<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1999
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 OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
9977 NORTH 90TH STREET, SUITE 180, SCOTTSDALE, ARIZONA 85258
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (480) 767-2300
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, par value $.01 per share
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At , 1999, the aggregate market value of common stock held by
non-affiliates of the Registrant was approximately $00,000,000 based upon the
closing sale price of the common stock on such date, as reported on The Nasdaq
Stock Market.
At August 31, 1999, the number of shares of common stock outstanding was
0,000,000.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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DRAFT SUBJECT TO FINAL REVISION
PART I
ITEM 1. BUSINESS
OVERVIEW
The TesseracT Group, Inc. (the "Company") is an integrated education management
organization which provides proprietary educational services from preschool
through post-secondary education. Formed in 1986 as a Minnesota corporation, the
Company now operates 37 school sites in six states serving over 8,000 preschool
to post-secondary students. The Company consists of three components:
- THE TESSERACT SCHOOLS. The TesseracT Schools operate both private and
public charter schools serving preschool through grade 12. Currently, there are
four TesseracT Schools in operation in four states.
- SUNRISE EDUCATIONAL SERVICES, INC. ("SUNRISE"). Sunrise, acquired by the
Company on December 18, 1997, operates 24 preschools in four states with the
majority of operations concentrated in Arizona. In addition, Sunrise currently
serves in excess of 700 public charter school students in Arizona.
- ACADEMY OF BUSINESS, INC. ("ABC"). ABC, acquired by the Company in
January 1998, is a two-year college accredited by the North Central Association
of Colleges and Schools. In addition to offering traditional business and
paralegal training, ABC provides various Microsoft certifications and Novell
training.
The strategy of the Company is to integrate all of these capabilities in
specific high growth markets and deliver these services wherever possible from
one single educational facility that is conveniently located in neighborhoods
under the banner of a TesseracT Family Learning Center. The Company's objective
is to leverage its investment through high asset utilization and scalable
economies into significant profitable growth. Typically, these centers will be
established in conjunction with large, master-planned community developers who
donate the land to the project.
The Company's mission is to provide a proprietary alternative of high quality
educational services from preschool through post-secondary education. To achieve
its objective, the Company plans to build on its experience and expertise in
both the private and public education sectors.
PAST ACTIVITIES
After initially focusing on the development of a network of private preschool
and elementary schools, the Company in 1989 temporarily shifted its strategic
focus to contract management of public schools from 1990 through 1996. This
strategy proved to be unsuccessful and the management contracts for public
schools in Hartford, Connecticut, Baltimore, Maryland and South Miami Beach,
Florida were terminated.
CURRENT OPERATIONS
Following the Company's experiences with contract management of public schools
along with the related restrictions and problems and the rapidly evolving
acceptance of a "private" alternative, the Company made
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the strategic decision to focus its attention and resources on becoming an
integrated education management organization. Execution of this strategy has
focused on entrance into the growing public charter school market, and vertical
integration of the range of services provided by the Company through the
acquisitions of Sunrise and ABC and expansion of the Company's private school
business.
TESSERACT FAMILY LEARNING CENTERS. The Company has developed a family learning
center model. The model incorporates private preschools, extended day services,
enrichment services and adult education into the facilities being specifically
developed for charter schools and such additional uses.
CHARTER SCHOOLS. Both The TesseracT Schools and Sunrise are utilizing public
charter schools in the implementation of the Company's strategy.
Public charter schools are generally autonomous entities authorized by the state
or locality to conduct operations independent from the surrounding public school
district. Laws vary by state but generally charters are granted by state boards
of education, either directly or in conjunction with local school districts or
public universities, which can also revoke a charter if the school fails to meet
its obligations under the charter.
Although charter operators are required to meet certain educational standards,
they often will be free from various state and local regulations. Therefore, in
many states, charter schools can hire their own teachers and other staff, use
their own curriculum and manage their operations independent from public school
district bureaucracy.
Whereas traditional public schools often hold near monopolies on education,
charters must attract students based on their educational approach and program
offerings. Charters compete for students, with a per-pupil allocation of funds
generally comparable, although sometimes less than that available to, other
public schools. Charters can only succeed if they deliver an education of
sufficiently high quality to attract students, while keeping costs at a level
that generates a reasonable return to the operator.
Presently, 39 states plus the District of Columbia have enacted some form of
charter legislation. The charter school application and approval process is
highly competitive, with many individuals, non-profit organizations, and private
and for-profit companies all pursuing a limited number of available charters. In
addition, traditional public schools and the teachers' unions have provided
strong opposition to the charter movement in many states.
During 1997, the Company received a charter from the state of Arizona to open
and operate 12 charter schools. The first such charter school opened in
September 1998 in Paradise Valley, Arizona, and currently serves approximately
300 students. In addition, Sunrise has entered into a contract to manage the
charter operations of Preschool Services, Inc. ("PSI"), a non-profit
organization (see "Certain Relationships and Related Transactions"). The PSI
charter schools are located in many of the Phoenix area Sunrise preschools.
During fiscal 2000, the Company anticipates submitting additional applications
to operate charter schools in various states. However, there can be no assurance
that the Company will be successful in obtaining all or a portion of the
charters requested. In addition, the Company believes that in selected high
growth communities, it may be able to partner with real estate developers who
will subsidize a portion of the Company's capital costs in return for the
Company's agreement to operate a public charter school in a new housing
development. The Company believes that funding levels in various charter states
will allow the Company to open and operate elementary and secondary public
charter schools that will be successful, both educationally and financially.
Public charter schools offer a more immediate opportunity for financial return
than private schools since no tuition is required for attendance and therefore,
they generally open at or near capacity.
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SUNRISE. Sunrise operates high quality private preschools, many of which also
include kindergarten through third grade public charter schools. Sunrise's
private preschools offer comprehensive educational child care services for
children beginning at age six weeks. Sunrise currently operates 24 preschools in
Arizona and Colorado. Sunrise's preschools currently serves approximately 3,500
students. Sunrise offers both full and half-day programs, before and after
school programs for older students, as well as extended hours at several of its
preschools. Where permitted by local ordinances, the Company plans to operate
ABC classes in certain of its preschool facilities subject to demand and space
availability. There are currently two such facilities integrated in this manner.
Sunrise differentiates itself from most preschools by offering a comprehensive
education-based curriculum that incorporates innovative teaching techniques and
programs, and by offering its parents and children modern facilities and
equipment. Sunrise's education-based programs emphasize, among other things, the
use of learning centers to enhance a child's development. The programs are
designed to appeal to parents who consider education and development, rather
than custodial care, as being most important in choosing a child care facility.
In addition to the regular learning programs, all of the Sunrise child care
centers offer computer-based learning programs using state-of-the-art software
and a number of extra-curricular programs.
In June 1997, Sunrise was selected to manage the charter school operations of
PSI. These charter schools, operating as Sunray Charter Schools, opened in
September 1997 providing kindergarten through third grade classes at many of
Sunrise's Arizona facilities. In consideration for the management of the charter
program and for the use of certain of Sunrise's preschool facilities and
personnel, Sunrise earns a management fee and is reimbursed for the facility
costs and lease expense of the occupied space. In addition, Sunrise benefits
from having the preschoolers of new families attracted to Sunray Charter Schools
along with the retention of the kindergarten and elementary-age children for the
Company's before and after school programs.
ABC. ABC is a two-year college offering courses primarily in business and
paralegal training, with its main campus in Phoenix, Arizona. In addition to
offering traditional business courses, ABC offers comprehensive training to
students preparing for various Microsoft certifications, including Systems
Engineer, Solutions Provider and Office User certifications. ABC also provides
Novell training. ABC intends to expand its Microsoft certification and training
programs in order to benefit from the high demand in the workplace for systems
engineers and other trained technicians as well as for ongoing training for such
personnel. ABC currently serves over 350 students.
ABC is focused on providing post-secondary education to working adults and it
strives to meet the unique needs of these individuals by providing services that
meet the following criteria. First, ABC provides convenient access to the
educational environment through both location and user friendly delivery of the
curriculum. This criteria will be further enhanced as the Company develops more
combined educational facilities in conjunction with its TesseracT Schools and
Sunrise facilities that will allow adult students to participate in ABC programs
at neighborhood facilities with on-site child care. Second, ABC programs provide
knowledge and skills with immediate practical value in the workplace and can be
completed in a reasonable amount of time. Third, ABC programs are instructed by
faculty with practical experience in fields related to those they instruct and
the classroom environment is characterized by a low student-to-faculty ratio.
Finally, ABC's educational programs and administrative services are designed to
accommodate the working adult's schedule.
ABC is accredited by the North Central Association of Colleges and Schools, a
regional accrediting association recognized by the United States Department of
Education ("DOE"). Accreditation provides the basis for the recognition and
acceptance by employers, other post-secondary education institutions and
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governmental entities of the degrees and credits earned by students, and the
ability to participate in Federal Financial Aid programs under Title IV.
THE TESSERACT PRIVATE SCHOOLS. The Company was originally organized to design,
develop, market and operate a network of for-profit, private preschool and
elementary schools utilizing the TesseracT teaching philosophy. In September
1987, the Company began operation of its first school in Eagan, Minnesota, and a
year later, opened its second school in Paradise Valley, Arizona. These two
preschool and elementary schools provide the foundation for the TesseracT
Schools component of the Company's current operations. Through its affiliation
with the TesseracT Schools, the Company has developed a number of teacher
training materials for schools utilizing the TesseracT educational system and
other materials for overall school improvement. The TesseracT Schools will
continue to be used by the Company to further develop and refine these
materials. The Company's TesseracT system is an educational program developed to
meet children's individual needs by redesigning the classroom environment,
changing the role of the teacher and increasing the use of technology in the
classroom.
During school year 1998-1999, the Company opened three additional
TesseracT private schools. Private preschools through eighth grade schools were
opened in the Phoenix suburbs of Ahwatukee and North Scottsdale in September
1998. In addition, a preschool and elementary school was opened in Northfield,
New Jersey to serve as a feeder school to the college preparatory school in Mays
Landing, but both schools were closed in fiscal year 1998-1999 due to low
enrollments. For school year 1999, the TesseracT private schools will serve
approximately 1,400 students. The Company believes that its TesseracT
educational system can be implemented in other preschool, elementary and
secondary schools throughout the United States.
In addition to the significant capital requirements of acquiring a satisfactory
school facility and providing all necessary improvements, fixtures, equipment
and furniture, there will likely be a long lead time required to establish a new
private school's reputation and attract a sufficient number of students willing
to pay the private school tuition. Accordingly, the Company anticipates that its
new private schools will generally take two to three years to operate profitably
and therefore will be expanded more slowly than its charter schools.
COMPETITION
Competition in the Company's markets is highly fragmented. The Company faces
competition from non-profit private entities and from the public school system
and public colleges. Many of the Company's competitors in both the private and
public sector have greater financial and other resources than the Company. In
addition, the Company anticipates integration of new services by certain of its
competitors that will provide additional competition for the Company. This
includes the addition of before and after school programs by public school
systems and the entrance into the private school market by large for-profit
childcare companies. There is no assurance that the Company will be able to
compete effectively in any of the markets in which it operates.
For preschool age children, the Company competes with other curriculum-based
preschools. Also seeking enrollments of preschool age children are large
for-profit childcare companies, as well as other childcare providers (including
in-home individual childcare providers and corporations that provide childcare
for their employees). However, the Company believes that persons in its target
market - parents seeking curriculum-based programs for their children - seek
services not commonly provided by these childcare providers.
For school age children, the Company competes with other for-profit private
schools, with non-profit schools and, more importantly, with the public school
system. The Company is not aware of any secular
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competitor that currently competes beyond a regional level. Several charter
school providers like Edison Schools and National Heritage are growing rapidly.
The Company believes the growth of other like providers is a positive indicator
the industry is maturing and views this as a positive event.
The post-secondary education market is highly fragmented with no private or
public institution enjoying a significant market share. The Company competes for
students with two-year and four-year degree granting institutions, which include
nonprofit public and private colleges and proprietary institutions. Competition
among educational institutions is believed to be based on the quality of the
educational program, perceived reputation of the institution, cost of the
program, and employability of the graduates.
While price is an important factor in competition, the Company believes that
other important factors include offering professionally developed educational
programs, well-equipped facilities, trained teachers, and other related
services. Particularly in the preschool market, many of these services are not
offered by the Company's competition.
REGULATION
Schools and preschools are subject to a variety of state and local regulations
and licensing requirements. These regulations and licensing requirements vary
greatly from jurisdiction to jurisdiction. Generally, the governmental agencies
review the safety, fitness and adequacy of the buildings and equipment, the
ratio of staff personnel to enrolled children, the dietary program, the daily
curriculum, compliance with health standards and the qualifications of the
Company's personnel. In most jurisdictions, these agencies conduct scheduled and
unscheduled inspections of the schools and preschools, and licenses must be
renewed periodically. Repeated failures by a school or preschool to comply with
applicable regulations can subject it to sanctions that might include probation,
suspension, or revocation of the license to operate. The Company believes that
each of its schools and preschools is in substantial compliance with such
requirements.
The Company's post-secondary operations are subject to the Higher Education Act
of 1986, as amended (the "HEA"), in order for students to participate in Federal
Financial Aid programs under Title IV of the HEA. The Company's post-secondary
operations are also subject to the general oversight of the DOE and are required
to be accredited by an association recognized by the DOE. The DOE reviews all
institutions participating in Title IV for compliance with applicable HEA
standards and regulations. Under the HEA, accrediting associations are required
to include the monitoring of certain aspects of Title IV compliance as part of
their accreditation evaluations. The Company is also subject to regulation
promulgated by applicable state higher education regulatory bodies.
The Company's participation in Title IV programs, through its wholly-owned
subsidiary ABC, is subject to audit by independent auditors annually and to
program reviews by the Department of Education and other federal, state, or
accrediting agencies. Instances of noncompliance, should they exist and be
discovered through the audit process, could result in refunds of financial
assistance and imposition of fines and penalties.
The DOE has regulations that contain objective measurement criteria to determine
the financial capabilities of educational institutions participating in student
financial assistance programs. The regulations apply only to those institutions
offering post-secondary courses and training. The criteria, which are applied on
the subsidiary level, include among other things having cash and receivables
from unrelated parties equal to or greater than current liabilities, maintaining
a positive tangible net worth, and restrictions on the amount of operating
losses incurred within a two-year period.
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Due to operating losses incurred by ABC prior to the acquisition by the Company,
the financial capability tests have not been met at June 30, 1999. As a result,
the Company may be required to post a letter of credit for at least one-half of
the Title IV funds received by ABC during 1998, which amounted to $1,709,000.
Any changes in or new interpretations of applicable laws, rules or regulations
could have a material adverse effect on the Company by limiting its
authorizations to operate or permissible activities, or by increasing the costs
of doing business in the Company's markets. The failure to maintain any required
licenses, approvals, authorizations, or accreditations could also have a
material adverse effect on the Company.
To assist the Company in complying with all of these regulations, TesseracT
recently "outsourced" the processing of this function to Arthur Andersen.
INSURANCE
The Company currently maintains comprehensive general liability insurance,
workers compensation, automobile liability, property, excess umbrella liability
and student accident insurance. The policies provide for a variety of coverage
and are subject to various limits. Companies involved in the education and care
of children, however, may not be able to obtain insurance for the total risks
inherent in their operations. In particular, general liability coverage can have
reduced limits per claim for child abuse. The Company carries fire and other
casualty insurance on its facilities and liability insurance in amounts which
management feels are adequate for its operations in the foreseeable future.
The company self-insures for potential employee health care costs with certain
stop loss insurance coverage. Claims expense is recorded in the year of
occurrence through the accrual of claim reserve based upon ultimate claim costs.
SEASONALITY
The Company historically has lower operating revenues in the summer due to lower
summer enrollment at the TesseracT Schools and Sunrise facilities. The Company
seeks to improve summer results through camps and other programs.
EMPLOYEES
At September 15, 1999, the Company had approximately 980 employees, of which 280
were teachers or administrators at the TesseracT Schools, 625 (including 140
part-time employees) were employed by Sunrise and 60 were employed by ABC. The
Company is not subject to any collective bargaining agreement and believes that
its employee relations are good.
ITEM 2. PROPERTIES
At September 15, 1999, the Company operated 37 school sites, including 24
preschool centers, 4 private schools, 17 charter schools, and 3 college campuses
the ABC sites. All of the facilities are leased, with the exception of three
TesseracT Schools, which are owned by the Company. The leases generally include
option renewal periods of 5 to 25 years, at the Company's discretion. Each of
the leases contain provisions for lease payment increases based on the Consumer
Price Index or other similar formulas. The Company is generally responsible for
taxes, insurance, maintenance, and other expenses related to the operation of
the leased facilities.
The Company leases 12,940 square feet of space for its corporate offices in
Scottsdale, Arizona.
At June 30, 1999, the Company had two Charter schools in Arizona under
construction pursuant to a development agreement. During the first quarter of
fiscal year 2000, the Company plans to finalize the financing related to
these schools.
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ITEM 3. LEGAL PROCEEDINGS
At June 30, 1999, the Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders by the Company during
the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
The Company's common stock trades on The NASDAQ Stock Market under the symbol
TSST. As of June 30, 1999, the Company's common stock was held by approximately
3,000 shareholders of record or through nominee or street name accounts with
brokers.
PRICE RANGE OF COMMON STOCK:
<TABLE>
<CAPTION>
COMMON STOCK PRICE
------------------
1999 HIGH LOW
------------------
<S> <C> <C>
First Quarter $5.00 $2.69
Second Quarter 3.88 2.56
Third Quarter 4.88 2.63
Fourth Quarter 3.63 2.94
1998
First Quarter $6.25 $2.24
Second Quarter 5.63 4.31
Third Quarter 6.63 4.06
Fourth Quarter 6.31 4.81
</TABLE>
DIVIDEND POLICY:
The Company has never paid cash dividends on its stock and anticipates that it
will continue to retain its earnings, if any, to finance the growth of the
business.
ITEM 6. SELECTED FINANCIAL DATA
The table below shows selected financial data for the periods indicated. This
information should be read in conjunction with the Consolidated Financial
Statements and related notes contained in Item 14 herein and Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in Item 7 herein.
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended June 30,
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONAL
DATA:
Revenue $ 37,276 $ 15,294 $ 4,835 $ 115,090 $ 213,582
School operating profit (loss) 3,862 (409) 1,082 (2,672) (3,745)
Net earnings (loss) (10,689) (3,437) 566 (9,507) (7,443)
Net earnings (loss) per common
share (diluted) (1.12) (.40) .08 (1.27) (1.09)
Weighted average shares
outstanding 9,579 8,574 7,501 7,477 6,822
</TABLE>
<TABLE>
<CAPTION>
Year Ended June 30,
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit) $(10,478) $ 3,269 $ 20,054 $ 12,927 $ (6,986)
Long-term marketable securities -- -- -- 7,322 28,972
Total assets 63,224 49,263 29,057 29,684 43,481
Long-term debt 22,605 8,578 -- 309 636
Shareholders' equity 22,760 32,749 24,880 24,312 29,825
</TABLE>
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The accompanying consolidated financial statements for the fiscal year ended
June 30, 1999, reflect the results of operations of the Company and its wholly
owned subsidiaries, Sunrise Educational Services, Inc. ("Sunrise") and Academy
of Business, Inc. ("ABC"). The Company acquired Sunrise, a Scottsdale,
Arizona-based operator of 32 preschool centers, primarily in Arizona, in
December 1997. Sunrise has also expanded into the operation of private schools
and has a contract to manage public charter schools in many of its Arizona
sites.
For the year ended June 30, 1999, the results of operations for Preschool
Services, Inc. ("PSI"), a Hawaii non-profit corporation, have been combined in
the accompanying consolidated financial statements due to implied control. (See
Note 2 of the consolidated financial statements contained in Item 14 herein)
The results were immaterial for fiscal 1998 and were not combined.
Operating results for the year ended June 30, 1997, reflect the operations of
the two private schools owned and operated by the Company during 1997.
RESULTS OF OPERATIONS
COMPARISON OF THE YEARS ENDED JUNE 30, 1999 AND 1998. Total revenue in 1999
increased 144% to $37,276,000 as compared to $15,294,000 in 1998. This increase
is primarily the result of a full year's operation related to the acquisitions
of Sunrise and ABC and an increase in the number of charter schools open during
1999. During 1999, the Company provided services to approximately 1257 private
school students and 480 charter school students.
Operating expenses, representing costs directly associated with the school
operations, were $33,447,000 in 1999 compared to $14,885,000 in 1998. The
increase primarily relates to a full year of costs associated with the
operations of Sunrise and ABC along with costs associated with the increased
private and charter schools open during 1999, as discussed above.
New school development costs represent costs incurred in the current year for
schools set to open in the subsequent year. During 1999, costs totaling $967,000
were incurred associated with the September 1999 anticipated opening of two new
TesseracT charter schools in Arizona. One of these sites has opened and the
other remains unopened. These costs relate to personnel, advertising, student
recruitment, and facility set-up. In 1998, costs totaling $646,000 were incurred
related to the opening of three new private schools in September 1998.
Selling, general, and administrative expenses in 1999 were $9,404,000 or 25.2%
of revenue compared to $3,931,000 or 29.9% of revenue in 1998. The increase
reflects added personnel, travel and other costs associated with establishing
necessary administrative support for anticipated growth, and costs associated
with other acquisition opportunities pursued by the Company during 1999.
During the fourth quarter of 1999, the Company entered into an agreement with
Arthur Andersen LLP. ("AA") under which AA will provide the Company with certain
agreed upon accounting, tax, and information technology services. In return for
services provided under the agreement, the Company incurred AA implementation
costs of $1,500,000 during 1999. This fee, along with costs incurred by the
Company in relocating the corporate headquarters from Minnesota to Arizona in
the fourth quarter of 1999, is included as restructuring and relocation expenses
on the accompanying consolidated statement of operations.
School closure expenses represent costs incurred related to the Company's
decision to close certain schools in New Jersey, Hawaii and Arizona. During the
fourth quarter of 1999, management made the
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decision to close the Mays Landing and Northfield private schools effective the
end of the school year. This decision was primarily due to the low level of
enrollment at the school in 1999 as well as the lack of a significant increase
in enrollment projected for 2000. Additionally, the Company also decided to
close certain under-performing schools in Hawaii. The school closure expenses
primarily relate to remaining lease commitment liabilities at these schools as
well as a write down of the remaining fixed assets to their estimated net
realizable value.
Other income (expense) in 1999 was a net expense of $321,000 compared to income
of $1,269,000 in 1998. Other income for both 1999 and 1998 includes settlement
proceeds of $650,000 related to the final settlement of issues regarding amounts
owed to the Company under the Hartford management contract. The reduction of
other income (expense) was primarily due to a reduction in investment income in
1999 compared to 1998 is due to lower investment levels in the current year and
an increase in interest expense in 1999 primarily related to the financing
transactions entered into by the Company during 1999 and 1998.
For 1999, the Company recorded a net loss of $10,689,000 or $1.12 per share
compared to a net loss of $3,437,000 or $.40 per share in 1998. The increase in
the net loss is primarily due to restructuring and relocation expenses of
$1,654,000, school closure expenses of $2,205,000, $1,000,000 of additional
interest expense, poor operating performance at ABC, and increased site
operating costs.
COMPARISON OF THE YEARS ENDED JUNE 30, 1998 AND 1997. Total revenue in 1998 was
$15,294,000 compared to $4,835,000 in 1997. The increase is the result of the
acquisitions of Sunrise and ABC and an increase in the number of private schools
open during 1998. Revenue recorded on the operations of Sunrise and ABC
subsequent to their acquisition was $8,027,000 and $1,464,000, respectively.
In September 1997, the Company opened new college preparatory high schools in
Mays Landing, New Jersey, and South Bend, Indiana. These two schools, along with
the original two TesseracT private schools in Eagan, Minnesota, and Paradise
Valley, Arizona, brought to four the number of private TesseracT schools owned
and operated by the Company.
Private school and other costs, representing costs directly associated with the
school operations, were $14,885,000 in 1998 compared to $3,753,000 in 1997. The
increase primarily relates to costs associated with the operations of Sunrise
and ABC subsequent to their acquisition. In addition, the current year includes
start-up costs relating to the September 1997 opening of the Mays Landing and
South Bend private schools and the expansion of the Company's private school in
Eagan.
During 1998, the Company decided to close the South Bend College Preparatory
High School. This decision was primarily due to the low level of enrollments at
the school in 1998 as well as the lack of a significant increase in enrollments
projected for 1999. The majority of computers and furniture at the school has
been transferred to other TesseracT schools. Total costs anticipated to be
incurred related to the closing of the school have been included in the 1998
financial statements.
New school development costs represent costs incurred in the current year for
schools set to open in the subsequent year. During 1998, costs totaling $646,000
were incurred associated with the September 1998 opening of three new TesseracT
private schools. These costs relate to personnel, advertising, student
recruitment, and facility set-up. In 1997, costs totaling $363,000 were incurred
related to the opening of the two college preparatory schools in September 1997.
Selling, general, and administrative expenses in 1998 were $4,469,000 compared
to $3,421,000 in 1997. The increase reflects added personnel, travel and other
costs associated with the integration of the
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acquisitions of Sunrise and ABC and costs associated with other acquisition
opportunities pursued by the Company during 1998.
Other income in 1998 was $1,269,000 compared to $3,268,000 in 1997. Other income
for both 1998 and 1997 includes settlement proceeds of $650,000 related to the
final settlement of issues regarding amounts owed to the Company under the
Hartford management contract. Settlement income for 1997 also includes
$1,250,000 received from the Company's investment management firm to resolve all
issues relating to the firm's management of the company's investment portfolio.
The reduction in investment income in 1998 compared to 1997 is due to lower
investment levels in the current year.
Interest expense in 1998 was $125,000 compared to $17,000 in 1997. Interest
expense totaling $68,000 was incurred on equipment financing debt at Sunrise.
The remaining interest expense in 1998 relates to the financing transactions
entered into by the company on three school properties during 1998.
For 1998, the Company recorded a net loss of $3,437,000 or $.40 per share
compared to net earnings of $566,000 or $.08 per share in 1997. The change is
primarily due to the new school start-up and development costs, costs associated
with the integration of the two acquisitions during the year and the settlement
income recorded in the prior year.
CAPITAL RESOURCES AND LIQUIDITY
During 1999, the Company satisfied its working capital needs principally from
cash on hand at the beginning of the year and cash received from financing
transactions entered into during the year. The net decrease in cash of
$2,998,000 is primarily comprised of the following:
- - Net cash used in operating activities totaled $5,331,000, primarily due to
the net loss incurred in 1999 along with changes in current assets and
liabilities.
- - Net cash used in investing activities totaled $19,678,000 primarily due to
purchases of furniture, fixtures and equipment for schools along with new
school construction expenditures.
- - Cash generated from financing activities totaled $22,011,000 during 1999
primarily from proceeds on sale/leaseback and mortgage financing transactions
along with draws on available lines of credit.
As discussed in Note 4 to the consolidated financial statements contained in
Item 14 herein, during fiscal 1997, the Company reached final agreement with
Hartford officials on the remaining amounts owed to the Company in settlement of
a disputed contract amount. Under the terms of the agreement, the Company is
scheduled to receive additional annual installments of $650,000 on each of July
10, 1999, 2000 and 2001.
As discussed in Note 18 to the consolidated financial statements contained in
Item 14 herein, due to operating losses incurred by ABC subsequent to its
acquisition by the Company, the financial capability tests have not been met at
June 30, 1999. As a result, the Company may be required to post a letter of
credit for at least one-half of the Title IV funds received by ABC during 1999,
which amounted to approximately $1,709,000.
During 2000, the Company anticipates investing approximately $5,360,000 to
complete construction on two schools in Arizona and approximately $750,000 to
outfit new schools and upgrade technology at existing schools. The Company
anticipates financing a significant portion of the construction costs and other
capital asset purchases through equipment financing leases. If the Company is
unable to secure financing on terms acceptable to the Company, the capital asset
purchases will have to be deferred or made from available cash reserves.
10
<PAGE> 12
During the three years ended June 30, 1999, the Company has incurred cumulative
net losses totaling approximately $13,560,000. As a result of these losses and
investments the Company has made in acquisitions and for the purchase of capital
assets, the Company has used cash of approximately $12,846,000 during the past
three years. The Company has a cash balance of $2,545,000 and negative working
capital of $10,478,000 as of June 30, 1999. These factors, among other things,
may indicate that the Company will be unable to continue as going concern for a
reasonable period of time.
Management continues to pursue various options in order to provide necessary
financing. As discussed in Note 20 to the consolidated financial statements,
management's plans to resolve near term cash flow issues include the following
transactions:
- - A private placement equity financing to provide approximately $7,500,000 in
cash flow, less offering costs. A restructuring of both the $5,000,000 and
$1,000,000 credit lines, which are currently payable, into long-term debt.
- - At June 30, 1999, the Company has approximately $5,385,000 of construction in
process. The Company is seeking permanent financing for these projects in
order to convert this asset into necessary cash.
Management believes that if it can finalize some of the financing alternatives
that it is pursing together with its projected improvement in operating results
for 2000, the Company will generate sufficient resources to ensure uninterrupted
performance of its operating obligations as currently structured and
anticipated. The Company's continuance as a going concern is dependent upon its
ability to generate sufficient cash flow to meet its obligations in a timely
manner, to obtain additional financing as required, and ultimately to attain
profitability. There can be no assurance, however, that these sources will be
available to the Company on acceptable terms or when necessary.
YEAR 2000 ISSUE
The Year 2000 issue ("Y2K") refers to a condition in computer software where a
two digit field rather than a four digit field is used to distinguish a calendar
year. Unless corrected, some computer programs, hardware and non-information
system technology systems could be unable to process information containing
dates subsequent to December 31, 1999. As a result, such programs and systems
could experience miscalculations, malfunctions or disruptions.
The Company has recently completed its initial assessment of potential exposure
of its own core business information systems for Y2K readiness and is in the
process of assessing the readiness of significant suppliers, business partners,
banking agencies and governmental agencies.
During the fourth quarter of 1999, the Company entered into an agreement with
Arthur Andersen, LLP. ("AA") to provide certain agreed upon accounting, tax and
information technology services. In connection with the information technology
services, the Company has begun a system conversion, integrating its current
multiple financial systems into a consolidated system and implementing
PeopleSoft for all financially significant systems. Management expects the
conversion process to be completed for all critical internal information systems
prior to the end of 1999. All hardware and software upgrades required for the
system conversion are Y2K compliant.
To date, excluding the cost of upgrading our current information system, the
amount the Company has spent on Year 2000 efforts was immaterial. Additionally,
excluding the cost of upgrading our current information systems, we currently
believe that the additional costs of implementing our Y2K plan will not exceed
$200,000 and will not have a material effect on the Company's financial
position. These expenditures include our evaluation of our systems and the
replacement and upgrading of non-compliant hardware and software. There can be
no assurance that the cost estimates associated with the Company's Y2K issues
will prove to be accurate or that those actual costs will not have a material
adverse effect on the Company's results from operations and financial condition.
The Company is in the process of contacting our key business partners asking
for assurances that they have taken steps to evaluate their Year 2000
compliance. The Company is not dependent upon a single source for any products
or services. In the event a significant supplier, bank or other business
partner or vendor is unable to provide products or services to the Company due
to a Y2K failure, the Company believes it has adequate alternate sources for
such products or services. For the year ending June 30, 1999 67% of the
Company's revenue was for tuition and programs funded from state and federal
sources. Processing of payments due to the Company by state and federal
agencies will be handled by their respective computer systems. The Company is in
the process of assessing the Y2K state of readiness at these federal agencies
and will complete that assessment prior to December 1999. However, any prolonged
interruption would have a material adverse impact on the education industry and
upon the Company's business, results of operations, liquidity and financial
condition.
A significant number of the Company's customers consist of individuals who make
tuition payments to the Company on behalf of themselves or their children in
exchange for educational services. The ability of these customers to make
tuition payments is not expected to be affected by the Year 2000 issue.
The Company has developed a preliminary contingency plan for the IT systems and
material non-IT systems that we control. In the event that we have not completed
the system enhancement to our IT systems prior to January 1, 2000, we will use
contingent manual systems as required. Due to the AA agreement, management
believes we would be able to respond effectively. Our contingency plan for
material Non-IT systems that we control includes, among other things,
investigating the availability and replacement costs of such systems that are
not Y2K compliant and adjusting clocks on such Non-IT systems that are not date
sensitive.
11
<PAGE> 13
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
During 1999, the Company adopted Statement of Financial Accounting Standards No.
131, Disclosures about Segments of an Enterprise and Related Information ("SFAS
No. 131") SFAS No. 131 requires disclosures of business and geographic segments
in the consolidated financial statements of the Company. The adoption did not
have an impact on the Company's financial position or its results from
operations since it only impacted disclosures in its financial statements.
Management does not expect the impact of accounting standards that are not yet
effective to have a material impact on the Company's financial position or
results from operations.
FORWARD-LOOKING STATEMENTS
Certain statements made in this Annual Report on Form 10-K are "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
These forward-looking statements involve risks and uncertainties, and actual
results may be materially different. These forward-looking statements include,
but are not limited to, statements herein regarding the opening of additional
private schools, the application for and receipt of additional public charter
school contracts and the opening of new charter schools, the completion of
future strategic acquisitions, the integration of services into single education
facilities, the profitability of existing and new private and public charter
schools, the development of partnerships with real estate developers in high
growth communities, the ability to secure financing on acceptable terms, and the
ability of the Company to compete in the education industry.
Factors that could cause actual results to differ from those expected include,
but are not limited to, general economic conditions such as inflation and
interest rates, both nationally and in Arizona where the Company's operations
are concentrated; competitive conditions within the Company's markets, including
the acceptance of the education services offered by the Company; unanticipated
expenses; the ability of the Company to successfully integrate all of its
services into single education facilities; the ability of the Company to obtain
public charter school contracts; changes in government regulation of the
education industry or in state charter school statutes; the availability of
equipment financing at acceptable terms; and future claims for accidents at the
Company's education facilities and the extent of insurance coverage for such
claims.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and related notes and schedule are
included in Item 14 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
In May 1999, Arthur Andersen LLP, the Company's independent public accountants,
resigned in order to enter into an agreement to provide professional accounting
and information processing services that would impair Arthur Andersen LLP's
independence. The report of independent public accountants received from Arthur
Andersen LLP on the Company's financial statements as of and for the years ended
June 30, 1998 and 1997, did not contain an adverse opinion or a disclaimer of
opinion and were not qualified or modified as to uncertainty, audit scope or
accounting principles.
During the fiscal years ended June 30, 1998 and 1997, there were no
disagreements between the company and Arthur Andersen LLP on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedures, which disagreement, if not resolved to the satisfaction of
12
<PAGE> 14
Arthur Andersen LLP would have caused it to make reference of the subject matter
of the disagreement in connection with its reports.
In July 1999, PricewaterhouseCoopers LLP, was appointed by the Board of
Directors as the Company's independent accountant.
13
<PAGE> 15
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated herein by reference to the
information set forth under the captions "Proposal Number One: Election of
Directors" and "Executive Officers and Compensation" in the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to the
information set forth under the caption "Executive Officers and Compensation" in
the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference to the
information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by reference to the
information set forth under the captions "Certain Relationships and Related
Transactions" and "Compensation Committee Interlocks and Insider
Participation" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(b) REPORTS ON FORM 8-K
Form 8-K dated May 14, 1999, regarding the resignation of Arthur Andersen
LLP as the Company's independent accountant.
(c) EXHIBITS
The following exhibits are filed as part of this Annual Report on Form
10-K for the year ended June 30, 1999.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
<S> <C>
3.1 Restated Articles of Incorporation of the Company, as
amended.
3.2 By-Laws of the Company. (1)
4.1 Specimen Certificate of Common Stock.
4.2 Share Rights Plan dated September 8, 1993. (2)
</TABLE>
14
<PAGE> 16
<TABLE>
<S> <C>
10.1* Employment Agreement between the Company and Philip E.
Geiger dated August 10, 1993. (3)
10.2* 1988 The TesseracT Group, Inc. Stock Option Plan, as
amended. (4)
10.3* Employment Agreement between the Company and John T. Golle
dated January 1, 1991. (5)
10.4* Amendment to Employment Agreement between the Company and
John T. Golle dated September 8, 1993. (6)
10.5* 1992 The TesseracT Group, Inc. Long-Term Executive Stock
Option Plan, as amended. (7)
10.6* Amendment to Employment Agreement between the Company and
John T. Golle dated March 20, 1992. (8)
10.7 Lease dated June 9, 1998, between EduCorp Properties, Inc.
as lessor and The TesseracT Group, Inc. as lessee.
10.8 Amended and Restated Lease dated June 9, 1998, between
EduCorp Properties, Inc. as lessor and The TesseracT Group,
Inc. as lessee.
10.9* Employment Agreement dated November 3, 1997, between the
Company and Todd K. Severson. (9)
10.10* Employment Agreement dated February 16, 1998, between the
Company and Tony L. Verbeten. (10)
10.11 Lease Agreement dated January 31, 1983, between Earl H.
Jones and Venture Educational Programs, Inc. (11)
10.12 Lease Agreement dated April 1, 1984, between McClintock
Associates Limited Partnership, an Arizona Limited
Partnership, and Venture Educational Programs, Inc. (11)
10.13 Lease Agreement dated October 24, 1986, between Peoria
Investment Company, Inc., an Arizona corporation, and Sunrise
Educational Services, Inc., an Arizona corporation.
(11)
10.14 Lease Agreement dated October 16, 1986, between Sun School I
Limited Partnership, an Arizona limited partnership, and
Sunrise Educational Services, Inc., an Arizona corporation.
(11)
10.15 Lease Agreement dated April 1, 1986, between Sunrise
Partners, an Arizona corporation, and Sunrise Educational
Services, Inc., an Arizona corporation. (11)
10.16 Lease Agreement dated February 5, 1987 between Sun School II
Limited Partnership, an Arizona limited partnership, and
Sunrise Educational Services, Inc., an Arizona corporation.
</TABLE>
15
<PAGE> 17
<TABLE>
<S> <C>
10.17 Lease Agreement dated June 26, 1987, between Huber Farm
Service of Phoenix, Inc., an Arizona corporation and Sunrise
Educational Services, Inc., an Arizona corporation. (11)
10.18 Lease Agreement, dated July 29, 1988, between Sunrise
Educational Services, Inc. and Investad, Inc. (12)
10.19 Lease Agreement, dated July 25, 1988, between Sunrise
Educational Services, Inc., and LV Properties, an Arizona
general partnership. (12)
10.20 Lease Agreement, dated May 12, 1988, between Sunrise
Educational Services, Inc. and Jaymark Komer and Eugene
Victor Komer and Ruth Lena Komer, as Trustees of the Komer
Family Trust dated December 30, 1980. (12)
10.21 Lease Agreement, dated July 29, 1988, between Sunrise
Educational Services, Inc. and Kailua Beach Center, Inc. (12)
10.22 Lease Agreement, dated January 11, 1988, between Sunrise
Educational Services, Inc. and Mercado Developers. (13)
10.23 Amendment of Lease Agreement dated March 8, 1990, between
Sunrise Educational Services, Inc. and Jaymark Komer and
Komer Family Trust dated May 12, 1988. (14)
10.24 Purchase Agreement and Registration Rights Agreement dated
April 6, 1990, between Sunrise Educational Services, Inc.
and Lepercq Capital Management, Inc. (15)
10.25 Lease Agreement, dated July 1, 1991, between Sunrise
Educational Services, Inc. and Maruni Arizona, Inc. (16)
10.26 Purchase Agreement, dated November 18, 1991, between Sunrise
Educational Services, Inc., LN Investment Capital Limited
Partnership, Lepercq Investment Limited Partnership II and LN
Investment Capital Limited Partnership II. (17)
10.27 Amendment of Lease Agreement dated July 22, 1998, between
Sunrise Educational Services, Inc. and Jaymark Komer and
Komer Family Trust. (18)
10.28 Management Agreement, dated November 14, 1993, between
United Church of Christ and Sunrise Educational Services,
Inc. (19)
10.29 Term Sheet Agreement, dated December 7, 1992, between Joy of
Christ Lutheran Church and Sunrise Educational Services,
Inc.(20)
10.30 Agreement between Lutheran Church of Honolulu and Sunrise
Educational Services, Inc., dated May 19, 1993. (20)
10.31 Administrative Services Agreement, License, and Equipment
Lease, dated February 1, 1994, between Sunrise Educational
Services, Inc., and Preschool Services, Inc. (19)
</TABLE>
16
<PAGE> 18
<TABLE>
<S> <C>
10.32 Asset Purchase Agreement between Children's Choice Learning
Center, Inc. and Sunrise Preschool, Inc. dated June 26,
1996, with one amendment dated June 28, 1996. (21)
10.33 Form of Credit and Security Agreement between Imperial Bank
and Sunrise Educational Services, Inc. dated April 24, 1997.
(22)
11 Statement re Computation of Per Share Earnings (Loss).
23.1 Consent of PricewaterhouseCoopers LLP.
23.2 Consent of Arthur Andersen LLP
27 Financial Data Schedule (EDGAR version only).
</TABLE>
------------------------------
* Management contract or compensatory plan or arrangement.
(1) Incorporated herein by reference to Exhibit 3.3 to the
Company's Form S-18 Registration Statement (Registration
Number 33-39481-C).
(2) Incorporated herein by reference to the same numbered Exhibit
to the Company's Annual Report on Form 10-K for the year ended
June 30, 1993.
(3) Incorporated herein by reference to Exhibit 10.2 to the
Company's Form 10-Q for the quarter ended December 31, 1994.
(4) Incorporated herein by reference to the same numbered Exhibit
to the Company's Annual Report on Form 10-K for the year ended
June 30, 1996.
(5) Incorporated herein by reference to Exhibit 10.17 to the
Company's Amendment No. 1 to Form S-18 Registration Statement
(Registration Number 33-39481-C).
(6) Incorporated herein by reference to Exhibit 10.28 to the
Company's Annual Report on Form 10-K for the year ended June
30, 1993.
(7) Incorporated herein by reference to Exhibit Number 10.26 to
the Company's Annual Report on Form 10-K for the year ended
June 30, 1993.
(8) Incorporated herein by reference to Exhibit 10.24 to Amendment
No. 2 to the Company's Form S-1 Registration Statement
(Registration Number 33-46791).
(9) Incorporated herein by reference to Exhibit 10 to the
Company's Form 10-Q for the quarter ended December 31, 1997.
(10) Incorporated herein by reference to Exhibit 10 to the
Company's Form 10-Q for the quarter ended March 31, 1998.
(11) Incorporated herein by reference to exhibits to Sunrise
Educational Services, Inc, Commission File Number 0-16425
("Sunrise") Form S-1 filed July 10, 1987.
17
<PAGE> 19
(12) Incorporated herein by reference to exhibits to Sunrise Form
10-K filed on or about October 31, 1988.
(13) Incorporated herein by reference to exhibits to Sunrise Form
10-K filed on or about October 30, 1989.
(14) Incorporated herein by reference to exhibits to Sunrise Form
10-Q filed on or about January 31, 1990.
(15) Incorporated herein by reference to exhibits to Sunrise Form
8-K filed on or about April 20, 1990.
(16) Incorporated herein by reference to exhibits to Sunrise Form
10-K filed on or about October 28, 1991.
(17) Incorporated herein by reference to exhibits to Sunrise Form
10-Q filed on or about December 16, 1991.
(18) Incorporated herein by reference to exhibits to Sunrise Form
10-K filed on or about October 21, 1992.
(19) Incorporated herein by reference to exhibits to Sunrise Form
10-KSB for the year ended July 31, 1994.
(20) Incorporated herein by reference to exhibits to Sunrise Form
10-KSB filed on or about October 8, 1993.
(21) Incorporated herein by reference to exhibits to Sunrise Form
8-K filed on or about September 9, 1996.
(22) Incorporated herein by reference to exhibits to Sunrise Form
10-QSB filed on March 11, 1997.
18
<PAGE> 20
THE TESSERACT GROUP, INC. [DRAFT]
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Report of Independent Public Accountants - PricewaterhouseCoopers LLP 20
Report of Independent Public Accountants - Arthur Andersen LLP 21
Consolidated Statements of Operations 22
Consolidated Balance Sheets 23
Consolidated Statements of Shareholders' Equity 24
Consolidated Statements of Cash Flows 25
Notes to Consolidated Financial Statements 26-42
Schedule II - Valuation and Qualifying Accounts 43
</TABLE>
19
<PAGE> 21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and the Board of
Directors of The TesseracT Group, Inc.:
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statement of operations, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of The
TesseracT Group, Inc. and its subsidiaries at June 30, 1999, and the results of
their operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these statements in accordance with generally accepted auditing standards,
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 20, the Company
incurred a net loss of $10,689,000 during the year ended June 30, 1999. In
addition, as of June 30, 1999, the Company had a working capital deficit of
$10,478,000. These factors raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are also described in Note 20. The financial statements do not include any
adjustment that might result from the outcome of this uncertainty.
Our audit was conducted for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The schedule listed in the
index to consolidated financial statements and schedules is presented for
purposes of complying with the Securities and Exchange Commission's rules and is
not a required part of the basic financial statements. The 1999 information on
this schedule has been subjected to the auditing procedures applied in the audit
of the basic financial statements and, in our opinion, is fairly stated in all
material respects in relation to the basic consolidated financial statements
taken as a whole.
PricewaterhouseCoopers LLP
Phoenix, Arizona
September 27, 1999.
20
<PAGE> 22
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To The TesseracT Group, Inc.
We have audited the accompanying consolidated balance sheet of The TesseracT
Group, Inc. (a Minnesota corporation) and subsidiaries as of June 30, 1998, and
the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the years ended June 30, 1998 and 1997. These financial
statements and the schedule referred to below are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of The TesseracT Group, Inc. and
subsidiaries as of June 30, 1998, and the results of their operations and their
cash flows for the years ended June 30, 1998 and 1997, in conformity with
generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The schedule listed in the
index to consolidated financial statements and schedules is presented for
purposes of complying with the Securities and Exchange Commission's rules and is
not a required part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in our audit of the basic financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
September 3, 1998.
21
<PAGE> 23
THE TESSERACT GROUP, INC. [DRAFT]
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
REVENUE:
School tuition and other $ 37,276 $ 15,294 $ 4,835
OPERATING EXPENSES:
Personnel costs 15,854 7,269 2,487
Site operating costs 10,685 4,061 749
Insurance, taxes, rent and other 4,156 2,437 299
Depreciation and amortization 2,719 1,118 218
-------- -------- --------
33,414 14,885 3,753
-------- -------- --------
SCHOOL OPERATING PROFIT (LOSS) 3,862 409 1,082
-------- -------- --------
NEW SCHOOL DEVELOPMENT COSTS 967 646 363
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 9,404 4,469 3,421
RESTRUCTURING AND RELOCATION EXPENSES 1,654 -- --
SCHOOL CLOSURE EXPENSES 2,205 -- --
-------- -------- --------
OPERATING LOSS (10,368) (4,706) (2,702)
-------- -------- --------
OTHER INCOME (EXPENSE):
Settlement income 650 650 1,900
Investment income 284 744 1,385
Interest expense (1,255) (125) (17)
-------- -------- --------
(321) 1,269 3,268
-------- -------- --------
Earnings (loss) before income tax expense (10,689) (3,437) 566
Income tax expense -- -- --
Net earnings (loss) $(10,689) $ (3,437) $ 566
======== ======== ========
Net earnings (loss) per common share
(basic and diluted) $ (1.12) $ (.40) $ .08
======== ======== ========
Weighted average common shares outstanding
(basic and diluted) 9,579 8,574 7,501
======== ======== ========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
22
<PAGE> 24
THE TESSERACT GROUP, INC. [DRAFT]
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
June 30, June 30,
1999 1998
-------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,545 $ 5,543
Settlement receivable 650 650
Accounts receivable, net of allowance (1999 - $131, 1998 - $248) 1,958 2,370
Prepaid rent 719 834
Other current assets 1,509 1,093
-------- --------
Total current assets 7,381 10,490
INTANGIBLE ASSETS, NET 17,291 18,984
PROPERTY AND EQUIPMENT, NET 37,002 19,479
DEPOSITS AND OTHER ASSETS 1,550 310
-------- --------
$ 63,224 $ 49,263
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Lines of credit $ 5,999 470
Accounts payable 1,999 984
Other current liabilities 9,861 5,767
-------- --------
Total current liabilities 17,859 7,221
-------- --------
LONG-TERM OBLIGATIONS 21,615 8,578
OTHER 990 715
-------- --------
22,605 9,293
-------- --------
TOTAL LIABILITIES 40,464 16,514
-------- --------
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 1999 - 9,780,331 shares; 1998 - 9,570,803
shares 98 96
Additional paid-in capital 58,371 57,673
Accumulated deficit (35,709) (25,020)
-------- --------
Total shareholders' equity 22,760 32,749
-------- --------
$ 63,224 $ 49,263
======== ========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
23
<PAGE> 25
THE TESSERACT GROUP, INC. [DRAFT]
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in thousands)
<TABLE>
<CAPTION>
Common Stock
---------------------- Additional
Number Paid-in Accumulated
of Shares Amount Capital Deficit Total
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE, JUNE 30, 1996 7,489 $ 75 $ 46,386 $(22,149) $ 24,312
Net earnings -- -- -- 566 566
Issuance of common stock upon exercise
of stock options 1 -- 2 -- 2
-------- -------- -------- -------- --------
BALANCE, JUNE 30, 1997 7,490 75 46,388 (21,583) 24,880
Net loss -- -- -- (3,437) (3,437)
Issuance of common stock upon exercise
of stock options 133 1 589 -- 590
Common stock issued for acquisitions 1,948 20 9,604 -- 9,624
Fair value of Sunrise Educational
Services, Inc. options and warrants at
acquisition date -- -- 1,092 -- 1,092
-------- -------- -------- -------- --------
BALANCE, JUNE 30, 1998 9,571 96 57,673 (25,020) 32,749
Net loss -- -- -- (10,689) (10,689)
Issuance of common stock upon
exercise of stock options 9 -- 30 -- 30
Issuance of common stock in
connection with agreement for
professional services 200 2 398 -- 400
Issuance of warrants in connection
with line of credit -- -- 270 -- 270
-------- -------- -------- -------- --------
BALANCE, JUNE 30, 1999 9,780 $ 98 $ 58,371 $(35,709) $ 22,760
======== ======== ======== ======== ========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
24
<PAGE> 26
THE TESSERACT GROUP, INC. [DRAFT]
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net earnings (loss) $(10,689) $ (3,437) $ 566
Adjustments to reconcile net earnings (loss) to net
cash used in operating activities:
Depreciation and amortization 2,886 1,264 316
Provision for doubtful accounts (482) 87 10
Gain on marketable securities -- -- (49)
School closure reserve 1,600 -- --
Changes in operating assets and liabilities:
Accounts receivable 894 (1,265) (14)
Other current assets (301) (1,211) (603)
Deposits and other assets (1,240) -- --
Intangibles 962 -- --
Accounts payable 1,015 (101) 101
Other current liabilities 24 (1,026) (524)
-------- -------- --------
Net cash used in operating activities (5,331) (5,689) (197)
-------- -------- --------
INVESTING ACTIVITIES:
Payment for acquisitions, net of cash acquired -- (7,106) --
Purchases of property and equipment (25,242) (11,822) (896)
Proceeds from sales and maturities of marketable securities 5,564 -- 9,592
-------- -------- --------
Net cash provided by (used in) investing
activities (19,678) (18,928) 8,696
-------- -------- --------
FINANCING ACTIVITIES:
Proceeds from long-term debt borrowings 20,745 6,550 --
Payments on long-term debt borrowings (2,179) -- --
Increase in bank overdraft 1,045 -- --
Issuance of warrants/common stock and
exercise of stock options 700 590 2
Proceeds/(repayments) on short-term borrowings 1,700 (226) (646)
-------- -------- --------
Net cash provided by (used in) financing
activities 22,011 6,914 (644)
-------- -------- --------
Increase (decrease) in cash and cash equivalents (2,998) (17,703) 7,855
Cash and cash equivalents at beginning of year 5,543 23,246 15,391
-------- -------- --------
Cash and cash equivalents at end of year $ 2,545 $ 5,543 $ 23,246
======== ======== ========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
25
<PAGE> 27
THE TESSERACT GROUP, INC. [DRAFT]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - NATURE OF BUSINESS
The TesseracT Group, Inc. (the "Company"), formerly known as Education
Alternatives, Inc., is an integrated education management company, serving
preschool students, private and public charter elementary, middle, and high
school students, and post-secondary career college students primarily in
Arizona, with additional schools located in Colorado, Minnesota, Texas and
Washington, D.C.
In May 1999, the Company relocated its corporate headquarters from Minneapolis,
Minnesota to Scottsdale, Arizona. Costs incurred in connection with the move
totaled $154,000 and have been reflected in the accompanying financial
statements in restructuring and relocation expenses.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION: The Company recognizes revenue for each school
ratably as earned over the related school year.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated.
Due to the implied control of Preschool Services, Inc. ("PSI"), a Hawaii
non-profit corporation, by the Company's management presence on PSI's Board of
Directors, the accounts of PSI have been combined in the accompanying financial
statements. Prior to its acquisition by the Company in December 1997, Sunrise
had transferred a portion of its operations to PSI. Sunrise provided PSI with
management, administration, and educational programs for PSI's child care
centers and leased substantially all of the equipment and other property
necessary for the operation of the related child care centers to PSI under an
Administrative Services Agreement, License and Equipment Lease (the "PSI
Agreement"). The PSI Agreement stipulated that Sunrise was to receive an
administrative services fee equal to 9% of revenue for providing the services
described above. The results of PSI for the period from the acquisition of
Sunrise (December 1977) through June 30, 1998, were not included in the
consolidated financial statements for the year ended June 30, 1998 due to
immateriality.
During 1997, Sunrise entered into an additional agreement with PSI to provide
management, administration and educational programs to the public charter
schools operated by PSI. In return for providing these services, Sunrise
receives an administrative fee equal to 12.5% of total charter school revenue
received by PSI. In addition, PSI operates these charter schools in certain of
the Sunrise preschool centers.
CASH AND CASH EQUIVALENTS AND MARKETABLE SECURITIES: Cash and cash equivalents,
consisting of highly liquid investments with maturities of three months or less
when purchased, are stated at cost which approximates market.
INTANGIBLE ASSETS: Intangible assets are a result of business acquisitions,
which include costs in excess of net assets acquired, non-compete agreements,
and customer base. Intangibles are stated at cost and are being amortized on a
straight-line basis over various periods up to 25 years. Amortization expense
for the
26
<PAGE> 28
years ended June 30, 1999, 1998, 1997 was $761,000, $426,000 and $0,
respectively. The Company periodically evaluates the recoverability of
intangibles resulting from business acquisitions and measures the amount of
impairment, if any, by assessing current and future levels of cash flows as well
as other factors, such as business trends and prospects and other market
conditions.
PROPERTY AND EQUIPMENT: Property and equipment are stated at cost and
depreciated on the straight-line method over their estimated useful lives,
ranging from three to thirty years. The Company uses accelerated methods of
depreciation for income tax purposes.
ADVERTISING COSTS: Advertising costs consist primarily of print media and
brochures and are expensed when the related advertising occurs. Total
advertising expense totaled $1,517,000 for the year ended June 30, 1999 and was
immaterial for years ending June 30, 1998 and 1997.
DEBT ACQUISITION COSTS: Costs incurred related to the acquisition of debt are
capitalized and amortized over the term of the related debt under the effective
interest method. Upon early payment of debt, related debt acquisition costs are
removed from the accounts.
FAIR VALUE OF FINANCIAL INSTRUMENTS: The carrying amounts of cash and cash
equivalents, receivables, other current assets, accounts payable, and amounts
included in other current liabilities meeting the definition of financial
instruments approximate fair value because of the short-term maturity of these
instruments.
The carrying amount of long-term obligations, including the current portion of
long-term debt, approximates fair value based on quoted market prices for
similar issues or on the current rates offered to the Company for debt of the
same maturity.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF: The
Company follows the provisions of Statement of Financial Accounting Standards
No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived
Assets to be Disposed Of ("SFAS No. 121"). SFAS No. 121 requires that long-lived
assets and certain identifiable intangibles be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of an asset to future net cash flows
expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets. Assets to be
disposed of are recorded at the lower of the carrying amount or net realizable
value (fair value less costs to sell).
CLOSED SCHOOLS: In fiscal 1999 the Company closed two schools in New Jersey. In
connection with the closings, the Company established a reserve for estimated
loss on impairment of assets and lease commitments of approximately $1,600,000
of which approximately $300,000 relates to lease payments.
EARNINGS (LOSS) PER COMMON SHARE: The Company adopted Statement of Financial
Accounting Standards No. 128, Earnings Per Share ("SFAS No. 128") in the second
quarter of fiscal 1998 and has restated previously reported amounts. Basic
earnings per share ("EPS") and diluted EPS replace primary EPS and fully diluted
EPS. Basic EPS is calculated by dividing net earnings (loss) by the weighted
average number of common shares outstanding for the period. Diluted EPS is
calculated by dividing net earnings (loss) by the weighted average number of
common shares and dilutive potential common shares outstanding for the period.
27
<PAGE> 29
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.
FINANCIAL STATEMENT RECLASSIFICATIONS: Certain prior year amounts have been
reclassified to conform to the current year presentation. These
reclassifications had no effect on the previously reported results of operations
or shareholders' equity.
SELF INSURANCE: The Company self-insures for potential employee health care
costs with certain stop loss insurance coverage. Claims expense is recorded in
the year of occurrence through the accrual of claim reserve based upon ultimate
claim costs.
STOCK-BASED COMPENSATION: Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation ("FAS 123") defines a fair value based method of
accounting for employee stock options or similar equity instruments. However, it
allows an entity to continue to account for these plans according to Accounting
Principles Board Opinion No. 25 ("APB 25"), provided pro forma disclosures of
net income are made as if the fair value based method of accounting defined in
FAS 123 had been applied. The Company has elected to continue to measure
compensation expense under APB 25. See Note 13 for required pro forma
disclosures.
NOTE 3 - ACQUISITIONS
In January 1998, the Company acquired all of the outstanding stock of Academy of
Business, Inc. ("ABC"), a Phoenix, Arizona-based post-secondary career college,
for cash of approximately $1,600,000. ABC is accredited by the North Central
Association of Colleges and Schools, and is an Authorized Academic Training
Provider for Microsoft. In addition to offering traditional business courses,
ABC offers comprehensive training to students preparing for various Microsoft
certifications. This acquisition has been accounted for as a purchase, with
goodwill recorded on the transaction being amortized on the straight-line method
over a period of 25 years.
In December 1997, the Company acquired Sunrise Educational Services, Inc.
("Sunrise"), a Scottsdale, Arizona-based operator of approximately 30 preschool
centers, primarily in Arizona. Sunrise has expanded into the operation of
private schools and has a contract to manage public charter schools in many of
its Arizona centers. This acquisition has been accounted for as a purchase. The
purchase price was approximately $13,800,000 and consisted of $4,200,000 in cash
and 1,950,000 shares of the Company's common stock. In addition, transaction
costs approximating $3,300,000 were incurred in the consummation of this
acquisition. Goodwill recorded on the transaction is being amortized on the
straight-line method over a period of 25 years. In accordance with the terms of
the merger agreement, the Company granted stock options and warrants to purchase
553,724 shares of common stock at exercise prices ranging from $1.27 to $6.04
per share to Sunrise employees and directors as replacement options and warrants
for previously issued Sunrise options and warrants.
Summarized below are the unaudited pro forma combined results of operations of
the Company for the years ended June 30, 1998 and 1997, assuming the Sunrise
acquisition was consummated as of the beginning of each period presented.
Excluded from the pro forma results of operations for the years ended June 30,
1998 and 1997, are charges of $1,114,000 or $.12 per share and $602,000 or $.06
per share, respectively, which provided for impaired assets and rental
commitments in connection
28
<PAGE> 30
with Sunrise's management of seven centers with a non-profit organization. The
pro forma results are not necessarily indicative of the operating results that
would have been achieved had the acquisition occurred on the date indicated, nor
are they indicative of future operating results.
<TABLE>
<CAPTION>
Year Ended June 30,
1998 1997
------- --------
<S> <C> <C>
Revenue $22,997 $ 19,251
Net loss (5,249) (204)
Net loss per common share $ (.55) $ (.02)
</TABLE>
NOTE 4 - SETTLEMENT AGREEMENT
During 1997, the Company reached a final agreement with Hartford, Connecticut
officials on amounts owed the Company under its school management contract that
was canceled in January 1996. Under the final settlement, the Company will
receive $3,250,000, payable in five annual installments of $650,000, which began
in July 1997. These annual payments are being recorded in income as they are
received. A settlement receivable of $650,000 is recorded on the Company's
balance sheet to account for this. In addition, both parties released each other
from any further claims under the management contract.
NOTE 6 - CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to concentration of
credit risk consist of primarily cash and cash equivalents.
The Company's cash and cash equivalents are placed with major banks and
financial institutions. The Company, in the normal course of business, maintains
cash balances in excess of Federal Deposit Insurance Corporation's insurance
limits. Historically, the Company has not experienced any losses related to cash
and cash equivalents due to such concentration of credit risk.
The Company receives a significant amount of charter school revenues from state
and federal agencies. As of and for the year ended June 30, 1999, approximately
56% and 27% of the Company's accounts receivable and revenue, respectively,
were from state and federal agencies.
NOTE 7 - MARKETABLE SECURITIES
During 1995, the company and the firm hired to manage the Company's investment
portfolio became involved in a dispute over the purchase and management of
certain securities included in the Company's investment portfolio. The Company
and its investment management firm entered into a preliminary settlement
agreement on June 30 1995, whereby the investment management firm agreed to
reimburse the Company $3,000,000 for losses on the Company's portfolio. During
fiscal 1997, the company and its investment management firm entered into a final
settlement agreement whereby the investment management firm agreed to pay the
company an additional $1,250,000 in fiscal 1997 to resolve all remaining
disputes relating to the firm's management of the Company's investment
portfolio.
During 1997, the Company received proceeds of $9,592,000 on the sale and
maturity of marketable securities and realized gains of $49,000 during 1997. For
purposes of calculating realized gains and losses on sales of marketable
securities, the amortized cost of each security sold was used.
29
<PAGE> 31
NOTE 8 - PROPERTY AND EQUIPMENT
Property and equipment at June 30 consist of the following:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Land $ 10,264,000 $ 6,928,000
Buildings 13,436,000 6,062,000
Leasehold improvements 3,041,000 1,621,000
Furniture and equipment 7,247,000 3,222,000
Vehicles 1,081,000 711,000
Construction in progress 5,698,000 2,385,000
Less accumulated depreciation and
amortization (3,765,000) (1,450,000)
------------ ------------
$ 37,002,000 $ 19,479,000
============ ============
</TABLE>
Property and equipment held under capital lease arrangements totaled $13,794,000
and $7,946,000 as of June 30, 1999 and 1998, respectively. Accumulated
depreciation for capital leases is included with owned assets above.
Depreciation expense, including property and equipment held under capital lease
arrangements, totaled $2,155,000, $692,000 and $218,000 for the years ended June
30, 1999, 1998 and 1997, respectively.
NOTE 9 - LINES OF CREDIT
The Company currently has a $5,000,000 working capital line of credit from a
related party, bearing interest at 12%. Total borrowings outstanding at June 30,
1999, totaled approximately $4,999,000. The line of credit is due and payable on
September 30, 1999. The Company has the option to extend payment until March 31,
2000 with the issuance of 250,000 additional warrants for the purchase of the
Company's common stock at $3.00 per share. At March 31, 2000, if unpaid, the
related party holder of the line of credit can elect to convert the debt into
the Company's common stock at the lesser of $1.00 per share for each dollar owed
or the lowest closing price during the previous thirty days prior to the
conversion of shares.
In addition, the Company has outstanding a $1,000,000 working capital line of
credit with a bank bearing interest at 9.75%. Total borrowings outstanding at
June 30, 1999 were $1,000,000. The line is due and payable on September 29,
1999. Interest is due on outstanding borrowings at September 29, 1999.
At June 30, 1998, the Company had available a $500,000 working capital line of
credit bearing interest at prime 8.5% plus 1.5%. Total borrowings outstanding
amounted to $470,000. The line of credit was paid off in fiscal 1999.
30
<PAGE> 32
NOTE 10 - OTHER CURRENT LIABILITIES
Other current liabilities at June 30 consist of the following:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Deferred revenue and prepaid tuition $ 2,648,000 $ 2,279,000
School closure reserve 1,600,000 -
Cash overdraft 1,045,000 -
Reserve for contract and other contingencies 178,000 1,254,000
Amount due on Sunrise acquisition - 722,000
Accrued payroll and related costs 1,134,000 597,000
Current portion of long-term debt 1,970,000 270,000
Other 1,286,000 645,000
----------- -----------
$ 9,861,000 $ 5,767,000
=========== ===========
</TABLE>
NOTE 11 - LONG -TERM OBLIGATIONS
Financing Obligation: During 1999 and 1998, the Company entered into sale
leaseback agreements related to four properties. Total proceeds from these
financings in 1999 and 1998 amounted to $5,796,000 and $7,917,000, respectively.
Under the terms of the agreements, the Company is required to prepay, on
September 1 of each year, the next 12-months lease payments, estimated property
taxes and insurance premiums into an escrow account. The account is jointly
controlled by the lender and the Company. Each month funds are transferred from
the escrow account to pay rent, property taxes and or insurance, if applicable.
Amounts in this account have been reflected as prepaid rent in the accompanying
financial statements. Interest on funds remaining in the escrow account are
credited to the Company. The leases require the Company to pay all applicable
real estate taxes, utility expenses, and insurance costs. In addition, the
leases prohibit the Company from buying back any shares of the Company's stock,
declaring dividends, or repaying any indebtedness to affiliates of the Company,
unless certain financial ratios are met as defined in the agreements.
These agreements are reflected as financings in the accompanying financial
statements, and have an initial term of 15 years with provisions for two 10-year
renewals.
Long-term obligations at June 30, consist of the following:
<TABLE>
<CAPTION>
June 30, June 30,
1999 1998
---------- ----------
<S> <C> <C>
Note payable; principal and interest payable
monthly through August 2003; interest payable
monthly at prime plus 1.75%, 10.42% at June 30,
1998; collateralized with certain of the
Company's accounts receivable and equipment. $ -- $ 903,000
Note payable; on April 15, 1999, the Company
refinanced the note payable described above;
principal and interest at 9.5%, payable
monthly through January 2000. 741,000 --
Note payable; principal and interest at 10%,
payable monthly through August 2001. 900,000 --
</TABLE>
31
<PAGE> 33
<TABLE>
<CAPTION>
June 30, June 30,
1999 1998
------------ ------------
<S> <C> <C>
Note payable; principal and interest at 10%, payable monthly
through April 2006; collateralized by leasehold improvements 45,000 --
Note payable; principal and interest at 11%, payable monthly with a
balloon note due December 2003; collateralized by real estate 8,151,000 --
Financing obligations; principal, interest at 6.2%, property tax and
insurance payments prepaid annually each September 1 through 2013;
collateralized by school facilities and property 13,130,000 7,917,000
Capital lease obligation; principal and interest at 12.63%, payable
monthly through February 2003; collateralized by furniture and fixtures 233,000 --
Capital lease obligation; principal and interest at 9.75%., payable
monthly through December 2001; collateralized by computer
equipment 184,000 --
Capital lease obligation; principal and interest at 7.44%, payable
monthly through May 2002; collateralized by communication
equipment 104,000 --
Capital lease obligations; principal and interest at various rates,
payments monthly through December 2001; collateralized by three buses 60,000 --
Capital lease obligations; principal and interest at 13.61%, payments
monthly through June 2001; collateralized by office equipment 37,000 28,000
------------ ------------
23,585,000 8,848,000
Less current portion (1,970,000) (270,000)
------------ ------------
Long-Term Obligations $ 21,615,000 $ 8,578,000
============ ============
</TABLE>
Future minimum principal payments of long-term obligations for the next five
years consists of:
<TABLE>
<CAPTION>
<S> <C>
June 30, 2000 $ 1,970,000
2001 1,403,000
2002 986,000
2003 863,000
2004 7,028,000
Thereafter 11,335,000
-----------
$23,585,000
===========
</TABLE>
32
<PAGE> 34
Total interest paid in the years ended June 30, 1999, 1998 and 1997 was
$1,209,000, $125,000 and $17,000, respectively. Capitalized interest totaled
$138,000 for the year ended June 30, 1999 and was immaterial for the years
ending June 30, 1998 and 1997.
NOTE 12 - OPERATING LEASES
The Company leases certain school facilities, office space, vehicles, and
equipment under various operating lease agreements, the last of which expires in
2013. At June 30, 1999, future minimum lease payments under noncancelable
operating leases are as follows:
<TABLE>
<CAPTION>
Year Ending June 30,
<S> <C>
2000 $ 3,250,000
2001 3,042,000
2002 2,723,000
2003 2,113,000
2004 1,342,000
2005 and thereafter 6,896,000
-----------
$19,366,000
</TABLE>
Total rent expense for the years ended June 30, 1999, 1998, and 1997 was
$3,839,000, $2,065,000 and $313,000 respectively.
The facility leases generally require the Company to pay all applicable real
estate taxes, utility expenses, and insurance costs. In addition, certain of the
agreements provide for the escalation of future rents based on the Consumer
Price Index or other formulas. Renewal of the facility lease agreements is for
periods of five to 25 years. For those leases that require fixed rental
escalations during their lease terms, rent expense is recognized on a
straight-line basis, resulting in deferred rent of approximately $313,000 and
$368,000 at June 30, 1999 and 1998, respectively. This liability will be
satisfied through future rental payments.
NOTE 13 - SHAREHOLDERS' EQUITY
STOCK OPTIONS: Under the terms of the Company's 1988 Stock Option Plan, as
Amended and Restated, 1,900,000 shares of common stock have been reserved for
issuance under the plan to directors, officers, employees or other individuals
or entities who are not employees but who provide services to the Company. The
stock options are exercisable over periods of up to ten years from the date of
grant and may be issued as incentive or nonqualified stock options.
Under the terms of the Company's 1992 Long-Term Executive Stock Option Plan,
1,100,000 shares of common stock have been reserved for issuance to key
employees of the Company, upon the exercise of stock options. The stock options
issuable under the 1992 Plan are nonqualified and are exercisable over periods
of up to ten years from the date of grant.
33
<PAGE> 35
At June 30, 1999, 775,000 shares are available for grant under the two option
plans. Stock option activity was as follows:
<TABLE>
<CAPTION>
1999 1998 1997
----------------------------- ----------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- ------------- ---------- ------------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding,
July 1 1,744,390 $ 4.50 1,356,767 $ 4.97 1,367,405 $ 5.43
Granted 471,667 4.10 751,982 4.29 267,200 3.15
Exercised (9,528) 3.38 (132,654) 4.45 (667) 2.94
Canceled or expired (305,628) 4.49 (231,705) 6.57 (277,171) 5.47
---------- ------------- ---------- ------------- ---------- -------------
Options outstanding,
June 30 1,900,901 4.41 1,744,390 4.50 1,356,767 5.79
---------- ------------- ---------- ------------- ---------- -------------
Options exercisable,
June 30 925,635 $ 4.50 777,962 $ 4.50 410,881 $ 5.79
</TABLE>
The following table summarizes information relating to currently outstanding and
exercisable options as of June 30, 1999:
<TABLE>
<CAPTION>
Average Weighted Weighted
Range of Remaining Average Average
Exercise Contractual Options Exercise Options Exercise
Prices Life in Years Outstanding Price Exercisable Price
- ------------- ------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
$2.55 - $3.85 5.71 456,102 $ 3.41 235,288 $ 3.48
$4.00 - $5.75 7.48 1,421,466 4.68 667,014 4.75
$7.50 - $9.00 5.88 23,333 7.71 23,333 7.71
------------- ------------ ------------ ------------ ------------
7.03 1,900,901 $ 4.41 925,635 $ 4.50
</TABLE>
In accordance with the terms of the Merger agreement between the Company and
Sunrise, the Company granted options to purchase 252,982 shares of common stock
at exercise prices ranging from $1.27 to $6.04 per share to Sunrise employees
and directors as replacement options for previously issued Sunrise options.
These grants are included in the 1998 grants above.
WARRANTS: In accordance with the terms of the merger agreement between the
Company and Sunrise, the Company issued warrants to purchase 300,742 shares of
common stock at exercise prices ranging from $3.10 to $5.87 per share as
replacement warrants for previously issued Sunrise warrants. All of these
warrants, which expire at various times through November 2001, were exercisable
at June 30, 1998.
During fiscal 1999 the Company obtained a $5,000,000 line of credit from a
related party (Note 17). In connection with the agreement, the Company issued
warrants for the purchase of 150,000 shares of the Company's common stock at
$3.00 per share.
SHARE RIGHTS PLAN: Under the terms of the Company's share rights plan, the
Company distributed as a dividend one right for each share of the Company's
common stock outstanding on October 1, 1993. Each right entitles its holder to
buy one one-hundredth of a share of a new series of junior participating
preferred stock at an exercise price of $175, subject to adjustment. The rights
will be exercisable only if a
34
<PAGE> 36
person or group acquires ownership of at least 20% of the Company's outstanding
common stock or announces a tender offer to acquire 20% or more of the common
stock.
As permitted under the provisions of Statement of Financial Accounting Standards
No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), the Company
has elected to continue to account for stock option and warrant grants under APB
Opinion No. 25, under which no compensation cost has been recognized. Had the
Company accounted for its stock option and warrant grants and recorded
compensation cost in accordance with SFAS No. 123, the Company's pro forma net
earnings (loss) and net earnings (loss) per common share for the year ended June
30 would have been as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Net earnings (loss) - as reported $(10,689,000) $ (3,437,000) $ 566,000
Net loss - proforma (12,443,000) (4,267,000) (6,000)
Net earnings (loss) per common share
- - as reported (basic and diluted) $ (1.12) $ (.40) $ .08
Net earnings (loss) per common share
- - proforma (basic and diluted) $ (1.30) $ (.50) $ --
</TABLE>
The fair value of each option and warrant grant is estimated on the date of the
grant using the Black-Scholes option pricing model with the following weighted
average assumptions:
<TABLE>
<CAPTION>
1999 1998 1997
-------------- -------------- --------------
<S> <C> <C> <C>
Risk free interest rate 5.1% 5.5%-6.2% 5.3%-6.4%
Expected life 5 years 3 to 7 years 7 years
Expected volatility 74.1% 58.4% 58.5%
Dividend yield 0% 0% 0%
</TABLE>
NOTE 15 - INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets (liabilities) as of June 30 are as follows:
<TABLE>
<CAPTION>
1999 1998
-------------- --------------
<S> <C> <C>
Federal net operating loss benefit, net of
amount to be credited to equity $ 9,915,000 $ 7,240,000
Capital loss carryforward benefit 701,000 701,000
Accrued expenses 61,000 411,000
Other 378,000 444,000
-------------- --------------
11,055,000 8,796,000
Valuation allowance 11,055,000 (8,796,000)
-------------- --------------
Net deferred income taxes $ - $ -
============== ==============
</TABLE>
At June 30, 1999, the Company had net operating loss carryforwards of
$39,600,000 for federal tax purposes expiring from 2004 through 2019 and capital
loss carryforwards of $2,063,000, expiring through 2002. The Company has
determined that the realization of the loss carryforwards and the other deferred
tax assets does not meet the recognition criteria under SFAS No. 109 and,
accordingly, a valuation allowance has been established for the tax benefit of
these items as of June 30, 1999 and 1998.
35
<PAGE> 37
As a result of the acquisitions discussed in Note 3, the Company acquired net
operating loss carryforwards for federal tax purposes approximating $3,000,000,
which are available to offset future taxable income, if any, through 2013.
Section 382 of the Internal Revenue Code of 1986 as amended, restricts the use
of net operating losses where a corporation has had a change in ownership as
defined. Potential limitation of the acquired net operating loss carryforwards
has not been determined. Any tax benefit realized from the use of the acquired
operating loss carryforwards will be applied to reduce goodwill.
Consolidated income tax expense differed from the expected amount computed by
applying the U.S. federal income tax rate of 34% to income before income taxes
for the years ended June 30 as follows:
NOTE 16 - SEGMENT INFORMATION
The Company is organized primarily on the basis of educational product lines
offered. Segment data does not include a charge for corporate overhead
allocation or restructuring and relocation charges. Presentation of segment
information for the year ended June 30, 1998, has not been included since the
information is impractical to present and the cost to develop would be
excessive. The table below presents information about reportable segments for
the year ended June 30, 1999:
<TABLE>
<CAPTION>
Charter Preschools Private College Total
<S> <C> <C> <C> <C> <C>
Revenue $ 5,100,000 $ 17,496,000 $ 11,851,000 $ 2,829,000 $ 37,276,000
------------ ------------ ------------ ------------ ------------
Operating Income (Loss)
Before Depreciation,
Amortization and Taxes 386,000 585,000 1,364,000 (1,067,000) 1,268,000
Depreciation and
amortization 78,000 1,369,000 1,055,000 217,000 2,719,000
Interest -- 105,000 1,130,000 -- 1,235,000
------------ ------------ ------------ ------------ ------------
Income (loss) before
corporate general
and other 308,000 (889,000) (821,000) (1,284,000) (2,686,000)
Corporate general and
administrative cost
and restructuring and
relocation expenses (8,003,000)
Net loss $(10,689,000)
=============
Long-Lived Assets:
Property and,
equipment, net $ 795,000 $ 2,039,000 $ 32,831,000 $ 589,000 $ 36,254,000
Net Intangible assets -- 14,161,000 -- -- 14,161,000
Other corporate
assets 3,878,000
------------
Total long-lived
assets $ 54,293,000
============
</TABLE>
Geographic information has not been provided because the company's schools are
located primarily in the Southwestern United States and disclosure would not be
meaningful.
36
<PAGE> 38
NOTE 17 - RELATED PARTY TRANSACTIONS
In addition to the related-party transactions described elsewhere, certain
shareholders and directors provided legal and accounting services to the
Company. Total amounts incurred for these services for the years ended June 30,
1999, 1998, and 1997 were $321,000, $490,000 and $216,000 respectively.
In January 1998, the Company terminated a real estate development agreement with
TesseracT Development Company II ("TDC II"), a general partnership in which the
chairman and chief executive officer of the Company had a 25% interest, for an
aggregate payment of $240,000. This agreement granted TDC II the opportunity to
develop the next ten TesseracT schools, with an option to develop the succeeding
twenty TesseracT schools.
As more fully described in Note 9, the Company currently has a $5,000,000
working capital line of credit from a related party. Total borrowings
outstanding at June 30, 1999, totaled $4,999,000. The line of credit is due and
payable on September 30, 1999. The Company has the option to extend payment
until March 31, 2000, with the issuance of warrants for the purchase of
additional 250,000 shares of the Company's common stock at $3.00 per share. At
March 31, 2000, if unpaid, the related party holder of the note can elect to
convert the debt into the Company's common stock at $1.00 per share for each
dollar owed.
NOTE 18 - PARTICIPATION IN STUDENT FINANCIAL ASSISTANCE PROGRAMS
The Company's participation in the U.S. Department of Education's Title IV
programs, through its wholly-owned subsidiary ABC, is subject to audit by
independent auditors annually and to program reviews by the Department of
Education and other federal, state, or accrediting agencies. Instances of
noncompliance, should they exist and be discovered through the audit process,
could result in refunds of financial assistance and imposition of fines and
penalties.
The Department of Education has regulations that contain objective measurement
criteria to determine the financial capabilities of educational institutions
participating in student financial assistance programs. The regulations apply
only to those institutions offering post-secondary courses and training. The
criteria, which are applied on the subsidiary level, include among other things
having cash and receivables from unrelated parties equal to or greater than
current liabilities, maintaining a positive tangible net worth, and restrictions
on the amount of operating losses incurred within a two-year period.
Due to additional operating losses incurred by ABC, the financial capability
tests had not been met at June 30, 1999. As a result, the Company may be
required to post a letter of credit for at least one-half of the Title IV funds
received by ABC during 1999, which amounted to approximately $1,709,000.
NOTE 19 - COMMITMENTS AND CONTINGENCIES
EMPLOYMENT AGREEMENT: The Company has employment agreements with executive
officers of the Company which would require severance benefits to be paid if
employment is terminated for various reasons, including termination following a
change of ownership or control of the Company as defined by the agreements. The
estimated maximum contingent liability for severance payments that the Company
would be required to make under the employment agreements is approximately
$820,000 at June 30, 1999.
DEVELOPMENT AGREEMENT: During 1999, the Company entered into a development
agreement for the construction of two schools in Arizona. As of June 30, 1999,
the Company has advanced approximately $4,400,000 related to those projects
which is reflected in the accompanying financial statements as
37
<PAGE> 39
construction in progress. The terms of the Related leases are for periods from
twenty to twenty-five years with certain provisions for extension. Additional
commitments for the completion of the schools amounted to approximately
$5,600,000. Although management believes that these projects will be completed,
in the event that the developer is unable to complete these projects, the
Company may have to provide necessary funds for completion. One of the schools
opened in August 1999 and under the terms of the lease agreement has monthly
lease payments of approximately $59,000.
AGREEMENT FOR PROFESSIONAL SERVICES: In May 1999, the Company entered into an
agreement for professional services with Arthur Andersen LLP. ("AA") Under the
terms of the agreement, AA will provide certain agreed upon accounting services,
tax services and information technology services. The term of the agreement is
for five years beginning July 1, 1999, with an option to extend for five years.
In return for services as provided under the agreement, the Company will pay AA
implementation costs of approximately $1,500,000 and a monthly fee based upon a
percentage of the Company's annual revenue ranging from 3.0% to 3.8%. For the
year ended June 30, 1999 the cost incurred related to implementation was
$1,500,000 which is reflected in the accompanying financial statements as a
restructuring expense. The implementation fee was paid with a $200,000 cash
payment, a $900,000 note payable and the issuance of 200,000 shares of the
Company's common stock.
Additionally, in the event that the average closing price of the Company's
common stock for the ten days preceding July 1, 2000 ("average share price"), is
less than $5 but more than $3 per share, the Company is required to either issue
additional shares of the Company's common stock so that the total number of
shares held by AA times the average share price totals $1,000,000 or pay the
difference between $5 and the average share price times the 200,000 shares
currently held by AA.
The agreement contains certain performance incentives under a service level
document that provides for incentive fees of at least $1,200,000 over the term
of the agreement. Performance incentives earned will be payable, at the
Company's option, in options for the Company's common stock or cash.
REGULATION: Schools and preschools are subject to a variety of state and local
regulations and requirements. Additionally, the Company operates public schools
under certain charter agreements and management contracts. The Department of
Education has regulatory criteria related to financial requirements of financial
institutions participating in student financial assistance programs for
post-secondary courses and training. Although management believes that the
Company will be able to meet federal, state and local regulations, the failure
to maintain required licenses, charters, approvals or accreditations could have
a material adverse effect on the Company's financial position and results from
operations.
NOTE 20 - GOING CONCERN MATTERS
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. As shown in the financial
statements during the years ended June 30, 1999 and 1998, the Company incurred
losses of $10,689,000 and $3,437,000, respectively. As of June 30, 1999, the
Company had a negative working capital of $10,478,000. These factors, among
other things, may indicate that the Company will be unable to continue as a
going concern for a reasonable period of time.
The financial statements do not include any adjustments relating to the
recoverability and classification of liabilities that might be necessary should
the Company be unable to continue as a going concern.
Management has plans in process to resolve near term cash flow issues which
include the following transactions:
- - A private placement equity financing to provide approximately
$7,500,000 in cash flows, less offering costs.
38
<PAGE> 40
- - A restructuring of both the $5,000,000 and $1,000,000 credit lines,
which are currently payable, into long-term debt.
- - At June 30, 1999, the Company has approximately $5,385,000 of
construction in progress. The Company is seeking permanent financing
for these projects to provide necessary cash.
Management believes that if it can finalize financing alternatives that it is
pursuing together with its projected improvement in operating results for 2000,
the Company will generate sufficient resources to permit uninterrupted
performance of its operating obligations as currently structured and
anticipated. The Company's continuance as a going concern is dependent upon its
ability to generate sufficient cash flow to meet its obligations in a timely
manner, to obtain additional financing as required, and ultimately to attain
profitability. There can be no assurance, however, that these sources would be
available to the Company on acceptable terms or when necessary.
NOTE 21 - SUBSEQUENT EVENTS
SALE OF CLOSED SCHOOL: In August 1999 the Company sold property related to a New
Jersey school closed in June 1999. The related loss on sale of $245,000 was part
of the closed school reserve at June 30, 1999.
MANAGEMENT AGREEMENTS: In July 1999, the Company entered into management
contracts with two 501(c)3 corporations for the management and operation of
charter schools in Texas and Washington D.C. Under the terms of the agreement,
the Company will receive a management fee of approximately 12.5% of each
school's charter revenue. Funds required for operations will be advanced to the
Company and distributed by the Company to cover related costs.
NOTE 22 -- SUPPLEMENTAL CASH FLOW DISCLOSURE
Supplemental disclosure of non-cash investing and financing information for the
year ending June 30, 1999 (in thousands)
1999
Issuance of warrants to Pioneer for debt $270
Financing
Note payable to Arthur Andersen $900
Issuance of common stock to Arthur
Andersen for debt financing $400
Note receivable on sale of land/building $640
39
<PAGE> 41
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
THE TESSERACT GROUP, INC.
<TABLE>
<CAPTION>
Column C
Column A Column B Additions Column D Column E
- ---------------------------- ------------ ------------------------------ -------------- ---------------
Balance at Charged to Charged
Beginning of Costs and to Other Balance at
Description Period Expenses Accounts Deductions End of Period
- ---------------------------- ------------ ------------- ------------ -------------- ---------------
<S> <C> <C> <C> <C> <C>
Year ended June 30, 1999:
Allowance for uncollectible
accounts receivable $ 248,000 $ 482,000 $ 13,000 $612,000(1) $ 131,000
Closed School Reserve $ -- $ 1,600,000(2) $ -- $ -- $1,600,000
Year ended June 30, 1998:
Allowance for uncollectible
accounts receivable $ 30,000 $ 87,000 $ 131,000(3) $ -- $ 248,000
Year ended June 30,1997:
Allowance for uncollectible
accounts receivable $ 53,000 $ 10,000 $ -- $(33,000)(4) $ 30,000
</TABLE>
(1) The reduction in the allowance for uncollectible accounts receivable
was made to bring the allowance in line with the anticipated
uncollectible accounts receivable at June 30, 1999.
(2) The Company established a closed school reserve during fiscal 1999
related for schools that were approved for closure by the Board of
Directors prior to June 30, 1999.
(3) The addition is the result of the allowance for uncollectible accounts
receivable existing at the date of acquisition of Sunrise and ABC.
(4) The reduction in the allowance for uncollectible accounts receivable
was made to bring the allowance in line with the anticipated
uncollectible accounts receivable at June 30, 1997.
40
<PAGE> 42
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By /s/ Richard C. Yonker
------------------------
Richard C. Yonker
Date: September 28, 1999 Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ John T. Golle September 28, 1999
- --------------------------------------
John T. Golle
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
/s/ Robert I. Karon September 28, 1999
- --------------------------------------
Robert I. Karon
Director
/s/ Gale R. Mellum September 28, 1999
- --------------------------------------
Gale R. Mellum
Director
/s/ Benjamin Nazarian September 28, 1999
- --------------------------------------
Benjamin Nazarian
Director
/s/ Martha Taylor Thomas September 28, 1999
- --------------------------------------
Martha Taylor Thomas
Director
/s/ Harold Nelkin September 28, 1999
- --------------------------------------
Harold Nelkin
Director
/s/ Richard C. Yonker September 28, 1999
- --------------------------------------
Richard C. Yonker
Chief Financial Officer
(Principal Financial and Accounting Officer)
<PAGE> 43
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
<S> <C>
3.1 Restated Articles of Incorporation of the Company, as
amended.
3.2 By-Laws of the Company. (1)
4.1 Specimen Certificate of Common Stock.
4.2 Share Rights Plan dated September 8, 1993. (2)
</TABLE>
<PAGE> 44
<TABLE>
<S> <C>
10.1* Employment Agreement between the Company and Philip E.
Geiger dated August 10, 1993. (3)
10.2* 1988 The TesseracT Group, Inc. Stock Option Plan, as
amended. (4)
10.3* Employment Agreement between the Company and John T. Golle
dated January 1, 1991. (5)
10.4* Amendment to Employment Agreement between the Company and
John T. Golle dated September 8, 1993. (6)
10.5* 1992 The TesseracT Group, Inc. Long-Term Executive Stock
Option Plan, as amended. (7)
10.6* Amendment to Employment Agreement between the Company and
John T. Golle dated March 20, 1992. (8)
10.7 Lease dated June 9, 1998, between EduCorp Properties, Inc.
as lessor and The TesseracT Group, Inc. as lessee.
10.8 Amended and Restated Lease dated June 9, 1998, between
EduCorp Properties, Inc. as lessor and The TesseracT Group,
Inc. as lessee.
10.9* Employment Agreement dated November 3, 1997, between the
Company and Todd K. Severson. (9)
10.10* Employment Agreement dated February 16, 1998, between the
Company and Tony L. Verbeten. (10)
10.11 Lease Agreement dated January 31, 1983, between Earl H.
Jones and Venture Educational Programs, Inc. (11)
10.12 Lease Agreement dated April 1, 1984, between McClintock
Associates Limited Partnership, an Arizona Limited
Partnership, and Venture Educational Programs, Inc. (11)
10.13 Lease Agreement dated October 24, 1986, between Peoria
Investment Company, Inc., an Arizona corporation, and Sunrise
Educational Services, Inc., an Arizona corporation.
(11)
10.14 Lease Agreement dated October 16, 1986, between Sun School I
Limited Partnership, an Arizona limited partnership, and
Sunrise Educational Services, Inc., an Arizona corporation.
(11)
10.15 Lease Agreement dated April 1, 1986, between Sunrise
Partners, an Arizona corporation, and Sunrise Educational
Services, Inc., an Arizona corporation. (11)
10.16 Lease Agreement dated February 5, 1987 between Sun School II
Limited Partnership, an Arizona limited partnership, and
Sunrise Educational Services, Inc., an Arizona corporation.
</TABLE>
<PAGE> 45
<TABLE>
<S> <C>
10.17 Lease Agreement dated June 26, 1987, between Huber Farm
Service of Phoenix, Inc., an Arizona corporation and Sunrise
Educational Services, Inc., an Arizona corporation. (11)
10.18 Lease Agreement, dated July 29, 1988, between Sunrise
Educational Services, Inc. and Investad, Inc. (12)
10.19 Lease Agreement, dated July 25, 1988, between Sunrise
Educational Services, Inc., and LV Properties, an Arizona
general partnership. (12)
10.20 Lease Agreement, dated May 12, 1988, between Sunrise
Educational Services, Inc. and Jaymark Komer and Eugene
Victor Komer and Ruth Lena Komer, as Trustees of the Komer
Family Trust dated December 30, 1980. (12)
10.21 Lease Agreement, dated July 29, 1988, between Sunrise
Educational Services, Inc. and Kailua Beach Center, Inc. (12)
10.22 Lease Agreement, dated January 11, 1988, between Sunrise
Educational Services, Inc. and Mercado Developers. (13)
10.23 Amendment of Lease Agreement dated March 8, 1990, between
Sunrise Educational Services, Inc. and Jaymark Komer and
Komer Family Trust dated May 12, 1988. (14)
10.24 Purchase Agreement and Registration Rights Agreement dated
April 6, 1990, between Sunrise Educational Services, Inc.
and Lepercq Capital Management, Inc. (15)
10.25 Lease Agreement, dated July 1, 1991, between Sunrise
Educational Services, Inc. and Maruni Arizona, Inc. (16)
10.26 Purchase Agreement, dated November 18, 1991, between Sunrise
Educational Services, Inc., LN Investment Capital Limited
Partnership, Lepercq Investment Limited Partnership II and LN
Investment Capital Limited Partnership II. (17)
10.27 Amendment of Lease Agreement dated July 22, 1998, between
Sunrise Educational Services, Inc. and Jaymark Komer and
Komer Family Trust. (18)
10.28 Management Agreement, dated November 14, 1993, between
United Church of Christ and Sunrise Educational Services,
Inc. (19)
10.29 Term Sheet Agreement, dated December 7, 1992, between Joy of
Christ Lutheran Church and Sunrise Educational Services,
Inc.(20)
10.30 Agreement between Lutheran Church of Honolulu and Sunrise
Educational Services, Inc., dated May 19, 1993. (20)
10.31 Administrative Services Agreement, License, and Equipment
Lease, dated February 1, 1994, between Sunrise Educational
Services, Inc., and Preschool Services, Inc. (19)
</TABLE>
<PAGE> 46
<TABLE>
<S> <C>
10.32 Asset Purchase Agreement between Children's Choice Learning
Center, Inc. and Sunrise Preschool, Inc. dated June 26,
1996, with one amendment dated June 28, 1996. (21)
10.33 Form of Credit and Security Agreement between Imperial Bank
and Sunrise Educational Services, Inc. dated April 24, 1997.
(22)
11 Statement re Computation of Per Share Earnings (Loss).
23.1 Consent of PricewaterhouseCoopers LLP.
23.2 Consent of Arthur Andersen LLP
27 Financial Data Schedule (EDGAR version only).
</TABLE>
------------------------------
* Management contract or compensatory plan or arrangement.
(1) Incorporated herein by reference to Exhibit 3.3 to the
Company's Form S-18 Registration Statement (Registration
Number 33-39481-C).
(2) Incorporated herein by reference to the same numbered Exhibit
to the Company's Annual Report on Form 10-K for the year ended
June 30, 1993.
(3) Incorporated herein by reference to Exhibit 10.2 to the
Company's Form 10-Q for the quarter ended December 31, 1994.
(4) Incorporated herein by reference to the same numbered Exhibit
to the Company's Annual Report on Form 10-K for the year ended
June 30, 1996.
(5) Incorporated herein by reference to Exhibit 10.17 to the
Company's Amendment No. 1 to Form S-18 Registration Statement
(Registration Number 33-39481-C).
(6) Incorporated herein by reference to Exhibit 10.28 to the
Company's Annual Report on Form 10-K for the year ended June
30, 1993.
(7) Incorporated herein by reference to Exhibit Number 10.26 to
the Company's Annual Report on Form 10-K for the year ended
June 30, 1993.
(8) Incorporated herein by reference to Exhibit 10.24 to Amendment
No. 2 to the Company's Form S-1 Registration Statement
(Registration Number 33-46791).
(9) Incorporated herein by reference to Exhibit 10 to the
Company's Form 10-Q for the quarter ended December 31, 1997.
(10) Incorporated herein by reference to Exhibit 10 to the
Company's Form 10-Q for the quarter ended March 31, 1998.
(11) Incorporated herein by reference to exhibits to Sunrise
Educational Services, Inc, Commission File Number 0-16425
("Sunrise") Form S-1 filed July 10, 1987.
<PAGE> 47
(12) Incorporated herein by reference to exhibits to Sunrise Form
10-K filed on or about October 31, 1988.
(13) Incorporated herein by reference to exhibits to Sunrise Form
10-K filed on or about October 30, 1989.
(14) Incorporated herein by reference to exhibits to Sunrise Form
10-Q filed on or about January 31, 1990.
(15) Incorporated herein by reference to exhibits to Sunrise Form
8-K filed on or about April 20, 1990.
(16) Incorporated herein by reference to exhibits to Sunrise Form
10-K filed on or about October 28, 1991.
(17) Incorporated herein by reference to exhibits to Sunrise Form
10-Q filed on or about December 16, 1991.
(18) Incorporated herein by reference to exhibits to Sunrise Form
10-K filed on or about October 21, 1992.
(19) Incorporated herein by reference to exhibits to Sunrise Form
10-KSB for the year ended July 31, 1994.
(20) Incorporated herein by reference to exhibits to Sunrise Form
10-KSB filed on or about October 8, 1993.
(21) Incorporated herein by reference to exhibits to Sunrise Form
8-K filed on or about September 9, 1996.
(22) Incorporated herein by reference to exhibits to Sunrise Form
10-QSB filed on March 11, 1997.
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form 10-K (of The TesseracT Group, Inc. of our report
dated September 27, 1999 relating to the consolidated financial statements and
financial statement schedules, which appears in this Form 10-K.
PricewaterhouseCoopers LLP
Phoenix, Arizona
September 28, 1999
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the inclusion in this
Form 10-K of our report dated September 3, 1998, and to all references to our
Firm included in this Form 10-K
Arthur Andersen LLP
Minneapolis, Minnesota
September 28, 1999
41
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-END> JUN-30-1999
<CASH> 2,545
<SECURITIES> 0
<RECEIVABLES> 2,615
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 7,381
<PP&E> 37,002
<DEPRECIATION> (3,765)
<TOTAL-ASSETS> 63,224
<CURRENT-LIABILITIES> 17,859
<BONDS> 0
0
0
<COMMON> 98
<OTHER-SE> 58,371
<TOTAL-LIABILITY-AND-EQUITY> 63,224
<SALES> 37,276
<TOTAL-REVENUES> 37,276
<CGS> 0
<TOTAL-COSTS> 33,414
<OTHER-EXPENSES> 14,230
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,255
<INCOME-PRETAX> (10,689)
<INCOME-TAX> 0
<INCOME-CONTINUING> (10,689)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,689)
<EPS-BASIC> (1.12)
<EPS-DILUTED> (1.12)
</TABLE>
