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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 for the fiscal year ended December 31, 1996
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 0-22844
SYLVAN LEARNING SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Maryland 52-1492296
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1000 Lancaster Street, Baltimore Maryland 21202
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410)843-8000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
Common Stock, Par Value $.01 NASDAQ
Securities registered pursuant to the Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]. No [ ].
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 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 aggregate market value of voting Common Stock held by non-affiliates of
the registrant was approximately $453 million as of March 17, 1997.
The registrant had 24,516,623 shares of Common Stock outstanding as of March 17,
1997.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Part III of this Form 10-K will be filed by
amendment on Form 10-K/A, which will be filed with the Securities and Exchange
Commission not later than April 30, 1997.
INDEX
Page No.
--------
PART I.
Item 1. Business................................................ 3
Item 2. Properties.............................................. 10
Item 3. Legal Proceedings....................................... 11
Item 4. Submission of Matters to a Vote of Security Holders..... 11
PART II.
Item 5. Market for Registrant's Common
Equity and Related Stockholder Matters................ 12
Item 6. Selected Financial Data................................. 12
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................................ 16
Item 8. Financial Statements and Supplementary Data............. 23
Item 9. Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure................ 23
PART III.
Items 10., 11., 12. and 13. will be filed by
amendment on Form 10-K/A which will be
filed with the Securities and Exchange
Commission not later than April 30, 1997....................... 24
PART IV.
Item 14. Exhibits, Financial Statements, Schedules,
and Reports on Form 8-K............................... 24
SIGNATURES
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PART I.
ITEM 1. BUSINESS
Sylvan Learning Systems, Inc. ("The Company" or "Sylvan") is a leading
international provider of educational and testing services. The Company delivers
a broad array of supplemental and remedial educational services and
computer-based testing services through three principal segments. Through its
Core Educational Services segment, the Company designs and delivers
individualized tutorial services to school-age children and adults through its
network of 620 franchised and Company-owned Sylvan Learning Centers in 49
states, five Canadian provinces, Hong Kong, South Korea and Guam. Sylvan
Prometric, the Company's testing services segment, administers computer-based
tests for major corporations, professional associations and governmental
agencies through its network of certification centers which are located
throughout the world. In addition, the Company's Contract Educational Services
segment now serves 72 schools and over 10,000 students by providing educational
services to public and non-public school districts receiving funding under
federal and state programs and provides contract educational and training
services on-site to employees of large corporations. In 1996, total systemwide
revenues were approximately $285.5 million, composed of $165.1 million from core
educational services ($139.5 million from franchised Learning Centers and $25.6
million from Company-owned Learning Centers, product sales and franchise sales
fees), $87.0 million from testing services and $33.4 million from contract
educational services. In December 1996, the Company acquired Wall Street
Institute International, B.V. and its commonly-controlled affiliates. Wall
Street and its affiliates teach the English language in Europe and Latin America
through a network of over 170 franchised and company-owned centers. Note 19 of
the 1996 audited financial statements contains additional disclosures regarding
the Company's business and geographic segments. As discussed further below, the
Company, in March 1997, announced a proposed merger with National Education
Corporation.
Proposed Merger With National Education Corporation
In March 1997, the Company announced a proposed merger with National
Education Corporation ("NEC") in a stock-for-stock transaction. NEC is a
publicly-held provider of distance learning services, supplemental multimedia
educational materials, and professional training products and services. Under
the terms of the merger, the Company would issue 0.58 shares of its common stock
for each share of NEC common stock. Following the transaction, which is expected
to be accounted for as a pooling-of-interests, shareholders of NEC would hold
approximately 47% on a fully-diluted basis of the common stock of the combined
company. The transaction is expected to be completed in the third quarter of
1997 and has been approved by the boards of directors of both companies. The
transaction is subject to federal anti-trust review and approval by the
shareholders of both companies.
Core Educational Services: Sylvan Learning Centers
Sylvan is widely recognized as providing high quality educational services
with consistent, quantifiable results, and has delivered its core educational
service to more than 1,000,000 students primarily in grades three through eight
over the past 17 years. The Company's core educational service segment provides
supplemental instruction in reading, mathematics and reading readiness,
featuring an extensive series of standardized diagnostic tests, individualized
instruction, a student motivational system and continued involvement from both
parents and the child's regular school teacher.
Typically, a parent contacts a Sylvan Learning Center because the parent
believes that his or her child may have insufficient reading or mathematics
skills. Parents learn about Sylvan from the Company's media advertising, from a
referral from another parent or from school personnel. Learning Center personnel
ask the parent to bring the student to the Learning Center to complete a series
of standardized diagnostic tests and to receive educational consultation.
Approximately 35% of phone inquiries result in a visit to a Learning Center. The
Learning Center's Sylvan-trained educators use test results to diagnose
students' weaknesses and to design an individual learning program for each
student. After the initial testing and consultation, the Company estimates that
more than 90% of parents enroll the student in a full course of study. The
program typically requires four to six months to complete and comprises
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approximately 36 to 60 hours of instruction. Instruction is generally given
twice a week for one hour per visit. Sylvan requires that all instructors be
certified teachers. The cost of the tests and initial consultation ranges from
$95 to $250, and fees average $35 per hour. The Company estimates that the
typical program costs approximately $1,500.
Learning Centers range from 1,000 to 3,500 square feet. Instruction is
given at U-shaped tables designed to ensure that teachers work with no more than
three students at a time. The student's individualized one hour lesson includes
a five segment mastery approach. There are special incentives, such as tokens
redeemable for novelties and toys, to motivate the student to achieve the
program's objectives and to strengthen the student's enthusiasm for learning.
Personal computers at each Learning Center are used by the student as a
supplementary learning tool. The Learning Center's Director of Education
monitors the progress of each student after each hour of instruction.
Instructors schedule parent conferences after every 12 hours of a student's
program. Throughout a student's course of study, the Learning Center tests the
student using the same standardized diagnostic tests, and the results are shared
with the parents in personal conferences, during which the student's
continuation in a Sylvan program is discussed.
Franchise Operations. As of December 31, 1996, there were a total of 620
Learning Centers in 49 states, five Canadian provinces, Hong Kong, South Korea
and Guam operated by the Company or its franchisees. As of that date, there were
434 franchisees operating 581 Sylvan Learning Centers. During 1996, 55
franchised Learning Centers were opened and 6 were closed. In addition, during
1996, 11 franchisee-owned Learning Centers were acquired by the Company. Fewer
than 2% of franchisees are currently more than three months in arrears in the
payment of franchise royalties, and the Company does not believe that the
closing of any or all of the Learning Centers of these franchisees would have a
material adverse effect on the Company because the royalties earned from these
franchisees only represented approximately 1% of total franchise royalties
earned by the Company in 1996.
The Company licenses franchisees to operate Sylvan Learning Centers in a
specified territory, the size of which depends on the number of school-age
children and average household incomes in the area. Franchisees must obtain the
Company's approval for the location and design of the Learning Center and of all
advertising, and must operate the Learning Center in accordance with the
Company's methods, standards and specifications. Most Learning Centers are
located in suburban areas and have approximately 10 employees, two of whom are
typically full-time employees and eight of whom are part-time instructors. The
cost to open a typical franchised Learning Center ranges from approximately
$79,000 to $145,000, including the franchise license fee, furniture, equipment
and an initial supply of certain items required to be purchased under the
Company's franchise agreement.
The Company actively manages its franchise system. The Company requires
franchisees and their employees to attend two weeks of initial training in
Learning Center operations and Sylvan's educational programs. The Company also
offers franchisees continuing training each year. The Company employs field
operations managers that act as "consultants" to provide assistance to
franchisees in technology implementation, business development, marketing,
education and operations. These employees also facilitate regular communications
between franchisees and the Company.
Sylvan operates a quality assurance review program to maintain the quality
of Sylvan Learning Centers. Sylvan's field operations managers confirm
franchisee compliance with the Company's standards, including training
requirements, exclusive use of approved educational materials and programs,
correct administration of testing materials, proper execution of supervisory
procedures, sufficient time spent in parent/teacher conferences, staffing and
Learning Center appearance. Sylvan's consultants counsel franchisees that fail
to meet the Company's quality or financial performance standards and assist
these franchisees in developing a plan to improve their Learning Centers'
performance. When necessary, the Company assists franchisees in selling their
franchises.
The Company believes there is significant potential for additional
franchised Learning Centers both domestically and internationally. A number of
territories with only one Learning Center could support one or more additional
Learning Centers based upon the number of school-age children in the market
area. The Company is actively encouraging existing franchisees in these
territories to open additional Learning Centers. In addition, management has
identified at least 246 territories in North America, primarily in smaller
markets, in which there are no Learning
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Centers. The Company is actively seeking franchisees for a number of these
territories. Approximately 38 new territories were sold in 1996.
The Company has sold franchise rights for the operation of Learning Centers
in South Korea, Hong Kong, China and Israel. Franchisees in these countries
offer the English version of the Sylvan program, and may not offer a foreign
language version of the program without paying additional fees to the Company to
subsidize the additional development costs. In pricing international franchise
rights, the Company takes into account estimates of the number of centers that
could be opened in an area.
The Company's typical franchise agreement (the "License Agreement") grants
a license to operate a Sylvan Learning Center and to use Sylvan's trademarks
within a specified territory. The franchisee is required to purchase from Sylvan
certain diagnostic and instructional materials, student record forms, parental
information booklets and explanatory and promotional brochures developed by the
Company. Sylvan specifies requirements for other items necessary for operation
of a Learning Center, such as computers, instructional materials and furniture.
The Company currently offers a License Agreement with an initial term of ten
years, subject to unlimited additional ten year extensions at the franchisee's
option on the same terms and conditions. The initial license fee ranges from
$34,000 to $42,000, depending on factors such as the number of school-age
children in the territory. Royalties are either 8% or 9% of gross revenues of
the Learning Center, and the royalty rate depends upon the demographics of the
territory and is specified in the License Agreement. Advertising spending
requirements range from $1,000 to $3,500 per month, or up to 6% of gross
revenues, whichever is greater. The License Agreement has been revised
periodically, and several franchisees are operating under older agreements with
variations from the above terms. Approximately 10% of franchisees operate under
older agreements with royalties as low as 6% and without any requirement to
contribute to the national advertising fund. The remaining 90% of the
franchisees are required to contribute a minimum of 1.0% to 1.5% of gross
revenues to the national advertising fund. The fund is administered by the
Sylvan National Advertising Committee, Inc., which is owned equally by the
Company and the Sylvan Franchise Owners Association. Franchisees must submit
monthly financial data to the Company.
Company-owned Learning Centers. As of December 31, 1996, Sylvan owned and
operated 39 Learning Centers: five in Baltimore, six in Dallas, six in Los
Angeles, five in the greater Philadelphia area, six in South Florida, six in the
greater Washington, D.C. area and five in the greater Minneapolis area. The
Company's operation of Learning Centers enables it to test new educational
programs, marketing plans and Learning Center management procedures. As of
December 31, 1996, nine of the Company-owned Learning Centers contained
Technology Centers for computer-based testing. Company-owned Learning Centers in
Baltimore, Dallas, Los Angeles, Philadelphia, South Florida, greater Washington
D.C. and greater Minneapolis give the Company a local presence in key markets,
which has been helpful in marketing the Company's services to school districts
utilizing Title I funds and to employers interested in the Sylvan-At-Work and
PACE programs (see "Contract Educational Services" on page 7). The Company may
consider selected acquisitions of additional Learning Centers now operated by
franchisees.
Sylvan Prometric
Sylvan has established 221 testing centers which are located in existing
Learning Centers, 20 stand-alone testing centers and, with the acquisition of
Drake in September 1995, added an additional 990 testing centers, 594 of which
are located in North America and the remainder in 95 foreign countries. In
addition, Sylvan acquired contract rights from the National Association of
Securities Dealers ("NASD") and assumed management of 56 NASD testing centers in
April 1996. Pursuant to the contract, the Company is in the process of reducing
the number of these testing centers. The Learning Center and stand-alone sites
contain up to 20 networked computers. The Company believes that it can increase
capacity by adding workstations at existing testing centers, as well as by
opening new testing centers. Opening a new testing center has taken, on average,
30 to 60 days. Computer-based tests, which can be offered during regular school
hours and on weekends, increase utilization of Learning Centers. Testing also
increases public awareness of Sylvan Learning Centers and the Company's core
educational services.
Sylvan provides the supporting infrastructure and administration, including
computer equipment and software systems in each testing center and where
appropriate, registration and scheduling of candidates, downloading of
individual tests and training of Learning Center personnel in accordance with
procedures established by the sponsoring
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testing organization. The franchisee provides the space and Learning Center
personnel for staffing the testing center. The Company provides training and
certification of the Testing center personnel as computer-based test
administrators. The Company enters into contracts directly with the testing
organization, such as Educational Testing Services ("ETS"), under which Sylvan
receives a fee based upon the number of tests given. The Company has entered
into a separate agreement with each franchisee that operates a testing center,
whereby the franchisee receives a fee per test that decreases as the volume of
the tests delivered increases. The independently owned and managed testing
centers must meet certain criteria established by the Company for administering
computer-based testing. The owners of the testing centers are required to
furnish the space, equipment and personnel needed for their operation and
receive compensation for test delivery in various forms including hardware
obsolescence guarantees and marketing assistance for their core business.
Principal customers in the information technology ("IT") industry are
Novell, Inc. and Microsoft Corp. IT customers sponsor worldwide certification
programs for various professionals such as network administrators and engineers,
service technicians, instructors, application specialists and developers, and
system administrators, operators and engineers. Certification testing for Novell
and Microsoft accounted for $40.6 million, or 47%, of Sylvan Prometric's
revenues in fiscal 1996.
ETS, a leading educational testing firm, develops and administers more than
9.5 million tests each year, including the Graduate Record Exam ("GRE"), the
Graduate Management Admissions Test ("GMAT"), The Test of English as a Foreign
Language ("TOEFL"), the National Teachers Exam ("NTE") and the Advanced
Placement Program, sponsored by organizations such as the College Board. The
largest tests administered by ETS are the SAT, which is given annually to over
1.6 million college-bound students, and the PSAT, which is given annually to all
students in grade 10 or 11. As one of the largest and most influential test
developers and administrators, ETS is leading the conversion of tests to
computer-based format from pencil and paper versions.
The Company developed a working relationship with ETS as a result of a
joint venture between ETS and a predecessor of the Company in the late 1980s.
This relationship facilitated the Company's entering into a master agreement
with ETS (the "ETS Agreement"), under which the Company is the exclusive
commercial provider of computer-based tests administered by ETS. This
exclusivity provision does not apply to the SAT, PSAT and Achievement Tests
which are sponsored by the College Board.
During 1996, the Company recognized approximately $19.6 million, or 23% of
Sylvan Prometric's revenues in fiscal 1996, from services for ETS. The Company
provides testing services through contracts with ETS both domestically and
internationally. In April 1994, the Company entered into a ten year contract
with ETS to develop test sites and provide computer-based tests internationally.
During 1996, the Company expanded international testing for ETS to 88 permanent
and temporary sites in 54 countries. The terms of the contract stipulate that
the Company will be compensated for its services through a fee equal to approved
costs, plus 10 percent, and the Company recognizes revenues accordingly. The
Company also will be reimbursed for its cost of capital and any foreign exchange
losses. During 1996, the Company recognized revenues of approximately $7.6
million under this contract.
Sylvan has been designated as the exclusive commercial provider of
computer-based tests administered by ETS (excluding tests not currently offered
by the College Board in computer-based format) so long as Sylvan is able to
provide sufficient capacity to meet the demand of candidates seeking to take
computer-based versions of tests, as determined in accordance with criteria set
forth in the ETS Agreement. The ETS Agreement provides that ETS may establish
ETS-operated testing centers, client-specific testing locations or testing
centers at colleges. However, ETS has agreed that Sylvan will receive at least
one-half of ETS' U.S. volume of computer-based tests covered by the ETS
Agreement. At present, there are no ETS-operated testing centers in existence.
Under the ETS Agreement, the Company began offering computer-based versions
of ETS' PRAXIS examination, which is used to license beginning teachers, in
September 1992, and the GRE, which is used by graduate schools to evaluate
applicants, in October 1992. In August 1992, Sylvan and ETS were jointly awarded
a contract by the National Council of State Boards of Nursing to develop and
deliver exclusively a computer-based licensing examination (NCLEX) for
registered and practical nurses. Beginning in April 1994, the test has been
offered exclusively in the computer-based version.
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In addition to the tests offered through its partnership with ETS, the
Company is one of two entities licensed by the FAA to deliver computer-based
versions of various pilot and mechanic licensing tests for private aviation. In
addition to FAA testing, the Company provides testing services for organizations
in many other fields, such as for computer professionals, medical laboratory
technicians, and military candidates.
Effective December 1, 1996, the Company purchased the privately held Wall
Street Institute International, B.V. and its commonly controlled affiliates
(collectively, "WSI"), a European based franchisor and operator of learning
centers where English is taught through a combination of computer-based and live
instruction. Typically, the instructional programs are approximately nine months
to one year in duration. With more than 170 franchised centers in operation
throughout Europe and Latin America, WSI had revenues of approximately $14.0
million for the fiscal year ended August 31, 1996.
The acquisition of WSI is an important step in Sylvan's strategy to
increase its services to the adult education marketplace and to expand
internationally. Sylvan began building a global network for the delivery of
computer-based testing services in early 1994 through an exclusive international
alliance with ETS. In addition to offering the English language programs, WSI
locations can be utilized by Sylvan to administer certain computer-based testing
programs throughout Europe and Latin America.
WSI, which started franchising in 1991, has 82 centers in Spain with the
remainder in France, Germany, Italy, Portugal, Switzerland, Mexico, Chile, and
Venezuela. WSI 's international expansion was accomplished by selling Master
Licensing agreements, with each Master Licensor obtaining franchisees to open
centers in their development areas. Sylvan plans to continue this strategy to
expand WSI's presence globally, with a focus on Asia and the Pacific Rim region.
Contract Educational Services: Public and Non-Public School Based Programs
Funded by Federal Title I and state-based programs; PACE and Sylvan-At-Work
Title I and state-based programs. The federal government and various state
and local governmental agencies allocate funds to local school districts to
provide supplemental and remedial education to academically and economically
disadvantaged students. The main program is the Title I (formerly Chapter I)
program, administered by the U.S. Department of Education. Federal law now
contains minimum student performance standards for each school district
receiving Title I funds. The Company believes that, because of its proven record
of achieving measurable improvement in the reading and mathematics skills of its
students nationwide, it is positioned to provide supplemental educational
services to school districts receiving Title I and similar state funds. As of
December 31, 1996, the Company had contracts to provide remedial educational
services to the following public schools: 22 Baltimore schools, 10 District of
Columbia schools, seven schools in four districts in Texas and Maryland, 14
schools in Chicago, three schools in Newark, five St. Paul schools, two schools
in Broward County, Florida, and one school in New Orleans. In January, 1997 the
Company was awarded contracts to provide services in public schools in the
districts of Charleston, Oklahoma City, and Richmond. In 1996, approximately 14%
of total revenues for the contract educational services segment were derived
from the contracts with the Baltimore City Schools.
Using Company personnel, Sylvan offers virtually the same core educational
services to students in schools as is offered at Sylvan Learning Centers. The
school designates a classroom to be the Learning Center for the duration of the
contract and modifies the classroom to resemble a typical Learning Center.
Sylvan personnel administer standardized diagnostic tests and, based on the
results, prescribe an individualized learning program for each child. Students
typically receive two hours of instruction per week, which includes use of
personal computers as in a Learning Center. The Company can provide these
services to students after school, on Saturdays, during the summer or as a
"pullout" program during the regular school day, which is the method currently
prescribed by all current contracts. There is a high degree of individual
attention, with student to teacher ratios of no more than three to one. The
program is designed to include a high degree of parental involvement, and
teachers make a special effort to involve parents.
Under most of its contracts, the Company has guaranteed that each student
who receives instruction in the Sylvan program and meets prescribed attendance
requirements will achieve some minimum measure of improvement required
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by the school districts, as measured by standardized tests. Improvement is
measured using various standardized measures, including normal curve equivalents
("NCE's"), a generally accepted statistical measure of student performance. The
typical minimum improvement required is two NCE's per year. If a student does
not achieve the required improvement, the Company will provide 12 hours of
remedial instruction to that student during the following summer or school year
without charge. The Company has not incurred significant expense related to this
guarantee. Under the contracts, the school districts pay the Company a set fee
for all services, materials and equipment. The contracts have terms of one to
three years, with the latest expiring in June 1998. All of the contracts contain
provisions for cancellation by school district officials based on funding
constraints.
The Company is actively seeking contracts to provide its core educational
program to other school systems, offering to tailor its program to the system's
specific needs, and is in discussions with several other major school districts.
In addition to serving public school students, Sylvan can provide its service to
parochial or private school students through contracts with public school
districts. Public school districts are responsible for administering the Title I
funding for the non-public schools. Because government-funded services to any
parochial school students generally cannot legally be provided in the parochial
school, Sylvan offers the flexibility of conducting the program at a nearby
Learning Center, or providing temporary facilities.
PACE. In March 1995, the Company acquired The PACE Group ("PACE"), a
provider of educational and training services to large corporations throughout
the United States. Services offered by PACE include racial and gender workplace
diversity training and skills improvement programs such as writing, advanced
reading, listening and public speaking. This acquisition complements the
Company's Sylvan-At-Work program and extends the core educational services the
Company offers to adults in the corporate workplace. PACE provides educational
and training services, typically on-site, to businesses throughout the United
States and generated $10.1 million in revenues for the year ended December 31,
1996. Management believes PACE is capitalizing on the trend toward outsourcing
of training services by large corporations. PACE licenses most of these programs
from the individuals who developed them and pays royalties ranging from 5% to
15% of the revenues generated from the programs. These programs are typically
offered on-site from one to several days at a time and are conducted by trained
instructors employed by PACE, or, in some cases, PACE will train the customer's
employees to conduct the programs. Additionally, a corporation may purchase a
site license to offer a particular PACE program. PACE currently has 26 sales
offices throughout the United States and markets the programs locally through
its sales force. PACE customers include Ford Motor Company, IBM, BankOne,
General Motors and AT&T.
Sylvan-At-Work. The Company's Sylvan-At-Work program, which has been
offered since 1990, is a modified version of Sylvan's core educational service
provided to businesses on-site. Programs are currently offered for Motorola,
Inc. at one site in Austin, Texas; for Texas Instruments Incorporated at three
sites in the Dallas area; and, for Martin Marietta Energy Systems, Inc. at one
site in Tennessee.
Marketing
The Company and its franchisees market Sylvan's core educational service to
parents of school-aged children at all grade levels and academic abilities. Far
beyond tutoring, Sylvan Learning Centers' supplemental education utilizes a
diagnostic and prescriptive approach to address the specific needs of each and
every student. A portion of Sylvan's advertising includes spots on morning and
evening news on the national networks. Sylvan's advertising campaign
demonstrates the benefits of its personalized educational services through
testimonials of actual parents and Sylvan teachers. It positions Sylvan as the
leader in supplemental education and emphasizes Sylvan's high quality
curriculum, personalized attention and positive results: better grades and
improved self-esteem. Franchisees form local cooperatives to collectively
purchase local television and radio advertising and usually supplement their
efforts with local newspaper and direct mail. The company also has additional
marketing support for specific programs, including Reading, Math, Algebra,
Geometry, Study Skills, SAT/ACT College Prep, and Writing.
The Company is actively involved in marketing computer-based testing
services to national and international academic testing organizations, such as
ETS, and licensing and professional certification organizations. The Company's
network of testing centers, centralized registration capability and
computer-based testing experience offer
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important competitive advantages. The Company markets its school-based
educational services to several public school systems and state education
departments. In 1995 and 1996, this marketing effort has been expanded to seek
contracts for both public and non-public schools, where both are administered by
the local public school district.
Marketing efforts for the PACE programs are focused on large corporations
seeking to outsource their training and educational programs, through PACE's 26
sales offices throughout the United States. PACE's strategy is to offer
solutions to the customer's training needs rather than marketing specific
products.
Competition
The Company is aware of only two direct national corporate competitors in
its core educational services segment: Huntington Learning Centers, Inc. and
Kumon Educational Institute. The Company believes these competitors operate
fewer centers than Sylvan and that these firms concentrate their services within
a smaller geographic area. In most areas served by Sylvan Learning Centers, the
primary competition is from individual tutors. State and local education
agencies also fund tutoring by individuals, which competes with the Company's
core educational services segment.
The Company is not aware of any other private businesses competing to
provide Title I programs for public school students, and the Company's most
significant competitor remains the public school system itself. Given the unique
position of public education in the United States, the Company believes that
educational reforms implemented directly by school officials will not face the
same degree of public resistance that the Company may face. The Company also
competes with school reform efforts sponsored by private organizations and
universities and with consultants hired by school districts to provide
assistance in the identification of problems and implementation of solutions.
The Company is aware of several entities that currently provide Title I and
state-based programs for students attending parochial and private schools on a
contract basis.
Sylvan Prometric also has a small number of direct competitors. These
competitors include organizations that have opened centers to offer specific
computer-based tests under contracts with the administrators of those tests.
Government Regulation
Title I. Title I school districts are responsible for implementing Title I
in carrying out their educational programs. Final Title I regulations, which
were issued July 3, 1995, as well as provisions of Title I itself, direct Title
I school districts to satisfy obligations including involving parents in their
children's education, evaluating and reporting on student progress, providing
equitable services and other benefits to eligible non-public school students in
the district and other programmatic and fiscal requirements. In contracting with
school districts to provide Title I services, the Company has become, and will
continue to be, subject to various Title I requirements and may become
responsible to the school district for carrying out specific functions required
by law. For example, under the Baltimore City Schools' contract, Sylvan has
responsibility for soliciting parental involvement, introducing program content
adequate to achieve certain educational gains and maintaining the
confidentiality of student records. The Company's failure to adhere to Title I
requirements or to carry out regulatory responsibilities undertaken by contract
may result in contract termination, financial liability, or other sanctions.
Franchise. The sale of franchises is regulated by various state authorities
as well as the Federal Trade Commission (the "FTC"). The FTC requires that
franchisors make extensive disclosure to prospective franchisees but does not
require registration. A number of states require registration and prior approval
of the franchise offering document. In addition, several states have "franchise
relationship laws" or "business opportunity laws" that limit the ability of a
franchisor to terminate franchise agreements or to withhold consent to the
renewal or transfer of these agreements. While the Company's franchising
operations have not been materially adversely affected by such existing
regulation, the Company cannot predict the effect of any future legislation or
regulation.
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Trademarks
The Company has a federal trademark registration for the words "Sylvan
Learning Center" and distinctive logo (a reading child), a service mark for the
words "Sylvan Prometric" and various other trademarks and service marks and has
applications pending for a number of other distinctive phrases. The Company also
has obtained Canadian registrations of a number of the same trademarks. The
Company's License Agreement grants the franchisee the right to use the Company's
trademarks in connection with operation of the franchisee's Learning Center.
Employees
As of December 31, 1996, the Company had approximately 2,850 employees,
1,250 of whom were classified as full-time and 1,600 of whom were classified as
part-time. Most of the Company's part-time employees are teachers in
school-based programs, Company-owned Learning Centers and Sylvan-At-Work
programs. None of the Company's employees is represented by a union, and the
Company considers its relationship with its employees to be good.
Backlog
The Company supplies its educational and testing services when requested;
consequently, the Company has not experienced any backlog of services.
Effect of Environmental Laws
The Company is in compliance with all environmental laws. Future compliance
with environmental laws is not expected to have a material effect on the
business.
ITEM 2. PROPERTIES
The Company leases approximately 108,000 square feet of space in Baltimore,
Maryland for its administrative offices. In addition, the Company leases
approximately 55,000 square feet in Minneapolis, Minnesota for general office
space and a registration center. The Company also leases space for the 39
Company-owned Learning Centers in Maryland, Texas, California, Pennsylvania,
Delaware, New Jersey, Florida, Minnesota and Virginia, ranging from 1,500 to
3,500 square feet per Learning Center. The Company began leasing space for
Technology Centers in areas where there is no Learning Center franchise or
centers acquired from NASD. These spaces range from 500 to 3,500 square feet.
The Company had 80 Technology Centers leased as of December 31, 1996. The
Company leases 29 international testing sites ranging from 500 to 5,000 square
feet with the lease terms from three to five years.
10
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company may be a party to routine litigation
incidental to its business. At this time, the Company is the defendant in a
legal proceeding pending in the United States District Court for the Northern
District of Iowa, Civil Action No. C96-334MJM, filed on November 18, 1996 by
ACT, Inc., an Iowa nonprofit corporation formerly known as American College
Testing Program, Inc. ("ACT"). ACT's claim arises out of the Company's purchase
of contract rights to administer testing services for the National Association
of Securities Dealers, Inc. ("NASD"). ACT has asserted that the Company
tortiously interfered with ACT's relations, contractual and quasi-contractual,
with the NASD, caused ACT to suffer the loss of its advantageous economic
prospects with the NASD and other ACT clients and that the Company has
monopolized and attempted to monopolize the computer-based testing services
market. ACT has claimed unspecified amounts of compensatory, treble and punitive
damages, as well as injunctive relief. The Company believes that all of ACT's
claims are without merit.
At this time the Company is not a party, either as plaintiff or defendant,
in any other material litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter ended December 31, 1996.
11
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has traded on the NASDAQ Stock Market since its
initial public offering on December 9, 1993. It's trading symbol is SLVN. The
high and low trade prices for 1995 and 1996 for the Company's common stock are
set out in the following table. These prices are as reported by NASDAQ, and
reflect inter-dealer price quotations, without retail mark-up, mark down or
commission and may not necessarily represent actual transactions. All amounts
reported in the 1996 Annual Report on Form 10-K and in the 1996 audited
financial statements have been retroactively restated to reflect the effects of
a 3 for 2 stock split which occurred in November 1996.
1995 High Low
---- ------ -----
1st Quarter $13.17 $11.17
2nd Quarter $14.33 $11.09
3rd Quarter $21.67 $14.33
4th Quarter $21.17 $15.33
1996 High Low
---- ------ -----
1st Quarter $26.17 $18.00
2nd Quarter $27.50 $21.33
3rd Quarter $27.50 $18.67
4th Quarter $33.00 $24.25
No dividends were declared on the Company's Common Stock during the years
ended December 31, 1996 and 1995, and the Company does not anticipate paying
dividends in the foreseeable future.
The number of registered shareholders of record as of March 17, 1997 was
213.
During the year ended December 31, 1996, the Company issued 861,500 shares
of its common stock that were not registered under the Securities Act of 1933.
On November 8, 1996, the Company issued 824,000 shares to JLC Learning
Corporation pursuant to a Securities Purchase Agreement. On October 23, 1996,
the Company issued 37,500 shares to Jannick Education, Inc. for the purchase of
five franchised learning centers.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Sylvan is the successor to Sylvan Learning Corporation (the "Predecessor").
The Predecessor was founded in 1979 to develop the Sylvan Learning Centers
concept. In April 1985, Kinder-Care Learning Centers, Inc. ("Kinder-Care")
acquired the Predecessor and in July 1985, completed an initial public offering
of the Predecessor's common stock. The Predecessor operated as a public company
until February 1988, when Kinder-Care repurchased all of the publicly-held
shares of the Predecessor.
On February 1, 1991, the Predecessor and KEE, Incorporated ("KEE"), a
computer training software development business owned by a group of investors
including Messrs. Hoehn-Saric and Becker, entered into a joint venture by
contributing substantially all of their assets to Sylvan KEE Systems, a Maryland
general partnership (the "Partnership"), each in exchange for a 50% interest in
the Partnership. Messrs. Hoehn-Saric and Becker assumed management
responsibility for the Partnership. The Partnership operated the business
through January 26, 1993, when KEE purchased all of the Predecessor's
outstanding common stock from Kinder-Care. The $8.0 million purchase price was
paid with $4.5 million in cash and KEE's $3.5 million 12% promissory note. The
cash portion of the purchase price came from the net proceeds of KEE's private
placement of $10.0 million of Series A Preferred Stock.
Following KEE's purchase of the stock of the Predecessor, the Partnership
was dissolved, and all of its assets and liabilities were transferred to KEE.
KEE changed its name to Sylvan KEE Systems, Inc. and later to Sylvan Learning
Systems, Inc. in contemplation of the disposition of the assets of the KEE
division. During 1993, Sylvan sold all of KEE's assets and liabilities for $2.2
million to Computer Innovations Distribution Inc., which operates
12
under the name Computerland of Canada and is a subsidiary of SHL Systemhouse
Inc. Sylvan realized a gain of approximately $364,000 from this transaction.
KEE's business had generated operating losses for all periods and is presented
in the Statements of Operations as a discontinued operation.
The following combined statement of operations data for the twelve months
ended December 31, 1992 are unaudited and consist of the operations of the
Partnership which was formed on February 1, 1991. On January 26, 1993, Sylvan
acquired the Predecessor and dissolved the Partnership. The selected statement
of operations data for the year ended December 31, 1993 consists of the results
of the Partnership for the month of January 1993 plus the results of Sylvan for
the eleven months ended December 31, 1993. The selected financial data for the
years ended December 31, 1994, 1995 and 1996 have been derived from Sylvan's
financial statements which have been audited by Ernst & Young LLP. The financial
data should be read in conjunction with the historical Financial Statements and
Notes thereto.
On February 17, 1995, the Company acquired by merger all of the outstanding
stock of Remedial Education and Diagnostic Services, Inc. and READS, Inc.
(collectively, "READS"). READS is based in Philadelphia, Pennsylvania and
provides remedial and education services, psychological, diagnostic and
counseling services, career awareness training, and a variety of consulting
services. Services are delivered under contracts with school districts,
county-wide educational agencies and municipalities in the Eastern United
States. During 1994, the Company acquired by merger all of the outstanding stock
of Learning Services, Inc. ("LSI") and all of the outstanding stock of Loralex
Corporation ("Loralex"). These companies owned and operated a total of nine
Sylvan Learning Centers located in the Northeast United States and Florida,
respectively. All of these acquisitions have been accounted for by the Company
as poolings-of-interests and, accordingly, the Company's financial statements
have been restated for all periods prior to these acquisitions to include the
results of operations of READS, LSI and Loralex. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Background." The
selected statements of operations data include the operations of PACE from March
1, 1995 and the operations of Drake from October 1, 1995, the respective periods
each of these subsidiaries were owned by the Company, as further described in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Background". The selected statements of operations data include the
operations of Wall Street Institute International B.V. ("WSI") from December 1,
1996 through December 31, 1996, the period that WSI was owned by the Company, as
further described in "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Background".
13
Partnership
and Sylvan Sylvan
Partnership Combined ---------------------------------------
Year Year Year Year Year
Ended Ended Ended Ended Ended
December 31, December 31, December 31, December 31, December 31,
1992(1) 1993(1) 1994(1) 1995 1996
--------- --------- --------- --------- ---------
(in thousands, except per share data)
Statements of Operations Data:
Revenues:
Franchise royalties .............................. $ 5,695 $ 6,510 $ 7,921 $ 9,223 $ 11,160
Franchise sales fees ............................. 352 1,008 1,256 2,132 3,184
Company-owned learning center
services ...................................... 3,692 7,246 8,605 11,520 18,528
Product sales .................................... 1,537 1,297 2,234 3,188 3,927
Testing services ................................. 1,300 3,572 13,665 34,566 86,951
Contract educational services .................... 7,124 9,989 13,563 27,362 33,366
Other ............................................ 481 -- -- -- --
--------- --------- --------- --------- ---------
Total revenues ................................ 20,181 29,622 47,244 87,991 157,116
--------- --------- --------- --------- ---------
Cost and expenses:
Franchise services ............................... 2,195 2,778 3,84 15,875 6,532
Company-owned learning center
expense ....................................... 3,400 6,873 7,655 10,369 16,073
Cost of product sales ............................ 1,782 1,009 1,759 2,431 2,952
Testing service expense .......................... 2,022 3,052 14,025 30,348 71,518
Contract educational services
expense ....................................... 6,316 8,751 11,880 25,120 29,071
General and administrative expense(4) ............ 5,433 6,255 4,998 6,206 8,755
Loss on impairment of assets ..................... -- -- -- 3,316 --
--------- --------- --------- --------- ---------
Total cost and expenses ....................... 21,148 28,718 44,158 83,665 134,901
--------- --------- --------- --------- ---------
Operating income (loss) .............................. (967) 904 3,086 4,326 22,215
Non-operating income (expense) ....................... (112) (171) 224 391 363
Interest income (expense), net ....................... (307) (999) 152 (960) 1,015
--------- --------- --------- --------- ---------
Income (loss) from continuing
operations before income taxes and
extraordinary items .............................. (1,386) (266) 3,462 3,757 23,593
Income taxes ......................................... (8) (7) (76) (209) (8,850)
--------- --------- --------- --------- ---------
Income (loss) from continuing
operations before extraordinary
items ............................................ (1,394) (273) 3,386 3,548 14,743
Discontinued operations(2):
Loss from operations, net of tax ................. (1,700) (375) -- -- --
Gain on disposal ................................. 427 580 -- -- --
--------- --------- --------- --------- ---------
Income (loss) from discontinued
operations .................................... (1,273) 205 -- -- --
--------- --------- --------- --------- ---------
Net income (loss) before extraordinary
items ............................................ (2,667) (68) 3,386 3,548 14,743
Extraordinary items(3) ............................... -- (177) -- -- --
--------- --------- --------- --------- ---------
Net income(loss) ................................. $ (2,667) $ (245) $ 3,386 $ 3,548 $ 14,743
========= ========= ========= ========= =========
Income (loss) from continuing
operations per share(5) .......................... $ (0.02) $ 0.23 $ 0.22 $ 0.60
========= ========= ========= =========
Net income (loss) per share(5) ....................... $ (0.02) $ 0.23 $ 0.22 $ 0.60
========= ========= ========= =========
Weighted average shares outstanding(5) ............... 11,553 15,119 15,972 23,582
========= ========= ========= =========
Balance Sheet Data (at period end):
Net working capital (deficit) ........................ $ (2,559) $ 12,869 $ 11,530 $ 38,317 $ 28,387
Intangible assets and deferred contract
costs ............................................ 149 7,000 7,932 82,849 122,932
Total assets ......................................... 9,979 32,242 42,499 165,407 250,579
Long-term debt and capital leases .................... 1,690 2,899 6,168 4,416 4,049
Stockholders' or partners' equity (deficit) .......... (210) 23,971 31,834 136,464 179,591
(footnotes on next page)
14
- ----------
(1) Prior to February 1, 1991, the Sylvan Learning Centers business was
conducted by Sylvan Learning Corporation (the "Predecessor"). On February
1, 1991, the Predecessor contributed the Sylvan Learning Centers business
to Sylvan KEE Systems, a Maryland general partnership (the "Partnership")
in exchange for a 50% partnership interest, and Sylvan contributed its
computer training software development business to the Partnership in
exchange for the other 50% partnership interest. On January 26, 1993,
Sylvan acquired the Predecessor and dissolved the Partnership. On September
3, 1993, Sylvan sold its computer training software development business.
On February 17, 1995, Sylvan acquired by merger all of the outstanding
stock of Remedial Education and Diagnostic Services, Inc. and READS, Inc.
(collectively, "READS"). READS is based in Philadelphia, Pennsylvania and
provides remedial and education services, psychological, diagnostic and
counseling services, career awareness training, and a variety of consulting
services. Services are delivered under contracts with school districts,
county-wide educational agencies and municipalities in the Eastern United
States.
During 1994, Sylvan acquired by merger all of the outstanding stock of
Learning Services, Inc. ("LSI") and all of the outstanding stock of Loralex
Corporation ("Loralex"). These companies owned and operated a total of nine
Sylvan Learning Centers located in the Northeast United States and Florida.
The READS, Loralex and LSI acquisitions have been accounted for by Sylvan
as poolings-of-interests and, accordingly, Sylvan's financial statements
have been restated for all periods presented to include the results of
operations of READS, LSI and Loralex. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Background."
(2) Represents Sylvan's computer training software development business which
was sold in September 1993; a Canadian computer training business, 80.1% of
which was sold in 1992; and Sylvan's tuition financing subsidiary which was
sold in October 1991.
(3) Represents the $350,000 gain on extinguishment of a $3.5 million debt to
Learning Centers, Inc., and a $527,000 loss on an extinguishment of $5.0
million of notes payable to stockholders.
(4) The Company has reclassified certain operating expenses previously included
in general and administrative expense to division-specific expense
categories. This change has been reflected for all periods presented.
(5) All share and per share data have been restated to retroactively reflect a
3-for-2 stock split of the Company's common stock for stockholders of
record on November 7, 1996.
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
ALL STATEMENTS CONTAINED HEREIN THAT ARE NOT HISTORICAL FACTS, INCLUDING BUT NOT
LIMITED TO, STATEMENTS REGARDING THE ANTICIPATED IMPACT OF UNCOLLECTIBLE
ACCOUNTS RECEIVABLE ON FUTURE LIQUIDITY, EXPENDITURES TO DEVELOP LICENSING AND
CERTIFICATION TESTS UNDER EXISTING CONTRACTS, THE COMPANY'S CONTINGENT PAYMENT
OBLIGATIONS RELATING TO THE PACE AND DRAKE ACQUISITIONS, FUTURE CAPITAL
REQUIREMENTS, POTENTIAL ACQUISITIONS AND THE COMPANY'S FUTURE DEVELOPMENT PLANS
ARE BASED ON CURRENT EXPECTATIONS. THESE STATEMENTS ARE FORWARD LOOKING IN
NATURE AND INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES. ACTUAL RESULTS MAY
DIFFER MATERIALLY. AMONG THE FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY ARE THE FOLLOWING: CHANGES IN THE FINANCIAL RESOURCES OF THE
COMPANY'S CLIENTS; TIMING AND EXTENT OF TESTING CLIENTS' CONVERSIONS TO
COMPUTER-BASED TESTING; AMOUNT OF REVENUES EARNED BY THE COMPANY'S PACE AND
DRAKE OPERATIONS; THE AVAILABILITY OF SUFFICIENT CAPITAL TO FINANCE THE
COMPANY'S BUSINESS PLAN ON TERMS SATISFACTORY TO THE COMPANY; GENERAL BUSINESS
AND ECONOMIC CONDITIONS; AND OTHER RISK FACTORS DESCRIBED IN THE COMPANY'S
REPORTS FILED FROM TIME TO TIME WITH THE COMMISSION. THE COMPANY WISHES TO
CAUTION READERS NOT TO PLACE UNDUE RELIANCE ON ANY SUCH FORWARD LOOKING
STATEMENTS, WHICH STATEMENTS ARE MADE PURSUANT TO THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1955 AND, AS SUCH, SPEAK ONLY AS OF THE DATE MADE.
Background
In April 1991, the Partnership acquired a computer training business from
Computerland of Canada through a subsidiary, Learning Technologies of Canada,
Inc. ("LTC"). In June 1992, the Partnership sold 80.1% of the stock of LTC to
Computerland of Canada. Computerland of Canada purchased the remaining 19.9% of
LTC's stock in connection with Sylvan's sale of the entire KEE business in 1993.
The Partnership recognized a net gain of $427,000 upon the sale of 80.1% of
LTC's stock in 1992, and Sylvan recognized a gain of $216,000 upon the sale of
the remaining 19.9% of LTC's stock in 1993.
During 1994, Sylvan acquired by merger all of the outstanding shares LSI
and Loralex. These companies owned and operated a total of nine Sylvan Learning
Centers located in the greater Philadelphia area and Southern Florida,
respectively. On February 17, 1995, in exchange for 525,108 shares of Sylvan's
Common Stock (having a then market value of approximately $6.0 million), Sylvan
acquired READS, a Philadelphia, Pennsylvania-based contract provider of various
remedial education, diagnostic and consulting services to non-public schools.
Each of these acquisitions has been accounted for by Sylvan as a
pooling-of-interests and, accordingly, Sylvan's financial statements have been
restated for all prior periods presented to include the results of operations of
LSI, Loralex and READS. In 1994, the LSI and Loralex Learning Centers generated
an aggregate of $4.1 million of revenues and $834,000 of operating income.
READS' revenues for 1994 totaled $7.7 million (including $2.6 million from a
related not-for-profit entity) and operating income of $630,000. Effective
February 28, 1995, Sylvan acquired PACE, a provider of educational services to
large corporations. The acquisition was accounted for using the purchase method
of accounting, and Sylvan's results of operations from March 1, 1995 include the
operations of PACE. PACE had total revenues of $9.6 million and $1.4 million of
operating income in 1994.
On December 13, 1995 Sylvan consummated the purchase of privately-held
Drake, a leading provider of computer-based certification, licensure and
assessment testing, at which time the Company transferred an initial purchase
price valued at approximately $70.0 million to the Sellers. The transaction was
effective September 30, 1995. An additional amount of $8.1 million is payable to
the Sellers based on the 1996 financial results of the Sylvan Prometric
division. Additional consideration may be payable to the Sellers if defined
future operating results of the computer-based testing business are achieved.
16
Effective December 1, 1996, Sylvan acquired Wall Street Institute
International B.V. and its commonly-controlled affiliates ("WSI"), a
European-based franchisor and operator of learning centers that teach the
English language. This transaction was accounted for using the purchase method
of accounting and Sylvan's results of operations from December 1, 1996 include
the operations of WSI. WSI had total revenues of $14.3 million and $4.2 million
of operating income for its most recent fiscal year which ended August 31, 1996.
Sylvan paid $4.9 million of the approximately $20.0 million purchase price in
cash and the remainder in 714,884 shares of Sylvan common stock. Sylvan has
agreed to register 209,520 of such shares under the Securities Act of 1933, as
amended on April 28, 1997.
The discussion of Sylvan's results of operations herein relates to the
continuing operations of Sylvan. The results of operations discussion of PACE is
included for the period from March 1, 1995. The results of operations discussion
of Drake is included for the period from October 1, 1995. The results of
operations discussion of WSI is included for the period December 1, 1996 through
December 31, 1996.
Sylvan generates revenues from three business segments: core educational
services which primarily consist of franchise sales, royalties and Sylvan-owned
Learning Center revenues; testing services, which consist of computer-based
testing fees paid to Sylvan primarily by test administrators; and contract
educational services, which consist of revenues attributable to providing
supplemental and remedial education services to school districts and major
corporations.
Results of Operations
Comparison of results for the year ended December 31, 1996 to the year ended
December 31, 1995.
Revenues. Total revenues increased by $69.1 million, or 79%, to $157.1
million for the year ended December 31, 1996, compared to the same period in
1995. This increase resulted from higher revenues in all business segments --
core educational services, testing services and contract educational services.
Core educational services revenues increased by $10.7 million, or 41%, to
$36.8 million for 1996. Franchise royalties increased $1.9 million or 21%, for
1996. This increase in franchise royalties was due to an overall 19% increase in
revenues at existing Learning Centers open for more than one year combined with
a net increase of 49 new full and satellite Centers opened in 1996. A satellite
Center is a center operating within an existing franchise territory.
Franchise sales fees increased by $1.1 million, or 49%, to $3.2 million for
the year ended December 31, 1996 compared to the same period in 1995. For the
year ended December 31, 1996, there were four area development agreements sold
for $1.7 million and 38 franchise Center licenses sold, as compared to 43
franchise Center licenses and two area development agreements sold for $550,000
in the same period in 1995.
Revenues from Company-owned Learning Centers increased by $7.0 million, or
61%, to $18.5 million during 1996. Revenue growth related to student enrollment
increases for Centers operating over 12 months as of December 31, 1996 resulted
in $3.4 million, or 30%, of the increase for 1996 compared to 1995.
Approximately $3.2 million of the revenue increase resulted from the acquisition
of eleven centers from two franchisees. The opening of one new Center after
December 31, 1995 resulted in an additional $350,000 of revenue during 1996.
Product sales increased by $739,000, or 23%, to $3.9 million for 1996 resulting
from overall student enrollment increases at franchised Centers.
Contract educational services revenue increased by $6.0 million, or 22%, to
$33.4 million for the year ended December 31, 1996. Revenue from public and
non-public school contracts increased by $4.1 million for the year
17
ended December 31, 1996. Revenue from PACE accounted for $1.9 million of the
increase for 1996. The PACE increase results from the fact that the acquisition,
accounted for as a purchase, was effective February 28, 1995, and as such the
1995 results only reflect ten months of PACE results.
Revenue from public and non-public school contracts obtained after December
31, 1995 contributed $2.2 million to revenue for 1996. Revenue from existing
public school public and non-public contracts increased by $2.8 million in 1996,
primarily related to the contracts being in effect for a full year in 1996.
Revenue from existing public and non-public school contracts decreased by $0.9
million in 1996 due to non-recurring revenues included in the 1995 period.
Testing services revenue increased by $52.4 million, or 152%, to $87.0
million during the year ended December 31, 1996, compared to the year ended
December 31, 1995. The significant increase in testing services revenues
resulted primarily from the acquisition of Drake which provided increased
revenues from information technology (IT) clients. Increased services under
Educational Testing Service (ETS) contracts, including the cost-plus
international contract and GRE, and other professional testing revenue
increases, including the implementation of a management contract with the
National Association of Securities Dealers, Inc. ("NASD"), also contributed to
the increase in testing services revenues. Effective March 1, 1996, the Company
entered into a management contract with the NASD to operate their testing
centers delivering computer-based testing to securities brokers and dealers. The
Company has a 10 year contract to provide testing for the NASD.
Cost and Expenses. Franchise services expense increased by $0.7 million, to
$6.5 million or 46% of franchise royalties and sales for the year ended December
31, 1996, compared to $5.9 million, or 52% of franchise royalties and sales for
the year ended December 31, 1995. The increased margin in 1996 primarily relates
to the effects of leveraging the fixed costs of supporting this line of business
over a larger revenue base.
Company-owned Learning Center expense increased by $5.7 million, to $16.1
million or 87% of Company-owned Learning Center services revenues for the year
ended December 31, 1996, compared to $10.4 million, or 90% of Company-owned
Learning Center services revenues for the year ended December 31, 1995. $3.1
million of the increase relates to the acquisition of 11 Learning Centers. The
remaining increase in expenses were primarily advertising, labor and general
overhead associated with increased Center enrollment. Expenses for Centers
operating over 12 months as of December 31, 1996 accounted for $2.2 million of
the increase for 1996, and represent 64% of incremental same Center revenue. The
opening of one new Company-owned Learning Center since December 31, 1995
increased expenses by $375,000, or 107% of the revenue of that Center for the
year ended December 31, 1996.
Contract educational services expense increased by $4.0 million to $29.1
million, or 87% of contract educational services revenues during 1996, compared
to $25.1 million, or 92% of contract educational services revenues during 1995.
The decline in contract educational services expenses as a percentage of revenue
resulted from increased revenues without corresponding increases in overhead.
Operating expenses for Title I schools increased $2.9 million for the year ended
December 31, 1996, while operating expenses for PACE accounted for $1.1 million
of the increase for the same period. The PACE increase results from the fact
that the acquisition, accounted for as a purchase, was effective February 28,
1995, and as such the 1995 results only reflect ten months of PACE results.
Testing services expenses for the year ended December 31, 1996 increased by
$41.2 million to $71.5 million, or 82% of total testing services revenue,
compared to $30.3 million, or 88% of total testing services revenue for the year
ended December 31, 1995. The increase resulted primarily from the acquisition of
Drake and the increased registration and delivery costs associated with
additional volume of tests. 1996 expenses include $2.4 million of amortization
of contract rights related to the Drake acquisition. 1995 expenses included $4.1
million of amortization of contract rights, imputed interest and salary
termination charges related to the Drake acquisition. Excluding non-
18
recurring charges, testing services expenses as a percentage of testing services
revenues increased to 79% in 1996 from 76% in 1995. The principal reasons for
the percentage increase in 1996 are the full year of amortization of goodwill
associated with the Drake acquisition and the partial year amortization of
certain deferred contract costs and contract rights in 1996 and increased
staffing levels required to meet the growth in business volumes that occurred
during 1996 and expected growth in business volumes in 1997.
General and administrative expense increased by $2.6 million to $8.8
million during 1996 from $6.2 million during 1995, but decreased as a percentage
of revenues from 7% to 6%. The percentage decline resulted from increased
revenues from all segments without corresponding increases in overhead. Interest
expense decreased by $1.3 million to $0.5 million during 1996 from $1.8 million
during 1995 due principally to the $1.1 million of interest expense imputed on
the purchase of Drake discussed in the following section.
Comparison of results for the year ended December 31, 1995 to the year ended
December 31, 1994.
Revenues. Total revenues increased by $40.8 million, or 86%, to $88.0
million for the year ended December 31, 1995, compared to the same period in
1994. This increase resulted from higher revenues in all business segments--core
educational services, testing services and contract educational services.
Core educational services revenues increased by $6.1 million, or 30%, to
$26.1 million for 1995. Franchise royalties increased $1.3 million or 16%, for
1995. This increase in franchise royalties was due to a net increase of 31 new
Centers in new territories and 15 new satellite Centers (Centers operating
within existing franchise territories) in 1995, combined with an overall 14%
increase in revenues at existing Learning Centers open for more than one year.
Franchise sales fees increased $876,000 to $2.1 million for the year ended
December 31, 1995 compared to the same period in 1994. For the year ended
December 31, 1995, there were two area development agreements sold for $550,000
and 43 franchise Center licenses sold, as compared to 31 franchise Center
licenses and one $117,000 area development agreement sold in the same period in
1994.
Revenues from Company-owned Learning Centers increased $2.9 million, or
34%, to $11.5 million during 1995. The increase primarily resulted from same
center revenue growth related to student enrollment increases. Product sales
increased $954,000 or 43%, to $3.2 million for 1995. Approximately $338,000 of
the increase in product sales was due to sales of new versions of Math and
Algebra programs (which began in the second half of 1994) with the remainder
resulting from overall increases in student enrollment.
Contract educational services revenue increased by $13.8 million to $27.4
million for the year ended December 31, 1995. Revenues from public and
non-public school contracts increased $5.4 million for the year ended December
31, 1995, due to $2.8 million in revenue from new public and non-public school
contracts obtained after December 31, 1994, and by a $2.6 million increase in
revenues from public and non-public school contracts existing in 1994 accounted
for using the percentage of completion method. Revenues from PACE accounted for
$8.3 million of the increase. The PACE acquisition, accounted for as a purchase,
was effective February 28, 1995.
Testing service revenues increased $20.9 million to $34.6 million for the
year ended December 31, 1995. Testing services revenues accounted for
approximately 39% of total revenues for the year ended December 31, 1995,
compared to 29% of total revenues for the same period in 1994. Revenues from
Drake, acquired as of September 30, 1995, accounted for $11.7 million of the
increase and consisted primarily of revenues from information technology
clients. Revenue from the ETS international contract accounted for $3.7 million
of the increase resulting from the fact that the contract was in effect during
the entire 1995 period, as compared to six
19
months in 1994, as well as increasing activity in international development.
During 1995, Sylvan sold the exclusive development rights for testing centers in
India for $500,000 and in the Middle East for $500,000. The remaining increase
in testing services revenues for the year ended December 31, 1995 was
attributable to a $1.7 million increase in revenue from the NCLEX test for the
licensing of registered and practical nurses, which began in April 1994,
$769,000 of revenue from test development fees for ASVAB (the Armed Services
Vocational Aptitude Battery tests) and other test volume increases in the GRE,
PRAXIS and FAA tests.
Cost and Expenses. Franchise services expense increased by $2.0 million, to
$5.9 million or 52% of franchise royalties and sales for the year ended December
31, 1995, compared to $3.9 million, or 42% of franchise royalties and sales for
the year ended December 31, 1994. The reduced margin in 1995 primarily relates
to increased marketing and advertising costs incurred to produce a new national
advertising campaign.
Company-owned Learning Center expense increased $2.7 million, to $10.4
million or 90% of Company-owned Learning Center services revenues for the year
ended December 31, 1995, compared to $7.7 million, or 89% of Company-owned
Learning Center services revenues for the year ended December 31, 1994. The
increased expenses were primarily advertising, labor and general overhead
associated with increased Center enrollment.
Contract educational services expense increased $13.2 million to $25.1
million, or 92% of contract educational services revenues during 1995, compared
to $11.9 million, or 88% of contract educational services revenues during 1994.
Operating expenses for public and non-public school contracts increased $5.4
million for the year ended December 31, 1995, while operating expenses for PACE
accounted for $7.5 million for the same period. The increase in contract
educational services expense as a percent of related revenues during the year
resulted from the following three factors: (i) 1994 included consulting fee
revenues of $500,000 with no associated costs; (ii) higher total cost estimates
relating to contracts obtained from READS accounted for under the percentage of
completion method and (iii) PACE operating margins of approximately 10% during
1995 reduced overall segment margins.
Testing services expense for 1995 increased $16.3 million to $30.3 million,
or 88% of total testing service revenues, compared to $14.0 million, or 103% of
total testing services revenues for 1994. The decrease in testing services
expense as a percentage of testing services revenues was attributable to several
factors, including the fixed and semi-variable nature of test delivery and
registration costs included in this segment. In addition, Sylvan recognized $1
million of testing revenues in the 1995 period related to the sale of exclusive
development rights for testing centers in India and the Middle East and $769,000
of testing revenues related to the contract to develop the ASVAB test. These
revenues have significantly higher margins than fees for test delivery and
registration services. The ability of Sylvan to generate fees in the future from
the sale of development rights and test development services cannot be assured.
Testing services expenses during the fourth quarter of 1995 included
amortization expense of $2.1 million related to contract rights recorded upon
the acquisition of Drake, which is primarily composed of amortization related to
two contracts which will be fully amortized by June 1996, and $1.1 million of
non-recurring interest expense imputed on the unpaid purchase price from
September 30, 1995 to December 13, 1995, the closing date for the acquisition.
The Company also paid salaries to Drake employees which have been identified and
notified of their termination totalling approximately $800,000 in the fourth
quarter of 1995.
General and administrative expense increased by $1.2 million to $6.2
million during 1995 from $5.0 million during 1994, but decreased as a percentage
of revenues from 11% to 7%. The percentage decline resulted from increased
revenues from all segments without corresponding increases in overhead. Interest
expense increased by $1.2 million to $1.8 million during 1995 from $0.6 million
during 1994 due principally to the $1.1 million of interest expense imputed on
the purchase of Drake discussed above.
20
During 1995 Sylvan recorded a non-recurring loss on impairment of assets of
$3.3 million associated with the Drake acquisition. The Drake acquisition and
resulting consolidation of operations resulted in the determination that certain
assets in this division are not recoverable and, therefore, have been written
down to their realizable value.
During 1995 the Company reduced its valuation allowance relating to
deferred income tax assets by $3.1 million. Approximately $1.1 million of this
reduction was recorded through the allocation of the Drake purchase price. The
remaining decrease of $2.0 million reduced the Company's effective tax rate by
54%.
Liquidity and Capital Resources
Cash provided by operating activities was $23.3 million for the year ended
December 31, 1996 as compared to cash used in operating activities of $3.0
million in the comparable period of 1995. Cash flow from operations before
working capital changes increased from $14.8 million in the 1995 period to $29.2
million in the 1996 period, primarily as a result of significant overall growth
in Company operations before considering non-cash charges, which primarily
consist of depreciation, amortization and deferred income taxes.
Sylvan's investment in working capital has significantly reduced cash flow,
particularly as a result of the growth in accounts and notes receivable. The
$9.0 million increase in accounts and notes receivable is the result of a 79%
increase in revenue during 1996. Of the $9.0 million cash flow reduction
attributable to an increase in accounts and notes receivable, $4.9 million is
related to Sylvan's expanding testing contracts and $1.1 million is related to
new and expanded public school contracts. The increase in amounts due from
expanding testing contracts resulted from higher domestic testing volumes and a
significant increase in billings under the international contract with ETS to
establish overseas testing capacity. Payments are typically made by ETS monthly
for domestic activity and quarterly for international services. Accounts
receivable from public school-based programs have increased due to billings
under new contracts obtained in 1996. Increases in revenue for all business
segments contributed to the remaining accounts and note receivable increase of
$3.0 million. Sylvan believes that uncollectible accounts receivable will not
have a significant effect on future liquidity, as a significant portion of its
accounts receivable are due from enterprises with substantial financial
resources, such as ETS and governmental units.
Sylvan continues to incur expenditures for additions to property and
equipment, which totaled $13.3 million in the 1996 period. These additions
consist primarily of furniture and equipment for general business expansion,
including expenditures for new public school-based programs' classrooms and
equipment needed for overseas testing centers operated by Sylvan. Under the
international testing contract with ETS, Sylvan is reimbursed for overseas
equipment expenditures as the equipment is depreciated. This reimbursement
includes a financing charge over the reimbursement period. Sylvan may spend up
to $1.8 million over the next 18 months to develop licensing and certification
tests under contracts with various testing organizations.
The increase in other investments resulted primarily from the purchase of
non-voting convertible preferred stock in Jostens Learning Corporation for $21.9
million by issuance of 824,000 shares of the stock of the Company.
The Company's accounts payable and accrued expenses have increased by $13.7
million to $26.0 million at December 31, 1996 from $12.3 million at December 31,
1995. Approximately $3.3 million of the increase relates to the 1996 acquisition
of WSI, which was accounted for under the purchase method of accounting. In
addition, $4.9 million of the increase relates to accrued payments due to
non-affiliated testing centers as discussed in Note 2 to the 1996 audited
financial statements. The remaining $5.5 million increase relates to the overall
increase in expense levels due to the Company's growth. The Company's deferred
revenue has increased by $2.9 million
21
to $9.4 million at December 31, 1996 from $6.5 million at December 31, 1995.
Approximately $1.6 million of the increase relates to the acquisition of WSI.
The remaining increase of $1.3 million relates to the overall increase in
business volumes due to the Company's growth. The noncurrent liabilities due to
former shareholders of Drake and Wall Street Institute will be satisfied through
issuance of common stock in 1997.
The Company paid the NASD $4.9 million during the year ended December 31,
1996 pursuant to an agreement related to the management of the NASD testing
centers and the acquisition of contract rights to provide testing based on a ten
year contract with the NASD. The Company also acquired the computer equipment in
the NASD testing centers.
During the year ended December 31, 1996, the Company incurred $10.4 million
in costs to obtain new contracts with certain Drake Authorized Testing Centers
to deliver computer-based testing. These expenditures were recorded as deferred
contract costs and are being amortized over the contract terms of three years.
The Company has entered into a loan agreement with a bank, (hereinafter the
"credit line") that provides an unsecured revolving line of credit. The credit
line allows the Company to borrow a maximum of $15.0 million through the
expiration date of May 31, 1998, at which time the total outstanding principal
balance can be converted into a term loan, at the option of the Company. The
term loan would be repaid over 24 months from the time of issuance. The credit
line and the term loan both bear interest at a floating rate equal to the 30 day
London Interbank Offered Rate ("LIBOR") plus 1.15% per annum. The credit line
had no outstanding borrowings at December 31, 1996. During 1996 the Company
repaid $3.5 million of borrowings made under a previous line of credit
agreement.
During 1996, Sylvan received $5.1 million of cash as a result of the
exercise of stock options and warrants to purchase 661,700 shares of Common
Stock.
Sylvan believes that its capital resources will be sufficient over the next
12 to 24 months to fund expected expansion of its business, including working
capital needs and expected investments in property and equipment.
Sylvan continues to review other companies in the education or
computer-based testing industries for potential acquisitions. Additional capital
resources may be necessary to acquire and thereafter operate additional
businesses.
Contingent Matters
In connection with the PACE acquisition, Sylvan will be required to make a
contingent payment equal to 6.5 times PACE's 1997 earnings before interest and
income taxes ("EBIT"). If PACE's EBIT is less than $2.7 million for 1997, the
PACE shareholders may elect to have the payment calculation based on EBIT for
either calendar year 1998 or 1999. The contingent payment is payable partially
in cash and partially in Common Stock. The amount of any contingent payment to
the PACE Stockholders will be capitalized as goodwill when paid and amortized
over the remaining estimated recovery period. PACE is expected to meet its cash
needs from its operations. PACE provides most of its services to large
corporations with favorable credit histories. PACE operations are not capital
intensive and historically have generated positive cash flow from operations.
The agreement with Drake provides for future contingent payments based on
achievement of certain specified revenue targets between 1997 and 1998 (or 1999
at election of the Sellers). The contingent payment of up to $40.0 million, if
earned, is payable 12.5% in cash (or more at discretion of the Company) with the
remainder in shares of Common Stock. The amount of any contingent payments will
be capitalized as goodwill when paid and amortized over the remaining estimated
recovery period. Based on testing revenues earned by the Company in
22
1996, 20% of the Revenue Escrow Shares have been earned. These 357,143 Revenue
Escrow Shares will be released to the sellers in April 1997. At December 31,
1996, an additional $8.1 million of goodwill which relates to the earned shares
was recorded which will be amortized over the remaining life of 24 years.
Effects of Inflation
Inflation has not had a material effect on Sylvan's revenues and income
from continuing operations in the past three years. Inflation is not expected to
have a material future effect.
Quarterly Fluctuations
Sylvan's revenues and operating results have varied substantially from
quarter to quarter and may continue to vary, depending upon the timing of
implementation of new computer-based testing contracts and contracts funded
under Title I or similar programs. Based on Sylvan's limited experience,
revenues generated by computer-based testing services may vary based on the
frequency or timing of delivery of individual tests and the speed of test
administrators' conversion of tests to computer-based format. Revenues or
profits in any period will not necessarily be indicative of results in
subsequent periods.
ITEM 8. FINANCIAL STATEMENTS
The financial statements of the Company are included on pages 30 through 60
of the report as indicated on page 29.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in accountants, disagreements, or other events
requiring reporting under this Item.
23
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF SYLVAN LEARNING SYSTEMS, INC.
Information required under the caption "Directors and Executive Officers of
Sylvan Learning Systems, Inc." will be included in the Form 10-K/A, which will
be filed by April 30, 1997.
Information required pertaining to compliance with Section 16 (a) of the
Securities and Exchange Act of 1934 under the caption "Directors and Executive
Officers of Sylvan Learning Systems, Inc." will be included in the Form 10-K/A,
which will be filed by April 30, 1997.
ITEM 11. EXECUTIVE COMPENSATION
Information required under the caption "Executive Compensation" will be
included in the Form 10-K/A, which will be filed by April 30, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required under the caption "Security Ownership of Certain
Beneficial Owners and Management" will be included in the Form 10-K/A, which
will be filed by April 30, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required is set forth under the caption "Certain Relationships
and Related Transactions" will be included in the Form 10-K/A, which will be
filed by April 30, 1997.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
1. Financial Statements
The response to this portion of Item 14 is submitted as a separate section
of this Report.
24
2. Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
Financial Statements and Schedules Omitted:
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are
inapplicable and therefore have been omitted.
(b) Reports on Form 8-K:
The following reports on Forms 8-K and 8-K/A were filed by the Registrant
during the fourth quarter ended December 31, 1996:
1) Report on Form 8-K dated November 8, 1996 and amended under Form 8-K/A
on December 9, 1996 relating to a Securities Purchase Agreement dated
November 1, 1996 by and between Registrant and JLC Holdings, Inc.,
Software Systems Corp and JLC Learning Corporation.
2) Report on Form 8-K dated November 18, 1996 relating to a complaint
filed against Registrant by ACT, Inc.
25
3. Exhibits
(a) Exhibits:
Exhibit
Number Description
------ -----------
3.01 Articles of Amendment and Restatement of the Charter.(b)
3.02 Amended and Restated Bylaws.(b)
3.03 Amended and Restated Bylaws dated September 27, 1996.
4.01 Specimen Common Stock Certificate.(b)
4.02 Registration Rights Agreement dated as of January 26, 1993
by and among Sylvan KEE Systems, Inc., the holders of Junior
Preferred Stock and the investors listed on Exhibit A
hereto.(b)
4.03 Form of Warrant to Purchase Common Stock of Sylvan KEE
Systems, Inc. dated January 26, 1993.(b)
4.04 Form of Warrant to Purchase Common Stock of Sylvan KEE
Systems, Inc. dated July 14, 1993.(b)
4.05 Form of Option to Purchase Common Stock dated July 27,
1995.(a)
4.06 Rights Agreement by and between Registrant and State Street
Bank & Trust Company dated as of October 1, 1996.(i)
5.01 Opinion of Piper & Marbury L.L.P.(a)
10.01 Agreement of Lease by and between Rouse & Associates-Quarry
and KEE Systems, Inc. dated May 15, 1990.(b)
10.02 Agreement of Lease by and between Rouse & Associated-Quarry
and KEE Systems, Inc. dated May 6, 1990.(b)
10.03 Lease Agreement between Harbor East Parcel G-Office, LLC and
Sylvan Learning Systems, Inc. dated August 24, 1995.(c)
10.04 Master Agreement Between Educational Testing Service and
Sylvan Learning Systems, Inc. for Computer-Based Testing
Services at Sylvan Technology Centers dated September 1,
1993. (Portions of this document have been omitted pursuant
to a request for confidential treatment.)(b)
10.05 Term Lease Master Agreement between Sylvan Learning Systems
and IBM Credit Corporation dated March 31, 1992.(b)
10.06 Director Stock Option Plan.(b)
10.07 Employee Stock Option Plan.(b)
10.08 Management Stock Option Plan.(b)
10.19 KEE, Incorporated Non-Qualified Stock Option Plan.(b)
10.10 Sylvan Employee Confidentiality and Non-Disclosure Agreement
and Covenant Not to Compete.(b)
10.11 $2.5 Million Revolving Loan, $3.76 Million Term Loan and
$5.0 Million Revolving Loan with NationsBank.(d)
10.12 Indemnification Agreement by and between Sylvan KEE Systems,
Tom D. Wippman and David H. Jacobson dated September 17,
1992.(b)
10.13 Guaranty Agreement by Sylvan KEE Systems in favor of
Encyclopedia Britannica, Inc. dated October 1, 1992.(b)
10.14 Form of Non-Competition Agreement by and between Sylvan KEE
Systems, Inc. and Douglas L. Becker dated January 26,
1993.(b)
10.15 Certification and Testing Services Agreement by and between
TRO Learning, Inc. and Sylvan Learning Systems, Inc. dated
August 31, 1993.(b)
10.16 Plato Educational Products Purchase and License Agreement by
and between TRO Learning, Inc. and Sylvan Learning Systems,
Inc. dated August 31, 1993.(b)
10.17 Form of Franchise Agreement.(b)
10.18 Form of Technology Center Agreement.(b)
10.19 Agreement and Plan of Reorganization dated July 14, 1994 by
and between Registrant and Learning Services, Inc.(e)
26
10.20 Agreement and Plan of Reorganization dated July 14, 1994 by
and between Registrant and Loralex Learning, Inc.(e)
10.21 Agreement and Plan of Reorganization dated February 17, 1995
by and between Registrant and Remedial Education and
Diagnostic Services, Inc.(f)
10.22 Agreement and Plan of Reorganization dated as of March 1,
1995, by and between Registrant and the PACE Group.(g)
10.23 Agreement and Plan of Reorganization dated as of July 28,
1995, by and between Registrant and Drake Prometric, L.P.(h)
10.24 Lease Agreement dated August 24, 1995, First Amendment dated
May 13, 1996 and Second Amendment dated November 11, 1996 by
and between Registrant and Harbor East, LLC.
10.25 Revolving Credit Note to NationsBank, N.A. dated December
31, 1996.
10.26 Senior Management Option Plan dated March 29, 1996.
10.27 Securities Purchase Agreement by and between Registrant and
JLC Holdings, Inc., Software Systems Corporation and JLC
Learning Corporation dated November 1, 1996.(j)
11.00 Statement re: Computation of Per Share Earnings.
21.00 Subsidiaries of the Registrant.
23.01 Consent of Ernst & Young LLP.
(a) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-1 dated February 26, 1996.
(b) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-1 (Registration No. 33-69558).
(c) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-3 as amended by a Registration Statement on Form S-1
(No. 33-97870).
(d) Incorporated by reference from the Exhibits to the Company's Quarterly
Report for the Quarter ended September 30, 1995.
(e) Incorporated by reference to the Company's Current Report on Form 8-K dated
July 20, 1994.
(f) Incorporated by reference to the Company's Current Report on Form 8-K dated
February 27, 1995.
(g) Incorporated by reference to the Company's Current Report on Form 8-K dated
May 5, 1995.
(h) Incorporated by reference to the Company's Current Report on Form 8-K dated
July 21, 1995.
(i) Incorporated by reference to the Company's Current Report on Form 8-K dated
September 27, 1996.
(j) Incorporated by reference to the Company's Current Report on Form 8-K dated
November 1, 1996.
27
SIGNATURES
----------
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
of the undersigned, thereunto duly authorized on March 26, 1997.
SYLVAN LEARNING SYSTEMS, INC.
(Registrant)
By: /s/ R. Christopher Hoehn-Saric
------------------------------
R. Christopher Hoehn-Saric
Chairman of the Board
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 and on March 26, 19967
Signature Capacity
- --------- --------
/s/ R. Christopher Hoehn-Saric Director and Chairman of
- ----------------------------------- the Board
R. Christopher Hoehn-Saric
/s/ Douglas L. Becker Secretary
- -----------------------------------
Douglas L. Becker
/s/ B. Lee McGee Vice President and Chief
- ----------------------------------- Financial Officer
B. Lee McGee
/s/ Donald Berlanti Director
- -----------------------------------
Donald Berlanti
/s/ Phillip Samper Director
- -----------------------------------
Phillip Samper
/s/ James H. McGuire Director
- -----------------------------------
James H. McGuire
28
Item 14 (a) (1)
INDEX TO FINANCIAL STATEMENTS
Page
----
The Company:
Report of Independent Auditors.......................................................................................... 30
Consolidated Balance Sheets as of December 31, 1995 and December 31, 1996............................................... 31
Consolidated Statements of Operations for the years ended December 31, 1994, 1995 and 1996.............................. 33
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1994, 1995
and 1996.............................................................................................................. 34
Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1995 and 1996.............................. 35
Notes to Consolidated Financial Statements.............................................................................. 36
Item 14 (a) 2 - Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts......................................................................... 61
29
Report of Independent Auditors
The Board of Directors and Stockholders
Sylvan Learning Systems, Inc.
We have audited the accompanying consolidated balance sheets of Sylvan Learning
Systems, Inc. and subsidiaries as of December 31, 1995 and 1996, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1996. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Sylvan Learning
Systems, Inc. and subsidiaries at December 31, 1995 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
/s/ Ernst & Young
Baltimore, Maryland
February 27, 1997
30
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, December 31,
1995 1996
------------- -------------
Assets
Current assets:
Cash and cash equivalents $ 2,528,865 $ 11,082,263
Available-for-sale securities 30,379,065 16,298,988
Receivables:
Accounts receivable 20,578,345 31,518,862
Costs and estimated earnings in excess of billings
on uncompleted contracts 3,028,558 3,565,201
Notes receivable 1,583,843 3,000,190
------------- -------------
25,190,746 38,084,253
Allowance for doubtful accounts (1,466,027) (1,378,854)
------------- -------------
23,724,719 36,705,399
Inventory 3,639,392 4,469,577
Deferred income taxes 1,271,925 619,553
Prepaid expenses 1,942,806 2,643,885
------------- -------------
Total current assets 63,486,772 71,819,665
Notes receivable, less current portion 1,875,359 474,043
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 673,181 549,448
Property and equipment:
Furniture and equipment 19,564,005 30,556,702
Leasehold improvements 1,958,236 5,427,734
------------- -------------
21,522,241 35,984,436
Accumulated depreciation (6,142,009) (11,271,237)
------------- -------------
15,380,232 24,713,199
Intangible assets:
Goodwill 74,653,356 103,986,427
Contract rights 7,857,346 13,881,337
Other 2,451,091 2,570,091
------------- -------------
84,961,793 120,437,855
Accumulated amortization (4,640,450) (10,736,219)
------------- -------------
80,321,343 109,701,636
Deferred contract costs, net of accumulated amortization
of $684,177 as of December 31, 1995 and $2,066,893 as of
December 31, 1996 2,528,029 13,230,340
Investments in affiliates 182,320 3,895,602
Other investments 338,681 24,219,888
Other assets 620,754 1,975,030
------------- -------------
Total assets $ 165,406,671 $ 250,578,851
============= =============
31
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, December 31,
1995 1996
------------- -------------
Liabilities and stockholders' equity
Current liabilities:
Accounts payable and accrued expenses $ 12,253,614 $ 25,962,463
Bank lines of credit 3,500,000 --
Current portion of long-term debt 1,895,567 2,474,607
Billings in excess of costs and estimated earnings
on uncompleted contracts 237,644 65,465
Due to former shareholders of Wall Street Institute -- 4,920,565
Deferred revenue 6,487,134 9,413,183
Other current liabilities 795,967 596,311
------------- -------------
Total current liabilities 25,169,926 43,432,594
Long-term debt, less current portion 2,520,512 1,574,682
Deferred income taxes 884,612 2,338,154
Due to former shareholders of Drake -- 8,142,856
Due to former shareholders of Wall Street Institute -- 15,150,115
Other long-term liabilities 367,790 349,771
Commitments and contingent liabilities -- --
Stockholders' equity:
Preferred stock, par value $.01 per share--authorized
10,000,000 shares, no shares issued and
outstanding as of December 31, 1996 and 1995 -- --
Common stock, par value $.01 per share--authorized
40,000,000 shares, issued and outstanding shares of
20,930,193 as of December 31, 1995 and 22,566,215
as of December 31, 1996 209,302 225,662
Additional paid-in capital 139,793,913 168,555,237
Foreign currency translation adjustments 70,000 (4,131)
Retained earnings (accumulated deficit) (3,609,384) 10,813,911
------------- -------------
Total stockholders' equity 136,463,831 179,590,679
------------- -------------
Total liabilities and stockholders' equity $ 165,406,671 $ 250,578,851
============= =============
See accompanying notes.
32
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Statements of Operations
Years Ended December,31,
-----------------------------------------------------------
1994 1995 1996
-----------------------------------------------------------
Revenues
Franchise royalties $ 7,920,666 $ 9,222,996 $ 11,159,986
Franchise sales fees 1,255,835 2,131,990 3,183,954
Company-owned learning center services 8,605,254 11,520,024 18,527,854
Product sales 2,233,779 3,188,181 3,927,493
Contract educational services 13,563,560 27,361,930 33,366,684
Testing services 13,664,969 34,565,697 86,950,689
------------- ------------- -------------
Total revenues 47,244,063 87,990,818 157,116,660
Cost and expenses
Franchise services 3,840,575 5,875,095 6,531,733
Company-owned learning center expense 7,655,129 10,368,983 16,073,377
Cost of product sales 1,758,857 2,431,156 2,951,771
Contract educational services expense 11,880,494 25,119,852 29,070,498
Testing services expense 14,024,666 30,348,283 71,518,481
General and administrative expense 4,998,399 6,205,480 8,755,406
Loss on impairment of assets -- 3,315,541 --
------------- ------------- -------------
Total expenses 44,158,120 83,664,390 134,901,266
------------- ------------- -------------
Operating income 3,085,943 4,326,428 22,215,394
Other income (expense)
Investment and other income 708,390 872,245 1,543,785
Interest expense (556,488) (1,832,377) (529,469)
Gain on sale of company center 151,214 -- --
Equity in net income of unconsolidated
subsidiaries 72,747 390,692 363,396
------------- ------------- -------------
Income before income taxes 3,461,806 3,756,988 23,593,106
Income taxes (76,249) (209,159) (8,850,000)
------------- ------------- -------------
Net income $ 3,385,557 $ 3,547,829 $ 14,743,106
============= ============= =============
Earnings per common and common equivalent share $0.23 $0.22 $0.60
============= ============= =============
Earnings per common share, assuming full dilution $0.22 $0.21 $0.60
============= ============= =============
See accompanying notes.
33
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Foreign Retained
Additional Currency Earnings Total
Common Paid-In Translation (Accumulated Stockholders'
Stock Capital Adjustments Deficit) Equity
-------- ------------ ----------- ------------ ------------
Balance at January 1, 1994 $125,719 $ 34,382,852 $ -- $(10,537,770) $ 23,970,801
Options and warrants exercised for purchase
of 454,935 shares of common stock 4,549 3,048,194 3,052,743
Shares of common stock issued to ETS 1,305 1,498,695 1,500,000
Additional registration costs relating to 1993
stock offering (69,950) (69,950)
Distributions to shareholders of pooled entity (5,000) (5,000)
Net income for 1994 3,385,557 3,385,557
-------- ------------ -------- ------------ ------------
Balance at December 31, 1994 131,573 38,859,791 -- (7,157,213) 31,834,151
Options and warrants exercised for purchase
of 731,871 shares of common stock 7,319 4,210,937 4,218,256
Issuance of 262,446 shares of common stock in
connection with the acquisition of PACE 2,624 3,158,237 3,160,861
Issuance of 3,928,572 shares of common stock
in connection with the acquisition of Drake 39,286 49,460,714 49,500,000
Issuance of 2,850,000 shares of common
stock, net of offering costs of $3,367,266 28,500 44,104,234 44,132,734
Foreign currency translation adjustment 70,000 70,000
Net income for 1995 3,547,829 3,547,829
-------- ------------ -------- ------------ ------------
Balance at December 31, 1995 209,302 139,793,913 70,000 (3,609,384) 136,463,831
Options and warrants exercised for purchase of 661,700
shares of common stock, including income tax
benefit of $1,887,006 6,617 6,991,426 6,998,043
Issuance of 824,000 shares of common stock in connection
with the investment in Jostens Learning Corporation 8,240 21,209,760 21,218,000
Issuance of 116,605 shares of common stock in
connection with other acquisitions 1,166 27,225 (319,811) (291,420)
Exercise of underwriter's overallotment option to purchase
33,750 shares of common stock in connection with 1995
public stock offering 337 532,913 533,250
Foreign currency translation adjustment (74,131) (74,131)
Net income for 1996 14,743,106 14,743,106
-------- ------------ -------- ------------ ------------
Balance at December 31, 1996 $225,662 $168,555,237 $ (4,131) $ 10,813,911 $179,590,679
======== ============ ======== ============ ============
See accompanying notes.
34
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended
December 31,
---------------------------------------------------
1994 1995 1996
---------------------------------------------------
Operating activities
Net income $ 3,385,557 $ 3,547,829 $ 14,743,106
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation 2,429,646 3,351,925 5,129,228
Amortization 1,000,446 4,323,351 7,478,485
Interest imputed on purchase of Drake -- 1,125,000 --
Loss on impairment of assets -- 3,315,541 --
Provision for doubtful accounts 183,628 (42,631) 55,738
Deferred income taxes -- (387,313) 2,105,914
Equity in net income of unconsolidated subsidiaries (72,747) (390,692) (363,396)
Other (268,214) -- --
Changes in operating assets and liabilities:
Accounts and notes receivable (3,213,189) (10,108,638) (9,041,497)
Cost and estimated earnings in excess of billings
on uncompleted contracts (2,528,600) (1,021,779) (412,910)
Inventory (994,685) (1,457,262) (238,312)
Prepaid expenses (57,898) (1,359,046) (404,354)
Other assets (461,105) (246,085) (1,068,363)
Accounts payable and accrued expenses (260,876) (3,194,458) 4,326,761
Billings in excess of costs and estimated earnings
on uncompleted contracts 262,208 (455,600) (233,665)
Deferred revenue and other long-term liabilities 164,423 (39,159) 1,213,549
------------ ------------ ------------
Net cash provided by (used in) operating activities (431,406) (3,039,017) 23,290,284
------------ ------------ ------------
Investing activities
Change in advances to unconsolidated subsidiaries (104,291) 287,970 (98,922)
Purchase of available-for-sale securities (17,615,859) (91,603,867) (31,260,524)
Proceeds from sale of available-for-sale securities 13,245,422 66,595,240 45,340,601
Investment in and advances to affiliates -- -- (3,250,964)
Increase in other investments -- -- (2,329,874)
Proceeds from sale of company-owned center 119,084 -- --
Purchase of property and equipment (7,940,669) (4,802,278) (13,271,749)
Refund of deposits on equipment 31,104 -- --
Purchase of contract rights -- -- (4,890,576)
Cash received upon acquisition of PACE -- 682,411 --
Cash received upon acquisition of Wall Street Institute -- -- 2,012,565
Purchase of Drake Prometric, L. P., including direct costs of
acquisition, net of cash acquired -- (16,979,737) --
Cash paid for intangible assets -- (500,000) --
Expenditures for deferred contract costs and other assets (1,779,011) (801,586) (6,941,769)
------------ ------------ ------------
Net cash used in investing activities (14,044,220) (47,121,847) (14,691,212)
------------ ------------ ------------
Financing activities
Payments to stockholders (238,956) (775,223) (199,656)
Proceeds from exercise of options and warrants 2,982,794 4,218,256 5,111,037
Proceeds from issuance of common stock 1,500,000 44,132,734 533,250
Proceeds from issuance of long-term debt 4,800,000 -- --
Payments on long-term debt and capital lease obligations (2,163,581) (2,175,695) (1,916,174)
Proceeds from bank lines of credit -- 3,500,000 --
Payments on bank lines of credit -- -- (3,500,000)
------------ ------------ ------------
Net cash provided by financing activities 6,880,257 48,900,072 28,457
------------ ------------ ------------
Effects of exchange rate changes on cash -- 70,000 (74,131)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (7,595,369) (1,190,792) 8,553,398
Cash and cash equivalents at beginning of period 11,315,026 3,719,657 2,528,865
------------ ------------ ------------
Cash and cash equivalents at end of period $ 3,719,657 $ 2,528,865 $ 11,082,263
============ ============ ============
See accompanying notes.
35
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Basis of Presentation and Description of Business
Sylvan Learning Systems, Inc. and subsidiaries (the Company) is an international
provider of educational and testing services. The Company conducts operations in
three separate business segments - core educational services, testing services,
and contract educational services. The core educational services segment designs
and delivers individualized tutorial services to school-age children and adults
through a network of 620 franchised and Company-owned Sylvan Learning Centers in
operation in 49 states, five Canadian provinces, Hong Kong, Guam and South
Korea. In addition, in December 1996 the Company acquired Wall Street Institute
International, B.V. and its commonly controlled affiliates. Wall Street and its
affiliates teach the English language in non-English speaking countries in
Europe and Latin America through a network of over 170 franchised and
company-owned centers. The Company's testing segment ("Sylvan Prometric")
administers computer-based tests for major corporations, professional
associations and governmental agencies through a network of certification
centers which are located throughout the world. The contract educational
services segment provides educational programs to employees of large
corporations, and to public and non-public school districts through contracts
funded by federal Title I and state-based programs.
The consolidated financial statements include the accounts of Sylvan Learning
Systems, Inc. and its wholly-owned subsidiaries. All intercompany accounts and
transactions have been eliminated in consolidation. Investments in affiliates
owned more than 20%, but not in excess of 50%, and corporate joint ventures are
reported using the equity method.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts and related disclosures. Actual results
could differ from those estimates.
2. Accounting Policies
Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
36
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
2. Accounting Policies (continued)
Investments
Available-for-sale securities are carried at fair value, with the unrealized
gains and losses, net of tax, reported in a separate component of stockholders'
equity. The amortized cost of debt securities in this category is adjusted for
amortization of premiums and accretion of discounts to maturity. Such
amortization is included in investment income. Realized gains and losses and
declines in value judged to be other than temporary on available-for-sale
securities are included in investment income. The cost of securities sold is
based on the specific identification method. Interest and dividends on
securities classified as available-for-sale are included in investment income.
Inventory
Inventory, consisting primarily of computer software and educational,
instructional, and marketing materials and supplies, is stated at the lower of
cost (first-in, first-out) or market value.
Accounting For Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of
In 1995, the Company adopted the provisions of Financial Accounting Standards
Board Statement No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of. The Statement prescribes the accounting
for the impairment of long-lived assets, such as property and equipment and
intangible assets, as well as the accounting for long-lived assets that are held
for disposal. The initial adoption of this Statement in 1995 did not have a
material impact on the reported results of operations of the Company.
Property and Equipment
Property and equipment is stated at cost. Depreciation is provided using the
straight-line method over the estimated useful lives of the assets.
Intangible Assets
Goodwill consists of the cost in excess of fair value of the net assets of
entities acquired in purchase transactions, and is amortized over the expected
periods of benefit, which range from 10 to 25 years. At December 31, 1995 and
1996, accumulated amortization of goodwill is $1,110,944 and $4,803,586,
respectively.
37
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
2. Accounting Policies (continued)
Contract rights consist of the allocated cost of acquiring computer-based
testing contracts in business combinations accounted for as purchases. Contract
rights are being amortized using the straight-line method over the term of the
related contract, which range from three months to 10 years. At December 31,
1995 and 1996, accumulated amortization of contract rights is $2,978,112 and
$5,193,199, respectively.
Deferred Contract Costs
Deferred contract costs include costs incurred to develop computer-based tests
under contractual arrangements with customers. Under these arrangements, the
Company incurs certain costs related to the development of new computer-based
tests on behalf of the customer in return for the right to deliver the
computer-based tests and collect a testing fee from either the candidate or the
sponsoring organization. These costs are capitalized and amortized over the
shorter of the estimated utility period of the test or the contractual period
for delivery of the test.
Deferred contract costs also include payments and accruals of approximately
$10,400,000 in 1996 made to non-affiliated computer-based testing centers that
have entered into three-year contracts with Sylvan to deliver information
technology computer-based certification tests. In accordance with the terms of
these contracts, the independent testing centers have received an advance
payment and will receive no additional fees upon delivery of the computer-based
certification tests. These costs are being amortized over the contractual term
of three years.
Revenue Recognition
Franchise sales fees relate to single-center and area franchise sales. Revenue
related to these sales is recognized when all material services or conditions
relating to the sales have been substantially performed or satisfied by the
Company. For single-center franchise sales, the criteria for substantial
performance include: (1) receipt of an executed franchise license agreement, (2)
receipt of full payment of the franchise fee, (3) completion of requisite
training by the franchisee or center director, and (4) completion of site
selection assistance and site approval. Area franchise sales generally transfer
to the licensee the right to develop and operate centers in a specified
territory, primarily in a foreign country, and the Company's future obligations
are insignificant. Area franchise fees are recognized upon the signing of the
license agreement and the determination that (1) all material services or
conditions relating to the sale have been satisfied and the fee is
non-refundable, (2) a minimum payment of 50% of the fee is required within 90
days of the date of the agreement, and (3) the Company has the ability to
estimate the collectibility of any unpaid amounts. Franchise sales
38
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
2. Accounting Policies (continued)
fees not meeting the recognition criteria are recorded as deferred revenue if
not refundable, or deposits from franchisees if refundable. Commissions paid on
sales of franchises are recorded as a current asset until the corresponding
revenue is recognized.
Fixed price contracts with school districts receiving funds under the federal
Title I program and state-based programs are accounted for using the
percentage-of-completion method. Income is recognized based on the percentage of
contract completion determined by the total expenses incurred to date as a
percentage of total estimated expenses at the completion of the contract. Total
contract income is estimated as contract revenue less total estimated costs
considering the most recent cost information. Revenues from cost-plus-fee
contracts are recognized on the basis of costs incurred during the period plus
the fee earned.
Franchise royalties are reported as revenue as the royalties are earned and
become receivable, unless collection is not assured or the royalties are 90 days
or more in arrears.
Revenue from the sale of products to franchisees is recognized when shipped.
Testing revenues are recognized upon the completion of tests.
Stock Options Granted to Employees
The Company records compensation expense for all stock-based compensation plans
using the intrinsic value method prescribed by APB Opinion No. 25, Accounting
for Stock Issued to Employees. In October 1995 the Financial Accounting
Standards Board issued FASB Statement No. 123, Accounting for Stock-Based
Compensation, which encourages companies to recognize expense for stock-based
awards based on their estimated value on the date of grant. Statement No. 123,
effective for 1996, does not require companies to change their existing
accounting for stock-based awards, but if the new fair value method is not
adopted, pro forma income and earnings per share data should be provided in the
notes to the financial statements. The Company has disclosed in Note 13, the
required pro forma information as if the fair value method had been adopted.
Foreign Currency Translation
The financial statements of certain foreign subsidiaries that are measured in
local functional currencies have been translated into U.S. dollars in accordance
with FASB Statement No. 52, Foreign Currency Translation. All balance sheet
accounts have been translated using the rates of exchange at the balance sheet
date. Results of operations have been translated using the average rates
prevailing throughout the year. Translation gains or losses resulting from the
changes in exchange rates from year to year, are accumulated as a separate
component of stockholders' equity.
39
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
2. Accounting Policies (continued)
The financial statements of other foreign subsidiaries, primarily those
subsidiaries providing services overseas to Educational Testing Services (see
Note 17), prepare financial statements using the U.S. dollar as the functional
currency. The transactions of these subsidiaries that are denominated in foreign
currencies have been remeasured in U.S. dollars. Any resulting gain or loss is
recorded as an adjustment of the amount due from ETS as the contract with ETS
requires ETS to bear the risk of realized translation gains or losses.
Reclassifications and Stock Split
Certain amounts in the 1995 and 1994 consolidated financial statements have been
reclassified to conform with the 1996 presentation.
In October 1996, the Company declared a 3-for-2 stock split of its common stock
for stockholders of record on November 7, 1996. Accordingly, all share and per
share data including stock option, warrant and earnings per share information
have been restated in the consolidated financial statements to retroactively
reflect the stock split.
3. Acquisitions
Wall Street Institute International, B.V. and Affiliates
Effective December 1, 1996, the Company acquired substantially all of the
operating net assets of Wall Street Institute International, B.V. and its
commonly controlled affiliates (collectively, "WSI"). The Company and the
sellers signed a definitive purchase agreement in December 1996 that provided
for an effective date of the sale of December 1, 1996. The Company's control of
the operations of WSI commenced at the effective date, and the Company recorded
the acquisition using the purchase method of accounting on December 1, 1996. WSI
is a European-based franchisor and operator of learning centers that teach the
English language through a combination of computer-based and live instruction.
WSI has a network of more than 170 franchised centers in operation throughout
Europe and Latin America.
The purchase price of WSI consisted of cash of $4,921,000, 505,364 shares of
restricted common stock valued at $9,250,000, and 209,520 shares of unrestricted
common stock valued at $5,900,000. The restricted stock may not be transferred
by the sellers for a period of three years, unless the Company, in its sole
discretion, removes the restriction. The Company must use its best efforts to
register the 209,520 shares of unrestricted common stock by April 28, 1997. In
the event that the Company is unable to register the common stock by April 28,
1997, the sellers are entitled to interest calculated at an increasing rate (10%
to 15%) on the initial value of the common stock until such
40
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
3. Acquisitions (continued)
time as the unrestricted common stock is registered. If the unrestricted common
stock is unregistered at any time during the period from October 28, 1997
through November 12, 1997, the sellers at their option may require the Company
to repurchase the unrestricted common stock for $5,900,000, plus any unpaid
interest. Of the 505,364 shares of restricted common stock issued to the
sellers, 124,292 shares are held in escrow to indemnify the Company against any
subsequent losses resulting from any misrepresentation or breach of certain
covenants. The unrestricted common stock held in escrow will be released in
varying amounts to the sellers through 2001.
In connection with the acquisition of WSI, the Company in January 1997 loaned
the principal stockholder of the seller $2,500,000. The loan is due in lump sum
in January 2000, and bears interest payable quarterly at the rate of prime plus
one percent. The loan is secured by restricted common stock of the Company with
a value of $2,500,000, adjusted annually for changes in the market price of the
Company's common stock.
The Company on the closing date of the acquisition entered into option
agreements to purchase two franchisees of WSI, and granted the owners of these
same franchisees put rights that require, in certain circumstances and at the
election by the right holders, the Company to purchase the franchisees. At the
Company's option it may purchase the two franchisees at any time during the
period from September 1, 2001 through September 1, 2005 for an amount equal to
seven times the previous fiscal years' earnings before interest and taxes,
adjusted for certain defined items. The franchisees may require the Company to
purchase substantially all of their net assets during the same four-year period
if defined levels of operating results are met or exceeded at the end of the
most recently completed fiscal year. The purchase price is payable 10% in cash
and 90% in common stock, or at the Company's option, entirely in cash.
The total purchase price of $21,071,000, including $1,000,000 of direct
acquisition costs, was allocated as follows:
Working capital $ 2,795,000
Fixed assets 1,125,000
Other assets 329,000
Goodwill 19,852,000
-----------
24,101,000
Less liabilities assumed
Debt 1,417,000
Deferred revenue 1,613,000
-----------
3,030,000
-----------
$21,071,000
===========
41
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
3. Acquisitions (continued)
Goodwill is being amortized over its estimated useful life of 25 years. The cash
portion of the purchase price was recorded as a current liability at December
31, 1996, and the portion of the purchase price represented by common stock has
been recorded as a noncurrent liability at December 31, 1996. Upon closing of
the transaction in January 1997, the Company paid the cash portion of the
purchase price to the sellers of $4,921,000 and recorded the issuance of 714,884
shares of common stock to the sellers through a reduction in the noncurrent
liability of $15,150,115. In December 1996, the Company recorded $172,000 of
imputed interest expense related to the acquisition.
The following unaudited pro forma summary presents the consolidated results of
operations as if the WSI acquisition had occurred at the beginning of the
respective periods presented, and does not purport to be indicative of what
would have occurred had the acquisition been made at that date or of results
which may occur in the future:
Year ended December 31,
1995 1996
-----------------------
(in thousands)
Revenues $101,130 $169,778
Net income $5,563 $16,882
Net income per share - fully diluted $0.32 $0.67
The PACE Group
Effective February 28, 1995, the Company purchased the assets and liabilities of
The PACE Group ("PACE"), a provider of educational services to corporations. The
initial consideration for the acquisition was 262,446 shares of common stock
having an aggregate market value of $3,160,861. The acquisition was accounted
for using the purchase method of accounting. Additional contingent consideration
is payable in an amount equal to 6.5 times PACE's earnings before interest and
income taxes (EBIT) in 1997, determined in accordance with generally accepted
accounting principles. If EBIT is less than $2.7 million in 1997, the PACE
shareholders may elect to have the payment calculation based on EBIT for either
calendar year 1998 or 1999. The contingent payment is payable two-thirds in cash
and one-third in shares of common stock, unless the PACE shareholders determine
that a smaller cash payment is desired for their income tax purposes. The
Company will record any additional consideration payable to the PACE
shareholders as additional goodwill, and will amortize that amount over the
remaining amortization period. At February 28, 1995, goodwill of approximately
$3.5 million was recorded and is being amortized over a period of 25 years.
42
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
3. Acquisitions (continued)
Results of operations of PACE are included in the accompanying consolidated
statements of operations from March 1, 1995. For the year ended December 31,
1996, PACE EBIT was approximately $1.2 million (unaudited).
Drake Prometric, L.P.
Effective September 30, 1995, the Company acquired Drake Prometric, L.P.
("Drake"), a Minneapolis based provider of computer-based certification,
licensure and assessment testing programs. As of that date, Drake had a network
of 820 testing centers on six continents, 472 of which were located in North
America and the remainder in 69 foreign countries.
The Company acquired Drake for an initial purchase price of $20.0 million in
cash and 5,714,286 restricted shares of common stock (the "Initial Shares"). Of
the Initial Shares, 1,785,714 shares (the "Revenue Escrow Shares") were placed
in escrow and will be released to the sellers to the extent that certain revenue
targets relating to portions of the combined computer-based testing business are
achieved from 1996 through 1998. The sellers may receive up to an additional
$40.0 million (payable 12.5% in cash and the balance in either cash or
restricted shares of common stock, at the Company's option) to the extent other
revenue targets relating to portions of the combined computer-based testing
business are achieved in 1998 or 1999 (with the measuring year selected by the
sellers).
The acquisition was accounted for using the purchase method of accounting. The
initial purchase price consisted of the following components, totaling $70.6
million.
Cash, net of $1,125,000 of imputed interest .................. $18,875,000
Initial Shares, excluding contingently issuable
Revenue Escrow Shares (3,928,572 shares),
with an estimated fair market value of
$12.60 per share ....................................... 49,500,000
Acquisition costs ............................................ 1,847,227
Accrued Drake reorganization costs ........................... 422,954
-----------
$70,645,181
===========
43
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
3. Acquisitions (continued)
The purchase price includes 714,285 shares of common stock placed in escrow to
indemnify the Company for potential undisclosed liabilities, as these shares are
likely to ultimately be released from escrow. The Company also accrued $422,954
of costs related to estimated Drake employee termination costs resulting from
the integration of the Drake business. The purchase price was adjusted for
imputed interest between the effective date and December 13, 1995, the date the
Drake acquisition was consummated. This amount, calculated using a rate of 8%
per annum, was $1,125,000.
Approximately $4.8 million of contract rights and $69.8 million of goodwill were
recorded. The contract rights are being amortized over their respective terms,
and no term exceeds five years. Goodwill is being amortized over 25 years, its
estimated useful life. The Company will record the contingent consideration
consisting of the 1,785,714 Revenue Escrow Shares and the additional contingent
payment of up to $40.0 million when the contingencies are resolved and the
additional consideration is payable. Based on testing revenues earned by the
Company in 1996, 20% of the Revenue Escrow Shares have been earned. These
357,143 Revenue Escrow Shares will be released to the sellers in April 1997. At
December 31, 1996, an additional $8.1 million of goodwill which relates to the
earned shares was recorded which will be amortized over the remaining life of 24
years.
Remedial Education and Diagnostic Services, Inc. and READS, Inc.
On February 17, 1995, the Company acquired by merger all of the outstanding
stock of Remedial Education and Diagnostic Services, Inc. and READS, Inc.
(collectively, "READS") in exchange for 525,108 shares of common stock. The
acquisition was accounted for as a pooling of interests and accordingly, the
Company's financial statements for periods prior to the merger have been
restated to include the results of operations, financial position and cash flows
of READS.
READS is based in Philadelphia, Pennsylvania and provides remedial and education
services, psychological, diagnostic and counseling services, career awareness
training, and a variety of consulting services. Services are delivered under
contracts with school districts, county-wide educational agencies and
municipalities in the eastern United States.
44
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
4. Available-For-Sale Securities
The following is a summary of available-for-sale securities (cost approximates
fair value):
December 31,
1995 1996
----------- -----------
Stock mutual fund $ -- $ 3,500,061
U.S. Treasury bills and
notes 14,005,903 2,998,927
Municipal bonds 16,373,162 9,800,000
----------- -----------
$30,379,065 $16,298,988
=========== ===========
The Company has not had any significant realized or unrealized gains or losses
on its investments during the periods presented. As of December 31, 1996, the
Company has approximately $6.5 million of investments that mature in 1997, $1.8
million of investments that mature in 2004 and $8.0 million of investments that
mature in 2026. These investments are classified as current as the Company
expects to sell them in 1997.
5. Acquisition of Contract Rights
In August 1996 the Company acquired the right to provide computer-based tests on
behalf of the National Association of Securities Dealers, Inc. ("the NASD") for
a period of ten years. In addition, Sylvan assumed certain lease obligations of
approximately 50 testing centers previously operated by the NASD, and acquired
equipment and leasehold improvements related to these leased centers. Sylvan
paid the NASD $5,146,000 to acquire these rights and fixed assets, of which
$4,871,832 was recorded as contract rights and $242,841 was recorded as fixed
assets. In addition, as contemplated by the terms of the contract, the Company
will incur in the first six months of 1997 an additional $1,395,000 of costs
related to the acquisition of the contract rights from the NASD. The total
contract rights recorded of $6,266,832 are being amortized over the contract
life of 10 years using the straight-line method.
45
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
6. Costs and Estimated Earnings on Uncompleted Contracts
Costs and estimated earnings on uncompleted fixed-price contracts and
cost-plus-fee contracts are as follows:
December 31,
-----------------------------------------------------------------
1995 1996
------------------------------- ------------------------------
Fixed Price Cost-Plus-Fee Fixed Price Cost-Plus-Fee
Contracts Contracts Contracts Contracts
------------ ------------ ------------ ------------
Cost incurred on uncompleted contracts $ 10,108,393 $ 5,199,044 $ 13,420,902 $ 6,749,577
Estimated earnings 2,592,135 519,265 4,788,132 916,168
------------ ------------ ------------ ------------
12,700,528 5,718,309 18,209,034 7,665,745
Less: Billings to date 11,966,610 3,062,906 17,507,158 4,331,725
------------ ------------ ------------ ------------
$ 733,918 $ 2,655,403 $ 701,876 $ 3,334,020
============ ============ ============ ============
Included in the accompanying consolidated balance
sheets under the following captions:
Cost and estimated earnings in excess of billings
on uncompleted contracts $ 922,232 $ 2,106,326 $ 505,787 $ 3,059,414
Cost and estimated earnings in excess of billings
on uncompleted contracts, less current portion 124,104 549,077 274,842 274,606
Billings in excess of costs and estimated earnings
on uncompleted contracts (237,644) -- (65,465) --
Other long-term liabilities (74,774) -- (13,288) --
------------ ------------ ------------ ------------
$ 733,918 $ 2,655,403 $ 701,876 $ 3,334,020
============ ============ ============ ============
7. Investments
Investments in Affiliates
At December 31, 1995, the Company's investments in affiliates consists of (i) a
50% interest in Sylvan National Advertising Committee, Inc. ("SNAC") in the
amount of $97,266, which is engaged in purchasing advertising and marketing
services for Sylvan Learning Centers, and (ii) a 34% interest in ADEPT Merger,
Inc. ("ADEPT") in the amount of $85,054, a corporate joint venture formed to
develop a computer-based examination for safe automobile driver certifications.
At December 31, 1996, the Company's investments in affiliates consists of a 50%
interest in SNAC ($559,584), a 10% interest in Caliber Learning Network, Inc.
($2,850,964), a corporate joint venture formed to develop distance learning
programs, and a 34% interest in ADEPT ($485,054).
46
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
7. Investments (continued)
Consolidated retained earnings at December 31, 1996 includes $644,561 related to
undistributed earnings of equity method investees.
Other Investments
Other investments consist of non-marketable investments in common and preferred
stocks of private companies in which the Company does not exercise significant
influence. These investments are carried at the lower of cost or estimated net
realizable value.
At December 31, 1996, other investments consist primarily of a $21.9 million
non-voting convertible preferred stock investment in Jostens Learning
Corporation, a company that develops educational software products.
8. Bank Lines of Credit
The Company has entered into a loan agreement with a bank, (hereinafter, "the
credit line") that provides an unsecured revolving line of credit. The credit
line allows the Company to borrow a maximum of $15.0 million through the
expiration date of May 31, 1998, at which time the total outstanding principal
balance can be converted into a term loan, at the option of the Company. The
term loan would be repaid over 24 months from the time of issuance. The credit
line and the term loan both bear interest at a floating rate equal to the 30 day
London Interbank Offered Rate ("LIBOR") plus 1.15% per annum (6.68% at December
31, 1996). The balance on the credit line was $3.5 million at December 31, 1995
and no amounts were outstanding at December 31, 1996.
9. Long-Term Debt
Long-term debt consists of the following:
December 31,
1995 1996
-----------------------
Note payable to a bank, bearing interest at 1.10%
over the LIBOR (6.63% at December 31, 1996)
The loan is payable in monthly installments of
$80,000 plus interest through May, 1999 $3,280,000 $2,320,000
Other notes payable bearing interest
at rates ranging from 8% to 14% 1,136,079 1,729,289
---------- ----------
$4,416,079 $4,049,289
========== ==========
47
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
9. Long-Term Debt (continued)
Future maturities of long-term debt as of December 31, 1996 are as follows:
Years ending December 31:
1997 $2,474,607
1998 1,174,682
1999 400,000
----------
$4,049,289
==========
10. Leases
Operating Leases
The Company conducts all of its operations from leased facilities. These
facilities include the Company's corporate headquarters and other office
locations, warehouse space, certain testing sites, and Company-owned learning
centers. The terms of these leases are five years or less, with the exception of
the Company's corporate headquarters, which has a lease term of ten years, and
generally contain renewal options. The Company also leases certain equipment
under operating leases of 36 months or less.
Future minimum lease payments at December 31, 1996, by year and in the
aggregate, under all noncancellable operating leases are as follows:
Years ending December 31:
1997 $ 5,210,839
1998 4,405,175
1999 3,389,597
2000 2,779,558
2001 2,364,000
Thereafter 9,548,518
-----------
$27,697,687
===========
Rent expense for cancelable and noncancellable leases was $5.7 million, $3.6
million and $2.3 million for the years ended December 31, 1996, 1995 and 1994,
respectively.
48
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
11. Contingencies
On November 18, 1996, ACT, Inc. filed suit against the Company alleging that the
Company violated federal antitrust laws and committed various state law torts in
connection with the operations of its computer-based testing operations and in
obtaining a testing services contract from the NASD. The Company believes the
grounds of the lawsuit are without merit and intends to defend the lawsuit
vigorously. Management is unable to predict the ultimate outcome of the lawsuit,
but believes that the ultimate resolution of the matter will not have a material
effect on consolidated financial position.
The Company is subject to other legal actions arising in the ordinary course of
its business. In management's opinion, the Company has adequate legal defenses
and/or insurance coverage with respect to the eventuality of such actions and
does not believe any settlement would materially affect the Company's financial
position.
12. Fair Value of Financial Instruments
The fair value of the Company's financial instruments, which consist primarily
of cash and cash equivalents, accounts and notes receivable, available-for-sale
investments, accounts payable, and short and long-term debt, approximate their
carrying amounts reported in the consolidated balance sheets.
It was not practical to estimate the fair value of the Company's other
investments because of the lack of quoted market prices of the underlying equity
securities and the inability to determine fair value without incurring excessive
costs. Management does not believe that the value of these investments have been
impaired.
13. Stock Options and Warrants
Stock Options
Under a non-qualified stock option plan for key employees adopted by the
stockholders, the Company has outstanding stock options at December 31, 1996 to
purchase 300,509 shares of common stock for $2.54 per share and options to
purchase 287,947 shares of common stock for $.63 per share. All outstanding
options are fully vested and expire on December 31, 1997, and no additional
options may be granted under this plan
The Company also has an Employee Stock Option Plan ("the Employee Plan") which
provides for the granting of stock options to purchase up to 3,200,000 shares of
common stock. All options granted under the Employee Plan vest ratably over a
five-year period and expire six years after date
49
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
13. Stock Options and Warrants (continued)
of grant. At December 31, 1996, options to purchase 2,984,917 shares of common
stock have been granted under the Employee Plan.
Under a Management Stock Option Plan ("Management Plan"), the Company has
outstanding stock options at December 31, 1996 to purchase 163,500 shares of
common stock for $11.25 per share. All outstanding options are fully vested, and
expire on December 1, 2001. No additional options may be granted under the
Management Plan.
In March 1996, the Company established the Senior Management Stock Option Plan
("the Senior Management Plan") to replace the Management Plan. The Senior
Management Plan provides for the granting of stock options to purchase up to
2,250,000 shares of common stock. At December 31, 1996, options to purchase
1,035,000 shares of common stock have been granted under the Senior Management
Plan. Options granted under this plan expire ten years after the date of grant.
Of this amount, options for 165,000 shares became immediately vested, with the
balance vesting ratably over three years.
In October 1993 the stockholders approved the establishment of the Director
Stock Option Plan ("Director Plan") for all non-employee members of the Board of
Directors. Under the Director Plan, options to purchase 172,500 shares of common
stock may be issued to certain members of the Board of Directors. No individual
is eligible to receive more than 33,750 options under this plan and options
granted under this plan expire at varying times three months after a director
ceases his term on the Board. At December 31, 1996, options to purchase 168,750
shares of common stock have been granted under the Director Stock Option Plan.
During 1995 the Board of Directors granted 37,500 options to the former
shareholder of READS at an exercise price of $11.62 per share. These options
vest ratably over a five-year period. In addition, an option to purchase an
aggregate of 75,000 shares of common stock at an exercise price of $13.16 per
share was granted in connection with the purchase of the rights to contracts to
provide remedial education services to certain non-public schools under the
federal Title I Program. All of these options are exercisable at December 31,
1996.
In 1994 the Company sold 130,436 shares of restricted stock and options to
purchase common stock to ETS for $1.5 million. During 1995, the Company received
$2.0 million of cash as a result of the exercise by ETS of options to purchase
173,913 shares of common stock. Pursuant to the initial option agreement, upon
exercise of the initial option, ETS was granted an additional one-year option to
purchase 121,458 shares at an exercise price of $16.47 per share. This option
was exercised on October 22, 1996.
50
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
13. Stock Options and Warrants (continued)
The following table summarizes the stock option activity of the Company.
Weighted
Options Options Average
Outstanding Outstanding Exercisable Exercise Prices
----------- ----------- ----------- ---------------
Balances at January 1, 1994 2,540,465 1,115,469
Granted 484,413
Became exercisable 515,159
Exercised (450,147) (450,147)
--------- ---------
Balance at December 31, 1994 2,574,731 1,180,481
Granted 919,083
Became exercisable 573,684
Exercised (258,663) (258,663)
--------- ---------
Balances at December 31, 1995 3,235,151 1,495,502 $ 7.69
Granted 1,847,875 $21.92
Became exercisable 765,823
Exercised (384,563) (384,563) $10.87
Forfeited (84,450) (84,450) $11.24
--------- ---------
Balances at December 31, 1996 4,614,013 1,792,312
========= =========
Weighted average exercise price at
December 31, 1996 $13.06 $6.67
========= =========
Exercise prices for options outstanding as of December 31, 1996 ranged from
$0.63 to $26.67 consisting of the following ranges:
Weighted Weighted
Range of Options Average Options Average Weighted Average Remaining
Exercise Prices Outstanding Exercise Prices Exercisable Exercise Prices Contractual Life
--------------- ----------- --------------- ----------- --------------- ----------------
$0.63-$2.54 588,456 $1.61 588,456 $ 1.61 1.0 years
$5.22-$9.12 1,416,550 $6.17 786,745 $ 6.11 3.2 years
$10.17-$17.00 764,882 $13.23 252,111 $11.31 4.6 years
$17.00-$26.67 1,844,125 $21.92 165,000 $20.33 8.1 years
51
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
13. Stock Options and Warrants (continued)
Options exercised and the range of related option prices follow:
Year ended Options exercised Exercise Prices Per Share
---------- ----------------- -------------------------
1994 450,147 $0.63-$7.33
1995 258,663 $0.63-$11.50
1996 384,563 $0.63-$16.47
For the years ended December 31, 1995 and 1996, pro forma net income and
earnings per share information required by Statement 123 has been determined as
if the Company had accounted for its stock options using the fair value method.
The fair value of these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted average
assumptions for 1995 and 1996 respectively: risk-free interest rate of 6.00% and
6.00%, dividend yield of 0% and 0%, volatility factors of the expected market
price of the Company's common stock of .428 and .399, and an expected life of
granted options which varies from zero to five years depending upon the vesting
period. The weighted-average grant-date fair value of options granted during
1996 was $8.33.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting periods. The Company's pro
forma information follows:
1995 1996
---------- -----------
Pro forma net income $2,651,259 $11,885,334
========== ===========
Pro forma earnings per share:
Primary $0.17 $0.49
===== =====
Fully diluted $0.16 $0.49
===== =====
The effect of compensation expense from stock options on 1995 pro forma net
income reflects only the vesting of 1995 awards. However, 1996 pro forma net
income reflects the second year
52
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
13. Stock Options and Warrants (continued)
of vesting of the 1995 awards and the first year of vesting of 1996 awards.
Because the granted stock options vest over periods ranging from zero to five
years, not until 2001 is the full effect of recognizing compensation expense for
stock options representative of the possible effects on pro forma net income for
future years.
Stock Warrants
In January 1993, the Company issued warrants to purchase 272,721 shares of
Series A Convertible Preferred Stock for $4.39 per share, which approximated
fair market value at the date of issuance. On December 9, 1993 in connection
with the initial public offering, the warrants automatically converted into
common stock warrants which allow holders to purchase 409,085 shares of common
stock for $2.93 per share. During 1996 and 1995, warrants to purchase 134,499
and 235,497 shares were exercised, respectively. The remaining 39,089 warrants
expire in September 1997.
The Company also issued warrants to purchase 205,167 shares of common stock for
$2.93 per share to the placement agent for the January 1993 preferred stock
offering. Warrants to purchase 88,182 and 100,983 shares were exercised in 1996
and 1995, respectively. The remaining 16,002 warrants expire in January 1998.
In July 1993 warrants to purchase 239,364 shares of common stock for $5.22 per
share were issued in connection with a $5.0 million financing. Warrants to
purchase 54,457, 136,728 and 4,788 shares of common stock were exercised in
1996, 1995 and 1994, respectively. The remaining 43,391 warrants expire in July
1998.
14. Impairment Loss
In September 1995 the Company determined that certain assets of the testing
services segment were impaired as a result of the acquisition of Drake. These
assets, consisting of computer equipment, software and other assets, were
impaired because of dissimilar technical requirements for Drake computer-based
tests, or because their use was limited by virtue of the acquisition of similar
productive assets from Drake. The amount of the impairment loss was determined
by evaluating the likely sales proceeds from the disposition of the assets as
compared to their book value.
53
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
15. Income Taxes
Significant components of the provision for income taxes are as follows:
December 31,
1994 1995 1996
----------------------------------------------
Current:
Federal $ -- $ 250,334 $ 4,991,497
Foreign -- 133,887 372,996
State 76,249 212,251 1,379,593
----------- ----------- -----------
Total current 76,249 596,472 6,744,086
Deferred(benefit):
Federal -- (300,168) 1,773,051
State -- (87,145) 332,863
----------- ----------- -----------
Total deferred -- (387,313) 2,105,914
----------- ----------- -----------
$ 76,249 $ 209,159 $ 8,850,000
=========== =========== ===========
The Company uses the liability method to account for income taxes. Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amount of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Significant components of the
Company's deferred tax assets and liabilities are summarized as follows:
54
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
15. Income Taxes (continued)
December 31,
1995 1996
----------- -----------
Deferred tax assets:
Net operating loss carryforwards $ 3,288,617 $ 2,277,600
Loss on impairment of assets 302,729 71,601
Deferred revenue 427,574 443,618
Allowance for doubtful accounts 163,008 301,205
Amortization of intangible assets 361,537 459,040
Equity share of income from affiliates 19,499 53,841
Inventory reserve 53,050 60,094
Non-deductible reserves -- 75,920
Other 9,826 133,056
----------- -----------
Total deferred tax assets 4,625,840 3,875,975
Deferred tax liabilities:
Deferred contract costs -- 1,746,807
Contract rights 1,113,887 316,619
Depreciation 252,332 684,508
Amortization of software 202,157 175,183
Unbilled receivables 293,567 266,432
Prepaid expenses 86,080 106,586
Other 12,904 20,841
----------- -----------
Total deferred tax liabilities 1,960,927 3,316,976
----------- -----------
Net future income tax benefits 2,664,913 558,999
Valuation allowance for net deferred
tax assets (2,277,600) (2,277,600)
----------- -----------
Net deferred tax assets (liabilities) $ 387,313 $(1,718,601)
=========== ===========
The net operating loss carryforwards at December 31, 1996 are related to a
subsidiary of the Company, and are available only to offset future taxable
income of the subsidiary. These net operating loss carryforwards will begin to
expire in 2007.
The reconciliation of the reported income tax expense to the amount that would
result by applying the U.S. federal statutory tax rates to income before income
taxes is as follows:
55
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
15. Income Taxes (continued)
Year ended December 31,
1994 1995 1996
-----------------------------------------------------
Tax expense at U.S. statutory rate $ 1,151,000 $ 1,277,000 $ 8,022,000
Permanent differences -- 828,000 813,000
State income tax expense, net of
federal tax effect 216,000 123,000 1,130,000
Reduction for income of pooled entities
operating as S-corporations prior to date
of merger (357,000) -- --
Tax effect of foreign income taxed at lower rate -- (87,000) (704,000)
Change in valuation allowance affecting
tax expense (912,000) (2,026,000) --
Available tax credits -- -- (254,000)
Other (22,000) 94,000 (157,000)
----------- ----------- -----------
$ 76,000 $ 209,000 $ 8,850,000
=========== =========== ===========
Income before income taxes from foreign operations was $2.8 million in 1996 and
$0.6 million in 1995.
16. Earnings Per Share
Income per common and common equivalent share is based upon the average number
of shares of common stock outstanding during each year, adjusted for the
dilutive effect of common stock equivalents determined using the modified
treasury stock method in 1994, and the treasury stock method in 1995 and 1996.
Earnings per common share, assuming full dilution, is calculated on the same
basis as the previously described primary computation, except that the
computations assume that the end-of-year market price of the Company's common
stock (rather than the average market price during the year) is used to
determine the number of shares that would be assumed to be repurchased using the
treasury stock method.
As described more fully in Note 3, the Company may be required to issue
additional shares of common stock in future years in connection with the
acquisition of PACE. The 1995 and 1996 earnings per share calculations assume
that 95,693 and 88,890 shares, respectively, are issuable upon the determination
of the final purchase price. These respective amounts were calculated assuming
that PACE were to achieve its respective current year operating results in the
year of
56
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
16. Earnings Per Share (continued)
determination. The calculation also assumes that net income is reduced by
$171,000 and $630,000 as a result of the additional goodwill amortization that
would have been recorded in 1995 and 1996, respectively, if the assumed
contingent shares were issued on the date of acquisition.
The Company may also be required to issue additional shares of common stock as a
result of the Drake acquisition. The 357,143 Revenue Escrow shares to be
released in April 1997 (as discussed in Note 3) are considered outstanding in
1996 for primary and fully diluted earnings per share. The remaining contingent
shares are not considered in the computations since the effect on earnings per
share is antidilutive in 1995 and 1996 if the conditions required for issuance
of the contingent shares are assumed to have been met.
December 31,
1994 1995 1996
--------------------------------------------------
Per common and common equivalent share:
Weighted average number of shares of common
stock outstanding during the period 13,107,967 13,718,007 21,614,816
Dilutive effect of options and warrants 1,763,895 1,851,103 1,379,485
Common stock contingently issuable -- 95,693 446,033
---------- ---------- ----------
Total common and common equivalent shares of
stock considered outstanding during the year 14,871,862 15,664,803 23,440,334
========== ========== ==========
Per common share, assuming full dilution 15,119,015 15,971,819 23,582,023
========== ========== ==========
17. Major Customers and Concentration of Credit Risk
The Company has an agreement with Educational Testing Services ("ETS") to be the
exclusive commercial provider of ETS computer-based tests through the year 2000.
In addition, in 1994 the Company entered into a ten-year contract with ETS to
provide computer-based tests internationally. The international testing contract
with ETS stipulates that the Company will be compensated for its services for a
fee equal to approved costs plus 10 percent, and the Company recognizes revenues
accordingly. Operating costs under the contract will be paid at cost plus 10
percent on a quarterly basis by ETS. Start-up costs will be paid ratably over a
period not to exceed 10 years. The Company incurs financing costs to fund the
contract and ETS has agreed to reimburse these costs at the prime rate of
interest. Total revenues from ETS represented approximately 12.5%, 20.5% and
21.8% of consolidated revenues for the years ended December 31, 1996, 1995 and
1994, respectively.
57
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
17. Major Customers and Concentration of Credit Risk (continued)
The testing business acquired upon the acquisition of Drake in September 1995 is
highly concentrated with two customers. These customers contributed
approximately 23% and 28% to consolidated revenues during 1996 and the fourth
quarter of 1995, respectively. The Company expects the contracts with these two
customers to be renewed at the expiration date of the existing contracts. The
failure of these contracts to be renewed under similar terms would have a
detrimental effect on future operating results and significantly impair the
Company's ability to recover the remaining goodwill balance of approximately
$74.0 million related to the acquisition of Drake.
Financial instruments which potentially subject the Company to credit risk are
investments in available-for-sale securities, accounts receivable and notes
receivable. The Company maintains an allowance for losses on receivables based
on the collectibility of all amounts owed. The Company generally does not
require collateral for trade receivables. Notes receivable are generally
collateralized by assets of the debtors. At December 31, 1996, the Company does
not have any significant concentrations of credit risk.
18. Defined Contribution Retirement Plan
The Company sponsors a defined contribution retirement plan under section 401(k)
of the Internal Revenue Code. The provisions of this plan allow for voluntary
employee contributions, subject to certain annual limitations, and discretionary
Company contributions which are allocated to eligible participants based upon
compensation. All employees are eligible after meeting certain service
requirements. The Company made no contributions to this plan in any of the
periods presented.
19. Business and Geographic Segment Information
The Company's operations are classified into three primary business segments:
core educational services, contract educational services and testing services.
The core educational services segment involves the design and delivery of
personalized tutorial services to individuals through a network of franchised
and Company-owned Sylvan Learning Centers. The contract educational services
segment offers educational services under contract to public and private school
districts receiving funding under the federal Title I and other education
programs and provides contract educational and training services on-site to
employees of large corporations. The testing services segment delivers
computer-based tests both domestically and internationally.
58
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
19. Business and Geographic Segment Information (continued)
Summarized financial information by business segment for the years ended
December 31, 1994, 1995 and 1996 is as follows:
Year ended December 31,
1994 1995 1996
---------------------------------------------------------------
Operating revenue:
Core educational services $ 20,015,534 $ 26,063,191 $ 36,799,287
Contract educational services 13,563,560 27,361,930 33,366,684
Testing services 13,664,969 34,565,697 85,281,600
Other -- -- 1,669,089
------------- ------------- -------------
Total revenue $ 47,244,063 $ 87,990,818 $ 157,116,660
============= ============= =============
Operating income (loss):
Core educational services $ 4,849,654 $ 5,299,391 $ 8,064,192
Contract educational services 1,207,265 1,608,245 3,081,660
Testing services (2,970,976) (2,581,208) 10,237,792
Other -- -- 831,750
------------- ------------- -------------
Total operating income $ 3,085,943 $ 4,326,428 $ 22,215,394
============= ============= =============
Total assets:
Core educational services $ 8,051,776 $ 12,863,792 $ 41,744,146
Contract educational services 5,585,433 17,904,803 18,485,036
Testing services 17,329,631 98,200,486 127,651,141
Other -- -- 26,345,435
Corporate 11,531,959 36,437,590 36,353,093
------------- ------------- -------------
Total assets $ 42,498,799 $ 165,406,671 $ 250,578,851
============= ============= =============
Depreciation and amortization:
Core educational services $ 591,747 $ 895,430 $ 945,968
Contract educational services 419,624 823,742 1,082,981
Testing services 2,310,947 5,601,471 9,846,889
Other -- -- 64,673
Corporate 107,774 354,633 667,202
------------- ------------- -------------
Total depreciation and amortization $ 3,430,092 $ 7,675,276 $ 12,607,713
============= ============= =============
Capital expenditures:
Core educational services $ 809,080 $ 331,022 $ 888,959
Contract educational services 909,900 2,338,719 2,381,177
Testing services 6,221,689 1,894,847 5,937,046
Other -- -- --
Corporate -- 237,690 4,064,567
------------- ------------- -------------
Total capital expenditures $ 7,940,669 $ 4,802,278 $ 13,271,749
============= ============= =============
There were no significant intersegment sales or transfers during the period.
Operating income or loss by business segment excludes interest income and
expense, earnings and losses on equity
59
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
19. Business and Geographic Segment Information (continued)
investments, and investment and other income of $375,863 in 1994, ($569,440) in
1995 and $1,377,712 in 1996. Allocated corporate expenses are applied to each
segment based on each segment's percentage of total revenues. Corporate assets
consist principally of cash and cash equivalents, corporate property and
equipment, and other assets.
The Company reports information related to geographic locations based on the
location of the regional service centers, which for the years ended December 31,
1995 and 1996 is as follows:
1995 1996
------------ ------------
Operating revenue:
North America $ 77,305,710 $128,093,523
Europe 7,980,827 18,804,612
Asia/Pacific Rim 2,704,281 10,218,525
------------ ------------
Total revenue $ 87,990,818 $157,116,660
============ ============
Operating income:
North America $ 2,383,827 $ 11,122,080
Europe 1,205,230 8,232,240
Asia/Pacific Rim 737,371 2,861,074
------------ ------------
Total operating income $ 4,326,428 $ 22,215,394
============ ============
Identifiable assets:
North America $155,784,373 $208,822,558
Europe 7,440,001 36,563,504
Asia/Pacific Rim 2,182,297 5,192,789
------------ ------------
Total identifiable assets $165,406,671 $250,578,851
============ ============
There were no reportable geographic segments meeting disclosure criteria for the
year ended December 31, 1994.
20. Supplemental Cash Flow Information
Interest payments were $0.4 million, $1.8 million and $0.5 million for the years
ended December 31, 1996, 1995 and 1994, respectively. The 1995 amount includes
imputed interest payments of $1.1 million related to the acquisition of Drake.
Income tax payments were $4.0 million, $1.8 million and $57,000 for the years
ended December 31, 1996, 1995, and 1994, respectively.
60
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C COL. D COL. E
- ------------------------------------------------------------------------------------------------------------------------------------
ADDITIONS
-----------------------------------
BALANCE AT BALANCE AT
DESCRIPTION BEGINNING OF CHARGED TO COSTS CHARGED TO OTHER DEDUCTIONS-DESCRIBE END OF
PERIOD AND EXPENSES ACCOUNTS-DESCRIBE PERIOD
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1996
DEDUCTED FROM ASSET ACCOUNTS:
ALLOWANCE FOR DOUBTFUL ACCOUNTS $1,466,027 $ 280,444 $ 0 ($ 367,617)(1) $1,378,854
INVENTORY RESERVE $ 132,626 $ 70,000 $ 0 ($ 44,316)(2) $ 158,310
---------- ---------- ---------- ---------- ----------
TOTALS $1,598,653 $ 350,444 $ 0 ($ 411,933) $1,537,164
========== ========== ========== ========== ==========
YEAR ENDED DECEMBER 31,1995
DEDUCTED FROM ASSET ACCOUNTS:
ALLOWANCE FOR DOUBTFUL ACCOUNTS $ 490,226 $ 531,929 $ 950,000(3) ($ 506,128)(1) $1,466,027
INVENTORY RESERVE $ 228,415 $ 22,615 $ 0 ($ 118,404)(2) $ 132,626
---------- ---------- ---------- ---------- ----------
TOTALS $ 718,641 $ 554,544 $ 950,000 ($ 624,532) $1,598,653
========== ========== ========== ========== ==========
YEAR ENDED DECEMBER 31,1994
DEDUCTED FROM ASSET ACCOUNTS:
ALLOWANCE FOR DOUBTFUL ACCOUNTS $ 626,643 $ 158,621 ($ 295,038)(1) $ 490,226
INVENTORY RESERVE $ 486,471 $ 20,330 ($ 278,386)(2) $ 228,415
---------- ---------- ---------- ----------
TOTALS $1,113,114 $ 178,951 ($ 573,424) $ 718,641
========== ========== ========== ==========
(1) REDUCTION OF RESERVE DUE TO ACTUAL ACCOUNTS RECEIVABLE WRITE OFFS.
(2) REDUCTION OF RESERVE DUE TO SALES OF RESERVED INVENTORY AND CHANGES IN
ESTIMATES.
(3) REPRESENTS THE RESERVE BALANCE ACQUIRED BY THE PURCHASE OF PACE AND DRAKE
DURING 1995 AS FOLLOWS:
PACE $200,000
DRAKE $750,000
61
EXHIBIT INDEX
Exhibit
Number Description Page No.
- ------ ----------- --------
3.03 Amended and Restated Bylaws dated
September 27, 1996 ___
10.24 Lease Agreement dated August 24, 1995, First
Amendment dated May 13, 1996 and Second
Amendment dated November 11, 1996 by and
between Registrant and Harbor East, LLC. ___
10.25 Revolving Credit Note to NationsBank, N.A. dated
December 31, 1996. ___
10.26 Senior Management Option Plan dated March 29, 1996 ___
11.00 Statement re: Computation of Per Share Earnings ___
21.00 Subsidiaries of the Registrant. ___
23.01 Consent of Ernst & Young LLP ___
62