Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2005

or

For the transition period from              to             .

Commission File Number 000-50952

EDUCATE, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (410) 843-8000

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  ¨.    No  x.

The registrant had 42,586,019 shares of Common Stock outstanding as of May 2, 2005.

Table of Contents

EDUCATE, INC.

INDEX

Table of Contents

Educate, Inc.

Consolidated Balance Sheets

(Dollar amounts in thousands)

See notes to consolidated financial statements (unaudited).

1

Table of Contents

Educate, Inc.

Consolidated Balance Sheets (continued)

(Dollar amounts in thousands)

See notes to consolidated financial statements (unaudited).

2

Table of Contents

Educate, Inc.

Consolidated Statements of Income

(Dollar amounts in thousands, except per share data)

(unaudited)

See notes to consolidated financial statements (unaudited).

3

Table of Contents

Educate, Inc.

Consolidated Statements of Cash Flows

(Dollar amounts in thousands)

(unaudited)

See notes to consolidated financial statements (unaudited).

4

Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share data)

1. Organization, Basis of Presentation, and Summary of Significant Accounting Policies

Description of Business

Educate, Inc. and subsidiaries (the “Company”) is a national provider of tutoring and other supplemental education services to pre-kindergarten through twelfth grade, or pre-K-12, students. The Company operates through two business segments summarized as follows:

Beginning in 2005, the Company began including the operations of its Online Learning Services segment in its Learning Center segment. All segment information has been restated to conform to the new presentation.

Basis of Presentation

The unaudited interim financial information as of March 31, 2005 has been prepared in accordance with generally accepted accounting principles for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, it does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Due principally to the timing of school semesters and holiday schedules, the Company is subject to seasonality on reported revenues and expenses that affect reported results of operations. The Company’s Learning Center segment generally experiences lower revenues in the fourth quarter. Learning Center franchisees pay royalties to the Company based on a percentage of cash receipts. Since customers of these franchisees frequently make payments for services in advance, royalty revenues earned by the Company are higher in periods of increased enrollment, particularly in the spring months prior to commencement of peak summer service periods. In addition, the Company’s Catapult Learning segment generates a disproportionate amount of revenues during the first six months of the calendar year. This occurs because many school districts are on break during the summer months and use the first semester in the fourth calendar quarter to evaluate the specific needs of individual students prior to enrolling students into the Company’s supplemental education programs. In addition, a disproportionate amount of costs associated with the Company’s Catapult Learning segment are incurred and expensed in periods when reported revenue is seasonally at a low point. As a result of these factors, quarter-to-quarter comparisons of results of operation may not be indicative of future results of operations.

Certain amounts previously reported for 2004 have been reclassified to conform to the 2005 presentation.

Summary of Significant Accounting Policies

Stock – Based Compensation

The Company accounts for all stock-based compensation plans using the intrinsic value method. Under the intrinsic value method, if the exercise price of the employee stock option equals the estimated fair value of the underlying stock on the date of grant, no compensation expense is generally recognized. Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“Statement 123”) encourages companies to recognize expense for stock-based awards based on their estimated fair value on the date of grant. Statement 123 requires the disclosure of pro forma data in the notes to the financial statements if the fair value method is not adopted.

5

Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)

The Company has granted stock options and restricted common stock to employees and directors. These grants are discussed more fully in Note 10.

Pro forma net income and earnings per share data have been determined as if the Company had accounted for its stock-based awards using prescribed fair value based methods. For all grants prior to May 14, 2004, the date the Company filed a registration statement with the Securities and Exchange Commission to sell its common stock in a public offering, the Company used the minimum value method. The minimum value method assumes that the fair value of an award is equal to the excess of the fair value of the underlying common stock at the date of grant over the present value of both the exercise price and the expected dividend payments, each discounted at the risk-free rate, over the expected life of the option.

For all stock options granted after May 14, 2004, the Company used the Black-Scholes option pricing model. The Black-Scholes option pricing model was developed for estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Black-Scholes and other option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company’s common stock has been publicly traded only since September 2004, the expected stock price volatility over the expected life of granted options has been based on published volatility measures of companies in the Company’s industry. These estimates of volatility may change in future periods, and the effects could be material.

The following assumptions were used in calculating pro forma stock compensation expense:

The weighted average estimated fair value of stock-based awards was $5.10 for the three months ended March 31, 2005 and $10.68 for the three months ended March 31, 2004.

6

Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)

For the purpose of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting periods. The Company’s pro forma information is as follows:

New Accounting Pronouncements

In December 2004 the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, which is a revision of Statement 123. Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their estimated fair values. Pro forma disclosure is no longer an alternative.

Statement 123(R) was originally required to be adopted no later than July 1, 2005. On April 14, 2005 the SEC announced that non-small business registrants would not be required to adopt Statement 123(R) until the first fiscal year beginning after June 15, 2005 which effectively extended the adoption deadline for the Company to January 1, 2006. The Company expects to adopt the standard on January 1, 2006.

2. Acquisitions

On February 8, 2005, the Company acquired all the stock of Gateway Learning Corporation (“HOP”), the owner of the branded “Hooked on Phonics” early reading, math and study skills programs. The results of operations of HOP are included in the Company’s consolidated statements of income beginning February 1, 2005.

The initial purchase price totaled approximately $10,699 including acquisition costs of $966. The Company also extinguished $2,982 of acquired debt at closing. Contingent consideration may be payable to the seller based upon future direct response television advertising spending related to the HOP business. As of March 31, 2005, no amounts are payable under the contingent consideration provisions of the purchase agreement. Additionally, the purchase price is subject to adjustment upon the completion of a review of the working capital obtained at closing.

The purchase price allocation to assets and liabilities acquired is preliminary pending final resolution of the contingencies related to the purchase price and final determination of the valuation of the intangible assets acquired. The purchase price was preliminarily allocated to acquired assets totaling $19,274, including identifiable amortizable and indefinite-lived intangible assets of $727 and $7,994, respectively, and liabilities of $8,575.

7

Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)

During the first quarter of 2005, the Company purchased 17 Sylvan Learning Center franchised territories. The combined purchase of these territories included cash paid of $5,417, acquisition costs of $101 and the assumption of liabilities of $3,749, which were primarily obligations to provide services to customers.

Pro forma financial information has not been included for these acquisitions because they are not material to the consolidated operations and financial position of the Company.

3. Goodwill

Changes in the carrying amount of goodwill during the period from December 31, 2004 through March 31, 2005 are summarized as follows:

4. Intangible Assets Other Than Goodwill

A summary of other intangible assets at March 31, 2005 and December 31, 2004 is as follows:

8

Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)

As of March 31, 2005, estimated future amortization expense of intangible assets subject to amortization is as follows:

5. Long-Term Debt

Long-term debt consists of the following:

9

Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)

In order to manage interest rate exposure and to comply with certain covenants of the Company’s credit agreement, the Company has entered into three interest rate swap agreements. A notional amount of $40,000 in variable rate debt has been swapped to a counter party in exchange for a fixed interest rate commitment of 2.58% per annum. A second agreement with a notional amount of $10,000 in variable rate debt has been swapped to a counter party in exchange for a fixed interest rate commitment of 3.44% per annum. These agreements will terminate on July 1, 2006. A third agreement effective from July 1, 2006 through May 1, 2007 with a notional amount of $50,000 in variable rate debt has been swapped to a counter party in exchange for a fixed interest rate commitment of 4.03% per annum. Interest paid under these agreements is recorded as interest expense in the period in which it is incurred.

On April 28, 2005, one of the Company’s consolidated subsidiaries entered into an Amended and Restated Credit Agreement (the “Agreement”) with a bank syndicate, replacing the existing 2004 Term Loan facility. The Agreement provides for an increase in the term loan facility to $140 million and other amendments to lower the interest rate spread over a variable rate, extend the maturities, and provide for increased flexibility in certain other terms and conditions of the term loan facility. No amendments were made to the agreement concerning the revolving credit facility.

At the Company’s election the modified term loan will bear interest at the base rate or Eurodollar rate plus a margin, currently at 200 basis points. Pursuant to the Agreement, quarterly principal payments based upon a 100-year amortization schedule are due until the seventh year, when the remaining balance is due. The obligations under the Agreement are guaranteed by the Company and certain direct and indirect subsidiaries of the Company. These obligations are secured by a senior interest in substantially all of the assets of certain of the consolidated subsidiaries of the Company.

The Agreement includes usual and customary covenants for transactions of this type, including covenants limiting liens on assets of certain of the Company’s subsidiaries, certain asset sales, payment of dividends, incurrence of additional indebtedness, and mergers or making fundamental changes to the business.

The Agreement is expected to constitute a substantial modification of the terms of the prior agreement in accordance with generally accepted accounting principles. Accordingly, the Company currently expects to write off financing costs of approximately $1.5 million related to the prior term facility during the three-month period ending June 30, 2005.

6. Income Taxes

The Company’s income tax provisions for all periods consist of federal, state, and foreign income taxes. The tax provision for the three-month period ended March 31, 2005 is based on the estimated effective tax rate applicable for the full year. Currently, the effective tax rate for the Company for the year ending December 31, 2005 is expected to be 38%. Due to potential changes in the mix of earnings between tax jurisdictions, the Company’s consolidated effective tax rate may fluctuate during 2005.

10

Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)

7. Stockholders’ Equity

Changes in the Company’s stockholders’ equity during the period December 31, 2004 through March 31, 2005 are summarized as follows:

8. Comprehensive Income

The components of comprehensive income, net of related taxes, are as follows:

9. Earnings Per Share

Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per common share include the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.

11

Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)

A reconciliation of the numerators and denominators for basic and diluted earnings per common share are as follows:

10. Stock Option Plan

During 2003, the Company adopted a stock option plan that provides for the granting of options to purchase up to 3,680,000 shares of common stock to selected employees and directors of the Company. All options granted during 2003 were issued with an exercise price of $3.71 per share, which is equal to the estimated fair value of the common stock at the date of the grant, vest over a four-year period, and expire 10 years after the date of the grant.

During 2004, the Company adopted a stock option plan that provides for the granting of options to purchase up to 700,000 shares of common stock to selected employees and directors of the Company. At December 31, 2004 options to purchase 194,000 shares of common stock had been granted under this plan with a weighted average exercise price of $11.76 per share. Of this amount, 16,000 shares immediately vested with the balance vesting ratably over four years. Options under this plan expire 10 years after the grant date.

During the period from January 1, 2005 through March 31, 2005 the Company issued options to purchase 83,000 shares of common stock to employees of the Company with a weighted average exercise price of $12.60 per share. Options will vest ratably over a four-year period.

At March 31, 2005 the Company had outstanding options to purchase 3,830,409 shares of common stock at a weighted average exercise price of $4.62 per share.

12

Table of Contents

Educate, Inc.

Notes to Consolidated Financial Statements (Unaudited, Continued)

(Dollar amounts in thousands, except per share data)

11. Businesses and Geographic Segment Information

The Company is organized on the basis of educational services provided and segments are business units that offer distinct services. Beginning in 2005, the Company began to manage the operations of its previous Online Learning Services segment within its Learning Center segment, and accordingly now has two operating segments. All segment information has been restated to conform to the new presentation. The segments are managed separately as they have different customer bases and delivery channels. Reportable segments are as follows:

The Company evaluates performance and allocates resources based on operating income. There are no significant intercompany sales or transfers.

The following tables set forth information on the Company’s reportable segments: