<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 for the quarter ended June 30, 1996 or
-------------
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from to .
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Commission File Number 0-22844
----------------
SYLVAN LEARNING SYSTEMS, INC.
-----------------------------
(Exact name of registrant as specified in its charter)
Maryland 52-1492296
--------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9135 Guilford Road, Columbia, Maryland 21046
-------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410)880-0889
--------------
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 [ ].
The registrant had 15,424,704 shares of Common Stock outstanding as of July 31,
1996.
<PAGE>
SYLVAN LEARNING SYSTEMS, INC.
-----------------------------
INDEX
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<TABLE>
<CAPTION>
PAGE NO.
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<S> <C>
PART I.--FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
. Balance Sheets--December 31, 1995 and June 30, 1996 . . 3
. Statements of Operations--Three months ended June 30,
1995, three months ended June 30, 1996 . . . . . . . . . 5
. Statements of Operations--Six months ended June 30, 1995,
six months ended June 30, 1996 . . . . . . . . . . . . . 6
. Statements of Cash Flows--Six months ended June 30, 1995,
six months ended June 30, 1996 . . . . . . . . . . . . . 7
. Notes to Unaudited Financial Statements-June 30,1996 . . 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . 11
PART II.--OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . 17
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
</TABLE>
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1995 1996
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(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,528,865 $ 7,058,046
Available-for-sale securities 30,379,065 18,225,370
Receivables:
Accounts receivable 20,578,345 25,781,968
Costs and estimated earnings in excess of
billings on uncompleted contracts 3,028,558 4,671,603
Notes receivable 1,583,843 1,306,343
------------ ------------
25,190,746 31,759,914
Allowance for doubtful accounts (1,466,027) (1,528,938)
------------ ------------
23,724,719 30,230,976
Inventory 3,639,392 3,832,357
Deferred income taxes 1,271,925 1,271,925
Prepaid expenses 1,942,806 2,838,374
------------ ------------
Total current assets 63,486,772 63,457,048
Notes receivable, less current portion 1,875,359 1,958,919
Costs and estimated earnings in excess of
billings on uncompleted contracts, less
current portion 673,181 186,497
Property and equipment:
Furniture and equipment 19,564,005 21,859,431
Leasehold improvements 1,958,236 2,260,537
------------ ------------
21,522,241 24,119,968
Accumulated depreciation (6,142,009) (8,030,597)
------------ ------------
15,380,232 16,089,371
Intangible assets:
Goodwill 74,653,356 81,202,049
Contract rights 7,857,346 7,857,346
Other 2,451,091 2,451,091
------------ ------------
84,961,793 91,510,486
Accumulated amortization (4,640,450) (7,974,870)
------------ ------------
80,321,343 83,535,616
Deferred contract costs, net of accumulated
amortization of $684,177 as of December 31,
1995 and $1,105,021 as of June 30, 1996 2,528,029 7,066,410
Other assets 1,141,755 1,489,575
------------ ------------
Total assets $165,406,671 $173,783,436
============ ============
</TABLE>
3
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1995 1996
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(UNAUDITED)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 12,253,614 $ 16,873,102
Bank lines of credit 3,500,000 --
Current portion of long-term debt and capital
lease obligations 1,895,567 1,316,433
Billings in excess of costs and estimated
earnings on uncompleted contracts 237,644 262,061
Deferred revenue 6,487,134 7,707,078
Other current liabilities 795,967 670,828
------------ ------------
Total current liabilities 25,169,926 26,829,502
Long-term debt, less current portion 2,465,399 1,840,000
Capital lease obligations, less current portion 55,113 --
Deferred income taxes 884,612 884,612
Other long-term liabilities 367,790 338,695
Commitments and contingent liabilities -- --
Stockholders' equity:
Common stock, par value $.01 per
share--authorized 40,000,000 shares, issued
and outstanding shares of 13,953,462 as of
December 31, 1995 and 14,234,228 as of June
30, 1996 139,534 142,342
Additional paid-in capital 139,863,681 142,515,764
Foreign currency translation adjustments 70,000 30,859
Retained earnings (accumulated deficit) (3,609,384) 1,201,662
------------ ------------
Total stockholders' equity 136,463,831 143,890,627
------------ ------------
Total liabilities and stockholders' equity $165,406,671 $173,783,436
============ ============
</TABLE>
See accompanying notes.
4
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
--------------------------
1995 1996
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(UNAUDITED) (UNAUDITED)
<S> <C> <C>
REVENUES
Franchise royalties $ 2,403,478 $ 2,988,542
Franchise sales fees 504,185 152,386
Testing services 5,742,703 23,259,302
Company-owned learning center services 2,876,726 4,030,405
Contract educational services 6,598,595 8,266,243
Product sales 907,330 872,852
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Total revenues 19,033,017 39,569,730
COST AND EXPENSES
Testing services expense 4,414,980 19,366,489
Company-owned learning center expense 2,521,381 3,289,792
Contract educational services expense 5,698,531 6,979,756
Cost of product sales 702,737 735,913
General and administrative expense 3,321,458 4,728,607
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Total expenses 16,659,087 35,100,557
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Operating income 2,373,930 4,469,173
OTHER INCOME (EXPENSE)
Investment and other income 188,991 346,272
Interest expense (133,126) (70,593)
Equity in net income of Sylvan National
Advertising Committee, Inc. 72,192 161,268
----------- ------------
Income from continuing operations before income
taxes 2,501,987 4,906,120
Income taxes (482,052) (1,874,000)
----------- ------------
Net income $ 2,019,935 $ 3,032,120
=========== ============
PER COMMON AND COMMON EQUIVALENT SHARE
Net income $0.20 $0.19
=========== ============
</TABLE>
See accompanying notes.
5
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------------
1995 1996
----------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
REVENUES
Franchise royalties $ 4,528,408 $ 5,511,025
Franchise sales fees 877,970 364,871
Testing services 11,001,901 41,059,451
Company-owned learning center services 5,338,349 7,398,507
Contract educational services 12,528,501 17,810,353
Product sales 1,761,144 1,982,675
----------- -----------
Total revenues 36,036,273 74,126,882
COST AND EXPENSES
Testing services expense 9,030,569 34,524,809
Company-owned learning center expense 4,777,719 6,323,869
Contract educational services expense 10,945,650 15,297,884
Cost of product sales 1,353,120 1,640,082
General and administrative expense 6,182,052 9,003,419
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Total expenses 32,289,110 66,790,063
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Operating income 3,747,163 7,336,819
OTHER INCOME (EXPENSE)
Investment and other income 367,958 742,035
Interest expense (263,673) (178,376)
Equity in net income of Sylvan National
Advertising Committee, Inc. 44,525 253,568
----------- -----------
Income from continuing operations before income
taxes 3,895,973 8,154,046
Income taxes (593,607) (3,343,000)
----------- -----------
Net income $ 3,302,366 $4,811,0476
=========== ===========
PER COMMON AND COMMON EQUIVALENT SHARE
Net Income $ 0.32 $ 0.30
=========== ===========
</TABLE>
See accompanying notes.
6
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------------
1995 1996
------------ --------------
(Unaudited) (Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 3,302,366 $ 4,811,046
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Depreciation 1,597,290 2,171,331
Amortization 819,095 3,755,264
Provision for doubtful accounts 107,579 60,000
Equity in net income of unconsolidated
affiliate (44,525) (253,568)
Changes in operating assets and
liabilities:
Accounts and notes receivable (5,954,269) (5,003,800)
Costs and estimated earnings in excess of
billings on uncompleted contracts (465,837) (853,696)
Inventory (10,689) (453,115)
Prepaid expenses (678,661) (653,314)
Other assets (375,916) (173,291)
Accounts payable and accrued expenses 979,802 2,287,947
Billings in excess of costs and estimated
earnings on uncompleted contracts (696,341) (312,418)
Other current liabilities (596,515) (27,571)
Deferred revenue and other long-term
liabilities 480,179 1,300,144
----------- ------------
Net cash provided by (used in) operating
activities (1,536,442) 6,654,959
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INVESTING ACTIVITIES
Investment in and changes in advances to
unconsolidated affiliates 90,871 (26,207)
Purchase of available-for-sale securities -- (12,819,592)
Proceeds from sale of available-for-sale
securities 1,378,408 24,973,287
Purchase of property and equipment (2,107,449) (2,880,966)
Contract Termination fee paid to Drake
Authorized Testing Centers -- (4,177,748)
Purchase of assets and contract rights from NASD -- (4,774,000)
Cash received upon acquisition of PACE 682,411 --
Expenditures for deferred contract costs and
other assets (749,623) (185,623)
----------- ------------
Net cash used in investing activities (705,382) 109,151
----------- ------------
FINANCING ACTIVITIES
Proceeds from exercise of options and warrants 15,661 2,117,073
Proceeds from issuance of common stock -- 440,250
Payments on long-term debt (566,526) (809,596)
Proceeds from (paydown of) borrowings on line of
credit 600,000 (3,500,000)
Payments on capital lease obligations (391,263) (444,301)
----------- ------------
Net cash used in financing activities (342,128) (2,196,574)
----------- ------------
Effects of exchange rate changes on cash -- (38,355)
----------- ------------
Net increase (decrease) in cash and cash
equivalents (2,583,952) 4,529,181
Cash and cash equivalents at beginning of period 3,719,657 2,528,865
----------- ------------
Cash and cash equivalents at end of period $ 1,135,705 $ 7,058,046
=========== ============
</TABLE>
See accompanying notes.
7
<PAGE>
SYLVAN LEARNING SYSTEMS, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS
JUNE 30, 1996
NOTE A--BASIS OF PRESENTATION
---------------------
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three months and six months ended June 30, 1996 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 1996. For further information, refer to the financial
statements and footnotes thereto included in the Company's annual report on Form
10-K for the year ended December 31, 1995.
NOTE B--ACQUISITIONS
------------
The PACE Group
Effective February 28, 1995, the Company purchased the assets and liabilities of
The PACE Group ("PACE"), a provider of educational services to corporations. The
initial consideration for the acquisition was 174,964 shares of the Company's
common stock having an aggregate market value of $3,160,861. The acquisition was
accounted for using the purchase method of accounting. Additional contingent
consideration is payable in an amount equal to 6.5 times PACE's earnings before
interest and income taxes (EBIT) in 1997, determined in accordance with
generally accepted accounting principles. If EBIT is less than $2.7 million in
1997, the PACE shareholders may elect to have the payment calculation based on
EBIT for either calendar year 1998 or 1999. The contingent payment is payable
two-thirds in cash and one third in shares of Sylvan common stock, unless the
PACE shareholders determine that a smaller cash payment is required for their
tax purposes. The Company will record any additional consideration payable to
the PACE shareholders as additional goodwill, and will amortize that amount over
the remaining amortization period.
Drake Prometric, L.P.
Effective September 30, 1995, the Company acquired Drake Prometric, L.P.
("Drake"), a Minneapolis based provider of computer-based certification,
licensure and assessment testing programs. The acquisition was accounted for
using the purchase method of accounting. The Company acquired Drake for an
initial purchase price of $20 million in cash and 3,809,524 restricted shares of
Common Stock (the "Initial Shares"). Of the Initial Shares, 1,190,476 shares
(the "Revenue Escrow Shares") were placed in escrow and will be released to the
sellers to the extent that certain
8
<PAGE>
revenue targets relating to portions of the combined computer-based testing
business of Sylvan and Drake are achieved from 1996 through 1998. The sellers
may receive up to an additional $40 million (payable 12.5% in cash and the
balance in either cash or restricted shares of Common Stock, at Sylvan's option)
to the extent other revenue targets relating to portions of the combined
computer-based testing business of Sylvan and Drake are achieved in 1998 or 1999
(with the measuring year selected by the sellers). The Company will record the
contingent consideration consisting of the 1,190,476 Revenue Escrow Shares and
the additional contingent payment of up to $40 million when the contingencies
are resolved and the additional consideration is payable.
In June 1996, also in connection with the acquisition, the Company paid and
accrued $6.4 million in contract termination fees to certain Drake Authorized
Testing Centers that had contracts to provide computer based testing delivery.
These cancellation costs were recorded as additional costs related to the Drake
acquisition and are being amortized over the remaining amortization period.
NOTE C--INCOME TAXES
------------
At December 31, 1995 the Company had net operating loss carryforwards of
approximately $2,500,000 for income tax purposes that expire in years 2007 and
2008. The operation of certain provisions of the Internal Revenue Code will
limit the amount of the net operating loss carryforwards available to offset
taxable income in any one year. During 1996, approximately $2.5 million of net
operating loss carryforwards are available to offset taxable income. The
Company's effective tax rate has increased from 15% during the first six months
of 1995 to 41% during the first six months of 1996 mainly due to non-deductible
amortization expense of intangible assets related to the Drake acquisition and a
lower net operating loss carryforward available for use in 1996. The Company's
income tax provision of $3,343,000 for the six month period ended June 30, 1996,
consists of federal, state, and foreign income taxes.
NOTE D--CREDIT LINE
-----------
The Company has entered into a loan agreement with a bank, hereinafter the
"credit line", that provides an unsecured revolving line of credit. The credit
line allows the Company to borrow a maximum of $15 million on a revolving basis
through May 31, 1998, with the option to repay any balance at that date over two
years through May 31, 2000. The credit line bears interest at a floating rate
equal to the 30 day London Interbank Offered Rate ("LIBOR") plus 1.15% per
annum. During the six months ended June 30, 1996, all outstanding borrowings
under the line of credit were repaid in their entirety.
NOTE E--EARNINGS PER SHARE
------------------
Earning per common and common equivalent share is computed using the weighted
average number of common and common equivalent shares outstanding during each
period presented. The weighted average number of shares used for the three
months ended June 30, 1996 and 1995 was 15,826,211 and 10,253,552, respectively.
The weighted average number of shares used for the six month periods ended June
30, 1996 and 1995 was 15,727,828 and 10,194,231, respectively. The difference
between the number of shares used to determine earnings per common and common
equivalent share
9
<PAGE>
earnings per common share assuming full dilution is immaterial. Common stock
equivalents consist of stock options and warrants (using the treasury stock
method).
NOTE F -- CONTINGENT MATTERS
------------------
During 1993, the Company committed to purchase and license instructional
learning system software from a company (the "Seller") to be used in the
Company's contract education sites and to be sold to its franchised Sylvan
Learning Centers. The agreement requires the acquisition of a minimum of $4.0
million of courseware in CD ROM format. As of June 30, 1996, the Company had
paid for and accepted delivery of $3.0 million in courseware. Prior to August
31, 1996 the Company is required to place a minimum order of $1.0 million. As
stipulated in the contract, management currently intends to offset the
commitment for future orders against certain obligations the Seller may have to
the Company as described below.
In 1993, the Company purchased from the Seller the rights to certain testing
contracts and agreed to pay the Seller a royalty equal to 27% of the excess
testing contract revenues earned by August 31, 1997 over $7.4 million.
Conversely, the Seller agreed to pay the Company a reverse royalty equal to 27%
of any testing contract revenue deficiency under $7.4 million that may occur by
August 31, 1997. An installment payment of no more than $1 million is payable to
the Company under the reverse royalty agreement in October 1996 in the event
that testing contract revenues are less than $5.5 million, with any remaining
amount due in October 1997 based on the August 31, 1997 calculation, however the
total reverse royalty can not exceed $2.0 million. The Company expects, based on
the amount of revenue earned on these testing contracts through June 30, 1996
and projections of additional testing contract revenue through August 31, 1996,
that the Seller will owe the Company approximately $1 million in October 1996.
No amounts have been recorded related to the royalty arrangement at June 30,
1996.
NOTE G -- RECLASSIFICATIONS
-----------------
Certain amounts in the 1995 financial statements have been reclassified to
conform with the 1996 presentation.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
All statements contained herein that are not historical facts, including but
not limited to, statements regarding the anticipated impact of uncollectible
accounts receivable on future liquidity, expenditures to develop licensing and
certification tests under existing contracts, amounts payable to or by the
Company in connection with a 1993 software agreement, the Company's contingent
payment obligations relating to the PACE and Drake acquisitions, future capital
requirements and the Company's future development plans are based on current
expectations. These statements are forward looking in nature and involve a
number of risks and uncertainties. Actual results may differ materially. Among
the factors that could cause actual results to differ materially are the
following: Changes in the financial resources of the Company's clients; timing
and extent of testing clients' conversions to computer-based testing; amount of
revenues earned pursuant to certain testing contracts acquired in connection
with the 1993 software agreement and revenues earned by the Company's PACE and
Drake operations; the availability of sufficient capital to finance the
Company's business plan on terms satisfactory to the Company; general business
and economic conditions; and the other risk factors described in the Company's
reports filed from time to time with the Commission. The Company wishes to
caution readers not to place undue reliance on any such forward looking
statements, which statements are made pursuant to the Private Securities
Litigation Reform Act of 1995 and, as such, speak only as of the date made.
The Company generates revenue from three business segments: Core educational
services which primarily consists of franchise sales, royalties, and
Company-owned Learning Center revenue; testing services, which consists of
computer-based testing fees paid to the Company primarily by test
administrators; and contract educational services, which consists of revenue
attributable to providing supplemental and remedial education services to school
districts and major corporations.
RESULTS OF OPERATIONS
Comparison of results for the quarter and six months ended June 30, 1996 to
results for the quarter and six months ended June 30, 1995.
Revenue. Total revenues increased by $20.5 million, or 108% to $39.6 million for
the quarter ended June 30, 1996 and increased by $38.1 million, or 106%, to
$74.1 million for the six months ended June 30, 1996 compared to the same
respective periods in 1995. These increases resulted from higher revenues in all
business segments --core educational services, testing services, and contract
educational services.
Core educational services revenue increased by $1.3 million, or 20%, to
$8.0 million during the second quarter of 1996 and by $2.8 million, or 22%, to
$15.3 million for the first six months of 1996 compared to the comparable 1995
periods. Franchise royalties increased $585,000, or 24%, to $3.0 million for the
quarter ended June 30, 1996 and by $983,000, or 22%, to $5.5 million for the
first six months of 1996 compared to the comparable 1995 periods. This increase
in franchise royalties was due to an overall 18% and 17% increase in revenues at
existing Learning Centers open for more than one year, for the three months and
six months ended June 30, 1996, respectively, combined with a net increase of 19
new full and satellite Centers opened in the quarter ended June 30, 1996, and 34
new full and satellite Centers opened in the first six months of 1996. A
satellite Center is a center operating within an existing franchise territory.
11
<PAGE>
Franchise sales fees decreased by $352,000, or 70%, to $152,000 for the
quarter ended June 30, 1996, and by $513,000, or 58%, to $365,000 for the six
months ended June 30, 1996, compared to the comparable periods in 1995. For the
quarter ended June 30, 1996, there were three franchise Center licenses sold,
compared to 14 franchise Center licenses sold in the 1995 quarter. For the six
months ended June 30, 1996, there were nine franchise Center licenses sold
compared to 17 franchise Center licenses and a $270,000 area development
agreement sold for the six months ended June 30, 1995.
Revenue from Company-owned Learning Centers increased by $1.2 million, or 40%,
to $4.0 million during the second quarter of 1996 and by $2.1 million, or 39%,
to $7.4 million during the first six months of 1996 compared to the comparable
periods in 1995. Revenue growth related to student enrollment increases for
Centers operating over 12 months as of June 30, 1996 resulted in $815,000, or
28%, of the increase for the quarter ended June 30, 1996, and $1.5 million, or
28%, of the increase for the first six months of 1996 compared to the comparable
1995 periods. The opening of three new Centers after June 30, 1995 resulted in
an additional $339,000 of revenue during the second quarter of 1996 and $574,000
during the first six months of 1996. Product sales in the second quarter of 1996
were comparable to the second quarter of 1995 and increased $222,000, or 13% to
$2.0 million in the first six months of 1996 compared to the same period in 1995
due to overall student enrollment increases at franchised Centers.
Testing services revenue increased by $17.5 million, or 305%, to $23.3 million
during the second quarter of 1996, and increased by $30 million, or 273%, to
$41 million for the first six months of 1996, compared to the comparable periods
in 1995. The significant increase in testing services revenues resulted
primarily from the acquisition of Drake which provided increased revenues from
Information Technology (IT) clients. Increased services under the cost-plus
Educational Testing Service (ETS) international contract and the implementation
of a management contract with the National Association of Securities Dealers,
Inc. (NASD) also contributed to the increase in testing services revenues.
Effective March 1, 1996, the Company entered into a management contract with the
NASD to operate their testing centers delivering computer-based testing to
securities brokers and dealers. The management contract continues through August
30, 1996 at which time most NASD testing centers could be closed if it is cost
beneficial. The company has a 10 year contract to provide testing for the NASD.
Contract educational services revenue increased by $1.7 million, or 25%, to
$8.3 million for the quarter ended June 30, 1996, and by $5.3 million, or 42%,
to $17.8 million for the six months ended June 30, 1996 compared to the
comparable 1995 periods. Revenue from public and non-public school contracts
increased by $1.9 million for the quarter ended June 30, 1996, and by
$4.1 million for the six months ended June 30, 1996. Revenue from PACE contracts
decreased by $208,000 for the quarter ended June 30, 1996, and increased by
$1.2 million for the six months ended June 30, 1996. The PACE increase for the
six months ended June 30, 1996 results from the fact that the acquisition,
accounted for as a purchase, was effective February 28, 1995.
Revenue from existing public and non-public school contracts decreased by
$400,000 for the quarter ended June 30, 1996, and decreased by $800,000 for the
six months ended June 30, 1996 due to reduced funding levels on certain
contracts. Revenue from public and non-public school contracts
12
<PAGE>
obtained after June 30, 1995 contributed $2.3 million to revenue for the quarter
ended June 30, 1996, and $4.9 million for the six months ended June 30, 1996.
The increased revenue from new public and non-public school contracts is
primarily due to contracts with 15 new schools in Baltimore City, 10 schools in
Chicago, Illinois, and five schools in St. Paul, Minnesota.
Cost and Expenses. Company-owned Learning Center expenses increased by $768,000,
to $3.3 million, or 82% of total Company-owned Learning Center services revenue
in the second quarter of 1996, compared to $2.5 million, or 88% of total
Company-owned Learning Center services revenue in the second quarter of 1995.
Company-owned Learning Center expenses increased by $1.5 million, to
$6.3 million, or 85% of total Company-owned Learning Center services revenue for
the six months ended June 30, 1996, compared to $4.8 million, or 89% of total
Company-owned Learning Center services revenue for the six months ended June 30,
1995. The increased expenses were primarily advertising and labor associated
with increased center enrollment. Expenses for Centers operating over 12 months
as of June 30, 1996 accounted for $460,000 of the increase for the second
quarter of 1996, and represent 56% of incremental same Center revenue. Expenses
for Centers operating over 12 months as of June 30, 1996 accounted for $986,000
of the increase for the first six months of 1996, and represent 66% of
incremental same Center revenue. The opening of three new Company-owned Learning
Centers since June 30, 1995 increased expenses by $308,000, or 91% of the
revenue of those Centers for the second quarter of 1996, and by $560,000, or 98%
of the revenue of those Centers for the first six months of 1996.
Testing services expenses for the second quarter of 1996 increased by $15
million to $19.4 million, or 83% of total testing services revenue, compared to
$4.4 million, or 77% of total testing services revenue for the second quarter of
1995. Testing services expense for the first six months of 1996 increased by
$25.5 million to $34.5 million, or 84% of total testing services revenue,
compared to $9 million, or 82% of total testing services revenue for the same
period in 1995. The increase resulted primarily from the acquisition of Drake
and the increased registration and delivery costs associated with additional
volume of tests. The increase in testing services expense as a percentage of
revenues was primarily a result of high margin development revenues from the
Armed Services Vocational Aptitude Battery (ASVAB) beta test which decreased the
percentage of delivery cost to revenue in 1995. The percentage of expenses to
revenue adjusted for the ASVAB development revenue would have been 88% for both
the second quarter and six months ended June 30, 1995.
Contract educational services expense increased by $1.3 million to $7.0
million, or 84%, of contract educational services revenue for the quarter ended
June 30, 1996, compared to $5.7 million, or 86%, of contract educational
services revenue for the second quarter of 1995, and increased by $4.4 million
to $15.3 million, or 86%, of contract educational services revenue during the
six months ended June 30, 1996, compared to $10.9 million, or 87%, of contract
educational services revenue during the first six months of 1995. Operating
expenses for public and non-public school contracts increased by $1.5 million,
or 79% of the related revenue increase for the quarter ended June 30, 1996, and
by $3.3 million, or 79% of the related revenue increase for the six months ended
June 30, 1996. Operating expenses for PACE decreased by $192,000, or 92% of the
related revenue decrease for the quarter ended June 30, 1996 and increased by
$1.1 million, or 95% of the related revenue increase for the six months ended
June 30, 1996. The PACE increase for the six months ended June 30, 1996
13
<PAGE>
results from the fact that the acquisition, accounted for as a purchase, was
effective February 28, 1995.
General and administrative expenses increased by $1.4 million to $4.7 million
during the second quarter of 1996 compared to the second quarter of 1995, but
decreased as a percentage of revenue from 17% to 12%; general and administrative
expenses increased by $2.8 million to $9.0 million during the first six months
of 1996, compared to the same period in 1995, but decreased as a percentage of
revenue from 17% to 12%. These percentage declines resulted from increased
revenues primarily from franchise royalties, testing services, and contract and
Company-owned Learning Center services without corresponding increases in
administrative staff salaries and expenses.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $6.7 million for the six months
ended June 30, 1996 as compared to cash used in operating activities of
$1.5 million in the comparable period of 1995. Cash flow from operations before
working capital changes increased from $5.8 million in the 1995 period to
$10.5 million in the 1996 period, primarily as a result of significant earnings
from Company operations. The $5.0 million of cash used due to the increase in
accounts and notes receivable was substantially offset by the $3.6 million of
cash provided by the increase in accounts payable and accrued expenses, and
deferred revenue. These increases resulted primarily from the significant growth
of the testing division, including the effects of the Drake acquisition.
During the first six months of 1996, the Company sold a net of $12.1 million
of available-for-sale securities. The Company used cash to pay off the
outstanding line of credit borrowings of $3.5 million, to purchase $2.9 million
of property and equipment, and to acquire certain contract rights and other
assets of $4.8 million as described below.
The Company continues to incur expenditures for additions to property and
equipment, which totaled $2.9 million in the second quarter of 1996. These
additions primarily consisted of furniture and equipment for general business
expansion, including expenditures for new public and non-public school
classrooms and equipment needed for overseas testing centers operated by the
Company. Under the international testing contract with ETS, the Company is
reimbursed for overseas equipment expenditures as the equipment is depreciated.
This reimbursement includes a financing charge over the reimbursement period.
The Company may spend up to $2 million over the next 15 months to develop
licensing and certification tests under contracts with various testing
organizations.
The Company paid the NASD $4.8 million in early April 1996 pursuant to an
asset transfer agreement related to the management of the NASD testing centers
and the acquisition of contract rights to provide testing based on a ten year
contract with the NASD. The assets transferred by the NASD consisted mainly of
computer equipment in the NASD testing centers.
During the six months ended June 30, 1996, the Company paid $4.2 million in
contract termination fees to certain Drake Authorized Testing Centers that had
contracts to provide computer
14
<PAGE>
based testing delivery. These cancellation costs were recorded as additional
costs related to the Drake acquisition and are being amortized over the
remaining amortization period.
The Company has entered into a loan agreement with a bank, hereinafter the
"credit line" that provides an unsecured revolving line of credit. The credit
line allows the Company to borrow a maximum of $15 million on a revolving basis
through May 31, 1998, with the option to repay any balance at that date over two
years through May 31, 2000. There were no outstanding borrowings under the
credit line at June 30, 1996. The credit line bears interest at a floating rate
equal to the 30 day London Interbank Offered Rate ("LIBOR") plus 1.15% per
annum.
During the six months ended June 30, 1996, the Company received $2.1 million
of cash as a result of the exercise of stock options and warrants to purchase
258,266 shares of Common Stock.
The Company believes that its capital resources will be sufficient on a
short-term basis and over the next 24 months to fund the continued expansion of
the business, including working capital needs and expected investments in
property and equipment.
CONTINGENT MATTERS
During 1993, the Company committed to purchase and license instructional
learning system software from a company (the "Seller") to be used in the
Company's contract education sites and to be sold to its franchised Sylvan
Learning Centers. The agreement requires the acquisition of a minimum of
$4.0 million of courseware in CD ROM format. As of June 30, 1996, the Company
had paid for and accepted delivery of $3.0 million in courseware. Prior to
August 31, 1996, the Company is required to place a minimum order of
$1.0 million. As stipulated in the contract, management currently intends to
offset the commitment for future orders against certain obligations the Seller
may have to the Company as described below. In 1993 the Company purchased from
the Seller the rights to certain testing contracts and agreed to pay the Seller
a royalty equal to 27% of the excess contract revenues earned through August 31,
1997 over $7.4 million. Conversely, the Seller agreed to pay the Company a
reverse royalty equal to 27% of any revenue deficiency below $7.4 million
through August 31, 1997. An installment payment of no more than $1 million is
payable by the Seller in October 1996 to the Company under the reverse royalty
agreement in the event that revenues are less than $5.5 million through August
31, 1996, with any remaining amount due in October 1997 based on the August 31,
1997 calculation, however the total reverse royalty can not exceed $2.0 million.
The Company expects, based on the amount of revenue earned on these contracts
through June 30, 1996 and projections of additional revenues through August 31,
1996, that the Seller will owe the Company approximately $1 million in October
1996. No amounts have been recorded related to the royalty arrangement at June
30, 1996.
In connection with the PACE acquisition, the Company will be required to make
a contingent payment equal to 6.5 times PACE's 1997 earnings before interest and
income taxes ("EBIT"). If PACE's EBIT is less than $2.7 million for 1997, the
PACE shareholders may elect to have the payment calculation based on EBIT for
either calendar year 1998 or 1999. The contingent payment is payable partially
in cash and partially in Common Stock. The amount of any contingent payment to
the PACE Stockholders will be capitalized as goodwill when paid and amortized
over the
15
<PAGE>
remaining estimated recovery period. PACE is expected to meet its cash needs
from its operations. PACE provides most of its services to large corporations
with favorable credit histories. PACE operations are not capital intensive and
historically PACE has generated positive cash flow from operations.
The agreement with Drake provides for future contingent payments based on the
achievement of certain specified revenue targets between 1997 and 1998 (or 1999
at election of the Sellers). The contingent payments of up to $40 million, if
earned, are payable 12.5% in cash (or more at the discretion of the Company)
with the remainder in shares of Common Stock. The amount of any contingent
payments will be capitalized as goodwill when paid and amortized over the
remaining estimated recovery period.
QUARTERLY FLUCTUATIONS
The Company's revenues and operating results have varied substantially from
quarter to quarter and may continue to vary, depending upon the timing of
implementation of new computer-based testing contracts and contracts funded
under the public and non-public school programs or similar programs. Based on
the Company's limited experience, revenue generated by computer based testing
services may vary based on the frequency or timing of delivery of individual
tests and the speed of test administrators' conversion of tests to
computer-based format. Revenue or profits in any period will not necessarily be
indicative of results in subsequent periods.
16
<PAGE>
PART II -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(A) REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the three months
ended June 30, 1996.
SIGNATURES
- ----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on behalf by the undersigned
thereunto duly authorized.
Sylvan Learning Systems, Inc.
Date: August 12, 1996 /s/B. Lee McGee
-----------------------
B. Lee McGee, Vice President
and Chief Financial Officer
17
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<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
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<SECURITIES> 18,225,370
<RECEIVABLES> 33,905,330
<ALLOWANCES> 1,528,938
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