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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the period ended: September 30, 2002
Commission File Number: 000-21363
 

 
EDUCATION MANAGEMENT CORPORATION
(Exact name of registrant as specified in its charter)
 
Pennsylvania
 
25-1119571
(State or other jurisdiction of
Incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
210 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  ¨
 
The number of shares of the registrant’s Common Stock outstanding as of September 30, 2002 was 35,274,029.
 


Table of Contents
 
INDEX
 
        
    PAGE    

PART I—
 
FINANCIAL INFORMATION
    
      
3-8
      
9-12
      
12
      
12
PART II—
 
OTHER INFORMATION
    
      
13
      
13
      
13
      
13
      
13
      
13
  
14
  
15-16

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Table of Contents
 
PART I
 
ITEM 1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
EDUCATION MANAGEMENT CORPORATION
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
 
    
September 30, 2001

    
June 30, 2002

    
September 30, 2002

 
    
(unaudited)
           
(unaudited)
 
Assets
                    
Current assets:
                          
Cash and cash equivalents
  
$
4,604
 
  
$
84,477
 
  
$
66,010
 
Restricted cash
  
 
2,370
 
  
 
1,756
 
  
 
2,428
 
    


  


  


Total cash
  
 
6,974
 
  
 
86,233
 
  
 
68,438
 
Receivables, net
  
 
31,606
 
  
 
30,378
 
  
 
43,298
 
Inventories
  
 
5,248
 
  
 
3,932
 
  
 
6,261
 
Deferred and prepaid income taxes
  
 
4,946
 
  
 
12,847
 
  
 
12,847
 
Other current assets
  
 
9,081
 
  
 
6,652
 
  
 
8,344
 
    


  


  


Total current assets
  
 
57,855
 
  
 
140,042
 
  
 
139,188
 
    


  


  


Property and equipment, net
  
 
158,564
 
  
 
191,698
 
  
 
203,370
 
Deferred income taxes and other long-term assets
  
 
14,170
 
  
 
10,977
 
  
 
10,848
 
Intangible assets, net of amortization
  
 
68,493
 
  
 
149,938
 
  
 
149,034
 
    


  


  


Total assets
  
$
299,082
 
  
$
492,655
 
  
$
502,440
 
    


  


  


Liabilities and shareholders’ investment
                          
Current liabilities:
                          
Current portion of long-term debt
  
$
47
 
  
$
25,076
 
  
$
77
 
Accounts payable
  
 
16,575
 
  
 
17,550
 
  
 
11,565
 
Accrued liabilities
  
 
15,836
 
  
 
26,458
 
  
 
22,564
 
Advance payments and deferred tuition
  
 
74,129
 
  
 
70,588
 
  
 
109,423
 
    


  


  


Total current liabilities
  
 
106,587
 
  
 
139,672
 
  
 
143,629
 
    


  


  


Long-term debt, less current portion
  
 
29,360
 
  
 
3,500
 
  
 
3,480
 
Deferred income taxes and other long-term liabilities
  
 
61
 
  
 
2,906
 
  
 
2,887
 
Shareholders’ investment:
                          
Common stock
  
 
305
 
  
 
352
 
  
 
354
 
Additional paid-in capital
  
 
108,092
 
  
 
250,271
 
  
 
253,587
 
Treasury stock, at cost
  
 
(2,083
)
  
 
(1,495
)
  
 
(1,495
)
Retained earnings
  
 
56,760
 
  
 
97,091
 
  
 
99,929
 
Accumulated other comprehensive income
  
 
—  
 
  
 
358
 
  
 
69
 
    


  


  


Total shareholders’ investment
  
 
163,074
 
  
 
346,577
 
  
 
352,444
 
    


  


  


Total liabilities and shareholders’ investment
  
$
299,082
 
  
$
492,655
 
  
$
502,440
 
    


  


  


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

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EDUCATION MANAGEMENT CORPORATION
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Dollars in thousands, except per share amounts)
 
    
Three months
ended September 30,

    
2001

  
2002

Net revenues
  
$
91,874
  
$
128,143
Costs and expenses:
             
Educational services
  
 
67,132
  
 
94,130
General and administrative
  
 
20,724
  
 
28,160
Amortization of intangible assets
  
 
309
  
 
965
    

  

    
 
88,165
  
 
123,255
    

  

Income before interest and taxes
  
 
3,709
  
 
4,888
Interest expense, net
  
 
479
  
 
310
    

  

Income before income taxes
  
 
3,230
  
 
4,578
Provision for income taxes
  
 
1,247
  
 
1,740
    

  

Net income
  
$
1,983
  
$
2,838
    

  

Earnings per share:
             
Basic
  
$
.07
  
$
.08
    

  

Diluted
  
$
.06
  
$
.08
    

  

Weighted average number of shares outstanding (000’s):
             
Basic
  
 
30,336
  
 
35,152
Diluted
  
 
32,134
  
 
36,578
 
The accompanying notes to condensed consolidated financial statements are an integral part of these statements.

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EDUCATION MANAGEMENT CORPORATION
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Dollars in thousands)
 
    
Three months ended September 30,

 
    
2001

    
2002

 
Cash flows from operating activities:
                 
Net income
  
$
1,983
 
  
$
2,838
 
Adjustments to reconcile net income to net cash flows from operating activities:
                 
Depreciation and amortization
  
 
6,853
 
  
 
9,250
 
Changes in current assets and liabilities:
                 
Restricted cash
  
 
(2,152
)
  
 
(672
)
Receivables
  
 
(5,003
)
  
 
(12,920
)
Inventories
  
 
(1,720
)
  
 
(2,329
)
Other current assets
  
 
(4,357
)
  
 
(1,692
)
Accounts payable
  
 
10,286
 
  
 
3,492
 
Accrued liabilities
  
 
1,313
 
  
 
(3,894
)
Advance payments and deferred tuition
  
 
21,681
 
  
 
38,835
 
    


  


Total adjustments
  
 
26,901
 
  
 
30,070
 
    


  


Net cash flows from operating activities
  
 
28,884
 
  
 
32,908
 
    


  


Cash flows from investing activities:
                 
Acquisition of subsidiaries, net of cash acquired
  
 
(25,325
)
  
 
—  
 
Expenditures for property and equipment
  
 
(20,132
)
  
 
(29,395
)
Other items, net
  
 
(2,784
)
  
 
(105
)
    


  


Net cash flows from investing activities
  
 
(48,241
)
  
 
(29,500
)
    


  


Cash flows from financing activities:
                 
Revolving credit facility activity, net
  
 
(24,225
)
  
 
(25,000
)
Principal payments on debt
  
 
(28
)
  
 
(19
)
Proceeds from issuance of Common Stock
  
 
1,142
 
  
 
3,318
 
    


  


Net cash flows from financing activities
  
 
(23,111
)
  
 
(21,701
)
    


  


Effective exchange rate changes on cash
  
 
—  
 
  
 
(174
)
    


  


Net change in cash and cash equivalents
  
 
(42,468
)
  
 
(18,467
)
Cash and cash equivalents, beginning of period
  
 
47,072
 
  
 
84,477
 
    


  


Cash and cash equivalents, end of period
  
$
4,604
 
  
$
66,010
 
    


  


Supplemental disclosure of cash flow information
                 
Cash paid during the period for:
                 
Interest
  
$
469
 
  
 
213
 
Income taxes
  
 
152
 
  
 
22
 
 
The accompanying notes to condensed consolidated financial statements are an integral part of these statements.

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EDUCATION MANAGEMENT CORPORATION
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
1.    NATURE OF OPERATIONS:
 
Education Management Corporation (“EDMC” or the “Company”) is among the largest providers of private postsecondary education in North America, based on student enrollment and revenue. EDMC’s Art Institutes offer master’s, bachelor’s, associate’s and non-degree programs in the areas of design, media arts, fashion, and culinary arts. EDMC’s Argosy Education Group, Inc. (“Argosy”) provides graduate and undergraduate degree programs in various fields including psychology, education, business, law and the health sciences. The Company has provided career-oriented education for 40 years.
 
2.    BASIS OF PRESENTATION:
 
The accompanying condensed consolidated financial statements should be read in conjunction with the notes to consolidated financial statements included in the Fiscal 2002 Annual Report on Form 10-K. The accompanying condensed consolidated balance sheet as of June 30, 2002 has been derived from the audited balance sheet included in the Company’s Fiscal 2002 Annual Report on Form 10-K. The accompanying interim financial statements are unaudited; however, management believes that all adjustments necessary for a fair presentation have been made and all such adjustments are considered normal and recurring. The results for the three-month period ended September 30, 2002 are not necessarily indicative of the results to be expected for the full fiscal year. Unless otherwise noted, references to 2002 and 2003 refer to the periods ended September 30, 2001 and 2002, respectively.
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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.
 
Certain prior period balances have been reclassified to conform to the current period presentation.
 
3.    CAPITAL STOCK:
 
Reflected below is a summary of the Company’s capital stock:
 
    
Par Value

  
Authorized

    
September 30, 2001

  
June 30, 2002

    
September 30, 2002

Issued:
                              
Preferred Stock
  
$
.01
  
10,000,000
    
—  
  
—  
    
—  
Common Stock
  
$
.01
  
60,000,000
    
30,479,880
  
35,182,203
    
35,364,211
Held in treasury:
                              
Common Stock
  
 
N/A
  
N/A
    
125,658
  
90,182
    
90,182
 
4.    BUSINESS ACQUISITIONS:
 
On December 21, 2001, the Company purchased Argosy, a leading provider of postgraduate professional education. The Company has consolidated Argosy’s results of operations as of the acquisition date. The following table reports pro forma information as if the acquisition of Argosy had been completed at the beginning of the stated period (unaudited, in thousands, except per share amounts):
 
    
Three months ended September 30,

    
2001

  
2002

Net revenues
             
As reported
  
$
91,874
  
$
128,143
Pro forma
  
 
106,528
  
 
128,143
Net Income
             
As reported
  
$
1,983
  
$
2,838
Pro forma
  
 
587
  
 
2,838
Diluted earnings per share
             
As reported
  
$
0.06
  
$
0.08
Pro forma
  
 
0.02
  
 
0.08
 

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5.    EARNINGS PER SHARE:
 
Basic EPS is computed using the weighted average number of shares outstanding during the period, while diluted EPS is calculated to reflect the potential dilution related to stock options, using the treasury stock method.
 
Reconciliation of diluted shares (in thousands):
 
    
Three months ended September 30,

    
2001

  
2002

Basic shares
  
30,336
  
35,152
Dilution for stock options
  
1,798
  
1,426
    
  
Diluted shares
  
32,134
  
36,578
    
  
 
For the quarter ended September 30, 2002, options to purchase 108,644 shares were excluded from the diluted earnings per share calculation because of their antidilutive effect (due to the exercise price of such options exceeding the average market price for the period).
 
6.    COMPREHENSIVE INCOME:
 
Comprehensive income consisted of the following (in thousands):
 
    
Three months ended
September 30,

 
    
2001

  
2002

 
Net income
  
$
1,983
  
$
2,838
 
Other comprehensive income:
               
Foreign currency translation
  
 
—  
  
 
(289
)
    

  


Comprehensive income
  
$
1,983
  
 
2,549
 
    

  


 
Accumulated other comprehensive income represents only the foreign currency translation adjustment of approximately $69,000 as of September 30, 2002.
 
7.    SEGMENT REPORTING:
 
The Company’s principal business is providing post-secondary education. The services of EDMC’s operations are discussed in more detail under Note 1, “Nature of Operations.” In accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”), EDMC manages its business according to two segments: The Art Institutes and Argosy. Effective for fiscal 2003, ITI, Information Technology Institute Incorporated (“ITI”) is combining locations with Art Institute facilities and is now reported within the Art Institutes d ivision. The Company did not own Argosy or ITI for the comparable prior period.
 
These segments are based upon the method by which management makes operating decisions and assesses performance. Corporate information is included where it is needed to reconcile segment data to the consolidated financial statements.
 
Summary information by reportable segment is as follows (in thousands):
 
    
Three months ended
September 30,

 
    
2001

  
2002

 
Net revenue
               
                 
Art Institutes
  
$
91,874
  
$
110,606
 
Argosy
  
 
—  
  
 
17,537
 
    

  


    
$
91,874
  
$
128,143
 
    

  


Income before interest and taxes
               
Art Institutes
  
$
3,709
  
$
6,532
 
Argosy
  
 
—  
  
 
(1,644
)
    

  


    
$
3,709
  
$
4,888
 
    

  


 
    
As of September 30,

    
2001

  
2002

Total assets
             
Art Institutes
  
$
270,453
  
$
281,343
Argosy
  
 
—  
  
 
138,275
    

  

    
 
270,453
  
 
419,618
Corporate
  
 
28,629
  
 
82,822
    

  

Consolidated
  
$
299,082
  
$
502,440
    

  

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8.    INTANGIBLE ASSETS:
 
In the first quarter of fiscal 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), under which goodwill is no longer amortized. As required by SFAS 142, an independent appraisal company evaluated the intangible assets for impairment as of July 1, 2001 and no impairment existed. In addition, the Company evaluates the intangible assets for impairment annually (or more frequently, if needed), with any resulting impairment reflected as an operating expense.
 
Amortization of intangible assets for the three months ended September 30, 2002 was approximately $965,000. Estimated amortization expense for amortized intangible assets for the next five fiscal years ending June 30 is as follows:
 
Fiscal years

    
(in thousands)

2003 (remainder)
    
2,981
2004
    
3,614
2005
    
3,475
2006
    
2,503
2007
    
1,907
 
Intangible assets consisted of the following (in thousands):
 
    
As of June 30, 2002

    
As of September 30, 2002

    
Weighted Average Amortization Period (years)

    
Gross Carrying Amount

  
Accumulated Amortization

    
Gross Carrying Amount

  
Accumulated Amortization

    
Curriculum
  
$
7,567
  
$
(1,645
)
  
$
7,861
  
$
(1,961
)
  
6
Accreditation
  
 
3,486
  
 
(433
)
  
 
3,486
  
 
(504
)
  
12
Bachelors’ program
  
 
1,100
  
 
(125
)
  
 
1,100
  
 
(144
)
  
15
Student contracts and applications
  
 
6,929
  
 
(1,322
)
  
 
6,929
  
 
(1,799
)
  
3
Software
  
 
256
  
 
(55
)
  
 
252
  
 
(75
)
  
3
Title IV
  
 
750
  
 
(30
)
  
 
750
  
 
(42
)
  
16
Tradename
  
 
500
  
 
—  
 
  
 
500
  
 
—  
 
  
Indefinite
Other
  
 
2,768
  
 
(1,117
)
  
 
2,768
  
 
(1,169
)
  
13
    

  


  

  


  
Total
  
$
23,356
  
$
(4,727
)
  
$
23,646
  
$
(5,692
)
  
6
    

  


  

  


  
 
The only change in the carrying amount of goodwill of $131,080 for the three months ended September 30, 2002 was a decrease of approximately $229,000 in the Art Institutes segment, due to the foreign currency translation adjustment.
 
9.    SUBSEQUENT EVENTS:
 
Subsequent to September 30, 2002, the following acquisitions occurred:
 
On October 3, 2002, the Company acquired the Center for Digital Imaging and Sound (“CDIS”) in Burnaby, British Columbia, Canada.
 
On October 15, 2002, the Company purchased assets and assumed certain liabilities of the California Design College located in Los Angeles, California. This acquisition is subject to receiving certain regulatory approvals.
 
On November 8, 2002, the Company acquired the Institute of Digital Arts (“IDA”) in Richmond, British Columbia, Canada.
 
These transactions are accounted for as purchases in accordance with SFAS 141, “Business Combinations.” These entities were purchased for $25.8 million in the aggregate. CDIS and IDA will provide EDMC with a strong base for the addition of Art Institute programs in Vancouver. The purchase of the California Design College will allow EDMC to expand on its current base of students in the Los Angeles area.

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ITEM 2— MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
                    FINANCIAL CONDITION
 
This Quarterly Report on Form 10-Q 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 the use of forward-looking terminology such as “believes,” “estimates,” “anticipates,” “continues,” “contemplates,” “expects,” “may,” “will,” “could,” “should” or “would” or the negatives thereof. Those statements are based on the intent, belief or expectation of the Company as of the date of this Quarterly Report. Any 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 and Canada or international economic conditions, governmental regulations and other 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 events, conditions or circumstances on which any such statement is based. The following discussion of the Company’s results of operations and financial condition should be read in conjunction with the interim unaudited condensed consolidated financial statements of the Company and the notes thereto, included herein. Unless otherwise noted, references to 2002 and 2003 are to the periods ended September 30, 2001 and 2002, respectively.
 
Critical Accounting Policies
 
In preparing the Company’s financial statements in conformity with accounting principles generally accepted in the United States, judgements and estimates are made about the amounts reflected in the financial statements. As part of the financial reporting process, the Company’s management collaborates to determine the necessary information on which to base judgements and develop estimates used to prepare the financial statements. Historical experience and available information are used to make these judgements and estimates. However, different amounts could be reported using different assumptions and in light of different facts and circumstances. Therefore, actual amounts could differ from the estimates reflected in the financial statements.
 
The Company believes that the following critical accounting policies affect the more significant judgements and estimates used in the preparation of the financial statements:
 
Revenue Recognition and Receivables
 
The Company’s net revenues consist of tuition and fees, student housing charges and bookstore and restaurant sales. Net revenues are reduced for student refunds and scholarships. Bookstore and restaurant revenue is recognized when the sale occurs. Advance payments represent that portion of payments received but not earned and are reflected as a current liability in the accompanying consolidated balance sheets. These payments are typically related to future academic periods and are for the most part, refundable.
 
The Company bills tuition and housing revenues at the beginning of an academic term and recognizes the revenue on a pro rata basis over the term of instruction or occupancy. For most Art Institute programs, the academic and fiscal quarters are the same; therefore, unearned revenue is not significant at the end of a fiscal quarter. However, certain recently-acquired schools have programs with class starting and ending dates that differ from the Company’s fiscal quarters. Therefore, at the end of the fiscal quarter, the Company has revenue from these programs that has not yet been earned in accordance with the Securities and Exchange Commission’s Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements.” Unearned tuition revenue of approximately $6.3 million and $5.2 million, related to programs not on the Art Institutes’ quarterly academic calendar, is included with advanced payments and deferred tuition in the accompanying condensed consolidated balance sheets as of September 2001 and 2002, respectively.
 
Argosy’s academic programs follow a semester schedule and several programs were in session as of September 30, 2002. Accordingly, unearned revenue of approximately $21.0 million related to Argosy is included with advanced payments and deferred tuition in the accompanying condensed consolidated balance sheet.
 
Refunds are calculated in accordance with federal, state and accrediting agency standards.
 
The trade receivable balances are comprised of individually insignificant amounts due primarily from students throughout the United States and Canada. The Company determines its allowance for doubtful accounts by categorizing gross receivables based upon the enrollment status of the student (in-school, out-of-school, summer leave of absence and balances in collection) and establishes a reserve based on the likelihood of collections (in-school receivables having the lowest percentage reserved).

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Use of Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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.
 
Long-Lived Assets
 
The Company evaluates the recoverability of property, plant and equipment and intangible assets other than goodwill whenever events or changes in circumstances indicate the carrying amount of any such assets may not be fully recoverable. Changes in circumstances include economic conditions or operating performance. The Company’s evaluation is based upon assumptions about the estimated future undiscounted cash flows. If the future cash flows are less than the carrying value, the Company would recognize an impairment loss. The Company continually applies its best judgement when performing these evaluations to determine the timing of the testing, the undiscounted cash flows used to assess recoverability and the fair value of the asset.
 
The Company evaluates the recoverability of the goodwill attributable to each reporting unit as required under SFAS No. 142, “Goodwill and Other Intangible Assets,” by comparing the fair value of each reporting unit with its carrying value. The Company continually applies its best judgement when performing these evaluations to determine the financial projections used to assess the fair value of each reporting unit.
 
Results of Operations
 
Three months ended September 30, 2002 compared to the three months ended September 30, 2001
 
Net revenues increased by 39.5% to $128.1 million in 2003 from $91.9 million in the first quarter of 2002 primarily due to an increase in student enrollment of 33.7% to 32,814 from 24,550 in the prior year, accompanied by tuition increases.
 
Art Institute net revenues increased by 20.4% to $110.6 million in 2003 from $91.9 million in the first quarter of 2002. Total student enrollment at the Art Institutes increased 14.5% over the prior year to 28,108 from 24,550, accompanied by a tuition increase of approximately 7% over the prior year. Enrollment at locations operated by the Art Institutes for 24 months or more increased 9.5% to 25,976 compared to 23,732 in the prior year. In addition to growth at established locations, results for fiscal 2003 include a full quarter of revenue for International Fine Arts College (“IFAC”), which the Company acquired in the first quarter of the prior year.
 
Argosy’s net revenues were approximately $17.5 million for the three-month period ended September 30, 2002. Argosy’s enrollment for this period was 4,706. The Company did not own Argosy in the comparable prior quarter.
 
Educational services expense increased by $27.0 million, or 40.2%, to $94.1 million in 2003 from $67.1 million in 2002, due primarily to the incremental costs incurred to support higher student enrollment. These costs include employee compensation, rent and other facility operating costs, and depreciation and amortization. Overall, educational services expense as a percentage of revenue increased 40 basis points from 73.1% in fiscal 2002 to 73.5% in 2003. Art Institutes’ educational services expenses increased 18.5% to $79.8 million in 2003, as compared to $67.1 million in 2002. As a percentage of revenue, Art Institutes’ expenses improved 90 basis points to 72.2% in 2003 from 73.1% for the first quarter of 2002. The improvement at the Art Institutes is attributable to reductions in costs at established locations, partially offset by increases at those Art Institutes recently acquired or opened. Argosy’s educational services expenses were $14.3 million for 2003, representing approximately 81.7% of net revenues.
 
General and administrative expense was $28.2 million in 2003, up 35.9% from $20.7 million in 2002. The increase over the comparable quarter in the prior year primarily reflects increases in costs related to newly-acquired entities as well as increases in marketing and admissions expenses. As a percentage of net revenues, general and administrative expense decreased 60 basis points to 22.0% as compared to 22.6% in the first quarter of fiscal 2002. Art Institutes’ general and administrative expenses increased 14.3% to $23.7 million in 2003, as compared to $20.7 million in 2002. As a percentage of revenue, Art Institutes’ expenses improved 120 basis points to 21.4% in 2003 from 22.6% for the first quarter of 2002. The improvement at the Art Institutes is attributable primarily to operating leverage on marketing and admissions expenditures at established school locations and on centralized staff functions. Argosy’s general and administrative expenses were $4.5 million for 2003, representing approximately 25.5% of net revenues.
 
Amortization of intangibles increased by $656,000 to $965,000 in 2003, as compared to $309,000 in the first quarter of fiscal 2002. This increase results from amortization of intangibles associated with the acquisitions of IFAC, ITI, Argosy, and the amortization of ongoing curriculum development at The Art Institute Online.

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EBIT increased by $1.2 million to $4.9 million in 2003 from $3.7 million in 2002. The EBIT margin decreased to 3.8% for the quarter as compared to 4.0% for the prior year.
 
Art Institute EBIT increased $2.8 million to $6.5 million for the three months ended September 30, 2002 as compared to $3.7 million in the prior year. The Art Institute EBIT margin increased by 190 basis points to 5.9% for the quarter as compared to 4.0% for the prior year through increases in revenue and margin improvements at the Art Institutes in both educational services and general and administrative costs. In addition, certain centralized costs are now allocated to the Argosy division. This served to improve the Art Institute EBIT margin, as compared to the prior year.
 
Argosy had an operating loss of $1.6 million, including the allocated centralized costs from EDMC, representing 9.4% of their net revenues for the three months ended September 30, 2002. The Company did not own Argosy for the comparable quarter in the prior year. Argosy’s net loss for the first quarter is attributed primarily to seasonally low revenue accompanied by certain costs and expenses that do not fluctuate as significantly as revenues.
 
Net interest expense was $310,000 in 2003, as compared to $479,000 in 2002. The Company’s outstanding borrowings were reduced significantly at the end of the second quarter of 2002 from cash received in the Company’s secondary stock offering (the “Offering”). Net interest expense includes, among other items, the amortization of fees paid in connection with obtaining the Company’s credit agreement (the “Credit Agreement”) and interest expense on mortgage indebtedness at one of the Company’s schools, partially offset by interest income.
 
The Company’s effective tax rate was 38.0% for the first quarter of fiscal 2003, as compared to 38.6% in the comparable quarter of the prior year. The improvement in the rate as compared to the prior year is primarily due to the reduced impact of non-deductible expenses as a percent of income before income taxes. The effective rates differed primarily due to the combined federal and state statutory rates due to expenses that are non-deductible for tax purposes.
 
Net income increased by $855,000 to $2.8 million in 2003 from $2.0 million in 2002. The increase is attributable to improved results from operations at the Art Institutes, lower interest expense, and a reduced effective tax rate, partially offset by operating losses at Argosy and an increase in amortization of intangibles.
 
Seasonality and Other Factors Affecting Quarterly Results
 
The Company’s quarterly revenues and income fluctuate primarily as a result of the pattern of student enrollments. The Company experiences a seasonal increase in new enrollments in the fall (fiscal year second quarter), which is traditionally when the largest number of new students 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 enrollments at the Company’s schools are 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. Historically, the Company’s profitability has been lowest in its fiscal first quarter due to lower revenues combined with expenses incurred in preparation for the peak enrollments in the fall quarter. The Company anticipates that the seasonal pattern in revenues and earnings will continue in the future.
 
Liquidity and Capital Resources
 
As of September 30, 2002, the Company’s unrestricted cash balance was $66.0 million, a decrease of $18.5 million from $84.5 million at June 30, 2002 and an increase of $61.4 million over September 30, 2001. Cash increased significantly compared to fiscal 2002, as a result of the Offering that occurred in November 2001. The reduction in cash of $18.5 million as compared to June 30, 2002 was primarily a result of the Company’s repayment of borrowings outstanding at year-end.
 
The Company generated positive cash flow from operating activities of $32.9 million for the three months ended September 30, 2002, an increase of $4.0 million over the comparable period for fiscal 2002, due primarily to increases in net income and non-cash charges.
 
The Company had a working capital deficit of $4.4 million as of September 30, 2002, as compared to $370,000 of working capital as of June 30, 2002 and a deficit of $48.7 million as of September 30, 2001. The increase in working capital over the prior year reflects the cash infusion from the Offering and cash flows from operations. Net receivables increased $12.9 million from June 30, 2002 and $11.7 million from September 30, 2001, primarily as a result of the receivables related to the acquisitions that occurred over the past twelve months, higher student enrollment and the corresponding revenue increases.

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The Company’s Credit Agreement allows borrowings up to $150 million on a revolving basis. The Credit Agreement, which will expire September 20, 2004, contains customary covenants that, among other matters, require the Company to meet specified financial ratios, restrict the repurchase of Common Stock and limit the incurrence of additional indebtedness. As of September 30, 2002, the Company had no borrowings under this facility and was in compliance with all covenants under the Credit Agreement.
 
Borrowings under the Credit Agreement are available to the Company to finance acquisitions and fund seasonal 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. Additionally, Title IV proceeds for continuing students can be received up to ten days prior to the start of an academic quarter. For most of the Company’s Art Institute schools, the academic and financial quarters coincide.
 
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. The Company used $25.8 million of cash subsequent to September 30, 2002 (see Note 9) for the acquisition of three new schools.
 
The following table describes the Company’s commitments under various contracts and agreements as of September 30, 2002 (in thousands):
 
    
Total amounts committed

  
Payments due by fiscal year

       
2003 (remainder)

  
2004-2005

 
2006-2007

 
2008-
Thereafter

Standby letters of credit(1)
  
$
826
  
$
—  
  
$
—  
 
$     —  
 
$
—  
Mortgage obligation
  
 
3,559
  
 
59
  
 
162
 
    3,338
 
 
—  
Operating leases
  
 
479,847
  
 
42,380
  
 
100,447
 
      94,567    
 
 
242,453
    

  

  

 
 

Total commitments
  
$
483,406
  
$
42,439
  
$
100,609
 
$97,905
 
$
242,453

(1)
 
The Company does not anticipate these letters of credit will be drawn on.
 
The Company anticipates its total capital spending for fiscal 2003 will increase as compared to the prior year, both in-total and as a percentage of revenue. The 2003 expenditures relate principally to the investment in schools acquired or started during the previous several years and those added in 2003, continued expansion and improvements to current facilities, new culinary arts programs, additional or replacement school and housing facilities, classroom and administrative technology and construction of a new facility for Argosy University – Twin Cities.
 
The majority of the Company’s facilities are leased. Future commitments on existing leases will be paid from cash provided from operating activities.
 
ITEM
 
3—QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
 
The Company is exposed to market risks in the ordinary course of business that include foreign currency exchange rates. The Company does not utilize interest rate swaps, forward or option contracts on foreign currencies or commodities, or other types of derivative financial instruments. The Company is subject to fluctuations in the value of the Canadian dollar relative to the U.S. dollar. The Company does not believe it is subject to material risks from reasonably possible near-term change in exchange rates.
 
ITEM 4—CONTROLS AND PROCEDURES
 
The Company maintains disclosure controls and procedures designed to ensure that it is able to collect the information it is required to disclose in the reports it files with the Securities and Exchange Commission (SEC) and to process, summarize and disclose this information within the time periods specified in the SEC’s rules. The Company’s management, including the chief executive officer and chief financial officer, evaluated disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”). Based on that evaluation, the Company concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic filings with the SEC.
 
Since the Evaluation Date, there have not been any significant changes in the Company’s internal controls or in other factors that could significantly affect such controls.

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PART II
 
ITEM 1— LEGAL PROCEEDINGS
 
Not Applicable
 
ITEM 2— CHANGES IN SECURITIES
 
Not Applicable
 
ITEM 3— DEFAULTS UPON SENIOR SECURITIES
 
Not Applicable
 
ITEM 4— SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
Not Applicable
 
ITEM 5— OTHER INFORMATION
 
Not Applicable
 
ITEM 6— EXHIBITS AND REPORTS ON FORM 8-K
 
(a)    Exhibits:
 
 
(15.1)
 
Independent Accountants’ Review Report
 
 
(99.1)
 
Certifications Pursuant to 18 U.S.C. Section 1350
 
 
(99.2)
 
Statement regarding Western State University College of Law (incorporated by reference to Exhibit 99 to the
             Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002).
 
(b)    Reports on Form 8-K:
 
  No reports on Form 8-K were filed for the three months ended September 30, 2002.

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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
EDUCATION MANAGEMENT CORPORATION
(Registrant)
 
Date:  November 13, 2002
/s/    ROBERT B. KNUTSON         

Robert B. Knutson
Chairman and Chief Executive Officer
 
/s/    ROBERT T. MCDOWELL        

Robert T. McDowell
Executive Vice President and Chief Financial Officer

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CERTIFICATIONS
 
I, Robert B. Knutson, certify that:
 
1.    I have reviewed this quarterly report on Form 10-Q of Education Management Corporation;
 
2.    Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3.    Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4.    The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
 
 
a)
 
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
 
b)
 
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
 
c)
 
presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
 
5.    The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
 
 
a)
 
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
 
b)
 
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
 
6.    The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
 
Date: November 13, 2002
/s/    ROBERT B. KNUTSON        

Robert B. Knutson
Chairman and Chief Executive Officer

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I, Robert T. McDowell, certify that:
 
1.    I have reviewed this quarterly report on Form 10-Q of Education Management Corporation;
 
2.    Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3.    Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4.    The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
 
 
a)
 
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
 
b)
 
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
 
c)
 
presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
 
5.    The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
 
 
a)
 
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
 
b)
 
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
 
6.    The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
 
Date:  November 13, 2002
 
/s/ ROBERT T. MCDOWELL

   
Robert T. McDowell
   
Executive Vice President and Chief Financial Officer

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