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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
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 000-27817
EDISON SCHOOLS INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3915075
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
521 Fifth Avenue, 11th Floor, New
York, NY 10175 (Address of
principal executive offices) (Zip
Code)
Registrant's telephone number, including area code (212) 419-1600
Former name, former address and former fiscal year, if changed since last report
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.
(1) Yes X No (2) Yes X No
The number of shares outstanding of each of the Registrant's classes of common
stock:
52,018,855
(Number of shares of Class A Common Stock Outstanding as of October 31, 2002)
1,805,132
(Number of shares of Class B Common Stock Outstanding as of October 31, 2002)
EDISON SCHOOLS INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of September 30, 2002 (unaudited) and
June 30, 2002...................................................................... 3
Condensed Consolidated Statements of Operations for the Three Months Ended
September 30, 2002 and 2001 (unaudited)............................................ 4
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
September 30, 2002 and 2001 (unaudited)............................................ 5
Notes to Condensed Consolidated Financial Statements (unaudited)..................... 6-10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.................................................. 10-24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................... 26
ITEM 4. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.............................
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS................................................ 26
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS........................ 26
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................. 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 26
ITEM 5. OTHER INFORMATION................................................ 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................. 27
SIGNATURES....................................................... 28
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
EDISON SCHOOLS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
September 30,
2002 June 30,
(Unaudited) 2002
-------------- -------------
ASSETS
Current assets:
Cash and cash equivalents............................................ $ 31,512 $ 40,648
Accounts receivable.................................................. 72,144 68,589
Notes receivable, net................................................ 15,699 12,481
Other receivables.................................................... 7,153 9,551
Other current assets................................................. 13,448 8,666
-------------- -------------
Total current assets............................................... 139,956 139,935
Property and equipment, net............................................. 111,386 111,106
Restricted cash ........................................................ 6,400 6,715
Notes receivable, net, less current portion ............................ 69,228 68,412
Other receivables, less current portion ................................ 238 231
Long-term receivables .................................................. 22,819 26,461
Investments ............................................................ 1,250 1,250
Other assets ........................................................... 30,399 27,266
-------------- -------------
Total assets ...................................................... $ 381,676 $ 381,376
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings ............................................... $ 57,994 $ 34,000
Current portion of long-term debt ................................... 21,365 18,364
Accounts payable .................................................... 22,440 24,686
Accrued expenses .................................................... 41,691 50,557
-------------- -------------
Total current liabilities ......................................... 143,490 127,607
Long-term debt, less current portion ................................... 7,073 9,807
Stockholders' notes payable ............................................ 6,604 6,604
Other liabilities ...................................................... 2,707 2,487
-------------- -------------
Total liabilities ................................................. 159,874 146,505
-------------- -------------
Minority interest in subsidiary ........................................ 2,469 2,487
-------------- -------------
Stockholders' Equity:
Class A common, par value $.01; 150,000,000 shares authorized; 52,018,855
shares issued and outstanding at September 30, 2002 and June 30, 2002 520 520
Class B common, par value $.01; 5,000,000 shares authorized; 1,805,132
shares issued and outstanding at September 30, 2002 and June 30, 2002 .. 18 18
Additional paid-in capital.............................................. 495,504 489,279
Unearned stock-based compensation ...................................... (408) (823)
Accumulated deficit .................................................... (276,301) (256,610)
-------------- -------------
Total stockholders' equity ........................................ 219,333 232,384
-------------- -------------
Total liabilities and stockholders' equity ........................ $ 381,676 $ 381,376
============== =============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
EDISON SCHOOLS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(In thousands except per share amounts)
(Unaudited)
-------------------------------
2002 2001
------------- -------------
Gross Student Funding..................................... $ 79,545 $ 97,267
============= =============
Net revenue............................................... $ 73,092 $ 89,745
------------- -------------
Education and operating expenses:
Direct site expenses
Company paid......................................... 34,971 40,699
Client paid.......................................... 29,593 39,674
Administration, curriculum and development............. 15,920 11,126
Depreciation and amortization.......................... 10,039 7,855
Pre-opening expenses................................... 2,011 3,735
------------- -------------
Total education and operating expenses............... 92,534 103,089
------------- -------------
Loss from operations...................................... (19,442) (13,344)
Other income (expense):
Interest income........................................... 2,216 2,252
Interest expense.......................................... (2,152) (1,411)
Other..................................................... 18 6
------------- -------------
Total other.......................................... 82 847
------------- -------------
Loss before provision for state and local taxes........... (19,360) (12,497)
Provision for state and local taxes....................... (331) (175)
------------- -------------
Net loss.................................................. $ (19,691) $ (12,672)
============= =============
Per common share data:
Basic and diluted net loss per share................... $ (0.37) $ (0.24)
============= =============
Weighted average shares of common stock outstanding used
in computing basic and diluted net loss per share..... 53,824 53,120
============= =============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
EDISON SCHOOLS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(Dollars in thousands)
Unaudited
----------------------
2002 2001
---------- ----------
Cash flows from operating activities:
Net loss .................................................. $(19,691) $(12,672)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ........................... 9,014 7,710
Amortization of other costs ............................. 2,089 310
Stock-based compensation ................................ 84 (5,338)
Loss (gain) on disposal of property and equipment ....... 382 --
Interest on notes receivable ............................ (2,071) (1,258)
Changes in working capital accounts ..................... (16,056) (8,139)
Other ................................................... (79) (6)
---------- ----------
Cash used in operating activities ................... (26,328) (19,393)
---------- ----------
Cash flows from investing activities:
Additions to property and equipment ....................... (5,866) (4,447)
Proceeds from disposition of property and equipment, net 152 --
Proceeds from notes receivable and advances due from
charter schools .......................................... 2,040 2,134
Notes receivable and advances due from charter schools .... (3,964) (17,362)
Business acquisition, net ................................. -- 149
Other assets .............................................. 1,056 (1,965)
---------- ----------
Cash used in investing activities ................... (6,582) (21,491)
---------- ----------
Cash flows from financing activities:
Net borrowings under lines of credit ...................... 25,325 --
Proceeds from issuance of stock and warrants .............. -- 526
Costs in connection with debt financing ................... (7,079) --
Proceeds from notes payable ............................... 10,000 --
Payments on notes payable and capital leases .............. (4,786) (4,745)
Restricted cash ........................................... 314 (638)
---------- ----------
Cash provided by (used in) financing activities ..... 23,774 (4,857)
---------- ----------
Decrease in cash and cash equivalents ............... (9,136) (45,741)
Cash and cash equivalents at beginning of period ............. 40,648 96,195
---------- ----------
Cash and cash equivalents at end of period ................... $ 31,512 $ 50,454
========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the periods for:
Interest ................................................ $ 950 $ 1,308
Taxes ................................................... $ 163 $ 23
Supplemental disclosure of non-cash investing and
financing activities:
Obligations assumed in connection with new contracts ...... $ 9,700
Property and equipment acquired under capitalized lease
obligations .............................................. $ 1,080
Additions to property and equipment included in
accounts payable ......................................... $ 3,024 $ 6,744
Increase in additional paid in capital in conjunction
with issuance of stock purchase warrants with debt ....... $ 6,557
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
EDISON SCHOOLS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. Basis of Presentation
The unaudited condensed consolidated financial statements have been
prepared by Edison Schools Inc. (the "Company") in accordance with generally
accepted accounting principles ("GAAP") for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the
opinion of management, all adjustments, consisting of normal recurring items
necessary to present fairly the financial position and results of operations
have been included. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such SEC rules
and regulations. These financial statements should be read in conjunction with
the financial statements and related notes included in the Company's Annual
Report on Form 10-K/A for the year ended June 30, 2002.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Significant estimates include
revenues, certain district paid school expenses, recoverability of long-lived
assets and notes receivable, liabilities incurred from workers' compensation,
commercial and other claims and losses on school contracts. Other estimates
include useful lives of property and equipment and the deferred income tax
valuation allowance. Actual results could differ from these estimates.
Because new schools are opened in the first fiscal quarter of each
year, trends in the Company's business, whether favorable or unfavorable, will
tend not to be reflected in the Company's quarterly financial results, but will
be evident primarily in year-to-year comparisons. The first quarter of our
fiscal year has historically reflected less revenue and lower expenses than the
other three quarters. The Company generally has a lower gross site margin in the
first fiscal quarter than in the remaining fiscal quarters. The Company also
recognizes pre-opening costs primarily in the first and fourth quarters. Summer
school revenues and expenses are also recognized in the first and fourth
quarters.
Since inception, the Company has incurred losses from operations and
has had negative cash flow from operations. The cash needs of the business have
been financed through a combination of debt and equity financing. In the first
quarter of fiscal 2003, the Company entered into additional financings
subsequent to year end (see Note 5). The terms of these financings require the
Company to comply with certain financial covenants. The Company believes it will
be able to comply with the terms of such covenants based on its forecasted
operating plan for fiscal 2003.
In order to achieve its operating plan, the Company plans to improve
the gross site contribution margins at the individual schools it manages while
maintaining educational quality and continuing to reduce central expenses as a
percentage of net revenue. The Company has undertaken a "reengineering" process
to increase efficiency and help attain profitability while improving client
service. Part of this initiative includes the streamlining of processes within
the Company, reductions in personnel and the implementation of cost control
measures.
In addition to the above, the Company is dependent upon the
continuation of its school management agreements for recurring revenues and
growth. Some of the management agreements may be terminated at will by the
school district or charter board. The Company may also seek the early
termination of, or not seek to renew, a limited number of management agreements
in any year.
If the Company is unable to meet its plan, it may not be able to meet
the terms of financings discussed above, resulting in the borrowings becoming
due. If this were to occur, the Company may be forced to restructure or
refinance its indebtedness, seek additional equity capital, sell assets or
reduce its growth plan. The Company cannot be certain that it will be able to
obtain additional financing on favourable terms, if at all.
2. Description of Business
Edison Schools Inc. (the "Company") (formerly known as The Edison
Project Inc. and Subsidiaries) manages elementary and secondary public schools
under contracts with school districts and charter schools located in 23 states,
and Washington, D.C. The Company opened its first four schools in the fall of
1995, and, as of September 30, 2002, is operating 150 schools with approximately
80,000 students.
The Company provides the education program, recruits and manages
personnel, and maintains and operates the facilities at each school it manages.
The Company also assists charter schools in obtaining facilities and the related
financing. As compensation for its services, the Company earns gross student
funding comparable to the funding spent on other public schools in the school
district in which the school is located.
3. Recently Issued Accounting Standards
In June 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
and measured initially at fair value when the liability is incurred rather than
at the date of a commitment to an exit or disposal plan. Costs covered by SFAS
No. 146 include lease termination costs and certain employee severance costs
that are associated with a restructuring, discontinued operation, plant closing
or other exit or disposal activity. SFAS No. 146 is effective for exit or
disposal activities that are initiated after December 31, 2002. The Company is
currently assessing the impact of this statement.
6
4. Net Loss Per Share
In accordance with Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings per Share", basic earnings per share is computed using the
weighted-average number of common shares outstanding during the period. Diluted
earnings per share is computed using the weighted-average number of common and
common stock equivalent shares outstanding during the period. Common stock
equivalent shares, such as convertible preferred stock, stock options, and
warrants, have been excluded from the computation, as their effect is
antidilutive for all periods presented.
The calculations of basic and fully diluted net loss per share for the three
month period ended September 30, 2002 and 2001 are as follows:
Three Months Ended
September September
2002 2001
---- ----
Net Loss .......................................... $(19,691) $(12,672)
======== ========
Class A Common Stock outstanding at beginning
of period ...................................... 52,019 49,249
Class B Common Stock outstanding at beginning
of period ...................................... 1,805 2,433
Add:
Issuance of Class A Common Stock
(on a weighted average basis) ................... -- 1,690
Conversion of Class B Common Stock
(on a weighted average basis) ................... -- (252)
-------- --------
Weighted average shares of common stock outstanding
used in computing basic net loss per share ..... 53,824 53,120
======== ========
Basic and fully diluted net loss per share ........ $ (0.37) $ (0.24)
======== ========
5. Financing
On October 3, 2001, the Company formed Edison Receivables Company LLC
("Edison Receivables"), for the purpose of purchasing and financing certain
receivables of the Company. The Company owns all of the membership interests in
Edison Receivables, a Delaware limited liability company with a separate legal
existence from the Company. The Company has sold or contributed certain accounts
receivable arising from the Company's provision of school management services in
the ordinary course of its business and related security to Edison Receivables.
Edison Receivables has its own separate creditors who are entitled to be
satisfied out of Edison Receivables' assets prior to any value in it becoming
available to the Company. The Company has no right, title or interest in Edison
Receivables' assets, including the accounts receivable assigned to it by the
Company.
In November 2001, Edison Receivables entered into a $35.0 million
revolving credit facility with Merrill Lynch Mortgage Capital Inc. ("MLMCI"),
collateralized by certain accounts receivable purchased from or contributed by
the Company. Borrowings are limited to specified percentages of eligible
accounts receivable, as defined. The line of credit had a term of one year.
Interest is determined on a Eurodollar or prime rate basis at the Company's
option. The Company has agreed to pay a commitment fee of .50% per annum on the
unused portion of the commitment.
On July 31, 2002, the revolving credit agreement with MLMCI was amended
to add School Services LLC ("School Services") as an additional lender and MLMCI
as agent of the lenders, increase the line to $55.0 million, and extend the term
of the agreement and the line of credit provided thereunder to June 30, 2003.
The agreement and the line of credit were subsequently extended to July 15,
2003. As of September 30, 2002, $49.3 million was outstanding under this line of
credit bearing interest at LIBOR plus 7.0% and was collateralized by receivables
with a book value of $81.2 million that were sold in a true sale to Edison
7
Receivables by the Company. The agreement requires that the Company observe
certain financial covenants and restrictions including a minimum consolidated
tangible net worth and a maximum consolidated debt to equity ratio.
In addition, the Company separately entered into a Credit and Security
Agreement, dated as of July 31, 2002, with School Services, pursuant to which
the Company has the right to borrow up to $20.0 million, at an interest rate set
at 12.0 percent per annum. The facility will also be reduced by the amount of
certain fees and costs which the Company has agreed to pay School Services and
its affiliates. This facility is collateralized by certain real property owned
by the Company and certain of its subsidiaries, notes payable from charter
schools and other debtors of the Company and substantially all other assets of
the Company. This facility matures on June 30, 2004 but has significant
prepayment obligations tied to refinancings of notes receivable from charter
schools and such other debtors and to any sale or transfer of any such real
property. The agreement requires the Company to observe certain financial
covenants and restrictions including minimum consolidated tangible net worth, a
maximum consolidated debt to equity ratio and a minimum EBITDA requirement for
fiscal 2003. As of September 30, 2002, $20.0 million was outstanding under this
facility.
In connection with the establishment of the credit facilities described
above, the Company also issued warrants for the purchase of up to an aggregate
of 10,710,973 shares of class A common stock of the Company, which equals 16.6%
of the total outstanding shares of common stock of the Company, including the
shares issuable upon exercise of the warrants. The warrants have an exercise
price of $1.00 per share and are exercisable at any time following their
issuance and prior to July 31, 2007.
The value of the warrants on the date of issuance, determined using the
black scholes model, amounted to approximately $6,557 million. This amount has
been credited to additional paid-in capital and deducted and reflected as a
discount in the related indebtedness. The discount will be amortized over the
respective one and two year terms of the related financing agreements.
Also in connection with the establishment of the credit facility, the
Company agreed to pay approximately $8.8 million in fees and costs associated
with the facility, including a $1.6 million payment due upon maturity of the
School Services facility. These fees and costs have been capitalized and being
amortized over the respective term of the facility.
6. Stock-Based Compensation
For financial reporting purposes, the Company accounts for stock-based
compensation in accordance with the intrinsic value method of accounting
prescribed by Accounting Principles Board ("APB") No. 25 "Accounting for Stock
Issued to Employees." In accordance with this method, no compensation expense is
recognized in the accompanying financial statements in connection with the
awarding of stock option grants to employees provided that, as of the grant
date, all terms associated with the award are fixed and the fair value of the
company's stock, as of the grant date, is not greater than the amount an
employee must pay to acquire the stock as defined. To the extent that stock
options are granted to employees with variable terms or if the fair value of the
Company's stock as of the measurement date is greater than the amount an
employee must pay to acquire the stock, then the Company will recognize
compensation expense.
7. Notes Receivable
The Company provides financing in the form of interest and non-interest
bearing loans and advances to charter school boards to assist in the purchase or
renovation of charter school facilities. Certain of the loans are evidenced by
notes and other advances which are made in concert with a management contract or
without fixed repayment terms. In order for the notes to be repaid, the Company
generally assists charter school boards in obtaining third party lender
financing. Often third party financing requires the Company to guarantee loans
on behalf of these charter schools. A default by any charter school under a
credit facility that is guaranteed by the Company may result in a claim against
the Company for the full amount of the borrowings.
Of the approximately $84.9 million of notes and other financing at
September 30, 2002, approximately $65.0 million was collateralized and the
remaining balance of $19.9 million was uncollateralized and in some cases
subordinated to other senior debt. Of the approximately $80.9 million in notes
receivable, net at June 30, 2002, approximately $61.1 million was collateralized
and the remaining balance of $19.8 million was uncollateralized and, in some
cases, subordinated to other senior debt. Although the Company intends to
refinance many of these notes, should the Company be required to foreclose on
the collateral to these notes, it may not be able to liquidate such collateral
for proceeds sufficient to cover the notes.
8
Notes receivable consist of the following:
September 30, 2002 June 30, 2002
------------------ -------------
Notes receivable and other financing due
from charter schools...................... $ 90,468 $ 86,434
Allowance for loan losses ................. (5,541) (5,542)
-------- --------
84,927 80,892
Less, current portion...................... (15,699) (12,480)
-------- --------
Total notes receivable..................... $ 69,228 $ 68,412
======== ========
8. Commitments and Contingencies
Long term lease obligations
The Company has entered into various non-cancelable operating leases
for office space and currently leases school sites. These leases expire at
various dates through the year 2020. In the event that the management agreements
for the schools operating in these facilities are not renewed or are terminated,
the Company would be obligated to continue paying rent on the facilities as
follows:
2003 $ 2,437
2004 3,039
2005 2,821
2006 3,028
2007 3,041
Thereafter 34,400
-------------------
$48,766
===================
In the event of non-renewal or termination, the Company retains the
right to sub-lease the property to another tenant.
Litigation
Between May 15, 2002 and July 3, 2002, ten class action lawsuits were
filed against the Company and certain of its officers and directors in the
United States District Court for the Southern District of New York. These
lawsuits are largely identical and each alleges that the Company and certain of
its officers and directors violated Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934. They seek an unspecified amount of compensatory damages,
costs and expenses related to bringing the actions, and in a few instances,
injunctive relief. Plaintiffs allege that Edison's public disclosures from
November 1999 to March 2002 regarding its financial condition were materially
false and misleading because the Company allegedly improperly inflated its total
revenues by including certain payments, including payments for teacher salaries,
that were paid directly to third parties by local school districts and charter
school boards that contracted with the Company. Several of the lawsuits also
mention two restatements of the Company's financial statements, one regarding a
warrant purchased in 1998 by a philanthropic organization and the other
regarding a severance agreement between the Company and one of its senior
officers, made by the Company as a result of the May 14, 2002 cease-and-desist
order. In July 2002, several plaintiffs filed motions to be appointed lead
plaintiff and also moved to consolidate the ten lawsuits in one action. In
August 2002, those plaintiffs jointly submitted a proposed order pursuant to
which Milberg Weiss would be named lead counsel and a pension fund, the Hawaiian
Electricians Fund, would be named lead plaintiff. The court has not yet ruled on
plaintiffs' motions to consolidate or plaintiffs' proposed order. The Company
believes that it has strong defenses to the claims raised by these lawsuits,
however the outcome of this Litigation cannot be determined at this time. If the
Company were not to prevail, the amounts involved could be material to the
financial position, results of operations and cash flows of the Company.
The Company is also involved in various legal proceedings from time to
time incidental to the conduct of its business. For example, we are currently
involved in lawsuits filed in Baltimore, Maryland and Peoria, Illinois
questioning the authority of these school districts to enter into management
agreements with the Company. In addition, the school district of York,
Pennsylvania has appealed the decision of the state charter-granting authority
to grant a charter to one of the Company's
9
customers. We currently believe that any ultimate liability arising out of such
proceedings will not have a material adverse effect on the Company's financial
position, results of operations or cash flows.
Employment Agreements
The Company has entered into employment agreements with certain of its
executives. Such agreements may be terminated by either the executive or the
Company at any time and provide, among other things, certain termination
benefits. As of September 30, 2002, the aggregate termination benefits of the
executives and certain other employees approximated $1.7 million.
Additionally, the Company has a severance arrangement with its Chairman
that provides for the Chairman to receive a payment if he terminates his
employment for good reason, including not being reappointed to the position of
Chairman. The Chairman would not receive payment in the case of death,
disability, or termination for cause. Included in accrued expenses at September
30, 2002 and June 30, 2002 is approximately $3.2 million related to this
severance arrangement.
Guarantees
The Company has guaranteed certain debt obligations of charter school
boards with which it has management agreements. As of September 30, 2002, the
Company had provided guarantees totaling approximately $20.7 million. These debt
obligations mature from June 2003 to November 2005.
As of September 30, 2002, the debt obligations of the charter school
boards are current. Under the guarantor agreements, the Company is also required
to maintain minimum cash balances that may increase under certain circumstances,
as well as satisfy certain financial reporting covenants. The Company was not in
compliance with a financial covenant under a guarantee of a charter school board
debt obligation with an outstanding balance of approximately $2.5 million at
September 30, 2002. The Company has received notification from the Lender that
it is not immediately making demand under the Guaranty while the Lender works
with the Company to evaluate options. Notwithstanding the foregoing, the Lender
reserves all its rights and remedies under the Guaranty. The company was also
not in compliance with a financial covenant under a guarantee of another charter
school board debt obligation with an outstanding balance of approximately $1.9
million. The company is in discussions with the lender to resolve this.
The Company has an agreement to indemnify a charter board lender from
any liability or obligations related to the presence of any hazardous substance
at a charter school site. The Company does not expect that any sums it may have
to pay in connection with this liability would have a materially adverse effect
on its consolidated financial position, or results of operation for fiscal 2003.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain of the matters and subject areas discussed in this Quarterly
Report on Form 10-Q contain "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. All statements other than
statements of historical information provided herein are forward-looking
statements and may contain information about financial results, economic
conditions, trends and known uncertainties based on our current expectations,
assumptions, estimates and projections about our business and our industry.
These forward-looking statements involve risks and uncertainties. Our actual
results could differ materially from those anticipated in these forward-looking
statements as a result of several factors, as more fully described under the
caption "Additional Risk Factors that May Affect Future Results" and elsewhere
in this Quarterly Report. Readers are cautioned not to place undue reliance on
these forward-looking statements, which reflect management's analysis, judgment,
belief or expectation only as of the date hereof. The forward-looking statements
made in this Quarterly Report on Form 10-Q relate only to events as of the date
on which the statements are made. We undertake no obligation to publicly update
any forward-looking statements for any reason, even if new information becomes
available or other events occur in the future.
Overview
We are the nation's largest private operator of public schools serving
students from kindergarten through 12th grade. We contract with local school
districts and public charter school boards to assume educational and operational
responsibility for individual schools in return for per-pupil funding that is
generally comparable to that spent on other public schools in the
10
area. We opened our first four schools in August 1995 and have grown rapidly in
every subsequent year, currently serving approximately 80,000 students in 150
schools located in 23 states and the District of Columbia.
From our formation in 1992 until opening our first schools in fiscal
1996, we were a development stage company focused on research, development and
marketing of the Edison school design and curriculum and raising capital to
support our business plan. From 1992 until 1995, Edison's team of leading
educators and scholars developed an innovative, research-backed curriculum and
school design. We operated as a partnership prior to November 1996, when we
converted to a corporation. As of September 30, 2002, our accumulated deficit
since November 1996 was approximately $276.3 million. In addition, prior to
November 1996, we incurred losses of approximately $61.8 million, which are
reflected in our additional paid-in capital.
Edison's curriculum expenses include the ongoing costs to maintain and
support Edison's educational design. These expenses include the salaries and
wages of trained educators in our central office curriculum department, the
costs of providing professional training to our staff and teachers, including
materials, and the ongoing costs of maintaining and updating the teaching
methods and educational content of our program.
We make a significant investment in each school we open. The investment
generally includes: o Initial staff training and professional development; o
Technology, including laptop computers for teachers; o Books and other materials
to support the Edison curriculum and school design; and o Upgrades in
facilities.
Gross Student Funding
Gross student funding represents the gross contractual funding for our
schools before all expenses. The difference between gross student funding and
net revenues consists of costs that Edison is not primarily obligated to pay.
Gross student funding is not equivalent to revenue as defined by
generally accepted accounting principles.
Net Revenue
Revenues are principally earned from contractual agreements to manage
and operate contract and charter schools. The Company also earns revenue from
summer school and after-school program fees. The Company recognizes revenue for
each managed school pro rata over the eleven months from August through June,
typically the period over which we perform our services, in accordance with
Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements."
Most of our management agreements provide that we earn a fee based upon
the number of children that attend our schools and, therefore, we only earn
revenue to the extent students attend our schools. In most instances, there is a
'base' fee per pupil and several 'categorical' fee components paid only for
students in certain categories (e.g., low-income, English as a second language,
etc.). In some of our schools, our fee has a fixed component and variable
component. Even in contracts where we have a fixed fee component, we have
generally agreed to forego or reduce our fee if there is a budget shortfall at
the charter school.
The Company is generally responsible to its clients for all aspects of
the management of its schools including but not limited to the academic
achievement of the students; selection, training and compensation of school
personnel; procurement of curriculum and equipment necessary for operations of
the school; and the safe operation of the school facilities. Gross student
funding represents gross contractual funding for our schools before all costs.
Net revenue represents gross student funding less costs that we are not
primarily obligated to pay. The Company follows the guidance of EITF 99-19,
"Reporting Revenue Gross as a Principal versus Net as an Agent," and EITF 01-14,
"Income Statement Characterization of
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Reimbursements Received for 'Out-of-Pocket' Expenses Incurred" regarding
classification of revenues. Specifically, the Company recognizes revenues net of
expenses that the Company is not primarily obligated to pay.
The Company recognizes per-pupil funding from local, state and federal
sources, including Title I and special education funding. Significant management
estimates and assumptions are required to determine these funding levels,
particularly in interim periods. On a quarterly basis, the Company records
adjustments to revenue, if necessary, for enrollment fluctuations, changes to
per-pupil funding estimates, and changes to estimates for federal and state
categorical grant funding. Anticipated losses on contracts are charged to
earnings when identified.
In January 2002, the Emerging Issues Task Force ("EITF") issued EITF
01-14 "Income Statement Characterization of Reimbursements Received for
'Out-of-Pocket' Expenses Incurred." EITF 01-14 clarifies EITF 99-19, "Reporting
Revenue Gross as a Principal versus Net as an Agent," which provides guidance on
whether revenues should be presented gross or net of certain costs. After
consultation with its independent auditors, the Company believes that EITF 01-14
should be interpreted to require it to present as revenue and expense only those
direct site expenses that the Company is primarily obligated to pay. In
accordance with the transition provisions of EITF 01-14, the Company adopted
EITF 01-14 effective January 1, 2002 and has reclassified all historical periods
to conform with the new presentation and, in the interest of transparency, added
a "gross student funding" line to its statements of operations. Gross student
funding is not equivalent to revenue as defined by GAAP.
In November 2001, the EITF issued EITF 01-09, "Accounting for
Consideration Given by a Vendor to a Customer." EITF 01-09 addresses the
appropriate income statement characterization of consideration given by a vendor
to a customer, specifically whether that consideration should be presented in
the vendor's income statements as a reduction of revenue or as an expense. In
consultation with its independent auditors the Company determined that
consideration given to two customers was, in effect, an adjustment of the
Company's contract price and should be accounted for as a reduction in revenue
rather than as an expense subsequent to the promulgation of EITF 01-09. In
accordance with the transition provisions of EITF 01-09, the Company adopted
EITF 01-09 effective January 1, 2002 and has reclassified all historical periods
to conform with the new presentation.
Direct Site Expenses
Direct site expenses include most of the expenses incurred on-site at
our schools. The largest component of this expense is salaries and wages,
primarily for principals and teachers, which are often paid for by our clients
on our behalf, in which case they are disclosed as "direct site expense--client
paid." The remaining direct site expenses include on-site administration,
facility maintenance, utilities and, in some cases, student transportation. Once
staffing levels for the school year are determined, most of these expenses are
fixed, and accordingly, variations in enrollment will generally not change the
overall cost structure of a school for that year. Direct site expenses do not
include teacher training and other pre-opening expenses associated with new
schools, financing costs or depreciation and amortization related to technology,
including computers for teachers and students, curriculum materials and capital
improvements to school buildings.
Gross Site Contribution
We define gross site contribution as net revenue less direct site
expenses. Gross site contribution is a measurement of ongoing site-level
operating performance of our schools. We believe it serves as a useful operating
measurement when evaluating our schools' financial performance. Gross site
contribution does not reflect all site-related costs, including depreciation and
amortization or interest expense and principal repayment related to site-level
investments, or on-site pre-opening expenses, and accordingly gross site
contribution does not represent site-level profitability.
Administration, Curriculum and Development Expenses
Support from our central office is important for the successful
delivery of our curriculum and school design. Administration, curriculum and
development expenses include those amounts related to the creation and
enhancement of our curriculum, and our general, administrative and sales and
marketing functions. These costs include costs for curriculum, assessment and
training professionals, sales and marketing personnel, financial reporting,
legal, technological support, travel expenses and other development activities.
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Pre-Opening Expenses
Pre-opening expenses consist principally of various administrative and
personnel costs incurred prior to the opening of a new school or the expansion
of an existing school, particularly the costs for the initial training and
orientation of professional staff, recruitment and travel expenses and expenses
for temporary offices and staff. In connection with the establishment of a new
school, we seek to hire the school's principal several months in advance of the
school's opening. This allows the principal to hire staff, most of whom receive
substantial professional training in the Edison education design prior to the
first day of school. Pre-opening expenses generally are first incurred in the
fourth quarter of the fiscal year prior to the school's opening or expansion and
generally continue into the first or second quarter of the fiscal year in which
the school opens. These costs are expensed as incurred.
Depreciation and Amortization
Depreciation and amortization relates primarily to the investments we
make in each school for books and other educational materials, including
enrollment fees for the Success for All program, computers and other technology,
and facility improvements. These investments support the Edison curriculum and
school design and relate directly to our provision of educational services. The
depreciation and amortization of investments in our central office is also
included.
Enrollment
Our annual budgeting process establishes site-specific revenue and
expense objectives, which include assumptions about enrollment and anticipated
per-student funding. While our budgets include desired enrollment levels, we do
not attempt to maximize enrollment based upon the physical capacity of our
facilities. Our budgets are designed to achieve both financial and academic
goals, both of which we believe are critical to the success of our business.
Therefore, our budgets are designed to achieve the proper balance between
financial performance and academic standards. We implement various strategies to
achieve optimal enrollment, including local recruiting, media advertising, and
coordinating with our school district partners and community groups. Since some
site costs are partially fixed, incremental enrollment can positively affect
profitability. Further, due to the closely correlated relationship of site
revenue and expenses, school personnel closely manage expenses based upon actual
enrollment.
Reengineering
On August 21, 2002, the Company announced several initiatives emerging
from a company-wide "reengineering" effort. The initiatives are intended to
redesign Edison's infrastructure to improve service delivery to its schools;
increase student achievement and customer satisfaction; and accelerate Edison's
path to profitability. Among other changes, the Company announced significant
improvements in its headquarters operations including an enhanced customer
service function; strengthening of its financial reporting and facilities
financing unit; a ramp up of its communications function; a more efficient
organization of its general financial function, and an alignment of its internal
functions with a consolidated and streamlined regional structure. The Company
has and will continue to incur expenses related to this reengineering.
Results of Operations
Fiscal Quarter Ended September 30, 2002 Compared to Fiscal Quarter Ended
September 30, 2001
Net Revenue. Our net revenue decreased to $73.1 million for the three
months ended September 30, 2002 from $89.7 million for the same period in the
prior year, a decrease of 18.5%. The decrease was primarily due to a significant
new contract that is accounted for on a fixed fee basis versus our traditional
gross approach and the ending of certain unprofitable client relationships
offset by new revenue from a 8.1% increase in student enrollment (excluding
summer school students) from approximately 74,000 in the 2001-2002 school year
to approximately 80,000 in the 2002-2003 school year, reflecting both the
opening of new schools and the expansion of existing schools.
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Direct Site Expenses. Our direct site expenses decreased to $64.6
million for the three months ended September 30, 2002 from $80.4 million for the
same period in the prior year, a decrease of 19.7%. The decrease in direct site
expenses was primarily due to a significant new contract that is accounted for
on a fixed fee basis versus our traditional gross approach and the ending of
certain unprofitable client relationships offset by the 8.1% increase in student
enrollment. The largest element of direct site expenses is personnel costs.
Personnel costs included in direct site expenses decreased to $56.0 million for
the quarter ended September 30, 2002 from $64.9 million for the same period in
the prior year. Of the total direct site expense, $29.6 million was client paid,
down from $39.7 million in the same period of the prior year. These client paid
expenses consist entirely of personnel costs at our schools.
Gross Site Contribution. Our gross site contribution was $8.5 million
for the three months ended September 30, 2002 compared to $9.4 million for the
same period in the prior year. If you adjust the September 30, 2001 gross site
contribution for $2.7 million of revenues from a one-time consulting engagement,
our gross site contribution was $8.5 million for the three months ended
September 30, 2002 compared to $6.7 million for the same period of the prior
year. The increase in gross site contribution was due to a decrease in cost of
providing services, primarily as a result of the ending of certain unprofitable
client relationships and improved operations at existing schools, which were the
result of providing best practice standards between schools in non-personnel
expenses.
Administration, Curriculum and Development Expenses. Our
administration, curriculum and development expenses increased to $15.9 million
for the three months ended September 30, 2002 from $11.1 million for the three
months ended September 30, 2001, an increase of 43.2%. Excluding non-cash stock
compensation charges and credits in both years and non-recurring charges in
connection with a consulting engagement in fiscal 2002, our administration,
curriculum and development expenses increased to $15.8 million for the three
months ended September 30, 2002 from $14.0 million for the three months ended
September 30, 2001, an increase of 12.9%. The increase was due, in part, to
greater personnel costs resulting from an increase over a 12 month period of
approximately 100 new headquarters employees and an accrual of $400,000 for
severed employees, as a result of our re-engineering. We expect the effects of
the decline in headquarters personnel from the re-engineering will be evident in
future quarters.
Depreciation and Amortization. Our depreciation and amortization
increased to $10.0 million for the three months ended September 30, 2002 from
$7.9 million for the three months ended September 30, 2001, an increase of
26.6%. The increased depreciation and amortization resulted from additional
capital expenditures for our curriculum materials, computers and related
technology, and facility improvements related to our enrollment and central
office growth.
Pre-Opening Expenses. Our pre-opening expenses decreased to $2.0
million for the three months ended September 30, 2002 from $3.7 million for the
three months ended September 30, 2001, a decrease of 45.9%. This decrease was
associated primarily with opening new schools, of which all but two were in
Philadelphia. As all training was conducted in Philadelphia, the Company spent
significantly less in airfare, hotels and meals as compared to the same period
for the prior year.
Education and Operating Expenses. Our total education and operating
expenses decreased to $92.5 million for the three months ended September 30,
2002 from $103.1 million for three months ended September 30, 2001.
EBITDA, Net of Other Charges. EBITDA, net of other charges, means the
net loss we would have shown if we did not take into consideration our interest
expense, interest income, income tax expense, depreciation and amortization and
stock-based compensation charges and credits. These costs are discussed above.
This amount for the three months ended September 30, 2002 was a negative $9.3
million compared to a negative $10.8 million for the three months ended
September 30, 2001. The increase in EBITDA, net of other charges, resulted
primarily from site based operational improvements. On a per-student basis
(excluding summer school students), EBITDA, net of other charges improved to
negative $117 in the three months ended September 30, 2002 compared to negative
$146 for the same period of the prior year.
Loss from Operations. Our loss from operations increased to $19.4
million for the three months ended September 30, 2002 from $13.3 million for the
three months ended September 30, 2001, an increase of 45.9%. Excluding stock
compensation charges and credits and non-recurring charges in connection with a
consulting engagement in fiscal 2002, our loss from operations increased to
$19.5 million for the first quarter of fiscal 2003 from $19.2 million for the
first quarter of fiscal 2002, an increase of 1.6%.
Other Income and Expense. Other income, net, was $0.08 million for the
three months ended September 30, 2002 compared to $0.8 million in the three
months ended September 30, 2001. The decline was primarily due to the $0.7
million increase in interest expense.
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Net Loss and Net Loss Attributable to Common Stockholders. Our net loss
increased to $19.7 million for the three months ended September 30, 2002 from
$12.7 million for the three months ended September 30, 2001, an increase of
55.1%. Excluding stock compensation charges and credit, our net loss increased
to $19.6 million for the three months ended September 30, 2002 from $18.0
million for the three months ended September 30, 2001, an increase of 8.9%.
Liquidity and Capital Resources
We have historically operated in a negative cash flow position. To date
we have financed our cash needs through a combination of equity and debt
financing. We have also utilized debt and equipment leasing arrangements to
finance computers and other technology investments in our schools.
On October 3, 2001, the Company formed Edison Receivables Company LLC
("Edison Receivables") for the purpose of purchasing and financing certain
receivables of the Company. The Company owns all of the membership interests in
Edison Receivables, a Delaware limited liability company with a separate legal
existence from the Company. The Company has sold or contributed certain accounts
receivable arising from the Company's provision of school management services in
the ordinary course of its business and related security to Edison Receivables.
Edison Receivables has its own separate creditors who are entitled to be
satisfied out of Edison Receivables' assets prior to any value in it becoming
available to the Company. The Company has no right, title or interest in Edison
Receivables' assets, including the accounts receivable assigned to it by the
Company.
In November 2001, Edison Receivables entered into a $35.0 million
revolving credit facility (the "MLMCI Facility") with Merrill Lynch Mortgage
Capital Inc. ("MLMCI"), collateralized by certain accounts receivable purchased
from or contributed by the Company. Borrowings are limited to specified
percentages of eligible accounts receivable, as defined. The MLMCI Facility
originally had a term of one year, with interest determined on a Eurodollar or
prime rate basis at the Company's option and a commitment fee of .50% per annum
on the unused portion of the commitment.
On July 31, 2002, the MLMCI Facility was amended to add School Services
LLC ("School Services") as an additional lender and MLMCI as agent of the
lenders, increase the line of credit to $55.0 million, and extend the term of
the agreement and the line of credit provided thereunder to June 30, 2003. The
agreement and the line of credit were subsequently extended to July 15, 2003.
The interest rate under the amended MLMCI Facility was increased to LIBOR plus
7.0% or prime plus 4.5% at the Company's option. We agreed to pay certain fees
and costs related to the MLMCI Facility, aggregating approximately $3.2 million.
As of September 30, 2002, $49.3 million was outstanding under this line of
credit bearing interest at LIBOR plus 7.0% and was collateralized by receivables
with a book value of $81.2 million that were sold in a true sale to Edison
Receivables by the Company. The agreement requires that the Company observe
certain financial covenants and restrictions including a minimum consolidated
tangible net worth and a maximum consolidated debt to equity ratio.
Additionally, on July 31, 2002 the Company entered into a two-year
Credit and Security Agreement (the "New Credit Facility") with School Services,
which provides for a term loan in the amount of $10.0 million, collateralized by
property held by 110th and 5th Associates, LLC, a wholly owned subsidiary of the
Company, and a revolving loan not to exceed $10.0 million, collateralized by all
the Company's assets other than the property collateralizing the term loan.
Interest on both the term and revolving loans was set at 12.0% per annum. The
facility will be reduced by the amount of certain fees and costs which the
Company has agreed to pay School Services and its affiliates, aggregating
approximately $2.8 million. Additionally, we agreed to pay a fee of $1.6 million
at loan maturity or the earlier prepayment of the term loan component of the
facility. This facility is secured by certain real property owned by the Company
and certain of its subsidiaries, notes payable from charter schools and other
debtors of the Company and all other assets of the Company generally, other than
accounts receivable sold to Edison Receivables. This facility matures on June
30, 2004. However, the loan commitment is to be reduced by an agreed upon
percentage of the net proceeds of any refinancing paid to the Company. The
agreement requires the Company to observe certain financial covenants and
restrictions including a minimum consolidated tangible net worth, a maximum
consolidated debt to equity ratio and a minimum EBITDA requirement for fiscal
2003. As of September 30, 2002 $20.0 million was outstanding under these
facilities.
15
In connection with the establishment of the amended MLMCI Facility and
the New Credit Facility, the Company also issued warrants for the purchase of up
to 10,710,973 shares of Class A common stock of the Company, which equals 16.6%
of the total outstanding shares of common stock of the Company, including the
shares issuable upon exercise of the warrants. The warrants have an exercise
price of $1.00 per share and are exercisable at any time following their
issuance and prior to July 31, 2007.
For the three months ended September 30, 2002, we used approximately
$26.3 million for operating activities. This use primarily resulted from $19.7
million of net loss and a $16.1 million net decrease in working capital accounts
partially offset by depreciation and amortization totaling $9.0 million.
For the three months ended September 30, 2002, we used approximately
$6.6 million in investing activities. During this period, we invested
approximately $5.9 million in our schools and central office. This amount
includes the investments we made in technology and curriculum in each of the
schools we open. We have also advanced funds to our charter board clients or
their affiliates to help obtain, renovate and complete school facilities. The
amounts advanced for the three months ended September 30, 2001 were
approximately $4.0 million. During this same period, we also received
approximately $2.0 million in repayments on advances previously made. Also, the
Company invested approximately $1.1 million in other assets.
For the three months ended September 30, 2002, we received, net,
approximately $23.8 million for our financing activities. These amounts include
borrowings of under our lines of credit $25.3 million and borrowings under
our term loan of $10.0 million. These proceeds were partially offset by costs in
connection with our equity financing of $7.1 million and the repayment of notes
payable and capital lease obligations totaling $4.8 million.
We expect our cash on hand, together with borrowings under financing
arrangements, as mentioned above, and expected reimbursements of advances we
have made to charter boards, will be sufficient to meet our working capital
needs to operate our existing schools through fiscal 2003. Our near-term capital
needs are generally growth related and are dependent upon our rate of growth and
our mix of charter schools and contract schools, as charter schools usually
require us to advance funds to help charter boards obtain, renovate and complete
school facilities. We anticipate refinancing with third-party lenders up to
$50.0 million of loans we have made to charter boards to fund our current growth
plans for the 2003-2004 school year. While we have completed such financings in
the past, we cannot be certain we will obtain such financing on favorable terms,
if any. To the extent we cannot raise sufficient funds through the refinancing
of our loans to charter boards with third-party lenders, we may seek additional
capital through offerings of debt or equity securities and expanded financing
arrangements or reduce our growth plans. Depending on the terms of any financing
arrangements, such funding may be dilutive to existing shareholders, and we
cannot be certain that we will be able to obtain additional financing on
favorable terms, if at all. Notwithstanding the above statements, management
does not presently have any intention of issuing any substantial incremental
equity in the near term other than equity associated with management
compensation plans
Our longer term cash requirements are for capital to fund capital
expenditures related to growth, anticipated working capital needs and general
corporate purposes. We expect to fund such expenditures and other longer term
liquidity needs with cash generated from operations, the proceeds from offerings
of debt or equity securities and expanded financing arrangements. Depending on
the terms of any financing arrangements, such funding may be dilutive to
existing shareholders, and we cannot be certain that we will be able to obtain
additional financing on favorable terms, if at all.
We ran summer school programs for 51 districts in the state of Missouri
during May, June and July of 2002. We spent approximately $19 million, which
includes teachers' salaries, curriculum and other educational/promotional
materials, over the two month period. Of the amounts we recognized as revenue
for the 2002 summer program, payment terms of the related billings range from 12
to 18 months. Therefore, cash receipts of revenue will lag outlay of cash for
expenditures by more than one year. Of the amounts we recognized as revenue for
the 2001 summer school program, 84.6% of the revenue had been collected as of
November 14, 2002 with the remainder scheduled for collection through January
2003.
In general, our ability to achieve positive cash flow will be dependent on the
volume of schools with positive gross site contribution to offset central office
and overhead expenses. Because gross site contribution is the difference between
site revenue and site expenditures, positive gross site contribution can be
achieved at a range of enrollment levels. While higher enrollment tends to have
a positive effect on gross site contribution, our growth and cash flow do not
depend on 100% enrollment.
Capital expenditures for fiscal 2003 are expected to be approximately
$15.0 million, which includes approximately $5.0 million for computers and
other technology at our schools, approximately $7.0 million for curriculum
materials,
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approximately $1.0 million for the purchase and improvement of property at our
schools, and $2.0 million for technology, leasehold improvements, and other
capital items at our headquarters. Additionally, we expect to make additional
advances or loans approximating $7.0 million to new charter board clients to
help secure and renovate school properties during the 2002-2003 school year
pursuant to our philanthropic commitments, a portion of which we expect will be
refinanced through third parties. In addition, we expect to make charitable
donations of approximately $3.0 million to benefit one of our clients.
Additional Risk Factors That May Affect Future Results
Our business, operating results or financial condition could be
materially adversely affected by any of the following factors. You should also
refer to the information set forth in this report, including our financial
statements and the related notes.
We have a history of losses and may not achieve profitability in the future
We have incurred substantial net losses in every fiscal period since we
began operations. For the quarter ended September 30, 2002, our net loss was
$19.7 million. As of September 30, 2002, our accumulated deficit since November
1996, when we converted from a partnership to a corporation, was approximately
$276.3 million. In addition, prior to November 1996, we incurred losses of
approximately $61.8 million, which are reflected in our additional paid-in
capital. We have not yet demonstrated that we can profitably manage public
schools. In order to achieve profitability, we believe it will be necessary to
improve gross site margin while maintaining educational quality and continuing
to reduce central expenses as a percentage of net revenue. We have recently
undertaken a "reengineering" process intended to increase our efficiency and
help us attain profitability while improving client service. There can be no
assurance, however, that we will be successful in meeting the objectives of the
reengineering. Even if we do achieve profitability, we may not sustain or
increase profitability on a quarterly or annual basis. Failure to become and
remain profitable may adversely affect the market price of our class A common
stock and our ability to raise additional capital and continue operations.
The private, for-profit management of public schools remains a relatively new
and uncertain industry, and it may not become publicly accepted
Our future is highly dependent upon the development, acceptance and
expansion of the market for private, for-profit management of public schools.
This market has only recently developed, and we are among the first companies to
provide these services on a for-profit basis. We believe the first meaningful
example of a school district contracting with a private company to provide core
instructional services was in 1992, and we opened our first schools in August
1995. The development of this market has been accompanied by significant press
coverage and public debate concerning for-profit management of public schools.
If this business model fails to gain acceptance among the general public,
educators, politicians and school boards, we may be unable to grow our business
and the market price of our class A common stock would be adversely affected.
The success of our business depends on our ability to improve the academic
achievement of the students enrolled in our schools and we may face difficulties
in doing so in the future
We believe that our growth will be dependent upon our ability to
demonstrate general improvements in academic performance at our schools. Our
management agreements contain performance requirements related to test scores.
To the extent average student performance at our schools increases, whether due
to improvements in achievement over time by individual students in our schools
or changes in the average performance levels of new students entering our
schools, aggregate absolute improvements in student performance will be more
difficult to achieve. If academic performance at our schools declines, is
perceived to decline, or simply fails to improve, we could lose business and our
reputation could be seriously damaged, which would impair our ability to gain
new business or renew existing school management agreements.
We could incur losses at our schools if we are unable to enroll enough students
Because the amount of revenue we earn for operating each school
primarily depends on the number of students enrolled, and because many facility
and on-site administrative costs are fixed, achieving site-specific enrollment
objectives is an important factor in our ability to achieve satisfactory
financial performance at a school. We may be unable to recruit enough students
to attend all grades in our new schools or maintain enrollment at all grades in
our existing schools. We sometimes do not have enough students to fill some
grades in some schools, particularly the higher grades. It is sometimes more
difficult to enroll students in the higher grades because older students and
their parents are reluctant to change schools.
17
To the extent we are unable to meet or maintain enrollment objectives at a
school, the school will be less financially successful and our financial
performance will be adversely affected.
We may not be able to attract and retain highly skilled principals and teachers
in the numbers required to grow our business
Our success depends to a very high degree on our ability to attract and
retain highly skilled school principals and teachers. Currently, there is a
well-publicized nationwide shortage of teachers and other educators in the
United States. In addition, we may find it difficult to attract and retain
principals and teachers for a variety of reasons, including, but not limited to,
the following:
o we generally require our teachers to work a longer day and a
longer year than most public schools;
o we tend to have a larger proportion of our schools in
challenging locations, such as low-income urban areas, which
may make attracting principals and teachers more difficult;
and
o we believe we generally impose more accountability on
principals and teachers than do public schools as a whole.
These factors may increase the challenge we face in an already
difficult market for attracting principals and teachers. We have also
experienced higher levels of turnover among teachers than is generally found in
public schools nationally, which we attribute in part to these factors. If we
fail to attract and retain highly skilled principals and teachers in sufficient
numbers, we could experience client dissatisfaction and lost growth
opportunities, which would adversely affect our business.
We must open a large number of new schools in a short period of time at the
beginning of each school year and, if we encounter difficulties in this process,
our business and reputation could suffer
It is the nature of our business that virtually all of the new schools
we open in any year must be opened within a few weeks of each other at the
beginning of the school year. Each new school must be substantially functional
when students arrive on the first day of school. This is a difficult logistical
and management challenge, and the period of concentrated activity preceding the
opening of the school year places a significant strain on our management and
operational functions. We expect this strain will increase if we are successful
in securing larger numbers of school management agreements in the future. If we
fail to successfully open schools by the required date, we could lose school
management agreements, incur financial losses and our reputation as well as our
ability to attract future clients would be damaged.
We depend upon cooperative relationships with teachers' unions, both at the
local and national levels
Union cooperation at the local level is often critical to us in
obtaining new management agreements and renewing existing management agreements.
In those school districts subject to collective bargaining, provisions of
collective bargaining agreements must typically be modified in areas such as
length of school day, length of school year, negotiated compensation policies
and prescribed methods of evaluation in order to implement the Edison design at
a contract school. We regularly encounter resistance from local teachers' unions
during school board debates over whether to enter into a management agreement
with us. In addition, local teachers' unions have occasionally, albeit
ultimately unsuccessfully, initiated litigation challenging our management
agreements. If we fail to achieve and maintain cooperative relationships with
local teachers' unions, we could lose business and our ability to grow could
suffer. In addition, at the national level, the American Federation of Teachers
and the National Education Association have substantial financial and other
resources that could be used to influence legislation, local teachers' unions
and public opinion in a way that would hurt our business.
We could be liable for events that occur at our schools
We could become liable for the actions of principals, teachers and
other personnel in our schools. In the event of on-site accidents, injuries or
other harm to students, we could face claims alleging that we were negligent,
provided inadequate supervision or were otherwise liable for the injury. We
could also face allegations that teachers or other personnel committed child
abuse, sexual abuse or other criminal acts. In addition, if our students commit
acts of violence, we could face allegations that we failed to provide adequate
security or were otherwise responsible for their actions, particularly in light
of recent highly publicized incidents of school violence. Although we maintain
liability insurance, this insurance coverage may not be adequate to fully
protect us from these kinds of claims. In addition, we may not be able to
maintain our liability
18
insurance in the future at reasonable prices or at all. A successful liability
claim could injure our reputation and hurt our financial results. Even if
unsuccessful, such a claim could cause unfavorable publicity, entail substantial
expense and divert the time and attention of key management personnel, which
could cause our financial results to suffer.
Our management agreements with school districts and charter boards are
terminable under specified circumstances and generally expire after a term of
five years
Our management agreements generally have a term of five years. We
cannot be assured that any management agreements will be renewed at the end of
their terms. In addition, some of our management agreements may be terminated by
the school district or charter board at will, with or without good reason, and
all of our management agreements may be terminated for cause, including in some
cases for failure to meet specified educational standards, such as academic
performance based on standardized test scores. As a result of payment disputes
or changes within a school district, such as changes in the political climate,
we do from time to time face pressure to permit a school district or charter
board to terminate our management agreement even if they do not have a legal
right to do so. We may also seek the early termination of, or not seek to renew,
a limited number of management agreements in any year. If a significant number
of management contracts are not renewed or are terminated, it could have a
material adverse effect on our financial condition and results of operations.
Our largest management agreement to date is terminable "at will" by the client
and under other specified circumstances
On August 1, 2002, the company signed an agreement to manage 26 schools
in Philadelphia. It is our largest cluster of schools to date. This agreement
has been and continues to be the subject of substantial attention in education
and business circles as well as in the local and national press. The contract is
subject to termination at will by the school district. The contract is also
subject to termination if we fail to meet our obligations, including meeting
specified student achievement targets. If the contract is terminated, or if we
fail to successfully deliver the program, raise student achievement or manage
the program's costs, our financial results, operations and reputation may be
adversely affected.
Our management agreements involve financial risk
Under the majority of our management agreements, we agree to operate a
school in return for per-pupil funding that generally does not vary with our
actual costs. To the extent our actual costs under a management agreement exceed
our budgeted costs, or our actual revenue is less than planned because we are
unable to enroll as many students as we anticipated or for any other reason, we
could lose money at that school. In addition, from time to time we have
disagreements with our clients as to the actual amount of, or the method of
calculating, the revenue owed to us under the terms of the management
agreements, resulting in lower revenue than planned. We are generally obligated
by our management agreements to continue operating a school for the duration of
the contract even if it becomes unprofitable to do so.
We have limited experience operating four-year high schools
An element of our strategy is to increase our business with existing
customers by opening new schools in school districts with whom we have an
existing relationship. An important aspect of this strategy is to open Edison
high schools in districts in which we operate elementary and middle schools.
Because we have limited experience operating high schools, our complete high
school curriculum, school design and operating plan are not fully tested. In
addition, school districts typically spend more per pupil on high school
education than on elementary education. By contrast, some of our management
agreements provide that we recognize for each student, regardless of grade
level, the average per-pupil funding spent by the school district for all grade
levels. For this reason, in these schools we recognize less funding per high
school student than is spent by the school district for each of its high school
students. In these situations, our success depends upon our ability to deliver
our high school design based on the same per-pupil spending as in our elementary
schools. If we are unable to successfully and profitably operate high schools,
our ability to pursue our growth strategy will be impaired, which could
adversely affect the market price of our class A common stock.
Our lengthy sales cycle and uncertainties inherent in the process through which
we develop new business could delay new business and affect our rate of growth
The time between initial contact with a potential contract or charter
client and the ultimate opening of a school, and related recognition of revenue,
typically ranges between 9 and 27 months. Our sales cycle for contract schools
is generally lengthy due to the approval process at the local school board
level, the political sensitivity of converting a public school to
19
private management and the need, in some circumstances, for cooperation from
local unions. We also have a lengthy sales cycle for charter schools for similar
reasons, as well as the need to arrange for facilities to house the school. In
addition, we are increasingly presented with potential opportunities to take
over the management of several schools in a single district or area at the same
time, which likewise have a lengthy sales cycle. The outcome of these
opportunities can have a meaningful effect on our rate of growth. As a result of
our lengthy sales cycle, we have only a limited ability to forecast the timing
of new management agreements. Any delay in completing, or failure to complete,
management agreements could hurt our financial performance. Press speculation
concerning the outcome of these processes may adversely affect our stock price
from time to time.
We could lose money if we underestimate the real estate costs associated with
acquiring or renovating a charter school
If we incur unexpected real estate cost overruns in acquiring or
renovating a charter school, we could lose money in operating the school. Our
decision to enter into a management agreement for a charter school and our
estimate of the financial performance of the charter school, are based, in part,
on the estimated facility financing cost associated with renovating an existing
facility or building a new facility to house the charter school. This cost
varies widely from minimal amounts for minor upgrades to larger amounts for a
new construction, which typically range from $4.0 million to $10.0 million, per
facility. If these expenses exceed our estimates for the charter school, the
charter school could lose money and our financial results would be adversely
affected.
We have advanced and loaned money to charter school boards that may not be
repaid
As of September 30, 2002, we have outstanding loans or advances to
charter boards of $84.9 million, net of allowances, to finance the purchase or
renovation of school facilities we manage. Approximately $19.9 million of these
loans, representing 16 schools, are uncollateralized or subordinated to a senior
lender. In addition, with respect to the loans that are collateralized, if we
were required to foreclose on the collateral securing those loans, we might not
be able to liquidate the collateral for proceeds sufficient to cover the loan
amount. If any of these advances or loans are not repaid when due, our financial
results could be adversely affected.
Some of our charter schools recently obtained tax-exempt financing to
repay these loans and advances, but there can be no assurance that our other
charter schools will be able to obtain such tax-exempt financing. While we are
currently exploring a variety of other financing structures to assist charter
schools in repaying these loans and advances, there can be no assurance that we
will be able to implement any of these financing structures.
We could become liable for financial obligations of charter boards
We could have facility financing obligations for charter schools we no
longer operate, because the terms of our facility financing obligations for some
of our charter schools exceeds the term of the management agreement for those
schools. For nine of our charter schools, we have entered into a long-term lease
for the school facility that exceeds the current term of the management
agreement by as much as 15 years. If our management agreements were to be
terminated, or not renewed in these charter schools, our obligations to make
lease payments would continue, which could adversely affect our financial
results. For example, as of December 2001, we terminated a management agreement
covering three schools for which we continue to have a long-term lease
obligation in connection with the school's facilities. Although we have signed a
lease with the school covering the 2002-2003 school year, we have no assurance
that the lease will be renewed or that we will be able to find other tenants to
lease the facility.
As of September 30, 2002, our aggregate future lease obligations
totaled $48.8 million, with varying maturities over the next 20 years. In nine
of our charter schools, we have provided some type of permanent credit support
for the school building, typically in the form of loan guarantees or cash
advances. As of September 30, 2002 the amount of loans we had guaranteed totaled
$20.7 million. Although the term of these arrangements is coterminous with the
term of the corresponding management agreement, our guarantee does not expire
until the loan is repaid in full. The lenders under these facilities are not
committed to release us from our obligations unless replacement credit support
is provided. The default by any charter school under a credit facility that we
have guaranteed could result in a claim against us for the full amount of the
borrowings. Furthermore, in the event any charter board becomes insolvent or has
its charter revoked, our loans and advances to the charter board may not be
recoverable, which could adversely affect our financial results. In addition, we
have generally indemnified our charter school and contract school partners from
any liability or damages occurring or allegedly occurring or arising out of any
environmental conditions at the school site, if such conditions were caused or
created by substances brought on the site by Edison.
20
Our financial results are subject to seasonal patterns and other fluctuations
from quarter to quarter
We expect our results of operations to experience seasonal patterns and
other fluctuations from quarter to quarter. The factors that could contribute to
fluctuations, which could have the effect of masking or exaggerating trends in
our business and which could hurt the market price of our class A common stock,
include:
o Because new schools are opened in the first fiscal quarter of
each year, increases in student enrollment and related revenue
and expenses will first be reflected in that quarter.
Subsequent to the first quarter, student enrollment is
expected to remain relatively stable throughout a school year,
and, accordingly, trends in our business, whether favorable or
unfavorable, will tend not to be reflected in our quarterly
financial results, but will be evident primarily in
year-to-year comparisons.
o We recognize revenue for each managed school pro rata over the
11 months from August through June, typically the period over
which we perform our services and, except for revenue related
to our summer school programs, we recognize no school revenue
in July. Most of our site costs are also recognized over the
11 months from August through June. For this reason, the first
quarter of our fiscal year has historically reflected less
revenue and lower expenses than the other three quarters, and
we expect this pattern to continue.
o Our recognition of site-related expenses in the first fiscal
quarter is proportionally greater than the revenue recognition
because some site expenses are incurred in July and no revenue
is recorded in July, with the exception of revenue related to
our summer school programs. This results in lower gross site
margin in the first fiscal quarter than in the remaining
fiscal quarters. We also recognize pre-opening costs primarily
in the first and fourth quarters.
o We recognize revenue from our summer school programs during
the first and fourth fiscal quarters. To the extent our summer
school program becomes a more significant part of our
business, this could significantly alter seasonal patterns.
Our financial results can vary among the quarters within any fiscal
year for other reasons, including unexpected enrollment changes, greater than
expected costs of opening schools or delays in opening new schools.
We expect our market to become more competitive
We expect the market for providing private, for-profit management of
public schools will become increasingly competitive. Currently, we compete with
a relatively small number of companies that provide these services, and they
have to date primarily focused on the operation of charter schools. Some of
these companies have begun to compete with us for contract schools. In addition,
a variety of other types of companies and entities could enter the market,
including colleges and universities, private companies that operate higher
education or professional education schools. Our existing competitors and new
market entrants could have financial, marketing and other resources
significantly greater than ours. We also compete for public school funding with
existing public schools, who may elect not to enter into management agreements
with private managers or who may pursue alternative reform initiatives, such as
magnet schools and inter-district choice programs. In addition, in jurisdictions
where voucher programs have been authorized, we will begin to compete with
existing private schools for public tuition funds. Voucher programs provide for
the issuance by local or other governmental bodies of tuition vouchers to
parents worth a certain amount of money that they can redeem at any approved
school of their choice, including private schools. If we are unable to compete
successfully against any of these existing or potential competitors, our
revenues could be reduced, resulting in increased losses.
Failure to raise necessary additional capital could restrict our growth and
hinder our ability to compete
We have had negative cash flow in every fiscal period since we began
operations. We have regularly needed to raise funds in order to operate our
business and fund our growth, including the construction and renovation of
charter school facilities, and may need to raise additional funds in the future.
We cannot be certain that we will be able to obtain additional financing on
favorable terms, if at all, or that our charter clients will be able to repay
our loans and advances to them. If we issue additional equity or convertible
21
debt securities, stockholders may experience dilution or the new equity or
convertible debt securities may have rights, preferences or privileges senior to
those of existing holders of class A common stock. If we cannot raise funds on
acceptable terms, if and when needed, or if our charter clients are unable to
repay our loans and advances to them, or if we are required to repay any loans
that we have guaranteed, we may not be able to take advantage of future
opportunities, grow our business or respond to competitive pressures or
unanticipated requirements, which could seriously harm our business.
The terms of our credit agreements impose significant restrictions on our
business
Under the MLMCI Facility and the New Credit Facility, we are required
to comply with certain financial covenants, including maintaining specified
financial ratios. Our ability to meet future financial ratios and comply with
other covenants can be affected by events beyond our control, such as general
economic conditions. Our failure to comply with such covenants would prevent us
from borrowing additional amounts under our credit facilities and could result
in a default under those facilities, which could cause the indebtedness
outstanding under the facilities to become immediately due and payable. If we
are unable to meet our debt obligations, we could be forced to restructure or
refinance our indebtedness, seek additional equity capital or sell assets. We
may be unable to obtain financing or sell assets on satisfactory terms, or at
all.
We have issued warrants for the purchase of Class A Common Stock in connection
with certain credit facilities that, if exercised, will dilute our current
equity holders and could have an adverse effect on the market price for the
shares of Class A Common Stock
Warrants issued in connection with the establishment of the Credit
Facilities are for the purchase of up to 10,710,973 shares of class A common
stock at $1 per share. The shares to be issued in connection with the Warrants
equal approximately 16.6% of the total outstanding shares of common stock of the
Company, (including the shares issuable upon exercise of the Warrants but prior
to any resale of such shares by the holders). The issuance of such shares will
dilute the current stockholders of the Company and could have an adverse effect
on the market price for the shares of class A common stock. In addition, the
shares issuable upon exercise of the Warrants are being registered pursuant to a
registration statement, and any sales of such shares may have a further adverse
effect on the market price for the shares of the class A common stock.
We may not be able to recover the property value associated with our termination
of the Edison Corporate Headquarters Project
We previously purchased property in New York, New York for the purchase
price of $10 million, and entered into an agreement with the Museum of African
Art to develop the property for a mixed use project consisting of our new
corporate headquarters, a charter school and a facility to house the Museum. We
recently terminated our plans to develop this property and construct new
corporate headquarters. Accordingly, we may choose to sell the property to the
Museum or another third party. While we hope to be able to sell the property at
a price equal to or greater than our purchase price, we have no guarantee that
we will be able to do so, and may choose to sell the property at a loss.
We rely on government funds for specific education programs, and our business
could suffer if we fail to comply with rules concerning the receipt and use of
the funds
We benefit from funds from federal and state programs to be used for
specific educational purposes. Funding from the federal government under Title I
of the Elementary and Secondary Education Act, which provides federal funds for
children from low-income families, accounted for approximately 4% of our gross
student funding revenue for fiscal 2002. During the same period, we estimate
that funding from other federal and state programs accounted for approximately
an additional 10% of our total revenue. A number of factors relating to these
government programs could lead to adverse effects on our business and financial
results:
o These programs have strict requirements as to eligible
students and allowable activities. If we or our school
district and charter board clients fail to comply with the
regulations governing the programs, we or our clients could be
required to repay the funds or be determined ineligible to
receive these funds.
o If the income demographics of a district's population were to
change over the life of our management agreement for a school
in the district, resulting in a decrease in Title I funding
for the school, we would recognize less revenue for operating
the school.
22
o Funding from federal and state education programs is allocated
through formulas. If federal or state legislatures or, in some
case, agencies were to change the formulas, we could receive
less funding.
o Federal, state and local education programs are subject to
annual appropriations of funds. Federal or state legislatures
or local officials could drastically reduce the funding amount
of appropriation for any program, thus decreasing the amount
of funding available to us.
o The company's Edison Extra summer school program, which served
approximately 35,000 students in Missouri during the summer of
2002, is funded through state summer school funds. If the
Missouri state government fails to maintain current funding
levels for summer school programs, Edison Extra revenue would
be adversely affected.
o Most federal education funds are administered through state
and local education agencies, which allot funds to school
boards and charter boards. These state and local education
agencies are subject to extensive government regulation
concerning their eligibility for federal funds. If these
agencies were declared ineligible to receive federal education
funds, the receipt of federal education funds by our school
board or charter board clients could be delayed, which could
in turn delay our payment from our school board and charter
board clients.
o The federal No Child Left Behind Act of 2001, which includes
the Title I program referenced above, contains a range of new
accountability measures for public schools. Schools that fail
to make adequate yearly progress (AYP) toward meeting state
standards may lose some of their student enrollment due to
school choice provisions, may be required to allocate a
portion of their Title I funding toward the provision of
supplemental services to some students, and may be subject to
state takeover or other forms of district or state
intervention. If schools run by the company fail to make AYP,
these new requirements could adversely affect the company's
revenue and/or reputation.
We are subject to extensive government regulation because we benefit from
federal funds, and our failure to comply with government regulations could
result in the reduction or loss of federal education funds
Because we benefit from federal funds, we must also comply with a
variety of federal laws and regulations not directly related to any federal
education program, such as federal civil rights laws and laws relating to
lobbying. Our failure to comply with these federal laws and regulations could
result in the reduction or loss of federal education funds. In addition, our
management agreements are potentially covered by federal procurement rules and
regulations because our school district and charter board clients pay us, in
part, with funds received from federal programs. Federal procurement rules and
regulations generally require competitive bidding, awarding contracts based on
lowest cost and similar requirements. If a court or federal agency determined
that a management agreement was covered by federal procurement rules and
regulations and was awarded without compliance with those rules and regulations,
then the management agreement could be voided and we could be required to repay
any federal funds we received under the management agreement.
Failure of our charter board clients to obtain federal tax-exempt status could
jeopardize the school's charter and restrict our ability to finance the school
Many of our charter school clients apply for federal tax-exempt status.
One state in which we currently operate seven charter schools and hope to open
additional charter schools in the future, and one other state, requires charter
schools to secure federal tax-exempt status. One of our charter school clients
in the first state received notice from the Internal Revenue Service of an
appealable denial of its application for federal tax-exempt status. While this
charter school client was ultimately successful in obtaining tax-exempt status,
there can be no assurance that other charter school clients will not experience
difficulty in obtaining such status. Any failure to receive or delay in
receiving federal tax-exempt status by a charter school in this state could
jeopardize the school's charter and its ability to repay amounts owed to us. The
failure to receive federal tax-exempt status by a charter school in any state
could also, among other things, inhibit that charter school's ability to solicit
charitable contributions or participate in tax-exempt financing.
23
We earn all of our revenue from public sources and any reduction in general
funding levels for education could hurt our business
All of our revenue is derived from public sources. If general levels of
funding for public education were to decline, the field of school districts in
which we could profitably operate schools would likewise diminish, and our
ability to grow by adding new schools would suffer. In addition, our management
agreements generally provide that we bear the risk of lower levels of per-pupil
funding, which would be directly reflected in lower revenue to us, even if our
costs do not decline accordingly, thus adversely affecting our financial
results.
Restrictions on government funding of for-profit school management companies
could hurt our business
Any restriction on the use of federal or state government educational
funds by for-profit companies could hurt our business and our ability to grow.
From time to time, a variety of proposals have been introduced in state
legislatures to restrict or prohibit the management of public schools by
private, for-profit entities like us. For example, a recently-passed bill in
California prohibits the state department of education from contracting with a
private, for-profit education manager to manage public schools for which the
state assumes control pursuant to a new state educational reform measure.
Additionally, Idaho's charter school law may, subject to interpretation,
restrict our ability to manage schools in that state. To the extent that states
or the federal government were to adopt legislation prohibiting for-profit
entities from operating public schools, the market for our services would
decline and our business results could suffer. The operation of our charter
schools depends on the maintenance of the underlying charter grant
The operation of our charter schools depends on the maintenance of the
underlying charter grant
Our charter schools operate under a charter that is typically granted
by a state authority to a third-party charter holder, such as a community group
or established non-profit organization. Our management agreement in turn is with
the charter holder. If the state charter authority were to revoke the charter,
which could occur based on actions of the charter holder outside of our control,
we would lose the right to operate that school. In addition, many state charter
school statutes require periodic reauthorization. Charter schools accounted for
33.0% of our gross student funding in fiscal 2002, or approximately $171.0
million. If state charter school legislation were not reauthorized or were
substantially altered in a meaningful number of states, our business and growth
strategy would suffer and we could incur additional losses.
Our stock price has been volatile and we expect it to continue to be volatile in
the future
The market price of our class A common stock has fluctuated
significantly in response to the risks discussed above, as well as other
factors, some of which are beyond our control. These other factors include:
o variations in our quarterly operating results;
o changes in securities analysts' estimates of our financial
performance;
o changes in the public perception of our schools' academic
performance;
o termination or non-renewal of existing management agreements;
o changes in market valuations of similar companies;
o speculation in the press or investment community;
o actions by institutional shareholders;
o pending and potential litigation;
o future sales of our class A common stock or other securities;
and
o general stock market volatility.
24
Since our class A common stock has been publicly traded, its market
price has fluctuated over a wide range and we expect it to continue to do so in
the future.
We have been named in several shareholder class action and shareholders
derivative lawsuits
We have been named in several putative class actions lawsuits filed in
the Southern District of New York, and a few shareholder derivative actions,
also filed in New York. We intend to vigorously defend these lawsuits. However,
there can be no assurance that the Company will be successful, and an adverse
resolution of the lawsuits could have a material adverse effect on our financial
position and results of operations in the period in which the lawsuits are
resolved. We are not presently able to reasonably estimate potential losses, if
any, related to the lawsuits. Lawsuits may cause defaults under our material
agreements, prevent us from obtaining additional funds under our existing line
of credit or obtain additional financing, and such litigation could result in
substantial costs and divert management's attention and resources.
We may face additional securities litigation or other litigation
In addition to the securities class action litigation currently being
brought against us as more fully described in the risk factor above, we may also
in the future be the target of similar litigation. Additional securities
litigation could result in substantial costs and divert management's attention
and resources. We may also face other types of litigation. For example, the
Company and a private pension fund were unable to close a proposed financing
transaction and the Company chose instead to do a transaction with School
Services LLC. The Company could face litigation in connection with that
decision. While we intend to vigorously defend against any such lawsuit, there
can be no assurance that the Company will be successful, and an adverse
resolution of any lawsuit could have a material adverse effect on our financial
position, shareholder equity, and results of operations in the period in which
the lawsuits are resolved.
We must comply with the terms of a settlement agreement entered into by the
Company and the Securities and Exchange Commission
On May 14, 2002, the Company entered into a settlement agreement with
the Securities and Exchange Commission, pursuant to which the Company agreed to
enhance disclosure of its revenue recognition practices, by adopting a statement
of operations presentation that includes a line item for "Gross Student
Funding," as well as full disclosure of all expenses paid by Edison and all
expenses paid by the local districts, and its internal accounting system by
creating an Internal Audit Department. The Company intends to fully comply with
the terms and conditions of the settlement agreement. However, if we fail to
comply with the settlement agreement, or are perceived by the Securities and
Exchange Commission to have failed to comply, we may face additional scrutiny
from the Commission, which could have a material adverse effect on our financial
condition and results of operations.
We may be delisted from the NASDAQ National Market, which could result in a
limited public market for our class A common stock
On August 27, 2002, we received notice from Nasdaq that the price of
our class A common stock had closed below the minimum $1.00 per share for 30
consecutive trading days as required for continued listing under Nasdaq's
marketplace rules. The notification letter stated that we had 90 days, or until
November 25, 2002, to regain compliance with the rule, i.e., for our securities
to close above $1.00 for ten (10) consecutive trading days. In and of itself,
the notification letter does not result in delisting; under Nasdaq's rules, on
receipt of a staff determination letter (which the Company has not received), an
issuer may file and argue for an extension or exception to Nasdaq's listing
requirements, and the Association may grant such extensions or exceptions where
it deems appropriate. Delisting from the Nasdaq market could adversely affect
the liquidity and price of our class A common stock and could have a long-term
impact on our ability to raise future capital.
Additionally, Nasdaq's listing requirements provide that companies must
have an audit committee composed of at least three independent directors. On the
advice of their legal advisors, three of our directors who are affiliates of
School Services resigned from the board of directors prior to the time that we
and School Services entered into material negotiations regarding the Credit and
Security Agreement between the Company and School Services. Two of these
directors were members of the audit committee. At approximately the same time,
another director joined the Company and thus became ineligible to remain on the
audit committee. As a result, we currently do not have an audit committee.
We currently have two independent directors on our board and have
secured commitments from four other individuals to serve as independent
directors if elected by our stockholders at our annual meeting to be held on
December 5, 2002. One director nominee has been appointed to fill a vacant
position on the board effective on or about November 15 and will assume
immediately the position of chairman of the audit committee.
25
Anti-takeover provisions of Delaware law and our charter and bylaws could
prevent or delay a change in control
Provisions of Delaware law, our charter and our bylaws could make it
more difficult for a third party to acquire us, even if doing so would be
beneficial to our stockholders. These provisions could limit the price that
certain investors might be willing to pay in the future for shares of class A
common stock, and could have the effect of delaying, deferring or preventing a
change in control of us. These provisions include:
o the high-vote nature of our class B common stock;
o restrictions on removal of directors, which may only be
effected for cause and only by a vote of the holders of 80% of
our class of common stock that elected the director;
o Section 203 of the General Corporation Law of Delaware which
could have the effect of delaying transactions with interested
stockholders;
o a prohibition of stockholder action by written consent; and
procedural and notice requirements for calling and bringing
action before stockholder meetings
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We currently have market risk sensitive instruments related to interest
rates. We had outstanding long-term notes payable of $28.4 million at September
30, 2002. Interest rates on the notes are fixed and range from 9.5% to 18.68%
per annum and have terms of 24 to 48 months.
We do not believe that we have significant exposure to changing
interest rates on long-term debt because interest rates for our debt is fixed.
We have not undertaken any additional actions to cover interest rate market risk
and are not a party to any other interest rate market risk management
activities.
Additionally, we do not have significant exposure to changing interest
rates on invested cash, which was approximately $50.5 million at September 30,
2002. We invest cash mainly in money market accounts and other investment-grade
securities. We do not purchase or hold derivative financial instruments for
trading purposes.
ITEM 4. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
(a) Within the 90 days prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
Executive Vice President and Chief Financial Officer, of the effectiveness of
the design and operation of the Company's disclosure controls and procedures
pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company's
Chief Executive Officer and Executive Vice President and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective in
timely alerting them to material information relating to the Company (including
its consolidated subsidiaries) required to be included in the Company's periodic
SEC filings.
(b) There were no significant changes in our internal controls or in
other factors that could significantly affect our disclosure controls
subsequent to the Evaluation Date and, subsequent to such date, no corrective
actions with regard to significant deficiencies and material weaknesses were
taken.
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
Please refer to Note 8 to the condensed consolidated financial
statements contained in Part I, Item 1 of this report.
Item 2. Changes in securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Securities Holders
None
Item 5. Other information
None
26
Item 6. Exhibits and Reports on Form 8-K.
Exhibits:
10.54 Letter Agreement, dated October 25, 2002, between the Company
and Lowell W. Robinson
10.55 Indemnification Agreement, dated as of October 28, 2002, between
the Company and Lowell W. Robinson
99.1 Certification by Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
99.2 Certification by Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
Reports on Form 8-K:
The Company did not file any reports on Form 8-K during the quarter
for which this report is filed.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EDISON SCHOOLS INC.
Date November 14, 2002 /s/ H. Christopher Whittle
------------------------------------------
H. Christopher Whittle
Chief Executive Officer and Director
Date November 14, 2002 /s/ Christopher J. Scarlata
------------------------------------------
Christopher J. Scarlata
Executive Vice President and
Chief Financial Officer
(Principal Accounting Officer)
28
CERTIFICATIONS
I, H. Christopher Whittle, Chief Executive Officer of Edison Schools Inc.,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Edison Schools Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function);
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 /s/ H. Christopher Whittle
--------------------------
H. Christopher Whittle
Chief Executive Officer
I, Christopher J. Scarlata, Executive Vice President and Chief Financial
Officer of Edison Schools Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Edison Schools Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function);
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 /s/ Christopher J. Scarlata
---------------------------
Christopher J. Scarlata
Executive Vice President and
Chief Financial Officer
Exhibit Index
10.54 Letter Agreement, dated October 25, 2002, between the Company and
Lowell W. Robinson
10.55 Indemnification Agreement, dated as of October 28, 2002, between the
Company and Lowell W. Robinson
99.1 Certification by Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
99.2 Certification by Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
29