<PAGE>
UNITED STATES
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 December 31, 1998.
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 1-11111
THE TESSERACT GROUP, INC.
-------------------------
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1581297
--------- ----------
State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
3800 West 80th Street
Suite 1400
MINNEAPOLIS, MINNESOTA 55431
----------------------- -----
(Address of principal executive offices) (Zip Code)
(612) 837-8700
--------------
(Registrant's telephone number, including area code)
NOT APPLICABLE
--------------
(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. Yes X No
As of February 5, 1999, there were issued and outstanding 9,579,306 shares of
Common Stock, $.01 par value.
<PAGE>
THE TESSERACT GROUP, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
DECEMBER 31, 1998
<TABLE>
<CAPTION>
<S> <C>
PAGE
NUMBER
-------
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed consolidated balance sheets as of
December 31, 1998 and June 30, 1998 3
Condensed consolidated statements of operations for
the three months ended December 31, 1998 and 1997 4
Condensed consolidated statements of operations for
the six months ended December 31, 1998 and 1997 5
Condensed consolidated statements of cash flows for
the six months ended December 31, 1998 and 1997 6
Notes to condensed consolidated financial statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 8
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 10
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 10
Signatures 11
</TABLE>
-2-
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE TESSERACT GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
December 31, June 30,
(DOLLARS IN THOUSANDS) 1998 1998
------------ -------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 4,821 $ 5,543
Settlement receivable -- 650
Accounts receivable, net 3,065 2,370
Other current assets 2,627 1,927
-------- --------
Total current assets 10,513 10,490
INTANGIBLE ASSETS, NET 16,735 18,984
PROPERTY AND EQUIPMENT, NET 30,959 19,479
OTHER ASSETS 915 310
-------- --------
$ 59,122 $ 49,263
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Line of credit $ -- $ 470
Accounts payable 1,218 984
Other current liabilities 8,573 5,767
-------- --------
Total current liabilities 9,791 7,221
LONG-TERM OBLIGATIONS 20,261 8,578
OTHER
720 715
-------- --------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Preferred stock, $.01 par value, 5,000,000
shares authorized; no shares issued and
outstanding -- --
Common stock, $.01 par value, 25,000,000
shares authorized; issued and outstanding 9,579,306
shares at December 31, 1998 and 9,570,803 at
June 30, 1998 96 96
Additional paid-in capital 57,702 57,673
Accumulated deficit (29,448) (25,020)
-------- --------
Total shareholders' equity 28,350 32,749
-------- --------
$ 59,122 $ 49,263
-------- --------
-------- --------
</TABLE>
See notes to condensed consolidated financial statements.
-3-
<PAGE>
THE TESSERACT GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) December 31,
------------------------------------
1998 1997
-------------- -------------
<S> <C> <C>
REVENUE $ 9,818 $ 1,768
OPERATING EXPENSES 9,772 1,537
------- -------
SCHOOL OPERATING PROFIT 46 231
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES 1,155 1,130
------- -------
OPERATING LOSS (1,109) (899)
------- -------
OTHER INCOME (EXPENSE)
Investment income 82 253
Interest expense (460) --
------- -------
(378) 253
------- -------
LOSS BEFORE INCOME TAX EXPENSE (1,487) (646)
INCOME TAX EXPENSE -- --
------- -------
NET LOSS $(1,487) $ (646)
------- -------
------- -------
NET LOSS PER COMMON SHARE $ (.16) $ (.08)
------- -------
------- -------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
(BASIC AND DILUTED) 9,579 7,791
------- -------
------- -------
</TABLE>
See notes to condensed consolidated financial statements.
-4-
<PAGE>
THE TESSERACT GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Six months ended
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) December 31,
------------------------------------
1998 1997
-------------- -------------
<S> <C> <C>
REVENUE $ 16,773 $ 2,545
OPERATING EXPENSES 18,360 2,759
-------- --------
SCHOOL OPERATING LOSS (1,587) (214)
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES 2,261 2,074
-------- --------
OPERATING LOSS (3,848) (2,288)
-------- --------
OTHER INCOME (EXPENSE)
Investment income 138 583
Interest expense (718) --
-------- --------
(580) 583
-------- --------
LOSS BEFORE INCOME TAX EXPENSE (4,428) (1,705)
INCOME TAX EXPENSE -- --
-------- --------
-------- --------
NET LOSS $ (4,428) $ (1,705)
-------- --------
-------- --------
NET LOSS PER COMMON SHARE $ (.46) $ (.22)
-------- --------
-------- --------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
(BASIC AND DILUTED) 9,578 7,642
-------- --------
-------- --------
</TABLE>
See notes to condensed consolidated financial statements.
-5-
<PAGE>
THE TESSERACT GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six months ended
(IN THOUSANDS) December 31,
---------------------------------------
1998 1997
--------------- --------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (4,428) $ (1,705)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 1,271 189
Provision for doubtful accounts 42 --
Changes in operating assets and liabilities 1,572 1,284
-------- --------
Net cash used in operating activities (232) (1,543)
-------- --------
INVESTING ACTIVITIES
Additions to property and equipment (12,040) (4,168)
Purchase of Sunrise Educational Services, Inc.,
net of cash acquired -- (667)
Cash of Preschool Services, Inc. 1,137 --
-------- --------
Net cash used in investing activities (10,903) (4,835)
-------- --------
FINANCING ACTIVITIES
Proceeds from exercise of stock options 30 23
Proceeds from financing transactions 12,295 --
Repayment of long-term debt (601) --
-------- --------
Net cash provided by financing activities 11,724 23
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (722) (5,044)
Cash and cash equivalents at beginning of period 5,543 23,246
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,821 $ 18,202
-------- --------
-------- --------
</TABLE>
See notes to condensed consolidated financial statements.
-6-
<PAGE>
THE TESSERACT GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q
and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management,
all adjustments (consisting solely of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for
the three-month and six-month periods ended December 31, 1998, are not
necessarily indicative of the results that may be expected for the year
ending June 30, 1999. For further information, refer to the financial
statements and footnotes thereto included in the Company's annual report on
Form 10-K for the year ended June 30, 1998.
2. ACCOUNTING POLICIES
BASIS OF CONSOLIDATION: The condensed consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries.
Intercompany balances and transactions have been eliminated in
consolidation.
USE OF ESTIMATES: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and contingency
disclosures included in the financial statements. Ultimate results could
differ from these estimates.
3. PRESCHOOL SERVICES, INC.
The Company adopted the general guidelines of Emerging Issues Task Force
97-2 effective July 1, 1998, and accordingly has consolidated Preschool
Services, Inc. ("PSI"), a Hawaii non-profit corporation, in which the
Company has a controlling interest. Prior to the Company's December 1997
acquisition of Sunrise Educational Services, Inc. ("Sunrise"), Sunrise had
transferred a portion of its operations to PSI. Sunrise provides PSI with
management, administration, and educational programs for PSI's child care
centers and charter schools and leases substantially all of the equipment
and other property necessary for the operation of the related educational
facility to PSI under an Administrative Services Agreement, License and
Equipment Lease (the "PSI Agreement"). The PSI Agreement stipulates that
Sunrise is to receive a fee for providing the services described above. The
results of operations of PSI for the period from the acquisition of Sunrise
(December 18, 1997) through June 30, 1998, were not material to the
consolidated financial statements of the Company for the year ended June
30, 1998.
Prior to its acquisition by the Company, Sunrise had written off amounts
due from PSI due to the historical and anticipated inability of PSI to
generate sufficient cash flow to make the lease and other payments due to
Sunrise. As of June 30, 1998, the cumulative amount written off by Sunrise
related to the PSI Agreement approximated $1,800,000. During the six months
ended December 31, 1998, PSI generated sufficient cash flow to reimburse
Sunrise the entire amount previously written off. This reimbursement has
been recorded as a reduction of previously recorded goodwill associated
with the Sunrise acquisition.
-7-
<PAGE>
4. LONG TERM OBLIGATIONS
During the six months ended December 31, 1998, the Company completed the
refinancing of two school facilities. Total proceeds from the refinancings
were $5,800,000, representing the facilities cost. Interest payments on the
financing, amounting to approximately $630,000 on an annual basis, are
subject to annual increases based upon changes in the Consumer Price Index.
The financing obligations are structured as leases, having an initial term
of 15 years, with the Company having two 10-year renewal options. The terms
of the lease require that the Company prepay, on September 1 of each year,
the next 12 months rent, estimated property taxes, and insurance premiums
into an account jointly controlled by the Company and the lesser.
During the six months ended December 31, 1998, the Company also financed a
newly constructed private school facility with a $6,500,000, 11% mortgage.
The terms of the mortgage require that the Company prepay, on September 1
of each year, the next 12 months principal and interest payments, estimated
property taxes, and insurance premiums into an account jointly controlled
by the Company and the lender. Upon meeting certain financial criteria at
the school, the Company can require the lender to refinance the facility
with sale/leaseback financing. In addition, the lender has the option to
refinance the facility with sale/leaseback financing at any time.
In addition to the above referenced facility financing obligations, the
Company has outstanding approximately $900,000 of installment notes with a
bank at December 31, 1998. The installment notes contain covenants
regarding the maintenance of certain cash and working capital balances and
meeting certain net worth, debt, and cash flow ratios. At December 31,
1998, these covenants were not met. The Company is currently negotiating
with the bank on a waiver or amendment to these covenants. There can be no
assurance that a waiver or amendment will be obtained, at which time the
installment notes could become payable in full on demand. At December 31,
1998, the entire amount of the installment notes has been recorded as a
current liability in the accompanying condensed consolidated balance
sheets.
5. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 131, Disclosures about
Segments of an Enterprise and Related Information ("SFAS No. 131"), will be
effective for the Company's fiscal year ending June 30, 1999. SFAS No. 131
requires disclosures of business and geographic segments in the
consolidated financial statements of the Company. The Company is currently
analyzing the impact it will have on the disclosures in its financial
statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Revenue for the three and six months ended December 31, 1998, was $9,818,000 and
$16,773,000, respectively, compared to $1,768,000 and $2,545,000 for the same
periods of the prior year. Operating expenses for the three and six months ended
December 31, 1998, were $9,772,000 and $18,360,000, respectively, compared to
$1,537,000 and $2,759,000 for the same periods of the prior year. The increase
in both revenue and operating expenses in the three and six month periods is due
to the acquisitions of Sunrise Educational Services, Inc. ("Sunrise") in
December 1997 and Academy of Business, Inc. ("ABC") in January 1998. In
addition, increases in revenue and operating expenses result from the four new
TesseracT private and charter schools opened by the Company in September 1998.
The decline in operating results for the three and six month periods is
primarily the result of costs incurred in the integration of the Sunrise and ABC
acquisitions as well as operating results associated with the new schools opened
in September 1998.
-8-
<PAGE>
Selling, general, and administrative expenses totaled $1,155,000 and $2,261,000
for the three and six months ended December 31, 1998, respectively, compared to
$1,130,000 and $2,074,000, for the same periods of the prior year. The increase
reflects added personnel, travel, and other costs associated with the
integration of Sunrise and ABC, along with costs incurred in the pursuit of
additional private and charter school business.
The Company recorded interest expense of $460,000 and $718,000 in the three and
six months periods ended December 31, 1998, primarily resulting from the recent
school financings completed by the Company. Investment income totaled $82,000
and $138,000, respectively, in the three and six months ended December 31, 1998,
compared to $253,000 and $583,000 in the same periods of the prior year. The
current year decrease is due to lower cash investment levels.
The Company reported a net loss of $1,487,000 or $.16 per share in the three
months ended December 31, 1998, compared to a net loss of $646,000 or $.08 per
share in the same period of the prior year. For the six months ended December
31, 1998, the Company reported a net loss of $4,428,000 or $.46 per share,
compared to a net loss of $1,705,000 or $.22 per share for the same period of
the prior year. The increase in the current year net loss is due to the net
losses incurred at Sunrise and ABC, increased costs associated with the facility
financings completed by the Company, as well as full periods of operating costs
related to the new schools opened in September 1998.
CAPITAL RESOURCES AND LIQUIDITY
During the six months ended December 31, 1998, net cash used in operating
activities totaled $1,543,000, primarily due to the net loss incurred during the
six months, offset by changes in operating assets and liabilities and non-cash
charges.
Additions to property and equipment during the first six months of the year
totaled $12,040,000, primarily related to costs at two new private schools
constructed in the Phoenix metropolitan area. The refinancing of these two
schools were completed during the first half of fiscal 1999, generating proceeds
of approximately $11,750,000.
At December 31, 1998, the Company has outstanding approximately $900,000 of
installment notes with a bank. The installment notes contain covenants regarding
the maintenance of certain cash and working capital balances and meeting certain
net worth, debt, and cash flow ratios. These covenants were not met at December
31, 1998. The Company is currently negotiating with the bank on a waiver or
amendment to the covenants. There can be no assurance that a waiver or amendment
will be obtained, at which time the installment notes could become payable in
full on demand.
Management currently believes that cash on hand and cash projected to be
generated from operations will be adequate to ensure uninterrupted performance
of its operating obligations as currently structured and anticipated. If the
Company does not achieve its projected operating results , is unable to secure
adequate equipment financing, and/or is unable to obtain debt waivers,
management believes that it has options available to obtain necessary capital,
including issuance of subordinated debt or private placement equity financing.
There can be no assurance, however, that these sources would be available to the
Company on acceptable terms, or at all.
YEAR 2000 ISSUE
Based on an internal analysis, the Company does not believe that the Year 2000
issue will materially affect its information technology, which consists of the
Company's financial and accounting systems. The Company is in the process of
integrating its current multiple financial and accounting systems into a
consolidated system that will be Year 2000 compliant. This integration is
scheduled to be completed in 1999. Failure to meet such schedule may have a
material adverse effect on the Company's operations. The Company anticipates
incurring costs of approximately $200,000 over the next six to nine months to
replace its current financial systems and replace or upgrade related hardware.
-9-
<PAGE>
The Company does not believe that the Year 2000 compliance of its suppliers or
customers will materially effect the Company's operations. The Company does not
intend to solicit assurances of Year 2000 compliance from its suppliers because
the products purchased from such suppliers are available from numerous
substitute sources and are not fundamental to the Company's operations as a
service provider. The Company's customers consist primarily of individuals who
make tuition payments to the Company on behalf of themselves or their children
in exchange for educational services. The Company does not believe soliciting
assurances of Year 2000 compliance from its customers is practical or necessary
as the ability of these customers to make tuition payments is not expected to be
materially affected by the Year 2000 issue.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's 1998 Annual Meeting of Shareholders held on November 12, 1998,
the shareholders approved the following:
1. Election of directors to serve until his successor is duly elected. The
directors were elected as follows:
DIRECTORS NOMINEE VOTES FOR VOTES FOR WHICH AUTHORITY WITHHELD
Robert I. Karon 9,008,855 51,415
Gale R. Mellum 9,006,535 53,765
2. Proposed to ratify the appointment of Arthur Andersen LLP as independent
public accountants for the 1999 fiscal year. The proposal received
9,031,116 votes for and 15,923 votes against. There were 13,261
abstentions and no broker non-votes.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS:
27 Financial Data Schedule (EDGAR version only).
(B) REPORTS ON FORM 8-K:
No reports on Form 8-K were filed during the three months ended
December 31, 1998.
-10
<PAGE>
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.
THE TESSERACT GROUP, INC.
Date: February 9, 1999 By /s/ John T. Golle
-----------------
John T. Golle
Chairman and Chief
Executive Officer
Date: February 9, 1999 By /s/ Tony L. Verbeten
--------------------
Tony L. Verbeten
Chief Financial Officer
-11-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
REGISTRANTS FORM 10-Q FOR THE QUARTER ENDED DECEMBER 31, 1998 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 4,821
<SECURITIES> 0
<RECEIVABLES> 3,065
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 10,513
<PP&E> 30,959
<DEPRECIATION> 0
<TOTAL-ASSETS> 59,122
<CURRENT-LIABILITIES> 9,791
<BONDS> 20,261
0
0
<COMMON> 96
<OTHER-SE> 28,254
<TOTAL-LIABILITY-AND-EQUITY> 59,122
<SALES> 0
<TOTAL-REVENUES> 16,773
<CGS> 0
<TOTAL-COSTS> 18,360
<OTHER-EXPENSES> 2,261
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 718
<INCOME-PRETAX> (4,428)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,428)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,428)
<EPS-PRIMARY> (.46)
<EPS-DILUTED> (.46)
</TABLE>
