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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: JUNE 30, 2000 COMMISSION FILE NUMBER: 000-21363
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EDUCATION MANAGEMENT CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
PENNSYLVANIA 25-1119571
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
300 SIXTH AVENUE, PITTSBURGH, PA 15222
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (412) 562-0900
SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(TITLE OF CLASS)
PREFERRED SHARE PURCHASE RIGHTS
(TITLE OF CLASS)
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 the definitive proxy statement 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 common stock held by non-affiliates of
the registrant as of September 20, 2000 was approximately $349,419,335. The
number of shares of Common Stock outstanding on September 20, 2000 was
29,145,386 shares.
Documents incorporated by reference: Portions of the definitive Proxy Statement
of the registrant for the annual meeting of shareholders to be held on November
2, 2000 ("Proxy Statement") are incorporated by reference into Part III of this
Form 10-K. The incorporation by reference herein of portions of the Proxy
Statement shall not be deemed to incorporate by reference the information
referred to in Item 402(a)(8) of Regulation S-K.
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PART I
Forward-Looking Statements: This Annual Report on Form 10-K contains
statements that may be forward-looking statements within the meaning of the U.S.
Private Securities Litigation Reform Act of 1995. Those statements can be
identified by their use of terms such as "believes," "estimates," "anticipates,"
"continues," "contemplates," "expects," "may," "will," "could," "should" or
"would" or the negatives thereof or other variations thereon or comparable
terminology. Those statements are based on the intent, belief or expectation of
Education Management Corporation ("EDMC" or the "Company") as of the date of
this Annual Report. Such forward-looking statements are not guarantees of future
performance and may involve risks and uncertainties that are outside the control
of the Company. Actual results may vary materially from the forward-looking
statements contained herein as a result of changes in United States or
international economic conditions, governmental regulations and other factors,
including those factors described at the end of the response to Item 7 under the
heading "Risk Factors." The Company expressly disclaims any obligation or
understanding to release publicly any updates or revisions to any
forward-looking statement contained herein to reflect any change in the
Company's expectations with regard thereto or any change in the events,
conditions or circumstances on which any such statement is based. The following
discussion should be read in conjunction with the Consolidated Financial
Statements and Notes thereto filed in response to Item 8 of this Annual Report.
ITEM 1--BUSINESS
BUSINESS OVERVIEW
EDMC is among the largest providers of proprietary postsecondary education
in the United States, based on student enrollment and revenues. The Company was
organized as a Pennsylvania corporation in 1962 and completed its initial public
offering (the "IPO") in 1996. Through its main operating unit, the Art
Institutes ("The Art Institutes"), the Company offers bachelor's and associate's
degree programs and non-degree programs in the areas of design, media arts,
culinary arts and fashion. The Company's Art Institutes have graduated over
100,000 students. In the fall quarter beginning October 1999, EDMC's schools had
24,502 students enrolled, representing all 50 states and over 112 countries.
The Company's main operating unit, The Art Institutes, consisted of 18
schools in 17 cities throughout the United States as of June 30, 2000. The Art
Institute of Washington (located in Arlington , VA) and The Art Institute of Los
Angeles -- Orange County began operations in July 2000. Art Institute programs
are designed to provide the knowledge and skills necessary for entry-level
employment in various fields, including graphic design, media arts & animation,
multimedia & web design, video production, interior design, industrial design,
culinary arts, photography, and fashion. These programs typically are completed
in 18 to 48 months and culminate in a bachelor's or associate's degree. In the
summer quarter beginning July 2000, 16 Art Institutes offered bachelor's degree
programs, and EDMC expects to continue to introduce bachelor's degree programs
at schools in states that permit proprietary postsecondary institutions to offer
such programs.
The Company offers a culinary arts curriculum at 11 Art Institutes,
including The Illinois Institute of Art at Chicago, which began offering
culinary arts classes in January 2000. In addition, The New York Restaurant
School ("NYRS"), a culinary arts and restaurant management school located in New
York City, offers an associate's degree program and certificate programs in
these fields.
The Company also owns NCPT (The National Center for Paralegal Training),
which offers paralegal certificate programs, and The National Center for
Professional Development, which maintains consulting relationships with five
colleges and universities to assist in the development, marketing and delivery
of paralegal, legal nurse consultant and financial planning certificate
programs.
EDMC's graduates are employed by a broad range of employers nationwide.
Approximately 90% of the calendar year 1999 graduates of all programs at EDMC's
schools who were available for employment obtained positions in fields related
to their programs of study within six months of graduation.
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THE BUSINESS OF EDUCATION
EDMC's primary mission is to promote student success by providing students
with the education necessary to meet employers' current and anticipated needs.
To achieve this objective, the Company focuses on marketing to a broad range of
potential students, admitting students who possess the relevant interests and
capabilities, providing students with programs of study taught by industry
professionals, and assisting students with job placement.
STUDENT RECRUITMENT AND MARKETING
The general reputation of The Art Institutes and referrals from current
students, alumni and employers are the largest sources of new students. The
Company also employs marketing tools such as television and print media
advertising, the Internet, high school visits and recruitment events. EDMC uses
its internal advertising agency to create publications, television and radio
commercials, videos and other promotional materials for the Company's schools.
The Company estimates that in fiscal 2000 referrals accounted for 34% of new
student enrollment at The Art Institutes, high school recruitment programs
accounted for 20%, broadcast advertising accounted for 21%, print media
accounted for 7%, the Company's web sites accounted for 13%, and international
marketing accounted for less than 1%. The remainder was classified as
miscellaneous.
In fiscal 2000, The Art Institutes' marketing efforts generated inquiries
from approximately 294,000 qualified prospective students. The Art Institutes'
inquiry-to-application conversion ratio has decreased from 10.2% in fiscal 1998
to 9.7% in fiscal 2000, and the applicant-to-new student ratio has decreased
from 66.0% in fiscal 1998 to 63.8% in fiscal 2000.
The Company also employs approximately 95 representatives who make
presentations at high schools to promote The Art Institutes. Each Art Institute
also conducts college preview seminars at which prospective students can meet
with a representative, view artwork and videos, and receive enrollment
information. In fiscal 2000, representatives visited over 10,000 high schools
and attended approximately 2,100 career events. Summer teenager and teacher
workshops are held to inform students and educators of the education programs
offered by The Art Institutes. The Company's marketing efforts to reach young
adults and working adults who may be attracted to evening programs are conducted
through local newspaper advertising, direct mail campaigns and broadcast
advertising.
STUDENT ADMISSIONS AND RETENTION
Each applicant for admission to an Art Institute is required to have a high
school diploma or a recognized equivalent and to submit a written essay.
Prospective students are interviewed to assess their qualifications, their
interest in the programs offered by the applicable Art Institute and their
commitment to their education. In addition, the curricula, student services,
education costs, available financial resources and student housing are reviewed
during interviews, and tours of the facilities are conducted for prospective
students.
Art Institute students are of varying ages and backgrounds. For fiscal
2000, approximately 32% of the entering students matriculated directly from high
school, approximately 26% were between the ages of 19 and 21, approximately 30%
were 22 to 29 years of age and approximately 12% were 30 years old or older.
Students at the Company's schools may fail to finish their programs for a
variety of personal, financial or academic reasons. To reduce the risk of
student withdrawals, each Art Institute devotes staff resources to advise
students regarding academic and financial matters, part-time employment and
housing. Remedial courses are mandated for students with lower academic skill
levels and tutoring is encouraged for students experiencing academic
difficulties. The Art Institutes' net annual persistence rate, which measures
the number of students who are enrolled during a fiscal year and either graduate
or advance to the next fiscal year, was 66.4% in fiscal 1998 and 64.8% in fiscal
2000.
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EDUCATION PROGRAMS
The Art Institutes offer the following degree programs. Not all programs
are offered at each Art Institute. (For internal purposes, the Company
classifies its degree programs according to four "schools" or areas of study.)
THE SCHOOL OF DESIGN
Associate's Degree Programs
Computer-Aided Drafting & Design
Animation Art & Design
Graphic Design
Interior Design
Industrial Design Technology
Bachelor's Degree Programs
Media Arts & Animation
Game Art & Design
Graphic Design
Interior Design
Industrial Design Technology
THE SCHOOL OF CULINARY ARTS
Associate's Degree Programs
Culinary Arts
Restaurant and Catering Management
Bachelor's Degree Programs
Culinary Management
THE SCHOOL OF MEDIA ARTS
Associate's Degree Programs
Audio Production
Broadcasting
Information Technology & Design
Multimedia & Web Design
Photography
Video Production
Bachelor's Degree Programs
Internet Marketing & Advertising
Multimedia & Web Design
THE SCHOOL OF FASHION
Associate's Degree Programs
Fashion Design
Fashion Marketing
Visual Merchandising
Bachelor's Degree Programs
Fashion Design
Fashion Marketing and Management
NYRS offers an associate's degree program in culinary arts and restaurant
management and certificate programs in culinary arts, pastry arts, culinary
skills and restaurant management.
Approximately 7.4% of the average quarterly student enrollment at the
Company's schools in fiscal 2000 were in specialized diploma programs. Academic
credits from the specialized diploma programs at the Art Institutes and NYRS are
transferable into bachelor's and associate's degree programs at those schools.
Diploma programs are designed for working adults who seek to supplement their
education or are interested in enhancing their marketable skills.
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GRADUATE EMPLOYMENT
Based on information received from graduating students and employers, the
Company believes that students graduating from The Art Institutes during the
five calendar years ended December 31, 1999 obtained employment in fields
related to their programs of study as follows:
PERCENTAGE OF AVAILABLE
NUMBER OF GRADUATES WHO OBTAINED
GRADUATING CLASSES AVAILABLE EMPLOYMENT RELATED TO
(CALENDAR YEAR) GRADUATES(1)(2) PROGRAM OF STUDY(2)(3)
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1999........................................... 4,621 89.6%
1998........................................... 3,941 90.5
1997........................................... 3,811 89.0
1996........................................... 3,676 86.8
1995........................................... 3,734 87.4
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(1) The term "Available Graduates" refers to all graduates except those who are
pursuing further education, deceased, in active military service, who have
medical conditions that prevent such graduates from working, who are
continuing in a professional unrelated career, or who are international
students no longer residing in the United States.
(2) If the graduates of NCPT and NYRS (since its acquisition in August 1996)
were included in this table, then the number of graduates and placement
rates for 1996, 1997, 1998, and 1999 would have been 4,167, 4,749, 4,719,
and 5,279, and 86.4%, 87.3%, 90.9%, and 90.1%, respectively.
(3) The information presented reflects employment in fields related to
graduates' programs of study within six months after graduation.
For calendar year 1999, the approximate average starting salaries of
graduates of degree and diploma programs at The Art Institutes were as follows:
The School of Culinary Arts--$24,460; The School of Design--$26,206; The School
of Fashion--$22,041; and The School of Media Arts--$25,785.
Each Art Institute offers career-planning services to all graduating
students through its Career Services department. Specific career advice is
provided during the last two quarters of a student's education. In addition to
individualized training in interviewing and networking techniques and
resume-writing, a Career Development course is also required for all students.
Students also receive portfolio counseling where appropriate. The Art Institutes
maintain contact with approximately 15,000 employers nationwide. Career Services
advisors educate employers about the programs at The Art Institutes and the
caliber of their graduates and also participate in professional organizations,
trade shows and community events to keep apprised of industry trends and
maintain relationships with key employers. Career Services staff also visit
employer sites to learn more about their operation and better understand their
recruiting needs.
Employers of Art Institute graduates include numerous small and
medium-sized companies, as well as larger companies with a national or
international presence. The following companies are representative of the larger
companies that employ Art Institute graduates: AT&T, Microsoft Corporation,
Marriott International, Inc., Home Depot, Viacom, The Gap, Federated Department
Stores, The Boeing Company, Eddie Bauer, Inc., Ethan Allen Interiors Inc.,
FlightSafety International, Humongous Entertainment, Inc., Kinko's Corporation,
Sodexho, The May Department Stores Company, The Neiman Marcus Group, Inc.,
Aramark, Nintendo of America, Nordstrom, Inc., The Ritz-Carlton, Sears Roebuck
and Co., Sierra On-Line, Inc., Starwood Hotels & Resorts, Fox Entertainment
Group, TCI International, Inc., Time Warner Inc., and The Walt Disney Company.
ACCREDITATION
Accreditation is a process through which an institution submits itself to
qualitative review by an organization of peer institutions. Accrediting agencies
primarily examine the academic quality of the instructional programs of an
institution, and a grant of accreditation is generally viewed as certification
that an institution's programs meet generally accepted academic standards.
Accrediting agencies also review the administrative and financial operations of
the institutions they accredit to ensure that each institution has the resources
to perform its educational mission.
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Pursuant to provisions of the Higher Education Act of 1965, as amended
("HEA"), the U.S. Department of Education relies on accrediting agencies to
determine whether institutions' educational programs qualify them to participate
in federal financial aid programs under Title IV of the HEA ("Title IV
Programs"). The HEA specifies certain standards that all recognized accrediting
agencies must adopt in connection with their review of postsecondary
institutions. All of EDMC's schools are accredited by one or more accrediting
agencies recognized by the U.S. Department of Education. Six of the Company's
schools are accredited by one of the six regional accrediting agencies that
accredit virtually all of the public and private non-profit colleges and
universities in the United States.
The following table shows the location of each of EDMC's schools, the name
under which it operates, the year of its establishment, the date EDMC opened or
acquired it, the number of students enrolled as of October 1999 (the beginning
of the second (fall) quarter of fiscal 2000), and the accrediting agencies (for
schools accredited by more than one recognized accrediting agency, the primary
accrediting agency is listed first).
FISCAL YEAR FALL
CALENDAR EDMC ENROLLMENT
YEAR ACQUIRED/ (OCTOBER
SCHOOL LOCATION ESTABLISHED OPENED 1999) ACCREDITING AGENCY
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The Art Institute of
Atlanta.................... Atlanta, GA 1949 1971 1,909 Commission on Colleges of the
Southern Association of
Colleges and Schools ("SACS")
The Art Institute of
Charlotte.................. Charlotte, NC 1973 2000 157 Accrediting Council of
Independent Colleges and
Schools ("ACICS")
The Art Institute of
Colorado................... Denver, CO 1952 1976 1,976 Accrediting Commission of
Career Schools and Colleges
of Technology ("ACCSCT"),
ACICS
The Art Institute of
Dallas..................... Dallas, TX 1964 1985 1,544 SACS
The Art Institute of Fort
Lauderdale................. Fort Lauderdale, FL 1968 1974 2,761 ACCSCT, ACICS
The Art Institute of
Houston.................... Houston, TX 1974 1979 1,677 SACS, ACCSCT
The Art Institute of Los
Angeles.................... Los Angeles, CA 1997 1998 856 ACCSCT & ACICS as a branch of
The Art Institute of
Pittsburgh
The Art Institute of Los
Angeles - Orange County.... Orange County, CA 2000 2001 - ACCSCT & ACICS as a branch of
The Art Institute of Colorado
The Art Institute Online
(1)........................ Pittsburgh, PA 1999 2000 - Approved to offer programs as
a division of The Art
Institute of Pittsburgh
The Art Institute of
Philadelphia............... Philadelphia, PA 1971 1980 2,536 ACCSCT, ACICS
The Art Institute of
Phoenix.................... Phoenix, AZ 1995 1996 894 ACCSCT & ACICS as a branch of
The Art Institute of Colorado
The Art Institute of
Pittsburgh................. Pittsburgh, PA 1921 1970 2,443 ACCSCT, ACICS
The Art Institute of
Portland................... Portland, OR 1963 1998 439 Commission on Colleges of the
Northwest Association of
Schools and Colleges
("NWASC")
The Art Institutes
International at San
Francisco.................. San Francisco, CA 1939 1998 217 ACCSCT, ACICS
The Art Institute of
Seattle.................... Seattle, WA 1946 1982 2,623 NWASC
The Art Institute of
Washington................. Arlington, VA 2000 2001 - SACS, as a branch of The Art
Institute of Atlanta
The Art Institutes
International Minnesota.... Minneapolis, MN 1964 1997 737 ACICS
The Illinois Institute of Art
at Chicago................. Chicago, IL 1916 1996 1,073 ACCSCT
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FISCAL YEAR FALL
CALENDAR EDMC ENROLLMENT
YEAR ACQUIRED/ (OCTOBER
SCHOOL LOCATION ESTABLISHED OPENED 1999) ACCREDITING AGENCY
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The Illinois Institute of Art
at Schaumburg.............. Schaumburg, IL 1983 1996 699 ACCSCT, as a branch of The
Illinois Institute of Art at
Chicago
Massachusetts Communications
College.................... Boston, MA 1988 2000 573 New England Association of
Schools and Colleges, Inc.
through its Commission on
Technical and Career
Institutions
NCPT: The National Center for
Paralegal Training......... Atlanta, GA 1973 1973 350 ACICS
The New York Restaurant
School..................... New York, NY 1980 1997 1,038 ACCSCT, ACICS, New York State
Board of Regents
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(1) The October 1999 enrollment for The Art Institute of Fort Lauderdale and The
Art Institute of Phoenix includes students taking online courses in
partnership with The Art Institute Online.
Accrediting agencies monitor each institution's performance in specific
areas. In the event that the information provided by a school to an accrediting
agency indicates that such school's performance in one or more areas falls below
certain parameters, the accrediting agency may require that school to supply it
with supplemental reports on the accrediting agency's specific areas of concern
until that school meets the accrediting agency's performance guideline or
standard. A school that is subject to this heightened monitoring must seek the
prior approval of its accrediting agency in order to open or commence teaching
at new locations. The accrediting agencies do not consider requesting that a
school provide supplemental reports to be a negative action.
ACCSCT has notified two of the Company's schools that, due to concerns
regarding student completion rates for certain programs at each of those
schools, such schools were required to provide certain supplemental reports to
the agency. ACCSCT's standards define a program's completion rate as the
percentage of students who started that program during a twelve-month period who
have either graduated from that program within a period of time equal to 150% of
that program's length or withdrawn from that program during the same period in
order to accept full-time employment in the occupation or job category for which
the program was offered. Because that calculation can only be performed after a
student's scheduled completion date, it does not provide a timely basis for a
school to take action to affect student outcomes. For that reason, for internal
purposes, the Company uses the net annual persistence rate as a method to track
the retention rate of students.
STUDENT FINANCIAL ASSISTANCE
Many students at EDMC's schools must rely, at least in part, on financial
assistance to pay the cost of their education. The largest source of such
support is the federal programs of student financial assistance under Title IV
of the HEA. Additional sources of funds include other federal grant programs,
state grant and loan programs, private loan programs and institutional grants
and scholarships. To provide students access to financial assistance resources
available through Title IV Programs, a school must be (i) authorized to offer
its programs of instruction by the relevant agency of the state in which it is
located, (ii) accredited by an agency recognized by the U.S. Department of
Education, and (iii) certified as an eligible institution by the U.S. Department
of Education. In addition, the school must ensure that Title IV Program funds
are properly accounted for and disbursed in the correct amounts to eligible
students. All Art Institutes and NYRS participate in Title IV Programs.
NATURE OF FEDERAL SUPPORT FOR POSTSECONDARY EDUCATION
While the states support public colleges and universities primarily through
direct state subsidies, the federal government provides a substantial part of
its support for postsecondary education in the form of grants and loans to
students who can use this support at any institution that has been certified as
eligible by the U.S. Department of Education. Students at EDMC's schools receive
loans, grants and work-study funding to fund their education under several Title
IV Programs, of which the two largest are the Federal Family Education Loan
("FFEL")
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program and the Federal Pell Grant ("Pell") program. The Company's schools also
participate in the Federal Supplemental Educational Opportunity Grant ("FSEOG")
program, the Federal Perkins Loan ("Perkins") program, and the Federal
Work-Study ("FWS") program.
FFEL. The FFEL program consists of two types of loans; Stafford loans,
which are made available to students regardless of financial need, and PLUS
loans, which are made available to parents of students classified as dependents.
Under the Stafford loan program, a student may borrow up to $2,625 for the first
academic year, $3,500 for the second academic year and, in certain educational
programs, $5,500 for each of the third and fourth academic years. Students who
are classified as independent can obtain an additional $4,000 for each of the
first and second academic years and, depending upon the educational program, an
additional $5,000 for each of the third and fourth academic years. Amounts
received by students in the Company's schools under the Stafford loan program in
fiscal 2000 equaled approximately 37% of the Company's net revenues. PLUS loans
may be obtained by the parents of a dependent student in an amount not to exceed
the difference between the total cost of that student's education (including
allowable expenses) and other aid to which that student is entitled. Amounts
received by parents of students in the Company's schools under the PLUS loan
program in fiscal 2000 equaled approximately 16% of the Company's net revenues.
Pell. Pell grants are the primary component of the Title IV Programs under
which the U.S. Department of Education makes grants to students who demonstrate
financial need. Every eligible student is entitled to receive a Pell grant;
there is no institutional allocation or limit. During fiscal 2000, Pell grants
ranged up to $3,125 per year; beginning on July 1, 2000, the limit was increased
to $3,300 per year. Amounts received by students enrolled in the Company's
schools in fiscal 2000 under the Pell program represented approximately 6% of
the Company's net revenues.
FSEOG. FSEOG awards are designed to supplement Pell grants for the neediest
students. FSEOG grants generally range in amount from $300 to $1,200 per year;
however, the availability of FSEOG awards is limited by the amount of those
funds allocated to an institution under a formula that takes into account the
size of the institution, its costs and the income levels of its students. The
Company is required to make a 25% matching contribution for all FSEOG program
funds disbursed. Resources for this institutional contribution may include
institutional grants and scholarships and, in certain states, portions of state
grants and scholarships. In fiscal 2000, the Company's required 25%
institutional match was approximately $975,000. Amounts received by students in
the Company's schools under the FSEOG program in fiscal 2000 represented
approximately 1% of the Company's net revenues.
Perkins. Eligible undergraduate students may borrow up to $4,000 under the
Perkins program during each academic year, with an aggregate maximum of $20,000,
at a 5% interest rate and with repayment delayed until nine months after a
student ceases enrollment as at least a half-time student. Perkins loans are
made available to those students who demonstrate the greatest financial need.
Perkins loans are made from a revolving account, with 75% of new funding
contributed by the U.S. Department of Education, and the remainder by the
applicable school. Subsequent federal capital contributions, which must be
matched by school funds, may be received if an institution meets certain
requirements. Each school collects payments on Perkins loans from its former
students and relends those funds to currently enrolled students. Collection and
disbursement of Perkins loans is the responsibility of each participating
institution. During fiscal 2000, the Company collected approximately $3 million
from its former students. In fiscal 2000, the Company's required matching
contribution was approximately $256,000. The Perkins loans disbursed to students
in the Company's schools in fiscal 2000 represented approximately 1% of the
Company's net revenues. Ten of the Company's schools participate in the Perkins
program.
Federal Work-Study. Under the FWS program, federal funds are made available
to pay up to 75% of the cost of part-time employment of eligible students, based
on their financial need, to perform work for the institution or for off-campus
public or non-profit organizations. At least 5% of an institution's FWS
allocation must be used to fund student employment in community service
positions. In fiscal 2000, FWS funds represented less than 1% of the Company's
net revenues.
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OTHER FINANCIAL ASSISTANCE SOURCES
Students at several of the Company's schools participate in state grant
programs. In fiscal 2000, approximately 3% of the Company's net revenues was
derived from state grant programs. In addition, certain students at some of the
Company's schools receive financial aid provided by the United States Department
of Veterans Affairs, the United States Department of the Interior (Bureau of
Indian Affairs) and the Rehabilitative Services Administration of the U.S.
Department of Education (vocational rehabilitation funding). In fiscal 2000,
financial assistance from such federal and state programs equaled 1.5% of the
Company's net revenues. The Art Institutes also provide institutional
scholarships to qualified students. In fiscal 2000, institutional scholarships
had a value equal to approximately 4% of the Company's net revenues. The Company
has also arranged alternative supplemental loan programs that allow students to
repay a portion of their loans after graduation and allow students with lower
than average credit ratings to obtain loans. The primary objective of these loan
programs is to lower the monthly payments required of students. Such loans are
without recourse to the Company or its schools.
AVAILABILITY OF LENDERS
During fiscal 2000, five lending institutions provided over 80% of all
federally guaranteed loans to students attending the Company's schools. While
the Company believes that other lenders would be willing to make federally
guaranteed student loans to its students if loans were no longer available from
its current lenders, there can be no assurances in this regard. In addition, the
HEA requires the establishment of lenders of last resort in every state to make
certain loans to students at any school that cannot otherwise identify lenders
willing to make federally guaranteed loans to its students.
One student loan guaranty agency (USA Group Guarantee Services, formerly
United Student Aid Funds) currently guarantees approximately 90% of all
federally guaranteed student loans made to students enrolled at the Company's
schools. The Company believes that other guaranty agencies would be willing to
guarantee loans to the Company's students if that agency ceased guaranteeing
those loans or reduced the volume of those loans it guaranteed.
FEDERAL OVERSIGHT OF TITLE IV PROGRAMS
Each institution that participates in Title IV Programs must annually
submit to the U.S. Department of Education an audit by an independent accounting
firm of that school's compliance with Title IV Program requirements, as well as
audited financial statements. The U.S. Department of Education also conducts
compliance reviews, which include on-site evaluations, of several hundred
institutions each year, and directs student loan guaranty agencies to conduct
additional reviews relating to student loan programs. In addition, the Office of
the Inspector General of the U.S. Department of Education conducts audits and
investigations in certain circumstances. Under the HEA, accrediting agencies and
state licensing agencies also have responsibilities for overseeing institutions'
compliance with certain Title IV Program requirements. As a result, each
participating institution is subject to frequent and detailed oversight and must
comply with a complex framework of laws and regulations or risk being required
to repay funds or becoming ineligible to participate in Title IV Programs.
Cohort Default Rates. The U.S. Department of Education may impose sanctions
on institutions whose former students default at an "excessive" rate on the
repayment of federally guaranteed student loans. A school's cohort default rate
under the FFEL program is calculated on an annual basis as the rate at which
student borrowers scheduled to begin repayment on their loans in one federal
fiscal year default on those loans by the end of the next federal fiscal year.
Any institution whose FFEL cohort default rate equals or exceeds 25% for three
consecutive years will no longer be eligible to participate in that program or
the Federal Direct Student Loan Program for the remainder of the federal fiscal
year in which the U.S. Department of Education determines that such institution
has lost its eligibility and for the two subsequent federal fiscal years. In
addition, an institution whose FFEL cohort default rate for any federal fiscal
year exceeds 40% may have its eligibility to participate in all Title IV
Programs limited, suspended or terminated. Since the calculation of FFEL cohort
default rates involves the collection of data from many non-governmental
agencies (i.e., lenders and non-federal guarantors), as well as the U.S.
Department of Education, the HEA provides a formal process for the review and
appeal of the accuracy of FFEL cohort default rates before the U.S. Department
of Education takes any action against an
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institution based on its FFEL cohort default rates. As part of that process, the
U.S. Department of Education provides each institution with its FFEL cohort
default rate on a preliminary basis for review. Preliminary cohort default rates
are subject to revision by the U.S. Department of Education based on information
that schools and guaranty agencies identify and submit to the U.S. Department of
Education for review in order to correct any errors in the data previously
provided.
None of the Company's schools has had an FFEL cohort default rate of 25% or
greater for any of the last three consecutive federal fiscal years. For federal
fiscal year 1997, the most recent year for which such rates have been published,
the average FFEL cohort default rate for borrowers at all proprietary
institutions was 15.4%. For that year, the combined FFEL cohort default rate for
all borrowers at the Company's schools was 14.3%. For federal fiscal year 1998,
the combined preliminary FFEL cohort default rate for all borrowers at the
Company's schools was 10.2% and its individual schools' preliminary rates ranged
from 2.0% to 17.5%,
If an institution's FFEL cohort default rate equals or exceeds 25% in any
of the three most recent federal fiscal years, or if its cohort default rate for
loans under the Perkins program exceeds 15% for the most recent federal award
year (i.e., July 1 through June 30), that institution may be placed on
provisional certification status for up to four years. Provisional certification
does not limit an institution's access to Title IV Program funds, but does
subject that institution to closer review by the U.S. Department of Education
and possible summary adverse action if that institution commits a material
violation of Title IV Program requirements. To EDMC's knowledge, the U.S.
Department of Education reviews an institution's compliance with the cohort
default rate thresholds described in this paragraph only when that school is
otherwise subject to a U.S. Department of Education certification review. Six of
the Company's schools had Perkins cohort default rates in excess of 15% for
students who were to begin repayment during the federal award year ending June
30, 1999, the most recent year for which such rates have been calculated. For
each of those schools, funds from the Perkins program equaled 1% of the school's
net revenues in fiscal 2000. To date, none of those schools has been placed on
provisional certification status for this reason. If an institution is placed on
such status for this reason and the institution reduces its Perkins cohort
default rate to below 15% in a subsequent year, the institution can ask the U.S.
Department of Education to remove the provisional status.
Each of the Company's schools has adopted a student loan default management
plan. Those plans provide for extensive loan counseling, methods to increase
student persistence and completion rates and graduate employment rates,
strategies to increase graduate salaries and, for most schools, the use of
external agencies to assist the school with loan counseling and loan servicing
if a student ceases to attend that school. Those activities are in addition to
the loan servicing and collection activities of FFEL lenders and guaranty
agencies.
Regulatory Oversight. The U.S. Department of Education is required to
conduct periodic reviews of the eligibility and certification of every
institution participating in Title IV Programs. A denial of recertification
precludes a school from continuing to participate in Title IV Programs.
The Art Institute of Colorado, The Art Institute of Pittsburgh, The Art
Institute of Fort Lauderdale and The Art Institute of Portland submitted their
re-certification application during fiscal 2000 and are awaiting their re-
certification. Additionally, The Art Institute of Phoenix and the Art Institute
of Los Angeles, as additional locations of The Art Institute of Colorado and The
Art Institute of Pittsburgh, respectively, are included on the recertification
applications of their main campuses. During fiscal 2001, six of the Company's
schools are scheduled to apply for recertification.
The Art Institutes International at San Francisco, The Art Institute of
Portland, Massachusetts Communications College, and The Art Institute of
Charlotte are provisionally certified by the United States Department of
Education due to their recent acquisition by the Company. NCPT's paralegal
certificate program became eligible for FFELP loans effective June 30, 2000.
NCPT is provisionally certified as are all institutions during their first year
of access to the Title IV program. The Art Institute of Washington and the Art
Institute of Los Angeles - Orange County are seeking eligibility as additional
locations of their main campuses, The Art Institute of Atlanta and The Art
Institute of Colorado, respectively.
The HEA requires each accrediting agency recognized by the U.S. Department
of Education to undergo comprehensive periodic review by the U.S. Department of
Education to ascertain whether such accrediting
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agency is adhering to required standards. Each accrediting agency that accredits
any of the Company's schools has been reviewed by the U.S. Department of
Education within the past four years and re-approved for continued recognition
by the U.S. Department of Education.
Financial Responsibility Standards. All institutions participating in Title
IV Programs must satisfy a series of specific standards of financial
responsibility. Institutions are evaluated for compliance with those
requirements as part of the U.S. Department of Education's quadrennial
recertification process and also annually as each institution submits its
audited financial statements to the U.S. Department of Education. For the year
ended June 30, 2000, the Company believes that, on an individual institution
basis, each of its schools then participating in Title IV Programs satisfied the
financial responsibility standards. The Illinois Institute of Art at Schaumburg,
The Art Institute of Phoenix and The Art Institute of Los Angeles are combined
with their main campuses, The Illinois Institute of Art at Chicago, The Art
Institute of Colorado, and The Art Institute of Pittsburgh, respectively, for
that purpose.
Restrictions on Operating Additional Schools. The HEA generally requires
that certain institutions, including proprietary schools, be in full operation
for two years before applying to participate in Title IV Programs. However,
under the HEA and applicable regulations, an institution that is certified to
participate in Title IV Programs may establish an additional location and apply
to participate in Title IV Programs at that location without reference to the
two-year requirement if such additional location satisfies all other applicable
requirements. In addition, a school that undergoes a change of ownership
resulting in a change in control (as defined under the HEA) must be reviewed and
recertified for participation in Title IV Programs under its new ownership. Most
of a school's change of ownership application can be reviewed prior to the
change of ownership. If the application is considered to be substantially
complete, the U.S. Department of Education may generate a temporary Provisional
Program Participation Agreement allowing the school's students to continue to
receive federal funding, subject to certain conditions. After the change of
ownership and the remainder of the application is submitted, if the school is
recertified, it is recertified on a provisional basis. During the time a school
is provisionally certified, it may be subject to summary adverse action for a
material violation of Title IV Program requirements and may not establish
additional locations without prior approval from the U.S. Department of
Education. However, provisional certification does not otherwise limit an
institution's access to Title IV Program funds. The Company's expansion plans
are based, in part, on its ability to add additional locations and acquire
schools that can be recertified.
Certain of the state authorizing agencies and accrediting agencies with
jurisdiction over the Company's schools also have requirements that may, in
certain instances, limit the ability of the Company to open a new school,
acquire an existing school or establish an additional location of an existing
school. The Company does not believe that those standards will have a material
adverse effect on the Company or its expansion plans.
The "90/10 Rule." Under a provision of the HEA commonly referred to as the
"90/10 Rule," a proprietary institution such as each of EDMC's schools will
cease to be eligible to participate in Title IV Programs if, on a cash
accounting basis, more than 90% of its revenues for the prior fiscal year was
derived from Title IV Programs. Any school that violates the 90/10 Rule
immediately becomes ineligible to participate in Title IV Programs and is unable
to apply to regain its eligibility until the following fiscal year. For fiscal
2000, the range for the Company's schools was from approximately 52% to
approximately 75%.
Restrictions on Payment of Bonuses, Commissions or Other Incentives. The
HEA prohibits an institution from providing any commission, bonus or other
incentive payment based directly or indirectly on success in securing enrollment
or financial aid to any person or entity engaged in any student recruitment,
admission or financial aid awarding activity. EDMC believes that its current
compensation plans are in substantial compliance with HEA requirements.
STATE AUTHORIZATION
Each of EDMC's schools is authorized to offer education programs and grant
degrees or diplomas by the state in which such school is located. The level of
regulatory oversight varies substantially from state to state. In some states,
the schools are subject to licensure by the state education agency and also by a
separate higher education agency. State laws establish standards for
instruction, qualifications of faculty, location and nature of
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facilities, financial policies and responsibility and other operational matters.
State laws and regulations may limit the ability of the Company to obtain
authorization to operate in certain states or to award degrees or diplomas or
offer new degree programs. Certain states prescribe standards of financial
responsibility that are different from those prescribed by the U.S. Department
of Education. The Company believes that each of the Company's schools is in
substantial compliance with applicable state authorizing and licensure laws.
EMPLOYEES
As of June 30, 2000, EDMC employed 2,360 full-time and 862 part-time staff
and faculty.
COMPETITION
The postsecondary education market is highly competitive. The Art
Institutes compete with traditional public and private two-year and four-year
colleges and universities and other proprietary schools. Certain public and
private colleges and universities may offer programs similar to those of The Art
Institutes. Public institutions often receive government subsidies, government
and foundation grants, tax-deductible contributions and other financial
resources generally not available to proprietary schools. Accordingly, public
institutions may have facilities and equipment superior to those in the private
sector, and can offer lower tuition prices. However, tuition at private
non-profit institutions is, on average, higher than The Art Institutes' tuition.
SEASONALITY IN RESULTS OF OPERATIONS
EDMC has experienced seasonality in its results of operations primarily due
to the pattern of student enrollment. Historically, EDMC's lowest quarterly
revenues and income have been in the first quarter (July to September) of its
fiscal year due to fewer students being enrolled during the summer months and
the expenses incurred in preparation for the peak in enrollment in the fall
quarter (October to December). EDMC expects that this seasonal trend will
continue.
ITEM 2--PROPERTIES
As of June 30, 2000, EDMC's schools were located in major metropolitan
areas in 15 states. Typically, the schools occupy an entire building or several
floors or portions of floors in a building. The Company and its subsidiaries
currently lease the majority of their facilities.
The following table sets forth certain information as of June 30, 2000 with
respect to the principal properties used by the Company and its subsidiaries:
SQUARE FEET
-----------------
LOCATION (CITY/STATE) LEASED OWNED
--------------------- ------- -------
Phoenix, AZ............. 58,635
Los Angeles, CA......... 56,150
Orange County, CA....... 54,850
San Francisco, CA....... 43,060
Denver, CO.............. 35,725 98,840
Ft. Lauderdale, FL(1)... 117,900
Atlanta, GA............. 117,985
Charlotte, NC........... 16,915
Chicago, IL............. 62,577
Schaumburg, IL.......... 33,970
Boston, MA.............. 27,000
Minneapolis, MN......... 67,750
New York, NY............ 41,805
Portland, OR............ 34,155
Philadelphia, PA(2)..... 158,810
Pittsburgh, PA.......... 36,930 172,790
Pittsburgh, PA(3)....... 128,200
Dallas, TX.............. 95,420
Houston, TX............. 80,545
Seattle, WA............. 58,975 74,635
Arlington, VA........... 32,330
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- ---------------
(1) One of the properties occupied by The Art Institute of Fort Lauderdale is
owned by a limited partnership that includes among its limited partners one
current member of EDMC's management who is also a director.
(2) One of the properties occupied by The Art Institute of Philadelphia is owned
indirectly by a limited partnership that includes among its limited partners
one current member of EDMC's management who is also a director and another
current director of EDMC.
(3) This lease for the former location of the Art Institute of Pittsburgh
expired in August 2000.
ITEM 3--LEGAL PROCEEDINGS
EDMC and its wholly-owned subsidiaries The Art Institutes International,
Inc. and The Art Institute of Houston, Inc. are defendants in a suit in the
District Court of Harris County, Texas, filed on June 30, 1999 by 145 former and
current students of The Art Institute of Houston. There have been subsequent
amendments to the complaint adding 244 plaintiffs and naming the president of
The Art Institute of Houston as an additional defendant. Plaintiffs claim, among
other things, that they were misled about the nature, quality and utility of the
education they would receive at The Art Institute of Houston. The complaint
seeks unspecified compensatory and consequential damages, exemplary or punitive
damages, additional damages under the Texas Deceptive Trade Practices Act, and
attorneys' fees, expenses and interest. Given the nature of plaintiffs' claims
and the inherent uncertainties of litigation, management is unable to predict
the ultimate number, scope or duration of any such claims or the eventual
outcome or costs of defending any such claims.
The Company is also a defendant in certain other legal proceedings arising
out of the conduct of its businesses. In the opinion of management, based upon
its investigation of these claims and discussion with legal counsel, the
ultimate outcome of such other legal proceedings, individually and in the
aggregate, will not have a material adverse effect on the consolidated financial
position, results of operations or liquidity of the Company.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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PART II
ITEM 5-- MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS
The Common Stock is traded on the Nasdaq National Market System under the
symbol "EDMC." As of September 20, 2000, there were 29,145,386 shares of Common
Stock outstanding held by 529 holders of record. The prices set forth below
reflect the high and low sales prices for the Company's Common Stock, as
reported in the consolidated transaction reporting system of the Nasdaq National
Market System.
1999 2000
---------------- ----------------
THREE MONTHS ENDED HIGH LOW HIGH LOW
- ------------------ ---- --- ---- ---
September 30.................... $20.13 $14.50 $21.13 $12.38
December 31..................... 24.00 15.63 14.81 8.69
March 31........................ 31.75 21.75 14.63 11.00
June 30......................... 30.75 14.56 18.69 14.88
EDMC has not declared or paid any cash dividends on its capital stock
during the past two years. EDMC currently intends to retain future earnings, if
any, to fund the development and growth of its business and does not anticipate
paying any cash dividends in the foreseeable future.
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ITEM 6--SELECTED FINANCIAL DATA
The following summary consolidated financial and other data should be read
in conjunction with the Company's Consolidated Financial Statements and Notes
thereto filed in response to Item 8 and the information included in response to
Item 7 below. Most of the summary data presented below is derived from the
Company's consolidated financial statements audited by Arthur Andersen LLP,
independent public accountants, whose report covering the financial statements
as of June 30, 1999 and 2000 and for each of the three years in the period ended
June 30, 2000 also is filed in response to Item 8 below. The summary
consolidated income statement data for the years ended June 30, 1996 and 1997
and the summary consolidated balance sheet data as of June 30, 1996, 1997 and
1998 are derived from audited financial statements not included herein.
YEAR ENDED JUNE 30,
----------------------------------------------------
1996(7) 1997(7) 1998 1999 2000
------- ------- ---- ---- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
INCOME STATEMENT DATA:
Net revenues.............................. $147,863 $182,849 $221,732 $260,805 $307,249
ESOP expense(1)........................... 1,366 -- -- -- --
Income before extraordinary item(2)....... 6,846 9,985 14,322 18,752 22,530
Net income................................ 5,920 9,985 14,322 18,752 22,530
Dividends on Series A Preferred
Stock(3)................................ 2,249 83 -- -- --
Other Series A Preferred Stock
transactions(3)......................... -- 403 -- -- --
PER SHARE DATA(3):
Basic:
Income before extraordinary item........ $ .33 $ .40 $ .50 $ .64 $ .78
Net income.............................. $ .27 $ .40 $ .50 $ .64 $ .78
Weighted average number of shares
outstanding, in thousands(4)......... 13,826 23,878 28,908 29,314 28,964
Diluted:
Income before extraordinary item........ $ .19 $ .36 $ .48 $ .61 $ .75
Net income.............................. $ .15 $ .36 $ .48 $ .61 $ .75
Weighted average number of shares
outstanding, in thousands(4)......... 23,748 27,342 29,852 30,615 29,921
OTHER DATA:
Capital expenditures(5)................... $ 14,981 $ 18,487 $ 17,951 $ 54,933 $ 57,073
Enrollment at beginning of fall
quarter(6).............................. 13,407 15,838 18,763 21,518 24,502
AS OF JUNE 30,
----------------------------------------------------
1996 1997 1998 1999 2000
---- ---- ---- ---- ----
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents................. $ 27,399 $ 33,227 $ 47,310 $ 32,871 $ 39,538
Receivables, net.......................... 8,172 10,547 11,678 15,333 16,735
Current assets............................ 39,858 48,886 65,623 55,709 66,713
Total assets.............................. 101,412 126,292 148,783 178,746 240,675
Current liabilities....................... 27,264 36,178 38,097 45,188 62,891
Long-term debt (including current
portion)................................ 65,919 34,031 38,382 37,231 64,283
Shareholders' investment.................. 9,656 57,756 73,325 96,805 112,950
- ---------------
(1) Expense incurred in connection with the Education Management Corporation
Employee Stock Ownership Plan and Trust (the "ESOP") equals the sum of the
payments on borrowings associated with the ESOP's acquisition of securities
from EDMC, plus repurchases of shares from participants in the ESOP, less
the dividends paid on the shares of Series A 10.19% Convertible Preferred
Stock, $.0001 par value (the "Series A Preferred Stock") previously held by
the ESOP. In fiscal 1996, the borrowings associated with the ESOP were
repaid in full. Therefore, subsequent thereto there has not been, nor will
there be in the future,
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ESOP expense resulting from the repayment of such loan or, so long as the
Common Stock is publicly traded, from repurchases of shares.
(2) During fiscal 1996, the Company incurred a $1.5 million penalty in
connection with the prepayment of debt, which is classified as an
extraordinary item, net of the related income tax benefit.
(3) Dividends on the outstanding shares of Series A Preferred Stock, dividends
accrued but not paid on outstanding shares of Series A Preferred Stock and a
redemption premium paid upon redemption of 75,000 shares of Series A
Preferred Stock have been deducted from net income in calculating net income
per share.
(4) The weighted average shares outstanding used to calculate basic income per
share does not include potentially dilutive securities (such as stock
options, warrants and convertible preferred stock). Diluted income per share
includes, where dilutive, the equivalent shares of Common Stock calculated
under the treasury stock method for the assumed exercise of options and
warrants and conversion of shares of Series A Preferred Stock.
(5) Capital expenditures for fiscal 1999 and 2000 reflect approximately $5.1
million and $13.2 million included in accounts payable at year-end,
respectively.
(6) Excludes students enrolled in programs at those colleges and universities
with which the Company has consulting arrangements.
(7) Charges of $0.5 million and $0.4 million are reflected in 1996 and 1997,
respectively, to account for non-cash compensation expense related to the
performance-based vesting of nonqualified stock options.
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ITEM 7-- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion of the Company's results of operations and
financial condition should be read in conjunction with the information filed in
response to Item 6 above and Item 8 below. Unless otherwise specified, any
reference to a "year" is to a fiscal year ended June 30.
BACKGROUND
EDMC is among the largest providers of proprietary postsecondary education
in the United States, based on student enrollment and revenues. Through its
operating units, primarily The Art Institutes, the Company offers bachelor's and
associate's degree programs and non-degree programs in the areas of design,
media arts, culinary arts, fashion and paralegal studies. The Company has
provided career-oriented education programs for over 35 years, and its Art
Institutes have more than 100,000 graduates. As of June 30, 2000, the Company
operated 20 schools in 17 major metropolitan areas throughout the United States.
The Art Institute of Washington and the Art Institute of Los Angeles, Orange
County began operations in July 2000.
Net revenues, income before interest and taxes and net income increased in
each of the last two years. Net revenues are presented after deducting refunds,
scholarships and other adjustments. Net revenues increased 38.6% to $307.2
million in 2000 from $221.7 million in 1998. Income before interest and taxes
increased 55.3% to $38.3 million in 2000 from $24.7 million in 1998. Net income
increased by 57.3% to $22.5 million in 2000 from $14.3 million in 1998. Average
quarterly student enrollment at the Company's schools was 22,264 in 2000
compared to 17,002 in 1998. The increase in average enrollment relates to, among
other factors, new education programs and additional school locations, along
with expanded bachelor's degree and evening degree program offerings.
The Company's revenues consist of tuition and fees, student housing fees
and student supply store and restaurant sales. In 2000, the Company derived
89.6% of its net revenues from net tuition and fees paid by, or on behalf of,
its students. Tuition revenue generally varies based on the average tuition
charge per credit hour and the average student population. Student supply store
and housing revenue is largely a function of the average student population. The
average student population is influenced by the number of continuing students
attending school at the beginning of a fiscal period and by the number of new
students entering school during such period. New students enter The Art
Institutes at the beginning of each academic quarter, which typically commence
in January, April, July and October. The Company believes that the size of its
student population is influenced by the number of graduating high school
students, the attractiveness of its program offerings, the effectiveness of its
marketing efforts, changes in technology, the persistence of its students, the
length of its education programs and general economic conditions. The
introduction of additional program offerings at existing schools and the
establishment of new schools (through acquisition or start-up) are important
factors influencing the Company's average student population.
Tuition increases have been implemented in varying amounts in each of the
past several years. Historically, the Company has been able to pass along cost
increases through increases in tuition. The Company believes that it can
continue to increase tuition as educational costs at other postsecondary
institutions, both public and private, continue to rise. The Company's schools
implemented tuition rate increases averaging approximately 5% during 2000.
Tuition rates vary by geographic region, but are generally consistent by program
at the respective schools.
The majority of students at The Art Institutes rely on funds received under
various government-sponsored student financial aid programs, especially Title IV
Programs, to pay a substantial portion of their tuition and other
education-related expenses. For the year ended June 30, 2000, approximately 62%
of the Company's net revenues were indirectly derived from Title IV Programs.
Educational services expense consists primarily of costs related to the
development, delivery and administration of the Company's education programs.
Major cost components are faculty compensation, administrative salaries, costs
of educational materials, facility and school occupancy costs, information
systems costs, bad debt expense and depreciation and amortization of property
and equipment. The Company's faculty comprised approximately 46% full-time and
approximately 54% part-time employees, for both 1999 and 2000.
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General and administrative expense consists of marketing and student
admissions expenses and certain central staff departmental costs such as
executive management, finance and accounting, legal and corporate development
and other departments that do not provide direct services to the Company's
students. The Company has centralized many of these services to gain consistency
in management reporting, efficiency in administrative effort and control of
costs.
Amortization of intangibles relates to the values assigned to identifiable
intangible assets and goodwill. These intangible assets arose principally from
the acquisitions of the schools discussed below.
In December 1997, the Company purchased certain assets of the Louise
Salinger School in San Francisco, California for $0.6 million in cash. The
Company also entered into a consulting agreement with its former president in
exchange for an option to purchase 20,000 shares of Common Stock. The school was
renamed The Art Institutes International at San Francisco.
In February 1998, the Company acquired certain assets related to the
operations of Bassist College in Portland, Oregon for approximately $0.9 million
in cash. The purchase agreement provides for additional consideration based upon
a specified percentage of gross revenues over a five-year period. The school was
renamed The Art Institute of Portland.
In October 1998, the Company acquired the assets of Socrates Distance
Learning Technologies Group for approximately $0.5 million in cash. This
acquisition was made to further the development of the Company's distance
learning capabilities.
In August 1999, the Company acquired the outstanding stock of the American
Business & Fashion Institute in Charlotte, North Carolina, for $0.5 million in
cash. The school was renamed The Art Institute of Charlotte.
In August 1999, the Company acquired the outstanding stock of Massachusetts
Communications College in Boston, Massachusetts for approximately $7.2 million
in cash.
Start-up schools and smaller acquisitions are expected to incur operating
losses during the first two to three years following their opening or purchase.
The combined operating losses of the Company's newer schools were approximately
$6.7 million in 2000.
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RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage
relationships of certain income statement items to net revenues.
YEAR ENDED JUNE 30,
---------------------------
1998 1999 2000
---- ---- ----
Net revenues.................................... 100.0% 100.0% 100.0%
Costs and expenses:
Educational services............................ 66.4 65.5 65.5
General and administrative...................... 21.7 21.9 21.5
Amortization of intangibles..................... 0.7 0.5 0.5
----- ----- -----
88.9 87.8 87.5
----- ----- -----
Income before interest and taxes................ 11.1 12.2 12.5
Interest expense (income), net.................. -- -- 0.3
----- ----- -----
Income before income taxes...................... 11.1 12.2 12.2
Provision for income taxes...................... 4.7 5.0 4.9
----- ----- -----
Net income...................................... 6.5% 7.2% 7.3%
===== ===== =====
YEAR ENDED JUNE 30, 2000 COMPARED WITH YEAR ENDED JUNE 30, 1999
NET REVENUES
Net revenues increased by 17.8% to $307.2 million in 2000 from $260.8
million in 1999. The revenue increase was primarily due to an increase in
average quarterly student enrollment ($25.4 million) and tuition increases of
approximately 5% ($16.2 million). The average academic year (three academic
quarters) tuition rate for a student attending classes at an Art Institute on a
recommended full schedule increased to $11,703 in 2000 from $11,262 in 1999.
Net housing revenues increased by 23.2% to $18.1 million in 2000 from $14.7
million in 1999 and revenues from the sale of educational materials in 2000
increased by 11.8% to $13.8 million. Both increased primarily as a result of
higher average student enrollment. Refunds increased from $8.0 million in 1999
to $8.6 million in 2000. As a percentage of gross revenue, refunds decreased
from 1999.
EDUCATIONAL SERVICES
Educational services expense increased by $30.4 million, or 17.8%, to
$201.2 million in 2000 from $170.7 million in 1999. The increase was primarily
due to additional costs required to service higher student enrollment,
accompanied by normal cost increases for wages and other services at the schools
owned by EDMC prior to 1999 ($23.0 million) and schools added in 1999 and 2000
($7.5 million). Higher costs associated with establishing and supporting new
schools and developing new education programs contributed to the increase. As a
percentage of net revenues, educational services expense was consistent between
years.
GENERAL AND ADMINISTRATIVE
General and administrative expense increased by 15.8% to $66.2 million in
2000 from $57.2 million in 1999 due to the incremental marketing and student
admissions expenses incurred to generate higher student enrollment at the
schools owned by EDMC prior to 1999 ($5.0 million) and additional marketing and
student admissions expenses at the schools added in 1999 and 2000 ($3.1
million). General and administrative expense decreased slightly as a percentage
of net revenues in 2000 compared to 1999, reflecting operating leverage related
to central support functions.
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AMORTIZATION OF INTANGIBLES
Amortization of intangibles increased by $0.3 million, or 25.6%, to $1.5
million in 2000 from $1.2 million in 1999, as a result of additional
amortization associated with fiscal 2000 acquisitions.
INTEREST EXPENSE (INCOME), NET
The Company had net interest expense of $726,000 in 2000 as compared to
interest income of $113,000 in 1999. The average outstanding debt balance
increased from $4.6 million in 1999 to $15.6 million in 2000. The increase in
borrowings relates primarily to capital expenditures, acquisitions and the
repurchase of shares of Common Stock.
PROVISION FOR INCOME TAXES
The Company's effective tax rate decreased to 40.1% in 2000 from 41.1% in
1999. This reduction reflects a more favorable distribution of taxable income
among the states in which the Company operates and a decrease in nondeductible
expenses as a percentage of taxable income. The effective rates differed from
the combined federal and state statutory rates due to expenses that are
nondeductible for income tax purposes.
NET INCOME
Net income increased by $3.8 million or 20.1% to $22.5 million in 2000 from
$18.8 million in 1999. The increase resulted from improved operations at the
Company's schools owned prior to 1999 and a lower effective income tax rate.
YEAR ENDED JUNE 30, 1999 COMPARED WITH YEAR ENDED JUNE 30, 1998
NET REVENUES
Net revenues increased by 17.6% to $260.8 million in 1999 from $221.7
million in 1998. The revenue increase was primarily due to an increase in
average quarterly student enrollment ($23.2 million) and tuition increases of
approximately 6% ($12.5 million). The average academic year (three academic
quarters) tuition rate for a student attending classes at an Art Institute on a
recommended full schedule increased to $11,262 in 1999 from $10,350 in 1998.
Net housing revenues increased by 13.4% to $14.7 million in 1999 from $12.9
million in 1998 and revenues from the sale of educational materials in 1999
increased by 17.3% to $12.3 million. Both increased primarily as a result of
higher average student enrollment. Refunds increased from $7.1 million in 1998
to $8.0 million in 1999. As a percentage of gross revenue, refunds decreased
slightly from 1998.
EDUCATIONAL SERVICES
Educational services expense increased by $23.4 million, or 15.9%, to
$170.7 million in 1999 from $147.3 million in 1998. The increase was primarily
due to additional costs required to service higher student enrollment,
accompanied by normal cost increases for wages and other services at the schools
owned by EDMC prior to 1998 ($15.8 million) and schools added in 1998 and 1999
($6.0 million). Higher costs associated with establishing and supporting new
schools and developing new education programs contributed to the increase. As a
percentage of net revenues, educational services expense decreased from 66.4% in
1998 to 65.5% in 1999, reflecting leverage on fixed costs.
GENERAL AND ADMINISTRATIVE
General and administrative expense increased by 18.9% to $57.2 million in
1999 from $48.1 million in 1998 due to the incremental marketing and student
admissions expenses incurred to generate higher student enrollment at the
schools owned by EDMC prior to 1998 ($4.8 million), and additional marketing and
student admissions expenses at the schools added in 1998 and 1999 ($2.9
million). General and administrative expense increased slightly as a percentage
of net revenues in 1999 compared to 1998 as a result of increased advertising
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expenditures designed to promote awareness of and generate inquiries about the
newer locations and new program offerings.
AMORTIZATION OF INTANGIBLES
Amortization of intangibles decreased by $0.4 million, or 25.3%, to $1.2
million in 1999 from $1.6 million in 1998, as a result of certain intangible
assets becoming fully amortized.
INTEREST EXPENSE (INCOME), NET
The Company had net interest income of $113,000 in 1999 as compared to
$3,000 in 1998. The average outstanding debt balance decreased from $5.6 million
in 1998 to $4.6 million in 1999. Accordingly, less interest cost on borrowings
has been offset against interest earned on investments.
PROVISION FOR INCOME TAXES
The Company's effective tax rate decreased to 41.1% in 1999 from 42.0% in
1998. This reduction reflects a decrease in nondeductible expenses as a
percentage of taxable income. The effective rates differed from the combined
federal and state statutory rates due to expenses that are nondeductible for
income tax purposes.
NET INCOME
Net income increased by $4.4 million or 30.9% to $18.8 million in 1999 from
$14.3 million in 1998. The increase resulted from improved operations at the
Company's schools owned prior to 1998, reduced amortization of intangibles and a
lower effective income tax rate.
SEASONALITY AND OTHER FACTORS AFFECTING QUARTERLY RESULTS
The Company's quarterly revenues and income fluctuate primarily as a result
of the pattern of student enrollment. The Company experiences a seasonal
increase in new enrollment in the fall (fiscal year second quarter), which is
traditionally when the largest number of new high school graduates begin
postsecondary education. Some students choose not to attend classes during
summer months, although the Company's schools encourage year-round attendance.
As a result, total student enrollment at the Company's schools is highest in the
fall quarter and lowest in the summer months (fiscal year first quarter). The
Company's costs and expenses, however, do not fluctuate as significantly as
revenues on a quarterly basis. The Company anticipates that the seasonal pattern
in revenues and earnings will continue in the future.
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QUARTERLY FINANCIAL RESULTS (UNAUDITED)
The following table sets forth the Company's quarterly results for 1999 and
2000.
1999
-----------------------------------------------
SEPT. 30 DEC. 31 MAR. 31 JUNE 30
(SUMMER) (FALL) (WINTER) (SPRING)
--------- -------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net revenues....................................... $50,079 $74,986 $70,575 $65,165
Income before interest and taxes................... $ 698 $16,646 $10,249 $ 4,105
Income before income taxes......................... $ 732 $16,543 $10,365 $ 4,171
Net income......................................... $ 425 $ 9,749 $ 6,105 $ 2,473
Net income per share
--Basic.......................................... $ .01 $ .33 $ .21 $ .08
--Diluted........................................ $ .01 $ .32 $ .20 $ .08
2000
-----------------------------------------------
SEPT. 30 DEC. 31 MAR. 31 JUNE 30
(SUMMER) (FALL) (WINTER) (SPRING)
--------- -------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net revenues....................................... $60,850 $87,023 $83,195 $76,181
Income before interest and taxes................... $ 1,693 $19,566 $11,968 $ 5,115
Income before income taxes......................... $ 1,570 $19,247 $11,881 $ 4,918
Net income......................................... $ 926 $11,524 $7 ,113 $ 2,967
Net income per share
--Basic.......................................... $ .03 $ .40 $ .25 $ .10
--Diluted........................................ $ .03 $ .39 $ .24 $ .10
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flow from operations has been the primary source of
financing for capital expenditures and growth. Additionally, the Company
maintains a revolving credit facility. Cash flow from operations was $28.6
million, $35.7 million and $46.8 million for 1998, 1999 and 2000, respectively.
For the years ended June 30, 1999 and 2000, cash flow from operations and cash
flow from investing activities are reflected net of approximately $5.1 million
and $13.2 million of capital expenditures included in accounts payable as of
June 30, 1999 and 2000, respectively. As a result of the significant increase in
capital expenditures, the Company had net working capital of $3.8 million as of
June 30, 2000, down from $10.5 million as of June 30, 1999.
As of June 30, 2000, gross trade accounts receivable increased by $6.7
million, or 34.3%, to $26.1 million from the prior year as a result of the
increased net revenues and acquisitions. The allowance for doubtful accounts
increased by $4.7 million, or 50.4%, to $14.1 million in 2000 from $9.4 million
in 1999.
During the year, the Company entered into a Credit Agreement (the "Credit
Agreement") that provides for borrowings up to $100.0 million and expires
February 18, 2005. Borrowings under this facility are unsecured and bear
interest at one of three rates set forth in the Credit Agreement, at the
election of the Company. Certain outstanding letters of credit reduce this
facility. As of June 30, 2000, the Company had approximately $35.3 million of
borrowing capacity available under the Credit Agreement. The Credit Agreement
contains customary covenants that, among other matters, require the Company to
meet specified interest and leverage ratio requirements and restrict the
repurchase of Common Stock and the incurrence of additional indebtedness. As of
June 30, 2000, the Company was in compliance with all covenants under the Credit
Agreement.
Borrowings under the Credit Agreement are used by the Company primarily to
fund working capital needs resulting from the seasonal pattern of cash receipts
throughout the year. The level of accounts receivable reaches a peak immediately
after the billing of tuition and fees at the beginning of each academic quarter.
Collection of these receivables is heaviest at the start of each academic
quarter.
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The Company believes that cash flow from operations, supplemented from time
to time by borrowings under the Credit Agreement, will provide adequate funds
for ongoing operations, planned expansion to new locations, planned capital
expenditures and debt service during the term of the Credit Agreement.
CAPITAL EXPENDITURES
Capital expenditures made during the three years ended June 30, 2000
reflect the implementation of the Company's initiatives emphasizing the addition
of new schools and education programs and investment in classroom technology.
The aggregate purchase price and costs of subsequent improvements made during
the fiscal year related to the buildings acquired in Denver and Pittsburgh was
approximately $29.2 million. The Company's capital expenditures were $18.0
million, $54.9 million and $57.1 million for 1998, 1999 and 2000, respectively.
The Company expects that total capital spending for 2001 will decrease as a
percentage of net revenues, as compared to 2000. The anticipated expenditures
relate principally to the investment in schools acquired or started during the
previous several years and to be added in 2001, continued improvements to
current facilities, additional or replacement school and housing facilities and
classroom and administrative technology.
The Company leases the majority of its facilities. Future commitments on
existing leases will be paid from cash provided by operating activities.
REGULATION
The Company indirectly derived approximately 62% of its net revenues from
Title IV Programs in 2000. U.S. Department of Education regulations prescribe
the timing of disbursements of funds under Title IV Programs. Students must
apply for a new loan for each academic year. Lenders generally provide loan
funds in multiple disbursements each academic year. For first-time students in
their first academic quarter, the initial loan disbursement is generally
received at least 30 days after the commencement of that academic quarter.
Otherwise, the first loan disbursement is received, at the earliest, 10 days
before the commencement of the student's academic quarter.
U.S. Department of Education regulations require Title IV Program funds
received by the Company's schools in excess of the tuition and fees owed by the
relevant students at that time to be, with these students' permission,
maintained and classified as restricted until they are billed for the portion of
their education program related to those funds. Funds transferred through
electronic funds transfer programs are held in a separate cash account and
released when certain conditions are satisfied. These restrictions have not
significantly affected the Company's ability to fund daily operations.
Education institutions participating in Title IV Programs must satisfy a
series of specific standards of financial responsibility. The U.S. Department of
Education has adopted standards to determine an institution's financial
responsibility to participate in Title IV Programs. The regulations establish
three ratios: (i) the equity ratio, measuring an institution's capital
resources, ability to borrow and financial viability; (ii) the primary reserve
ratio, measuring an institution's ability to support current operations from
expendable resources; and (iii) the net income ratio, measuring an institution's
profitability. Each ratio is calculated separately, based on the figures in the
institution's most recent annual audited financial statements, and then weighted
and combined to arrive at a single composite score. Such composite score must be
at least 1.5 for the institution to be deemed financially responsible without
conditions or additional oversight.
Regulations promulgated under the HEA also require all proprietary
education institutions to comply with the "90/10 Rule," which prohibits
participating schools from deriving 90% or more of total revenue from Title IV
Programs in any year.
If an institution fails to meet any of these requirements, it may be deemed
to be not financially responsible by the U.S. Department of Education, or
otherwise ineligible to participate in Title IV Programs. The Company believes
that all of its participating schools met these requirements as of June 30,
2000.
EFFECT OF INFLATION
The Company does not believe its operations have been materially affected
by inflation.
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IMPACT OF NEW ACCOUNTING STANDARDS
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," was issued. The statement establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value.
Additionally, SFAS No. 133 requires that changes in a derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. This statement has been amended by SFAS No. 137 "Accounting for Derivative
Instruments and Hedging Activities -- Deferral of the effective date of SFAS No.
133." SFAS No. 137 will be effective for all fiscal quarters of fiscal years
beginning after June 15, 2000. The Company does not anticipate that these
standards will have a significant impact on its financial statements.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 101, Revenue Recognition ("SAB No. 101"), to provide
guidance on the recognition, presentation and disclosure of revenue in financial
statements. SAB No. 101 explains the SEC staff's general framework for revenue
recognition. SAB No. 101 does not change existing literature on revenue
recognition, but rather clarifies the SEC's position on pre-existing literature.
SAB No. 101 did not require the Company to change existing revenue recognition
policies and, therefore, had no impact on the Company's financial position or
results of operations at June 30, 2000.
RISK FACTORS
In addition to the important factors described elsewhere in this Annual
Report on Form 10-K, the following factors, among others, could affect the
Company's business, results of operations, financial condition and prospects in
fiscal 2001 and later years: (i) the perceptions of the U.S. Congress, the U.S.
Department of Education and the public concerning proprietary postsecondary
education institutions to the extent those perceptions could result in changes
in the HEA in connection with its reauthorization; (ii) EDMC's ability to comply
with federal and state regulations and accreditation standards, including any
changes therein or changes in the interpretation thereof; (iii) the Company's
ability to foresee changes in the skills required of its graduates and to design
new courses and programs to develop those skills; (iv) the ability of the
Company to gauge successfully which markets are underserved in the skills that
the Company's schools teach; (v) the Company's ability to gauge appropriate
acquisition and start-up opportunities and to manage and integrate them
successfully; (vi) the Company's ability to defend litigation successfully; and
(vii) competitive pressures from other education institutions.
ITEM 7A--QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The fair values and carrying amounts of the Company's financial
instruments, primarily accounts receivable and debt, are approximately
equivalent. The debt instruments bear interest at floating rates based upon
market rates or at fixed rates that approximate market rates. All other
financial instruments are classified as current and will be utilized within the
next operating cycle.
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ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE SHAREHOLDERS OF EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES:
We have audited the accompanying consolidated balance sheets of Education
Management Corporation (a Pennsylvania corporation) and Subsidiaries as of June
30, 1999 and 2000, and the related consolidated statements of income,
shareholders' investment and cash flows for each of the three years in the
period ended June 30, 2000. 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 in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Education Management
Corporation and Subsidiaries as of June 30, 1999 and 2000, and their results of
operations and their cash flows for each of the three years in the period ended
June 30, 2000 in conformity with accounting principles generally accepted in the
United States.
/s/ Arthur Andersen LLP
Pittsburgh, Pennsylvania,
July 27, 2000
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
AS OF JUNE 30,
-------------------
1999 2000
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents, including restricted balances
of $725 and $679....................................... $ 32,871 $ 39,538
Receivables:
Trade, net of allowances of $9,367 and $14,088......... 10,100 12,057
Notes, advances and other.............................. 5,233 4,678
Inventories............................................... 2,038 3,145
Deferred income taxes..................................... 2,476 2,872
Other current assets...................................... 2,991 4,423
-------- --------
Total current assets................................. 55,709 66,713
-------- --------
PROPERTY AND EQUIPMENT, NET................................. 96,081 135,358
DEFERRED INCOME TAXES AND OTHER LONG-TERM ASSETS............ 7,514 10,677
INTANGIBLE ASSETS, NET OF AMORTIZATION OF $4,532 AND
$5,516.................................................... 19,442 27,927
-------- --------
TOTAL ASSETS......................................... $178,746 $240,675
LIABILITIES AND SHAREHOLDERS' INVESTMENT
CURRENT LIABILITIES:
Current portion of long-term debt......................... $ 731 $ 16
Accounts payable.......................................... 12,110 19,898
Accrued liabilities....................................... 11,438 13,062
Advance payments.......................................... 20,909 29,915
-------- --------
Total current liabilities............................ 45,188 62,891
-------- --------
LONG-TERM DEBT, LESS CURRENT PORTION........................ 36,500 64,267
OTHER LONG-TERM LIABILITIES................................. 253 567
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' INVESTMENT:
Common Stock, par value $.01 per share; 60,000,000 shares
authorized; 29,546,833 and 29,877,025 shares issued.... 295 299
Additional paid-in capital................................ 93,736 96,585
Treasury stock, 85,646 and 907,446 shares at cost......... (495) (9,733)
Retained earnings......................................... 3,269 25,799
-------- --------
TOTAL SHAREHOLDERS' INVESTMENT....................... 96,805 112,950
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' INVESTMENT....... $178,746 $240,675
======== ========
The accompanying notes to consolidated financial statements are an integral
part of these statements.
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE YEARS ENDED JUNE 30,
------------------------------
1998 1999 2000
---- ---- ----
NET REVENUES................................................ $221,732 $260,805 $307,249
COSTS AND EXPENSES:
Educational services...................................... 147,336 170,742 201,187
General and administrative................................ 48,094 57,162 66,209
Amortization of intangibles............................... 1,611 1,203 1,511
-------- -------- --------
197,041 229,107 268,907
-------- -------- --------
INCOME BEFORE INTEREST AND TAXES............................ 24,691 31,698 38,342
Interest expense (income), net............................ (3) (113) 726
-------- -------- --------
INCOME BEFORE INCOME TAXES.................................. 24,694 31,811 37,616
Provision for income taxes................................ 10,372 13,059 15,086
-------- -------- --------
NET INCOME.................................................. $ 14,322 $ 18,752 $ 22,530
======== ======== ========
EARNINGS PER SHARE:
Basic.................................................. $ .50 $ .64 $ .78
Diluted................................................ $ .48 $ .61 $ .75
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (IN 000'S):
Basic.................................................. 28,908 29,314 28,964
Diluted................................................ 29,852 30,615 29,921
The accompanying notes to consolidated financial statements are an integral
part of these statements.
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
FOR THE YEARS ENDED JUNE 30,
------------------------------
1998 1999 2000
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 14,322 $ 18,752 $ 22,530
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FLOWS FROM
OPERATING ACTIVITIES:
Depreciation and amortization........................ 14,316 16,766 20,200
Deferred credit for income taxes..................... (1,184) (1,992) (1,895)
Changes in current assets and liabilities:
Receivables....................................... (1,084) (3,655) (1,237)
Inventories....................................... (577) (105) (978)
Other current assets.............................. (87) (650) (1,312)
Accounts payable.................................. 1 57 (724)
Accrued liabilities............................... 473 3,940 2,148
Advance payments.................................. 2,413 2,571 8,090
-------- -------- --------
Total adjustments............................... 14,271 16,932 24,292
-------- -------- --------
Net cash flows from operating activities.......... 28,593 35,684 46,822
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of subsidiaries, net of cash acquired......... (1,488) (500) (8,602)
Expenditures for property and equipment................... (17,951) (49,862) (48,983)
Other items, net.......................................... (233) (674) (1,241)
-------- -------- --------
Net cash flows from investing activities.......... (19,672) (51,036) (58,826)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under revolving credit facilities.......... 8,000 1,500 27,650
Principal payments on debt................................ (3,689) (2,651) (1,666)
Net proceeds from issuance of Common Stock................ 851 2,205 1,925
Repurchase of shares...................................... -- (141) (9,238)
-------- -------- --------
Net cash flows from financing activities.......... 5,162 913 18,671
-------- -------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS..................... 14,083 (14,439) 6,667
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 33,227 47,310 32,871
-------- -------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 47,310 $ 32,871 $ 39,538
======== ======== ========
The accompanying notes to consolidated financial statements are an integral
part of these statements.
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' INVESTMENT
(DOLLARS IN THOUSANDS)
COMMON
STOCK AT ADDITIONAL STOCK TOTAL
PAR PAID-IN TREASURY SUBSCRIPTIONS RETAINED SHAREHOLDERS'
VALUE CAPITAL STOCK RECEIVABLE EARNINGS INVESTMENT
--------- ---------- -------- ------------- -------- -------------
Balance, June 30, 1997......... $289 $87,748 $ (354) $(122) $(29,805) $ 57,756
Net income................... -- -- -- -- 14,322 14,322
Payments on stock
subscriptions
receivable................ -- -- -- 114 -- 114
Exercise of stock options.... 1 611 -- -- -- 612
Stock options issued in
connection with
acquisition of
subsidiary................ -- 77 -- -- -- 77
Issuance of Common Stock
under employee stock
purchase plan............. -- 444 -- -- -- 444
---- ------- ------- ----- -------- --------
Balance, June 30, 1998......... 290 88,880 (354) (8) (15,483) 73,325
Net income................... -- -- -- -- 18,752 18,752
Payments on stock
subscriptions
receivable................ -- -- -- 8 -- 8
Purchase of Common Stock..... -- -- (141) -- -- (141)
Exercise of stock options.... 5 4,278 -- -- -- 4,283
Issuance of Common Stock
under employee stock
purchase plan............. -- 578 -- -- -- 578
---- ------- ------- ----- -------- --------
Balance, June 30, 1999......... 295 93,736 (495) -- 3,269 96,805
Net income................... -- -- -- -- 22,530 22,530
Purchase of Common Stock..... -- -- (9,238) -- -- (9,238)
Exercise of stock options.... 3 2,126 -- -- -- 2,129
Issuance of Common Stock
under employee stock
purchase plan............. 1 723 -- -- -- 724
---- ------- ------- ----- -------- --------
Balance, June 30, 2000....... $299 $96,585 $(9,733) $ -- $ 25,799 $112,950
==== ======= ======= ===== ======== ========
The accompanying notes to consolidated financial statements are an integral
part of these statements.
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. OWNERSHIP AND OPERATIONS:
Education Management Corporation ("EDMC" or the "Company") is among the
largest providers of proprietary postsecondary education in the United States,
based on student enrollment and revenues. Through its operating units, primarily
The Art Institutes ("The Art Institutes"), the Company offers bachelor's and
associate's degree programs and non-degree programs in the areas of design,
media arts, culinary arts, fashion and paralegal studies. The Company has
provided career-oriented education programs for over 35 years.
As of June 30, 2000, EDMC operated 20 schools in 17 major metropolitan
areas throughout the United States. The Art Institute of Washington and The Art
Institute of Los Angeles -- Orange County began operations in July 2000. The
Company's main operating unit, The Art Institutes, offers programs designed to
provide the knowledge and skills necessary for entry-level employment in various
fields, including graphic design, media arts & animation, multimedia & web
design, video production, interior design, industrial design, culinary arts,
photography, and fashion. Those programs typically are completed in 18 to 48
months and culminate in a bachelor's or associate's degree. As of June 30, 2000,
12 Art Institutes offered bachelor's degree programs.
As of June 30, 2000, the Company offered a culinary arts curriculum at 11
Art Institutes and The New York Restaurant School ("NYRS"), a culinary arts and
restaurant management school located in New York City. NYRS offers an
associate's degree program and certificate programs.
The Company offers paralegal and legal nurse consulting training and
financial planning certificate programs for college graduates and working adults
at NCPT in Atlanta, and through relationships with five colleges and
universities.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF CONSOLIDATION AND PRESENTATION
The consolidated financial statements include the accounts of Education
Management Corporation and its subsidiaries. All significant intercompany
transactions and balances have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from these estimates.
GOVERNMENT REGULATIONS
The Art Institutes and NYRS ("the participating schools") participate in
various federal student financial assistance programs ("Title IV Programs")
under Title IV of the Higher Education Act of 1965, as amended (the "HEA").
Approximately 62% of the Company's net revenues in 2000 were indirectly derived
from funds distributed under these programs to students at the participating
schools.
The participating schools are required to comply with certain federal
regulations established by the U.S. Department of Education. Among other things,
they are required to classify as restricted certain Title IV Program funds in
excess of charges currently applicable to students' accounts. Such funds are
reported as restricted cash in the accompanying consolidated balance sheets.
The participating schools are required to administer Title IV Program funds
in accordance with the HEA and U.S. Department of Education regulations and must
use due diligence in approving and disbursing funds and servicing loans. In the
event a participating school does not comply with federal requirements or if
student loan default rates are at a level considered excessive by the federal
government, that school could lose its eligibility to participate in Title IV
Programs or could be required to repay funds determined to have been improperly
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disbursed. Management believes that the participating schools are in substantial
compliance with the federal requirements and that student loan default rates are
not at a level considered to be excessive.
EDMC makes contributions to Federal Perkins Loan Programs (the "Funds") at
certain Art Institutes. Current contributions to the Funds are made 75% by the
federal government and 25% by EDMC. The Company carries its investments in the
Funds at cost, net of an allowance for estimated future loan losses.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments purchased with a
maturity of three months or less to be cash equivalents. These investments are
stated at cost which, based upon the scheduled maturities, approximates market
value.
U.S. Department of Education regulations require Title IV Program funds
received by the Company's schools in excess of the tuition and fees owed by the
relevant students at that time to be, with these students' permission,
maintained and classified as restricted until the students are billed for the
portion of their education program related to those funds. Funds transferred
through electronic funds transfer programs are held in a separate cash account
and released when certain conditions are satisfied. These restrictions have not
significantly affected the Company's ability to fund daily operations.
ACQUISITIONS
On December 19, 1997, the Company purchased certain assets of the Louise
Salinger School in San Francisco, California, for $600,000 in cash. The Company
also entered into a consulting agreement with the former president in exchange
for an option to purchase 20,000 shares of the Company's Common Stock at an
exercise price of $12.97 (the closing price as of the acquisition date). The
assets acquired were principally accounts receivable and equipment. The school
was renamed The Art Institutes International at San Francisco.
On February 7, 1998, the Company acquired certain assets related to the
operations of Bassist College in Portland, Oregon for approximately $900,000 in
cash. The purchase agreement provides for certain adjustments based upon the
resolution of certain liabilities and additional consideration based upon a
specified percentage of gross revenues over a five-year period. The assets
acquired were principally accounts receivable and equipment. The school was
renamed The Art Institute of Portland.
On October 1, 1998, the Company acquired the assets of Socrates Distance
Learning Technologies Group for approximately $500,000 in cash. This acquisition
was made to further the development of the Company's distance learning
capabilities.
On August 17, 1999, the Company acquired the outstanding stock of the
American Business & Fashion Institute in Charlotte, North Carolina, for $500,000
in cash. The school was renamed The Art Institute of Charlotte.
On August 26, 1999, the Company acquired the outstanding stock of
Massachusetts Communications College in Boston, Massachusetts for approximately
$7.2 million in cash.
These acquisitions were accounted for using the purchase method of
accounting, with the excess of the purchase price over the fair value of the
assets acquired being assigned to identifiable intangible assets and goodwill.
The results of the acquired entities have been included in the Company's results
from the respective dates of acquisition. The pro forma effects, individually
and collectively, of the acquisitions in the Company's consolidated financial
statements would not materially impact the reported results.
LEASE ARRANGEMENTS
The Company conducts a major part of its operations from leased facilities.
In addition, the Company leases a portion of its furniture and equipment. In
those cases in which the lease term approximates the useful life of the leased
asset or the lease meets certain other prerequisites, the leasing arrangement is
classified as a capitalized lease. The remaining lease arrangements are treated
as operating leases.
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PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated depreciation.
Expenditures for additions and major improvements are capitalized, while those
for maintenance, repairs and minor renewals are expensed as incurred. The
Company uses the straight-line method of depreciation for financial reporting,
while using different methods for tax purposes. Depreciation is based upon
estimated useful lives, ranging from 3 to 30 years. Leasehold improvements are
amortized over the term of the lease, or over their estimated useful lives,
whichever is shorter.
FINANCIAL INSTRUMENTS
The fair values and carrying amounts of the Company's financial
instruments, primarily accounts receivable and debt, are approximately
equivalent. The debt instruments bear interest at floating rates based upon
market rates or at fixed rates that approximate market rates. All other
financial instruments are classified as current and will be utilized within the
next operating cycle.
REVENUE RECOGNITION AND RECEIVABLES
The Company's net revenues consist of tuition and fees, student housing
charges and supply store and restaurant sales. In fiscal 2000, the Company
derived 89.6% of its net revenues from tuition and fees paid by, or on behalf
of, its students. Net revenues, as presented, are reduced for student refunds
and scholarships.
The Company recognizes tuition and housing revenues on a monthly pro rata
basis over the term of instruction, typically an academic quarter. Student
supply store and restaurant sales are recognized as they occur. Refunds are
calculated in accordance with federal, state and accrediting agency standards.
Advance payments represent that portion of payments received but not earned and
are reflected as a current liability in the accompanying consolidated balance
sheets.
The trade receivable balances are comprised of individually insignificant
amounts due primarily from students throughout the United States.
COSTS AND EXPENSES
Educational services expense consists primarily of costs related to the
development, delivery and administration of the Company's education programs.
Major cost components are faculty compensation, administrative salaries, costs
of educational materials, facility leases and school occupancy costs,
information systems costs and bad debt expense, along with depreciation and
amortization of property and equipment.
General and administrative expense consists of marketing and student
admissions expenses and certain central staff departmental costs such as
executive management, finance and accounting, legal, corporate development and
other departments that do not provide direct services to the Company's students.
Amortization of intangibles relates primarily to the values assigned to
identifiable intangibles and goodwill, which arose principally from the
acquisitions discussed above. These intangible assets are amortized over periods
ranging from 2 to 40 years.
NEW ACCOUNTING STANDARDS
In December 1999, the Securities and Exchange Commission (SEC) released
Staff Accounting Bulletin No. 101, Revenue Recognition ("SAB No. 101"), to
provide guidance on the recognition, presentation and disclosure of revenue in
financial statements. SAB No. 101 explains the SEC staff's general framework for
revenue recognition. SAB No. 101 does not change existing literature on revenue
recognition, but rather clarifies the SEC's position on pre-existing literature.
SAB No. 101 did not require the Company to change existing revenue recognition
policies and, therefore, had no impact on the Company's financial position or
results of operations at June 30, 2000.
32
33
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
YEAR ENDED JUNE 30,
-----------------------------
1998 1999 2000
---- ---- ----
(IN THOUSANDS)
Cash paid during the period for:
Interest (net of amount capitalized)........ $ 771 $ 313 $ 175
Income taxes................................ 13,373 13,846 15,590
Noncash investing and financing activities:
Expenditures for property and equipment
included in accounts payable............. -- 5,071 13,161
Tax deduction for options exercised......... 291 2,664 928
RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the
current year presentation.
3. SHAREHOLDERS' INVESTMENT:
Pursuant to the Company's Preferred Share Purchase Rights Plan (the "Rights
Plan"), one Preferred Share Purchase Right (a "Right") is associated with each
outstanding share of Common Stock. Each Right entitles its holder to buy one
two-hundredth of a share of Series A Junior Participating Preferred Stock, $.01
par value, at an exercise price of $50, subject to adjustment (the "Purchase
Price"). The Rights Plan is not subject to shareholder approval.
The Rights will become exercisable under certain circumstances following a
public announcement by a person or group of persons (an "Acquiring Person") that
they acquired or commenced a tender offer for 17.5% or more of the outstanding
shares of Common Stock. If an Acquiring Person acquires 17.5% or more of the
Common Stock, each Right will entitle its holder, except the Acquiring Person,
to acquire upon exercise a number of shares of Common Stock having a market
value of two times the Purchase Price. In the event that the Company is acquired
in a merger or other business combination transaction or 50% or more of its
consolidated assets or earning power are sold after a person or group of persons
becomes an Acquiring Person, each Right will entitle its holder to purchase, at
the Purchase Price, that number of shares of the acquiring company having a
market value of two times the Purchase Price. The Rights will expire on the
tenth anniversary of the closing of the IPO and are subject to redemption by the
Company at $.01 per Right, subject to adjustment.
On December 2, 1998, the Company's Board of Directors authorized a
two-for-one stock split effected in the form of a stock dividend. The
distribution was made on December 29, 1998 to shareholders of record as of the
close of business on December 8, 1998. Shareholders received one share of Common
Stock for each outstanding share of Common Stock owned.
On November 10, 1997, certain principal shareholders of the Company sold
6,141,984 shares of Common Stock in a public offering. The Company did not
receive any proceeds from this offering and was reimbursed by the selling
shareholders for all out-of-pocket expenses related to this offering.
4. EARNINGS PER SHARE:
Basic EPS is computed using the weighted average number of shares actually
outstanding during the period, while diluted EPS is calculated to reflect the
potential dilution related to stock options.
33
34
RECONCILIATION OF DILUTED SHARES
YEAR ENDED JUNE 30,
--------------------------
1998 1999 2000
---- ---- ----
(IN THOUSANDS)
Basic shares..................................... 28,908 29,314 28,964
Dilution for stock options....................... 944 1,301 957
------ ------ ------
Diluted shares................................... 29,852 30,615 29,921
====== ====== ======
5. PROPERTY AND EQUIPMENT:
Property and equipment consisted of the following as of June 30:
1999 2000
---- ----
(IN THOUSANDS)
Assets (asset lives in years)
Land................................................ $ 2,800 $ 4,400
Buildings and improvements (15 to 30)............... 16,075 29,272
Equipment and furniture (3 to 10)................... 89,528 114,272
Leasehold interests and improvements (2 to 20)...... 50,399 59,446
Construction in progress............................ 12,550 19,707
-------- --------
Total............................................ 171,352 227,097
Less accumulated depreciation....................... 75,271 91,739
-------- --------
$ 96,081 $135,358
======== ========
6. LONG-TERM DEBT:
The Company and its subsidiaries were indebted under the following
obligations as of June 30:
1999 2000
---- ----
(IN THOUSANDS)
Revolving credit facilities............................. $36,500 $64,150
Other indebtedness...................................... 731 133
------- -------
37,231 64,283
Less current portion.................................... 731 16
------- -------
$36,500 $64,267
======= =======
During the year, the Company entered into a revolving credit agreement (the
"Credit Agreement") that provides for borrowings up to $100.0 million and
expires February 18, 2005. Borrowings under this facility are unsecured and bear
interest at one of three rates set forth in the Credit Agreement, at the
election of the Company. Certain outstanding letters of credit reduce this
facility. The Credit Agreement contains customary covenants that, among other
matters, require the Company to meet specified interest and leverage ratio
requirements, restrict the repurchase of Common Stock and the incurrence of
additional indebtedness. As of June 30, 2000, the Company was in compliance with
all covenants under the Credit Agreement. As of June 30, 2000, the average
interest rate for borrowings under the Credit Agreement was 8.00%.
34
35
Relevant information regarding borrowings under the revolving credit
facilities under both the Credit Agreement and the prior borrowing agreement is
reflected below:
YEAR ENDED JUNE 30,
-----------------------------
1998 1999 2000
------- ------- -------
(IN THOUSANDS)
Outstanding borrowings, end of period......... $35,000 $36,500 $64,150
Approximate average outstanding balance
throughout the period....................... 530 2,550 15,215
Approximate maximum outstanding balance during
the period.................................. 35,000 37,000 79,850
Weighted average interest rate for the
period...................................... 8.50% 7.48% 7.45%
7. COMMITMENTS AND CONTINGENCIES:
The Company and its subsidiaries lease certain classroom, dormitory and
office space under operating leases, which expire on various dates through
August 2019. Rent expense under these leases was approximately $24,904,000,
$28,250,000, and $33,645,000 respectively for 1998, 1999 and 2000. The
approximate minimum future commitments under non-cancelable, long-term operating
leases as of June 30, 2000 are reflected below:
FISCAL YEARS (IN THOUSANDS)
- ------------ --------------
2001................................................... 31,038
2002................................................... 27,080
2003................................................... 24,844
2004................................................... 24,444
2005................................................... 24,205
Thereafter............................................. 156,621
--------
$288,232
========
The Company has a management incentive compensation plan that provides for
the awarding of cash bonuses to management personnel using formalized guidelines
based upon the operating results of each subsidiary and the Company.
The Company and its wholly-owned subsidiaries The Art Institutes
International, Inc. ("AII") and The Art Institute of Houston, Inc. and its
president are defendants in a suit brought by former and current students who
allege being misled about the benefits or quality of educational services
provided to them at The Art Institute of Houston. The complaint does not specify
the amount of damages being sought. Given the nature of plaintiffs' claims and
the inherent uncertainties of litigation, management is unable to predict the
ultimate number, scope, or duration of any such claims or the eventual outcome
or costs of defending any such claims.
The Company is also a defendant in certain other legal proceedings arising
out of the conduct of its businesses. In the opinion of management, based upon
its investigation of these claims and discussion with legal counsel, the
ultimate outcome of such legal proceedings, individually and in the aggregate,
will not have a material adverse effect on the consolidated financial position,
results of operations or liquidity of the Company.
8. RELATED PARTY TRANSACTIONS:
The Art Institute of Philadelphia, Inc., a wholly-owned subsidiary of AII,
leases one of the buildings it occupies from a partnership in which the
subsidiary serves as a 1% general partner and an executive officer/director and
a director of EDMC are minority limited partners. The Art Institute of Fort
Lauderdale, Inc., another wholly-owned subsidiary of AII, leases part of its
facility from a partnership in which an executive officer/director of EDMC is a
minority limited partner. Total rental payments under these arrangements were
approximately $1,894,000, $1,901,000 and $2,214,000 for the years ended June 30,
1998, 1999, and 2000, respectively.
35
36
9. EMPLOYEE BENEFIT PLANS:
The Company sponsors a retirement plan that covers substantially all
employees. This plan provides for matching Company contributions of 100% of
employee 401(k) contributions up to 3% of compensation and 50% of contributions
between 4% and 6% of compensation. Other contributions to the plan are at the
discretion of the Board of Directors. The expense relating to these plans was
approximately $1,198,000, $2,198,000, and $1,181,000 for the years ended June
30, 1998, 1999 and 2000, respectively.
The Company's retirement plan includes an ESOP, which enables eligible
employees to have stock ownership in the Company. The ESOP provides for the
allocations of forfeited shares and cash to be made to the accounts of eligible
participating employees based upon each participant's compensation level
relative to the total compensation of all eligible employees. Eligible employees
vest their ESOP accounts based on a seven-year schedule, which includes credit
for past service. Distribution of shares from the ESOP is made following the
retirement, disability or death of an employee. For employees who terminate for
any other reason, their vested balance will be offered for distribution in
accordance with the terms of the ESOP.
10. DEFERRED INCOME TAXES AND OTHER LONG-TERM ASSETS:
Deferred income taxes and other long-term assets consist of the following
as of June 30:
1999 2000
---- ----
(IN THOUSANDS)
Investment in Federal Perkins Loan Program, net of
allowance for estimated future loan losses of $1,155
and $1,209............................................. $2,617 $ 2,819
Cash value of life insurance, net of loans of $781 each
year; face value of $6,065............................. 2,324 2,620
Deferred income taxes.................................... 548 2,046
Other.................................................... 2,025 3,192
------ -------
$7,514 $10,677
====== =======
11. ACCRUED LIABILITIES:
Accrued liabilities consist of the following as of June 30:
1999 2000
---- ----
(IN THOUSANDS)
Payroll taxes and payroll related....................... $ 6,924 $ 7,714
Income and other taxes.................................. 545 404
Other................................................... 3,969 4,944
------- -------
$11,438 $13,062
======= =======
12. INCOME TAXES:
The provision for income taxes includes current and deferred taxes as
reflected below:
YEAR ENDED JUNE 30,
-----------------------------
1998 1999 2000
------- ------- -------
(IN THOUSANDS)
Current taxes:
Federal..................................... $ 9,780 $11,824 $14,020
State....................................... 1,776 3,227 2,961
------- ------- -------
Total current taxes...................... 11,556 15,051 16,981
------- ------- -------
Deferred taxes................................ (1,184) (1,992) (1,895)
------- ------- -------
Total provision.......................... $10,372 $13,059 $15,086
======= ======= =======
36
37
The provision for income taxes reflected in the accompanying consolidated
statements of income vary from the amounts that would have been provided by
applying the federal statutory income tax rate to earnings before income taxes
as shown below:
YEAR ENDED JUNE 30,
--------------------
1998 1999 2000
---- ---- ----
Federal statutory income tax rate...................... 35.0% 35.0% 35.0%
State and local income taxes, net of federal income tax
benefit.............................................. 4.7 4.9 4.4
Amortization of goodwill and other intangibles......... .6 .5 .4
Nondeductible expenses................................. 1.0 .7 .4
Other, net............................................. .7 -- (.1)
---- ---- ----
Effective income tax rate......................... 42.0% 41.1% 40.1%
==== ==== ====
Net deferred income tax assets (liabilities) consist of the following
as of June 30:
1998 1999 2000
------- ------- -------
(IN THOUSANDS)
Deferred income tax--current................... $ 2,361 $ 2,476 $ 2,872
Deferred income tax--long term................. (1,329) 548 2,046
------- ------- -------
Net deferred income tax asset................ $ 1,032 $ 3,024 $ 4,918
======= ======= =======
Consisting of:
Allowance for doubtful accounts........... $ 3,494 $ 3,850 $ 5,649
Assigned asset values in excess of tax
basis................................... (1,753) (1,585) (1,767)
Depreciation.............................. (314) 1,508 1,687
Financial reserves and other.............. (395) (749) (651)
------- ------- -------
Net deferred income tax asset................ $ 1,032 $ 3,024 $ 4,918
======= ======= =======
13. STOCK-BASED COMPENSATION:
The Company adopted a Stock Incentive Plan in October 1996 (the "1996
Plan") for directors, executive management and key personnel. During fiscal
2000, the 1996 Plan was amended to provide for the issuance of stock-based
incentive awards with respect to a maximum of 5,000,000 (previously 2,500,000)
shares of Common Stock. During 1998, 1999 and 2000, options covering a total of
40,000, 1,372,523 and 1,253,500 shares, respectively, were granted under the
1996 Plan. Options issued under this plan provide for time-based vesting over
four years.
The Company also has two non-qualified management stock option plans under
which options to purchase a maximum of 1,119,284 shares of Common Stock were
granted to management employees prior to 1996. Substantially all outstanding
options under these non-qualified plans are fully vested. Under the terms of the
three plans, the Board of Directors granted options to purchase shares at prices
varying from $1.27 to $19.38 per share, representing the fair market value at
the time of the grant. Compensation expense related to vesting of certain
options of $375,000 was recognized for the year ended June 30, 1997.
The Company also has an employee stock purchase plan. The plan allows
eligible employees of the Company to purchase up to an aggregate of 1,500,000
shares of Common Stock at quarterly intervals through periodic payroll
deduction. The number of shares of Common Stock issued under this plan was
36,508, 37,620 and 59,800 in 1998, 1999 and 2000, respectively.
The Company accounts for these plans under Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees." Had compensation
expense for the stock option and stock purchase plans been
37
38
determined consistent with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net income and earnings per share would have been
reduced to the following pro forma amounts:
1998 1999 2000
------- ------- -------
Net income (in 000's):.................. As reported $14,322 $18,752 $22,530
Pro forma $13,591 $16,850 $19,421
Basic EPS:.............................. As reported $ .50 $ .64 $ .78
Pro forma $ .47 $ .57 $ .67
Diluted EPS:............................ As reported $ .48 $ .61 $ .75
Pro forma $ .46 $ .55 $ .65
SUMMARY OF STOCK OPTIONS
1998 1999 2000
--------------------- ---------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- -------- ------- -------- ------- --------
Outstanding, beginning of
year..................... 2,192,716 $ 5.00 2,110,240 $ 5.21 2,872,653 $10.11
Granted.................... 60,000 13.14 1,372,523 15.54 1,253,500 9.47
Exercised.................. 115,476 5.09 544,610 4.42 270,392 4.44
Forfeited.................. 27,000 7.50 65,500 13.29 86,770 12.72
---------- ------ ---------- ------ ---------- ------
Outstanding, end of year... 2,110,240 $ 5.21 2,872,653 $10.11 3,768,991 $10.25
========== ====== ========== ====== ========== ======
Exercisable, end of year... 1,267,164 1,031,753 1,403,885
========== ========== ==========
Weighted average fair value
of options granted*...... $ 5.21 $ 7.97 $ 5.58
========== ========== ==========
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ---------------------------------------------------------------------- ----------------------------
WEIGHTED-AVERAGE
RANGE OF REMAINING CONTRACTUAL WEIGHTED-AVERAGE WEIGHTED-AVERAGE
EXERCISE PRICES OPTIONS LIFE (YEARS) EXERCISE PRICE OPTIONS EXERCISE PRICE
- --------------- ------- ------------ -------------- ------- --------------
$ 1.59 - $ 1.75 283,624 1.39 $ 1.65 283,624 $1.65
2.85 - 3.60 193,704 3.62 3.02 193,704 3.02
7.50 - 11.13 1,952,033 8.25 8.70 555,400 7.60
12.38 - 19.38 1,339,630 8.25 15.36 371,158 15.23
--------- ----- ------ --------- -----
3,768,991 7.49 $10.25 1,403,885 $7.78
========= ===== ====== ========= =====
- ---------------
* The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions for grants:
1998 1999 2000
---- ---- ----
Risk-free interest rate................................ 6.12% 4.97% 6.45%
Expected dividend yield................................ 0 0 0
Expected life of options (years)....................... 6 6 6
Expected volatility rate............................... 33.7% 46.0% 55.0%
ITEM 9-- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
38
39
PART III
ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The information required by this Item will be contained in the Proxy
Statement under the captions "Nominees as Directors for Terms Expiring at the
2003 Annual Meeting of Shareholders," "Directors Continuing in Office,"
"Executive Officers of the Company," and "Section 16(a) Beneficial Ownership
Reporting Compliance," and is incorporated herein by reference.
ITEM 11--EXECUTIVE COMPENSATION
The information required by this Item will be contained in the Proxy
Statement under the captions "Compensation of Executive Officers," "Directors'
Compensation," "Compensation Committee Interlocks and Insider Participants" and
"Employment Agreements," and is incorporated herein by reference.
ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be contained in the Proxy
Statement under the caption "Security Ownership," and is incorporated herein by
reference.
ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be contained in the Proxy
Statement under the caption "Certain Transactions," and is incorporated herein
by reference.
PART IV
ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The exhibits listed on the Exhibit Index on pages E-1 and E-2 of this
Form 10-K are filed herewith or are incorporated herein by reference.
(1) Financial Statements:
The following financial statements of the Company and its subsidiaries
are included in Part II, Item 8, on pages 25 through 38 of this Form
10-K.
Report of Independent Public Accountants
Consolidated Balance Sheets for years ended June 30, 1999 and 2000
Consolidated Statements of Income for years ended June 30, 1998, 1999
and 2000
Consolidated Statements of Cash Flows for years ended June 30, 1998,
1999 and 2000
Consolidated Statements of Shareholders' Investment for years ended
June 30, 1998, 1999 and 2000
Notes to Consolidated Financial Statements
(2) Supplemental Financial Statement Schedules
Valuation and Qualifying Accounts, on page S-1 of this Form 10-K, is
filed herewith.
(b) No reports on Form 8-K were filed during the three months ended June
30, 2000.
39
40
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.
EDUCATION MANAGEMENT CORPORATION
By: /s/ ROBERT B. KNUTSON
------------------------------------
Robert B. Knutson
Chairman and Chief Executive Officer
Date: September 28, 2000
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ ROBERT B. KNUTSON Chairman and Chief September 28, 2000
- --------------------------------------------- Executive Officer; Director
Robert B. Knutson
/s/ ROBERT P. GIOELLA President and Chief September 28, 2000
- --------------------------------------------- Operating Officer; Director
Robert P. Gioella
/s/ JOHN R. MCKERNAN, JR. Vice Chairman; Director September 28, 2000
- ---------------------------------------------
John R. McKernan, Jr.
/s/ ROBERT T. MCDOWELL Executive Vice President and September 28, 2000
- --------------------------------------------- Chief Financial Officer
Robert T. McDowell
/s/ MIRYAM L. KNUTSON Director September 28, 2000
- ---------------------------------------------
Miryam L. Knutson
/s/ JAMES J. BURKE, JR. Director September 28, 2000
- ---------------------------------------------
James J. Burke, Jr.
/s/ ALBERT GREENSTONE Director September 28, 2000
- ---------------------------------------------
Albert Greenstone
/s/ ROBERT H. ATWELL Director September 28, 2000
- ---------------------------------------------
Robert H. Atwell
/s/ WILLIAM M. CAMPBELL, III Director September 28, 2000
- ---------------------------------------------
William M. Campbell, III
/s/ JAMES S. PASMAN, JR. Director September 28, 2000
- ---------------------------------------------
James S. Pasman, Jr.
/s/ DANIEL M. FITZPATRICK Vice President and Controller September 28, 2000
- ---------------------------------------------
Daniel M. Fitzpatrick
40
41
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT METHOD OF FILING
- ------- ------- ----------------
3.01 Amended and Restated Articles of Incorporation Incorporated herein by
reference to Exhibit 3.01
to the Annual Report on
Form 10-K for the year
ended June 30, 1997 (the
"1997 Form 10-K")
3.02 Articles of Amendment filed on February 4, 1997 Incorporated herein by
reference to Exhibit 3.02
to the 1997 Form 10-K
3.03 Restated By-laws Incorporated herein by
reference to Exhibit 3.03
to the 1997 Form 10-K
4.01 Specimen Common Stock Certificate Incorporated herein by
reference to Exhibit 4.01
to Amendment No. 3 filed
on October 28, 1996 to the
Registration Statement on
Form S-1 (File No.
333-10385) filed on August
19, 1996 (the "Form S-1")
4.02 Rights Agreement, dated as of October 1, 1996, between Education Incorporated herein by
Management Corporation and Mellon Bank, N.A reference to Exhibit 4.02
to the 1997 Form 10-K
4.03 Amendment No. 1, dated November 9, 1999, to the Rights Agreement Incorporated herein by
dated as of October 1, 1996 between the Company and ChaseMellon reference to Exhibit 4.01
Shareholder Services, L.L.C., as Rights Agent to Quarterly Report on
Form 10-Q for the quarter
ended September 30, 1999
(the "September 30, 1999
10-Q")
4.04 Letter Agreement dated November 9, 1999 by and among the Company, Incorporated herein by
Baron Capital Group, Inc., BAMCO, Inc., Baron Capital Management, reference to Exhibit 4.02
Inc. and Ronald Baron to the September 30, 1999
10-Q
4.05 Credit Agreement, dated February 18, 2000, among Education Incorporated herein by
Management Corporation, certain banks, National City Bank of reference to Exhibit 4.01
Pennsylvania and First Union National Bank to Quarterly Report on
Form 10-Q for the quarter
ended March 31, 2000 (the
"March 31, 2000 Form
10-Q")
4.06 First Amendment to Credit Agreement, dated March 31, 2000 among Incorporated herein by
Education Management Corporation, certain banks, National City reference to Exhibit 4.02
Bank of Pennsylvania and First Union National Bank to the March 2000 Form
10-Q
10.01 Education Management Corporation Retirement Plan Incorporated herein by
reference to Exhibit 10.01
to the Annual Report on
Form 10-K for the year
ended June 30, 1999 (the
"1999 Form 10-K")
E-1
42
EXHIBIT
NUMBER EXHIBIT METHOD OF FILING
- ------- ------- ----------------
10.02 Education Management Corporation Management Incentive Stock Incorporated herein by
Option Plan, effective November 11, 1993 reference to Exhibit 10.05
to the Form S-1*
10.03 EMC Holdings, Inc. Management Incentive Stock Option Plan, Incorporated herein by
effective July 1, 1990 reference to Exhibit 10.06
to Amendment No. 1*
10.04 Form of Management Incentive Stock Option Agreement, dated Incorporated herein by
various dates, between EMC Holdings, Inc. and various management reference to Exhibit 10.07
employees to Amendment No. 1*
10.05 Form of Amendment to Management Incentive Stock Option Agreement, Incorporated herein by
dated January 19, 1995, among Education Management Corporation reference to Exhibit 10.08
and various management employees to Amendment No. 1*
10.06 Education Management Corporation Deferred Compensation Plan Incorporated herein by
reference to Exhibit 10.06
to the 1999 Form 10-K*
10.07 1996 Employee Stock Purchase Plan Incorporated herein by
reference to Exhibit 10.12
to Amendment No. 1
10.08 Education Management Corporation 1996 Stock Incentive Plan Incorporated herein by
reference to Exhibit 10.13
to Amendment No. 1*
10.09 Third Amended and Restated Employment Agreement, dated as of Incorporated herein by
September 8, 1999 between Robert B. Knutson and Education reference to Exhibit 10.09
Management Corporation to the 1999 Form 10-K*
10.10 Form of Employment Agreement, dated as of June 4 and September 8, Incorporated herein by
1999, between certain executives and Education Management reference to Exhibit 10.10
Corporation to the 1999 Form 10-K*
10.11 Form of EMC-Art Institutes International, Inc. Director's and/or Incorporated herein by
Officer's Indemnification Agreement reference to Exhibit 10.17
to the Form S-1
10.12 Senior Management Team Incentive Compensation Plan Incorporated herein by
reference to Exhibit 10.12
to the 1999 Form 10-K*
10.13 Common Stock Registration Rights Agreement, dated as of August Incorporated herein by
15, 1996, among Education Management Corporation and Marine reference to Exhibit 10.19
Midland Bank, Northwestern Mutual Life Insurance Company, to the 1997 Form 10-K
National Union Fire Insurance Company of Pittsburgh, PA, Merrill
Lynch Employees LBO Partnership No. I, L.P., Merrill Lynch IBK
Positions, Inc., Merrill Lynch KECALP L.P., 1986, Merrill Lynch
Offshore LBO Partnership No. IV, Merrill Lynch Capital
Corporation, Merrill Lynch Capital Appreciation Partnership IV,
L.P., Robert B. Knutson and certain other individuals
21.01 Material subsidiaries of Education Management Corporation Filed herewith
23.01 Consent of Arthur Andersen LLP Filed herewith
27.01 Financial Data Schedule Filed herewith
- ---------------
* Management contract or compensatory plan or arrangement
E-2
43
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
We have audited in accordance with auditing standards generally accepted in the
United States, the consolidated financial statements of Education Management
Corporation and Subsidiaries included in this registration statement, and have
issued our report thereon dated July 27, 2000. Our audit was made for the
purpose of forming an opinion on the basic financial statements taken as a
whole. The schedule listed in Item 14(a)(2) of this Form 10-K is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
/s/ Arthur Andersen LLP
Pittsburgh, Pennsylvania
July 27, 2000
SCHEDULE
EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN THOUSANDS)
BALANCE AT ADDITIONS BALANCE AT
BEGINNING CHARGED TO END OF
OF PERIOD EXPENSES DEDUCTIONS OTHER(A) PERIOD
---------- ---------- ---------- -------- ----------
ALLOWANCE ACCOUNTS FOR:
Year ended June 30, 1998
Uncollectible accounts receivable......... $7,393 $5,443 $4,518 $ -- $ 8,318
Estimated future loan losses.............. 602 430 -- -- 1,032
Year ended June 30, 1999
Uncollectible accounts receivable......... $8,318 $5,660 $4,611 $ -- $ 9,367
Estimated future loan losses.............. 1,032 123 -- -- 1,155
Year ended June 30, 2000
Uncollectible accounts receivable......... $9,367 $7,551 $2,986 $156 $14,088
Estimated future loan losses.............. 1,155 54 -- -- 1,209
- ---------
(a) Allowance for uncollectible accounts receivable acquired in connection with
acquisitions of subsidiaries.
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