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UNITED STATES
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, 1998
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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
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SYLVAN LEARNING SYSTEMS, INC.
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(Exact name of registrant as specified in its charter)
Maryland 52-1492296
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1000 Lancaster Street, Baltimore, Maryland 21202
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 843-8000
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
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Common Stock, Par Value $.01 NASDAQ
Securities registered pursuant to the Section 12(g) of the Act: None
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (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 $1.4 billion as of March 15, 1999.
The registrant had 50,874,171 shares of Common Stock outstanding as of March 15,
1999.
DOCUMENTS INCORPORATED BY REFERENCE
-----------------------------------
Certain information in Sylvan Learning Systems, Inc.'s definitive Proxy
Statement for its 1999 Annual Meeting of Shareholders, which will be filed with
the Securities and Exchange Commission pursuant to Regulation 14A no later than
April 30, 1999 is incorporated by reference in Part III of this Form 10-K.
1
INDEX
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PART I. Page No.
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Item 1. Business.............................................. 3
Item 2. Properties............................................ 11
Item 3. Legal Proceedings..................................... 11
Item 4. Submission of Matters to a Vote of Security Holders... 12
PART II.
Item 5. Market for Registrant's Common
Equity and Related Stockholder Matters............... 12
Item 6. Selected Financial Data............................... 13
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations........ 15
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk.......................................... 25
Item 8. Financial Statements and Supplementary Data........... 25
Item 9. Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure............... 25
PART III.
Items 10., 11., 12. and 13. are incorporated by reference from
Sylvan Learning Systems, Inc.'s definitive Proxy
Statement which will be filed with the Securities and
Exchange Commission, pursuant to Regulation 14A,
not later than April 30, 1999.......................... 26
PART IV.
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K............................... 26
SIGNATURES............................................................. 30
2
PART I.
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Item 1. Business
Sylvan Learning Systems, Inc. ("the Company" or "Sylvan") is the leading
international provider of educational services to families, schools and
industry. The Company provides lifelong educational services through three
separate business segments: the Sylvan Prometric division principally delivers
computer-based testing for academic admissions, information technology and
professional certification programs; the Sylvan Learning Centers division
provides personalized instructional services to students of all ages and skill
levels; and the Sylvan Contract Educational Services division principally
provides supplemental educational services and professional development through
contracts with school systems and other organizations. Sylvan subsidiaries
include PACE, which provides corporate consulting, training and professional
development services, the Canter Group, which provides professional development
and graduate degree programs for teachers, Wall Street Institute and Aspect,
which deliver English language instruction to professionals and college
students, respectively. Through its affiliate, Caliber Learning Network, Inc.,
formed as a joint initiative between Sylvan and MCI Communications Corp., Sylvan
has the ability to distribute world-class adult professional education and
training programs. Sylvan's services are delivered through its network of more
than 3,000 educational and testing centers around the globe. In 1998, total
system-wide revenues were approximately $622.2 million, composed of $246.6
million from the Sylvan Learning Centers segment ($197.4 million from franchised
Learning Centers and $49.2 million from Company-owned Learning Centers, product
sales, franchise sales fees and other franchise service revenues), $275.1
million from the Sylvan Prometric segment and $100.5 million from the Sylvan
Contract Educational Services segment. Note 21 of the 1998 audited financial
statements contains additional disclosures regarding the Company's business and
geographic segments.
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 1.2 million students primarily in grades three through
eight over the past 19 years. The Company's Sylvan Learning Centers 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 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 $1,650.
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
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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 supplemental 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, 1998, there were a total of 727
Learning Centers in 49 states, six Canadian provinces, Hong Kong and Guam
operated by the Company or its franchisees. As of that date, there were 420
franchisees operating 663 Sylvan Learning Centers. During 1998, 60 franchised
Learning Centers were opened and seven were closed. In addition, during 1998,
13 franchisee-owned Learning Centers were acquired by the Company.
Approximately 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 represented less than 1% of total franchise royalties earned by the
Company in 1998.
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 which are
typically full-time employees and eight of which 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 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 field managers 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 208 territories in North America, primarily in smaller markets, in which
there are no Learning Centers. The Company is actively seeking franchisees for a
number of these territories. Forty-seven new territories were sold in 1998.
4
The Company has sold franchise rights for the operation of Learning Centers in
Hong Kong, China, the United Kingdom and Spain. 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
$38,000 to $46,000, 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 8% 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 9% 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 91% of the
franchisees are required to contribute a minimum of 1.5% of gross revenues to
the national advertising fund. The fund is administered by the SLC National
Advertising Fund, Inc. ("SNAF"). The Franchise Owners Association ("FOA") owns
the SNAF. The FOA is an association whose members consist of Sylvan franchise
owners. Franchisees must submit monthly financial data to the Company.
Company-owned Learning Centers. As of December 31, 1998, Sylvan owned and
operated 63 Learning Centers: five in Baltimore, seven in Dallas, eight in
Houston, six in Los Angeles, five in Orange County, California, nine in the
greater Philadelphia area, seven in South Florida, eight in the greater
Washington, D.C. area, three in the greater Salt Lake City metropolitan 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, 1998, eleven of the
Company-owned Learning Centers contained Technology Centers for computer-based
testing. Company-owned Learning Centers 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.
Schulerhilfe. On October 28, 1998, the Company acquired Schulerhilfe, a major
provider of tutoring services in Germany. Schulerhilfe has approximately 177
company-owned centers and approximately 700 franchise locations in Germany,
Italy and Austria. Schulerhilfe operates based on a similar business model as
the Sylvan Learning Centers, with small class sizes and instruction based on
attendance 2 or 3 times per week per student. Competition consists of one other
national provider of tutoring services in Germany combined with small, local
tutors.
Sylvan Prometric
The Company conducts its testing business through 2,437 testing centers, 1,202
of which are located in the United States and Canada and the remainder of which
are located in 128 foreign countries. These centers are classified as either
Sylvan Technology Centers ("STCs") or Authorized Prometric Testing Centers
("APTCs"). STCs are generally located in certain existing Sylvan Learning Center
franchisee and Company-owned and operated sites. During 1998, the Company added
456 testing centers, of which 279 were APTCs. 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 can take up to 120
days. Computer-based tests, which can be offered during regular school hours
and on weekends at STCs, increase the utilization and the public awareness of
Sylvan Learning Centers.
5
For STCs, 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 and certification of STC personnel in accordance
with procedures established by the sponsoring testing organization. The
franchisee provides the space and staffing for the testing center. The Company
enters into contracts directly with the testing organization, such as
Educational Testing Service, Inc. ("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 fees per test that decrease as the volume of the tests
delivered increases.
APTCs must meet certain criteria established by the Company for administering
computer-based testing and are required to furnish the space, equipment and
personnel needed for their operation and receive compensation for test delivery
in various forms including marketing assistance for their core business. APTC's
administer computer-based tests principally in the information technology ("IT")
industry.
Principal customers in the IT industry are Microsoft Corporation and Novell,
Inc. 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 Microsoft and Novell
accounted for $52.9 million, or 19%, of Sylvan Prometric's revenues in fiscal
1998.
ETS, a leading educational testing firm, develops and administers more than
9.0 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, of which 2.3 million are given
annually to college-bound students, and the PSAT, of which 1.9 million are 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 that are sponsored by the
College Board.
During 1998, the Company recognized approximately $54.4 million, or 20% of
Sylvan Prometric's revenues in fiscal 1998, from all services for ETS. The
Company provides testing services through two contracts with ETS to provide
services both in North America and internationally. Sylvan initially signed a
contract for computer-based test delivery in North America in 1993 with a term
expiring in 1999. This North American contract was renegotiated in 1997 and now
extends through 2005. The North American contract continues to provide that
Sylvan will be ETS's exclusive commercial provider of computer-based testing
services in North America, provided Sylvan can provide sufficient capacity to
meet candidate testing demand, in accordance with the criteria set forth in the
contract. Further, the contract provides that the Company will deliver not less
than 50% of ETS's computer-based testing volume (excluding College Board tests)
in North America.
The North American contract also provides that ETS may establish computer-
based test sites (subject to the requirement for 50% of the computer-based
testing volume being delivered by the Company) at three specific ETS locations,
at ETS client specific locations and at test centers located in colleges,
universities and similar institutions. At present, the Company administers and
delivers ETS examinations at approximately 84 institutional test sites. During
1998, the Company recognized approximately $21.7 million under the North
American contract.
6
ETS and the Company entered into an international contract for delivery of ETS
computer-based tests in 1994. 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 revenue accordingly. The
Company also is reimbursed for its cost of capital and any foreign exchange
losses. During 1998, the Company recognized revenues of approximately $32.7
million under this contract. In return for the cost plus compensation, the
Company is required to establish a network of international computer-based
testing sites and to deliver ETS's computer-based tests. The contract provides
that the Company shall be the exclusive provider of computerized commercial
testing capacity to ETS for all secure testing programs outside North America.
ETS may establish its own test sites only where Sylvan fails to provide
sufficient capacity as defined by the contract or where the Company's costs of
providing the service would be prohibitive. There are no ETS sites for
computer-based testing operated internationally. During 1998, the Company
expanded international testing for ETS to a total of 116 permanent and 30
temporary sites in 79 countries.
Under the ETS agreements, the Company offers computer-based versions of ETS'
PRAXIS examination, which is used to license beginning teachers, the GRE, which
is used by graduate schools to evaluate applicants, and through a contract with
the National Council of State Boards of Nursing, a computer-based licensing
examination (NCLEX) for registered and practical nurses. In October 1997,
Sylvan and ETS converted the GMAT examination to computer-based delivery on a
world-wide basis. In July 1998, Sylvan and ETS converted the TOEFL examination
to computer-based delivery in the Americas, Europe, Africa, Middle East,
Australia and certain Asia-Pacific countries.
In addition to the tests offered through its partnership with ETS, the Company
is one of three entities licensed by the FAA to deliver computer-based versions
of various pilot and mechanical licensing tests for general aviation and the
sole source provider for certain pre-employment tests. In addition to FAA
testing, the Company provides testing services for organizations in many other
fields, such as for computer professionals, securities dealers, medical
laboratory technicians and military candidates.
During 1998, the Company won a contract with the Driving Standards Agency
(DSA) of Great Britain to deliver all drivers' license theory tests in the
countries of England, Scotland and Wales. The contract has an estimated value of
$125 million over a six-year term through August 2004. Currently, more than one
million people per year take the theory test for student drivers. Under the
contract, Sylvan will operate 158 testing centers at which it will deliver a
computer-based version of the drivers' exam. The centers will be located within
20 miles of most testing candidates' homes. Sylvan expects to begin delivering
tests through these centers in January 2000.
The Company, in December 1996, purchased 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.
WSI has more than 250 company-owned and franchised centers in operation
throughout Europe and Latin America.
The 1996 acquisition of WSI was 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 will be utilized by Sylvan to administer certain computer-based
testing programs throughout Europe and Latin America, and accordingly is
considered part of the Company's Sylvan Prometric testing division.
WSI has 86 centers in Spain (65 franchised and 21 company-owned) 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 the Middle East, Africa and the
Pacific Rim region.
7
Effective December 1, 1997, the Company purchased Block Testing Services L.P.
, Block State Testing Services L.P. and National Assessment Institute, Inc.,
(collectively "NAI/Block"), commonly-controlled companies engaged in the
business of designing, marketing, selling, distributing and administering paper
and pencil and computer-based electronic tests for the licensing of individuals.
NAI/Block operates 14 regional offices that administer licensing examinations on
the state, county and local municipality level for various industries, including
but not limited to the construction, cosmetology, real estate and medical
industries. These 14 regional offices provide examinations for 44 states, the
District of Columbia and the Virgin Islands. On January 1, 1999, the Company
entered into an agreement with The Chauncey Group International, Ltd.
("Chauncey") to form Experior Assessments LLC ("Experior"), a joint venture to
be engaged in the business of developing and administering state and municipal
sponsored licensing and certification programs and other related services. In
exchange for a 50% interest in Experior, Sylvan contributed the net assets of
NAI/Block, excluding certain working capital balances. Chauncey will contribute
the net assets of the Insurance Testing Corp ("ITC") in exchange for its 50%
interest in Experior. ITC provides computer-based testing, licensing and
continuing education services to state insurance departments.
On May 6, 1998 the Company acquired all of the outstanding common stock of
Aspect International Language Schools, B.V. and subsidiaries ("Aspect"). Aspect
is a leading provider of English language training programs for college students
from non-English speaking companies. Founded in 1992, Aspect delivers intensive
English language programs at 27 schools in five countries.
Sylvan Contract Educational Services
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 remedial education to academically and economically disadvantaged
students. The main program is the Title 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, 1998, the Company had contracts to
provide supplemental remedial educational services to 139 public schools,
including 33 in Los Angeles, 19 in Compton, California, 11 in Detroit, Michigan
and 9 in Chicago, Illinois.
Using Company personnel, Sylvan offers virtually the same 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 Sylvan 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 the
use of personal computers as in a Sylvan 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 most 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 have the parents involved.
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 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
8
services, materials and equipment. The contracts have terms of one to three
years, with the latest expiring in June 2001. 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.
Educational Inroads. On May 30, 1997 the Company acquired by merger all of
the outstanding stock of I-R, Inc. and Independent Child Study Teams, Inc.
(collectively, "Educational Inroads") in exchange for 1,414,000 shares of common
stock. I-R, Inc. and Independent Child Study Teams, Inc. were commonly owned by
two shareholders. Educational Inroads provides remedial and special education
services to public and non-public school systems, with current contracts in New
Jersey, Maryland, Louisiana, Washington D.C. and other school districts.
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. 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 14 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.
The Canter Group. In January 1998, the Company acquired Canter and
Associates, Inc. and Canter Educational Productions, Inc. (collectively, "The
Canter Group" or "Canter"), a leading provider of training, staff development
and graduate courseware for educators. This acquisition will allow Sylvan to
provide teachers with advanced degree programs and professional development at a
time when the demand for teachers is in excess of supply.
Marketing
The Company and its franchisees market Sylvan's Learning Center services 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 commercials 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
9
offers important competitive advantages. The Company markets its school-based
educational services to several public school systems and state education
departments. 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. WSI markets its English language instruction services through
the use of national television and radio advertising programs in Spain as well
as through locally-placed advertising by its franchisees and company-owned
centers in various countries.
Marketing efforts for the PACE programs are focused on large corporations
seeking to outsource their training and educational programs, through PACE's 14
sales offices throughout the United States. PACE's strategy is to offer
solutions to the customer's training needs rather than marketing specific
products.
Marketing efforts for Aspect are focused mainly through sales agents
worldwide, primarily through direct response advertising brochures.
Competition
The Company is aware of only three direct national corporate competitors in
its Sylvan Learning Centers segment: Huntington Learning Centers, Inc., Kumon
Educational Institute and Kaplan Educational Centers. 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 Sylvan Learning Centers segment.
The Company's contract educational services segment'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,
including National Computer System's Virtual University Enterprises division and
Harcourt General, which offers computer-based testing at approximately 180
sites. The language training market is highly fragmented with numerous public
and private sector operators. These include Berlitz/ELS, E.F. (a Swedish
company) and Opening (a Spanish company). Berlitz is the largest of these
companies in this market segment, with annual revenues of approximately $220
million.
Government Regulation
Title I. Title I school districts are responsible for implementing Title I in
carrying out their educational programs. Title I regulations, 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.
10
Franchise. The sales of franchises are 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.
Trademarks
The Company has a federal trademark registration for the words "Sylvan
Learning Center" and distinctive logo (a reading child), a federal service mark
registration 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 foreign 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. Additionally, the Company has a federal trademark registration
for the words "Wall Street Institute" and distinctive logo (Statue of Liberty),
as well as foreign trademark registrations and pending applications for the WSI
trademark and logo.
Employees
As of December 31, 1998, the Company had approximately 6,300 employees, 3,800
of whom were classified as full-time and 2,500 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 Schulerhilfe centers. None of the
Company's employees are represented by a union and the Company considers its
relationship with its employees to be good.
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 most of its facilities, consisting principally of
administrative office space and Learning Centers and testing sites. The Company
leases three facilities in Baltimore, Maryland for its administrative offices.
In addition, the Company leases: a facility in Minneapolis, Minnesota for
general office space and a registration center; space in Woodlawn, Maryland for
a registration center; and, space in Baltimore, Maryland for a Logistics Center.
The Company also leases: space for the 63 Company-owned Learning Centers in
Maryland, Texas, California, Pennsylvania, Delaware, New Jersey, Florida,
Minnesota, Virginia and Utah; the Company also leases space for 53 international
testing sites; and, 177 Schulerhilfe centers in Germany. In addition, the
Company's Aspect subsidiary owns 5 buildings in the United Kingdom.
Item 3. Legal Proceedings
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 acquisition of rights to administer testing services
for the National Association of Securities Dealers, Inc. ("NASD"). ACT has
asserted that the Company tortuously interfered with ACT's relations,
11
contractual and quasi-contractual, with the NASD, that the Company 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. If ACT
were awarded significant compensatory or punitive damages, it could materially
adversely affect the Company's results of operations and financial condition.
Additionally, if ACT were granted significant injunctive relief, the Company may
be required to dispose of, limit expansion or curtail existing operations of its
Sylvan Prometric division, which, in turn, would materially adversely affect the
Company's results of operations, financial condition and prospects for growth.
In February 1998, the Court ruled that ACT may proceed only on three of its five
antitrust theories and otherwise narrowed the scope of ACT's antitrust claims.
In March 1998, the Court denied the Company's motion to dismiss ACT's state law
claims. Formal discovery commenced in 1998 with document production and is
expected to continue at least through the summer of 1999 with depositions. The
Company believes that all of ACT's claims are without merit but is unable to
predict the outcome of the ACT litigation at this time.
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, 1998.
PART II.
--------
Item 5. Market for Registrants's Common
Equity and Related Stockholder Matters
The Company's Common Stock is traded on the NASDAQ National Market. The
Company's trading symbol is SLVN. The high and low trade prices for 1997 and
1998 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 1998 Annual Report on
Form 10-K and in the 1998 audited financial statements have been retroactively
restated to reflect the effects of a 3 for 2 stock split which occurred in May
1998.
1997 High Low
- --------------- ------ ------
1st Quarter $25.17 $16.17
2nd Quarter $24.92 $15.92
3rd Quarter $29.67 $21.83
4th Quarter $30.83 $25.33
1998 High Low
- --------------- ------ ------
1st Quarter $32.33 $21.67
2nd Quarter $35.00 $28.00
3rd Quarter $36.88 $19.88
4th Quarter $32.25 $17.13
No dividends were declared on the Company's Common Stock during the years
ended December 31, 1997 and 1998, and the Company does not anticipate paying
dividends in the future.
The number of registered shareholders of record as of March 15, 1999 was 435.
12
During the year ended December 31, 1998, the Company issued 123,973 shares of
its common stock that were not registered under the Securities Act of 1933. On
November 10, 1998 the Company issued 123,973 shares to Embassy & Company
pursuant to the acquisition of ZGS Zentrale Gelsenkirchener SCHULERHILFE J.
Gratze + M. Mohr GbR mbH ("Schulerhilfe Partnership") and all of the outstanding
common stock of SCHULERHILFE Gesellschaft fur Nachhilfeunterricht mbH
("Schulerhilfe Corporation").
Item 6. Selected Consolidated Financial Data
The selected financial data for the years ended December 31, 1994, 1995, 1996,
1997 and 1998 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 Consolidated Financial Statements and Notes
thereto.
The Company consummated significant purchase business combinations in each of
the four years in the period ended December 31, 1998. These business
combinations affect the comparability of the amounts presented, and the
following data should be read in conjunction with Note 3 to the Consolidated
Financial Statements.
Selected Consolidated Financial Data
Year Ended Year Ended Year Ended Year Ended Year Ended
December 31, December 31, December 31, December 31, December 31,
1994 1995 (1) 1996 (2) 1997 (3) 1998 (4) (5)
----------- ---------- ------------ ------------ ------------
(in thousands, except per share data)
Statements of Operations Data:
Revenues............................................ $ 94,205 $ 139,286 $ 219,973 $ 301,011 $ 440,330
Cost and expenses:
Direct costs (6)................................... 85,037 124,146 187,819 263,523 359,613
General and administrative expense (6)............. 4,998 6,205 8,049 19,693 15,530
Transaction costs related to pooling-of-interests.. - - - 5,000
Restructuring and asset impairment charges......... - 3,316 - 4,000 3,730
----------- ---------- ------------ ------------ ------------
Total costs and expenses.......................... 90,035 133,667 195,868 287,216 383,873
----------- ---------- ------------ ------------ ------------
Operating income.................................... 4,170 5,619 24,105 13,795 56,457
Non-operating income................................ 277 1,402 2,108 31,330 1,777
Interest income, net................................ (313) (2,623) (1,320) (801) (943)
----------- ---------- ------------ ------------ ------------
Income before income taxes.......................... 4,134 4,398 24,893 44,324 57,291
Income taxes........................................ (187) (356) (9,139) (16,420) (21,582)
----------- ---------- ------------ ------------ ------------
Net income $ 3,947 $ 4,042 $ 15,754 $ 27,904 $ 35,709
=========== ========== ============ ============ ============
Earnings per common share, diluted (7): ....... $ 0.15 $ 0.15 $ 0.40 $ 0.62 $ 0.70
=========== ========== ============ ============ ============
Diluted shares (7) 26,512 27,701 38,963 44,890 51,286
=========== ========== ============ ============ ============
Balance Sheet Data (at period end):
Cash and cash equivalents...................... $ 7,118 $ 6,652 $ 18,720 $ 29,818 $ 33,170
Available-for-sale securities.................. 2,357 30,735 16,474 82,951 6,166
Net working capital............................ 12,999 39,044 28,836 112,874 15,100
Intangible assets and deferred contract costs.. 8,104 83,289 123,461 193,192 293,710
Total assets................................... 62,679 19,238 278,078 496,779 659,796
Long-term debt, including current portion...... 12,093 12,272 39,621 74,744 67,611
Stockholders' equity........................... 34,294 139,131 182,768 340,460 488,833
(1) Effective September 30, 1995, Sylvan acquired Drake Prometric, L.P.
("Drake"), a leading provider of computer-based certification, licensure and
assessment testing. The transaction was accounted for using the purchase
method of accounting, and Sylvan's results of operations from October 1,
1995 include the operations of Drake.
13
(2) Effective December 1, 1996, Sylvan acquired Wall Street International, B.V.,
and its commonly controlled affiliates (collectively "Wall Street"), 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 Wall Street.
(3) Effective December 1, 1997, the Company purchased the assets and liabilities
of Block Testing Services L.P. and Block State Testing Services L.P. and
also acquired all of the outstanding common stock of National Assessment
Institute, Inc., (collectively, "NAI/Block"), commonly controlled companies
engaged in the business of designing, marketing, selling, distributing and
administering paper and pencil tests for the licensing of individuals. The
acquisition, which was paid for by issuing 642,901 shares of common stock
valued at $24.6 million in January 1998, was accounted for using the
purchase method of accounting, and Sylvan's results of operations from
December 1, 1997 include the operations of NAI/Block.
(4) On January 1, 1998, the Company acquired all of the outstanding capital
stock of Canter for $25 million plus additional consideration if Canter
achieves certain EBITDA targets. The acquisition was accounted for as a
purchase, and Sylvan's results of operations from January 1, 1998 include
the operations of Canter.
Effective October 28, 1998, the Company acquired all the operating assets
and liabilities of ZGS Zentrale Gelsenkirchener SCHULERHILFE J. Gratze + M.
Mohr GbR mbH ("Schulerhilfe Partnership") and all of the outstanding common
stock of SCHULERHILFE Gesellschaft fur Nachhilfeunterricht mbH
("Schulerhilfe Corporation," and collectively with Schulerhilfe Partnership,
"Schulerhilfe"), in exchange for an initial purchase price of $16.5 million
in cash and 123,973 shares of restricted common stock valued at $2.5
million. The results of operations of Schulerhilfe for the period from
October 28, 1998 through December 31, 1998 are included in Sylvan's 1998
results of operations.
(5) Includes certain non-recurring expenses related to the merger with Aspect.
These expenses include $5.0 million of transaction-related costs, such as
legal, accounting and advisory fees, $1.2 million of compensation to former
shareholders of Aspect, who are no longer with the Company and were not
replaced and $3.7 million of costs, classified in the financial statements
as restructuring costs that relate to the integration of Aspect with Sylvan.
The net effect of the above items was a decrease in pre-tax income of $9.9
million and net income of $8.9 million, or $0.17 per diluted share.
(6) The Company has reclassified certain operating expenses previously included
in general and administrative expense to direct costs. This change has been
reflected for all periods presented.
(7) All share and per share data have been restated to reflect a 3-for-2 stock
dividend paid on November 7, 1996 and a 3-for-2 stock dividend paid on May
22, 1998.
14
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 Schulerhilfe and Canter acquisitions, future
capital requirements, potential acquisitions, the failure to remediate or the
cost of remediating Year 2000 Issues 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 tutorial and
teacher training operations; the availability of sufficient capital to finance
the Company's business plan on terms satisfactory to the Company; the failure
to remediate or the cost of remediating Year 2000 Issues; 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 1995 and, as such, speak only as of the date made.
Overview
The Company generates revenues from three business segments: Sylvan Learning
Centers, which primarily consist of franchise royalties, franchise sales fees
and Company-owned Learning Center revenues; Sylvan Contract Educational
Services, which consists of revenues attributable to providing supplemental
remedial education services to public and non-public schools and major
corporations as well as providing teacher training services; and Sylvan
Prometric, which consists of computer-based testing fees paid to the Company
and the operations of WSI and Aspect. The following selected segment data is
derived from the Company's audited consolidated financial statements.
Year Ended December 31,
----------------------------------------
1996 1997 1998
------------ ------------ ------------
Operating revenue:
Sylvan Learning Centers............... $ 38,898 $ 46,629 $ 64,754
Sylvan Contract Educational Services.. 58,186 66,582 100,519
Sylvan Prometric...................... 122,889 187,800 275,057
-------- -------- --------
Total revenue..................... $219,973 $301,011 $440,330
======== ======== ========
Direct costs:
Sylvan Learning Centers............... $ 27,442 $ 39,186 $ 45,415
Sylvan Contract Educational Services.. 53,459 56,352 85,870
Sylvan Prometric...................... 106,918 167,985 228,328
-------- -------- --------
Total direct costs................ $187,819 $263,523 $359,613
======== ======== ========
Results of Operations
Comparison of results for the year ended December 31, 1998 to the year ended
December 31, 1997.
Revenues. Total revenues increased by $139.3 million, or 46%, to $440.3
million for the year ended December 31, 1998, compared to the same period in
1997. This increase resulted from higher revenues in all business segments
Sylvan Learning Centers, Sylvan Contract Educational Services and Sylvan
Prometric.
15
Sylvan Learning Centers revenue consists primarily of Learning Services
royalties, franchise sales fees and revenue from Company-owned Centers.
Learning Centers revenue increased by $18.1 million, or 39%, for the year ended
December 31, 1998, compared to the same period in 1997. Overall, franchise
royalties increased by $2.5 million or 19% for the year ended December 31,
1998, despite the acquisition of 13 franchised Centers during 1998. Excluding
the effect of the Center acquisitions, franchise royalties increased 24% in
1998. The increase in royalties was due to a net increase of 60 new Centers
opened during 1998, combined with same center revenue increases of 18% for the
year ended December 31, 1998.
Franchise sales fees increased by $1.2 million, or 27%, to $5.8 million for
the year ended December 31, 1998, compared to the same period in 1997. The
increase in sales is principally due to international sales increasing by $0.5
million compared to 1997. Domestic territory and area development sales
increased by $0.7 million in 1998.
Revenues from Company-owned Learning Centers increased by $9.3 million, or
37%, to $34.4 million during 1998. The acquisition of 13 centers in 1998
resulted in $8.2 million of additional revenue in 1998. On a full year basis,
same center revenues increased by $3.5 million, or 16%, in 1998 compared to
revenues in 1997.
On October 28, 1998, the Company acquired a major German tutoring company
known as Schulerhilfe. The business has over 700 franchised centers and 178
Company-owned locations. This purchase resulted in an additional $2.4 million
in revenue in 1998. The remaining revenue increase in 1998 of $2.7 million is
principally due to increased product sales.
Sylvan Contract Educational Services revenue increased by $33.9 million, or
51%, to $100.5 million for the year ended December 31, 1998. Canter, acquired
in January 1998, contributed $24.8 million of the increase. Public and
nonpublic school contracts contributed $11.1 million of the increase, while
PACE services revenue decreased by $2.0 million.
The $11.1 million increase in revenue from public and nonpublic schools for
the year ended December 31, 1998 is the result of $17.4 million in revenue from
new contracts, offset by a decrease of $3.7 million in revenue from contracts
in existing districts lost or reduced due to local district budget
constraints. This segment's revenue also declined by $2.6 million as a result
of the disposition in late 1997 of an unrelated business assumed upon the
acquisition of Educational Inroads.
Sylvan Prometric revenue increased by $87.3 million, or 46%, to $275.1
million during the year ended December 31, 1998, compared to the same period in
1997. The increase in testing services revenues resulted mainly from volume
increases in Information Technology (IT) ($26.8 million), Academic admissions
($6.0 million) and Professional certification testing ($3.6 million), the full
year impact of the December 1997 NAI/Block acquisition ($11.6 million), and
increased revenue from English language instruction businesses ($23.4 million).
Increases in testing volumes resulted primarily from increased testing volumes
with Microsoft and certain other IT clients, and increased services under
Educational Testing Service (ETS) contracts, which included the cost-plus
international contract for delivery of the GRE, GMAT, and TOEFL examinations
($15.9 million).
Cost and Expenses. Total direct costs increased 36%, from $263.5 million in
1997 to $359.6 million in 1998, but decreased as a percentage of total revenues
from 88% in 1997 to 82% in 1998. However, both periods presented contain
certain non-recurring costs, as further discussed below. Excluding these non-
recurring costs, total direct costs decreased as a percentage of total revenues
from 82% in 1997 to 81% in 1998.
Sylvan Learning Centers expenses increased $6.2 million to $45.4 million or
70% of Learning Centers revenue in 1998 compared to $39.2 million, or 84% of
Learning Centers revenue in 1997. Included in Sylvan Learning Centers expenses
for the 1997 period is a non-recurring $5.0 million contribution of the
Company's Common Stock to a corporation whose sole purpose is to develop and
fund advertising programs for Sylvan Learning Centers. Excluding this
contribution, Sylvan Learning Centers expenses as a percentage of revenue
16
would have been 73% in 1997. Approximately $9.8 million of the increase in
recurring expenses was due to direct costs associated with higher revenues at
existing centers and the acquisition of 13 franchised learning centers in 1998.
As a percentage of revenues, expenses for Company-owned centers decreased from
85% in 1997 to 84% in 1998. The Company's fourth quarter 1998 acquisition of
Schulerhilfe accounted for $2.0 million of increased expenses.
Sylvan Contract Educational Services expenses increased by $29.5 million to
$85.9 million, or 85% of Sylvan Contract Educational Services revenue during
the year ended December 31, 1998, compared to $56.4 million or 85% of Sylvan
Contract Educational Services revenue during the year ended December 31, 1997.
Sylvan Prometric expenses for the year ended December 31, 1998 increased by
$60.3 million to $228.3 million, or 83% of total Sylvan Prometric revenue,
compared to $168.0 million, or 89% of total Sylvan Prometric revenue for the
year ended December 31, 1997. The 1998 period included $1.2 million of
compensation to the former owners of Aspect, who are no longer with the Company
and have not been replaced. During the second quarter of 1997, Sylvan Prometric
expenses included contributions of $10.0 million to a nonprofit corporation
whose sole purpose is to fund promotional and channel support programs for the
Sylvan Prometric distribution channel. The 1997 period included $2.2 million in
non-recurring charges related to the Aspect merger. Excluding these non-
recurring expenditures, expenses as a percentage of total Sylvan Prometric
revenue remained constant at 83% in both years. Lower delivery costs per
computer-based test as a result of increased volumes and efficiencies in the
1998 period were offset by certain favorable volume-based pricing adjustments
in 1997 and higher expenses as a percentage of revenue in the English language
business in 1998 as a result of the 1997 period containing a higher level of
franchise sales.
General and administrative expenses decreased by $4.2 million to $15.5
million during 1998, and decreased as a percentage of revenues from 7% to 4%.
Included in 1997 general and administrative expenses were non-recurring
expenses related to a contribution of the Company's common stock valued at $6.5
million to Sylvan Learning Foundation, Inc., a nonprofit foundation formed to
promote various educational pursuits, and a $3.2 million contribution to
International Education Forum, Inc., a not-for-profit foundation formed to
provide exchange programs for international students in the United States.
Excluding these non-recurring expenses, general and administrative expenses
increased from 3.3% of total revenues for 1997 to 3.5% of total revenues for
1998.
During the year ended December 31, 1998, Sylvan incurred $5.0 million of non-
recurring transaction-related costs relating to the pooling-of-interests with
Aspect. The transaction costs consist principally of legal, accounting and
advisory fees.
In connection with the acquisition of Aspect in 1998, the Company recorded a
$3.7 million restructuring charge associated with the merger and integration of
the combined operations. These charges consist primarily of contract
cancellation costs of $2.6 million, severance and other employee related costs
of $0.4 million, and liabilities of $0.7 million incurred to discontinue
certain foreign exchange programs of Aspect. The contract cancellation costs
are payments made to repurchase master franchise rights under which Sylvan is
in default of contractual non-competition provisions as a result of the
acquisition of Aspect. Through December 31, 1998, $1.1 million of contract
cancellation costs and $0.7 million of other restructuring charges have been
paid, with the remainder expected to be paid during 1999. The net effect of the
$3.7 million restructuring charge, the $1.2 million in compensation paid to
former owners and the $5.0 million of transaction-related costs was a decrease
in pre-tax income of $9.9 million and net income of $8.9 million, or $0.17 per
diluted share for the year ended December 31, 1998.
Non-Operating Income. Non-operating income, consisting of investment and
other income and equity in net losses of investees accounted for under the
equity method, decreased from $31.3 million in 1997 to $1.8 million in 1998.
The decrease is principally attributable to a $28.5 million net termination fee
from the breakup
17
of the NEC acquisition recorded in 1997, and an increase in the allocable
losses of Caliber of $1.5 million in 1998.
The Company's effective tax rate has increased from 37% in 1997 to 38% in
1998 due primarily to $5.0 million of transaction costs related to the
acquisition of Aspect for which there is no allowable income tax deduction.
Comparison of results for the year ended December 31, 1997 to the year ended
December 31, 1996.
Revenues. Total revenues increased by $81.0 million, or 37%, to $301.0
million for the year ended December 31, 1997, compared to the same period in
1996. This increase resulted from higher revenues in all business segments
Sylvan Learning Centers, Sylvan Contract Educational Services and Sylvan
Prometric.
Sylvan Learning Centers revenues increased by $7.7 million, or 20%, to $46.6
million for 1997. Franchise royalties increased $1.9 million or 20%, for 1997.
This increase in franchise royalties was due to an overall 10% increase in
revenues at existing Learning Centers open for more than one year combined with
a net increase of 60 new Learning Centers opened in 1997.
Franchise sales fees increased by $1.3 million, or 41%, to $4.5 million for
the year ended December 31, 1997, compared to the same period in 1996. During
1997, there were six area development agreements sold for $2.9 million and 42
franchise Learning Center licenses sold, compared to four area development
agreements sold for $1.7 million and 38 franchise Center licenses sold during
1996. Product sales decreased by $190,000, or 5%, to $3.7 million for 1997.
Revenues from Company-owned Learning Centers increased by $4.4 million, or
21%, to $25.0 million during 1997, primarily as a result of student enrollment
increases for Centers operating over 12 months as of December 31, 1997 and, to
a lesser extent, the Company's acquisition in 1997 of thirteen Learning Centers
from five franchisees.
Sylvan Contract Educational Services revenue increased by $8.4 million, or
14%, to $66.6 million for the year ended December 31, 1997. Revenue from public
and non-public contracts increased by $2.2 million for the year ended December
31, 1997, primarily the result of contracts with new school districts. Revenue
from PACE contracts accounted for $6.2 million of the increase for 1997. The
PACE increase resulted primarily from contracts with new customers.
Revenue from new public and non-public contracts obtained after December 31,
1996 contributed $5.3 million to revenue for 1997. Revenue from existing
public and non-public contracts obtained before December 31, 1996 decreased by
$3.1 million in 1997, primarily related to reduced funding in certain school
districts and certain contracts expiring in 1997.
Sylvan Prometric revenue increased by $64.9 million, or 53%, to $187.8
million during the year ended December 31, 1997, compared to the year ended
December 31, 1996. The increase in testing services revenues resulted mainly
from increased services under Educational Testing Service (ETS) contracts,
which included the cost-plus international contract, GRE, GMAT, and TOEFL, and
certain volume-based pricing adjustments, testing in the information technology
and professional licensure businesses. WSI, acquired in December 1996,
contributed $19.0 million of the revenue increase. Revenues for Aspect
increased by $16.5 million, or 46%, as a result of volume growth.
Cost and Expenses. Total direct costs increased 40%, from $187.8 million in
1996 to $263.5 million in 1997 and increased as a percentage of total revenues
from 85% in 1996 to 88% in 1997 primarily as a result of non-recurring expenses
of $15.0 million being included in direct costs in 1997, as discussed below.
Total direct costs in 1997 also include $2.2 million of non-recurring expenses
related to Aspect. Excluding the non-recurring
18
expenses, total direct costs as a percentage of total revenues would be 82% for
the year ended December 31, 1997.
Sylvan Learning Centers expense increased 43% from $27.4 million in 1996 to
$39.2 million in 1997 and increased as a percentage of revenue from 71% in 1996
to 84% in 1997. Included in Sylvan Learning Centers expense for the 1997 period
is advertising expense related to a non-recurring $5.0 million contribution of
the Company's common stock to a non-profit corporation whose sole purpose is to
develop and fund advertising programs for the Sylvan Learning Centers.
Excluding the non-recurring contribution, 1997 expense was 73% of revenues.
Franchise services expense increased by $8.4 million, to $18.0 million or 83%
of franchise related revenues for the year ended December 31, 1997, compared to
$9.6 million, or 53% of franchise related revenues for the year ended December
31, 1996. The lower margin in franchise services was primarily due to the non-
recurring expense discussed above, as well as to costs incurred for development
of new financing and after-school programs and additional management staff for
the Sylvan Learning Centers division.
Company-owned Learning Center expense increased by $3.4 million, to $21.2
million or 85% of Company-owned Learning Center services revenue for the year
ended December 31, 1997, compared to $17.8 million, or 86% of Company-owned
Learning Center services revenues for the year ended December 31, 1996. The
increase resulted from $1.1 million of expenses associated with 13 acquired
Learning Centers, and increases in advertising, labor and general overhead
associated with increased Center enrollment. Expenses for Centers operating
over 12 months as of December 31, 1997 accounted for $2.3 million of the
increase for 1997.
Sylvan Contract Educational Services expense increased by $2.9 million to
$56.4 million, or 85% of Sylvan Contract Educational Services revenues during
1997, compared to $53.5 million, or 92% of contract educational services
revenues during 1996. Operating expenses for public and non-public schools
decreased $1.1 million, while operating expenses for PACE increased by $3.5
million for the year ended December 31, 1997. The decrease in Sylvan Contract
Educational Services expense as a percentage of revenue for 1997 versus 1996 is
the result of increased profit margins for PACE and public and non-public
services in 1997, as well a higher mix of revenue from PACE contracts which
generate a higher profit margin than public and non-public services. In March
1998, the additional contingent consideration payable to the former
shareholders of PACE resulting from the purchase of PACE in 1995 was determined
to be $25.8 million, which was recorded as additional goodwill and is being
amortized over the estimated remaining useful life of 22 years. This amount
increased the amount of amortization associated with the Sylvan Contract
Educational Services segment by $1.2 million in 1998.
Sylvan Prometric expenses for the year ended December 31, 1997 increased by
$61.1 million to $168.0 million, or 89% of total Sylvan Prometric revenue,
compared to $106.9 million, or 87% of total Sylvan Prometric revenue for the
year ended December 31, 1996. The increase in Sylvan Prometric expense as a
percentage of Sylvan Prometric revenues was predominantly a result of a non-
recurring marketing expense of $10.0 million related to a contribution to IT
Training Marketing Company, a nonprofit corporation whose sole purpose is to
fund promotional and channel support programs for the Sylvan Prometric
distribution channel. The 1996 expense includes $2.4 million of non-recurring
charges related to the Drake acquisition, incurred during the first and second
quarter of 1996. Excluding these effects, expenses as a percentage of total
testing revenue for 1996 and 1997 were 85% and 84%, respectively. This
decrease in recurring expenses as a percentage of Sylvan Prometric revenue was
primarily due to the fixed expenses of the division being spread over a higher
revenue base as well as the effects of a full year of results of WSI, at higher
incremental margins, being included in 1997 compared to only one month for the
1996 period.
General and administrative expenses increased by $11.6 million to $19.7
million during 1997 and increased as a percentage of revenues from 4% to 7%.
Included in general and administrative expenses is a non-recurring expense of
$9.7 million related to a contribution of the Company's common stock valued at
$6.5 million to Sylvan Learning Foundation, Inc., a nonprofit foundation formed
to promote various educational pursuits and a $3.2 million contribution to
International Forum, Inc., a not-for-profit foundation formed to provide
exchange
19
programs for international students in the United States. Excluding these non-
recurring expenses, general and administrative expenses were 3.7% of total
revenues for 1996 and 3.3% of total revenues for 1997.
In March 1997, the Company and National Education Corporation ("NEC")
executed a definitive agreement pursuant to which the Company was to acquire
NEC. In May 1997, NEC accepted a competing offer which resulted in the
termination of NEC's agreement with the Company. As a result, NEC paid the
Company a $30.0 million termination fee, which has been recorded, net of $1.5
million of transaction costs, as a separate component of non-operating income.
In May 1997, the Company determined that certain assets of Sylvan Prometric
were impaired as a result of certain strategic changes that were made as a
result of pursuing the NEC acquisition. During and after the acquisition
negotiations with NEC, the Company developed certain plans that resulted in
required changes in both software systems and hardware currently utilized in
Sylvan Prometric's network of centers. The plans continued to be valid for the
Company even after the NEC acquisition was terminated. The impaired assets,
consisting of computer equipment and software, were impaired as a result of
changes in the technical requirements and specifications of certain computer
hardware and software. The amount of the impairment loss was determined by
evaluating the likely sales proceeds from the disposition of the assets
compared to their book value. The Company determined that it was unlikely that
the net cash proceeds from the sale of any assets would be significant, and
therefore recorded an impairment loss equal to the net book value of the assets
of $4.0 million. During 1998, these assets were disposed of for no significant
consideration.
Investment and other income increased by $3.1 million to $4.8 million during
1997, primarily due to the $2.0 million non-cash dividend income received from
the Company's investment in JLC Holdings, Inc. and the higher cash and
investment balances resulting from the NEC termination fee and the proceeds
received from the sale of the Company's common stock during 1997. The
Company's interest expense decreased by $0.5 million due to the repayment of
all outstanding Educational Inroads debt in the second quarter of 1997.
The Company reported losses of $2.0 million in 1997 from its investment in
affiliates, consisting primarily of $1.4 million attributable to Caliber
Learning Network, Inc., in which the Company has an equity investment. The
Company and MCI Communications Corp. organized Caliber in November of 1996.
The Company's effective tax rate remained constant at 37% in 1996 and 1997.
Future Assessment of Recoverability and Impairment of Goodwill
In connection with its various acquisitions, the Company recorded goodwill,
which is being amortized on a straight-line basis over periods of 10 to 25
years, its estimated periods that the Company will be benefited by such
goodwill. At December 31, 1998, the unamortized goodwill was $275.8 million
(which represented 42% of total assets and 56% of stockholders' equity).
Goodwill arises when an acquirer pays more for a business than the fair value
of the tangible and separately measurable intangible net assets. For financial
reporting purposes, goodwill and all other intangible assets are amortized over
the estimated period benefited. The Company has determined the life for
amortizing goodwill based upon several factors, the most significant of which
are the relative size, historical financial viability and growth trends of the
acquired companies and the relative lengths of time such companies have been in
existence.
Management of the Company periodically reviews the Company's carrying value
and recoverability of unamortized goodwill. If the facts and circumstances
suggest that the goodwill may be impaired, the carrying value of such goodwill
will be adjusted which will result in an immediate charge against income during
the period of the adjustment and/or the length of the remaining amortization
period may be shortened, which will result in an increase in the amount of
goodwill amortization during the period of adjustment and each period
thereafter until fully amortized. Once adjusted, there can be no assurance that
there will not be further
20
adjustments for impairment and recoverability in future periods. Of the various
factors to be considered by management of the Company in determining whether
goodwill is impaired, the most significant will be (i) losses from operations,
(ii) loss of customers, and (iii) industry developments, including the
Company's inability to maintain its market share, development of competitive
products or services, and imposition of additional regulatory requirements.
Liquidity and Capital Resources
The Company in 1998 generated $58.1 million of cash flow from operations, a
decrease of $1.1 million as compared to 1997. This decrease is attributable to
an increase in net income excluding non-cash charges (principally depreciation
and amortization) of $9.5 million, offset by a net additional investment in
operating assets (principally accounts and notes receivable) of 10.6 million.
The Company's investment in working capital continues to reduce net cash flow
from operations, particularly as a result of the growth in accounts and notes
receivable. The $18.5 million increase in accounts and notes receivable is
principally the result of a 47% increase in revenue during 1998. Of the $18.5
million cash flow reduction attributable to an increase in accounts and notes
receivable, approximately $8.4 million relates to Sylvan's expanding testing
contracts, with the remainder of the increase related to the Company's other
operating segments. 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. ETS typically makes monthly payments for domestic
activity and quarterly payments for international services. Notes receivable
for new area development agreements accounted for $5.0 million of the increase
in 1998. Notes receivable from tuition financing activities increased by
$5.4 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.
The Company's investing activities include the net sale of $77.1 million in
available-for-sale securities. The proceeds were used in part to fund the
acquisitions of Canter and Schulerhilfe and to settle a portion of the
contingent consideration that was payable to the former shareholders of PACE.
The remaining securities are readily marketable and available for use in
current operations. The Company also made $11.6 million of additional
investments in or loans to affiliates accounted for using the equity method,
consisting primarily of additional investments in Caliber Learning Network,
Inc.
Effective January 1, 1998, the Company acquired all of the outstanding stock
of Canter & Associates, Inc. and Canter Educational Productions, Inc.
(collectively, "Canter"), commonly controlled companies engaged in the business
of providing materials and training programs for educators, for an initial
purchase price of $25.0 million in cash.
Effective October 28, 1998, the Company acquired all the operating assets and
liabilities of ZGS Zentrale Gelsenkirchener SCHULERHILFE J. Gratze + M. Mohr
GbR mbH ("Schulerhilfe Partnership") and all of the outstanding common stock of
SCHULERHILFE Gesellschaft fur Nachhilfeunterricht mbH ("Schulerhilfe
Corporation," and collectively with Schulerhilfe Partnership, "Schulerhilfe"),
in exchange for an initial purchase price of $16.5 million in cash and 123,973
shares of restricted common stock valued at $2.5 million.
21
Sylvan continues to incur expenditures for additions to property and
equipment, which totaled $58.3 million in 1998. These additions consist
primarily of furniture and equipment for general business expansion, including
expenditures for the headquarters facility, 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.
The Company has entered into a long-term revolving credit facility with a
group of banks, (hereinafter the "credit facility") that provides an unsecured
revolving line of credit. The credit facility allows the Company to borrow a
maximum of $100.0 million through the expiration date of December 31, 2003.
The credit facility bears interest at either the prime rate, the federal funds
rate plus 0.5%, or rates based on the Eurodollar rate plus a contractual
margin. The credit facility had outstanding prime rate borrowings of $8.0
million at December 31, 1998, bearing interest at 7.75%. Effective January 7,
1999, the borrowings began to bear interest at 6.06%, based on the Eurodollar
rate.
During 1998, the Company received $6.4 million of cash as a result of the
exercise of stock options and warrants to purchase 653,652 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 existing 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.
The Company has entered into an agreement providing an exclusive option to
acquire 54 percent of the shares of Universidad Europea de Madrid (UEM) for
approximately $51 million. The purchase price would include payment of
approximately $28.5 million in cash and the assumption of approximately $22.5
million in existing debt. Total revenues for the year ended December 31, 1998
for UEM are estimated to be $49 million and recurring earnings before interest,
taxes and depreciation are estimated to be $15.5 million. All required
regulatory approvals have been received and this transaction is expected to
close during the second or third quarter of 1999.
Year 2000 Compliance
The Year 2000 Issue is the result of computer programs written using two
digits (rather than four) to define the applicable year. Absent corrective
actions, programs with date-sensitive logic may recognize "00" as 1900 rather
than 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, production
difficulties, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company has established a corporate-wide Year 2000 task force with
representatives from all divisions. The task force has conducted a
comprehensive review of the Company's information technology and non-
information technology systems affected by the Year 2000 issue and has
developed an implementation plan to resolve them. The Company measures its
progress towards completion based on the level of efforts completed to date
compared to the total expected. The process involves five phases:
Phase I Inventory and Data Collection. This phase involves conducting a
comprehensive inventory of the Company's information systems which includes but
is not limited to telecommunications systems, computer hardware, software and
networks as well as building infrastructure such as HVAC, elevators and
security systems. The identification of key third party vendors is also
involved. During this phase, all new systems are
22
required to have passed Year 2000 compliance tests before being purchased and
implemented. The Company commenced this phase in the first quarter of 1998 and
the phase is complete.
Phase II Assessment / Date Impact. In this phase, systems identified during
Phase I are reviewed to determine what impact, if any, the Year 2000 Issue has
on the operation of these systems. This phase also identifies the effects of
Year 2000 being a leap year. This phase is 95% complete.
Phase III Remediation. This phase involves modifying, replacing or
upgrading the systems that have failed during Phase II. The remediation phase
is 55% complete and is expected to be completed by the middle of the second
quarter of 1999.
Phase IV Testing. This phase involves review of systems for compliance and
re-testing as necessary. The testing phase is 55% complete and is expected to
be completed by the end of the second quarter of 1999.
Phase V Implementation. This phase involves implementing the systems after
they have been successfully remediated and tested. This is the final step in
assuring that the systems are Year 2000 complaint. The phase is 55% complete
and is expected to be completed by the end of the third quarter of 1999.
The Company believes the cost to remedy all Year 2000 Issues to be $4.5
million and has expended $1.0 million through December 31, 1998. The Company is
not aware of any material non-compliance that would require repair or
replacement that would have a material effect on its financial position. As
part of the Year 2000 Issue process, formal communication with the Company's
suppliers, customers and other support services has been initiated and efforts
will continue until positive statements of readiness have been received from
all third parties. To date, the Company is not aware of any non-compliance by
its customers or suppliers that would have material impact on the Company's
business. Nevertheless, there can be no assurance that unanticipated non-
compliance will not occur, and such non-compliance could require material costs
to repair or could cause material disruptions if not repaired. The Company is
in the process of developing a strategy to address these potential consequences
that may result from unresolved Year 2000 Issues, which will include the
development of one or more contingency plans by mid 1999.
Euro Conversion
On January 1, 1999, certain countries of the European Union established fixed
conversion rates between their existing currencies and one common currency, the
euro. The euro is now traded on currency exchanges and may be used in business
transactions. Beginning in January 2002, new euro-denominated currencies will
be issued and the existing currencies will be withdrawn from circulation. The
Company is currently evaluating the systems and business issues raised by the
euro conversion. These issues include the need to adapt computer and other
business systems and equipment and the competitive impact of cross-border
transparency. The Company has not yet completed its estimate of the potential
impact likely to be caused by the euro conversion; however, at present the
Company has no reason to believe the euro conversion will have a material
impact on the Company's financial condition or results of operations.
Contingent Matters
In connection with the Company's acquisition of Canter and based on Canter's
earnings in 1998, additional consideration of $28.5 million is payable to the
seller in cash of $16.3 million and the remainder in shares of restricted
common stock which has been valued at $12.2 million. As of December 31, 1998,
the Company has recorded this additional consideration as a liability and
additional goodwill which will be amortized over the remaining amortization
period of 24 years. Additional variable amounts of contingent consideration are
also payable to the seller if specified levels of earnings are achieved in 1999
and 2000, payable in equal amounts of cash and stock. The Company will record
the contingent consideration when the contingencies are resolved and the
additional consideration is payable.
23
In connection with the Company's acquisition of Schulerhilfe, the Company may
be obligated to pay the sellers up to an additional $13.3 million of
consideration in February 2000 (payable in either cash or common stock at the
discretion of the Company) based on the amount of 1999 franchise fees which
have been collected by Schulerhilfe on or before January 31, 2000. The Company
will record this contingent consideration when the contingencies are resolved
and the additional consideration is payable.
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 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. In addition, franchise license
fees earned by the Company in its Sylvan Learning Centers and testing services
segments may vary significantly from quarter to quarter. Revenues or profits
in any period will not necessarily be indicative of results in subsequent
periods.
24
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risk from changes in interest rates and
foreign currency exchange rates, which could affect its future results of
operations and financial condition. The Company manages its exposure to these
risks through its regular operating and financing activities.
Foreign Currency Risk
The Company derives approximately 29% of its revenues from customers outside
of the United States. This business is transacted through a network of
international subsidiaries, generally in the local currency that is considered
the functional currency of that foreign subsidiary. The Company generally
views its investment in the majority of its foreign subsidiaries as long-term.
The functional currencies of these foreign subsidiaries are principally
denominated in the Spanish peseta, the British pound sterling, and the
Australian dollar. The effects of a change in foreign currency exchange rates
on the Company's net investment in foreign subsidiaries are reflected in other
comprehensive income. A 10% depreciation in year-end 1998 functional
currencies relative to the U.S. dollar would result in a $300,000 decrease in
consolidated stockholders' equity.
The Company's investment in certain foreign subsidiaries providing
information technology testing services is considered temporary. These
subsidiaries regularly remit collected testing fees, generally paid in advance
of the test and denominated in foreign currencies, to the U.S. parent, which
upon test delivery, pays the test sponsor's fee and retains the residual. The
principal currencies of these subsidiaries are the British pound sterling, the
German deutsche mark and the Japanese yen. The Company is generally not
exposed to foreign exchange rate fluctuations related to collected fees on
undelivered tests as a result of contractual provisions with test sponsors.
Foreign exchange gains and losses during the period from the date of test
delivery through the date of payment of the test sponsor have not been
material, and the Company's exposure to such exchange losses at December 31,
1998, assuming a 10% deterioration in foreign exchange rates, would not be
material.
The Company's foreign operations providing international academic testing
services under a cost-plus contract with ETS are not exposed to foreign
currency risk. Under the contract, foreign exchange rate gains and losses are
a component of the reimbursable contract costs.
Interest Rate Risk
The fair value of the Company's cash and cash equivalents would not be
significantly impacted by either a 100 basis point increase or decrease in
interest rates due to the short-term nature of the Company's portfolio. At
December 31, 1998, the Company's investment in available-for-sale, interest-
bearing securities is not material.
The Company's long-term revolving credit facility bears interest at variable
rates, and the fair value of this instrument is not significantly affected by
changes in market interest rates. A hypothetical 100 basis points increase in
interest rates under the credit facility for one year would increase interest
expense by an immaterial amount.
Item 8. Financial Statements
The financial statements of the Company are included on pages 32 through 68
of the report as indicated on page 31.
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.
25
PART III.
---------
Item 10. Directors and Executive Officers of Sylvan Learning Systems, Inc.
Information required is set forth under the caption "Election of Directors"
in the Proxy Statement relating to the 1999 Annual Meeting of Shareholders,
which is incorporated by reference.
Information required pertaining to compliance with Section 16 (a) of the
Securities and Exchange Act of 1934 is set forth under the caption "Election of
Directors" in the Proxy Statement relating to the 1999 Annual Meeting of
Shareholders, which is incorporated by reference.
Item 11. Executive Compensation
Information required is set forth under the caption "Executive Compensation"
in the Proxy Statement relating to the 1999 Annual Meeting of Shareholders,
which is incorporated by reference.
Item 12. Security Ownership and Certain Beneficial Owners and Management
Information required is set forth under the caption "Security Ownership" in
the Proxy Statement relating to the 1999 Annual Meeting of Shareholders, which
is incorporated by reference.
Item 13. Certain Relationships and Related Transactions
Information required is set forth under the caption "Certain Transactions" in
the Proxy Statement relating to the 1999 Annual Meeting of Shareholders, which
is incorporated by reference.
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.
2. Financial Statement Schedules
All schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are inapplicable or
immaterial and therefore have been omitted.
(b) Reports on Form 8-K:
The Registrant did not file any reports on Form 8-K during the fourth
quarter ended December 31, 1998.
26
3. Exhibits
(a) Exhibits:
Exhibit
Number Description
- ----------- -----------
3.01 Articles of Amendment and Restatement of the Charter.(b)
3.03 Amended and Restated Bylaws dated September 27, 1996.(n)
4.01 Specimen Common Stock Certificate.(b)
4.02 Form of Warrant to Purchase Common Stock of Sylvan KEE Systems,
Inc. dated January 26, 1993.(b)
4.03 Form of Warrant to Purchase Common Stock of Sylvan KEE Systems,
Inc. dated July 14, 1993.(b)
4.07 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)
10.20 Agreement and Plan of Reorganization dated July 14, 1994 by and between Registrant and Loralex Learning,
Inc.(e)
27
Exhibit
Number Description
- ----------- -----------
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.(n)
10.25 Revolving Credit Note to NationsBank, N.A. dated December 31, 1996.(n)
10.26 Senior Management Option Plan dated March 29, 1996.(n)
10.27 Securities Purchase Agreement by and between Registrant and JLC Holdings, Inc., Software Systems
10.28 Corporation and JLC Learning Corporation dated November 1, 1996.(j)
Agreement and Plan of Reorganization dated January 28, 1997 by and between Registrant and Wall Street
Institute.(k)
10.29 Agreement and Plan of Reorganization dated May 30, 1997 among Registrant and I-R, Inc. and Independent
Child Study Teams, Inc.(l)
10.30 Sylvan Learning Systems, Inc. Employee Stock Purchase Plan.(m)
10.31 Sylvan Learning Systems, Inc. 1998 Stock Incentive Plan.(o)
10.32 Asset Purchase Agreement by and among Sylvan Learning Systems, Inc., Block Testing Services L.P. and
Block State Testing Services L.P, dated as of December 1, 1997.(p)
10.33 Agreement and Plan of Reorganization by and among Sylvan Learning Systems, Inc., Block Testing Services
L.P., National Assessment Institute, Inc. and NAI Merger Corp, dated as of December 1, 1997.(p)
10.34 Stock Exchange Agreement dated as of April 7, 1998 between Aspect International Language Schools, B.V.,
the Stockholders and Sylvan Learning Systems, Inc.(q)
10.35 Agreement and Plan of Reorganization dated January 28, 1997 by and between Registrant and ZGS Zentrale
Gelsenkirchener SCHULERHILFE J. Gratze + M. Mohr GbR mbH and SCHULERHILFE Gesellschaft fur
Nachhilfeunterricht mbH.
10.36 Credit Agreement among Sylvan Learning Systems, Inc., Various Banks, NationsBank, N.A., as Syndication
Agent and Bankers Trust Company, as Lead Arranger and Administrative Agent.
10.37 Stock Purchase Agreement effective as of January 1, 1998, by and among Sylvan Learning Systems, Inc., a
Maryland corporation, Marlene Canter, the sole stockholder of Canter & Associates, Inc. and Canter
Educational Productions, Inc.
21.00 Subsidiaries of the Registrant.
23.01 Consent of Ernst & Young LLP.
23.02 Consent of Deloitte & Touche L.L.P.
23.03 Consent of Deloitte & Touche
23.04 Consent of Smith, Lange & Phillips L.L.P.
27.01 Financial Data Schedule for the years ended December 31, 1996 and 1997.
27.02 Financial Data Schedule for the year ended December 31, 1998.
99.01 Opinion of Deloitte & Touche L.L.P.
99.02 Opinion of Deloitte & Touche L.L.P.
99.03 Opinion of Deloitte & Touche
99.04 Opinion of Smith, Lange & Phillips L.L.P.
99.05 Opinion of Smith, Lange & Phillips L.L.P.
(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).
28
(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.
(k) Incorporated by reference to the Company's Current Report on Form 8-K dated
January 28, 1997.
(l) Incorporated by reference to the Company's Current Report on Forms 8-K and
Form 8-K/A dated April 17, 1997 and May 30, 1997.
(m) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-8 dated February 18, 1997.
(n) Incorporated by reference from the Exhibits to the Company's Form 10-K
filed March 31, 1997.
(o) Incorporated by reference from the Exhibits to the Company's 1998 Proxy
Statement filed April 21, 1998.
(p) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-3 dated February 23, 1998.
(q) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-3 dated August 10, 1998.
29
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 31, 1999.
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 31, 1999
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
/s/Rick Inatome Director
------------------------------------------
Rick Inatome
/s/R. William Pollock Director
------------------------------------------
R. William Pollock
/s/Nancy S. Cole Director
------------------------------------------
Nancy S. Cole
30
Item 14 (a) (1)
INDEX TO FINANCIAL STATEMENTS
The Company: Page
----
Report of Independent Auditors............................................................... 32
Consolidated Balance Sheets as of December 31, 1997 and December 31, 1998.................... 33
Consolidated Statements of Income for the years ended December 31, 1996, 1997 and 1998....... 35
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1997
and 1998................................................................................... 36
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998... 37
Notes to Consolidated Financial Statements................................................... 38
31
Report of Independent Auditors
The Board of Directors and Stockholders
Sylvan Learning Systems, Inc.
We have audited the consolidated balance sheets of Sylvan Learning Systems, Inc.
as of December 31, 1998 and 1997, and the related consolidated statements of
income, stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1998. These financial statements are the
responsibility of the management of Sylvan Learning Systems, Inc. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the 1996 combined financial statements of I-R,
Inc. and Independent Child Study Teams, Inc., or the 1997 and 1996 financial
statements of Aspect, Inc. and Anglo World Education Limited and subsidiaries,
each wholly-owned subsidiaries. Those statements reflect total assets of
$17,198,487 as of December 31, 1997, and total revenues of $35,613,484, and
$48,152,198 for the years ended December 31, 1997 and 1996, respectively. Those
statements were audited by other auditors whose reports have been furnished to
us, and our opinion, insofar as it relates to data included for these
subsidiaries, is based solely on the reports of the other auditors.
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 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 and the reports of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Sylvan Learning Systems, Inc. at December
31, 1998 and 1997, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
- ----------------------------
Baltimore, Maryland
February 25, 1999
32
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
(Amounts in thousands, except per share data)
December 31, December 31,
1997 1998
------------------- ------------
(Restated - Note 1)
Assets
Current assets:
Cash and cash equivalents $ 29,818 $ 33,170
Available-for-sale securities 82,951 6,166
Receivables:
Accounts receivable 59,721 71,248
Costs and estimated earnings in excess of billings
on uncompleted contracts 3,900 7,806
Notes receivable from tuition financing 978 2,977
Other notes receivable 2,943 8,922
Other receivables 8,752 2,404
------------ ------------
76,294 93,357
Allowance for doubtful accounts (2,509) (2,963)
------------ ------------
73,785 90,394
Inventory 4,999 9,841
Deferred income taxes 3,755 1,831
Prepaid expenses 6,303 10,093
Other current assets 265 1,843
------------ ------------
Total current assets 201,876 153,338
Notes receivable from tuition financing, less current portion - 3,415
Other notes receivable, less current portion 6,232 9,882
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 352 637
Property and equipment:
Land and buildings 5,710 9,917
Furniture and equipment 59,201 111,490
Leasehold improvements 7,988 13,156
------------ ------------
72,899 134,563
Accumulated depreciation (21,532) (36,682)
------------ ------------
51,367 97,881
Intangible assets:
Goodwill 183,172 292,693
Contract rights 13,973 13,973
Other 2,522 3,111
------------ ------------
199,667 309,777
Accumulated amortization (16,799) (26,322)
------------ ------------
182,868 283,455
Deferred contract costs, net of accumulated amortization
of $6,205 as of December 31, 1997 and $11,740
as of December 31, 1998 10,324 10,255
Investments in and advances to affiliates 12,464 18,532
Other investments 28,017 44,230
Net assets to be transferred to joint venture - 31,575
Other assets 3,279 6,596
------------ ------------
Total assets $ 496,779 $ 659,796
============ ============
33
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
(Amounts in thousands, except per share data)
December 31, December 31,
1997 1998
------------------ ------------
(Restated - Note 1)
Liabilities and stockholders' equity
Current liabilities:
Accounts payable and accrued expenses $ 40,754 $ 57,177
Income taxes payable 5,590 11,784
Current portion of long-term debt 1,253 1,128
Current portion of due to shareholders of
acquired companies 13,794 40,719
Deferred revenue 26,323 27,411
Other current liabilities 1,288 19
------- -------
Total current liabilities 89,002 138,238
Long-term debt, less current portion 2,428 12,504
Deferred income taxes 7,620 6,961
Due to shareholders of acquired companies,
less current portion 56,366 12,239
Other long-term liabilities 903 1,021
------- -------
Total liabilities 156,319 170,963
Stockholders' equity:
Preferred stock, par value $.01 per share--authorized
10,000 shares, no shares issued and
outstanding as of December 31, 1997 and 1998 - -
Common stock, par value $.01 per share--authorized
90,000 shares, issued and outstanding shares of
45,450 as of December 31, 1997 and 50,952
as of December 31, 1998 455 510
Additional paid-in capital 302,022 410,694
Retained earnings 39,144 75,852
Accumulated other comprehensive income (loss) (1,161) 1,777
------- -------
Total stockholders' equity 340,460 488,833
------- -------
Total liabilities and stockholders' equity $496,779 $659,796
======= =======
See accompanying notes.
34
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Statements of Income
(Amounts in thousands, except per share data)
Year Ended December 31,
------------------------------------------------------------
1996 1997 1998
------------ ------------ ------------
(Restated - Note 1) (Restated - Note 1)
Revenues $ 219,973 $ 301,011 $ 440,330
Cost and expenses
Direct costs 187,819 263,523 359,613
General and administrative expense 8,049 19,693 15,530
Transaction costs related to pooling-of-interests - - 5,000
Restructuring and asset impairment charges - 4,000 3,730
----------- ----------- ------------
Total expenses 195,868 287,216 383,873
Operating income 24,105 13,795 56,457
Other income (expense)
Termination fee, net of direct costs - 28,500 -
Investment and other income 1,747 4,836 5,281
Interest expense (1,320) (801) (943)
Equity in net income (loss) of affiliates 361 (2,006) (3,504)
----------- ----------- ------------
Income before income taxes 24,893 44,324 57,291
Income taxes (9,139) (16,420) (21,582)
----------- ----------- ------------
Net income $ 15,754 $ 27,904 $ 35,709
=========== =========== ============
Earnings per common share, basic $0.43 $0.66 $0.73
=========== =========== ============
Earnings per common share, diluted $0.40 $0.62 $0.70
============ ============ ============
See accompanying notes.
35
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Amounts in thousands)
Retained Accumulated
Additional Earnings Other Total
Common Paid-In (Accumulated Comprehensive Stockholders'
Stock Capital Deficit) Income Equity
------ ---------- ------------ ------------- -------------
Balance at January 1, 1996 - as restated (Note 1) $ 356 $ 140,450 $ (1,768) $ 93 $ 139,131
Options and warrants exercised for purchase of 993
shares of common stock, including income tax
benefit of $1,887 10 6,988 6,998
Issuance of 1,236 shares of common stock in connection
with the investment in JLC Learning Corporation 12 21,206 21,218
Issuance of 175 shares of common stock in
connection with other acquisitions 2 27 (320) (291)
Exercise of underwriter's overallotment option to purchase
51 shares of common stock in connection with 1995
public stock offering 533 533
Comprehensive income:
Net income for 1996 15,754 15,754
Other comprehensive income:
Foreign currency translation adjustment (269) (269)
Unrealized loss on available-for-sale securities (6) (6)
-----------
Total comprehensive income 15,479
-----------
Distributions to former shareholders (300) (300)
-------- -------- ------- ------- -----------
Balance at December 31, 1996 - as restated (Note 1) 380 169,204 13,366 (182) 182,768
Options and warrants exercised for purchase of 1,706
shares of common stock, including income tax
benefit of $8,156 17 13,102 13,119
Issuance of 536 shares of common stock in connection with
contingent consideration related to the acquisition of Drake 5 8,137 8,142
Issuance of 1,072 shares of common stock in connection
with the acquisition of WSI 11 15,309 15,320
Issuance of 404 shares of common stock to Sylvan
Learning Foundation as charitable contribution 4 6,537 6,541
Issuance of 309 shares of common stock to IT Training
Marketing Company as marketing expense 3 6,997 7,000
Issuance of 265 shares of common stock to SLC National
Advertising Fund, Inc. as advertising expense 3 4,997 5,000
Issuance of 3,098 shares of common stock for cash -
net of offering costs of $3,645 31 73,660 73,691
Capital contribution by former shareholders of Educational Inroads 2,811 2,811
Issuance of 94 shares of common stock in connection
with other acquisitions 1 718 719
Stock options to purchase 317 shares of common stock
granted to non-employees 550 550
Comprehensive income:
Net income for 1997 27,904 27,904
Other comprehensive income:
Foreign currency translation adjustment (990) (990)
Unrealized loss on available-for-sale securities 11 11
-----------
Total comprehensive income 26,925
-----------
Distributions to former shareholders (2,126) (2,126)
-------- -------- ------- ------- -----------
Balance at December 31, 1997 - as restated (Note 1) 455 302,022 39,144 (1,161) 340,460
Options and warrants exercised for purchase of 654
shares of common stock, including income tax
benefit of $5,176 7 11,531 11,538
Stock options granted to non-employees 539 539
Issuance of 27 shares of common stock in connection
with the Employee Stock Purchase Plan 527 527
Issuance of 2,570 shares of common stock in connection with
contingent consideration related to the acquisition of Drake 26 39,179 39,205
Issuance of 964 shares of common stock in connection
with the acquisition of NAI / Block 10 24,990 25,000
Issuance of 345 shares of common stock in connection with
contingent consideration related to the acquisition of PACE 3 11,305 11,308
Issuance of 277 shares of common stock in connection
with other investments 3 7,997 8,000
Issuance of 258 shares of common stock in connection
with the purchase of assets 3 7,454 7,457
Issuance of 124 shares of common stock in connection
with the acquisition of Schulerhilfe 1 2,527 2,528
Issuance of 205 shares of common stock in connection
with other acquisitions 2 1,477 681 2,160
Capital contribution by former shareholders of Aspect 1,300 1,300
Comprehensive income:
Net income for 1998 35,709 35,709
Other comprehensive income:
Foreign currency translation adjustment 2,938 2,938
-----------
Total comprehensive income 38,647
-----------
Other (154) 318 164
------- ---------- ----------- ---------- -----------
Balance at December 31, 1998 $ 510 $ 410,694 $ 75,852 $ 1,777 $ 488,833
======= ========== =========== ========== ===========
See accompanying notes.
36
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Amounts in thousands)
Year Ended
December 31,
--------------------------------------------------------
1996 1997 1998
---------------- ------------------ ------------
(Restated - Note 1) (Restated - Note 1)
Operating activities
Net income $ 15,754 $ 27,904 $ 35,709
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation 6,462 8,790 15,599
Amortization 7,494 10,071 16,724
Non-cash marketing and advertising expense - 11,500 -
Non-cash compensation expense - - 1,300
Non-cash issuance of options to non-employees - 550 539
Non-cash dividend income - (2,000) (1,167)
Loss on impairment of assets - 4,000 -
Gain on sale of property and equipment - (651) -
Equity in net (income) loss of affiliates (361) 2,006 3,504
Deferred income taxes 2,073 1,834 1,265
Changes in operating assets and liabilities:
Accounts and notes receivable (10,269) (27,304) (18,543)
Cost and estimated earnings in excess of billings
on uncompleted contracts (413) (137) (4,191)
Inventory (183) (398) (4,202)
Prepaid expenses and other current assets (299) (1,892) (4,451)
Accounts payable and accrued expenses 3,428 4,831 8,475
Income taxes payable 2,197 13,437 11,346
Deferred revenue and other current liabilities 4,458 6,684 (3,781)
---------------- ---------------- -----------
Net cash provided by operating activities 30,341 59,225 58,126
---------------- ---------------- -----------
Investing activities
Purchase of available-for-sale securities (31,286) (92,522) (2,502)
Proceeds from sale of available-for-sale securities 45,542 26,045 79,611
Investment in and advances to affiliates (3,445) (9,653) (11,572)
Increase in other investments (2,330) (4,136) (5,046)
Purchase of property and equipment (14,866) (30,964) (58,294)
Proceeds from sale of property and equipment 11 1,916 -
Purchase of contract rights (4,891) - -
Purchase of Canter, including direct costs of
acquisition, net of cash acquired - - (24,086)
Purchase of Schulerhilfe, including direct costs of
acquisition, net of cash acquired - - (16,649)
Payment of contingent consideration for PACE acquisition - - (13,532)
Purchase of Wall Street Institute, including direct costs of
acquisition, net of cash acquired 2,013 (4,671) -
Cash paid for other businesses, net of cash acquired 570 (1,851) (13,777)
Expenditures for deferred contract costs (6,942) (1,443) (2,771)
Increase in other assets (999) (731) (5,895)
---------------- ---------------- -----------
Net cash used in investing activities (16,623) (118,010) (74,513)
---------------- ---------------- -----------
Financing activities
Payments on loans to stockholders of acquired companies (38) (493) -
Proceeds from exercise of options and warrants 5,111 4,964 6,362
Proceeds from issuance of common stock 533 73,691 527
Proceeds from issuance of long-term debt 364 452 22,039
Payments on long-term debt and capital lease obligations (2,793) (5,675) (11,985)
Distributions (301) (793) -
Proceeds from bank lines of credit 200 13,575 114,396
Payments on bank lines of credit (3,812) (14,575) (114,107)
---------------- ---------------- -----------
Net cash provided by (used in) financing activities (736) 71,146 17,232
---------------- ---------------- -----------
Effects of exchange rate changes on cash (914) (1,263) 2,507
---------------- ---------------- -----------
Net increase in cash and cash equivalents 12,068 11,098 3,352
Cash and cash equivalents at beginning of period 6,652 18,720 29,818
---------------- ---------------- -----------
Cash and cash equivalents at end of period $ 18,720 $ 29,818 $ 33,170
================ ================ ============
See accompanying notes.
37
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
1. Basis of Presentation and Description of Business
Sylvan Learning Systems, Inc. and subsidiaries ("the Company" or "Sylvan") is an
international provider of educational and testing services. The Company
conducts operations in three separate business segments Sylvan Learning
Centers, Sylvan Prometric, and Sylvan Contract Educational Services. The Sylvan
Learning Centers segment designs and delivers individualized tutorial programs
to school-age children and adults through a network of 727 franchised and
Company-owned Sylvan Learning Centers in operation in 49 states, six Canadian
provinces, Hong Kong and Guam. The Sylvan Prometric segment administers
computer-based tests for major corporations, professional associations and
governmental agencies through a network of certification centers which are
located throughout the world. This segment also includes the operations of
Wall Street Institute, B.V., a European-based franchisor and operator of
learning centers that teach the English language through a combination of
computer-based and live instruction, as well as Aspect International Language
Schools, B.V. ("Aspect"). Aspect focuses principally on intensive English
language instruction to students and professionals worldwide through its 27
language schools in five countries. The Sylvan Contract Educational Services
segment principally 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.
As discussed in Note 3, during fiscal year 1998, the Company consummated mergers
with three franchisees of Sylvan Learning Centers and with Aspect. These
mergers were each consummated by the exchange of all of the outstanding shares
of voting common stock of the acquired company for shares of common stock of the
Company and were accounted for as poolings-of-interest. The accompanying
consolidated financial statements have been restated to retroactively combine
the financial statements of the combining companies as if the mergers had
occurred on January 1, 1996, the beginning of the earliest period presented.
The Company's fiscal year ends on December 31. The accounts of its wholly-owned
subsidiary, Aspect, have been consolidated on the basis of a year ending on
September 30. Such fiscal period corresponds with Aspect's natural business
year.
38
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
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.
Investments
Available-for-sale securities are carried at fair value, with any unrealized
gains and losses, net of tax, reported in other comprehensive income. 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.
Property and Equipment
Property and equipment is stated at cost. Depreciation is determined using the
straight-line method over the estimated useful lives of the assets.
Included in property and equipment are the direct costs of developing or
obtaining software for internal use. In March 1998, the AICPA issued Statement
of Position 98-1 ("SOP 98-1") Accounting for the Costs of Computer Software
Developed or Obtained For Internal Use. SOP 98-1 is effective beginning January
1, 1999 and requires the capitalization of direct costs incurred in connection
with developing or obtaining software for internal use. The adoption of SOP 98-
1 in 1999 will not have any effect on the Company's current accounting policies.
39
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
2. Accounting Policies (continued)
Intangible Assets
Goodwill consists of the cost in excess of fair value of the identifiable net
assets of entities acquired in purchase transactions, and is amortized on a
straight-line basis, over the estimated future periods to be benefited, which
range from 10 to 25 years. At December 31, 1997 and 1998, accumulated
amortization of goodwill was $8,873 and $16,886, respectively.
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 on a straight-line basis, over the term of the
related contract, which range from nine months to 10 years. At December 31,
1997 and 1998, accumulated amortization of contract rights was $6,899 and
$8,068, respectively.
Deferred Contract Costs
Deferred contract costs include direct 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 of approximately $10,400 made in
1996 to non-affiliated computer-based testing centers that have entered into
three-year contracts with the Company 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.
Impairment of Long-Lived Assets
Long-lived assets, including intangible assets, are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be fully recoverable. If an impairment indicator is present,
the Company evaluates whether an impairment exists on the basis of undiscounted
expected future cash flows from operations for the remaining amortization
period. If an impairment exists, the asset is reduced by the estimated
shortfall of discounted cash flows.
40
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
2. Accounting Policies (continued)
Revenue Recognition
Revenue related to single-center and area franchise 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 fees not meeting the recognition criteria are recorded as deferred revenue
if not refundable, or deposits from franchisees if refundable.
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 reasonably assured. Revenues from
educational services, including English language instruction, are recognized in
the period the services are provided.
Revenue from the sale of products to franchisees is recognized when shipped.
Testing revenues are recognized upon the completion of tests.
Advertising
The Company expenses advertising costs as incurred, except for direct-response
advertising, which is capitalized and amortized over its expected period of
future benefit.
41
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
2. Accounting Policies (continued)
Capitalized direct-response advertising consists primarily of the costs to
produce direct-mail order catalogues and brochures that are used to solicit
students of educational programs who have responded directly to the advertising.
The capitalized production costs are amortized over the period of the respective
programs, ranging from one to three years.
At December 31, 1997 and 1998, advertising costs totaling approximately $1,800
and $5,000, respectively, were reported as assets. The acquisition of
Canter in 1998 contributed to the majority of this increase. Advertising expense
for the year ended December 31, 1996, 1997 and 1998 was $5,952, $8,514 and
$13,950, respectively.
Stock Options Granted to Employees and Non-Employees
The Company records compensation expense for all stock-based compensation plans
using the intrinsic value method prescribed by APB Opinion 25, Accounting for
Stock Issued to Employees ("APB 25"). Under APB 25, if the exercise price of
the Company's employee stock options equals the estimated fair value of the
underlying stock on the date of grant, no compensation expense is generally
recognized. Statement of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation ("Statement 123") encourages companies to recognize
expense for stock-based awards based on their estimated fair value on the date
of grant. Statement 123 requires disclosure of pro forma income and earnings
per share data in the notes to the financial statements if the fair value method
is not elected. The Company supplementally discloses in Note 12 to these
financial statements the pro forma information as if the fair value method had
been adopted.
The Company records compensation expense for all stock options granted to non-
employees in an amount equal to the estimated fair value at the date of grant,
determined using the Black-Scholes option valuation model. The compensation
expense is recognized ratably over the vesting period.
Foreign Currency Translation
The financial statements of certain foreign subsidiaries that are measured in
local functional currencies are translated into U.S. dollars using the current
rate method. All balance sheet accounts are translated using the exchange rates
at the balance sheet date. Income statement amounts have been translated using
the average exchange rates for the year. Translation gains or losses resulting
from the changes in exchange rates from year to year, are reported in other
comprehensive income.
The financial statements of other foreign subsidiaries, primarily those
subsidiaries providing services overseas to Educational Testing Services, Inc.
("ETS") (see Note 19), prepare financial statements using the U.S. dollar as the
functional currency. The transactions of these subsidiaries
42
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
2. Accounting Policies (continued)
that are denominated in foreign currencies have been remeasured into 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 foreign
currency gains or losses.
Comprehensive Income
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income ("Statement 130"). Statement
130 establishes new rules for the reporting and display of comprehensive income
and its components. The adoption of Statement 130 had no impact on the
Company's net income or stockholders' equity. Statement 130 requires
non-owner changes in stockholders' equity, including unrealized gains or losses
on the Company's available-for-sale securities and foreign currency translation
adjustments, which prior to adoption were reported separately in stockholders'
equity, to be included in other comprehensive income. Statement 130 requires
the disclosure of comprehensive income in a financial statement. The Company
has elected to report comprehensive income in the statement of stockholders'
equity. Prior year financial statements have been reclassified to conform to
the requirements of Statement 130.
Impact of Recently Issued Accounting Standard
In 1998, the AICPA issued SOP 98-5, Reporting the Costs of Start-up Activities
("SOP 98-5"). SOP 98-5 is effective beginning on January 1, 1999, and requires
that start-up costs capitalized prior to January 1, 1999 be written-off and any
future start-up costs to be expensed as incurred. The Company previously
capitalized pre-contract costs directly associated with specific anticipated
contracts as well as development costs for new educational programs that were
estimated to be recoverable. SOP 98-5 defines start-up costs to include pre-
contract costs and costs to introduce a new product, and accordingly, previously
capitalizable costs are required to be written-off upon adoption of SOP 98-5.
The unamortized balance of pre-contract and new product development costs
(approximately $2,000 as of December 31, 1998) will be written-off as a
cumulative effect of an accounting change as of January 1, 1999.
Reclassifications
Certain amounts in the 1996 and 1997 consolidated financial statements have been
reclassified to conform to the 1998 presentation.
43
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
3. Acquisitions
Canter & Associates, Inc. and Canter Educational Productions, Inc.
Effective January 1, 1998, the Company acquired all of the outstanding stock of
Canter & Associates, Inc. and Canter Educational Productions, Inc.
(collectively, "Canter"), commonly controlled companies engaged in the business
of providing materials and training programs for educators, for an initial
purchase price of $25,000 in cash. The acquisition was accounted for using the
purchase method of accounting and goodwill of $24,559 was recorded and is being
amortized over a period of 25 years. The results of operations of Canter for
the period from January 1, 1998 through December 31, 1998 are included in the
accompanying 1998 consolidated statement of income.
In connection with the Company's acquisition of Canter and based on Canter's
earnings in 1998, additional consideration of $28,558 is payable to the seller
in cash of $16,319 and the remainder in shares of restricted common stock which
has been valued at $12,239. As of December 31, 1998, the Company has recorded
this additional consideration as a liability and additional goodwill which will
be amortized over the remaining amortization period of 24 years. Additional
variable amounts of contingent consideration are also payable to the seller if
specified levels of earnings are achieved in 1999 and 2000, payable in equal
amounts of cash and stock. The Company will record the contingent consideration
when the contingencies are resolved and the additional consideration is payable.
Schulerhilfe
Effective October 28, 1998, the Company acquired all the operating assets and
liabilities of ZGS Zentrale Gelsenkirchener SCHULERHILFE J. Gratze + M. Mohr GbR
mbH ("Schulerhilfe Partnership") and all of the outstanding common stock of
SCHULERHILFE Gesellschaft fur Nachhilfeunterricht mbH ("Schulerhilfe
Corporation," and collectively with Schulerhilfe Partnership, "Schulerhilfe"),
in exchange for an initial purchase price of $16,554 in cash and 124 shares of
restricted common stock valued at $2,528. The Schulerhilfe Partnership designs
and delivers individualized tutorial services to school-age children and adults
through a network of 700 franchised learning centers throughout Germany and
Austria. The Schulerhilfe Corporation designs and delivers individualized
tutorial programs to school-age children and adults through a network of 177
company-owned learning centers throughout Germany.
The acquisition was accounted for using the purchase method of accounting and
goodwill of $19,749 was recorded and is being amortized over a period of 25
years. The results of operations of Schulerhilfe for the period from October
28, 1998 through December 31, 1998 are included in the accompanying 1998
consolidated statement of income.
44
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
3. Acquisitions (continued)
In addition to the initial purchase price, the sellers may receive up to an
additional $13,300 in February 2000 (payable in either cash or common stock at
the discretion of the Company) based on the amount of 1999 franchise fees which
have been collected by Schulerhilfe on or before January 31, 2000. The Company
will record this contingent consideration when the contingencies are resolved
and the additional consideration is payable.
The following combined unaudited pro forma results of operations of the Company
give effect to the Canter and Schulerhilfe acquisitions as though they had
occurred on January 1, 1997.
Year ended December 31
----------------------------------
1997 1998
----------------------------------
Revenues $336,208 $452,087
Net income 30,581 37,352
Earnings per share diluted 0.67 0.73
Sylvan Learning Center Franchises
During March 1998, the Company consummated acquisitions of all of the
outstanding common stock of three Sylvan Learning Center franchise businesses in
exchange for a total of 79 shares of Sylvan common stock. The acquisitions were
accounted for as poolings-of-interest, and accordingly, the Company's
consolidated financial statements for periods prior to the mergers have been
restated to include the results of operations, financial position and cash flows
of these businesses.
Aspect
On May 6, 1998 the Company acquired all of the outstanding common stock of
Aspect International Language Schools, B.V. and subsidiaries ("Aspect") in
exchange for 2,004 shares of Sylvan common stock. The acquisition was accounted
for as a pooling-of-interests, and accordingly, the Company's consolidated
financial statements for periods prior to the merger have been restated to
include the results of operations, financial position and cash flows of Aspect.
Aspect is a leading provider of English language training programs for college
students from non-English speaking companies. Founded in 1992, Aspect delivers
intensive English language programs at 27 schools in five countries.
45
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
3. Acquisitions (continued)
Combined and separate results of operations of Sylvan, Aspect and the Sylvan
Learning Center Franchises during the years prior to the mergers are as follows:
Sylvan
Company Prior Learning
to Restatement Aspect Centers Combined
------------------------------------------------------------
Year ended December 31, 1997
Revenues $246,212 $52,460 $2,339 $301,011
Net income (loss) 29,434 (1,810) 280 27,904
Earnings per share - diluted 0.69 0.62
Year ended December 31, 1996
Revenues $181,936 $35,938 $2,099 $219,973
Net income 14,796 641 317 15,754
Earnings per share - diluted 0.40 0.40
The following table presents the combined and separate results of operations of
the companies from January 1, 1998 through the date of merger. The table
excludes the Sylvan Learning Centers which were acquired on March 1, 1998
(unaudited):
Sylvan Aspect Combined
--------------------------------------------------
Three months ended March 31, 1998
Revenues $75,356 $10,967 $86,323
Net income (loss) 5,647 (1,380) 4,267
Earnings per share diluted 0.12 0.09
In connection with the acquisition of Aspect, the Company recorded a $3,730
restructuring charge associated with the merger and integration of the combined
operations. These charges consist primarily of contract cancellation costs of
$2,600, severance and other employee related costs of $390, and liabilities of
$590 incurred to discontinue certain foreign exchange programs of Aspect. The
contract cancellation costs are payments made to repurchase master franchise
rights under which Sylvan is in default of contractual non-competition
provisions as a result of the acquisition of Aspect.
46
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
3. Acquisitions (continued)
Details of the restructuring charge are as follows:
Paid Through Balance at
Original December 31, December 31,
Accrual 1998 1998
--------------------------------------------------
Contract cancellation costs $2,600 $1,100 $1,500
Severance and other employee costs 390 87 303
Costs to exit foreign exchange program 590 590 -
Other 150 - 150
--------------------------------------------------
$3,730 $1,777 $1,953
==================================================
It is expected that the remaining unpaid amounts will be paid in 1999.
NAI/Block
Effective December 1, 1997, the Company purchased the assets and liabilities of
Block Testing Services L.P. and Block State Testing Services L.P. and also
acquired all of the outstanding stock of National Assessment Institute, Inc.,
(collectively "NAI/Block"), commonly controlled companies engaged in the
business of designing, marketing, selling, distributing and administering paper
and pencil tests and the licensing of individuals. The consideration for the
acquisition was 964 shares of common stock having an aggregate market value of
$25,000. The acquisition was accounted for using the purchase method of
accounting and goodwill of $27,113 was recorded and is being amortized over a
period of 25 years.
I-R, Inc. and Independent Child Study Teams, Inc.
On May 30, 1997, the Company acquired by merger all of the outstanding stock of
I-R, Inc. and Independent Child Study Teams, Inc. (collectively, "Educational
Inroads") in exchange for 2,121 shares of common stock. I-R, Inc. and
Independent Child Study Teams, Inc. were commonly owned by two shareholders that
provide remedial and special educational services to public and non-public
school systems.
The acquisition was accounted for as a pooling-of-interests and accordingly, the
Company's consolidated financial statements for periods prior to the merger have
been restated to include the combined results of operations, financial position
and cash flows of Educational Inroads.
47
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
3. Acquisitions (continued)
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 recorded the
acquisition using the purchase method of accounting. 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 franchised centers in operation throughout Europe and Latin America.
The total purchase price of WSI of $21,071 consisted of cash of $4,921; 758
shares of restricted common stock valued at $9,250; 314 shares of unrestricted
common stock valued at $5,900 and $1,000 of direct acquisition costs. The
sellers may not transfer the restricted stock for a period of three years from
the date of issuance, unless the Company, in its sole discretion, removes the
restriction. Of the 758 shares of restricted common stock issued to the
sellers, 186 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. Goodwill of $21,163 is being
amortized over its estimated useful life of 25 years.
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 year's 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 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.
Under the purchase agreement, additional contingent consideration was payable in
an amount equal to 6.5 times PACE's earnings before interest and income taxes
(EBIT) in 1997 as elected by the sellers, determined in accordance with
generally accepted accounting principles. EBIT in 1997 was $3,966, resulting in
additional consideration of $25,777 of which $14,469 was paid in cash and
the remainder in 345 shares of
48
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
3. Acquisitions (continued)
common stock (see Note 8). The Company has recorded this additional
consideration as additional goodwill, and is amortizing that amount over the
remaining amortization period of 22 years.
Drake Prometric, L.P.
Effective September 30, 1995, the Company acquired Drake Prometric, L.P.
("Drake"), a provider of computer-based certification, licensure and assessment
testing programs. The Company acquired Drake for an initial purchase price of
$70,600, consisting of $20,000 in cash and 8,571 shares of restricted common
stock. The purchase agreement further provided for the payment of contingent
consideration to the extent that certain revenue targets relating to portions of
the combined computer-based testing business were achieved from 1996 through
1998. In addition, the sellers could receive up to an additional $40,000 of
consideration to the extent other revenue targets were achieved in 1998 or 1999,
with the measuring year selected by the sellers. As of December 31, 1998, all
contingencies surrounding the payment of additional consideration to the sellers
were resolved and total contingent consideration of $71,748 was recorded in
1996, 1997 and 1998, consisting of restricted common stock valued at $47,348 and
amounts to be paid in cash of $24,400 (see Note 8).
4. Available-For-Sale Securities
The following is a summary of available-for-sale securities (cost approximates
fair value):
December 31,
---------------
1997 1998
------- ------
Municipal securities funds $ 8,200 $ --
Cash reserve fund 38,246 3,366
Municipal bonds 36,505 2,800
------- ------
$82,951 $6,166
======= ======
The Company has not had any significant realized or unrealized gains or losses
on its investments during the periods presented. As of December 31, 1998, the
Company has approximately $3,400 of investments that mature within one year,
$1,800 of investments that mature between one and five years, and $1,000 of
investments that mature beyond five years. These investments are classified as
current as the Company views its available-for-sale securities as available for
use in its current operations.
49
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
5. Investments
Investments in Affiliates
At December 31, 1998 and 1997, the Company's investments in and advances to
affiliates consists primarily of its 10% voting interest in Caliber Learning
Network, Inc. ("Caliber"), including related loans. Caliber is a publicly-
traded company formed for the purpose of providing adults throughout the United
States with university-quality continuing education using multimedia technology.
The Company's investment in and advances to Caliber consisted of the following
at December 31:
1997 1998
---------- ----------
Invested capital $ 3,936 $14,300
Loans and related interest 3,362 -
Amounts due for management fee 2,880 517
---------- ----------
10,178 14,817
Allocable share of losses from inception (1,501) (4,403)
---------- ----------
$ 8,677 $10,414
========== ==========
From its inception in 1996 through December 31, 1997, Caliber relied almost
entirely on the Company's resources, systems and personnel for administrative,
management, accounting and financial functions. In consideration for these
services, the Company charged Caliber a management fee of $2,880 which was paid
in May 1998 upon the consummation of Caliber's initial public offering.
Although Caliber has developed its own infrastructure, the Company continues to
provide to Caliber certain accounting and administrative services. Caliber has
agreed to pay an annual management fee of $2,000 in 1998 and 1999 for these
services.
During 1997, the Company assigned the leases for 32 testing centers to Caliber
for the use by Caliber in its operations. Upon assignment of the centers,
Caliber assumed the revenue stream from the ongoing testing operations and paid
the Company a fee of $4,000 to manage the continuing testing operations in 1997.
During 1997 and 1998, the Company paid Caliber $1,200 and $2,042, respectively,
for the administration of computer-based tests at these testing centers.
The Company also maintains investments in and advances to other affiliates
totaling $3,787 and $8,118 at December 31, 1997 and 1998, respectively. The
Company's allocable share of losses related to these investments for the years
ended December 31, 1997 and 1998 was $(647) and $(602), respectively.
50
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
5. Investments (continued)
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, 1997 and 1998, other investments consist primarily of an
investment in non-voting convertible preferred stock and junior subordinated
debentures of JLC Learning Corporation ("JLC"), a company that develops
educational software products. At December 31, 1997 and 1998, the Company's
investment in JLC was $24,038 and $25,700, respectively. During 1996, 1997 and
1998, the Company recorded dividend income from this investment in the amount of
$333, $2,000 and $1,167, respectively.
In November 1998, the Company purchased 53 shares of 6% redeemable convertible
preferred stock of The Chauncey Group International, Ltd. ("Chauncey"), a
subsidiary of Educational Testing Services ("ETS"), for consideration of $8,000.
Chauncey designs, develops and administers occupational, certification and
professional assessment programs.
The Company also maintains other investments not readily marketable totaling
$3,979 and $10,530 at December 31, 1997 and 1998, respectively.
6. Net Assets to be Transferred to Joint Venture
On January 1, 1999, the Company entered into an agreement with Chauncey to form
Experior Assessments LLC ("Experior"), a joint venture to be engaged in the
business of developing and administering state and municipal sponsored licensing
and certification programs and other related services. In exchange for a 50%
interest in Experior, Sylvan will contribute the net assets of NAI/Block (see
Note 3), excluding certain working capital balances. These net assets will be
transferred at historical cost with no gain or loss recorded on the
transfer. As of December 31, 1998, the Company has classified the net assets
to be contributed to Experior of $31,575 as net assets to be transferred to
joint venture in the accompanying consolidated balance sheet.
51
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
7. Long-term Debt
Long-term debt consists of the following:
December 31,
----------------------
1997 1998
-------- --------
Long-term revolving credit facility with banks $ -- $ 8,000
Various notes payable bearing interest
at rates ranging from 8% to 10.75%. 3,681 5,632
-------- --------
3,681 13,632
Less: current portion of long-term debt 1,253 1,128
-------- --------
Total long-term debt $ 2,428 $ 12,504
======== ========
The revolving credit facility with a group of six banks allows the Company to
borrow up to an aggregate of $100,000. Additionally, the Company has been pre-
approved to increase the aggregate borrowings by $50,000 in increments of
$10,000. Outstanding borrowings under this facility are unconditionally
guaranteed by a pledge of the capital stock of the Company's subsidiaries, and
are due on December 31, 2003. Outstanding borrowings bear interest at either the
prime rate, the federal funds rate plus 0.5%, or rates based on the Eurodollar
rate plus a contractual margin. As of December 31, 1998, $8,000 of prime rate
borrowings bearing interest at 7.75% were outstanding. Effective January 7,
1999, the borrowings began to bear interest at 6.06%, based on the Eurodollar
rate.
52
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
8. Due to Shareholders of Acquired Companies
Due to shareholders of acquired companies consists of the following (see also
Note 3):
December 31,
----------------------------------------
1997 1998
----------------------------------------
Amounts payable to former owners of NAI/Block, paid
in 964 shares of common stock in January 1998 $ 25,000 $ -
Amounts payable to former shareholder of Canter in cash - 16,319
Amounts payable to former shareholder of Canter in 535
shares of common stock - 12,239
Amounts payable to former shareholders of WSI in cash 262 -
Amounts payable to former shareholders of PACE in cash 13,532 -
Amounts payable to former shareholders of PACE,
paid in 345 shares of common stock in April 1998 11,309 -
Amounts payable to former shareholders of Drake, paid in
1,071 shares of common stock in April 1998 20,057 -
Amounts payable to former shareholders of Drake in cash - 24,400
----------------- -------------------
70,160 52,958
Less: current portion (13,794) (40,719)
----------------- -------------------
$ 56,366 $ 12,239
================= ===================
9. 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 substantially all 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, 1998 by year and in the aggregate, under
all non-cancelable operating leases are as follows:
Years ending December 31:
1999 $16,298
2000 14,620
2001 11,357
2002 9,762
2003 8,452
Thereafter 23,333
-------
$83,822
=======
53
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
9. Leases (continued)
Rent expense under all cancelable and non-cancelable leases was approximately
$7,500, $9,500 and $13,600 for the year ended December 31, 1996, 1997 and 1998,
respectively.
10. 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.
11. 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, due to shareholders of acquired companies (cash
portion), 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 has been
impaired.
12. Stock Options
The Company has five stock options plans that provide for the granting of stock
options to employees, officers and directors. The 1998 Stock Incentive Plan
("1998 Plan") is the only plan with significant stock option awards available
for grant. Prior plans have outstanding stock options at December 31, 1998.
The 1998 Plan allows for the grant of up to 3,750 shares of common stock in the
form of incentive and non-qualified stock options, stock appreciation rights,
stock awards, phantom stock awards, convertible securities and performance
awards that expire six years after the date of grant. During 1998, non-
qualified options to purchase 1,095 shares of
54
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
12. Stock Options (continued)
common stock were granted under the 1998 Plan. Options outstanding under all of
the Company's stock option plans have been granted at prices which are equal to
the market value of the stock on the date of grant and vest ratably over periods
not exceeding six years.
During 1997, the Company established the Sylvan Technology Center Stock Option
Plan ("the STC Plan") for the franchisee owners of Sylvan Technology Centers.
The STC Plan provides for the granting of stock options to purchase up to 450
shares of common stock. During 1997, 317 options were granted that vest ratably
over a three-year period and expire 10 years after the date of grant or on the
date of cessation of operations of the center. The fair value of these options,
determined using the Black-Scholes option valuation model, was $1,386, of which
$550 and $539 of expense was recognized in 1997 and 1998, respectively, with the
remainder to be recognized in expense over the next two years as the options
vest.
The following table summarizes the stock option activity of the Company.
1996 1997 1998
--------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------------------------------------------------------------------------------------------
Outstanding at beginning of
year 4,853 $ 5.13 6,921 $ 8.71 6,935 $13.75
Granted 2,772 14.61 1,714 23.73 2,989 26.77
Exercised (577) 7.25 (1,621) 2.92 (659) 9.92
Forfeited (127) 7.47 (79) 11.83 (198) 17.03
--------------------------------------------------------------------------------------------
Outstanding at end of year 6,921 $ 8.71 6,935 $13.75 9,067 $17.86
============================================================================================
Exercisable at end of year 2,688 $ 4.45 2,691 $ 8.51 3,584 $10.80
============================================================================================
Weighted-average fair value of
options granted during the year $ 5.55 $ 7.15 $11.26
=============== =============== ===============
55
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
12. Stock Options (continued)
Exercise prices for options outstanding as of December 31, 1998 ranged from
$3.48 to $31.25 as follows:
Weighted
Weighted Average Weighted
Average Remaining Average
Exercise Contractual Exercise
Prices of Life of Prices of
Range of Outstanding Outstanding Outstanding Exercisable Exercisable
Exercise Prices Options Options Options Options Options
- ------------------------------------------------------------------------------------------------------
$3.48-$6.08 1,245 $4.48 0.9 years 1,223 $4.45
- ------------------------------------------------------------------------------------------------------
$6.78-$11.62 850 9.17 2.7 years 605 9.02
- ------------------------------------------------------------------------------------------------------
$13.55-$19.77 2,948 15.30 5.9 years 1,563 14.58
- ------------------------------------------------------------------------------------------------------
$21.50-$31.25 4,024 25.71 6.1 years 193 26.02
- ------------------------------------------------------------------------------------------------------
For the years ended December 31, 1996, 1997 and 1998, 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 the
Black-Scholes option pricing model with the following weighted average
assumptions for 1996, 1997 and 1998: risk-free interest rate of 6.00%, dividend
yield of 0%, volatility factors of the expected market price of the Company's
common stock of .399, .280 and .360, respectively, and an expected life of
granted options which varies from four to six years depending upon the vesting
period.
The Black-Scholes option pricing 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:
1996 1997 1998
--------- --------- ----------
Pro forma net income $12,896 $24,477 $25,446
Pro forma earnings per share:
Basic 0.35 0.58 0.52
Diluted 0.33 0.55 0.50
56
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
13. Impairment Loss
In May 1997, the Company determined that certain assets of Sylvan Prometric were
impaired as a result of certain strategic changes that were made as a result of
pursuing the National Education Corporation ("NEC") acquisition (see Note 14).
During and after the acquisition negotiations with NEC, the Company developed
certain plans that resulted in required changes in both software systems and
hardware currently utilized in Sylvan Prometric's network of centers. The plans
continued to be valid for the Company even after the NEC acquisition was
terminated. The impaired assets, consisting of computer equipment and software,
were impaired as a result of changes in the technical requirements and
specifications of certain computer hardware and software. The amount of the
impairment loss was determined by evaluating the likely sales proceeds from the
disposition of the assets compared to their book value. The Company determined
that it was unlikely that the net cash proceeds from the sale of any assets
would be significant, and therefore recorded an impairment loss equal to the net
book value of the assets of $4,000. During 1998, these assets were disposed of
for no significant consideration.
14. Termination Fee
In March 1997, the Company and NEC executed a definitive agreement pursuant to
which the Company was to acquire NEC. In May 1997, NEC accepted the offer of
Harcourt General, Inc. to acquire all of the stock of NEC which resulted in the
termination of NEC's agreement with the Company and NEC's payment to the
Company of the $30,000 termination fee required by that agreement. The Company
also incurred $1,500 of expenses in connection with the NEC transaction, and
reported the net termination fee of $28,500 in 1997.
15. Contributions
During 1997, the Company made certain cash expenditures and common stock
contributions resulting in an aggregate expense to the Company of approximately
$21,500. The $21,500, recorded as operating expenses, was attributable to
contributions of (i) $3,000 in cash and common stock valued at $7,000 to IT
Training Marketing Company, a nonprofit corporation whose sole purpose is to
fund promotional and channel support programs for the Sylvan Prometric
distribution channel, (ii) common stock valued at $5,000 to SLC National
Advertising Fund, Inc., a nonprofit corporation whose sole purpose is to develop
and fund advertising programs for the Sylvan Learning Centers and (iii) common
stock valued at $6,500 to Sylvan Learning Foundation, a nonprofit foundation
formed to promote various educational pursuits.
57
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
16. Income Taxes
Significant components of the provision for income taxes are as follows:
Year ended December 31,
-------------------------
1996 1997 1998
------ ------- -------
Current:
Federal $5,078 $ 8,956 $12,367
Foreign 550 1,292 1,521
State 1,403 1,618 2,865
------ ------- -------
Total current 7,031 11,866 16,753
Deferred (benefit):
Federal 1,773 3,396 1,083
Foreign - 306 3,097
State 335 852 649
------ ------- -------
Total deferred 2,108 4,554 4,829
------ ------- -------
Total provision $9,139 $16,420 $21,582
====== ======= =======
For the year ended December 31, 1996, 1997 and 1998, foreign income before
income taxes was $3,800, $12,900 and $16,470, respectively.
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
as follows:
Year ended December 31,
-----------------------
1997 1998
------- -------
Deferred tax assets:
Net operating loss carryforwards $ 765 $ 252
Loss on impairment of assets 779 483
Deferred revenue 630 1,018
Allowance for doubtful accounts 548 853
Advertising costs 5,305 2,360
Amortization of intangible assets 643 204
Equity share of losses from affiliates 827 2,115
Charitable contribution carryforward 2,425 1,535
Tax credit carryforwards 926 1,154
Other 538 1,329
------- -------
Total deferred tax assets 13,386 11,303
58
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
16. Income Taxes (continued)
Year ended December 31,
--------------------------------
1997 1998
--------------- ---------------
Deferred tax liabilities:
Deferred contract costs 2,066 917
Contract rights 170 79
Depreciation 1,755 1,521
Deferred income 11,388 11,670
Accrued receivables 559 1,136
Other 565 720
------- -------
Total deferred tax liabilities 16,503 16,043
------- -------
Net future income tax liabilities (3,117) (4,740)
Valuation allowance for deferred
tax assets (765) (252)
------- -------
Net deferred tax liabilities $(3,882) $(4,992)
======= =======
The net operating loss carryforwards at December 31, 1998 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 (34% in 1996 and 1997,
35% in 1998) to income before income taxes is as follows:
Year ended December 31,
--------------------------
1996 1997 1998
------ ------- -------
Tax expense at U.S. statutory rate $8,464 $15,070 $20,052
Permanent differences 813 2,662 1,237
State income tax expense, net of
federal tax benefit 1,130 1,555 2,284
Tax effect of foreign income taxed at lower rate (734) (3,244) (1,852)
Utilized tax credits (254) - -
Other (280) 377 (139)
------ ------- -------
$9,139 $16,420 $21,582
====== ======= =======
59
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
17. Earnings Per Share
The following table summarizes the computations of basic and diluted earnings
per share:
Year ended December 31,
-------------------------
1996 1997 1998
------- ------- -------
Numerator used in basic and diluted
earnings per common share:
Net income $15,754 $27,904 $35,709
======= ======= =======
Denominator:
Denominator for basic earnings per common
share weighted average shares 36,626 42,412 48,962
Effect of dilutive securities:
Employee stock options 2,069 1,850 2,151
Common stock contingently issuable 268 628 173
------- ------- -------
Total dilutive potential common shares 2,337 2,478 2,324
------- ------- -------
Denominator for diluted earnings per common
share weighted average shares and
assumed conversions 38,963 44,890 51,286
======= ======= =======
Earnings per common share, basic $ 0.43 $ 0.66 $ 0.73
Earnings per common share, diluted $ 0.40 $ 0.62 $ 0.70
18. Shares Reserved For Future Issuance
The Company as of December 31, 1998 has reserved 9,602 shares of common stock
for future issuance upon the exercise of all outstanding stock options and the
issuance of shares of common stock in connection with purchase business
combinations.
19. Major Customers and Concentration of Credit Risk
The Company has an agreement with ETS to be the exclusive commercial provider of
ETS domestic computer-based tests through the year 2005. The contract to
provide international computer-based tests runs through the year 2003. The
international testing contract with ETS stipulates that the Company will be
compensated for its services for a fee equal to approved costs
60
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
19. Major Customers and Concentration of Credit Risk (continued)
plus 10 percent, and the Company recognizes revenues accordingly. Operating
costs under the contract are paid at cost plus 10 percent on a monthly basis by
ETS. Total revenues from ETS represented approximately 8.9%, 11.3% and 12.4% of
consolidated revenues for the years ended December 31, 1996, 1997 and 1998,
respectively.
The Company's information technology testing business is highly concentrated
with two customers. These customers contributed approximately 25.7%, 13.1% and
12.0% to consolidated revenues for the year ended December 31, 1996, 1997 and
1998, respectively. The Company expects the contracts with these two customers
to be renewed at the expiration date of the current 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 related to this business of
approximately $130,886.
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, 1998, the Company does
not have any significant concentrations of credit risk.
20. 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 discretionary contributions to this plan of $248
in 1997 and $315 in 1998.
21. Business and Geographic Segment Information
Description of Services From Which Each Reportable Segment Derives its Revenues
The Company provides lifelong educational services through three distinct
operating segments. The Sylvan Learning Centers division provides personalized
instructional services to students of all ages and skill levels, through its
network of franchised and Company-owned learning centers located in 49 states,
five Canadian provinces, Hong Kong and Guam. The Sylvan Contract Educational
Services division provides educational services and professional development to
children and adults through contracts with school systems and other
organizations. These services
61
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
21. Business and Geographic Segment Information (continued)
to children are delivered at over 700 schools and in the case of its
professional development services for adults, at the contracting parties'
facilities. The Sylvan Prometric division delivers computer-based testing for
academic admissions and professional certification programs through a network of
computer testing centers located throughout the world, and includes the
operations of Wall Street Institute and Aspect. Wall Street Institute is a
European-based franchisor and operator of learning centers for English language
instruction that will administer certain computer-based testing programs
throughout Europe and Latin America. Aspect is an international provider of
intensive English language instruction to professionals worldwide through its 27
language schools in five countries.
Measurement of Segment Profit or Loss and Segment Assets
The Company evaluates performance and allocates resources based on operating
income before corporate general and administrative expenses and income taxes.
The accounting policies used by the reportable segments are the same as those
used by the Company as described in Note 2 to the consolidated financial
statements. There are no significant intercompany sales or transfers.
Factors Management Uses to Identify the Company's Reportable Segments
The Company's reportable segments are business units that offer distinct
services. The segments are managed separately as they have different customer
bases and delivery channels.
The following table sets forth information on the Company's reportable segments:
Year Ended December 31, 1996
---------------------------------------------------------
Sylvan Sylvan Contract
Learning Centers Educational Services Sylvan Prometric
---------------- -------------------- ----------------
Revenues $38,898 $ 58,186 $122,889
Depreciation and
amortization 998 1,940 9,729
Segment profit 11,456 4,727 15,971
Segment assets 14,432 27,496 171,683
Expenditures for long-
lived assets 914 2,690 7,197
62
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
21. Business and Geographic Segment Information (continued)
Year Ended December 31, 1997
---------------------------------------------------------
Sylvan Sylvan Contract
Learning Centers Educational Services Sylvan Prometric
---------------- -------------------- ----------------
Revenues $46,629 $ 66,582 $187,800
Depreciation and
amortization 756 1,614 14,002
Loss on impairment of
assets - - 4,000
Unusual item - contribution
to marketing fund - - 10,000
Significant non-cash
charges (advertising) 5,000 - -
Segment profit 7,443 10,230 15,815
Segment assets 22,309 57,064 275,522
Expenditures for long-
lived assets 1,688 4,661 19,861
Year Ended December 31, 1998
---------------------------------------------------------
Sylvan Sylvan Contract
Learning Centers Educational Services Sylvan Prometric
---------------- -------------------- ----------------
Revenues $64,754 $ 100,519 $ 275,057
Depreciation and
amortization 1,565 5,762 23,016
Unusual item - transaction
costs - - 5,000
Restructuring charges - - 3,730
Segment profit 19,339 14,649 37,999
Segment assets 56,841 127,276 391,434
Expenditures for long-
lived assets 2,274 8,607 42,732
63
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
21. Business and Geographic Segment Information (continued)
The following tables reconcile the reported information on segment profit and
assets to income before income taxes and total assets reported in the statements
of income and balance sheets for the years ended December 31, 1996, 1997 and
1998:
1996 1997 1998
--------- --------- ---------
Total profit for
reportable segments $ 32,154 $ 33,488 $ 71,987
Corporate general and
administrative expense (8,049) (19,693) (15,530)
Other income (expense),
net of direct costs 788 30,529 834
-------- -------- --------
Income before income taxes $ 24,893 $ 44,324 $ 57,291
======== ======== ========
1996 1997 1998
--------- --------- ---------
Segment assets $213,611 $354,895 $575,551
Cash and available for sale
securities - corporate 27,381 86,631 5,967
Deferred income taxes 620 3,755 1,832
Property, plant and equipment -
Corporate 5,249 6,810 9,746
Investments in and advances
to affiliates 5,896 12,464 13,919
Other investments 22,220 28,017 40,372
Other non-segment assets 3,102 4,207 12,409
-------- -------- --------
Total assets $278,079 $496,779 $659,796
======== ======== ========
Included in corporate general and administrative expense for the year ended
December 31, 1997 was a contribution of the Company's common stock valued at
$6,500 as discussed in Note 15 to these financial statements.
Depreciation and amortization expense in the amounts of $1,289, $2,489 and
$1,980 were charged to corporate departments during the year ended December 31,
1996, 1997 and 1998, respectively. Expenditures for corporate long-lived assets
were $4,065, $4,754 and $4,681 during the year ended December 31, 1996, 1997 and
1998, respectively.
64
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
21. Business and Geographic Segment Information (continued)
Enterprise-Wide Disclosures - Information on Geographic Areas
Year Ended December 31, 1996 .
----------------------------
Revenues Long-lived Assets
--------- -----------------
United States $165,539 $25,679
Foreign countries - total 54,434 7,502
-------- -------
Consolidated total $219,973 $33,181
======== =======
Year Ended December 31, 1997 .
----------------------------
Revenues Long-lived Assets
--------- -----------------
United States $212,336 $40,182
Foreign countries - total 88,675 11,185
-------- -------
Consolidated total $301,011 $51,367
======== =======
Year Ended December 31, 1998 .
----------------------------
Revenues Long-lived Assets
--------- -----------------
United States $313,043 $73,128
Foreign countries - total 127,287 24,753
-------- -------
Consolidated total $440,330 $97,881
======== =======
Revenues are attributed to countries based on the location of the customer.
Revenues from individual foreign countries did not exceed 10% of consolidated
revenues in any of the years presented. Long-lived assets domiciled in
individual foreign countries did not exceed 10% of consolidated long-lived
assets in any of the years presented. Note 19 to the financial statements
contains information about major customers of the Company.
65
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
22. Supplemental Cash Flow Information
Interest payments were approximately $1,300, $800 and $900 for the year ended
December 31, 1996, 1997 and 1998, respectively. Income tax payments were $4,200,
$2,700 and $8,600 for the year ended December 31, 1996, 1997, and 1998,
respectively.
In connection with the 1998 acquisitions of Canter and Schulerhilfe for combined
consideration of $44,082, the Company acquired assets with a fair value of
$50,465 and assumed liabilities of $6,383.
In connection with the 1997 acquisition of NAI/Block for total consideration of
$25,000, the Company acquired assets with a fair value of $29,616 and assumed
liabilities of $4,616.
In connection with the 1996 acquisition of WSI for total consideration of
$21,071, the Company acquired assets with a fair value of $24,101 and assumed
liabilities of $3,030.
23. Quarterly Financial Data (Unaudited)
Quarter ended
---------------------------------------------------
March 31, June 30, September 30, December 31,
1997 1997 1997 1997
--------- -------- ------------- ------------
Operating revenues $61,406 $ 69,510 $71,960 $98,135
Operating expenses 57,061 83,810 61,302 81,043
Loss on impairment of assets -- 4,000 -- --
------- -------- ------- -------
Operating income (loss) 4,345 (18,300) 10,658 17,092
Non-operating items, net 333 28,933 805 458
------- -------- ------- -------
Income before income taxes 4,678 10,633 11,463 17,550
Income taxes (1,953) (3,916) (3,993) (6,558)
------- -------- ------- -------
Net income $ 2,725 $ 6,717 $ 7,470 $10,992
======= ======== ======= =======
Net income per common share:
Basic $ 0.07 $ 0.17 $ 0.17 $ 0.24
======= ======== ======= =======
Diluted $ 0.06 $ 0.16 $ 0.16 $ 0.22
======= ======== ======= =======
Shares used in computation:
Basic 40,152 40,332 43,702 45,517
======= ======== ======= =======
Diluted 42,960 42,747 45,966 49,101
======= ======== ======= =======
66
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
23. Quarterly Financial Data (Unaudited) (continued)
During the second quarter of 1997, the Company recognized an impairment loss of
$4,000, income from a termination fee of $28,500 and recorded expense related to
contributions which totaled $21,500. These transactions are described in Notes
13, 14 and 15, respectively.
The net effect of the above non-recurring items was an increase in pre-tax
income of $3,000 and net income of $1,900, or $.04 per diluted share.
Diluted earnings per common share for the year ended December 31, 1997 is $0.62.
The total diluted earnings per common share derived from the addition of the
quarterly amounts in 1997 is $0.60. This difference is caused by differences in
the estimated effect of contingently issuable shares related to the acquisition
of PACE in the quarterly periods as compared to the annual period.
Quarter ended
---------------------------------------------------
March 31, June 30, September 30, December 31,
1998 1998 1998 1998
--------- ------- ------------- ------------
Operating revenues $86,323 $99,328 $109,701 $144,978
Operating expenses 80,108 89,384 89,386 116,265
Transaction costs -- 5,000 -- --
Restructuring costs -- 3,730 -- --
------- ------- -------- --------
Operating income 6,215 1,214 20,315 28,713
Non-operating items, net 367 147 (690) 1,010
------- ------- -------- --------
Income before income taxes 6,582 1,361 19,625 29,723
Income taxes (2,315) (2,839) (6,323) (10,105)
------- ------- -------- --------
Net income $ 4,267 $(1,478) $ 13,302 $ 19,618
======= ======= ======== ========
Net income per common share:
Basic $ 0.09 $(0.03) $ 0.27 $ 0.39
======= ======= ======== ========
Diluted $ 0.09 $(0.03) $ 0.26 $ 0.37
======= ======= ======== ========
Shares used in computation:
Basic 47,760 48,185 48,535 50,592
======= ======= ======== ========
Diluted 49,926 48,185 50,596 53,334
======= ======= ======== ========
During the year ended December 31, 1998, the Company recognized certain non-
recurring expenses related to the merger with ASPECT. These expenses include
$5,000 of transaction-related costs, such as legal, accounting and advisory
fees, and $3,730 of costs, classified in the financial statements as
restructuring costs that relate to the integration of ASPECT with Sylvan.
67
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar and share amounts in thousands, except per share data)
23. Quarterly Financial Data (Unaudited) (continued)
The net effect of the above non-recurring items was a decrease in pre-tax income
of $8,730 and net income of $7,857, or $0.15 per diluted share.
Diluted earnings per common share for the year ended December 31, 1998 is $0.70.
The total diluted earnings per common share derived from the addition of the
quarterly amounts in 1998 is $0.69. This difference is caused by the effect of
in-the-money options and warrants and contingently issuable shares which were
excluded from the second quarter computation because the effect was anti-
dilutive, but included in the annual computation because the effect was
dilutive.
68