<PAGE>
As filed with the Securities and Exchange Commission on March 16, 1999
Registration No. 333-70747
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
Amendment No. 2
to
FORM S-1
REGISTRATION STATEMENT
Under
The Securities Act of 1933
--------------
CAREER EDUCATION CORPORATION
(Exact name of registrant as specified in its charter)
--------------
Delaware 8200 39-3932190
(State or other (Primary Standard (I.R.S. Employer
jurisdiction of Industrial Classification Identification No.)
incorporation or Code No.)
organization)
2800 West Higgins Road, Suite 790
Hoffman Estates, Illinois 60195
(847) 781-3600
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
--------------
JOHN M. LARSON
President and Chief Executive Officer
Career Education Corporation
2800 West Higgins Road, Suite 790, Hoffman Estates, Illinois 60195, (847) 781-
3600
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
Copies to:
LAWRENCE D. LEVIN, ESQ. DENNIS V. OSIMITZ, ESQ.
Katten Muchin & Zavis Sidley & Austin
525 West Monroe Street, Suite 1600 One First National Plaza
Chicago, Illinois 60661 Chicago, Illinois 60603
(312) 902-5200 (312) 853-7000
--------------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering: [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: [_]
--------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this
Registration Statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933 or until the Registration Statement
shall become effective on such date as the Securities and Exchange Commission,
acting pursuant to Section 8(a), may determine.
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- -------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We and +
+the Selling Stockholders may not sell these securities until the registration +
+statement filed with the Securities and Exchange Commission is effective. +
+This prospectus is not an offer to sell these securities, and it is not +
+soliciting an offer to buy these securities in any state where the offer or +
+sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED MARCH 16, 1999
2,000,000 Shares
[LOGO OF CAREER EDUCATION]
Common Stock
--------
Of the shares of common stock in this offering, 250,000 shares are being sold
by us and 1,750,000 shares are being sold by the selling stockholders named
under "Principal and Selling Stockholders." We will not receive any of the
proceeds from the shares of common stock sold by the selling stockholders. The
Underwriters have an option to purchase a maximum of 300,000 additional shares
to cover over-allotments of shares.
Our common stock is traded on The Nasdaq National Market under the symbol
"CECO." On March 12, 1999, the last reported sales price of our common stock on
The Nasdaq National Market was $27.75.
Investing in the common stock involves material risks. See "Risk Factors" on
page 7.
<TABLE>
<CAPTION>
Price Underwriting Proceeds to
to Discounts and Proceeds Selling
Public Commissions to Us Stockholders
------ ------------- -------- ------------
<S> <C> <C> <C> <C>
Per Share............................ $ $ $ $
Total................................ $ $ $ $
</TABLE>
Delivery of the shares of common stock will be made on or about ,
1999, against payment in immediately available funds.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
Credit Suisse First Boston
Salomon Smith Barney
Legg Mason Wood Walker
Incorporated
Prospectus dated , 1999
<PAGE>
[INSIDE FRONT COVER]
CAREER
EDUCATION
CORPORATION
LOGO
BUILDING
THE FUTURE
OF PRIVATE
POST-
SECONDARY
EDUCATION
Photograph of five students from Allentown Business School walking on campus.
INFORMATION TECHNOLOGIES
VISUAL COMMUNICATION
AND DESIGN TECHNOLOGIES
BUSINESS STUDIES
CULINARY ARTS
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary.................. 1
Risk Factors........................ 7
Use of Proceeds..................... 14
Dividend Policy..................... 14
Price Range of Common Stock......... 14
Capitalization...................... 15
Unaudited Pro Forma Condensed
Consolidated Financial Data........ 16
Selected Historical Consolidated
Financial and Other Data........... 20
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 22
</TABLE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
Business............................ 30
Financial Aid and Regulation........ 42
Management.......................... 53
Principal and Selling Stockholders.. 62
Description of Capital Stock........ 64
Shares Eligible for Future Sale..... 65
Underwriting........................ 67
Notice to Canadian Residents........ 69
Legal Matters....................... 70
Experts............................. 70
Where You Can Find More Information. 70
Index to Financial Statements....... F-1
</TABLE>
----------------
Notes to Readers of this Prospectus
You should keep in mind the following points as you read this prospectus:
. The term "school" means a campus or group of campuses known by a single
brand name, such as The Katharine Gibbs Schools or the Al Collins Graphic
Design School. The term "campus" means a single location of any school,
such as the New York campus of The Katharine Gibbs Schools or the Al
Collins Graphic Design School in Tempe, Arizona. The term "institution"
means a main campus and its additional locations, as such are defined
under regulations of the U.S. Department of Education.
. This offering is for 2,000,000 shares; however, the underwriters have a
30-day option to purchase up to 300,000 additional shares to cover over-
allotments. Some of the disclosures in this prospectus would be different
if the underwriters exercise the option. Unless we tell you otherwise,
the information in this prospectus assumes that the underwriters will not
exercise the option.
----------------
Special Note Regarding Forward-Looking Statements
This prospectus contains "forward-looking" statements that have been made
pursuant to the Private Securities Litigation Reform Act of 1995 which reflect
our expectations regarding our future growth, results of operations,
performance and business prospects and opportunities. Wherever possible, words
such as "anticipate," "believe," "plan," "expect" and similar expressions have
been used to identify these forward-looking statements. These statements
reflect our current beliefs and are based on information currently available to
us. Accordingly, these statements are subject to risks and uncertainties,
including those listed under "Risk Factors," which could cause our actual
growth, results, performance and business prospects and opportunities to differ
from those expressed in, or implied by, these statements. Except as otherwise
required by federal securities law, we are not obligated to update or revise
these forward-looking statements to reflect new events or circumstances.
----------------
You should rely only on the information contained in this document or to
which we have referred you. We have not authorized anyone to provide you with
information that is different. This document may only be used where it is legal
to sell these securities. The information in this document may only be accurate
on the date of this document.
(i)
<PAGE>
PROSPECTUS SUMMARY
This summary highlights some of the information in this prospectus. It may
not contain all of the information that is important to you. To understand this
offering fully, you should read the entire prospectus carefully, including the
risk factors and the financial statements.
The Company
Career Education Corporation is a provider of private, for-profit
postsecondary education in North America, with approximately 15,900 students
enrolled as of October 31, 1998. We operate 13 schools, with 22 campuses
located in 14 states and two Canadian provinces. Our schools enjoy long
operating histories and offer a variety of bachelor's degree, associate degree
and non-degree programs in career-oriented disciplines within our core
curricula of:
. information technologies
. visual communication and design technologies
. business studies
. culinary arts
We have experienced significant growth both internally and through
acquisitions with our net revenue increasing from $7.5 million in 1994 to
$144.2 million in 1998. In addition, our net income increased to $4.3 million
in 1998 from a net loss of $1.6 million in 1994.
CEC was founded in January 1994 by John M. Larson, our President and Chief
Executive Officer, who has over 24 years of experience in the career-oriented
education industry. We were formed to capitalize on opportunities in the large
and highly fragmented postsecondary school industry. Since our inception, we
have completed 13 acquisitions. We have acquired schools that we believe
possess strong curricula, leading reputations and broad marketability but that
have been undermanaged from a marketing and financial standpoint. We seek to
apply our expertise in operations, marketing and curricula development, as well
as our financial strength, to improve the performance of these schools.
Our Acquisition History
<TABLE>
<CAPTION>
Number of Year Month
School Campuses Founded Acquired
------ --------- ------- --------
<S> <C> <C> <C>
Al Collins Graphic Design School..................... 1 1978 1/94
Brooks College....................................... 1 1970 6/94
Allentown Business School............................ 1 1869 7/95
Brown Institute...................................... 1 1946 7/95
Western Culinary Institute........................... 1 1983 10/96
School of Computer Technology........................ 2 1967 2/97
The Katharine Gibbs Schools.......................... 7 1911 5/97
International Academy of Merchandising & Design...... 2 1977 6/97
International Academy of Design...................... 2 1983 6/97
Southern California School of Culinary Arts.......... 1 1994 3/98
Scottsdale Culinary Institute........................ 1 1986 7/98
Harrington Institute of Interior Design.............. 1 1931 1/99
McIntosh College..................................... 2 1896 3/99
</TABLE>
1
<PAGE>
Our Business and Operating Strategy
Our company was founded based on a business and operating strategy which we
believe has enabled us to achieve significant improvements in the performance
of our schools. We believe this strategy will enable us to continue to
capitalize on the favorable economic, demographic and social trends which are
driving demand for career-oriented education. These trends include greater
technological skills required for entry-level jobs, increasing numbers of high
school graduates and a greater recognition of the value of higher education.
The key elements of our strategy are:
. Focusing on Core Curricula. Our schools offer educational programs
principally in four career-related fields of study identified by us as
areas with highly interested and motivated students, strong entry-level
employment opportunities and ongoing career and salary advancement
potential.
. Adapting and Expanding Educational Programs. Each of our schools strives
to meet the changing needs of its students and the employment markets by
regularly refining and adapting its existing educational programs,
selectively duplicating successful programs offered elsewhere in our
school system and introducing entirely new programs of study.
. Investing for Future Growth. We make substantial investments in our
infrastructure to prepare us for continued growth. We devote particular
attention to attracting and retaining both corporate and campus-level
management, and we focus on employee development to facilitate internal
promotions. Our investments in facilities and classroom technologies help
us attract and retain students and prepare them for the increasing
technical demands of the workplace.
. Emphasizing School Management Autonomy and Accountability. We provide
significant operating autonomy and appropriate performance-based
incentives to our campus-level managers. We believe these policies create
an important sense of personal responsibility for achieving campus
performance objectives and provide us with a significant advantage in
recruiting and retaining highly-motivated, entrepreneurial individuals.
. Direct Response Marketing. We seek to increase school enrollment and
profitability through intensive local, regional and national direct
response marketing programs specifically crafted for each school to
maximize its market penetration. We also use the Internet to attract
potential students and believe this medium will be an increasingly
important marketing tool.
. Improving Student Retention. We focus substantial attention on student
retention, as modest improvements in student retention can result in
meaningful increases in school revenue and profitability. We strive to
improve retention by treating students as valued customers.
. Emphasizing Employment of Graduates. We devote significant resources to
graduate placement efforts because we believe that maintaining high
employment rates for graduates of our schools enhances the overall
reputation of the schools and their ability to attract new students.
Approximately 92.5% of our students graduating during the 1998 academic
year, which is July 1, 1997 to June 30, 1998, obtained employment related
to their program of study within six months of graduation.
2
<PAGE>
Our Growth Strategy
We believe we can continue to achieve superior long-term growth in revenue
and profitability through:
. Expanding Existing Operations. We intend to achieve continued growth
at our existing campuses by executing our business and operating
strategy.
. Acquiring Additional North American Schools. We continually evaluate
opportunities to acquire schools in the U.S. and Canada that have
leading reputations, broad marketability and demonstrated compliance
with regulatory requirements and accreditation standards. In March
1998, we hired a Director of Strategic Planning and Development to
proactively identify and evaluate these opportunities. We seek to
acquire schools which we believe will benefit from the implementation
of our business and operating strategy.
. Establishing New Campuses. We expect to open new campuses, most likely
as additional locations of existing institutions, to capitalize on new
markets or geographic regions that exhibit strong enrollment potential
or the opportunity to establish a successful school operation in one
of our core curricula areas.
. Entering New Service Areas. We plan to develop new services, such as
distance learning, which we believe offer strong long-term growth
potential. Distance learning offers educational products and services
through video, Internet and other distribution channels. We also plan
to expand our contract training operations, which provide customized
training on a contract basis for business and government
organizations.
. Expanding Internationally. We may also acquire or establish operations
outside North America where we believe significant opportunities
exist.
Our Address
CEC was incorporated in Delaware on January 5, 1994. Our principal executive
offices are located at 2800 West Higgins Road, Suite 790, Hoffman Estates,
Illinois 60195 and our telephone number is (847) 781-3600. Our web site is
located at http://www.careered.com. Web sites for our schools can be accessed
through hyperlinks at our web site. Information contained in our web site is
not a part of this prospectus.
The Offering
<TABLE>
<C> <S>
Common stock offered by us....................... 250,000 shares
Common stock offered by the selling stockholders. 1,750,000 shares
Common stock outstanding after the offering...... 7,498,046 shares (1)
Use of proceeds.................................. We will use the net proceeds to us from the sale of the shares offered by us
in this offering for general corporate purposes. See "Use of Proceeds." We
will not receive any proceeds from the sale of shares by the selling
stockholders.
Nasdaq National Market symbol.................... CECO
</TABLE>
- --------
(1) Excludes 909,384 shares of common stock issuable upon the exercise of stock
options outstanding at December 31, 1998 at a weighted average exercise
price of $16.38 per share and 187,774 shares reserved for issuance under
our stock plans.
3
<PAGE>
Recent Developments
Acquisitions
On March 9, 1999, we acquired McIntosh College for $5 million, subject to
adjustment. McIntosh College was founded in 1896 and provides degree and
diploma programs in business studies, information technologies and culinary
arts at its campus in Dover, New Hampshire. McIntosh College had a student
population of approximately 800 as of December 1998 and is accredited by the
New England Association of Schools and Colleges--Commission on Technical and
Career Institutions.
On January 4, 1999, we acquired Harrington for $3.3 million, subject to
adjustment. Harrington was founded in 1931 and provides degree and diploma
programs in interior design and related fields at its campus in Chicago,
Illinois. Harrington had a student population of approximately 425 as of
September 30, 1998 and is accredited by the National Association of Schools of
Art and Design.
On December 29, 1998, we entered into an agreement to acquire the Brooks
Institute of Photography. Brooks Institute was founded in 1945 which is located
in Santa Barbara, California. As of June 30, 1998, the school had a student
population of approximately 290, approximately 40% of which was foreign
students. The completion of the proposed acquisition is subject to a number of
conditions, including approval by California state regulators. We cannot assure
you that this acquisition will be completed. Brooks Institute is accredited by
the Accrediting Council for Independent Colleges and Schools.
On December 3, 1998, we entered into a letter of intent to acquire
Briarcliffe College. Briarcliffe College was founded in 1966 and provides
diploma, associate degree and bachelor's degree programs in business,
information technology, visual communications, graphic design technologies and
other fields at its campuses in Bethpage and Patchogue, New York. Briarcliffe
College had a student population of approximately 1,400 as of October 15, 1998
and is accredited by Middle States Association of Colleges and Schools. We
cannot assure you that this acquisition will be completed.
Strategic Relationships
On October 29, 1998, we entered into an agreement with Le Cordon Bleu
Limited granting us exclusive rights to use the "Le Cordon Bleu" name in the
U.S. and Canada in connection with our culinary education programs. We have
developed a curriculum with Le Cordon Bleu for use at our culinary schools. We
do not expect to implement this curriculum until late in our second quarter of
this year. The initial term of this agreement expires on December 31, 2008.
In January 1999, we began offering professional education loans to students
at our U.S. campuses pursuant to an agreement with Sallie Mae, a student loan
marketing association. Sallie Mae designed a private loan program for our
students to supplement federal, state and other private financial aid programs.
This program offers variable interest rate loans tied to the prime rate,
determination of eligibility within 24 hours, repayment deferral until students
have been out of school for six months and a single billing statement with
other federal student loans serviced by Sallie Mae.
4
<PAGE>
Summary Consolidated Financial and Other Data
You should read the consolidated financial and other operating data below in
conjunction with the consolidated financial statements and notes thereto
appearing elsewhere in this prospectus. See "Unaudited Pro Forma Condensed
Financial Data" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------
1998
--------------------------
Pro Forma
1996 1997 Historical As Adjusted (1)
-------- -------- ---------- ---------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenue:
Tuition and registration
fees, net................. $ 29,269 $ 74,842 $132,926 $135,458
Other, net................. 4,311 7,756 11,306 11,778
-------- -------- -------- --------
Total net revenue........ 33,580 82,598 144,232 147,236
Depreciation and
amortization (2)........... 2,134 8,121 12,163 12,357
Compensation expense related
to the initial public
offering................... -- -- 1,961 1,961
Income from operations...... 2,420 2,315 9,101 9,645
Net income (loss) (3)....... $ 1,495 $ (880) $ 4,296 $ 5,108
======== ======== ======== ========
Net income (loss)
attributable
to common stockholders (4). $ 137 $ (9,307) $ 1,869 $ 5,010
======== ======== ======== ========
Net income per diluted share
attributable
to common stockholders (5). $ 0.67
========
Other Data:
EBITDA (6).................. $ 4,554 $ 10,436 $ 21,264 $ 22,002
EBITDA margin (6)........... 13.6% 12.6% 14.7% 14.9%
Cash flow provided by (used
in):
Operating activities....... 5,275 (194) 22,227
Investing activities....... (9,518) (45,214) (12,356)
Financing activities....... 8,076 56,659 (4,897)
Capital expenditures, net... 1,231 3,822 6,383
Student population (7)...... 4,537 10,889 15,900
Number of campuses (8)...... 5 18 20
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998
-----------------------
Actual As Adjusted(1)
-------- --------------
(Dollars in thousands)
<S> <C> <C>
Balance Sheet Data:
Cash.................................................... $ 23,548 $23,548
Working capital......................................... 15,994 15,994
Total assets............................................ 132,887 132,887
Long-term debt.......................................... 22,617 16,811
Total stockholders' investment.......................... 84,636 90,442
</TABLE>
- --------
(1) Gives effect to (a) our acquisition of Scottsdale Culinary, (b) the use of
proceeds from our initial public offering of common stock to retire
indebtedness, (c) the conversion of all classes of preferred stock into
common stock and the exercise of warrants in connection with our initial
public offering as if they had occurred on January 1, 1998, and is adjusted
for our sale of 250,000 shares of common stock in this offering and the
application of the estimated net proceeds therefrom as described in "Use of
Proceeds," as if it had occurred as of the beginning of the year. See
"Unaudited Pro Forma Condensed Consolidated Financial Data" and Note 2 of
the Notes to our Consolidated Financial Statements.
5
<PAGE>
(2) Includes depreciation of property and equipment, amortization of goodwill
and covenants not-to-compete and excludes the amortization of debt discount
and deferred financing costs.
(3) For the year ended December 31, 1997, net income includes an extraordinary
loss of $418, which is net of a $233 tax benefit, resulting from the early
extinguishment of debt. See Note 6 of the Notes to our Consolidated
Financial Statements. For the year ended December 31, 1998, net income
includes a charge of $205, net of taxes of $149, related to the cumulative
effect of a change in accounting principle, in connection with the adoption
of Statement of Position 98-5 "Reporting on the Costs of Start-up
Activities." See Note 4 of the Notes to our Consolidated Financial
Statements.
(4) Includes reductions to net income (loss) for dividends paid or added to the
redemption value of preferred stock and the accretion to redemption value
of preferred stock and warrants. See Note 3 of the Notes to our
Consolidated Financial Statements.
(5) Pro forma net income per diluted share is based upon the weighted average
number of common and common stock equivalent shares outstanding totalling
7,513,000 for the year ended December 31, 1998. This number includes (a)
outstanding shares of common stock and common stock equivalents, (b)
275,000 shares of common stock assumed to have been issued in our initial
public offering to repay indebtedness as if our initial public offering
occurred at the beginning of the year, (c) approximately 292,000 additional
weighted average shares of common stock related to the conversion of
preferred stock and the exercise of warrants which occurred in connection
with our initial public offering, as if such conversion occurred at the
beginning of the year, and (d) approximately 209,000 shares of common stock
assumed to be issued in this offering, to repay indebtedness as if the
offering occurred at the beginning of the year.
(6) For any period, EBITDA equals earnings before interest expense, taxes,
depreciation and amortization, including amortization of debt discount and
deferred financing costs. EBITDA margin equals EBITDA as a percentage of
net revenue. We have included information concerning EBITDA and EBITDA
margin because we believe they allow for a more complete analysis of our
results of operations. EBITDA and EBITDA margin should not be considered as
alternatives to, nor is there any implication that they are more meaningful
than, any measure of performance or liquidity as promulgated under
generally accepted accounting principles.
(7) Represents the total number of students attending our schools as of October
31.
(8) Represents the total number of campuses operated by us as of the end of the
period.
6
<PAGE>
RISK FACTORS
Before you invest in our common stock, you should be aware that there are
various risks, including those described below. You should carefully consider
these risk factors, and all of the other information included in this
prospectus before you decide whether to purchase shares of our common stock.
Any of the following risks could materially adversely affect our business,
results of operations or financial condition and could result in a complete
loss of your investment.
Failure to Comply with Extensive Regulations Could Have a Material Adverse
Effect on our Business
Failure to comply with extensive regulations by our U.S. schools could
result in financial penalties.
We derive a majority of our revenue from U.S. federal student financial aid
programs. To participate in such programs, a U.S. institution must obtain and
maintain authorization by the appropriate state education agencies,
accreditation by an accrediting agency recognized by the Department of
Education, and certification by the Department of Education. As a result, our
U.S. schools are subject to extensive regulation by these agencies. These
regulations cover virtually all phases of our operations, including our
educational programs, facilities, instructional and administrative staff,
administrative procedures, financial operations and financial strength. They
also affect our ability to acquire or open additional schools or change our
corporate structure. These regulatory agencies periodically revise their
requirements and modify their interpretations of existing requirements.
If one of our schools were to violate any of these regulatory requirements,
we could suffer a financial penalty. The regulatory agencies could also place
limitations on or terminate our schools' operations, including our receipt of
federal student financial aid funds, which could have a material adverse effect
on our business, results of operations or financial condition. We believe that
we substantially comply with the requirements of these regulatory agencies, but
we cannot predict with certainty how all of these requirements will be applied,
or whether we will be able to comply with all of the requirements in the
future. Some of the most significant regulatory requirements and risks that
apply to our U.S. schools are described in the following paragraphs. Please see
"Financial Aid and Regulation" for more detailed information on the regulations
and other requirements that apply to us.
The U.S. Congress may change the law or reduce funding for federal student
financial aid programs, which could harm our business.
The U.S. Congress regularly reviews and revises the laws governing the
federal student financial aid programs and annually determines the funding
level for each of these programs. Any action by Congress that significantly
reduces funding for the federal student financial aid programs or the ability
of our schools or students to participate in these programs could have a
material adverse effect on our business, results of operations or financial
condition. Legislative action may also increase our administrative costs and
burden and require us to modify our practices in order for our schools to
comply fully with applicable requirements, which could have a material adverse
effect on our business, results of operations or financial condition. Please
see "Financial Aid and Regulation--Nature of Federal Support for Postsecondary
Education in the U.S." and "--Regulation of Federal Student Financial Aid
Programs for U.S. Schools--Legislative Action" for more information regarding
legislative action that could affect our funding.
If we do not meet financial responsibility standards, our schools may lose
eligibility to participate in federal student financial aid programs.
To participate in the federal student financial aid programs, an institution
must either satisfy numeric standards of financial responsibility, or post a
letter of credit in favor of the Department of Education and possibly accept
other conditions on its participation in the federal student financial aid
programs. The Department of Education has determined that we and some of our
institutions did not satisfy the numeric standards based on our audited
financial statements for 1996 and 1997 and our February 1998 balance sheet,
which reflects the results of our initial public offering. Currently, we have
posted letters of credit for eleven of our institutions totalling approximately
$17.6 million. The Department of Education has also placed a limit on
7
<PAGE>
the total amount of federal student financial aid available to students at the
Southern California School of Culinary Arts. We filed our 1998 financial
statements with the Department of Education in February 1999 and asked it to
release most, if not all, of our outstanding letters of credit and to increase
or eliminate the funding cap for the Southern California School of Culinary
Arts. We cannot assure you that we or our institutions will satisfy the numeric
standards or that the Department of Education will take any action with respect
to the letters of credit or funding limitation. For more information on our
compliance with these standards, please see "Financial Aid and Regulation--
Regulation of Federal Student Financial Aid Programs for U.S. Schools--
Financial Responsibility Standards."
Our schools may lose eligibility to participate in federal student
financial aid programs if their student loan default rates are too high.
An institution may lose its eligibility to participate in some or all of the
federal student financial aid programs, if defaults by its students on their
federal student loans exceed specified rates. If any of our institutions,
depending on its size, loses eligibility to participate in federal student
financial aid programs because of high student loan default rates, it could
have a material adverse effect on our business, results of operations or
financial condition. For information regarding our default rates and other
requirements, please see "Financial Aid and Regulation--Regulation of Federal
Student Financial Aid Programs for U.S. Schools--Cohort Default Rates."
Our schools may lose eligibility to participate in federal student
financial aid programs if the percentage of their revenue derived from
those programs is too high.
A proprietary institution loses its eligibility to participate in the
federal student financial aid programs if it derives more than 85% of its
revenue from these programs in any fiscal year ending before October 1998 or
90% of its revenue from these programs in any fiscal year ending after October
1998. If any of our institutions, depending on its size, loses eligibility to
participate in federal student financial aid programs, it could have a material
adverse effect on our business, results of operations or financial condition.
Please see "Financial Aid and Regulation--Regulation of Federal Student
Financial Aid Programs for U.S. Schools--The "85/15 Rule"' for a discussion of
the percentage of our institutions' revenues derived from federal student
financial aid programs.
If regulators do not approve our acquisitions, our ability to participate
in federal student financial aid programs would be limited.
When we acquire an institution, the Department of Education and most
applicable state education agencies and accrediting agencies consider that a
change of ownership or control of the institution has occurred. A change of
ownership or control of an institution under the standards of the Department of
Education generally results in the suspension of the institution's
participation in the federal student financial aid programs until the
Department of Education reviews and recertifies the institution. If we were
unable to reestablish the state authorization, accreditation or Department of
Education certification of an institution we acquired, depending on the size of
that acquisition, that failure could have a material adverse effect on our
business, results of operations or financial condition.
If regulators do not approve transactions involving a change of control of
us or our schools, we may lose our ability to participate in federal
student financial aid programs.
If there is a change of control of us or of any of our institutions under
the standards of applicable state education agencies or accrediting agencies or
the Department of Education, the affected institutions must seek the approval
of the relevant agencies. The failure of any of our institutions to reestablish
its state authorization, accreditation or Department of Education certification
could result in a suspension or loss of federal student financial aid funding,
which could have a material adverse effect on our business, results of
operations or financial condition.
We have been advised by the Department of Education that this offering will
not be a change of control under its standards. We believe that this offering
will be considered a change of control by the state education agency in Arizona
and one of the state education agencies in Illinois, based on the numeric
thresholds that
8
<PAGE>
these agencies apply in determining whether a transfer of stock is a change of
control. As a result, three of our campuses will be required to apply to be
reauthorized by the applicable state agency. We do not believe that this
offering will be considered a change of control by other applicable state
education agencies or applicable accrediting agencies, based on our review of
their standards and our familiarity with their procedures.
The Department of Education, applicable state education agencies or
applicable accrediting agencies may consider other transactions or events to
constitute a change of control. Some of these transactions or events, such as a
significant acquisition or disposition of our common stock, may be beyond our
control.
If our schools do not maintain their state authorizations and
accreditations, they may not operate or participate in federal student
financial aid programs.
An institution that grants degrees, diplomas or certificates must be
authorized by the relevant education agencies of the state in which it is
located and, in some cases, other states. Requirements for authorization vary
substantially among the states. State authorization and accreditation by an
accrediting agency recognized by the Department of Education are also required
for an institution to participate in the federal student financial aid
programs. Loss of state authorization or accreditation by any of our campuses,
depending on the size of the campus, could have a material adverse effect on
our business, results of operations or financial condition. For a more detailed
discussion of the requirements of state education agencies and accrediting
bodies, please see "Financial Aid and Regulation--State Authorization for U.S.
Schools" and "--Accreditation for U.S. Schools."
Failure to comply with extensive Canadian regulations could affect the
ability of our Canadian Schools to receive financial aid.
Approximately 70% of students enrolled at our Canadian schools receive
assistance from Canadian governmental financial aid programs. Depending on
their province of residence, Canadian students may receive loans under the
Canada Student Loan Program, the Ontario Student Loans Plan and the Quebec
Loans and Bursaries Program.
Our Canadian schools must meet the eligibility standards to administer these
programs and must comply with extensive statutes, regulations and other
requirements. Our International Academy of Design school in Toronto may be
required to share the cost of student loan defaults if defaults by its students
on their Ontario Student Assistance Plan loans exceed specified rates. Our
Toronto school currently does not have a default rate that exceeds the
applicable threshold. If our Canadian schools cannot meet these and other
eligibility standards or fail to comply with applicable requirements, it could
have a material adverse effect on our business, results of operations or
financial condition.
The Canadian, Ontario and Quebec governments are currently in the process of
changing the legislative, regulatory and other requirements relating to student
financial assistance programs due to political and budgetary pressures.
Although we do not anticipate a significant reduction in the funding for these
programs, any change that significantly reduces funding or the ability of our
schools to participate in these programs could have a material adverse effect
on our business, results of operations or financial condition.
Risks Specific to our Business Could Have a Material Adverse Effect on Us
Failure to effectively manage our growth could harm our business.
We have grown rapidly since our incorporation in January 1994. Our rapid
growth could place a strain on our management, operations, employees or
resources. We cannot assure you that we will be able to maintain or accelerate
our current growth rate, effectively manage our expanding operations or achieve
planned growth on a timely or profitable basis. If we are unable to manage our
growth effectively, our business, results of operations or financial condition
could be materially adversely affected.
9
<PAGE>
We have a history of losses and our future profitability is uncertain.
Since our inception in 1994, we have experienced a net loss for 1994 and
1997; and a net loss attributable to common stockholders for 1994, 1995 and
1997. To the extent that we earned net income or income attributable to common
stockholders for any prior periods, the amounts earned were not substantial.
See "Selected Historical Consolidated Financial and Other Data," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our Consolidated Financial Statements and the related notes thereto appearing
elsewhere in this prospectus. We cannot assure you that we will be profitable
in the future.
If we cannot effectively pursue and integrate acquired schools, it could
harm our business.
We expect to continue to rely on acquisitions as a key component of our
growth. From time to time, we engage in, and we are currently engaged in,
evaluations of, and discussions with, possible acquisition candidates,
including those discussed under "Prospectus Summary--Recent Developments." We
cannot assure you that we will continue to be able to identify suitable
acquisition opportunities or to acquire any such schools on favorable terms.
Furthermore, we cannot assure you that any acquired schools can be successfully
integrated into our operations or be operated profitably. Acquisitions involve
a number of special risks and challenges, including the diversion of
management's attention, assimilation of the operations and personnel of
acquired schools, adverse short-term effects on reported operating results,
possible loss of key employees and difficulty of presenting a unified corporate
image. Continued growth through acquisition may also subject us to
unanticipated business or regulatory uncertainties or liabilities. We cannot
assure you that any potential acquisition will enhance our business and will
not ultimately have a material adverse effect on us.
When we acquire an existing school, we typically allocate a significant
portion of the purchase price to fixed assets, curriculum, goodwill and
intangibles, such as covenants not-to-compete. For our acquisitions to date, we
have amortized goodwill over a period of 40 years and intangible assets over
periods of three to five years. In addition, our acquisition of a school in the
U.S. would be a change of ownership, which may result in the suspension of that
school's participation in the federal student financial aid programs until it
obtains the Department of Education's approval. If we fail to manage our
acquisition program effectively, it could have a material adverse effect on our
business, results of operations or financial condition.
Opening new schools and adding new services could be difficult for us.
To date, we have added new schools only through acquisitions. However, in
the future we expect to open and operate new schools, most likely as additional
locations of existing schools, but possibly also as separate, freestanding
institutions. Establishing new schools poses unique challenges and would
require us to make investments in management, capital expenditures, marketing
expenses and other resources different, and in some cases greater, than those
required with respect to the operation of acquired schools. To open a new
school, we would be required to obtain appropriate state or provincial and
accrediting agency approvals. In addition, to be eligible for federal student
financial aid programs, such a school would have to be certified by the
Department of Education. We have never established a new school, and we cannot
assure you that we will be able to do so successfully or profitably.
While we expect that our career-oriented school business will continue to
provide the substantial majority of our revenue in the near term, we plan to
expand our contract training business, currently offered to a limited extent by
a few of our schools, and may also decide to provide other education-related
services, such as distance learning. We cannot be certain which, if any, new
service areas we will decide to enter or whether we will succeed in markets
beyond our current career-oriented school business.
10
<PAGE>
Our failure to effectively manage the operations of newly established
schools or service areas, or any diversion of management's attention from our
core career-oriented school operating activities, could have a material adverse
effect on our business, results of operations or financial condition. For a
more detailed description of our growth strategy and the related regulatory
concerns, please see "Business--Growth Strategy" and "Financial Aid and
Regulation--Regulation of Federal Student Financial Aid Programs for U.S.
Schools--Opening Additional Schools and Adding Educational Programs."
Failure to keep pace with changing market needs and technology could harm
our business.
Prospective employers of our graduates increasingly demand that their entry-
level employees possess appropriate technological skills. Educational programs
at our schools, particularly programs in information technologies and visual
communications, must keep pace with these evolving requirements. If we cannot
respond to changes in industry requirements, it could have a material adverse
effect on our business, results of operations or financial condition.
Competitors with greater resources could harm our business.
The postsecondary education market is highly competitive. Our schools
compete with traditional public and private two-year and four-year colleges and
universities and other proprietary schools. Some public and private colleges
and universities, as well as other private career-oriented schools, may offer
programs similar to those of our schools. Although tuition at private nonprofit
institutions is, on average, higher than tuition at our schools, some public
institutions are able to charge lower tuition than our schools, due in part to
government subsidies, government and foundation grants, tax-deductible
contributions and other financial sources not available to proprietary schools.
Some of our competitors in both the public and private sectors have
substantially greater financial and other resources than us.
Expansion outside of the U.S. and Canada could adversely affect our
business.
Although we currently operate only in the U.S. and Canada, we intend to
explore opportunities outside those markets. There may be difficulties and
complexities associated with our expansion into international markets, and we
cannot assure you that our strategies will succeed beyond the U.S. and Canada.
International operations present inherent risks, including currency
fluctuations, varying political and economic conditions, unanticipated changes
in regulation, trade barriers, staffing and management problems and adverse tax
consequences. Also, in expanding internationally, we would be required to
comply with different, and potentially more onerous, regulatory requirements.
We cannot assure you that such factors will not have a material adverse effect
on our business, results of operations or financial condition in the future.
Failure to obtain additional capital in the future could reduce our ability
to grow.
We believe that funds from operations, cash, investments and borrowings
under our $60 million credit facility pursuant to our credit agreement will be
adequate to fund our current operating plans for the foreseeable future.
However, we may need additional debt or equity financing in order to carry out
our strategy of growth through acquisitions. For this reason, we are in the
process of amending our credit agreement to increase the amount of the credit
facility from $60 million to $90 million. We cannot assure you that the credit
facility will be increased. We may also need additional debt or equity
financing in the future to carry out our growth strategy. The amount and timing
of such additional financing will vary principally depending on the timing and
size of acquisitions and the sellers' willingness to provide financing
themselves. To the extent that we require additional financing in the future
and are unable to obtain such additional financing, we may not be able to fully
implement our growth strategy.
11
<PAGE>
Our credit agreement limits our ability to take various actions.
Our credit agreement limits our ability to take certain actions, including
paying dividends, disposing of assets and incurring certain additional
indebtedness. Accordingly, we may be restricted from taking certain actions
which management believes would be desirable and in the best interests of us
and our stockholders. The credit agreement also requires us to maintain
specified financial ratios and satisfy certain financial tests. We were in
compliance with all ratios and financial tests as of December 31, 1998, and
believe that we remain in compliance. However, a breach of any covenants
contained in the credit agreement could result in an event of default under
that agreement and allow the lenders to accelerate the indebtedness, which
could have a material adverse effect on our business, results of operations or
financial condition.
The loss of our key personnel, including John M. Larson and William A.
Klettke, could harm our business.
Our success to date has depended, and will continue to depend, largely on
the skills and efforts of John M. Larson, our President and Chief Executive
Officer, William A. Klettke, our Senior Vice President and Chief Financial
Officer, and our other key personnel. Our success also depends, in large part,
upon our ability to attract and retain highly qualified faculty, school
presidents and administrators and corporate management. Due to the nature of
our business, we may have difficulty locating and hiring qualified personnel,
and retaining such personnel once hired. None of our employees is subject to an
employment or noncompetition agreement other than Mr. Larson. We do not
maintain life insurance on any of our employees. The loss of the services of
any of our key personnel, or our failure to attract and retain other qualified
and experienced personnel on acceptable terms, could have a material adverse
effect on our business, results of operations or financial condition.
If we fail to be Year 2000 compliant, it could harm our business.
Most companies face potentially serious problems because many information
technology ("IT") hardware and software systems and non-IT systems containing
embedded technology may not properly recognize calendar dates beginning in the
year 2000. This problem could force systems to either shut down or provide
incorrect data and information. We began the process of identifying the
necessary changes to our computer programs and hardware as well as assessing
the progress of our significant vendors in their remediation efforts in late
1997.
We are unable at this time to fully assess the possible impact on our
business, results of operations and financial condition that may result from
any disruptions to our business caused by Year 2000 problems in any systems
controlled by us or any third party with whom we have a material relationship.
These third parties primarily include the Department of Education, state
education agencies, accrediting agencies, guaranty agencies and student loan
lenders. We do not believe that the cost to remedy our internal Year 2000
problems will have a material adverse effect on our business, results of
operations or financial condition. We cannot assure you, however, that our
systems or those of third parties with whom we interact will be free of Year
2000 problems. Please see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Year 2000 Compliance" for detailed
information on our state or readiness, potential risk and contingency plan
regarding the Year 2000 issue.
Anti-takeover provisions in our charter documents and Delaware law could
make an acquisition of us difficult.
Our Certificate of Incorporation, our by-laws and Delaware law contain
provisions that may delay, defer or inhibit a future acquisition of us not
approved by our board of directors. These provisions are intended to encourage
any person interested in acquiring us to negotiate with and obtain the approval
of our board of directors in connection with the transaction. Our Certificate
of Incorporation also permits our board of directors to issue shares of
preferred stock with such voting, conversion and other rights as it determines,
without any
12
<PAGE>
further vote or action by our stockholders. By using preferred stock, we could
(1) discourage a proxy contest, (2) make the acquisition of a substantial block
of our common stock more difficult or (3) limit the price investors may be
willing to pay in the future for shares of our common stock. In addition, our
by-laws provide that (1) special meetings of our stockholders may be called
only by our board of directors and (2) only two of our six Directors may be
elected at such special meetings. These provisions also could discourage bids
for your shares of common stock at a premium and could have a material adverse
effect on the market price of your shares. Please see "Description of Capital
Stock" for more detailed information on these provisions.
Risks Specific to this Offering
Heller Equity Capital Corporation can exercise significant influence over
us.
After the offering Heller Equity Capital Corporation will own approximately
21.0% of our common stock. Heller is currently entitled to designate, and has
designated, two members of our board of directors. Beginning on the date of our
next annual meeting of stockholders, Heller will be entitled to designate one
member of our board of directors. However, we have nominated the second Heller
representative to our board for re-election at our next annual meeting of
stockholders. As a result, Heller can exercise considerable influence over our
operations and business strategy. For more information regarding our
relationship with Heller, please see "Management--Arrangements for Nomination
as Director," "Principal and Selling Stockholders" and "Description of Capital
Stock."
Our stock price may continue to be volatile.
Since the beginning of the fourth quarter of 1998, the market price for our
common stock has ranged from $14.12 to $30.62. Factors such as quarterly
variations in our operating results, announcements of acquisitions by us or our
competitors, new regulations or interpretations of regulations applicable to
our schools, changes in accounting treatments or principles and changes in
earnings estimates by securities analysts, as well as general political
economic and market conditions, could cause the market price of our common
stock to continue to fluctuate significantly. The market price for our common
stock may also be affected by our ability to meet or exceed analysts' or
"street" expectations, and any failure to meet such expectations, even if
minor, could have a material adverse effect on the market price of our common
stock. In addition, the stock market has from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices of equity securities of many companies and that have often been
unrelated to the operating performance of such companies.
The number of shares eligible for public sale after this offering could
cause our stock price to decline.
The sale of a substantial number of shares of our common stock, or the
perception that such sales could occur, could adversely affect prevailing
market prices for our common stock. We currently have approximately 7,218,046
shares of common stock outstanding. Substantially all of these shares are
eligible for immediate sale in the public market without restriction unless
such shares are held by persons who are deemed to be our "affiliates" because
they, directly or indirectly through one or more intermediaries, control, or
are controlled by, or are under common control, with us. Upon completion of the
offering, 1,719,567 shares will be held by our affiliates. 2,027,320 shares of
common stock are subject to lock-up agreements between the holders of our
shares and the representatives of the underwriters, pursuant to which the
holders have agreed that they will not, directly or indirectly, sell or
otherwise dispose of any shares of common stock, or securities or other rights
convertible into or exchangeable or exercisable for any shares of common stock,
for 90 days after the date of the offering without the prior written consent of
Credit Suisse First Boston Corporation. Upon expiration of this period
substantially all of the shares subject to the lock-up agreements will be
eligible for sale under Rule 144, subject to volume and other limitations,
other than the holding period requirement, of such rule. Upon consummation of
this offering, an additional 899,687 shares of common stock are issuable at
various dates upon exercise of options granted to certain of our employees,
officers, directors and consultants pursuant to stock option agreements. After
the offering, our affiliates holding 1,562,007 shares of our common stock have
been granted registration rights. We cannot predict the effect, if any, that
future sales of shares, or the availability of shares for future sales, will
have on the market price of the common stock prevailing from time to time or on
our ability to raise capital through an offering of our equity securities.
13
<PAGE>
USE OF PROCEEDS
The net proceeds to us from the sale of the shares of common stock offered
by us in this offering, after deduction of the estimated discounts, commissions
and offering expenses payable by us, are estimated to be approximately $5.8
million. If the underwriters exercise in full the over-allotment option granted
to them by us, the net proceeds to us from the sale of the shares of common
stock offered by us in this offering, after deduction of the estimated
discounts, commissions and offering expenses payable by us, are estimated to be
approximately $13.1 million. We will not receive any of the proceeds from the
sale of common stock by the selling stockholders. We will use our net proceeds
from this offering for general corporate purposes.
DIVIDEND POLICY
We have never paid a cash dividend on our common stock. We do not anticipate
paying any cash dividends on our common stock in the foreseeable future and we
plan to retain our earnings to finance future growth. The declaration and
payment of dividends on our common stock are subject to the discretion of our
board of directors. Our board's decision to pay future dividends will depend on
general business conditions, the effect on our financial condition and other
factors our board may consider to be relevant. Our ability to pay dividends on
our common stock is limited if we are not in compliance with the terms of our
credit agreement or we fail to meet a specified leverage ratio.
PRICE RANGE OF COMMON STOCK
The following table sets forth the range of high and low sales prices per
share for our common stock as reported on The Nasdaq National Market, where the
stock trades under the symbol " CECO," for the periods indicated. The initial
public offering price of our common stock on January 28, 1998 was $16.00 per
share.
<TABLE>
<CAPTION>
Price Range
of Common
Stock
-------------
High Low
------ ------
<S> <C> <C>
1998:
First Quarter (from January 28, 1998).......................... $22.12 $17.62
Second Quarter................................................. 27.50 21.50
Third Quarter.................................................. 26.75 17.37
Fourth Quarter................................................. 30.00 14.12
1999:
First Quarter (through March 12, 1999)......................... $30.62 $27.50
</TABLE>
On March 12, 1999, the last sale price of the common stock as reported on
The Nasdaq National Market was $27.75 per share. As of March 12, 1999, there
were 27 holders of record of the common stock.
14
<PAGE>
CAPITALIZATION
The following table sets forth our cash and capitalization consisting of
long-term debt plus stockholders' investment: (1) as of December 31, 1998 and
(2) as adjusted to reflect the proceeds from our sale of 250,000 shares of
common stock in this offering, net of estimated underwriting discounts and
commissions and offering expenses. We will not receive any of the proceeds of
the sale of common stock by the selling stockholders. The information set forth
below should be read in conjunction with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and our financial statements
and the related notes thereto included elsewhere in this prospectus.
<TABLE>
<CAPTION>
December 31, 1998
--------------------------
Actual As Adjusted
----------- -------------
(Dollars in thousands)
<S> <C> <C>
Cash................................................ $ 23,548 $ 23,548
=========== ===========
Long-term debt...................................... $ 22,617 $ 16,811
Stockholders' investment:
Common stock, $.01 par value, 50,000,000 shares
authorized;
7,152,896 shares issued and outstanding (1)...... 72 74
Preferred stock, $.01 par value, 1,000,000 shares
authorized, no shares issued
and outstanding.................................. -- --
Additional paid-in capital........................ 95,481 101,285
Foreign currency translation...................... (822) (822)
Accumulated deficit............................... (10,095) (10,095)
----------- -----------
Total stockholders' investment.................. 84,636 90,442
----------- -----------
Total capitalization............................ $ 107,253 $ 107,253
=========== ===========
</TABLE>
- --------
(1) Does not include (a) 909,384 shares of common stock issuable upon the
exercise of outstanding options at a weighted average exercise price of
$16.38 per share and (b) 187,774 shares of common stock reserved for
issuance under our stock plans. See "Management--Stock Plans," "Description
of Capital Stock" and Notes 10 and 15 of the Notes to our Consolidated
Financial Statements.
15
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA
The unaudited pro forma condensed consolidated statement of operations of
Career Education Corporation for the year ended December 31, 1998 gives effect
to (1) the acquisition of Scottsdale Culinary, (2) events occurring at the time
of our initial public offering of common stock, including the use of proceeds
to retire indebtedness and (3) our sale of 250,000 shares of common stock in
this offering, as if they had occurred at the beginning of the year. The
historical results of operations of Scottsdale Culinary are for the period from
January 1, 1998 to the date of acquisition, July 31, 1998.
The unaudited pro forma condensed consolidated statement of operations for
the year ended December 31, 1998 was prepared from the audited historical
statement of operations of Career Education Corporation for the year ended
December 31, 1998 and the unaudited statement of operations of Scottsdale
Culinary for the seven months ended July 31, 1998, the date of acquisition.
The unaudited pro forma condensed consolidated balance sheet gives effect to
our sale of 250,000 shares of common stock in this offering and the application
of the estimated net proceeds therefrom to retire outstanding indebtedness.
All unaudited pro forma condensed consolidated financial data includes all
adjustments necessary (consisting only of normal recurring entries) for a fair
presentation thereof and, in the opinion of management, have been prepared on
the same basis as the audited financial statements. The unaudited pro forma
financial data are a presentation of historical results with accounting and
other adjustments. The unaudited pro forma financial data do not reflect the
effects of any anticipated changes to be made by us to the historical
operations, are presented for informational purposes only and should not be
construed to be indicating (1) the results of our operations or financial
position that actually would have occurred had the acquisitions and the initial
public offering been consummated as of the date indicated or (2) the results of
our operations or our financial position in the future.
The unaudited pro forma condensed consolidated financial data reflect the
Scottsdale Culinary acquisition using the purchase method of accounting. The
acquired assets and assumed liabilities of Scottsdale Culinary are stated at
values representing an allocation of the purchase price based upon the
estimated fair market value at the date of the acquisition.
The following unaudited pro forma condensed consolidated financial
statements and accompanying notes are qualified in their entirety by reference
to, and should be read in conjunction with, "Management's Discussion and
Analysis of Financial Condition and Results of Operations," the financial
statements and notes thereto of Career Education Corporation and Scottsdale
Culinary and the other historical financial information included elsewhere in
this prospectus.
16
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
STATEMENT OF OPERATIONS
For the Year Ended December 31, 1998
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Historical
-----------------------------
Scottsdale
(preacquisition,
January 1, 1998
through Pro Forma Offering Pro Forma
CEC July 31, 1998) Adjustments Pro Forma Adjustments As Adjusted
-------- ---------------- ----------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Tuition and
registration fees,
net.................. $132,926 $ 2,532 $ -- $135,458 $-- $135,458
Other, net............ 11,306 472 -- 11,778 -- 11,778
-------- ------- ------- -------- ---- --------
Total net revenue... 144,232 3,004 -- 147,236 -- 147,236
Operating Expenses:
Educational services
and facilities....... 57,151 1,445 -- 58,596 -- 58,596
General and
administrative....... 63,856 821 -- 64,677 -- 64,677
Depreciation and
amortization......... 12,163 54 140 (1) 12,357 -- 12,357
Compensation expense
related to the
initial public
offering............. 1,961 -- -- 1,961 -- 1,961
-------- ------- ------- -------- ---- --------
Total operating
expenses........... 135,131 2,320 140 137,591 -- 137,591
-------- ------- ------- -------- ---- --------
Income from operations.. 9,101 684 (140) 9,645 -- 9,645
Interest (expense)
income, net............ (1,250) 12 (131)(2) (1,369) 523(8) (846)
-------- ------- ------- -------- ---- --------
Income before provision
for income taxes....... 7,851 696 (271) 8,276 523 8,799
Provision (benefit) for
income taxes........... 3,350 -- 126 (3) 3,476 219(3) 3,695
-------- ------- ------- -------- ---- --------
Net Income ............. 4,501 (4) 696 (397) 4,800 303 5,103
Dividends paid or
accrued on preferred
stock................ (274) -- 274 (5) -- -- --
Accretion to
redemption value
of preferred stock
and warrants......... (2,153) -- 2,055 (5) (98) -- (98)
-------- ------- ------- -------- ---- --------
Net income attributable
to
common stockholders.... $ 2,074 (4) $ 696 $ 1,932 $ 4,702 $303 $ 5,005
======== ======= ======= ======== ==== ========
Net income per share
attributable to common
stockholders:
Basic................. $ 0.32 $ 0.66 $ 0.69
======== ======== ========
Diluted............... $ 0.30 $ 0.64 $ 0.67
======== ======== ========
Weighted average number
of shares outstanding:
Basic................. 6,521 567 (6) 7,088 209(9) 7,297
======== ======= ======== ==== ========
Diluted............... 6,797 507 (6)(7) 7,304 209(9) 7,513
======== ======= ======== ==== ========
</TABLE>
17
<PAGE>
UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED BALANCE SHEET
As of December 31, 1998
(In thousands)
<TABLE>
<CAPTION>
Offering Pro
Assets Historical Adjustments Forma
------ ---------- ----------- --------
<S> <C> <C> <C>
Current assets............................... $ 40,928 $ -- $ 40,928
Property and equipment, net.................. 46,403 -- 46,403
Other assets:
Intangibles, net........................... 42,645 -- 42,645
Other noncurrent assets.................... 2,911 -- 2,911
-------- ------- --------
Total other assets......................... 45,556 -- 45,556
-------- ------- --------
Total assets................................. $132,887 $ -- $132,887
======== ======= ========
<CAPTION>
Liabilities and Stockholders' Investment
----------------------------------------
<S> <C> <C> <C>
Current liabilities.......................... $ 24,934 $ -- $ 24,934
Long-term debt, net.......................... 22,300 (5,806)(8) 16,494
Other long term liabilities.................. 1,017 -- 1,017
-------- ------- --------
Total liabilities.......................... 48,251 (5,806) 42,445
Stockholders' investment..................... 84,636 5,806 (8) 90,442
-------- ------- --------
Total liabilities and stockholders'
investment................................ $132,887 $ -- $132,887
======== ======= ========
</TABLE>
18
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED FINANCIAL DATA
The following notes identify the pro forma adjustments made to the
historical amounts in the unaudited pro forma condensed consolidated financial
data:
(1) Depreciation of property and equipment, based on appraised values and
estimated useful lives, which range from five to 31 years, in excess of the
historical amounts, which was only recorded from the date of the
acquisitions to the end of each period, is recorded as an adjustment. The
adjustment also gives effect to the amortization of goodwill and covenants
not-to-compete. Intangible assets recorded in conjunction with the
acquisition of Scottsdale Culinary relate to goodwill of approximately $7.9
million. Goodwill is amortized on a straight-line basis over its estimated
useful life of 40 years. Amortization expense, reflecting the amortization
of goodwill for the entire year presented in excess of historical amounts,
has been recorded as an adjustment.
(2) Reflects (a) additional interest expense at an imputed average interest
rate of 9% of approximately $0.5 million associated with debt incurred to
finance the Scottsdale Culinary acquisition and (b) a reduction of interest
expense of approximately $0.3 million associated with proceeds from our
initial public offering used to repay outstanding indebtedness, at an
assumed weighted average interest rate of 9.0%.
(3) Reflects an adjustment to record a provision for federal and state income
taxes at an effective income tax rate of 42%.
(4) Excludes the cumulative effect of change in accounting principle of $205,
which is net of a $149 tax benefit.
(5) Shares of redeemable preferred stock, including accrued paid-in-kind
dividends, were converted into common stock and substantially all warrants
were exercised in connection with our initial public offering. Accrued
dividends and any accretion to redemption value related to those shares of
preferred stock and warrants, assumed to have been issued at the beginning
of each period presented to consummate the acquisition, have been added
back to net income attributable to common stockholders to derive pro forma
income attributable to common stockholders. Therefore, such amounts are
eliminated.
(6) Represents an adjustment of (a) approximately 275,000 shares of common
stock assumed to have been issued in our initial public offering to repay
indebtedness and (b) approximately 292,000 additional shares of common
stock related to the conversion of preferred stock and exercise of warrants
which occurred in connection with our initial public offering as if both
events occurred at the beginning of the year.
(7) Includes an adjustment for common stock equivalents of 216,000 shares.
(8) Net proceeds from the offering, estimated to be $5.8 million, net of fees
and expenses, are assumed to repay outstanding indebtedness which existed
during 1998. Accordingly, debt assumed to be repaid with proceeds from the
offering and related interest expense of $0.5 million have been eliminated.
(9) Represents an adjustment of common stock assumed to have been issued in
this offering to repay indebtedness.
19
<PAGE>
SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OTHER DATA
The following selected historical consolidated financial and other data are
qualified by reference to, and should be read in conjunction with, our
consolidated financial statements and the related notes thereto appearing
elsewhere in this prospectus and "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The selected statement of
operations data set forth below for the years ended December 31, 1996, 1997 and
1998 and the balance sheet data as of December 31, 1997 and 1998 are derived
from our audited consolidated financial statements included elsewhere in this
prospectus. The statement of operations data for the years ended December 31,
1994 and 1995 and the balance sheet data as of December 31, 1994, 1995 and 1996
are derived from audited financial statements which are not included in this
prospectus.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1994(1) 1995 1996 1997 1998
------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenue:
Tuition and registration
fees, net............... $ 5,794 $ 16,330 $ 29,269 $ 74,842 $132,926
Other, net............... 1,692 3,066 4,311 7,756 11,306
------- -------- -------- -------- --------
Total net revenue....... 7,486 19,396 33,580 82,598 144,232
Operating Expenses:
Educational services and
facilities.............. 3,074 8,565 14,404 34,620 57,151
General and
administrative.......... 4,887 9,097 14,622 37,542 63,856
Depreciation and
amortization............ 980 1,330 2,134 8,121 12,163
Compensation expense
related to the initial
public offering......... -- -- -- -- 1,961
------- -------- -------- -------- --------
Total operating
expenses.............. 8,941 18,992 31,160 80,283 135,131
------- -------- -------- -------- --------
Income (loss) from
operations............... (1,455) 404 2,420 2,315 9,101
Interest expense.......... 134 311 717 3,108 1,250
------- -------- -------- -------- --------
Income (loss) before
provision for income
taxes, extraordinary item
and cumulative effect of
change in accounting
principle................ (1,589) 93 1,703 (793) 7,851
Provision (benefit) for
income taxes............. -- 24 208 (331) 3,350
------- -------- -------- -------- --------
Income (loss) before
extraordinary item and
cumulative effect of
change in accounting
principle................ (1,589) 69 1,495 (462) 4,501
Extraordinary loss on
early extinguishment of
debt (net of taxes of
$233).................... -- -- -- (418) --
------- -------- -------- -------- --------
Income (loss) before
cumulative effect of
change in accounting
principle................ (1,589) 69 1,495 (880) 4,501
Cumulative effect of
change in accounting
principle (net of taxes
of $149)................. -- -- -- -- (205)
------- -------- -------- -------- --------
Net income (loss)......... $(1,589) $ 69 $ 1,495 $ (880) $ 4,296
======= ======== ======== ======== ========
Income (loss) attributable
to common stockholders:
Income (loss) before
extraordinary item and
cumulative effect of
change in accounting
principle............... $(1,589) $ 69 $ 1,495 $ (462) $ 4,501
Dividends on preferred
stock (2)............... (393) (777) (1,128) (2,159) (274)
Accretion to redemption
value of preferred stock
and warrants (3)........ -- (96) (230) (6,268) (2,153)
------- -------- -------- -------- --------
Income (loss) before
extraordinary item and
cumulative effect of
change in accounting
principle, attributable
to common stockholders... (1,982) (804) 137 (8,889) 2,074
Extraordinary loss, net... -- -- -- (418) --
Cumulative effect of
change in accounting
principle, net........... -- -- -- -- (205)
------- -------- -------- -------- --------
Net income (loss)
attributable to common
stockholders............. $(1,982) $ (804) $ 137 $ (9,307) $ 1,869
======= ======== ======== ======== ========
Net income (loss) per
share attributable to
common stockholders:
Basic.................... $ (1.06) $ 0.18 $ (12.12) $ 0.29
======== ======== ======== ========
Diluted.................. $ (1.06) $ 0.13 $ (12.12) $ 0.27
======== ======== ======== ========
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------
1994(1) 1995 1996 1997 1998
------- ------ ------ ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Other Data:
EBITDA (4).................... $ (475) $1,734 $4,554 $10,436 $21,264
EBITDA margin (4)............. (6.3)% 8.9% 13.6% 12.6% 14.7%
Cash flow provided by (used
in):
Operating activities......... (1,000) 235 5,275 (194) 22,227
Investing activities......... (2,372) (3,478) (9,518) (45,214) (12,356)
Financing activities......... 6,014 4,566 8,076 56,659 (4,897)
Capital expenditures, net..... 153 897 1,231 3,822 6,383
Student population (5)........ 1,131 3,347 4,537 10,889 15,900
Number of campuses (6)........ 2 4 5 18 20
</TABLE>
<TABLE>
<CAPTION>
December 31,
---------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents........ $ 2,642 $ 3,965 $ 7,798 $ 18,906 $ 23,548
Working capital.................. 578 1,314 1,379 13,806 15,994
Total assets..................... 11,704 23,584 36,208 117,617 132,887
Long-term debt................... 2,313 8,034 16,459 64,035 22,617
Redeemable preferred stock and
warrants........................ 8,243 13,628 14,561 40,160 --
Total stockholders' investment... (1,982) (2,756) (2,589) (7,404) 84,636
</TABLE>
- --------
(1) Commencing January 5, 1994, the date of our incorporation.
(2) Represents the dividends paid on, or added to, the redemption value of
outstanding preferred stock. See Note 3 of the Notes to our Consolidated
Financial Statements.
(3) See Note 3 of the Notes to our Consolidated Financial Statements.
(4) For any period, EBITDA equals earnings before interest expense, taxes,
depreciation and amortization, including amortization of debt discount and
deferred financing costs. EBITDA margin equals EBITDA as a percentage of
net revenue. We have included information concerning EBITDA and EBITDA
margin because we believe they allow for a more complete analysis of our
results of operations. EBITDA and EBITDA margin should not be considered as
alternatives to, nor is there any implication that they are more meaningful
than, any measure of performance or liquidity as promulgated under
generally accepted accounting principles.
(5) Represents the total student population at our schools as of October 31.
(6) Represents the total number of campuses operated by us as of the end of the
period.
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
You should read the following discussion together with the financial
statements and related notes included elsewhere in this prospectus. The results
discussed below are not necessarily indicative of the results to be expected in
any future periods. This discussion contains forward-looking statements. See
"Special Note Regarding Forward-Looking Statements."
Background and Overview
We are a provider of private, for-profit postsecondary education in North
America, with approximately 15,900 students enrolled as of October 31, 1998. We
operate 13 schools, with 22 campuses located in 14 states and two Canadian
provinces. Our schools enjoy long operating histories and offer a variety of
bachelor's degree, associate degree and non-degree programs in career-oriented
disciplines within our core curricula of:
. information technologies,
. visual communication and design technologies,
. business studies, and
. culinary arts.
We have experienced significant growth both internally and through
acquisitions. Net revenue and EBITDA have increased in each of the years we
have operated. Our net revenue increased to $144.2 million in 1998, from $7.5
million in 1994 and EBITDA increased to $21.3 million in 1998, from a loss of
$0.5 million in 1994. We have invested significant amounts of capital in the
hiring of additional personnel and increased marketing and capital improvements
at each of the schools we have acquired. We have also hired additional
corporate staff to support our continued growth. The increased costs of
personnel and marketing are expensed as incurred and are reflected in general
and administrative expenses. Additional depreciation and amortization is
reflected as a result of the capital improvements.
We believe that EBITDA, while not a substitute for generally accepted
accounting principles' measures of operating results, is an important measure
of our financial performance and that of our schools. Our management believes
that EBITDA is particularly meaningful due principally to the role acquisitions
have played in our development. Our rapid growth through acquisitions has
resulted in significant non-cash depreciation and amortization expense, because
a significant portion of the purchase price of a school acquired by us is
generally allocated to fixed assets, goodwill and other intangible assets. As a
result of our ongoing acquisition strategy, non-cash amortization expense may
continue to be substantial.
Our principal source of revenue is tuition collected from our students. The
academic year is at least 30 weeks in length, but varies both by individual
school and program of study. The academic year is divided by term, which is
determined by start dates which vary by school and program. Payment of each
term's tuition may be made by full cash payment, financial aid and/or an
installment payment plan. If a student withdraws from school prior to the
completion of the term, we refund the portion of tuition already paid which is
attributable to the period of the term that is not completed. Revenue is
recognized ratably over the period of the student's program.
Our campuses charge tuition at varying amounts, depending not only on the
particular school, but also upon the type of program and the specific
curriculum. Each of our campuses typically implements one or more tuition
increases annually.
Other revenue consists of bookstore sales, placement fees, dormitory and
cafeteria fees and restaurant revenue. Other revenue is recognized during the
period services are rendered.
Educational services and facilities expense includes costs directly
attributable to the educational activity of our schools, including salaries and
benefits of faculty, academic administrators and student support personnel.
22
<PAGE>
Educational services and facilities expense also includes costs of educational
supplies and facilities (including rents on school leases), certain costs of
establishing and maintaining computer laboratories, costs of student housing
and all other physical plant and occupancy costs, with the exception of costs
attributable to our corporate offices.
General and administrative expense includes salaries and benefits of
personnel in recruitment, admissions, accounting, personnel, compliance and
corporate and school administration. Costs of promotion and development,
advertising and production of marketing materials, and occupancy of the
corporate offices are also included in this expense category.
Depreciation and amortization includes costs associated with the
depreciation of purchased computer laboratories, equipment, furniture and
fixtures, courseware, owned facilities, capitalized equipment leases and
amortization of intangible assets, primarily goodwill and non-competition
agreements with the previous owners of our schools.
Acquisitions
On February 28, 1997, we acquired all of the outstanding capital stock of
the School of Computer Technology for a purchase price of approximately $4.9
million. In addition, we paid approximately $1.8 million to the former owners
of the School of Computer Technology pursuant to non-competition agreements.
Effective May 31, 1997, we acquired all of the outstanding capital stock of
Gibbs for a purchase price of approximately $19.0 million. In addition, we paid
$7.0 million to the former owner of Gibbs pursuant to a non-competition
agreement.
On June 30, 1997, we acquired all of the outstanding capital stock of the
International Academy of Merchandising & Design for an initial purchase price
of $3.0 million, which amount was further increased by $4.7 million during
1998, based on the results of the International Academy of Merchandising &
Design operations and the calculation of the final purchase price adjustment.
In addition, we paid $2.0 million to the former owners of the International
Academy of Merchandising & Design pursuant to covenants not-to-compete.
Also on June 30, 1997, we acquired all of the capital stock of International
Academy of Design for a purchase price of $6.5 million. In addition, we paid
$2.0 million to the former owners of International Academy of Design pursuant
to covenants not-to-compete.
On March 13, 1998, we acquired all of the outstanding capital stock of
Southern California School of Culinary Arts for a purchase price of
approximately $1.0 million.
On July 31, 1998, we acquired certain assets and assumed certain liabilities
of Scottsdale Culinary. The purchase price was approximately $9.9 million.
On January 4, 1999, we acquired all of the outstanding capital stock of
Harrington for a purchase price of approximately $3.3 million, subject to
adjustment.
On March 9, 1999, we acquired certain assets and assumed certain liabilities
of McIntosh College. The purchase price was approximately $5 million, subject
to adjustment.
23
<PAGE>
Results of Operations
The following table summarizes our operating results as a percentage of net
revenue for the periods indicated.
<TABLE>
<CAPTION>
Year Ended
December 31,
--------------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Revenue:
Tuition and registration, net........................... 87.2% 90.6% 92.2%
Other, net.............................................. 12.8 9.4 7.8
----- ----- -----
Net revenue............................................ 100.0 100.0 100.0
----- ----- -----
Operating expenses:
Educational services and facilities..................... 42.9 41.9 39.6
General and administrative.............................. 43.5 45.5 44.3
Depreciation and amortization........................... 6.4 9.8 8.4
Compensation expense related to the initial public
offering............................................... -- -- 1.4
----- ----- -----
Total operating expenses............................... 92.8 97.2 93.7
----- ----- -----
Income (loss) from operations............................ 7.2 2.8 6.3
Interest expense, net.................................... 2.1 3.8 0.9
----- ----- -----
Income (loss) before provision for taxes, extraordinary
item and cumulative effect of change in accounting
principle............................................... 5.1 (1.0) 5.4
Provision (benefit) for income taxes..................... 0.6 (0.4) 2.3
----- ----- -----
Income (loss) before extraordinary item and cumulative
effect of change in accounting principle................ 4.5 (0.6) 3.1
Extraordinary loss on early extinguishment of debt, net.. -- (0.5) --
Cumulative effect of change in accounting principle, net. -- -- (0.1)
----- ----- -----
Net income (loss)........................................ 4.5 (1.1) 3.0
===== ===== =====
Net income (loss) attributable to common stockholders.... 0.4% (11.3)% 1.3%
===== ===== =====
</TABLE>
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenue. Net tuition revenue increased 78%, from $74.8 million in 1997 to
$132.9 million in 1998, due to an approximately 20.5% increase in the average
number of students attending the schools which were owned by us during 1997 and
tuition increases effective in 1998 for these schools, as well as added net
tuition revenue of $42.8 million for schools acquired during and after 1997.
Other net revenue increased 46%, from $7.8 million in 1997 to $11.3 million in
1998, due to an increase in student population for schools owned during the
1997 period.
Educational Services and Facilities Expense. Educational services and
facilities expense increased 65%, from $34.6 million in 1997 to $57.2 million
in 1998. Of this increase, $5.9 million was attributable to the increase in
student population for schools owned during 1997 and $16.6 million was
attributable to the addition of educational services and facilities for schools
acquired during and after 1997.
General and Administrative Expense. General and administrative expense
increased 70%, from $37.5 million in 1997 to $63.9 million in 1998. The
increase was primarily attributable to $11.9 million of expenses for schools
acquired during and after 1997, costs totalling $3.9 million related to
increased personnel at the corporate level to enhance our infrastructure, and
increased advertising and marketing (including admissions) of $8.8 million for
schools owned during 1997. The increase in advertising and marketing expenses
reflected, in part, the fact that the former owners of the acquired schools had
reduced their expenditures in these areas prior to our acquisition of the
schools.
Depreciation and Amortization Expense. Depreciation and amortization expense
increased 50%, from $8.1 million in 1997 to $12.2 million in 1998. The increase
was due to increased capital expenditures for schools
24
<PAGE>
owned during 1997 and related increased depreciation expense of $0.3 million in
1998. Additionally, depreciation expense increased $2.2 million due to the
depreciation expense for schools acquired during and after 1997. Amortization
expense increased from $3.5 million in 1997 to $5.1 million in 1998, primarily
due to additional amortization of non-competition agreements and goodwill for
the acquisition of schools after 1997.
Compensation Expense Related to the Initial Public Offering. Pursuant to
amended stock option agreements with two stockholders, compensation expense
totalling approximately $2.0 million was recognized upon consummation of our
initial public offering in February 1998.
Interest Expense. Interest expense decreased 60%, from $3.1 million in 1997
to $1.3 million in 1998. The decrease was primarily due to a reduction of
indebtedness resulting from the application of the net proceeds of our initial
public offering in February 1998.
Provision (Benefit) for Income Taxes. The provision (benefit) for income
taxes increased from a $0.3 million benefit in 1997 to a $3.4 million provision
in 1998 as a result of changes in pretax income (loss).
Net Income (Loss) before Extraordinary Item and Cumulative Effect of Change
in Accounting Principle. Net income (loss) before extraordinary item and
cumulative effect of change in accounting principle increased to a net income
of $4.5 million in 1998 from a net loss of $0.5 million in 1997.
Extraordinary Item. During 1997, we recorded an extraordinary expense of
$0.4 million, net of tax, due to the early retirement of debt related to a
credit facility which was terminated and replaced by our current credit
facility.
Cumulative Effect of Change in Accounting Principle. During 1998, we adopted
Statement of Position 98-5, "Reporting on the Costs of Start-up Activities." In
connection therewith, we recorded a charge of $0.2 million, net of tax.
Net Income (Loss). Net income (loss) increased to a net income of $4.3
million in 1998 from a net loss of $0.9 million in 1997, due to the factors
noted above.
Net Income (Loss) Attributable to Common Stockholders. Net income (loss)
attributable to common stockholders increased from a loss of $9.3 million in
1997 to net income of $1.9 million in 1998. The primary reason for this
increase was due to the increase in net income (loss) discussed above and
decreases in dividends on preferred stock and accretion to redemption value of
preferred stock and warrants in connection with our initial public offering.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenue. Net tuition revenue increased 156% from $29.3 million in 1996 to
$74.8 million in 1997, due to an approximately 18% increase in the average
number of students attending the schools which were owned by us during 1996 and
tuition increases effective in 1997 for these schools, as well as added net
tuition revenue of $34.2 million for schools acquired after 1996. Other net
revenue increased 80%, from $4.3 million in 1996 to $7.8 million in 1997, due
to an increase in student population for schools owned during 1996 and the
addition of $2.0 million from schools acquired after 1996.
Educational Services and Facilities Expense. Educational services and
facilities expense increased 140%, from $14.4 million in 1996 to $34.6 million
in 1997. Of this increase, $5.2 million was attributable to the increase in
student population and associated facility costs for schools owned during 1996
and $15.0 million was attributable to the addition of educational services and
facilities for schools acquired after 1996.
General and Administrative Expense. General and administrative expense
increased 157%, from $14.6 million in 1996 to $37.5 million in 1997. The
increase was primarily attributable to costs totalling $1.1 million related to
increased personnel at the corporate level to enhance our infrastructure and
increased advertising and
25
<PAGE>
marketing, including admissions, of $1.9 million for schools owned during 1996,
as well as the addition of $17.9 million of expenses for schools acquired after
1996. The increase in advertising and marketing expenses reflected, in part,
the fact that the former owners of the acquired schools had reduced their
expenditures in these areas prior to their acquisition by us.
Depreciation and Amortization Expense. Depreciation and amortization expense
increased 281%, from $2.1 million in 1996 to $8.1 million in 1997. The increase
was due to increased capital expenditures for schools owned during 1996 and
related increased depreciation expense of $0.2 million in 1997. Additionally,
depreciation expense increased $2.3 million due to the depreciation expense for
schools acquired after 1996. Amortization expense increased from an immaterial
amount in 1996 to $3.5 million in 1997, primarily due to additional
amortization of non-competition agreements for the acquisition of schools after
1996.
Interest Expense. Interest expense increased 333% from $0.7 million in 1996
to $3.1 million in 1997. The increase was primarily due to interest expense on
borrowings used to finance the acquisition of schools after 1996.
Provision (Benefit) for Income Taxes. The benefit for income taxes increased
from a provision in 1996 of $0.2 million to a benefit of $0.3 million in 1997.
Income (Loss) before Extraordinary Item. Net income (loss) before
extraordinary item decreased to a net loss of $0.5 million in 1997 from net
income before extraordinary item of $1.5 million in 1996, due to the factors
noted above.
Extraordinary Item. During 1997, we recorded an extraordinary expense of
$0.4 million, net of tax, due to the early retirement of debt related to a
credit facility which was terminated and replaced by our current credit
facility.
Net Income (Loss). Net income (loss) decreased to a net loss of $0.9 million
in 1997 from net income of $1.5 million in 1996, due to the factors noted
above.
Net Income (Loss) Attributable to Common Stockholders. Net income
attributable to common stockholders decreased from $0.1 million in 1996 to a
loss of $9.3 million in 1997. The primary reasons for this decrease were the
extraordinary item referred to above; increased dividends on preferred stock,
primarily due to the issuance of additional shares; and increased accretion in
the redemption value of preferred stock and warrants as a result of our growth.
All outstanding preferred stock converted into common stock and all outstanding
warrants were exercised prior to the consummation of our initial public
offering.
Seasonality
Our results of operations fluctuate primarily as a result of changes in the
level of student enrollment at our schools. Our schools experience a seasonal
increase in new enrollments in the fall, traditionally when the largest numbers
of new high school graduates begin postsecondary education. Furthermore,
although we encourage year-round attendance at all schools, some schools have
summer breaks for some of their programs. As a result of these factors, total
student enrollment and net revenue are typically highest in the fourth quarter,
which is October through December, and lowest in the second quarter, which is
April through June, of our fiscal year. Our costs and expenses do not, however,
fluctuate as significantly on a quarterly basis. We anticipate that these
seasonal trends will continue.
Liquidity and Capital Resources
On February 4, 1998, we sold 3,277,500 of our shares of common stock at
$16.00 per share pursuant to our initial public offering. We used net proceeds
from that offering totalling $45.6 million to repay borrowings of $41.5 million
under our former credit facility and amounts owed to former owners of acquired
businesses of
26
<PAGE>
$4.1 million which were outstanding at that time. Prior to that offering, we
financed our operating activities through cash generated from operations, and
we financed acquisitions through a combination of additional equity investments
and credit facilities. Net cash provided by operating activities increased to
$22.2 million in 1998 from net cash used of $0.2 million in 1997, due primarily
to increases in net income and depreciation and amortization and the result of
the non-cash compensation expense related to options.
Capital expenditures increased to $6.4 million in 1998 from $3.8 million in
1997. These increases were primarily due to investments in capital equipment as
a result of increasing student population. We expect capital expenditures to
continue to increase as new schools are acquired, student population increases
and current facilities and equipment are upgraded and expanded.
Our net receivables as a percentage of net revenue decreased to 9% in 1998
from 15% in 1997. This change was primarily due to increased revenues at
schools acquired during 1997. Based upon past experience and judgment, we
establish an allowance for doubtful accounts with respect to tuition
receivables. When a student withdraws, the receivable balance attributable to
such student is charged to this allowance for doubtful accounts. Our historical
bad debt expense as a percentage of revenue for the years ended December 31,
1996, 1997 and 1998 has ranged from 1.8% to 3.6%.
In October 1998, we refinanced our credit agreement. We can borrow up to $60
million under a revolving credit facility ($10 million of which may be drawn in
Canadian Dollars), such amount is reduced by outstanding letters of credit. We
can obtain up to $35 million in letters of credit. The credit agreement matures
on October 26, 2003. Our borrowings under the credit agreement bear interest,
payable quarterly, at either (1) the bank's base or prime rate depending on
whether the particular loan is denominated in U.S. or Canadian dollars, plus a
specified number of basis points, ranging from 0 to 75, based upon our leverage
ratio or (2) LIBOR, plus a specified number of basis points, ranging from 75 to
200 based upon our leverage ratio. Under the credit agreement, we are required,
among other things, to maintain (1) financial ratios with respect to debt to
EBITDA and interest coverage and (2) a specified level of net worth. We are
also subject to limitations on, among other things, payment of dividends,
disposition of assets and incurrence of additional indebtedness. We are
required to pledge the stock of our subsidiaries as collateral for the
repayment of our obligations under the credit agreement. At December 31, 1998,
we had approximately $28.9 million of outstanding letters of credit and $11.3
million of outstanding borrowings under our credit facility. As a result, at
December 31, 1998, our remaining credit availability under the credit agreement
was approximately $19.8 million. We are currently in the process of amending
the credit agreement to increase the credit facility from $60 million to $90
million. We cannot assure you that the credit facility will be increased.
Market Risk
We are exposed to the impact of interest rate changes, foreign currency
fluctuations and changes in the market value of our investments. We have not
entered into interest rate caps or collars or other hedging instruments.
Our exposure to changes in interest rates is limited to borrowings under
revolving credit agreements, which have variable interest rates tied to the
prime and LIBOR rates. The weighted average annual interest rate of these
credit agreements and bank note payables was 8.25% at December 31, 1998. In
addition, we had debt with fixed annual rates of interest of 7.0% totaling
$10.8 million at December 31, 1998. We estimate that the fair value of each of
our debt instruments approximated its market value at December 31, 1998.
We are subject to fluctuations in the value of the Canadian dollar vis-a-vis
the U.S. dollar. Our investment in our Canadian operations is not significant
and the fair value of the assets and liabilities of these operations at
December 31, 1998 approximated their fair value.
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Year 2000 Compliance
The Year 2000 Problem. Many IT hardware and software systems and non-IT
systems containing embedded technology, such as microcontrollers and microchip
processors, can only process dates with six digits, for example, 03/17/98,
instead of eight digits, for example, 03/17/1998. This limitation may cause IT
systems and non-IT systems to experience problems processing information with
dates after December 31, 1999. For example, 01/01/00 could be processed as
01/01/2000 or 01/01/1900 or with other dates, such as September 9, 1999, which
was a date traditionally used as a default date by computer programmers. These
problems may cause IT systems and non-IT systems to suffer miscalculations,
malfunctions or disruptions. These problems are commonly referred to as "Year
2000" problems. In late 1997, we began our audit, testing and remediation
project to assess our exposure to Year 2000 problems both because of our own IT
systems and non-IT systems and because of the systems of our significant
vendors, including those who process and disburse student financial aid for us.
The discussion below details our efforts to ensure Year 2000 compliance.
Our State of Readiness. Through our audit, testing and remediation project,
we have identified and evaluated the readiness of our IT systems and non-IT
systems, which, if not Year 2000 compliant, could have a material adverse
effect on us. We held planning strategy sessions in the first quarter of 1998
and conducted our Year 2000 audits, upgrade assessments and budget alignments
during the remainder of 1998. Our evaluation indicated that our administrative
IT systems are Year 2000 compliant, but identified the following areas of
concern:
. our accounting and financial reporting system
. our student database system
. the systems of third party vendors which process student financial aid
applications and loans for us
. the Department of Education's systems for processing and disbursing
student financial aid
. financial institutions which provide loans to our students
Based on our assessment and vendors' representations, we believe that the
financial and accounting systems, including those necessary for financial aid,
of our significant third party vendors will be Year 2000 compliant by mid-year
1999.
We believe that the material non-IT systems that we control are Year 2000
compliant and have begun the process of surveying our landlords, utility
providers and other providers of non-IT systems to confirm that such systems
are compliant. We expect to complete this process in the second quarter of
1999.
We also expect that all of our Year 2000 testing will be completed by the
second quarter of 1999.
The Risks Associated with Our Year 2000 Issues. Although we are unable at
this time to quantify with certainty our internal costs resulting from our Year
2000 problems, we do not believe that the cost of remediating our internal Year
2000 problems or the lost opportunity costs arising from any necessary
diversion of our personnel to Year 2000 problems will have a material adverse
effect on our business, results of operations or financial condition. We
estimate that the cost of replacing non-compliant servers and desktop computers
to be approximately $200,000. Alternatively, we estimate that the cost of
upgrading such servers and desktop computers to be approximately $100,000. The
choice to replace or upgrade these servers and computers will be made on a
case-by-case basis.
We believe the greatest Year 2000 compliance risk, in terms of magnitude, is
that the Department of Education may fail to complete its remediation efforts
in a timely manner and federal student financial aid funding for our students
could be interrupted for a period of time. During any such time, students may
not be able to pay their tuition in a timely matter. Because we derive
approximately 70% of our revenue from U.S. federal student financial aid
programs, such delay is likely to have a material adverse effect on our
business, results of operations and financial condition. Other than public
comments provided by the Department of
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Education that contingency plans have been drafted and will be tested by March
31, 1999, we are unable to predict the likelihood of this risk occurring.
According to the Department of Education, its systems should be brought into
certifiable compliance by the end of March, 1999.
Contingency Plans. At this time, we expect to be Year 2000 compliant and are
satisfied that our significant vendors are or will be compliant. However, to
avoid interruptions of our operations, we have begun developing contingency
plans in the event that we experience any Year 2000 problems. With respect to
IT-systems, we have distributed guidelines to each of our campuses regarding
data backup practices to store the information for our critical business
processes in case any of them experience Year 2000 problems. Our contingency
plan with respect to the material non-IT systems that we control includes,
among other things, investigating the availability and replacement cost of such
non-IT systems that have Year 2000 problems, isolating such systems that are
not Year 2000 compliant so that they do not affect other systems and adjusting
the clocks on such non-IT systems that are not date sensitive. We do not
believe that the total costs of such Year 2000 compliance activities will be
material.
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BUSINESS
The discussion below contains certain forward-looking statements (as such
term is defined in Section 21E of the Securities Exchange Act of 1934) that are
based on the beliefs of our management, as well as assumptions made by, and
information currently available to, our management. Our actual growth, results,
performance and business prospects and opportunities could differ materially
from those expressed in, or implied by, any such forward-looking statements.
See "Special Note Regarding Forward-Looking Statements" and "Risk Factors."
Overview
We are a provider of private, for-profit postsecondary education in North
America, with approximately 15,900 students enrolled as of October 31, 1998. We
operate 13 schools, with 22 campuses located in 14 states and two Canadian
provinces. Our schools enjoy long operating histories and offer a variety of
bachelor's degree, associate degree and non-degree programs in career-oriented
disciplines. We have experienced significant growth both internally and through
acquisitions with our net revenue increasing from $7.5 million in 1994 to
$144.2 million in 1998. In addition, our net income increased to $4.3 million
in 1998 from a net loss of $1.6 million in 1994.
Career Education Corporation was founded in January 1994 by John M. Larson,
our President and Chief Executive Officer, who has over 24 years of experience
in the career-oriented education industry. We were formed to capitalize on
opportunities in the large and highly fragmented postsecondary school industry.
Since our inception, we have completed 13 acquisitions. We have acquired
schools that we believe possess strong curricula, leading reputations and broad
marketability but that have been undermanaged from a marketing and financial
standpoint. We seek to apply our expertise in operations, marketing and
curricula development, as well as our financial strength, to improve the
performance of these schools.
Our schools offer educational programs principally in the following four
career-related fields of study--identified by us as areas with highly
interested and motivated students, strong entry-level employment opportunities
and ongoing career and salary advancement potential:
. Information Technologies: These programs include PC/LAN, PC/Net, computer
technical support, computer network operation, computer information
management and computer programming.
. Visual Communication and Design Technologies: These programs include
desktop publishing, graphic design, fashion design, interior design,
graphic imaging, webpage design and animation.
. Business Studies: These programs include business administration and
business operations.
. Culinary Arts: These programs include culinary arts, culinary arts and
restaurant management and pastry arts.
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The schools acquired by us are summarized in the following table:
<TABLE>
<CAPTION>
Year Month Principal Degree
School Founded Acquired Curricula(1) Granting
------ ------- -------- ------------ --------
<S> <C> <C> <C> <C>
Al Collins Graphic Design School 1978 1/94 IT, VC Yes
Tempe, AZ
Brooks College 1970 6/94 VC Yes
Long Beach, CA
Allentown Business School 1869 7/95 B, IT, Yes
Allentown, PA S, VC
Brown Institute 1946 7/95 CA, E, Yes
Mendota Heights, MN IT, RTB, VC
Western Culinary Institute 1983 10/96 CA No
Portland, OR
School of Computer Technology 1967 2/97 CA, IT Yes
Fairmont, WV
Pittsburgh, PA
The Katharine Gibbs Schools 1911 5/97 B, IT, Yes
Boston, MA S, VC
Melville, NY
Montclair, NJ
New York, NY
Norwalk, CT (2)
Piscataway, NJ (3)
Providence, RI (3)
International Academy of Merchandising & Design 1977 6/97 VC Yes
Chicago, IL
Tampa, FL
International Academy of Design 1983 6/97 VC No
Montreal, PQ
Toronto, ON
Southern California School of Culinary Arts 1994 3/98 CA No
South Pasadena, CA
Scottsdale Culinary Institute 1986 7/98 CA Yes
Scottsdale, AZ
Harrington Institute of Interior Design 1931 1/99 VC Yes
Chicago, IL
McIntosh College 1896 3/99 B, IT, CA Yes
Dover, NH
</TABLE>
- --------
(1) The programs offered by our schools include business studies ("B"),
culinary arts ("CA"), electronics ("E"), information technologies ("IT"),
radio and television broadcasting ("RTB"), secretarial studies ("S") and
visual communication and design technologies ("VC").
(2) The Gibbs campus in Norwalk, Connecticut is now using the name Gibbs
College.
(3) Does not offer degree programs.
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Industry Background
Based on estimates for 1996 by the Department of Education's National Center
for Education Statistics, postsecondary education is a $225 billion industry in
the U.S., with over 14 million students obtaining some form of postsecondary
education. Of this total, approximately 3.2 million students are enrolled in
approximately 4,600 private, degree-granting schools. Federal funds available
to support postsecondary education exceed $40 billion each year and have grown
steadily over the last two decades. Additionally, the federal government
guaranteed over $32 billion in student loans in 1997 and is expected to
guarantee loans at comparable levels in the future. State, local and private
funds for career-oriented training are also available.
Several national economic, demographic and social trends are converging to
contribute to growing demand for career-oriented school education:
Changes in Workplace Demands. The workplace is becoming increasingly
knowledge-intensive. Rapid advances in technology have increased demands on
employers and their employees, requiring many new workers to have some form of
training or education beyond the high school level. The increasing
technological skills required for entry level jobs are spurring demand for
specialized training which, in many cases, is not provided by traditional two
and four year colleges. The U.S. Department of Labor projects that between 1996
and 2006 jobs requiring (1) a bachelor's degree are expected to increase
approximately 25%, (2) an associate degree are expected to increase
approximately 22% and (3) postsecondary vocational training is expected to
increase approximately 7%. As of December 31, 1998, approximately 70% of our
students were enrolled in bachelor's degree programs and associate degree
programs and the remaining 30% were enrolled in vocational diploma/certificate
programs. Furthermore, career-oriented schools generally have the ability to
react quickly to the changing needs of the nation's business and industrial
communities. Additionally, to meet the new workplace demands, many major
companies are now using career-oriented institutions to provide customized
training for their employees on a contractual basis. Small to medium-sized
companies are also using proprietary career-oriented schools to fill their
needs for training to maintain or increase the skill levels of their employees.
Increasing Numbers of High School Graduates. Currently, U.S. high school
graduates represent over 2.6 million new prospective postsecondary students
each year, the largest pool of potential enrollees. Over the 18 years prior to
1993, the number of high school graduates had been declining. However, this
trend has changed favorably as children of the "baby boom" generation are
entering their high school years. These members of the "echo boom," as it is
commonly known, are expected to boost enrollment in postsecondary educational
programs to as high as 15.8 million students by 2006, an increase of over 10%
from approximately 14.3 million in the fall of 1996.
Growing Demand for Postsecondary Education. High school graduates and adults
are seeking postsecondary education in increasing numbers. According to the
U.S. Department of Commerce, approximately 65% of all 1996 high school
graduates continued their education that same year, compared with 53% a decade
earlier. The Department of Labor projects the number of jobs requiring at least
an associate degree or higher to grow by more than 14% between 1996 and 2006.
In addition, enrollment in postsecondary programs is expected to increase
substantially as individuals seek to enhance their skills or re-train for new
job requirements. In part because of the recent trend toward corporate
downsizing, the National Center for Education Statistics estimates that over
the next several years initial enrollments in postsecondary education
institutions by working adults will increase more rapidly than initial
enrollments by recent high school graduates. The number of adults enrolled in
postsecondary education programs in the U.S. is estimated by the National
Center for Education Statistics to reach 6.3 million by 2000, or 43% of the
total number of people enrolled.
Recognition of the Value of Postsecondary Education. We believe that
prospective students are increasingly recognizing the income premium and other
improvements in career prospects associated with a postsecondary education. On
average, (1) a female with an associate's degree earns 33% more than a female
high school graduate, and a male with an associate's degree earns 19% more than
a male high school graduate, while (2) a female with a bachelor's degree earns
57% more than a female high school graduate, and a male
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with a bachelor's degree earns 53% more than a male high school graduate.
Independent research studies have demonstrated that prospective students
consider these benefits in making their education decisions.
Reduction in Public Education Funding. The reduction of federal, state or
provincial and local funding of public educational institutions in recent years
has forced educational institutions to cut back spending on general operations.
As a result, some schools have become underfunded and overcrowded. This trend
may provide an opportunity for proprietary institutions to serve, at more
competitive prices, the postsecondary education needs of individuals who would
have otherwise attended public schools.
Decreasing Size of Military Forces. Due to defense budget cuts and the
corresponding reduction in the U.S. armed forces, the U.S. military, a
traditional provider of technical and career-oriented training, is able to
provide fewer educational opportunities. According to the U.S. Department of
Defense, the aggregate number of military personnel has declined by 32% since
1987, with the aggregate number of individuals on active duty in the military
services declining from 2.2 million in 1987 to 1.5 million in 1996. This has
left an educational void to be filled by other sources, including proprietary
career-oriented schools.
We believe that private, for-profit, career-oriented schools are uniquely
positioned to take advantage of these national trends. We also believe that
similar factors are creating a favorable climate for career-oriented
postsecondary education in Canada and other international markets.
Business and Operating Strategy
We were founded based upon a business and operating strategy which we
believe has enabled us to achieve significant improvements in the performance
of our schools. We believe this strategy will enable us to continue to
capitalize on the favorable economic, demographic and social trends which are
driving demand for career-oriented education, thereby strengthening our
position as a premier, professionally managed system of career-oriented
postsecondary educational institutions. The key elements of our business and
operating strategy are as follows:
Focusing on Core Curricula. Our schools offer educational programs
principally in four career-related fields of study:
. information technologies, including Internet and intranet technologies,
offered at 15 campuses
. visual communication and design technologies, offered at 14 campuses
. business studies, offered at ten campuses
. culinary arts, offered at six campuses
We perceive a growing demand by employers for individuals possessing skills
in these particular fields. We also believe there are many entry-level
positions and ongoing career and salary advancement potential for individuals
who have received advanced training in these areas. We recognize that these
employment opportunities have attracted highly interested and motivated
students. These students include both recent high school graduates and adults
seeking formal training in these fields as well as degrees, diplomas and
certificates evidencing their knowledge and skills. Our experience and
expertise in these attractive areas of study enable us to differentiate ourself
from many of our competitors and to effectively tailor our acquisition and
marketing plans.
Adapting and Expanding Educational Programs. We strive to meet the changing
needs of our students and the employment market. We continually refine and
adapt our courses to ensure that both students and employers are satisfied with
the quality and breadth of our educational programs. Through various means,
including student and employer surveys and curriculum advisory boards comprised
of business and community members, our schools regularly evaluate their program
offerings and consider revisions to existing classes and programs, as well as
the introduction of new courses and programs of study within our core
curricula. We selectively duplicate programs that have been successful
elsewhere in our school system. In 1998, we successfully duplicated nine
programs and plan to continue this curricula transfer in the future. For
example, we introduced information technology programs at Gibbs similar to
those already offered at Brown and culinary arts programs at Brown like those
offered at Western.
Investing for Future Growth. We make substantial investments in our people,
facilities, management information systems and classroom technologies to
prepare our company for continued growth. We devote particular attention to
attracting and retaining both corporate and school level management, and focus
on
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employee development in order to facilitate internal promotions. We make
substantial investments in facilities and classroom technologies to attract,
retain and prepare students for the increasing technical demands of the
workplace. Additionally, we have made significant investments in our management
information systems to standardize applications and processes across our
schools in order to maintain effective and expedient communication between our
schools and corporate management, as well as to ensure the smooth integration
of newly acquired schools.
Emphasizing School Management Autonomy and Accountability. We provide
significant autonomy and appropriate performance-based incentives to our
campus-level managers, which we believe offers important benefits for the
organization. We believe these policies foster an important sense of personal
responsibility for achieving campus performance objectives. We also believe our
willingness to grant local autonomy provides us and our schools with a
significant advantage in recruiting and retaining highly-motivated individuals
with an entrepreneurial spirit. Management of each of our campuses is
principally directed by a campus president and local managers, who are
accountable for the campuses' operations and profitability. Business strategy,
finance and consolidation accounting functions are, however, centralized at our
executive offices in Hoffman Estates, Illinois. When a new school is acquired,
we evaluate the capabilities of existing campus management personnel, and
typically retain a significant portion, which contributes to our ability to
rapidly integrate acquired schools into our system. We also determine the
acquired school's needs for additional or stronger managers in key areas and,
where necessary, take appropriate action by hiring new managers or assigning
experienced staff to the school's campuses.
Direct Response Marketing. We seek to increase school enrollment and
profitability through intensive local, regional and national direct response
marketing programs designed to maximize each school's market penetration. We
also use the Internet to attract potential students and believe that this
medium will be an increasingly important marketing tool. Because many of our
schools have been significantly undermarketed prior to their acquisition, we
believe that major benefits can result from carefully crafted, targeted
marketing programs that leverage schools' curriculum strength and brand name
recognition. After every school acquisition, we design a marketing program
tailored to the particular school to highlight its strengths and to improve
student lead generation and student enrollment rates. Our management uses a
diversified media, direct response approach, including direct mail, Internet-
based advertising, infomercials, other television-based advertising, newspaper
advertising and other print media, to attract potential students. We place
particular emphasis on high school recruitment because it produces a steady
supply of new students.
Improving Student Retention. We emphasize the retention of students, from
initial enrollment to completion of their courses of study, at each of our
schools. Because, as at any postsecondary educational institution, a
substantial portion of our students never finish their educational programs for
personal, financial or academic reasons, substantial increases in revenue and
profitability can be achieved through modest improvements in student retention
rates. Our costs to keep current students in school are much less than the
expense of the marketing efforts associated with attracting new students;
therefore, student retention efforts, if successful, are extremely beneficial
to operating results. We strive to improve retention by treating students as
valued customers. We consider student retention the responsibility of the
entire staff of each school, from admissions to faculty and administration to
career counseling services, and provide resources and support for the retention
efforts developed by our local school administrators. School personnel
typically employ an approach based upon establishing personal relationships
with students; for example, students may receive a telephone call from a school
counselor or faculty member if they miss classes. In addition, our corporate
staff regularly tracks retention rates at each school and provides feedback and
support to the efforts of local school administrators. As of December 31, 1998,
our retention rate was approximately 77%. This rate was determined in
accordance with the standards of the Accrediting Council for Independent
Colleges and Schools, which determines retention rates by dividing the total
number of student dropouts by the sum of (1) beginning student population, (2)
new starts and (3) student re-enters.
Emphasizing Employment of Graduates. We believe that the high rates of
employment for graduates of our schools enhance the overall reputation of the
schools as well as their ability to attract new students. High placement rates
also lead to low student loan default rates, which are necessary to allow our
schools to continue to participate in the federal student financial aid
programs. We consider student placement to be a high priority and allocate a
significant amount of time and resources to placement services. Due at least in
part to this
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<PAGE>
emphasis, 92.5% of our graduates for the 1998 academic year who were available
for employment had found employment relating to their fields of study within
six months of graduation. We are committed to maintaining or improving these
graduate employment rates and newly acquired schools will be expected to meet
similar graduate employment success standards.
Growth Strategy
We believe we can achieve superior long-term growth in revenue and
profitability by continuing to expand existing operations and acquire
additional schools in attractive North American markets. We believe we can
achieve additional growth in the future by establishing new campuses and also
by entering new service areas and expanding internationally.
Expanding Existing Operations. We believe that our existing 22 campuses can
achieve significant internal growth in enrollment, revenue and profitability.
We are executing our business and operating strategy, including all of the
elements described above, to accomplish this growth. We believe that expansion
of operations at our existing schools, along with acquisitions of new schools,
will be the primary generators of our growth in the near term.
Acquiring Additional North American Schools. To date, we have grown by
acquiring new schools in the U.S. and Canada and then applying our expertise in
marketing and school management to increase enrollment, revenue and
profitability at those schools. We expect that this process will continue to be
one of the most important elements of our growth strategy. We have an active
acquisition program and from time to time engage in, and are currently engaged
in, evaluations of, and discussions with, possible acquisition candidates,
including evaluations and discussions relating to acquisitions that may be
material in size or scope. See "Prospectus Summary--Recent Developments" and
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations--Acquisitions."
We make selective acquisitions of for-profit, career-oriented schools which
have capable faculty and operations staff, as well as quality educational
programs, which stand to benefit from our educational focus, marketing and
operating strengths. We target schools which we believe have the potential to
generate superior financial performance. Generally, such schools demonstrate
the following characteristics:
. "Schools of Choice"--Possessing leading reputations in career-oriented
disciplines within local, regional and national markets
. Success--Demonstrating the ability to attract, retain and place students,
while meeting applicable federal and state regulatory criteria and
accreditation standards
. Marketable Curricula--Offering programs that provide students with
relevant training and the skills necessary to obtain attractive jobs and
advance in their selected fields
. Broad Marketability--Attracting students from each of the high school,
adult, foreign and contract training market segments
. Attractive Facilities and Geographic Locations--Providing geographically
desirable locations and modern facilities to attract and prepare students
for the demands of the increasingly competitive workplace
We believe that significant opportunities exist for growth through
acquisition. Some opportunities result from institutions having limited
resources to manage increasingly complex regulations or to fund the significant
cost of developing new educational programs necessary to meet changing demands
of the employment market. We believe that a substantial number of schools
exhibiting the characteristics described above exist in the U.S. and Canadian
markets and that such schools can be successfully integrated into our marketing
and administrative structure. We believe that competition in Canada is not
currently as intense as in the U.S. Few of
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the largest U.S. operators of postsecondary career-oriented schools currently
have a significant Canadian presence. We believe that, given our existing
Canadian operations, we are well-positioned to take advantage of these
opportunities.
We analyze acquisition targets for their long-term profit potential,
enrollment potential and long-term demographic trends, concentration of likely
employers within the region, level of competition, facility costs and
availability and quality of management and faculty. We carefully investigate
any potential acquisition target for its history of regulatory compliance, both
as an indication of future regulatory costs and compliance issues and as an
indication of the school's overall condition. Significant regulatory compliance
issues in the school's past will generally remove a school from our
consideration as an acquisition candidate.
After we have completed an acquisition, we immediately begin to apply our
business strategy to boost enrollment and improve the acquired schools'
profitability. We assist acquired schools in achieving their potential through
a highly focused and active management role, as well as through capital
contributions. We selectively commit resources to improve marketing,
advertising, administration and regulatory compliance at each acquired school.
Further resources may also be committed to enhance management depth. We retain
acquired schools' brand names to take advantage of their established reputation
in local, regional and national markets as "schools of choice."
By acquiring new schools, we are also able to realize economies of scale in
terms of our management information systems, accounting and audit functions,
employee benefits and insurance procurement. We also benefit from the exchange
of ideas among school administrators regarding faculty development, student
retention programs, recruitment, curriculum, financial aid and student
placement programs.
Establishing New Campuses. Although, to date, we have added new campuses
only through acquisitions, in the future we expect to develop, open and operate
new campuses ourselves. These new campuses will most likely be established as
additional locations of existing institutions, but also may be established as
entirely separate, free-standing institutions. Opening new campuses would
enable us to capitalize on new markets or geographic locations that exhibit
strong enrollment potential and/or the potential to establish a successful
operation in one of our core curricula areas. We believe that this strategy
will allow us to continue to grow rapidly even if appropriate acquisition
opportunities are not readily available. We have not yet developed specific
plans for any new campuses, nor made any determination as to when we will first
develop, open and operate a new campus.
Entering New Service Areas. While we expect that our current career-oriented
school operations will continue to provide the substantial majority of our
revenue in the near term, we plan to develop new education-related services
which we believe offer strong long-term growth potential. Among the service
areas being actively considered is distance learning, which offers educational
products and services through video, Internet and other distribution channels.
We also plan to expand our contract training business, which provides
customized training on a contract basis for business and government
organizations, and which is currently a limited part of the operations of a few
of our schools. Although we have not yet actively targeted the growing market
for contract training services, we believe that contract training can become a
much more significant part of our business.
Expanding Internationally. Although all of our current operations are
located in North America, we believe that trends similar to those impacting the
market for postsecondary career-oriented education in the U.S. and Canada are
occurring outside of North America. As a result, we believe that there may be
significant international opportunities in private, for-profit postsecondary
education. To take advantage of these opportunities, we may at some time in the
future elect to acquire or establish operations outside North America.
Student Recruitment
Our schools seek to attract students with both the desire and ability to
complete their academic programs. Therefore, to produce interest among
potential students, each of our schools engages in a wide variety of marketing
activities.
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We believe that the reputation of our schools in local, regional and
national business communities and the recommendations of satisfied former
students are important factors contributing to success in recruiting new
students. Each school's admissions office is charged with marketing the
school's programs through a combination of admissions representatives, direct
mailings and radio, Internet, television and print media advertising, in
addition to providing the information needed by prospective students to assist
them in making their enrollment decisions.
As of December 31, 1998, our schools employed approximately 200 admissions
representatives, each of whom focuses his or her efforts on the following
areas: (1) out-of-area/correspondence recruiting, (2) high school recruiting or
(3) in-house/local recruiting. Correspondence representatives work with
students who live outside of the immediate school area to generate interest
through correspondence with potential enrollees who have learned of the school
through regional or national advertising. We believe we are able to
significantly boost enrollment by targeting students outside of the local
population. High school recruiting representatives conduct informational
programs at local secondary schools and follow up with interested students
outside of school, either at their homes or on our school campus. The
interpersonal relationships formed with high school counselors and faculty may
have significant influence over a potential student's choice of school. We
believe that the relationships of our schools' representatives with the
counseling departments of high schools are good and that the brand awareness
and placement rates of our schools assist representatives in gaining access to
counselors. In-house representatives are also available to speak with
prospective students who visit campuses and to respond to calls generated
through the school's advertising campaigns. Representatives interview and
advise students interested in specific careers to determine the likelihood of
their success in completing their educational programs. The admissions
representatives are full-time, salaried employees of the schools. Regulations
of the Department of Education prevent us from giving our U.S. employees
incentive compensation based, directly or indirectly, upon the number of
students recruited.
We also engage in significant direct mail campaigns. Mailing lists are
purchased from a variety of sources, and brochures are mailed regularly during
the course of the year, with frequency determined by the number of school
starts in a given year. We believe direct mailings offer a fast and cost-
effective way to reach a targeted population.
In addition, each school develops advertising for a variety of media,
including radio, television and the Internet, which is run locally, regionally
and sometimes nationally. While multi-media advertising is generally more
appropriate for local markets, some initiatives have been successfully utilized
on a national basis. We have found infomercials to be a particularly effective
tool nationally because their length enables schools to convey a substantial
amount of information about their students, their faculty, their facilities
and, most importantly, their course offerings. We also believe that the
personal flavor of the presentation typical of infomercials is well-suited to
attracting potential applicants. As an additional marketing tool, all of our
schools have established web sites, which can be easily accessed for
information about these schools and their educational programs. Although we
retain independent advertising agencies, we design and produce a portion of our
direct marketing and multi-media advertising and communications in-house,
through Market Direct, Inc., a wholly-owned subsidiary. While a majority of
Market Direct's operations involve designing and producing advertising for us,
Market Direct also provides these services to other businesses outside of the
postsecondary education industry as opportunities arise.
We closely monitor the effectiveness of our marketing efforts. We estimate
that, in 1998, admissions representatives were responsible for attracting
approximately 37% of student enrollments, direct mailings were responsible for
approximately 13%, television, radio and print media advertising were
responsible for approximately 37%, and the remaining approximately 13% was
attributable to various other methods.
Student Admissions and Retention
The admissions and entrance standards of each school are designed to
identify those students who are best equipped to meet the requirements of their
chosen fields of study. The most important qualifications for students include
a strong desire to learn, passion for their area of interest, initiative and a
high likelihood of
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successfully completing their programs. These characteristics are generally
identified through personal interviews by admissions representatives. We
believe that a success-oriented student body results in higher retention and
placement rates, increased satisfaction on the part of students and their
employers and lower student default rates on government loans. To be qualified
for admission to one of our schools, each applicant must have a high school
diploma or a General Education Development certificate. Many of our schools
also require that applicants obtain certain minimum scores on academic
assessment examinations. For 1998, approximately 39% of entering students at
our campuses enrolled directly from high school.
We recognize that our ability to retain students until graduation is an
important indicator of our success and that modest improvements in retention
rates can result in meaningful increases in school revenue and profitability.
As with other postsecondary educational institutions, many of our students do
not complete their programs for a variety of personal, financial or academic
reasons. As a result, student retention is considered an entire school's
responsibility, from admissions to faculty and administration to career
counseling services. To minimize student withdrawals, faculty and staff members
at each of our campuses strive to establish personal relationships with
students. Each campus devotes staff resources to advising students regarding
academic and financial matters, part-time employment and other matters that may
affect their success. However, while there may be many contributors, each
campus has one administrative employee specifically responsible for monitoring
and coordinating the student retention efforts. In addition, our corporate
staff regularly tracks retention rates at each campus and provides feedback and
support to appropriate local campus administrators.
Curriculum Development and Faculty
We believe that curriculum is the single most important component of our
operations, because students choose, and employers recruit from, career-
oriented schools based on the type and quality of technical education offered.
The curriculum development efforts of our schools are a product of their
operating partnership with students and the business and industrial
communities.
The relationship of each of our schools with the business community plays a
significant role in the development and adaptation of school curriculum. Each
school has one or more program advisory boards composed of members of the local
and regional business community who are engaged in businesses directly related
to the educational offerings provided by the school. These boards provide
valuable input to the school's education department, which allows the school to
keep our programs current and provide graduates with the training and skills
that these employers seek.
We also endeavor to enhance and maintain the relevancy of our curricula by
soliciting ideas through student and employer surveys and by requiring students
in selected programs to complete an internship during their school experience.
We have developed a number of techniques designed both to gain valuable
industry insight for ongoing curriculum development and enhance the overall
student experience. These techniques include (1) classroom discussions with
industry executives, (2) part-time job placement within a student's industry of
choice, and (3) classroom case studies that are based upon actual industry
issues.
Our schools are in continuous contact with employers through their faculty,
many of whom are industry professionals. The schools hire a significant number
of part-time faculty holding positions in business and industry because
specialized knowledge is required to teach many of the schools' courses and to
provide students with current, industry-specific training. The schedules of
business and industry professionals often permit them to teach the many evening
courses offered by our schools. Unlike traditional four-year colleges,
instructors in our schools are not awarded tenure and are evaluated, in part,
based upon student evaluations. As of December 31, 1998, our schools employed
approximately 1,460 faculty and staff members, of which approximately 32% were
full-time employees and approximately 68% had been hired on a part-time,
adjunct basis.
School Administration
We provide significant operational autonomy and appropriate performance-
based compensation to local school administrators who have demonstrated the
ability to undertake such responsibility, based on our belief
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that success is driven by performance at the local level through enrollment
growth, student retention rates and placement rates. In addition, each of our
schools requires, to a certain extent, different resources and operating
tactics due to a variety of factors, including curriculum, demographics,
geographic location and size. Management of each of our schools is principally
in the hands of a school president who has accountability for the school's
operations and profitability. Each of our schools has five primary operating
departments: admissions, financial aid, education, placement and accounting.
Business strategy, finance and consolidation accounting functions are
centralized at our corporate headquarters. Our corporate staff develops long-
term and short-term operating strategies for the schools and works closely with
local administrators to accomplish their goals and ensure adherence to our
strategy. We maintain stringent quality standards and controls at both the
corporate and individual school levels. Activities at the corporate level
include regular reporting processes which track the vital statistics of each
school's operations, including leads, enrollments, retention rates, placements,
and financial data. These reports provide real-time data which allow management
to monitor the performance of each campus. Each operating department at the
campus level is also required to compile quantitative reports at regular
intervals, including reports on admissions, financial aid, academic performance
and placement.
We use a number of quality and financial controls. Information is tracked
through an advanced, PC-based management information system, which currently
runs on a decentralized basis, but also allows centralized access to account
information.
Tuition and Fees
Currently, total tuition for completion of a diploma/certificate program
offered by our schools, assuming full time attendance, ranges from $5,400 to
$23,000, for completion of an associate degree program ranges from $13,000 to
$23,000, and for completion of a bachelor's degree program ranges from $32,000
to $49,500. In addition to these tuition amounts, students at our schools
typically must purchase textbooks and supplies as part of their educational
programs.
Our institutions bill students for their tuition and other institutional
charges based on the specific instructional format or formats of the school's
educational programs. Each institution's refund policies must meet the
requirements of the Department of Education and such institution's state and
accrediting agencies. Generally, under the Department of Education's
requirements, if a first-time student ceases attendance before the point in
time that is 60% of the period of enrollment for which the student has been
charged, the institution will refund institutional charges based on the amount
of time for which the student was charged but did not attend. After a student
has attended 60% or more of such period of enrollment, the institution will
retain 100% of the institutional charges for that period of enrollment. After
the student's first enrollment period, the institution refunds institutional
charges for subsequent periods of enrollment based on the number of weeks
remaining in the period of enrollment in which the student withdrew. In certain
circumstances, institutions must apply state refund requirements when
determining refunds for students.
Graduate Employment
We believe that employment of graduates of our schools in occupations
related to their fields of studies is critical to the reputation of the schools
and their ability to continue to recruit students successfully. We believe that
our schools' most successful form of recruiting is through referrals from
satisfied graduates. A strong placement office is important to maintain and
elevate the school's reputation, as well as managing the rate at which former
students default on their loans.
We devote a significant amount of time and resources to student placement,
which we believe to be the ultimate indicator of our success. We believe that
our average placement rate is attractive to prospective students. Student
placement is a top priority of each of our schools beginning on the first day
of student enrollment. This approach heightens the students' awareness of the
placement department and keeps students
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focused on their goal--job placement within their field of choice. Moreover,
each of our schools includes career development instruction in our curricula,
which includes the preparation of resumes, cover letters, networking and other
essential job-search tools. Placement office resources are regularly available
to our graduates. With such assistance, our graduates find employment with a
wide variety of businesses located not only in the schools' local markets but
also regionally and nationally.
Each campus' placement department also plays a role in marketing the campus'
curriculum to the business community to produce job leads for graduates. As of
December 31, 1998, approximately 65 employees worked in the placement
departments of our campuses. Placement counselors participate in professional
organizations, advisory boards, trade shows and community events to keep
apprised of industry trends and maintain relationships with key employers.
Partnerships with local and regional businesses are established through
internships and curriculum development programs and facilitate placement of
graduates in local and regional businesses. The placement department also
assists current students in finding part-time jobs while attending school.
These part-time placements often lead to permanent positions.
Based on survey information received from graduating students and employers,
we believe that of the 6,615 students graduating from our schools during the
1998 academic year, 92.5% of the 6,088 available graduates, which excludes
students who are continuing their education, are in active military service or
are disabled or deceased, as well as students from foreign countries who are
legally ineligible to work in the U.S., obtained employment in fields related
to their program of study within six months following their graduation.
The reputation of Gibbs allows it to charge fees to employers upon placement
of many of its students. Our other schools do not currently receive such
placement fees, nor, we believe, do any of our principal proprietary
competitors. We believe that, as an additional source of revenue, we may be
able to replicate the Gibbs' placement fee program at some of our other
schools.
Technology
We are committed to providing our students access to the technology
necessary for developing skills required to succeed in the careers for which
they are training. Through regular consultation with business representatives,
we ensure that all our schools provide their students with industry-current
computer hardware, computer software and equipment meeting industry-specific
technical standards. In each program, students use the types of equipment that
they will eventually use in their careers of choice. For example, graphic
animation students use sophisticated computer multimedia animation and digital
video editing equipment and supplies, and visual communication and design
technologies students make significant use of technologies for computer-related
design and layout and digital pre-press applications.
Employees
As of December 31, 1998, Career Education Corporation and our schools had a
total of approximately 1,200 full-time and 985 part-time employees. Neither
Career Education Corporation nor any of our schools has any collective
bargaining agreements with our employees. We consider our relations with our
employees to be good.
Competition
The postsecondary education market is highly fragmented and competitive,
with no single institution having a significant market share. Our schools
compete with traditional public and private two-year and four-year colleges and
universities, other proprietary schools and alternatives to higher education
such as immediate employment and military service. Private and public colleges
and universities may offer courses of study similar to those of our schools.
Some public institutions are able to charge lower tuition than our schools due
in part to government subsidies, government and foundation grants, tax-
deductible contributions and other financial sources not available to
proprietary schools. However, tuition at private, non-profit institutions is,
on
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average, higher than the average tuition rates of our schools. Other
proprietary career-oriented schools also offer programs that compete with those
of our schools. We believe that our schools compete with other educational
institutions principally based upon quality of their educational programs,
reputation in the business community, costs of programs and graduates' ability
to find employment. Some of our competitors in both the public and private
sectors may have substantially greater financial and other resources than us.
Changes in the regulatory environment have stimulated consolidation in the
postsecondary education industry. Regulations adopted in recent years have
tightened standards for educational content, established strict standards for
student loan default rates, required intensified scrutiny by state education
agencies and accrediting agencies and created more stringent standards for the
evaluation of an institution's financial responsibility and administrative
capability. As a result, career-oriented schools have been forced to close
because they lacked sufficient quality or financial resources or could not
manage the increased regulatory burden. At the same time, despite increasing
demand, potential new entrants face significant barriers to entry due to the
highly regulated nature of the industry and the considerable expense of start-
up operations.
Facilities
Our corporate headquarters are located in Hoffman Estates, Illinois, near
Chicago, and our 22 campuses are located in 14 states and two Canadian
provinces. Each campus contains teaching facilities, including modern
classrooms, laboratories and, in the case of the schools with culinary arts
programs, large, well-equipped kitchens. Admissions and administrative offices
are also located at each campus. Additionally, Brooks' campus includes a
dormitory and student cafeteria, and Western and Scottsdale Culinary lease and
operate restaurants in conjunction with their culinary arts program.
We lease all of our facilities, except the primary Gibbs facility in
Montclair, New Jersey, which we own. As of December 31, 1998, we owned
approximately 19,000 square feet and leased approximately 809,000 square feet.
The leases have remaining terms ranging from less than one year to eleven
years.
We actively monitor facility capacity in light of our current utilization
and projected enrollment growth. We have plans to lease at least 90,000
additional square feet in 1999 to accommodate our growth. We believe that our
schools can acquire any necessary additional capacity on reasonably acceptable
terms. We devote capital resources to facility improvements and expansions as
necessary.
Legal Proceedings
We and our institutions are subject to occasional lawsuits, investigations
and claims arising out of the ordinary conduct of our business, including the
following:
On February 24, 1997, 30 former and current students in Brown's PC/LAN
program brought a suit entitled Peter Alsides, et al. v. Brown Institute, Ltd.
in the Fourth Judicial District in Hennepin County, Minnesota against Brown
alleging breach of contract, fraud, misrepresentation, violation of the
Minnesota Consumer Fraud Act, violation of the Minnesota Deceptive Trade
Practices Act and negligent misrepresentation. Plaintiffs allege that Brown
failed to provide them with the education for which they contracted and which
had been represented to them upon enrollment. There are currently 41
plaintiffs, who are seeking to recover their tuition, interest and costs. Brown
believes that all of these claims are frivolous and without merit and is
vigorously contesting the allegations. Brown's motion for summary judgment was
granted in May 1998. Plaintiffs have appealed the motion and the appeal is
pending.
Although outcomes cannot be predicted with certainty, we do not believe that
the above-described matter or any other legal proceeding to which we are a
party will have a material adverse effect on our business, results of
operations or financial condition.
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FINANCIAL AID AND REGULATION
Our schools and students in the U.S. and Canada participate in a wide
variety of government-sponsored financial aid programs. For this reason, our
schools are subject to extensive regulatory requirements imposed by government
funding agencies and other bodies. For the 1997-98 award year, which is July 1,
1997 to June 30, 1998, we derived approximately 70% of our total net revenue on
a cash basis from such financial aid received by our students. We estimate that
over 70% of our students receive government-sponsored financial aid. Our
students also finance their education through family contributions and
individual resources.
Nature of Federal Support for Postsecondary Education in the U.S.
While many states support public colleges and universities primarily through
direct state subsidies, the federal government provides a substantial part of
its support for postsecondary education in the form of grants and loans to
students who can use those funds at any institution that has been certified as
eligible by the Department of Education. These federal programs are authorized
by Title IV of the Higher Education Act of 1965, as amended, and are
collectively referred to as the "Title IV Programs."
Most aid under the Title IV Programs is awarded on the basis of financial
need, generally defined under the Higher Education Act as the difference
between the cost of attending the institution and the amount a student can
reasonably contribute to that cost. All recipients of Title IV Program funds
must maintain a satisfactory grade point average and progress in a timely
manner toward completion of their program of study.
Students at our schools receive grants, loans and work opportunities to fund
their education under the following Title IV Programs, although not every
campus participates in all programs: (1) the Federal Family Education Loan
("FFEL") program, (2) the William D. Ford Federal Direct Loan ("FDL") program,
(3) the Federal Pell Grant ("Pell") program, (4) the Federal Supplemental
Educational Opportunity Grant ("FSEOG") program, (5) the Federal Perkins Loan
("Perkins") program and (6) the Federal Work-Study ("FWS") program .
FFEL. Loans made under the FFEL program are federally guaranteed. Loans are
made by banks and other lending institutions, but if a student or parent
defaults on a loan, payment is guaranteed by a federally recognized guaranty
agency, which is then reimbursed by the Department of Education. Students with
financial need qualify for interest subsidies while in school and during grace
periods. Our schools and their students use a wide variety of lenders and
guaranty agencies and have not experienced difficulties in identifying lenders
and guaranty agencies willing to make and guarantee FFEL loans.
FDL. Under the FDL program, students or their parents may obtain loans
directly from the Department of Education rather than from commercial lenders.
The conditions on FDL loans are generally the same as on loans made under the
FFEL program.
Pell. Under the Pell program, the Department of Education makes grants to
students who demonstrate financial need.
FSEOG. FSEOG awards are designed to supplement Pell grants for the neediest
students. An institution is required to make a 25% matching contribution for
all federal funds received under this program.
Perkins. Perkins loans are made from a revolving institutional account, 75%
of which is capitalized by the Department of Education and the remainder by the
institution. Each institution is responsible for collecting payments on Perkins
loans from its former students and lending those funds to currently enrolled
students.
FWS. Under the FWS program, federal funds are used to pay up to 75% of the
cost of part-time employment of eligible students to perform work for the
institution or certain off-campus organizations. The remaining 25% is paid by
the institution or the employer.
Regulation of Federal Student Financial Aid Programs for U.S. Schools
To participate in the Title IV Programs, an institution must be authorized
to offer its programs of instruction by the relevant agencies of the state in
which it is located, accredited by an accrediting agency
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recognized by the Department of Education and certified as eligible by the
Department of Education. The Department of Education will certify an
institution to participate in the Title IV Programs only after the institution
has demonstrated compliance with the Higher Education Act and the Department
of Education's extensive regulations regarding institutional eligibility. An
institution must also demonstrate its compliance to the Department of
Education on an ongoing basis. These standards are applied primarily on an
institutional basis, with an institution defined as a main campus and its
additional locations, if any. Under this definition, each of our U.S. campuses
is a separate institution, except for Gibbs-Piscataway, which is an additional
location of Gibbs-Montclair, and the School of Computer Technology-Fairmont,
which is an additional location of the School of Computer Technology-
Pittsburgh. All of our U.S. schools currently participate in the Title IV
Programs.
The substantial amount of federal funds disbursed through the Title IV
Programs coupled with the large numbers of students and institutions
participating in those programs have led to instances of fraud, waste and
abuse. As a result, Congress has required the Department of Education to
increase its level of regulatory oversight of institutions to ensure that
public funds are properly used. Under the Higher Education Act, accrediting
agencies and state licensing agencies also have responsibilities for
overseeing institutions' compliance with Title IV Program requirements. As a
result, each of our institutions is subject to frequent reviews and detailed
oversight and must comply with a complex framework of laws and regulations.
Because the Department of Education periodically revises its regulations and
changes its interpretation of existing laws and regulations, we cannot assure
you that the Department of Education will agree with our understanding of each
Title IV Program requirement.
Significant factors relating to the Title IV Programs that could adversely
affect us include the following:
Legislative Action. Political and budgetary concerns significantly affect
the Title IV Programs. Congress must reauthorize the Higher Education Act
approximately every six years. The most recent reauthorization in October 1998
reauthorized the Higher Education Act for an additional five years. Congress
reauthorized all of the Title IV Programs in which our schools participate,
generally in the same form and at funding levels no less than for the prior
year. While the 1998 reauthorization of the Higher Education Act made numerous
changes to Title IV Program requirements, we believe that these changes will
not have a material adverse effect on our business, results of operations or
financial condition. Changes made by the 1998 reauthorization of the Higher
Education Act include:
.expanding the adverse effects on schools of high student loan default
rates,
. increasing from 85% to 90% the portion of a proprietary school's revenue
that may be derived each year from the Title IV Programs,
. revising the refund standards that require an institution to return a
portion of the Title IV Program funds for students who withdraw from
school,
. giving the Department of Education flexibility to continue an
institution's Title IV participation without interruption in some
circumstances following a change of ownership or control,
.changing the formula for calculating the interest rate on FFEL and FDL
loans, and
. modifying the definition of default from 180 days to 270 days past due
for loans payable in monthly installments.
In addition, Congress reviews and determines federal appropriations for the
Title IV Programs on an annual basis. Congress can also make changes in the
laws affecting the Title IV Programs in those annual appropriations bills and
in other laws it enacts between the Higher Education Act reauthorizations.
Since a significant percentage of our revenue is derived from the Title IV
Programs, any action by Congress that significantly reduces Title IV Program
funding or the ability of our schools or students to participate in the Title
IV Programs could have a material adverse effect on our business, results of
operations or financial condition. Legislative action may also increase our
administrative costs and require us to adjust our practices in order for our
schools to comply fully with the Title IV Program requirements.
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Cohort Default Rates. A significant component of Congress' initiative to
reduce abuse in the Title IV Programs has been the imposition of limitations on
institutions whose former students default on the repayment of their federally
guaranteed or funded student loans above specific rates. All of our
institutions have implemented aggressive student loan default management
programs aimed at reducing the likelihood of students failing to repay their
loans in a timely manner. Those programs emphasize the importance of students
meeting loan repayment requirements and provide for extensive loan counseling,
methods to increase student persistence and completion rates and graduate
employment rates, and proactive borrower contacts after students cease
enrollment.
An institution's cohort default rate under the FFEL and FDL programs is
calculated on an annual basis as the rate at which student borrowers scheduled
to begin repayment on their loans in one federal fiscal year default on those
loans by the end of the next federal fiscal year. An institution whose cohort
default rates equal or exceed 25% for three consecutive years will no longer be
eligible to participate in the FFEL or FDL programs, and beginning with fiscal
year 1996 cohort default rates, the Pell program, for the remainder of the
federal fiscal year in which the Department of Education determines that such
institution has lost its eligibility and for the two subsequent federal fiscal
years. An institution whose cohort default rate under the FFEL or FDL program
for any federal fiscal year exceeds 40% may have its eligibility to participate
in all of the Title IV Programs limited, suspended or terminated by the
Department of Education.
None of our institutions has FFEL or FDL cohort default rates of 25% or
greater for three consecutive years. The following table sets forth the FFEL
and FDL cohort default rates for our institutions for federal fiscal years
1994, 1995 and 1996, the most recent years for which the Department of
Education has published such rates:
<TABLE>
<CAPTION>
FFEL and FDL
Cohort Default
School Rate
------ ------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Al Collins Graphic Design School
Tempe, AZ 15.4% 13.8% 19.3%
Allentown Business School
Allentown, PA 9.7 10.7 7.1
Brooks College
Long Beach, CA 21.1 17.8 18.3
Brown Institute
Mendota Heights, MN 17.4 18.1 19.6
Harrington Institute of Interior Design
Chicago, IL 8.9 5.6 0.0
International Academy of Merchandising & Design
Chicago, IL 13.8 15.5 13.3
Tampa, FL 12.0 13.3 15.0
The Katharine Gibbs Schools
Boston, MA 16.2 16.9 16.7
Melville, NY 12.7 15.8 17.7
Montclair, NJ and Piscataway, NJ 14.5 15.8 16.2
New York, NY 17.3 14.5 18.9
Norwalk, CT 16.0 27.0 17.8
Providence, RI 14.9 14.8 13.1
McIntosh College
Dover, NH 6.8 11.3 10.1
School of Computer Technology
Pittsburgh, PA and Fairmont, WV 12.9 11.2 9.3
Scottsdale Culinary Institute
Scottsdale, AZ 4.0(1) 6.1 5.6
Western Culinary Institute
Portland, OR 9.8 14.3 11.4
</TABLE>
- --------
(1) This is a preliminary rate. The Department of Education has not yet
published a final 1996 rate for this institution.
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An institution whose cohort default rate under the FFEL or FDL program
equals or exceeds 25% for any one of the three most recent federal fiscal
years, or whose cohort default rate under the Perkins program exceeds 15% for
any year, may be placed on provisional certification status by the Department
of Education for up to four years. Nine of our institutions have Perkins cohort
default rates in excess of 15% for students who were scheduled to begin
repayment in the 1996-97 federal award year, the most recent year for which
such rates have been calculated. The Perkins cohort default rates for these
nine institutions ranged from 20.7% to 100.0%. To date, the Department of
Education has placed only two of our institutions, Gibbs-Melville and Gibbs-
Montclair, on provisional certification for their cohort default rates. Both
institutions were placed on provisional certification for their Perkins default
rates, either alone or in combination with other reasons. Total Perkins loans
disbursed during 1997-98 represented less than 1% of our total net revenue. See
"--Eligibility and Certification Procedures."
Financial Responsibility Standards. All institutions participating in the
Title IV Programs must satisfy specific standards of financial responsibility.
The Department of Education evaluates institutions for compliance with these
standards each year, based on the institution's annual audited financial
statements, and following a change of ownership of the institution.
Under new regulations which took effect July 1, 1998, the Department of
Education calculates the institution's composite score based on its:
. equity ratio, which measures the institution's capital resources, ability
to borrow and financial viability,
. primary reserve ratio, which measures the institution's ability to
support current operations from expendable resources and
. net income ratio, which measures the institution's ability to operate at
a profit.
An institution that does not meet the Department of Education's minimum
composite score may demonstrate its financial responsibility by posting a
letter of credit in favor of the Department of Education in an amount equal to
at least 50% of the Title IV Program funds received by the institution during
its prior fiscal year and possibly accepting other conditions on its
participation in the Title IV Programs.
In periodic reviews of our financial statements for 1997 and prior years, as
well as our February 28, 1998 balance sheet reflecting the results of our
initial public offering, the Department of Education has questioned certain
accounting issues and has found that we and some of our institutions when
measured on an individual basis failed the numeric tests under the Department
of Education's former and current standards of financial responsibility. To
satisfy the Department of Education's concerns, we have posted letters of
credit on behalf of all institutions we have acquired since October 1996. The
Department of Education reduced the number and amount of our letters of credit
in September 1998 following its review of our 1997 financial statements and our
February 28, 1998 balance sheet. The Department of Education also noted that
the funds derived from our initial public offering, shortly after the close of
our 1997 fiscal year, would have a positive effect on our financial
responsibility. As a result, we currently have posted letters of credit
totaling approximately $17.6 million on behalf of the following schools, which
represent 11 institutions as defined by the Department of Education:
<TABLE>
<S> <C> <C>
. Gibbs -- $8.9 million
. International Academy of Merchandising & Design -- $3.4 million
. Scottsdale Culinary -- $1.3 million
. Southern California School of Culinary Arts -- $2.0 million
. Western -- $2.0 million
</TABLE>
In addition, in December 1998 when the Department of Education certified the
Southern California School of Culinary Arts to participate in the Title IV
Programs under our ownership, it imposed a condition providing that school may
not disburse more than $2.0 million in Title IV Program funds during its
initial period of certification ending June 30, 2000. We believe the Department
of Education added this condition because the
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Southern California School of Culinary Arts had not participated in the Title
IV Programs under its prior owner. For a period of time during 1997 and 1998,
the Department of Education imposed a similar limitation on the total Title IV
Program funding at three of our other schools: Gibbs, the School of Computer
Technology and the International Academy of Merchandising & Design. In June
1998, the Department of Education removed the limitation on Title IV Program
funding for these three schools.
We believe our 1998 audited financial statements conform with generally
accepted accounting principles and demonstrate that we and most if not all of
our institutions satisfy the Department of Education's composite score for
financial responsibility, without any conditions. We filed our 1998 financial
statements with the Department of Education in February 1999 and asked it to
release most, if not all, of our outstanding letters of credit and to increase
or eliminate the Title IV Program funding limitation for the Southern
California School of Culinary Arts. We cannot assure you that we or our
institutions will satisfy the numeric standards or that the Department of
Education will take any action with respect to the letters of credit or funding
limitation.
Under a separate standard of financial responsibility, an institution that
has made late student refunds in either of its last two fiscal years must post
a letter of credit with the Department of Education in an amount equal to 25%
of the total Title IV Program refunds paid by the institution in its prior
fiscal year. Based on this standard, we currently have posted a total of
$120,000 in letters of credit with respect to two Gibbs campuses and one
International Academy of Merchandising & Design campus.
Change of Ownership or Control. When we acquire an institution that is
eligible to participate in the Title IV Programs, that institution undergoes a
change of ownership resulting in a change of control as defined by the
Department of Education. Upon such a change of control, an institution's
eligibility to participate in the Title IV Programs is generally suspended
until it has applied for and been recertified by the Department of Education as
an eligible institution under our ownership, which requires that the
institution also reestablish its state authorization and accreditation. The
time required to act on such an application may vary substantially. Pending
recertification by the Department of Education, the institution may receive and
disburse Title IV Program funds to its students only if those funds were
committed prior to the change of control. If an institution is recertified
following a change of control, it will be on a provisional basis.
The 1998 reauthorization of the Higher Education Act provides that the
Department of Education may provisionally and temporarily certify an
institution undergoing a change of control under certain circumstances while
the Department of Education reviews the institution's application. The
Department of Education has not yet issued regulations regarding how it will
interpret or apply this amendment to the Higher Education Act.
Each of the U.S. institutions we have acquired has undergone a certification
review under our ownership and has been certified to participate in the Title
IV Programs, with the exception of Harrington. We acquired Harrington in
January 1999 and the Department of Education has granted it temporary and
provisional certification, pending a full certification review. Nine of our
U.S. institutions are presently participating in Title IV Programs under
provisional certification and the remaining eight have been granted regular
certification.
Some other types of transactions can also cause a change of control. The
Department of Education, the state education agencies and the accrediting
agencies that accredit our schools have their own definitions of when a
transaction is deemed a change of control. With respect to a publicly traded
corporation, such as us, Department of Education regulations provide that a
change of control occurs when there is an event that would obligate that
corporation to file a Current Report on Form 8-K with the Securities and
Exchange Commission disclosing a change of control. This standard is subject to
interpretation by the Department of Education. We cannot predict how the
Department of Education will apply this standard in the future, or whether the
Department of Education will change this standard. A significant purchase or
disposition of our common stock could be determined by the Department of
Education to be a change of control under this standard. Most of the states and
accrediting agencies include the sale of a controlling interest of common stock
in the definition of a change of control. A change of control under the
definition of one of these agencies would require the affected institution to
reaffirm its state authorization or accreditation. The requirements to obtain
such reaffirmation from the states and accrediting agencies with jurisdiction
over our schools vary widely.
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We have been advised by the Department of Education that this offering will
not be a change of control under its standard. We believe that this offering
will be a change of control under the standards of the Arizona State Board for
Private Postsecondary Education and the Illinois State Board of Education, but
will not be a change of control under the standards of any other applicable
state education agencies or the accrediting agencies that accredit our schools.
As a result, Collins and Scottsdale Culinary, our only campuses in Arizona, and
International Academy of Merchandising & Design-Chicago, our only campus
authorized by the Illinois State Board, will be required to be reauthorized by
the Arizona State Board and the Illinois State Board, respectively. We believe
that this offering will not affect the ability of those three campuses to
participate in the Title IV Programs unless the Arizona State Board or the
Illinois State Board fails to reauthorize any of those campuses in a timely
manner. The failure of any of those campuses to reobtain state authorization
could have a material adverse effect on our business, results of operations or
financial condition. We believe this offering will not affect the ability of
our other institutions to participate in the Title IV Programs.
The potential adverse effects of a change of control could influence future
decisions by us and our stockholders regarding the sale, purchase, transfer,
issuance or redemption of our capital stock.
Opening Additional Schools and Adding Educational Programs. The Higher
Education Act generally requires that proprietary institutions be fully
operational for two years before applying to participate in the Title IV
Programs. However, an institution that is certified to participate in the Title
IV Programs may establish an additional location and apply to participate in
the Title IV Programs at that location without reference to the two-year
requirement, if such additional location satisfies all other applicable
eligibility requirements. Our expansion plans are based, in part, on our
ability to open new campuses as additional locations of our existing
institutions.
Generally, an institution that is eligible to participate in the Title IV
Programs may add a new educational program without Department of Education
approval if that new program leads to an associate level or higher degree and
the institution already offers programs at that level, or if it prepares
students for gainful employment in the same or related occupation as an
educational program that has previously been designated as an eligible program
at that institution and meets minimum length requirements. If an institution
erroneously determines that an educational program is eligible for the Title IV
Programs, the institution would likely be liable for repayment of the Title IV
Program funds provided to students in that educational program. We do not
believe that current Department of Education regulations will create
significant obstacles to our plans to add new programs.
Some of the state education agencies and accrediting agencies with
jurisdiction over our campuses also have requirements that may affect schools'
ability to open a new campus, acquire an existing campus, establish an
additional location of an existing institution or begin offering a new
educational program. We do not believe that these standards will have a
material adverse effect on our expansion plans.
The "85/15 Rule." Under a provision of the Higher Education Act commonly
referred to as the "85/15 Rule," a proprietary institution, such as each of our
institutions, would cease being eligible to participate in the Title IV
Programs if, on a cash accounting basis, it derived more than 85% of its
revenue for any fiscal year from the Title IV Programs. Any institution that
violates this rule becomes ineligible to participate in the Title IV Programs
as of the first day of the fiscal year following the fiscal year in which it
exceeds 85%, and is unable to apply to regain its eligibility until the next
fiscal year. If one of our institutions violated the 85/15 Rule and became
ineligible to participate in the Title IV Programs but continued to disburse
Title IV Program funds, the Department of Education would require the
institution to repay all Title IV Program funds received by the institution
after the effective date of the loss of eligibility.
We have calculated that, since this requirement took effect in 1995, none of
our institutions has derived more than 83% of its revenue from the Title IV
Programs for any fiscal year. The 1998 reauthorization of the Higher Education
Act increased the percentage of applicable revenue that a for-profit
institution can derive from the Title IV Programs from 85% to 90%. We regularly
monitor compliance with this requirement to
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minimize the risk that any of our institutions would derive more than the
maximum percentage of its revenue from the Title IV Programs for any fiscal
year. If an institution appeared likely to approach the maximum percentage
threshold, we would evaluate making changes in student funding and financing to
ensure compliance with the rule.
Administrative Capability. The Department of Education assesses the
administrative capability of each institution that participates in the Title IV
Programs under a series of separate standards. Failure to satisfy any of the
standards may lead the Department of Education to find the institution
ineligible to participate in the Title IV Programs or to place the institution
on provisional certification as a condition of its participation. One standard
which applies to programs with the stated objective of preparing students for
employment requires the institution to show a reasonable relationship between
the length of the program and the entry-level job requirements of the relevant
field of employment. We believe we have made the required showing for each of
our applicable programs. Short-term educational programs that provide less than
600 clock hours of instruction must demonstrate that 70% of all students who
enroll in such programs complete them within a prescribed time and 70% of the
graduates of such programs obtain employment in the occupation for which they
were trained within a prescribed time. Some of the Gibbs institutions offer
such short-term programs, but students enrolled in these programs represent a
small percentage of our total enrollment. To date, the applicable institutions
have been able to establish that their short-term educational programs meet the
required completion and placement percentages.
Other standards provide that an institution may be found to lack
administrative capability and be placed on provisional certification if its
student loan default rate under the FFEL and FDL programs is 25% or greater for
any of the three most recent federal fiscal years, or if its Perkins cohort
default rate exceeds 15% for any federal award year. Two of our institutions
have been placed on provisional certification or determined by the Department
of Education to lack administrative capability due to their Perkins default
rates, either alone or in conjunction with other reasons.
An additional standard prohibits an institution from providing any
commission, bonus or other incentive payment based directly or indirectly on
success in securing enrollments or financial aid to any person or entity
engaged in any student recruitment, admission or financial aid awarding
activity. We believe that our current compensation plans are in compliance with
the Higher Education Act standards, although the regulations of the Department
of Education do not establish clear criteria for compliance.
Eligibility and Certification Procedures. The Higher Education Act and its
implementing regulations require each institution to apply to the Department of
Education for continued certification to participate in the Title IV Programs
at least every six years, or when it undergoes a change of control, opens an
additional location or raises the highest academic credential it offers. The
Department of Education may place an institution on provisional certification
status if it finds that the institution does not fully satisfy all of the
eligibility and certification standards. The Department of Education may
withdraw an institution's provisional certification without advance notice if
the Department of Education determines that the institution is not fulfilling
all material requirements, and may more closely review an institution that is
provisionally certified if it applies for approval to open a new location or
make any other significant change. Provisional certification does not otherwise
limit an institution's access to Title IV Program funds.
An institution seeking certification to participate in the Title IV Programs
after a change of control will be provisionally certified for a limited period,
following which the institution must reapply for continued certification. If at
that time the institution satisfies all conditions for full certification, the
Department of Education will recertify the institution and remove the
provisional status. Otherwise, the Department of Education may recertify the
institution on a continued provisional basis. Each institution that we have
acquired was initially certified by the Department of Education for
participation in the Title IV Programs under our ownership on a provisional
basis. Seven of our institutions remain on provisional certification status
because the initial period of their provisional certification has not expired.
Two institutions have been recertified by the Department of Education upon the
expiration of their initial provisional period, but remain on provisional
status
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for other reasons. Gibbs-Melville is on provisional certification status
because its Perkins cohort default rate at the time of the Department of
Education's review was above 30%, and the institution was told that it would
remain on provisional certification until it reduced its Perkins default rate
below 30%. Gibbs-Montclair is on provisional certification status because its
Perkins cohort default rate is above 30% and because of other reasons that we
believe are now fully resolved.
Compliance with Regulatory Standards and Effect of Regulatory Violations.
Our schools are subject to audits and program compliance reviews by various
external agencies, including the Department of Education, state education
agencies, guaranty agencies and accrediting agencies. The Higher Education Act
and its implementing regulations also require that an institution's
administration of Title IV Program funds be audited annually by an independent
accounting firm, and the resulting audit report submitted to the Department of
Education for review. If the Department of Education or another regulatory
agency determined that one of our institutions improperly disbursed Title IV
Program funds or violated a provision of the Higher Education Act or the
Department of Education's regulations, that institution could be required to
repay such funds, and could be assessed an administrative fine. The Department
of Education could also subject the institution to heightened cash monitoring,
under which the institution's federal funding requests are more carefully
reviewed by the Department of Education, or the Department of Education could
transfer the institution from the advance system of receiving Title IV Program
funds to the reimbursement system, under which a institution must disburse its
own funds to students and document the students' eligibility for Title IV
Program funds before receiving such funds from the Department of Education.
Violations of Title IV Program requirements could also subject us or our
schools to other civil and criminal penalties.
Significant violations of Title IV Program requirements by us or any of our
institutions could be the basis for a proceeding by the Department of Education
to limit, suspend or terminate the participation of the affected institution in
the Title IV Programs. Generally, such a termination extends for 18 months
before the institution may apply for reinstatement of its participation. There
is no proceeding pending to fine any of our institutions or to limit, suspend
or terminate any of our institutions' participation in the Title IV Programs,
and we have no reason to believe that any such proceeding is contemplated. Any
such action that substantially limited our schools' participation in the Title
IV Programs could have a material adverse effect on our business, results of
operations or financial condition.
State Authorization for U.S. Schools
We are subject to extensive regulation in each of the 14 states in which we
currently operate schools and in other states in which our schools recruit
students. Each of our campuses must be authorized by the applicable state
agency or agencies to operate and grant degrees or diplomas to its students. In
addition, state authorization is required for an institution to become and
remain eligible to participate in the Title IV Programs. Currently, each of our
U.S. campuses is authorized by the applicable state agency or agencies.
The level of regulatory oversight varies substantially from state to state.
In some states, the campuses are subject to licensure by an agency that
regulates proprietary schools and also by a separate higher education agency.
State laws establish standards for instruction, qualifications of faculty,
location and nature of facilities, financial policies and other operational
matters. State laws and regulations may limit our ability to operate or to
award degrees or diplomas or offer new degree programs. Some states prescribe
standards of financial responsibility that are different from those prescribed
by the Department of Education. We believe that each of our campuses is in
substantial compliance with state authorizing and licensure laws. If any one of
our campuses lost its state authorization, the campus would be unable to offer
its programs and we would be forced to close that campus. Closing one of our
campuses for any reason could have a material adverse effect on our business,
results of operations or financial condition.
Accreditation for U.S. Schools
Accreditation is a non-governmental process through which an institution
submits to a qualitative review by an organization of peer institutions.
Accrediting agencies primarily examine the academic quality of the
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institution's instructional programs, and a grant of accreditation is generally
viewed as confirmation that an institution's programs meet generally accepted
academic standards. Accrediting agencies also review the administrative and
financial operations of the institutions they accredit to ensure that each
institution has the resources to perform its educational mission.
Accreditation by an accrediting agency recognized by the Department of
Education is required for an institution to be certified to participate in the
Title IV Programs. Accrediting agencies must adopt specific standards in
connection with their review of postsecondary institutions to be recognized by
the Department of Education. All of our U.S. campuses are accredited by an
accrediting agency recognized by the Department of Education. Thirteen of our
campuses are accredited by the Accrediting Council for Independent Colleges and
Schools ("ACICS"), four of our campuses are accredited by the Accrediting
Commission of Career Schools and Colleges of Technology ("ACCSCT"), one of our
campuses is accredited by the Accrediting Commission for Community and Junior
Colleges of the Western Association of Schools and Colleges, one of our
campuses is accredited by the National Association of Schools of Art and Design
and one of our campuses is accredited by the New England Association of Schools
and Colleges--Commission on Technical and Career Institutions. In addition,
four of our campuses' interior design programs are accredited by the Foundation
for Interior Design Education Research and two of our campuses' culinary arts
programs are accredited by the American Culinary Federation Educational
Institute Accrediting Commission, accrediting agencies which are not recognized
by the Department of Education.
An accrediting agency may place a campus on "reporting" status to monitor
one or more specified areas of performance. A campus placed on reporting status
is required to report periodically to its accrediting agency on that campus'
performance in the specified areas. ACICS has placed five campuses,
International Academy of Merchandising & Design-Chicago, International Academy
of Merchandising & Design-Tampa, Gibbs-Boston, Gibbs-Melville, and Gibbs-
Providence, on financial reporting status, and one campus, Gibbs-Montclair, on
placement reporting status. ACCSCT has placed two campuses, Brown and Collins,
on completion and placement reporting status. Each of these campuses has
submitted all requested data in the identified area to its accrediting agency.
The placement of these eight campuses on reporting status by their accrediting
agencies has not had a material adverse effect on our business, results of
operations or financial condition, and we do not believe that it will have that
effect in the future.
Canadian Regulation
Depending on their province of residence, our Canadian students may receive
loans under the Canada Student Loan Program, the Ontario Student Loans Plan and
the Quebec Loans and Bursaries Program. Canadian schools must meet eligibility
standards to administer these programs and must comply with extensive statutes,
rules, regulations and requirements. We believe our Canadian schools currently
hold all necessary registrations, approvals and permits and meet all
eligibility requirements to administer these governmental financial aid
programs. If our Canadian schools cannot meet these and other eligibility
standards or fail to comply with applicable requirements, it could have a
material adverse effect on our business, results of operations or financial
condition.
Ontario. The Ontario Ministry of Education and Training provides financial
assistance to eligible students through the Ontario Student Assistance Plan
("OSAP"). This plan includes two main components, the Canada Student Loan
Program and the Ontario Student Loans Plan. For our International Academy of
Design school in Toronto to maintain its right to administer OSAP it must,
among other things, be registered and in good standing under the Ontario
Private Vocational Schools Act and abide by the rules, regulations and
administrative manuals of the Canada Student Loan Program, Ontario Student
Loans Plan and other OSAP-related programs. In order to attain initial
eligibility, an institution has to establish that it has (1) been in good
standing under the Ontario Private Vocational Schools Act for at least 12
months, (2) offers an eligible program for at least 12 months and (3) graduates
at least one class in an eligible program that satisfied specific requirements
with respect to class size and graduation rate. Pursuant to Ontario Ministry
rules, during the first two years of initial eligibility, an institution has
its administration of OSAP independently audited, and full eligibility is not
granted until these audits confirmed that the school is properly administering
OSAP. Our
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International Academy of Design school in Toronto has been granted full
eligibility. Under Ontario Ministry rules, our Toronto school must advise the
Ontario Ministry before the school takes any material action that may result in
its failure or inability to meet any rules, regulations or requirements related
to OSAP.
In order for our International Academy of Design school in Toronto to
establish a new branch, it must obtain OSAP-designation from the Ontario
Ministry. We do not believe that OSAP's requirements will create significant
obstacles to our plans to acquire additional institutions or open new branches
in Ontario.
Our International Academy of Design school in Toronto may submit
applications for loans only to students enrolled in educational programs that
have been designated as OSAP-eligible by the Ontario Ministry. To be eligible,
among other things, a program must be registered with the Private Vocational
Schools Unit of the Ontario Ministry, must be of a minimum length and must lead
to a diploma or certificate. We do not anticipate that these program approval
requirements will create significant problems with respect to our plans to add
new educational programs.
Under Ontario Ministry rules, an institution cannot automatically acquire
OSAP designation through the acquisition of other OSAP-eligible institutions.
When there is a change of ownership, including a change in controlling
interest, in a non-incorporated OSAP-eligible institution, the Ontario Ministry
will require evidence of the institution's continued capacity to properly
administer the program before extending OSAP designation to the new owner. We
do not believe that this offering will be considered a change of ownership for
purposes of OSAP. Given that the Ontario Ministry periodically revises its
regulations and other requirements and changes its interpretations of existing
laws and regulations, we cannot assure you that the Ontario Ministry will agree
with our understanding of each requirement.
Our International Academy of Design school in Toronto is required to audit
its OSAP administration annually and the Ontario Ministry is authorized to
conduct its own audits of our administration of these programs. We have
complied with these requirements on a timely basis. Based on the most recent
annual compliance audits, our International Academy of Design school in Toronto
is in substantial compliance with OSAP requirements and we believe that the
school continues to be in substantial compliance with these requirements.
The Ontario Ministry has the authority to take any measures it deems
necessary to protect the integrity of the administration of OSAP. If the
Ontario Ministry deems a failure to comply to be minor, the Ontario Ministry
will advise us of the deficiency and provide us with an opportunity to remedy
it. If the Ontario Ministry deems the failure to comply to be serious in
nature, the Ontario Ministry has the authority to: (1) condition our continued
OSAP designation upon our meeting specific requirements during a specific time
frame; (2) suspend our OSAP designation; or (3) revoke our OSAP designation.
When the Ontario Ministry determines that any non-compliance in our OSAP
administration is serious, the Ontario Ministry has the authority to contract
with an independent auditor, at our expense, to conduct a full audit in order
to quantify the deficiencies and to require repayment of all loan amounts. In
addition, the Ontario Ministry may impose a penalty up to the amount of the
damages assessed in the independent audit.
Adopting a practice similar to that of the U.S. Department of Education, the
Ontario Ministry now calculates for each school student loan default rates on
the basis of incidences of default and expresses the default rates as a
percentage of the total number of loans issued to students attending that
school. Beginning with loans issued in the 1998-99 award year, August 1, 1998
to July 31, 1999, institutions with a 1997 default rate which is 15 percentage
points or more above the 1997 provincial average of 23.5% will be required to
share the cost of defaults. In the 1999-2000 award year, this policy will also
apply to institutions with a 1997 default rate 10 percentage points or more
above 23.5%. Our International Academy of Design school in Toronto had an
average program-wide total default rate for 1998 of 23.8%.
We may only operate a private vocational school in Ontario if the school is
registered under the Ontario Private Vocational Schools Act. Upon payment of
the prescribed fee and satisfaction of the conditions prescribed by the
regulations under the Ontario Private Vocational Schools Act and by the Private
Vocational
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Schools Unit of the Ontario Ministry, an applicant or registrant such as our
International Academy of Design school in Toronto is entitled to registration
or renewal of registration to conduct or operate a private vocational school
unless:
. the school cannot reasonably be expected to be financially responsible in
the conduct of the private vocational school,
. the past conduct of the officers or directors provides reasonable grounds
for belief that the operations of the school will not be carried on in
accordance with relevant law and with integrity and honesty,
. it can reasonably be expected that the course or courses of study or the
method of training offered by the school will not provide the skill and
knowledge requisite for employment in the vocation or vocations for which
the applicant or registrant is offering instruction, and
. the applicant is carrying on activities that are, or will be, if the
applicant is registered, in contravention of the Ontario Private
Vocational Schools Act or the regulations under that Act.
An applicant for registration to conduct or operate a private vocational
school is required to submit with the application a bond in an amount
determined in accordance with the regulations under the Ontario Private
Vocational Schools Act. Our International Academy of Design school in Toronto
is currently registered under the Ontario Private Vocational Schools Act for
both of its locations, and we do not believe that there will be any impediment
to renewal of such registrations on an annual basis.
The Ontario Private Vocational Schools Act provides that a "registration" is
not transferable. However, the Private Vocational Schools Unit of the Ontario
Ministry takes the position that a purchase of shares of a private vocational
school does not invalidate the school's registration under the Ontario Private
Vocational Schools Act. We do not believe that this offering will invalidate
the registrations of our International Academy of Design school in Toronto.
If our International Academy of Design school in Toronto is convicted of
violating the Ontario Private Vocational Schools Act or the regulations under
that Act, the school can be fined up to $25,000 Canadian dollars.
Quebec. Our Quebec students may receive loans under the Quebec Loans and
Bursaries Program subject to student eligibility criteria. Under an Act
Respecting Private Education, our International Academy of Design school in
Montreal may not operate as a private educational institution without holding a
permit issued by the Quebec Minister of Education. Permits cannot be
transferred without the written authorization of the Quebec Minister and we
must notify that Minister of any amalgamation, sale or transfer affecting our
Quebec school. The Quebec Minister can modify or revoke our permit in certain
circumstances, such as if we do not comply with the conditions, restrictions or
prohibitions of the permit or if we are to become insolvent. We must be
provided with a chance to present our views before our permit can be revoked.
We do not believe that this offering will be considered a "sale or transfer"
affecting our International Academy of Design school in Montreal, for the
purposes of applicable law; however, because the Quebec Minister periodically
revises its legal requirements and changes its interpretation of existing law,
we cannot assure you that the Quebec Minister will agree with our understanding
of each requirement. We also do not believe that there will be any impediment
to renewal of the permit issued to our International Academy of Design school
in Montreal or that the Quebec Minister's requirements will create significant
obstacles to our plans to open new branches or add new educational programs at
our International Academy of Design school in Montreal, or to acquire
additional schools in Quebec.
The Canadian, Ontario and Quebec governments are currently in the process of
changing the legislative, regulatory and other requirements relating to student
financial assistance programs due to political and budgetary pressures.
Although we do not anticipate a significant reduction in the funding for these
programs, any change that significantly reduces funding or the ability of our
schools to participate in these programs could have a material adverse effect
on our business, results of operations or financial condition.
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MANAGEMENT
Directors and Executive Officers
The following table sets forth certain information with respect to our
executive officers and directors:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
John M. Larson.......... 47 President, Chief Executive Officer, Secretary and Director
William A. Klettke...... 46 Senior Vice President, Chief Financial Officer and Treasurer
Robert E. Dowdell....... 53 Director
Thomas B. Lally......... 54 Director
Wallace O. Laub......... 74 Director
Keith K. Ogata.......... 44 Director
Patrick K. Pesch........ 42 Director
</TABLE>
John M. Larson has served as our President and Chief Executive Officer and
one of our Directors since January 1994. From July 1993 until our formation,
Mr. Larson served as a consultant to Heller Equity Capital Corporation
("Heller"), working with Heller to establish CEC. From January through May
1993, Mr. Larson served as the Eastern Regional Operating Manager of
Educational Medical, Inc., which provides career-oriented postsecondary
education. From 1989 until 1993, Mr. Larson served as the Senior Vice President
of College Operations of Phillips Colleges, Inc., overseeing a nationwide
system of 58 schools, which offered a wide range of academic programs. From
March through September 1989, he served as Senior Vice President of Operations
for the Geneva Companies, a mergers and acquisitions firm. From 1980 to 1989,
Mr. Larson was Vice President of Marketing at National Education Centers, Inc.,
a subsidiary of National Education Corporation, where he managed the entire
admissions program, including marketing and advertising efforts, with a team of
approximately 500 employees. Mr. Larson has also served in marketing positions
with DeVry Inc., at its Chicago and Kansas City campuses. Mr. Larson received a
Bachelor's of Science in Business Administration from the University of
California at Berkeley and has completed the Executive Management Program at
Stanford University.
William A. Klettke has served as our Senior Vice President and Chief
Financial Officer since March 1996. From 1987 until 1995, Mr. Klettke was
Executive Vice President and Chief Financial Officer for ERO, Inc., a licensed
distributor of children's toys. In these positions, Mr. Klettke was responsible
for finance, accounting, management information systems, human resources,
forecasting, treasury, legal, acquisitions and two operating subsidiaries. From
1976 to 1987, Mr. Klettke served in various positions with The Enterprise
Companies, a paint and coatings manufacturer, and a subsidiary of Insilco,
starting as an accountant and progressing to Senior Vice President of Finance
and Administration. Mr. Klettke is a Certified Public Accountant and holds
Bachelor's of Arts degrees in Psychology and Sociology from Baker University, a
Bachelor's of Science in Accounting from Illinois State University and a
Master's Degree in Management from Northwestern University. Mr. Klettke is also
the President and a Director of the Career Education Scholarship Fund, a not-
for-profit corporation.
Robert E. Dowdell has been one of our Directors since our inception in
January 1994. From 1989 to present, Dowdell has served as Chief Executive
Officer and director of Marshall & Swift, L.P., a publishing company. Mr.
Dowdell is also a director of ADMS, a software provider and LaQuinta Spring,
L.P., in which he is the general partner.
Thomas B. Lally has been one of our Directors since January 28, 1998. Mr.
Lally was designated to be a director by Heller. He has been the President of
Heller since 1996 and an Executive Vice President of Heller Financial, Inc.
("HFI"), the parent of Heller, since 1994, with direct responsibility for the
asset quality oversight of HFI's portfolio of loan and equity investments. Mr.
Lally joined HFI in 1974.
Wallace O. Laub has been one of our Directors since October 1994. Mr. Laub
was a co-founder of National Education Corporation, Inc., where he served as
Executive Vice President and director from 1955 to 1993. From 1981 to 1990, Mr.
Laub served as a director of the Distance Education Training Council, a trade
association and accrediting agency for distance education companies. Mr. Laub
is now retired.
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Keith K. Ogata has been one of our Directors since January 28, 1998. Mr.
Ogata is currently president of, and a private investor in, 3-K Financial
Corporation. From 1995 to 1997, Mr. Ogata served as President of National
Education Centers, Inc., a subsidiary of National Education Corporation. From
1991 to June 1997, he served as Vice President, Chief Financial Officer and
Treasurer of National Education Corporation, with responsibility for finance,
accounting, treasury, tax, mergers and acquisitions, human resources, investor
and public relations and information systems.
Patrick K. Pesch has been one of our Directors since 1995. Mr. Pesch was
designated as director by Heller. Since 1992, Mr. Pesch has served as a Senior
Vice President of HFI, and also as an officer of Heller, managing a portfolio
of loan and equity investments, as well as serving as a credit officer of one
of HFI's principle business units. Mr. Pesch also serves as a director of
Kimpex, Inc., a Canadian company and as an officer and director of Amersig
Graphics, Inc.
None of our executive officers or directors are related to one another.
Certain Other Significant Employees of the Company
The following table sets forth information with respect to some of our other
significant employees:
<TABLE>
<CAPTION>
Name Position
- ---- --------
<S> <C>
J. Patrick Andrews............... Director of Advertising
Jon R. Coover.................... National Director of Marketing
Mari-Ann Deering................. Director of Human Resources
Nick Fluge....................... Managing Director
John Fraccaro.................... Director of Information Technology
Jacob P. Gruver.................. Managing Director
Patricia Kapper.................. Director of Education
James R. McEllhiney.............. Director of Regulatory Compliance
Carol A. Menck................... Managing Director
Robert W. Nachtsheim............. Controller
Steve B. Sotraidis............... Managing Director
Todd H. Steele................... Director of Strategic Planning and Development
Mark J. Tobin.................... Director of Student Finance
</TABLE>
J. Patrick Andrews has served as our Director of Advertising since October
1995. From 1994 until he joined our corporate management, Mr. Andrews was
Advertising Manager for two of our schools, Collins and Brooks. For
approximately 12 years prior to joining us, Mr. Andrews managed the advertising
and marketing functions for Spartan, a 2,800 student school in Tulsa, Oklahoma.
Mr. Andrews holds a Bachelor's of Arts in Journalism from the University of
South Carolina and a Masters in Marketing from the University of Texas.
Dr. Jon R. Coover has served as our National Director of Marketing since May
1997, after serving for 14 months as Director of Education at our largest
school, Brown. Dr. Coover's background in private career education includes
holding positions as Vice President of Marketing for the Rasmussen Business
Colleges, Minneapolis, Minnesota; Vice President of Operations at Virginia
College, Birmingham, Alabama; President of Dominion College, Roanoke, Virginia;
President of Nettle Junior College, Sioux Falls, South Dakota; Co-Director of
New York Restaurant School in New York City; and Regional Director with DeVry
Institute of Technology. Dr. Coover holds a Bachelor's of Science in Business
Administration and an M.B.A. from California Western University and a Ph.D. in
Business from California Coast University.
Mari-Ann Deering has served as our Director of Human Resources since July
1998. Ms. Deering joined our corporate management with 19 years of human
resources experience in the veterinary pharmaceutical industry. Ms. Deering
served as the Director of Human Resources--North America for Fort Dodge Animal
Health, Overland Park, Kansas, a division of American Home Products, from 1997
until 1998. She was Vice
54
<PAGE>
President of Human Resources and Administration of Southwest Technologies, a
medical device company, from 1996 until 1997. Her prior experience also
includes 16 years in human resource management with Sanofi Animal Health from
1979 until 1995 where her final position was Vice President of Human Resources.
Ms. Deering holds a Bachelor's of Science degree in Business Administration
from AVILA College, Kansas City, Missouri and an M.B.A. from Rockhurst College,
Kansas City, Missouri.
Nick Fluge has served as one of our Managing Directors since July 1997. Mr.
Fluge has served as Director and President of Western since 1989. From 1984
until 1988, Mr. Fluge was Director of Retail/Restaurants and a member of the
management team of Western. With over 20 years of experience in the
hospitality/foodservice industry and as a Certified Culinary Educator with the
American Culinary Federation, Mr. Fluge has chaired American Culinary
Federation Food Salons, judged wine competitions and written columns for
various periodicals, including The National Culinary Review. Mr. Fluge has been
a Team Leader for the Accrediting Commission of Career Schools and Colleges of
Technology (ACCSCT) since 1992. Mr. Fluge is a member of the Oregon Department
of Education--Career College Division. Mr. Fluge holds a Bachelor's of Science
degree in Political Science from Portland State University.
John Fraccaro has served as our Director of Information Technology since
March 1998. Mr. Fraccaro has held Consulting and Principal Consulting positions
with New Resources Corporation from 1997 until 1998 and with Coopers & Lybrand
L.L.C. from 1993 until 1996. Mr. Fraccaro was a Director of Information
Technology for Sara Lee Hosiery from 1996 until 1997 and Manager of Database
Development and Support for Kraft General Food from 1990 until 1993. Mr.
Fraccaro has held several positions with software vendors including
ComputerVision, Ingres and CompuGraphic. Mr. Fraccaro holds a Bachelor's of
Science in Education from Northern Illinois University.
Jacob P. Gruver has served as one of our Managing Directors since May 1997.
From August 1994 to May 1997, Mr. Gruver served as our Director of Finance.
From 1989 until joining our management team, Mr. Gruver was Vice President and
Controller of Wyoming Technical Institute in Laramie, Wyoming, a moderately
sized career-oriented school. In such positions, he managed all financial
functions, including budgeting and implementation of management
information/financial systems. From 1978 to 1989, Mr. Gruver audited career-
oriented schools and other clients at a regional public accounting firm in
Laramie, Wyoming. Mr. Gruver received a Bachelor's of Science in Accounting
from National College.
Patricia Kapper, Ed.D, has served as our Director of Education since August
1997. From 1990 until joining our management team, Dr. Kapper was Dean of
Academic Affairs (Chief Academic Officer) of DeVry Institute of Technology,
Addison, Illinois. From 1986 until 1990, Dr. Kapper held academic management
positions with Milwaukee Area Technical College, from 1984 to 1986 as Associate
Dean of Business and Graphic and Applied Arts and from 1986 to 1990 as Dean of
Business and Graphic Arts. Dr. Kapper holds a Bachelor's of Arts in Business
Education from the University of Wisconsin--Eau Claire, a Master's of Science
in Teaching from the University of Wisconsin--Whitewater, and a doctorate in
Adult Education from Northern Illinois University.
James R. McEllhiney has served as our Director of Regulatory Compliance
since August 1997. Mr. McEllhiney served as our Director of Education from
August 1994 until August 1997. Prior to joining our corporate management in
August 1994, Mr. McEllhiney was the Vice President of Academic Affairs for
Phillips Colleges, Inc. In this position, Mr. McEllhiney managed regulatory
compliance, including processing change of ownership applications for over 60
acquisitions, and oversaw corporate educational administration for this group
of 92 schools. From 1975 to 1988, Mr. McEllhiney managed regulatory compliance
and served as Chief Academic Officer for MetriData Computing, a 40 unit career-
oriented school company. Prior to joining MetriData, Mr. McEllhiney was an
instructor and Academic Dean at Northwood Institute. Mr. McEllhiney holds a
Bachelor's of Science in Education and a Master's of Science in Psychology from
Indiana State University.
55
<PAGE>
Carol A. Menck has served as one of our Managing Directors since January
1999. From 1997 to 1999, Ms. Menck served as the President of The School of
Computer Technology--Pittsburgh with oversight responsibility over the campus
in Fairmont. From 1993 until joining us, Ms. Menck was Director of an ITT
Technical Institute. From 1991 until 1993, she served as Director of Phillips
Junior College--Spokane, Washington. From 1987 to 1991 she served as President
of Bradford School--Portland, Oregon. From 1976 until 1987, she held various
positions at Trend Colleges--Vancouver, Washington. Her final position at Trend
was Operations Manager. Ms. Menck received a Bachelor's of Arts in Political
Science from Gonzaga University in Spokane, Washington and a Juris Doctorate
from Gonzaga Law School in Spokane, Washington.
Robert W. Nachtsheim has served as our Controller since December 1995. Mr.
Nachtsheim joined our corporate management with 19 years of accounting and
financial analysis experience in multiple industries. From 1993 until 1995, Mr.
Nachtsheim served as Controller for Century 21 North Central, Inc., overseeing
the financial performance of 600 midwestern Century 21 franchises. His prior
experience includes six years as the Director of Financial Analysis and
Reporting for Newark Electronics, a nationwide electronics distributor, and 11
years with Amoco Corporation in various accounting positions. Mr. Nachtsheim
holds a Bachelor's of Science in Accountancy from the University of Missouri
and an M.B.A. in Finance from DePaul University.
Steve B. Sotraidis has served as one of our Managing Directors since July 1,
1997. Mr. Sotraidis joined our administrative management team in June 1994. Mr.
Sotraidis joined Brooks College in 1970 and has managed Brooks' overall
operations since 1975. Mr. Sotraidis holds a Bachelor's of Science in
Psychology and completed two years of graduate work in Industrial Psychology at
California State University at Long Beach.
Todd H. Steele has served as our Director of Strategic Planning and
Development since March 1998. Mr. Steele served as a director from our
inception in January 1994 until March 1998. From December 1996 until joining
our management team, he served as a Vice President of Baker, Fentress & Co., an
investment company, making equity investments in private companies. From May
1990 to November 1996, he served as a Vice President of HFI and Heller, also
making equity investments in private companies. Mr. Steele holds a Bachelor's
of Arts in Economics from Northwestern University and an M.B.A. in finance from
the University of Chicago.
Mark J. Tobin has served as our Director of Student Finance since March
1996. Mr. Tobin joined DeVry, Inc., in 1984 and, from 1989 until joining our
corporate management, Mr. Tobin was Director of Student Finance for DeVry, Inc.
In that position, Mr. Tobin was responsible for student finance policy
development, technical and operations assistance and performance monitoring for
the DeVry Institutes of Technology and the Keller Graduate School of
Management. From 1984 to 1989, Mr. Tobin held corporate financial aid
management positions at DeVry, Inc. Prior to his tenure at DeVry, Inc. from
1984 until 1996, Mr. Tobin was Director of Financial Aid at Carthage College
from 1978 until 1984 and Marian College from 1973 until 1978. Mr. Tobin holds a
Bachelor's of Arts in Psychology from Northeastern Illinois State College and a
Master's of Education degree in Student Personnel Work in Higher Education from
Loyola University of Chicago.
Board of Directors
Our board of directors is divided into three classes with staggered three-
year terms. The terms of Messrs. Dowdell and Pesch expire at the annual meeting
of our stockholders in 1999, the terms of Messrs. Laub and Ogata expire at the
annual meeting of our stockholders in 2000, and the terms of Messrs. Lally and
Larson expire at the annual meeting of our stockholders in 2001. At each annual
meeting of our stockholders, the successors to the directors whose terms expire
will be elected for a three-year term.
Arrangements for Nomination as Director
We have entered into an agreement with Heller pursuant to which Heller is
entitled to designate individuals for nomination to our board of directors.
Heller is entitled to designate two directors as long as it owns at least 25%
of our capital stock. The number of directors that Heller is entitled to
designate will be reduced to one when Heller no longer owns 25% of our capital
stock, and the agreement terminates when
56
<PAGE>
Heller no longer owns at least 10% of our capital stock. This agreement
provides that we will cause these Heller designees to be nominated and solicit
proxies from our stockholders to vote in favor of them, and will appoint the
Heller designees to the Compensation and Audit Committees of the board. Messrs.
Pesch and Lally are the current designees of Heller. After this offering,
Heller will own approximately 21.0% of our common stock. Accordingly, Heller
will not be entitled to designate its second nominee, Mr. Pesch, to the board
at our 1999 Annual Meeting of Stockholders. However, the board of directors has
nominated Mr. Pesch for re-election to the board.
Committees of the Board of Directors
The board of directors has established an Audit Committee and a Compensation
Committee. Both the Audit Committee and the Compensation Committee are
currently composed entirely of directors who are not our officers or employees.
The Audit Committee generally has responsibility for recommending
independent auditors to the board of directors for selection, reviewing the
plan and scope of the annual audit, reviewing our audit and control functions
and reporting to the full board of directors regarding all of the foregoing.
The members of the Audit Committee are Messrs. Dowdell, Lally, Ogata and Pesch.
The Compensation Committee generally has responsibility for recommending to
the board guidelines and standards relating to the determination of executive
compensation, reviewing our executive compensation policies and reporting to
the board of directors regarding the foregoing. The Compensation Committee also
has responsibility for administering our incentive compensation plans,
determining the number of options to be granted to our executive officers
pursuant to such plans and reporting to the board of directors regarding the
foregoing. The members of the Compensation Committee are Messrs. Lally, Laub
and Pesch.
Compensation of Directors
All directors who are not employees are paid an annual fee of $6,000 and are
paid $1,000 for each board meeting attended and $500 for each board committee
meeting attended. Non-employee directors are also reimbursed for their
reasonable out-of-pocket expenses incurred in attending board and committee
meetings. In addition, the Career Education Corporation 1998 Non-Employee
Directors' Stock Option Plan provides for annual option grants to each director
who is not an employee. For a more detailed description of our stock plans,
please see "--Stock Plans--Career Education Corporation 1998 Non-Employee
Directors' Stock Option Plan."
Compensation Committee Interlocks and Insider Participation
Thomas B. Lally, Wallace O. Laub, Patrick K. Pesch and Scott D. Steele, who
resigned as a director on January 23, 1998, served as the members of the
Compensation Committee during 1998. Scott Steele resigned due to time
constraints imposed by his work for Electra Fleming, Inc., of which Mr. Steele
serves as a principal, and because of a general policy of Electra Fleming
against its principals serving on the boards of publicly-held corporations in
which Electra Fleming or any of its affiliates has an equity interest.
We entered into a Registration Rights Agreement with Heller, dated as of
February 3, 1998. Under this agreement, Heller is entitled, subject to certain
exceptions, to demand that we register shares of common stock held by Heller on
up to three occasions and to cause us to register such shares in any
registration by us for our own account or for the account of other security
holders.
Executive Compensation
The following table sets forth information with respect to all compensation
paid by us for services rendered during the fiscal years ended December 31,
1997 and 1998, to our Chief Executive Officer and our other executive officer
(each, a "Named Executive Officer").
57
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Long Term
Compensation Compensation
------------------ ------------
Securities
Underlying All Other
Name and Principal Positions Year Salary($) Bonus($) Options(#) Compensation
---------------------------- ---- --------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C>
John M. Larson,
President and Chief
Executive Officer.......... 1998 $308,333 $201,810 180,000(1) $ 7,659(2)
1997 $229,167 $143,000 21,105 $17,018(3)
William A. Klettke,
Senior Vice President and
Chief Financial Officer..... 1998 $169,167 $ 73,815 45,000 $ 6,491(4)
1997 $152,500 $ 47,580 9,844 $ 6,771(5)
</TABLE>
- --------
(1) On February 8, 1999, 80,000 of these options were cancelled and then
reissued. The exercise price and vesting terms were not changed.
(2) Includes $6,000 in 401(k) matching contributions by us and $1,659 in term
life insurance premium payments by us.
(3) Includes $8,594 in 401(k) matching contributions by us and $8,424 in term
life insurance premium payments by us.
(4) Includes $6,400 in 401(k) matching contributions by us and $91 in term life
insurance premium payments by us.
(5) Includes $6,100 in 401(k) matching contributions by us and $671 in term
life insurance premium payments by us.
OPTION GRANTS IN 1998
The following table contains information concerning the grant of stock
options by us to our Named Executive Officers during 1998.
<TABLE>
<CAPTION>
Percentage
Number of of Total Potential Realizable Value
Shares Options at Assumed Annual Rates of
Underlying Granted to Stock Price Appreciation
Options Employees Exercise or for Option Term (2)
Granted in Fiscal Base Price Expiration ---------------------------
Name (#) (1) Year ($/Sh) Date 5% ($) 10% ($)
---- ---------- ---------- ----------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
John M. Larson.......... 60,000 10.2% $16.00 1/28/2008 $ 603,739 $ 1,529,993
120,000(3) 20.3% $26.25 7/28/2008 $ 1,981,018 $ 5,020,289
William A. Klettke...... 15,000 2.5% $16.00 1/28/2008 $ 150,935 $ 382,498
30,000 5.1% $26.25 7/28/2008 $ 495,255 $ 1,255,072
</TABLE>
- --------
(1) These options were granted under the Career Education Corporation 1998
Employee Incentive Compensation Plan. Each of these options is a non-
qualified stock option and vests in five equal annual installments on each
of the first five anniversaries of the date grant.
(2) Potential realizable value is presented net of the option exercise price,
but before any federal or state income taxes associated with exercise, and
is calculated assuming that the fair market value on the date of the grant
appreciates at the indicated annual rates, compounded annually, for the
term of the option. The 5% and 10% assumed rates of appreciation are
mandated by the rules of the Securities and Exchange Commission and do not
represent our estimate or projection of future increases in the price of
our common stock. Actual gains are dependent on the future performance of
our common stock and the option holder's continued employment throughout
the vesting periods. The amounts reflected in the table may not necessarily
be achieved.
(3) On February 8, 1999, 80,000 of these options were cancelled and then
reissued. The exercise price and vesting terms were not changed.
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<PAGE>
FISCAL YEAR-END OPTION VALUES
The following table contains information regarding the Named Executive
Officers' unexercised options as of December 31, 1998. Neither of the Named
Executive Officers exercised any options during 1998.
<TABLE>
<CAPTION>
Number of Shares
Underlying
Unexercised Options Value of Unexercised in-the-Money
as of December 31, Options as of December 31,
1998(#) 1998($)(1)
------------------------- ---------------------------------
Name Exercisable/Unexercisable Exercisable/Unexercisable
---- ------------------------- ---------------------------------
<S> <C> <C>
John M. Larson..... 131,878/185,840 $3,689,796/$1,465,142
William A. Klettke. 19,104/51,774 $466,923/$426,074
</TABLE>
- --------
(1) The value per option is calculated by subtracting the exercise price of the
option from the closing price of our common stock of $30.00 per share on
December 31, 1998.
Employment Agreement
We have entered into an Employment and Non-Competition Agreement with Mr.
Larson, dated as of October 9, 1997, which has an initial term ending July 31,
2000. This agreement is subject to successive, automatic employer extensions if
we give written notice at least 90 days prior to the expiration date. The
agreement provides for an initial base salary of $250,000 plus bonus
compensation established by our board of directors. Effective July 29, 1998,
Mr. Larson's base salary was increased to $350,000 per annum. The agreement
provides for continuation of salary, bonus and benefits for one year following
Mr. Larson's termination of employment with us, other than termination by us
for "Cause" or termination by Mr. Larson without "Good Reason". Cause is
defined under the agreement to include indictment or conviction of Mr. Larson
on any felony criminal charges, willful misconduct or malfeasance in the
performance of Mr. Larson's duties, and a material breach by Mr. Larson of the
terms of the agreement. Good Reason includes a material breach by us of the
terms of the agreement, a material change by us in Mr. Larson's duties or
responsibilities and a change of control of us. The agreement also prohibits
Mr. Larson from disclosing confidential information and prohibits him from
engaging in activities competitive with us for a period which includes the term
of his employment with us or service as one of our directors and continues for
two years thereafter. However, if Mr. Larson's employment with us is terminated
by us without "Cause" or by Mr. Larson for "Good Reason," the non-competition
period will expire on the later of the termination of Mr. Larson's service as a
director with us or six months after the termination of his employment. In such
case, we may extend the non-competition period up to an additional 18 months if
we pay Mr. Larson's base salary, a portion of his bonus and benefits during
this additional period. If the term of the agreement expires and we refuse its
renewal or Mr. Larson refuses its renewal for Good Reason, the non-competition
period will expire on the later of the termination of Mr. Larson's employment
or the termination of his service as a director. In such case, we may extend
the non-competition period for up to an additional two years if we pay Mr.
Larson's base salary, a portion of his bonus and benefits during this
additional period.
Stock Plans
Career Education Corporation 1995 Stock Option Plan
Effective August 1, 1995, our board of directors adopted the Career
Education Corporation 1995 Stock Option Plan, pursuant to which options to
acquire shares of common stock may be granted to employees, advisors,
consultants and non-employee directors as may be determined by the option
committee of the board of directors. As of December 31, 1998, options to
acquire 145,022 shares of common stock were outstanding under the 1995 Stock
Option Plan, and an additional 12,990 shares of common stock were reserved for
issuance under the 1995 Stock Option Plan. The compensation committee of the
board of directors serves as the option committee and administers the 1995
Stock Option Plan and determines with respect to each grant the number of
shares subject to the option, the exercise price, the period of the option and
the time at which the option may be exercised, as well as any terms and
conditions of the option amount. Exercise prices may not be less than the fair
market value of our common stock as determined by the option committee as of
the date of issuance of each stock option. Options may be granted as either (1)
incentive stock options, as defined in the
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<PAGE>
Internal Revenue Code, for which the option price must be at least 100% of the
fair market value of the shares subject to the option on the grant date, or
110% in the case of an option granted to a person holding more than 10% of the
voting power of all classes of our stock, and which are not exercisable after
ten years from the grant date or five years in the event of an option granted
to a 10% holder, or (2) non-qualified stock options, which are not subject to
such restrictions.
Career Education Corporation 1998 Employee Incentive Compensation Plan
Our board of directors has adopted, and our stockholders have approved, the
Career Education Corporation 1998 Employee Incentive Compensation Plan. The
1998 Employee Plan is a flexible plan that provides the compensation committee
of the board of directors broad discretion to fashion the terms of the awards
to provide eligible participants with stock-based and performance-related
incentives as the compensation committee deems appropriate. The 1998 Employee
Plan permits the issuance of awards in a variety of forms, including: (1)
nonqualified and incentive stock options for the purchase of common stock, (2)
stock appreciation rights, (3) restricted stock, (4) deferred stock, (5) bonus
stock and awards in lieu of obligations, (6) dividend equivalents, (7) other
stock-based awards and (8) performance awards and cash incentive awards.
Options granted will provide for the purchase of common stock at prices
determined by the compensation committee.
The persons eligible to participate in the 1998 Employee Plan are officers,
employees and consultants of us or any of our subsidiaries who, in the opinion
of the compensation committee, contribute to the growth and success. The
purpose of the 1998 Employee Plan is to promote our overall financial
objectives by motivating eligible participants to achieve long-term growth in
stockholder equity and to retain the association of these individuals. The 1998
Employee Plan is administered by the compensation committee.
The 1998 Employee Plan provides for the award of up to 600,000 shares of
common stock. At the discretion of the compensation committee, shares of common
stock subject to an award under the 1998 Employee Plan that remain unissued
upon termination of such award, are forfeited or are received by us as
consideration for the exercise or payment of an award may be reissued under the
1998 Employee Plan. On February 17, 1999, our board of directors authorized
that the total number of shares available under the 1998 Employee Plan be
increased from 600,000 to 1,350,000 and that the total number of shares which
may be granted to any participant under the 1998 Employee Plan in any fiscal
year be increased from 100,000 to 250,000. In the event of a stock dividend,
stock split, recapitalization, sale of substantially all of our assets,
reorganization or other similar event, the compensation committee will adjust
the aggregate number of shares of common stock subject to the 1998 Employee
Plan and the number, class and price of shares subject to outstanding awards.
Career Education Corporation 1998 Non-Employee Directors' Stock Option Plan
Our board of directors has adopted, and our stockholders have approved, the
Career Education Corporation 1998 Non-Employee Directors' Stock Option Plan.
The 1998 Directors' Plan grants nonqualified stock options for the purchase of
common stock to directors who are not our employees.
The purpose of the 1998 Directors' Plan is to promote our overall financial
objectives by motivating directors to achieve long-term growth in our
stockholder equity, to further align the interest of such directors with those
of our stockholders and to retain the association of these directors. The 1998
Directors' Plan is administered by the compensation committee.
The 1998 Directors' Plan provides for the award of up to 200,000 shares of
common stock. The 1998 Directors' Plan provides for (1) the grant of an option
to purchase 8,000 shares of common stock to each participant who is a non-
employee director on January 28, 1998 or, if after such date, the date such
individual is first elected or appointed as a non-employee director and (2) a
grant of an option to purchase 3,000 shares of common stock on the date of each
regular annual stockholder meeting after the effective date of the 1998
Directors' Plan to each participant who is a non-employee director upon such
date and either is continuing as a non-employee director subsequent to the
meeting or who is elected at such meeting to serve as a non-employee
60
<PAGE>
director, other than a meeting in the year of such participant's initial
election or appointment. Options granted under the 1998 Directors' Plan provide
for the purchase of common stock at the fair market value on the date of grant
and become exercisable in three equal annual installments, commencing on the
date of grant. No stock option granted under the 1998 Directors' Plan may be
exercisable later than the tenth anniversary date of its grant.
Career Education Corporation 1998 Employee Stock Purchase Plan
Our board of directors has adopted, and our stockholders have approved, the
Career Education Corporation 1998 Employee Stock Purchase Plan, effective as of
April 1, 1998. A total of 500,000 shares of common stock have been reserved for
issuance under the 1998 Stock Purchase Plan. The Stock Purchase Plan permits
our eligible employees to purchase common stock through payroll deductions with
all such deductions credited to an account under the Stock Purchase Plan.
The 1998 Stock Purchase Plan operates on a calendar year basis. To be
eligible to participate in the Stock Purchase Plan, an employee must file all
requisite forms prior to a specified due date known as a "grant date."
Initially, the first day of each calendar quarter of each year will be a grant
date and the last day of each calendar quarter of each year will be an exercise
date. However, the determination of the grant dates and the exercise dates are
completely within the discretion of the compensation committee of the board of
directors. On each exercise date, participants' payroll deductions credited to
their accounts will be automatically applied to the purchase price of common
stock at a price per share equal to 85% of the fair market value of our common
stock on the exercise date. Employees may end their participation in the Stock
Purchase Plan at any time during an offering period, and their payroll
deductions to date will be refunded. Participation ends automatically upon
termination of employment. Payroll deductions may not exceed $5,000 for any
employee in any purchase period. No more than 25,000 shares in the aggregate
may be issued to all participants in any purchase period.
Employees are eligible to participate in the 1998 Stock Purchase Plan if
they are customarily employed by us or a designated subsidiary. No person will
be able to purchase common stock under the 1998 Stock Purchase Plan if such
person, immediately after the purchase, would own stock possessing 5% or more
of the total combined voting power or value of all outstanding shares of all
classes of our stock.
Limitation of Liability and Indemnification Matters
Our Certificate of Incorporation contains provision which eliminate the
personal liability of our directors to us or our stockholders for monetary
damages for breach of their fiduciary duty as a director to the fullest extent
permitted by the Delaware General Corporation Law except for liability (1) for
any breach of their duty of loyalty to us or our stockholders, (2) for acts or
omissions not in good faith or which involve intentional misconduct or a
knowing violation of law, (3) for unlawful payments of dividends or unlawful
stock repurchases or redemptions, or (4) for any transaction from which the
director derived an improper personal benefit. These provisions will not affect
a director's responsibilities under any other laws, such as the federal
securities laws or state or federal environmental laws.
Our Certificate of Incorporation also contains provisions which require us
to indemnify our directors, and permit us to indemnify our officers and
employees, to the fullest extent permitted by Delaware law, including those
circumstances in which indemnification would otherwise be discretionary, except
that we are not obligated to indemnify any such person (1) with respect to
proceedings, claims or actions initiated or brought voluntarily by any such
person and not by way of defense, or (2) for any amounts paid in settlement of
an action indemnified against by us without our prior written consent. We have
obtained directors' and officers' liability insurance and has entered into
indemnity agreements with each of our directors providing for the
indemnification described above.
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<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth information regarding the beneficial
ownership of our common stock as of March 12, 1999 and as adjusted to reflect
the sale of the shares of common stock being offered hereby by: (1) each
person, or group of affiliated persons, known by us to beneficially own more
than 5% of the outstanding shares of common stock, (2) each of our directors,
(3) each of our Named Executive Officers, (4) each of the selling stockholders
and (5) all of our directors and executive officers as a group. Unless
otherwise indicated below, the persons in the table have sole voting and
investment power with respect to all shares shown as beneficially owned by
them.
<TABLE>
<CAPTION>
Shares of Common Number of
Stock Beneficially Shares of Shares of Common Stock
Owned Prior to the Common Stock Beneficially Owned After
Offering (1) Being Offered the Offering (1)
------------------------------------- ---------------------------
Number Percent Number Number Percent
----------- ---------------------- -------------- ------------
<S> <C> <C> <C> <C> <C>
Heller Equity Capital
Corporation (2)........ 2,549,944 35.3 987,937 1,562,007 20.8
Electra Investment Trust
P.L.C. and Electra
Associates, Inc. (3)... 962,511 13.3 710,000 252,511 3.4
Baron Capital Group,
Inc. (4)............... 560,000 7.8 -- 560,000 7.5
BankAmerica Corporation
(5).................... 381,000 5.3 -- 381,000 5.1
John M. Larson.......... 165,350(6) 2.2 30,000 135,350 1.8
William A. Klettke (7).. 52,621 * -- 52,621 *
Robert E. Dowdell (8)... 101,441 1.4 -- 101,441 1.3
Thomas B. Lally (9)..... 6,333 * -- 6,333 *
Wallace O. Laub (10).... 32,151 * -- 32,151 *
Keith K. Ogata (9)...... 30,333 * -- 30,333 *
Patrick K. Pesch (11)... 10,133 * -- 10,133 *
Mark A. Bounds.......... 16,063 * 6,000 10,063 *
John M. Goense (12)..... 45,179 * 10,000 35,179 *
John H. Underwood (13).. 16,063 * 6,063 10,000 *
All directors and
executive officers as a
group
(7 persons)............ 398,362 5.4 30,000 368,362 4.8
</TABLE>
- --------
* Less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. The number of shares beneficially owned
by a person and the percentage ownership of that person includes shares of
common stock subject to options held by that person that are currently
exercisable or exercisable within 60 days of March 12, 1999 (including
options that will become exercisable upon consummation of the offering).
(2) As reported on a Schedule 13D/A filed with the Securities and Exchange
Commission on February 1, 1999 jointly by The Fuji Bank, Limited, Fuji
America Holdings, Inc., Heller Financial, Inc. and Heller Equity Capital
Corporation ("HECC"). According to the Schedule 13D/A, HECC has sole voting
and sole dispositive power with respect to 2,549,944 shares of common
stock. The address of HECC is 500 West Monroe Street, Chicago, Illinois
60661.
(3) As reported on a Schedule 13G filed with the Securities and Exchange
Commission on February 16, 1999 jointly by Electra Investment Trust P.L.C.
("EIT") and Electra Associates, Inc. ("EAI"). According to the Schedule
13G, EIT has sole voting and sole dispositive power with respect to 887,305
shares of
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<PAGE>
common stock and EAI is (a) the nominee for certain foreign investors
represented by Selectra Investment and Management Ltd. ("Selectra") and (b)
the owner of record of 75,206 shares of common stock owned by such foreign
investors. EAI votes and will dispose of such shares in accordance with
Selectra's instructions. EIT and EAI are affiliated entities, and their
address is c/o Electra Investment Trust P.L.C., 65 Kingsway, London, England
WC2B 6QT.
(4) As reported on a Schedule 13G filed with the Securities and Exchange
Commission on January 22, 1999 jointly by Baron Capital Group, Inc., BAMCO,
Inc., Baron Small Cap Fund and Ronald Baron (collectively, the "Baron
Entities"). According to the Schedule 13G, each of the Baron Entities have
shared voting and shared dispositive power with respect to 560,000 shares of
common stock. The address of each of the Baron Entities is (or, in the case
of Ronald Baron, is c/o) 767 Fifth Avenue, New York, NY 10153.
(5) As reported on a Schedule 13G filed with the Securities and Exchange
Commission on January 28, 1999 jointly by BankAmerica Corporation ("BAC"),
Bank of America NT&SA ("B of A"), NB Holdings Corp. ("NBHC"), NationsBank
NA ("NB"), NationsBanc Advisors Inc. ("NBAI") and TradeStreet Investment
Associates ("TSIA"). According to the Schedule 13G, BAC has shared voting
and shared dispositive power with respect to 381,100 shares of common
stock, B of A has sole voting and sole dispositive power with respect to
13,200 shares of common stock, NBHC has shared voting and shared
dispositive power with respect to 367,900 shares of common stock, NB has
sole voting and sole dispositive power with respect to 50,300 shares of
common stock and shared voting and shared dispositive power with respect to
317,600 shares of common stock, NBAI has shared voting and shared
dispositive power with respect to 220,000 shares of common stock and TSIA
has sole voting and sole dispositive power with respect to 317,600 shares
of common stock. The address of BAC, NBHC, NBAI and TSIA is 100 North Tryon
Street, Charlotte, NC 28255. The address of NB is 110 South Tryon Street,
Charlotte, NC 28255. The address of B of A is 555 California Street, San
Francisco, CA 94104.
(6) Includes 149,718 shares of common stock which may be acquired by Mr. Larson
upon the exercise of stock options which are currently exercisable or
exercisable within sixty (60) days of March 12, 1999. Mr. Larson has also
agreed to offer up to 20,000 additional shares in the over-allotment
option.
(7) Includes 22,104 shares of common stock which may be acquired by Mr. Klettke
upon the exercise of stock options which are currently exercisable or
exercisable within sixty (60) days of March 12, 1999.
(8) Includes 2,834 shares of common stock held by Mr. Dowdell, as Custodian for
Brian M. Dowdell under the Uniform Transfers to Minors Act; 2,834 shares of
common stock held by Mr. Dowdell, as Custodian for Sharon T. Dowdell under
the Uniform Transfers to Minors Act; 3,825 shares of common stock held by
Robert E. Dowdell Defined Benefit Plan and Trust, under Agreement dated
12/9/96; 5,000 shares of common stock held by Mr. Dowdell and Grace C.
Dowdell, as Trustees under a Trust Agreement dated July 1, 1991; and 42,313
shares of common stock which may be acquired by Mr. Dowdell upon the
exercise of stock options which are currently exercisable or exercisable
within sixty (60) days of March 12, 1999.
(9) Includes 5,333 shares of common stock which may be acquired upon the
exercise of stock options which are currently exercisable or exercisable
within sixty (60) days of March 12, 1999.
(10) Includes 10,668 shares of common stock which may be acquired upon the
exercise of stock options which are currently exercisable or exercisable
within sixty (60) days of March 12, 1999.
(11) Includes 2,700 shares of common stock held by Mr. Pesch's individual
retirement account, 1,100 shares of common stock held by Cathy Pesch's
individual retirement account (Cathy Pesch is Mr. Pesch's spouse), 1,000
shares of common stock held in a joint account with Cathy Pesch and 5,333
shares of common stock which may be acquired upon the exercise of stock
options which are currently exercisable or exercisable within sixty (60)
days of March 12, 1999.
(12) Represents shares of common stock held by Mr. Goense as Trustee for the
John M. Goense Rev. Trust U/A/D 06/19/89.
(13) Mr. Underwood was a Senior Vice President of Heller Financial, Inc. from
July, 1995 through January, 1997 and a Vice President of Heller Equity
Capital Corporation from July, 1989 through January, 1997.
63
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of 50,000,000 shares of common stock,
$.01 par value per share, and 1,000,000 shares of preferred stock, $.01 par
value per share.
The following summarizes the material provisions of our Certificate of
Incorporation and by-laws that are included as exhibits to the registration
statement of which this prospectus is a part. We believe this summary contains
a description of all of the material terms of our capital stock.
Common Stock
As of March 12, 1999, 7,218,046 shares of common stock were outstanding and
held by 27 holders of record. Subject to the rights of holders of preferred
stock, the holders of outstanding shares of common stock are entitled to share
ratably in dividends declared out of assets legally available therefor at such
time and in such amounts as the board of directors may from time to time
lawfully determine. Each holder of common stock is entitled to one vote for
each share held. Subject to the rights of holders of any outstanding preferred
stock, upon our liquidation, dissolution or winding up, any assets legally
available for distribution to stockholders as such are to be distributed
ratably among the holders of our common stock at that time outstanding. All
shares of common stock currently outstanding are, and all shares of common
stock offered by hereby when duly issued and paid for will be, fully paid and
nonassessable, not subject to redemption and assessment and without conversion,
preemptive or other rights to subscribe for or purchase any proportionate part
of any new or additional issues of any class or of securities convertible into
stock of any class.
Preferred Stock
Preferred stock may be issued by us in series from time to time with such
designations, relative rights, priorities, preferences, qualifications,
limitations and restrictions thereof, to the extent that such are not fixed in
our Certificate of Incorporation, as the board of directors determines. The
rights, preferences, limitations and restrictions of different series of
preferred stock may differ with respect to dividend rates, amounts payable on
liquidation, voting rights, conversion rights, redemption provisions, sinking
fund provisions and other matters. The board of directors may authorize the
issuance of preferred stock which ranks senior to our common stock with respect
to the payment of dividends and the distribution of assets on liquidation. In
addition, the board of directors is authorized to fix the limitations and
restrictions, if any, upon the payment of dividends on common stock to be
effective while any shares of preferred stock are outstanding. The board of
directors, without stockholder approval, may issue preferred stock with voting
and conversion rights which could adversely affect the voting power of the
holders of common stock. The issuance of preferred stock may have the effect of
delaying, deferring or preventing a change in control of us. We have no present
intention to issue shares of preferred stock.
Certain Corporate Provisions
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law. In general, this statute prohibits a publicly held Delaware
corporation from engaging, under certain circumstances, in a "business
combination" with an "interested stockholder" for a period of three years after
the date of the transaction in which the person becomes an interested
stockholder, unless either (1) prior to the date at which the stockholder
became an interested stockholder the board of directors approved either the
business combination or the transaction in which the person becomes an
interested stockholder, (2) the stockholder acquires more than 85% of the
outstanding voting stock of the corporation (excluding shares held by directors
who are officers or held in certain employee stock plans) upon consummation of
the transaction in which the stockholder becomes an interested stockholder or
(3) the business combination is approved by the board of directors and by two-
thirds of the outstanding voting stock of the corporation (excluding shares
held by the interested stockholder) at a meeting of the stockholders (and not
by written consent) held on or subsequent to the date of the business
combination. An "interested stockholder" is a person who, together with
affiliates and
64
<PAGE>
associates, owns or at any time within the prior three years did own, 15% or
more of the corporation's voting stock. Section 203 defines a "business
combination" to include, without limitation, mergers, consolidations, stock
sales and asset based transactions and other transactions resulting in a
financial benefit to the interested stockholder. A business combination by us
with Heller or Electra would not be prohibited by Section 203.
Our Certificate of Incorporation and by-laws contain a number of provisions
relating to corporate governance and to the rights of stockholders. Some of
these provisions may be deemed to have a potential "anti-takeover" effect in
that such provisions may delay, defer or prevent a change of control of us.
These provisions include (1) a requirement that stockholder action may be taken
only at stockholder meetings; (2) notice requirements in the by-laws relating
to nominations to the board of directors and to the raising of business matters
at stockholders meetings; and (3) the classification of the board of directors
into three classes, each serving for staggered three year terms. See
"Management--Directors and Executive Officers."
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is Harris Trust and
Savings Bank.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the offering, we will have an aggregate of approximately
7,498,046 shares of common stock outstanding, assuming no exercise of the
underwriters' over-allotment option and no exercise of outstanding options.
Substantially all of these shares will be freely tradable without restriction
or further registration under the Securities Act of 1933, unless held by
persons who are deemed to be our "affiliates" because they, directly or
indirectly through one or more intermediaries control, or are controlled by, or
are under common control, with us. Upon completion of the offering 1,719,567
shares will be held by our affiliates.
All selling stockholders, directors, executive officers and some of our
other current stockholders have agreed with the underwriters that, for a period
of 90 days from the date of this prospectus, they will not offer to sell or
otherwise sell, dispose of or grant rights with respect to any shares of common
stock, now owned or hereafter acquired directly by such holders or with respect
to which they have the power of disposition, otherwise than with the prior
written consent of Credit Suisse First Boston Corporation. As a result of these
contractual restrictions, notwithstanding possible earlier eligibility for sale
under the provisions of Rules 144, 144(k) and 701 of the Securities Act of
1933, shares subject to lock-up agreements will not be salable until the
agreements expire or unless prior written consent is received from Credit
Suisse First Boston Corporation. Any early waiver of the lock-up agreements by
the underwriters, which, if granted, could permit sales of a substantial number
of shares and could adversely affect the trading price of our shares, may not
be accompanied by an advance public announcement by us.
In general, under Rule 144 a person, or persons whose shares are aggregated,
who has beneficially owned "restricted shares" for at least one year, including
persons who may be deemed our "affiliate," would be entitled to sell within any
three-month period a number of shares that does not exceed the greater of one
percent of the number of shares of common stock then outstanding or the average
weekly trading volume of our common stock during the four calendar weeks
preceding the filing of a Form 144 with respect to such sale. Sales under Rule
144 are also subject to manner of sale provisions and notice requirements and
to the availability of current public information about us. In addition, a
person who is not deemed to have been our affiliate at any time during the 90
days preceding a sale, and who has beneficially owned for at least two years
the shares proposed to be sold, would be entitled to sell such shares under
Rule 144(k) without regard to the requirements described above. We are unable
to estimate accurately the number of restricted shares that will be sold under
Rule 144 because this will depend in part on the market price for our common
stock, the personal circumstances of the seller and other factors.
65
<PAGE>
Upon consummation of the offering, options to purchase 899,687 shares of
common stock will be issued and outstanding, of which options to purchase
282,279 shares of common stock will be exercisable.
Registration Rights
Under a registration rights agreement, Electra is entitled, subject to
various exceptions, to demand that we register shares of common stock held by
Electra on two or three occasions, depending on the circumstances, and to cause
us to register such shares in any registration by us for our own account or for
the account of other security holders. Additionally, at any time that we are
eligible to use Commission Form S-3 for registration of securities, Electra
will be entitled, subject to various exceptions, to cause us to register such
shares held by Electra on a registration statement on Form S-3. Upon
consummation of the offering, Electra will hold 252,511 shares covered by the
registration rights agreement.
Under a registration rights agreement, Heller is entitled, subject to
various exceptions, to demand that we register shares of common stock held by
Heller on up to three occasions and to cause us to register such shares in any
registration by us for our own account or for the account of other security
holders. Additionally, at any time that we are eligible to use Form S-3 for
registration of securities, Heller will be entitled, subject to certain
exceptions, to cause us to register such shares held by Heller on a
registration statement on Form S-3. Upon consummation of the offering, Heller
will hold 1,562,007 shares which will be covered by the registration rights
agreement.
Under a Stock Transfer and Registration Rights Agreement, Le Cordon Bleu is
entitled, subject to certain exceptions, to cause us to register shares issued
to them in connection with their license arrangement with us in any
registration by us for our own account or for the account of other security
holders through October 29, 2000. Le Cordon Bleu was issued 50,601 shares of
common stock in February 1999 upon completion of a program manual in connection
with the license arrangement, and an additional 50,601 shares of common stock
will be issued to Le Cordon Bleu in February 2000.
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<PAGE>
UNDERWRITING
Under the terms and subject to the conditions contained in an Underwriting
Agreement dated , 1999, the underwriters named below, for whom Credit
Suisse First Boston Corporation, Salomon Smith Barney Inc. and Legg Mason Wood
Walker, Incorporated are acting as representatives, have severally but not
jointly agreed to purchase from the selling stockholders the following
respective numbers of shares of common stock. Their obligations are subject to
conditions contained in the Underwriting Agreement.
<TABLE>
<CAPTION>
Number of
Underwriter Shares
----------- ---------
<S> <C>
Credit Suisse First Boston Corporation..........................
Salomon Smith Barney Inc........................................
Legg Mason Wood Walker, Incorporated............................
---------
Total....................................................... 2,000,000
=========
</TABLE>
The Underwriting Agreement provides that the underwriters will be obligated
to purchase all the shares of common stock in this offering (other than those
shares covered by the over-allotment option described below) if any are
purchased. The Underwriting Agreement provides that, in the event of a default
by an underwriter, in certain circumstances the purchase commitments of non-
defaulting underwriters may be increased or the Underwriting Agreement may be
terminated.
We and Mr. Larson have granted to the underwriters an option, expiring at
the close of business on the 30th day after the date of this prospectus, to
purchase up to 280,000 additional shares from us and 20,000 additional shares
from Mr. Larson at the public offering price less the underwriting discounts
and commissions, all as set forth on the cover page of this prospectus. Such
option may be exercised only to cover over-allotments in the sale of the shares
of common stock. To the extent such option is exercised, each underwriter will
become obligated, subject to certain conditions, to purchase approximately the
same percentage of such additional shares of common stock as it was obligated
to purchase pursuant to the Underwriting Agreement.
We and the selling stockholders have been advised by the representatives
that the underwriters propose to offer shares of common stock to the public
initially at the public offering price set forth on the cover page of this
prospectus and, through the representatives, to selling group members at such
price less a concession of $ per share, and the underwriters and such selling
group members may allow a discount of $ per share on sales to certain other
broker-dealers. After the public offering, the public offering price and
concession and discount to broker-dealers may be changed by the
representatives.
The following table summarizes the compensation to be paid to the
underwriters by the selling stockholders and us, and the expenses payable by
us.
<TABLE>
<CAPTION>
Total
-------------------
Without With
Per Over- Over-
Share allotment allotment
-------- --------- ---------
<S> <C> <C> <C>
Underwriting discounts and commissions paid by
CEC.............................................. $ $ $
Expenses payable by CEC........................... $ $ $
Underwriting discounts and commissions paid by
selling stockholders............................. $ $ $
</TABLE>
We, our executive officers and directors and certain other of our current
stockholders have agreed not to offer, sell, contract to sell, announce an
intention to sell, pledge or otherwise dispose of, directly or indirectly, or
file with the Securities and Exchange Commission a registration statement under
the Securities Act of 1933 relating to, any shares of our common stock or
securities or other rights convertible into or exchangeable or exercisable for
any shares of our common stock without the prior written consent of Credit
Suisse First Boston
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<PAGE>
Corporation, for a period of 90 days after the date of this prospectus, except
that such restrictions will not apply to (1) our ability to grant employee or
director stock options pursuant to the terms of a plan in effect on the date of
this prospectus or issuance of common stock pursuant to the exercise of such
options and (2) issuances of common stock to Le Cordon Bleu pursuant to its
agreement with us.
The underwriters have reserved for sale, at the public offering price, up to
60,000 shares of our common stock in this offering for employees, directors and
other persons associated with us who have expressed an interest in purchasing
such shares of our common stock in this offering. The number of shares
available for sale to the general public in this offering will be reduced to
the extent such persons purchase such reserved shares. Any reserved shares not
so purchased will be offered by the underwriters to the general public on the
same terms as the other shares offered hereby.
We and the selling stockholders have agreed to indemnify the underwriters
against certain liabilities, including civil liabilities under the Securities
Act, or to contribute to payments which the underwriters may be required to
make in respect thereof.
The representatives, on behalf of the underwriters, may engage in over-
allotment, stabilizing transactions, syndicate covering transactions, penalty
bids and "passive" market making in accordance with Regulation M under the
Securities Exchange Act of 1934. Over-allotment involves syndicate sales in
excess of the offering size, which creates a syndicate short position.
Stabilizing transactions permit bids for and purchases of our common stock so
long as the stabilizing bids do not exceed a specified maximum. Syndicate
covering transactions involve purchases of our common stock in the open market
after the distribution has been completed in order to cover syndicate short
positions. Penalty bids permit the underwriters to reclaim a selling concession
from a syndicate member when our common stock originally sold by such syndicate
member is purchased in a stabilizing transaction or syndicate covering
transaction to cover syndicate short positions. In "passive" market making,
market makers in our common stock who are underwriters or prospective
underwriters may, subject to certain limitations, make bids for or purchases of
our common stock until the time, if any, at which a stabilizing bid is made.
Such stabilizing transactions, syndicate covering transactions and penalty bids
may cause the price of our common stock to be higher than it would otherwise be
in the absence of such transactions. These transactions may be effected on The
Nasdaq National Market or otherwise and, if commenced, may be discontinued at
any time.
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<PAGE>
NOTICE TO CANADIAN RESIDENTS
Resale Restrictions
The distribution of our common stock in Canada is being made only on a
private placement basis exempt from the requirement that the Company and the
selling stockholders prepare and file a prospectus with the securities
regulatory authorities in each province where trades of common stock are
effected. Accordingly, any resale of our common stock in Canada must be made in
accordance with applicable securities laws which will vary depending on the
relevant jurisdiction, and which may require resales to be made in accordance
with available statutory exemptions or pursuant to a discretionary exemption
granted by the applicable Canadian securities regulatory authority. Purchasers
are advised to seek legal advice prior to any resale of our common stock.
Representations of Purchasers
Each purchaser of common stock in Canada who receives a purchase
confirmation will be deemed to represent to the Company, the selling
stockholders and the dealer from whom such purchase confirmation is received
that (1) such purchaser is entitled under applicable provincial securities laws
to purchase such common stock without the benefit of a prospectus qualified
under such securities laws, (2) where required by law, that such purchaser is
purchasing as principal and not as agent, and (3) such purchaser has reviewed
the text above under "Resale Restrictions."
Rights of Action (Ontario Purchasers)
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities law. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission or rights of action under the civil liability provisions
of the U.S. federal securities laws.
Enforcement of Legal Rights
All of the Company's directors and officers as well as the experts named
herein and the selling stockholders may be located outside of Canada and, as a
result, it may not be possible for Canadian purchasers to effect service of
process within Canada upon the Company or such persons. All or a substantial
portion of the assets of the Company and such persons may be located outside of
Canada and, as a result, it may not be possible to satisfy a judgment against
the Company or such persons in Canada or to enforce a judgment obtained in
Canadian courts against such Company or persons outside of Canada.
Notice to British Columbia Residents
A purchaser of common stock to whom the Securities Act (British Columbia)
applies is advised that such purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
common stock acquired by such purchaser pursuant to the offering. Such report
must be in the form attached to British Columbia Securities Commission Blanket
Order BOR #95/17, a copy of which may be obtained from the Company. Only one
such report must be filed in respect of common stock acquired on the same date
and under the same prospectus exemption.
Taxation and Eligibility for Investment
Canadian purchasers of common stock should consult their own legal and tax
advisors with respect to the tax consequences of an investment in our common
stock in their particular circumstances and with respect to the eligibility of
our common stock for investment by the purchaser under relevant Canadian
legislation.
69
<PAGE>
LEGAL MATTERS
The validity of our common stock offered hereby and other legal matters will
be passed upon for us by Katten Muchin & Zavis, Chicago, Illinois. Certain
legal matters in connection with this offering will be passed upon for the
underwriters by Sidley & Austin, Chicago, Illinois.
EXPERTS
The consolidated financial statements and schedule of Career Education
Corporation and its subsidiaries as of December 31, 1997 and 1998, and for each
of the three years in the period ended December 31, 1998, and the financial
statements of Scottsdale Culinary Institute, Inc. as of December 31, 1996 and
1997, and for each of the two years in the period ended December 31, 1997,
included in this prospectus and elsewhere in the registration statement, have
been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their reports with respect thereto, and are included herein in
reliance upon the authority of said firm as experts in giving said reports.
The statements of consolidated operations and accumulated deficit and of
cash flows of The Katharine Gibbs Schools, Inc. and subsidiaries for the years
ended December 31, 1995 and 1996 included in this prospectus have been audited
by Deloitte & Touche LLP, independent auditors, as stated in their report
appearing herein and is included in reliance upon the report of such firm given
upon their authority as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
This prospectus is part of a registration statement we filed with the SEC.
This prospectus does not contain all of the information contained in the
registration statement and all of the exhibits and schedules thereto. For
further information about us, please see the complete registration statement.
Summaries of agreements or other documents in this prospectus are not
necessarily complete. Please refer to the exhibits to the registration
statement for complete copies of such documents.
We file annual, quarterly and special reports, proxy statements and other
information with the SEC under the Exchange Act. The Exchange Act file number
for our SEC filings is 0-23245. You may read and copy any document we file at
the following SEC public reference rooms:
450 Fifth Street, N.W. Seven World Trade Center Citicorp Center
Judiciary Plaza Suite 1300 500 West Madison Street
Room 1024 New York, NY 10048 Suite 1400
Washington, D.C. 20549 Chicago, IL 60661
You may also inspect and copy our SEC filings, the complete registration
statement and other information at the offices of The Nasdaq Stock Market
located at 1735 K Street, N.W., Washington, D.C. 20006-1500.
You may obtain information on the operation of the public reference room in
Washington, D.C. by calling the SEC at 1-800-SEC-0330.
We file information electronically with the SEC. Our SEC filings also are
available from the SEC's Internet site at http://www.sec.gov, which contains
reports, proxy and information statements, and other information regarding
issuers that file electronically.
70
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Consolidated Financial Statements of Career Education Corporation and
Subsidiaries:
Report of Independent Public Accountants................................ F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998............ F-3
Consolidated Statements of Operations for the years ended December 31,
1996, 1997 and 1998.................................................... F-6
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1997 and 1998.................................................... F-8
Consolidated Statements of Stockholders' Investment for the years ended
December 31, 1996, 1997 and 1998....................................... F-9
Notes to Consolidated Financial Statements.............................. F-11
Consolidated Financial Statements of The Katharine Gibbs Schools, Inc. and
Subsidiaries:
Independent Auditors' Report............................................ F-31
Statements of Consolidated Operations and Accumulated Deficit for the
years ended December 31, 1995 and 1996................................. F-32
Statements of Consolidated Cash Flows for the years ended December 31,
1995 and 1996.......................................................... F-33
Notes to Consolidated Financial Statements.............................. F-34
Unaudited Condensed Consolidated Financial Statements of The Katharine
Gibbs Schools, Inc. and Subsidiaries:
Unaudited Condensed Consolidated Statements of Operations for the six
months ended June 30, 1996 and five months ended May 31, 1997.......... F-37
Unaudited Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 1996 and five months ended May 31, 1997.......... F-38
Notes to Unaudited Condensed Consolidated Financial Statements.......... F-39
Financial Statements of Scottsdale Culinary Institute, Inc.:
Report of Independent Public Accountants................................ F-40
Balance Sheets as of December 31, 1996 and 1997 and June 30, 1998
(unaudited)............................................................ F-41
Statements of Operations and Retained Earnings for the years ended
December 31, 1996 and 1997 and the six months ended June 30, 1997
(unaudited) and 1998 (unaudited)....................................... F-42
Statements of Cash Flows for the years ended December 31, 1996 and 1997
and for the six months ended June 30, 1997 (unaudited) and 1998
(unaudited)............................................................ F-43
Notes to Financial Statements........................................... F-44
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Career Education Corporation:
We have audited the accompanying consolidated balance sheets of CAREER
EDUCATION CORPORATION (a Delaware corporation) AND SUBSIDIARIES as of December
31, 1997 and 1998 and the related consolidated statements of operations,
stockholders' investment and cash flows for each of the three years in the
period ended December 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 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, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Career
Education Corporation and Subsidiaries as of December 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 December 31, 1998 in conformity with generally
accepted accounting principles.
As described in Note 4 to the consolidated financial statements, effective
January 1, 1998, the Company adopted the provisions of Statement of Position
98-5, "Reporting on the Costs of Start-Up Activities."
Arthur Andersen LLP
Chicago, Illinois
January 29, 1999
F-2
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
December 31,
---------------------
1997 1998
-------- --------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash................................................... $ 18,906 $ 23,548
Receivables--
Students, net of allowance for doubtful accounts of
$1,516 and $2,127 at December 31, 1997 and 1998,
respectively........................................ 10,812 11,408
Other................................................ 1,346 999
Inventories, prepaid expenses and other current assets. 2,232 4,514
Deferred offering costs................................ 2,900 --
Deferred income tax assets............................. 406 459
-------- --------
Total current assets............................... 36,602 40,928
-------- --------
PROPERTY AND EQUIPMENT, net ............................. 45,555 46,403
INTANGIBLE ASSETS, net................................... 33,579 42,645
DEFERRED INCOME TAX ASSETS............................... -- 865
OTHER ASSETS............................................. 1,881 2,046
-------- --------
TOTAL ASSETS............................................. $117,617 $132,887
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS--(Continued)
(Dollars in thousands)
<TABLE>
<CAPTION>
December 31,
-------------------
1997 1998
------- -------
<S> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' INVESTMENT
CURRENT LIABILITIES:
Current maturities of long-term debt..................... $ 3,888 $ 317
Accounts payable......................................... 3,580 2,425
Accrued expenses--
Payroll and related benefits........................... 1,605 2,944
Offering costs......................................... 2,447 --
Other.................................................. 3,800 9,089
Deferred tuition revenue................................. 7,476 10,159
------- -------
Total current liabilities............................ 22,796 24,934
------- -------
LONG-TERM DEBT, net of current maturities.................. 60,147 22,300
OTHER LONG-TERM LIABILITIES................................ 703 1,017
DEFERRED INCOME TAX LIABILITIES............................ 1,215 --
COMMITMENTS AND CONTINGENCIES..............................
REDEEMABLE PREFERRED STOCK AND WARRANTS
Redeemable Series A preferred stock, $0.01 par value;
50,000 shares authorized; 7,852 shares outstanding at
December 31, 1997, at liquidation value (stated value
plus accumulated dividends); no shares authorized or
outstanding at December 31, 1998........................ 10,112 --
Redeemable Series B preferred stock, $0.01 par value;
1,000 shares authorized; no shares outstanding at
December 31, 1997; no shares authorized or outstanding
at December 31, 1998.................................... -- --
Redeemable Series C preferred stock, $0.01 par value;
5,000 shares authorized; 4,954 shares outstanding at
December 31, 1997, at liquidation value (stated value
plus accumulated dividends); no shares authorized or
outstanding at December 31, 1998........................ 4,784 --
Redeemable Series D preferred stock, $0.01 par value;
25,000 shares authorized; 22,500 shares outstanding at
December 31, 1997, at liquidation value (stated value
plus accumulated dividends); no shares authorized or
outstanding at December 31, 1998........................ 22,175 --
Warrants exercisable into 202,297 shares of Class D
common stock at December 31, 1997, at an exercise price
of $0.01 per share, at estimated redemption value; no
warrants outstanding at December 31, 1998............... 2,659 --
Warrants exercisable into 32,947 shares of Class E common
stock at December 31, 1997, at an exercise price of
$0.01 per share, at estimated redemption value; no
warrants outstanding at December 31, 1998............... 430 --
------- -------
Total redeemable preferred stock and warrants........ 40,160 --
------- -------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS--(Continued)
(Dollars in thousands)
<TABLE>
<CAPTION>
December 31,
-----------------------
1997 1998
-------- --------
<S> <C> <C> <C>
STOCKHOLDERS' INVESTMENT:
Common stock, $0.01 par value; 50,000,000 shares
authorized; 7,152,896 shares issued and outstanding
at December 31, 1998................................ $ -- $ 72
Class A common stock, $0.01 par value; 5,625,600
shares authorized; 49,224 shares issued and
outstanding at December 31, 1997; no shares
authorized or outstanding at December 31, 1998...... 1 --
Class B common stock, $0.01 par value; 937,600 shares
authorized; 47,818 shares issued and outstanding at
December 31, 1997; no shares authorized or
outstanding at December 31, 1998.................... 1 --
Class C common stock, $0.01 par value; 937,600 shares
authorized; 655,382 shares issued and outstanding at
December 31, 1997; no shares authorized or
outstanding at December 31, 1998.................... 7 --
Class D common stock, $0.01 par value; 937,600 shares
authorized; no shares issued and outstanding at
December 31, 1997; no shares authorized or
outstanding at December 31, 1998.................... -- --
Class E common stock, $0.01 par value; 1,875,200
shares authorized; 16,380 shares issued and
outstanding at December 31, 1997; no shares
authorized or outstanding at December 31, 1998...... -- --
Preferred stock, $0.01 par value, 1,000,000 shares
authorized, no shares issued and outstanding at
December 31, 1998................................... -- --
Warrants............................................. 4,777 --
Additional paid-in capital........................... 71 95,481
Accumulated other comprehensive income............... (297) (822)
Accumulated deficit.................................. (11,964) (10,095)
-------- --------
Total stockholders' investment................... (7,404) 84,636
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' INVESTMENT......... $117,617 $132,887
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
<TABLE>
<CAPTION>
For the Years Ended
December 31,
-------------------------
1996 1997 1998
------- ------- --------
<S> <C> <C> <C>
REVENUE:
Tuition and registration fees, net................. $29,269 $74,842 $132,926
Other, net......................................... 4,311 7,756 11,306
------- ------- --------
Total net revenue.............................. 33,580 82,598 144,232
OPERATING EXPENSES:
Educational services and facilities................ 14,404 34,620 57,151
General and administrative......................... 14,622 37,542 63,856
Depreciation and amortization...................... 2,134 8,121 12,163
Compensation expense related to the initial public
offering.......................................... -- -- 1,961
------- ------- --------
Total operating expenses....................... 31,160 80,283 135,131
------- ------- --------
Income from operations......................... 2,420 2,315 9,101
INTEREST EXPENSE.................................... 717 3,108 1,250
------- ------- --------
Income (loss) before provision for income
taxes, extraordinary item and cumulative
effect of change in accounting principle...... 1,703 (793) 7,851
PROVISION (BENEFIT) FOR INCOME TAXES................ 208 (331) 3,350
------- ------- --------
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle..................................... 1,495 (462) 4,501
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT,
net of taxes of $233............................... -- (418) --
------- ------- --------
Income (loss) before cumulative effect of
change in accounting principle................ 1,495 (880) 4,501
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE,
net of taxes of $149............................... -- -- (205)
------- ------- --------
NET INCOME (LOSS)................................... $ 1,495 $ (880) $ 4,296
======= ======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS--(continued)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
For the Years Ended
December 31,
-----------------------
1996 1997 1998
------ ------- ------
<S> <C> <C> <C>
INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS:
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle......................................... $1,495 $ (462) $4,501
Dividends on preferred stock....................... (1,128) (2,159) (274)
Accretion to redemption value of preferred stock
and warrants...................................... (230) (6,268) (2,153)
------ ------- ------
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle attributable to common stockholders.. 137 (8,889) 2,074
Extraordinary loss................................. -- (418) --
Cumulative effect of change in accounting
principle......................................... -- -- (205)
------ ------- ------
Net income (loss) attributable to common
stockholders................................... $ 137 $(9,307) $1,869
====== ======= ======
INCOME (LOSS) PER SHARE ATTRIBUTABLE TO COMMON
STOCKHOLDERS:
Basic--
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle........................................ $ 0.18 $(11.58) $ 0.32
Extraordinary loss................................ -- (0.54) --
Cumulative effect of change in accounting
principle........................................ -- -- (0.03)
------ ------- ------
Net income (loss)............................... $ 0.18 $(12.12) $ 0.29
====== ======= ======
Diluted--
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle........................................ $ 0.13 $(11.58) $ 0.30
Extraordinary loss................................ -- (0.54) --
Cumulative effect of change in accounting
principle........................................ -- -- (0.03)
------ ------- ------
Net income (loss)............................... $ 0.13 $(12.12) $ 0.27
====== ======= ======
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic.............................................. 761 768 6,521
====== ======= ======
Diluted............................................ 1,030 768 6,797
====== ======= ======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-7
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
For the Year Ended
December 31
--------------------------
1996 1997 1998
------- -------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................ $ 1,495 $ (880) $ 4,296
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating
activities--
Depreciation, amortization and debt discount... 2,188 8,239 12,163
Warrants issued to a bank...................... -- 180 --
Deferred income taxes.......................... (208) (1,013) (1,311)
Extraordinary loss on early extinguishment of
debt.......................................... -- 418 --
Cumulative effect of change in accounting
principle..................................... -- -- 205
Compensation expense related to options........ -- -- 2,212
Gain on sale of property and equipment......... -- -- (14)
Changes in operating assets and liabilities,
net of acquisitions--
Receivables, net............................. 385 (5,208) (4,237)
Inventories, prepaid expenses and other
current assets.............................. (237) (3,959) 814
Deposits and other non-current assets........ -- -- (352)
Accounts payable............................. (138) 4,808 (1,383)
Accrued expenses and other liabilities....... 752 392 8,031
Deferred tuition revenue..................... 1,038 (3,171) 1,803
------- -------- -------
Net cash provided by (used in) operating
activities................................ 5,275 (194) 22,227
------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Business acquisitions, net of cash............... (8,250) (39,855) (5,860)
Acquisition and financing transaction costs...... -- (1,516) (372)
Purchase of property and equipment, net.......... (1,231) (3,822) (6,383)
Other assets..................................... (37) (21) (73)
Proceeds from sale of property and equipment..... -- -- 332
------- -------- -------
Net cash used in investing activities...... (9,518) (45,214) (12,356)
------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock......................... -- 30 52,765
Issuance of warrants............................. -- 4,789 --
Issuance of redeemable preferred stock and
warrants........................................ -- 17,556 --
Dividends paid on preferred stock................ (495) (495) (47)
Equity and debt financing costs.................. (553) (1,021) (7,085)
Book overdraft................................... 683 (683) --
Payments of long-term debt....................... (1,309) (513) (8,295)
Net proceeds (payments on) from revolving credit
facility........................................ 1,500 (8,239) --
Proceeds from term loan facility................. 8,250 3,400 --
Repayments of term loan facility................. -- (11,650) --
Net proceeds (payments on) from revolving loans
under Credit Agreement.......................... -- 39,985 (28,735)
Proceeds from issuance of term loans under Credit
Agreement....................................... -- 15,000 --
Payments on term loans under Credit Agreement.... -- (1,500) (13,500)
------- -------- -------
Net cash provided by (used in) financing
activities................................ 8,076 56,659 (4,897)
------- -------- -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH............ -- (143) (332)
------- -------- -------
NET INCREASE (DECREASE) IN CASH.................... 3,833 11,108 4,642
CASH, beginning of year............................ 3,965 7,798 18,906
------- -------- -------
CASH, end of year.................................. $ 7,798 $ 18,906 $23,548
======= ======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-8
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT
<TABLE>
<CAPTION>
Common Stock
-------------------------------------------------------------------------------------------------------------
Class A Class B Class C Class D Class E Common Stock
---------------- ---------------- ------------------ ---------------- ---------------- ------------------
5,625,600 $0.01 937,600 $0.01 937,600 $0.01 937,600 $0.01 1,875,200 $0.01 50,000,000 $0.01
Shares Par Shares Par Shares Par Shares Par Shares Par Shares Par
Authorized Value Authorized Value Authorized Value Authorized Value Authorized Value Authorized Value
---------- ----- ---------- ----- ---------- ------- ---------- ----- ---------- ----- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December
31, 1995........... 49,224 $ 492 47,818 $ 478 655,382 $ 6,554 -- $-- 7,726 $ 78 -- $ --
Net income........ -- -- -- -- -- -- -- -- -- -- -- --
Issuance of
stock............. -- -- -- -- -- -- -- -- 7,726 77 -- --
Dividends paid.... -- -- -- -- -- -- -- -- -- -- -- --
Dividends on
preferred stock
for the year...... -- -- -- -- -- -- -- -- -- -- -- --
Preferred stock
and warrant
accretion......... -- -- -- -- -- -- -- -- -- -- -- --
------- ----- ------- ----- -------- ------- --- ---- ------- ----- --------- -------
BALANCE, December
31, 1996........... 49,224 492 47,818 478 655,382 6,554 -- -- 15,452 155 -- --
Net loss.......... -- -- -- -- -- -- -- -- -- -- -- --
Foreign currency
translation.......
Total
comprehensive
income..........
Issuance of
warrants.......... -- -- -- -- -- -- -- -- -- -- -- --
Exercise of
warrants.......... -- -- -- -- -- -- -- -- 928 9 -- --
Dividends paid.... -- -- -- -- -- -- -- -- -- -- -- --
Dividends on
preferred stock... -- -- -- -- -- -- -- -- -- -- -- --
Preferred stock
and warrant
accretion......... -- -- -- -- -- -- -- -- -- -- -- --
------- ----- ------- ----- -------- ------- --- ---- ------- ----- --------- -------
BALANCE, December
31, 1997........... 49,224 492 47,818 478 655,382 6,554 -- -- 16,380 164 -- --
Net income........ -- -- -- -- -- -- -- -- -- -- -- --
Foreign currency
translation....... -- -- -- -- -- -- -- -- -- -- -- --
Total
comprehensive
income..........
Preferred stock
and warrant
accretion......... -- -- -- -- -- -- -- -- -- -- -- --
Dividends......... -- -- -- -- -- -- -- -- -- -- -- --
Compensatory
options........... -- -- -- -- -- -- -- -- -- -- -- --
Conversion of
preferred and
common stock...... (49,224) (492) (47,818) (478) (655,382) (6,554) -- -- (16,380) (164) 3,192,037 31,920
Issuance of
common stock...... -- -- -- -- -- -- -- -- -- -- 3,288,279 32,883
Warrants
exercised......... -- -- -- -- -- -- -- -- -- -- 657,267 6,573
Options
exercised......... -- -- -- -- -- -- -- -- -- -- 15,313 153
------- ----- ------- ----- -------- ------- --- ---- ------- ----- --------- -------
BALANCE, December
31, 1998........... -- $ -- -- $ -- -- $ -- -- $-- -- $ -- 7,152,896 $71,529
======= ===== ======= ===== ======== ======= === ==== ======= ===== ========= =======
<CAPTION>
Total
Amount
-------
<S> <C>
BALANCE, December
31, 1995........... $ 7,602
Net income........ --
Issuance of
stock............. 77
Dividends paid.... --
Dividends on
preferred stock
for the year...... --
Preferred stock
and warrant
accretion......... --
-------
BALANCE, December
31, 1996........... 7,679
Net loss.......... --
Foreign currency
translation.......
Total
comprehensive
income..........
Issuance of
warrants.......... --
Exercise of
warrants.......... 9
Dividends paid.... --
Dividends on
preferred stock... --
Preferred stock
and warrant
accretion......... --
-------
BALANCE, December
31, 1997........... 7,688
Net income........ --
Foreign currency
translation....... --
Total
comprehensive
income..........
Preferred stock
and warrant
accretion......... --
Dividends......... --
Compensatory
options........... --
Conversion of
preferred and
common stock...... 24,232
Issuance of
common stock...... 32,883
Warrants
exercised......... 6,573
Options
exercised......... 153
-------
BALANCE, December
31, 1998........... $71,529
=======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-9
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT (Continued)
<TABLE>
<CAPTION>
Preferred Stock Warrants
---------------- ----------- Accumulated
$0.01 par value, Class E Additional Other Total
1,000,000 shares Common Paid-in Comprehensive Accumulated Stockholders'
authorized Stock Capital Income Deficit Investment
---------------- ----------- ----------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31,
1995................... $-- $ -- $ 29,904 $ -- $ (2,793,833) $(2,756,327)
Net income............ -- -- -- -- 1,494,666 1,494,666
Issuance of stock..... -- -- 29,905 -- -- 29,982
Dividends paid........ -- -- -- -- (495,400) (495,400)
Dividends on preferred
stock................ -- -- -- -- (632,417) (632,417)
Preferred stock and
warrant accretion.... -- -- -- -- (229,975) (229,975)
---- ----------- ----------- --------- ------------ -----------
BALANCE, December 31,
1996................... -- -- 59,809 -- (2,656,959) (2,589,471)
---- ----------- ----------- --------- ------------ -----------
Net loss.............. -- -- -- -- (879,608) (879,608)
Foreign currency
translation.......... -- -- -- (296,602) -- (296,602)
-----------
Total comprehensive
income............. (1,176,210)
Issuance of warrants.. -- 4,788,563 -- -- -- 4,788,563
Exercise of warrants.. -- (11,136) 11,127 -- -- --
Dividends paid........ -- -- -- -- (495,400) (495,400)
Dividends on preferred
stock................ -- -- -- -- (1,663,137) (1,663,137)
Preferred stock and
warrant accretion.... -- -- -- -- (6,268,478) (6,268,478)
---- ----------- ----------- --------- ------------ -----------
BALANCE, December 31,
1997................... -- 4,777,427 70,936 (296,602) (11,963,582) (7,404,133)
---- ----------- ----------- --------- ------------ -----------
Net income............ -- -- -- -- 4,296,048 4,296,048
Foreign currency
translation.......... -- -- -- (525,238) -- (525,238)
-----------
Total comprehensive
income............. 3,770,810
Preferred stock and
warrant accretion.... -- -- -- -- (2,152,834) (2,152,834)
Dividends............. -- -- -- -- (274,424) (274,424)
Compensatory options.. -- -- 2,171,635 -- -- 2,171,635
Conversion of
preferred and common
stock................ -- -- 38,746,072 -- -- 38,770,304
Issuance of common
stock................ -- -- 45,786,186 -- -- 45,819,069
Warrants exercised.... -- (4,777,427) 8,540,301 -- -- 3,769,447
Options exercised..... -- -- 165,499 -- -- 165,652
---- ----------- ----------- --------- ------------ -----------
BALANCE, December 31,
1998................... $-- $ -- $95,480,629 $(821,840) $(10,094,792) $84,635,526
==== =========== =========== ========= ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-10
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1997 and 1998
1. DESCRIPTION OF THE COMPANY
Career Education Corporation ("CEC", collectively with its subsidiaries "we"
or "our") owns and operates companies, which provide private, for-profit
postsecondary education in North America. We operate 11 schools with 20
campuses that offer bachelor's degree, associate degree and non-degree programs
in information technologies, visual communications and design technologies,
business studies and culinary arts.
2. INITIAL PUBLIC OFFERING
On February 4, 1998, we sold 3,277,500 shares of our common stock at $16.00
per share pursuant to an initial public offering ("IPO"). The net proceeds from
the offering of $45.6 million were used to repay borrowings under the Credit
Agreement (Note 6) totaling $41.5 million and amounts owed to former owners of
acquired businesses of $4.1 million (Note 6) which were outstanding at that
time. Prior to the consummation of the IPO, all outstanding shares of all
series of preferred stock and accumulated dividends were converted into
2,423,485 shares of common stock and warrants (except for redeemable warrants
exercisable into 32,947 shares of Class E common stock) to purchase 624,320
shares of common stock were exercised. Subsequent to December 31, 1997 and
prior to the consummation of the IPO, we also authorized one class of preferred
stock and one class of common stock, increased the number of authorized shares
of common stock to 50,000,000 and completed a 9.376-for-1 stock split. The
effect of the split has been retroactively reflected for all periods presented
in the accompanying consolidated financial statements.
3. SIGNIFICANT ACCOUNTING POLICIES
a. Principles of Consolidation
The consolidated financial statements include the accounts of CEC and our
wholly owned subsidiaries. All significant intercompany transactions and
balances have been eliminated in the consolidation. The results of operations
of all acquired businesses have been consolidated for all periods subsequent to
the date of acquisition.
b. Concentration of Credit Risk
We extend unsecured credit for tuition to a significant portion of the
students who are in attendance at the campuses operated by our subsidiaries. A
substantial portion of credit extended to students is repaid through the
students' participation in various federally funded financial aid programs
under Title IV of the Higher Education Act of 1965, as amended ("Title IV
Programs"). The following table presents the amounts and percentages of the
Company's U.S. institutions' cash receipts collected from Title IV Programs for
the years ended December 31, 1996, 1997 and 1998 (such amounts were determined
based upon each U.S. institution's cash receipts for the twelve-month period
ended December 31, pursuant to the regulations of the United States Department
of Education ("DOE") at 34 C.F.R. (S) 600.5):
<TABLE>
<CAPTION>
For the Years Ended December 31,
------------------------------------
1996 1997 1998
----------- ----------- ------------
<S> <C> <C> <C>
Total Title IV funding.............. $26,931,030 $54,963,232 $ 90,086,463
Total cash receipts................. $38,036,509 $85,046,951 $132,552,679
Total Title IV funding as a
percentage of total cash receipts.. 71% 65% 68%
</TABLE>
F-11
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
We generally complete and approve the financial aid packet of each student
who qualifies for financial aid prior to the student's beginning class in an
effort to enhance the collectibility of our unsecured credit. Transfers of
funds from the financial aid programs are made in accordance with DOE
requirements. Changes in DOE funding of Title IV Programs could impact our
ability to attract students.
c. Marketing and Advertising Costs
Marketing and advertising costs are expensed as incurred. Marketing and
advertising costs included in general and administrative expenses were
$3,494,000, $10,640,000 and $16,915,000 for the years ended December 31, 1996,
1997 and 1998, respectively.
d. Inventories
Inventories consisting principally of program materials, books and supplies
are stated at the lower of cost, determined on a first-in, first-out basis, or
market.
e. Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are
recognized utilizing the straight-line method over the useful lives of the
related assets. Leasehold improvements and assets recorded under capital leases
are amortized on a straight-line basis over their estimated useful lives or
lease terms, whichever is shorter. Maintenance, repairs and minor renewals and
betterments are expensed; major improvements are capitalized. The estimated
cost basis and useful lives of property and equipment at December 31, 1997 and
1998, are as follows (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
---------------
1997 1998 Life
------- ------- ----------
<S> <C> <C> <C>
Buildings..................................... $ 1,190 $ 846 31 years
Classroom equipment, courseware and other
instructional materials...................... 39,518 44,754 3-15 years
Furniture, fixtures and equipment............. 7,768 7,722 3-10 years
Leasehold improvements........................ 4,325 7,266 1-7 years
Vehicles...................................... 17 17 5 years
------- -------
52,818 60,605
Less--Accumulated depreciation and
amortization................................. 7,263 14,202
------- -------
$45,555 $46,403
======= =======
</TABLE>
The gross cost of assets recorded under capital leases included above
amounts to $2,075,000 and $1,291,000 at December 31, 1997 and 1998,
respectively.
f. Intangible Assets
Intangible assets include the excess of cost over fair market value of
identifiable assets acquired through the business purchases described in Note
5. Goodwill is being amortized on a straight-line basis over their estimated
useful lives. Covenants not-to-compete entered into before 1997 are being
amortized on a straight-line basis over their useful lives. Those entered into
during and after 1997 are being amortized on an
F-12
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
accelerated method over their estimated useful lives. At December 31, 1997 and
1998, the cost basis and useful lives of intangible assets consist of the
following (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
--------------- Estimated
1997 1998 Lives
------- ------- ---------
<S> <C> <C> <C>
Goodwill........................................ $24,358 $38,080 40 years
Covenants not-to-compete........................ 13,250 13,055 3-5 years
------- -------
37,608 51,135
Less--Accumulated amortization.................. 4,029 8,490
------- -------
$33,579 $42,645
======= =======
</TABLE>
On an ongoing basis, we review intangible assets and other long-lived assets
for impairment whenever events or circumstances indicate that carrying amounts
may not be recoverable. To date, no such events or changes in circumstances
have occurred. If such events or changes in circumstances occur, we will
recognize an impairment loss if the undiscounted future cash flows expected to
be generated by the asset (or acquired business) are less than the carrying
value of the related asset. The impairment loss would adjust the asset to its
fair value.
g. Revenue Recognition
Revenue is derived primarily from programs taught at our schools. Tuition
revenue is recognized on a straight-line basis over the length of the
applicable course. Dormitory and cafeteria revenues charged to students are
recognized on a straight-line basis over the length of the students' program.
Other dormitory and cafeteria revenues are recognized as earned. Textbook sales
and other revenues are recognized as services are performed. If a student
withdraws, future revenue is reduced by the amount of the refund due to the
student. Refunds are calculated in accordance with federal, state and
accrediting agency standards. Deferred tuition revenue represents the portion
of payments received but not earned and is reflected as a current liability in
the accompanying consolidated balance sheets as such amount is expected to be
earned within the next year.
h. Management's Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent liabilities at the date of the financial statements
and reported amounts of revenues and expenses during the reported period.
Actual results could differ from those estimates.
i. Income Taxes
We file a consolidated federal income tax return and provide for deferred
income taxes under the asset and liability method of accounting. This method
requires the recognition of deferred income taxes based upon the tax
consequences of "temporary differences" by applying enacted statutory tax rates
applicable to future years to differences between the financial statement
carrying amounts and the tax basis of existing assets and liabilities.
F-13
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
j. Fair Value of Financial Instruments
The carrying value of current assets and liabilities reasonably approximates
their fair value due to their short maturity periods. The carrying value of our
debt obligations reasonably approximates their fair value as the stated
interest rate approximates current market interest rates of debt with similar
terms.
k. Accretion to Redemption Value of Preferred Stock and Warrants
Accretion to redemption value of redeemable preferred stock and warrants
represents the change in the redemption value of outstanding preferred stock
and warrants, which is being accreted over the earliest period redemption can
occur using the effective interest method. The redemption values are based on
the estimated fair market values of the classes of stock and consider the
amounts we have received for the sale of equity instruments, prices paid for
acquired businesses and our operations.
l. Income (Loss) Per Share Attributable to Common Stockholders
We compute earnings per share in accordance with Financial Accounting
Standard No. 128 "Earnings Per Share" which requires two calculations: basic
earnings per share and diluted earnings per share. The calculations primarily
differ by excluding dilutive common stock equivalents, convertible securities
and contingently issuable securities using the treasury method, when computing
basic earnings per share. The weighted average number of common shares used in
determining basic and diluted net income (loss) per share attributable to
common stockholders for the years ended December 31, 1996, 1997 and 1998 is as
follows (in thousands):
<TABLE>
<CAPTION>
For the Years
Ended December
31,
----------------
1996 1997 1998
----- ---- -----
<S> <C> <C> <C>
Common shares outstanding (basic)........................ 761 768 6,521
Common stock equivalents................................. 269 -- 259
Common stock contingently issuable....................... -- -- 17
----- --- -----
Diluted.................................................. 1,030 768 6,797
===== === =====
</TABLE>
For the year ended December 31, 1997, antidilutive common stock equivalents
totaling 568,332 were excluded from diluted weighted average number of common
shares outstanding.
Supplemental pro forma diluted income (loss) before extraordinary item and
cumulative effect of change in accounting principle and net income (loss) per
share attributable to common stockholders, had the debt retirement in
connection with the consummation of the IPO occurred at the beginning of the
year, would have been $(2.59) and $(2.73), respectively, for the year ended
December 31, 1997 and $0.33 and $0.30, respectively, for the year ended
December 31, 1998. This earnings per share data is computed based upon
historical information adjusted for the reduction in interest expense resulting
from the application of net proceeds from the IPO to reduce our indebtedness
and pro forma weighted average number of shares of common stock outstanding
which reflect the assumed sale of common stock in the IPO resulting in net
proceeds sufficient to pay indebtedness as described in Note 2.
F-14
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
m. Stock-Based Compensation
We account for stock-based compensation in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and
have adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation," (SFAS
No. 123) related to options and warrants issued to employees and directors.
Expense associated with stock options and warrants issued to non-employees/non-
directors is recorded in accordance with SFAS No. 123.
n. Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
No. 130"), which establishes standards for the reporting of comprehensive
income. This pronouncement requires that all items recognized under accounting
standards as components of comprehensive income, as defined in the
pronouncement, be reported in a financial statement that is displayed with the
same prominence as other financial statements. Comprehensive income includes
all changes in equity during a period except those resulting from investments
by owners and distributions to owners. We have adopted SFAS No. 130 at December
31, 1998 and have restated the Statements of Stockholders' Investment for all
periods presented to reflect comprehensive income and accumulated other
comprehensive income.
o. Foreign Currency Translation
We acquired the International Academy of Design, an entity with operations
in Canada, on June 30, 1997. At December 31, 1997 and 1998, revenues and
expenses related to these operations have been translated at average exchange
rates in effect at the time the underlying transactions occurred. Transaction
gains or losses are included in income. Assets and liabilities of this
subsidiary have been translated at the year-end exchange rate, with gains and
losses resulting from such translation being included in stockholders'
investment at December 31, 1997 and 1998.
p. Supplemental Disclosures of Cash Flow Information
<TABLE>
<CAPTION>
For the Year Ended
December 31
-------------------
1996 1997 1998
---- ------ -------
<S> <C> <C> <C>
CASH PAID FOR--
Interest.............................................. $407 $3,008 $ 1,534
Taxes, excluding a refund of $900 in 1998............. 80 2,446 1,860
==== ====== =======
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Accretion to redemption value of preferred stock and
warrants............................................... $230 $6,268 $(2,153)
Dividends on preferred stock added to liquidation
value.................................................. 632 1,663 (227)
Conversion of all Class A, B, C, and E common stock and
all series of redeemable preferred stock into 3,192,037
shares of common stock in connection with the IPO.
Value of the redeemable preferred stock at the date of
conversion............................................. -- -- 38,776
==== ====== =======
</TABLE>
q. Segment Information
We operate in one industry segment. Operations in geographic regions outside
the United States are not significant.
F-15
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
4. CHANGE IN ACCOUNTING PRINCIPLE
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position No. 98-5 ("SOP 98-5"), "Reporting on the Costs of Start-
Up Activities." SOP 98-5 requires that all nongovernmental entities expense the
costs of start-up activities (which include organization costs) as these costs
are incurred. As prescribed by the literature, we adopted the provisions of SOP
98-5 in the fourth quarter of 1998, effective January 1, 1998, and recorded a
net of tax charge of $205,000 representing the cumulative effect of the change
in accounting principle.
5. BUSINESS ACQUISITIONS
Western Culinary Institute (Western)
On October 21, 1996, we acquired certain assets and assumed certain
liabilities of Western Culinary Institute, a wholly owned subsidiary of
Phillips College, Inc. This acquisition was accounted for as a purchase and,
accordingly, the purchased assets and assumed liabilities have been recorded at
their estimated fair market values at the date of the acquisition. The purchase
price, as adjusted, of approximately $7,477,000 exceeded the fair market value
of net assets acquired, resulting in goodwill of approximately $646,000. In
connection with the purchase, the former owner of the school entered into a
four-year covenant not-to-compete agreement with us for a total price of
$400,000. At closing, we paid $7,000,000 to the former owner with funds
obtained through bank financing, assumed a $150,000 obligation and deposited
$1,250,000 into escrow.
School of Computer Technology, Inc. (SCT)
On February 28, 1997, through SCT Acquisition, Ltd., we acquired 100% of the
outstanding shares of capital stock of School of Computer Technology, Inc. This
acquisition was accounted for as a purchase and, accordingly, the acquired
assets and assumed liabilities have been recorded at their estimated fair
market values at the date of the acquisition. The purchase price, as adjusted,
of approximately $4,944,000 exceeded the estimated fair market value of net
assets acquired and liabilities assumed, resulting in goodwill of approximately
$3,111,000. In connection with the purchase, we entered into a three-year
covenant not-to-compete agreement with each of the former owners of the school
for a total price of $1,750,000.
At closing, we paid $400,000 to the former owners, deposited $5,000,000 into
escrow, and assumed a $1,800,000 note payable due to the former owners. Funds
paid were raised through the issuance of $2,000,000 of Series D preferred stock
and warrants and $3,400,000 of bank borrowings. The note was paid subsequent to
December 31, 1998.
The Katharine Gibbs Schools, Inc. (Gibbs)
On May 31, 1997, we acquired 100% of the outstanding shares of capital stock
of The Katharine Gibbs Schools, Inc. Gibbs has seven wholly-owned subsidiaries,
each of which owns and operates separate campuses. This acquisition was
accounted for as a purchase and, accordingly, the acquired assets and assumed
liabilities have been recorded at their estimated fair market values at the
date of the acquisition. The estimated fair market values of certain assets are
based upon preliminary appraisal reports. The purchase price, as adjusted, of
approximately $19,029,000 exceeded the fair market value of net assets acquired
and liabilities assumed, resulting in goodwill of approximately $8,434,000. In
connection with the purchase, we also entered into a covenant not-to-compete
agreement with the former owner of the schools in exchange for $7,000,000. The
covenant not-to-compete restricts the former owners' ability to own or operate
some types of for-profit postsecondary schools for five years.
F-16
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
At closing, we paid $5,400,000 to the former owner and deposited $18,850,000
into escrow with borrowings of $12,500,000 from a new bank financing
arrangement and $15,000,000 which was raised through the issuance of Series D
preferred stock.
International Academy of Merchandising & Design (IAMD)
On June 30, 1997, through IAMD, Acquisition I, Ltd. we acquired 100% of the
outstanding shares of capital stock of International Academy of Merchandising &
Design for $3,000,000. Subsequent to the purchase, IAMD Acquisition I, Ltd.
merged with and into International Academy of Merchandising & Design and
assumed its name. In 1998, the purchase price was increased by approximately
$4,700,000, pursuant to the earn-out provision in the purchase agreement. This
acquisition was accounted for as a purchase and, accordingly, the acquired
assets and assumed liabilities have been recorded at their estimated fair
market values at the date of the acquisition. The purchase price exceeded the
fair market value of net assets acquired and liabilities assumed, resulting in
goodwill of approximately $8,395,000.
In connection with the purchase, we also entered into covenant not-to-
compete agreements with the former owners of the school in exchange for
$2,000,000. The covenant not-to-compete restricts the former owners' ability to
own or operate some types of for-profit postsecondary schools for four years.
On June 30, 1997, we paid $100,000 to the former owners, issued $1,500,000
in notes payable to the former owners and issued letters of credit totaling
$3,400,000 to secure amounts owed to the former owners to consummate these
transactions. The funds to consummate these transactions were obtained through
the issuance of Series D preferred stock and warrants and bank borrowings. The
notes and amounts owed to former owners were paid upon the consummation of the
IPO (Note 2).
International Academy of Design (IAD)
On June 30, 1997, we purchased 100% of the capital stock of International
Academy of Design for $6,500,000. This acquisition was accounted for as a
purchase and, accordingly, the acquired assets and assumed liabilities have
been recorded at their estimated fair market values at the date of the
acquisition. The estimated fair market values of certain assets are based upon
preliminary appraisal reports. The purchase price, subject to certain
modifications, exceeded the fair market value of net assets acquired and
liabilities assumed, resulting in goodwill of approximately $5,648,000.
In connection with the purchase, we entered into covenant not-to-compete
agreements with the former owners of the school in exchange for $2,000,000. The
covenant not-to-compete restricts the former owners' ability to own or operate
certain types of postsecondary vocational schools for four years.
On June 30, 1997, we paid $3,820,000 to the former owners, deposited
$2,120,000 into escrow, and issued $2,550,000 in notes payable to the former
owners to consummate these transactions. The funds to consummate these
transactions were obtained through the issuance of Series D preferred stock and
warrants and bank borrowings. The notes were paid upon consummation of the IPO
(Note 2).
Southern California School of Culinary Arts (SCSCA)
On March 13, 1998, we purchased 100% of the outstanding shares of capital
stock of Southern California School of Culinary Arts for $1,000,000. The
acquisition was accounted for as a purchase and the purchase price exceeded the
fair value of assets acquired and liabilities assumed resulting in goodwill of
approximately $1,301,000.
F-17
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
Scottsdale Culinary Institute, Inc. (Scottsdale Culinary)
On July 31, 1998, we acquired certain assets and assumed certain liabilities
of Scottsdale Culinary Institute, Inc. for approximately $9,900,000. The
acquisition was accounted for as a purchase and the purchase price exceeded the
fair value of assets acquired and liabilities assumed, resulting in goodwill of
approximately $7,900,000.
Harrington Institute of Interior Design, Inc. (Harrington)
On January 4, 1999, we acquired 100% of the outstanding shares of capital
stock of the Harrington Institute of Interior Design, Inc. for $3,300,000,
subject to adjustment. The acquisition will be accounted for as a purchase,
with the excess of the purchase price over the net assets acquired, currently
estimated to be $2,800,000, recorded as goodwill.
Pro Forma Results of Operations
The following unaudited pro forma results of operations (in thousands,
except per share amounts) for the years ended December 31, 1996, 1997 and 1998,
assume that the business acquisitions subsequent to January 1, 1996 described
above occurred at the beginning of the year preceding the year of the
acquisition. The pro forma results below are based on historical results of
operations, include adjustments for depreciation, amortization, interest and
taxes and do not necessarily reflect actual results that would have occurred.
<TABLE>
<CAPTION>
For the Years Ended
December 31,
---------------------------
1996 1997 1998
------- -------- --------
(Unaudited)
<S> <C> <C> <C>
Net revenue........................................ $87,476 $111,310 $147,577
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle......................................... (5,051) (1,516) 4,565
Net income (loss).................................. (5,051) (1,934) 4,360
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle attributable to common stockholders..... (6,409) (9,944) 2,138
Net income (loss) attributable to common
stockholders...................................... (6,409) (10,362) 1,933
======= ======== ========
Basic income (loss) per share attributable to
common stockholders--
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle....................................... $ (8.42) $ (12.95) $ 0.33
======= ======== ========
Net income (loss).................................. $ (8.42) $ (13.49) $ 0.30
======= ======== ========
Diluted income (loss) per share attributable to
common stockholders--
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle....................................... $ (8.42) $ (12.95) $ 0.31
======= ======== ========
Net income (loss)................................ $ (8.42) $ (13.49) $ 0.28
======= ======== ========
</TABLE>
F-18
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
6. DEBT
Our long-term debt at December 31, 1997 and 1998, consists of the following:
<TABLE>
<CAPTION>
December 31,
---------------
1997 1998
------- -------
(in thousands)
<S> <C> <C>
Borrowings under Credit Agreement with a syndicate of banks as
discussed below--
Revolving loans............................................. $39,985 $11,250
Term loans.................................................. 13,500 --
</TABLE>
<TABLE>
<S> <C> <C>
Note payable to former owners of SCI, secured by bank letters
of credit, bearing annual interest of 7%, currently payable... -- 9,029
Notes payable to former owners of SCT, bearing annual interest
of 7%, principal due February 28, 2001, secured by bank letter
of credit..................................................... 1,800 1,800
Notes payable to former owners of IAMD, bearing annual interest
of 7%, repaid in connection with the IPO...................... 1,500 --
Amounts due to former owners of IAMD non-interest bearing,
repaid in connection with the IPO............................. 3,400 --
Notes payable to former owners of IAD bearing annual interest
of 7%, repaid in connection with the IPO...................... 2,550 --
Equipment under capital leases, secured by related equipment,
discounted at a weighted average interest rate of 10.5%....... 1,279 523
Other.......................................................... 21 15
------- -------
64,035 22,617
Less--Current portion.......................................... 3,888 317
------- -------
$60,147 $22,300
======= =======
</TABLE>
On May 30, 1997, we entered into a new credit agreement (the "Credit
Agreement") with a bank (syndicated on September 25, 1997) and prepaid
approximately $21,187,000 of outstanding revolving credit notes, term loans and
other obligations under our previous credit agreement with borrowings from term
loans and revolving credit notes which were permitted under the Credit
Agreement at that time. On October 26, 1998, the Credit Agreement was amended.
We can borrow, under the amended Credit Agreement, up to $60,000,000 under a
revolving credit facility ("Revolving Loans") and can obtain up to $35,000,000
in letters of credit, however, outstanding letters of credit reduce the
revolving credit facility availability. The amended Credit Agreement matures on
October 26, 2003. Borrowings under the amended Credit Agreement bear interest,
payable quarterly, at the bank's prime rate plus 0.50% (8.25% at December 31,
1998) or at LIBOR plus 1.75% (6.85% at December 31, 1998), at our election.
Interest rates are subject to change based upon our funded debt levels relative
to consolidated earnings before interest, taxes, depreciation and amortization
on a pro forma basis for the last four fiscal quarters. We are also required to
pay annual commitment fees of 0.25% on unused availability under the revolver
and 1.5% for unused letters of credit.
At December 31, 1998, we had outstanding, $11,250,000 in revolving credit
borrowings and outstanding letters of credit totaling approximately $28,935,000
(to meet certain Department of Education financial responsibility requirements
and to guarantee certain purchase price payments) under the Credit Agreement.
At December 31, 1998, all borrowings were at the bank's prime rate plus 0.50%.
Under our previous bank credit agreement, which we entered into in 1995,
(the "Agreement") we were permitted to borrow, on a consolidated basis,
$8,000,000 under a revolving credit note and $12,000,000 through a term loan.
On May 30, 1997, in connection with entering into the Credit Agreement and
prepaying
F-19
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
all amounts outstanding under the Agreement, we expensed prepayment penalty
fees and unamortized deferred financing costs and recorded an extraordinary
loss on the early extinguishment of debt of $651,000, net of related tax
benefit of $233,000.
CEC and our subsidiaries have collectively guaranteed repayment of amounts
outstanding under the Credit Agreement. In addition, we have pledged the stock
of our subsidiaries as collateral for repayment of the debt. We may voluntarily
make principal prepayments. Mandatory principal prepayments are required if we
generate excess cash flows, as defined, sell certain assets, or upon the
occurrence of certain other events. Under the Credit Agreement we are limited
in our ability to take certain actions, including paying dividends, as defined,
selling or disposing of certain assets or subsidiaries, making annual rental
payments in excess of 15% of consolidated revenues in any given year, and
issuing subordinated debt in excess of $5,000,000, among other things. We are
required to maintain certain financial ratios, including a quarterly interest
coverage ratio of at least 1.75:1, certain levels of consolidated net worth,
and funded debt to consolidated earnings before interest, taxes, depreciation,
and amortization of 3.50:1, among others. At December 31, 1998, we were in
compliance with the covenants of the Credit Agreement, as amended.
We intend to refinance amounts owed to former owners of acquired businesses
as noted above through availability under our Credit Agreement and, therefore,
such amounts have been classified as long-term.
At December 31, 1998, future annual principal payments of long-term debt are
as follows (in thousands):
<TABLE>
<S> <C>
1999............................. $ 317
2000............................. 153
2001............................. 1,861
2002............................. 7
2003............................. 20,279
-------
$22,617
=======
</TABLE>
7. STOCKHOLDERS' INVESTMENT
In connection with the consummation of the IPO on February 4, 1998, we
amended and restated our certificate of incorporation to authorize a total of
50,000,000 shares of common stock ("Common Stock") and authorize 1,000,000
shares of preferred stock, with a par value of $0.01, and converted all classes
of common stock described below into one class of Common Stock, with a par
value of $0.01, at a rate of 9.376 shares of Common Stock for every share of
existing common stock. The shares of common stock disclosed in these financial
statements and notes hereto retroactively reflect this split.
Prior to the IPO we had Class A, B, C, D, and E common stock. Class A and
Class B common stock had voting rights while Class C, D and E common stock was
nonvoting. Class B common stock was convertible into shares of Class A common
stock at any time at the discretion of the holder at a ratio of 1:1. Class C
common stock was convertible into shares of either Class A common stock or
Class B common stock at any time at the discretion of the holder at a ratio of
1:1. Class D common stock was convertible into shares of Class A common stock,
subject to certain restrictions. Class E common stock could only be converted
into shares of Class A common stock upon the occurrence of certain events.
8. Redeemable Preferred Stock
In connection with the IPO consummated on February 4, 1998, all classes of
redeemable preferred stock described below were converted into 2,423,233 shares
of Common Stock by dividing the liquidation value of preferred stock on that
date (including all accrued paid-in-kind dividends) by $16.00, the initial
public offering price of the common stock.
F-20
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
Series A
Series A and D preferred stock had a stated value of $1,000 per share, and
its holders were entitled to receive dividends at an annual rate of 7% of the
liquidation value per share ($1,000 per share plus dividends as defined).
Dividends were paid in equal semiannual installments on January 31 and July 31
of each year by increasing the liquidation value of the Series A and D
preferred stock. The mandatory redemption value of the Series A and D preferred
stock was increased to reflect these dividends.
On February 28, 1997, we entered into a securities purchase agreement with
existing common and preferred stockholders to raise funds for acquisitions. The
securities purchase agreement gave the stockholders the right to purchase up to
7,500 shares of Series D preferred stock for $1,000 per share and receive
warrants to purchase 83,671 shares of Class E common stock at an exercise price
of $.01 per share. Under this securities purchase agreement, we issued 7,500
shares of Series D preferred stock and warrants to purchase 83,671 shares of
Class E common stock to existing stockholders in connection with the
acquisition of SCT and Gibbs. The proceeds were allocated to preferred stock
and warrants based upon their relative market values after considering issuance
costs.
On May 30, 1997, we entered into another securities purchase agreement with
existing common and preferred stockholders to raise funds for additional
acquisitions. The securities purchase agreement gave the stockholders the right
to purchase up to an additional 15,000 shares of Series D preferred stock for
$1,000 per share and receive warrants to purchase 339,280 shares of Class E
common stock at an exercise price of $.01 per share. Under this securities
purchase agreement, we issued 15,000 shares of Series D preferred stock and
warrants to purchase 339,280 shares of Class E common stock to existing
stockholders in connection with the acquisitions of Gibbs, IAMD and IAD. The
proceeds were allocated to preferred stock and warrants based upon their
relative market values after considering issuance costs.
Series B
Series B preferred stock had a stated value of $1,000 per share, and its
holders were not entitled to any dividends on any outstanding shares.
Series C
Series C preferred stock had a stated value of $1,000 per share, and its
holders were entitled to receive cash dividends at an annual rate of 10% of the
liquidation value per share ($1,000 per share plus undeclared dividends as
defined). Dividends were payable in equal quarterly installments on each March
31, June 30, September 30 and December 31. To the extent dividends were
declared and not paid, they were added to the liquidation value. The Company
paid all dividends through December 31, 1997 on Series C preferred stock. In
July 1996, we increased the number of authorized shares of Series C preferred
stock and completed a 10-for-1 stock split. The stock split has been
retroactively reflected in the accompanying financial statements.
9. REDEEMABLE WARRANTS
In connection with the issuance of Series C preferred stock during 1995, we
issued warrants exercisable into 237,072 shares of Class D common stock. These
warrants were subject to adjustment, exercisable at any time, and had an
exercise price of $.01 per share. These warrants were adjusted to be 202,297
based upon the results of our operations through December 31, 1997 and were
exercised in connection with the IPO (Note 2) during 1998. We accreted the
difference between the value of the warrants at the date of issuance and the
IPO date using the effective interest method.
F-21
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
In connection with our previous credit agreement (Note 6), we issued
warrants exercisable into 20,618 shares (subject to adjustment under certain
circumstances) of Class D common stock. The warrants were exercisable at any
time and had an exercise price of $.01 per share. Based upon the terms and
provisions of the credit and warrant agreements, we assigned a value (based
upon the relative fair market value of the debt and warrants) of $79,997 to
these warrants. The fair market value of the warrants was determined with
reference to the exercise price of the warrants, the fair market value of our
common stock at the date the warrants were issued (considering its recent sale
of stock to third parties) and the period the warrants can be exercised. In
connection with the sales of Series D preferred stock through the various
securities purchase agreements, the warrants were exchanged for warrants (with
similar put and call features) to purchase 20,618 shares of Class E common
stock and also increased to include additional warrants to purchase 12,329
shares of Class E common stock. The value of these additional warrants,
totaling approximately $180,000 (based upon a Black-Scholes option pricing
model with assumptions as described in Note 10) was recorded as interest
expense in 1997. The warrant holder exercised the warrants in 1998.
10. STOCK OPTIONS AND WARRANTS
Stock Options
During 1994, certain stockholders were granted options to purchase up to a
total of approximately 13.5% of the outstanding shares of our common stock.
These options, which have an exercise price of $.10 per share, were to be
earned and become exercisable based upon certain financial returns earned and
realized in a cash payment by certain stockholders and are subject to other
conditions. In July 1995, the option agreements were amended to reduce the
total number of shares of common stock for which the options could be exercised
to 11.5% of the outstanding shares, and a supplemental option agreement was
entered into entitling one of these stockholders to purchase 20,618 shares of
common stock at $0.01 per share. The supplemental option vests over a five year
period. Under the supplemental option agreement, additional options to purchase
a total of 8,579 shares of common stock at an exercise price of $0.01 per share
were issued in 1997. These options vest over the same period as the initial
supplemental option.
On October 20, 1997, the original option agreements were further amended to
fix the number of shares that the stockholders may exercise only upon
completion of the IPO. Under these amended agreements, in addition to the
options issued under the supplemental option agreement, the stockholders may
purchase an aggregate of 122,615 shares of our common stock at any time after
the IPO closing, but prior to January 1, 2004. These options fully vested upon
the IPO closing. We recorded compensation expense of approximately $2.0 million
related to these agreements in 1998.
During 1995, we adopted the 1995 Stock Option Plan. Under this plan we can
grant up to 160,568 options exercisable into shares of Class E common stock to
certain members of management. The options vest and become exercisable in five
equal annual installments commencing with the first anniversary of the grant,
and expire 10 years from the date of grant, or earlier under certain
circumstances. Options issued under the 1995 Stock Option Plan to purchase
92,101 shares of common stock were fully vested upon the consummation of the
IPO.
During 1998, we approved the 1998 Employee Incentive Compensation Plan. The
plan provides for us to grant stock options, stock appreciation rights,
restricted stock, deferred stock and other awards which are exercisable into
shares of common stock to our directors, officers, employees and consultants.
Stock options may be either incentive stock options or nonqualified stock
options. No stock option or appreciation right shall be exercisable more than
ten years after the date of grant. We have reserved 600,000 shares of common
stock for distribution pursuant to awards issued under the plan.
F-22
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
During 1998, we approved the 1998 Non-Employee Directors' Stock Option
Plan. The plan provides for us to grant options to purchase shares of common
stock to directors. Each person who is a non-employee director shall be
granted an option to purchase 8,000 shares of common stock upon becoming a
director and on an annual basis, as long as such director continues to serve
as a director, shall receive an option to purchase 3,000 shares of common
stock. Each option becomes exercisable in three equal annual installments and
expires ten years from the date of grant. We have reserved 200,000 shares of
common stock for issuance under the plan.
Stock option activity under all of our stock option plans for the years
ended December 31, 1996, 1997 and 1998, was as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Shares Price Range Price
------- ------------ --------
<S> <C> <C> <C>
Outstanding as of December 31, 1995............ 54,334 $ 3.88 $ 3.88
Granted...................................... 30,922 3.88 3.88
-------
Outstanding as of December 31, 1996............ 85,256 3.88 3.88
Granted...................................... 68,782 13.85-14.71 14.59
Cancelled.................................... (2,672) 3.88 3.88
-------
Outstanding as of December 31, 1997............ 151,366 3.88-14.71 8.75
Granted...................................... 638,050 16.00-26.25 22.47
Exercised.................................... (9,313) 3.88-16.00 13.44
Cancelled.................................... (16,531) 14.71-26.25 16.95
-------
Outstanding as of December 31, 1998............ 763,572 $ 3.88-26.25 $19.50
======= ============ ======
Stock options exercisable at
December 31, 1997............................ 26,853 $ 3.88 $ 3.88
======= ============ ======
December 31, 1998............................ 126,450 $ 3.88-26.25 $ 8.07
======= ============ ======
</TABLE>
The following table summarizes information about all stock options
outstanding as of December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------- --------------------------------
Number Weighted Number
Outstanding Weighted Average Exercisable Weighted
as of Average Remaining at Average
Exercise Price Ranges December 31, 1998 Exercise Price Contractual Life December 31, 1998 Exercise Price
- --------------------- ----------------- -------------- ---------------- ----------------- --------------
<S> <C> <C> <C> <C> <C>
$ 0.01-$ 3.88........... 226,520 $ 1.39 6.73 214,681 $ 1.46
$13.85-$16.00........... 301,914 15.70 8.95 43,741 14.98
$19.25-$26.25........... 380,950 25.82 9.55 2,000 26.25
------- ------ ---- ------- ------
$ 0.01-$26.25........... 909,384 $16.38 8.64 260,422 $ 3.93
======= ====== ==== ======= ======
</TABLE>
F-23
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
The fair value of each option is estimated on the date of grant based on the
Black-Scholes option pricing model and assumptions used to value the options.
The weighted average fair value of the options granted during the years ended
December 31, 1996, 1997 and 1998 and assumptions used to value the options are
as follows:
<TABLE>
<CAPTION>
For the Years
Ended
--------------------
1996 1997 1998
----- ----- ------
<S> <C> <C> <C>
Dividend yield............................................ -- -- --
Risk-free interest rate................................... 5.7% 6.8% 8.0%
Volatility................................................ -- -- 60%
Expected life............................................. 10 10 10
Weighted average fair value of options granted............ $1.80 $2.58 $14.48
</TABLE>
Warrants
During 1997, in connection with the issuance of Class D preferred stock
through the various securities purchase agreements, we issued warrants
exercisable into a total of 422,951 shares of Class E common stock. These
warrants were exercisable at any time, had an exercise price of $.01 per share
and were exercised in connection with the consummation of the IPO.
A summary of warrant activity, including redeemable warrants, for the years
ended December 31, 1996, 1997 and 1998, is as follows:
<TABLE>
<CAPTION>
Shares Under Warrant
-------------------------------
Class D Class E
Common Stock Common Stock
--------------- ---------------
Shares Price Shares Price
-------- ----- -------- -----
<S> <C> <C> <C> <C>
Outstanding as of December 31, 1995.......... 257,690 $0.01 -- $ --
Issued..................................... -- -- -- --
-------- ----- -------- -----
Outstanding as of December 31, 1996.......... 257,690 0.01 -- --
Issued..................................... -- -- 435,281 0.01
Cancelled.................................. (34,776) 0.01 -- --
Exercised.................................. -- -- (928) 0.01
Exchanged.................................. (20,618) 0.01 20,618 0.01
-------- ----- -------- -----
Outstanding as of December 31, 1997.......... 202,296 0.01 454,971 0.01
Exercised.................................. (202,296) 0.01 (454,971) 0.01
-------- ----- -------- -----
Outstanding as of December 31, 1998.......... -- $ -- -- $ --
======== ===== ======== =====
Warrants exercisable at December 31, 1997.... 202,296 $0.01 454,971 $0.01
======== ===== ======== =====
</TABLE>
The fair value of each warrant is estimated on the date of grant based on
the Black-Scholes option pricing model assuming among other things, no dividend
yield, a risk-free interest rate of 6.59%, an expected volatility of 0.70 and
expected life of 8-10 years.
F-24
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
Pro Forma Results
Had we accounted for our stock options in accordance with SFAS No. 123, pro
forma income (loss) before extraordinary item and cumulative effect of change
in accounting principle and net income (loss), and pro forma income (loss)
before extraordinary item and cumulative effect of charge in accounting
principle and net income (loss) attributable to common stockholders would have
been as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
December 31,
-----------------------
1996 1997 1998
------- ------- ------
<S> <C> <C> <C>
Pro forma income (loss) before extraordinary item
and cumulative effect of change in accounting
principle....................................... $ 1,475 $ (505) $3,754
Pro forma net income (loss)...................... 1,475 (923) 3,549
Pro forma income (loss) before extraordinary item
and cumulative effect of change in accounting
principle attributable to common stockholders... 117 (8,932) 1,327
Pro forma net income (loss) attributable to
common stockholders............................. 117 (9,350) 1,122
======= ======= ======
Pro forma diluted income (loss) before
extraordinary item and cumulative effect of
change in accounting principle per share
attributable to common stockholders............. $ 0.11 $(11.63) $0.20
======= ======= ======
Pro forma diluted net income (loss) per share
attributable to common stockholders............. $ 0.11 $(12.17) $0.17
======= ======= ======
</TABLE>
The pro forma disclosure is not likely to be indicative of pro forma results
which may be expected in future years because of the fact that options vest
over several years, pro forma compensation expense is recognized as the options
vest and additional awards may also be granted.
11. INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31,
1996, 1997 and 1998, consists of the following (in thousands):
<TABLE>
<CAPTION>
For the Year Ended
December 31,
---------------------
1996 1997 1998
---- ------- ------
<S> <C> <C> <C>
Current--
Federal.......................................... $150 $ 685 $3,688
State and local.................................. 260 (3) 973
---- ------- ------
Total current.................................. 410 682 4,661
---- ------- ------
Deferred--
Federal.......................................... (172) (578) (923)
State and local.................................. (30) (76) (182)
Foreign.......................................... -- (359) (206)
---- ------- ------
Total deferred................................. (202) (1,013) (1,311)
---- ------- ------
Total provision (benefit) for income taxes......... $208 $ (331) $3,350
==== ======= ======
</TABLE>
F-25
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
A reconciliation of the statutory U.S. federal income tax rate to the
effective income tax rate for the years ended December 31, 1996, 1997 and 1998,
is as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
--------------------
1996 1997 1998
----- ----- ----
<S> <C> <C> <C>
Statutory U.S. Federal income tax rate.............. 34.0 % (34.0)% 34.0%
Foreign taxes....................................... -- (8.7) (0.3)
State income taxes, net of Federal benefit.......... 10.0 (6.6) 6.7
Permanent differences and other..................... 4.8 7.6 2.3
Valuation allowance................................. (36.6) -- --
----- ----- ----
Effective income tax rate........................... 12.2% (41.7)% 42.7%
===== ===== ====
</TABLE>
Components of deferred income tax assets and liabilities consist of the
following at December 31, 1997 and 1998 (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------
1997 1998
------ ------
<S> <C> <C>
Deferred income tax assets:
Tax net operating loss carryforwards.......................... $ 891 $1,788
Stock options................................................. -- 872
Allowance for doubtful accounts............................... 285 320
Amortization on covenants not-to-compete...................... 926 2,086
Other......................................................... 121 488
------ ------
Total deferred income tax assets............................ 2,223 5,554
------ ------
Deferred income tax liabilities:
Depreciation and amortization................................. 3,032 4,134
Other......................................................... -- 95
------ ------
Total deferred income tax liabilities....................... 3,032 4,229
------ ------
Net deferred income tax (liability) asset................... $ (809) $1,325
====== ======
</TABLE>
We have purchased certain tax net operating loss carryforwards in connection
with our business acquisitions. At December 31, 1998 we have federal and state
net operating loss carryforwards totalling $1.5 million and $8.4 million
respectively. We have not recorded a valuation allowance because we believe
that deferred income tax assets will be realized in the future.
12. COMMITMENTS AND CONTINGENCIES
Litigation
We are subject to occasional lawsuits, investigations and claims arising out
of the normal conduct of our business. In some cases, claims against acquired
businesses relating to events which occurred during the periods we did not own
them are indemnified by the former owners. Management does not believe the
outcome of any pending claims will have a material adverse impact on our
financial position or results of operations.
Leases
We rent most of our school facilities and certain equipment under non-
cancelable operating leases expiring at various dates through 2009. The
facility leases require us to make monthly payments covering rent, taxes,
insurance and maintenance costs. Rent expense, exclusive of taxes, insurance
and maintenance of the facilities and equipment for the years ended December
31, 1996, 1997 and 1998 was approximately $2,649,000, $8,049,000, and
$14,304,000, respectively.
F-26
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
Future minimum lease payments under these leases as of December 31, 1998,
are as follows (in thousands):
<TABLE>
<CAPTION>
Capital Operating
Leases Leases Total
------- --------- -------
<S> <C> <C> <C>
1999........................................... $382 $14,375 $14,757
2000........................................... 193 13,468 13,661
2001........................................... 75 11,550 11,625
2002........................................... 9 8,822 8,831
2003........................................... -- 7,833 7,833
2004 and thereafter............................ -- 24,432 24,432
---- ------- -------
659 $80,480 $81,139
======= =======
Less--Portion representing interest at a
weighted average rate of 10.5%................ 136
----
Principal payments............................. 523
Less--Current portion.......................... 302
----
$221
====
</TABLE>
On October 29, 1998, we entered into an agreement with Le Cordon Bleu
Limited granting us exclusive rights to use the "Le Cordon Bleu" name in the
United States and Canada in connection with our culinary education programs. We
are developing a curriculum with Le Cordon Bleu for use at our culinary schools
and upon approval of the curriculum, we will issue Le Cordon Bleu 50,601 shares
of Common Stock and one year later an additional 50,601 shares of Common Stock.
Under this agreement we will also pay Le Cordon Bleu royalties based on tuition
collected from students enrolled in Le Cordon Bleu programs at our schools. The
agreement expires on December 31, 2008 but can be renewed for two successive
five year terms.
13. REGULATORY
CEC and our U.S. schools are subject to extensive regulation by federal and
state governmental agencies and accrediting bodies. In particular, the Higher
Education Act ("HEA"), and the regulations promulgated thereunder by the U.S.
Department of Education ("DOE") subject our U.S. schools to significant
regulatory scrutiny on the basis of numerous standards that schools must
satisfy in order to participate in the various federal student financial
assistance programs under Title IV of the HEA ("Title IV Programs").
To participate in the Title IV Programs, an institution must be authorized
to offer its programs of instruction by the relevant agencies of the state in
which it is located, accredited by an accrediting agency recognized by the DOE
and certified as eligible by the DOE. The DOE will certify an institution to
participate in the Title IV Programs only after the institution has
demonstrated compliance with the HEA and the DOE's extensive regulations
regarding institutional eligibility. An institution must also demonstrate its
compliance to the DOE on an ongoing basis.
Political and budgetary concerns significantly affect the Title IV Programs.
Congress must reauthorize the HEA approximately every six years. The most
recent reauthorization in October 1998 reauthorized the HEA for an additional
five years (the "1998 HEA Reauthorization"). Congress reauthorized all of the
Title IV Programs in which our schools participate, generally in the same form
and at funding levels no less than for the prior year. Changes made by the 1998
HEA Reauthorization include (i) expanding the adverse effects on schools of
high student loan default rates, (ii) increasing from 85% to 90% the portion of
a proprietary school's revenue that may be derived each year from the Title IV
Programs, (iii) revising the refund standards that require an
F-27
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
institution to return a portion of the Title IV Program funds for students who
withdraw from school and (iv) giving the Department of Education flexibility to
continue an institution's Title IV participation without interruption in some
circumstances following a change of ownership or control.
A significant component of Congress' initiative to reduce abuse in the Title
IV Programs has been the imposition of limitations on institutions whose former
students default on the repayment of their federally guaranteed or funded
student loans above specific rates (cohort default rate). An institution whose
cohort default rates equal or exceed 25% for three consecutive years will no
longer be eligible to participate in the FFEL or FDL programs. An institution
whose cohort default rate under certain Title IV programs for any federal
fiscal year exceeds 40% may have its eligibility to participate in all of the
Title IV Programs limited, suspended or terminated by the DOE.
All institutions participating in the Title IV Programs must satisfy
specific standards of financial responsibility. The DOE evaluates institutions
for compliance with these standards each year, based on the institution's
annual audited financial statements and following a change of ownership of the
institution. In reviewing our financial statements, it has been the DOE's
practice to measure financial responsibilities on the basis of the financial
statements of both our institutions and CEC on a consolidated basis.
Under new regulations which took effect July 1, 1998, the DOE calculates the
institution's composite score based on its (i) equity ratio, which measures the
institution's capital resources, ability to borrow and financial viability;
(ii) primary reserve ratio, which measures the institution's ability to support
current operations from expendable resources; and (iii) net income ratio, which
measures the institution's ability to operate at a profit. An institution that
does not meet the DOE's minimum composite score may demonstrate its financial
responsibility by posting a letter of credit in favor of the DOE in an amount
equal to at least 50% of the Title IV Program funds received by the institution
during its prior fiscal year and possibly accepting other conditions on its
participation in the Title IV Programs.
In periodic reviews of our financial statements for 1997 and prior years, as
well as our February 28, 1998 balance sheet reflecting the results of our
initial public offering, the DOE has questioned certain accounting matters and
has found that we and certain of our institutions, when measured on an
individual basis failed the numeric tests under the DOE's former and current
standards of financial responsibility. To satisfy the DOE's concerns, we have
posted letters of credit on behalf of all institutions we have acquired since
October 1996 except Harrington. The DOE reduced the number and amount of our
letters of credit in September 1998 following its review of our 1997 financial
statements and our February 28, 1998 balance sheet. The DOE also noted that the
funds derived from our initial public offering, shortly after the close of our
1997 fiscal year, would have a positive effect on our financial responsibility.
As a result, we currently have posted letters of credit totaling approximately
$17.6 million on behalf of Gibbs, IAMD, Scottsdale, SCSCA, and Western.
We intend to file our audited 1998 financial statements with the DOE early
in 1999 and to ask it to release most, if not all, of our outstanding letters
of credit and to increase or eliminate the Title IV Program funding limitation
for SCSCA. At December 31, 1998, we believe, based on our audited 1998
financial statements, that we satisfy each of the DOE's standards of financial
responsibility and may participate in Title IV Programs without additional
monitoring. However, we believe that two of our institutions, while considered
financially responsible, may be subject to additional monitoring by the DOE. In
the event that the DOE does not measure the financial responsibility of such
institutions on the basis of the financial position of CEC, the DOE may require
us to post letters of credit on behalf of such institutions. Such letters of
credit, which would be calculated on an institution-specific basis, would be in
amounts substantially less than the letters of credit we
F-28
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
currently have outstanding. To the extent the outstanding letters of credit are
reduced or eliminated based upon the DOE's review, we will have additional
availability under the Credit Agreement.
The DOE also assesses the administrative capability of each institution that
participates in the Title IV Program. In addition, each institution is required
to apply to the DOE for continued certification to participate in the Title IV
Programs at least every six years, or when it undergoes a change of control,
opens an additional location or raises the highest academic credential it
offers.
When we acquire an institution that is eligible to participate in the Title
IV Programs, that institution undergoes a change of ownership resulting in a
change of control ("change of control") as defined by the DOE. Upon a change of
control, an institution's eligibility to participate in the Title IV Programs
is generally suspended until it has applied for and been recertified by the DOE
as an eligible institution under our ownership, which requires that the
institution also reestablish its state authorization and accreditation. If an
institution is recertified following a change of control, it will be on a
provisional basis. The 1998 HEA Reauthorization provides that the DOE may
provisionally and temporarily certify an institution undergoing a change of
control under certain circumstances while the DOE reviews the institution's
application. The DOE has not yet issued regulations or guidance regarding how
it will interpret or apply this amendment to the HEA. Each of the U.S.
institutions we have acquired has undergone a certification review under our
ownership and has been certified to participate in the Title IV Programs, with
the exception of Harrington, which we acquired in January, 1999.
Each of the U.S. institutions we have acquired has undergone a certification
review under our ownership and has been certified to participate in the Title
IV Programs, with the exception of Harrington, which we acquired in January
1999.
In Canada, there are several government programs which provide students
attending eligible institutions with government funding. The provisions
governing an eligible institution vary by province and generally require an
institution's programs qualifying for funding to meet certain rules and
regulations and also to have the administration of the program independently
audited.
14. RELATED-PARTY TRANSACTIONS
We have short-term employment and consulting agreements with certain
stockholders. Total expenses under these agreements were approximately
$298,000, $367,000 and $493,000, for the years ended December 31, 1996, 1997
and 1998, respectively.
15. EMPLOYEE BENEFIT PLANS
We maintain a contributory profit sharing plan established pursuant to the
provisions of Section 401(k) of the Internal Revenue Code that provides
retirement benefits for our eligible employees. This plan requires matching
contributions to eligible employees. Our matching contributions were $279,000,
$400,000, and $699,000 for the years ended December 31, 1996, 1997 and 1998,
respectively.
F-29
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1996, 1997 and 1998
We maintain an employee stock purchase plan which provides for the issuance
of up to 500,000 shares of common stock to be purchased by our eligible
employees through periodic offerings. Our employees may purchase common stock
through payroll deductions (not to exceed $20,000 per person within any
calendar year) at 85% of the fair market value.
F-30
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Career Education Corporation
Hoffman Estates, Illinois
We have audited the accompanying statements of consolidated operations and
accumulated deficit and of cash flows of The Katharine Gibbs Schools, Inc. and
subsidiaries (a wholly-owned subsidiary of PRIMEDIA Inc., formerly K-III
Communications Corporation) (the "Company") for the years ended December 31,
1995 and 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with 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, such consolidated financial statements present fairly, in
all material respects, the results of the Company's operations and its cash
flows for the years ended December 31, 1995 and 1996 in conformity with
generally accepted accounting principles.
DELOITTE & TOUCHE LLP
New York, New York
October 27, 1997
F-31
<PAGE>
THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED OPERATIONS AND ACCUMULATED DEFICIT
For the Years Ended December 31, 1995 and 1996
(Dollars In Thousands)
<TABLE>
<CAPTION>
1995 1996
------- -------
<S> <C> <C>
REVENUES:
Tuition and registration fees, net......................... $22,343 $25,831
Other, net................................................. 2,507 2,932
------- -------
Total revenues........................................... 24,850 28,763
------- -------
OPERATING COSTS AND EXPENSES:
Instruction................................................ 5,945 6,427
Selling, general and administrative........................ 16,937 18,991
Depreciation and amortization.............................. 2,400 2,235
Management fees charged by PRIMEDIA Inc.................... 354 397
------- -------
Total operating costs and expenses....................... 25,636 28,050
------- -------
INCOME (LOSS) FROM OPERATIONS................................ (786) 713
INTEREST EXPENSE............................................. 1,394 1,038
------- -------
NET LOSS..................................................... (2,180) (325)
ACCUMULATED DEFICIT, BEGINNING OF YEAR....................... (256) (2,436)
------- -------
ACCUMULATED DEFICIT, END OF YEAR............................. $(2,436) $(2,761)
======= =======
</TABLE>
See notes to consolidated financial statements.
F-32
<PAGE>
THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
For the Years Ended December 31, 1995 and 1996
(Dollars In Thousands)
<TABLE>
<CAPTION>
1995 1996
------- -------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss.................................................... $(2,180) $ (325)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization.............................. 2,400 2,235
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable--students............................ 463 397
Accounts receivable--other............................... (195) (174)
Prepaid expenses and other current assets................ (121) 496
Other non-current assets................................. (29) (75)
Increase (decrease) in:
Accounts payable and accrued expenses.................... 1,087 (209)
Advance student payments and other current liabilities... (1,158) 14
Deferred tuition revenue................................. 639 (655)
Other non-current liabilities............................ 199 152
------- -------
Net cash provided by operating activities............. 1,105 1,856
------- -------
INVESTING ACTIVITIES:
Purchases of property and equipment......................... (1,025) (1,157)
Investment in Perkins loan program, net..................... 9 21
------- -------
Net cash used in investing activities................. (1,016) (1,136)
------- -------
FINANCING ACTIVITIES:
Principal payments under capital lease obligations.......... (85) (103)
Increase in payable to PRIMEDIA Inc......................... 1,666 172
------- -------
Net cash provided by financing activities............. 1,581 69
------- -------
NET INCREASE IN CASH......................................... 1,670 789
CASH, BEGINNING OF PERIOD.................................... 3,837 5,507
------- -------
CASH, END OF PERIOD.......................................... $ 5,507 $ 6,296
======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid............................................... $ 26 $ 16
======= =======
NON-CASH INVESTING AND FINANCING ACTIVITIES--
Equipment acquired under capital lease obligations.......... $ 57 $ 86
======= =======
</TABLE>
See notes to consolidated financial statements.
F-33
<PAGE>
THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Years Ended December 31, 1995 and 1996
(Dollars In Thousands)
1. DESCRIPTION OF THE BUSINESS AND GENERAL
The Katharine Gibbs Schools, Inc. (which together with its subsidiaries is
herein referred to as the "Company") is headquartered in New York, New York,
and has wholly-owned subsidiary campuses in New York, New York; Melville, New
York; Boston, Massachusetts; Montclair, New Jersey; Piscataway, New Jersey;
Norwalk, Connecticut; and Providence, Rhode Island. The schools are private
post-secondary vocational schools which are engaged in the instruction of
business career education programs leading towards degrees or certificates of
completion in secretarial arts, business administration, hospitality
management, and hotel and restaurant management.
On March 7, 1994, the operating assets and liabilities of the Company were
acquired from Phillips Colleges, Inc. by The Katharine Gibbs Schools, Inc.
(formerly K-III KG Holdings Corporation), a wholly-owned subsidiary of PRIMEDIA
Inc. (formerly K-III Communications Corporation) (the ultimate parent company,
"PRIMEDIA").
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation--The consolidated financial statements include
the accounts of The Katharine Gibbs Schools, Inc. and its subsidiaries. All
significant intercompany transactions and balances have been eliminated in
consolidation.
Concentration of Credit Risk--The Company extends unsecured credit for
tuition to a significant portion of the students who are in attendance at the
schools. A substantial portion of credit extended to students is repaid through
the student's participation in Federally funded financial aid programs. The
Company generally completes and approves the financial aid packet of each
student who qualifies for financial aid prior to the student's beginning of
class in an effort to enhance the collectibility of its unsecured credit.
Transfers of funds from the financial aid programs to the Company are made in
accordance with the United States Department of Education (the "DOE")
requirements.
The Company participates in various Federal student financial aid programs
under Title IV of the Higher Education Act of 1965, as amended ("Title IV
Programs"). Approximately 62% and 63% of the Company's net revenue was
collected from funds distributed under these programs for 1995 and 1996,
respectively.
Marketing and Advertising Costs--Marketing and advertising costs are
expensed as incurred. Marketing and advertising costs included in selling,
general and administrative expenses were $4,282 and $5,687 for 1995 and 1996,
respectively.
Property and Equipment, Net--Depreciation and amortization are recognized
utilizing the straight-line method over their useful lives. Leasehold
improvements are amortized over their useful lives or lease term, whichever is
shorter. Improvements are capitalized while maintenance and repairs are
expensed as incurred.
Intangible Assets--Intangible assets include the excess of purchase price
over net assets acquired resulting from the business acquisition described in
Note 1. Intangible assets are being amortized on a straight-line basis over
their estimated useful life ranging from two to forty years.
F-34
<PAGE>
THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Years Ended December 31, 1995 and 1996
(Dollars In Thousands)
The recoverability of the carrying values of the excess of the purchase
price over the net assets acquired and other intangible assets is evaluated
quarterly to determine if an impairment in value has occurred. An impairment in
value will be considered to have occurred when it is determined that the
undiscounted future operating cash flows generated by the acquired business is
not sufficient to recover the carrying values of such intangible assets. If it
has been determined that an impairment in value has occurred, the excess of the
purchase price over the net assets acquired and other intangible assets would
be written down to an amount which will be equivalent to the present value of
the future operating cash flows to be generated by the acquired business.
Revenue Recognition--Revenue is derived primarily from courses taught at the
schools. Tuition revenue is recognized ratably over the length of the
applicable course. Textbook sales and other revenues are recognized as services
are performed. If a student withdraws, future revenue would be reduced by the
amount of refund due to the student. Refunds are calculated in accordance with
Federal, state and accrediting agency standards.
Deferred Rent Obligations--Certain of the schools' facility leases include
rental concessions, as defined in the various lease agreements. The Company
recognizes rent expense on a straight-line basis over the terms of the various
leases, ranging from 7 to 11 years. Rent expense recognized differs from the
actual cash payments required to be made under these lease agreements.
Use of Estimates--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make certain
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reported periods. Actual results may differ from these estimates. In
1996, the Company recorded an adjustment to reduce certain liabilities
established in prior periods, which decreased net loss by approximately $341.
3. INCOME TAXES
The results of operations of the Company are included in the consolidated
Federal income tax return of PRIMEDIA. The income tax provision has been
computed as if the Company filed a separate return. At December 31, 1996, the
Company, on a stand-alone basis, had aggregate net operating loss carryforwards
of approximately $4,200 for Federal and state income taxes. As a result of the
disposition of the Company on May 31, 1997, as discussed in Note 7, PRIMEDIA
will retain all net operating losses up to the date of disposition. Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts for income tax purposes.
4. COMMITMENTS AND CONTINGENCIES
Operating Leases--The Company rents seven of its eight administrative and
classroom facilities and certain equipment under noncancellable operating
leases. The facility leases require the Company to make monthly payments
covering rent, taxes, insurance and maintenance costs and expire at various
times through 2007. Rent expense under operating leases exclusive of taxes,
insurance and maintenance of the facilities and equipment for 1995 and 1996,
was approximately $3,418 and $4,098, respectively.
F-35
<PAGE>
THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Concluded)
For the Years Ended December 31, 1995 and 1996
(Dollars In Thousands)
Litigation--The Company is subject to occasional lawsuits, investigations
and claims arising out of the normal conduct of its business. Management does
not believe the outcome of any of these legal actions and claims will have a
material adverse impact on the Company's consolidated financial statements.
Regulatory--Each of the Company's schools has Federal financial assistance
programs which are subject to ongoing program reviews by the DOE, Title IV
program audits by external auditors and state program audits by state agencies.
Any regulatory violation could be the basis for the initiation of a suspension,
limitation or termination proceeding against the Company. To minimize risks
associated with noncompliance, the Company conducts periodic reviews of its
schools' financial conditions. Changes in DOE funding of Federal student
financial aid programs could impact the Company's ability to attract students.
Each of the Company's schools is also required to meet certain financial and
other standards in order to qualify to participate in Title IV programs. These
include maintaining an acid test ratio (defined as cash, cash equivalents and
current accounts receivable to current liabilities) of at least 1:1, having a
positive tangible net worth at the end of each fiscal year, collecting less
than 85% of its education revenues from Title IV funds on an annual basis, not
having cumulative net operating losses during its two most recent fiscal years
that result in a decline of more than 10% of the individual school's tangible
net worth at the beginning of that two-year period, and not having cohort
default rates on Federal student loans that equal or exceed 25% for three
consecutive federal fiscal years, amongst others. At December 31, 1996, each of
the Company's schools was in compliance with such requirements.
5. TRANSACTIONS WITH PARENT COMPANY
The note payable to PRIMEDIA accrues interest at PRIMEDIA's weighted average
borrowing rate. Interest expense of $1,368 and $1,022 on the note payable to
PRIMEDIA has been recorded for 1995 and 1996, respectively. The Company pays
PRIMEDIA management fees for costs and expenses incurred by PRIMEDIA on behalf
of the Company for certain services, including treasury, consulting, insurance,
tax, financing and other services.
6. EMPLOYEE BENEFIT PLANS
The Company participates in a PRIMEDIA contributory profit sharing plan,
established pursuant to the provisions of Section 401(k) of the Internal
Revenue Code, that provides retirement benefits for eligible employees of the
Company. This plan requires matching contributions to eligible employees. The
Company's matching contributions were $12, and $23 for 1995 and 1996,
respectively.
7. SUBSEQUENT EVENTS
On May 31, 1997, PRIMEDIA sold 100% of the outstanding shares of capital
stock of the Company to Career Education Corporation ("CEC") for approximately
$20,000. The sales price is subject to certain adjustments. In connection with
the sale, PRIMEDIA also entered into a covenant not-to-compete agreement with
CEC for proceeds totaling $7,000. The covenant not-to-compete restricts
PRIMEDIA's ability to own or operate certain types of post-secondary vocational
schools for a period of five years.
F-36
<PAGE>
THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Six Months Ended June 30, 1996, and
For the Five Months Ended May 31, 1997
(Unaudited, dollars in thousands)
<TABLE>
<CAPTION>
June 30, 1996 May 31, 1997
------------- ------------
<S> <C> <C>
REVENUE:
Tuition and registration
fees, net................ $12,179 $11,606
Other, net................ 1,316 1,222
------- -------
Total net revenue....... 13,495 12,828
------- -------
OPERATING COSTS AND
EXPENSES:
Instruction............... 3,247 3,029
Selling, general and
administrative........... 9,261 8,028
Depreciation and
amortization............. 1,199 901
Management fees charged by
PRIMEDIA, Inc............ 82 15
------- -------
Total operating
expenses............... 13,789 11,973
------- -------
Income (loss) from
operations............. (294) 855
------- -------
INTEREST EXPENSE............ 509 242
------- -------
Income (loss) before
provision for income
taxes.................. (803) 613
PROVISION FOR INCOME TAXES.. -- --
------- -------
NET INCOME (LOSS)........... $ (803) $ 613
======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
F-37
<PAGE>
THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 1996, and
For the Five Months Ended May 31, 1997
(Unaudited, dollars in thousands)
<TABLE>
<CAPTION>
June
30, May 31,
1996 1997
------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES.......................... $(1,436) $(1,057)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net.................... (542) (134)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in Payable to PRIMEDIA, Inc............. 2,464 (3,948)
------- -------
NET INCREASE (DECREASE) IN CASH............................... 486 (5,139)
CASH, beginning of period..................................... 5,506 6,296
------- -------
CASH, end of period........................................... $ 5,992 $ 1,157
======= =======
NONCASH INVESTING AND FINANCING ACTIVITIES:
Capital leases entered into for the purchase of equipment... $ 34 $ 158
======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
F-38
<PAGE>
THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1996, and May 31, 1997
1. BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and Article 10 of Regulation S-X. Accordingly, they do
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 only of normal recurring adjustments)
considered necessary for a fair presentation of financial position and the
results of operations and cash flows have been included, and the disclosures
made are adequate to prevent the information presented from being misleading.
Operating results for the six months ended June 30, 1996, and the five months
ended May 31, 1997, are not necessarily indicative of the results that may be
expected for the fiscal years ended December 31, 1996 and 1997. These financial
statements should be read in conjunction with, and have been prepared in
conformity with the accounting principles reflected in the financial statements
and related notes of The Katharine Gibbs Schools, Inc. and Subsidiaries (the
"Company") as of and for the year ended December 31, 1996.
2. SUBSEQUENT EVENTS
On May 31, 1997, PRIMEDIA, Inc. (formerly K-III Communications Corporation)
("PRIMEDIA"), the sole shareholder of the Company, sold 100% of the outstanding
shares of capital stock of the Company to Career Education Corporation ("CEC")
for approximately $20,000,000. The sales price is subject to certain
adjustments. In connection with the sale, PRIMEDIA also entered into a covenant
not-to-compete agreement with CEC for proceeds totaling $7,000,000. The
covenant not-to-compete restricts PRIMEDIA's ability to own or operate certain
types of postsecondary vocational schools for five years.
3. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reported period. Actual results could differ from these estimates.
F-39
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of
Scottsdale Culinary Institute, Inc.:
We have audited the accompanying balance sheets of SCOTTSDALE CULINARY
INSTITUTE, INC. (a Delaware corporation) as of December 31, 1996 and 1997, and
the related statements of operations and retained earnings and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with 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, the financial statements referred to above present fairly,
in all material respects, the financial position of Scottsdale Culinary
Institute, Inc. as of December 31, 1997 and 1996, and the results of its
operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.
Arthur Andersen LLP
Chicago, Illinois
September 25, 1998 (except
with respect to the matter
discussed in Note 7, as to
which the date is December
17, 1998)
F-40
<PAGE>
SCOTTSDALE CULINARY INSTITUTE, INC.
BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
December 31
----------- June 30
1996 1997 1998
----- ----- -----------
ASSETS (Unaudited)
<S> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................................. $ 359 $ 288 $ 766
Receivables, net of allowance for doubtful accounts of $5. 264 388 375
Inventories and other current assets...................... 62 63 64
----- ----- ------
Total current assets.................................. 685 739 1,205
PROPERTY AND EQUIPMENT, net of accumulated depreciation and
amortization............................................... 270 201 187
OTHER ASSETS................................................ 14 15 15
----- ----- ------
TOTAL ASSETS................................................ $ 969 $ 955 $1,407
===== ===== ======
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
<S> <C> <C> <C>
CURRENT LIABILITIES:
Accounts payable, accrued expenses and other current
liabilities.............................................. $ 251 $ 199 $ 163
Deferred tuition revenue.................................. 355 338 299
----- ----- ------
Total current liabilities............................. 606 537 462
LONG-TERM DEBT, net of current portion...................... 31 17 15
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock, no par value; 1,000,000 shares authorized;
51,000 shares issued and outstanding at December 31,
1997, December 31, 1996 and June 30, 1998................ 51 51 51
Additional paid-in capital................................ 145 145 145
Retained earnings......................................... 136 205 734
----- ----- ------
Total shareholders' equity............................ 332 401 930
----- ----- ------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $ 969 $ 955 $1,407
===== ===== ======
</TABLE>
The accompanying notes are an integral part of these statements.
F-41
<PAGE>
SCOTTSDALE CULINARY INSTITUTE, INC.
STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
(Dollars in thousands)
<TABLE>
<CAPTION>
For the Years For the Six Months
Ended December 31 Ended June 30
------------------ --------------------
1996 1997 1997 1998
-------- -------- --------- ---------
(Unaudited)
<S> <C> <C> <C> <C>
REVENUE:
Tuition and registration fees, net. $ 3,823 $ 4,428 $ 2,272 $ 2,469
Other, net......................... 408 415 221 232
-------- -------- --------- ---------
Total net revenue.............. 4,231 4,843 2,493 2,701
OPERATING EXPENSES:
Educational services and
facilities........................ 2,445 2,565 1,323 1,168
General and administrative......... 1,097 1,292 565 575
Depreciation and amortization...... 107 94 46 38
Rent paid to related party......... -- 62 -- 162
-------- -------- --------- ---------
Total operating expenses....... 3,649 4,013 1,934 1,943
-------- -------- --------- ---------
Income from operations......... 582 830 559 758
OTHER INCOME, net.................... 33 62 5 11
-------- -------- --------- ---------
NET INCOME........................... 615 892 564 769
Retained earnings, beginning of
period.............................. 250 136 136 205
Distributions to shareholders........ (729) (823) (206) (240)
-------- -------- --------- ---------
RETAINED EARNINGS, END OF PERIOD..... $ 136 $ 205 $ 494 $ 734
======== ======== ========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
F-42
<PAGE>
SCOTTSDALE CULINARY INSTITUTE, INC.
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
For the Six
For the Years Ended Months
December 31 Ended June 30
-------------------- --------------
1996 1997 1997 1998
--------- --------- ------ ------
(Unaudited)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................. $ 615 $ 892 $ 564 $ 769
Adjustments to reconcile net income to
net cash provided by operating
activities--
Depreciation and amortization........ 107 94 46 38
Loss on disposal of asset............ 1 3 1 --
Changes in operating assets and
liabilities--
Receivables, net................... (21) (124) (69) 13
Inventories and other current
assets............................ 7 (1) (2) (1)
Accounts payable, accrued expenses
and other current liabilities..... 95 (44) (29) (36)
Deferred tuition revenue........... (286) (17) 62 (39)
--------- --------- ------ ------
Net cash provided by operating
activities...................... 518 803 573 744
--------- --------- ------ ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment..... (134) (28) (3) (24)
Other assets........................... 2 (1) 1 --
--------- --------- ------ ------
Net cash used in investing
activities...................... (132) (29) (2) (24)
--------- --------- ------ ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Distributions to shareholders.......... (729) (823) (206) (240)
Repayments of long-term debt........... (14) (22) (10) (2)
Proceeds from issuance of long-term
debt.................................. 31 -- -- --
--------- --------- ------ ------
Net cash used in financing
activities...................... (712) (845) (216) (242)
--------- --------- ------ ------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS............................. (326) (71) 355 478
CASH AND CASH EQUIVALENTS, beginning of
period.................................. 685 359 359 288
--------- --------- ------ ------
CASH AND CASH EQUIVALENTS, end of period. 359 288 714 766
========= ========= ====== ======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for
interest.............................. 2 2 -- 16
========= ========= ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
F-43
<PAGE>
SCOTTSDALE CULINARY INSTITUTE, INC.
NOTES TO FINANCIAL STATEMENTS
(Information for the Six Months Ended June 30, 1997 and 1998 is Unaudited)
1. DESCRIPTION OF THE BUSINESS
Scottsdale Culinary Institute, Inc. (the "Company" or the "School") was
incorporated in June 1986 for the purpose of operating a school to provide
professional culinary education. The School, located in Scottsdale, Arizona,
provides professional culinary education leading to an Associate of
Occupational Studies degree in Culinary Arts and Sciences and Restaurant
Management. The School also operates a restaurant open to the public.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The financial statements and related notes thereto for the six months ended
June 30, 1997 and 1998 are unaudited and have been prepared on the same basis
as the audited financial statements included herein. In the opinion of
management, such unaudited financial statements include all adjustments
(consisting of normal recurring adjustments) necessary to present fairly
information set forth herein. Operating results for the six months ended June
30, 1998 are not necessarily indicative of results that may be expected for the
fiscal year ending December 31, 1998. The principal accounting policies of the
Company are as follows:
Concentration of Credit Risk
The Company extends unsecured credit for tuition to a significant portion of
the students who are in attendance at the School. A substantial portion of
credit extended to students is repaid through the students' participation in
federally funded financial aid programs under Title IV of the Higher Education
Act of 1965, as amended ("Title IV Programs"). Approximately 58%, 55%, 57% and
55% of the Company's net revenue was collected from Title IV Program funds for
the years ended December 31, 1996 and 1997 and for the six months ended June
30, 1997 and 1998, respectively. The Company generally completes and approves
the financial aid packet of each student who qualifies for financial aid prior
to the student's beginning class in an effort to enhance the collectibility of
its unsecured credit. Transfers of funds from the financial aid programs to the
Company are made in accordance with DOE requirements. Changes in DOE funding of
federal student financial aid programs could impact the Company's ability to
attract students.
Cash and Cash Equivalents
Cash and cash equivalents consists of cash in banks and money market funds.
Restricted Cash
Cash received from the U. S. Government under various student aid grant and
loan programs is considered to be restricted. Restricted cash is held in
separate bank accounts and does not become available for general use by the
Company until the financial aid is credited to the accounts of students and the
cash is transferred to an operating account. There is no restricted cash
included in the cash and cash equivalents balance at December 31, 1996,
December 31, 1997 and June 30, 1998.
Inventories
Inventories consisting principally of food and beverage, program materials,
books and supplies are stated at the lower of cost, determined on a first-in,
first-out basis or market.
F-44
<PAGE>
SCOTTSDALE CULINARY INSTITUTE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are
recognized utilizing the straight-line method over the related assets useful
lives. Leasehold improvements and assets recorded under capital leases are
amortized on a straight-line basis over the shorter of the estimated useful
life of the asset or the lease term. The cost basis and estimated useful lives
of property and equipment at December 31, 1996, December 31, 1997 and June 30,
1998, are as follows (dollars in thousands):
<TABLE>
<CAPTION>
December 31
----------- June 30
Asset Description 1996 1997 1998 Life
----------------- ----- ----- ------- ----------
<S> <C> <C> <C> <C>
Classroom equipment and other instructional
materials...................................... $ 492 $ 469 $478 5-10 years
Leasehold improvements.......................... 266 265 280 3-10 years
----- ----- ----
758 734 758
Less--Accumulated depreciation and amortization. 488 533 571
----- ----- ----
$ 270 $ 201 $187
===== ===== ====
</TABLE>
The Company reviews long-lived assets for impairment whenever events or
circumstances indicate that carrying amounts may not be recoverable. To date,
no such events or changes in circumstances have occurred. If such events or
changes in circumstances occur, the Company will recognize an impairment loss
if the undiscounted future cash flows expected to be generated by the asset (or
acquired business) are less than the carrying value of the related asset. The
impairment loss would adjust the asset to its fair value.
Revenue Recognition
Revenue is derived primarily from courses taught at the School. Tuition
revenue is recognized on a straight-line basis during the period of instruction
provided by the School. Other revenues consist of restaurant revenues and are
recognized as services are performed. If a student withdraws, future revenue is
reduced by the amount of refund due to the student. Refunds are calculated in
accordance with federal, state and accrediting agency standards. Deferred
tuition revenue represents the portion of tuition payments received but not
earned and is reflected as a current liability on the balance sheet as such
amount is expected to be earned within the next year.
Marketing and Advertising Costs
Marketing and advertising costs are expensed as incurred. Marketing and
advertising costs included in general and administrative expenses were
approximately $221,000, $191,000, $93,000 and $113,000 for the years ended
December 31, 1996 and 1997 and the six months ended June 30, 1997 and 1998,
respectively.
Income Taxes
The Company has elected to be treated as an S Corporation under the
provisions of Subchapter S of the Internal Revenue Code. Accordingly, the
shareholders of the Company are responsible for the federal taxes arising from
its operations. Therefore, no provision or liability for federal income taxes
has been included in these financial statements.
Use of Estimates
The preparation of financial statements, in conformity with generally
accepted accounting principles, requires management to make certain estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reported
period. Actual results could differ from these estimates.
F-45
<PAGE>
SCOTTSDALE CULINARY INSTITUTE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
3. LINE OF CREDIT
At December 31, 1996 and December 31, 1997, the Company had available a line
of credit providing for borrowings of up to $200,000, bearing interest at the
bank's reference rate plus 1.5%. The line of credit contains certain financial
covenants and is guaranteed by the shareholders. The line of credit was not
utilized at December 31, 1996 and December 31, 1997, and expired in April 1998.
4. COMMITMENTS AND CONTINGENCIES
Regulatory
The Company has federal financial assistance programs that are subject to
ongoing program reviews by the DOE and Title IV program audits by external
auditors. Based upon the results of such audits and reviews, the Company may
have to repay funds previously granted to its students through loans and
grants, and pay interest, fines and/or penalties. Management believes such
amounts would be minimal and does not expect them to have a material effect on
the results of operations of the Company.
The Company is also required to meet certain financial and other standards
in order to qualify to participate in Title IV programs. These include
maintaining an acid test ratio (defined as cash, cash equivalents, and current
accounts receivable to current liabilities) of at least 1:1, having a positive
tangible net worth at the end of each fiscal year, to collect less than 85% of
its education revenues from Title IV funds on an annual basis, not to have
cumulative net operating losses during the most recent fiscal years that result
in a decline of more than 10% of the Company's tangible net worth at the
beginning of that two-year period, and a student default rate on their federal
loans of not more than 25% for any three-year consecutive period, amongst
others.
Leases
The Company leases equipment under capital leases expiring at various dates
through 2002. In addition, the Company leases its school facility and certain
equipment under noncancellable operating leases expiring at various dates
through 2008. Rent expense, exclusive of taxes, insurance and maintenance of
the facility and equipment for the years ended December 31, 1996 and 1997 and
the six months ended June 30, 1997 and 1998 was approximately $369,000,
$436,000, $220,000 and $191,000, respectively.
Future minimum lease payments under these capital and operating leases as of
June 30, 1998 are as follows:
<TABLE>
<CAPTION>
Capital Operating
Leases Leases Total
------- ---------- ----------
<S> <C> <C> <C>
Remainder of 1998........................... $ 3,153 $ 166,742 $ 169,895
1999........................................ 6,304 320,307 326,611
2000........................................ 6,304 318,792 325,096
2001........................................ 6,304 318,792 325,096
2002........................................ 3,341 318,792 322,133
2003........................................ -- 318,066 318,066
2004 and thereafter......................... -- 1,205,750 1,205,750
------- ---------- ----------
25,406 $2,967,241 $2,992,647
========== ==========
Less--portion attributable to interest...... 6,904
-------
Principal payments.......................... 18,502
Less--Current portion....................... 3,527
-------
$14,975
=======
</TABLE>
F-46
<PAGE>
Litigation
The Company is subject to occasional lawsuits, investigations and claims
arising out of the normal conduct of its business. At June 30, 1998, the
Company is not a party to any material legal action.
5. RELATED-PARTY TRANSACTIONS
Effective October 15, 1997, the Company leases its office and school space
from an affiliated company operated by the Company's shareholders. Total rent
expense under this agreement was approximately $62,000 and $162,000 for the
year ended December 31, 1997 and the six months ended June 30, 1998,
respectively. In addition, the Company loaned the affiliated company $6,500.
This amount is included in receivables at December 31, 1997.
As of June 30, 1998, the Company has guaranteed a $750,000 bank loan of an
affiliated company. The Company's equipment serves as collateral for the loan.
6. EMPLOYEE BENEFIT PLAN
The Company maintains a contributory profit sharing plan established
pursuant to the provisions of Section 401(k) of the Internal Revenue Code that
provides retirement benefits for eligible employees of the Company. This plan
requires matching contributions to eligible employees. The Company's matching
contributions were approximately $9,600, $12,500, $0 and $9,300 for the years
ended December 31, 1996 and 1997 and the six months ended June 30, 1997 and
1998, respectively.
7. SUBSEQUENT EVENT
On July 31, 1998, SCI Acquisition, Ltd., a wholly owned subsidiary of Career
Education Corporation ("CEC"), purchased certain assets and assumed certain
liabilities of the Company for a sales price of approximately $9,900,000.
Subsequent to the purchase, SCI Acquisition, Ltd. changed its name to
Scottsdale Culinary Institute, Ltd.
F-47
<PAGE>
[INSIDE BACK COVER]
Map of North America with
Logos of the Company and its
Schools superimposed on the map
indicating the location of
each campus.
Below the map are the logos,
full names and addresses of
each of the schools
and their campuses.
<PAGE>
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
Set forth below is an estimate of the approximate amount of fees and
expenses (other than underwriting commissions and discounts) payable by the
Registrant in connection with the issuance and distribution of our common stock
pursuant to the prospectus contained in this Registration Statement. The
Registrant will pay all of these expenses.
<TABLE>
<CAPTION>
Approximate
Amount
-----------
<S> <C>
Securities and Exchange Commission registration fee........... $ 18,717
NASD filing fee............................................... 7,233
Nasdaq National Market application fee........................ 5,000
Accountants' fees and expenses................................ 150,000
Blue Sky fees and expenses.................................... 5,000
Legal fees and expenses....................................... 275,000
Transfer Agent and Registrar fees and expenses................ 10,000
Printing and engraving........................................ 200,000
Miscellaneous expenses........................................ 79,050
--------
Total..................................................... $750,000
========
</TABLE>
All expenses other than the Securities and Exchange Commission registration
fee and NASD filing fee are estimated.
Item 14. Indemnification of Directors and Officers
Article XII of the Registrant's Amended and Restated Certificate of
Incorporation provides that the Registrant shall indemnify its directors to the
full extent permitted by the General Corporation Law of the State of Delaware
and may indemnify its officers and employees to such extent, except that the
Registrant shall not be obligated to indemnify any such person (1) with respect
to proceedings, claims or actions initiated or brought voluntarily by any such
person and not by way of defense, or (2) for any amounts paid in settlement of
an action indemnified against by the Registrant without the prior written
consent of the Registrant. The Registrant has entered into indemnity agreements
with each of its directors. These agreements may require the Registrant, among
other things, to indemnify such directors against certain liabilities that may
arise by reason of their status or service as directors, to advance expenses to
them as they are incurred, provided that they undertake to repay the amount
advanced if it is ultimately determined by a court that they are not entitled
to indemnification and to obtain directors' liability insurance if available on
reasonable terms.
In addition, Article XII of the Registrant's Amended and Restated
Certificate of Incorporation provides that a director of the Registrant shall
not be personally liable to the Registrant or its stockholders for monetary
damages for breach of his or her fiduciary duty as a director, except for
liability (1) for any breach of the director's duty of loyalty to the
Registrant or its stockholders, (2) for acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, (3) for
willful or negligent conduct in paying dividends or repurchasing stock out of
other than lawfully available funds or (4) for any transaction from which the
director derives an improper personal benefit.
Reference is made to Section 145 of the General Corporation Law of the State
of Delaware which provides for indemnification of directors and officers in
certain circumstances.
The Registrant has purchased a directors' and officers' liability insurance
policy.
II-1
<PAGE>
Under the terms of the Underwriting Agreement, the Underwriters have agreed
to indemnify, under certain conditions, the Registrant, its directors, certain
of its officers and persons who control the Registrant within the meaning of
the Securities Act of 1933, as amended, against certain liabilities.
Item 15. Recent Sales of Unregistered Securities
Prior to the consummation of our initial public offering in February 1998,
the Registrant's outstanding capital stock consisted of (1) four classes of
common stock: Class A Voting Common Stock, $.01 par value; Class B Voting
Common Stock, $.01 par value; Class C Non-voting Common Stock, $.01 par value;
and Class E Non-voting Common Stock, $.01 par value (the Class A Common Stock,
Class B Common Stock, Class C Common Stock and Class E Common Stock are
collectively referred to as the "Existing Common Stock"); and (2) three classes
of preferred stock: preferred stock, Series A, $.01 par value; preferred stock,
Series C, $.01 par value; and Series D Preferred Stock, $.01 par value (the
Series A Preferred Stock, Series C Preferred Stock and Series D Preferred Stock
are collectively referred to as the "Existing Preferred Stock").
The following information reflects a 100-for-one split of the Registrant's
common stock effected as of July 31, 1995 and a 10-for-one split of our Series
C Preferred Stock effected as of July 26, 1996. It does not reflect the
following transactions effected immediately prior to the consummation of the
initial public offering: (1) the Amended and Restated Certificate of
Incorporation of the Registrant was amended to provide, among other things, for
(a) only two classes of capital stock, consisting of our common stock and
preferred stock, $.01 par value, (b) the conversion of all shares of Existing
Common Stock into Common Stock at the rate of 9.376 shares of Common Stock for
every share of Existing Common Stock, and (c) the conversion (the "Preferred
Stock Conversion") of all Existing Preferred Stock, including all accrued paid-
in-kind dividends thereon, into common stock at a rate determined by dividing
the liquidation value of the Existing Preferred Stock, including the
liquidation value of the accrued paid-in-kind dividends, by the initial public
offering price of our common stock in the initial public offering, converting
into 2,423,481 shares of common stock; and then (2) all outstanding warrants to
purchase Class D Non-Voting Common Stock, $.01 par value, and Class E Common
Stock were exercised for an aggregate of 624,062 shares of common stock.
On February 28, 1997, pursuant to a Securities Purchase Agreement dated as
of February 28, 1997, the Registrant issued (1) 1,391 shares of Series D
Preferred Stock and warrants to purchase 1,655 shares of Class E Common Stock
to Heller in exchange for total consideration of $1,391,000, (2) 468 shares of
Series D Preferred Stock and warrants to purchase 558 shares of Class E Common
Stock to Electra in exchange for total consideration of $468,000, (3) 84 shares
of Series D Preferred Stock and warrants to purchase 99 shares of Series E
Common Stock to Dowdell in exchange for total consideration of $84,000, (4) 16
shares of Series D Preferred Stock and warrants to purchase 19 shares of
Class E Common Stock to Larson in exchange for total consideration of $16,000,
(5) 15 shares of Series D Preferred Stock and warrants to purchase 18 shares of
Class E Common Stock to Klettke in exchange for total consideration of $15,000
and (6) 26 shares of Series D Preferred Stock and warrants to purchase 31
shares of Class E Common Stock to Laub in exchange for total consideration of
$26,000.
On May 30, 1997, pursuant to the February 1997 securities purchase
agreement, the Registrant issued (1) 3,995 shares of Series D Preferred Stock
and warrants to purchase 4,754 shares of Class E Common Stock to Heller in
exchange for total consideration of $3,995,000, (2) 1,348 shares of Series D
Preferred Stock and warrants to purchase 1,603 shares of Class E Common Stock
to Electra in exchange for total consideration of $1,348,000, (3) 44 shares of
Series D Preferred Stock and warrants to purchase 52 shares of Class E Common
Stock to Mr. Larson in exchange for total consideration of $44,000, (4) 42
shares of Series D Preferred Stock and warrants to purchase 50 shares of Class
E Common Stock to Mr. Klettke in exchange for total consideration of $42,000
and (5) 71 shares of Series D Preferred Stock and warrants to purchase 85
shares of Class E Common Stock to Mr. Laub in exchange for total consideration
of $71,000.
II-2
<PAGE>
On May 30, 1997, pursuant to a Securities Purchase Agreement dated as of May
30, 1997, the Registrant issued (1) 11,127 shares of Series D Preferred Stock
and warrants to purchase 26,842 shares of Class E Common Stock to Heller in
exchange for total consideration of $11,127,000, (2) 2,376 shares of Series D
Preferred Stock and warrants to purchase 5,732 shares of Class E Common Stock
to Electra in exchange for total consideration of $2,376,000 and (3) 122 shares
of Series D Preferred Stock and warrants to purchase 295 shares of Class E
Common Stock to Mr. Klettke in exchange for total consideration of $122,000.
On June 30, 1997, pursuant to the May 1997 Securities Purchase Agreement,
the Registrant issued 1,375 shares of Series D Preferred Stock and warrants to
purchase 3,317 shares of Class E Common Stock to Electra in exchange for total
consideration of $1,375,000.
On February 26, 1999, pursuant to a Stock Transfer and Registration Rights
Agreement and a Trademark License Program Development Agreement, both dated
October 29, 1998, the Registrant issued 50,601 shares of Common Stock to Le
Cordon Bleu.
No underwriters were involved in any of the transactions described above.
All of the securities issued in the foregoing transactions were issued by the
Registrant in reliance upon the exemption from registration available under
Section 4(2) of the Securities Act of 1933, including Regulation D promulgated
thereunder.
Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits.
<TABLE>
<C> <S>
1* Form of Underwriting Agreement.
2.1** Asset Purchase Agreement dated as of September 30, 1996, among
the Registrant, WCI Acquisition, Ltd., Phillips Educational
Group of Portland, Inc., and Phillips Colleges, Inc.
2.2** Stock Sale Agreement dated as of April 7, 1997, between K-III
Prime Corporation, Inc. and the Registrant.
2.3** Stock Purchase Agreement dated as of June 30, 1997, among IAMD
Acquisition I, Ltd. and Clem Stein, Jr., Marion Stein, Leonard
Rutstein, Barbara Ann Scott King, Thomas V. King, William W.
Wirtz and David Powell.
2.4** Share Purchase Agreement dated as of June 30, 1997, among the
Registrant and Clem Stein, Jr., Leonard Rutstein, Barbara Ann
Scott King and Lawrence N. Gross.
2.5*** Asset Purchase Agreement dated as of July 1, 1998, by and among
Scottsdale Institute, Inc., an Arizona corporation, The Frank G.
and Elizabeth S. Leite Revocable Trust dated April 14, 1992,
Frank G. Leite and Elizabeth S. Leite, and SCI Acquisition I,
Ltd., a Delaware Corporation.
3.1+ Amended and Restated Certificate of Incorporation of the
Registrant.
3.2+ Amended and Restated By-laws of the Registrant.
4.1** Specimen stock certificate representing common stock.
4.3* Credit Agreement dated as of October 26, 1998 among the
Registrant, as borrower, the Co-Borrowers named therein, the
lenders named therein, LaSalle National Bank, as administrative
agent and The Bank of Nova Scotia as foreign currency agent.
5* Opinion of Katten Muchin & Zavis as to the legality of the
securities being registered (including consent).
10.1** Career Education Corporation 1995 Stock Option Plan, as amended.
10.2** Form of Option Agreement under the Registrant's 1995 Stock
Option Plan.
10.3** Career Education Corporation 1997 Employee Incentive
Compensation Plan.
10.4** Form of Option Agreement under the Registrant's 1997 Employee
Incentive Compensation Plan.
</TABLE>
II-3
<PAGE>
<TABLE>
<C> <S>
10.5** Career Education Corporation 1997 Non-Employee Directors' Stock
Option Plan.
10.6** Form of Option Agreement under the Registrant's 1997 Non-
Employee Directors' Stock Option Plan.
10.7** Career Education Corporation 1998 Employee Stock Option Plan.
10.8** Amended and Restated Option Agreement dated July 31, 1995,
between the Registrant and John M. Larson.
10.9** Supplemental Option Agreement dated July 31, 1995, between the
Registrant and John M. Larson.
10.10** Amended and Restated Option Agreement dated July 31, 1995,
between the Registrant and Robert E. Dowdell.
10.11** Employment and Non-Competition Agreement as of October 9, 1997
between the Registrant and John M. Larson.
10.12** Form of Indemnification Agreement for Directors and Executive
Officers.
10.13** Career Education Corporation Amended and Restated Stockholders'
Agreement dated as of July 31, 1995, as amended on February 28,
1997 and May 30, 1997.
10.14** Registration Rights Agreements dated as of July 31, 1995,
between the Registrant, Electra Investment Trust P.L.C. and
Electra Associates, Inc.
10.15** Securities Purchase Agreement dated as of July 31, 1995 among
the Registrant, Electra Investment Trust P.L.C. and Electra
Associates, Inc. (the "Electra 1995 Agreement").
10.16** Securities Purchase Agreement dated as of February 28, 1997,
among the Registrant, Heller Equity Capital Corporation, Electra
Investment Trust P.L.C., Robert E. Dowdell, John M. Larson,
Wallace O. Laub and Constance L. Laub and William A. Klettke
(the "February 1997 Agreement").
10.17** Securities Purchase Agreement dated as of May 30, 1997 among the
Registrant, Heller Equity Capital Corporation, Electra
Investment Trust P.L.C. and William A. Klettke (the "May 1997
Agreement").
10.18** Form of Management Fee Agreement between the Registrant and each
of its subsidiaries.
10.19** Form of Tax Sharing Agreement between the Registrant and each of
its subsidiaries.
10.20+ Registration Rights Agreement between the Registrant Heller
Equity Capital Corporation dated as of February 3, 1998.
10.21+ Agreement between the Registrant and Heller Equity Capital
Corporation, regarding designation of directors of the
Registrant.
10.22++ Stock Purchase Agreement dated as of November 25, 1998 by and
between the Registrant, and Robert C. Marks and the Robert C.
Marks Trust dated October 9, 1997.
21.1++++ Subsidiaries of the Registrant.
23.1++++ Consent of Arthur Andersen LLP with respect to financial
statements of the Registrant.
23.2++++ Consent of Arthur Andersen LLP with respect to financial
statements of Scottsdale Culinary Institute, Inc.
23.3++++ Consent of Deloitte & Touche LLP with respect to financial
statements of The Katharine Gibbs Schools, Inc.
</TABLE>
II-4
<PAGE>
<TABLE>
<C> <S>
23.6* Consent of Katten Muchin & Zavis (contained in its opinion filed
as Exhibit 5 hereto).
24* Power of Attorney
27* Financial Data Schedule.
</TABLE>
- --------
* Previously filed.
** Incorporated by reference to the Exhibit of the same number to our
Registration Statement No. 333-37601 on Form S-1, effective as of January
28, 1998.
*** Incorporated by reference to our Report on Form 8-K dated August 14, 1998.
+ Incorporated by reference to the Exhibit of the same number to our Annual
Report on Form 10-K for the year ended December 31, 1997.
++ Incorporated by reference to our Report on Form 8-K dated January 15, 1999.
+++ Incorporated by reference to the Exhibit of the same number to each of our
Quarterly Reports on Form 10-Q for the quarterly periods ended March 31,
June 30 and September 30, 1998.
++++ Filed herewith.
(b) Financial Statement Schedules.
<TABLE>
<CAPTION>
Page
----
<S> <C>
Schedule II--Valuation and Qualifying Accounts....................... S-2
</TABLE>
Item 17. Undertakings
The Registrant hereby undertakes:
(1) To provide to the underwriters at the closing specified in the
underwriting agreement, certificates in such denominations and registered
in such names as required by the underwriters to permit prompt delivery to
each purchaser.
(2) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing provisions,
or otherwise, the Registrant has been advised that, in the opinion of the
Securities and Exchange Commission, such indemnification is against public
policy as expressed in the Securities Act of 1933 and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in
the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, the Registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to
a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the
Securities Act of 1933 and will be governed by the final adjudication of
such issue.
(3) For purposes of determining any liability under the Securities Act
of 1933, (a) the information omitted from the form of prospectus filed as
part of this Registration Statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the Registrant pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act of 1933 shall be deemed
to be part of this Registration Statement as of the time it was declared
effective and (b) each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused Amendment No. 2 to this Registration Statement to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Chicago, and State of Illinois on the 16th day of March, 1999.
Career Education Corporation
/s/ John M. Larson
By: _________________________________
John M. Larson
President and Chief Executive
Officer
* * *
Pursuant to the requirements of the Securities Act of 1933, Amendment No. 2
to this Registration Statement has been signed below by the following persons
in the capacities indicated on March 16, 1999.
<TABLE>
<CAPTION>
Signature Title
--------- -----
<S> <C>
/s/ John M. Larson President, Chief Executive Officer
___________________________________________ (Principal Executive Officer) and a
John M. Larson Director
* Senior Vice President and Chief Financial
___________________________________________ Officer (Principal Financial and
William A. Klettke Accounting Officer)
* Director
___________________________________________
Robert E. Dowdell
* Director
___________________________________________
Thomas B. Lally
* Director
___________________________________________
Wallace O. Laub
* Director
___________________________________________
Keith K. Ogata
* Director
___________________________________________
Patrick K. Pesch
</TABLE>
* The undersigned, by signing his name hereto, does sign and execute the
Amendment No. 2 to this Registration Statement on behalf of the above-named
Directors and officers of the Registrant pursuant to a Power of Attorney
executed by each such Director and officer and filed with the Securities and
Exchange Commission.
/s/ John M. Larson
By:__________________________________
John M. Larson
as Attorney-in-Fact
II-6
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
FINANCIAL STATEMENT SCHEDULE
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of Career Education Corporation:
We have audited, in accordance with generally accepted auditing standards,
the consolidated financial statements of Career Education Corporation and
Subsidiaries and issued our unqualified opinion thereon dated January 29, 1999.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The Valuation and Qualifying Account
Schedule is presented for purposes of additional analysis and is not a required
part of the basic financial statements. This information has been subjected to
the auditing procedures applied in our audits of the basic financial statements
and, in our opinion, is fairly stated in all material respects in relation to
the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois
January 29, 1999
S-1
<PAGE>
CAREER EDUCATION CORPORATION AND SUBSIDIARIES
FINANCIAL STATEMENT SCHEDULE
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Balance at Charges to Increase Due Balance at
Beginning Operating to Amounts End of
of Period Expenses Acquisitions Written-off Period
---------- ---------- ------------ ----------- ----------
(in thousands)
<S> <C> <C> <C> <C> <C>
Student receivable
allowance activity for
the year ended
December 31, 1996..... 258 760 30 (593) 455
Student receivable
allowance activity for
the year ended
December 31, 1997..... 455 1,400 1,040 (1,379) 1,516
Student receivable
allowance activity for
the year ended
December 31, 1998..... 1,516 4,983 71 (4,443) 2,127
</TABLE>
S-2
<PAGE>
EXHIBIT 21
CAREER EDUCATION CORPORATION
SUBSIDIARIES
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Subsidiary Jurisdiction
---------- of Incorporation
----------------
- -------------------------------------------------------------------------------
<S> <C>
Al Collins Graphic Design School, Ltd., Delaware
d/b/a Al Collins Graphic Design School
- -------------------------------------------------------------------------------
Allentown Business School, Ltd., Delaware
d/b/a Allentown Business School
- -------------------------------------------------------------------------------
Brooks College, Ltd., Delaware
d/b/a Brooks College
- -------------------------------------------------------------------------------
Brown Institute, Ltd., Delaware
d/b/a Brown Institute
- -------------------------------------------------------------------------------
CEC Management, Inc. Illinois
- -------------------------------------------------------------------------------
Harrington Institute of Interior Design, Inc., Illinois
d/b/a Harrington Institute of Interior Design
- -------------------------------------------------------------------------------
IAMD Limited (holding company) Delaware
- -------------------------------------------------------------------------------
International Academy of Merchandising & Design, Ltd., Illinois
d/b/a IAMD-Chicago
- -------------------------------------------------------------------------------
International Academy of Merchandising & Design, Inc., Florida
d/b/a IAMD-Tampa
- -------------------------------------------------------------------------------
International Academy of Merchandising and Design (Canada) Ontario
Ltd.,
d/b/a International Academy of Design-Toronto
- -------------------------------------------------------------------------------
International Academy of Design, Inc., Quebec
a.k.a. Academie Internationale du Design Inc.,
d/b/a International Academy of Design-Montreal and
d/b/a Academie Internationale du Design-Montreal
- -------------------------------------------------------------------------------
The Katharine Gibbs Schools, Inc. (holding company) Delaware
- -------------------------------------------------------------------------------
The Katharine Gibbs School of Montclair, Inc., New Jersey
d/b/a Katharine Gibbs School-Montclair
- -------------------------------------------------------------------------------
The Katharine Gibbs School of Piscataway, Inc., New Jersey
d/b/a Katharine Gibbs School-Piscataway
- -------------------------------------------------------------------------------
The Katharine Gibbs Corporation - New York, New York
d/b/a Katharine Gibbs School-New York
- -------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Subsidiary Jurisdiction
---------- of Incorporation
----------------
- -------------------------------------------------------------------------------
<S> <C>
The Katharine Gibbs Corporation - Melville, New York
d/b/a Katharine Gibbs School-Melville
- -------------------------------------------------------------------------------
The Katharine Gibbs School of Norwalk, Inc., Connecticut
d/b/a Gibbs College
- -------------------------------------------------------------------------------
The Katharine Gibbs School of Providence, Inc., Rhode Island
d/b/a Katharine Gibbs School-Providence
- -------------------------------------------------------------------------------
The Katharine Gibbs School of Boston, Inc., a private Massachusetts
two-year college,
d/b/a Katharine Gibbs School-Boston
- -------------------------------------------------------------------------------
Market Direct, Inc. Illinois
- -------------------------------------------------------------------------------
McIntosh Acquisition Corporation Delaware
- -------------------------------------------------------------------------------
School of Computer Technology, Inc., Delaware
d/b/a Computer Tech and d/b/a International Culinary Academy
- -------------------------------------------------------------------------------
Scottsdale Culinary Institute, Ltd., Delaware
d/b/a Scottsdale Culinary Institute
- -------------------------------------------------------------------------------
Southern California School of Culinary Arts, Ltd. Delaware
d/b/a Southern California School of Culinary Arts
- -------------------------------------------------------------------------------
Western Culinary Institute, Ltd., Delaware
d/b/a Western Culinary Institute
- -------------------------------------------------------------------------------
</TABLE>
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use in this
registration statement of our report dated January 29, 1999 on the financial
statements of CAREER EDUCATION CORPORATION and SUBSIDIARIES included herein and
to all references to our Firm included in this registration statement.
Arthur Andersen LLP
/s/ Arthur Andersen LLP
Chicago, Illinois
March 16, 1999
<PAGE>
Exhibit 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use in this
registration statement of our report dated September 25, 1998 (except with
respect to the matter discussed in Note 7, as to which the date is December 17,
1998), on the financial statements of SCOTTSDALE CULINARY INSTITUTE, INC.
included herein and to all references to our Firm included in this registration
statement.
Arthur Andersen LLP
/s/ Arthur Andersen LLP
Chicago, Illinois
March 16, 1999
<PAGE>
Exhibit 23.3
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Amendment No. 2 to Registration Statement No.
333-70747 of Career Education Corporation of our report dated October 27, 1997
on the statements of consolidated operations and accumulated deficit and of cash
flows of The Katherine Gibbs Schools, Inc. and subsidiaries for the years ended
December 31, 1995 and 1996, appearing in the Prospectus, which is a part of such
Registration Statement.
We also consent to the reference to us under the heading "Experts" in such
Prospectus.
DELOITTE & TOUCHE LLP
New York, New York
March 16, 1999
