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ePal's Fish: "We knew this marketplace was ripe and there were three trends that were coming together on a global scale that made us want to do this. The first was cloud computing, the second was the move to tablets and smart devices, and the third was a change that has been occurring within the science of learning, the pedagogy of learning." Name an industry that has been completely transformed by technology and you are probably naming one that is quite small, or had multiple previous attempts at transformation. The way we rent a movie, read the news, or take a picture may be completely different than the way our parents did, but these spaces evolved in a way you could see coming, if you chose to look. For spaces that involve billions of people, such as healthcare and education, this goes double. Everyone knows electronic medical records are more accurate than paper ones, that Pharmacy Benefit Management can help prevent accidental overdoses, or that schools equipped with computers and internet connections are better off than those without. Practically implementing these changes is another story. Into the education space waded a few execs from AOL who had not only seen industries transform through technology, they had spearheaded some of those changes. Miles Gilburne and Edmund Fish saw trends converging in the space and wanted in. Five years and some sixty-million dollars later, ePals (TSXV:SLN) is an early leader in the networking of education. Cantech Letter caught up with Fish in Vancouver. Edmund, how did ePals get its start? The company started in 2007 with the merger of a couple existing non-profits. It was started around the notion that the education publishing business would undergo the same transformation that every other publishing business that was transformed by the internet has undergone. There are certain immutable rules that all of us have lived by and in many cases, drove. Miles Gilburne, our CEO, was one of the three guys that built AOL and was an original seed investor in MacroMedia, among a host of other very successful internet companies. He has spent his career at that intersection and has done multiple public companies. Your management team has a history of being disruptors… Yes, exactly. For instance, I ran instant messaging at AOL and, in my previous company, Intertrust, we coined the phrase "Digital Rights Management". We knew that as the internet came along people would begin losing their rights and interests in data, and those would need to be managed, not squirreled away. We didn't realize it would become an acronym, however. Also, our CTO, Linda Dozier, invented publishing from a browser to a web page, and has the original US patents. She sold her company, Navisoft, to AOL in 1994. So, yes, all of us come from backgrounds relating to how the internet disrupts publishing, we have all done multiple companies in the space, and we have all been community builders. In the old days, at AOL we had the three "C's”: communications, community and content and that's what built the company. So that's the mindset you took into ePals? Yes, we knew this marketplace was ripe and there were three trends that were coming together on a global scale that made us want to do this. The first was cloud computing, the second was the move to tablets and smart devices, and the third was a change that has been occurring within the science of learning, the pedagogy of learning. The cloud was simple, but in 2006/2007 a lot of people were still not completely believing in it. But we didn't want to do an education business without it. We didn't want to slog, school by school, putting stuff on PCs... "To grow our capability, we did operating deals with Dell and Microsoft, and both companies became investors into the company. We’ve been told this is the only investment Microsoft’s made in the education space. Michael Dell signed off on Dell's investment personally." You didn't want to send out millions of CDs to drive adoption... (Laughs) No. But what really grew AOL was when we were able to put an icon on the desktop, it wasn't mailing millions of CDs. So that was an extremely early lesson in the cloud. We believe schools are the quintessential example of why the cloud makes sense... Why is that? As a business, they are closed one quarter of the year, they have peak usage between the hours of 8am to 2:45pm, and have very low usage the rest of the day. In the US, our government instituted a policy called "Cloud First". If the government is going to look for a computing solution they are to look for a cloud based one if at all possible. Schools represent a very visible part of public computing. The movement to the cloud was big. We knew could scale the business, and we could take it global. Then there was the movement to tablets. You could have lower costs and multiple scenarios. So we had meetings with guys like at MIT who were doing the One Laptop Per Child campaign, folks interested in smart phones and the like. We could see this trend. The tablet, we believed would revolutionize the computing models because they made them more affordable. India will have eighty or ninety million tablets distributed this year. Thailand is distributing tablets to all kids in K-12 schools. Can you tell me more about the changes happening in learning worldwide? What are the trends in the science of learning you mentioned? In US and Canada we are now seeing a trend towards moving learning away from "teaching to the test" and a rote mastery of facts into things that are essential for the workplace, such as communicating to various audiences, digital literacy, critical thinking and problem solving. This has been a movement outside North America in various countries for some time. In the US, we have something called the "Common Course Standards" which have now been adopted by forty four states and was actually driven by business so that graduates would start having more of the skills necessary for success in the workplace. So we knew this would help put the wind at our back. How did you tackle this initially? We wanted to focus on “global communities” of learners. Say a school in Vancouver was learning Spanish and wanted to connect with a classroom in Spain. Or a classroom in China was learning English and wanted to connect with a class whose first language was English. It was about the community, about creating a Facebook for learning, if you will. But it meant we had to go out and invent a whole bunch of things to do that. K-12 Schools have two primary drivers, the first is the need to be “safe and secure” – K-12 schools are compliance driven industries, where safety and security matters. Data protection is really important. "We wanted to demonstrate the network effect that ePals clearly shares with sites like Linkedin, and we also wanted to show that we could generate revenue at the same time. We’ve made some pretty good progress on that front – about $1.4 million in revenue in 2010, $3.7 in 2011, and we did $7.5 million in the first half of this year." The regulatory tangle seems like it would be a nightmare... We had to put real money and real science into this. We created security pyramids that allowed people (teachers, administrators, parents) to specify rules on their permitted user groups. We basically created virtual private networks, managed by groups of administrators, with the ability to delegate permissions to others downstream and with fine grained choices in rules resources and permissions. Of course, a permission model essentially means that an action is denied until it is shown to be permissible with the chosen rules. Corporate software is normally based on a permissions model, while most of the internet is not. We took a corporate approach, but applied internet rules to it. This took a number of years to do at scale and a good portion of the nearly $60-million the company has used in capital. Then, we started to grow the community so that it would exhibit what we call “network effects.” We had teachers and school districts joining from around the world – now with over 800,000 classrooms and over 9M members in 200 hundred countries and territories. We also did partnerships with National Geographic, International Baccalaureate, Microsoft, Dell and others. Why? Because great brands come from association with other great brands. We brought content in from The Smithsonian and others because learning in the end is about great content and other people. What is the economic model here? Well, we can't do the normal social network model, monetizing this with advertising would not be OK in schools. Rather, we find that education publishing is much more a subscription driven business. So, we created platform and media divisions that offer subscription-based services to schools, educational organizations and to users at home. Our platform group sells our policy managed tools to schools and districts on an recurring, per student, basis. To grow our capability, we did operating deals with Dell and Microsoft, and both companies became investors into the company. We’ve been told this is the only investment Microsoft’s made in the education space. Michael Dell signed off on Dell's investment personally. Our media division sells high quality digital and print content to school and home audiences typically on $18-50/ per year subscription levels. We believe that we are ultimately going to be an education media company, with diversified revenue lines that are starting to ramp nicely. That's why you have been gathering content? Yes. National Geographic, The Smithsonian, our Carus and Cobblestone assets, etc. We don't have to completely re-conceptualize the way a publishing industry transforms, we have to apply it to a set of requirements, rules and user needs that are in education. I think a major reason we’ll succeed is that we know how to take content and make it effective and appropriate in a digital format, for learning purposes, and how to create digital distribution models that really work. So that's how we started to build the media business and content business. We're now about 8.5-million registered users globally growing by several million more this year and to about 75-million or more over the next few years. Do your content providers charge a licensing fee? Sometimes, yes. Depends on the exchange of value. As we learn more we have started to believe education publishing will have a variation of a “cable model.” A service that combines online services and content together for recurring subscription fees that we share with providers. We did this at AOL, where content providers got cash from us based upon relative usage of the content. Real Networks did a same thing with One Pass. It's a very common model. Of course, our services encompass both “at school” and “at home” use. Though we spoken most about school-based purchasing, we know moms and dads (and grand parents) in North America spend well over ten billion dollars a year on supplemental education and materials for their kids. The rest of the world is, as you’d expect, much higher – I’ve seen estimates over $500-billion in the coming years, So, it's clear that if you look a few years, much of the growth of our business will come from outside North America. "We don’t have to completely re-conceptualize the way a publishing industry transforms, we have to apply it to a set of requirements, rules and user needs that are in education." Is your model one that includes recurring revenue? Yes. Unlike most internet businesses, we think that the majority of our revenue will recur annually, or even longer intervals than that. School purchases typically have pretty long lead times, but are very sticky thereafter. Consumer-based subscriptions typically grow faster but have more churn. The good news is that people plan to spend for their children over a number of years. As we approached the business, we wanted to make sure people knew this wasn't just an exercise in “eyeball building,” though. We wanted to demonstrate the network effect that ePals clearly shares with sites like Linkedin, and we also wanted to show that we could generate revenue at the same time. We’ve made some pretty good progress on that front – about $1.4 million in revenue in 2010, $3.7 in 2011, and we did $7.5 million in the first half of this year, looking at probably $17-20 for the year. So you are trying to generate revenue while not affecting the user experience. Is that tough line to walk? It can be, yes. The line we walk is the following: Our global community is free for teachers, parents and students to join. When schools and districts want the entire district to join and want control panels where they set the rules, that becomes a fee, typically four to eight dollars per student per year, but it comes out of the savings they get from moving to the cloud. We also offer additional “premium” services, typically on a subscription basis and commerce (one time) purchases as well. What are you hoping to accomplish in the next twelve to eighteen months? We have a set of strategic initiatives that involve building a truly global business starting with ventures in China and Europe, premium services for users that build off our platform, and enabling high quality publishers with access to our unique platform. Out of all the complexity, however, comes four simple metrics that are the key drivers of the business going forward: registered users, subscriptions, overall revenue, and average revenue per user. We will grow all those metrics. In the nearer term we think registered users grows to eleven to thirteen million users; we think we will cross the one million subscription level; we are looking to approach $20-million in revenue, up from $3.7-million in 2011. Historically, we do most of our business in the second half of the year, heavily weighted in the 4th quarter, so things seem to be shaping up well. Our ARPU should go from about thirty cents to about $1.70 per registered user, and we think that will continue to grow as we move forward. This is a very large play and in our view the most important element, strategically, is to embrace the global opportunity as it emerges with the nimbleness to double down on the opportunities that will arise as the market matures. ______________________________

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