<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED) JUNE 10, 1998
-------------
EDUCATIONAL MEDICAL, INC.
-------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE
--------
(STATE OR OTHER JURISDICTION OF INCORPORATION)
000-21567 65-0038445
- ------------------------ ---------------------------------
(COMMISSION FILE NUMBER (IRS EMPLOYER IDENTIFICATION NO.)
EDUCATIONAL MEDICAL, INC.
1327 NORTHMEADOW PARKWAY, SUITE 132
ROSWELL, GEORGIA 30076
----------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (770) 475-9930
--------------
<PAGE> 2
ITEM 5: OTHER EVENTS
On April 16, 1998, the Registrant filed a Registration Statement on
Form S-1 (SEC File No. 333-50221) with respect to 1,873,999 shares of the
Registrant's Common Stock to be sold by certain selling shareholders and 626,001
shares to be sold by the Registrant (the "Offering"). On May 26, 1998, the
Registrant released summary financial information for the fiscal year ended
March 31, 1998.
The Registrant has amended the above described Registration Statement
on Form S-1 to incorporate its consolidated financial statements as of and for
the year ended March 31, 1998 so that current information may be provided in the
Prospectus for the Offering; however, the Registrant's Annual Report on Form
10-K is not due to be filed until June 30, 1998. The Registrant is filing this
Current Report on Form 8-K solely for the purpose of filing its consolidated
financial statements as of and for the year ended March 31, 1998.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(a) Financial Statements of Business Acquired: Not Applicable
(b) Pro Forma Financial Information Relative to Acquired
Business: Not Applicable
(c) Exhibits
99.1 Consolidated Financial Statements of Educational
Medical, Inc. for the year ended March 31, 1998.
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 hereunto duly authorized.
EDUCATIONAL MEDICAL, INC.
Date: June 10, 1998 By:/s/ Vince Pisano
---------------------------------
Vince Pisano, Vice President and
Chief Financial Officer
2
<PAGE> 1
EXHIBIT 99.1
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
Report of Ernst & Young LLP, Independent Auditors........... F-2
Consolidated Financial Statements:
Consolidated Balance Sheets as of March 31, 1997 and 1998... F-3
Consolidated Statements of Income for the years ended March
31, 1996, 1997 and 1998................................... F-4
Consolidated Statements of Stockholders' Equity for the
years ended March 31, 1996, 1997 and 1998................. F-5
Consolidated Statements of Cash Flows for the years ended
March 31, 1996, 1997 and 1998............................. F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 2
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Educational Medical, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Educational
Medical, Inc. and subsidiaries as of March 31, 1997 and 1998 and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended March 31, 1998. 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 did not audit the financial statements of Nebraska Acquisition
Corporation, a wholly-owned subsidiary, or its predecessors (Educational
Management, Inc. and Wikert and Rhude, a general partnership) acquired by
Educational Medical, Inc. on March 31, 1997 in a business combination accounted
for as a pooling of interests as described in Note 4 to the consolidated
financial statements, which statements reflect total assets of approximately
$5,681,000 as of March 31, 1997, and total net revenues of approximately
$4,695,000, and $6,012,000 for the years ended March 31, 1996 and 1997,
respectively. Those statements were audited by other auditors whose report has
been furnished to us, and our opinion, insofar as it relates to data included
for Nebraska Acquisition Corporation, is based solely on the report of the other
auditors.
We conducted our audits in accordance with generally accepted auditing
standards. 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, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Educational Medical, Inc. and
subsidiaries at March 31, 1997 and 1998, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
March 31, 1998, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Atlanta, Georgia
June 2, 1998
F-2
<PAGE> 3
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31,
-------------------------
1997 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $14,047,889 $21,445,782
Restricted cash........................................... -- 384,295
Trade accounts receivable, less allowance for doubtful
accounts of $922,704 and $1,968,218, respectively....... 5,238,742 6,490,004
Notes receivable.......................................... -- 622,800
Prepaid expenses and other current assets................. 1,149,146 2,821,970
Income taxes receivable................................... 155,542 --
Deferred income tax assets................................ 1,208,669 702,814
----------- -----------
Total current assets............................... 21,799,988 32,467,665
Notes receivable, less allowance for doubtful accounts of
none and $326,007, respectively........................... -- 737,132
Property and equipment, net................................. 7,617,958 13,644,236
Deferred debt issuance costs, net of accumulated
amortization of none and $112,143, respectively........... 297,492 275,538
Covenants not to compete, net of accumulated amortization of
$1,194,238 and $1,481,359, respectively................... 1,082,987 945,033
Goodwill and other intangible assets, net of accumulated
amortization of $7,063,793 and $7,949,081, respectively... 10,152,625 31,273,709
Deferred income tax assets.................................. 944,629 1,777,824
Other assets................................................ 176,855 176,855
----------- -----------
Total assets....................................... $42,072,534 $81,297,992
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 820,784 $ 682,310
Other amounts due to sellers.............................. -- 3,517,602
Accrued compensation...................................... 858,049 1,241,079
Other accrued expenses.................................... 2,486,532 2,139,830
Deferred tuition income................................... 3,184,225 5,095,954
Current portion of notes payable and long-term debt....... 3,964,851 14,837,203
----------- -----------
Total current liabilities.......................... 11,314,441 27,513,978
Notes payable and long-term debt, less current portion...... 2,163,880 17,109,568
Other liabilities........................................... 394,145 1,002,465
----------- -----------
Total liabilities.................................. 13,872,466 45,626,011
Stockholders' equity:
Preferred stock, authorized 5,000,000 shares, none issued
and outstanding......................................... -- --
Common stock, $.01 par value -- authorized 15,000,000
shares, 7,418,100 and 7,729,529 shares issued and
outstanding at March 31, 1997 and 1998, respectively.... 74,181 77,295
Additional paid-in capital on common stock................ 30,222,776 33,739,114
Retained earnings (accumulated deficit)................... (1,996,889) 1,855,572
Less treasury stock, at cost, 34,817 common shares at
March 31, 1997, none at March 31, 1998.................. (100,000) --
----------- -----------
Total stockholders' equity......................... 28,200,068 35,671,981
----------- -----------
Total liabilities and stockholders' equity......... $42,072,534 $81,297,992
=========== ===========
</TABLE>
See accompanying notes.
F-3
<PAGE> 4
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
---------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Net revenues................................................ $43,346,533 $49,449,680 $59,675,509
School operating costs:
Cost of education and facilities.......................... 19,650,937 23,150,599 27,086,555
Selling and promotional................................... 6,533,229 7,530,741 8,643,485
Provision for losses on accounts and notes receivable..... 1,270,565 1,239,151 1,151,669
General and administrative expenses....................... 11,098,422 12,802,441 15,424,764
Amortization of goodwill and intangibles.................... 882,953 886,268 1,284,552
Other expenses:
Legal defense and settlement costs........................ 1,115,000 -- --
Loss on closure or relocation of schools.................. 50,000 143,585 --
Impairment of goodwill and intangibles.................... 764,000 -- --
Merger expenses........................................... -- 391,453 --
----------- ----------- -----------
Income from operations...................................... 1,981,427 3,305,442 6,084,484
Interest (income) expense, net (net of interest income of
$171,870 in 1996 and $476,194 in 1997 and net of interest
expense of $282,870 in 1998).............................. 822,434 284,162 (252,750)
----------- ----------- -----------
Income before income taxes and extraordinary item........... 1,158,993 3,021,280 6,337,234
Provision (benefit) for income taxes........................ 632,185 (845,363) 2,484,773
----------- ----------- -----------
Net income before extraordinary item........................ 526,808 3,866,643 3,852,461
Extraordinary item -- loss on early extinguishment of debt,
net of income taxes....................................... -- 308,683 --
----------- ----------- -----------
Net income.................................................. $ 526,808 $ 3,557,960 $ 3,852,461
=========== =========== ===========
Pro forma income tax data:
Income before income taxes and extraordinary item......... $ 1,158,993 $ 3,021,280
Provision (benefit) for income taxes...................... (486,505) 408,951
----------- -----------
Income before extraordinary item.......................... 672,488 2,612,329
Extraordinary item, net of income taxes................... -- 308,683
----------- -----------
Pro forma net income...................................... $ 672,488 $ 2,303,646
=========== ===========
Earnings per share:
Basic:
Income before extraordinary item........................ $ 0.28 $ 0.58 $ 0.52
Extraordinary item...................................... -- (0.07) --
----------- ----------- -----------
Net income.............................................. $ 0.28 $ 0.51 $ 0.52
=========== =========== ===========
Weighted average number shares outstanding.............. 2,371,041 4,484,492 7,382,307
=========== =========== ===========
Diluted:
Income before extraordinary item........................ $ 0.13 $ 0.41 $ 0.51
Extraordinary item...................................... -- (0.05) --
----------- ----------- -----------
Net income.............................................. $ 0.13 $ 0.36 $ 0.51
=========== =========== ===========
Weighted average number of shares outstanding........... 5,181,867 6,447,265 7,612,155
=========== =========== ===========
</TABLE>
See accompanying notes.
F-4
<PAGE> 5
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL
PAID-IN ADDITIONAL
CAPITAL ON PAID-IN COMMON RETAINED
CONVERTIBLE CONVERTIBLE CAPITAL ON STOCK EARNINGS
PREFERRED PREFERRED COMMON COMMON PURCHASE (ACCUMULATED TREASURY
STOCK STOCK STOCK STOCK WARRANTS DEFICIT) STOCK
----------- ------------ ------- ----------- ----------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at March 31, 1995............. $ 10,230 $ 6,732,160 $24,381 $ 42,424 $ 2,431,802 $(2,610,404) $ (35,000)
Accretion of value of common stock
purchase warrants................. -- -- -- -- 406,346 (406,346) --
Distributions to former Nebraska
Shareholders...................... -- -- -- -- -- (853,173) --
Net income.......................... -- -- -- -- -- 526,808 --
-------- ----------- ------- ----------- ----------- ----------- ---------
Balance at March 31, 1996............. 10,230 6,732,160 24,381 42,424 2,838,148 (3,343,115) (35,000)
Accretion of value of common stock
purchase warrants................. -- -- -- -- 281,398 (281,398) --
Issuance of common stock in
connection with initial public
offering.......................... -- -- 22,000 19,238,000 -- -- --
Conversion of note receivable to
treasury stock.................... -- -- -- -- -- -- (65,000)
Exercise of common stock purchase
warrants.......................... -- -- 1,417 367,583 (368,150) -- --
Cashless exercise of common stock
purchase warrants................. -- -- 9,333 2,742,063 (2,751,396) -- --
Conversion of convertible preferred
stock to common stock............. (10,230) (6,732,160) 17,050 6,725,340 -- -- --
Distributions to former Nebraska
Shareholders...................... -- -- -- -- -- (1,236,970) --
Reclassification of undistributed
Nebraska S Corporation earnings to
additional paid-in capital........ -- -- -- 693,366 -- (693,366) --
Recognition of deferred income tax
assets related to termination of
Nebraska Subchapter S Corporation
status upon consummation of
pooling of interests.............. -- -- -- 414,000 -- -- --
Net income.......................... -- -- -- -- -- 3,557,960 --
-------- ----------- ------- ----------- ----------- ----------- ---------
Balance at March 31, 1997............. -- -- 74,181 30,222,776 -- (1,996,889) (100,000)
Issuance of common stock in
connection with acquisitions...... -- -- 3,544 3,496,456 -- -- --
Exercise of common stock options.... -- -- 351 119,101 -- -- --
Treasury shares retired............. -- -- (349) (99,651) -- -- 100,000
Shares returned from escrow and
retired........................... -- -- (432) 432 -- -- --
Net income.......................... -- -- -- -- -- 3,852,461 --
-------- ----------- ------- ----------- ----------- ----------- ---------
Balance at March 31, 1998............. $ -- $ -- $77,295 $33,739,114 $ -- $ 1,855,572 $ --
======== =========== ======= =========== =========== =========== =========
<CAPTION>
TOTAL
-----------
<S> <C>
Balance at March 31, 1995............. $ 6,595,593
Accretion of value of common stock
purchase warrants................. --
Distributions to former Nebraska
Shareholders...................... (853,173)
Net income.......................... 526,808
-----------
Balance at March 31, 1996............. 6,269,228
Accretion of value of common stock
purchase warrants................. --
Issuance of common stock in
connection with initial public
offering.......................... 19,260,000
Conversion of note receivable to
treasury stock.................... (65,000)
Exercise of common stock purchase
warrants.......................... 850
Cashless exercise of common stock
purchase warrants................. --
Conversion of convertible preferred
stock to common stock............. --
Distributions to former Nebraska
Shareholders...................... (1,236,970)
Reclassification of undistributed
Nebraska S Corporation earnings to
additional paid-in capital........ --
Recognition of deferred income tax
assets related to termination of
Nebraska Subchapter S Corporation
status upon consummation of
pooling of interests.............. 414,000
Net income.......................... 3,557,960
-----------
Balance at March 31, 1997............. 28,200,068
Issuance of common stock in
connection with acquisitions...... 3,500,000
Exercise of common stock options.... 119,452
Treasury shares retired............. --
Shares returned from escrow and
retired........................... --
Net income.......................... 3,852,461
-----------
Balance at March 31, 1998............. $35,671,981
===========
</TABLE>
See accompanying notes.
F-5
<PAGE> 6
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
---------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income.............................................. $ 526,808 $ 3,557,960 $ 3,852,461
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation.......................................... 1,104,039 1,330,180 1,617,897
Amortization of other assets.......................... 931,076 886,555 1,284,552
Extraordinary item -- loss on early extinguishment of
debt, net of income taxes.......................... -- 308,683 --
Loss on closure or relocation of schools.............. 50,000 25,000 --
Impairment of goodwill and intangibles................ 764,000 -- --
Provision for losses on accounts and notes
receivable......................................... 1,270,565 1,239,151 1,151,669
Deferred income taxes................................. -- (1,563,995) 430,460
Amortization of discount on long-term debt............ 123,567 72,044 --
Changes in operating assets and liabilities, net of
assets acquired and liabilities assumed:
Restricted cash.................................... (235,000) 610,000 --
Accounts receivable................................ (673,666) (1,885,940) 22,255
Income taxes receivable............................ -- (155,542) 155,542
Prepaid expenses................................... (60,224) (68,651) (756,631)
Notes receivable................................... -- -- (1,478,790)
Other assets....................................... (40,292) 62,297 155,269
Accounts payable and accrued expenses.............. (61,741) 708,334 (3,133,196)
Deferred tuition income............................ 202,430 (1,826,398) (1,438,135)
Other liabilities.................................. 305,713 (563,021) 495,932
----------- ----------- -----------
Net cash provided by operating activities............... 4,207,275 2,736,657 2,359,285
INVESTING ACTIVITIES:
Purchases of businesses, net of cash acquired........... -- (1,400,000) 2,192,983
Purchases of property and equipment..................... (1,342,638) (2,079,501) (2,199,621)
----------- ----------- -----------
Net cash used in investing activities................... (1,342,638) (3,479,501) (6,638)
FINANCING ACTIVITIES:
Issuance of common stock................................ -- 19,260,000 --
Proceeds from notes payable and long-term debt.......... 391,837 532,295 9,000,000
Principal payments on acquisition notes payable......... (1,404,160) (1,890,493) (3,984,017)
Proceeds from exercise of common stock purchase
warrants.............................................. -- 850 --
Proceeds from exercise of common stock options.......... -- -- 119,452
Principal payments on senior subordinated debt.......... (500,000) (5,000,000) --
Increase in deferred financing costs.................... (86,222) (297,492) (90,189)
Distributions to former Nebraska Shareholders........... (790,193) (1,023,472) --
----------- ----------- -----------
Net cash (used in) provided by financing activities..... (2,388,738) 11,581,688 5,045,246
----------- ----------- -----------
Increase in cash and cash equivalents................... 475,899 10,838,844 7,397,893
Cash and cash equivalents at beginning of year.......... 2,733,146 3,209,045 14,047,889
----------- ----------- -----------
Cash and cash equivalents at end of year................ $ 3,209,045 $14,047,889 $21,445,782
=========== =========== ===========
</TABLE>
See accompanying notes.
F-6
<PAGE> 7
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
1. ORGANIZATION AND NATURE OF BUSINESS
Educational Medical, Inc. (the "Company") operates diversified
career-oriented postsecondary education schools. The Company offers diploma and,
in certain locations, degree programs through its 24 schools located in ten
states. The Company's schools offer degree and diploma programs designed to
provide enrolled students with the knowledge and skills necessary for entry
level employment in the fields of healthcare, business, information technology,
fashion and design.
Approximately 38%, 13%, 12%, and 11% of the Company's fiscal 1998 net
revenues were derived from its schools in California, Nebraska, Texas, and
Pennsylvania, respectively. No other schools in a single state represented over
10% of net revenues for the year ended March 31, 1998. Approximately 73% of the
Company's fiscal 1998 cash receipts were derived from Title IV programs as
provided for by the Higher Education Act of 1965, as amended. Cash receipts
approximated 96% of the Company's net revenues in fiscal 1998.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles ("GAAP") requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS/RESTRICTED CASH
Cash equivalents include overnight investments in a bank. These investments
are recorded at cost, which approximates market. The Company considers
investments with maturities of three months or less at the date of purchase to
be cash equivalents for purposes of the statements of cash flows.
At March 31, 1997 and 1998, the Company held $13,515,475 and $16,207,676,
respectively, in cash balances at certain financial institutions which amounts
were in excess of the $100,000 federally insured amounts. The Company monitors
the financial condition of these institutions since it is exposed to credit risk
for such excess amounts, however, at this time the Company does not believe any
of these institutions present such risk.
Restricted cash represents amounts received from the New Hampshire Higher
Education Assistance Foundation (NHHEAF) for student loans which will be
credited to individual student's account receivable balances once the student
enrolls at the College. Loan disbursements received for students who do not
ultimately enroll at the College are required to be returned to the NHHEAF. The
corresponding liability for these undisbursed loan proceeds has been recorded as
deferred tuition income in the accompanying consolidated balance sheet.
NOTES RECEIVABLE
Notes receivable consist of promissory notes with varying interest terms
issued to students. Such notes are payable in minimum monthly payments beginning
six months after the student's graduation and are due in a maximum of ten years.
F-7
<PAGE> 8
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LONG-LIVED ASSETS
The Company measures and records impairment losses on long-lived assets,
including property, equipment and intangibles, used in operations when events
and circumstances indicate that the assets might be impaired and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amounts of those assets.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation, including that
related to assets under capital leases, is computed using the straight-line
method over the estimated useful lives of the related assets or the remaining
lease terms for leasehold improvements, if shorter.
COVENANTS NOT TO COMPETE
Non-compete agreements obtained from the sellers of certain acquired
schools are being amortized on the straight-line basis over the lives of the
agreements, generally from two to 15 years.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill is amortized over periods ranging from 15 to 40 years. Other
intangible assets, which are similar in character to goodwill (acquired student
contracts, program curriculum, favorable leases assumed, accreditation and
acquired tradenames) are being amortized using the straight-line method over
periods ranging generally from two to ten years.
DEFERRED DEBT ISSUANCE COSTS
Deferred debt issuance costs represent fees and other costs associated with
obtaining long-term debt financing. Such amounts are amortized over the lives of
the related debt, using the straight-line method.
REVENUE RECOGNITION
Tuition revenue is recognized monthly on a straight-line basis over the
term of the course of study. Certain nonrefundable fees and charges are fully
recognized as revenue at the time a student begins classes.
The Company is generally required to refund a portion of a student's
unearned tuition who withdraws from a Company school. The amount of tuition, if
any, that may be retained by the Company after payment of any potential refund
is immediately recognized in the Company's consolidated statement of income.
Deferred tuition income represents the portion of student tuitions received
in advance of the course of study's completion.
INCOME TAXES
The Company uses the liability method of accounting for income taxes. Under
this method, deferred income tax assets and liabilities are determined based on
differences between the financial reporting and the tax bases of assets and
liabilities measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
PRO FORMA INCOME TAX DATA
Prior to March 31, 1997, the Nebraska Acquisition (see Note 4) consisted of
a Subchapter S Corporation and a partnership and, accordingly, was not subject
to federal or state income taxes. For informational
F-8
<PAGE> 9
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
purposes, the 1996 and 1997 statements of income include a pro forma
presentation that includes a provision for income taxes as if the Nebraska
Acquisition had been a taxable corporation for these periods and had filed a
consolidated income tax return with the Company. Such pro forma amounts were
based on the income tax laws and rates in effect during those periods and
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes."
STATEMENTS OF CASH FLOWS
The following non-cash transactions have been excluded from the
consolidated statements of cash flows:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
-----------------------------------
1996 1997 1998
-------- ---------- -----------
<S> <C> <C> <C>
Capital leases..................................... $347,000 $ 121,000 $ 392,000
Issuance of notes payable and other amounts due to
sellers in connection with acquisitions and
related non-compete agreements................... -- 4,100,000 23,517,602
Distribution of note receivable to former Nebraska
shareholders..................................... -- 213,498 --
Conversion of note receivable to treasury stock.... -- 65,000 --
Issuance of Common Stock in connection with
acquisitions..................................... -- -- 3,500,000
</TABLE>
STOCK COMPENSATION
The Company uses the intrinsic value method of accounting for its
stock-based compensation awards. As such, compensation expense is measured and
recorded if the exercise price of the stock options (or other awards) is below
the fair value of the Company's stock on the date of grant. The Company
discloses the pro forma effect of all stock compensation using the fair value
method as prescribed by Financial Accounting Standards Board Statement No. 123,
"Accounting for Stock-Based Compensation," ("SFAS 123"). See Note 9.
EARNINGS PER SHARE
Earnings per share are calculated using Statement of Financial Accounting
Standards No. 128, Earnings per Share, ("SFAS 128") and Securities and Exchange
Commission Staff Accounting Bulletin No. 98 ("SAB 98"). Basic earnings per share
include weighted average common shares outstanding. Diluted earnings per share
include weighted average common shares outstanding plus the dilutive effect of
outstanding preferred stock, stock options, and stock purchase warrants.
All earnings per share calculations include 761,263 shares issued on March
31, 1997 to effect the Nebraska Acquisition, less shares returned to the Company
pursuant to the contingency clause, as if outstanding for all periods.
NEW ACCOUNTING PRONOUNCEMENTS
In 1997, the Financial Accounting Standards Board issued Statement No. 131,
Disclosures about Segments of an Enterprise and Related Information ("SFAS
131"), which is effective for financial statements for periods after December
15, 1997. SFAS 131 requires the reporting of segment profit or loss, certain
specific revenue and expense items, segment assets, and a reconciliation of
these disclosed items in total to the consolidated financial statements. SFAS
131 also requires the restatement of comparative information for earlier years
in the initial year of application. The Company has not yet adopted SFAS 131
however there will be no impact on the financial statements, other than
disclosure.
F-9
<PAGE> 10
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. REGULATORY MATTERS
The Company derives a substantial portion of its net revenues from
financial aid received by its students under Title IV programs ("Title IV
Programs") administered by the United States Department of Education
("Department") pursuant to the federal Higher Education Act of 1965, ("HEA"), as
amended. In order to continue to participate in Title IV Programs, the Company
and its schools must comply with complex standards set forth in the HEA and the
regulations promulgated thereunder (the "Regulations"). Among other things these
Regulations require the Company's schools to exercise due diligence in approving
and disbursing funds and servicing loans, limit the proportion of cash receipts
by the Company's schools derived from Title IV Programs to no more than 85% of
the total net revenue derived from the school's students in its Title IV
eligible educational programs, and to exercise financial responsibility related
to maintaining certain financial covenants (including cash reserve for refunds,
an "acid test" ratio, a positive tangible net worth test and limitations on the
amount of operating losses in comparison to tangible net worth, as defined). All
of the Company's schools participate in Title IV Programs.
The failure of any of the Company's schools to comply with the requirements
of the HEA or the Regulations could result in the restriction or loss by the
Company or such school of its ability to participate in Title IV Programs. If
the Department determines that any of the Company's schools is not financially
responsible, the Department may require that the Company or such school post an
irrevocable letter of credit in an amount equal to not less than one-half of
Title IV Program funds received by the relevant school during the last complete
award year or, at the Department's discretion, require some other less onerous
demonstration of financial responsibility. One-half of Title IV funds received
by the Company's individual schools in the Company's most recent fiscal year
ranged from $.4 million to $5.0 million and one-half of the aggregate Title IV
funds received by all of the Company's schools in the most recent fiscal year
equaled $39.2 million. At March 31, 1998, the Company posted irrevocable letters
of credit for two of its schools totaling $181,000 which are payable to the
Department of Education and expire in October 1998.
Many of the financial responsibility standards are new, difficult to
interpret, and subject to the interpretation of the Department for
implementation. Further, the process for resolving lack of compliance with such
Regulations is also subject to interpretation and, in some cases, negotiation
with the Department. The Company believes each of its schools satisfies the
financial responsibility standards for fiscal 1998 except with respect to the
operating losses incurred by the Company's schools located in Roanoke and
Harrisonburg, Virginia.
In November 1997, the Department of Education published new regulations
regarding financial responsibility which are effective on July 1, 1998. The new
regulations will apply to the Company's fiscal years commencing April 1, 1999,
and thereafter. The regulations provide a transition year alternative which will
permit the Company to have its institutions' financial responsibility for the
fiscal year ended March 31, 1999 measured on the basis of either the new
regulations or the current regulations, whichever are more favorable. The new
standards replace the Acid Test Ratio, the Tangible Net Worth Standard and the
Net Operating Results Test with three different ratios: an equity ratio, a
primary reserve ratio and a net income ratio. The equity ratio measures the
institution's capital resources, ability to borrow and financial viability. The
primary reserve ratio measures the institution's ability to support current
operations from expendable resources. The net income ratio measures the ability
to operate at a profit. The results of each ratio are assigned a strength factor
on a scale from negative 1.0 to positive 3.0, with negative 1.0 reflecting
financial weakness and 3.0 reflecting financial strength. An institution's
strength factors are then weighted based on an assigned weighting percentage for
each ratio. The weighted scores for the three ratios are then added together to
produce a composite score for the institution. The composite score must be at
least 1.5 for the institution to be deemed financially responsible by the
Department of Education without the need for further financial monitoring. If
the institution's composite score is less than 1.5, but equal to or greater than
1.0, the institution may continue in the Title IV Program for a maximum period
of three (3) years, subject to more rigorous financial aid
F-10
<PAGE> 11
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. REGULATORY MATTERS (CONTINUED)
disbursement and financial monitoring requirements of the Department of
Education. Based on the Company's interpretation of the application of these new
standards to the Company's financial statements for the year ended March 31,
1998, the Company's calculations result in a composite score of 1.4 on a
consolidated basis, with each individual institution included in the
consolidating statements having a composite score greater than 1.5. The Company
is evaluating its options in order to comply with the new regulations.
4. ACQUISITIONS
During the fiscal years ended March 31, 1997 and 1998 the Company completed
three and two acquisitions, respectively, adding a total of twelve schools.
All of the acquisitions were accounted for under the purchase method of
accounting except the March 1997 Nebraska Acquisition. Under the purchase method
of accounting, the results of operations of the acquired companies are included
in the consolidated statement of income as of the acquisition date. The assets
and liabilities of the companies acquired in fiscal 1998 are included in the
Company's consolidated balance sheet based on a preliminary allocation of their
estimated fair values on the date of acquisition. The excess of cost over
acquired net assets of businesses acquired has been recorded as an intangible
asset and is being amortized on a straight line basis.
The following summarizes key information relevant to the fiscal 1998 and
1997 acquisitions:
HESSER ACQUISITION
On March 13, 1998, the Company acquired all of the outstanding stock of
Hesser, Inc. and certain real estate assets from an affiliate of Hesser, Inc
(collectively, the "Hesser Acquisition"). The purchase price of the Hesser
Acquisition was $17,683,372 consisting of $2,000,000 in cash, promissory notes
and other payables aggregating $13,683,372 and 202,532 shares of the Company's
Common Stock. The results of the Hesser Acquisition's operations are included in
the Company's consolidated statement of income effective March 1, 1998.
The Hesser Schools are located in Manchester, Nashua, Portsmouth and Salem,
New Hampshire and primarily offer bachelor degree and associate degree programs
in business, healthcare, information technology, criminal justice, electronic
engineering, early childhood education, and other careers. As of March 31, 1998,
the Company's Title IV funding for the Hesser Schools was suspended pending
Department of Education recertification.
CHI INSTITUTE ACQUISITION
On February 14, 1998, the Company acquired all of the outstanding stock of
Computer Hardware Service Company, Inc. ("CHI Institute Acquisition"). The
purchase price of the CHI Institute Acquisition was $12,834,230, consisting of
$1,500,000 in cash, promissory notes and other payables aggregating $9,834,230
and 151,900 shares of the Company's Common Stock. The results of the CHI
Institute Acquisition's operations are included in the Company's consolidated
statement of income effective February 1, 1998.
The CHI Institute Acquisition consists of two schools located in Broomall
and Southampton, Pennsylvania which offer associate degree and diploma programs
in business, healthcare and information technology. As of March 31, 1998, the
Company's Title IV funding for the CHI Institute Schools was suspended pending
Department of Education recertification.
F-11
<PAGE> 12
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. ACQUISITIONS (CONTINUED)
MARYLAND ACQUISITION
On December 12, 1996, the Company acquired substantially all of the assets
of one school located in Hagerstown, Maryland ("Maryland Acquisition") for
$2,700,000 in cash. The Maryland school offers healthcare and business diploma
and degree programs. The results of the Maryland Acquisition's operations are
included in the Company's consolidated statement of income effective December 1,
1996.
TEXAS ACQUISITION
On September 6, 1996, the Company acquired substantially all of the assets
of three schools located in Texas for $2,500,000 (the "Texas Acquisition"). The
schools offer healthcare degree and diploma programs and are located in San
Antonio, McAllen and El Paso, Texas. The results of the Texas Acquisition's
operations are included in the Company's consolidated statement of income
effective September 1, 1996.
The Company financed the purchase of the Texas schools with $1,250,000 in
cash and the remaining $1,250,000 payable in the form of a promissory note
bearing interest at 8% per annum and due in five equal annual principal
payments.
NEBRASKA ACQUISITION
On March 31, 1997, the Company acquired all of the outstanding stock of
Educational Management, Inc. ("Nebraska Acquisition"). The Nebraska Acquisition
consisted of two schools located in Lincoln and Omaha, Nebraska, which offer
business degree and diploma programs, and related real estate. In connection
with the acquisition, the Company issued 761,263 shares of its common stock,
agreed to pay $300,000 in non-compete agreements and paid approximately
$1,100,000 in cash which was used to pay off mortgage notes on certain real
estate owned by the Nebraska Acquisition.
This transaction was accounted for as a pooling of interests; therefore,
all financial statements presented have been restated to reflect the
acquisition. The Nebraska Acquisition prepared its financial statements using a
December 31 calendar year-end prior to the acquisition. Prior to the
acquisition, the Nebraska Acquisition and its predecessor filed its income tax
returns under the provisions of Subchapter S of the Internal Revenue Code and as
a partnership and hence recorded no provision for income taxes. Certain
adjustments were made to the Company's financial statements to record deferred
income taxes at the date of acquisition.
Net revenues and net income included in the Company's consolidated
statements of income are as follows:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31
-------------------------
1996 1997
----------- -----------
<S> <C> <C>
Net revenues:
Educational Medical, Inc................................. $38,651,827 $43,437,416
Nebraska Acquisition..................................... 4,694,706 6,012,264
----------- -----------
$43,346,533 $49,449,680
=========== ===========
Net income
Educational Medical, Inc................................. $ 79,424 $ 2,321,432
Nebraska Acquisition..................................... 447,384 1,236,528
----------- -----------
$ 526,808 $ 3,557,960
=========== ===========
</TABLE>
In connection with this acquisition, 95,074 shares of the 761,263 shares
issued were placed into escrow pending the resolution of certain financial aid
compliance matters with the Department of Education. In fiscal
F-12
<PAGE> 13
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. ACQUISITIONS (CONTINUED)
year 1998, the Company settled a portion of these contingencies and as a result
received 43,215 shares from the sellers' escrow and 32,809 shares were released
from escrow. The other 19,050 shares continue to be held in escrow for specified
periods.
SUMMARY PRO FORMA INFORMATION (UNAUDITED)
Summary unaudited pro forma results of operations for the years ended March
31, 1997 and 1998 for the four acquisitions accounted for as purchases, as if
the acquisitions had occurred at April 1, 1996 and April 1, 1997, respectively,
and as if the entities involved in the Texas and Hesser Acquisitions filed
Federal income tax returns as C Corporations rather than as Subchapter S
Corporations and a partnership, are as follows:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
--------------------------
1997 1998
----------- -----------
<S> <C> <C>
Net revenues.............................................. $70,739,000 $80,965,000
Income before extraordinary items......................... 2,428,000 3,668,000
Net income................................................ 2,119,000 3,668,000
Earnings per share:
Basic:
Income per share before extraordinary item........... $ 0.50 $ 0.48
Net income per share................................. $ 0.44 $ 0.48
Weighted average common and common equivalent shares
outstanding........................................ 4,838,924 7,709,134
Diluted:
Income per share before extraordinary item........... $ 0.36 $ 0.46
Net income per share................................. $ 0.31 $ 0.46
Weighted average common and common equivalent shares
outstanding........................................ 6,801,697 7,939,050
</TABLE>
These unaudited pro forma results of operations in fiscal 1997 and fiscal
1998 do note purport to represent what the Company's actual results of
operations would have been if the acquisitions had occurred on April 1, 1996 and
April 1, 1997, respectively, and should not serve as a forecast of the Company's
operating results for any future periods. The pro forma adjustments are based
solely on the available information and certain assumptions that management
believes are reasonable. Management believes the full impact of potential cost
savings has not been reflected in the pro forma results presented above,
although there can be no assurances such cost savings will be achieved.
Subsequent adjustments may be necessary upon final determination of the
allocation of the purchase prices.
F-13
<PAGE> 14
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
MARCH 31,
---------------------------
1997 1998
----------- ------------
<S> <C> <C>
Land and land improvements............................... $ 748,598 $ 927,598
Buildings and building improvements...................... 3,288,257 6,538,230
Equipment, furniture and fixtures........................ 7,451,297 10,018,311
Leasehold improvements................................... 1,517,178 3,133,234
----------- ------------
13,005,330 20,617,373
Less accumulated depreciation and amortization........... ( 5,387,372) (6,973,137)
----------- ------------
$ 7,617,958 $ 13,644,236
=========== ============
</TABLE>
6. NOTES PAYABLE AND LONG-TERM DEBT
Notes payable and long-term debt consist of the following:
<TABLE>
<CAPTION>
MARCH 31,
--------------------------
1997 1998
----------- -----------
<S> <C> <C>
Bank lines of credit and term loan, $36,000,000 principal,
monthly interest payments, matures March 13, 2001. As of
March 31, 1998, $15,819,000 was available under the lines
of credit(a).............................................. $ -- $ 9,000,000
8.75% mortgage payable, adjustable in 1998 up to prime plus
1.25%, to a bank, due in monthly installments of principal
and interest, secured by land and building of one
school.................................................... 625,668 595,076
Promissory notes payable to sellers of various schools
acquired, non-interest bearing or with interest rates
ranging from 7.5% to 11% per annum, principal and interest
payable periodically through February 2003(b)............. 1,790,000 21,180,000
9% note payable to a bank, due in monthly installments of
$15,000 plus interest. The note was paid in full in May
1998...................................................... -- 410,000
Various unsecured, non-interest bearing notes payable for
noncompetition agreements, payable periodically through
May 1999.................................................. 757,500 112,500
Various unsecured, non-interest bearing notes payable to
sellers of various schools acquired....................... 2,500,000 --
8% to 12% capital leases, payable periodically through
September 2002; secured by equipment...................... 455,563 649,195
----------- -----------
6,128,731 31,946,771
Less current portion........................................ (3,964,851) (14,837,203)
----------- -----------
$ 2,163,880 $17,109,568
=========== ===========
</TABLE>
- ---------------
(a) In March 1998, the Company entered into an amended and restated loan
agreement (the "Agreement") with a major U.S. Bank (the "Bank"). The
Agreement increases the Company's aggregate borrowing limit with the Bank to
$36,000,000 (the "Bank Credit Facility"). The total amount of the Bank
Credit Facility is divided into three separate facilities: (i) a three year
revolving line of credit of up to $10,000,000 which may be utilized for
advances or to support letters of credit; (ii) a revolving term loan
facility of up to $11,000,000 which may be utilized prior to March 31, 1999
for the purpose of financing permitted acquisitions, either directly or to
support stand by letters of credit, reducing to $9,000,000 in March 1999 and
subject to quarterly reductions of $750,000 thereafter; and (iii) a three
year non-revolving line of credit up to $15,000,000 which may be utilized
for the purpose of financing permitted
F-14
<PAGE> 15
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED)
acquisitions. Interest is charged on borrowings at different floating rates
above LIBOR depending on certain financial conditions of the Company and
depending on which facility amounts are drawn on. In addition, the Bank
Credit Facility provides for commitment fees to be paid on the unused
portion of the facility. The Bank Credit Facility also contains restrictions
on the payment of dividends and incurrence of additional debt, as well as
various other financial covenants. The Bank Credit Facility is secured by
substantially all of the assets of the Company.
(b) Included in the $21,180,000 above is a note issued in connection with the
Hesser Acquisition aggregating $11,000,000 which is due upon the Department
of Education's approval of the change in control. As of March 31, 1998 the
note was secured by an $11,000,000 letter of credit which expires in March
1999. In May 1998 the Company canceled the letter of credit and replaced it
by depositing $11,000,000 in an escrow cash account. On June 2, 1998 the
note was modified to provide that $1,500,000 of the principal amount is due
on April 1, 1999 and bears interest at 7.5% beginning 30 days following the
Department of Education's recertification of the Hesser schools. This
modification has been reflected in the financial statements as of March 31,
1998. Notes payable aggregating $21,042,500 are secured by the stock of the
Company's acquiring subsidiaries.
Aggregate maturities of long-term debt at March 31, 1998 are as follows:
<TABLE>
<S> <C>
Fiscal year ending March 31
1999...................................................... $14,837,203
2000...................................................... 3,679,488
2001...................................................... 10,482,850
2002...................................................... 1,410,979
2003...................................................... 1,149,051
Thereafter................................................ 387,200
-----------
$31,946,771
===========
</TABLE>
Interest paid during the years ended March 31, 1996, 1997 and 1998 was
approximately $1,328,000, $655,000 and $254,000, respectively.
7. OTHER AMOUNTS DUE TO SELLERS
In addition to the notes payable described in Note 6, the Company owes the
former Hesser, Inc. shareholders approximately $2,433,372 as part of the
purchase of Hesser, Inc. based on the ratio of certain assets to certain
liabilities of the Hesser Schools at the time of the acquisition. Of the total
amount due, $1,250,000 was paid in May 1998 and $1,183,372 was paid in June
1998.
In addition to the notes payable described in Note 6, the Company owes the
former Computer Hardware Service Company, Inc. shareholders approximately
$1,084,230 as part of the purchase of Computer Hardware Service Company, Inc.,
based on the ratio of certain assets to certain liabilities of the CHI Institute
Schools at the time of the acquisition. All of this amount was paid in May 1998.
8. STOCKHOLDERS' EQUITY
INITIAL PUBLIC OFFERING
On October 28, 1996, the Company completed its IPO. A total of 2,400,000
shares was sold at $10 per share which included 2,200,000 shares sold by the
Company and 200,000 shares sold by certain selling stockholders. The selling
stockholders sold an additional 210,000 shares in November 1996; the Company did
not receive any of the proceeds from the selling stockholders' sales. The net
proceeds to the Company were approximately $19.3 million and were partially used
to repay $4.8 million of subordinated debt. The balance of
F-15
<PAGE> 16
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. STOCKHOLDERS' EQUITY (CONTINUED)
the IPO proceeds will be used for general corporate purposes, including the
expansion of its operations through the acquisition of additional schools.
In connection with the early extinguishment of the $4.8 million in
subordinated debt in fiscal year 1997, the Company incurred an extraordinary
loss of $514,500 ($308,683, net of tax), as a result of the write-off of the
related unamortized deferred debt issuance costs and unamortized debt discount.
STOCK SPLIT
On June 20, 1996, the Company amended its certificate of incorporation to
increase the authorized Common Stock to 15,000,000 shares, retain the par value
of $.01 per share, and to provide a five-for-three Common Stock split. Such
amendment was effective upon the IPO. All common share and per common share
amounts have been adjusted for all periods to reflect the stock split.
PREFERRED STOCK
In 1996, the Company authorized 5,000,000 shares of Preferred Stock; terms
will be set upon issuance.
CONVERTIBLE PREFERRED STOCK
Prior to its IPO, the Company issued 1,023,049 shares of Convertible
Preferred Stock, $.01 par value. At the option of the holder, shares of
Convertible Preferred Stock converted into 1.67 shares of Common Stock and prior
to March 1996, were mandatorily redeemable at $6.66 per share, subject to
certain antidilution adjustments.
Through July 22, 1991, the shares of Convertible Preferred Stock accrued
dividends at an annual rate of 8%. In 1991, pursuant to the issuance of certain
notes payable bearing interest at 13% per annum (the "13% Notes"), the terms of
the Convertible Preferred Stock were amended to eliminate the cumulative
dividends feature and the mandatory redemption in all circumstances, but still
permitting conversion at the option of the holder. In May 1996, terms were again
amended to require automatic conversion of all outstanding shares of Convertible
Preferred Stock in the event of an IPO.
All outstanding shares of Convertible Preferred Stock converted into
1,705,082 shares of Common Stock at the IPO.
COMMON STOCK
As of March 31, 1998, the Company has reserved the following shares of
Common Stock for future issuance related to the following:
<TABLE>
<S> <C>
Common Stock purchase warrants.............................. 43,334
Stock options............................................... 1,127,004
---------
1,170,338
=========
</TABLE>
COMMON STOCK PURCHASE WARRANTS
The holders of the certain 13% Notes were also granted stock purchase
warrants allowing for the purchase of up to 1,333,333 shares of Common Stock at
$3 per share (the "$3 Warrants"), for a total of $4,000,000. The $3 exercise
price of the warrants was subject to adjustment for any future issuances of
equity or equity related securities at a per share price less than the exercise
price. As of the IPO, these warrants were exercised
F-16
<PAGE> 17
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. STOCKHOLDERS' EQUITY (CONTINUED)
for the purchase of 1,333,333 shares, less shares used for the cashless
exercise, yielding 933,333 additional shares of Common Stock.
The holders of the $3 warrants had certain rights to "put" their warrants
to the Company and the Company had certain rights to "call" the warrants. In May
1996, the terms of the warrants were amended to provide for a cashless exercise
based on the IPO price per share, in the event of an IPO of the Company's common
stock and to eliminate the "put" feature.
The $3 warrants were assigned a value of $1,050,000 when issued. The
difference between the $1,050,000 and the exercise price of $4,000,000 was being
accreted, using a method which approximated the effective interest rate method,
through the date of earliest exercise (50% through March 31, 1998 and 50%
through March 31, 1999). Accretion of $406,346 and $281,398 was charged to
accumulated deficit during the years ended March 31, 1996 and 1997,
respectively.
In connection with the issuance of the Convertible Preferred Stock in 1991,
a third party was granted warrants to purchase 26,667 shares of Common Stock
exercisable at $3.60 per share. These warrants expire July 31, 1999 and are
outstanding as of March 31, 1998.
At the time of the IPO, the Company issued to a third party, warrants to
purchase 16,667 shares of Common Stock at $10 per share. These warrants expire
October 28, 2001 and are outstanding as of March 31, 1998.
9. STOCK OPTION PLANS
The Company granted employees and non-employee directors options to
purchase its Common Stock. The employee options vest incrementally over periods
ranging from four to five years and expire five years after vesting. The
non-employee director options vest immediately and expire five years after
vesting.
A summary of the status of the Company's employee and director stock option
activity, and related information for the years ended March 31, is as follows:
<TABLE>
<CAPTION>
1996 1997 1998
------------------ ------------------ --------------------
WEIGHTED WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE OF EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------- -------- ------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
year......................... 190,833 $2.68 361,666 $3.13 821,499 $7.04
Granted...................... 175,000 3.60 465,500 10.10 277,333 9.34
Exercised.................... -- -- -- -- (34,662) 3.45
Canceled/forfeited........... (4,167) 2.40 (5,667) 8.12 (38,166) 7.40
------- ------- ---------
Outstanding at end of year..... 361,666 3.13 821,499 7.04 1,026,004 7.77
======= ======= =========
Exercisable at end of year..... 156,667 2.57 313,000 5.09 431,038 6.15
======= ======= =========
Options available for future
grant........................ 600,000 340,167 101,000
======= ======= =========
</TABLE>
F-17
<PAGE> 18
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. STOCK OPTION PLANS (CONTINUED)
The following table summarizes information about employee and director
stock options outstanding and exercisable at March 31, 1998 by exercise price:
<TABLE>
<CAPTION>
OPTIONS
OPTIONS OUTSTANDING EXERCISABLE
------------------------- -----------
NUMBER WEIGHTED NUMBER
OUTSTANDING AVERAGE EXERCISABLE
AT REMAINING AT
MARCH 31, CONTRACTUAL MARCH 31,
EXERCISE PRICE 1998 LIFE 1998
- -------------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
$ 2.40.................................................. 143,333 4.30 143,333
$ 4.00.................................................. 16,667 4.00 16,667
$ 3.60.................................................. 150,171 7.70 67,577
$10.00.................................................. 418,500 7.55 175,767
$11.50.................................................. 26,000 8.80 6,067
$ 8.50.................................................. 34,333 9.90 6,294
$ 7.06.................................................. 25,000 9.30 3,333
$ 7.63.................................................. 12,000 4.50 12,000
$ 9.88.................................................. 200,000 10.00 --
--------- -------
1,026,004 431,038
========= =======
</TABLE>
NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
On June 20, 1996, the Company adopted and its stockholders approved a
Non-employee Director Stock Option Plan (the "Directors' Plan") to attract and
retain the services of non-employee members of the Board of Directors and to
provide them with increased motivation and incentive to exert their best efforts
on behalf of the Company by enlarging their personal stake in the Company. The
maximum number of shares of Common Stock with respect to which options may be
granted under the Directors' Plan is 200,000 shares. As of March 31, 1998,
88,000 options were available for future grant.
Each member of the Board of Directors of the Company who otherwise (i) is
not currently an employee of the Company, (ii) is not a former employee still
receiving compensation for prior services, and (iii) is not currently receiving
remuneration from the Company in any capacity other than as a director shall be
eligible for the grant of stock options under the Directors' Plan
("Participant"). Currently, all directors other than the Chairman are eligible
to participate in the Directors' Plan.
On the date the Directors' Plan was adopted, each of the four existing
non-employee directors were each granted, contingent upon completion of the IPO,
options to purchase 25,000 shares of Common Stock of the Company at the per
share IPO price ($10). These options vested immediately upon consummation of the
IPO. Upon the election of any new member of the Board of Directors, such member
will be granted an option to purchase 25,000 shares of Common Stock at the fair
market value at date of grant, vesting in five equal annual installments
beginning on the first anniversary of the date of grant. Beginning with the next
annual meeting of the stockholders of the Company and provided that a sufficient
number of shares remain available under the Directors' Plan, each year
immediately following the date of the annual meeting of the Company there
automatically will be granted to each non-employee director who is then serving
on the Board an option to purchase 3,000 shares of the Common Stock of the
Company, which options will be immediately vested. On September 9, 1997, at the
annual meeting of the Board of Directors, each of the four non-employee
directors was issued an option to purchase an additional 3,000 shares of the
Company's common stock with an exercise price per share equal to the then
current fair market value of $7.63; such options vest immediately and are
exercisable for five years.
F-18
<PAGE> 19
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. STOCK OPTION PLANS (CONTINUED)
PRO FORMA INFORMATION
Pro forma information regarding net income and earnings per share is
required by SFAS 123, which also requires that the information be determined as
if the Company had accounted for its employee and director stock options granted
subsequent to April 1, 1995 under the fair value method described in SFAS 123.
The fair value of these stock options was estimated at the date of grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions for the years ended March 31, 1997 and 1998, respectively: (i)
dividend yield of 0%; (ii) expected volatility of .491 and .514; (iii) risk-free
interest rates of 6.18% and 6.09%; and (iv) expected life of 5.64 and 5.65
years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee and director stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
and director stock options.
For purposes of pro forma disclosure, the estimated fair value of the
employee and director options is amortized to expense over the options' vesting
period. The Company's pro forma information using SFAS 123 follows:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
-----------------------
1997 1998
---------- ----------
<S> <C> <C>
Pro forma income before extraordinary item.................. $2,201,907 $3,510,440
Pro forma net income........................................ $1,893,224 3,510,440
Pro forma earnings per common share:
Basic:
Income before extraordinary item....................... $ 0.49 $ 0.48
Net income............................................. 0.42 0.48
Diluted:
Income before extraordinary item....................... $ 0.34 $ 0.46
Net income............................................. 0.29 0.46
</TABLE>
Since SFAS 123 is applicable only to options granted subsequent to April 1,
1995, its pro forma effect will not be fully reflected until future years.
F-19
<PAGE> 20
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. INCOME TAXES
The components of the provision (benefit) for income taxes are as follows:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
-----------------------------------
1996 1997 1998
-------- ----------- ----------
<S> <C> <C> <C>
Current:
Federal.......................................... $484,376 $ 567,544 $1,701,104
State............................................ 147,809 151,088 353,209
-------- ----------- ----------
632,185 718,632 2,054,313
Deferred:
Federal.......................................... -- (1,218,248) 453,453
State............................................ -- (345,747) (22,993)
-------- ----------- ----------
-- (1,563,995) 430,460
-------- ----------- ----------
$632,185 $ (845,363) $2,484,773
======== =========== ==========
</TABLE>
At March 31, 1997, the Company recognized deferred income tax assets and
liabilities related to its Nebraska Acquisition. The predecessor entities
previously filed their income tax returns under the provisions of Subchapter S
of the Internal Revenue Code and as a partnership and hence recorded no
provision for income taxes or deferred income tax assets or liabilities at the
corporate level.
A reconciliation of the provision (benefit) for income taxes computed at
the statutory federal income tax rate on income before extraordinary item to the
Company's effective income tax rate follows:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
------------------------------------
1996 1997 1998
--------- ----------- ----------
<S> <C> <C> <C>
Federal........................................... $ 394,058 $ 1,027,235 $2,154,659
State, net of federal income tax benefit.......... 97,554 99,718 237,077
Permanent differences............................. 55,436 53,554 36,006
Increase (decrease) in deferred income tax asset
valuation allowance............................. 308,584 (1,319,987) --
Effect of Nebraska Acquisition filing as a
Subchapter S corporation........................ (152,111) (420,420) --
Effect of Nebraska Acquisition's termination of
Subchapter S corporation status................. -- (285,463) --
Utilization of AMT credit......................... (56,000) -- --
Other, net........................................ (15,336) -- 57,031
--------- ----------- ----------
$ 632,185 $ (845,363) $2,484,773
========= =========== ==========
</TABLE>
F-20
<PAGE> 21
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. INCOME TAXES (CONTINUED)
Deferred income taxes reflect the net income tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred income tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
MARCH 31,
-----------------------
1997 1998
---------- ----------
<S> <C> <C>
Deferred income tax assets:
Tradenames and other intangibles.......................... $ 575,393 $ 579,375
Property and equipment.................................... 369,236 911,789
Allowance for doubtful accounts........................... 330,135 902,084
Accrued expenses and other liabilities.................... 1,108,256 416,681
Other, net................................................ -- 50,000
---------- ----------
Total deferred income tax assets............................ 2,383,020 2,859,929
Total deferred income tax liabilities -- prepaid expenses... (229,722) (379,291)
---------- ----------
Net deferred income tax assets.............................. $2,153,298 $2,480,638
========== ==========
</TABLE>
The Company paid approximately $360,000, 1,076,000 and $2,130,000 of income
taxes in the years ended March 31, 1996, 1997 and 1998, respectively.
11. LEASES
The Company leases office, classroom and dormitory space under various
operating lease agreements expiring through 2006. Rent expense totaled
approximately $2,971,000, $3,650,000 and $4,396,000 for the years ended March
31, 1996, 1997 and 1998, respectively.
Approximate future minimum lease payments under noncancelable operating
leases in effect at March 31, 1998 are as follows:
<TABLE>
<S> <C>
Fiscal year ending March 31
1999...................................................... $ 4,472,000
2000...................................................... 3,909,000
2001...................................................... 3,288,000
2002...................................................... 2,715,000
2003...................................................... 2,099,000
Thereafter................................................ 4,018,000
-----------
$20,501,000
===========
</TABLE>
12. EMPLOYEE BENEFIT PLAN
The Company sponsors a defined contribution plan covering substantially all
employees; the plan is qualified under Section 401(k) of the Internal Revenue
Code. Under the provisions of the plan, eligible participating employees may
elect to contribute up to the maximum amount of tax deferred contribution
allowed by the Internal Revenue Code. The Company matches a portion of such
contributions up to a maximum percentage of the employees' compensation. The
Company's contributions to the plan and to predecessor plans assumed in the CHI
Acquisition were approximately $104,000, $133,000 and $111,000 for the years
ended March 31, 1996, 1997 and 1998, respectively.
F-21
<PAGE> 22
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. OTHER EXPENSES
IMPAIRMENT OF LONG-LIVED ASSETS
The Company's Roanoke, Virginia school has incurred significant operating
losses since its acquisition. Accordingly, the Company evaluated the
recoverability of the school's long-lived assets including its identifiable
intangible assets and goodwill. Based on the Company's expectation of future
cash flows, the Company determined that assets with a carrying amount of
$764,000 were impaired and recorded an impairment loss in fiscal year 1996 to
record such assets at management's estimate of the net present value of such
future cash flows. This estimate was based on estimated undiscounted future cash
flows to be generated by such assets.
CONTINGENCIES
In September 1995, the Company filed suit in connection with its 1993
purchase of its Hollywood, California school. The suit alleged that the sellers
made significant financial and operational misrepresentations to the Company.
The Company sought damages from the sellers. The Sellers denied the Company's
allegations and filed a Cross-Complaint against the Company alleging among other
things, breach of contract and fraud. Both parties agreed to dismiss their
claims in April 1997 when the Company agreed to pay a total of $564,892
representing all amounts outstanding on the acquisition notes payable to the
sellers and the notes payable for covenants not-to-compete, in addition to the
payment of a portion of the sellers' legal fees. All amounts, including the
Company's legal defense expenses, were accrued or paid as of March 31, 1997.
On June 24, 1994, eight students enrolled in one of the Company's programs
at its schools in the San Diego, California area filed a lawsuit against the
Company in the state court in California. In substance, the suit alleged that
there were material misrepresentations made with respect to the content of the
program and the potential outcomes achieved by the students who graduated from
it. The suit was certified as a class action in the fall of 1994. Although the
Company believes that it accurately described the course content and the
multiple outcomes to which the course could lead, in order to avoid further
legal expense and because of the uncertainty and risks inherent in any
litigation, the Company determined that it was desirable to settle the lawsuit.
A final settlement was approved in March 1996. Pursuant to the terms of the
settlement, the Company paid the plaintiffs $600,000 in the fiscal year ended
March 31, 1996 and an additional $400,000 on April 1, 1997. In addition, the
Company agreed to make available tuition credits of $1,150,000 to class members,
provided that students elected to utilize such tuition credits by July 17, 1996.
Any unused tuition credits were to be redeemed in cash by the Company for 10% of
the credit and $115,000 was accrued for these credits, as of March 31, 1996. All
of this settlement expense is reflected in the 1996 consolidated statement of
income. As of March 31, 1997, only a few students had requested tuition credits
and substantially all of the $115,000 balance was paid into the settlement fund
on April 1, 1997. The Company incurred $600,000 and $1,115,000 in expenses in
the fiscal years ended March 31, 1995 and 1996, respectively (of which $515,000
was accrued at March 31, 1997, respectively) related to legal costs to defend
the class action lawsuit and the settlement related to such suit.
On January 12, 1998, and prior to the acquisition by the Company, a jury
verdict of $102,000 was entered against Computer Hardware Service Company, Inc.
("CHSC") in favor of a former student concerning alleged injuries suffered by
the former student as a result of conduct of her fellow students and employees
of CHSC's Southampton location. The Plaintiff subsequently filed a separate
action seeking an award of attorney's fees and costs of approximately $120,000.
CHSC filed an appeal and has retained counsel in connection with its defense of
this matter. Should the appeal be successful, the Company will be liable for
payment of the total judgment plus Plaintiff's accrued fees and costs. As of
this time, no opinion can be rendered as to the ultimate outcome of this matter,
however, the Company has accrued the amount of the verdict, the separate action
and related legal defense costs.
F-22
<PAGE> 23
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. OTHER EXPENSES (CONTINUED)
The Company is also a party to routine litigation incidental to its
business, including ordinary course employment litigation. Management does not
believe that the resolution of any or all of such routine litigation is likely
to have a material adverse effect on the Company's financial condition or
results of operations.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash, cash equivalents and restricted cash: The carrying amounts
reported on the consolidated balance sheets for cash, cash equivalents and
restricted cash approximates their fair values.
Accounts and notes receivable: The carrying amounts reported on the
consolidated balance sheets for accounts and notes receivable approximates
their fair values.
Notes payable and long-term debt: The fair values of the Company's
notes payable and long-term debt are estimated using discounted cash flow
analyses, based on the Company's estimate of current borrowing rates for
credit facilities with maturities which approximate the weighted average
maturities for its existing long-term debt. At March 31, 1997 and 1998, the
estimated fair values of the Company's notes payable and long-term debt
approximates their carrying values.
15. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share for the years ended March 31, 1996, 1997, and 1998:
<TABLE>
<CAPTION>
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Numerator(1):
Net income....................................... $ 672,488 $2,303,646 $3,852,461
========== ========== ==========
Denominator:
Denominator for basic earnings per
share -- weighted average shares.............. 2,371,041 4,484,492 7,382,307
Effect of dilutive securities:
Convertible preferred stock................... 1,705,082 981,006 --
Options....................................... 222,936 301,222 214,145
Warrants...................................... 882,808 680,545 15,703
---------- ---------- ----------
Dilutive potential common shares(2).............. 2,810,826 1,962,773 229,848
---------- ---------- ----------
Denominator for diluted earnings per share --
adjusted weighted average shares............ 5,181,867 6,447,265 7,612,155
========== ========== ==========
Basic earnings per share
Income before extraordinary item................. $ 0.28 $ 0.58 $ 0.52
Extraordinary item............................... -- (0.07) --
---------- ---------- ----------
Net income....................................... $ 0.28 $ 0.51 $ 0.52
========== ========== ==========
Diluted earnings per share
Income before extraordinary item................. $ 0.13 $ 0.41 $ 0.51
Extraordinary item............................... -- (0.05) --
---------- ---------- ----------
Net income....................................... $ 0.13 $ 0.36 $ 0.51
========== ========== ==========
</TABLE>
F-23
<PAGE> 24
EDUCATIONAL MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. EARNINGS PER SHARE (CONTINUED)
- ---------------
(1) The fiscal year 1996 and 1997 numerator amounts reflect the pro forma
provision for income taxes recorded due to the Nebraska Acquisition.
Similarly, the basic and diluted per share amounts are the pro forma
earnings per share amounts. Historical earnings per share in fiscal year
1996 and 1997 is considered meaningless.
(2) Warrants and stock purchase options to purchase 16,667, 482,167, and 665,500
shares of common stock at March 31, 1996, 1997 and 1998, respectively, were
outstanding but were not included in the computation of diluted earnings per
share because the exercise price was greater than the average market price
of the common shares and, therefore, the effect would be antidilutive.
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations
for the fiscal years ended March 31, 1998 and 1997 (in thousands, except per
share data):
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31, 1998
-----------------------------------------------------
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net revenues....................................... $12,909 $13,740 $14,820 $18,207
Net income......................................... 213 584 1,308 1,747
Earnings per share data:
Basic:
Net income.................................... $ 0.03 $ 0.08 $ 0.18 $ 0.23
Diluted:
Net income.................................... 0.03 0.08 0.17 0.23
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31, 1997
-----------------------------------------------------
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net revenues....................................... $10,401 $12,039 $13,324 $13,686
Income before extraordinary item................... 72 698 1,141 1,956
Net income......................................... 72 698 832 1,956
Pro forma income before extraordinary item*........ 59 738 1,071 744
Pro forma net income*.............................. 59 738 762 744
Earnings per share data:
Basic:
Pro forma income before extraordinary item*... $ 0.03 $ 0.31 $ 0.18 $ 0.10
Pro forma net income*......................... 0.03 0.31 0.13 0.10
Diluted:
Pro forma income before extraordinary item*... 0.01 0.13 0.15 0.10
Pro forma net income*......................... 0.01 0.13 0.11 0.10
</TABLE>
- ---------------
* Pro forma reflects the adjustments described in "Pro Forma Income Tax Data" in
Note 2 and does not reflect the adjustments described in Note 4.
F-24
