the holders of the Shares and the Warrants, to enable it to perform its conversion, exercise and other obligations under this Agreement, the Certificate of Designation and the Warrants. Such number of reserved and available shares of Common Stock is not less than the sum of (i) 1,703,470 shares of Common Stock which would be issuable upon conversion in full of the Shares, and (ii) the number of shares of Common Stock issuable upon exercise of the Warrants (such number of shares of Common Stock, the "INITIAL MINIMUM"). All such authorized shares of Common Stock shall be duly reserved for issuance to the holders of the Shares and the Warrants. The shares of Common Stock issuable upon conversion of the Shares, and upon exercise of the Warrants are collectively referred to herein as the "UNDERLYING SHARES." The Shares, the Warrants and the Underlying Shares are collectively referred to herein as, the "SECURITIES." When issued in accordance with this Agreement, the Certificate of Designation and the Warrants, the Underlying Shares shall have been duly authorized, validly issued, fully paid and nonassessable, free and clear of all Liens. (e) NO CONFLICTS. The execution, delivery and performance of the Transaction Documents by the Company and the consummation by the Company of the transactions contemplated thereby do not and will not (i) conflict with or violate any provision of its certificate of incorporation, bylaws or other charter documents (each as amended through the date hereof), or -4- (ii) subject to obtaining the Required Approvals (as defined below), conflict with, or constitute a default (or an event which with notice or lapse of time or both would become a default) under, or give to others any rights of termination, amendment, acceleration or cancellation (with or without notice, lapse of time or both) of, any agreement, credit facility, indenture or instrument (evidencing a Company debt or otherwise) to which the Company or any Subsidiary is a party or by which any property or asset of the Company or any Subsidiary is bound or affected, or (iii) result in a violation of any law, rule, regulation, order, judgment, injunction, decree or other restriction of any court or governmental authority to which the Company is subject (including Federal and state securities laws and regulations), or by which any property or asset of the Company is bound or affected, except in the case of each of clauses (ii) and (iii), as could not, individually or in the aggregate, have or result in a Material Adverse Effect. The business of the Company is not being conducted in violation of any law, ordinance or regulation of any governmental authority, except for violations which, individually or in the aggregate, could not have or result in a Material Adverse Effect. (f) FILINGS, CONSENTS AND APPROVALS. Neither the Company nor any Subsidiary is required to obtain any consent, waiver, authorization or order of, give any notice to, or make any filing or registration with, any court or other Federal, state, local or other governmental authority or other Person in connection with the execution, delivery and performance by the Company of the Transaction Documents, other than (i) the filing of the Certificate of Designation with the Secretary of State of Delaware, (ii) the filings required pursuant to Section 3.11, (iii) the filing of the Underlying Securities Registration Statement with the Securities and Exchange Commission (the "COMMISSION") meeting the requirements set forth in the Registration Rights Agreement and covering the resale of the Underlying Shares by the Purchasers, (iv) the application(s) to the Nasdaq National Market ("NASDAQ") for the listing of the Underlying Shares for trading on the NASDAQ (and with any other national securities exchange or market on which the Common Stock is then listed for trading), (v) applicable Blue Sky filings, (vi) the consent of Sanwa Bank Credit Corporation and (vii) in all other cases where the failure to obtain such consent, waiver, authorization or order, or to give such notice or make such filing or registration could not have or result in, individually or in the aggregate, a Material Adverse Effect (collectively, the "REQUIRED APPROVALS"). (g) LITIGATION; PROCEEDINGS. Except as specifically disclosed in the SEC Documents, there is no action, suit, notice of violation, proceeding or investigation pending or, to the knowledge of the Company, threatened against or affecting the Company or any of its Subsidiaries or any of their respective properties before or by any court, governmental or administrative agency or regulatory authority (Federal, state, county, local or foreign) which (i) adversely affects or challenges the legality, validity or enforceability of any of the Transaction Documents or the Securities or (ii) could, individually or in the aggregate, have or result in a Material Adverse Effect. (h) NO DEFAULT OR VIOLATION. Except as described on Schedule 2.1(h) hereto, neither the Company nor any Subsidiary (i) is in default under or in violation of (and no event has occurred which has not been waived which, with notice or lapse of time or both, would result in a default by the Company or any Subsidiary under), nor has the Company or any Subsidiary received -5- notice of a claim that it is in default under or that it is in violation of, any indenture, loan or credit agreement or any other agreement or instrument to which it is a party or by which it or any of its properties is bound, (ii) is in violation of any order of any court, arbitrator or governmental body, or (iii) is in violation of any statute, rule or regulation of any governmental authority, except as could not individually or in the aggregate, have or result in a Material Adverse Effect. (i) PRIVATE OFFERING. Assuming the accuracy of the representations and warranties of the Purchasers set forth in Sections 2.2(b)-(g), the offer, issuance and sale of the Securities to the Purchasers as contemplated hereby are exempt from the registration requirements of the Securities Act of 1933, as amended (the "SECURITIES ACT"). Neither the Company nor any Person acting on its behalf has taken any action could subject the offering, issuance or sale of the Securities to the registration requirements of the Securities Act. (j) SEC DOCUMENTS; FINANCIAL STATEMENTS. The Company has filed all reports required to be filed by it under the Exchange Act, including pursuant to Section 13(a) or 15(d) thereof, for the three years preceding the date hereof (or such shorter period as the Company was required by law to file such material) (the foregoing materials being collectively referred to herein as the "SEC DOCUMENTS" and, together with the Schedules to this Agreement the "DISCLOSURE MATERIALS") on a timely basis or has received a valid extension of such time of filing and has filed any such SEC Documents prior to the expiration of any such extension. As of their respective dates, the SEC Documents complied in all material respects with the requirements of the Securities Act and the Exchange Act and the rules and regulations of the Commission promulgated thereunder, and none of the SEC Documents, when filed, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. All material agreements to which the Company is a party or to which the property or assets of the Company are subject have been filed as exhibits to the SEC Documents as required. The financial statements of the Company included in the SEC Documents comply in all material respects with applicable accounting requirements and the rules and regulations of the Commission with respect thereto as in effect at the time of filing. Such financial statements have been prepared in accordance with generally accepted accounting principles applied on a consistent basis ("GAAP") during the periods involved, except as may be otherwise specified in such financial statements or the notes thereto, and fairly present in all material respects the financial position of the Company and its consolidated subsidiaries as of and for the dates thereof and the results of operations and cash flows for the periods then ended, subject, in the case of unaudited statements, to normal, immaterial, year-end audit adjustments. Since Ocotber 30, 1997, except as specifically disclosed in the SEC Documents, (a) there has been no event, occurrence or development that has had or that could have or result in a Material Adverse Effect, (b) the Company has not incurred any liabilities (contingent or otherwise) other than (x) liabilities incurred in the ordinary course of business consistent with past practice and (y) liabilities not required to be reflected in the Company's financial statements pursuant to GAAP or required to be disclosed in filings made with the Commission, (c) the Company has not altered its method of accounting or the identity of its auditors and (d) the Company has not declared or made any payment or distribution of cash or other property to its stockholders or officers or directors (other than in compliance with existing Company stock option plans) with respect to its capital stock, or purchased, redeemed (or made any agreements to purchase or redeem) any shares of its -6- capital stock. The Company last filed audited financial statements with the Commission on January 15, 1998, and has not received any comments from the Commission in respect thereof. (k) INVESTMENT COMPANY. The Company is not, and is not an Affiliate (as defined in Rule 405 under the Securities Act) of, an "investment company" within the meaning of the Investment Company Act of 1940, as amended. (l) CERTAIN FEES. Except for certain fees payable to Miller, Johnson & Kuehn and Craig Hallum, no fees or commissions will be payable by the Company to any broker, financial advisor or consultant, finder, placement agent, investment banker, or bank with respect to the transactions contemplated by this Agreement. The Purchasers shall have no obligation with respect to any fees or with respect to any claims made by or on behalf of other Persons for fees of a type contemplated in this Section that may be due in connection with the transactions contemplated by this Agreement. The Company shall indemnify and hold harmless each of the Purchasers, their employees, officers, directors, agents, and partners, and their respective Affiliates, from and against all claims, losses, damages, costs (including the costs of preparation and attorney's fees) and expenses suffered in respect of any such claimed or existing fees, as such fees and expenses are incurred. (m) SOLICITATION MATERIALS. Neither the Company nor any Person acting on the Company's behalf has solicited any offer to buy or sell the Securities by means of any form of general solicitation or advertising. (n) FORM S-3 ELIGIBILITY. The Company is eligible to register securities for resale in transactions involving secondary offerings with the Commission under Form S-3 promulgated under the Securities Act. (o) EXCLUSIVITY. As long as the Preferred Stock is outstanding, the Company shall not issue and sell shares of Preferred Stock to any Person other than the Purchasers other than with the specific prior written consent of KA. (p) SENIORITY. Except for the Series 1997 Subordinated Convertible Debentures (the "1997 DEBENTURES"), no class of equity securities of the Company is senior to the Shares in right of payment, whether upon liquidation, dissolution, or otherwise. (q) LISTING AND MAINTENANCE REQUIREMENTS COMPLIANCE. Except as described on Schedule 2.1(q) hereto, the Company has not, in the two years preceding the date hereof, received notice (written or oral) from the NASDAQ or any other stock exchange, market or trading facility on which the Common Stock is or has been listed (or on which it has been quoted) to the effect that the Company is not in compliance with the listing or maintenance requirements of such exchange or market. The Company is, and has no reason to believe that it will not in the foreseeable future continue to be, in compliance with all such maintenance requirements. (r) PATENTS AND TRADEMARKS. The Company has, or has rights to use, all patents, patent applications, trademarks, trademark applications, service marks, trade names, copyrights, -7- licenses and rights (collectively, the "INTELLECTUAL PROPERTY RIGHTS") which are necessary or material for use in connection with its business, and which the failure to so have would have a Material Adverse Effect. To the best knowledge of the Company, all such Intellectual Property Rights are enforceable and there is no existing infringement by another Person of any of the Intellectual Property Rights. (s) REGISTRATION RIGHTS; RIGHTS OF PARTICIPATION. Except as set forth on SCHEDULE 6(b) to the Registration Rights Agreement, the Company has not granted or agreed to grant to any Person any rights (including "piggy-back" registration rights) to have any securities of the Company registered with the Commission or any other governmental authority which has not been satisfied. No Person, has any right of first refusal, preemptive right, right of participation, or any similar right to participate in the transactions contemplated by the Transaction Documents. (t) REGULATORY PERMITS. The Company and its Subsidiaries possess all certificates, authorizations and permits issued by the appropriate Federal, state or foreign regulatory authorities necessary to conduct their respective businesses as described in the SEC Documents, except where the failure to possess such permits could not, individually or in the aggregate, have or result in a Material Adverse Effect ("MATERIAL PERMITS"), and neither the Company nor any such Subsidiary has received any notice of proceedings relating to the revocation or modification of any Material Permit. (u) TITLE. Except for Liens existing on the Closing Date, the Company and the Subsidiaries have good and marketable title in fee simple to all real property and personal property owned by them which is material to the business of the Company and its Subsidiaries, in each case free and clear of all Liens, except for Liens as do not materially affect the value of such property and do not interfere with the use made and proposed to be made of such property by the Company and its Subsidiaries. Any real property and facilities held under lease by the Company and its Subsidiaries are held by them under valid, subsisting and enforceable leases with such exceptions as are not material and do not interfere with the use made and proposed to be made of such property and buildings by the Company and its Subsidiaries. (v) DISCLOSURE. The Company confirms that it has not provided the Purchasers or their agents or counsel with any information that constitutes or might constitute material non-public information. The Company understands and confirms that the Purchasers shall be relying on the foregoing representations in effecting transactions in securities of the Company. All disclosure provided to each of the Purchasers regarding the Company, its business and the transactions contemplated hereby, including the Schedules to this Agreement, furnished by or on behalf of the Company are true and correct and do not contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which they were made, not misleading. 2.2 REPRESENTATIONS AND WARRANTIES OF THE PURCHASERS. Each of the Purchasers, severally and not jointly, hereby represent and warrant to the Company as follows: -8- (a) ORGANIZATION; AUTHORITY. Such Purchaser, as applicable, is an entity duly formed, validly existing and in good standing under the laws of the jurisdiction of its formation with the requisite power and authority, to enter into and to consummate the transactions contemplated by the Transaction Documents and otherwise to carry out its obligations thereunder. The purchase by such Purchaser of the Securities hereunder has been duly authorized by all necessary action on the part of such Purchaser. Each of this Agreement and the Registration Rights Agreement has been duly executed and delivered by such Purchaser and constitutes the valid and legally binding obligation of such Purchaser, enforceable against it in accordance with its terms. (b) INVESTMENT INTENT. Such Purchaser is acquiring the Securities for its own account for investment purposes only and not with a view to or for distributing or reselling such Securities or any part thereof or interest therein, without prejudice, however, to such Purchaser's right, subject to the provisions of this Agreement and the Registration Rights Agreement, at all times to sell or otherwise dispose of all or any part of such Securities pursuant to an effective registration statement under the Securities Act and in compliance with applicable state securities laws or under an exemption from such registration. (c) PURCHASER STATUS. At the time such Purchaser was offered the Shares and the Warrants, it was, and at the date hereof it is, and at each exercise date under the Warrants, it will be, an "accredited investor" as defined in Rule 501(a) under the Securities Act. (d) EXPERIENCE OF THE PURCHASER. Such Purchaser, either alone or together with its representatives, has such knowledge, sophistication and experience in business and financial matters so as to be capable of evaluating the merits and risks of the prospective investment in the Securities, and has so evaluated the merits and risks of such investment. (e) ABILITY OF THE PURCHASER TO BEAR RISK OF INVESTMENT. Such Purchaser is able to bear the economic risk of an investment in the Securities and, at the present time, is able to afford a complete loss of such investment. (f) ACCESS TO INFORMATION. Such Purchaser acknowledges that it has reviewed the Disclosure Materials and has been afforded (i) the opportunity to ask such questions as it has deemed necessary of, and to receive answers from, representatives of the Company concerning the terms and conditions of the offering of the Securities and the merits and risks of investing in the Securities; (ii) access to information about the Company and the Company's financial condition, results of operations, business, properties, management and prospects sufficient to enable it to evaluate its investment; and (iii) the opportunity to obtain such additional information which the Company possesses or can acquire without unreasonable effort or expense that is necessary to make an informed investment decision with respect to the investment and to verify the accuracy and completeness of the information contained in the Disclosure Materials. Neither such inquiries nor any other investigation conducted by or on behalf of such Purchaser or its representatives or counsel shall modify, amend or affect such Purchaser's right to rely on the truth, accuracy and completeness of the Disclosure Materials and the Company's representations and warranties contained in the Transaction Documents. -9- (g) GENERAL SOLICITATION. Such Purchaser is not purchasing the Securities as a result of or subsequent to any advertisement, article, notice or other communication regarding the Securities published in any newspaper, magazine or similar media or broadcast over television or radio or presented at any seminar or any other general solicitation or general advertisement. (h) RELIANCE. Such Purchaser understands and acknowledges that (i) the Securities are being offered and sold to it without registration under the Securities Act in a private placement that is exempt from the registration provisions of the Securities Act and (ii) the availability of such exemption, depends in part on, and the Company will rely upon the accuracy and truthfulness of, the foregoing representations and such Purchaser hereby consents to such reliance. The Company acknowledges and agrees that such Purchaser makes no representations or warranties with respect to the transactions contemplated hereby other than those specifically set forth in this Section 2.2. ARTICLE III OTHER AGREEMENTS OF THE PARTIES 3.1 TRANSFER RESTRICTIONS. (a) Securities may only be disposed of pursuant to an effective registration statement under the Securities Act, to the Company or pursuant to an available exemption from or in a transaction not subject to the registration requirements of the Securities Act. In connection with any transfer of Securities other than pursuant to an effective registration statement or to the Company, except as otherwise set forth herein, the Company may require the transferor thereof to provide to the Company an opinion of counsel selected by the transferor, the form and substance of which opinion shall be reasonably satisfactory to the Company, to the effect that such transfer does not require registration of such transferred securities under the Securities Act. Notwithstanding the foregoing, the Company hereby consents to and agrees to register on the books of the Company and with any transfer agent for the securities of the Company any transfer of Securities by any Purchaser to an Affiliate of such Purchaser or to one or more funds under common management with such Purchaser, and any transfer among any such Affiliates or one or more funds, provided that the transferee certifies to the Company that it is an "accredited investor" as defined in Rule 501(a) under the Securities Act and that it is acquiring the Securities solely for investment purposes. Any such transferee shall agree in writing to be bound by the terms of this Agreement and shall have the rights and obligations of a Purchaser under this Agreement and the Registration Rights Agreement. (b) Each Purchaser agrees to the imprinting, so long as is required by this Section 3.1(b), of the following legend on the Securities: NEITHER THESE SECURITIES NOR THE SECURITIES INTO WHICH THESE SECURITIES ARE [CONVERTIBLE] [EXERCISABLE] HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM -10- REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS. Underlying Shares shall not contain the legend set forth above nor any other legend if the conversion of Shares and exercise of the Warrants or other issuances of Underlying Shares as contemplated hereby, by the Certificate of Designation or the Warrants occurs at any time while an Underlying Securities Registration Statement is effective under the Securities Act or, in the event there is not an effective Underlying Securities Registration Statement, at such time, if in the opinion of counsel to the Company, such legend is not required under applicable requirements of the Securities Act (including judicial interpretations and pronouncements issued by the staff of the Commission). The Company shall issue the Transfer Agent Instructions to the Company's transfer agent on the day that the Underlying Securities Registration Statement is declared effective by the Commission. The Company agrees that, in the event any Underlying Shares are issued with a legend in accordance with this Section 3.1(b), it will, within three (3) Trading Days after request therefor by any such Purchaser, provide such Purchaser with a certificate or certificates representing such Underlying Shares, free from such legend at such time as such legend would not have been required under this Section 3.1(b) had such issuance occurred on the date of such request. The Company may not make any notation on its records or give instructions to any transfer agent of the Company which enlarge the restrictions of transfer set forth in this Section. 3.2 ACKNOWLEDGMENT OF DILUTION. The Company acknowledges that the issuance of the Underlying Shares upon (i) conversion of the Shares in accordance with the terms of the Certificate of Designation, and (ii) exercise of the Warrants in accordance with its terms, will result in dilution of the outstanding shares of Common Stock. The Company further acknowledges that its obligation to issue Underlying Shares upon (x) conversion of the Shares in accordance with the terms of the Certificate of Designation, and (y) exercise of the Warrants in accordance with its terms, is unconditional and absolute, subject to the limitations set forth herein in the Certificate of Designation or pursuant to the Warrants, regardless of the effect of any such dilution. 3.3 FURNISHING OF INFORMATION. As long as any Purchaser owns Securities, the Company covenants to timely file (or obtain extensions in respect thereof and file within the applicable grace period) all reports required to be filed by the Company after the date hereof pursuant to Section 13(a) or 15(d) of the Exchange Act. As long as any Purchaser owns Securities, if the Company is not required to file reports pursuant to such sections, it will prepare and furnish to each Purchaser and make publicly available in accordance with Rule 144(c) promulgated under the Securities Act such information as is required for such Purchaser to sell the Securities under Rule 144 promulgated under the Securities Act. The Company further covenants that it will take such further action as any holder of Securities may reasonably request, all to the extent required from time to time to enable such Person to sell Underlying Shares without registration under the Securities Act within the limitation -11- of the exemptions provided by Rule 144 promulgated under the Securities Act. Upon the request of any such Person, the Company shall deliver to such Person a written certification of a duly authorized officer as to whether it has complied with such requirements. 3.4 INTEGRATION. The Company shall not, and shall use its best efforts to ensure that, no Affiliate shall, sell, offer for sale or solicit offers to buy or otherwise negotiate in respect of any security (as defined in Section 2 of the Securities Act) that would be integrated with the offer or sale of the Securities in a manner that would require the registration under the Securities Act of the sale of the Securities to the Purchasers. 3.5 INCREASE IN AUTHORIZED SHARES. If on any date the Company would be, if a notice of conversion or exercise (as the case may be) were to be delivered on such date, precluded from (a) issuing the number of Underlying Shares as would then be issuable upon a conversion in full of the Shares then outstanding, or (b) issuing the number of Underlying Shares upon exercise in full of the Warrants (the "CURRENT REQUIRED MINIMUM"), in either case, due to the unavailability of a sufficient number of authorized but unissued or reserved shares of Common Stock, then the Board of Directors of the Company shall promptly (and in any case, within 30 Business Days from such date) prepare and mail to the stockholders of the Company proxy materials requesting authorization to amend the Company's Certificate of Incorporation to increase the number of shares of Common Stock which the Company is authorized to issue to at least such number of shares as reasonably requested by the Purchasers in order to provide for such number of authorized and unissued shares of Common Stock to enable the Company to comply with its issuance, conversion exercise and reservation of shares obligations as set forth in this Agreement, the Certificate of Designation and the Warrants (the sum of (x) the number of shares of Common Stock then authorized, (y) the number of shares of Common Stock then outstanding plus all shares of Common Stock issuable upon exercise of all outstanding options, warrants and convertible instruments, and (z) the Current Required Minimum, shall be a reasonable number). In connection therewith, the Board of Directors shall (a) adopt proper resolutions authorizing such increase, (b) recommend to and otherwise use its best efforts to promptly and duly obtain stockholder approval to carry out such resolutions (and hold a special meeting of the stockholders no later than the 60th day after delivery of the proxy materials relating to such meeting) and (c) within five (5) Business Days of obtaining such stockholder authorization, file an appropriate amendment to the Company's Certificate of Incorporation to evidence such increase. 3.6 RESERVATION AND LISTING OF UNDERLYING SHARES. (a) The Company shall (i) not later than the tenth (10th) Business Day following the Closing Date prepare and file with the NASDAQ (and such other national securities exchange or market or trading or quotation facility on which the Common Stock is then listed) an additional shares listing application covering a number of shares of Common Stock which is not less than the Initial Minimum, (ii) take all steps necessary to cause such shares of Common Stock to be approved for listing in the NASDAQ (as well as on any such other national securities exchange or market or trading or quotation facility on which the Common Stock is then listed) as soon as possible thereafter, and (iii) provide to the Purchasers evidence of such listing, and the Company shall maintain the listing of its Common Stock thereon. If the number of Underlying Shares issuable upon conversion in full of the then outstanding Shares and upon exercise of the then unexercised portion of the Warrants exceeds 85% of the number of Underlying -12- Shares previously listed on account thereof with the NASDAQ (as well as on any such other national securities exchange or market or trading or quotation facility on which the Common Stock is then listed), then the Company shall take the necessary actions to immediately list a number of Underlying Shares as equals no less than the then Current Required Minimum. (b) The Company shall maintain a reserve of shares of Common Stock for issuance upon conversion of the Shares and upon exercise in full of the Warrants in accordance with this Agreement, the Certificate of Designation and the Warrants, respectively, in such amount as may be required to fulfill its obligations in full under the Transaction Documents, which reserve shall equal no less than the then Current Required Minimum. 3.7 CONVERSION AND EXERCISE PROCEDURES. The Transfer Agent Instructions, Conversion Notice (as defined in EXHIBIT A) and Notice of Exercise under the Warrants set forth the totality of the procedures with respect to the conversion of the Shares and exercise of the Warrants, including the form of legal opinion, if necessary, that shall be rendered to the Company's transfer agent and such other information and instructions as may be reasonably necessary to enable the Purchasers to convert their Shares and exercise the Warrants as contemplated in the Certificate of Designation and the Warrants (as applicable). 3.8 NOTICE OF BREACHES. Each of the Company and the Purchasers shall give prompt written notice to the other of any breach by it of any representation, warranty or other agreement contained in any Transaction Document, as well as any events or occurrences arising after the date hereof which would reasonably be likely to cause any representation or warranty or other agreement of such party, as the case may be, contained therein to be incorrect or breached as of the Closing Date. However, no disclosure by either party pursuant to this Section shall be deemed to cure any breach of any representation, warranty or other agreement contained in any Transaction Document. 3.9 CONVERSION AND EXERCISE OBLIGATIONS OF THE COMPANY. The Company shall honor conversions of the Shares and exercises of the Warrants and shall deliver Underlying Shares in accordance with the respective terms, conditions and time periods set forth in the Certificate of Designation and the Warrants. 3.10 RIGHT OF FIRST REFUSAL; SUBSEQUENT REGISTRATIONS. (a) The Company shall not, directly or indirectly, without the prior written consent of KA, offer, sell, grant any option to purchase, or otherwise dispose of (or announce any offer, sale, grant or any option to purchase or other disposition) any of its or its Affiliates' equity or equity-equivalent securities or a transaction intended to be exempt or not subject to registration under the Securities Act (a "SUBSEQUENT PLACEMENT") for a period of 180 days after the Closing Date, except (i) the granting of options or warrants to employees, officers and directors, and the issuance of shares upon exercise of options granted, under any stock option plan heretofore or hereinafter duly adopted by the Company, (ii) shares of Common Stock issuable upon exercise of any currently outstanding warrants and upon conversion of any currently outstanding convertible securities of the Company, in each case disclosed in Schedule 2.1(c), and (iii) shares of Common Stock issuable upon conversion of the Shares and upon exercise of the Warrants in accordance with the Certificate of Designation or the Warrants, respectively, unless (A) the Company delivers to KA a written notice (the "SUBSEQUENT -13- PLACEMENT NOTICE") of its intention effect such Subsequent Placement, which Subsequent Placement Notice shall describe in reasonable detail the proposed terms of such Subsequent Placement, the amount of proceeds intended to be raised thereunder, the Person with whom such Subsequent Placement shall be effected, and attached to which shall be a term sheet or similar document relating thereto and (B) KA shall not have notified the Company by 5:00 p.m. (Minnetonka, Minnesota time) on the tenth (10th) Trading Day after its receipt of the Subsequent Placement Notice of its willingness to cause KA to provide (or to cause its sole designee to provide), subject to completion of mutually acceptable documentation, financing to the Company on substantially the terms set forth in the Subsequent Placement Notice. If KA shall fail to notify the Company of its intention to enter into such negotiations within such time period, the Company may effect the Subsequent Placement substantially upon the terms and to the Persons (or Affiliates of such Persons) set forth in the Subsequent Placement Notice; PROVIDED, that the Company shall provide KA with a second Subsequent Placement Notice, and KA shall again have the right of first refusal set forth above in this paragraph (a), if the Subsequent Placement subject to the initial Subsequent Placement Notice shall not have been consummated for any reason on the terms set forth in such Subsequent Placement Notice within forty (40) Trading Days after the date of the initial Subsequent Placement Notice with the Person (or an Affiliate of such Person) identified in the Subsequent Placement Notice. (b) Except for (w) shares issued or registered in connection with the 1997 Debentures and the warrants issued in connection therewith, (x) Underlying Shares, (y) other "Registrable Securities" (as such term is defined in the Registration Rights Agreement) to be registered, and securities of the Company permitted pursuant to Schedule 6(b) of the Registration's Rights Agreement to be registered, in the Underlying Securities Registration Statement in accordance with the Registration Rights Agreement, and (z) Common Stock to be registered for resale in connection with financings permitted pursuant to paragraph (a)(i) - (iii) of Section 3.10(a), the Company shall not, without the prior written consent of KA (i) issue or sell any of its or any of its Affiliates' equity or equity-equivalent securities pursuant to Regulation S promulgated under the Securities Act, or (ii) register for resale any securities of the Company for a period of not less than 90 Trading Days after the date that the Underlying Securities Registration Statement is declared effective by the Commission. Any days that a Purchaser is unable to sell Underlying Shares under the Underlying Securities Registration Statement shall be added to such 90 Trading Day period for the purposes of (i) and (ii) above. 3.11 CERTAIN SECURITIES LAWS DISCLOSURES; PUBLICITY. The Company shall: (i) issue a press release reasonably acceptable to KA disclosing the transactions contemplated hereby on the Closing Date, (ii) file with the Commission a Report on Form 8-K disclosing the transactions contemplated hereby within ten (10) Business Days after the Closing Date, and (iii) timely file with the Commission a Form D promulgated under the Securities Act as required under Regulation D promulgated under the Securities Act and provide a copy thereof to the Purchasers promptly after the filing thereof. The Company shall, no less than two (2) Business Days prior to the filing of any disclosure required by clauses (ii) and (iii) above, provide a copy thereof to such Purchaser. No such filing or disclosure may be made that mentions any Purchaser by name without the prior consent of such Purchaser. -14- 3.12 TRANSFER OF INTELLECTUAL PROPERTY RIGHTS. Except in connection with the sale of all or substantially all of the assets of the Company, the Company shall not transfer, sell or otherwise dispose of any Intellectual Property Rights, or allow any of the Intellectual Property Rights to become subject to any Liens, or fail to renew such Intellectual Property Rights (if renewable and it would otherwise lapse if not renewed), without the prior written consent of KA. 3.13 USE OF PROCEEDS. The Company shall use the net proceeds from the sale of the Securities hereunder for working capital purposes and not to redeem any Company equity or equity-equivalent securities. Pending application of the proceeds of this placement in the manner permitted hereby, the Company will invest such proceeds in interest bearing accounts and/or short-term, investment grade interest bearing securities. 3.14 REIMBURSEMENT. If any Purchaser, other than by reason of its gross negligence or willful misconduct, becomes involved in any capacity in any action, proceeding or investigation brought by or against any Person, including stockholders of the Company, in connection with or as a result of the consummation of the transactions contemplated by Transaction Documents, the Company will reimburse such Purchaser for its reasonable legal and other expenses (including the cost of any investigation and preparation) incurred in connection therewith, as such expenses are incurred. In addition, other than with respect to any matter in which such Purchaser is a named party, the Company will pay such Purchaser the charges, as reasonably determined by such Purchaser, for the time of any officers or employees of such Purchaser devoted to appearing and preparing to appear as witnesses, assisting in preparation for hearings, trials or pretrial matters, or otherwise with respect to inquiries, hearings, trials, and other proceedings relating to the subject matter of this Agreement. The reimbursement obligations of the Company under this paragraph shall be in addition to any liability which the Company may otherwise have, shall extend upon the same terms and conditions to any Affiliates of such Purchaser who are actually named in such action, proceeding or investigation, and partners, directors, agents, employees and controlling persons (if any), as the case may be, of the Purchaser and any such Affiliate, and shall be binding upon and inure to the benefit of any successors, assigns, heirs and personal representatives of the Company, the Purchasers and any such Affiliate and any such Person. The Company also agrees that neither the Purchasers nor any such Affiliates, partners, directors, agents, employees or controlling persons shall have any liability to the Company or any Person asserting claims on behalf of or in right of the Company in connection with or as a result of the consummation of the Transaction Documents except to the extent that any losses, claims, damages, liabilities or expenses incurred by the Company result from the gross negligence or willful misconduct of the Purchasers or entity in connection with the transactions contemplated by this Agreement. -15- ARTICLE IV MISCELLANEOUS 4.1 FEES AND EXPENSES. At the Closing the Company shall pay $20,000 to Robinson Silverman in connection with the preparation and negotiation of the Transaction Documents. Other than the amounts contemplated in the immediately preceding sentence, and except as otherwise set forth in the Registration Rights Agreement, each party shall pay the fees and expenses of its advisers, counsel, accountants and other experts, if any, and all other expenses incurred by such party incident to the negotiation, preparation, execution, delivery and performance of this Agreement. The Company shall pay all stamp and other taxes and duties levied in connection with the issuance of the Securities. 4.2 ENTIRE AGREEMENT; AMENDMENTS. The Transaction Documents, together with the Exhibits and Schedules thereto, and the Transfer Agent Instructions contain the entire understanding of the parties with respect to the subject matter hereof and supersede all prior agreements and understandings, oral or written, with respect to such matters, which the parties acknowledge have been merged into such documents, exhibits and schedules. 4.3 NOTICES. Any and all notices or other communications or deliveries required or permitted to be provided hereunder shall be in writing and shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section prior to 8:00 p.m. (Minnetonka, Minnesota time) on a Business Day, (ii) the Business Day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Agreement later than 8:00 p.m. (Minnetonka, Minnesota time) on any date and earlier than 11:59 p.m. (Minnetonka, Minnesota time) on such date, (iii) the Business Day following the date of mailing, if sent by nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. The address for such notices and communications shall be as follows: If to the Company: TRO Learning, Inc. 4660 West 77th Street Edina, MN 55435 Facsimile No.: (612) 832-1210 Attn: Chief Financial Officer With copies to: Winston & Strawn 35 West Wacker Drive, 42nd Floor Chicago, IL 60601 Facsimile No.: (312) 558-5700 Attn: Leland E. Hutchinson If to KA: KA Investments LDC c/o Deephaven Capital Management LLC -16- 1712 Hopkins Crossroads Minnetonka, MN 55305 Facsimile No.: (612) 542-4244 Attn: Bruce Lieberman With copies to: Robinson Silverman Pearce Aronsohn & Berman LLP 1290 Avenue of the Americas New York, NY 10104 Facsimile No.: (212) 541-4630 Attn: Kenneth L. Henderson If to Kohler or Kohler IRA: Gary S. Kohler c/o Miller, Johnson & Kuehn 5500 Wayzata Blvd., 8th Floor Minneapolis, MN 55416 If to Twin City: Twin City Carpenters Pension Plan c/o Perkins Capital Management, Inc. 730 East Lake Street Wayzata, MN 55391 If to Stark: Stark International 1500 West Market Street Mequon, WI 53092 or such other address as may be designated in writing hereafter, in the same manner, by such Person. 4.4 AMENDMENTS; WAIVERS. No provision of this Agreement may be waived or amended except in a written instrument signed, in the case of an amendment, by both the Company and Purchasers holding in the aggregate at least 66 2/3% of the then outstanding Shares or, in the case of a waiver, by the party against whom enforcement of any such waiver is sought. No waiver of any default with respect to any provision, condition or requirement of this Agreement shall be deemed to be a continuing waiver in the future or a waiver of any other provision, condition or requirement hereof, nor shall any delay or omission of either party to exercise any right hereunder in any manner impair the exercise of any such right accruing to it thereafter. 4.5 HEADINGS. The headings herein are for convenience only, do not constitute a part of this Agreement and shall not be deemed to limit or affect any of the provisions hereof. 4.6 SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon and inure to the benefit of the parties and their successors and permitted assigns. The Company may not assign this Agreement or any rights or obligations hereunder without the prior written consent of each of the Purchasers. Except as set forth in Section 3.1(a), no Purchaser may assign this Agreement or any -17- of the rights or obligations hereunder (other than to an Affiliate of such Purchaser) without the consent of the Company. This provision shall not limit any Purchaser's right to transfer securities or transfer or assign rights hereunder or under the Registration Rights Agreement, provided that the Company shall receive notice of any such transfer. 4.7 NO THIRD-PARTY BENEFICIARIES. This Agreement is intended for the benefit of the parties hereto and their respective successors and permitted assigns and is not for the benefit of, nor may any provision hereof be enforced by, any other Person. 4.8 GOVERNING LAW. This Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of New York without regard to the principles of conflicts of law thereof. Each party hereby irrevocably submits to the exclusive jurisdiction of the state and federal courts sitting in the City of New York, borough of Manhattan, for the adjudication of any dispute hereunder or in connection herewith or with any transaction contemplated hereby or discussed herein (including with respect to the enforcement of the any of the Transaction Documents), and hereby irrevocably waives, and agrees not to assert in any suit, action or proceeding, any claim that it is not personally subject to the jurisdiction of any such court, that such suit, action or proceeding is improper. Each party hereby irrevocably waives personal service of process and consents to process being served in any such suit, action or proceeding by mailing a copy thereof to such party at the address in effect for notices to it under this Agreement and agrees that such service shall constitute good and sufficient service of process and notice thereof. Nothing contained herein shall be deemed to limit in any way any right to serve process in any manner permitted by law. 4.9 SURVIVAL. The representations, warranties, agreements and covenants contained herein shall survive the Closing and the delivery and conversion or exercise (as the case may be) of the Shares and the Warrants. 4.10 EXECUTION. This Agreement may be executed in two or more counterparts, all of which when taken together shall be considered one and the same agreement and shall become effective when counterparts have been signed by each party and delivered to the other party, it being understood that both parties need not sign the same counterpart. In the event that any signature is delivered by facsimile transmission, such signature shall create a valid and binding obligation of the party executing (or on whose behalf such signature is executed) the same with the same force and effect as if such facsimile signature page were an original thereof. 4.11 PUBLICITY. The Company and the Purchasers shall consult with each other in issuing any press releases or otherwise making public statements or filings and other communications with the Commission or any regulatory agency or stock market or trading facility with respect to the transactions contemplated hereby and neither party shall issue any such press release or otherwise make any such public statement, filings or other communications without the prior written consent of the other, which consent shall not be unreasonably withheld or delayed, except that no prior consent shall be required if such disclosure is required by law, in which such -18- case the disclosing party shall provide the other party with prior notice of such public statement, filing or other communication. Notwithstanding the foregoing, the Company shall not publicly disclose the name of any Purchaser or include the name of any Purchaser in any filing with the Commission, or any regulatory agency, trading facility or stock market without the prior written consent of such Purchaser, except to the extent such disclosure (but not any disclosure as to the controlling Persons thereof) is required by law, in which case the Company shall provide such Purchaser with prior notice of such disclosure. 4.12 SEVERABILITY. In case any one or more of the provisions of this Agreement shall be invalid or unenforceable in any respect, the validity and enforceability of the remaining terms and provisions of this Agreement shall not in any way be affecting or impaired thereby and the parties will attempt to agree upon a valid and enforceable provision which shall be a reasonable substitute therefor, and upon so agreeing, shall incorporate such substitute provision in this Agreement. 4.13 REMEDIES. In addition to being entitled to exercise all rights provided herein or granted by law, including recovery of damages, the Purchasers will be entitled to specific performance of the obligations of the Company under the Transaction Documents. Each of the Company and the Purchasers (severally and not jointly) agree that monetary damages may not be adequate compensation for any loss incurred by reason of any breach of its obligations described in the foregoing sentence and hereby agrees to waive in any action for specific performance of any such obligation the defense that a remedy at law would be adequate. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK SIGNATURE PAGE FOLLOWS] -19- IN WITNESS WHEREOF, the parties hereto have caused this Convertible Preferred Stock Purchase Agreement to be duly executed by their respective authorized signatories as of the date first indicated above. Company: . TRO LEARNING, INC. By: -------------------------------------------- Name: Title: Purchasers: KA INVESTMENTS LDC By: -------------------------------------------- Name: Title: -------------------------------------------- GARY S. KOHLER FIRST TRUST NATIONAL ASSOCIATION TTEE FBO GARY KOHLER IRA By: -------------------------------------------- Name: Title: INDUSTRICORP & CO., INC. FBO TWIN CITY CARPENTERS PENSION PLAN By: -------------------------------------------- Name: Title: STARK INTERNATIONAL By: -------------------------------------------- Name: Title: - ------------------------------------------------------------------------------- CONVERTIBLE PREFERRED STOCK PURCHASE AGREEMENT Among TRO LEARNING, INC., KA INVESTMENTS LDC, GARY S. KOHLER, FIRST TRUST NATIONAL ASSOCIATION TTEE FBO GARY KOHLER IRA, INDUSTRICORP & CO., INC. FBO TWIN CITY CARPENTERS PENSION PLAN, and STARK INTERNATIONAL January 13, 1999 - ------------------------------------------------------------------------------- EX-10.24 4 EX-10.24 EXHIBIT D NEITHER THESE SECURITIES NOR THE SECURITIES INTO WHICH THESE SECURITIES ARE EXERCISABLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM THE REGISTRATION REQUIREMENTS THEREUNDER AND IN COMPLIANCE WITH APPLICABLE STATE SECURITIES OR BLUE SKY LAWS. TRO LEARNING, INC. WARRANT Dated: January 13, 1999 TRO Learning, Inc., a Delaware corporation (the "Company"), hereby certifies that, for value received, [ ], or its registered assigns ("Holder"), is entitled, subject to the terms set forth below, to purchase from the Company up to a total of [ ] shares of Common Stock, $.01 par value per share (the "Common Stock"), of the Company (each such share, a "Warrant Share" and all such shares, the "Warrant Shares") at an exercise price equal to $9.51 per share (as adjusted from time to time as provided in Section 9, the "Exercise Price"), at any time and from time to time from and after the date hereof and through and including January 13, 2004 (the "Expiration Date"), and subject to the following terms and conditions: 1. REGISTRATION OF WARRANT. The Company shall register this Warrant, upon records to be maintained by the Company for that purpose (the "Warrant Register"), in the name of the record Holder hereof from time to time. The Company may deem and treat the registered Holder of this Warrant as the absolute owner hereof for the purpose of any exercise hereof or any distribution to the Holder, and for all other purposes, and the Company shall not be affected by notice to the contrary. 2. REGISTRATION OF TRANSFERS AND EXCHANGES. (a) The Company shall register the transfer of any portion of this Warrant in the Warrant Register, upon surrender of this Warrant, with the Form of Assignment attached hereto duly completed and signed, to the Transfer Agent or to the Company at the office specified in or pursuant to Section 3(b). Upon any such registration or transfer, a new warrant to purchase Common Stock, in substantially the form of this Warrant (any such new warrant, a "New Warrant"), evidencing the portion of this Warrant so transferred shall be issued to the transferee and a New Warrant evidencing the remaining portion of this Warrant not so transferred, if any, shall be issued to the transferring Holder. The acceptance of the New Warrant by the transferee thereof shall be deemed the acceptance of such transferee of all of the rights and obligations of a holder of a Warrant. (b) This Warrant is exchangeable, upon the surrender hereof by the Holder to the office of the Company specified in or pursuant to Section 3(b) for one or more New Warrants, evidencing in the aggregate the right to purchase the number of Warrant Shares which may then be purchased hereunder. Any such New Warrant will be dated the date of such exchange. 3. DURATION AND EXERCISE OF WARRANTS. (a) This Warrant shall be exercisable by the registered Holder on any business day before 8:00 P.M., New York City time, at any time and from time to time on or after the date hereof to and including the Expiration Date. At 8:00 P.M., New York City time on the Expiration Date, the portion of this Warrant not exercised prior thereto shall be and become void and of no value. Prior to the Expiration Date, the Company may not call or otherwise redeem this Warrant without the prior written consent of the Holder. (b) Subject to Sections 2(b), 6 and 10, upon surrender of this Warrant, with the Form of Election to Purchase attached hereto duly completed and signed, to the Company at its address for notice set forth in Section 12 and upon payment of the Exercise Price multiplied by the number of Warrant Shares that the Holder intends to purchase hereunder, in the manner provided hereunder, all as specified by the Holder in the Form of Election to Purchase, the Company shall promptly (but in no event later than 3 business days after the Date of Exercise (as defined herein)) issue or cause to be issued and cause to be delivered to or upon the written order of the Holder and in such name or names as the Holder may designate, a certificate for the Warrant Shares issuable upon such exercise, free of restrictive legends except (i) either in the event that a registration statement covering the resale of the Warrant Shares and naming the Holder as a selling stockholder thereunder is not then effective or the Warrant Shares are not freely transferable without volume restrictions pursuant to Rule 144(k) promulgated under the Securities Act of 1933, as amended (the "Securities Act"), or (ii) if this Warrant shall have been issued pursuant to a written agreement between the original Holder and the Company, as required by such agreement. Any person so designated by the Holder to receive Warrant Shares shall be deemed to have become holder of record of such Warrant Shares as of the Date of Exercise of this Warrant. A "Date of Exercise" means the date on which the Company shall have received (i) this Warrant (or any New Warrant, as applicable), with the Form of Election to Purchase -2- attached hereto (or attached to such New Warrant) appropriately completed and duly signed, and (ii) payment of the Exercise Price for the number of Warrant Shares so indicated by the holder hereof to be purchased. (c) This Warrant shall be exercisable, either in its entirety or, from time to time, for a portion of the number of Warrant Shares. If less than all of the Warrant Shares which may be purchased under this Warrant are exercised at any time, the Company shall issue or cause to be issued, at its expense, a New Warrant evidencing the right to purchase the remaining number of Warrant Shares for which no exercise has been evidenced by this Warrant. 4. PIGGYBACK REGISTRATION RIGHTS. During the term of this Warrant, the Company may not file any registration statement with the Securities and Exchange Commission (other than registration statements of the Company filed on Form S-8 or Form S-4, each as promulgated under the Securities Act, pursuant to which the Company is registering securities pursuant to a Company employee benefit plan or pursuant to a merger, acquisition or similar transaction including supplements thereto, but not additionally filed registration statements in respect of such securities) at any time when there is not an effective registration statement covering the resale of the Warrant Shares and naming the Holder as a selling stockholder thereunder, unless the Company provides the Holder with not less than 20 days notice of its intention to file such registration statement and provides the Holder the option to include any or all of the applicable Warrant Shares therein. The piggyback registration rights granted to the Holder pursuant to this Section shall continue until all of the Holder's Warrant Shares have been sold in accordance with an effective registration statement or upon the Expiration Date. The Company will pay all registration expenses in connection therewith. 5. DEMAND REGISTRATION RIGHTS. At any time during the term of this Warrant when the Warrant Shares are not registered pursuant to an effective registration statement, the Holder may make a written request for the registration under the Securities Act (a "Demand Registration"), of all of the Warrant Shares (the "Registrable Securities"), and the Company shall use its best efforts to effect such Demand Registration as promptly as possible, but in any case within 90 days thereafter. Any request for a Demand Registration shall specify the aggregate number of Registrable Securities proposed to be sold and shall also specify the intended method of disposition thereof. The right to cause a registration of the Registrable Securities under this Section 5 shall be limited to one such registration. In any registration initiated as a Demand Registration, the Company will pay all of its registration expenses in connection therewith. A Demand Registration shall not be counted as a Demand Registration hereunder until the registration statement filed pursuant to the Demand Registration has been declared effective by the Securities and Exchange Commission and maintained continuously effective for a period of at least 360 days or such shorter period when all Registrable Securities included therein have been sold in accordance with such registration statement, provided, however that any days on which such registration statement is not effective or on which the Holder is not permitted by the Company or any governmental authority to sell Warrant Shares under such registration statement shall not count towards such 360 day period. -3- 6. PAYMENT OF TAXES. The Company will pay all documentary stamp taxes attributable to the issuance of Warrant Shares upon the exercise of this Warrant; provided, however, that the Company shall not be required to pay any tax which may be payable in respect of any transfer involved in the registration of any certificates for Warrant Shares or Warrants in a name other than that of the Holder. The Holder shall be responsible for all other tax liability that may arise as a result of holding or transferring this Warrant or receiving Warrant Shares upon exercise hereof. 7. REPLACEMENT OF WARRANT. If this Warrant is mutilated, lost, stolen or destroyed, the Company shall issue or cause to be issued in exchange and substitution for and upon cancellation hereof, or in lieu of and substitution for this Warrant, a New Warrant, but only upon receipt of evidence reasonably satisfactory to the Company of such loss, theft or destruction and indemnity, if requested, satisfactory to it. Applicants for a New Warrant under such circumstances shall also comply with such other reasonable regulations and procedures and pay such other reasonable charges as the Company may prescribe. 8. RESERVATION OF WARRANT SHARES. The Company covenants that it will at all times reserve and keep available out of the aggregate of its authorized but unissued Common Stock, solely for the purpose of enabling it to issue Warrant Shares upon exercise of this Warrant as herein provided, the number of Warrant Shares which are then issuable and deliverable upon the exercise of this entire Warrant, free from preemptive rights or any other actual contingent purchase rights of persons other than the Holder (taking into account the adjustments and restrictions of Section 9). The Company covenants that all Warrant Shares that shall be so issuable and deliverable shall, upon issuance and the payment of the applicable Exercise Price in accordance with the terms hereof, be duly and validly authorized, issued and fully paid and nonassessable. 9. CERTAIN ADJUSTMENTS. The Exercise Price and number of Warrant Shares issuable upon exercise of this Warrant are subject to adjustment from time to time as set forth in this Section 9; provided however that the Exercise Price shall never be less than $.01 per Warrant Share issuable upon exercise. Upon each such adjustment of the Exercise Price pursuant to this Section 9, the Holder shall thereafter prior to the Expiration Date be entitled to purchase, at the Exercise Price resulting from such adjustment, the number of Warrant Shares obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of Warrant Shares issuable upon exercise of this Warrant immediately prior to such adjustment and dividing the product thereof by the Exercise Price resulting from such adjustment. (a) If the Company, at any time while this Warrant is outstanding, (i) shall pay a stock dividend (except scheduled dividends paid on outstanding preferred stock as of the date hereof which contain a stated dividend rate) or otherwise make a distribution or distributions on shares of its Common Stock or on any other class of capital stock payable in shares of Common Stock, (ii) subdivide outstanding shares of Common Stock into a larger number of shares, or (iii) combine outstanding shares of Common Stock into a smaller number of shares, the Exercise Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock (excluding treasury shares, if any) outstanding before such event and of which the -4- denominator shall be the number of shares of Common Stock (excluding treasury shares, if any) outstanding after such event. Any adjustment made pursuant to this Section shall become effective immediately after the record date for the determination of stockholders entitled to receive such dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision or combination, and shall apply to successive subdivisions and combinations. (b) In case of any reclassification of the Common Stock, any consolidation or merger of the Company with or into another person, the sale or transfer of all or substantially all of the assets of the Company or any compulsory share exchange pursuant to which the Common Stock is converted into other securities, cash or property, then the Holder shall have the right thereafter to exercise this Warrant only into the shares of stock and other securities and property receivable upon or deemed to be held by holders of Common Stock following such reclassification, consolidation, merger, sale, transfer or share exchange, and the Holder shall be entitled upon such event to receive such amount of securities or property equal to the amount of Warrant Shares such Holder would have been entitled to had such Holder exercised this Warrant immediately prior to such reclassification, consolidation, merger, sale, transfer or share exchange. The terms of any such consolidation, merger, sale, transfer or share exchange shall include such terms so as to continue to give to the Holder the right to receive the securities or property set forth in this Section 9(b) upon any exercise following any such reclassification, consolidation, merger, sale, transfer or share exchange. (c) If the Company, at any time while this Warrant is outstanding, shall distribute to all holders of Common Stock (and not to holders of this Warrant) evidences of its indebtedness or assets or rights or warrants to subscribe for or purchase any security (excluding those referred to in Sections 9(a), (b) and (d)), then in each such case the Exercise Price shall be determined by multiplying the Exercise Price in effect immediately prior to the record date fixed for determination of stockholders entitled to receive such distribution by a fraction of which the denominator shall be the Exercise Price determined as of the record date mentioned above, and of which the numerator shall be such Exercise Price on such record date less the then fair market value at such record date of the portion of such assets or evidence of indebtedness so distributed applicable to one outstanding share of Common Stock as determined by the Company's independent certified public accountants that regularly examines the financial statements of the Company (an "Appraiser"). (d) If, at any time while this Warrant is outstanding, the Company shall issue or cause to be issued rights or warrants to acquire or otherwise sell or distribute shares of Common Stock for a consideration per share less than the Exercise Price then in effect, then, forthwith upon such issue or sale, the Exercise Price shall be reduced to the price (calculated to the nearest cent) determined by multiplying the Exercise Price in effect immediately prior thereto by a fraction, the numerator of which shall be the sum of (i) the number of shares of Common Stock outstanding immediately prior to such issuance, and (ii) the number of shares of Common Stock which the aggregate consideration received (or to be received, assuming exercise or conversion in full of such rights, warrants and convertible securities) for the issuance of such additional shares of -5- Common Stock would purchase at the Exercise Price, and the denominator of which shall be the sum of the number of shares of Common Stock outstanding immediately after the issuance of such additional shares. Such adjustment shall be made successively whenever such an issuance is made. (e) For the purposes of this Section 9, the following clauses shall also be applicable: (i) RECORD DATE. In case the Company shall take a record of the holders of its Common Stock for the purpose of entitling them (A) to receive a dividend or other distribution payable in Common Stock or in securities convertible or exchangeable into shares of Common Stock, or (B) to subscribe for or purchase Common Stock or securities convertible or exchangeable into shares of Common Stock, then such record date shall be deemed to be the date of the issue or sale of the shares of Common Stock deemed to have been issued or sold upon the declaration of such dividend or the making of such other distribution or the date of the granting of such right of subscription or purchase, as the case may be. (ii) TREASURY SHARES. The number of shares of Common Stock outstanding at any given time shall not include shares owned or held by or for the account of the Company, and the disposition of any such shares shall be considered an issue or sale of Common Stock. (f) All calculations under this Section 9 shall be made to the nearest cent or the nearest 1/100th of a share, as the case may be. (g) Whenever the Exercise Price is adjusted pursuant to Section 9(c) above, the Holder, after receipt of the determination by the Appraiser, shall have the right to select an additional appraiser (which shall be a nationally recognized accounting firm), in which case the adjustment shall be equal to the average of the adjustments recommended by each of the Appraiser and such appraiser. The Holder shall promptly mail or cause to be mailed to the Company, a notice setting forth the Exercise Price after such adjustment and setting forth a brief statement of the facts requiring such adjustment. Such adjustment shall become effective immediately after the record date mentioned above. (h) If: (i) the Company shall declare a dividend (or any other distribution) on its Common Stock; or (ii) the Company shall declare a special nonrecurring cash dividend on or a redemption of its Common Stock; or (iii) the Company shall authorize the granting to all holders of the Common Stock rights or warrants to subscribe -6- for or purchase any shares of capital stock of any class or of any rights; or (iv) the approval of any stockholders of the Company shall be required in connection with any reclassification of the Common Stock of the Company, any consolidation or merger to which the Company is a party, any sale or transfer of all or substantially all of the assets of the Company, or any compulsory share exchange whereby the Common Stock is converted into other securities, cash or property; or (v) the Company shall authorize the voluntary dissolution, liquidation or winding up of the affairs of the Company, then the Company shall cause to be mailed to each Holder at their last addresses as they shall appear upon the Warrant Register, at least 30 calendar days prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, redemption, rights or warrants, or if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distributions, redemption, rights or warrants are to be determined or (y) the date on which such reclassification, consolidation, merger, sale, transfer or share exchange is expected to become effective or close, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer, share exchange, dissolution, liquidation or winding up; PROVIDED, HOWEVER, that the failure to mail such notice or any defect therein or in the mailing thereof shall not affect the validity of the corporate action required to be specified in such notice. 10. PAYMENT OF EXERCISE PRICE. The Holder may pay the Exercise Price in one of the following manners: (a) CASH EXERCISE. The Holder shall deliver immediately available funds; or (b) CASHLESS EXERCISE. The Holder shall surrender this Warrant to the Company together with a notice of cashless exercise, in which event the Company shall issue to the Holder the number of Warrant Shares determined as follows: X = Y (A-B)/A where: X = the number of Warrant Shares to be issued to the Holder. -7- Y = the number of Warrant Shares with respect to which this Warrant is being exercised. A = the average of the closing sale prices of the Common Stock for the five (5) trading days immediately prior to (but not including) the Date of Exercise. B = the Exercise Price. For purposes of Rule 144 promulgated under the Securities Act, it is intended, understood and acknowledged that the Warrant Shares issued in a cashless exercise transaction shall be deemed to have been acquired by the Holder, and the holding period for the Warrant Shares shall be deemed to have been commenced, on the issue date. 11. FRACTIONAL SHARES. The Company shall not be required to issue or cause to be issued fractional Warrant Shares on the exercise of this Warrant. The number of full Warrant Shares which shall be issuable upon the exercise of this Warrant shall be computed on the basis of the aggregate number of Warrant Shares purchasable on exercise of this Warrant so presented. If any fraction of a Warrant Share would, except for the provisions of this Section 11, be issuable on the exercise of this Warrant, the Company shall pay an amount in cash equal to the Exercise Price multiplied by such fraction. 12. NOTICES. Any and all notices or other communications or deliveries hereunder shall be in writing and shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section prior to 8:00 p.m. (New York City time) on a business day, (ii) the business day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section later than 8:00 p.m. (New York City time) on any date and earlier than 11:59 p.m. (New York City time) on such date, (iii) the business day following the date of mailing, if sent by nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. The addresses for such communications shall be: (i) if to the Company, to 4660 West 77th Street, Edina, MN 55435, Attention: Chief Financial Officer, or to facsimile no. (612) 832-1210, or (ii) if to the Holder, to the Holder at the address or facsimile number appearing on the Warrant Register or such other address or facsimile number as the Holder may provide to the Company in accordance with this Section 12. 13. WARRANT AGENT. The Company shall serve as warrant agent under this Warrant. Upon thirty (30) days' notice to the Holder, the Company may appoint a new warrant agent. Any corporation into which the Company or any new warrant agent may be merged or any corporation resulting from any consolidation to which the Company or any new warrant agent shall be a party or any corporation to which the Company or any new warrant agent transfers substantially all of its corporate trust or shareholders services business shall be a successor warrant agent under -8- this Warrant without any further act. Any such successor warrant agent shall promptly cause notice of its succession as warrant agent to be mailed (by first class mail, postage prepaid) to the Holder at the Holder's last address as shown on the Warrant Register. 14. MISCELLANEOUS. (a) This Warrant shall be binding on and inure to the benefit of the parties hereto and their respective successors and assigns. This Warrant may be amended only in writing signed by the Company and the Holder and their successors and assigns. (b) Subject to Section 14(a), above, nothing in this Warrant shall be construed to give to any person or corporation other than the Company and the Holder any legal or equitable right, remedy or cause under this Warrant. This Warrant shall inure to the sole and exclusive benefit of the Company and the Holder. (c) This Warrant shall be governed by and construed and enforced in accordance with the internal laws of the State of New York without regard to the principles of conflicts of law thereof. The Company and the Holder hereby irrevocably submit to the exclusive jurisdiction of the state and federal courts sitting in the City of New York, borough of Manhattan, for the adjudication of any dispute hereunder or in connection herewith or with any transaction contemplated hereby or discussed herein, and hereby irrevocably waives, and agrees not to assert in any suit, action or proceeding, any claim that it is not personally subject to the jurisdiction of any such court, or that such suit, action or proceeding is improper. Each of the Company and the Holder hereby irrevocably waives personal service of process and consents to process being served in any such suit, action or proceeding by receiving a copy thereof sent to the Company at the address in effect for notices to it under this instrument and agrees that such service shall constitute good and sufficient service of process and notice thereof. Nothing contained herein shall be deemed to limit in any way any right to serve process in any manner permitted by law. (d) The headings herein are for convenience only, do not constitute a part of this Warrant and shall not be deemed to limit or affect any of the provisions hereof. (e) In case any one or more of the provisions of this Warrant shall be invalid or unenforceable in any respect, the validity and enforceability of the remaining terms and provisions of this Warrant shall not in any way be affected or impaired thereby and the parties will attempt in good faith to agree upon a valid and enforceable provision which shall be a commercially reasonable substitute therefor, and upon so agreeing, shall incorporate such substitute provision in this Warrant. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK, SIGNATURE PAGE FOLLOWS] -9- IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed by its authorized officer as of the date first indicated above. TRO LEARNING, INC. By: --------------------------------------------- Name: --------------------------------------------- Title: --------------------------------------------- FORM OF ELECTION TO PURCHASE (To be executed by the Holder to exercise the right to purchase shares of Common Stock under the foregoing Warrant) To TRO Learning, Inc.: In accordance with the Warrant enclosed with this Form of Election to Purchase, the undersigned hereby irrevocably elects to purchase _____________ shares of Common Stock ("Common Stock"), $.01 par value per share, of TRO Learning, Inc. and , if such Holder is not utilizing the cashless exercise provisions set forth in this Warrant, encloses herewith $________ in cash, certified or official bank check or checks, which sum represents the aggregate Exercise Price (as defined in the Warrant) for the number of shares of Common Stock to which this Form of Election to Purchase relates, together with any applicable taxes payable by the undersigned pursuant to the Warrant. The undersigned requests that certificates for the shares of Common Stock issuable upon this exercise be issued in the name of PLEASE INSERT SOCIAL SECURITY OR TAX IDENTIFICATION NUMBER ____________________________________________ _______________________________________________________________________________ (Please print name and address) If the number of shares of Common Stock issuable upon this exercise shall not be all of the shares of Common Stock which the undersigned is entitled to purchase in accordance with the enclosed Warrant, the undersigned requests that a New Warrant (as defined in the Warrant) evidencing the right to purchase the shares of Common Stock not issuable pursuant to the exercise evidenced hereby be issued in the name of and delivered to: _______________________________________________________________________________ (Please print name and address) _______________________________________________________________________________ _______________________________________________________________________________ Dated: ________,___ Name of Holder: (Print) ------------------------------------- (By:) ------------------------------------- (Name:) (Title:) (Signature must conform in all respects to name of holder as specified on the face of the Warrant) FORM OF ASSIGNMENT [To be completed and signed only upon transfer of Warrant] FOR VALUE RECEIVED, the undersigned hereby sells, assigns and transfers unto ________________________________ the right represented by the within Warrant to purchase ____________ shares of Common Stock of TRO Learning, Inc. to which the within Warrant relates and appoints ________________ attorney to transfer said right on the books of TRO Learning, Inc. with full power of substitution in the premises. Dated: _______________, ____ _______________________________________ (Signature must conform in all respects to name of holder as specified on the face of the Warrant) _______________________________________ Address of Transferee _______________________________________ _______________________________________ In the presence of: __________________________ EX-10.25 5 EX-10.25 EXHIBIT B REGISTRATION RIGHTS AGREEMENT This Registration Rights Agreement (this "AGREEMENT") is made and entered into as of January 13, 1999, among TRO Learning, Inc., a Delaware corporation (the "COMPANY"), and KA Investments LDC ("KA"), Gary S. Kohler ("KOHLER"), First Trust National Association TTEE FBO Gary Kohler IRA ("KOHLER IRA"), Industricorp & Co., Inc. FBO Twin City Carpenters Pension Plan and ("TWIN CITY"), Stark International ("STARK", and together with KA, Kohler, Kohler IRA and Twin City, the "PURCHASERS"). This Agreement is made pursuant to the Convertible Preferred Stock Purchase Agreement, dated as of the date hereof between the Company and the Purchasers (the "PURCHASE AGREEMENT"). The Company and the Purchasers hereby agree as follows: 1. DEFINITIONS Capitalized terms used and not otherwise defined herein that are defined in the Purchase Agreement shall have the meanings given such terms in the Purchase Agreement. As used in this Agreement, the following terms shall have the following meanings: "ADVICE" shall have meaning set forth in Section 3(o). "AFFILIATE" means, with respect to any Person, any other Person that directly or indirectly controls or is controlled by or under common control with such Person. For the purposes of this definition, "CONTROL," when used with respect to any Person, means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise; and the terms of "AFFILIATED," "CONTROLLING" and "CONTROLLED" have meanings correlative to the foregoing. "BUSINESS DAY" means any day except Saturday, Sunday and any day which shall be a legal holiday or a day on which banking institutions in the state of New York generally are authorized or required by law or other government actions to close. "CLOSING DATE" shall have the meaning set forth in the Purchase Agreement. "COMMISSION" means the Securities and Exchange Commission. "COMMON STOCK" means the Company's common stock, par value $.01 per share. "EFFECTIVENESS DATE" means the 90th day following the Original Issue Date. "EFFECTIVENESS PERIOD" shall have the meaning set forth in Section 2(a). "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended. "FILING DATE" means the 45th day following the Original Issue Date. "HOLDER" or "HOLDERS" means the holder or holders, as the case may be, from time to time of Registrable Securities. "INDEMNIFIED PARTY" shall have the meaning set forth in Section 5(c). "INDEMNIFYING PARTY" shall have the meaning set forth in Section 5(c). "LOSSES" shall have the meaning set forth in Section 5(a). "PERSON" means an individual or a corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or political subdivision thereof) or other entity of any kind. "PREFERRED STOCK" means the Company's shares of Series C Convertible Preferred Stock, $.01 par value, to be issued to the Purchaser pursuant to the Purchase Agreement. "PROCEEDING" means an action, claim, suit, investigation or proceeding (including, without limitation, an investigation or partial proceeding, such as a deposition), whether commenced or threatened. "PROSPECTUS" means the prospectus included in the Registration Statement (including, without limitation, a prospectus that includes any information previously omitted from a prospectus filed as part of an effective registration statement in reliance upon Rule 430A promulgated under the Securities Act), as amended or supplemented by any prospectus supplement, with respect to the terms of the offering of any portion of the Registrable Securities covered by the Registration Statement, and all other amendments and supplements to the Prospectus, including post-effective amendments, and all material incorporated by reference or deemed to be incorporated by reference in such Prospectus. "REGISTRABLE SECURITIES" means the shares of Common Stock issuable (i) upon conversion in full of the Preferred Stock, and (ii) upon exercise of the Warrants; PROVIDED, HOWEVER, that in order to account for the fact that the number of shares of Common Stock issuable upon conversion of the shares of Preferred Stock is determined in part upon the market price of the Common Stock prior to the time of conversion, Registrable Securities contemplated by clause (i) above shall include (but not be limited to) a number of shares of Common Stock equal to 1,703,470 shares of Common Stock into which the shares of Preferred Stock are convertible, assuming such conversion occurred on the Closing Date, the Filing Date or the date the Company files an acceleration request with the Commission relating to the Registration Statement, whichever yields the lowest Conversion Price (as defined in the Purchase Agreement). The Company shall be required to file additional Registration Statements to the extent the sum of (i) the number of the -2- shares of Common Stock into which the shares of Preferred Stock are convertible, and (ii) the number of shares of Common Stock issuable upon exercise in full of the Warrants, exceeds the number of shares of Common Stock then registered (in the case of the first Registration Statement, in accordance with the immediately prior sentence.) The Company shall have ten (10) days to file such additional Registration Statements after notice of the requirement thereof, which the Holders may give at such time when the number of shares of Common Stock as are issuable upon conversion of shares of Preferred Stock and upon exercise of the Warrants, exceeds 85% of the number of shares of Common Stock to be registered in a Registration Statement hereunder. "REGISTRATION STATEMENT" means the registration statement and any additional registration statements contemplated by Section 2(a), including (in each case) the Prospectus, amendments and supplements to such registration statement or Prospectus, including pre- and post-effective amendments, all exhibits thereto, and all material incorporated by reference or deemed to be incorporated by reference in such registration statement. "RULE 144" means Rule 144 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the Commission having substantially the same effect as such Rule. "RULE 158" means Rule 158 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the Commission having substantially the same effect as such Rule. "RULE 415" means Rule 415 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the Commission having substantially the same effect as such Rule. "SECURITIES ACT" means the Securities Act of 1933, as amended. "SPECIAL COUNSEL" means one special counsel to the Holders, for which the Holders will be reimbursed by the Company pursuant to Section 4. "UNDERWRITTEN REGISTRATION OR UNDERWRITTEN OFFERING" means a registration in connection with which securities of the Company are sold to an underwriter for reoffering to the public pursuant to an effective registration statement. "WARRANTS" means the Common Stock purchase warrants issued to the Purchasers pursuant to the Purchase Agreement. 2. SHELF REGISTRATION -3- (a) On or prior to the Filing Date, the Company shall prepare and file with the Commission a "Shelf" Registration Statement covering all Registrable Securities for an offering to be made on a continuous basis pursuant to Rule 415. The Registration Statement shall be on Form S-3 (or if the Company is not then eligible to register for resale the Registrable Securities on Form S-3 such registration shall be on another appropriate form in accordance herewith, or, in connection with an Underwritten Offering hereunder, such other form agreed to by the Company and by the Holders of Registrable Securities). The Company shall use its best efforts to cause the Registration Statement to be declared effective under the Securities Act as promptly as possible after the filing thereof, but in any event prior to the Effectiveness Date, and shall use its best efforts to keep such Registration Statement continuously effective under the Securities Act until the date which is three years after the date that such Registration Statement is declared effective by the Commission or such earlier date when all Registrable Securities covered by such Registration Statement have been sold or may be sold without volume restrictions pursuant to Rule 144(k) (the "EFFECTIVENESS PERIOD"), PROVIDED, HOWEVER, that the Company shall not be deemed to have used its best efforts to keep the Registration Statement effective during the Effectiveness Period if it voluntarily takes any action that would result in the Holders not being able to sell the Registrable Securities covered by such Registration Statement during the Effectiveness Period, unless such action is required under applicable law or the Company has filed a post-effective amendment to the Registration Statement and the Commission has not declared it effective. (b) If the Holders of a majority of the Registrable Securities so elect, an offering of Registrable Securities pursuant to the Registration Statement may be effected in the form of an Underwritten Offering. In such event, and, if the managing underwriters advise the Company and such Holders in writing that in their opinion the amount of Registrable Securities proposed to be sold in such Underwritten Offering exceeds the amount of Registrable Securities which can be sold in such Underwritten Offering, there shall be included in such Underwritten Offering the amount of such Registrable Securities which in the opinion of such managing underwriters can be sold, and such amount shall be allocated pro rata among the Holders proposing to sell Registrable Securities in such Underwritten Offering. (c) If any of the Registrable Securities are to be sold in an Underwritten Offering, the investment banker in interest that will administer the offering will be selected by the Holders of a majority of the Registrable Securities included in such offering upon consultation with the Company. No Holder may participate in any Underwritten Offering hereunder unless such Holder (i) agrees to sell its Registrable Securities on the basis provided in any underwriting agreements approved by the Persons entitled hereunder to approve such arrangements and (ii) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents required under the terms of such arrangements. 3. REGISTRATION PROCEDURES In connection with the Company's registration obligations hereunder, the Company shall: -4- (a) Prepare and file with the Commission on or prior to the Filing Date, a Registration Statement on Form S-3 (or if the Company is not then eligible to register for resale the Registrable Securities on Form S-3 such registration shall be on another appropriate form in accordance herewith, or, in connection with an Underwritten Offering hereunder, such other form agreed to by the Company and by the Holders of Registrable Securities) which shall contain the "Plan of Distribution" attached hereto as ANNEX A (except if otherwise directed by the Holders), and cause the Registration Statement to become effective and remain effective as provided herein; PROVIDED, HOWEVER, that not less than five (5) Business Days prior to the filing of the initial Registration Statement or not less than two (2) Business Days prior to the filing of any related Prospectus or any amendment or supplement thereto (including any document that would be incorporated or deemed to be incorporated therein by reference), the Company shall, (i) furnish to the Holders, their Special Counsel and any managing underwriters, copies of all such documents proposed to be filed, which documents (other than those incorporated or deemed to be incorporated by reference) will be subject to the review of such Holders, their Special Counsel and such managing underwriters, and (ii) cause its officers and directors, counsel and independent certified public accountants to respond to such inquiries as shall be necessary, in the reasonable opinion of respective counsel to such Holders and such underwriters, to conduct a reasonable investigation within the meaning of the Securities Act. The Company shall not file the Registration Statement or any such Prospectus or any amendments or supplements thereto to which the Holders of a majority of the Registrable Securities, their Special Counsel, or any managing underwriters, shall reasonably object on a timely basis. (b) (i) Prepare and file with the Commission such amendments, including post-effective amendments, to the Registration Statement as may be necessary to keep the Registration Statement continuously effective as to the applicable Registrable Securities for the Effectiveness Period and prepare and file with the Commission such additional Registration Statements in order to register for resale under the Securities Act all of the Registrable Securities; (ii) cause the related Prospectus to be amended or supplemented by any required Prospectus supplement, and as so supplemented or amended to be filed pursuant to Rule 424 (or any similar provisions then in force) promulgated under the Securities Act; (iii) respond as promptly as reasonably possible to any comments received from the Commission with respect to the Registration Statement or any amendment thereto and as promptly as reasonably possible provide the Holders true and complete copies of all correspondence from and to the Commission relating to the Registration Statement; and (iv) comply in all material respects with the provisions of the Securities Act and the Exchange Act with respect to the disposition of all Registrable Securities covered by the Registration Statement during the applicable period in accordance with the intended methods of disposition by the Holders thereof set forth in the Registration Statement as so amended or in such Prospectus as so supplemented. (c) Notify the Holders of Registrable Securities to be sold, their Special Counsel and any managing underwriters as promptly as reasonably possible (and, in the case of (i)(A) below, not less than five (5) days prior to such filing) and (if requested by any such Person) confirm such notice in writing no later than one (1) Business Day following the day (i)(A) when a Prospectus or any Prospectus supplement or post-effective amendment to the Registration Statement is proposed to be filed; (B) when the Commission notifies the Company whether there will be a "review" of such -5- Registration Statement and whenever the Commission comments in writing on such Registration Statement (the Company shall provide true and complete copies thereof and all written responses thereto to each of the Holders); and (C) with respect to the Registration Statement or any post-effective amendment, when the same has become effective; (ii) of any request by the Commission or any other Federal or state governmental authority for amendments or supplements to the Registration Statement or Prospectus or for additional information; (iii) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement covering any or all of the Registrable Securities or the initiation of any Proceedings for that purpose; (iv) if at any time any of the representations and warranties of the Company contained in any agreement (including any underwriting agreement) contemplated hereby ceases to be true and correct in all material respects; (v) of the receipt by the Company of any notification with respect to the suspension of the qualification or exemption from qualification of any of the Registrable Securities for sale in any jurisdiction, or the initiation or threatening of any Proceeding for such purpose; and (vi) of the occurrence of any event that makes any statement made in the Registration Statement or Prospectus or any document incorporated or deemed to be incorporated therein by reference untrue in any material respect or that requires any revisions to the Registration Statement, Prospectus or other documents so that, in the case of the Registration Statement or the Prospectus, as the case may be, it will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (d) Use its best efforts to avoid the issuance of, or, if issued, obtain the withdrawal of (i) any order suspending the effectiveness of the Registration Statement, or (ii) any suspension of the qualification (or exemption from qualification) of any of the Registrable Securities for sale in any jurisdiction, at the earliest practicable moment. (e) If requested by any managing underwriter or the Holders of a majority in interest of the Registrable Securities to be sold in connection with an Underwritten Offering, (i) promptly incorporate in a Prospectus supplement or post-effective amendment to the Registration Statement such information as such managing underwriters and such Holders reasonably agree should be included therein, and (ii) make all required filings of such Prospectus supplement or such post-effective amendment as soon as practicable after the Company has received notification of the matters to be incorporated in such Prospectus supplement or post-effective amendment; PROVIDED, HOWEVER, that the Company shall not be required to take any action pursuant to this Section 3(e) that would, in the opinion of counsel for the Company, violate applicable law or be materially detrimental to the business prospects of the Company. (f) Furnish to each Holder, their Special Counsel and any managing underwriters, without charge, at least one conformed copy of each Registration Statement and each amendment thereto, including financial statements and schedules, all documents incorporated or deemed to be incorporated therein by reference, and all exhibits to the extent requested by such Person (including those previously furnished or incorporated by reference) promptly after the filing of such documents with the Commission. -6- (g) Promptly deliver to each Holder, their Special Counsel, and any underwriters, without charge, as many copies of the Prospectus or Prospectuses (including each form of prospectus) and each amendment or supplement thereto as such Persons may reasonably request; and the Company hereby consents to the use of such Prospectus and each amendment or supplement thereto by each of the selling Holders and any underwriters in connection with the offering and sale of the Registrable Securities covered by such Prospectus and any amendment or supplement thereto. (h) Prior to any public offering of Registrable Securities, use its best efforts to register or qualify or cooperate with the selling Holders, any underwriters and their Special Counsel in connection with the registration or qualification (or exemption from such registration or qualification) of such Registrable Securities for offer and sale under the securities or Blue Sky laws of such jurisdictions within the United States as any Holder or underwriter requests in writing, to keep each such registration or qualification (or exemption therefrom) effective during the Effectiveness Period and to do any and all other acts or things necessary or advisable to enable the disposition in such jurisdictions of the Registrable Securities covered by a Registration Statement; PROVIDED, HOWEVER, that the Company shall not be required to qualify generally to do business in any jurisdiction where it is not then so qualified or to take any action that would subject it to general service of process in any such jurisdiction where it is not then so subject or subject the Company to any material tax in any such jurisdiction where it is not then so subject. (i) Cooperate with the Holders and any managing underwriters to facilitate the timely preparation and delivery of certificates representing Registrable Securities to be delivered to a transferee pursuant to a Registration Statement, which certificates shall be free, to the extent permitted by applicable law, of all restrictive legends, and to enable such Registrable Securities to be in such denominations and registered in such names as any such managing underwriters or Holders may request at least two Business Days prior to any sale of Registrable Securities. (j) Upon the occurrence of any event contemplated by Section 3(c)(vi), as promptly as reasonably possible, prepare a supplement or amendment, including a post-effective amendment, to the Registration Statement or a supplement to the related Prospectus or any document incorporated or deemed to be incorporated therein by reference, and file any other required document so that, as thereafter delivered, neither the Registration Statement nor such Prospectus will contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (k) Use its best efforts to cause all Registrable Securities relating to such Registration Statement to be listed on the Nasdaq National Market ("NASDAQ") or on any other stock market or trading facility on which the shares of Common Stock are traded, listed or quoted (each a "SUBSEQUENT MARKET") as and when required pursuant to the Purchase Agreement. (l) Enter into such agreements (including an underwriting agreement in form, scope and substance as is customary in Underwritten Offerings) and take all such other actions in connection therewith (including those reasonably requested by any managing underwriters and the Holders of a majority of the Registrable Securities being sold) in order to expedite or facilitate the -7- disposition of such Registrable Securities, and whether or not an underwriting agreement is entered into, (i) make such representations and warranties to such Holders and such underwriters as are customarily made by issuers to underwriters in underwritten public offerings, and confirm the same if and when requested; (ii) in the case of an Underwritten Offering obtain and deliver copies thereof to each Holder and the managing underwriters, if any, of opinions of counsel to the Company and updates thereof addressed to each Holder and each such underwriter, in form, scope and substance reasonably satisfactory to any such managing underwriters and Special Counsel to the selling Holders covering the matters customarily covered in opinions requested in Underwritten Offerings and such other matters as may be reasonably requested by such Special Counsel and underwriters; (iii) immediately prior to the effectiveness of the Registration Statement, and, in the case of an Underwritten Offering, at the time of delivery of any Registrable Securities sold pursuant thereto, use its best reasonable efforts to obtain and deliver copies to the Holders and the managing underwriters, if any, of "cold comfort" letters and updates thereof from the independent certified public accountants of the Company (and, if necessary, any other independent certified public accountants of any subsidiary of the Company or of any business acquired by the Company for which financial statements and financial data is, or is required to be, included in the Registration Statement), addressed to the Company in form and substance as are customary in connection with Underwritten Offerings; (iv) if an underwriting agreement is entered into, the same shall contain indemnification provisions and procedures no less favorable to the selling Holders and the underwriters, if any, than those set forth in Section 5 (or such other provisions and procedures acceptable to the managing underwriters, if any, and holders of a majority of Registrable Securities participating in such Underwritten Offering); and (v) deliver such documents and certificates as may be reasonably requested by the Holders of a majority of the Registrable Securities being sold, their Special Counsel and any managing underwriters to evidence the continued validity of the representations and warranties made pursuant to clause 3(l)(i) above and to evidence compliance with any customary conditions contained in the underwriting agreement or other agreement entered into by the Company. (m) Make available for inspection by the selling Holders, any representative of such Holders, any underwriter participating in any disposition of Registrable Securities, and any attorney or accountant retained by such selling Holders or underwriters, at the offices where normally kept, during reasonable business hours, all financial and other records, pertinent corporate documents and properties of the Company and its subsidiaries, and cause the officers, directors, agents and employees of the Company and its subsidiaries to supply all information in each case reasonably requested by any such Holder, representative, underwriter, attorney or accountant in connection with the Registration Statement; PROVIDED, HOWEVER, that any information that is determined in good faith by the Company in writing to be of a confidential nature at the time of delivery of such information shall be kept confidential by such Persons, unless (i) disclosure of such information is required by court or administrative order or is necessary to respond to inquiries of regulatory authorities; (ii) disclosure of such information, in the opinion of counsel to such Person, is required by law; (iii) such information becomes generally available to the public other than as a result of a disclosure or failure to safeguard by such Person; or (iv) such information becomes available to such Person from a source other than the Company and such source is not known by such Person to be bound by a confidentiality agreement with the Company. (n) Comply with all applicable rules and regulations of the Commission. -8- (o) The Company may require each selling Holder to furnish to the Company such information regarding the distribution of such Registrable Securities and the beneficial ownership of Common Stock held by such Holder as is required by law to be disclosed in the Registration Statement, and the Company may exclude from such registration the Registrable Securities of any such Holder who unreasonably fails to furnish such information within a reasonable time after receiving such request. If the Registration Statement refers to any Holder by name or otherwise as the holder of any securities of the Company, then such Holder shall have the right to require (if such reference to such Holder by name or otherwise is not required by the Securities Act or any similar Federal statute then in force) the deletion of the reference to such Holder in any amendment or supplement to the Registration Statement filed or prepared subsequent to the time that such reference ceases to be required. Each Holder covenants and agrees that (i) it will not sell any Registrable Securities under the Registration Statement until it has received copies of the Prospectus as then amended or supplemented as contemplated in Section 3(g) and notice from the Company that such Registration Statement and any post-effective amendments thereto have become effective as contemplated by Section 3(c) and (ii) it and its officers, directors or Affiliates, if any, will comply with the prospectus delivery requirements of the Securities Act as applicable to it in connection with sales of Registrable Securities pursuant to the Registration Statement. Each Holder agrees by its acquisition of such Registrable Securities that, upon receipt of a notice from the Company of the occurrence of any event of the kind described in Section 3(c)(ii), 3(c)(iii), 3(c)(iv), 3(c)(v) or 3(c)(vi), such Holder will forthwith discontinue disposition of such Registrable Securities under the Registration Statement until such Holder's receipt of the copies of the supplemented Prospectus and/or amended Registration Statement contemplated by Section 3(j), or until it is advised in writing (the "ADVICE") by the Company that the use of the applicable Prospectus may be resumed, and, in either case, has received copies of any additional or supplemental filings that are incorporated or deemed to be incorporated by reference in such Prospectus or Registration Statement. 4. REGISTRATION EXPENSES -9- (a) All fees and expenses incident to the performance of or compliance with this Agreement by the Company, except as and to the extent specified in Section 4(b), shall be borne by the Company whether or not pursuant to an Underwritten Offering and whether or not the Registration Statement is filed or becomes effective and whether or not any Registrable Securities are sold pursuant to the Registration Statement. The fees and expenses referred to in the foregoing sentence shall include, without limitation, (i) all registration and filing fees (including, without limitation, fees and expenses (A) with respect to filings required to be made with the NASDAQ and any Subsequent Market on which the Common Stock is then listed for trading, and (B) in compliance with state securities or Blue Sky laws (including, without limitation, fees and disbursements of counsel for the Holders in connection with Blue Sky qualifications or exemptions of the Registrable Securities and determination of the eligibility of the Registrable Securities for investment under the laws of such jurisdictions as the managing underwriters, if any, or the Holders of a majority of Registrable Securities may designate)), (ii) printing expenses (including, without limitation, expenses of printing certificates for Registrable Securities and of printing prospectuses if the printing of prospectuses is requested by the managing underwriters, if any, or by the holders of a majority of the Registrable Securities included in the Registration Statement), (iii) messenger, telephone and delivery expenses, (iv) fees and disbursements of counsel for the Company and Special Counsel for the Holders, (v) Securities Act liability insurance, if the Company so desires such insurance, and (vi) fees and expenses of all other Persons retained by the Company in connection with the consummation of the transactions contemplated by this Agreement. In addition, the Company shall be responsible for all of its internal expenses incurred in connection with the consummation of the transactions contemplated by this Agreement (including, without limitation, all salaries and expenses of its officers and employees performing legal or accounting duties), the expense of any annual audit, the fees and expenses incurred in connection with the listing of the Registrable Securities on any securities exchange as required hereunder. (b) If the Holders require an Underwritten Offering pursuant to the terms hereof, the Company shall be responsible for all costs, fees and expenses in connection therewith, except for the fees and disbursements of the Underwriters (including any underwriting commissions and discounts) and their legal counsel and accountants. By way of illustration which is not intended to diminish from the provisions of Section 4(a), the Holders shall not be responsible for, and the Company shall be required to pay the fees or disbursements incurred by the Company (including by its legal counsel and accountants) in connection with, the preparation and filing of a Registration Statement and related Prospectus for such offering, the maintenance of such Registration Statement in accordance with the terms hereof, the listing of the Registrable Securities in accordance with the requirements hereof, and printing expenses incurred to comply with the requirements hereof. 5. INDEMNIFICATION -10- (a) INDEMNIFICATION BY THE COMPANY. The Company shall, notwithstanding any termination of this Agreement, indemnify and hold harmless each Holder, the officers, directors, agents (including any underwriters retained by such Holder in connection with the offer and sale of Registrable Securities), brokers (including brokers who offer and sell Registrable Securities as principal as a result of a pledge or any failure to perform under a margin call of Common Stock), investment advisors and employees of each of them, each Person who controls any such Holder (within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act) and the officers, directors, agents and employees of each such controlling Person, to the fullest extent permitted by applicable law, from and against any and all losses, claims, damages, liabilities, costs (including, without limitation, costs of preparation and attorneys' fees) and expenses (collectively, "LOSSES"), as incurred, arising out of or relating to any untrue or alleged untrue statement of a material fact contained in the Registration Statement, any Prospectus or any form of prospectus or in any amendment or supplement thereto or in any preliminary prospectus, or arising out of or relating to any omission or alleged omission of a material fact required to be stated therein or necessary to make the statements therein (in the case of any Prospectus or form of prospectus or supplement thereto, in light of the circumstances under which they were made) not misleading, except to the extent, but only to the extent, that such untrue statements or omissions are based solely upon information regarding such Holder furnished in writing to the Company by such Holder expressly for use therein, or to the extent that such information relates to such Holder or such Holder's proposed method of distribution of Registrable Securities and was reviewed and expressly approved in writing by such Holder expressly for use in the Registration Statement, such Prospectus or such form of Prospectus or in any amendment or supplement thereto. The Company shall notify the Holders promptly of the institution, threat or assertion of any Proceeding of which the Company is aware in connection with the transactions contemplated by this Agreement. (b) INDEMNIFICATION BY HOLDERS. Each Holder shall, severally and not jointly, indemnify and hold harmless the Company, its directors, officers, agents and employees, each Person who controls the Company (within the meaning of Section 15 of the Securities Act and Section 20 of the Exchange Act), and the directors, officers, agents or employees of such controlling Persons, to the fullest extent permitted by applicable law, from and against all Losses (as determined by a court of competent jurisdiction in a final judgment not subject to appeal or review) arising solely out of or based solely upon any untrue statement of a material fact contained in the Registration Statement, any Prospectus, or any form of prospectus, or in any amendment or supplement thereto, or arising solely out of or based solely upon any omission of a material fact required to be stated therein or necessary to make the statements therein not misleading to the extent, but only to the extent, that such untrue statement or omission is contained in any information so furnished in writing by such Holder to the Company specifically for inclusion in the Registration Statement or such Prospectus or to the extent that such information relates to such Holder or such Holder's proposed method of distribution of Registrable Securities and was reviewed and expressly approved in writing by such Holder expressly for use in the Registration Statement, such Prospectus or such form of Prospectus, or in any amendment or supplement thereto. In no event shall the liability of any selling Holder hereunder be greater in amount than the dollar amount of the net proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. -11- (c) CONDUCT OF INDEMNIFICATION PROCEEDINGS. If any Proceeding shall be brought or asserted against any Person entitled to indemnity hereunder (an "INDEMNIFIED PARTY"), such Indemnified Party shall promptly notify the Person from whom indemnity is sought (the "INDEMNIFYING PARTY") in writing, and the Indemnifying Party shall assume the defense thereof, including the employment of counsel reasonably satisfactory to the Indemnified Party and the payment of all fees and expenses incurred in connection with defense thereof; provided, that the failure of any Indemnified Party to give such notice shall not relieve the Indemnifying Party of its obligations or liabilities pursuant to this Agreement, except (and only) to the extent that it shall be finally determined by a court of competent jurisdiction (which determination is not subject to appeal or further review) that such failure shall have proximately and materially adversely prejudiced the Indemnifying Party. An Indemnified Party shall have the right to employ separate counsel in any such Proceeding and to participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of such Indemnified Party or Parties unless: (1) the Indemnifying Party has agreed in writing to pay such fees and expenses; or (2) the Indemnifying Party shall have failed promptly to assume the defense of such Proceeding and to employ counsel reasonably satisfactory to such Indemnified Party in any such Proceeding; or (3) the named parties to any such Proceeding (including any impleaded parties) include both such Indemnified Party and the Indemnifying Party, and such Indemnified Party shall have been advised by counsel that a conflict of interest is likely to exist if the same counsel were to represent such Indemnified Party and the Indemnifying Party (in which case, if such Indemnified Party notifies the Indemnifying Party in writing that it elects to employ separate counsel at the expense of the Indemnifying Party, the Indemnifying Party shall not have the right to assume the defense thereof and such counsel shall be at the expense of the Indemnifying Party). The Indemnifying Party shall not be liable for any settlement of any such Proceeding effected without its written consent, which consent shall not be unreasonably withheld. No Indemnifying Party shall, without the prior written consent of the Indemnified Party, effect any settlement of any pending Proceeding in respect of which any Indemnified Party is a party, unless such settlement includes an unconditional release of such Indemnified Party from all liability on claims that are the subject matter of such Proceeding. All fees and expenses of the Indemnified Party (including reasonable fees and expenses to the extent incurred in connection with investigating or preparing to defend such Proceeding in a manner not inconsistent with this Section) shall be paid to the Indemnified Party, as incurred, within ten (10) Business Days of written notice thereof to the Indemnifying Party (regardless of whether it is ultimately determined that an Indemnified Party is not entitled to indemnification hereunder; PROVIDED, that the Indemnifying Party may require such Indemnified Party to undertake to reimburse all such fees and expenses to the extent it is finally judicially determined that such Indemnified Party is not entitled to indemnification hereunder). (d) CONTRIBUTION. If a claim for indemnification under Section 5(a) or 5(b) is unavailable to an Indemnified Party (by reason of public policy or otherwise), then each Indemnifying Party, in lieu of indemnifying such Indemnified Party, shall contribute to the amount paid or payable by such Indemnified Party as a result of such Losses, in such proportion as is appropriate to reflect the relative fault of the Indemnifying Party and Indemnified Party in -12- connection with the actions, statements or omissions that resulted in such Losses as well as any other relevant equitable considerations. The relative fault of such Indemnifying Party and Indemnified Party shall be determined by reference to, among other things, whether any action in question, including any untrue or alleged untrue statement of a material fact or omission or alleged omission of a material fact, has been taken or made by, or relates to information supplied by, such Indemnifying Party or Indemnified Party, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such action, statement or omission. The amount paid or payable by a party as a result of any Losses shall be deemed to include, subject to the limitations set forth in Section 5(c), any reasonable attorneys' or other reasonable fees or expenses incurred by such party in connection with any Proceeding to the extent such party would have been indemnified for such fees or expenses if the indemnification provided for in this Section was available to such party in accordance with its terms. The parties hereto agree that it would not be just and equitable if contribution pursuant to this Section 5(d) were determined by PRO RATA allocation or by any other method of allocation that does not take into account the equitable considerations referred to in the immediately preceding paragraph. Notwithstanding the provisions of this Section 5(d), no Holder shall be required to contribute, in the aggregate, any amount in excess of the amount by which the proceeds actually received by such Holder from the sale of the Registrable Securities subject to the Proceeding exceeds the amount of any damages that such Holder has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No Person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any Person who was not guilty of such fraudulent misrepresentation. The indemnity and contribution agreements contained in this Section are in addition to any liability that the Indemnifying Parties may have to the Indemnified Parties. 6. MISCELLANEOUS (a) REMEDIES. In the event of a breach by the Company or by a Holder, of any of their obligations under this Agreement, each Holder or the Company, as the case may be, in addition to being entitled to exercise all rights granted by law and under this Agreement, including recovery of damages, will be entitled to specific performance of its rights under this Agreement. The Company and each Holder agree that monetary damages would not provide adequate compensation for any losses incurred by reason of a breach by it of any of the provisions of this Agreement and hereby further agrees that, in the event of any action for specific performance in respect of such breach, it shall waive the defense that a remedy at law would be adequate. (b) NO INCONSISTENT AGREEMENTS. Except as and to the extent specified in SCHEDULE 6(b) hereto, neither the Company nor any of its subsidiaries has, as of the date hereof, nor shall the Company or any of its subsidiaries, on or after the date of this Agreement, enter into any agreement with respect to its securities that is inconsistent with the rights granted to the Holders in this Agreement or otherwise conflicts with the provisions hereof. Except as and to the extent specified in SCHEDULE 6(b) hereto, neither the Company nor any of its subsidiaries has previously -13- entered into any agreement granting any registration rights with respect to any of its securities to any Person. Without limiting the generality of the foregoing, without the written consent of the Holders of a majority of the then outstanding Registrable Securities, the Company shall not grant to any Person the right to request the Company to register any securities of the Company under the Securities Act unless the rights so granted are subject in all respects to the prior rights in full of the Holders set forth herein, and are not otherwise in conflict or inconsistent with the provisions of this Agreement. (c) NO PIGGYBACK ON REGISTRATIONS. Except as and to the extent specified in SCHEDULE 6(b) hereto, neither the Company nor any of its security holders (other than the Holders in such capacity pursuant hereto) may include securities of the Company in the Registration Statement other than the Registrable Securities, and the Company shall not after the date hereof enter into any agreement providing any such right to any of its security holders. (d) PIGGY-BACK REGISTRATIONS. If at any time when there is not an effective Registration Statement covering all of the Registrable Securities and the Underlying Shares, the Company shall determine to prepare and file with the Commission a registration statement relating to an offering for its own account or the account of others (other than pursuant to the registration rights granted to the holders of the 1997 Subordinated Convertible Notes and the warrants issued in connection therewith) under the Securities Act of any of its equity securities, other than on Form S-4 or Form S-8 (each as promulgated under the Securities Act) or their then equivalents relating to equity securities to be issued solely in connection with any acquisition of any entity or business or equity securities issuable in connection with stock option or other employee benefit plans, then the Company shall send to each holder of Registrable Securities written notice of such determination and, if within twenty (20) days after receipt of such notice, any such holder shall so request in writing, the Company shall include in such registration statement all or any part of such Registrable Securities such holder requests to be registered; PROVIDED, HOWEVER, that the Company shall not be required to register any Registrable Securities pursuant to this Section 7(d) that are eligible for sale pursuant to Rule 144(k) of the Commission. (e) AMENDMENTS AND WAIVERS. The provisions of this Agreement, including the provisions of this sentence, may not be amended, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given, unless the same shall be in writing and signed by the Company and the Holders of at least two-thirds of the then outstanding Registrable Securities; PROVIDED, HOWEVER, that, for the purposes of this sentence, Registrable Securities that are owned, directly or indirectly, by the Company, or an Affiliate of the Company are not deemed outstanding. Notwithstanding the foregoing, a waiver or consent to depart from the provisions hereof with respect to a matter that relates exclusively to the rights of Holders and that does not directly or indirectly affect the rights of other Holders may be given by Holders of at least a majority of the Registrable Securities to which such waiver or consent relates; PROVIDED, HOWEVER, that the provisions of this sentence may not be amended, modified, or supplemented except in accordance with the provisions of the immediately preceding sentence. -14- (f) NOTICES. Any and all notices or other communications or deliveries required or permitted to be provided hereunder shall be in writing and shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in this Section prior to 8:00 p.m. (Minnetonka, Minnesota time) on a Business Day, (ii) the Business Day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile telephone number specified in the Purchase Agreement later than 8:00 p.m. (Minnetonka, Minnesota time) on any date and earlier than 11:59 p.m. (Minnetonka, Minnesota time) on such date, (iii) the Business Day following the date of mailing, if sent by nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. The address for such notices and communications shall be as follows: If to the Company: TRO Learning, Inc. 4660 West 77th Street Edina, MN 55435 Facsimile No.: (612) 832-1210 Attn: Chief Financial Officer With copies to: Winston & Strawn 35 West Wacker Drive, 42nd Floor Chicago, IL 60601 Facsimile No.: (312) 558-5700 Attn: Leland E. Hutchinson If to the KA: KA Investments LDC c/o Deephaven Capital Management LLC 1712 Hopkins Crossroads Minnetonka, MN 55305 Facsimile No.: (612) 542-4244 Attn: Bruce Lieberman -15- With copies to: Robinson Silverman Pearce Aronsohn & Berman LLP 1290 Avenue of the Americas New York, NY 10104 Facsimile No.: (212) 541-4630 Attn: Kenneth L. Henderson If to Kohler or Kohler IRA: Gary S. Kohler c/o Miller, Johnson & Kuehn 5500 Wayzata Blvd., 8th Floor Minneapolis, MN 55416 If to Twin City: Twin City Carpenters Pension Plan c/o Perkins Capital Management, Inc. 730 East Lake Street Wayzata, MN 55391 If to Stark: Stark International 1500 West Market Street Mequon, WI 53092 If to any other Person who is then the registered Holder: To the address of such Holder as it appears in the stock transfer books of the Company or such other address as may be designated in writing hereafter, in the same manner, by such Person. (g) SUCCESSORS AND ASSIGNS. This Agreement shall inure to the benefit of and be binding upon the successors and permitted assigns of each of the parties and shall inure to the benefit of each Holder. The Company may not assign its rights or obligations hereunder without the prior written consent of each Holder. Each Holder may assign their respective rights hereunder in the manner and to the Persons as permitted under the Purchase Agreement. (h) COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original and, all of which taken together shall constitute one and the same Agreement. In the event that any signature is delivered by facsimile transmission, such signature shall create a valid binding obligation of the party executing (or on whose behalf such signature is executed) the same with the same force and effect as if such facsimile signature were the original thereof. (i) GOVERNING LAW. This Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of New York without regard to the principles of conflicts of law thereof. Each party hereby irrevocably submits to the exclusive -16- jurisdiction of the state and federal courts sitting in the City of New York, borough of Manhattan, for the adjudication of any dispute hereunder or in connection herewith or with any transaction contemplated hereby or discussed herein (including with respect to the enforcement of the any of the Transaction Documents), and hereby irrevocably waives, and agrees not to assert in any suit, action or proceeding, any claim that it is not personally subject to the jurisdiction of any such court, that such suit, action or proceeding is improper. Each party hereby irrevocably waives personal service of process and consents to process being served in any such suit, action or proceeding by mailing a copy thereof to such party at the address in effect for notices to it under this Agreement and agrees that such service shall constitute good and sufficient service of process and notice thereof. Nothing contained herein shall be deemed to limit in any way any right to serve process in any manner permitted by law. (j) CUMULATIVE REMEDIES. The remedies provided herein are cumulative and not exclusive of any remedies provided by law. (k) SEVERABILITY. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction to be invalid, illegal, void or unenforceable, the remainder of the terms, provisions, covenants and restrictions set forth herein shall remain in full force and effect and shall in no way be affected, impaired or invalidated, and the parties hereto shall use their reasonable efforts to find and employ an alternative means to achieve the same or substantially the same result as that contemplated by such term, provision, covenant or restriction. It is hereby stipulated and declared to be the intention of the parties that they would have executed the remaining terms, provisions, covenants and restrictions without including any of such that may be hereafter declared invalid, illegal, void or unenforceable. (l) HEADINGS. The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. (m) SHARES HELD BY THE COMPANY AND ITS AFFILIATES. Whenever the consent or approval of Holders of a specified percentage of Registrable Securities is required hereunder, Registrable Securities held by the Company or its Affiliates (other than any Holder or transferees or successors or assigns thereof if such Holder is deemed to be an Affiliate solely by reason of its holdings of such Registrable Securities) shall not be counted in determining whether such consent or approval was given by the Holders of such required percentage. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK SIGNATURE PAGE TO FOLLOW] -17- IN WITNESS WHEREOF, the parties have executed this Registration Rights Agreement as of the date first written above. Company: . TRO LEARNING, INC. By: ------------------------------------ Name: Title: Purchasers: KA INVESTMENTS LDC By: ------------------------------------ Name: Title: ------------------------------------ GARY S. KOHLER FIRST TRUST NATIONAL ASSOCIATION TTEE FBO GARY KOHLER IRA By: ------------------------------------ Name: Title: INDUSTRICORP & CO., INC. FBO TWIN CITY CARPENTERS PENSION PLAN By: ------------------------------------ Name: Title: STARK INTERNATIONAL By: ------------------------------------ Name: Title: ANNEX A PLAN OF DISTRIBUTION The Selling Stockholders and any of their pledgees, assignees and successors-in-interest may, from time to time, sell any or all of their shares of Common Stock on any stock exchange, market or trading facility on which the shares are traded or in private transactions. These sales may be at fixed or negotiated prices. The Selling Stockholders may use any one or more of the following methods when selling shares: - ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers; - block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction; - purchases by a broker-dealer as principal and resale by the broker-dealer for its account; - an exchange distribution in accordance with the rules of the applicable exchange; - privately negotiated transactions; - short sales; - broker-dealers may agree with the Selling Stockholders to sell a specified number of such shares at a stipulated price per share; - a combination of any such methods of sale; and - any other method permitted pursuant to applicable law. The Selling Stockholders may also sell shares under Rule 144 under the Securities Act, if available, rather than under this prospectus. The Selling Stockholders may also engage in short sales against the box, puts and calls and other transactions in securities of the Company or derivatives of Company securities and may sell or deliver shares in connection with these trades. The Selling Stockholders may pledge their shares to their brokers under the margin provisions of customer agreements. If a Selling Stockholder defaults on a margin loan, the broker may, from time to time, offer and sell the pledged shares. Broker-dealers engaged by the Selling Stockholders may arrange for other brokers-dealers to participate in sales. Broker-dealers may receive commissions or discounts from the Selling Stockholders (or, if any broker-dealer acts as agent for the purchaser of shares, from the purchaser) in amounts to be negotiated. The Selling Stockholders do not expect these commissions and discounts to exceed what is customary in the types of transactions involved. The Selling Stockholders and any broker-dealers or agents that are involved in selling the shares may be deemed to be "underwriters" within the meaning of the Securities Act in connection with such sales. In such event, any commissions received by such broker-dealers or agents and any profit on the resale of the shares purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act. The Company is required to pay all fees and expenses incident to the registration of the shares, including fees and disbursements of counsel to the Selling Stockholders. The Company has agreed to indemnify the Selling Stockholders against certain losses, claims, damages and liabilities, including liabilities under the Securities Act. EXHIBIT E TRANSFER AGENT INSTRUCTIONS Ladies and Gentlemen: Reference is made to that certain Convertible Preferred Stock Purchase Agreement (the "PURCHASE AGREEMENT") between TRO Learning, Inc., a Delaware corporation (the "COMPANY"), and the buyers named therein (the "HOLDERS") pursuant to which the Company is issuing to the Holders its shares of Series C Convertible Preferred Stock, par value $.01 per share (the "PREFERRED SHARES"), and a Common Stock purchase warrant (the "WARRANT") which shall be convertible and exercisable, respectively, into shares of the Company's common stock, $.01 par value per share (the "COMMON STOCK"). The shares of Common Stock issuable upon conversion of the Preferred Shares and upon exercise of the Warrants are collectively referred to herein as "UNDERLYING SHARES." This letter shall serve as our irrevocable authorization and direction to you (provided that you are the transfer agent for the Company with respect to its Common Stock at such time) to issue Underlying Shares from time to time upon notice from the Company to issue such Underlying Shares. So long as you have previously received (x) a direction letter from the Company substantially in the form of EXHIBIT I attached hereto stating that a registration statement covering resales of Underlying Shares has been declared effective by the Securities and Exchange Commission under the Securities Act of 1933, as amended, and that Underlying Shares may be issued (or reissued if they have been issued at a time when there was not such an effective registration statement) or resold without any restrictive legend (the "DIRECTION LETTER") and (y) a copy of such registration statement, certificates representing Underlying Shares shall not bear any legend restricting transfer of Underlying Shares thereby and should not be subject to any stop-transfer restriction. Provided, however, that if you have not previously received (x) a copy of the Direction Letter and (y) a copy of such registration statement, then the certificates representing Underlying Shares shall bear the following legend: THESE SECURITIES HAVE NOT BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS. and, provided, further, that the Company may, from time to time, notify you to place stop-transfer restrictions on the certificates for Underlying Shares in the event, but only in the event, a registration statement covering Underlying Shares is subject to amendment for events then current. Please be advised that the Holders have relied upon this instruction letter as an inducement to enter into the Purchase Agreement and, accordingly, the Holders are a third party beneficiary to these instructions. Please execute this letter in the SPACE indicated to acknowledge your agreement to act in accordance with these instructions. Should you have any questions concerning this matter, please contact me at (612) 832-1413. Very truly yours, By: ----------------------------------- Name: ---------------------------------- Title: --------------------------------- ACKNOWLEDGED AND AGREED: - --------------------------------- By: ----------------------------- Name: --------------------------- Title --------------------------- -2- EXHIBIT I [FORM OF DIRECTION LETTER] [Addressee] [Address) To Whom It May Concern: The Registration Statement on Form S-3 (File No. 333-_______) of TRO Learning, Inc. (the "Registration Statement") was declared effective at ___:____.M. Eastern Time on ______, 199_. Upon issuance of the Underlying Shares referred to in the Company's instruction letter attached hereto, you are authorized to issue certificates for the Company's common stock without restrictive legends. Very truly yours, TRO Learning, Inc. By: --------------------------------- Name: Title: EX-10.26 6 EX-10.26 NUMBER SHARES X XX INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE TRO LEARNING, INC. THIS CERTIFIES THAT _________________[NAME]_________________ IS THE OWNER OF ____________________XXX________________________FULL PAID AND NON-ASSESSABLE SHARES OF THE SERIES C CONVERTIBLE PREFERRED STOCK TRANSFERABLE ONLY ON THE BOOKS OF THE CORPORATION BY THE HOLDER HEREOF IN PERSON OR BY DULY AUTHORIZED ATTORNEY UPON THE SURRENDER OF THIS CERTIFICATE PROPERLY ENDORSED. THE CORPORATION WILL FURNISH WITHOUT CHARGE TO EACH STOCKHOLDER WHO SO REQUESTS, THE POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL OR OTHER SPECIAL RIGHTS OF EACH CLASS OF STOCK OR SERIES THEREOF AND THE QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS OF SUCH PREFERENCES AND/OR RIGHTS. IN WITNESS WHEREOF, THE SAID CORPORATION HAS CAUSED THIS CERTIFICATE TO BE SIGNED BY ITS DULY AUTHORIZED OFFICERS AND TO BE SEALED WITH THE SEAL OF THE CORPORATION, THIS 13TH DAY OF JANUARY A.D. 1999. - ----------------------------- ----------------------------- SECRETARY PRESIDENT EX-10.27 7 EX-10.27 FIRST AMENDMENT TO SUBORDINATED CONVERTIBLE DEBENTURES DUE MARCH 27, 2004 OF TRO LEARNING, INC. TRO Learning, Inc., a Delaware corporation (the "Issuer"), hereby amends its Series 1997 10% Subordinated Convertible Debentures due March 27, 2004, in the aggregate principal amount of $3,050,000, represented by Debenture Certificates No. 1997/10-1 through No. 1997/10-55 (the "Debentures") as provided herein. RECITALS A. On March 27, 1997, the Issuer issued certificates representing the Debentures to the purchasers thereof. B. The Debentures are convertible into shares of the Issuer's Common Stock at the option of the holder at a conversion price which is subject to adjustment as provided in the Debentures. C. Section 4(b)(iv) of the Debentures incorrectly states the formula for adjusting such conversion price and does not accurately reflect the agreement between the Issuer and the purchasers of the Debentures with respect to such adjustment and the Issuer desires to amend the Debenture to accurately describe the formula for determination of adjustments under such Section. NOW, THEREFORE, in consideration of the above recitals and other good and valuable consideration, the Issuer hereby amends the Debentures as follows: 1. Section 4(b)(iv) is hereby deleted and restated in its entirety as follows: (iv) If the Issuer issues or sells any shares of Common Stock for a consideration per share less than the Conversion Price then in effect (other than dividends payable in shares of Common Stock), or issues any options, warrants, or other rights to purchase Common Stock at a consideration per share less than the Conversion Price then in effect, or issues securities convertible into Common Stock at a conversion price per share of less than the Conversion Price then in effect, then the Conversion Price in effect immediately prior to such issuance or sale shall be adjusted so as to equal a fraction, (a) the numerator of which shall be an amount equal to the sum of (A) the aggregate number of shares of Common Stock outstanding immediately prior to such issuance or sale multiplied by the applicable Conversion Price in effect immediately prior to such issuance or sale, and (B) the total consideration payable to the Issuer upon such issuance or sale of such Common Stock and/or such purchase rights or convertible securities, plus the consideration payable to the Issuer upon the exercise of such purchase rights or upon conversion of such convertible securities, and (b) the denominator of which shall be an amount equal to the aggregate number of shares of Common Stock outstanding immediately after such issuance or sale plus the number of shares of Common Stock issuable upon the exercise of any purchase rights and/or upon the conversion of convertible securities issued in such issuance. If the Conversion Price is adjusted as the result of the issuance of any options, warrants or other purchase rights or upon the issuance of convertible securities, no further adjustments of such Conversion Price shall be made at the time of the exercise of such options, warrants or other purchase rights or convertible securities. If securities are sold for a consideration other than cash, the amount of the consideration other than cash received by the Issuer shall be deemed to be the fair value of such consideration as determined by the Board of Directors of the Issuer. 2. Except as expressly provided herein, all of the terms, covenants and conditions of the Debentures remain in full force and effect. The Issuer has caused this First Amendment to Debenture to be executed as of November 13, 1997. TRO LEARNING, INC. By: -------------------------------- Its: -------------------------------- -2- EX-23.01 8 EX-23.01 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statement of TRO Learning, Inc. on Form S-8 (File No. 333-30963 and 333-61721) and on Form S-3 (File No. 333-44617) of our report dated December 3, 1998, on our audits of the consolidated financial statements and financial statement schedule of TRO Learning, Inc., as of October 31, 1998 and 1997, and for the years ended October 31, 1998, 1997 and 1996, which report is included in this Annual Report on Form 10-K. PRICEWATERHOUSECOOPERS LLP Chicago, Illinois December 3, 1998 EX-24.01 9 EX-24.01 POWER OF ATTORNEY The undersigned, a Director and/or Officer of TRO Learning, Inc., a Delaware corporation (the "Company"), does hereby constitute and appoint William R. Roach, John Murray and Mary Jo Murphy, his or her true and lawful attorneys and agents, each with full power and authority (acting alone and without the other) to execute in the name and on behalf of the undersigned as such Director and/or Officer, the Company's Annual Report on Form 10-K and related amendments, if any. The undersigned hereby grants unto such attorneys and agents, and each of them, full power of substitution and revocation in the premises and hereby ratifies and confirms all that such attorneys and agents may do or cause to be done by virtue of these presents. Dated this 22nd day of January, 1999 /s/ William R. Roach - ---------------------------------- POWER OF ATTORNEY The undersigned, a Director and/or Officer of TRO Learning, Inc., a Delaware corporation (the "Company"), does hereby constitute and appoint William R. Roach, John Murray and Mary Jo Murphy, his or her true and lawful attorneys and agents, each with full power and authority (acting alone and without the other) to execute in the name and on behalf of the undersigned as such Director and/or Officer, the Company's Annual Report on Form 10-K and related amendments, if any. The undersigned hereby grants unto such attorneys and agents, and each of them, full power of substitution and revocation in the premises and hereby ratifies and confirms all that such attorneys and agents may do or cause to be done by virtue of these presents. Dated this 22nd day of January, 1999 /s/ Tony Christianson - ---------------------------------- POWER OF ATTORNEY The undersigned, a Director and/or Officer of TRO Learning, Inc., a Delaware corporation (the "Company"), does hereby constitute and appoint William R. Roach, John Murray and Mary Jo Murphy, his or her true and lawful attorneys and agents, each with full power and authority (acting alone and without the other) to execute in the name and on behalf of the undersigned as such Director and/or Officer, the Company's Annual Report on Form 10-K and related amendments, if any. The undersigned hereby grants unto such attorneys and agents, and each of them, full power of substitution and revocation in the premises and hereby ratifies and confirms all that such attorneys and agents may do or cause to be done by virtue of these presents. Dated this 22nd day of January, 1999 /s/ John L. Krakauer - ---------------------------------- POWER OF ATTORNEY The undersigned, a Director and/or Officer of TRO Learning, Inc., a Delaware corporation (the "Company"), does hereby constitute and appoint William R. Roach, John Murray and Mary Jo Murphy, his or her true and lawful attorneys and agents, each with full power and authority (acting alone and without the other) to execute in the name and on behalf of the undersigned as such Director and/or Officer, the Company's Annual Report on Form 10-K and related amendments, if any. The undersigned hereby grants unto such attorneys and agents, and each of them, full power of substitution and revocation in the premises and hereby ratifies and confirms all that such attorneys and agents may do or cause to be done by virtue of these presents. Dated this 22nd day of January, 1999 /s/ Vernon B. Lewis, Jr. - ---------------------------------- POWER OF ATTORNEY The undersigned, a Director and/or Officer of TRO Learning, Inc., a Delaware corporation (the "Company"), does hereby constitute and appoint William R. Roach, John Murray and Mary Jo Murphy, his or her true and lawful attorneys and agents, each with full power and authority (acting alone and without the other) to execute in the name and on behalf of the undersigned as such Director and/or Officer, the Company's Annual Report on Form 10-K and related amendments, if any. The undersigned hereby grants unto such attorneys and agents, and each of them, full power of substitution and revocation in the premises and hereby ratifies and confirms all that such attorneys and agents may do or cause to be done by virtue of these presents. Dated this 22nd day of January, 1999 /s/ John Patience - ---------------------------------- POWER OF ATTORNEY The undersigned, a Director and/or Officer of TRO Learning, Inc., a Delaware corporation (the "Company"), does hereby constitute and appoint William R. Roach, John Murray and Mary Jo Murphy, his or her true and lawful attorneys and agents, each with full power and authority (acting alone and without the other) to execute in the name and on behalf of the undersigned as such Director and/or Officer, the Company's Annual Report on Form 10-K and related amendments, if any. The undersigned hereby grants unto such attorneys and agents, and each of them, full power of substitution and revocation in the premises and hereby ratifies and confirms all that such attorneys and agents may do or cause to be done by virtue of these presents. Dated this 22nd day of January, 1999 /s/ Jack R. Borsting - ---------------------------------- EX-27 10 EX-27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF INCOME FOUND IN THE COMPANY'S FORM 10-K FOR THE YEAR ENDED OCTOBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS OCT-31-1998 OCT-31-1998 466 0 16,427 920 648 18,662 1,073 3,204 27,407 20,283 3,050 0 0 64 3,605 27,407 43,278 43,278 5,009 5,009 32,984 814 2,217 3,068 0 3,068 0 0 0 3,068 0.48 0.47
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