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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 000-27817
EDISON SCHOOLS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 13-3915075
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
521 Fifth Avenue, 15th Floor, New York, NY 10175
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code (212) 419-1600
Former name, former address and former fiscal year,
if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
(1) Yes X No (2) Yes X No
The number of shares outstanding of each of the Registrant's classes of common
stock:
43,986,359
(Number of shares of Class A Common Stock Outstanding as of October 31, 2000)
3,321,673
(Number of shares of Class B Common Stock Outstanding as of October 31, 2000)
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EDISON SCHOOLS INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2000
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PAGE
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of September 30, 2000 (unaudited) and
June 30, 2000.................................................................................. 3
Condensed Consolidated Statements of Operations for the Three Months Ended
September 30, 2000 and 1999 (unaudited)........................................................ 4
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
September 30, 2000 and 1999 (unaudited)........................................................ 5
Notes to Condensed Consolidated Financial Statements (unaudited)................................. 6-8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................................................. 9-23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................... 23
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS............................................................ 24
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.................................... 24
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.............................................. 24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................... 24
ITEM 5. OTHER INFORMATION............................................................ 24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................................. 24
SIGNATURES................................................................... 25
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EDISON SCHOOLS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
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SEPTEMBER 30,
2000 JUNE 30,
(UNAUDITED) 2000
--------- ---------
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ASSETS:
Current assets:
Cash and cash equivalents ................................................... $ 76,014 $ 52,644
Accounts receivable ......................................................... 33,986 33,753
Notes and other receivables ................................................. 14,895 14,515
Other current assets ........................................................ 5,199 3,620
--------- ---------
Total current assets ..................................................... 130,094 104,532
Property and equipment, net .................................................... 133,011 98,134
Restricted cash ................................................................ 5,518 3,387
Notes and other receivables .................................................... 30,598 16,023
Stockholder notes receivable ................................................... 8,989 8,801
Investment ..................................................................... 8,089 8,024
Other assets ................................................................... 13,662 12,126
--------- ---------
Total assets ............................................................. $ 329,961 $ 251,030
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Current portion of long term debt ........................................... $ 11,333 $ 11,838
Accounts payable ............................................................ 31,509 15,453
Accrued expenses ............................................................ 20,781 16,211
--------- ---------
Total current liabilities ................................................ 63,623 43,502
Long term debt, less current portion ........................................... 17,700 17,830
Stockholders' notes payable .................................................... 6,611 6,611
Other liabilities .............................................................. 636 574
--------- ---------
Total liabilities ........................................................... 88,570 68,517
--------- ---------
Minority interest in subsidiary ................................................ 536 --
--------- ---------
Common stock:
Class A common, par value $.01; 150,000,000 shares authorized; 43,948,796 and
39,558,746 shares issued and outstanding at September 30, 2000 and
June 30, 2000, respectively ............................................. 440 396
Class B common, par value $.01; 5,000,000 shares authorized; 3,348,608
and 3,448,004 shares issued and outstanding at September 30, 2000
and June 30, 2000, respectively ......................................... 33 34
Additional paid-in capital ..................................................... 380,618 303,061
Unearned stock-based compensation .............................................. (2,823) (3,160)
Accumulated deficit ............................................................ (135,057) (115,518)
Stockholder note and accrued interest receivable ............................... (2,356) (2,300)
--------- ---------
Total stockholders' equity ............................................... 240,855 182,513
--------- ---------
Total liabilities and stockholders' equity ............................... $ 329,961 $ 251,030
========= =========
</TABLE>
The accompanying notes are an integral part of
these condensed consolidated financial statements
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EDISON SCHOOLS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
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(UNAUDITED)
2000 1999
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Revenue from educational services ......................... $ 64,791 $ 41,151
Education and operating expenses:
Direct site expenses ................................... 60,531 38,995
Administration, curriculum and development ............. 12,117 10,585
Preopening expenses .................................... 5,235 3,456
Depreciation and amortization .......................... 7,044 3,587
-------- --------
Total education and operating expenses .............. 84,927 56,623
-------- --------
Loss from operations ................................ (20,136) (15,472)
Other income (expense):
Interest income ........................................ 2,514 889
Interest expense ....................................... (1,193) (787)
Other .................................................. 19 (299)
-------- --------
Total other ......................................... 1,340 (197)
-------- --------
Loss from operations before provision for state taxes (18,796) (15,669)
Provision for state taxes ................................. (743) --
-------- --------
Net loss ....................................... (19,539) (15,669)
Preferred stock accretion ................................. -- (516)
-------- --------
Net loss attributable to common stockholders ........ $(19,539) $(16,185)
======== ========
Per common share data:
Basic and diluted net loss per share ................... $ (0.43) $ (5.21)
======== ========
Weighted average shares of common stock outstanding used
in computing basic and diluted net loss per share ... 45,404 3,107
======== ========
Pro forma per share data:
Pro forma basic and diluted net loss per share ......... $ (0.43) $ (0.46)
======== ========
Pro forma weighted average shares outstanding used in
computing basic and diluted net loss per share ...... 45,404 34,204
======== ========
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The accompanying notes are an integral part of
these condensed consolidated financial statements
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EDISON SCHOOLS INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(DOLLARS IN THOUSANDS)
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(UNAUDITED)
2000 1999
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Cash flows from operating activities:
Net loss .................................................................. $(19,539) $(15,669)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of property and equipment ................. 6,225 3,277
Amortization of other costs ............................................. 205 (50)
Stock-based compensation ................................................ 362 1,100
Equipment loss ......................................................... 24 119
Interest on stockholder note receivable ................................ (56) --
Changes in working capital accounts .................................... (5,437) 3,900
Other .................................................................. (43) --
-------- --------
Cash used in operating activities .................................. (18, 259) (7,323)
-------- --------
Cash flows from investing activities:
Additions to property and equipment ....................................... (20,767) (31,425)
Proceeds from disposition of property and equipment, net .................. 1,074 --
Proceeds from notes receivable and advances due from charter schools ...... 379 683
Notes receivable and advances due from charter schools .................... (15,234) (3,786)
Investment in non consolidated entity ..................................... (35) --
Minority interest investment in consolidated subsidiary ................... 550 --
Other assets ........................................................... 852 (3,855)
-------- --------
Cash used in investing activities .................................. (33,181) (38,383)
-------- --------
Cash flows from financing activities:
Issuance of stock and warrants ............................................ 78,858 41,741
Costs in connection with equity financing ................................. (1,282) --
Proceeds from notes payable ............................................... 2,625 --
Payments on notes payable and capital leases .............................. (3,261) (1,648)
Restricted cash ........................................................... (2,130) (196)
-------- --------
Cash provided by financing activities .......................... 74,810 39,897
-------- --------
Increase (decrease) in cash and cash equivalents ............................. 23,370 (5,809)
Cash and cash equivalents at beginning of period ............................. 52,644 27,922
-------- --------
Cash and cash equivalents at end of period ................................... $ 76,014 $ 22,113
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest ....................... $ 1,214 $ 671
======== ========
Supplemental disclosure of non-cash investing and financing activities:
Accretion of Series D preferred PIK dividend .............................. $ -- $ 516
======== ========
Additions to property and equipment included in
accounts payable ....................................................... $ 21,433 $ 7,413
======== ========
Additions to other assets included in accounts payable .................... $ 2,694 $ --
======== ========
</TABLE>
The accompanying notes are an integral part of
these condensed consolidated financial statements
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EDISON SCHOOLS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements have been
prepared by Edison Schools Inc. (the "Company") in accordance with generally
accepted accounting principles ("GAAP") for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the
opinion of management, all adjustments, consisting of normal recurring items
necessary to present fairly the financial position and results of operations
have been included. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with the generally
accepted accounting principles have been condensed or omitted pursuant to such
SEC rules and regulations. These financial statements should be read in
conjunction with the financial statements and related notes included in the
Company's Annual Report on Form 10-K for the year ended June 30, 2000.
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Significant estimates
include, among other things, certain school revenues and expenses, useful lives
of assets, recoverability of equipment, deferred income tax valuation allowance,
certain accrued expenses and expenses in connection with stock options and
warrants; actual results could differ from these estimates.
Because new schools are opened in the first fiscal quarter of each
year, trends in the Company's business, whether favorable or unfavorable, will
tend not to be reflected in the Company's quarterly financial results, but will
be evident primarily in year-to-year comparisons. The first quarter of our
fiscal year has historically reflected less revenue and lower expenses than the
other three quarters. Historically, the Company has a lower gross site margin in
the first fiscal quarter than in the remaining fiscal quarters. The Company also
recognizes pre-opening costs primarily in the first and fourth quarters.
2. DESCRIPTION OF BUSINESS
The Company manages elementary and secondary public schools under
contracts with school districts and charter school boards located in 21 states
and Washington, D.C. The Company opened its first four schools in the fall of
1995, and, as of September 30, 2000, operated 113 schools with approximately
57,000 students.
The Company provides the education program, recruits and manages
personnel, and maintains and operates the facilities at each school it manages.
The Company also assists charter school boards in obtaining facilities and the
related financing. As compensation for its services, the Company receives
revenues which approximate, on a per pupil basis, the average per pupil spending
of the school district in which the school is located.
3. EQUITY OFFERING
On October 5, 1999, the Board of Directors approved a proposal to amend
and restate the Company's certificate of incorporation. On October 26, 1999, the
amended and restated certificate of incorporation was approved by the Company's
shareholders. The amended and restated certificate of incorporation became
effective upon the closing of the IPO and, among other things, provided that
outstanding Series A through G Preferred stock converted into Class A Common
Stock upon the closing of the IPO with the number of shares upon conversion
calculated as the original purchase price of each share plus accrued and unpaid
dividends divided by the conversion price multiplied by nine-twentieths. In
addition, each preferred share converted into a number of shares of Class B
Common Sock upon the closing of the IPO calculated as the original purchase
price for each share plus accrued and unpaid dividends divided by the conversion
price multiplied by one-twentieth. Further, all outstanding shares of existing
common stock converted into nine-twentieths of a share of Class A Common Stock
and one-twentieth of a share of Class B Common Stock upon the closing of the
IPO. All fractional shares of Class A Common Stock and Class B Common Stock were
rounded up to the next larger number. Additional information concerning the IPO
and changes in the Company's capital structure since June 30, 1999 may be found
in the financial statements and notes thereto in the Annual Report on Form 10-K.
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In August 2000, the Company completed a secondary offering of an
additional 3,350,000 shares of Class A Common for net proceeds of approximately
$71.2 million. Also in August 2000, a philanthropic foundation exercised
warrants to purchase 600,000 shares of Class A Common and paid the Company
approximately $4.8 million. The shares obtained in such warrant exercise were
sold along with the Company's shares in the secondary offering.
4. NET LOSS PER SHARE AND PRO FORMA NET LOSS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." Pursuant
to SFAS No. 128, the basic and diluted earnings per common share information has
been shown on the Condensed Statement of Operations adjusted retroactively for
the periods presented to reflect the changes in the Company's capital structure
discussed in Note 3. SFAS No. 128 also replaced primary and fully diluted
earnings per share with basic and diluted earnings per share. Unlike primary
earnings per share, basic earnings per share excludes any dilutive effect of
options, warrants and convertible securities. Diluted earnings per share is very
similar to fully diluted earnings per share. Basic earnings per share is
computed using the weighted-average number of common shares outstanding during
the period. Diluted earnings per share is computed using the weighted-average
number of common and common stock equivalent shares outstanding during the
period. Common stock equivalent shares, such as convertible preferred stock,
stock options, and warrants, have been excluded from the computation, as their
effect is antidilutive for all periods presented.
The pro forma basic and diluted net loss per share is computed by
dividing the net loss by the weighted average number of shares of common stock
assuming conversion of convertible preferred stock outstanding during the period
under the if-converted method. Each outstanding share of common and preferred
stock automatically converted into 0.45 shares of class A common stock and 0.05
shares of class B common stock pursuant to the IPO discussed above. The
calculation of pro forma net loss per share for the three month periods ended
September 30, 2000 and 1999 are as follows:
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SEPTEMBER 2000 SEPTEMBER 1999
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Net Loss .............................................. $(19, 539) $(15,669)
========= ========
Class A Common stock outstanding at beginning of period 39,558 3,108
Class B Common stock outstanding at beginning of period 3,448 28,211
Add:
Issuance of Class A Common stock
(as if converted on a weighted average basis) ...... 2,497 2,885
Issuance of Class B Common stock
(as if converted on a weighted average basis) ...... (99) --
-------- --------
Pro forma weighted average number of shares
outstanding, assuming conversion of convertible
preferred stock .................................... 45,404 34,204
======== ========
Pro forma net loss per share .......................... $ (0.43) $ (0.46)
======== ========
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5. LINE OF CREDIT
In November 1999, the Company obtained a line of credit from Imperial
Bank (the "LOC") which provided for borrowings of up to $10.0 million. The LOC
is for three years and may be used for seasonal working capital needs and other
general corporate purposes. As of September 30, 2000, no amounts had been
borrowed under the LOC. The Company terminated the LOC in November 2000.
7
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6. INVESTMENT IN KSIXTEEN LLC
Effective July 1, 2000, Edison invested $35,000 to obtain a 35%
interest in Ksixteen LLC ("Ksixteen"), a company organized to provide
construction management, real estate development and financial advisory services
to charter schools. The Company and Ksixteen have also entered into a master
development agreement effective July 1, 2000 pursuant to which Ksixteen performs
(at the Company's direction) construction management and real estate development
and financing services on behalf of charter schools that have entered into
management agreements with the Company. The Company reports its investment in
Ksixteen under the equity method and, accordingly, recognizes its pro-rata share
of the net income or loss of Ksixteen based on its ownership interest. For the
quarter ended September 30, 2000, the Company recognized $29,000 of income
related to this investment.
7. CREATION OF ALLIANCE-EDISON LLC
On July 21, 2000, the Company formed Alliance-Edison LLC
("Alliance-Edison") by contributing $3.5 million for a 54.3% equity interest.
Alliance-Edison was established for the purpose of constructing the Dayton View
Academy charter school in Dayton, Ohio. Alliance-Edison's only asset is the
Dayton View Academy charter school facility, which has been constructed under a
five year ground lease (renewable for additional terms up to a total of 35
years) with the Dayton Metropolitan Housing Authority (the "Ground Lease").
Pursuant to the Ground Lease, Alliance-Edison has the option to purchase the
land at the conclusion of the lease term. The Company has also guaranteed
approximately $1.6 million of debt incurred by Alliance-Edison. The minority
interest investor contributed $550,000 in cash and a note for $2.4 million,
which is netted by minority interest in the accompanying condensed consolidated
balance sheet.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain of the matters and subject areas discussed in this Quarterly
Report on Form 10-Q contain "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. All statements other than
statements of historical information provided herein are forward-looking
statements and may contain information about financial results, economic
conditions, trends and known uncertainties based on our current expectations,
assumptions, estimates and projections about our business and our industry.
These forward-looking statements involve risks and uncertainties. Our actual
results could differ materially from those anticipated in these forward-looking
statements as a result of several factors, as more fully described under the
caption "Additional Risk Factors that May Affect Future Results" and elsewhere
in this Quarterly Report. Readers are cautioned not to place undue reliance on
these forward-looking statements, which reflect management's analysis, judgment,
belief or expectation only as of the date hereof. The forward-looking statements
made in this Quarterly Report on Form 10-Q relate only to events as of the date
on which the statements are made. We undertake no obligation to publicly update
any forward-looking statements for any reason, even if new information becomes
available or other events occur in the future.
OVERVIEW
We are the nation's largest private operator of public schools serving
students from kindergarten through 12th grade. We contract with local school
districts and public charter school boards to assume educational and operational
responsibility for individual schools in return for per-pupil funding that is
generally comparable to that spent on other public schools in the area. We
opened our first four schools in August 1995 and have grown rapidly in every
subsequent year, currently serving approximately 57,000 students in 113 schools
located in 21 states across the country and the District of Columbia.
From our formation in 1992 until opening our first schools in fiscal
1996, we were a development stage company focused on research, development and
marketing of the Edison school design and curriculum and raising capital to
support our business plan. From 1992 until 1995, Edison's team of leading
educators and scholars developed an innovative, research-backed curriculum and
school design. We operated as a partnership prior to November 1996, when we
converted to a corporation. As of September 30, 2000, our accumulated deficit
since November 1996 was approximately $135.1 million. In addition, prior to
November 1996, we incurred losses of approximately $61.8 million, which are
reflected in our additional paid-in capital. Because of our rapid growth, and in
view of the evolving nature of our business and our limited operating history,
we believe that period-to-period comparisons of our operating results may not be
meaningful.
Edison's curriculum expenses include the ongoing costs to maintain and
support Edison's educational design. These expenses include the salaries and
wages of trained educators in our central office curriculum department, the
costs of providing professional training to our staff and teachers, including
materials, and the ongoing costs of maintaining and updating the teaching
methods and educational content of our program.
We make a significant investment in each school we open. The investment
generally includes:
- Initial staff training and professional development;
- Technology, including laptop computers for teachers and, after
the first year of operation, a computer for the home of every
child above the second grade;
- Books and other materials to support the Edison curriculum and
school design, including enrollment fees for the Success for
All reading program; and
- Upgrades in facilities.
9
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REVENUE FROM EDUCATIONAL SERVICES
Our revenue is principally derived from contractual relationships to
manage and operate contract and charter schools. We also receive small amounts
of revenue, which represented less than 0.6% of total revenue in fiscal 2000,
from the collection of after-school program fees and food service costs. We
receive per-pupil revenue from local, state and federal sources, including Title
I and special education funding, in return for providing comprehensive education
to our students. The per-pupil revenue is generally comparable to the funding
spent on other public schools in the area. We recognize revenue for each school
pro rata over the 11 months from August through June. Because the amount of
revenue we receive for operating each school depends on the number of students
enrolled, achieving site-specific enrollment objectives is necessary for
satisfactory financial performance at the school. Both the amount of per-pupil
revenue and the initial enrollment at each school become known at the beginning
of the school year and generally tend not to vary significantly throughout the
year. For these reasons, our revenue for each school year is largely predictable
at the beginning of the school year.
DIRECT EXPENSES
Direct site expenses include most of the expenses incurred on-site at
our schools. The largest component of this expense is salaries and wages,
primarily for principals and teachers. The remaining direct site expenses
include on-site administration, facility maintenance and, in some cases,
transportation and food services. Once staffing levels for the school year are
determined, most of these expenses are fixed and, accordingly, variations in
enrollment will generally not change the overall cost structure of a school for
that year. Direct site expenses do not include teacher training and other
pre-opening expenses associated with new schools, financing costs or
depreciation and amortization related to technology, including computers for
teachers and students, curriculum materials and capital improvements to school
buildings.
GROSS SITE CONTRIBUTION AND GROSS SITE MARGIN
We define gross site contribution as revenue from educational services
less direct site expenses. Gross site margin is gross site contribution
expressed as a percentage of revenue from educational services. Gross site
contribution is a measurement of ongoing site-level operating performance of our
schools. We believe it serves as a useful operating measurement when evaluating
our schools' financial performance. Gross site contribution does not reflect all
site-related costs, including depreciation and amortization or interest expense
and principal repayment related to site-level investments, or on-site
pre-opening expenses, and accordingly gross site contribution does not represent
site-level profitability.
ADMINISTRATION, CURRICULUM AND DEVELOPMENT EXPENSES
Support from our central office is important for the successful
delivery of our curriculum and school design. Administration, curriculum and
development expenses include those amounts related to the creation and
enhancement of our curriculum, and our general, administrative and sales and
marketing functions. These costs include costs for curriculum, assessment and
training professionals, sales and marketing personnel, financial reporting and
legal and technological support and travel expenses and other development
activities.
PRE-OPENING EXPENSES
Pre-opening expenses consist principally of various administrative and
personnel costs incurred prior to the opening of a new school or the expansion
of an existing school, particularly the costs for the initial training and
orientation of professional staff, recruitment and travel expenses and expenses
for temporary offices and staff. In connection with the establishment of a new
school, we seek to hire the school's principal several months in advance of the
school's opening. This allows the principal to hire staff, most of whom receive
substantial professional training in the Edison education design prior to the
first day of school. Pre-opening expenses generally are first incurred in the
fourth quarter of the fiscal year prior to the school's opening or expansion and
continue into the first quarter of the fiscal year in which the school opens.
These costs are expensed as incurred.
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DEPRECIATION AND AMORTIZATION
Depreciation and amortization relates primarily to the investments we
make in each school for books and other educational materials, including
enrollment fees for the Success for All program, computers and other technology,
and facility improvements. These investments support the Edison curriculum and
school design and relate directly to our provision of educational services.
ENROLLMENT
Our annual budgeting process establishes site-specific revenue and
expense objectives, which include assumptions about enrollment and anticipated
per-student funding. While our budgets include desired enrollment levels, we do
not attempt to maximize enrollment based upon the physical capacity of our
facilities. Our budgets are designed to achieve both financial and academic
goals, both of which we believe are critical to the ongoing success of our
business. Therefore, our budgets are designed to achieve the proper balance
between financial performance and academic standards. While managed closely at
each school, our school enrollment levels are evaluated by management in the
aggregate.
RESULTS OF OPERATIONS
FISCAL QUARTER ENDED SEPTEMBER 30, 2000 COMPARED TO FISCAL QUARTER ENDED
SEPTEMBER 30, 1999
Revenue From Educational Services. Our revenue from educational
services increased to $64.8 million for the three months ended September 30,
2000 from $41.2 million for the same period of the prior year, an increase of
57.3%. The increase was primarily due to a 52.0% increase in student enrollment
from 37,500 in the 1999-2000 school year to 57,000 in the 2000-2001 school year,
reflecting both the opening of new schools and the expansion of existing
schools.
Direct Site Expenses. Our direct site expenses increased to $60.5
million for the three months ended September 30, 2000 from $39.0 million for the
same period of the prior year, an increase of 55.1%. Similar to the increase in
revenue from educational services, the increase in direct site expenses was
primarily due to the 52.0% increase in student enrollment. The largest element
of direct site expenses is personnel costs. Personnel costs included in direct
site expenses increased to $49.3 million for the three months ended September
30, 2000 from $29.1 million for the same period of the prior year.
Gross Site Contribution and Margin. Our gross site contribution was
$4.3 million for the three month period ended September 30, 2000 compared to
$2.2 million for the same period of the prior year. The corresponding gross site
margin increased to 6.6% for the three months ended September 30, 2000 from 5.2%
for the same period of the prior year. The increase in gross site contribution
of $2.1 million resulted from the larger revenues for the three month period
ended September 30, 2000 combined with an improved gross site margin for new and
expanded existing schools opened in the 2000-2001 school year.
Administration, Curriculum and Development Expenses. Our
administration, curriculum and development expenses increased to $12.1 million
for the three months ended September 30, 2000 from $10.6 million for the same
period of the prior year, an increase of 14.2%. The increase was substantially
due to greater personnel costs resulting from an increase of approximately 66
headquarters employees, which reflects a substantial increase in staff in our
school operations and curriculum and education divisions and an increase in our
central office administrative staff to enhance legal, contracting, and financial
reporting functions. Administration, curriculum and development expenses also
includes $362,000 of non-cash stock based compensation we incurred in the three
months ended September 30, 2000 compared to $1.1 million for the same period of
the prior year.
Pre-opening Expenses. Our pre-opening expenses increased to $5.2
million for the three months ended September 30, 2000 from $3.5 million for the
same period of the prior year, an increase of 48.6 %. This increase was
associated primarily with opening new schools and expanding existing schools for
the 2000-2001 school year, with 19,500 new students enrolled compared to
approximately 13,600 new students enrolled in the prior school year. Excluding
the non-cash charges discussed above, the combined administration, curriculum
and development and pre-opening expenses as a percentage of revenues decreased
to 26.2% for the three months ended September 30, 2000 from 31.4% for the same
period of the prior year.
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Depreciation and Amortization. Our depreciation and amortization
increased to $7.0 million for the three months ended September 30, 2000 from
$3.6 million for the same period of the prior year, an increase of 94.4%. The
increased depreciation and amortization resulted from additional capital
expenditures for our curriculum materials, computers and related technology
particularly the issuance of home computers, and facility improvements related
to the 52.0% increase in student enrollment. In addition, the delivery and
installation of the aforementioned capital assets to the sites earlier in the
current school year generated additional depreciation. The increase was also due
to approximately $190,000 of amortization expense related to obligations assumed
in connection with the Inkster School District contract agreement.
EBITDA, Net of Other Charges. EBITDA, net of other charges, is defined
as net loss excluding other income or loss, depreciation and amortization and
non-cash stock based compensation. This amount for the three months ended
September 30, 2000 was a loss of $12.7 million compared to a loss of $10.8
million for the same period of the prior year. The decline primarily resulted
from increased administration, curriculum and development, and pre-opening
expenses. On a per-student basis, negative EBITDA improved to $223 compared to
$288 for the same period one year ago.
Other Income and Expense. Other income, net was $1.3 million for the
three months ended September 30, 2000 compared to net expense of $197,000 in the
same period for the prior year. The increase was primarily due to increased
interest income resulting from higher invested cash balances. Interest income
was partially offset by increased interest expense from expanded borrowings.
Provision for taxes. For the three months ended September 30, 2000, we
have provided for amounts owed to the State of Michigan for corporate taxes
arising from our operation of several sites in that state.
LIQUIDITY AND CAPITAL RESOURCES
We have historically operated in a negative cash flow position. To date
we have financed our cash needs through a combination of equity and debt
financing. We intend to enter into debt financing arrangements to finance a
substantial portion of our expected technology and facilities-related
expenditures through fiscal 2001. As of October 31, 2000, we have not entered
into all such financing arrangements. Although we have successfully obtained
necessary financing in the past for technology and facilities-related
expenditures, there can be no assurance that we will be able to obtain them, or
on favorable terms, in the future.
For the three months ended September 30, 2000, we used approximately
$18.3 million for operating activities. This use primarily resulted from $19.5
million of net loss and a $5.4 million net decrease in working capital accounts
partially offset by depreciation and amortization totaling $6.4 million and
non-cash stock based compensation expense of $362,000.
For the three months ended September 30, 2000, we used approximately
$33.2 million in investing activities. During this period, we invested
approximately $20.8 million in our schools and central office. This amount
includes the investments we made in technology and curriculum in each of the
schools we open. We have also advanced funds to six of our charter board clients
or their affiliates to help obtain, renovate and complete school facilities. The
amounts advanced for the three months ended September 30, 2000 were
approximately $15.2 million. During this same period, we also received
approximately $400,000 in repayments on advances previously made. Also, the
Company disposed of leasehold improvements totaling approximately $1.1 million.
In July 2000, we received an equity contribution of $550,000 from the minority
shareholder of our consolidating subsidiary.
For the three months ended September 30, 2000, we received $74.8
million from our financing activities. The amounts received were from our
secondary offering, and the exercise of stock options and warrants. In August
2000, we completed a secondary offering in which we sold 3.4 million shares of
Class A Common Stock for net proceeds of approximately $71.2 million. Also in
August 2000, a philanthropic foundation exercised warrants to purchase 600,000
shares of Class A Common and paid to the Company approximately $4.8 million. For
the same period, we received approximately $1.4 million in proceeds from
financing arrangements for computers and other technology and $1.2 million for
facilities acquired through our consolidated subsidiary. These proceeds were
partially offset by the repayments of notes payable of approximately $3.3
million.
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We expect our cash on hand, together with borrowings under anticipated
financing arrangements to finance technology and facilities-related expenditures
together with expected reimbursements of advances we have made to charter
boards, will be sufficient to meet our working capital needs to operate our
existing business and schools. The Company's near term capital needs are
generally growth related and are dependent upon the Company's rate of growth and
its mix of independent charter schools versus contract schools. Independent
charter schools usually require us to advance funds to help charter boards
obtain, renovate and complete school facilities. As a result, our need for
additional funding will be impacted by our ability and desire to modulate the
mix of new and existing charter and contract schools for the 2001-2002 school
year. Also, we will likely require additional funding if our rapid growth
continues at our similar historical rate and our new schools for the 2001-2002
school year are of the same or similar mix as the 2000-2001 school year.
Our longer term requirements are for capital to fund operational
losses, capital expenditures related to growth and for anticipated working
capital needs and general corporate purposes. We expect to fund such
expenditures and other longer term liquidity needs with cash generated from
operations, the proceeds from the secondary offering and expanded financing
arrangements. Depending on the terms of any financing arrangements, such funding
may be dilutive to existing shareholders, and we cannot be certain that we will
be able to obtain additional financing on favorable terms, if at all.
In November 1999, we obtained a line of credit from Imperial Bank,
which provides for borrowings of up to $10.0 million. The line of credit has a
term of three years and may be used for seasonal working capital needs and other
general corporate purposes. The interest rate on the line of credit is LIBOR
plus 4% and it is secured by our general assets and is subject to financial
covenants and restrictions, including the prohibition on the payment of
dividends. We have terminated the line of credit in November 2000 and expect to
seek an alternative similar financing arrangement. However, we cannot be certain
that we will be able to obtain such a similar financing arrangement on favorable
terms, if at all.
In June 2000, the Company received a financing commitment for a 36 month
lease with Cisco Systems Credit Corporation. This lease will be used to finance
and be collateralized by certain equipment to be placed in schools. The lease
commitment is up to $2.4 million and has an effective rate of 11.0%. No amounts
were outstanding under this commitment at September 30, 2000.
On November 8, 2000, a charter board client obtained approximately
$11.4 million of permanent financing secured by certain of their school
facilities. The Company received $7.3 million from that financing as partial
repayment of outstanding advances related to the improvement of the facilities
and a note for $4.3 million, for the balance of the advance, which is secured by
a second mortgage in the facilities. As part of the financing arrangement, the
Company has guaranteed $8.6 million of the debt.
In general, our ability to achieve positive cash flow will be dependent
on the volume of schools with positive gross site contribution to offset central
office and overhead expenses. Because gross site contribution is the difference
between site revenues and site expenditures, positive gross site contribution
can be achieved at a range of enrollment levels. While higher enrollment tends
to have a positive effect on gross site contribution, our growth and cash flow
do not depend on 100% enrollment.
Capital expenditures estimated to be incurred during fiscal 2001, which
include estimates for schools opening in the 2000-2001 and 2001-2002 school
years, are expected to be approximately $85 million, which includes
approximately $32 million for computers and other technology, approximately $30
million for curriculum materials and approximately $12 million for the purchase
and improvement of property in New York, New York in connection with the
development of our new corporate headquarters. Our rate of growth for the
2001-2002 school year, as discussed above, could increase or decrease these
estimates. Also, for more information on the headquarters project, see below"-
We may incur substantial costs if we are unable to complete our Edison corporate
headquarters project" and "Properties." We expect to make further advances or
loans approximating $35 million to new charter board clients to help secure and
renovate school properties for the schools opening in the 2000-2001 school year,
a significant portion of which we expect will be refinanced through third
parties. We are also implementing enterprise-wide computer and software
packages. Such systems include financial reporting, payroll, purchasing,
accounts payable, human resources and other administrative modules as well as a
student data and school management package. We expect expenditures for the
software packages, together with related hardware, implementation costs and
other maintenance expenditures, will total approximately $15 to $20 million
through fiscal 2003, of which we had expended approximately $6.4 million through
September 30, 2000.
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ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
Our business, operating results or financial condition could be materially
adversely affected by any of the following factors. You should also refer to the
information set forth in this report, including our financial statements and the
related notes.
WE ARE A YOUNG COMPANY, HAVING OPENED OUR FIRST SCHOOLS IN FISCAL 1996; THIS
MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS
We opened our first schools and recorded our first revenue in fiscal 1996.
As a result, we have only five years of operating history on which you can base
your evaluation of our business and prospects. Our business and prospects must
be considered in light of the risks and uncertainties frequently encountered by
companies in the early stages of development, particularly companies like us who
operate in new and rapidly evolving markets. Our failure to address these risks
and uncertainties could cause our operating results to suffer and result in the
loss of all or part of your investment.
WE HAVE A HISTORY OF LOSSES AND EXPECT LOSSES IN THE FUTURE
We have incurred substantial net losses in every fiscal period since we
began operations. For the quarter year ended September 30, 2000, our net loss
was $19.5 million. As of September 30, 2000, our accumulated deficit since
November 1996, when we converted from a partnership to a corporation, was
approximately $135.1 million. In addition, prior to November 1996, we incurred
losses of approximately $61.8 million, which are reflected in our additional
paid-in capital. We have not yet demonstrated that public schools can be
profitably managed by private companies and we are not certain when we will
become profitable, if at all. Our ability to become profitable will depend upon
our ability to generate and sustain higher levels of both gross site
contribution and total revenue to allow us to reduce central expenses as a
percentage of total revenue. Even if we do achieve profitability, we may not
sustain or increase profitability on a quarterly or annual basis. Failure to
become and remain profitable may adversely affect the market price of our class
A common stock and our ability to raise capital and continue operations.
THE PRIVATE, FOR-PROFIT MANAGEMENT OF PUBLIC SCHOOLS IS A RELATIVELY NEW AND
UNCERTAIN INDUSTRY, AND IT MAY NOT BECOME PUBLICLY ACCEPTED
Our future is highly dependent upon the development, acceptance and
expansion of the market for private, for-profit management of public schools.
This market has only recently developed and we are among the first companies to
provide these services on a for-profit basis. We believe the first meaningful
example of a school district contracting with a private company to provide core
instructional services was in 1992, and we opened our first schools in August
1995. The development of this market has been accompanied by significant press
coverage and public debate concerning for-profit management of public schools.
If this business model fails to gain acceptance among the general public,
educators, politicians and school boards, we may be unable to grow our business
and the market price of our class A common stock would be adversely affected.
THE SUCCESS OF OUR BUSINESS DEPENDS ON OUR ABILITY TO IMPROVE THE ACADEMIC
ACHIEVEMENT OF THE STUDENTS ENROLLED IN OUR SCHOOLS, AND WE MAY FACE
DIFFICULTIES IN DOING SO IN THE FUTURE
We believe that our growth will be dependent upon our ability to demonstrate
general improvements in academic performance at our schools. Our management
agreements contain performance requirements related to test scores. As average
student performance at our schools increases, whether due to improvements in
achievement over time by individual students in our schools or changes in the
average performance levels of new students entering our schools, aggregate
absolute improvements in student performance will be more difficult to achieve.
If academic performance at our schools declines, or simply fails to improve, we
could lose business and our reputation could be seriously damaged, which would
impair our ability to gain new business or renew existing school management
agreements.
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WE COULD INCUR LOSSES AT OUR SCHOOLS IF WE ARE UNABLE TO ENROLL ENOUGH STUDENTS
Because the amount of revenue we receive for operating each school depends
on the number of students enrolled, and because many facility and on-site
administrative costs are fixed, achieving site-specific enrollment objectives is
an important factor in our ability to achieve satisfactory financial performance
at a school. We may be unable to recruit enough students to attend all grades in
our new schools or maintain enrollment at all grades in our existing schools. We
sometimes do not have enough students to fill some grades in some schools,
particularly the higher grades. It is sometimes more difficult to enroll
students in the higher grades because older students and their parents are
reluctant to change schools. To the extent we are unable to meet or maintain
enrollment objectives at a school, the school will be less financially
successful and our financial performance will be adversely affected.
WE ARE EXPERIENCING RAPID GROWTH, WHICH MAY STRAIN OUR RESOURCES AND
MAY NOT BE SUSTAINABLE
We have grown rapidly since we opened our first four schools in August 1995.
We operated 79 schools during the 1999-2000 school year and are operating 113
schools in the 2000-2001 school year. This rapid growth has sometimes strained
our managerial, operational and other resources, and we expect that continued
growth would strain these resources in the future. If we are to manage our rapid
growth successfully, we will need to continue to hire and retain management
personnel and other employees. We must also improve our operational systems,
procedures and controls on a timely basis. If we fail to successfully manage our
growth, we could experience client dissatisfaction, cost inefficiencies and lost
growth opportunities, which could harm our operating results. We cannot
guarantee that we will continue to grow at our historical rate.
WE MAY NOT BE ABLE TO ATTRACT AND RETAIN HIGHLY SKILLED PRINCIPALS AND TEACHERS
IN THE NUMBERS REQUIRED TO GROW OUR BUSINESS
Our success depends to a very high degree on our ability to attract and
retain highly skilled school principals and teachers. We hired approximately 27
new principals and approximately 1,400 new teachers to meet the needs of our new
schools for the 2000-2001 school year, in addition to satisfying our needs
resulting from normal turnover at existing schools. Currently, there is a
well-publicized nationwide shortage of teachers and other educators in the
United States. In addition, we may find it difficult to attract and retain
principals and teachers for a variety of reasons, including the following:
- we generally require our teachers to work a longer day and a longer
year than most public schools;
- we tend to have a larger proportion of our schools in challenging
locations, such as low-income urban areas, which may make attracting
principals and teachers more difficult; and
- we believe we generally impose more accountability on principals and
teachers than do public schools as a whole.
These factors may increase the challenge we face in an already difficult
market for attracting principals and teachers. We have also experienced higher
levels of turnover among teachers than is generally found in public schools
nationally, which we attribute in part to these factors. If we fail to attract
and retain principals and teachers in sufficient numbers or of a sufficient
quality, we could experience client dissatisfaction and lost growth
opportunities, which would adversely affect our business.
WE ARE CURRENTLY IMPLEMENTING NEW INFORMATION SYSTEMS, WHICH COULD CAUSE
DISRUPTIONS TO OUR BUSINESS
We are currently in the process of implementing a new student information
system, as well as a new accounting, financial reporting and management
information system. We may face difficulties in integrating these systems with
our existing information and other systems. If we fail to successfully implement
and integrate these new systems, we may not have access, on a timely basis, to
the information we need to effectively manage our schools, our business and our
growth.
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AS WE TRANSITION FROM OUR EXISTING TECHNOLOGY INFRASTRUCTURE TO AN IBM PLATFORM,
WE MAY FACE DIFFICULTIES AND DELAYS IN IMPLEMENTING THE NEW SYSTEM AND WE WILL
BECOME DEPENDENT UPON IBM TO A LARGE DEGREE TO MANAGE THE NEW SYSTEM
We recently announced that we have selected IBM to provide the computers and
related software for use in our schools and classrooms, as well as the
networking hardware and network management software necessary to connect our
schools nationwide. To date, we have only a letter of intent with IBM, and we
cannot be certain that we will reach a definitive agreement. IBM has performed a
significant portion of the installation, implementation and integration services
necessary for the deployment of this technology for the new schools we open for
2000-2001 school year. Implementation and intergration will continue over time
to existing schools, with the result that we will operate some schools using the
new IBM platform at the same time we operate schools on our existing platform,
which is based largely on Apple and other non-IBM technologies. We may face
significant difficulties and delays in this complex implementation, as well as
difficulties in the transition from our existing system to the new IBM system.
Additionally, we may face unforeseen implementation costs. Once the hardware and
software is installed, we cannot be certain that it will work satisfactorily or
at all. We also expect to engage the services of IBM to manage significant
portions of our technology function in the future, and any unsatisfactory
performance on the part of IBM could seriously impair the operations of our
schools. If we experience implementation or transition difficulties or delays,
or unexpected costs, our financial performance could be harmed and our
reputation could be compromised.
WE MUST OPEN A LARGE NUMBER OF NEW SCHOOLS IN A SHORT PERIOD OF TIME AT THE
BEGINNING OF EACH SCHOOL YEAR AND, IF WE ENCOUNTER DIFFICULTIES IN THIS PROCESS,
OUR BUSINESS AND REPUTATION COULD SUFFER
It is the nature of our business that virtually all of the new schools we
open in any year must be opened within a few weeks of each other at the
beginning of the school year. Each new school must be substantially functional
when students arrive on the first day of school. This is a difficult logistical
and management challenge, and the period of concentrated activity preceding the
opening of the school year places a significant strain on our management and
operational functions. We expect this strain will increase if we are successful
in securing larger numbers of school management agreements in the future. If we
fail to successfully open schools by the required date, we could lose school
management agreements, incur financial losses and our reputation would be
damaged. This could seriously compromise our ability to pursue our growth
strategy.
OUR BUSINESS COULD SUFFER IF WE LOSE THE SERVICES OF KEY EXECUTIVES
Our future success depends upon the continued services of a number of our
key executive personnel, particularly Benno C. Schmidt, Jr., our Chairman of the
Board of Directors, and H. Christopher Whittle, our President and Chief
Executive Officer. Mr. Schmidt and Mr. Whittle have been instrumental in
determining our strategic direction and focus and in publicly promoting the
concept of private management of public schools. If we lose the services of
either Mr. Schmidt or Mr. Whittle, or any of our other executive officers or key
employees, our ability to grow our business would be seriously compromised and
the market price of our class A common stock may be adversely affected. Also, we
do not maintain any key man insurance on any of our executives.
WE DEPEND UPON COOPERATIVE RELATIONSHIPS WITH TEACHERS' UNIONS, BOTH AT THE
LOCAL AND NATIONAL LEVELS
With respect to contract schools, but generally not charter schools, union
cooperation at the local level is often critical to us in obtaining new
management agreements and maintaining existing management agreements. In those
school districts where applicable, provisions of collective bargaining
agreements must typically be waived in areas such as length of school day,
length of school year, negotiated compensation policies and prescribed methods
of evaluation in order to implement the Edison design at a contract school. We
regularly encounter resistance from local teachers' unions during school board
debates over whether to enter into a management agreement with us. In addition,
local teachers' unions have occasionally initiated litigation challenging our
management agreements. If we fail to achieve and maintain cooperative
relationships with local teachers' unions, we could lose business and our
ability to grow could suffer, which could adversely affect the market price of
our class A common stock. In addition, at the national level, the American
Federation of Teachers and the National Education Association have substantial
financial and other resources that could be used to influence legislation and
public opinion in a way that would hurt our business.
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WE COULD BE LIABLE FOR EVENTS THAT OCCUR AT OUR SCHOOLS
We could become liable for the actions of principals, teachers and other
personnel in our schools. In the event of on-site accidents, injuries or other
harm to students, we could face claims alleging that we were negligent, provided
inadequate supervision or were otherwise liable for the injury. We could also
face allegations that teachers or other personnel committed child abuse, sexual
abuse or other criminal acts. In addition, if our students commit acts of
violence, we could face allegations that we failed to provide adequate security
or were otherwise responsible for their actions, particularly in light of recent
highly publicized incidents of school violence. Although we maintain liability
insurance, this insurance coverage may not be adequate to fully protect us from
these kinds of claims. In addition, we may not be able to obtain liability
insurance in the future at reasonable prices or at all. A successful liability
claim could injure our reputation and hurt our financial results. Even if
unsuccessful, such a claim could cause unfavorable publicity, entail substantial
expense and divert the time and attention of key management personnel.
OUR MANAGEMENT AGREEMENTS WITH SCHOOL DISTRICTS AND CHARTER BOARDS ARE
TERMINABLE UNDER SPECIFIED CIRCUMSTANCES AND GENERALLY EXPIRE AFTER A TERM OF
FIVE YEARS
Our management agreements generally have a term of five years. When we
expand by adding an additional school under an existing management agreement,
the term with respect to that school generally expires at the end of the initial
five-year period. We have limited experience in renewing management agreements,
and we cannot be assured that any management agreements will be renewed at the
end of their term. A management agreement covering two schools expired after the
1999-2000 school year and was not renewed. Management agreements representing 12
schools, accounting for 17.3% of our total revenue for fiscal 2000, will expire
at the end of the 2000-2001 school year, and agreements representing 12 schools,
accounting for 13.8% of our total revenue for fiscal 2000, will expire at the
end of the 2001-2002 school year. In addition, management agreements
representing 15 schools, accounting for 18.2% of our total revenue for fiscal
2000, are terminable by the school district or charter board at will, with or
without good reason, and all of our management agreements may be terminated for
cause, including a failure to meet specified educational standards, such as
academic performance based on standardized test scores. In addition, as a result
of changes within a school district, such as changes in the political climate,
we could from time to time face pressure to permit a school district or charter
board to terminate our management agreement even if they do not have a legal
right to do so. If we fail to renew a significant number of management
agreements at the end of their term, or if management agreements are terminated
prior to their expiration, our reputation and financial results would be
adversely affected.
OUR MANAGEMENT AGREEMENTS INVOLVE FINANCIAL RISK
Under all of our management agreements, we agree to operate a school in
return for per-pupil funding that generally does not vary with our actual costs.
To the extent our actual costs under a management agreement exceed our budgeted
costs, or our actual revenue is less than planned because we are unable to
enroll as many students as we anticipated or for any other reason, we could lose
money at that school. We are generally obligated by our management agreements to
continue operating a school for the duration of the contract even if it becomes
unprofitable to do so.
WE HAVE LIMITED EXPERIENCE OPERATING FOUR-YEAR HIGH SCHOOLS
An element of our strategy is to increase our business with existing
customers by opening new schools in school districts with whom we have an
existing relationship. An important aspect of this strategy is to open Edison
high schools in districts in which we operate elementary and middle schools.
Because we have limited experience operating high schools, our complete high
school curriculum, school design and operating plan are not fully tested. In
addition, school districts typically spend more per pupil on high school
education than on elementary education. By contrast, some of our management
agreements provide that we receive for each student, regardless of grade level,
the average per-pupil funding spent by the school district for all grade levels.
For this reason, in these schools we receive less per high school student than
is spent by the school district for each of its high school students. In these
situations, our success depends upon our ability to deliver our high school
design for the same per-pupil spending as in our elementary schools. If we are
unable to successfully and profitably operate high schools, our ability to
pursue our growth strategy will be impaired, which could adversely affect the
market price of our class A common stock.
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OUR LENGTHY SALES CYCLE COULD DELAY NEW BUSINESS
The time between initial contact with a potential contract or charter client
and the ultimate opening of a school, and related recognition of revenue,
typically ranges between 10 and 20 months. Our sales cycle for contract schools
is generally very long due to the approval process at the local school board
level, the political sensitivity of converting a public school to private
management and the need, in some circumstances, for cooperation from local
unions. We also have a lengthy sales cycle for charter schools for similar
reasons, as well as the need to arrange for facilities to house the school. As a
result of this lengthy sales cycle, we have only a limited ability to forecast
the timing of new management agreements. Any delay in completing, or failure to
complete, management agreements could hurt our financial performance.
WE COULD LOSE MONEY IF WE UNDERESTIMATE THE REAL ESTATE COSTS ASSOCIATED WITH
ACQUIRING OR RENOVATING A CHARTER SCHOOL
If we incur unexpected real estate cost overruns in acquiring or renovating
a charter school, we could lose money in operating the school. Our decision to
enter into a management agreement for a charter school, and our estimate of the
financial performance of the charter school, is based, in part, on the estimated
facility financing cost associated with renovating an existing facility or
building a new facility to house the charter school. This cost varies widely
from minimal amounts for minor upgrades to between $4.0 million to more than
$8.0 million for new construction. Each charter school absorbs a portion of its
facility financing costs each year through its leasing and similar expenses. If
these expenses exceed our estimates for the charter school, the charter school
could lose money and our financial results would be adversely affected.
WE HAVE ADVANCED AND LOANED MONEY TO CHARTER SCHOOL BOARDS THAT MAY NOT BE
REPAID
As of September 30, 2000, we had advances or loans to charter school boards
totaling approximately $43.1 million to finance the purchase or renovation of
school facilities we manage. We generally have not charged interest on these
loans and advances. Approximately $24.3 million of these loans, representing
seventeen schools, are unsecured or subordinated to a senior lender. Loans of
$18.8 million, representing four schools, may be accelerated upon termination of
the corresponding management agreement with the charter school. We currently
expect to make additional advances of at least $37.3 million in connection with
charter schools we opened in the 2000-2001 school year. If these advances or
loans are not repaid when due, our financial results could be adversely
affected.
WE COULD BECOME LIABLE FOR FINANCIAL OBLIGATIONS OF CHARTER BOARDS
We could have facility financing obligations for charter schools we no
longer operate, because the terms of our facility financing obligations for some
of our charter schools exceeds the term of the management agreement for those
schools. While the charter board is generally responsible for locating and
financing its own school building, the holders of school charters, which are
often non-profit organizations, typically do not have the resources required to
obtain the financing necessary to secure and maintain the school building. For
this reason, if we want to obtain a management agreement with the charter board,
we must often help the charter board arrange for the necessary financing. For
four of our charter schools, we have entered into a long-term lease for the
school facility which exceeds the current term of the management agreement by as
much as 14 years. If our management agreements were to be terminated, or not
renewed in these charter schools, our obligations to make lease payments would
continue, which could adversely affect our financial results. As of September
30, 2000, our aggregate future lease obligations totaled $28.5 million, with
varying maturities over the next 17 years. In four of our charter schools, we
have provided some type of permanent credit support for the school building,
typically in the form of loan guarantees or cash advances. To date, we have
generally not charged interest on these advances. Although the term of these
arrangements is coterminous with the term of the corresponding management
agreement, our guarantee does not expire until the loan is repaid in full. The
lenders under these facilities are not committed to release us from our
obligations unless replacement credit support is provided. The default by any
charter school under a credit facility that we have guaranteed could result in a
claim against us for the full amount of the borrowings. Furthermore, in the
event any charter board becomes insolvent or has its charter revoked, our loans
and advances to the charter board may not be recoverable, which could adversely
affect our financial results. As of September 30, 2000, the amount of loans we
had guaranteed totaled $9.7 million.
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KSIXTEEN LLC MAY BE UNABLE TO DEVELOP PROPERTIES FOR USE AS CHARTER SCHOOLS
We intend to rely on Ksixteen LLC to develop properties for use as charter
schools and they may be unable to develop the properties by the required date.
Ksixteen, a company recently formed by Edison, former members of Edison's real
estate department and an outside investor, has no operating history and has
never developed property as a separate entity. Any delay in the development of
charter school properties could prevent us from successfully opening charter
schools on time, which could result in lost charter school management
agreements, financial losses and damage to our reputation. In addition, in the
event of a failure by any of our charter schools to pay fees due Ksixteen LLC
for its services to the charter school, we could be obligated to pay those fees
to Ksixteen.
OUR FINANCIAL RESULTS ARE SUBJECT TO SEASONAL PATTERNS AND OTHER FLUCTUATIONS
FROM QUARTER TO QUARTER
We expect our results of operations to experience seasonal patterns and
other fluctuations from quarter to quarter. The factors that could contribute to
fluctuations, which could have the effect of masking or exaggerating trends in
our business and which could hurt the market price of our class A common stock,
include:
- Because new schools are opened in the first fiscal quarter of each year,
increases in student enrollment and related revenue and expenses will first
be reflected in that quarter. Subsequent to the first quarter, student
enrollment is expected to remain relatively stable throughout a school
year, and, accordingly, trends in our business, whether favorable or
unfavorable, will tend not to be reflected in our quarterly financial
results, but will be evident primarily in year-to-year comparisons.
- We recognize revenue for each school pro rata over the 11 months
from August through June, and we recognize no school revenue in July. Most
of our site costs are recognized over the 11 months from August through
June. For this reason, the first quarter of our fiscal year has
historically reflected less revenue and lower expenses than the other three
quarters, and we expect this pattern to continue.
- Our recognition of site-related expenses in the first fiscal quarter is
proportionally greater than the revenue recognition because some site
expenses are incurred in July and no revenue is recorded in July. This
results in lower gross site margin in the first fiscal quarter than in the
remaining fiscal quarters. We also recognize pre-opening costs primarily in
the first and fourth quarters.
Our financial results can vary among the quarters within any fiscal year for
other reasons, including unexpected enrollment changes, greater than expected
costs of opening schools or delays in opening new schools.
WE EXPECT OUR MARKET TO BECOME MORE COMPETITIVE
We expect the market for providing private, for-profit management of public
schools will become increasingly competitive. Currently, we compete with a
relatively small number of companies which provide these services, and they have
to date primarily focused on the operation of charter schools. These companies
could, however, begin to compete with us at any time for contract schools. In
addition, a variety of other types of companies and entities could enter the
market, including colleges and universities, other private companies that
operate higher education or professional education schools and others. Our
existing competitors and these new market entrants could have financial,
marketing and other resources significantly greater than ours. We also compete
for public school funding with existing public schools, who may elect not to
enter into management agreements with private managers or who may pursue
alternative reform initiatives, such as magnet schools and inter-district choice
programs. In addition, in jurisdictions where voucher programs have been
authorized, we will begin to compete with existing private schools for public
tuition funds. Voucher programs provide for the issuance by local or other
governmental bodies of tuition vouchers to parents worth a certain amount of
money that they can redeem at any approved school of their choice, including
private schools. If we are unable to compete successfully against any of these
existing or potential competitors, our revenues could be reduced, resulting in
increased losses.
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FAILURE TO RAISE NECESSARY ADDITIONAL DEBT AND/OR EQUITY CAPITAL COULD RESTRICT
OUR GROWTH AND HINDER OUR ABILITY TO COMPETE
We have had negative cash flow in every fiscal period since we began
operations and are not certain when we will have positive cash flow, if at all.
We have regularly needed to raise funds in order to operate our business and may
need to raise additional funds in the future through the sale of equity or debt
securities. We cannot be certain that we will be able to obtain additional
financing on favorable terms, if at all. If we issue additional equity or
convertible debt securities, stockholders may experience dilution or the new
equity or convertible debt securities may have rights, preferences or privileges
senior to those of existing holders of class A common stock. In addition, we
intend to enter into debt financing arrangements to finance a substantial
portion of our expected technology and facilities-related expenditures through
fiscal 2001. As of September 30, 2000, we have not entered into all such
financing arrangements. If we cannot raise funds on acceptable terms, if and
when needed, we may not be able to take advantage of future opportunities, grow
our business or respond to competitive pressures or unanticipated requirements,
which could seriously harm our business.
WE MAY INCUR SUBSTANTIAL COSTS IF WE ARE UNABLE TO COMPLETE OUR EDISON CORPORATE
HEADQUARTERS PROJECT
We have entered into a contract to purchase a lot located in the Harlem
section of the borough of Manhattan in New York City for a purchase price of $10
million. We intend to develop the property in partnership with the Museum of
African Art for a mixed-use project consisting of our corporate headquarters, a
charter school and a museum. We have not yet received the necessary zoning
approvals for this project. We have paid $3.0 million to the current owner of
the property and could be required to pay up to an additional $500,000 if we
need to extend the closing date in order to obtain the zoning approvals. If we
are unable to obtain the necessary zoning approvals by April 11, 2001, or if
prior to that time we decide to terminate the contract, we will be forced either
to forfeit any amounts paid to the current owner, which could be as much as $3.5
million, or to purchase the property without the zoning approvals. In addition,
we do not currently have a contract with the Museum of African Art for this
project or an agreement with any party to operate a charter school on that site.
We must also acquire additional property adjacent to the lot to house the entire
project. If we are unable to acquire the additional property, we will be
required to reduce the size of the project.
WE RELY ON GOVERNMENT FUNDS FOR SPECIFIC EDUCATION PROGRAMS, AND OUR BUSINESS
COULD SUFFER IF WE FAIL TO COMPLY WITH RULES CONCERNING THE RECEIPT AND USE OF
THE FUNDS
We benefit from funds from federal and state programs to be used for
specific educational purposes. Funding from the federal government under Title I
of the Elementary and Secondary Education Act, which provides federal funds for
children from low-income families, accounted for approximately 5.6% of our total
revenue for the quarter ended September 30, 2000. We estimate that funding from
other federal and state programs accounts for an additional 8.8% of our total
revenue. A number of factors relating to these government programs could lead to
adverse effects on our business:
- These programs have strict requirements as to eligible students and
allowable activities. If we or our school district and charter board
clients fail to comply with the regulations governing the programs, we
or our clients could be required to repay the funds or be determined
ineligible to receive these funds, which would harm our business.
- If the income demographics of a district's population were to change
over the life of our management agreement for a school in the district,
resulting in a decrease in Title I funding for the school, we would
receive less revenue for operating the school and our financial results
could suffer.
- Funding from federal and state education programs is allocated through
formulas. If federal or state legislatures or, in some case, agencies
were to change the formulas, we could receive less funding and the
growth and financial performance of our business would suffer.
- Federal, state and local education programs are subject to annual
appropriations of funds. Federal or state legislatures or local
officials could drastically reduce the funding amount of appropriation
for any program, which would hurt our business and our ability to grow.
- The authorization for the Elementary and Secondary Education Act,
including Title I, has expired and this act is being
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funded by Congress on an interim appropriation basis. If Congress does
not reauthorize or continue to provide interim appropriation for the
Elementary and Secondary Education Act, we would receive less funding
and our growth and financial results would suffer.
- Most federal education funds are administered through state and local
education agencies, which allot funds to school boards and charter
boards. These state and local education agencies are subject to
extensive government regulation concerning their eligibility for
federal funds. If these agencies were declared ineligible to receive
federal education funds, the receipt of federal education funds by our
school board or charter board clients could be delayed, which could in
turn delay our payment from our school board and charter board clients.
- We could become ineligible to receive these funds if any of our
high-ranking employees commit serious crimes.
WE COULD BE SUBJECT TO EXTENSIVE GOVERNMENT REGULATION BECAUSE WE BENEFIT FROM
FEDERAL FUNDS, AND OUR FAILURE TO COMPLY WITH GOVERNMENT REGULATIONS COULD
RESULT IN THE REDUCTION OR LOSS OF FEDERAL EDUCATION FUNDS
Because we benefit from federal funds, we must also comply with a variety of
federal laws and regulations not directly related to any federal education
program, such as federal civil rights laws and laws relating to lobbying. Our
failure to comply with these federal laws and regulations could result in the
reduction or loss of federal education funds which would cause our business to
suffer. In addition, our management agreements are potentially covered by
federal procurement rules and regulations because our school district and
charter board clients pay us, in part, with funds received from federal
programs. Federal procurement rules and regulations generally require
competitive bidding, awarding contracts based on lowest cost and similar
requirements. If a court or federal agency determined that a management
agreement was covered by federal procurement rules and regulations and was
awarded without compliance with those rules and regulations, then the management
agreement could be voided and we could be required to repay any federal funds we
received under the management agreement, which would hurt our business.
WE RECEIVE ALL OF OUR REVENUE FROM PUBLIC SOURCES AND ANY REDUCTION IN GENERAL
FUNDING LEVELS FOR EDUCATION COULD HURT OUR BUSINESS
All of our revenue is derived from public sources. If general levels of
funding for public education were to decline, the field of school districts in
which we could profitably operate schools would likewise diminish, and our
ability to grow by adding new schools would suffer. In addition, our management
agreements generally provide that we bear the risk of lower levels of per-pupil
funding, which would be directly reflected in lower revenue to us, even if our
costs do not decline accordingly.
RESTRICTIONS ON GOVERNMENT FUNDING OF FOR-PROFIT SCHOOL MANAGEMENT COMPANIES
COULD HURT OUR BUSINESS
Any restriction on the use of federal or state government educational funds
by for-profit companies could hurt our business and our ability to grow. From
time to time, a variety of proposals have been introduced in state legislatures
to restrict or prohibit the management of public schools by private, for-profit
entities like us. For example, a bill filed in Minnesota that would have
prohibited for-profit entities from managing charter schools in that state was
defeated in both 1997 and 1998. A similar bill in Massachusetts was not voted
out of committee. Additionally, Idaho's charter school law may, subject to
interpretation, restrict our ability to manage schools in that state. If states
were to adopt legislation prohibiting for-profit entities from operating public
schools, the market for our services could suffer.
THE OPERATION OF OUR CHARTER SCHOOLS DEPENDS ON THE MAINTENANCE OF THE
UNDERLYING CHARTER GRANT
Our charter schools operate under a charter that is typically granted by a
state authority to a third-party charter holder, such as a community group or
established non-profit organization. Our management agreement in turn is with
the charter holder or the charter board. If the state charter authority were to
revoke the charter, which could occur based on actions of the charter board
outside of our control, we would lose the right to operate that school. In
addition, many state charter school statutes require periodic reauthorization.
Charter schools accounted for 36% of our total revenue in fiscal 2000, or $79.6
million. If state charter school legislation were not reauthorized or were
substantially altered in a meaningful number of states, our business and growth
strategy would suffer and we could incur losses.
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OUR OFFICERS AND DIRECTORS WILL EXERCISE SIGNIFICANT CONTROL OVER OUR AFFAIRS,
WHICH COULD RESULT IN THEIR TAKING ACTIONS OF WHICH OTHER STOCKHOLDERS DO NOT
APPROVE
Based upon their holdings at October 31, 2000, our officers and directors
and entities affiliated with them together beneficially own 20,270,561 shares of
class A common stock and 3,133,161 shares of class B common stock. These shares
represent approximately 46.3% of the voting power of the class A common stock,
including the ability to elect three of the seven class A directors;
approximately 84.7% of the voting power of the class B common stock, including
the ability to elect all of the four class B directors; and approximately 61.1%
of the combined voting power of the class A and class B common stock. Of the
shares beneficially owned by our officers and directors and others affiliated
with them, 3,451,804 shares of class A common stock and 377,134 shares of class
B common stock are subject to options exercisable within 60 days of October 31,
2000. These stockholders, if they act together, will be able to exercise control
over all matters requiring approval by our stockholders, including the approval
of significant corporate transactions. This concentration of ownership may also
have the effect of delaying or preventing a change in control of our company and
could prevent stockholders from receiving a premium over the market price if a
change of control is proposed.
In addition, H. Christopher Whittle, our President and Chief Executive
Officer and a director, beneficially owns 4,234,069 shares of class A common
stock and 1,281,423 shares of class B common stock. These shares represent
approximately 11.7% of the voting power of the class A common stock;
approximately 36.5% of the voting power of the class B common stock, including
the ability to elect two of the four class B directors; and approximately 21.1%
of the combined voting power of the class A and class B common stock. Of the
shares beneficially owned by Mr. Whittle and his affiliates, 1,716,029 shares of
class A common stock and 189,745 shares of class B common stock are subject to
options exercisable within 60 days of October 31, 2000. Mr. Whittle and his
affiliates also own options not exercisable within 60 days of October 31, 2000
covering 2,726,638 shares of class A common stock and 292,775 shares of class B
common stock. To the extent Mr. Whittle exercises these options, his voting
power will be increased. In addition, if the other holders of class B common
stock sell a significant portion of their class B common stock, the voting power
of Mr. Whittle's class B common stock will further concentrate. Also, if the
other holders of class B common stock reduce their common stock holdings below a
specified threshold, then their class B common stock will automatically convert
into class A common stock, further increasing Mr. Whittle's voting power. The
class B common stock generally converts into class A common stock upon its
transfer. However, shares of class B common stock transferred to Mr. Whittle do
not automatically convert into class A common stock. Consequently, Mr. Whittle
can also increase his voting power by acquiring shares of class B common stock
from other stockholders.
PLEDGES OF SHARES OF OUR COMMON STOCK BY MR. WHITTLE COULD RESULT IN VOTING
POWER SHIFTING TO THE HANDS OF HIS LENDERS
Mr. Whittle and WSI Inc., a corporation controlled by Mr. Whittle, directly
or indirectly own 3,195,693 shares of class A common stock and 1,166,047 shares
of class B common stock, including an aggregate of 761,625 shares of class A
common stock and 84,625 shares of class B common stock which represents WSI's
interest in a limited partnership and a limited liability company that hold
Edison stock. These figures include shares issuable upon the exercise of options
within 60 days of October 31, 2000. Mr. Whittle and WSI have pledged to Morgan
Guaranty Trust Company of New York all of their direct and indirect interests in
Edison to secure personal obligations. These obligations become due in February
2003 and interest on these obligations is payable monthly. In addition, Mr.
Whittle may not vote his class A common stock and class B common stock on any
matter other than the election or removal of directors without Morgan's prior
written consent. Of these shares, Morgan allowed WSI to pledge up to 900,002
shares to other lenders. Upon satisfaction of WSI's obligations to the other
lenders, these shares would revert back to being pledged to Morgan. Morgan also
allowed WSI to grant options to purchase an aggregate of 61,425 of these shares
to other investors. If these options were not exercised, these shares would
revert back to being pledged to Morgan. If Mr. Whittle and WSI were to default
on their obligations to Morgan and Morgan were to foreclose on its pledge, the
class B common stock transferred directly or indirectly to Morgan would be
converted into class A common stock. Thereafter, based on current holdings, and
assuming the shares pledged to the other lenders and the shares subject to
options to other investors revert to the Morgan pledge, Morgan, together with
its affiliates who are currently stockholders of Edison, would beneficially own
6,922,441 shares of class A common stock, including shares subject to options
exercisable within 60 days of October 31, 2000. The holdings of Morgan and its
affiliates would then represent 15.3% of the voting power of the class A common
stock, 12.1% of the voting power of the class B common stock and 14.2% of the
combined voting power. This would enable Morgan to exercise greater influence
over corporate matters.
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OUR STOCK PRICE MAY BE VOLATILE
The market price of the class A common stock may fluctuate significantly in
response to the risks discussed above, as well as other factors, some of which
are beyond our control. These other factors include:
- variations in our quarterly operating results;
- changes in securities analysts' estimates of our financial performance;
- changes in market valuations of similar companies;
- future sales of our class A common stock or other securities; and
- general stock market volatility.
Since our class A common stock has been publicly traded, its market price
has fluctuated over a wide range and we expect it to continue to do so in the
future. In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. We may in the future be the target of similar litigation. Securities
litigation could result in substantial costs and divert management's attention
and resources.
ANTI-TAKEOVER PROVISIONS OF DELAWARE LAW AND OUR CHARTER AND BYLAWS COULD
PREVENT OR DELAY A CHANGE IN CONTROL
Provisions of Delaware law, our charter and our bylaws could make it more
difficult for a third party to acquire us, even if doing so would be beneficial
to our stockholders. These provisions could limit the price that certain
investors might be willing to pay in the future for shares of class A common
stock, and could have the effect of delaying, deferring or preventing a change
in control of Edison. These provisions include:
- the high-vote nature of the class B common stock;
- restrictions on removal of directors, which may only be effected for
cause and only by a vote of the holders of 80% of the class of common
stock that elected the director;
- Section 203 of the General Corporation Law of Delaware which could have
the effect of delaying transactions with interested stockholders;
- a prohibition of stockholder action by written consent; and
- procedural and notice requirements for calling and bringing action
before stockholder meetings.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We currently have market risk sensitive instruments related to interest
rates. We had outstanding long-term notes payable of $17.7 million at September
30, 2000. Interest rates on the notes are fixed and range from 14.1% to 20.4%
per annum and have terms of 36 to 48 months.
We do not believe that we have significant exposure to changing interest
rates on long-term debt because interest rates for our debt is fixed. We have
not undertaken any additional actions to cover interest rate market risk and are
not a party to any other interest rate market risk management activities.
Additionally, we do not have significant exposure to changing interest rates
on invested cash, which was approximately $76.0 million at September 30, 2000.
We invest cash mainly in money market accounts and other investment-grade
securities. We do not purchase or hold derivative financial instruments for
trading purposes.
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PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings from time to time
incidental to the conduct of its business. The Company currently believes that
any ultimate liability arising out of such proceedings will not have a material
adverse effect on its financial condition or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On November 17, 1999, we closed an initial public offering of our class
A common stock. The Registration Statement on Form S-1 (No. 333-84177) was
declared effective by the Securities and Exchange Commission on November 10,
1999, and we commenced the offering on that date. After deducting underwriting
discounts and commissions and offering expenses, our net proceeds from the
offering were approximately $109.7 million. We used the net proceeds of
approximately $109.7 million as follows: approximately $53.3 million of the net
proceeds for capital expenditures, approximately $29.2 million of the net
proceeds for advances to charter schools and approximately $27.2 million of the
net proceeds for operations which includes school pre-opening expenses. None of
the proceed amounts were paid directly or indirectly to any director, officer or
general partner of Edison or our associates, persons owning 10% or more of any
class of equity securities of Edison, or an affiliate of Edison.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
List of Exhibits
10.01 Promissory Note, dated July 5, 2000, issued to Tonya Hinch
27 Financial Data Schedule
Reports of Form 8-K
None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EDISON SCHOOLS INC.
Date November 14, 2000 /s/ H. Christopher Whittle
--------------------------------------
H. Christopher Whittle
President, Chief Executive Officer
and Director
Date November 14, 2000 /s/ James L. Starr
--------------------------------------
James L. Starr
Executive Vice President and
Chief Financial Officer (Principal
Accounting Officer)
25
