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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 MARCH 31, 2003
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:
51,234,154
(Number of shares of Class A Common Stock Outstanding as of April 30, 2003)
1,627,933
(Number of shares of Class B Common Stock Outstanding as of April 30, 2003)
1
EDISON SCHOOLS INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2003
PAGE
----
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS - Unaudited
Condensed Consolidated Balance Sheets as of March 31, 2003 and
June 30, 2002 ................................................................. 3
Condensed Consolidated Statements of Operations for the Three Months and Nine
Months Ended March 31, 2003 and 2002 .......................................... 4
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
March 31, 2003 and 2002 ....................................................... 5
Notes to Condensed Consolidated Financial Statements ............................ 6-13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ............................................. 13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .............. 31
ITEM 4. CONTROLS AND PROCEDURES ................................................. 31
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS ............................................... 31
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ....................... 31
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ................................. 31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............. 31
ITEM 5. OTHER INFORMATION ............................................... 31
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ................................ 32
SIGNATURES ...................................................... 32
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EDISON SCHOOLS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS -UNAUDITED
(DOLLARS IN THOUSANDS)
MARCH 31, 2003 JUNE 30,2002
-------------- ------------
ASSETS
Current assets:
Cash and cash equivalents ........................................................ $ 32,690 $ 40,648
Accounts receivable .............................................................. 75,621 68,589
Notes receivable, net ............................................................ 20,350 12,481
Other receivables ................................................................ 8,052 9,551
Other current assets ............................................................. 10,227 8,666
--------- ---------
Total current assets ........................................................... 146,940 139,935
Property and equipment, net ......................................................... 92,852 111,106
Restricted cash ..................................................................... 8,854 6,715
Notes receivable, net, less current portion ......................................... 61,975 68,412
Other receivables, less current portion ............................................. 3,281 231
Long-term receivables ............................................................... -- 26,461
Investment .......................................................................... 1,250 1,250
Other assets ........................................................................ 25,779 27,266
--------- ---------
Total assets ................................................................... $ 340,931 $ 381,376
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings ............................................................ $ 47,455 $ 34,000
Current portion of long-term debt ................................................ 19,286 18,364
Accounts payable ................................................................. 16,139 24,686
Accrued expenses ................................................................. 39,815 50,557
--------- ---------
Total current liabilities ...................................................... 122,695 127,607
Long-term debt, less current portion ................................................ 3,955 9,807
Stockholders' notes payable ......................................................... 6,604 6,604
Other liabilities ................................................................... 3,316 2,487
--------- ---------
Total liabilities .............................................................. 136,570 146,505
--------- ---------
Minority interest in subsidiary ..................................................... 2,434 2,487
--------- ---------
Stockholders' Equity:
Class A common, par value $.01; 150,000,000 shares authorized; 53,196,054 shares
issued and 51,234,154 outstanding at March 31, 2003 and 52,018,555 shares issued
and outstanding at June 30, 2002 .................................................... 532 520
Class B common, par value $.01; 5,000,000 shares authorized; 1,627,933 and
1,805,132 shares issued and outstanding at March 31, 2003 and at June 30, 2002,
respectively ........................................................................ 16 18
Additional paid-in capital .......................................................... 496,005 489,279
Unearned stock-based compensation ................................................... (213) (823)
Accumulated deficit ................................................................. (291,796) (256,610)
Treasury stock, 1,711,900 shares of Class A Common Stock at cost .................... (2,617) --
--------- ---------
Total stockholders' equity ..................................................... 201,927 232,384
--------- ---------
Total liabilities and stockholders' equity ..................................... $ 340,931 $ 381,376
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
EDISON SCHOOLS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS -UNAUDITED
FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2003 AND 2002
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------------- ----------------------------------
MARCH 31, 2003 MARCH 31, 2002 MARCH 31, 2003 MARCH 31, 2002
-------------- -------------- -------------- --------------
Gross Student Funding ............................. $ 115,399 $ 131,165 $ 311,052 $ 361,774
========= ========= ========= =========
Net revenue ....................................... $ 108,382 $ 121,904 $ 291,054 $ 327,286
--------- --------- --------- ---------
Education and operating expenses:
Direct site expenses
Company paid ................................. 47,579 50,161 131,253 142,043
Client paid .................................. 37,846 49,994 106,439 134,395
Administration, curriculum and development ..... 17,030 18,075 51,125 50,048
Depreciation and amortization .................. 9,027 9,453 26,092 27,014
Pre-opening expenses ........................... 432 402 3,422 5,608
--------- --------- --------- ---------
Total education and operating expenses ....... 111,914 128,085 318,331 359,108
--------- --------- --------- ---------
Loss from operations .............................. (3,532) (6,181) (27,277) (31,822)
Other income (expense):
Interest income ................................... 2,214 2,434 6,465 7,061
Interest expense .................................. (4,868) (1,769) (14,194) (4,788)
Other ............................................. 18 (6,753) 360 (6,732)
--------- --------- --------- ---------
Total other .................................. (2,636) (6,088) (7,369) (4,459)
--------- --------- --------- ---------
Loss before provision for state and local taxes ... (6,168) (12,269) (34,646) (36,281)
Provision for state and local taxes ............... (197) (514) (540) (835)
--------- --------- --------- ---------
Net loss .......................................... $ (6,365) $ (12,783) $ (35,186) $ (37,116)
========= ========= ========= =========
Per common share data:
Basic and diluted net loss per share ........... $ (0.12) $ (0.24) $ (0.66) $ (0.69)
========= ========= ========= =========
Weighted average shares of common stock
outstanding used in computing basic and
diluted net loss per share .................... 52,655 53,771 53,529 53,477
========= ========= ========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
EDISON SCHOOLS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
FOR THE NINE MONTHS ENDED MARCH 31, 2003 AND 2002
(DOLLARS IN THOUSANDS)
2003 2002
-------- --------
Cash flows from operating activities:
Net loss ....................................................................... $(35,186) $(37,116)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ............................................... 25,983 26,419
Amortization of contracts and deferred costs ................................ 2,797 980
Amortization of original issue discount on notes receivable ................. (113) (102)
Amortization of debt issuance costs and original issue discount on
indebtedness .............................................................. 7,742 --
Stock-based compensation .................................................... 589 (5,727)
Provision for notes receivable .............................................. 594 --
Provision for property and equipment and other assets ....................... 1,080 --
Loss on disposal of property and equipment .................................. 407 2,569
Interest on notes receivable ................................................ 265 (2,216)
Impairment of investment in unconsolidated entity ........................... -- 6,774
Changes in working capital accounts ......................................... (887) (10,089)
Other ....................................................................... (53) (42)
-------- --------
Cash provided by (used in) operating activities ........................... 3,218 (18,550)
-------- --------
Cash flows from investing activities:
Additions to property and equipment ............................................ (11,335) (16,588)
Proceeds from disposition of property and equipment, net ....................... 2,263 --
Proceeds from notes receivable and advances due from charter schools ........... 7,450 11,674
Notes receivable and advances due from charter schools ......................... (8,762) (36,029)
Proceeds received from a stockholder loan ...................................... 1,100 --
Business acquisition, net ...................................................... -- 149
Other assets ................................................................... (90) (1,824)
-------- --------
Cash (used in) investing activities ......................................... (9,374) (42,618)
-------- --------
Cash flows from financing activities:
Net borrowings under lines of credit ........................................... 15,510 20,000
Proceeds from term loan, included in short-term borrowings ..................... 10,000 --
Payments on notes payable and capital leases ................................... (15,293) (14,340)
Costs in connection with debt financing ........................................ (7,263) (840)
Proceeds from issuance of stock and warrants ................................... -- 1,811
Purchase of treasury stock ..................................................... (2,617) --
(Increase) decrease in restricted cash ......................................... (2,139) 3,598
-------- --------
Cash (used in) provided by financing activities ............................. (1,802) 10,229
-------- --------
Decrease in cash and cash equivalents ............................................ (7,958) (50,939)
Cash and cash equivalents at beginning of period ................................. 40,648 96,195
-------- --------
Cash and cash equivalents at end of period ....................................... $ 32,690 $ 45,256
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the periods for:
Interest .................................................................... $ 5,909 $ 4,025
State and local taxes ....................................................... $ 232 $ 712
Supplemental disclosure of non-cash investing and financing activities:
Obligations assumed in connection with new contracts ........................... $ 9,700
Property and equipment acquired under capital lease obligations ................ $ 2,111 $ 7,530
Additions to property and equipment included in accounts payable ............... $ 1,223 $ 4,279
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 GAAP 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 June 30, 2002 financial statements shown in the
condensed consolidated financial statements in this Form 10-Q were derived from
the audited financial statements included in the Company's Form 10-K/A filed on
October 2, 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 valuation allowance on deferred income
taxes. 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 annual losses from operations
and has had annual negative cash flows 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 (see Note 6). The Company's $55.0 million revolving credit facility
expires July 15, 2003 and we intend to refinance this debt with a new asset
based facility. If the Company is unable to refinance its revolving credit
facility, the Company may be forced to issue additional equity or restructure
existing debt.
In fiscal year 2003, the Company has continued to improve its gross site
contribution margins while maintaining education quality and continuing to
reduce operating expenses as a percentage of net revenue. The Company continues
its "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.
6
2. DESCRIPTION OF BUSINESS
The Company primarily manages elementary and secondary public schools
under contracts with school districts and charter schools located in 22 states,
and Washington, D.C. The Company opened its first four schools in the fall of
1995 and, as of March 31, 2003, is operating 149 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 related
financing for such facilities.
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 ("FASB") issued
Statement of Financial Accounting Standards ("FAS") No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities" ("FAS 146"). FAS 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 FAS 146 include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operations or other exit or disposal activities. FAS 146 is effective for exit
or disposal activities that are initiated after December 31, 2002.
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 clarifies the accounting
for, and disclosure of, the issuance of certain types of guarantees, including
the requirement that a liability be recorded in the guarantor's balance sheet at
the fair value of the guarantee upon issuance or substantial modification. The
initial recognition and measurement provisions of FIN 45 are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002. The
Company has not issued or modified any guarantees affected by FIN 45 (see note
9).
In December 2002, the FASB issued FAS 148, " Accounting For Stock Based
Compensation - Transition And Disclosure - An Amendment of FAS 123" ("FAS 148").
FAS 148 does not change the provisions of FAS 123 that permit the Company to
continue to apply the intrinsic value method of APB 25, Accounting For Stock
Issued To Employees ("APB 25"). Under FAS 148, companies that choose to adopt
the accounting provisions of FAS 123 may choose from three transition methods:
the prospective method, modified prospective method and retroactive restatement
method. The Company continues to account for stock compensation under APB 25,
and therefore under FAS 148 is required to disclose the net income and earnings
per share (basic and diluted), the compensation expense net of tax included in
net income, compensation that would have been included in net income had the
company adopted FAS 123 for all awards granted, modified or settled since
December 14, 1994 and pro forma net income and earnings per share beginning with
the quarter ended March 31, 2003.
In January 2003, the FASB issued Interpretation No. 46 (" FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective immediately for all new variable interest entities created or acquired
after January 31, 2003. For variable interest entities created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or annual period beginning after June 15, 2003. The Company does not
anticipate that the adoption of FIN 46 will have a material impact on its
financial statements.
4. 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 APB 25. 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
7
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.
In October 2002, the board of directors approved an amendment to the
Incentive Plan to increase the number of shares reserved for issuance to
8,500,000 Shares of Class A common stock. The Company's stockholders approved
this amendment in December 2002.
During the quarter ended March 31, 2003, 1,134,500 options on shares of
Class A common stock were issued. As of March 31, 2003, the Company had
approximately 3.0 million shares of Class A common stock reserved for future
grants under the Stock Incentive Plan. Any unused portion, in addition to shares
allocated to awards that are canceled or forfeited, is available for grant or
award in later years. Restricted stock grants vest as specified in the
respective grants.
In accordance with FAS 148, the table below summarizes the effect of
compensation costs for the three and the nine months ended March 31, 2003 and
March 31, 2002 for the Company's stock option issuances, if such stock options
had been accounted for based in the fair values at the grant date pursuant to
the provisions of FAS 123. If the Company adopted FAS 123, the Company's net
loss and basic and diluted net loss per share would have been adjusted to the
pro forma amounts below (in thousands, except for per share amounts):
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED MARCH 31, ENDED MARCH 31, ENDED MARCH 31, ENDED MARCH 31,
2003 2002 2003 2002
--------------- --------------- --------------- ----------------
Net loss--as reported ....... $ (6,365) $(12,783) $(35,186) $(37,116)
Adjustment to net loss for
proforma stock based
compensation expense net
of related tax effect ....... $ (4,002) $ (8,646) $(12,037) $(14,780)
Net loss--pro forma basis ... $(10,355) $(21,429) $(47,175) $(51,896)
Basic and diluted net loss
per share--as reported ...... $ (0.12) $ (0.24) $ (0.66) $ (0.69)
Basic net loss per share--
pro forma basis ............. $ (0.20) $ (0.40) $ (0.88) $ (0.97)
5. NET LOSS PER SHARE
In accordance with FAS 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 and
nine-month periods ended March 31, 2003 and 2002 are as follows (in thousands,
except for per share amounts):
8
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31, MARCH 31, MARCH 31,
2003 2002 2003 2002
-------- -------- -------- --------
Net Loss .......................................................... $ (6,365) $(12,783) $(35,186) $(37,116)
======== ======== ======== ========
Class A Common Stock outstanding at beginning
of period ...................................................... 51,145 51,794 52,019 49,249
Class B Common Stock outstanding at beginning
of period ...................................................... 1,805 1,836 1,805 2,433
Add:
Issuance of Class A Common Stock
(on a weighted average basis) .................................... 180 172 493 2,423
Conversion of Class B Common Stock
(on a weighted average basis) .................................... (177) (31) (177) (628)
Less:
Treasury stock acquired (on a weighted average basis) ............. (298) -- (611) --
-------- -------- -------- --------
Weighted average shares of common stock outstanding
used in computing basic and fully diluted net loss per share ... 52,655 53,771 53,529 53,477
======== ======== ======== ========
Basic and fully diluted net loss per share ........................ $ (0.12) $ (0.24) $ (0.66) $ (0.69)
======== ======== ======== ========
6. 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 pays 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 March 31, 2003, $41.8 million was outstanding under this line of
credit bearing interest at LIBOR plus 7.0% (at March 31, 2003 the rate was
8.28%) and was collateralized by receivables of $65.5 million that were sold in
a true sale to Edison Receivables by the Company. The agreement requires the
Company to observe certain financial covenants and restrictions including a
minimum consolidated tangible net worth and a maximum consolidated debt to
equity ratio.
9
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 had the right to borrow up to $20.0 million, at an interest rate of
12% per annum, net of certain fees and costs which the Company paid School
Services and its affiliates. The agreement provided for a $10 million term loan
collateralized by certain real property owned by the Company, and a $10 million
revolving line of credit collateralized by notes receivable from charter schools
and other debtors of the Company. Such borrowings are also collateralized by
substantially all the other assets of the Company. The facility matures on June
30, 2004 but has prepayment obligations tied to refinancings of the notes
receivable from charter schools and such other debtors and to any sale or
transfer of the real property. The agreement requires the Company to meet
certain financial covenants including a minimum consolidated tangible net worth,
a maximum consolidated debt to equity ratio and a minimum EBITDA requirement for
fiscal 2003.
The Company was not in compliance with the minimum consolidated tangible
net worth covenant at March 31, 2003 as defined in the MLMCI and School Services
agreements. In May 2003, the Company received a waiver of default from both
MLMCI and School Services with respect to compliance with this covenant at March
31, 2003. The Company expects to be back in compliance with this covenant at
June 30, 2003, the next measurement date. The Company expects to regain
compliance based on projected fourth quarter operating results.
In December 2002, a note receivable in the amount of $7.5 million was
refinanced, the Company maintains a $2.2 million subordinated note. Proceeds
from this refinancing were paid directly to School Services and applied to
amounts outstanding under the revolving line of credit. Of this amount, $1.3
million represented a permanent reduction in the line of credit and $4.0 million
was subsequently re-borrowed by the Company. In addition, the Company made a
$1.0 million payment on the revolving line of credit pursuant to an amendment to
reduce the line of credit commitment by $1.0 million to obtain the release of
certain collateral. As of March 31, 2003, $17.7 million was outstanding under
these facilities reflecting the maximum amount available under the terms of the
facilities.
Edison has entered into a written agreement to sell the real property
(Harlem) for $9.2 million. The closing is scheduled to take place on June 30,
2003, however, the buyer may exercise its right under New York law to extend
the close within a reasonable period post June 30, 2003. Edison recorded an
impairment charge of $750,000 to reduce the carrying value of the property to
its net realizable value based on this agreement. Proceeds from the sale will be
used to pay down outstanding debt under the School Services term loan. There are
no assurances that the sale will close by June 30, 2003, if at all.
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 at such time
equaled 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
$6.6 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 terms of the related financing agreements,
under the interest method.
Also in connection with the establishment of the credit facilities, the
Company paid or agreed to pay approximately $9.3 million in fees and costs
associated with the facility, including a $1.6 million payment due upon maturity
of the School Services facility. Such fees and costs have been deferred and are
being amortized over the respective term of the facilities under the interest
method.
7. STOCK REPURCHASE PLAN
During the quarter ended December 31, 2002, the Company commenced a stock
repurchase plan to buy back up to 5.4 million shares representing approximately
10% of the common stock outstanding. As of March 31, 2003, the Company had
repurchased approximately 1.7 million shares at a cost of $2.6 million
representing 32% of the total authorized under the repurchase plan.
8. NOTES RECEIVABLE
10
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 $82.3 million of notes receivable, net at March 31,
2003, approximately $61.6 million was collateralized and the remaining balance
of $20.7 million balance 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. The notes receivable, net are reported in the
balance sheet in accordance with their respective terms. The Company intends to
refinance certain of these notes (short-term and or long-term notes) at or prior
to their respective scheduled maturity dates. Although the Company intends to
refinance many of these notes, should the Company be required to foreclose on
the collateral to these notes, it might not be able to liquidate such collateral
for proceeds sufficient to cover the notes.
Notes receivable consist of the following:
MARCH 31, 2003 JUNE 30, 2002
-------------- -------------
Notes receivable from charter schools .... $ 88,461 $ 86,435
Allowance for loan losses ................ (6,136) (5,542)
-------- --------
82,325 80,893
Less, current portion, net ............... (20,350) (12,481)
-------- --------
Notes receivable non-current, net ........ $ 61,975 $ 68,412
======== ========
The Company has a note receivable outstanding in the amount of $8.5
million (net of an approximately $1.5 million allowance), which is
collateralized by the facility built from the note proceeds. The borrower has
failed to make interest payments in accordance with the note and therefore is in
default. The Company may initiate foreclosure proceedings on the facility in
order to recover the asset. At the current time, all available information
indicates that the carrying value of the note approximates fair value of the
facility. The Company will continue to assess the carrying value of the note as
the foreclosure proceedings progress.
9. COMMITMENTS AND CONTINGENCIES
GUARANTEES
The Company has guaranteed certain debt obligations of charter school
boards with which it has management agreements. As of March 31, 2003, the
Company had provided guarantees totaling approximately $27.1 million. These debt
obligations mature from June 2003 to December 2005. All of the guarantees were
issued or modified prior to the effective date of FIN 45, therefore the fair
value of the guarantees is not recorded on the balance sheet or disclosed in the
notes.
As of March 31, 2003, the charter school boards were current on their debt
obligations and not in default of their convenants. 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
covenants. The Company was not in compliance with certain financial covenants
under the guarantees of specific charter school board debt obligations with an
aggregate outstanding balance of approximately $8.6 million at March 31, 2003.
The Company has received notification from the lenders that they will not be
immediately making demand under the guarantees and will work with the Company
to execute a waiver or amend the aforementioned agreements.
Notwithstanding the foregoing, the lenders reserve all rights and remedies under
their respective guarantees. At the present time, the Company does not expect to
be required to make any debt payments under these obligations. The Company's
debt obligations and underlying covenants are unaffected by the above defaults.
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 material adverse affect on
its consolidated financial position, results of operations, or cash flows.
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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 March 31, 2003, the aggregate termination benefits of the
executives and certain other employees approximated $2.5 million.
Additionally, the Company has a severance arrangement with its Chairman
that provides for the Chairman to receive a payment if his employment is
terminated without cause or 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 March 31, 2003 and June 30, 2002 is $3.2 million
related to this severance arrangement.
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. On October
29, 2002, the Court consolidated all ten actions and appointed Hawaii
Electricians Annuity Fund as lead plaintiff and Milberg Weiss Bershad Hynes &
Lerach LLP as lead counsel. On April 7, 2003, plaintiffs filed a consolidated
amended class action complaint. The lawsuit 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 and Sections 11, 12(a)(2) and 15 of the
Securities Act of 1933. The lawsuit seeks an unspecified amount of compensatory
damages, rescission and/or rescissory damages, costs and expenses related to
bringing the action, and injunctive relief. Plaintiffs allege that the Company's
public disclosures from November 1999 to May 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,
accelerated revenues on an unexecuted contract with one school district, and
failed to timely recognize losses related to contracts with two school
districts. The lawsuit further alleges that the Company lacked adequate internal
accounting controls, manipulated the test scores of its students in order to
demonstrate improvement in the students' academic performance, and failed to
disclose that the Company agreed to fulfill the final two years of its contract
with the Sherman, Texas school district without pay. The lawsuit also mentions
three restatements of the Company's financial statements, one regarding a
warrant purchased in 1998 by a philanthropic organization, one regarding a
severance agreement between the Company and one of its senior officers, both of
which were made by the Company as a result of the May 14, 2002 cease-and-desist
order, and another regarding stock based compensation the Company granted to one
of its senior officers. The Company has negotiated a stipulation in this
consolidated action that allows defendants until August 1, 2003 to file a
responsive pleading. 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.
In addition, between May 15, 2002, and July 19, 2002, three lawsuits were
filed derivatively on behalf of the Company against certain of the Company's
officers and directors in the Supreme Court for the State of New York, County of
New York. Plaintiffs in these lawsuits contend that the Company's officers and
directors committed various common law torts against the Company in connection
with the allegedly improper inflation of the company's total revenues by
including certain expenses, including teacher salaries, that were paid directly
by local school districts and charter school boards. In particular, the
plaintiffs allege that the officers and directors named as defendants violated
their fiduciary duties to the Company by failing to implement and maintain an
adequate internal accounting control system, causing the Company to conceal from
the public its true financial condition, and using material non-public
information to sell shares of the Company common stock and thereby reap millions
of dollars in illegal insider trading gains. These lawsuits seek compensatory
damages in the amount of the profits that the individual defendants allegedly
made, as well as a constructive trust over such profits. On November 14, 2002,
the Court consolidated these actions. The Company has negotiated a stipulation
in this consolidated action that allows (1) plaintiffs until May 23, 2003 to
file a consolidated amended complaint and (2) defendants until July 22, 2003 to
file a responsive pleading. The Company believes that the Company's officers and
directors also have strong defenses to these lawsuits. See "Additional Risk
Factors That May Affect Future Results -- We have been named in a consolidated
shareholder class action and a few shareholder derivative lawsuits."
12
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 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.
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 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 149 schools
located in 22 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 March 31, 2003, our accumulated deficit since
November 1996 was approximately $291.8 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:
- Initial staff training and professional development;
- Technology, including laptop computers for teachers;
- Books and other materials to support the Edison curriculum and
school design; and
- Upgrades in facilities.
GROSS STUDENT FUNDING
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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 ("GAAP").
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, after-school program fees and the offering of its Achievement Management
System. 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 charter 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 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
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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.
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. 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
15
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 incurred expenses related to this reengineering in the first, second and
third quarters of approximately $2.3 million.
LOANS TO EXECUTIVE
Benno C. Schmidt, Jr. borrowed $1.6 million from the Company on June 5,
1992 and $200,000 from the Company on January 23, 1996, as evidenced by
promissory notes. The loans were recourse and were collateralized by a life
insurance policy on Mr. Schmidt. The amounts due from Mr. Schmidt under these
loans could be offset by the Company against the amount owed by the Company to
Mr. Schmidt under his severance agreement. In October 1999, the promissory notes
were amended to change the interest rate to the prime rate in effect from time
to time and to extend the date for payment of all principal and accrued interest
until the earlier of February 15, 2002 or the termination of Mr. Schmidt's
employment with the Company. Prior to this amendment, the notes bore interest at
an annual compound rate of 5.83%, and all principal and accrued interest payable
under the notes were due on the earlier of February 15, 2000 or the termination
of Mr. Schmidt's employment with the Company. In February 2002, the term of the
loans was extended to June 15, 2002. In June 2002, the term of the loans was
extended to August 31, 2002. Mr. Schmidt made a payment of $1.1 million in
October 2002, which was applied toward outstanding interest. The Company has
given notice to Mr. Schmidt that the remainder of the loans is due, and with his
cooperation is working to expedite collection of the outstanding balance of
principal and interest under the loans, which totaled $1.8 million and $0.2
million, respectively.
RESULTS OF OPERATIONS
THIRD QUARTER ENDED MARCH 31, 2003 COMPARED TO THIRD QUARTER ENDED MARCH 31,
2002
Net Revenue. Our net revenue decreased to $108.4 million for the three
months ended March 31, 2003 from $121.9 million for the same period in the prior
year, a decrease of 11.1%. The decrease in revenue was primarily due to the
ending of certain unprofitable relationships and the deferral of revenue for a
certain unsigned contract together totaling approximately $6.7 million, and a
change in three management contracts from gross or net accounting to fixed fee
arrangements totaling approximately $14.0 million. These decreases in revenues
are primarily offset by revenue from new and existing clients of approximately
$7.5 million from an 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.
Direct Site Expenses. Our direct site expenses decreased to $85.4 million
for the three months ended March 31, 2003 from $100.2 million for the same
period in the prior year, a decrease of 14.8%. The decrease in direct site
expenses was primarily due to the ending of certain unprofitable relationships
and the deferral of expenses for a certain unsigned contract together totaling
approximately $6.1 million, and a change in three management contracts from
gross or net accounting to fixed fee arrangements totaling approximately $14.7
million. These decreases in expenses are primarily offset by increased expenses
of $6.1 million related to new schools opened and the expansion of existing
schools.
Gross Site Contribution. Our gross site contribution was $22.9 million for
the three months ended March 31, 2003 compared to $21.7 million for the same
period in the prior year, an increase of 5.5%. The increase in gross site
contribution was due to the above discussed changes in Net Revenue and Direct
Site Expenses.
Administration, Curriculum and Development Expenses. Our administration,
curriculum and development expenses decreased to $17.0 million for the three
months ended March 31, 2003 from $18.1 million for the three months ended March
31, 2002, a decrease of 6.1%. Excluding non-cash stock-based compensation
charges of $0.3 million in fiscal 2003 and credits of $3.9 million in fiscal
2002 our administration, curriculum and development expenses decreased to $16.7
million for the three months ended March 31, 2003 from $22.0 million for the
three months ended March 31, 2002, a decrease of 24.1%. The decrease was due,
primarily, to charges in connection with a consulting engagement incurred in
fiscal 2002 only and the general reduction in expenses resulting from our
re-engineering effort.
16
Depreciation and Amortization. Our depreciation and amortization decreased
to $9.0 million for the three months ended March 31, 2003 from $9.5 million for
the three months ended March 31, 2002, a decrease of 5.3%. The decrease of $0.5
million resulted from lower capital expenditures in the current fiscal year for
our curriculum materials, computers and related technology, and facility
improvements.
Pre-Opening Expenses. Our pre-opening expenses were $0.4 million for both
the three months ended March 31, 2003 and 2002. The expenses in both periods
represent residual expenses for the school openings of fiscal 2003 and 2002.
Education and Operating Expenses. Our total education and operating
expenses decreased to $111.9 million for the three months ended March 31, 2003
from $128.1 million for three months ended March 31, 2002, a decrease of 12.6%.
The decrease primarily resulted from the reductions in direct site expenses of
$14.7 million and administration, curriculum and development expenses of $1.1
million noted above.
Loss from Operations. Our loss from operations decreased to $3.5 million
for the three months ended March 31, 2003 from $6.2 million for the three months
ended March 31, 2002, an improvement of 43.6%. Excluding the non-cash
stock-based compensation charges and credits as mentioned above in
Administration, Curriculum and Development Expenses, our loss from operations
decreased to $3.2 million for the three months ended March 31, 2003 from $10.1
million for the same period of the prior year, an improvement of 68.3%.
Other Income and Expense. Other expense, net, was an expense of $2.6
million for the three months ended March 31, 2003 compared to $6.1 million in
the three months ended March 31, 2002. Excluding a charge for the write-down of
our investment in Apex Online Learning Inc. ("APEX") in fiscal 2002 of $6.8
million, other expense, net, was $2.6 million for the three months ended March
31, 2003 compared to income of $0.7 million in the three months ended March 31,
2002. The decline was primarily due to a $3.1 million increase in interest
expense as a result of a more expensive financing arrangement in fiscal 2003.
Net Loss and Net Loss Attributable to Common Stockholders. Our net loss
decreased to $6.4 million for the three months ended March 31, 2003 from $12.8
million for the three months ended March 31, 2002, a decrease of 50.0%.
Excluding the non-cash stock-based compensation charges and credits and the
charge for APEX as mentioned above, our net loss decreased to $6.0 million for
the third quarter of fiscal 2003 from $9.9 million for the third quarter of
fiscal 2002, an improvement of 39.4%.
EBITDA. EBITDA means the net gain or loss we would have shown if we did not
take into consideration our interest expense, interest income, income tax
expense, depreciation and amortization. These costs are discussed above. EBITDA
for the three months ended March 31, 2003 was a positive $5.5 million compared
to a negative $3.5 million for the three months ended March 31, 2002. Included
in EBITDA are non-cash stock-based compensation charges of $0.3 million in
fiscal 2003 and credits of $3.9 million in fiscal 2002 and a $6.8 million charge
for the write-down of our investment in APEX in fiscal 2002. Excluding the
effect of these charges and credits, the increase in EBITDA resulted primarily
from site-based operational improvements and the reduction in administration,
curriculum and development expenses noted above. On a per-student basis
(excluding summer school students), EBITDA improved to a positive $69 in the
three months ended March 31, 2003 compared to a negative $47 for the same period
of the prior year.
THE NINE MONTHS ENDED MARCH 31, 2003 COMPARED TO THE NINE MONTHS ENDED MARCH 31,
2002
Net Revenue. Our net revenue decreased to $291.1 million for the nine
months ended March 31, 2003 from $327.3 million for the same period in the prior
year, a decrease of 11.1%. The decrease in revenue was primarily due to (1) the
ending of certain unprofitable relationships and the deferral of revenue for a
certain unsigned contract together totaling approximately $28.4 million, (2) a
non-recurring fee of $2.7 million, in connection with a consulting engagement in
fiscal 2002 and (3) a change in three management contracts from gross or net
accounting to fixed fee arrangements totaling approximately $27.7 million. These
decreases in revenues are primarily offset by revenue from new and existing
clients of approximately $23.1 million from an 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.
17
Direct Site Expenses. Our direct site expenses decreased to $237.7 million
for the nine months ended March 31, 2003 from $276.4 million for the same period
in the prior year, a decrease of 14.0%. The decrease in direct site expenses was
primarily due to the ending of certain unprofitable relationships and the
deferral of expenses for a certain unsigned contract together totaling
approximately $26.1 million, and a change in three management contracts from
gross or net accounting to fixed fee arrangements totaling approximately $30.9
million. These decreases in expenses are primarily offset by increased expenses
of $18.2 million related to new schools opened and the expansion of existing
schools.
Gross Site Contribution. Our gross site contribution was $53.4 million for
the nine months ended March 31, 2003 compared to $50.8 million for the same
period in the prior year, an increase of 5.1%. The increase in gross site
contribution was due to the above discussed changes in Net Revenue and Direct
Site Expenses.
Administration, Curriculum and Development Expenses. Our administration,
curriculum and development expenses increased to $51.1 million for the nine
months ended March 31, 2003 from $50.0 million for the nine months ended March
31, 2002, an increase of 2.2%. Excluding non-cash stock-based compensation
charges of $0.6 million in fiscal 2003 and credits of $5.7 million in fiscal
2002 our administration, curriculum and development expenses decreased to $50.5
million for the nine months ended March 31, 2003 from $55.7 million for the nine
months ended March 31, 2002, a decrease of 9.3%. The decrease was due primarily
to charges in connection with a consulting engagement incurred in fiscal 2002
only and the general reduction in expenses resulting from our re-engineering
effort.
Depreciation and Amortization. Our depreciation and amortization decreased
to $26.1 million for the nine months ended March 31, 2003 from $27.0 million for
the nine months ended March 31, 2002, a decrease of 3.3%. The decrease of $0.9
million resulted from lower capital expenditures for our curriculum materials,
computers and related technology, and facility improvements.
Pre-Opening Expenses. Our pre-opening expenses decreased to $3.4 million
for the nine months ended March 31, 2003 from $5.6 million for the nine months
ended March 31, 2002, a decrease of 39.3%. 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 $318.3 million for the nine months ended March 31, 2003
from $359.1 million for nine months ended March 31, 2002. The decrease primarily
resulted from the reductions in both direct site expenses of $38.7 million and
pre-opening expenses of $2.2 million.
Loss from Operations. Our loss from operations decreased to $27.3 million
for the nine months ended March 31, 2003 from $31.8 million for the nine months
ended March 31, 2002, a decrease of 14.2%. Excluding the non-cash stock-based
compensation charges and credits, as mentioned above in Administration,
Curriculum and Development Expenses, our loss from operations decreased to $26.7
million for the first nine months of fiscal 2003 from $37.5 million for the
first nine months of fiscal 2002, an improvement of 28.8%.
Other Income and Expense. Other expense, net, was $7.4 million for the
nine months ended March 31, 2003 compared to $4.5 million in the nine months
ended March 31, 2002. Excluding a charge for the write-down of our
investment in APEX of $6.8 million in fiscal 2002 the decline was primarily due
to a $9.4 million increase in interest expense as a result of a more expensive
financing arrangement in fiscal 2003.
Net Loss and Net Loss Attributable to Common Stockholders. Our net loss
decreased to $35.2 million for the nine months ended March 31, 2003 from $37.1
million for the nine months ended March 31, 2002, a decrease of 5.1%. Excluding
the non-cash stock-based compensation charges and credits, as mentioned above,
our net loss decreased to $34.6 million for the nine months ended March 31, 2003
from $42.8 million for the nine months ended March 31, 2002, a decrease of
19.2%.
EBITDA. EBITDA, means the net gain or loss we would have shown if we did
not take into consideration our interest expense, interest income, income tax
expense, depreciation and amortization. These costs are discussed above. EBITDA
for the nine months ended March 31, 2003 was a negative $0.8 million compared to
negative $11.5 million for the nine months ended March 31, 2002. Included in
EBITDA are non-cash stock-based compensation charges of $0.5 million in
18
fiscal 2003 and credits of $5.7 million in fiscal 2002 and a charge for the
write-down of our investment in APEX in fiscal 2002 of $6.8 million. Excluding
the effect of these charges and credits the increase in EBITDA resulted
primarily from site-based operational improvements and lower pre-opening costs.
On a per-student basis (excluding summer school students), EBITDA improved to
negative $10 in the nine months ended March 31, 2003 compared to negative $156
for the same period of the prior year.
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 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 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 March 31, 2003, $41.8 million was outstanding under this line of
credit bearing interest at LIBOR plus 7.0% and was collateralized by receivables
of $65.5 million that were sold in a true sale to Edison Receivables by the
Company. The agreement requires the Company to 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 had the right to borrow up to $20.0 million, at an interest rate of
12% per annum, net of certain fees and costs which the Company paid School
Services and its affiliates. The agreement provided for a $10 million term loan
collateralized by certain real property owned by the Company, and a $10 million
revolving line of credit collateralized by notes receivable from charter schools
and other debtors of the Company. Such borrowings are also collaterized by
substantially all the other assets of the Company. The facility matures on June
30, 2004 but has prepayment obligations tied to refinancings of the notes
receivable from charter schools and such other debtors and to any sale or
transfer of the real property. The agreement requires the Company to meet
certain financial covenants including a minimum consolidated tangible net worth,
a maximum consolidated debt to equity ratio and a minimum EBITDA requirement for
fiscal 2003.
The Company was not in compliance with the minimum consolidated tangible
net worth covenant at March 31, 2003 as defined in the MLMCI and School Services
agreements. In May 2003, the Company received a waiver of default from both
MLMCI and School Services with respect to compliance with this covenant at March
31, 2003. The Company expects to be back in compliance with this covenant at
June 30, 2003, the next measurement date. The Company expects to regain
compliance based on projected fourth quarter operating results.
In December 2002, a note receivable in the amount of $7.5 million was
refinanced, the Company maintains a $2.2 million subordinated note. Proceeds
from this refinancing were paid directly to School Services and applied to
amounts outstanding under the revolving line of credit. Of this amount, $1.3
million represented a permanent reduction in the line of credit and $4.0 million
was subsequently re-borrowed by the Company. In addition, the Company made a
$1.0 million payment on the revolving line of credit pursuant to an amendment to
reduce the line of credit commitment by $1.0 million to obtain the release of
certain collateral. As of March 31, 2003, $17.7 million was outstanding under
these facilities reflecting the maximum amount available under the terms of the
facilities.
19
Edison has entered into a written agreement to sell the real property
(Harlem) for $9.2 million. The closing is scheduled to take place on June 30,
2003, however, the buyer may exercise its right under New York law to extend
the close within a reasonable period post June 30, 2003. Edison recorded an
impairment charge of $750,000 to reduce the carrying value of the property to
its net realizable value based on this agreement. Proceeds from the sale will be
used to pay down outstanding debt under the School Services term loan. There are
no assurances that the sale will close by June 30, 2003, if at all.
In connection with the establishment of the amended MLMCI Facility and the
School Services 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 at such
time equaled 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 nine months ended March 31, 2003, we generated approximately $3.2
million of cash from operating activities. This positive cash flow resulted from
$35.2 million of net loss offset by $36.4 million of depreciation and
amortization and $2.0 million of other non-cash operating charges, including the
changes in the working capital accounts.
For the nine months ended March 31, 2003, we used approximately $9.4
million in investing activities. During this period, we invested approximately
$11.3 million in our schools and central office. This amount includes the
investments we made in technology and curriculum in each of the schools we
opened. We have also advanced funds of $8.8 million to our charter board clients
or their affiliates to help obtain, renovate and complete school facilities.
During this same period, we received proceeds of $2.2 from disposals of property
and equipment, primarily from a certain sale lease back transaction related to
certain technology equipment. We also received approximately $7.4 million of
proceeds from notes receivable and advances due from charter schools. In October
2002, we received a $1.1 million payment toward an executive's loan.
For the nine months ended March 31, 2003, we used approximately $1.8
million in our financing activities. This amount includes borrowings under our
lines of credit of $15.5 million and borrowings under our term loan of $10.0
million. These proceeds were partially offset by costs in connection with our
debt financing of $7.3 million and the repayment of notes payable and capital
lease obligations totaling $15.3 million and purchases of treasury stock of $2.6
million. The Company also increased the amount of restricted cash by $2.1
million to comply with certain agreements.
Our debt obligations as of June 30, 2002, September 30, 2002, December 31,
2002 and March 31, 2003 are summarized in the table below:
20
DEBT FACILITIES JUN. 2002 SEPT. 2002 DEC. 2002 MAR. 2003
--------------- --------- ---------- --------- ---------
Capital leases and notes payable .............. $ 28,171 $ 23,384 $ 16,168 $ 14,989
School Services term loan ..................... -- 10,000 10,000 10,000
School Services revolving loan ................ -- 10,000 7,666 7,666
MLMCI revolving loan .......................... 34,000 49,325 49,325 41,844
Shareholders notes payable .................... 6,604 6,604 6,604 6,604
------ ------- ------- -------
68,775 99,313 89,763 81,103
------ ------- ------- -------
Unamortized original issue discount ........... -- (6,276) (4,895) (3,803)
------ ------- ------- -------
In relation to the warrant issuance attached
to the financing ............................. $ 68,775 $ 93,037 $ 84,868 $ 77,300
====== ======= ======= =======
We expect our cash on hand, together with borrowings under financing
arrangements, as mentioned above, expected reimbursements of advances we have
made to charter boards and acceleration of collections of our accounts
receivable, will be sufficient to meet our working capital needs to operate our
existing schools through fiscal 2003. Our near-term capital needs for managed
schools, summer school and other new lines of business are generally 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. Our plan for fiscal year 2003
is to continue to refinance, with third-party lenders, a minimum of $17 million
of loans we have made to charter boards to support 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 at
all. To the extent we cannot raise sufficient funds through the refinancing of
our loans to charter boards with third-party lenders, we may seek to expand our
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. 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. Additionally,
our $55.0 million revolving credit facility expires on July 15, 2003 and we
intend to refinance this debt with a new aset based facility. If the Company is
unable to refinance its revolving credit facility, the Company may be forced to
issue additional equity or restructure existing debt. We expect to meet our
working capital needs to operate our schools in fiscal 2004 through cash
generated from operations, borrowings under financing arrangements, and
reimbursement of advances we have made to the charter boards.
Our longer term cash requirements are 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.
On May 8, 2003 we announced that the CEO and Founder, H. Christopher
Whittle and other members of management might make an offer to purchase all of
the outstanding shares ("Management Buyout") of Edison Schools Inc. We have been
told by our CEO that no financing for such an offer has yet been arranged. The
board of directors has established a committee for the purpose of receiving and
evaluating any offers. The result of a management buy out would be that the
company would no longer be traded on the NASDAQ. However, the committee may
receive other offers and or engage in other financing arrangements that may
result in the company remaining on the NASDAQ. There are no guarantees that any
offer will be made to purchase all of the outstanding common stock, or a
significant amount of the outstanding common stock nor are there any guarantees
that the company will execute new or amend existing financing arrangements.
We managed summer school programs for 51 districts in the state of
Missouri during May, June and July of 2002. The payment terms of the related
billings ranged from 12 to 18 months, therefore, cash receipts of revenue will
lag outlay of cash for expenditures by more than one year. As of December 31,
2002, we had accounts receivables of $59.0 million for managed
21
schools and $16.0 million for our summer school program. As of March 31, 2003,
our accounts receivables were $60.2 million for managed schools and $15.4
million for our summer school program.
In general, our ability to achieve positive cash flows 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 flows do
not depend totally on 100% enrollment.
Capital expenditures through March 31, 2003 have been approximately $14.0
million, which includes approximately $4.0 million for computers and other
technology at our schools, approximately $8.0 million for curriculum materials,
approximately $1.0 million for the purchase and improvement of property at our
schools, and $1.0 million for technology, leasehold improvements, and other
capital items at our headquarters. Additionally, we have made additional
advances or loans approximating $3.1 million to new charter board clients to
help secure and renovate school properties during 2002-2003 school year.
Pursuant to our philanthropic commitments, a portion of which we expect will be
refinanced through third parties, we expect to make charitable donations of
approximately $1.3 million over the remainder of the year to benefit certain
clients over the remainder of this fiscal school year.
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 March 31, 2003, our net loss was $6.4
million. As of March 31, 2003, our accumulated deficit since November 1996, when
we converted from a partnership to a corporation, was approximately $291.8
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 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 is still developing, 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
22
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. 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:
- we generally require our teachers to work a longer day and a
longer year than most public schools;
- 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
- 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 MAY 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'
23
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
certain 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 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 certain 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 which 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
24
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 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 occasionally 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 March 31, 2003, we have outstanding loans or advances to charter
boards of $82.3 million, net of allowances, to finance the purchase or
renovation of school facilities we manage. Approximately $20.7 million of these
loans, representing 18 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 have obtained
tax-exempt financing to repay these loans and advances, but there can be no
assurance that our other charter schools will continue 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. As of March 31, 2003, our aggregate future lease obligations totaled
$47.0 million, with varying maturities over the next 18 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 March 31, 2003 the amount of loans we had guaranteed totaled $27.1 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
25
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.
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:
- 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.
- 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.
- 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.
- 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.
26
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
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 or receive a waiver of any such default,
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,
at such time, equaled 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 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
terminated our plans to develop this property and construct new corporate
headquarters. We recently entered into a written agreement to sell the property
for $9.2 million, however there is no guarantee that the closing of such sale
will occur.
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
27
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:
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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
28
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.
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, in April 2003, Illinois
revised its charter school legislation to prohibit for profit entities from
operating or managing schools effective from the date of the bill through the
2004-2005 school year. 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. 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
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:
- variations in our quarterly operating results;
- changes in securities analysts' estimates of our financial
performance;
- changes in the public perception of our schools' academic
performance;
- termination or non-renewal of existing management agreements;
- changes in market valuations of similar companies;
- speculation in the press or investment community;
29
- actions by institutional shareholders;
- pending and potential litigation;
- future sales of our class A common stock or other securities;
and
- general stock market volatility.
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 A CONSOLIDATED SHAREHOLDER CLASS ACTION AND A FEW
SHAREHOLDERS DERIVATIVE LAWSUITS
We have been named in a consolidated putative class action lawsuit 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 improve 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.
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:
- the high-vote nature of our class B common stock;
- 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;
30
- Section 203 of the General Corporation Law of Delaware which
could have the effect of delaying transactions with interested
stockholders;
- 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 $23.2 million at March 31,
2003. Interest rates on the notes are fixed and range from 9.5% to 16.7% 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 $32.7 million at March 31, 2003.
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. 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 9 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
31
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
Exhibits:
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.
32
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 May 15, 2003 /s/ H. Christopher Whittle
-------------------------------------
H. Christopher Whittle
Chief Executive Officer
Date May 15, 2003 /s/ Christopher J. Scarlata
-------------------------------------
Christopher J. Scarlata
Executive Vice President and
Chief Financial Officer
(Principal Accounting Officer)
33
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: May 15, 2003 /s/ H. Christopher Whittle
----------------------------------------
H. Christopher Whittle
Chief Executive Officer
34
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: May 15, 2003 /s/ Christopher J. Scarlata
----------------------------------------
Christopher J. Scarlata
Executive Vice President and Chief
Financial Officer
35