EDISON SCHOOLS INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

(Mark One)
[X] ANNUAL REPORT ON FORM 10-K PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED JUNE 30, 2003

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER: 000-27817
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EDISON SCHOOLS INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 13-3915075
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

521 FIFTH AVENUE, 11TH FLOOR, 10175
NEW YORK, NEW YORK (Zip Code)
(Address of principal executive offices)

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REGISTRANT'S TELEPHONE NUMBER; INCLUDING AREA CODE:
(212) 419-1600

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
CLASS A COMMON STOCK, $ .01 PAR VALUE
CLASS B COMMON STOCK, $ .01 PAR VALUE
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The aggregate market value of the voting stock held by non-affiliates of
the registrant, computed using the closing sale price of the registrant's Class
A common stock on September 15, 2003, as reported on the Nasdaq National Market,
was approximately $81,102,000.

The number of shares of the registrant's Class A common stock outstanding
on September 15, 2003 was 52,500,319 and the number of shares of the
registrant's Class B common stock outstanding on September 15, 2003 was
1,627,933.
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EDISON SCHOOLS INC.

ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2003

1

Some of the statements under "Management's Discussion and Analysis of
Financial Condition and Result of Operations," "Business" and elsewhere in this
Annual Report are forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. We have based these forward-looking statements on our current expectations
and projections about our ability to, among other things:

- implement our business strategy;

- expand our customer base and increase the number of students enrolled in
schools managed by us;

- control costs;

- improve the academic achievement of students in our schools; and

- finance and manage our growth.

In some cases, you can identify forward-looking statements by words such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue," or the negative of these and
other similar words.

Forward-looking statements are subject to known and unknown risks,
uncertainties and other factors that may cause our actual results, levels of
activity, performance, achievements and prospects to be materially different
from those expressed or implied by such forward-looking statements. These risks,
uncertainties and other factors include those identified under "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Additional Risk Factors That May Affect Future Results" and
elsewhere in this report. You should also carefully review the risks outlined in
other documents that we file from time to time with the Securities and Exchange
Commission, including our Quarterly Reports on Form 10-Q that we file in fiscal
2004. All forward-looking statements included in this Annual Report are based on
information available to us up to and including the date of this document, and
we expressly disclaim any obligation to alter or update our forward-looking
statements, whether as a result of new information, future events or otherwise.

We are a Delaware corporation. Our principal executive offices are located
at 521 Fifth Avenue, 11th Floor, New York, New York 10175, and our telephone
number is (212) 419-1600. Our web site address is www.edisonschools.com. The
information on our web site is not incorporated by reference into this Annual
Report and should not be considered to be a part of this Annual Report. Our web
site address is included in this Annual Report as an inactive textual reference
only.

Certain Definitions: The terms "Edison," the "Company," "our" and "we" as
used in this Annual Report mean Edison Schools Inc. and its subsidiaries on a
consolidated basis. References to a given fiscal year mean the fiscal year
ending on June 30 of such year.

2

PART I

ITEM 1. BUSINESS

Edison is 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 students in other public schools in the
area. Over the course of three years of intensive research, Edison's team of
leading educators and scholars developed an innovative, research-backed
curriculum and school design. We opened our first four schools in August 1995,
and in the 2002-2003 school year we served approximately 80,000 students in 149
schools located in 22 states across the country and the District of Columbia.
This represents an increase of 6,000 students from the 2001-2002 school year.
For the 2002-2003 school year, approximately 53,000 students were enrolled in
our schools in grades pre-K-5, approximately 22,000 in grades 6-8 and
approximately 5,000 in grades 9-12. In the 2003-2004 school year, we expect to
enroll approximately 66,000 students in 130 schools located in 19 states and the
District of Columbia.

In addition to the direct management of public schools, Edison has begun to
enter new business areas such as consultative services, summer and after-school
programs and tutoring support. During the summer of 2003, we served
approximately 46,000 students in our summer school program.

Our managed school model offers public school authorities, who face
widespread concern about disappointing student achievement, the benefits of a
large private sector company with national support systems. We believe those
benefits include:

- the ability to create, implement and support a superior educational model
through focused research and development; and

- increased emphasis on accountability for achieving improved academic
performance.

These benefits contribute to an enhanced educational experience that we
believe has proven attractive to public school authorities, parents and teachers
alike. Elements of that experience include:

- a rich and challenging curriculum based on clear standards and high
expectations for all students;

- generally a significantly longer school day and year in schools that
adopt this part of our model;

- an enriched technology program;

- an emphasis on the professional growth of teachers through a commitment
to training, an explicit career ladder and a school management structure
that allows teachers to participate in the leadership of the school;

- a support system focused on improving student achievement;

- exposure to foreign language beginning in kindergarten in schools that
adopt this part of our model; and

- an emphasis on parental involvement and character development.

Our Newton Learning division provides school districts with extended
learning programs, including summer school, after-school and supplemental
education services. The primary benefits of a partnership with Newton Learning
are:

- complete management and implementation of all aspects of extended
learning programs

- an innovative curriculum focused on increasing student achievement

- expanded choices and opportunities for parents and educators

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The advantages of Newton Learning programs enable parents and educators to
use valuable time outside traditional school hours to raise student achievement.
Fundamental components of the Newton Learning programs include:

- a rich and challenging curriculum that is interesting to students and
allows for greater student participation

- assessments that measure student achievement and provide accountability

- programming tailored to the community

- teaching methods that motivate students

We have an experienced and talented management team led by H. Christopher
Whittle, founder of several media enterprises, including the first national
electronic news system for middle and high schools in the United States; Benno
C. Schmidt, Jr., former President of Yale University; Charles J. Delaney, former
President of UBS Capital Americas; Christopher D. Cerf, former Associate Counsel
to President Clinton from 1994 to 1996; and John E. Chubb, senior fellow at the
Brookings Institution and noted author and speaker on education reform. In
addition, the management team includes a number of former public school system
superintendents.

GOING-PRIVATE TRANSACTION

On July 14, 2003, the Company issued a press release announcing that it had
signed an Agreement and Plan of Merger (the "Merger Agreement"), dated as of
July 13, 2003, among the Company, Shakespeare Acquisition LLC (the "Parent"),
and its wholly-owned subsidiary, Shakespeare Acquisition Corporation (the
"Merger-Sub"). The Parent and Merger-Sub are newly formed entities organized for
the sole purpose of entering into the Merger Agreement and consummating the
transactions contemplated therein. Affiliates of Liberty Partners, a private
equity firm based in New York, and H. Christopher Whittle, the Chief Executive
Officer of the Company, control the Parent. Under the terms of the Merger
Agreement, the Merger-Sub will merge (the "Merger") into the Company with the
Company remaining as the surviving corporation, and the stockholders of the
Company will receive $1.76 in cash for each outstanding share of the Company's
Class A common stock and Class B common stock. Outstanding options and warrants
to purchase shares of the Company's Common Stock will become fully vested and
exercisable and, at the time of the merger, will be canceled and each holder of
such convertible security will receive a cash payment in an amount equal to the
excess, if any, of the common stock purchase price of $1.76 over the exercise
price of such convertible security, multiplied by the number of shares held by
the holder, subject to and net of any required income tax withholding. The
closing of the Merger is subject to various conditions, including approval of
the transaction by stockholders of the Company representing a majority of the
shares of Class A common stock and Class B common stock voting as a single class
on the transaction and other customary conditions to closing. Subject to these
conditions, the Company expects to complete the merger transaction in the fall
of 2003. A special meeting of Edison's stockholders will be scheduled as soon as
practicable following review of proxy materials filed in preliminary form with
the Securities and Exchange Commission (the "SEC") on August 22, 2003. There can
be no assurance that all required conditions will be met and the transaction
will be consummated in the fall of 2003 or at all.

After consummation of the Merger, the Company's Class A common stock will
no longer be traded on the Nasdaq National Market or any other securities
exchange, and the Company will become a privately-held company.

INDUSTRY BACKGROUND

During the 2001-2002 school year, over 14,500 school districts comprising
approximately 91,400 K-12 schools enrolled an estimated 47.7 million students.
Despite the growth in spending on public education over the last decade, student
achievement has progressed very little and remains low. For example, on the
National Assessment of Educational Progress ("NAEP"), only approximately 27% of
students in grades 4 and 8 met grade level standards in mathematics in 2000, the
last year for which results are available. In reading, only
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approximately 32% of students in grades 4 and 8 met grade level standards in
2002. Only approximately 30% of students in grades 4 and 8 met grade level
standards in writing in 2002. The NAEP, a testing program conducted by the U.S.
Department of Education since 1970, uses tests specially designed to measure how
well students meet grade level standards established by a national panel of
education experts. The tests are administered to random national samples of
students at three grade levels every other year, or every fourth year, in major
subjects.

Public education remains high on national, state and local political
agendas. President Bush and both major national political parties have placed
education at the center of their national platforms, and many state and local
authorities have enacted or encouraged measures to implement significant
educational reforms. Some of these reforms are programmatic innovations
occurring within public schools. Examples include expanded levels of teacher
training, higher standards, more rigorous testing and more effective technology.
Other initiatives have sought to reform the public education system itself by
embracing the market-oriented concepts of competition, accountability and a
broader range of parental choice. Key reform initiatives include the following:

- No Child Left Behind. On January 8, 2002, President Bush signed into law
the No Child Left Behind ("NCLB") Act, a comprehensive education reform
package that will have a wide range of effects on the education
establishment. Many of the NCLB provisions are designed to lift the
achievement level of under-performing students in traditionally
low-achieving schools. This new legislation mandates that schools that
fail to meet adequate yearly progress must take a series of steps to
remedy their poor academic performance. These steps may include:
providing supplemental services to its students; offering school choice
options to its students; spending more Title I funds on professional
development for teachers; reopening the school as a charter school; and
contracting with a private management company. Additionally, all newly
hired teachers must be highly qualified -- a new teacher must hold at
least a bachelor's degree and must demonstrate knowledge of the subjects
he or she is teaching by passing a rigorous state test.

- Charter Schools. Since Minnesota first enacted legislation in 1991, 40
states and the District of Columbia have passed charter school
legislation. Under the typical charter school statute, identified
entities, such as the state board of education or a state university, are
authorized to grant a specified number of charters to community groups or
non-profit entities to create a public school. A growing number of
charter boards in turn contract with private sector organizations to
operate the schools. In return for a large measure of autonomy from
regulation, the charter school is accountable for student academic
performance. Many charter school statutes limit the number of charter
schools or the number of students that may enroll in charter schools.
Currently, there are approximately 2,700 charter schools in operation,
with an estimated enrollment of almost 685,000 students in 37 states and
the District of Columbia.

- District Partnership Schools. District partnership schools are public
schools operated by private organizations based upon management
agreements with local school boards. Unlike charter schools, district
partnership schools do not require specific statutory authority, but are
created through a contract between a school management company and a
school board in accordance with existing authority.

- Voucher Programs. Voucher programs provide for the issuance to parents
of tuition vouchers worth a certain amount of money that they can redeem
at any approved school of their choice. These programs allow students to
choose among public schools, which would have to compete for students, or
possibly even attend private schools. Legislation in Wisconsin has
provided vouchers in Milwaukee since 1990, and legislation in Ohio has
provided for vouchers in Cleveland since 1996. In June 2002, the Supreme
Court ruled that the Cleveland program did not violate the First
Amendment of the U.S. Constitution, which has encouraged voucher
advocates across the country, (although in August 2002 a Florida circuit
court ruled that the state's 1999 voucher legislation violated the state
constitution.) Voucher legislation has also been introduced in several
other states, and private philanthropists have funded a number of voucher
programs.

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- Choices Offered by School Districts. School districts are offering
increased choice to their students by, for example, establishing magnet
schools serving students within the district and allowing students to
attend schools across district lines. Magnet schools are specialized
public schools offering unique programs, such as curricula emphasizing
math, science or the arts.

- State Takeover Statutes. Some states have exercised their ability under
local law to divest local school boards of their authority to manage an
identified school or schools within the district. These states include,
among others, Maryland, New Jersey, Michigan and Pennsylvania. One of
those states, Maryland, has opted to contract with us to provide
educational services at three identified schools in Baltimore. As a
result of a program instituted under Pennsylvania's Act 46, the School
Reform Commission of the School District of Philadelphia has contracted
with us to manage 26 schools. Additionally, as a result of a program
instituted under Pennsylvania's Educational Empowerment Act, we are
currently managing nine schools in Chester, Pennsylvania. The company
also manages a small school district in Michigan that is currently being
administered by an "emergency financial manager" appointed by the
governor.

Incorporating elements of both a market-oriented approach and programmatic
innovation, we are a leader in offering reform alternatives to local school
boards searching for new approaches to education. For the 2002-2003 school year,
we operated 98 district partnership schools with a total enrollment of 51,000
students and 51 charter schools with a total enrollment of 29,000 students. Of
these district partnership schools, 16 were operated under charters granted by
school districts, which provided the facilities. We categorize these schools as
district partnership schools because we do not provide the facilities and
therefore the economics of these arrangements closely resemble those of a
district partnership school. The remaining 82 district partnership schools were
operated under management agreements with local school boards. We also operated
summer school programs during the summer of 2003 serving approximately 46,000
students at 200 school sites in partnership with 70 school districts.

THE EDISON SOLUTION

As a private enterprise with national scale, Edison offers school districts
and charter boards a vehicle for overcoming many of the inherent constraints
that have impeded systemic reform of public schools. The Edison solution
consists of two equally critical and mutually reinforcing components:

- a research-backed curriculum and school design that we believe yields
significant improvement in student academic achievement as reflected in
average annual gains of 4.0 percentage points against state
criterion-referenced tests and 4.4 percentiles per year against national
norm-referenced tests from the 1995-1996 school year through the
2000-2001 school year; and

- support systems designed to ensure consistent, replicable and effective
implementation of our educational model as we expand into a wide range of
communities across the nation.

Examples of the latter include a national teacher and principal recruiting
system; an infrastructure to support teacher and principal training both before
and after a school opens; a national distribution network for curriculum
materials, technology equipment and supplies; and information and support
systems to track and enhance student progress against identified goals.

We believe that many public school authorities are attracted to the Edison
solution because, unlike some other school reform initiatives, it enables them
to stimulate positive, market-oriented, comprehensive school reform within the
framework of the existing, locally controlled public school system. By entering
into a partnership with us, such authorities enjoy the resources, systems,
continuity of focus and commitment to ongoing research and development
associated with a national private sector company while at the same time
retaining local control of public education. For example, our management
agreements typically provide for the district or charter board to maintain
ultimate oversight and supervision over the school. In addition to regular
reporting requirements and the ability to terminate the management agreement on
performance grounds, such oversight may take several forms, including the right
to reject Edison's candidate for school principal and the right to make
adjustments to the curriculum.

6

RESEARCH BEHIND THE EDISON SOLUTION

The Edison school design and curriculum grew out of a comprehensive
three-year research project conducted by a team of approximately 30 full-time
professional employees and numerous outside experts under the leadership of
Benno C. Schmidt, Jr., the former President of Yale University. Our design team
included respected education researchers, curriculum developers, teachers,
principals, school administrators, writers, technology specialists and experts
in school finance and management. Together, they brought a wide range of
perspectives on improving education through the reform of curriculum,
instruction, assessment, professional development, school organization and most
other elements of education. The research leading to the development of our
solution was extensive and systematic; our staff members interviewed educators,
reviewed a wide range of school programs and attempted to assemble the best
scientific evidence of the effects of potential reforms in K-12 education.

THE EDISON CURRICULUM AND SCHOOL DESIGN

Our schools combine innovative curriculum and instruction methods with
structures to assess and guide students, hold school administrators accountable
for student performance and encourage and facilitate parental involvement in
their children's education.

CURRICULUM

Demanding Program of Study. Our curriculum is guided by detailed and
demanding student academic standards that specify what students should know and
be able to do at the end of each school year in twenty fields of study, from
reading, writing and mathematics to economics, geography, visual arts and
foreign languages. Our curriculum is also rich in content. For example, students
at the junior and high school levels normally study three years of world history
and literature and two years of U.S. history and literature. In addition, all
high school students have the opportunity to complete biology, chemistry and
physics by the end of 11th grade, and we offer a wide range of advanced
placement courses to students in the 11th and 12th grades.

Professional Development. Our professional development program provides
opportunities for teachers and principals to learn how to implement our program
and develop their skills as educators. We typically provide teachers and
principals with two weeks of training before a school first opens and additional
support and training during the school's initial year. In addition, in schools
that have chosen a longer day teachers generally have two periods every day for
professional development, and our school calendars provide at least three days
for ongoing training each year. We also offer several major national curriculum
conferences annually for different specialists within our schools and many
regional conferences.

Proven Instruction Methods. We use instruction methods derived from
systematic research. For example, our elementary schools implement either
Success for All, a K-5 reading program developed at Johns Hopkins University and
refined through experimental studies directed by Johns Hopkins University, or
Open Court, another research-based program from SRA-McGraw Hill. Our schools
generally use mathematics programs developed through years of research by the
University of Chicago School Mathematics Project.

Emphasis on Core Values. We believe schools cannot be successful unless
the students display certain values, such as the willingness to take
responsibility for themselves and their education, respect for teachers and
other students, and the desire to become educated. Our educational program is
built around a defined set of core values: wisdom, justice, courage, compassion,
hope, respect, responsibility and integrity. We believe these core values help
us promote strong character in our students and a positive learning environment.
Our students receive instruction in these core values at every grade level. For
example, students in our elementary schools read out loud and have group
discussions of morality stories written for children. Also, our teacher training
in student discipline, classroom management and instruction is based on a
character education program that incorporates these values.

Regular Assessments of Student Performance. We routinely monitor our
students' progress against academic standards. We connect our standards and
instructional programs with state standards and

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assessments, and we believe our students are well prepared for state and local
tests, for which we are held accountable. Each quarter teachers complete a
unique report card, known as a Quarterly Learning Contract, which is a special
narrative report card that tracks student progress against academic standards
and sets specific goals for students. We believe this is a contrast to the
typical American report card that grades progress relative to each teacher's
subjective classroom standards. Our students take all standardized tests
required by state and local authorities, but we also have introduced a monthly
electronic benchmark assessment system that provides us with detailed
measurements of student progress toward achieving grade level academic
standards. These electronic assessments provide state-specific content via a
proprietary split-ASP technology model, giving our teachers a valuable tool that
enables them to adjust their daily instruction to help our students achieve the
academic requirements of their grade level. Approximately a million assessments
were administered electronically during the 2002-2003 school year alone.

Extensive Remedial Instruction. The Edison curriculum is designed to meet
the needs of all students, regardless of ability. We employ one-on-one tutoring
to help students master the academic requirements of their grade level.
Intensive remedial instruction in reading is available at all grade levels. In
addition, those schools that adopt our longer school day and year provide more
time for instruction.

Support for Students with Special Needs. We instruct special education
students in mainstream classrooms, to the extent we believe it is responsible to
do so. However, special education staff members are available at each site to
provide a full continuum of services, including additional support in regular
classrooms, resource rooms and self-contained environments for students with
greater needs. We offer students who have limited English proficiency
English-as-a-second-language programs or bilingual programs, depending on
community preference and needs.

SCHOOL DESIGN

Students and Teachers are Organized into Small
Schools-Within-A-School. Each of our schools consists of small, flexible
schools-within-a-school, called academies, where teachers typically follow the
same students from grade to grade for several years. We believe this
organization ensures that students are better known by their teachers, helps
foster student-teacher relationships and encourages teachers to feel more
ongoing responsibility for individual students. Within each academy, students
are generally organized into multi-grade groups, called houses, of 100 to 180
students each. Students typically remain within the same house until they
graduate from the particular academy. Each house is led by four to six teachers,
who usually work with students of every level of the house for the duration of
their academy experience and are responsible for the core academic program of
instruction in math, science, history, geography, civics, economics, reading and
language arts.

Longer School Day and Year. In district partnership and charter schools
that choose to adopt this part of our program, our students are in school an
average of 1,500 hours each year after the first year of their school's
operation, and our school year is approximately 200 days. Based on these
figures, we believe many of our students spend more time in school each year
than students in most other public schools. This provides our students with
substantially more time for learning than many public school students and
enables us to implement a richer curriculum. Our typical school schedule also
provides our students with less time during the shorter summer vacation to
forget what they learned during the school year.

Increased Integration of Technology. Our schools feature significant
technology resources. We generally provide each of our teachers with a laptop
computer. Computer labs are available in all schools to facilitate assessment of
student learning, and each classroom has at least one computer available for
student use. To encourage and increase communication and enable the sharing of
best practices, teachers, students and parents are electronically connected via
The Common, our Internet-based, internal message, conferencing and information
system that connects all our schools. We also have a distinctive program called
Technology as a Second Language to teach school staff, students and families to
use technology effectively.

Immediate and Comprehensive Change. In contrast to the small steps that
school reform usually must take, we believe it is important that schools launch
a comprehensive package of change all at once. We therefore make a substantial
initial investment to purchase computers and other technology, implement our
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curriculum and train teachers prior to commencing management of a school. This
enables our schools to integrate new curriculum, technology and professional
development and pursue excellence in all areas immediately and aggressively.

School-Level Accountability. We hold each school accountable for a high
level of demonstrated student progress as measured by conventional standardized
tests, official performance assessments and our own assessments. Staff
compensation and promotions within our schools are generally linked to
performance. Parents of students in our schools are encouraged to share
accountability for their children's progress by co-signing the Quarterly
Learning Contract, under which they make a moral commitment to help their
children achieve specified academic goals. The Quarterly Learning Contract
serves as the report card for our students and indicates to parents how well
their children are performing relative to our annual academic standards. In
addition to educational accountability, our schools are also held accountable
for financial management and student, parent and community satisfaction.

Principals Accountable for School Performance. Principals at our schools
are appraised and compensated based on meeting student academic performance,
financial management and community satisfaction goals. They are also responsible
for public reporting of their school's accounts and budgets. Principals receive
school report cards that track progress on all accountability criteria, and
principals are in turn appraised and compensated based on progress against the
accountability criteria. Principals for our district partnership and charter
schools are chosen in consultation with the school district or charter board and
normally hired four to six months before the school opens. This allows our
general managers to work closely with the new principals for several months to
thoroughly introduce them to our education system. In addition, new principals
receive two weeks of formal training on our education system.

Dedicated Teachers. We believe our schools attract motivated and dedicated
teachers due to the following factors:

- our innovative curriculum and approach to education;

- our commitment to professional development of teachers;

- increased access to resources and technology; and

- generally competitive salary levels.

Our schools are staffed by four levels of teachers: lead teacher, senior
teacher, teacher and resident teacher. We believe this four-tier seniority
system provides an attractive career path and allows new teachers to be mentored
by more experienced teachers. Teachers are hired based on classroom and
educational experience, expertise in a particular subject area, evidence of
leadership abilities in the context of teams, and interaction with staff,
students and families. Lead teachers have responsibility for the organizational
management of the teaching team, and classroom instruction is the primary focus
of senior teachers, teachers and resident teachers. In addition, lead teachers
serve on the management team of the school, which is led by the principal. In
this respect, teachers are offered the opportunity to participate in the
management of the school.

Partnerships with Families. We are committed to keeping families engaged
in their children's education, both at school and in the home. We actively
encourage parental involvement in the education of their children through
interaction with teachers, involvement in school affairs and numerous volunteer
opportunities. In addition, by co-signing the Quarterly Learning Contract,
parents commit to monitor the progress of their children in meeting stated
educational goals. Further, where funding is sufficient for implementation, we
believe our program of providing, following the first year of a school's
operation, computers to the families of our students above the second grade has
increased parents' level of involvement in the school.

Newton Learning. During the summer of 2003, Newton Learning, Edison's
extended learning division, served approximately 46,000 students in summer
school programs at 200 school sites in 70 districts in Missouri. Edison manages
none of these schools during the regular academic year. Newton's programs serve
students in grades K-12 and includes instruction in all subject areas. The
programs typically provide 168 hours
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of instruction for students during a five-week period. Newton Learning creates
site-specific educational programming, with core classes in academic subject
areas in the morning and elective courses in the afternoon.

THE EDISON OPERATING SYSTEM

The systems we have built to ensure consistent and effective
implementation, replicability and scalability are as essential to our managed
school model as the Edison curriculum and school design itself. Although there
are many outstanding public schools in the United States, we believe that the
basis for such success has been highly individualized, often, for example,
dependent on an especially dynamic principal. Edison has designed its support
systems with the objective of not only creating excellence, but also being able
to replicate it in a consistent manner in a widely diverse array of schools
across the country.

As of July 2003, the Company was re-organized into three operating
divisions -- Charter Schools, District Partnerships and Educational Services.
Each division is supported by Edison's other headquarters divisions: Education,
Business & Finance, Business & Technology Services, General Counsel, Human
Resources and Communications.

Channel Head Structure. Our managed schools are organized under two
operational executives who have operational and financial accountability over a
specific numbers of our schools. The two divisions are generally divided along
the lines of charter schools and district partnerships. The channel head is
responsible for student achievement, client services, financial performance, and
division growth. A third channel head oversees educational services, which
includes the businesses of Newton Learning, Tungsten Learning and Edison Ltd.
("Edison UK," as further discussed on page 19), and is responsible for financial
performance and division growth.

General Manager Structure. Edison's operational professionals provide the
most critical link between our central operations and each managed school site.
They are accountable for building and ensuring the operation of successful
schools, defined as schools that measurably enhance student achievement over
time and meet financial objectives. They work closely with regional achievement
directors from the education division to assess school progress against specific
achievement goals. In meeting their responsibility, general managers make
frequent site visits, analyze school academic and financial data, coordinate
central support operations that meet the needs of each school and hold regional
training sessions for principals and teachers. General managers report to a
channel head.

Education Division. Our Education Division oversees the implementation,
modification, support and effectiveness of our educational design. The Education
Division's 52 employees, together with approximately 150 of our teachers whom we
annually certify as trainers, provide a continuous stream of support to our
schools through the coordination of school wide and national training programs,
development of curricular standards and assessment of design effectiveness at
each school. The achievement department within the Education Division deploys
senior educators with a span of control of roughly 10 schools apiece to help
schools focus their instructional programs intensely on raising achievement. The
Education Division also collects, analyzes and publishes educational data for
use by our schools, our school district and charter board clients and the
public.

Assessment. The assessment department within our Education Division
monitors student achievement, school design and customer satisfaction criteria
of our schools, and analyzes these data to understand and measure our schools'
performance. This department also prepares monthly and annual reports on school
performance for our principals and general managers.

Recruiting. Strong educational leadership and teaching ability are vital
to the successful implementation of the Edison design. Our recruitment
department works year-round to attract outstanding principal candidates through
a variety of recruitment strategies, including direct headhunting, national
advertising and cultivation of outstanding internal candidates. The department
also recruits outstanding teacher candidates through a network of school-based
recruitment coordinators and through targeted recruitment efforts at over 100
college campuses, historically black colleges and highly regarded teacher
organizations.

10

Real Estate. Prior to finalizing a management agreement, we typically
review the physical condition, technology infrastructure, suitability and
student capacity of each school site, and estimate the costs of preparing the
facilities for an Edison school. Generally, once the management agreement is
finalized, we either contract with local architects and construction managers to
make the necessary modifications or work closely with client school districts,
depending on the terms of the management agreement. In some independent charter
school management agreements, we may be responsible for new construction, major
renovation or conversion of a commercial or industrial property. We often will
provide construction management and real estate development and financial
advisory services to charter schools. For more information on our real estate
arrangements, see "Properties."

Start-Up. As a management agreement is finalized with a charter or
district client, the assigned general manager sets up a local start-up office,
hires a start-up staff, and begins to complete each step outlined in our
start-up manual, a multi-volume guide that directs each phase of the start-up
process. The start-up office serves as the center for all school operations,
including student enrollment, staff recruitment and coordination with the
central office.

Purchasing. Our supply chain management department is responsible for
coordinating both the purchase and the delivery of each school's curriculum and
technology. We believe our size and growth have allowed us to achieve economies
of scale by realizing more competitive prices from vendors than could most
school districts.

Enrollment. We provide technical expertise and on-site support to assist
each school in reaching its targeted enrollment. The student enrollment team
supports a variety of student recruitment strategies, including door-to-door
distribution of recruitment literature, neighborhood information sessions,
posting of fliers in public areas, use of available print and electronic media
and interaction with community-based organizations. In the event that the number
of students seeking admission to an Edison school exceeds the school's capacity,
an open admissions lottery is held to determine which students are admitted and
which are placed on the school's waiting list.

Area Financial Management Unit. We hire financial staff to manage the
day-to-day financial operations of certain of our Edison schools. An area
financial management unit consists generally of one financial manager, two
business specialists and two student information specialists. Each unit
generally services a cluster of schools and is responsible for managing the
schools' budgets, processing certain site expenditures, handling financial
reporting to clients and monitoring school enrollment. We also employ financial
analysts in our central office to assess prospective management contracts and
monitor the budgets versus actual expenditures of our existing managed schools.
Our central office also monitors real estate financing and performs traditional
financial administrative functions.

Technology. Our technology department oversees the creation, modification,
and implementation of the technology components of the Edison curriculum and
school design. The department creates specifications for each school and
start-up office, oversees technology-related building modifications and
equipment installation, recruits and selects the school or community technology
manager, trains the technology manager and provides additional field support as
needed.

Family and Community Partnerships. Formal parent orientation begins once
the student body has been selected, but all parent meetings and community
information sessions that lead up to final student selection are part of the
families' introduction to Edison and the district partnership or charter school.
The parent orientation process is organized at each site by the school's student
support manager, a professional member of the school staff who facilitates
community interaction and coordinates social services within the school. The
student support manager works closely with the school's principal throughout the
start-up process to recruit parent volunteers, hold welcome meetings, orient
parents to the Edison curriculum and school design and coordinate the school's
grand opening celebration.

Pre-Opening Training. We provide a comprehensive, pre-opening professional
development program for principals and teachers at each of our new sites. Our
national leadership training gives new principals an intense overview of the
Edison design, including the start-up process, curriculum, student academic
standards,

11

school organization, school culture, technology, financial management and
measures of accountability. Training for all instructional school staff takes
place during the summer before the opening of the school and includes training
on instructional methodology, classroom management and the core curriculum in
each teacher's area of expertise.

Ongoing Training. We maintain the successful operation of each of our
schools through frequent site visits by our support personnel and through
ongoing professional development for school staff. In addition to local
training, principals and teachers regularly convene for national conferences,
where training typically focuses on student achievement, leadership strategies,
design modifications, community relations, new support services or
subject-specific training sessions. Principals and teachers can also utilize The
Common, our on-line network, to access additional resources and interact with
individuals from other Edison schools.

Site Monitoring and Accountability. To ensure that each Edison school
makes continuous progress in each of these areas, we generate a Monthly
Achievement Profile ("MAP") for each school site. The MAP provides a snapshot of
benchmark results, information related to attendance, enrollment, student and
teacher mobility, quality of instruction, student management, teaching
materials, and professional development. These reports are available online to
site and central personnel. Monthly financial estimates are also generated. In
addition, we compile a year-end Student Report Card for each school site. The
report includes information about student performance on standardized tests;
levels of parent, staff, and student satisfaction; the degree to which the
school adhered to and implemented the Edison school design, and the degree to
which the school met its budgetary requirements. The School Report Card serves
as the basis upon which the school principal is evaluated and, where state law
permits, compensated.

THE EDISON SOLUTION IMPLEMENTED

For the 2003-2004 school year, we expect to operate 130 schools located in
19 states and the District of Columbia with a combined student enrollment of
approximately 66,000. This represents a decrease of approximately 14,000
students from the 2002-2003 school year. We also offered summer school programs
at 200 sites in the summer of 2003.

We operate two types of managed schools: district partnership and charter.
In the case of most charter schools, we are required to arrange for a facility.
In some cases, however, we operate charter schools under a charter granted by
the local school board, which provides the facility. In these cases, we
categorize and count these schools as district partnership schools because we do
not provide the facilities and therefore the economics of the arrangement more
nearly resemble those of a district partnership school. We believe that Edison,
which is currently operating 79 district partnership schools, is the major
provider of district partnership schools for traditional K-12 instruction in the
United States, although other providers are now also operating district
partnership schools.

We consider grades pre-K-5, 6-8 and 9-12 to each be a school, and we count
grades pre-K-5, 6-8 and 9-12 as separate schools, even if they are located in
the same building. As we expand, we often introduce new grade levels gradually
rather than simultaneously opening all grade levels within a school. We consider
ourselves to have opened a new school if we introduce at least one grade level
at a different school level. For example, we consider a new school to have been
opened if we add grade 6 at a location housing an existing pre-K-5 school. In
some cases, we count grades pre-K-6 as one school if it is the local practice to
configure elementary schools in this manner. For the 2003-2004 school year, we
have 99 principals, and each principal is generally responsible for all the
Edison schools on his or her campus. Our students have generally been from
economically disadvantaged backgrounds, and approximately 77% of our students
participated in the federal free and reduced lunch program during the 2002-2003
school year. These students come from families with incomes at or below 185% of
the poverty level established by federal authorities.

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The following table provides information about the schools we are operating
for the 2003-2004 school year.

- ---------------

* Indicates charter schools operated under a charter granted by the local
school board.

** Charter contract remains in force, although discussions are in progress to
change the nature of this relationship.

*** Charter contract not currently signed, although we are providing management
services.

For information regarding terminations and expirations of our management
agreements see "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Management Agreements: Renewals and
Terminations."

COMPETITIVE STRENGTHS

Our business is characterized by the following strengths:

- Quantifiable Academic Improvement. Student achievement in our schools
has been substantial, as measured by a range of state and local tests.
From the 1995-1996 school year through the 2001-2002 school year, for
those schools that we have operated long enough to generate trend data,
typically by a school's second year with Edison, our students, on
average, gained 4.0 percentage points per year against state
criterion-referenced tests and 4.4 percentiles per year against national
norm-referenced test -- rates of gain that are one and a half to four
times as high as the districts and states in which our schools operate.

- Parental Satisfaction. Our schools enjoy high parental satisfaction.
According to a survey prepared for us by an independent market research
firm for the 2001-2002 school year, covering all of our schools then in
operation, over 50% of the parents of our students gave our schools
grades of A or A-. This compares to 27% of parents in a national sample
who gave the schools their students attend on average a grade of A or A-
in a similar study conducted by a different market research firm for the
2001-2002 school year.

- Extensive Infrastructure. We have a series of systems and support
personnel that permit us to implement our curriculum and school design in
district partnership and charter schools in communities across the United
States. The systems were developed over our previous eight years of
operating schools and include curriculum development, recruiting
capabilities, assessment mechanisms, professional development systems,
financial management and acquisition systems, and systems to assess
prospective management agreements.

- Achievement Management Systems. In order to manage effectively our
national network of schools, we have developed a unique achievement
management system, which includes our Benchmark Assessment System, our
MAP, and our achievement directors. The Benchmark Assessment System is an
on-line assessment tool designed to track student proficiency on
state-mandated high stakes tests. With the data derived from the
Benchmark system, teachers and administrators can obtain real time data
on student progress against state standards. Similarly, the MAP is a
reporting framework that provides Edison's management with all
information relevant to the implementation of the Edison school design.
The MAP includes Benchmark results, student discipline information,
teacher training and turnover information, and indications of the rate of
completion of other aspects of the design, such as the delivery of
curriculum materials. The achievement directors and vice presidents, who
are part of the Education Division, then bring these tools together to
develop detailed student achievement plans and to coach principals and
lead teachers in implementing them.

- Experienced Management Team. We have an experienced management team led
by H. Christopher Whittle, founder of several media enterprises including
the first national electronic news system for

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middle and high schools in the United States, Benno C. Schmidt, Jr.,
former President of Yale University, Charles J. Delaney, former President
of UBS Capital America, Christopher D. Cerf, former Associate Counsel to
President Clinton from 1994 to 1996, and John E. Chubb, senior fellow at
the Brookings Institution and a noted author and speaker on education.
Our management team also features a number of former school system
superintendents, including Deborah M. McGriff, former superintendent of
the Detroit public schools.

- Significant Investment in Research and Development. Prior to opening our
first four schools during the 1995-1996 school year, we conducted a
three-year research project led by a core team of educators, researchers,
policy experts and other professionals to create an innovative and, we
believe, effective model for operating more efficient and effective
public schools. This research project led to the creation of Edison's
curriculum and school design, which integrate many successful educational
practices into a comprehensive school solution for grades K-12, guided by
high academic standards, supported by research-backed innovations in most
areas of schooling and emphasizing assessment and accountability. Since
then, Edison's management team has continued to assess the effectiveness
of each element of the company's systems, and has developed tools (such
as the Benchmarks and MAP) to improve their impact.

GROWTH STRATEGY AND BUSINESS DEVELOPMENT

We have historically focused on the direct management of public schools in
the United States. Although we expect that school management will continue to be
a major contributor of future business growth, we have developed strengths and
capabilities through running schools that we believe can help students in other
ways. We have begun to offer a variety of services in other areas such as summer
and after-school programs and tutoring support.

We believe that the market for these services is significant. School
districts are increasingly looking for district-wide support, as NCLB has
increased the pressure to show adequate gains in student achievement. We believe
that our track record for raising student achievement positions us well to meet
the increasing demand by school districts for proven academic and achievement
services.

We have also taken our first measured steps in expanding our presence
outside the U.S., and in fiscal 2003 we established a wholly-owned subsidiary in
the United Kingdom ("UK"). The UK has a similar market focus to the U.S. on
raising student achievement, and the private sector has already begun to play a
material role in meeting this need. We plan to tailor the capabilities we have
built in the U.S. to meet the specific needs of UK schools.

Our future business growth will benefit from a well-diversified set of
business activities that build off our competitive strengths and share the
common benefit of helping schools and school districts drive gains in student
achievement. Our business growth activities are organized as follows:

District Partnership Division. The district partnership channel will
continue to form partnerships with school districts under which Edison will
manage or help turn around one or more district schools. Because larger
districts generally have the budget flexibility required to successfully
partner with us, the district partnership channel will focus its efforts on
the more than 800 school districts with over 10,000 students enrolled. This
channel will also seek to develop opportunities to run schools where
management is assumed by state government (as we have done in Maryland), an
action that we anticipate will be increasingly common, given the increasing
political support for school accountability measures. The sales cycle for
developing district partnership schools ranges from nine to 18 months.

Charter School Division. The charter school channel will continue to
work to develop new charter schools in states with favorable charter
legislation. This requires developing relationships with local community
groups, developing charter applications, obtaining charters from state
authorizers, selecting a school site, managing the construction or
renovation of the building, and arranging third-party financing (such as a
bank mortgage) or interim financing through the Company. A development vice
president assigned to the charter channel must determine which
jurisdictions are most suitable to the development

16

of a charter school. Edison will seek to set up charter schools in
jurisdictions with favorable state charter statues, an established
non-profit community agency interested in holding the charter, a viable
site acquisition strategy, and the support of state and local officials for
charter schools. Typically, the development process for a charter school
ranges from 18 to 27 months, beginning with Edison's first contact with a
community group interested in setting up a new charter school.

Educational Services Group. A newly formed channel, the Educational
Services Group encompasses all of the diversified businesses outside of our
traditional direct management of schools. These initiatives are organized
into three separate business lines -- Newton Learning, Tungsten Learning
and Edison UK.

Newton Learning: This business line encompasses all of our "extended
learning" services. As school districts strive to find new avenues for
raising student achievement, they are increasingly focusing on how to
better use the time after the traditional school day and school year ends.
Given their primary focus on the core school day program, many school
districts are turning to outside providers for a turnkey summer or
after-school program. Over the past four years, we have developed a popular
summer program in Missouri. This past summer we have expanded our summer
school presence into New York and California. In addition, we have
contracted with several school districts to launch after-school programs
for this fall. Aggressively expanding our summer school program both within
and outside Missouri, and developing a material after-school business are
both key strategic priorities. The sales cycle for these offerings is
relatively short, typically from three to six months.

Beyond the summer and after-school markets, NCLB has opened up a new
market for supplemental education services. Schools not making sufficient
adequate yearly progress in achievement are required to provide higher
poverty families additional academic support for their children after
regular school hours, funded through Title I. Providers such as Newton
Learning apply by state to be an "approved provider," and then market their
services to parents. These services are typically in the form of tutoring
or small class size instruction, during the after-school or summer hours.
We view this as a potentially large market that lends itself to the
strengths and capabilities we have demonstrated in our existing summer
school programs.

Tungsten Learning (formerly Affiliates). This business line,
developed over the past year, is built on the intellectual property
developed in our directly managed schools. We are now offering these
resources to entire school districts on a consultative, behind-the-scenes
basis. The initial product offering is built around our Benchmark
Assessment System that provides teachers and administrators real-time data
on students' learning progress against year-end standards, thereby
providing a powerful tool to help teachers adjust their teaching strategies
to accelerate student achievement. Our service includes professional
development and achievement support. We are targeting these services to
districts with between 2,000 and 20,000 students. We anticipate that the
sales cycle for Tungsten services will be six to nine months in most cases.

Edison UK. Over the past few years, we have received many requests
from school officials, politicians and others outside the U.S. interested
in seeing Edison replicate our efforts in their schools. Interest has been
particularly strong in the UK. Over the past year we have responded to this
interest and have launched a joint effort with Essex County, UK, which
includes almost 600 schools, to develop a comprehensive school improvement
program. This program has expanded upon our U.S. capabilities to meet the
specific needs of Essex County schools and UK schools in general. We expect
to launch these capabilities this coming academic year in several early
adopter Essex County schools.

ACADEMIC PERFORMANCE

School districts and charter boards generally retain us both to improve the
academic performance of the students who will be in our schools and to create
competition, which they hope will stimulate academic progress in the other
schools in the district. Our students are required to take the same local, state
and national tests administered by other public schools in the district. States
regularly require students to take assessments based on state standards, known
as criterion-referenced tests, and school districts also typically require
17

students to take tests that compare student performance against national peer
group performance, known as national norm-referenced tests. Both types of tests
are scored by independent authorities and result in publicly available data
about student performance. As of the end of the 2001-2002 school year, our
seventh academic year, these tests have provided hundreds of measures of our
students' achievement.

Student academic achievement in our schools has been substantial, as
measured by these independent external assessments. The following summarizes
available results for schools that were open during the 2001-2002 school year:

- On criterion-referenced tests -- tests that gauge the ability of students
to achieve specified standards, and increasingly the type of test being
used by states to hold schools accountable -- Edison schools have, from
1995 to 2002, increased the percentage of students achieving standards by
an average of 4.0 percentage points every year.

- On norm-referenced tests -- tests that gauge the achievement of students
relative to their peers nationwide -- Edison schools have, from 1995 to
2002, increased the national percentile rank of its students by an
average of 4.4 percentiles every year.

- Edison's average annual rates of gain are several times the rates of gain
in comparable public schools in the districts in which Edison works.
Comparing the gain rates of Edison schools to over 1,100 schools with
similar levels of economic disadvantage and ethnicity shows Edison
schools out-gaining comparable schools by two to three points per year.
These differences are statistically significant.

- Edison schools not only have a strong record of helping more students
each year achieve state standards; they have sharply reduced the numbers
of students failing state tests altogether. From 1995 to 2002, Edison
schools reduced the failure rate on criterion-referenced tests by an
average of 3.6 percentage points every year.

- Edison schools are successfully serving increasing percentages of
African-American students. The average annual gain rates of Edison
schools with predominantly African-American students (90 percent or
higher) are 4.7 percentage points on criterion-referenced tests and 4.4
percentiles on norm-referenced tests, respectively. These gain rates are
similar to our national averages and several times the gain rates of the
districts and states in which our predominantly African-American schools
are located -- strong evidence that students in these Edison schools are
beginning to bridge the racial achievement gap.

- Edison is also succeeding with schools that have failed to succeed in the
past. Edison has been asked to work in a number of schools that, under
federal NCLB legislation, "need improvement" based on their inability to
make adequate yearly progress. After becoming Edison schools, these
chronically failing schools have posted average annual gain rates of 5.8
percentage points and 4.3 percentiles on criterion-and norm-referenced
tests, respectively -- several times state and local norms.

LABOR RELATIONS

We are committed to developing a positive relationship with teachers'
unions at both the local and national levels. We work in successful partnership
with local teachers' unions in numerous schools across the country, and believe
our distinctive curriculum and school design can be successfully delivered in
the context of a unionized school. In this regard, we believe we are unique
among school management companies, which generally have declined to operate in
schools subject to collective bargaining.

Our commitment to developing a successful working relationship with unions
reflects the fact that a majority of our schools are district partnerships
rather than charter schools. As a general proposition, unions do not represent
teachers at charter schools in the United States. In contrast, at least in those
states with strong public employee labor laws, school teachers in traditional
public schools generally have elected to organize. Approximately 46% of the
students we educate attend schools operated under collective bargaining
agreements, many specifically modified to accommodate the Edison design. In some
charter schools, the charter incorporates by reference portions of collective
bargaining agreements.

18

Although we strive to maintain positive union relations, we regularly
encounter resistance from teachers unions in local school board debates over
whether to enter into a management agreement with us. Local teachers' unions
have also occasionally initiated litigation challenging our management
agreements. The concept of a private sector school manager in public education
is still not necessarily an acceptable alternative. In addition, both national
teachers unions historically have opposed privatization in public schools. While
we reject that label and regard our approach to be more of a public/private
partnership that draws on the strengths of both sectors, the unions' historical
perspective often influences local debates.

For several reasons, we believe that our relations with unions at all
levels will continue to improve:

- as an organization, we remain committed to that improvement;

- many union members recognize that we are the only significant private
sector organization in this area that seeks to work within the existing
public school system;

- notwithstanding the perception of some opinion leaders, significant
elements within teachers unions are committed to meaningful reforms,
including any initiative that improves student performance, preserves the
integrity of the public school system as a whole and protects the rights
of teachers as professionals. We believe that our approach, unlike many
other reform initiatives, is consistent with these objectives;

- we believe that some local union leaders have concluded that working with
us is an effective defensive strategy against other more threatening
initiatives, such as vouchers or non-unionized charters; and

- many aspects of our curriculum and school design, such as extensive
professional development and an enhanced leadership role for teachers in
the management of the school, have long enjoyed the support of the
unions.

CONTRACTUAL ARRANGEMENTS FOR ESTABLISHING DISTRICT PARTNERSHIPS AND CHARTER
SCHOOLS

District Partnership Schools. Our management agreements for operating
district partnership schools are typically negotiated with the district school
board. Management agreements generally last for five years, provide us with
per-student funding generally comparable to that received by other schools in
the district and give us substantial control over a school, under the board's
ultimate supervision. We deliver and support our curriculum, manage the school's
budget, provide periodic assessment reports to the school district, hire
teachers and, in collaboration with the school district, choose the school's
principal.

Charter Schools. Our management agreements for operating charter schools
are negotiated with the charter boards, which generally consist of community
groups or established non-profit entities. Public school districts typically can
also issue charters and may retain us to operate charter schools. The terms and
conditions of these management agreements are similar to our management
agreements for district partnership schools. We often also help the charter
boards arrange for financing to obtain the facilities for the charter schools
and often provide interim financing. In some cases, we have entered into
long-term leases for the charter school facilities. We have also provided
permanent credit support for many of our charter school buildings, typically in
the form of loan guarantees or cash collateral.

GOVERNMENT LAWS AND REGULATIONS

Federal and State Education Programs. The schools we manage receive funds
derived from numerous federal and state programs to be used for specific
educational purposes. If, on behalf of those schools, we fail to comply with the
requirements of the various programs, we could be required to repay the funds
and those schools could be determined ineligible for receipt of future federal
funds. Most of the schools we manage receive funds under Title I of the
Elementary and Secondary Education Act of 1965. This program supports
educationally disadvantaged children in areas of high poverty. Some of our
schools also receive funds from other programs under this act, including Title
II, Part A, which provides funding for the professional development of teachers,
Title II, Part D, which provides funding for technology programs, Title VII,
which provides funding for bilingual education programs, Title V, which provides
funding for innovative education

19

programs, and the Public Charter School Program, which provides start-up funding
for charter schools. We have policies and procedures in place in order to comply
with the regulations and requirements of these programs.

Although we receive these federal and state funds indirectly through local
school boards and charter boards, our receipt of these funds subjects us to
extensive governmental regulation and scrutiny. We could lose all or part of
these funds if we fail to comply with the applicable statutes or regulations, if
the federal or state authorities reduce the funding for the programs or if the
schools we manage are determined to be ineligible to receive funds under such
programs. To the extent that the laws and regulations governing federal and
state programs change or are interpreted in a manner that would prevent school
districts and public charter schools from using federal funds to pay for the
services we provide, the loss of all or part of these funds would hurt our
business.

No Child Left Behind Act. This act is the 2001 reauthorization of the
Elementary and Secondary Education Act of 1965. It contains numerous
requirements pertaining to the receipt of a range of federal funds, including
Title I. Two significant requirements are new standards pertaining to teacher
qualifications, and the requirement that schools make adequate yearly progress
("AYP") toward state standards for students. The AYP requirements must be met
not only by the aggregate school population, but also by ethnic/racial
subgroups, students with disabilities, and English language learners. Schools
that fail to make 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. Failure to meet teacher qualification and
related standards may result in the loss of NCLB funds at the school or district
that failed to meet the Act's requirements.

Individuals with Disabilities in Education Act. This act requires that
students with qualified disabilities receive an appropriate education through
special education and related services provided in a manner reasonably
calculated to enable the child to receive educational benefit in the least
restrictive environment. Our responsibility to provide the potentially extensive
services required by this act varies depending on state law, type of school and
the terms of our management agreements. We are generally responsible for
ensuring the requirements of this act are met in our charter schools, unless
state law assigns that responsibility to another entity. In our district
partnership schools, we typically share responsibility with school districts for
ensuring that the requirements of this act are met. If we are found in violation
of this act in one of our schools, we may incur costs relating to the provision
of compensatory education services, and may be liable for reasonable attorney
fees incurred by the families of individual students with disabilities.

Family Educational Rights and Privacy Act. The schools we manage are
subject to the federal Family Educational Rights and Privacy Act, which protects
the privacy of a student's educational record, and generally prohibits a school
from disclosing a student's records to a third party without the prior consent
of his or her parents. The law also gives parents certain rights with respect to
their minor children's education records. The failure of our schools to comply
with this law may result in termination of their eligibility to receive federal
education funds.

Gun-Free Schools Act. The Gun-Free Schools Act, which became effective in
1994, requires the schools we manage to effect certain policies, assurances and
reports regarding the discipline of students who bring weapons to our schools.
If those schools violate any of these requirements, they may be deemed
ineligible to receive certain Federal education funds.

Federal Civil Rights Laws. The schools we manage must comply with federal
civil rights laws or those schools could be determined ineligible to receive
funds from federal programs or face criminal or civil penalties. These laws
include the following:

- Title VI of the Civil Rights Act of 1964. Title VI prohibits recipients
of federal financial assistance from discriminating on the basis of race,
color or national origin.

- Title IX of the Education Amendments of 1972. Title IX prohibits
discrimination on the basis of gender by recipients of federal financial
assistance.
20

- Section 504 of the Rehabilitation Act of 1973. Section 504 prohibits
discrimination on the basis of disability by recipients of federal
financial assistance.

- Americans With Disabilities Act of 1990. This act prohibits
discrimination in employment against a qualified individual with a
disability and requires that buildings, facilities and vehicles
associated with public services be accessible to individuals with
disabilities.

- Age Discrimination Act of 1975. This act prohibits recipients of federal
financial assistance from discriminating on the basis of age.

- Age Discrimination in Employment Act of 1967. This act prohibits
discrimination on the basis of age in employment.

- Equal Pay Act of 1963. This act prohibits discrimination on the basis of
gender in the payment of wages.

- Title VII of the Civil Rights Act of 1964. Title VII prohibits
discrimination on the basis of gender in employment.

Drug-Free Workplace Act of 1988. The Drug-Free Workplace Act requires a
recipient of federal funds to certify that it provides a drug-free workplace. If
we violate the certification and reporting requirements of this act, then we
could be determined ineligible to receive federal funds.

State Regulations. We are also subject to state statutory and regulatory
requirements in the states in which we operate. All states have standards for
the operation of schools concerning, for example, the length of the school year,
curriculum, hours of the school day, physical education and other areas. We
could be in violation of our management agreements with charter boards or school
districts if we fail to comply with these standards.

For more information on the effect of government laws and regulations on
our business, see "Item 7. Management's Discussion and Analysis of Financial
Conditions and Results of Operations -- Additional Risk Factors That May Affect
Future Results -- 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" and "-- 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."

SECURITY

We believe our school design helps maintain order and security by
encouraging closer relationships among teachers, students and families. In
addition, we have taken the following steps to ensure safety at our schools:

- We regularly engage national school security consultants to oversee the
design and effectiveness of security at our schools;

- We have developed a security review process for our schools. Each year a
selected number of schools will participate in a review that includes
three site visits, a complete security walkthrough and evaluation, a set
of crisis management and safety training sessions for principals and all
school staff, and a crisis drill and security walkthrough follow-up;

- We have developed a security officer training program that all Edison
security officers attend; and

- We have entered into national contracts with several safety companies for
items such as security cameras, metal detectors and emergency kits.

HUMAN RESOURCES

As of June 30, 2003, we had 336 full-time headquarters employees. In
addition, 112 principals, over 4,400 teachers and approximately 1,500 members of
administrative staff and management worked in our schools for the 2002-2003
school year.
21

COMPETITION

We have a number of direct competitors, although to date the companies that
are most similar to us in terms of corporate strategy have focused primarily or
exclusively on operating charter schools rather than contracting with school
districts. Companies that compete with us include Chancellor-Beacon Academies,
Mosaica Education, Charter Schools USA, The Leona Group, National Heritage
Academy, SABIS Educational Systems and Victory Schools. In addition, other
private school operators, post-secondary education providers or childcare
providers could possibly enter our market. For example, Bright Horizons Family
Solutions, a provider of corporate sponsored childcare, recently opened its
first private school, and it or other childcare providers could seek
opportunities in the charter or district partnership schools market. KIPP, a
national non-profit organization, provides support and training to schools using
the KIPP model as developed in KIPP Academies in Houston and New York City.

ITEM 2. PROPERTIES

Of the 130 schools we are currently operating in fiscal 2004, the district
partnership schools generally operate in existing facilities provided by our
school district clients, though we manage the maintenance and operation of these
facilities. Of our 79 district partnership schools, 16 are operated under a
charter held by a public school district which provides a facility.

Significant real estate investments are often necessary when we establish a
charter school for a charter board and existing facilities are not available.
Generally, these investments are either made by the charter board or by us, and
we work closely with the charter board to locate, develop and finance the
charter school's facilities. A suitable location often needs to be found prior
to completing a charter application for a particular jurisdiction. The building
or renovation process generally lasts at least several months and can vary
widely in expense from minimal upgrades to new construction, which typically
costs from $4.0 million to $10.0 million. Innovative financing methods are often
needed to compensate for the limited amount of state and local funding available
to develop charter school facilities and we have employed a variety of
approaches, including owning or leasing the building, advancing funds for the
building to the charter board with various repayment terms, or having the
charter board directly own or lease the facility, sometimes assisted by a
subordinated loan from us. We also consider providing guarantees to lending
institutions to allow the charter board flexibility in obtaining financing.

Our executive offices are located in New York, New York in a leased
facility consisting of approximately 77,000 square feet.

In fiscal 2000, we purchased property in New York, New York for the
purchase price of $10.0 million and entered into an agreement with the Museum
for African Art to develop the property for a mixed use project consisting of
new corporate headquarters, a charter school and a facility to house the Museum.
In the fourth quarter of fiscal 2002, we decided to discontinue the project and
recorded an impairment charge of approximately $3.6 million reflecting soft
costs invested in the project since inception. On August 1, 2003 we closed on
the sale of this property to the Museum for African Art. During August 2003 we
entered into a non-binding contract to sell our non-income-producing Miami
property for $1.1 million.

ITEM 3. LEGAL PROCEEDINGS

Litigation Related to the Proposed Merger. Edison is aware of a number of
purported class action complaints that have been filed in the Court of Chancery
of the State of Delaware (the "Delaware Complaints") and the Supreme Court of
the State of New York County of New York (the "New York Complaints") challenging
the Merger. Thus far, 12 Delaware Complaints have been filed, including:
Golombuski v. Whittle, et al., Del. Ch., C.A. No. 20421; Scala v. Whittle, et
al., Del. Ch., C.A. No. 20422; Merullo v. Whittle, et al., Del. Ch., C.A. No.
20423; Jones v. Whittle, et al., Del. Ch., C.A. No. 20424; Gail K. Fischmann
Trust v. Whittle, et al., Del. Ch., C.A. No. 20427; Jotkovitz v. Whittle, et
al., Del. Ch., C.A. No. 20428; Young v. Balousek, et al., Del. Ch., C.A. No.
20426; Divino v. Edison Schools Inc., et al., Del. Ch., No. 20431; Kern v.
Edison Schools Inc., et al., Del. Ch., No. 20435; Kochalka v. Whittle, et al.,
Del. Ch., C.A. No. 20437; Carter v. Whittle, et al., Del. Ch., No. 20446; and
Khan v. Whittle, et al., Del. Ch., C.A.
22

20460. All of the Delaware Complaints name Edison and certain members of the
Company's board of directors as defendants. Some of the Delaware Complaints name
Liberty Partners as a defendant. As of the date of this Annual Report, only the
complaints in C.A. Nos. 20421 and 20435 have been served on the Company. On
September 5, 2003, an order of dismissal without prejudice was granted in C.A.
No. 20424.

In addition, Edison is aware of three New York Complaints that have been
filed thus far, including: Lee v. Edison Schools Inc., et al., Index No.
03/602236; Devine v. Edison Schools Inc., et al., Index No. 03/602295; and
Borghesi v. Whittle, et al., Index No. 03/602420. All of the New York Complaints
name Edison and certain members of the Company's board of directors as
defendants. Two of the New York Complaints name Liberty Partners as a defendant.
One of the New York Complaints names several members of Edison's senior
management as defendants. As of the date of this Annual Report, only the
complaint in Index No. 03/602295 has been served on the Company. That complaint
was amended on September 3, 2003.

Both the Delaware Complaints and the New York Complaints allege, among
other things, that the defendants purportedly breached duties owed to Edison's
stockholders in connection with the transaction by failing to: (1) appropriately
value Edison's worth as a merger candidate; (2) expose Edison to the marketplace
in an effort to obtain the best transaction reasonably available; (3) adequately
ensure that no conflicts of interest exist between defendants' own interests and
their fiduciary obligation to maximize stockholder value; and (4) disclose
certain material facts in their preliminary proxy statement regarding the
transaction. Plaintiffs seek, among other things: (1) an order that the
complaints are properly maintainable as a class action; (2) a declaration that
defendants have breached their fiduciary duties and other duties to the
plaintiffs and other members of the purported class; (3) injunctive relief; (4)
monetary damages; (5) attorneys' fees, costs and expenses; (6) corrective and
complete disclosures made to the plaintiffs and the class; and (7) such other
and further relief as the court may deem just and proper. Edison plans to defend
these lawsuits, as well as any other similar lawsuits that may be filed,
vigorously. 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.

Other 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 unspecified 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 SEC's May 14, 2002
cease-and-desist order, and another regarding stock based compensation the
Company granted to one of its senior officers. On August 1, 2003, the Company
and certain of its officers and directors filed a motion to dismiss the
consolidated amended class action complaint. Plaintiffs had until September 26,
2003 to file any opposition to the motion to dismiss. The Company believes that
it has strong defenses to the claims raised by these lawsuits. However, the
outcome of this litigation cannot be determined

23

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. On November 14, 2002, the Court consolidated these actions. On
September 19, 2003, plaintiffs filed a consolidated amended derivative
complaint. The lawsuit alleges that the Company's officers and directors
violated their fiduciary duties to 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 permitting the Company to disseminate to the public misleading
and inaccurate information concerning the Company's financial condition, by
failing to establish and maintain adequate internal accounting controls to
ensure to the accuracy of the Company's financial statements, by using material
non-public information to sell shares of the Company's common stock and thereby
reap millions of dollars in illegal insider trading gains and by participating
in or approving the proposed going private transaction. The lawsuit seeks an
order enjoining the consummation of the going private transaction, unspecified
compensatory damages in the amount sustained by the Company as a result of the
named defendants' breaches of fiduciary duties, compensatory damages in the
amount of the profits the individual defendants allegedly made, as well as a
constructive trust over such profits, and costs and fees related to the lawsuit.
The Company has negotiated a stipulation in this consolidated action that allows
defendants until December 3, 2003 to file a responsive pleading. The Company
believes that the Company's officers and directors also have strong defenses to
these lawsuits. We are also involved in various legal proceedings from time to
time incidental to the conduct of our 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 us. 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 our clients. Company also currently investigated whether a former
employee inappropriately transferred nonmaterial amount of money to certain
Company vendors. We currently believe that any ultimate liability arising out of
such proceedings will not have a material adverse effect on our financial
condition or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of our stockholders during the fourth
quarter of fiscal 2003.

24

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our Class A common stock began trading on the Nasdaq National Market on
November 11, 1999, under the symbol "EDSN." The following table sets forth for
the indicated periods the high and low sale prices of our Class A common stock
as reported by the Nasdaq National Market.

There is no established trading market for our Class B common stock. Class
B common stock may be converted into Class A common stock at any time on a
one-for-one basis. Each share of Class B common stock will automatically convert
into one share of Class A common stock upon its transfer in most circumstances
or upon the occurrence of other specified events.

As of September 15, 2003, we had approximately 173 holders of record of
Class A common stock and 35 holders of record of Class B common stock. Because
many of these shares are held by brokers and other institutions on behalf of
stockholders, we are unable to estimate the total number of stockholders
represented by these holders of record.

We have never paid or declared any cash dividends on our common stock or
other securities and do not anticipate paying cash dividends in the foreseeable
future. We currently intend to retain all future earnings, if any, for use in
the operation of our business.

On July 31, 2002 we issued warrants for the purchase of up to 10,710,973
shares of our Class A common stock in connection with the amendment of a
revolving credit agreement with Merrill Lynch Mortgage Capital Inc. ("MLMCI")
and School Services LLC ("School Services") (the "MLMCI Facility") and the
establishment of a credit and security agreement with School Services (the
"School Services Facility"). 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 warrants issued in these transactions were issued in reliance on
the exemption from registration set forth under Section 4(2) of the Securities
Act. No underwriters were involved in this issuance of securities. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."

ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data should be read in conjunction with
our consolidated financial statements and the related notes and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in this Annual Report. The statement of operations data for
the years ended June 30, 2001, 2002 and 2003, and the balance sheet data as of
June 30, 2002 and 2003, are derived from, and are qualified by reference to,
audited financial statements included in this Annual Report. The statement of
operations data for the years ended June 30, 1999 and 2000 and the balance sheet
data as of June 30, 1999, 2000 and 2001 are derived from our audited
consolidated financial statements that are not included in this Annual Report.
Please see Note 2 of the notes to our consolidated financial statements for (i)
information on

25

direct site expenses which are paid by our clients on our behalf and (ii)
information concerning the calculation of basic and diluted net loss per share.

The following table includes EBITDA and a subsequent table provides a
reconciliation of EBITDA to net loss. The term EBITDA will also be used
throughout management's discussion and analysis of the Company's financial
condition and results of operations. EBITDA is defined as net income (loss)
before income tax expense (benefit), interest expense, interest income,
depreciation and amortization. EBITDA is not a generally accepted accounting
principal ("GAAP") measure and should not be considered an alternative to any
other measure of performance presented in accordance with GAAP. You should not
consider EBITDA in isolation from, or as a substitute for, net income (loss),
cash flows from operating activities and other consolidated income or cash flow
statement data prepared in accordance with GAAP, or as a measure of
profitability or liquidity. EBITDA is presented because management believes that
it could be useful for investors in assessing operating performance and
performance relative to financial obligations. Additionally, EBITDA is a measure
commonly used by financial analysts because of its usefulness in evaluating
operating performance. EBITDA, as used by Edison, is not necessarily comparable
with similarly titled measures of other companies because all companies do not
calculate EBITDA in the same fashion.

NON-GAAP FINANCIAL MEASURE

The following table presents a reconciliation of the non-GAAP financial
measure of EBITDA to the most directly comparable GAAP financial measure for
each of the periods indicated.

RECONCILIATION FROM NET LOSS TO EBITDA

- ---------------

* Included in EBITDA is stock-based compensation of $22.4 million, $11.8
million, $1.6 million, $(13.3) million and $0.8 million for years ending June
30, 1999, 2000, 2001, 2002 and 2003, respectively.

27

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis of the financial condition and
results of operations of Edison should be read in conjunction with "Item 6.
Selected Financial Data" and our financial statements and the related notes
included in this Annual Report. This discussion and analysis contains
forward-looking statements that involve risks and uncertainties. Our actual
results may differ materially from those anticipated in these forward-looking
statements as a result of certain factors that include, but are not limited to,
those set forth under "-- Additional Risk Factors That May Affect Future
Results."

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 students in other public schools in the
area. We opened our first four schools in August 1995, and in the 2002-2003
school year we served approximately 80,000 students in 149 schools located in 22
states across the country and the District of Columbia. For the 2003-2004 school
year, we expect enrollment of approximately 66,000 students in 130 schools
located in 19 states and the District of Columbia. In addition to the direct
management of public schools, Edison has begun to enter related business areas
such as consultative services, summer and after-school programs and tutoring
support. During the summer of 2003, we served approximately 46,000 students in
our summer school program.

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 June 30, 2003, our accumulated deficit since
November 1996 was approximately $281.6 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 managed 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.

GOING-PRIVATE TRANSACTION

On July 14, 2003, the Company issued a press release announcing that it had
signed an Agreement and Plan of Merger (the "Merger Agreement"), dated as of
July 13, 2003, among the Company, Shakespeare Acquisition LLC (the "Parent"),
and its wholly-owned subsidiary, Shakespeare Acquisition Corporation (the
"Merger-Sub") dated as of July 13, 2003. The Parent and Merger-Sub are newly
formed entities organized for the sole purpose of entering into the Merger
Agreement and consummating the transactions contemplated therein. Affiliates of
Liberty Partners, a private equity firm based in New York, and H. Christopher
Whittle, the Chief Executive Officer of the Company, control the Parent. Under
the terms of the Merger Agreement, the Merger-Sub will merge (the "Merger") into
the Company with the Company remaining as the surviving corporation, and the
stockholders of the Company will receive $1.76 in cash for each outstanding
share of the Company's Class A common stock and Class B common stock.
Outstanding options and warrants to purchase shares of the Company's Common
Stock will become fully vested and exercisable and, at the time of the
28

merger, will be canceled and each holder of such convertible security will
receive a cash payment in an amount equal to the excess, if any, of the common
stock purchase price of $1.76 over the exercise price of such convertible
security, multiplied by the number of shares held by the holder. The closing of
the Merger is subject to various conditions, including approval of the
transaction by stockholders of the Company representing a majority of the shares
of Class A common stock and Class B common stock voting as a single class on the
transaction and other customary conditions to closing. Subject to these
conditions, the Company expects to complete the merger transaction in the fall
of 2003. A special meeting of Edison's stockholders will be scheduled as soon as
practicable following review of proxy materials filed in preliminary form with
the Securities and Exchange Commission on August 22, 2003. There can be no
assurance that all required conditions will be met and the transaction will be
consummated in the fall of 2003 or at all.

After consummation of the Merger, the Company's Class A common stock will
no longer be traded on the Nasdaq National Market or any other securities
exchange, and the Company will become a privately-held company.

NET REVENUE

Revenues are principally earned from contractual agreements to manage and
operate district partnership and charter schools. The Company also earns revenue
from summer school and after-school program fees. The Company recognizes revenue
for each managed school pro rata over the eleven months from August through
June, typically the period over which we perform our services, in accordance
with Staff Accounting Bulletin 101 "Revenue Recognition in Financial
Statements."

Most of our management agreements provide that we earn a fee based upon the
number of children that attend our schools, and therefore, we only earn revenue
to the extent students attend our schools. In most instances, there is a "base"
fee per pupil and several "categorical" fee components paid only for students in
certain categories (e.g., low-income, English as a second language, etc.). In
some of our 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. The Company follows the
guidance of the Emerging Issues Task Force ("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. Issued in January 2002, EITF
01-14 clarifies EITF 99-19, which provides guidance on whether revenues should
be presented gross or net of certain costs. After consultation with our
independent auditors, the Company determined that EITF 01-14 should be
interpreted to require us 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.

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 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 accordance with
the transition provisions of EITF 01-09, the Company adopted EITF 01-09
effective January 1, 2002.

29

DIRECT SITE EXPENSES

Direct site expenses include most of the expenses incurred on-site at our
schools. The largest component of this expense is salaries and wages, primarily
for principals and teachers, which are often paid for by our clients on our
behalf, in which case they are disclosed as "direct site expense -- client
paid." The remaining direct site expenses include on-site administration,
facility maintenance, utilities and, in some cases, student transportation. Once
staffing levels for the school year are determined, most of these expenses are
fixed, and accordingly, variations in enrollment will generally not change the
overall cost structure of a school for that year. Direct site expenses do not
include teacher training and other pre-opening expenses associated with new
schools; financing costs or depreciation and amortization related to technology,
including computers for teachers and students; curriculum materials; and capital
improvements to school buildings.

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 relate primarily to the investments we make
in each school for books and other educational materials, including enrollment
fees for the Success for All program, computers and other technology, and
facility improvements. These investments support the Edison curriculum and
school design and relate directly to our provision of educational services. The
depreciation and amortization of investments in our central office is also
included.

ENROLLMENT

Our annual budgeting process establishes site-specific revenue and expense
objectives, which include assumptions about enrollment and anticipated
per-student funding. While our budgets include desired enrollment levels, we do
not attempt to maximize enrollment based upon the physical capacity of our
facilities. Our budgets are designed to achieve both financial and academic
goals, both of which we believe are critical to the success of our business.
Therefore, our budgets are designed to achieve the proper balance between
financial performance and academic standards.

We implement various strategies to achieve optimal enrollment, including
local recruiting, media advertising, and coordinating with our school district
partners and community groups. Since some site costs are partially fixed,
incremental enrollment can positively affect profitability. Further, due to the
closely correlated relationship of site revenue and expenses, school personnel
closely manage expenses based upon actual enrollment. As discussed below under
"Financial Performance," we do not believe that achieving 100% of enrollment
capacity at each school is necessary to achieve positive cash flow.

30

REENGINEERING

On August 21, 2002, the Company announced several initiatives emerging from
a Company-wide "reengineering" effort. The initiatives are intended to redesign
Edison's infrastructure to improve service delivery to its schools; increase
student achievement and customer satisfaction; and accelerate Edison's path to
profitability. Among other changes, the Company announced significant
improvements in its headquarters operations including enhancing customer
service; strengthening its financial reporting and business functions; a ramp up
of its communications function; and an alignment of its internal functions with
a consolidated and streamlined regional structure. The Company has incurred
expenses related to this reengineering effort of approximately $2.3 million in
fiscal 2003.

FINANCIAL PERFORMANCE

We have incurred substantial net losses in every fiscal year since we began
operations. For the fiscal year ended June 30, 2003, our net loss was $25.0
million. As of June 30, 2003, our accumulated deficit since November 1996, when
we converted from a partnership to a corporation, was approximately $281.6
million. In addition, prior to November 1996, we incurred losses of
approximately $61.8 million, which are reflected in our additional paid-in
capital.

The following table sets forth various financial data expressed as a
percentage of net revenue for the periods indicated:

In order to achieve profitability in our managed schools business, we
believe it will be necessary to improve the direct contribution from our sites
while maintaining educational quality and reducing central expenses as a
percentage of net revenue. The latter improvement is largely dependent on our
ability to increase our net revenue through expanded student enrollment while
controlling central costs.

In general, we believe that reaching positive cash flow in our managed
school business, like achieving profitability, will be dependent on increasing
our aggregate contribution from sites without a proportionate increase in
central expenses. Because a site's contribution is the difference between site
revenues and site expenditures, positive contribution can be achieved at a range
of enrollment levels. While higher enrollment tends to have a positive effect on
a site's contribution, our financial success does not depend on 100% enrollment
at each site.

31

MANAGEMENT AGREEMENTS: RENEWALS AND TERMINATIONS

Our management agreements generally have a term of five years. When we
expand by adding an additional school under an existing management agreement,
the term with respect to that school generally expires at the end of the initial
five-year period. We cannot be assured that a management agreement will be
renewed at the end of its term. Four management agreements covering eight
schools expired at the end of the 2002-2003 school year and were not renewed. In
addition, termination of a management agreement may occur prior to its
expiration date for a variety of reasons. Four management agreements covering 38
of the schools we are operating for the 2003-2004 school year are terminable by
the school district or charter board at will, with or without good reason.
Moreover, all of our management agreements may be terminated for cause,
including in some cases a failure to meet specified educational standards, such
as academic performance based on standardized test scores. In addition, as a
result of payment disputes or changes within a school district, such as changes
in the political climate, from time to time we face pressure to permit a school
district or charter board to terminate our management agreement even if they do
not have a contractual right to do so. We may also seek the early termination
of, or not seek to renew, a limited number of management agreements in any year.
Five management agreements covering 14 schools, two due to expire at the end of
the 2003-2004 school year, two at the end of the 2004-2005 school year, and one
at the end of the 2005-2006 school year were terminated at the end of the
2002-2003 school year. In addition, one management agreement expiring at the end
of the 2003-2004 school year, was terminated in December of fiscal 2003. It is
likely that each year some management agreements will expire un-renewed or be
terminated prior to expiration.

Management agreements representing 24 schools, accounting for 16.2% of net
revenue for fiscal 2003, will expire at the end of the 2003-2004 school year,
and agreements representing 29 schools, accounting for 22.4% of net revenue for
fiscal 2003, will expire at the end of the 2004-2005 school year.

See "Additional Risk Factors That May Affect Future Results -- Our
management agreements with school districts and charter boards are terminable
under specified circumstances and generally expire after a term of five years."

DISTRICT PARTNERSHIP SCHOOLS COMPARED TO CHARTER SCHOOLS

We operate two types of managed schools: district partnership and charter.
A district partnership school is a public school we operate under a management
agreement with a local school board. A charter school is a school we operate
under a management agreement with a charter holder, which is typically a
community group or non-profit entity that has been granted a state-authorized
charter to create a public school. The cost of operating a district partnership
school and a charter school is similar, except that, in the case of a charter
school, we are typically required to arrange for a facility. In some cases, we
operate charter schools under a charter granted by the local school board, which
provides the facility. In these cases, we categorize these schools as district
partnership schools because we do not provide the facilities and therefore the
economics of these arrangements closely resemble those of a district partnership
school. Charter school facilities that are not provided by a local school board
are financed in a variety of ways, including bank debt, municipal bonds,
sale/leaseback arrangements, third-party ownership by real estate investment
trusts and philanthropy. At times, we advance funds or guarantee loans to our
charter board clients to assist them in arranging for facilities. As of June 30,
2003, we had approximately $82.8 million in loans and advances outstanding, net
of allowances and guaranteed loans of $26.7 million, to our charter board
clients. Our facility investment for a charter school generally exceeds our
investment in facilities for a district partnership school. Because of these
higher costs, we generally seek to establish charter schools in areas with
higher per-pupil revenue.

STOCK-BASED AND OTHER NON-CASH COMPENSATION EXPENSES

Beginning in 1995, we granted a number of stock options with four- and
five-year terms. In the fourth quarter of fiscal 1999, we extended the term of
these options to ten years and made other changes in their provisions that we
believe are customary for options granted by public companies. As a result, we
were required to record compensation expense at that time representing the
difference between the exercise price of the options and the deemed fair market
value of the shares underlying the stock options. In this regard, we

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recognized an expense of $17.4 million in the fourth quarter of fiscal 1999.
This amount was in addition to $5.0 million of stock-based compensation expenses
recorded in fiscal 1999 in connection with stock options that were subject to
variable accounting treatment. We have recognized, and expect to continue to
recognize, expenses related to the option amendments over the vesting periods of
the individual stock options. These additional expenses were approximately $1.4
million for fiscal 2001, $1.0 million for fiscal 2002 and $814,000 for fiscal
2003. Such expenses are expected to be approximately $100,000 for fiscal 2004.

To the extent we accelerate stock options or otherwise modify the
provisions of stock options in the future, we could incur additional non-cash
charges. We may also, from time to time, grant options below fair market value,
which could result in further charges at the time of grant.

In November 1999, H. Christopher Whittle, the Chief Executive Officer of
the Company and a Company's directors, exercised options to purchase 725,000
shares of common stock at $3.00 per share through the issuance of a promissory
note to the Company for $2,175,000. In addition, we loaned him $4,445,700 in
November 1999 and $1,248,500 in April 2000 to pay estimated income taxes
resulting from the transaction. These notes mature five years from their date of
issuance. The notes bear interest at a floating rate and were issued with
recourse solely to the shares acquired upon exercise of the options. Therefore,
we treat the options as if they had not been exercised and account for them as a
variable stock award pursuant to the provisions of EITF 95-16 "Accounting for
Stock Compensation Arrangements with Employer Loan Features under APB Opinion
25." Accordingly, the Company reflects compensation in the form of a charge or
credit to operations and an offsetting adjustment to additional paid-in capital
for periodic changes in the market value of the 725,000 common shares subject to
exercise to the extent such price exceeds the option exercise price of $3.00 per
share, until such notes are paid. In fiscal 2000, the Company recognized a
compensation charge of approximately $13.6 million. In fiscal 2001, the market
value of the Company's common stock decreased from $23.19 per share at the
beginning of the year to $22.84 per share at June 30, 2001. As a result, the
Company recognized a compensation credit of $253,750. In fiscal 2002, the market
price of the Company's common stock declined from $22.84 per share at the
beginning of the year to a value below the exercise price of $3.00 per share by
year-end. Accordingly, the remaining amount of compensation expense recognized
in prior years, including a portion related to fiscal 1999, of $14,384,000 was
reversed. In fiscal 2003, the market price of the Company's common stock did not
exceed $3.00 per share, and accordingly no compensation expense was recognized
during the period.

LOANS TO EXECUTIVES

Benno C. Schmidt, Jr., the Company's Chairman of the Board of Directors,
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 loans are overdue 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 $215,000, respectively, as of June 30,
2003.

H. Christopher Whittle borrowed $6.6 million from the Company on November
15, 1999 and $1.2 million from the Company on April 13, 2000. The loans
represented the total amount required for Mr. Whittle to purchase the shares
upon exercise of his March 1997 option to purchase 270,000 shares of Class A
common stock and 30,000 shares of Class B common stock at $3.00 per share and
his December 1997

33

option to purchase 382,500 shares of Class A common stock and 42,500 shares of
Class B common stock at $3.00 per share and to pay related income tax
obligations. The Company also agreed to loan Mr. Whittle any additional amount
necessary to pay any additional taxes or tax penalties incurred by him in
connection with his purchase of the shares. The loans are collateralized only by
the shares and bear interest at the greater of the prime rate or the Company's
actual borrowing rate, if any, from time to time, with payment of the principal
amount and accrued interest on the November 1999 loan due in full in November
2004 and payment of the principal amount and accrued interest on the April 2000
loan due in full in April 2005. The balance of principal and interest
outstanding under these loans was $7.9 million and $2.5 million, respectively,
as of June 30, 2003. Proceeds from collection of these notes will be credited to
additional paid-in capital when received.

INCOME TAXES

We have not recorded any provision for federal income taxes because we have
incurred net losses from our inception through June 30, 2003. As of June 30,
2003, we had approximately $220 million of net operating loss carry forwards for
federal income tax purposes. Approximately $45 million are expected to expire
between fiscal 2010 and 2018, and approximately $175 million are expected to
expire between fiscal 2019 and 2022. Due to the uncertainty of the Company's
ability to realize the tax benefit of such losses, a valuation allowance has
been established to equal the total net deferred tax assets.

For fiscal 2003, we recorded a provision for taxes that reflects state and
local taxes arising from our operations of several sites.

SEASONALITY

Because new schools are opened in the first fiscal quarter of each year,
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. The first quarter of our fiscal year has historically
reflected lower revenue and lower expenses than the other three quarters. We
expect this pattern to continue unless our non-managed school businesses both
exhibit a different pattern of revenue and expense and become significant
contributors. We generally have lower contribution from our managed school sites
in the first fiscal quarter than in the remaining fiscal quarters. We also
recognize pre-opening costs primarily in the first and fourth quarters. Summer
school revenues and expenses are also recognized in the first and fourth fiscal
quarters.

Our financial results can vary from quarter to quarter for other reasons,
including changes in school enrollment throughout the fiscal year. For more
information on the seasonality of our financial results, see "-- Additional Risk
Factors That May Affect Future Results -- Our financial results are subject to
seasonal patterns and other fluctuations from quarter to quarter."

RESULTS OF OPERATIONS

FISCAL YEAR ENDED JUNE 30, 2003 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2002

Net Revenue. Our net revenue decreased to $425.6 million for fiscal 2003
from $465.1 million for the prior year, a decrease of 8.5%. The decrease was
primarily due to the ending of certain relationships totaling approximately
$41.1 million; a change in the terms of three contracts, which resulted in a
change from gross to net accounting, thereby decreasing net revenue by
approximately $40.4 million; non-recurring revenue of approximately $2.7 million
in connection with a consulting engagement in fiscal 2002; and a decrease in
revenues of approximately $0.4 million from our summer school program, resulting
mainly from more contracts recorded on a net accounting basis than in the prior
year. The decreases were offset by an increase in revenue from new and existing
clients of approximately $45.1 million, primarily from a 8% increase in student
enrollment (excluding summer school students) from approximately 74,000 in the
2001-2002 school year to approximately 80,000 in the 2002-2003 school year,
reflecting both the opening of new schools and the expansion of existing
schools.

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Direct Site Expenses. Our direct site expenses decreased to $329.9 million
for fiscal 2003 from $390.1 million for the prior year, a decrease of 15.4%. The
decrease in direct site expenses was primarily due to the ending of certain
contractual relationships totaling $40.5 million, the change in the term of
three contracts, which resulted in a change from gross to net accounting,
thereby reducing expenses, resulting mainly from more contracts on a net
accounting basis than in the prior year by approximately $44.7 million, and a
reduction in expenses for our summer school program of $1.7 million. These
decreases were offset by an 8% increase in student enrollment related to new
schools opened and the expansion of existing schools, which generated increased
expenses of approximately $26.6 million. Of the total direct site expenses,
$143.7 million was client paid, down from $178.7 million in the same period of
the prior year. These client-paid expenses consist entirely of personnel costs
at our schools.

Administration, Curriculum and Development Expenses. Our administration,
curriculum and development expenses decreased to $67.8 million for fiscal 2003
from $71.2 million for fiscal 2002, a decrease of 4.8%. Included in
administration, curriculum and development expenses are stock compensation
charges of approximately $0.8 million and income of $13.3 million in fiscal 2003
and 2002, respectively; going-private costs of approximately $0.9 million in
fiscal 2003; and approximately $7.5 million of costs related to an SEC inquiry
and our sales and marketing activities in Philadelphia in fiscal 2002. Excluding
these amounts, our administration, curriculum and development expenses decreased
to $66.1 million for fiscal 2003 from $77.0 million for fiscal 2002, a decrease
of 14.2%. This improvement principally resulted from the reengineering process
implemented in fiscal 2003.

Impairment Charges. Our impairment charges in fiscal 2002 totaling $36.9
million consisted of specific event-related charges including $33.3 million
related to the write-off of goodwill triggered by the reduction in the Company's
share price and a $3.6 million charge related to management's decision to
discontinue our corporate headquarters project. The Company had no impairment
charges in fiscal 2003.

Loss on Disposal of Assets. Our loss on disposal of assets decreased to
$3.1 million for fiscal 2003 from $4.8 million for fiscal 2002, a decrease of
35.4%. The decrease was primarily a result of the Company's improved ability to
redeploy assets used in terminated relationships to other schools, as well as
improved recoveries from the sale of assets to clients with which we ended
relationships in fiscal 2003.

Depreciation and Amortization. Our depreciation and amortization decreased
to $34.9 million for fiscal 2003 from $37.4 million for fiscal 2002, a decrease
of 6.7%. The decrease in depreciation and amortization resulted from beginning
the year with fewer depreciable assets than the prior year and fewer required
capital expenditures for curriculum materials, computers and related technology,
and facility improvements related to renewal and expansion schools. Capital
spending in our central office also declined.

Pre-Opening Expenses. Our pre-opening expenses decreased to $3.8 million
for fiscal 2003 from $6.2 million for fiscal 2002, a decrease of 38.7%. These
costs are associated primarily with the opening of new schools. In fiscal 2003,
all but five of our new schools were in Philadelphia. The decrease is a result
of the fact that all training was conducted in Philadelphia, and therefore 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 (inclusive of depreciation and amortization) as a percentage of net
revenue decreased to 103.2% for fiscal 2003 from 117.5% for fiscal 2002.
Excluding stock compensation charges of approximately $0.8 million and income of
$13.3 million in fiscal 2003 and 2002, respectively; going private costs of
approximately $0.9 million in fiscal 2003; approximately $7.5 million of costs
related to an SEC inquiry and our sales and marketing activities in Philadelphia
in fiscal 2002 and impairment charges of $36.9 million, education and operating
expenses as a percentage of net revenue decreased to 102.8% for fiscal 2003 from
110.8% for fiscal 2002. This decrease primarily resulted from a decrease in
direct site expenses and central administration, curriculum and development
expenses as a percentage of net revenue.

EBITDA. EBITDA for fiscal 2003 was $21.5 million compared to a net loss of
$50.8 million for fiscal 2002. Included in EBITDA are stock compensation charges
of approximately $0.8 million and income of $13.3 million in fiscal 2003 and
2002, respectively; going-private costs of approximately $0.9 million in fiscal

35

2003; approximately $7.5 million of costs related to an SEC inquiry and our
sales and marketing activities in Philadelphia in fiscal 2002 and impairment
charges of $36.9 million in fiscal 2002. These costs are discussed above.
Additionally, included in EBITDA is a $6.8 million charge for a write-down of
our investment in Apex Learning Inc. in fiscal 2002. Please see "Item 6.
Selected Financial Data -- Non-GAAP Financial Measure" for a reconciliation of
net loss to EBITDA.

Loss from Operations. Our loss from operations decreased to $13.8 million
for fiscal 2003 from $81.5 million for fiscal 2002, a decrease of 83.1%.

Other Income and Expense. Other income (expense), net, was an expense of
$10.4 million for fiscal 2003 compared to an expense of $3.5 million in fiscal
2002. The increase was primarily due to a $12.9 million increase in interest
expense as a result of an increase in net borrowings under our lines of credit
and term loan in fiscal 2003 as well as significantly higher financing costs as
compared to the prior year and a reduction in interest income of $1.0 million
offset by a reduction in loss on investment of $6.8 million, which represented a
fiscal 2002 reduction in the carrying value of our investment in Apex Learning
Inc.

Net Loss and Net Loss Attributable to Common Stockholders. Our net loss
decreased to $25.0 million for fiscal 2003 from $86.0 million for fiscal 2002, a
decrease of 70.9%.

FISCAL YEAR ENDED JUNE 30, 2002 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2001

Net Revenue. Our net revenue increased to $465.1 million for fiscal 2002
from $350.5 million for the prior year, an increase of 32.7%. The increase was
primarily due to revenue from new and existing clients of approximately $109.1
million, primarily resulting from a 29.8% increase in student enrollment
(excluding summer school students) from approximately 57,000 in the 2000-2001
school year to approximately 74,000 in the 2001-2002 school year, reflecting
both the opening of new schools and the expansion of existing schools; an
approximately $17.8 million increase in revenue generated from our summer school
program in fiscal 2002; and non-recurring revenue of $2.7 million in connection
with a consulting engagement in fiscal 2002. These increases in revenue are
offset by the ending of certain relationships totaling approximately $15.0
million.

Direct Site Expenses. Our direct site expenses increased to $390.1 million
for fiscal 2002 from $291.2 million for the prior year, an increase of 34.0%.
The increase in direct site expenses was primarily due to (1) the 29.8% increase
in student enrollment related to new schools opened and the expansion of
existing schools, which generated increased expenses of approximately $102.9
million and (2) increased expenses related to the growth in our summer program
of approximately $8.6 million. These increases in direct site expense are offset
by the ending of certain relationships totaling approximately $12.6 million. Of
the total direct site expenses, $178.7 million was client paid, up from $129.2
million in the same period of the prior year. These client paid expenses consist
entirely of personnel costs at our schools.

Administration, Curriculum and Development Expenses. Our administration,
curriculum and development expenses increased to $71.2 million for fiscal 2002
from $57.9 million for fiscal 2001, an increase of 23.0%. The increase was due,
in part, to greater personnel costs resulting from an increase of approximately
107 new headquarters employees, which reflects a substantial increase in staff
in our school operations and education divisions and an increase in our central
office administrative staff to enhance legal, contracting, and financial
reporting functions. Other charges included within administration, curriculum
and development expenses in fiscal 2002 that contributed to the increase on a
net basis include (1) approximately $7.5 million of costs related to an inquiry
by the Securities and Exchange Commission and our sales and marketing activities
in Philadelphia, and (2) specific event related charges comprised of $4.1
million of costs related to a write-down of a note receivable as a result of a
discontinued new school project and a $5.5 million charge related to a reserve
against notes to charter schools as a result of the difficult credit environment
affecting the Company's ability to arrange third-party lender financing coupled
with the credit risk of specific charter school notes and management's intention
to accelerate the refinancing of individual notes to third-party lenders. These
costs were offset by $13.3 million of income from non-cash stock compensation
adjustments. In fiscal 2001, other charges include $3.9 million resulting from a
write-down of our curriculum materials inventory and a stock compensation charge
of $1.6 million.

36

Impairment Charges. Our impairment charges for fiscal 2002 totaled $36.9
million, consisting of $33.3 million related to the write-off of goodwill
triggered by the reduction in the Company's share price and a $3.6 million
charge related to management's decision to discontinue our corporate
headquarters project. The company had no impairment charges in fiscal 2001.

Loss on Disposal of Assets. Our loss on disposal of assets increased to
$4.8 million for fiscal 2002 from $1.1 million for fiscal 2001, an increase of
$3.7 million. The increase was primarily a result of an increase in the number
of schools closed.

Depreciation and Amortization. Our depreciation and amortization increased
to $37.4 million for fiscal 2002 from $33.6 million for fiscal 2001, an increase
of 11.3%. The increased depreciation and amortization resulted from additional
capital expenditures for our curriculum materials, computers and related
technology, and facility improvements related to our enrollment and central
office growth.

Pre-Opening Expenses. Our pre-opening expenses decreased to $6.2 million
for fiscal 2002 from $8.6 million for fiscal 2001, a decrease of 27.9%. This
decrease was associated primarily with opening new schools for the 2001-2002
school year, with approximately 17,000 new students enrolled, of which 2,000
students were from existing LearnNow schools, compared to approximately 19,500
new students enrolled in the prior school year.

Education and Operating Expenses. Our total education and operating
expenses (inclusive of depreciation and amortization) as a percentage of net
revenue in fiscal 2002 increased to 117.5% for fiscal 2002 from 112.0% for
fiscal 2001. Excluding specific event related charges of $32.0 million,
including $14.4 million of income from a non-cash stock compensation adjustment;
$4.0 million of costs related to a discontinued new school project; $5.5 million
of costs related to a reserve against loans to charter schools; $36.9 million of
impairment charges as mentioned above, education and operating expenses as a
percentage of net revenue decreased to 110.6% for fiscal 2002 from 112.0% for
fiscal 2001. This decrease primarily resulted from continued revenue growth and
increased operating leverage and a decrease in administration, curriculum and
development expenses as a percentage of net revenue.

EBITDA. EBITDA for fiscal 2002 was a net loss of $50.8 million compared to
a net loss of $8.6 million for fiscal 2001. Included in EBITDA in fiscal 2002
are $36.9 million of impairment charges discussed above, a $4.1 million
write-down of notes receivable, a $5.5 million reserve against notes receivable
and a $6.8 million charge for a write-down of our investment in Apex Learning
Inc. Additionally, included in EBITDA are a non-cash stock compensation credit
of $13.3 million in fiscal 2002 and a non-cash stock compensation charge of $1.6
million in fiscal 2001. Please see "Item 6. Selected Financial Data -- Non-GAAP
Financial Measure" for a reconciliation of EBITDA to net income.

Loss from Operations. Our loss from operations increased to $81.5 million
for fiscal 2002 from $41.9 million for fiscal 2001, an increase of 94.5%.

Other Income and Expense. Other income (expense), net, was an expense of
$3.5 million for fiscal 2002 compared to income of $4.0 million in fiscal 2001.
The decline was primarily due to the $6.8 million reduction in the carrying
value of our investment in Apex Learning Inc. in fiscal 2002.

Net Loss and Net Loss Attributable to Common Stockholders. Our net loss
increased to $86.0 million for fiscal 2002 from $38.5 million for fiscal 2001,
an increase of 123.4%.

LIQUIDITY AND CAPITAL RESOURCES

To date we have financed our cash needs through a combination of equity and
debt financing. From our inception through June 30, 2003, we raised $509.0
million of equity capital. During the same period, we used $171.2 million of
cash for operating activities and $305.2 million of cash for investing
activities. We have also utilized debt and equipment leasing arrangements to
finance computers and other technology investments in our schools.

37

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 such assets 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 the MLMCI Facility, then
a $35.0 million revolving credit facility with MLMCI, collateralized by certain
accounts receivable purchased from or contributed by the Company. Borrowings
were limited to specified percentages of eligible accounts receivable, as
defined. The MLMCI Facility originally had a term of one year, with interest
determined on a Eurodollar or prime rate basis at the Company's option and a
commitment fee of .50% per annum on the unused portion of the commitment.

On July 31, 2002, the MLMCI Facility was amended to add School Services 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 June 30, 2003, $38.8 million was
outstanding under this line of credit bearing interest at LIBOR plus 7.0% and
was collateralized by receivables of approximately $74.5 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 the School Services
Facility, dated as of July 31, 2002, 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 School Services 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 (as
defined in the credit and security agreement) requirement for fiscal 2003.

On July 15, 2003, Edison Receivables signed an agreement extending the
MLMCI Facility until November 15, 2003 in order to, among other reasons,
facilitate the consummation of the merger. Additionally, the amendment lowered
the minimum consolidated tangible net worth covenant for the periods ending June
30, 2003 and September 30, 2003.

As was reported in our form 10Q filed on May 15, 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 Facilities. 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 and therefore
was not in default. Due to the posting of net income of $10.2 million in the
fourth quarter, the Company was in compliance with this covenant at June 30,
2003.

In December 2002, a note receivable in the amount of $7.5 million was
refinanced, with the Company receiving approximately $5.3 million and
maintaining 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

38

of credit portion of the School Services Facility. 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 portion of the School Services
Facility pursuant to an amendment to reduce the line of credit commitment by
$1.0 million to obtain the release of certain collateral. As of June 30, 2003,
$17.7 million was outstanding under the School Services Facility reflecting the
maximum amount available.

On August 1, 2003, the Company closed the sale of its New York property to
the Museum for African Art for a purchase price of approximately $9.0 million,
of which approximately $8.8 million was paid directly to School Services and
applied to amounts outstanding under the term loan portion of the School
Services Facility, representing a permanent reduction in this facility. This
sale resulted in a non-cash write-off of approximately $726,000. After the sale
of the New York property, debt under the School Services Facility was reduced to
approximately $8.9 million.

In connection with the amendment of the MLMCI Facility and establishment of
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. 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.

As reported in its form 10-Q filed on May 15, 2003, the Company was not in
compliance at March 31, 2003 with the minimum consolidated tangible net worth
covenant in the MLMCI and School Services Facilities. In May 2003, the Company
received a waiver of default from both MLMCI and School Services with respect to
compliance with this covenant. The Company was in compliance with the covenant
at June 30, 2003. While the Company amended the MCMLI facility to lower the
minimum consolidated tangible net worth covenant under the School Services
facility and expects that it will not be in compliance with such covenant at
September 30, 2003. The Company has reduced it's borrowing under the School
services facility subsequent to year end with the proceeds from the sale of its
Harlem property (August 2003) and expects to further reduce such borrowings to
approximately $3.3 million with the proceeds of certain notes receivable in
October 2003, as discussed in Note 1. The Company will be able to repay all
outstanding borrowings under this facility, to the extent required, out of its
cash on hand.

DEBT

Our debt obligations as of June 30, 2002, September 30, 2002, December 31,
2002, March 31, 2003 and June 30, 2003 are summarized in the table below:

39

The following is a summary of our contractual commitments associated with
our debt and lease obligations including related interest payments as of June
30, 2003:

LIQUIDITY

Historically, we have had negative cash flows from operations. For the year
ending June 30, 2003, the Company generated $6.8 million in cash from
operations. Since inception, the cash needs of the business have been financed
through a combination of debt and equity financing, however, in the fiscal 2002
and 2003 the Company raised no additional equity. As of June 30, 2002, the
Company's debt (excluding original issue discount) was $68.8 million and at June
30, 2003 our debt (excluding original issue discount) was $73.2 million, down
from a high of $99.0 million at September 30, 2002. For the years ended June 30,
2002 and 2003, net income was negative $86.0 million and negative $25.0 million,
respectively, while EBITDA was negative $50.8 million and positive $21.5
million, respectively.

We expect cash on-hand, borrowings under existing financing arrangements
and cash flows from operations to generate sufficient liquidity to meet all of
the Company's cash flow requirements through fiscal 2004. Our $55.0 million
revolving credit facility became due on July 15, 2003 and was extended to
November 15, 2003 in order to bridge this existing facility to the closing of
the Company's going private transaction. We believe that should the Company need
to, it would be able to obtain an asset based revolving credit facility to meet
the Company's borrowing needs in fiscal 2004 for the following primary reasons:
(1) the Company has sufficient collateral, including accounts receivable, notes
receivable from charter boards, and owned real estate, to more than adequately
support an asset based revolving credit facility sufficient to meet its
borrowing needs in fiscal 2004 and (2) the Company's fiscal 2004 operating plan
reflects growth in EBITDA from its fiscal 2003 level of $21.5 million. On
September 29, 2003, the Company paid the remaining outstanding balance under the
School Services Facility of $8.9 million.

While the above represents the Company's base case liquidity assessment, we
are in the process of other business transactions which would not adversely
affect the base case assessment. In this connection, we are working with one of
our charter board clients to refinance certain indebtedness of the charter board
incurred for purposes of school facility construction and renovation. We will
receive cash of approximately $17.0 million in repayment of the our notes
receivable from this charter board as a result of this refinancing which is
expected to close in October 2003.

As a part of the going private transaction, an affiliate of Liberty
Partners, the private equity investment entity that will finance the
transaction, has committed to provide a debt facility up to $70.0 million to
replace the Company's existing credit facilities. This commitment is also
intended to provide financing for future growth.

Our longer-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 district partnership schools, as charter schools
usually require us to advance funds to help charter boards obtain, renovate and
complete school facilities. We expect to fund such expenditures and other
longer-term liquidity needs with cash generated from operations and expanded
debt financing arrangements. We also plan to refinance, with third-

40

party lenders, a minimum of $10.0 million of loans we have made to charter
boards to partially support our growth plans for the 2004-2005 school year.
While we have completed such financings of charter school loans in the past, we
cannot be certain that we will obtain such financing in support of our
longer-term capital needs on favorable terms, if at all.

We managed summer school programs for 70 districts in the state of Missouri
during May, June and July of 2003. The payment terms of the related billings
range from five to 21 months. Therefore, certain cash receipts of revenue will
lag the outlay of cash for expenditures by over a year. As of June 30, 2003, we
had accounts receivable of $57.3 million for managed schools and $31.6 million
for our summer school program. The managed schools receivables reflect a decline
of $10.2 million from the balance as of June 30, 2002. Additionally, our summer
school receivables include $14.4 million from the prior year scheduled to be
fully collected by December 31, 2003 and $36.0 million in current year
receivables.

In general, our ability to achieve positive cash flows in the managed
schools channel will be dependent on the volume of schools with positive
contribution to offset central office and overhead expenses. Because a site's
contribution is the difference between site revenue and site expenditures,
positive contribution can be achieved at a range of enrollment levels. While
higher enrollment tends to have a positive effect on a site's contribution, our
growth and cash flows do not depend totally on 100% enrollment.

During the year the Company also purchased 1,711,000 of its shares as of
June 30, 2003, under its announced share repurchase plan. The shares purchased
represent approximately 32% of the total authorized under the repurchase plan,
which allows the company to repurchase up to 5,400,000 shares. We are currently
not repurchasing any shares.

CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES

For fiscal 2003, we generated $7.4 million from operating activities. This
positive cash flow primarily resulted from a $25.0 million net loss and a $20.8
million net increase in working capital accounts, partially offset by a $0.4
million decrease in accrued interest on notes receivable, depreciation and
amortization totaling $48.3 million, $3.7 million of asset write-offs and
disposals and $0.8 million of stock-based compensation expense.

For fiscal 2002, we used $23.7 million for operating activities. This use
primarily resulted from a $86.0 million net loss, a $20.9 million net increase
in working capital accounts, a $1.9 million increase in accrued interest on
notes receivable and stock-based compensation income of $13.3 million, partially
offset by depreciation and amortization totaling $39.8 million, $5.4 million of
asset write-off and disposals, $9.5 million of notes receivable write-off and
allowances, impairment charges totaling $36.9 million and a $6.8 million
reduction in the carrying value of our investment in Apex Learning Inc. (see
Note 11 of the consolidated financial statements).

CASH USED IN INVESTING ACTIVITIES

For fiscal 2003, we used $11.8 million in investing activities.
Additionally there were non-cash transactions of $3.4 million. During this
period, we invested $12.7 million in our schools and central office. These
amounts include the investments we made in technology and curriculum in each of
the schools we opened. We also advanced funds to our charter board clients for
their affiliates to help maintain and complete school facilities. The amounts
advanced during fiscal 2003 to our charter board clients or their affiliates
were

41

$9.7 million. During this period, we also received $8.2 million in repayments on
advances previously made and $2.4 million of proceeds from the disposition of
property and equipment and other assets.

For fiscal 2002, we used $48.1 million in investing activities.
Additionally there were non-cash transactions of $16.0 million. During this
period, we invested $17.1 million in our schools and central office. These
amounts include the investments we made in technology and curriculum in each of
the schools we opened. We also advanced funds to our charter board clients for
their affiliates to help maintain and complete school facilities. The amounts
advanced during fiscal 2002 to our charter board clients or their affiliates
were $41.9 million. During this period, we also received $15.0 million in
repayments on advances previously made. During fiscal 2002, we increased
security deposits by $2.1 million, funded a $1.0 million philanthropic
contribution, and incurred $1.2 million of deferred contract costs.

CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES

For fiscal 2003, we used $9.9 million for financing activities. These
amounts included net borrowings of $12.5 million on the MLMCI Facility and $10.0
million from the term loan component of the School Services Facility. These
proceeds were partially offset by the repayments of notes payable of $20.2
million, $2.6 million used for the purchase of treasury stock, $7.5 million of
costs in connection with our debt financing and $2.1 million in funding of
restricted cash.

For fiscal 2002, we received $16.2 million from our financing activities.
These amounts included borrowings of $34.0 million on the MLMCI Facility, $1.8
million received from the exercise of stock options and warrants, $2.1 million
received from a minority investee, and the release of approximately $700,000 of
restricted cash. These proceeds were partially offset by the repayments of notes
payable of $21.0 million and $1.3 million of deferred financing costs.

PHILANTHROPY

Philanthropic entities supported 10 of the 149 schools we operated in the
2002-2003 school year. We tend to use philanthropy in those areas where the
per-pupil expenditures would otherwise make it difficult to achieve satisfactory
financial performance, such as California where all of our schools have been
supported by philanthropic entities. These philanthropic entities provide funds
directly to our school district or charter board clients and not to Edison.
Philanthropic support generally helps fund the initial capital investment in
curriculum, technology, and facilities necessary to open a school and is not
used for ongoing annual operations. Although some of our school district and
charter board clients have used philanthropic funds in the past and we expect
some of them to use philanthropic funds in the future, we do not rely on
philanthropic support significantly for our growth strategy. The D2F2 Foundation
(the "Foundation") has supported some of our schools in California and has
indicated that it intends to provide support in the future for schools operated
or to be operated by us, primarily in California. We issued a warrant to the
Foundation to purchase up to 1,698,750 shares of Class A common stock and
188,750 shares of Class B common stock at an exercise price of $7.96 per share,
which has been fully exercised. Additionally, we entered into an agreement with
one client whereby we committed to raise $10.5 million in unrestricted
philanthropic funds, to be contributed over a three-year period ending June 30,
2004. The funds were to be used for schools the Company manages and were to be
expended on agreed-upon costs, including school facility, technology and
curriculum materials. To date, we have secured commitments from two
philanthropic organizations to contribute approximately $3.9 million and
commitments from two senior Company officers for an additional $1.2 million. To
date, $2.8 million has been received from the two philanthropic entities, and we
have donated $5.2 million. Our commitment will be amortized, net of third-party
donations received, over the contract life (five years) as a reduction in
revenue. Any contributions received from senior officers will reduce the
Company's obligation and be credited to additional paid-in capital.

CHARTER SCHOOL FACILITY FINANCINGS

Significant real estate investments are often necessary when we establish a
charter school for a charter board and existing facilities are not available.
While a charter board is generally responsible for locating and

42

financing its own school building, it typically does not have the resources
required to obtain the financing necessary to secure and maintain the building.
For this reason, if we want to obtain a management agreement with a charter
board, we must often help the charter board arrange for appropriate facilities.
Innovative financing methods are often needed to compensate for the limited
amount of state and local funding available to develop charter school
facilities. We have employed a variety of approaches, including owning or
leasing the building, advancing funds for the building to the charter board
under various repayment terms, or having the charter board directly own or lease
the facility from a third party, sometimes assisted by a subordinated loan from
us. We also consider providing guarantees to lending institutions to allow the
charter board flexibility in obtaining financing. We determine the most
economically viable option available for each school, and we purchase real
estate only if we determine it is the best available financing option. In the
past, we have utilized a variety of third-party financing, including bank debt,
municipal bonds, sale/lease-back arrangements and philanthropy.

We expect to continue to advance funds to our charter board clients as well
as spend directly, to the extent capital is available, on charter school
facilities. We have been successful in securing various financing arrangements
in the past, but our ability to obtain any such financing arrangements in the
future cannot be assured. As of June 30, 2003, we had guarantees totaling $26.7
million for facility-related debt of six of our charter school clients,
representing 12 schools in fiscal 2003. The underlying debt comes due in fiscal
2003 and fiscal 2008.

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 exceed the terms of the management agreements for those
schools. We have entered into long-term leases for school facilities for four of
our charter board clients that exceed the current terms of the management
agreements 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. The Company currently has one facility financing obligation for a
building occupied by a former client during the 2002-2003 school year. As of
June 30, 2003 the Company had entered into a two-year sub-lease agreement with
another charter school in the area beginning with the 2003-2004 school year. Our
aggregate future lease obligations as of June 30, 2003 totaled $29.9 million,
with varying maturities over the next 17 years.

We have provided some type of permanent credit support for the school
building, typically in the form of loan guarantees, loans or cash advances, for
12 of our charter board clients. As of June 30, 2003, the amount of loans we had
guaranteed totaled $26.7 million. Although the term of such an arrangement is
coterminous with the term of the corresponding management agreement, our
guarantee does not expire until the loan is repaid in full. The lenders under
these facilities are not committed to release us from our obligations unless
replacement credit support is provided. The default by any charter board client
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. We have also set aside restricted cash as collateral in the
amount of $500,000 for the loans we guarantee. As of June 30, 2003, we had
advances or loans to charter school boards totaling a net of approximately $82.8
million related to the purchase or renovation of school facilities we manage. We
often have not charged interest on these loans and advances. Loans totaling
approximately $12.3 million, representing 16 schools, are uncollateralized. We
currently expect to make additional advances of at least $6.5 million during the
2004 fiscal year. If these advances or loans are not repaid when due, our
financial results could be adversely affected.

Subsequent to June 30, 2003, the Company is in the process of assuming two
facilities in full satisfaction of outstanding loans to one former and one
current charter board client totaling approximately $14.9 million. Both
facilities will continue to be used by the existing charter schools, which have
entered into lease arrangements with Edison. The Company believes, based on
recent appraisals, that the value of the buildings are adequate to cover the
carrying value of the notes.

43

INVESTMENT IN APEX LEARNING INC.

In July 1999, we acquired a 16.5% ownership interest in Apex Learning Inc.
("Apex"), a company that provides interactive advanced placement courses for
high school students over the Internet. Concurrently, Vulcan Ventures
Incorporated, then the majority stockholder of Apex, invested $30.0 million in
Edison. We initially invested $5.0 million in Apex and were obligated to invest
up to an additional $5.0 million in the future, if any third party were to
invest in Apex. In December 1999, we invested all of the additional $5.0 million
in Apex, increasing our ownership interest at that time to 19.7%. Because of the
nature of our relationship with Apex through June 2000, we were required to
recognize a pro rata portion of Apex's losses based upon our ownership interest.
In the fiscal year ended June 30, 2000, we recognized $2.0 million of loss as
our share of Apex's net loss. We modified our relationship with Apex on June 30,
2000, and as a result we no longer account for this investment on the equity
basis.

During the third quarter of fiscal 2002, we recorded a non-cash charge to
reduce the carrying value of our 19.7% cost basis investment in Apex to reflect
an other-than-temporary decline in value of $6.8 million (representing the
excess of carrying value over fair value, which resulted in a carrying value of
$1.3 million as of March 31, 2002). We determined that our investment was
impaired based on the terms of a third quarter fiscal 2002 transaction involving
Apex equity instruments between two existing investors. Management assessed this
impairment to be other than temporary due to the sharp decline in fair value as
determined and in consideration of the overall market condition for private
equity companies. Before such time, we had concluded there was not an
other-than-temporary impairment based, in part, on the application of customary
valuation techniques which indicated that fair value approximated carrying
value. Among the key assumptions included in the valuation were market
conditions for educational-related companies, trends in Apex operating results
and valuations of market comparables. Based on an updated appraisal of this
investment, management believes the fair value of the investment continues to
approximate its carrying value at June 30, 2003.

ANTICIPATED CAPITAL EXPENDITURES

Capital expenditures for fiscal 2004 are expected to be approximately $7.7
million, which includes approximately $4.1 million for computers and other
technology at our schools, approximately $2.2 million for curriculum materials,
approximately $0.4 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 expect to make additional
advances or loans approximating $8.1 million to new charter board clients to
help secure and renovate school properties during the 2003-2004 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 $2.0 million to benefit one of our clients.

RECENTLY ISSUED ACCOUNTING STANDARDS

In November 2002, the Financial Accounting Standards Board ("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.

In December 2002, the FASB issued 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. 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

44

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 is in the
process of evaluating the impact FIN 46 will have on its financial statements.

In May 2003, the FASB issued FAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." FAS 150
establishes standards for classifying and measuring as liabilities certain
financial instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity. FAS 150 represents a significant
change in practice in the accounting for a number of financial instruments,
including mandatory redeemable equity instruments and certain equity derivatives
that frequently are used in connection with share repurchase programs. FAS 150
is effective for all financial instruments created or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The Company adopted FAS 150 on June 1, 2003. The
Company currently does not have financial instruments with a characteristic of
both debt and equity, therefore, the adoption of this statement is not expected
to have a material impact on the Company's consolidated financial statements.

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 Annual Report, including our financial statements
and the related notes.

WE HAVE A HISTORY OF LOSSES AND MAY NOT ACHIEVE ANNUAL PROFITABILITY IN THE
FUTURE

We have incurred substantial net losses in every fiscal year since we began
operations. For the year ended June 30, 2003, our net loss was $25.0 million. As
of June 30, 2003, our accumulated deficit since November 1996, when we converted
from a partnership to a corporation, was approximately $281.6 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
annual profitability, we believe it will be necessary to improve site
profitability while maintaining educational quality and reducing central
expenses as a percentage of net revenue. 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 should the Company remain public.

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 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

45

business and the market price of our Class A common stock, should we remain
public, would be adversely affected.

THE SUCCESS OF OUR BUSINESS DEPENDS ON OUR ABILITY TO IMPROVE THE ACADEMIC
ACHIEVEMENT OF THE STUDENTS ENROLLED IN OUR SCHOOLS, AND WE MAY FACE
DIFFICULTIES IN DOING SO IN THE FUTURE

We believe that our growth will be dependent upon our ability to
demonstrate general improvements in academic performance at our schools. Our
management agreements contain performance requirements related to test scores.
To the extent average student performance at our schools increases, whether due
to improvements in achievement over time by individual students in our schools
or changes in the average performance levels of new students entering our
schools, aggregate absolute improvements in student performance will be more
difficult to achieve. If academic performance at our schools declines, is
perceived to decline, or simply fails to improve, we could lose business and our
reputation could be seriously damaged, which would impair our ability to gain
new business or renew existing school management agreements.

WE COULD INCUR LOSSES AT OUR SCHOOLS IF WE ARE UNABLE TO ENROLL ENOUGH
STUDENTS

Because the amount of revenue we earn for operating each school primarily
depends on the number of students enrolled, and because many facility and
on-site administrative costs are fixed, achieving site-specific enrollment
objectives is an important factor in our ability to achieve satisfactory
financial performance at a school. We may be unable to recruit enough students
to attend all grades in our new schools or maintain enrollment at all grades in
our existing schools. We sometimes do not have enough students to fill some
grades in some schools, particularly the higher grades. It is sometimes more
difficult to enroll students in the higher grades because older students and
their parents are reluctant to change schools. 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
46

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 and incur financial losses. 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
district partnership school. We regularly encounter resistance from local
teachers' unions during school board debates over whether to enter into a
management agreement with us. In addition, local teachers' unions have
occasionally, albeit ultimately unsuccessfully, initiated litigation challenging
our management agreements. If we fail to achieve and maintain cooperative
relationships with local teachers' unions, we could lose business and our
ability to grow could suffer. In addition, at the national level, the American
Federation of Teachers and the National Education Association have substantial
financial and other resources that could be used to influence legislation, local
teachers' unions and public opinion in a way that would hurt our business.

WE COULD BE LIABLE FOR EVENTS THAT OCCUR AT OUR SCHOOLS

We could become liable for the actions of principals, teachers and other
personnel in our schools. In the event of on-site accidents, injuries or other
harm to students, we could face claims alleging that we were negligent, provided
inadequate supervision or were otherwise liable for the injury. We could also
face allegations that teachers or other personnel committed child abuse, sexual
abuse or other criminal acts. In addition, if our students commit acts of
violence, we could face allegations that we failed to provide adequate security
or were otherwise responsible for their actions, particularly in light of
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 it does not have a
contractual 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,
there could be 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
47

termination at will by the school district. The contract is also subject to
termination if we fail to meet our obligations, including meeting specified
student achievement targets. If the contract is terminated, or if we fail to
successfully deliver the program, raise student achievement or manage the
program's costs, our financial results, operations and reputation may be
adversely affected.

OUR MANAGEMENT AGREEMENTS INVOLVE FINANCIAL RISK

Under the majority of our management agreements, we agree to operate a
school in return for per-pupil funding that generally does not vary with our
actual costs. To the extent our actual costs under a management agreement exceed
our budgeted costs, or our actual revenue is less than planned because we are
unable to enroll as many students as we anticipated or for any other reason, we
could lose money at that school. In addition, from time to time we have
disagreements with our clients as to the actual amount of, or the method of
calculating, the revenue owed to us under the terms of the management
agreements, resulting in lower revenue than planned. We are generally obligated
by our management agreements to continue operating a school for the duration of
the contract even if it becomes unprofitable to do so.

WE HAVE LIMITED EXPERIENCE OPERATING FOUR-YEAR HIGH SCHOOLS

An element of our strategy is to increase our business with existing
customers by opening new schools in school districts with 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 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 district partnership or
charter client and the ultimate opening of a school, and related recognition of
revenue, typically ranges between nine and 27 months. Our sales cycle for
district partnership 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
48

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 June 30, 2003, we have outstanding loans or advances to charter
boards of $82.8 million, net of allowances, to finance the purchase or
renovation of school facilities we manage. Approximately $12.3 million of these
loans, representing 16 schools, are uncollateralized or subordinated to a senior
lender. In addition, with respect to the loans that are collateralized, if we
were required to foreclose on the collateral securing those loans, we might not
be able to liquidate the collateral for proceeds sufficient to cover the loan
amount. If any of these advances or loans are not repaid when due, our financial
results could be adversely affected. Some of our charter schools 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 exceed the terms of the management agreements for those
schools. For four 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 June 30, 2003, our aggregate future lease obligations totaled
$29.9 million, with varying maturities over the next 17 years. In four 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 June 30, 2003 the amount of loans we had guaranteed totaled $26.7 million.
Although the term of these arrangements is coterminous with the term of the
corresponding management agreement, our guarantee does not expire until the loan
is repaid in full. The lenders under these facilities are not committed to
release us from our obligations unless replacement credit support is provided.
The default by any charter school under a credit facility that we have
guaranteed could result in a claim against us for the full amount of the
borrowings. Furthermore, in the event any charter board becomes insolvent or has
its charter revoked, our loans and advances to the charter board may not be
recoverable, which could adversely affect our financial results. In addition, we
have generally indemnified our charter school and district partnership 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 managed school revenue in July. Most of our site costs
are

49

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 site contribution 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 district partnership schools. In
addition, a variety of other types of companies and entities could enter the
market, including colleges and universities or 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, which may elect not to enter into management agreements
with private managers or which may pursue alternative reform initiatives, such
as magnet schools and inter-district choice programs. In addition, in
jurisdictions where voucher programs have been authorized, we will begin to
compete with existing private schools for public tuition funds. Voucher programs
provide for the issuance by local or other governmental bodies of tuition
vouchers to parents worth a certain amount of money that they can redeem at any
approved school of their choice, including private schools. If we are unable to
compete successfully against any of these existing or potential competitors, our
revenues could be reduced, resulting in increased losses.

FAILURE TO RAISE NECESSARY ADDITIONAL CAPITAL COULD RESTRICT OUR GROWTH AND
HINDER OUR ABILITY TO COMPETE

We have had negative cash flow in every fiscal period since we began
operations. We have regularly needed to raise funds in order to operate our
business and fund our growth, including the construction and renovation of
charter school facilities, and may need to raise additional funds in the future.
We cannot be certain that we will be able to obtain additional financing on
favorable terms, if at all, or that our charter clients will be able to repay
our loans and advances to them. If we issue additional equity or convertible
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 and School Services Facilities, 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 could 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
50

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, if 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 were issued in connection with the MLMCI and School Services
Facilities 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 exercise of the
warrants 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) at the time of
issuance. The exercise of such warrants 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 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 5% of our net
revenue for fiscal 2003. During the same period, we estimate that funding from
other federal and state programs accounted for approximately an additional 9% of
our total net 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 were to 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 Newton Learning summer school program, which served
approximately 46,000 students in Missouri during the summer of 2003, is
funded through state summer school funds. If the Missouri state
government fails to maintain current funding levels for summer school
programs, Newton 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.
51

- 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 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 were covered by federal procurement rules and regulations
and had been 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 had received under the management agreement.

FAILURE OF OUR CHARTER BOARD CLIENTS TO OBTAIN FEDERAL TAX-EXEMPT STATUS COULD
JEOPARDIZE THE SCHOOL'S CHARTER AND RESTRICT OUR ABILITY TO FINANCE THE SCHOOL

Many of our charter school clients apply for federal tax-exempt status. One
state in which we currently operate seven charter schools and hope to open
additional charter schools in the future, and one other state, requires charter
schools to secure federal tax-exempt status. One of our charter school clients
in the first state received notice from the Internal Revenue Service of an
appealable denial of its application for federal tax-exempt status. While this
charter school client was ultimately successful in obtaining tax-exempt status,
there can be no assurance that other charter school clients will not experience
difficulty in obtaining such status. Any failure to receive or delay in
receiving federal tax-exempt status by a charter school in this state could
jeopardize the school's charter and its ability to repay amounts owed to us. The
failure to receive federal tax-exempt status by a charter school in any state
could also, among other things, inhibit that charter school's ability to solicit
charitable contributions or participate in tax-exempt financing.

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
52

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
35.2% of our net revenue in fiscal 2003, or approximately $150.0 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;

- 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.

FAILURE TO OBTAIN SHAREHOLDER APPROVAL FOR THE GOING-PRIVATE TRANSACTION

On July 14, 2003, Edison announced that it had signed a definitive merger
agreement with a company formed by H. Christopher Whittle, the Company's Chief
Executive Officer and Founder, and an affiliate of Liberty Partners, a private
equity firm based in New York. The merger, which would result in the company no
longer being listed on the Nasdaq, is subject to the approval of the
shareholders. If a majority of the shareholders owning Edison's outstanding
shares do not approve the merger, the market price of the Company's Class A
common stock may be adversely impacted. In addition, as part of the proposed
merger, Liberty Partners agreed to provide a senior secured credit facility to
Edison in the principal amount of $70.0 million in order to permit Edison to
refinance certain existing credit facilities. If the shareholders do not approve
the merger this commitment will terminate, and the Company may face difficulty
securing new lines of credit and/or refinancing the MLMCI Facility, which
expires on November 15, 2003.

53

WE HAVE BEEN NAMED IN A NUMBER OF CONSOLIDATED SHAREHOLDER CLASS ACTIONS AND A
FEW SHAREHOLDER 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 have also been named in a number of purported class
actions complaints filed in the Court of Chancery of the State of Delaware and
the Supreme Court of the State of 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 and prevent us from obtaining additional
funds under our existing line of credit or securing other financing. 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, in the
summer of 2002 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. The Company could face litigation in
connection with that decision. While we would vigorously defend against any such
lawsuit, there is no assurance that the Company would 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.

In addition, in August 2003 a lawsuit was filed against the School District
of the City of Inkster, Michigan, the State of Michigan, and several other
defendants in connection with the accidental death of a child on school district
property. Edison has, pursuant to its management agreement with the Inkster
district, indemnified the school district for actions taken by the Company
during the term of the agreement. Accordingly, to the extent the district has
some liability, the Company may in turn be liable under the indemnification.
Moreover, while Edison has not been named as a defendant, the complaint may be
(and in all likelihood will) be amended to include Edison as a defendant.

While we intend to vigorously defend this lawsuit, both on behalf of the
district and the Company if the Company is named as a defendant, there can be no
assurance that the district or the Company will be successful, and an adverse
resolution of this lawsuit could result in substantial costs (in the form of a
judgment or settlement) and/or negative publicity.

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 the Company. 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;

- 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

54

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We currently have market risk sensitive instruments related to interest
rates. As disclosed in Note 8 of the notes to our financial statements, we had
outstanding long-term notes payable of $9.8 million and 3.1 million at June 30,
2002 and 2003, respectively. Interest rates on the notes are fixed and range
from 9.5% to 15.04% per annum and have terms of 36 to 37 months.

We do not believe that we have significant exposure to changing interest
rates on long-term debt because the interest rates for our debt are 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 $40.6 million and $26.3 million
at June 30, 2002 and June 30, 2003, respectively. 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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our financial statements together with the related notes and the report of
PricewaterhouseCoopers LLP, independent auditors, are set forth in the Index to
Financial Statements at Item 14 and incorporated herein by this reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES.

Within 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision 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.

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.

55

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The following persons are the executive officers and directors of Edison as
of the date of this proxy statement. Each executive officer will serve until a
successor is elected by the board of directors or until the earlier of his
resignation or removal. Neither any of these persons nor Edison has been
convicted in a criminal proceeding during the past five years (excluding traffic
violations or similar misdemeanors), and none of these persons has been a party
to any judicial or administrative proceeding during the past five years that
resulted in a judgment, decree or final order enjoining the person from future
violations of, or prohibiting activities subject to, federal or state securities
laws or a finding of any violation of federal or state securities laws. The
directors and executive officers of Edison are citizens of the United States and
can be reached c/o Edison, 521 Fifth Avenue, 11th Floor, New York, NY, 10175,
telephone number 212-419-1600.

Our executive officers and directors, and their ages as of September 15,
2003, are as follows:

The following are the names and present principal occupations or
employment, and material occupations, positions, offices or employments for the
past five years, of each director and executive officer of Edison:

H. Christopher Whittle, Edison's founder, has served as Chief Executive
Officer since July 1998. He served as president from March 1997 through July
2002. He has served as a director since 1992 and also served as our Chairman of
the Board of Directors from 1992 until March 1995. He is the President and sole
stockholder of WSI Inc., a corporation wholly owned by Mr. Whittle with the
current primary purpose of holding Mr. Whittle's personal investments. From 1986
to 1994, Mr. Whittle was Chairman and Chief Executive Officer of Whittle
Communications L.P., which developed magazines and other print publications, as
well as Channel One, an advertising-supported daily news and information
television program for schools. Before that, Mr. Whittle was the founder of
13-30 Corporation, the predecessor of Whittle Communications L.P., and served as
the publisher of Esquire magazine from 1979 to 1986.

Benno C. Schmidt, Jr. has served as Chairman of the Board of Directors
since March 1997. He also served as our Chief Executive Officer from 1992 to
June 1998, our President from 1992 to February 1997 and our Chief Education
Officer from July 1998 through April 1999. Mr. Schmidt served as President of
Yale University from 1986 to 1992. He also served as Dean of the Columbia
University School of Law from 1984 to 1986. He is currently Chairman of the
Board of Trustees of the City University of New York.

Christopher D. Cerf has served as President since July 2002 and as Chief
Operating Officer since May 1999. He has also served as a director since
November 2000. He also served as our General Counsel from June 1997 to April
2000. Prior to joining us, he was a partner in the law firm of Wiley, Rein and
Fielding from

56

1991 to 1994 and from May 1996 to May 1997. Between 1994 and May 1996, he served
in the White House as Associate Counsel to the President. Mr. Cerf is also a
former high school history teacher.

Charles J. Delaney has served as our Vice Chairman, Business and Finance,
since July 2002 and as a director since July 1999. Prior to joining Edison, Mr.
Delaney was the President of UBS Capital Americas, which is the manager for two
private equity funds that make investments in the U.S. and Latin America, from
January 2000 through June 2002. Mr. Delaney served as President of UBS Capital
LLC or its predecessor companies from May 1989 to June 2002. UBS Capital
Americas and UBS Capital LLC are affiliated with UBS AG.

Christopher J. Scarlata has served as Chief Financial Officer and Executive
Vice President since August 1, 2002. From April 2001 through July 2002, he was
our Controller. Prior to joining us, he served as Controller for Walker Digital
LLC from March 2000 through December 2000 and as assistant controller for
Mitchell Madison Group LLC from 1996 through February 2000. Before that, Mr.
Scarlata was an auditor for PricewaterhouseCoopers LLP.

John E. Chubb has served as our Chief Education Officer and Executive Vice
President since May 1999. Prior to that, he served as Edison's Executive Vice
President of Curriculum, Instruction and Assessment from 1992 to April 1999.

John B. Balousek has been a director since December 2002. He currently
serves on the Boards of Directors of Central Garden & Pet Company, Aptimus, Inc.
and Interland, Inc. From 1998 to 1999, Mr. Balousek served as Executive Vice
President and a founder of PhotoAlley.com, a San Francisco-based start-up
company providing electronic commerce services. From March 1996 to July 1996, he
served as Chairman and Chief Executive Officer of True North Technologies, a
digital and interactive services company of True North Communications. From 1991
to February 1996, Mr. Balousek served as President, Chief Operating Officer and
director of Foote Cone & Belding Communications, Inc. ("FCB") a global
advertising and communications company. From 1979, he served in various
positions at FCB, and earlier he worked in brand management at Procter & Gamble.

Joan Ganz Cooney has served as a director since November 2000. She is the
Chairman, Executive Committee, of the Sesame Workshop, formerly the Children's
Television Workshop. Ms. Cooney co-founded the Children's Television Workshop as
its Executive Director in 1968 and was named its President-Chief Executive
Officer in 1970 and Chairman-Chief Executive Officer in 1988. She assumed her
present responsibilities in 1990. Ms. Cooney is a Trustee of the Museum of
Television and Radio and The New York and Presbyterian Hospitals, Inc. She is a
life Trustee of the National Child Labor Committee and of WNET, Channel 13.

Reverend Floyd H. Flake has served as a director since November 2000. He
served as President of Edison Charter Schools from May 2000 until September
2002, and currently serves the Company as a consultant. Reverend Flake has
served as the President of Wilberforce University since July 2002. From January
1986 to December 1997, Reverend Flake served as a member of the United States
House of Representatives, representing the 6th district of New York. He has also
been the Senior Pastor of the Allen African Methodist Episcopal Church in
Jamaica, Queens since 1976. Reverend Flake currently serves on the Board of
Directors of the Fannie Mae Foundation, The Princeton Review, The New York City
Investment Fund Civic Capital Corporation, The Initiative for a Competitive
Inner City, and the Federal Deposit Insurance Corporation Advisory Committee on
Banking Policy. Reverend Flake is also a Senior Fellow at the Manhattan
Institute for Social and Economic Policy, an Adjunct Fellow on the Advisory
Board of the Brookings Institute Center on Urban and Metropolitan Policy and a
member of the NYC 2012 Olympic Committee.

Ronald F. Fortune has served as a director since December 2002. He is the
founder of Edumetrics Learning, an early stage startup focused on building
educational content for students at schools and home. From 1990 until December
1999, Mr. Fortune was the President and Chief Executive Officer of Computer
Curriculum Corporation ("CCC"), an educational software company. Prior to
becoming Chief Executive Officer of CCC, he was CCC's Chief Operating Officer
(1988-1990), Vice President of Sales (1986-1988) and sales representative
(1979-1986). Mr. Fortune has served as President of CEO Forum, a Washington,

57

D.C. based organization advocating the use of technology in schools, and is
currently a Senior Advisor to Project Pipeline, a nonprofit teacher recruitment
and credentialing institution. He has served as a classroom teacher and as an
administrator.

Edward S. Harris has served as a director since March 2003. From December
2002, Mr. Harris has been an independent financial consultant. From December
1998 to December 2002, Mr. Harris was Director of Investment Management for
Vulcan Ventures Inc., a private equity firm founded and controlled by Paul
Allen, the co-founder of Microsoft. From 1992 to 1998, Mr. Harris was Chief
Financial Officer for three technology companies: Claircom Communications Group,
L.P., an affiliate of McCaw Cellular Incorporated and provider of specialized
air-to-ground wireless communications services; Starwave Incorporated, a leading
internet company; and Mirror Software, Inc., a provider of medical imaging
software. Mr. Harris was an investment banker with Salomon Brothers Inc. from
1985 to 1990 and with Sumishin Capital from 1990 to 1992. Mr. Harris is on the
Board of Directors of two other public companies: Click2Learn.com, a Bellevue,
Washington provider of online learning solutions, and First Virtual
Communications, a Santa Clara, California company that provides rich media
communications products worldwide.

Lowell W. Robinson has served as a director and Chairman of the Audit
Committee since November 2002. Mr. Robinson is Special Council to the President
of Polytechnic University. He was Senior Executive Vice President and Chief
Financial Officer for HotJobs.com from 2000 to February 2002, when the company
was sold to YAHOO Inc. From 1997 until 1999, Mr. Robinson was Executive Vice
President, Global Business Services and Chief Financial Officer of PRT Group
Inc. From 1994 until 1997, Mr. Robinson was Executive Vice President and Chief
Financial Officer at ADVO, Inc. Mr. Robinson spent eight years at Citigroup
(1986-1993) where he was Vice President and Chief Financial Officer for The
Traveler's Managed Care and Employee Benefits Operations from 1991 to 1993; the
Chief Financial Officer for Citicorp's Global Insurance and Capital Investments
Divisions from 1988 to 1991; and the Controller for Citicorp's Consumer Services
Group -- International from 1986-1988. Prior to joining Citigroup, Mr. Robinson
was Director of Finance and Operations for Uncle Ben's Inc., the domestic and
international rice subsidiary of Mars, Inc. From 1973 to 1983, Mr. Robinson held
senior financial positions at Kraft/General Foods. Mr. Robinson is on the Board
of Directors of Financial Executives International, New York City Chapter and is
on the Forbes Magazine CFO Advisory Board.

Timothy P. Shriver has served as a director since September 2001. He has
served as President and Chief Executive Officer of Special Olympics, Inc. since
July 1996, and on June 22, 2002, he was named Chairman of the Board of Special
Olympics, Inc. Mr. Shriver serves on the Boards of Directors for the Education
Compact for Learning and Citizenship, the Frank Porter Graham Child Development
Center at the University of North Carolina, and the American Association for
Retarded Citizens (AAMR). In 1994, Shriver helped launch and currently chairs
the Collaborative for Academic, Social & Emotional Learning (CASEL), a national
organization promoting effective school-based prevention programming.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE. All reports were
timely filed.

Code of Ethics. In September 2003, the Company's Board of Directors
approved a Code of Ethics for the Company's senior executives, including the
principal executive officer, principal financial officer, and principal
accounting officer or controller (as those terms are defined in the applicable
SEC rules). A copy of the Code of Ethics is filed as an exhibit to this Annual
Report.

58

ITEM 11. EXECUTIVE COMPENSATION

COMPENSATION OF EXECUTIVE OFFICERS

The table below sets forth, for the fiscal years ended June 30, 2001, 2002
and 2003, the total compensation earned by the Company's Chief Executive Officer
and each of its four other executive officers who were most highly compensated
during fiscal 2003 (the "Named Executive Officers").

SUMMARY COMPENSATION TABLE

- ---------------

(1) Represents the number of shares covered by options to purchase shares of
Common Stock granted during the respective years. The Company has never
granted stock appreciation rights.

(2) Mr. Whittle's compensation does not include accrued interest relating to two
loans to Mr. Whittle from the Company. For more information on these loans,
see "Certain Transactions -- Loans to Executives." Interest on the two loans
is not due until November 2004 and April 2005, respectively.

(3) At June 30, 2003, 950,000 shares of a 1,000,000-share restricted stock award
made on October 1, 2003 were vested. The remaining 50,000 shares were
subject to vesting based on the judgment of the Board of Directors regarding
certain performance objectives for fiscal year 2003. Based on the closing
price on June 30, 2003, the 950,000 shares were worth $1,425,000.

(4) Represents supplemental life insurance premium paid on behalf of the
executive.

(5) Represents 401(k) matching contribution.

(6) Includes a $50,000 relocation bonus.

(7) Estimate.

OPTION GRANTS IN FISCAL 2003

The following table sets forth each grant of stock options during the year
ended June 30, 2003 to the Named Executive Officers. All of these options were
granted at fair market value as determined by the Board of Directors on the date
of the grant. The Company granted no stock appreciation rights during the year
ended June 30, 2003. The following table shows the hypothetical value of the
options granted at the end of the option terms if the stock price were to
appreciate annually by 5% and 10%, respectively. These assumed rates of

59

growth are required by the SEC for illustration purposes only and are not
intended to forecast possible future stock prices.

- ---------------

(1) Represents the product of (i) the difference between (A) the product of the
per-share fair market value at the time of the grant compounded annually at
the assumed rate of appreciation over the term of the option, and (B) the
per-share exercise price of the option, and (ii) the number of shares
underlying the grant at the fiscal year end.

OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES

No options were exercised by the Named Executive Officers during the fiscal
year ended June 30, 2003. The table below sets forth information concerning the
number and value of unexercised options held by each of the Named Executive
Officers on June 30, 2003.

- ---------------

(1) Includes options held by WSI Inc., a corporation of which Mr. Whittle is the
President and sole stockholder.

The value of unexercised in-the-money options at fiscal year-end has been
calculated on the basis of $1.50, which was the last sales price per share of
the Class A common stock on June 30, 2003, as reported on the Nasdaq National
Market, less the per-share exercise price.

EMPLOYMENT AGREEMENTS

The Company and Mr. Whittle entered into an agreement as of December 18,
2001 in which Edison agreed to employ Mr. Whittle through June 30, 2004 at an
annual base salary of $1.00, retroactive to July 1, 2001. Mr. Whittle received
base compensation of $1.00 during fiscal year 2002. The agreement was amended
effective November 15, 2002 to increase his annual base salary to $345,000, pro
rated from November 15, 2002 for fiscal year 2003, and to provide for an annual
performance bonus potential of up to 150% of his base salary, pro rated from
November 15, 2002 for fiscal year 2003. Under the December 18, 2001 agreement,
Mr. Whittle was issued an option to acquire 1,000,000 shares of Edison's Class A
common stock at a price of $25.00 per share, and Edison accelerated the vesting
of three outstanding options to acquire, respectively (1) 149,999 shares of
Class A common stock and 16,667 shares of Class B common stock at a price of
$22.00 per share, (2) 1,125,000 shares of Class A common stock and 125,000
shares of Class B common stock at a price of $32.00 per share, and (3) 1,260,000
shares of Class A common stock and 140,000 shares of Class B common stock at a
price of $56.00 per share, so that Mr. Whittle became entitled to exercise each
option in full. Edison also agreed to reimburse Mr. Whittle for 75% of
reasonable expenses incurred on Edison's behalf, commensurate with his position,
and continued its prior commitment to maintain long-term disability insurance
and $800,000 face amount term life insurance for Mr. Whittle's benefit. On June
26, 2003, the

60

Company's Audit Committee approved increasing Mr. Whittle's reimbursement for
reasonable expenses to 100%, effective July 1, 2003. If Edison were to terminate
Mr. Whittle's employment without cause or if Mr. Whittle were to terminate his
employment for "good reason," the unvested portion of any outstanding options
would vest in full. Under this agreement, "good reason" is defined as Mr.
Whittle's assignment to materially less significant duties, Edison's failure to
reappoint Mr. Whittle to his then current position or Edison's failure to
perform Edison's material obligations under this agreement. Mr. Whittle has
agreed not to compete against Edison during the term of his employment and for
one year afterwards and not to solicit the employment or other services of any
of Edison's executive employees for one year after his termination. For more
information on the Company's loans to Mr. Whittle in connection with his
exercise of stock options, see "Certain Transactions -- Loans to Executives."

The Company and Benno C. Schmidt, Jr. entered into an agreement on June 20,
2000 in which Edison agreed to employ Mr. Schmidt through June 30, 2003. In June
2003, the agreement was extended until December 31, 2003. Pursuant to this
agreement, Mr. Schmidt is entitled to an annual base salary of $298,080, subject
to annual increases or decreases. The agreement provides that Mr. Schmidt may
also receive incentive bonuses at the discretion of Edison's board of directors.
Under the agreement, Edison maintains term life insurance in the amount of $5.0
million for Mr. Schmidt, proceeds of which will first be used to offset loans
Edison has made to Mr. Schmidt, with any excess amount for his benefit. If
Edison terminates Mr. Schmidt's employment without cause or if Mr. Schmidt
terminates his employment for "good reason," he is entitled to receive his base
salary and the bonus he earned from the prior fiscal year for 12 months
following the effective date of his termination and an additional lump sum
payment of $3.2 million. The lump sum payment may be used to offset any
outstanding balance on the two loans Edison has made to Mr. Schmidt.

The Company and Charles J. Delaney entered into an employment agreement in
October 2002 in which Edison agreed to employ Mr. Delaney until June 2004 with
an annual base salary of $295,000. The agreement included a signing bonus of
$73,750. Under the agreement, Mr. Delaney was eligible for a bonus of up to
$450,000 for fiscal year 2003 based on the Company's achievement of specified
financial goals, with such bonus to be paid quarterly upon approval by Edison's
board of directors. Additionally, Mr. Delaney was awarded 1,000,000 shares of
restricted stock for services to be rendered during fiscal year 2003, of which
950,000 have vested. As of July 31, 2003, Edison amended its employment
agreement. Under the amended agreement, Mr. Delaney is eligible for a bonus of
up to $450,000 for fiscal year 2004 based on Edison's achievement of specified
financial goals, with such bonus to be paid within 60 days of the end of fiscal
year 2004. Mr. Delaney also received an additional grant of 1,000,000 shares of
restricted stock for services to be rendered during fiscal year 2004, including
440,000 shares ("Time Vested Restricted Stock") that will vest ratably over 12
months. The remaining 560,000 shares ("Performance Vested Restricted Stock")
vest at the end of fiscal year 2004 to the same extent as the percentage of
annual bonus awarded to Mr. Delaney for fiscal year 2004. If, prior to a change
in control, Mr. Delaney's employment is terminated without cause or if he
terminates his employment for "good reason" during fiscal year 2004, Edison's
board of directors shall, as of the termination date, evaluate Mr. Delaney's
performance and determine what portion of the annual bonus for fiscal year 2004
to award to Mr. Delaney and what portion of the Performance Vested Restricted
Stock will vest. Vesting of the Time Vested Restricted Stock will cease on the
termination date. In the event of a change in control prior to June 30, 2004
(the consummation of the merger will be a change in control for purposes of Mr.
Delaney's employment agreement), Mr. Delaney's employment agreement will
terminate automatically unless extended by mutual agreement. In connection with
such termination, Edison will accelerate the vesting of (1) 50% of the unvested
portion of the Time Vested Restricted Stock, (2) a pro-rata portion, based
solely on the passage of time, of the Performance Vested Restricted Stock and
(3) 50% of that portion of the Performance Vested Restricted Stock that did not
vest as a result of the pro-rata acceleration described in (2). Any unvested
shares of restricted stock remaining after the accelerated vesting described
above will be forfeited. In addition, upon such termination, Edison will pay Mr.
Delaney, at Edison's option in either a lump sum or in equal installments over
the remaining pay periods in fiscal year 2004, the sum of (1) 50% of Mr.
Delaney's remaining salary for fiscal year 2004 and (2) the total of (A) a
pro-rata portion, based solely on the passage of time, of Mr. Delaney's bonus
potential for fiscal year 2004 and (B) 50% of Mr. Delaney's bonus potential
remaining after calculation of the pro-rata bonus portion. Mr. Delaney has
agreed not to compete against Edison during his term of employment and for one
year thereafter.
61

The Company and Christopher D. Cerf entered into an agreement in July 1999
in which the Company agreed to employ Mr. Cerf until June 2002 with an annual
base salary of $240,000. The agreement is automatically renewed for successive
one-year terms unless otherwise terminated as provided in the agreement, and was
so renewed at the end of June 2002. The agreement was amended effective November
15, 2002 to increase Mr. Cerf's base salary to $295,000 and to provide for a
performance bonus of up to 150% of his base salary for each fiscal year. Mr.
Cerf received base compensation of $293,269 during fiscal 2003. Under this
agreement, Mr. Cerf received a bonus of $50,000 in August 2000, as well as
reimbursement of certain documented expenses, in connection with his relocation
to New York City. The Company also agreed to maintain long-term disability
insurance and term life insurance in the amount of $800,000 for Mr. Cerf's
benefit. If Mr. Cerf is terminated without cause, he is entitled to receive his
base salary for twelve months following the effective date of his termination
less any amount he earns during the last six months of this period as a result
of new employment. If Mr. Cerf is terminated for cause, he is entitled to
receive his base salary only through the effective date of termination. Mr. Cerf
has agreed not to compete against the Company during his term of employment and
for one year thereafter.

The Company and John E. Chubb entered into an agreement in March 1995 in
which the Company agreed to employ Mr. Chubb with an annual base salary of
$200,000. Mr. Chubb received base compensation of $286,538 during fiscal 2003.
In June 2000, the Board of Directors provided that Mr. Chubb would be eligible
to receive a bonus of up to $100,000 beginning with fiscal 2001. In February
2003, the Board approved annual performance bonus potential of up to $400,000
for Mr. Chubb, with 75% of such bonus linked to academic achievement of students
in schools managed by Edison. If Mr. Chubb is terminated without cause, he is
entitled to receive as severance pay his base salary for six months following
the effective date of his termination less any amount he earns as a result of
new employment. If Mr. Chubb is terminated for cause, he is entitled to receive
his base salary only through the effective date of termination. Mr. Chubb has
agreed not to compete against the Company during his term of employment and for
one year thereafter.

REPORT OF THE COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION

This report addresses the compensation policies of the Company applicable
to its officers during fiscal 2003. The Company's executive compensation program
is administered by the Compensation Committee of the Board of Directors, which
is composed of three non-employee directors. The Compensation Committee is
responsible for determining the compensation package of each executive officer,
including the Chief Executive Officer. The current Compensation Committee did
not begin functioning until January 2003. Prior to such time, the Board of
Directors acted as a committee of the whole to fulfill responsibilities of the
Compensation Committee.

OVERVIEW AND PHILOSOPHY

The Company's executive compensation program is designed to promote the
following objectives:

- To recognize and reward exceptional performance by the Company's
executives.

- To provide incentives for high levels of current and future performance.

- To align the objectives and rewards of the Company's executives with
those of the stockholders of the Company.

The Compensation Committee believes an executive compensation program that
achieves these objectives will properly motivate and compensate the Company's
current officers as well as enable the Company to attract other officers who may
be needed by the Company in the future.

EXECUTIVE COMPENSATION PROGRAM

The Company's executive compensation program consists of base salary,
annual incentive compensation in the form of cash bonuses, and long-term equity
incentives in the form of stock options and grants of restricted stock.
Executive officers also are eligible to participate in certain benefit programs
that are generally

62

available to all employees of the Company, such as life insurance benefits and
the Company's 401(k) savings plan.

Base Salary. At the beginning of each year, the Compensation Committee, or
in the absence of such committee, the full Board of Directors, establishes an
annual salary plan for the Company's senior executive officers based on
recommendations made by the Company's Chief Executive Officer. Salary
determinations depend both upon the Company's financial performance and upon the
individual's performance as measured by specific objectives.

Annual Incentive Compensation. The Company's executive bonus program is
designed to provide its senior executive officers with cash incentives to
achieve the Company's financial and student achievement goals. At the beginning
of each year, the Compensation Committee or, in the absence of such committee,
the full Board establishes target annual bonuses for each executive officer,
based on recommendations made by the Company's Chief Executive Officer, which
the executive will receive if his or her targeted objectives for the year are
achieved. Cash bonuses are paid annually. For fiscal 2003, estimated annual cash
bonuses for the Named Executive Officers totaled $1,785,000.

Long-Term Equity Incentives. The Company's stock option program is
intended to align the long-term interests of the Company's employees and its
stockholders and to assist in the retention of employees. The size of an
executive's option grant is generally intended to reflect the executive's
position with the Company and his or her contributions to the Company. Executive
stock options typically vest over a three- to five-year period, sometimes based
partially on tenure and partially on specified measurements of the annual
performance of the Company and/or the executive, to encourage continued
employment by the Company. In fiscal 2003, all stock options were granted at an
option exercise price at least equal to the fair market value of the Class A
common stock on the date of the grant. The Company may also from time to time
make grants of restricted stock. During fiscal 2003 the Company made one
restricted stock grant.

BENEFITS

The Company's executive officers are entitled to receive medical and life
insurance benefits and to participate in the Company's 401(k) retirement savings
plan on the same basis as other full-time employees of the Company.

SUMMARY OF COMPENSATION OF CHIEF EXECUTIVE OFFICER

In fiscal 2002, Mr. Whittle, the Company's Chief Executive Officer,
received base compensation of $207,004.

COMPLIANCE WITH INTERNAL REVENUE CODE SECTION 162(M)

Section 162(m) of the Internal Revenue Code generally disallows a tax
deduction to public companies for compensation in excess of $1 million paid to
the corporation's Chief Executive Officer and four other most highly paid
executive officers. Qualifying performance-based compensation will not be
subject to the deduction limitation if certain requirements are met. The
Compensation Committee or, in the absence of such committee, the Board of
Directors periodically reviews the potential consequences of Section 162(m) and
may structure the performance-based portion of its executive compensation to
comply with certain exemptions in Section 162(m). However, the Compensation
Committee, or in the absence of such committee, the Board of Directors reserves
the right to use its judgment to authorize compensation payments that do not
comply with the exemptions in Section 162(m) when a determination is made that
such payments are appropriate and

63

in the best interests of the stockholders, after taking into consideration
changing business conditions or the officer's performance.

By the Compensation Committee.

John B. Balousek
Joan Ganz Cooney
Ronald F. Fortune

COMPENSATION OF DIRECTORS

Non-employee directors receive an annual retainer of $27,500, paid
quarterly, as well as a fee of $2,000 per in-person board meeting attended.
Additionally, non-employee directors receive a fee of $500 per hour for
telephonic meetings of the board, with a minimum fee of $500, paid quarterly.
For service on board committees, non-employee directors who are members of the
Communications/Government Affairs, Compensation, and Education Committees
receive an annual fee of $5,000, paid quarterly. For service on the Finance
Committee, non-employee directors who are members receive an annual fee of
$12,500, paid quarterly, with the chairman of the Audit Committee receiving an
additional annual fee of $35,000, paid quarterly. The Company entered into an
indemnification agreement with the chairman of the Audit Committee under which
it provides him with contractual protection against liabilities and expenses
incurred in connection with his service on the board. The chairman's service on
the board is conditioned upon the Company's maintaining an adequate level of
director and officer's insurance. Non-employee members of the Finance Committee
also receive $500 for each telephonic meeting of the committee, paid quarterly.

A Special Committee of the board was appointed in April 2003 to consider
the go-private transaction. Committee members, who are all independent
non-employee directors, receive a base fee of $37,500, with the chairman of the
committee receiving a base fee of $60,000. Special Committee members also
receive $1,000 for each in-person meeting attended and $500 for each telephonic
meeting. Outside directors are reimbursed for reasonable out-of-pocket expenses
incurred in attending meetings of the Board of Directors. No director who is an
employee of the Company receives separate compensation for services rendered as
a director.

The following table sets forth certain information with respect to options
granted to non-employee directors during the fiscal year ended June 30, 2003.

- ---------------

(1) The closing sale price of the Class A common stock on the Nasdaq National
Market on the grant date.

(2) The option vests ratably over 36 months, with the first monthly vesting
occurring on the last day of the month in which the grant was made.

(3) The option vest ratably over 36 months, with the first monthly vesting
occurring on March 31, 2003.

64

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

The following table sets forth certain information regarding the beneficial
ownership of Edison's common stock as of September 15, 2003 by

- each person known to the Company to beneficially own more than 5% of the
outstanding shares of either class of Edison's common stock;

- each director of the Company;

- each executive officer of the Company named in the Summary Compensation
Table set forth under the heading "Compensation of Executive Officers"
set forth in Item 11; and

- all executive officers and directors of the Company as a group.

Unless otherwise set forth herein, the business address of the named
beneficial owner is c/o Edison Schools Inc., 521 Fifth Avenue, 11th Floor, New
York, New York 10175 and the beneficial owners named in the table have, to the
knowledge of Edison, sole voting and dispositive power with respect to the
shares beneficially owned, subject to community property laws.

- ---------------

* Less than 1%.

(1) Assumes all shares of Class B common stock were converted into Class A
common stock.

(2) Percentage ownership is based on 52,484,154 shares of Class A common stock
and 1,627,933 shares of Class B common stock outstanding on September 15,
2003. Shares of common stock subject to stock options and warrants which
are currently exercisable or will become exercisable within 60 days after
September 15, 2003 are deemed outstanding for computing the percentage
ownership of the person or group holding such options or warrants, but are
not deemed outstanding for computing the percentage ownership of any other
person or group.

(3) Based on holdings reported on a Schedule 13G filed with the SEC on March
31, 2003.

(4) Based on holdings reported on a Schedule 13G/A filed with the SEC on July
23, 2003.

(5) Based on information provided by Edison's transfer agent and Edison's
records. Includes 2,170 shares of Class A common stock and 242 shares of
Class B common stock issuable upon exercise of an option that will be
exercisable within 60 days of September 15, 2003.

(6) Consists of 8,558,014 shares of Class A common stock issuable upon exercise
of warrants held by School Services LLC that are presently exercisable.

(7) Based on holdings reported on a Schedule 13G filed with the SEC on February
14, 2003, the shares are beneficially owned by one or more open-end
investment companies or other managed accounts that are advised or
sub-advised by Waddell & Reed Ivy Investment Company, which is a subsidiary
of Waddell & Reed Financial, Inc. ("WDR"), or Waddell & Reed Investment
Management Company, which is a subsidiary of Waddell & Reed, Inc. ("WRI").
WRI is a subsidiary of Waddell & Reed Financial Services, Inc., which in
turn is a subsidiary of WDR.

(8) Includes 1,462,501 shares of Class A common stock and 162,501 shares of
Class B common stock held of record by WPA Investment L.P., 337,500 shares
of Class A common stock and 37,500 shares of Class B common stock held of
record by Whittle Leeds Education Company LLC and 832,596 shares of Class A
common stock and 92,512 shares of Class B common stock issuable upon
exercise of options that will be exercisable within 60 days of September
15, 2003.

(9) Includes 7,065 shares of Class A common stock and 685 shares of Class B
common stock held of record by Christina W. Schmidt, Mr. Schmidt's
daughter. Mr. Schmidt disclaims beneficial ownership of all such shares of
common stock. Also includes 848,534 shares of Class A common stock and
74,356 shares of Class B common stock issuable upon exercise of options
that will be exercisable within 60 days of September 15, 2003.

(10) Includes 2,412 shares of Class A common stock and 170,881 shares of Class B
common stock held of record by WSI Inc., 1,462,501 shares of Class A common
stock and 162,501 shares of Class B common stock held of record by WPA
Investment L.P., 337,500 shares of Class A common stock and 37,500 shares
of Class B common stock held of record by Whittle Leeds Education Company
LLC, 4,876,816 shares of Class A common stock and 390,017 shares of Class B
common stock issuable upon exercise of options that will be exercisable
within 60 days of September 15, 2003, and 832,596 shares of Class A common
stock and 92,512 shares of Class B common stock issuable upon exercise of
options held of record by WSI Inc. that will be exercisable within 60 days
of September 15, 2003. Mr. Whittle has pledged 59,205 shares of Class A
common stock and 665,795 shares of Class B common stock to the Company as
collateral for loans (the "Whittle Pledge"). Mr. Whittle and WSI Inc. have
pledged all of their shares of Class A common stock and Class B common
stock, including all options to acquire

66

Class A common stock and Class B common stock, to JPMorgan Chase Bank to
secure personal obligations of Mr. Whittle. 117,500 shares of Class A
common stock held by WSI Inc. are also subject to an option held by
JPMorgan Chase Bank. JPMorgan Chase Bank's security interest in the shares
of Class A and Class B common stock is subordinate to the shares pledged to
the Company pursuant to the Whittle Pledge.

(11) Consists of 251,369 shares of Class A common stock and 18,041 shares of
Class B common stock issuable upon exercise of options that will be
exercisable within 60 days of September 15, 2003.

(12) Includes 654,850 shares of Class A common stock and 38,317 shares of Class
B common stock issuable upon exercise of options that will be exercisable
within 60 days of September 15, 2003, and 600 shares of Class A common
stock held by a trust for the benefit of Mr. Cerf's children.

(13) Includes 14,583 shares of Class A common stock issuable upon exercise of an
option that will be exercisable within 60 days of September 15, 2003.

(14) Consists of 58,500 shares of Class A common stock issuable upon exercise of
options that will be exercisable within 60 days of September 15, 2003.

(15) Includes 6,964 shares of Class A common stock and 265 shares of Class B
common stock issuable upon exercise of options that will be exercisable
within 60 days of September 15, 2003.

(16) Includes 18,333 shares of Class A common stock issuable upon exercise of
options that will be exercisable within 60 days of September 15, 2003.

(17) Consists of 78,583 shares of Class A common stock and 1,000 shares of Class
B common stock issuable upon exercise of options that will be exercisable
within 60 days of September 15, 2003.

(18) Consists of 4,583 shares of Class A common stock issuable upon exercise of
an option that will be exercisable within 60 days of September 15, 2003

(19) Consists of 2,917 shares of Class A common stock issuable upon exercise of
an option that will be exercisable within 60 days of September 15, 2003.

(20) Consists of 4,583 shares of Class A common stock issuable upon exercise of
an option that will be exercisable within 60 days of September 15, 2003.

(21) Consists of 13,333 shares of Class A common stock issuable upon exercise of
options that will be exercisable within 60 days of September 15, 2003.

(22) Includes shares described in footnotes 9 through 21 above.

EQUITY COMPENSATION PLAN INFORMATION

The table below sets forth information, as of June 30, 2003, regarding
securities authorized for issuance under the Company's equity compensation
plans.

- ---------------

(1) 83,320 of these securities may be issued as either Class A common stock or
Class B common stock. The remainder may only be issued as Class A common
stock.

(2) Includes shares that may be issued as restricted stock under the Company's
1999 Stock Incentive Plan.

67

(3) Consists of stock options that the Company granted prior to its initial
public offering in November 1999. These options were not issued pursuant to
a plan but rather as individual grants made on terms and conditions
determined by the Board of Directors at the time of grant.

(4) 526,419 of these securities may be issued as either Class A common stock or
Class B common stock. The remainder may only be issued as Class A common
stock.

ITEM 13. CERTAIN TRANSACTIONS

Loans to Executives. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Loans to Executives."

Consulting Agreement. On October 1, 2002, the Company entered into an
Independent Contractor Agreement with Empowerment Ministries ("Contractor")
under which Contractor provides the consulting services of Rev. Floyd H. Flake,
its employee, for up to three days per month at a monthly fee of $6,000. Rev.
Flake is also a director of the Company.

Retainment of Financial Advisor by H. Christopher Whittle. On February 13,
2003, Mr. Whittle, our Chief Executive Officer and a director of the Company,
retained Bear Stearns and Co. ("Bear Stearns") to serve as financial advisor to
Mr. Whittle and Mr. Cerf, our President and Chief Operating Officer and a
director of the Company, in connection with the going-private transaction. Mr.
Cerf's brother is a senior managing director at Bear Stearns. Whether or not the
Merger occurs, Shakespeare Acquisition LLC (and not the Company) has agreed to
pay Mr. Whittle's reasonable out-of-pocket fees and expenses directly relating
to the Merger, including the fees and expenses of Bear Stearns.

Retainment of Financial Advisor by H. Christopher Whittle. On February 13,
2003, Mr. Whittle, our Chief Executive Officer and a director of the Company,
retained Bear Stearns and Co. ("Bear Stearns") to serve as financial advisor to
Mr. Whittle and Mr. Cerf, our President and Chief Operating Officer and a
director of the Company, in connection with the going-private transaction. Mr.
Cerf's brother is a senior managing director at Bear Stearns. Whether or not the
Merger occurs, Shakespeare Acquisition LLC (and not the Company) has agreed to
pay Mr. Whittle's reasonable out-of-pocket fees and expenses directly relating
to the Merger, including the fees and expenses of Bear Stearns.

68

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORMS 8-K

(a) The following documents are filed as part of this Form 10-K:

1. Financial Statements. The following consolidated financial
statements of Edison Schools Inc. are filed as part of this Form 10-K on
the pages indicated:

INDEX TO FINANCIAL STATEMENTS

2. Schedules are omitted as the required information is inapplicable
or the information is presented in the financial statements or related
notes.

3. Exhibits. The exhibits listed in the Exhibits Index immediately
preceding such exhibits are filed as part of this Annual Report on Form
10-K.

(b) Reports on Form 8-K

On May 14, 2003, we filed a current report on Form 8-K discussing our
financial results for the third quarter ended March 31, 2003, including as
an exhibit thereto a press release and financial statement for such
quarter.

On May 15, 2003, we filed a current report on Form 8-K/A explaining
that the current report on Form 8-K filed on May 14, 2003 inadvertently
omitted the exhibit providing the financial statement for the quarter ended
March 31, 2003.

On July 14, 2003, we filed a current report on Form 8-K disclosing
that we had issued a press release dated as of July 13, 2003 announcing
that the Company had signed an Agreement and Plan of Merger with
Shakespeare Acquisition LLC and its wholly-owned subsidiary. Shakespeare
Acquisition Corporation, including as exhibits thereto such press release
and the Agreement and Plan of Merger.

On September 12, 2003, we filed a current report on Form 8-K
discussing our financial results for the fiscal year ended June 30, 2003,
including as an exhibit thereto a press release with a financial statement
for such year.

On September 15, 2003, we filed a current report on Form 8-K
discussing our financial results for the fiscal year ended June 30, 2003,
including as an exhibit thereto a transcript of a public conference call
for investors and analysts held on September 12, 2003 regarding the
Company's financial results for such year.

69

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 on the 29th day of
September, 2003.

EDISON SCHOOLS INC.

By: /s/ H. CHRISTOPHER WHITTLE
------------------------------------
H. Christopher Whittle
Chief Executive Officer and Director

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on the 29th day of September, 2003.

71

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors of Edison Schools Inc.:

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows present fairly, in all material respects, the financial position
of Edison Schools Inc. (the "Company") at June 30, 2002 and 2003, and the
results of its operations and its cash flows for each of the three years in the
period ended June 30, 2003, in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.

PRICEWATERHOUSECOOPERS LLP

New York, New York
September 12, 2003, except for the ninth paragraph of Note 8, as to which the
date is September 29, 2003.

72

EDISON SCHOOLS INC.

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial
statements.
73

EDISON SCHOOLS INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these consolidated financial
statements.
74

EDISON SCHOOLS INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30, 2001, 2002 AND 2003

The accompanying notes are an integral part of these consolidated financial
statements.

75

EDISON SCHOOLS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial
statements.
76

EDISON SCHOOLS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30 2001, 2002 AND 2003

1. DESCRIPTION OF BUSINESS

Edison Schools Inc. (the "Company") (formerly known as The Edison Project
Inc. and Subsidiaries) manages elementary and secondary public schools under
contracts with school districts and charter school boards located in 22 states
and Washington, D.C. The Company opened its first four schools in the fall of
1995, and, for the year ended June 30, 2003, the Company operated 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 managed school. The Company
also assists charter schools in obtaining facilities and the related financings.
Additionally, the Company has begun to diversify into related business areas
such as consultative services, summer and after-school programs and tutoring.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

BASIS OF PRESENTATION

The consolidated financial statements include the accounts of the Company
and its subsidiaries, including Edison Receivables Company LLC ("Edison
Receivables"), established in fiscal 2002, its 54.3% interest in Alliance Edison
LLC, and Edison Schools Ltd. ("Edison UK"), established in fiscal 2003, after
the elimination of intercompany transactions.

LIQUIDITY AND RISK

Historically, the Company has had negative cash flows from operations. For
the year ended June 30, 2003, the Company generated $6.8 million in cash from
operations. Since inception, the cash needs of the business have been financed
through a combination of debt and equity financing.

The Company expects cash on-hand, borrowings under existing financing
arrangements and cash flows from operations to generate sufficient liquidity to
meet all of the Company's cash flow requirements through fiscal 2004. The
Company's $55.0 million revolving credit facility became due on July 15, 2003
and was extended to November 15, 2003 in order to bridge this existing facility
to the closing of the Company's going private transaction, which is further
discussed in Note 19. Management believes that should the Company need to, it
would be able to obtain an asset based revolving credit facility to meet the
Company's borrowing needs in fiscal 2004 for the following primary reasons: (1)
the Company has sufficient collateral, including accounts receivable, notes
receivable from charter boards, and owned real estate, to more than adequately
support an asset based revolving credit facility sufficient to meet its
borrowing needs in fiscal 2004 and (2) the Company's fiscal 2004 operating plan
reflects growth in earnings before interest, taxes, depreciation and
amortization from its fiscal 2003 level of $21.5 million. On September 29, 2003,
the Company paid the remaining balance outstanding under the School Services
Facility of $8.9 million.

While the above represents the Company's base case liquidity assessment,
the Company is in the process of other business transactions which would not
adversely affect the base case assessment. In this connection, the Company is
working with one of its charter board clients to refinance certain indebtedness
of the charter board incurred for purposes of school facility construction and
renovation. The Company will receive cash of approximately $17.0 million in
repayment of the Company's notes receivable from this charter board as a result
of this refinancing which is expected to close in October 2003. Approximately
$5.6 million of such proceeds are required to be applied to reduce borrowings
outstanding under the Company's revolving credit and term loan facility with
School Services Inc., which would result in a remaining balance due under this
facility of approximately $3.3 million.

77

EDISON SCHOOLS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

As discussed further in note 19, the Company is involved in a going private
transaction, which is subject to shareholder approval. As a part of the going
private transaction, an affiliate of Liberty Partners, the private equity
investment entity that will finance the transaction, has committed to provide a
debt facility up to $70.0 million to replace the Company's existing credit
facilities. This commitment is also intended to provide financing for future
growth.

As discussed further in note 19, the Company is involved in a going private
transaction, which is subject to shareholder approval. As a part of the going
private transaction, an affiliate of Liberty Partners, the private equity
investment entity that will finance the transaction, has committed to provide a
debt facility up to $70.0 million to replace the Company's existing credit
facilities. This commitment is also intended to provide financing for future
growth.

CASH AND CASH EQUIVALENTS

For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, time deposits, highly liquid debt securities and money market
accounts, generally all with original maturities of three months or less. The
Company maintains funds in accounts in excess of federally insured limits;
however, management believes that it minimizes risk by maintaining deposits in
high-quality financial institutions.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Routine maintenance and repairs
are expensed as incurred. The cost of major additions, replacements, and
improvements are capitalized. Gains and losses from sales or retirements of
property and equipment are included in results for the period. Depreciation is
computed on a straight-line basis over the estimated useful lives of the
respective assets (30 years for buildings, the remaining lease term or useful
life, whichever is shorter, for leasehold improvements and three to five years
for all other items).

From time to time, the Company purchases or renovates existing buildings to
ready them for charter school use. It is the Company's intention to recapture
purchase or renovation costs through sale to a third party or through the sale
or lease of the building to the charter school board. Buildings or renovations
completed and ready for charter school use are depreciated on a straight-line
basis over the estimated useful life of the building.

LONG-LIVED ASSETS

The carrying amount of long-lived assets is reviewed on a regular basis for
the existence of facts or circumstances, both internally and externally, that
suggest impairment. The Company determines if the carrying amount of a
long-lived asset is impaired based on anticipated undiscounted cash flows before
interest from the use of the asset. In the event of impairment, a loss is
recognized based on the amount by which the carrying amount exceeds the fair
value of the asset. Fair value is determined based on appraised value of the
assets or the anticipated cash flows from the use of the asset, discounted at a
rate commensurate with the risk involved.

RESTRICTED CASH

Restricted cash consists of cash held in escrow in compliance with certain
debt agreements, credit issued for the benefit of certain technology suppliers,
collateral for certain insurance policies, amounts for guarantee of contract
performance in certain states and certain amounts restricted for use in the
start-up of future Edison schools. The Company classifies restricted cash
balances as current and non-current based on terms of related agreements that
govern the use of the restricted cash. Restricted cash balances classified as
current are included in other current assets in the consolidated balance sheets.

78

EDISON SCHOOLS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

REVENUE RECOGNITION

Revenues are principally earned from contractual agreements to manage and
operate district and charter schools. The Company also earns revenue from summer
school and after-school program fees and other supplemental educational
services. The Company recognizes revenue for each managed school over the period
services are performed, pro rata over the typical school year, 11 months from
August through June, in accordance with Staff Accounting Bulletin 101 "Revenue
Recognition in Financial Statements."

Most of the Company's management agreements provide that it earns a fee
based upon the number of children who attend the schools it manages, and
therefore the Company only earns revenue to the extent students attend the
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 charter schools, the
Company's fee has a fixed component and a variable component. Even in contracts
with a fixed-fee component, the Company has generally agreed to forego or reduce
its 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. The Company follows the
guidance of Emerging Issues Task Force ("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 often purchases certain essential services, such as
transportation, from third parties and/or from our clients. In addition,
teachers in schools generally remain employees of our clients and are often paid
through the clients' payroll systems. Where such arrangements exist, the client
deducts the amounts it has expended for staff salaries and/or purchased services
from the amount owed to the Company when remitting payment. These amounts are
disclosed as "Direct Site Expenses -- Client paid" on the Company's Consolidated
Statements of Operations where the Company is deemed to be the primary obligor
with respect to such services.

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
operations when identified.

PRE-OPENING COSTS

The Company expenses pre-opening costs, which consist of training,
personnel and other costs, that are incurred prior to the fiscal year in which
operations commence at new school sites.

NOTES RECEIVABLE

Notes receivable are recorded at face value, less an original issue
discount if the note has a less than fair value stated rate of interest. The
original issue discount is calculated using the difference between the stated
rate and the Company's rate of interest associated with the cost of funds for
the period in which the note is issued. It is management's policy to recognize
any note as uncollectible when, based on its assessment of events and
circumstances, the collection of the note is not reasonably assured. If it is
probable that the Company will not collect all amounts due according to the
contractual terms of the note, the Company
79

EDISON SCHOOLS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

provides an allowance for the loan using the methodology under Statement of
Financial Accounting Standards ("FAS") 114 "Accounting by Creditors for
Impairment of a Loan." An allowance is established when the estimated discounted
cash flows of the loan are lower than the carrying value of that loan. Interest
income is generally recognized on an accrual basis. The Company evaluates loans
for which an allowance for loss has been established and recognizes interest
income to the extent principal and/or interest payments are not past due in
excess of 90 days. Otherwise, interest income is recorded when received.

DEFERRED CHARTER COSTS

Deferred charter costs arise when the Company provides cash to certain
charter schools, which issue non-interest bearing notes to the Company in
return. In these situations, the Company discounts the non-interest bearing
notes and records the corresponding discount as deferred charter costs. These
costs represent the accounting recognition given to the Company's right to
operate the charter school. Deferred charter costs are included in other assets
and are amortized on a straight-line basis over the life of the related
contract.

Net deferred charter costs were $411,018 and $256,517 and accumulated
amortization was $4,188,774 and $4,332,626 as of June 30, 2002 and 2003,
respectively.

STOCK-BASED COMPENSATION

For financial reporting purposes, the Company accounts for stock-based
compensation in accordance with the intrinsic value method of accounting
prescribed by Accounting Principles Board Opinion ("APB") 25 "Accounting for
Stock Issued to Employees." In accordance with this method, no compensation
expense is recognized in the accompanying financial statements in connection
with the awarding of stock option grants to employees provided that, as of the
grant date, all terms associated with the award are fixed and the fair value of
the Company's stock, as of the grant date, is not greater than the amount an
employee must pay to acquire the stock as defined. To the extent that stock
options are granted to employees with variable terms or if the fair value of the
Company's stock as of the measurement date is greater than the amount an
employee must pay to acquire the stock, then the Company will recognize
compensation expense. In addition, the Company discloses the effect of such
stock-based compensation in accordance with FAS 148 "Accounting For Stock-Based
Compensation -- Transition And Disclosure -- An Amendment of FAS 123." (See Note
13.)

ADVERTISING EXPENSES

Advertising costs consist primarily of print media and brochures and are
expensed when the related advertising occurs. Advertising expense for the years
ended June 30, 2001, 2002, and 2003 amounted to approximately $1.8 million,
$862,000 and $933,000 respectively.

INCOME TAXES

Deferred taxes represent the tax effects of differences between the
financial reporting and tax bases of the Company's assets and liabilities at the
enacted tax rates in effect for the years in which the differences are expected
to reverse. The Company evaluates the recoverability of deferred tax assets and
establishes a valuation allowance when it is more likely than not that some
portion or all of the deferred tax assets will not be realized. Income tax
expense consists of the tax payable for the period and the change during the
period in deferred tax assets and liabilities, net of any valuation allowance.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts of the Company's financial instruments, including cash
and cash equivalents, accounts receivable, short-term borrowings, accounts
payable and accrued liabilities, approximate fair value because of their short
maturities. The carrying amount of the Company's notes receivable, in the
aggregate,

80

EDISON SCHOOLS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

capital leases and other equipment financing obligations approximates the fair
value of such instruments based upon management's best estimate of interest
rates that would be available for similar financial instruments at June 30,
2003.

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 stock options and warrants,
have been excluded from the computation, as their effect is antidilutive for all
periods presented.

The calculation of basic and fully diluted net loss per share for the year
ended June 30, 2001 is as follows:

Net loss.................................................... $(38,511,724)
============
Class A common stock outstanding at beginning of period..... 39,558,746
Class B common stock outstanding at beginning of period..... 3,448,004
Add:
Issuance of Class A common stock (on a weighted average
basis)................................................. 5,974,982
Conversion of Class B common stock (on a weighted average
basis)................................................. (1,014,991)
------------
Weighted average number of shares outstanding used in
computing basic and diluted net loss per share............ 47,966,741
============
Basic and diluted net loss per share...................... $ (0.80)
============

The calculation of basic and fully diluted net loss per share for the year
ended June 30, 2002 is as follows:

Net loss.................................................... $(86,039,852)
============
Class A common stock outstanding at beginning of period..... 49,249,005
Class B common stock outstanding at beginning of period..... 2,433,126
Add:
Issuance of Class A common stock (on a weighted average
basis)................................................. 2,510,107
Conversion of Class B common stock (on a weighted average
basis)................................................. (627,994)
------------
Weighted average number of shares outstanding used in
computing basic and diluted net loss per share............ 53,564,244
============
Basic and diluted net loss per share...................... $ (1.61)
============

81

EDISON SCHOOLS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The calculation of basic and fully diluted net loss per share for the year
ended June 30, 2003 is as follows:

Net loss.................................................... $(25,027,545)
============
Class A common stock outstanding at beginning of period..... 52,018,855
Class B common stock outstanding at beginning of period..... 1,805,132
Add:
Issuance of Class A common stock (on a weighted average
basis)................................................. 602,405
Conversion of Class B common stock (on a weighted average
basis)................................................. (177,199)
Less:
Treasury stock acquired (on a weighted average basis)..... (885,692)
------------
Weighted average number of shares outstanding used in
computing basic and diluted net loss per share............ 53,363,501
============
Basic and diluted net loss per share...................... $ (0.47)
============

MANAGEMENT ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Significant estimates include revenues,
certain district paid school expenses, recoverability of long-lived assets and
notes receivable, liabilities incurred from workers' compensation, commercial
and other claims and losses on school contracts. Other estimates include useful
lives of property and equipment and the deferred income tax valuation allowance.
Actual results could differ from these estimates.

SEGMENTS

Management evaluates its operating performance as a single segment. The
Company's Chief Operating Officer reviews school performance based on a
comprehensive, whole school approach. Real estate, after-school programs, summer
school programs, food services and various other activities represent in total
less than 10% of net revenue and are not evaluated on an individual basis.

RECENTLY ISSUED ACCOUNTING STANDARDS

In November 2002, the Financial Accounting Standards Board ("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.

In December 2002, the FASB issued FAS 148, as described above. 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. 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

82

EDISON SCHOOLS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 is in the
process of evaluating the impact FIN 46 will have on its financial statements.

In May 2003, the FASB issued FAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." FAS 150
establishes standards for classifying and measuring as liabilities certain
financial instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity. FAS 150 represents a significant
change in practice in the accounting for a number of financial instruments,
including mandatorily redeemable equity instruments and certain equity
derivatives that frequently are used in connection with share repurchase
programs. FAS 150 is effective for all financial instruments created or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. The Company adopted FAS 150 on
June 1, 2003. The Company currently does not have financial instruments with a
characteristic of both debt and equity. Therefore, the adoption of this
statement is not expected to have a material impact on the Company's
consolidated financial statements.

RECLASSIFICATION

Certain reclassifications have been made to the 2001 and 2002 financial
statements to conform to the current year presentation.

3. NOTES RECEIVABLE

The Company provides financing in the form of interest and non-interest
bearing loans and advances to charter school boards to assist in the purchase or
renovation of charter school facilities. Certain of the loans are evidenced by
notes and other advances which are made in concert with a management contract or
without fixed repayment terms. In order for the notes to be repaid, the Company
generally assists charter school boards in obtaining third-party lender
financing. Often third-party financing requires the Company to guarantee loans
on behalf of these charter schools. A default by any charter school under a
credit facility that is guaranteed by the Company may result in a claim against
the Company for the full amount of the borrowings. (See Note 16.)

Of the approximately $82.8 million in notes receivable, net at June 30,
2003, approximately $70.5 million was collateralized, of which $7.5 million was
subordinated to other senior debt. The remaining balance of $12.3 million was
uncollateralized, of which $860,265 was subordinated to other senior debt.
Although the Company intends to assist the charter boards in the refinancing 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.

In the fourth quarter of fiscal 2002, the Company wrote down a note
receivable of approximately $4.0 million related to a discontinued new school
project. Additionally, as a result of the difficult credit environment affecting
the Company's ability to arrange third-party lender financing, the credit risk
of specific charter school notes and management's intention to accelerate the
refinancing of individual notes with third-

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party lenders, the Company determined that it will not collect all of the
amounts due pursuant to the contractual terms of notes and established an
allowance for loan losses of approximately $5.5 million. This charge is included
in administration, curriculum and development expense in the consolidated
statements of operations. At June 30, 2003, the allowance for loan losses was
approximately $5.7 million. The allowance for loan losses applies to notes
receivable with an outstanding balance of $54.6 million and $65.0 million at
June 30, 2002 and 2003, respectively. The average balance of these loans during
fiscal 2003 was $65.7 million. Interest income recognized on such loans amounted
to $5.8 million in fiscal 2003. Substantially, all of such interest income was
received in cash. During fiscal 2003, the activity in the allowance for loan
losses consisted of $125,749 charged to operations, direct write-downs on
$2,012,987 and recoveries of $1,887,238. As of June 30, 2003 the Company had
$14,020,922 of loans for which interest income is not being recognized unless
received in cash.

Notes receivable consist of the following:

- ---------------

* Includes $1,180,394 and $413,184 of the allowance for loan losses in fiscal
2002 and 2003, respectively.

Notes receivable due from charter schools include interest-bearing notes at
interest rates ranging from 7% to 10.5% per annum. Management believes that the
stated rates reflect the fair market rates for these notes. The notes amounted
to $77,470,044 and $74,309,307 at June 30, 2002 and 2003, respectively, and
mature at various dates through the year 2021.

Notes receivable from charter schools also include discounted and
non-interest bearing notes with an aggregate face value, of $9,371,773 and
$8,870,005 at June 30, 2002 and 2003, respectively, less unamortized imputed
discount of $407,137 and $246,701 at June 30, 2002 and 2003, respectively.
Interest imputed on these notes ranges from 8% to 10% per annum. This imputed
rate is management's estimate of the fair market interest rate for these loans
based on the Company's estimated borrowing rate at the time of the loan, which
ranged from approximately 8% to 10%, and management's assessment of the
incremental risk associated with these loans.

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Aggregate maturities of notes receivable are as follows:

For the fiscal year ending June 30,
2004...................................................... $ 8,902,744
2005...................................................... 25,562,461
2006...................................................... 20,024,725
2007...................................................... 5,818,114
2008...................................................... --
Thereafter................................................ 28,401,697
-----------
88,709,741
Less: amount representing discount.......................... (246,701)
Less: allowance............................................. (5,667,941)
-----------
Total notes receivable, net................................. $82,795,099
===========

Subsequent to June 30, 2003, the Company is in the process of assuming two
facilities in full satisfaction of outstanding loans to one former and one
current charter board client totaling approximately $14.9 million. Both
facilities will continue to be used by the existing charter schools, which have
entered into lease arrangements with the Company. The Company believes, based on
recent appraisals, that the value of the buildings is adequate to cover the
carrying value of the notes.

The Company expects to make additional loans of approximately $2.2 million
for commitments to charter board clients during fiscal 2004.

4. PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

Depreciation expense amounted to $31,367,287, $35,691,452 and $33,396,532
for the years ended June 30, 2001, 2002 and 2003 respectively. Capitalized
interest of $521,593 was recorded for the year ended June 30, 2001 in connection
with the development of the Company's computer system. The Company wrote off
equipment of approximately $623,000 and $457,000 during the years ended June 30,
2002 and 2003, respectively. These amounts are included in administration,
curriculum and development expense in the consolidated statements of operations.

Assets under capital leases as of June 30, 2002 and 2003 totaled
$29,912,579 and $30,286,586, respectively, and related accumulated amortization
totaled $9,855,563 and $14,849,391, respectively. At

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June 30, 2002 and 2003, $29,390,639 and $29,744,788 of assets under capital
leases are included in furniture, fixtures, and equipment with the remaining
balances included in leasehold improvements, respectively.

The Company disposed of leasehold improvements, furniture, fixtures and
equipment and curriculum with a net book value of approximately $5,855,000 and
$4,372,000 resulting in a loss of approximately $4,784,000 and $2,357,000 during
the years ended June 30, 2002 and 2003, respectively.

In May 2001, two charter schools in Detroit, Michigan issued tax-exempt
bonds and used a portion of the proceeds to settle outstanding obligations due
the Company. The Company received from one school approximately $9,600,000 which
is included in proceeds from disposition of property and equipment in the
statement of cash flows for the year ended June 30, 2001. Additionally, the
Company received from the second school approximately $4,300,000 for notes
receivable.

In June 2003, the Company entered into a contract to buy a facility in
Missouri for approximately $2.0 million to be used as a school.

5. PROPERTY HELD FOR SALE

During fiscal 2001, the Company purchased property in New York, New York
for $10 million and entered into an agreement with the Museum for African Art to
develop the property for a mixed use project consisting of a new corporate
headquarters, a charter school and a facility to house the Museum. In the fourth
quarter of fiscal 2002, the Company discontinued the project in New York and
recognized an impairment charge of approximately $3.6 million to reduce the
value of the property to its appraised value. In June 2003, the Company entered
into a contract to sell the New York property for approximately $9.0 million,
resulting in a loss of $726,000, which is included in loss on disposal of assets
in fiscal 2003. In August 2003, the sale of the property closed.

Additionally, in fiscal 2002 the Company purchased land in Miami, Florida
for approximately $1.0 million dollars for a new school development project that
was subsequently discontinued. In August 2003, the Company entered into a
contract to sell the Miami land for $1.1 million.

As of June 30, 2002 and 2003, other long-term assets included approximately
$10.6 million and $1.2 million of purchased land held for sale, respectively.

6. BUSINESS COMBINATIONS

Effective July 1, 2001, the Company acquired the 65% equity interest of
Ksixteen, LLC that it did not own for approximately $130,000 in cash, giving it
100% ownership and enhanced operational efficiencies. The acquisition was
accounted for under the purchase method. The purchase price exceeded the fair
value of the net assets acquired by approximately $806,000, which was recorded
as goodwill and subsequently written off as of June 30, 2002.

Effective July 3, 2001, the Company acquired 100% of the outstanding shares
of LearnNow, Inc. as a means to enhance its growth prospects. LearnNow was a
privately-held school management company that operated seven charter schools
serving approximately 2,000 students. During the third quarter of fiscal 2002,
the Company finalized its determination of the purchase price and the allocation
thereof. The acquisition was accounted for under the purchase method and
included a cash payment of $3.0 million in fiscal 2001 and approximately $31.3
million in Company Class A common stock (approximately 1.3 million shares). In
connection with the acquisition, the Company assumed liabilities of $3.6 million
(primarily accounts payable, accrued personnel costs and other accrued expenses)
and acquired tangible assets of $1.7 million (primarily restricted cash,
accounts receivable, notes receivable, fixed assets and other assets). The
allocation of the purchase price resulted in recorded intangibles of
approximately $36.2 million. Of this amount, LearnNow

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contracts of approximately $4.5 million were classified as an intangible asset
separate from goodwill to be amortized over 15 years on a straight-line basis.
The remaining balance was classified as goodwill.

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Following the acquisition, the LearnNow schools were incorporated into the
Company's school operating model and ceased to exist as a separate business
unit. Accordingly, in assessing goodwill for impairment, the Company determined
that the value of the common stock issued in the acquisition would be used as a
measure of impairment. Based on the significant decline in the Company's stock
price, goodwill was deemed to be fully impaired in the fourth quarter of 2002
resulting in a charge to operations of approximately $32.5 million.
Additionally, approximately $0.8 million of the original $4.5 million intangible
asset was deemed impaired as a result of certain terminated contracts and also
charged to operations in the fourth quarter of fiscal 2002. Both charges are
included in impairment charges in the consolidated statements of operations for
fiscal 2002.

The carrying amount of the intangible asset was $3,447,076 and $2,400,253,
net of accumulated amortization of $298,333 and $1,345,156 as of June 30, 2002
and 2003, respectively. The remaining intangible asset is being amortized over
the next eight years. As a result of an early contract termination in fiscal
2003 the unamortized balance of the intangible asset related to the terminated
contract was fully amortized, resulting in additional amortization expense of
$663,814. The unamortized balance of the intangible asset at June 30, 2003 will
be amortized over the next eight years at $300,032 per year.

7. ACCRUED COMPENSATION, BENEFITS AND OTHER EXPENSES

Accrued compensation, benefits and other expenses consist of the following:

8. 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") (the "MLMCI
Facility") collateralized by certain accounts receivable purchased from or
contributed by the Company. Borrowings are limited to specified percentages of
eligible accounts receivable, as defined. The MLMCI Facility originally had a
term of one year, with interest determined on a Eurodollar or prime rate basis
at the Company's option and a commitment fee of .50% per annum on the unused
portion of the commitment.

On July 31, 2002, the MLMCI Facility was amended to add School Services LLC
("School Services") as an additional lender and MLMCI as agent of the lenders,
increase the line to $55.0 million, and extend the term of the agreement and the
line of credit provided thereunder to June 30, 2003. The MLMCI Facility was
subsequently extended to July 15, 2003. As of June 30, 2003, $38.8 million was
outstanding under this line of

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

credit bearing interest at LIBOR plus 7.0% and was collateralized by receivables
of approximately $74.5 million that were sold in a true sale to Edison
Receivables by the Company. LIBOR was 2.28% and 1.19% at June 30, 2002 and 2003,
respectively. As of June 30, 2003, $2.6 million was undrawn and available
against this facility. 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 (the "School Services
Facility"), 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 School Services 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.
It also 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 requirement for EBITDA (as defined in the agreement).

In connection with the amendment of the MLMCI Facility and establishment of
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. 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.

On July 15, 2003, Edison Receivables signed an agreement extending the
MLMCI Facility until November 15, 2003. Additionally, the amendment lowered the
minimum consolidated tangible net worth covenant for June 30 and September 30,
2003.

In December 2002, a note receivable in the amount of $7.5 million was
refinanced, with the Company receiving approximately $5.3 million and
maintaining a $2.2 million subordinated note. The subordinate note bears
interest at 10.0% and is due in January 2006. Proceeds from this refinancing
were paid directly to School Services and applied to amounts outstanding under
the revolving line of credit portion of the School Services Facility. 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 portion of
the School Services Facility pursuant to an amendment to reduce the line of
credit commitment by $1.0 million to obtain the release of certain collateral.
As of June 30, 2003, $17.7 million was outstanding under the School Services
Facility, reflecting the maximum amount available.

On August 1, 2003, the Company closed the sale of its New York property to
the Museum for African Art for a purchase price of approximately $9.0 million,
of which approximately $8.8 million was paid directly to School Services and
applied to amounts outstanding under the term loan portion of the School
Services Facility. Pursuant to terms of the agreement, the term loan portion of
the School Services Facility was permanently reduced by such amount. In
September, 2003 the Company repaid the remaining outstanding

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

obligation of $8.9 million on the School Services Facility. As a result of such
payments, the Company will recognize interest expense in the amount of
approximately $5.6 million related to original issue discount and deferred
financing costs.

As reported in its form 10-Q filed on May 15, 2003, the Company was not in
compliance at March 31, 2003 with the minimum consolidated tangible net worth
covenant in the MLMCI and School Services Facilities. In May 2003, the Company
received a waiver of default from both MLMCI and School Services with respect to
compliance with this covenant. The Company was in compliance with the covenant
at June 30, 2003. While the Company amended the MLMCI Facility to lower the
minimum consolidated tangible net worth covenant, it did not amend a similar
minimum consolidated tangible net worth covenant under the School Services
Facility and expects that it will not be in compliance with such covenant at
September 30, 2003. The Company has reduced its borrowing under the School
Services Facility subsequent to year end with the proceeds from the sale of its
New York property (August 2003) and expects to further reduce such borrowings to
approximately $3.3 million with the proceeds of certain notes receivable in
October 2003, as discussed in Note 1. The Company will be able to repay all
outstanding borrowings under the School Service Facility, to the extent
required, out of its cash on hand.

Long-term debt consists of the following:

- ---------------

(a) Notes payable at June 30, 2002 and 2003 consist of notes with four financing
companies collateralized by computer equipment, furniture and other assets
of the Company. All notes are similarly structured and generally provide for
equal monthly installments, including interest and principal, over a term of
36 to 37 months. Monthly payments to each note holder range from
approximately $16,000 to $314,000. Certain notes also provide for a final
installment of up to 17.5% of the original principal amount. Interest rates
are fixed and range from 9.5% to 15.04% per annum.

(b) In June 2000, the Company entered into a 36-month financing agreement with
the IBM Credit Corporation for the purchase of software. Such software has
been used to support the technology used in the Company's schools throughout
the United States of America. During fiscal 2003, the finance agreement was
paid in full.

In connection with amounts outstanding under the notes payable and capital
lease obligations at June 30, 2002 and 2003, the Company had outstanding stock
purchase warrants to lenders that provide for the purchase of up to 15,000
shares of common stock at a purchase price of $12.30 per share. The stock
purchase warrants are fully exercisable and expire in fiscal 2005. At the time
of issuance, the value of the warrants was not deemed significant pursuant to a
calculation using the "Black-Scholes Option-pricing Model." Accordingly, no
value was assigned to the warrants.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company is subject to certain reporting debt covenants under several of
its debt agreements. If the Company were to fail to maintain a certain minimum
cash balance it would be required to post additional cash collateral.

9. LEASES

The Company has entered into several lease agreements for school site
computers and equipment. The agreements, which are accounted for as capital
leases, provide that the Company will lease equipment for terms of 36 to 37
months with interest rates of 8.18% to 16.09%. Also, the Company has various
non-cancelable operating leases for office space and school sites. These leases
expire at various dates through the year 2020. At June 30, 2003, the present
value of the minimum lease payments under the capital leases and rental
commitments under operating leases with terms in excess of one year are as
follows:

Total rental expense for each of the three years ended June 30, 2001, 2002
and 2003 related to operating leases amounted to approximately $5,686,000,
$6,382,000, and $6,132,000 respectively.

The Company has entered into operating leases for four charter school
facilities with lease terms in excess of the initial term of the management
agreement for the schools operating in those facilities.

The first facility, currently housing two schools, has been leased for an
18-year term expiring in June 2017 and has annual lease payments of
approximately $1,000,000. The management agreement to operate the schools in
this facility expired in December 2001. The Company continued to lease the
facility to the former client during all of fiscal 2002 and 2003. In fiscal
2004, the Company has leased the facility to a new client for a two-year term
for a total of $1,800,000.

The second facility, currently housing two schools, has been leased for a
15-year term expiring in September 2013. The annual lease payment is $782,400
through fiscal 2007 and increases to $932,400 for fiscal 2008 through fiscal
2013. The management agreement to operate in this facility expired in June 2002;
however, the contract remains in forced and the company is renegotiating a new
contract.

The third facility, currently housing one school, has been leased for a
20-year term expiring in June 2019. The annual lease payment is $36,000 through
fiscal 2019. The management agreement to operate in this facility expires in
June 2006.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The fourth facility, currently housing two schools, has been leased for a
20-year term expiring in November 2020. The annual lease payment is $362,000 per
year and increases by 9% in fiscal 2006, 2011 and 2016 resulting in a final
annual rent of $468,800. The management agreement to operate in this facility
expires in June 2005.

The Company's lease obligations noted above all exceed the length of the
current management agreement. In the event that the management agreements are
not renewed, the Company would be obligated to continue paying rent on the
facilities. All of the leased buildings are occupied by schools.

10. RELATED PARTY TRANSACTIONS

STOCKHOLDER NOTES RECEIVABLE

Included in other current receivables is a stockholder note receivable
consisting of two recourse notes from the Chairman of the Company that arose in
connection with his employment agreements, with principal amounts of $1.6
million and $200,000 and total accrued unpaid interest at June 30, 2002 and 2003
of $1,234,000 and $215,000, respectively. The note agreements, as amended
October 15, 1999, bear interest at the prime rate per annum as defined by
JPMorgan Chase and do not require periodic interest or principal payments until
maturity. The notes are collateralized by the assignment of the proceeds of a
life insurance policy and, in the event of termination of the Chairman's
employment, can be offset against the severance pay obligation of the Company.
The receivable matured on August 30, 2002. In October 2002 the Company received
a payment of $1.1 million, which was applied towards outstanding interest. The
Company has given notice to the Chairman that the notes are overdue and with his
full cooperation is working to expedite collection of the outstanding balances.

In November 1999, the Company's Chief Executive Officer exercised options
to purchase 725,000 shares of common stock at $3.00 per share through the
issuance of a promissory note to the Company for $2,175,000. In addition, the
Company loaned him $4,445,700 in November 1999 and $1,248,500 in April 2000 to
pay estimated income taxes resulting from the transaction. These notes mature
five years from their date of issuance and bear interest at the greater of the
prime rate or the Company's actual borrowing rate, in effect from time to time,
at maturity. Since the notes bear interest at a floating rate and were issued
with recourse solely to the shares acquired upon exercise of the options, for
accounting purposes the options are not treated as exercised, but rather as a
variable stock award pursuant to the provisions of EITF 95-16 "Accounting for
Stock Compensation Arrangements with Employer Loan Features under APB Opinion
25." Therefore, until such loans are paid, the Company recognizes a compensation
charge or credit for changes in the market price of the Company's common stock
to the extent such price exceeds the option exercise price of $3.00 per share.
In addition, the loan related to the options is not treated as issued and the
loans related to the estimated income taxes were treated as compensation expense
in 2000. At the time such loans and related interest income are paid, additional
paid-in capital will be credited. As a result of the decline in the market price
of the Company's common stock in 2001 and 2002, the Company recognized a
compensation credit of $253,751 and $14,384,005 related to these stock options.
These amounts are included in administration, curriculum and development in the
statements of operations. No compensation credits or charges were recognized in
2003, as the market price of the Company's common stock did not exceed $3.00 per
share.

STOCKHOLDERS' NOTES PAYABLE

Certain stockholders were issued promissory notes dated December 18, 1997
for $4,407,903 and January 1, 1998 for $592,097 (see Note 12). In addition, as
part of the private placement (see Note 12), the Company issued to stockholders,
promissory notes dated December 30, 1997 for $611,025, January 28, 1998 for
$61,130, August 24, 1998 for $487,844 and December 14, 1998 for $450,595. The
principal balance for each of the notes is payable on the tenth anniversary of
the dates of issuance. Each note bears interest at 7% per annum, of which 50% is
payable at maturity and the balance payable each April 1, starting in fiscal
1999
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

and thereafter. For the years ended June 30, 2001, 2002 and 2003, interest
expense under the notes amounted to $502,924, $520,269, and $538,351,
respectively. Included in other liabilities at June 30, 2002 and 2003 is
interest payable under the notes of $1,084,676 and $1,353,788, respectively.

11. INVESTMENT IN APEX LEARNING INC.

In July 1999, the Company entered into a preferred stock purchase agreement
with Apex Learning Inc. ("Apex") providing for the purchase of up to 2,000,000
shares of Apex preferred stock, par value $0.001 per share, for a purchase price
of $5.00 per share. The Company purchased 1,000,000 shares in July 1999 for a
total investment of $5,000,000, which represented approximately 16.5% ownership
in the corporation. In December 1999, an additional $5,000,000 was invested in
the corporation, increasing the Company's ownership to 19.7%. Due to the nature
of the Company's relationship with the corporation, the investment was accounted
for under the equity method. As of June 30, 2000, the Company modified its
relationship with the corporation such that the Company no longer had
significant influence through board representation, and thereafter the
investment has been accounted for under the cost method.

During the third quarter of fiscal 2002, the Company recorded a non-cash
charge to reduce the carrying value of its 19.7% cost basis investment in
privately-held Apex to reflect an other-than-temporary decline in value of $6.8
million (representing the excess of carrying value over fair value, which
resulted in a carrying value of approximately $1.3 million as of June 30, 2002).
Apex provides interactive advanced placement courses for high school students
over the internet. The Company determined that its investment was impaired given
the terms of a third quarter fiscal 2002 transaction involving Apex equity
instruments between two existing investors. Management assessed this impairment
to be other than temporary based on the sharp decline in fair value as
determined and in consideration of the overall market condition for private
equity companies. Prior thereto, the Company had concluded there was not an
other-than-temporary impairment based, in part, on its application of customary
valuation techniques which indicated that fair value approximated carrying
value. Among the key assumptions included in the valuation were market
conditions for educational-related companies, trends in Apex operating results
and valuations of market comparables. Based on an updated appraisal of this
investment, management believes that fair value of the investment continues to
approximate its carrying value at June 30, 2003.

12. COMMON AND PREFERRED STOCK

The Company has 150,000,000 authorized shares of Class A common stock,
5,000,000 authorized shares of Class B common stock and 5,000,000 authorized
shares of preferred stock. At June 30, 2003, 51,484,154 shares of Class A common
stock, net of stock held in treasury, and 1,627,933 shares of Class B common
stock were outstanding. There were no outstanding shares of preferred stock.

In general, holders of Class A common stock have the same rights as the
holders of Class B common stock, except that:

- holders of Class A common stock have one vote per share and holders of
Class B common stock have ten votes per share; and

- holders of Class B common stock elect, as a separate class, four of the
11 members of the Company's Board of Directors and the holders of Class A
common stock elect, as a separate class, the remaining seven directors.

The holders of Class A common stock and Class B common stock have
cumulative voting rights in the election of their respective directors. On other
matters presented to the stockholders for their vote or approval, the holders of
Class A common stock and Class B common stock will vote together as a single
class, except as to matters affecting the rights of the two classes of common
stock or as may be required by Delaware law. Class B common stock may be
converted into Class A common stock at any time on a one-for-one basis. Each
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EDISON SCHOOLS INC.

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share of Class B common stock will automatically convert into one share of Class
A common stock upon its transfer, in most circumstances, or upon the occurrence
of other specified events.

As a result of a covenant under the School Services Facility, the Company
cannot declare a dividend to holders of common stock without the prior consent
of the School Services, LLC.

WSI, a stockholder, holds two options to purchase shares of the Company's
common stock. Under the first option, WSI has the right to purchase up to
382,500 shares of Class A common stock and 42,500 shares of Class B common stock
at $20 per share. Under the second option, WSI has the right to purchase up to
450,000 shares of Class A common stock and 50,000 shares of Class B common stock
at $40 per share. The options expire on March 14, 2005. At the time of grant in
March 1995, the options were accounted for pursuant to the provision of APB 25,
and accordingly the Company recorded no compensation expense.

In connection with a private placement that closed in December 1997, August
1998 and December 1998, the Company sold units consisting of a share of stock,
three options for fractional shares of common stock, and a note payable for 22.8
cents per share. The first option entitles the holder to .0086359 share of Class
A common stock and .0009595 share of Class B common stock at an exercise price
of $20.00 per share. The option expires between calendar years 2003 and 2005.
The second option entitles the holder to .0086359 share of Class A common stock
and .0009595 share of Class B common stock at an exercise price of $3.00 per
share. The option became vested upon the completion of the Company's initial
public offering and expires 10 years after vesting. The third option entitles
the holder to .0129537 share of Class A common stock and .0014393 share of Class
B common stock at an exercise price of $16.00 per share. However, this option
only vests if the Company is a public company and its closing price has been
$32.00 per share for more than 90 consecutive days. This option expires 10 years
after vesting. As of June 30, 2003, stock options issued and outstanding in
conjunction with the private placement entitled the holders to purchase 300,788
shares of Class A common stock and 33,454 shares of Class B common stock at an
average exercise price of $14.00. In fiscal 2003, options to purchase 54,919
shares of Class A common stock and 6,110 shares of Class B common stock at a
share price of $20 expired.

In June 1998, the Company, in exchange for $2,500,000, issued a warrant to
the D2F2 Foundation (the "Foundation") to purchase 1,698,750 shares of Class A
common stock and 188,750 shares of Class B common stock at a price of $7.96 per
share. The warrant had an expiration date of June 1, 2005, but had been fully
exercised at June 30, 2002. The warrant proceeds were required to be used by
Edison to provide services to selected schools, as approved from time to time by
the Foundation during the five years following the agreement's execution. Under
the terms of the warrant, if the full amount of the cash proceeds were not spent
by Edison during the five-year period, Edison would be required to return
unexpended amounts, and a pro rata portion of the warrant (or shares already
issued under the warrant, if applicable) could be canceled or redeemed at
Edison's option at their issuance price. This amount was received and properly
recorded as restricted cash in the Company's financial statements. The Company
has accounted for the proceeds in accordance with EITF 96-13 "Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock." In July 2003, the Foundation extended the time the Company
has to spend the remaining balance of approximately $608,000 until June 30,
2004.

In August 2000, the Company completed a secondary public offering in which
it sold 3,350,000 shares of Class A common stock for net proceeds of
approximately $71.0 million. In March 2001, the Company completed another
secondary offering of an additional 3,531,026 shares of Class A common stock for
net proceeds of approximately $81.0 million.

In October 2002, the Company awarded a restricted stock grant of 1,000,000
shares to a senior executive of the Company. The per-share market value on the
date of the award was $0.31 per share. At June 30, 2003, 950,000 shares of such
award were vested. Vesting of the balance was approved by the Company's board of
directors in September 2003.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

During fiscal 2003, the Company purchased 1,711,900 shares of treasury
stock for $2,617,193. The repurchase was based on management's belief that the
stock was undervalued.

13. STOCK OPTIONS

In October 1999, the board of directors approved the adoption of the 1999
Stock Incentive Plan (the "Incentive Plan") for employees and authorized the
compensation committee of the board of directors to administer the Incentive
Plan under which options, restricted stock, and other stock-based awards for a
maximum of 2,500,000 shares of Class A common stock could be issued. In October
2000, the board of directors approved an amendment to the Incentive Plan to
increase the number of shares reserved for issuance to 4,500,000 shares of Class
A common stock. The Company's stockholders approved this amendment in November
2000. In August 2001, the board of directors approved an amendment to the
Incentive Plan to increase the number of shares reserved for issuance to
6,500,000 shares of Class A common stock. The Company's stockholders approved
this amendment in December 2001. 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. To the extent that all or
part of a stock-based award issued under the Incentive Plan is cancelled, the
related shares are available for future award grants. As of June 30, 2003, the
Company has 2,034,068 shares of Class A common stock reserved for future grants
under the Incentive Plan. The board of directors sets the vesting term for each
stock option award. Stock options typically vested over 12 to 60 months and
generally expire in ten years.

A summary of the Company's stock option activity is as follows:

The cancelled options in each of fiscal 2001, 2002 and 2003 shown in the
table above resulted from forfeitures rather than expirations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes information about stock options outstanding
at June 30, 2003:

Had compensation cost for the Company's stock option issuances been
determined based on the fair value at the grant date for awards made in the
years ended June 30, 2001, 2002 and 2003 consistent with the provisions of FAS
No. 123, the Company's net loss and basic and diluted net loss per share would
have been adjusted to the pro forma amounts indicated below:

The fair value of each option grant is estimated on the date of the grant
using the "Black-Scholes Option-pricing Model" with the following weighted
average assumptions used for grants for each of the years ended June 30, 2001,
2002 and 2003: zero dividend yield; no volatility for fiscal year 2001, 70%
volatility in fiscal 2002 and 130% volatility in fiscal 2003; a weighted average
risk-free interest rate of 5.50%, 5.31% and 3.91%, respectively; and expected
lives of 9.46, 10.00 and 9.5 years, respectively.

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EDISON SCHOOLS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes the weighted-average grant-date fair values
of options granted:

14. INCOME TAXES

There is no provision (benefit) for federal income taxes for the years
ended June 30, 2001, 2002 and 2003, since the Company has incurred net losses
since inception. The Company has provided approximately $603,000, $1.0 million
and $914,501 in fiscal 2001, 2002 and 2003, respectively for state and local
income and franchise taxes. Due to the uncertainty of the Company's ability to
realize the tax benefit of such losses, a valuation allowance has been
established to equal the total net deferred tax assets.

The components of the Company's net deferred tax assets are as follows:

At June 30, 2003, the Company had approximately $220 million of net
operating loss carryforwards available to reduce its future taxable income.
Under current Federal income tax law, approximately $45 million of such
carryforwards will expire between 2010 and 2018 and approximately $175 million
will expire between 2019 and 2023.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

For the years ended June 30, 2001, 2002 and 2003 the valuation allowance
increased (decreased) by $15,672,789, $49,093,863 and $(30,965,128),
respectively.

15. EMPLOYEE BENEFIT PLANS

The Company provides a 401(k) and a 403(b) defined contribution plans for
substantially all full-time employees and teachers. The Company matches each
participant's contribution up to 50% of the first $1,000 contributed.
Participants become fully vested in the match after one year. Contributions to
the 401(k) and a 403(b) plans made by the Company for each of the three years
ended June 30, 2001, 2002 and 2003 amounted to $334,191, $416,440, and $332,826,
respectively.

16. COMMITMENTS AND CONTINGENCIES

FUNDRAISING AGREEMENTS

The Company has entered into an agreement with one of its clients whereby
it committed to raise $10.5 million in unrestricted philanthropic funds, to be
contributed over a three-year period ending June 30, 2004. The funds are to be
used for schools the Company manages and are to be expended on agreed-upon costs
including school facility, technology, curriculum material, etc. Two senior
Company officers have committed to donate $1.2 million. The Company will
amortize its commitment, net of third-party donations received, over the
contract life (five years) as a reduction in revenue in accordance with EITF
01-09. Any contribution received from senior officers will serve to reduce the
Company's obligation and be credited to additional paid-in-capital. At June 30,
2003, $2.5 million remains to be funded under this commitment.

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 June 30, 2003, the aggregate termination benefits of the
executives and certain other employees approximated $2.4 million.

Additionally, the Company has a severance arrangement with its Chairman
that provides for a payment in the event the Company terminates the Chairman's
employment without cause or the Chairman terminates his employment for good
reason, including not being reappointed to the position of Chairman. Included in
accrued expenses at June 30, 2002 and 2003 is approximately $3.2 million related
to this severance arrangement.

GUARANTEES

The Company has guaranteed certain debt obligations of charter school
boards with which it has management agreements. As of June 30, 2003, the Company
had provided guarantees totaling approximately $26.7 million. These debt
obligations mature from November 2003 to June 2008.

As of June 30, 2003, the debt obligations of the charter school boards are
current. Under the guarantee agreements, the Company is also required to satisfy
certain financial reporting covenants. Additionally, should a charter board fail
to comply with the terms of its debt agreement, the Company may be requested to
perform under the terms of its guarantee. The Company was not in compliance with
a financial covenant under a guarantee of a charter school board debt obligation
with an outstanding balance of approximately $3.4 million at June 30, 2003. In
September, 2003 the Company received a waiver from the lender.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

LITIGATION

Litigation Related to the Merger. The Company is aware of a number of
purported class action complaints that have been filed in the Court of Chancery
of the State of Delaware (the "Delaware Complaints") and the Supreme Court of
the State of New York County of New York (the "New York Complaints") challenging
the merger discussed in note 19. All of the Delaware Complaints name the
Company, and certain members of the Company's board of directors, as defendants.
Only certain of the complaints have been served on the Company.

In addition, the Company is aware of three New York Complaints that have
been filed. All of the New York Complaints name the Company, and certain members
of the Company's board of directors as defendants. One of the New York
Complaints names several members of the Company's senior management as
defendants.

Both the Delaware Complaints and the New York Complaints allege, among
other things, that the defendants purportedly breached duties owed to Edison's
stockholders in connection with the transaction by failing to: (1) appropriately
value Edison's worth as a merger candidate; (2) expose Edison to the marketplace
in an effort to obtain the best transaction reasonably available; (3) adequately
ensure that no conflicts of interest exist between defendants' own interests and
their fiduciary obligation to maximize stockholder value; and (4) disclose
certain material facts in their preliminary proxy statement regarding the
transaction. Plaintiffs seek, among other things: (1) an order that the
complaints are properly maintainable as a class action; (2) a declaration that
defendants have breached their fiduciary duties and other duties to the
plaintiffs and other members of the purported class; (3) injunctive relief; (4)
monetary damages; (5) attorneys' fees, costs and expenses; (6) corrective and
complete disclosures made to the plaintiffs and the class; and (7) such other
and further relief as the court may deem just and proper. Edison plans to defend
these lawsuits, as well as any other similar lawsuits that may be filed,
vigorously. 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.

Other 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 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
unspecified 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 such 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 SEC's May
14, 2002 cease-and-desist order, and another regarding stock based compensation
the Company granted to one of its senior officers. On August 1, 2003, the
Company and certain of its officers and directors filed a motion to dismiss the
consolidated amended class action complaint. The Company believes that it has
strong defenses to the claims

99

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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. On November 14, 2002, the Court consolidated these actions. The
lawsuit alleges that the Company's officers and directors violated their
fiduciary duties to 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 permitting the Company to disseminate to the public misleading
and inaccurate information concerning the Company's financial condition, by
failing to establish and maintain adequate internal accounting controls to
ensure to the accuracy of the Company's financial statements, by using material
non-public information to sell shares of the Company's common stock and thereby
reap millions of dollars in illegal insider trading gains and by participating
in or approving the proposed going private transaction. The lawsuit seeks an
order enjoining the consummation of the going private transaction, unspecified
compensatory damages in the amount sustained by the Company as a result of the
named defendants' breaches of fiduciary duties, compensatory damages in the
amount of the profits the individual defendants allegedly made, as well as a
constructive trust over such profits, and costs and fees related to the lawsuit.
The Company has negotiated a stipulation in this consolidated action that allows
defendants until December 3, 2003 to file a responsive pleading. The Company
believes that the Company's officers and directors also have strong defenses to
these lawsuits.

The Company is also involved in various legal proceedings from time to time
incidental to the conduct of our business. For example, the Company is currently
involved in lawsuits filed in Baltimore, Maryland and Peoria, Illinois
questioning the authority of these school districts to enter into management
agreements with us. 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 our clients. We currently believe that any ultimate liability arising
out of such proceedings will not have a material adverse effect on the Company's
financial condition, results of operations or cash flows.

17. CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the Company to credit risk
consist primarily of cash and cash equivalents, notes receivable to charter
schools, and accounts receivable. The Company manages its credit risk by
maintaining cash and cash equivalents with financial institutions that it
believes are financially sound and through the contractual arrangements that it
has entered into with each district and charter school.

Accounts receivable primarily consist of short-term and long-term
receivables from various district and charter schools. Credit risk is affected
by changing conditions within the economy of individual states and school
districts in which the Company operates. Uncollectible accounts have been
isolated and have not been significant to date; as a result, an allowance for
doubtful accounts is not deemed necessary at this time. The Company will
establish an allowance for doubtful accounts when it has determined that factors
surrounding the credit risk of specific customers, historical trends and other
information so warrant.

Notes receivable from charter schools are both short-term and long-term.
Credit risk associated with those amounts is affected not only by the economy of
individual states and school districts in which the charter school operates, but
on the continued existence of charter school laws. The Company has established
an allowance for loan losses based upon its assessment of the credit risk of the
specific charter school, recent trends and other information.

100

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

18. QUARTERLY FINANCIAL DATA (UNAUDITED)

Summarized unaudited quarterly data for the years ended June 30, 2003 and
2002 are as follows (dollars in thousands, except for per share amounts):

19. SUBSEQUENT EVENTS

GOING-PRIVATE TRANSACTION

On July 14, 2003, the Company issued a press release announcing that it had
signed an Agreement and Plan of Merger (the "Merger Agreement"), dated as of
July 13, 2003, among the Company, Shakespeare Acquisition LLC (the "Parent"),
and its wholly-owned subsidiary, Shakespeare Acquisition Corporation (the
"Merger-Sub"). The Parent and Merger-Sub are newly formed entities organized for
the sole purpose of entering into the Merger Agreement and consummating the
transactions contemplated therein. Affiliates of Liberty Partners, a private
equity firm based in New York, and H. Christopher Whittle, the Chief Executive
Officer of the Company, control the Parent. Under the terms of the Merger
Agreement, the Merger-Sub will merge (the "Merger") into the Company with the
Company remaining as the surviving corporation, and the stockholders of the
Company will receive $1.76 in cash for each outstanding share of the Company's
Class A common stock and Class B common stock. Outstanding options and warrants
to purchase shares of the Company's Common Stock will become fully vested and
exercisable and, at the time of the merger, will be canceled and each holder of
such convertible security will receive a cash payment in an amount equal to the
excess, if any, of the common stock purchase price of $1.76 over the exercise
price of such convertible security, multiplied by the number of shares held by
the holder, subject to and net of any required income tax withholdings. The
closing of the Merger is subject to various conditions, including approval of
the transaction by stockholders of the Company representing a majority of the
shares of Class A common stock and Class B common stock voting as a single class
on the transaction and other customary conditions to closing. Subject to these
conditions, the Company expects to complete the merger transaction in the fall
of 2003. A special meeting of Edison's stockholders will be scheduled as soon as
practicable following review of proxy materials filed in preliminary form with
the Securities and Exchange Commission on August 22, 2003. There can be no
assurance that all required conditions will be met and the transaction will be
consummated in the fall of 2003 or at all. After consummation of the Merger, the
Company's Class A common stock will no longer be traded on the Nasdaq National
Market or any other securities exchange and the Company will become a privately-
held company.

100

EXHIBIT INDEX

101

102

103

- ---------------

* Incorporated by reference to the Registrant's Registration Statement
on Form S-1/A, filed October 5, 1999.

** Incorporated by reference to the Registrant's Registration Statement
on Form S-1, filed August 2, 1999.

*** Incorporated by reference to the Registrant's Registration Statement
on Form S-1/A, filed September 10, 1999.

**** Incorporated by reference to the Registrant's Registration Statement
on Form S-1/A, filed July 7, 2000.

+ Incorporated by reference to the Registrant's Registration Statement
on Form S-1, filed June 16, 2000.

++ Incorporated by reference to the Registrant's Registration Statement
on Form S-1/A, filed October 18, 1999.

+++ Incorporated by reference to the Registrant's Registration Statement
on Form S-1/A, filed October 29, 1999.

++++ Incorporated by reference to the Registrant's Annual Report on Form
10-K for the year ended June 30, 2000 (File No. 000-27817).

+++++ Incorporated by reference to the Registrant's Annual Report on Form
10-K for the year ended June 30, 2002.

+ Incorporated by reference to the Registrant's Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 2001.

++ Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended December 31, 2001.

+++ Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 2002.

++++ Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended December 31, 2002.

+++++ Incorporated by reference to the Registrant's Current Report on Form 8-K
dated July 14, 2003.

104