<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported):
July 15, 1997
----------------------------
SYLVAN LEARNING SYSTEMS, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Maryland 0-22844 52-1492296
-------- ---------------------- --------------------
(State of Incorporation) (Commission File Number) (IRS Employer Identification
Number)
1000 Lancaster Street
Baltimore, Maryland 21202
--------------------------------------------------
(Address of principal executive offices) (Zip Code)
(410) 843-8000
--------------
(Registrant's telephone number)
<PAGE>
Item 5. Other Events.
The supplemental consolidated financial statements of Sylvan Learning Systems,
Inc. ("the Company") attached hereto as Exhibits for each of the three years in
the period ended December 31, 1996 and for the quarters ended March 31, 1997 and
1996 have been restated to give retroactive effect to the Company's merger with
I-R, Inc. and Independent Child Study Teams, Inc. (collectively, "Educational
Inroads") on May 30, 1997. The merger was accounted for by the Company as a
pooling-of-interests and, accordingly, the Company's financial statements and
schedule have been restated for all periods prior to the merger to include the
results of operations, financial position and cash flows of Educational Inroads.
As of the date of this report, the Company has not issued financial statements
for a period including the merger date and, therefore, the financial statements
are considered "supplemental." Upon the issuance of financial statements for a
period that includes the date of the merger, the supplemental consolidated
financial statements and schedule will become the historical consolidated
financial statements and schedule of the Company.
Also attached hereto as Exhibits are revised Management's Discussion and
Analysis of Financial Condition and Results of Operations based on the
supplemental consolidated financial statements described above.
SELECTED SUPPLEMENTAL CONSOLIDATED FINANCIAL DATA(1)
<TABLE>
<CAPTION>
PARTNERSHIP
AND SYLVAN
PARTNERSHIP COMBINED SYLVAN
------------ ------------ ---------------------------------------------
YEAR ENDED YEAR ENDED YEAR ENDED THREE MONTHS
DECEMBER 31, DECEMBER 31, DECEMBER 31, ENDED MARCH 31,
------------ ------------ --------------------------- ----------------
1992 1993 1994 1995 1996 1996 1997
------------ ------------ ------- -------- -------- ------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
DATA:
Revenues................ $33,821 $51,519 $68,748 $111,059 $181,936 $41,506 $51,944
Cost and expenses:
Direct costs .......... 28,840 44,056 60,388 96,708 150,449 36,423 43,630
General and
administrative
expense(2)............ 5,433 6,255 4,998 6,206 8,755 2,069 2,961
Loss on impairment of
assets................ -- -- -- 3,316 -- -- --
------- ------- ------- -------- -------- ------- -------
Total expenses......... 34,273 50,311 65,386 106,230 159,204 38,492 46,591
------- ------- ------- -------- -------- ------- -------
Operating income
(loss)................. (452) 1,208 3,362 4,829 22,732 3,014 5,353
Non-operating income
(expense).............. 1 (116) 224 391 363 92 (128)
Interest income
(expense), net......... (594) (1,290) (62) (1,440) 551 142 480
------- ------- ------- -------- -------- ------- -------
Income (loss) from
continuing operations
before income taxes and
extraordinary items.... (1,045) (198) 3,524 3,780 23,646 3,248 5,705
Income taxes............ (16) (7) (76) (209) (8,850) (1,469) (2,258)
------- ------- ------- -------- -------- ------- -------
Income (loss) from
continuing operations
before extraordinary
items.................. (1,061) (205) 3,448 3,571 14,796 1,779 3,447
Discontinued
operations(3):
Loss from operations,
net of tax............ (1,700) (375) -- -- -- -- --
Gain on disposal....... 427 580 -- -- -- -- --
------- ------- ------- -------- -------- ------- -------
Income (loss) from
discontinued
operations............ (1,273) 205 -- -- -- -- --
------- ------- ------- -------- -------- ------- -------
Net income (loss) before
extraordinary items.... (2,334) -- 3,448 3,571 14,796 1,779 3,447
Extraordinary items(4).. -- (177) -- -- -- -- --
------- ------- ------- -------- -------- ------- -------
Net income (loss)(6)... $(2,334) $ (177) $ 3,448 $ 3,571 $ 14,796 $ 1,779 $ 3,447
======= ======= ======= ======== ======== ======= =======
Net income (loss) from
continuing operations
per share(5)........... $ (0.02) $ 0.21 $ 0.21 $ 0.59 $ 0.07 $ 0.12
======= ======= ======== ======== ======= =======
Net income (loss) per
share(5)(6)............ $ (0.01) $ 0.21 $ 0.21 $ 0.59 $ 0.07 $ 0.12
======= ======= ======== ======== ======= =======
Weighted average shares
outstanding(5)......... 12,967 16,533 17,386 24,996 24,901 27,207
======= ======= ======== ======== ======= =======
BALANCE SHEET DATA (AT
PERIOD END):
Cash and cash
equivalents............ $ 673 $11,499 $ 4,366 $ 2,903 $ 11,198 $ 4,272 $12,789
Available-for-sale
securities............. 127 1,248 2,537 30,735 16,449 22,725 10,730
Net working capital
(deficit).............. (3,302) 12,665 13,166 39,407 29,603 44,580 40,228
Intangible assets and
deferred contract
costs.................. 149 7,000 7,932 82,849 122,932 81,173 120,948
Total assets............ 18,446 42,003 50,046 174,070 259,590 174,200 260,380
Long-term debt and
capital leases......... 5,578 6,640 9,814 9,854 32,228 10,519 22,524
Stockholders' or
partners' equity....... 326 24,563 32,481 137,148 180,323 141,206 201,880
</TABLE>
- -------
(1) Prior to February 1, 1991, the Sylvan Learning Centers business was
conducted by Sylvan Learning Corporation (the "Predecessor"). On February
1, 1991, the Predecessor contributed the Sylvan Learning Centers business
to Sylvan KEE Systems, a Maryland general partnership (the "Partnership")
in exchange for a 50% partnership interest, and Sylvan contributed its
computer training software development business to the Partnership in
exchange for the other 50% partnership interest. On January 26, 1993,
Sylvan acquired the Predecessor and dissolved the Partnership. On
September 3, 1993, Sylvan sold its computer training software development
business.
During 1994, Sylvan acquired by mergers all of the outstanding stock of
Learning Services, Inc. ("LSI") and Loralex Corporation ("Loralex"). These
companies owned and operated a total of nine Sylvan Learning Centers located
in the Northeast United States and Florida. On February 17, 1995, Sylvan
acquired by merger all of the outstanding stock of Remedial Education and
Diagnostic Services, Inc. and READS, Inc. (collectively, "READS"), a
Philadelphia-based provider of remedial, education and a variety of
consulting services to school districts, county-wide educational agencies
and municipalities in the Eastern United States. The READS, Loralex and LSI
acquisitions have been accounted for by Sylvan as poolings-of-interests and,
accordingly, Sylvan's financial statements have been restated for all
periods presented to include the results of operations of READS, Loralex and
LSI.
Effective September 30, 1995 Sylvan acquired Drake Prometric, L.P.
("Drake"), a leading provider of computer-based certification, licensure and
assessment testing. The transaction was accounted for using the purchase
method of accounting, and Sylvan's results of operations from October 1,
1995 include the operations of Drake.
Effective December 1, 1996, Sylvan acquired Wall Street, a European-based
franchisor and operator of learning centers that teach the English language.
This transaction was accounted for using the purchase method of accounting
and Sylvan's results of operations from December 1, 1996 include the
operations of Wall Street. Sylvan paid $4.9 million of the $20.1 million
purchase price in cash and the remainder in 714,884 shares of Common Stock.
On May 30, 1997, the Company consummated its acquisition by merger of all of
the outstanding common stock of Educational Inroads. Educational Inroads
provided contract educational services to school districts in New Jersey and
several other states. The Educational Inroads acquisition has been accounted
for by Sylvan as a pooling-of-interests and, accordingly, Sylvan's financial
statements have been restated for all periods prior to the acquisition to
include the results of operations of Educational Inroads. Educational
Inroads generated revenues of $24.8 million in 1996. As of the date of this
Prospectus, the Company has not issued financial statements for a period
including the date the Educational Inroads acquisition was consummated, and,
until that time, these restated financial statements are considered
"supplemental." Upon the issuance of financial statements for a period that
includes the consummation date of the Educational Inroads acquisition, the
supplemental consolidated financial statements will become the historical
consolidated financial statements of the Company.
(2) The Company has reclassified certain operating expenses previously
included in general and administrative expense to direct costs. This
change has been reflected for all periods presented.
(3) Represents Sylvan's computer training software development business which
was sold in September 1993 and a Canadian computer training business,
80.1% of which was sold in 1992.
(4) Represents the $350,000 gain on extinguishment of a $3.5 million debt to
Learning Centers, Inc., and a $527,000 loss on an extinguishment of $5.0
million of notes payable to stockholders, each recorded in 1993.
(5) All share and per share data have been restated to retroactively reflect a
3-for-2 stock split of the Company's common stock for stockholders of
record on November 7, 1996.
(6) Reducing compensation expense relating to Educational Inroads stockholders
to reflect their post-acquisition contractual compensation levels and
eliminating non-recurring acquisition transaction costs would result in
supplemental pro forma net income and net income per share of $16,266,000
and $0.65, respectively, in 1996 and $4,017,000 and $0.14, respectively in
the first quarter of 1997.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
(c) 23.01 Consent of Ernst & Young LLP
(d) 99.1 Management's Discussion and Analysis of Financial Condition
and Results of Operations for the Quarters Ended March 31,
1996 and March 31, 1997 and for the Years Ended December 31,
1994, 1995 and 1996
99.2 Supplemental Consolidated Financial Statements and Schedule
for each of the three years in the period ended December 31,
1996 (audited)
99.3 Supplemental Consolidated Financial Statements for the three
months ended March 31, 1996 and March 31, 1997 (unaudited)
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: July 14, 1997 SYLVAN LEARNING SYSTEMS, INC.
By: /s/ B. Lee McGee
-------------------------------
B. Lee McGee, Vice President
and Chief Financial Officer
<PAGE>
Exhibit 23.01
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the following Registration
Statements of our report dated July 10, 1997, with respect to the supplemental
consolidated financial statements and schedule of Sylvan Learning Systems, Inc.
included in the Current Report on Form 8-K dated on or about July 14, 1997.
Registration Statements on Form S-3
<TABLE>
<CAPTION>
Registration Number Date Filed
- ----------------------------------------------------
<S> <C>
33-92014 May 8, 1995
33-92852 May 30, 1995
333-1674 February 26, 1996
333-16111 November 14, 1996
333-21261 February 6, 1997
333-26633 May 7, 1997
</TABLE>
Registration Statements on Form S-8
<TABLE>
<CAPTION>
Name Registration Number Date Filed
- ------------------------------------------------------------------------------
<S> <C> <C>
1987-1991 Employee Stock
Option Plan 33-77384 April 6, 1994
1993 Director Stock
Option Plan 33-77386 April 6, 1994
1993 Employee Stock
Option Plan 33-77390 April 6, 1994
1993 Management Stock
Option Plan 33-77388 April 6, 1994
1997 Employee Stock
Purchase Plan 333-21963 February 18, 1997
</TABLE>
/s/ ERNST & YOUNG LLP
Baltimore, Maryland
July 10, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 11,198,106
<SECURITIES> 16,448,759
<RECEIVABLES> 43,004,037
<ALLOWANCES> (1,378,854)
<INVENTORY> 4,469,577
<CURRENT-ASSETS> 77,485,980
<PP&E> 43,495,994
<DEPRECIATION> (15,577,693)
<TOTAL-ASSETS> 259,589,521
<CURRENT-LIABILITIES> 47,883,047
<BONDS> 0
0
0
<COMMON> 239,802
<OTHER-SE> 180,082,791
<TOTAL-LIABILITY-AND-EQUITY> 259,589,521
<SALES> 181,935,961
<TOTAL-REVENUES> 181,935,961
<CGS> 0
<TOTAL-COSTS> 159,203,953
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,071,323
<INCOME-PRETAX> 23,646,321
<INCOME-TAX> (8,850,000)
<INCOME-CONTINUING> 14,796,321
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,796,321
<EPS-PRIMARY> 0.60
<EPS-DILUTED> 0.59
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 12,789
<SECURITIES> 10,730
<RECEIVABLES> 45,678
<ALLOWANCES> (1,339)
<INVENTORY> 4,441
<CURRENT-ASSETS> 76,922
<PP&E> 46,005
<DEPRECIATION> (17,438)
<TOTAL-ASSETS> 260,380
<CURRENT-LIABILITIES> 36,694
<BONDS> 0
0
0
<COMMON> 250
<OTHER-SE> 201,630
<TOTAL-LIABILITY-AND-EQUITY> 260,380
<SALES> 51,944
<TOTAL-REVENUES> 51,944
<CGS> 0
<TOTAL-COSTS> 46,591
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 209
<INCOME-PRETAX> 5,705
<INCOME-TAX> (2,258)
<INCOME-CONTINUING> 3,447
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,447
<EPS-PRIMARY> 0.12
<EPS-DILUTED> 0.12
</TABLE>
<PAGE>
EXHIBIT 99.1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION FOR THE THREE MONTHS ENDED MARCH 31, 1996 AND MARCH 31, 1997 AND FOR
THE THREE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996.
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, the Company's contingent payment
obligations relating to the PACE and Drake acquisitions, future capital
requirements, potential acquisitions 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, 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 discussion and analysis below is based on the Company's Supplemental
Consolidated Financial Statements and related Notes thereto included herein.
OVERVIEW
Sylvan generates revenues from three business segments: core educational
services which primarily consist of franchise sales, royalties and Sylvan-
owned Learning Center revenues; testing services, which consist of computer-
based testing fees paid to Sylvan; and contract educational services, which
consist of revenues attributable to providing supplemental and remedial
education services to public and non-public schools and major corporations.
The following selected supplemental segment data for the years ended December
31, 1994, 1995 and 1996 is derived from the Company's audited supplemental
consolidated financial statements.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
------------------------- ---------------
1994 1995 1996 1996 1997
------- -------- -------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Operating revenue:
Core educational services........... $20,016 $ 26,063 $ 36,799 $ 7,213 $ 9,231
Contract educational services....... 35,067 50,430 58,186 16,493 17,574
Testing services.................... 13,665 34,566 86,951 17,800 25,139
------- -------- -------- ------- -------
Total revenue..................... $68,748 $111,059 $181,936 $41,506 $51,944
======= ======== ======== ======= =======
Direct costs:
Core educational services........... $13,255 $ 18,675 $ 25,557 $ 5,605 $ 6,829
Contract educational services....... 33,108 47,685 53,373 15,331 16,168
Testing services.................... 14,025 30,348 71,519 15,487 20,633
------- -------- -------- ------- -------
Total direct costs................ $60,388 $ 96,708 $150,449 $36,423 $43,630
======= ======== ======== ======= =======
</TABLE>
RESULTS OF OPERATIONS
Comparison of results for the quarter ended March 31, 1997 and the quarter
ended March 31, 1996.
Revenue. Total revenues increased 25%, from $41.5 million in the first
quarter of 1996 to $51.9 million in the first quarter of 1997. This increase
resulted from higher revenues in all business segments -- core educational
services, testing services and contract educational services.
<PAGE>
Core educational services revenues increased 28%, from $7.2 million in the
first quarter of 1996 to $9.2 million in the first quarter of 1997. Franchise
royalties increased $0.5 million or 19%, to $3.0 million in the first quarter
of 1997 compared to the same period in 1996. This increase in franchise
royalties was due to the net increase of 18 Learning Centers opened in new
territories and three Learning Centers opened in existing franchise
territories in the first quarter of 1997, combined with an overall 14%
increase in revenues at existing Learning Centers open for more than one year
as of March 31, 1997. Franchise sales fees increased to $0.7 million in the
first quarter of 1997 compared to $0.2 million in the same period in 1996. In
the first quarter of 1997, five franchise Learning Center licenses and a $0.5
million area development agreement were sold, compared to six franchise
Learning Center licenses sold in the first quarter of 1996. The ability of
Sylvan to generate fees in the future from the sale of area development
agreements or franchise Learning Center licences cannot be assured.
Revenues from Company-owned Learning Centers increased 44%, from $3.4
million in the first quarter of 1996 to $4.9 million in the first quarter of
1997. Of the increase, $0.9 million resulted from the acquisition of 11
Learning Centers from two franchisees during the fourth quarter of 1996.
Revenue growth related to student enrollment increases at Learning Centers
operating more than one year as of March 31, 1997 resulted in $0.6 million of
the increase.
Contract educational services revenues increased 7%, from $16.5 million in
the first quarter of 1996 to $17.6 million in the first quarter of 1997. This
was due to both greater volumes of training and increases in the number of
public and non-public school contracts.
Testing services revenues increased 41%, from $17.8 million in the first
quarter of 1996 to $25.1 million in the first quarter of 1997. The increase
resulted primarily from the Company's acquisition of Wall Street during the
fourth quarter of 1996, increased volumes from IT, professional licensure and
certification clients and increased services under the ETS contracts.
Cost and Expenses. Total direct costs increased 20%, from $36.4 million in
the first quarter of 1996 to $43.6 million in the first quarter of 1997 but
decreased as a percentage of total revenues from 88% in the first quarter of
1996 to 84% in the first quarter of 1997. Core educational services expense
increased 22% from $5.6 million to $6.8 million in the first quarter of 1997.
Company-owned Learning Center services expense increased 41% from $3.0 million
in the first quarter of 1996 to $4.3 million in the first quarter of 1997 but
decreased as a percentage of Company-owned Learning Center services revenue
from 90% in the first quarter of 1996 to 88% in the first quarter of 1997.
$1.1 million of the increase related to the acquisition of 11 Learning Centers
from two franchisees. The remaining increase in expenses was primarily for
advertising, labor and other Learning Center expenses associated with
increased enrollment. Expenses for Learning Centers operating more than one
year as of March 31, 1997 accounted for $0.2 million of the increase and
represented 38% of incremental same-Learning Center revenue.
Contract educational services expense increased 5%, from $15.3 million in
the first quarter of 1996 to $16.2 million in the first quarter of 1997 but
decreased as a percentage of contract educational services revenues from 93%
in the first quarter of 1996 to 92% in the first quarter of 1997. Operating
expenses for PACE accounted for $0.3 million of this increase.
Testing services expense increased 33%, from $15.5 million in the first
quarter of 1996 to $20.6 million in the first quarter of 1997 but decreased as
a percentage of testing services revenues from 87% in the first quarter of
1996 to 82% in the first quarter of 1997. The expense in the first quarter of
1996 included $1.2 million of non-recurring charges related to the Drake
acquisition. Therefore, recurring expenses in the first quarter of 1996 were
80% of testing services revenues for that period. The increase in recurring
testing services expense as a percentage of testing services revenues was
primarily a result of increased salary and other operating costs resulting
from the integration of test delivery systems and growth in business that
occurred after the first quarter of 1996 and expected growth in business
volumes in 1997.
<PAGE>
General and administrative expense increased 43%, from $2.1 million in the
first quarter of 1996 to $3.0 million in the first quarter of 1997 and
increased as a percentage of total revenues from 5% in the first quarter of
1996 to 6% in the first quarter of 1997. The increase resulted from increases
in administrative staff salaries and expenses as well as increases in rent
expense related to the Company's new headquarters.
The Company's effective tax rate decreased from 45% in the first quarter of
1996 to 40% in the first quarter of 1997 mainly because a greater portion of
the Company's earnings were generated in foreign jurisdictions having lower
tax rates than the United States.
Comparison of results for the year ended December 31, 1996 to the year ended
December 31, 1995.
Revenues. Total revenues increased 64%, from $111.1 million in 1995 to
$181.9 million in 1996. This increase resulted from greater revenues in all
business segments--core educational services, testing services and contract
educational services.
Core educational services revenues increased 41%, from $26.1 million in 1995
to $36.8 million in 1996. Franchise royalties increased 21%, from $9.2 million
in 1995 to $11.2 million in 1996. This increase in franchise royalties was due
to an overall 19% increase in revenues at Learning Centers that had been
operating for more than one year as of December 31, 1996 combined with a net
increase of 49 Learning Centers opened during 1996.
Franchise sales fees increased 49%, from $2.1 million in 1995 to $3.2
million in 1996. During 1996, there were four area development agreements sold
for $1.7 million and 38 franchise Learning Center licenses sold, compared to
two area development agreements sold for $550,000 and 43 Learning Center
licenses sold during 1995.
Revenues from Company-owned Learning Centers increased 61%, from $11.5
million in 1995 to $18.5 million in 1996. Revenue growth related to increased
student enrollment at Learning Centers that had been operating for more than
one year as of December 31, 1996 resulted in $3.4 million, or 30%, of the
increase from 1995 to 1996. Approximately $3.2 million of the revenue increase
resulted from the acquisition of 11 Learning Centers from two franchisees. The
opening of one new Learning Center during 1996 resulted in an additional
$350,000 of revenues during 1996. Product sales increased 23%, from $3.2
million in 1995 to $3.9 million in 1996. This increase resulted from overall
student enrollment increases at franchised Learning Centers.
Contract educational services revenues increased 15%, from $50.4 million in
1995 to $58.2 million in 1996. Revenues from public and non-public school
contracts accounted for $5.9 million of the increase, and greater revenues
from PACE accounted for $1.9 million of the increase. The PACE increase
primarily resulted from the fact that the acquisition, accounted for as a
purchase, was effective February 28, 1995, and as such the 1995 revenues of
Sylvan only reflect ten months of PACE revenues.
Revenues from public and non-public school contracts executed during 1996
contributed $2.2 million to 1996 revenues. Revenues from public and non-public
school contracts executed during 1995 increased by $4.6 million in 1996,
primarily because a full year of revenues were generated under these contracts
during 1996.
Testing services revenues increased 152%, from $34.6 million in 1995 to
$87.0 million in 1996. The significant increase in testing services revenues
resulted primarily from the September 1995 acquisition of Drake, which
provided increased revenues from IT clients. Increased services under ETS
contracts, including the cost-plus international contract and the Graduate
Record Exam (the "GRE"), and other professional testing revenue increases,
including NASD testing, which began in February 1996, also contributed to the
increase in testing services revenues.
<PAGE>
Cost and Expenses. Total direct costs increased 56%, from $96.7 million in
1995 to $150.4 million in 1996 but decreased as a percentage of total revenues
from 87% in 1995 to 83% in 1996. Core educational services expense increased
37% from $18.7 million in 1995 to $25.6 million in 1996. Franchise services
expense increased 11%, from $5.9 million in 1995 to $6.5 million in 1996 but
decreased as a percentage of franchise royalties and sales revenues from 52%
in 1995 to 46% in 1996. The increased margin in 1996 primarily related to the
effects of leveraging the fixed costs of supporting this line of business over
a larger revenue base. Company-owned Learning Center expense increased 55%,
from $10.4 million in 1995 to $16.1 million in 1996 but decreased as a
percentage of Company-owned Learning Center services revenues from 90% in 1995
to 87% in 1996. Of the increase, $3.1 million related to the acquisition of 11
Learning Centers. The remaining increase primarily resulted from advertising,
labor and general overhead associated with increased enrollment at Learning
Centers that had been operating prior to 1996.
Contract educational services expense increased 12%, from $47.7 million in
1995 to $53.4 million in 1996 but decreased as a percentage of contract
educational services revenues from 95% in 1995 to 92% in 1996. The decline in
these expenses as a percentage of contract educational services revenues
resulted from increased revenues without corresponding increases in overhead.
Operating expenses for public and non-public school contracts increased $4.6
million during 1996, while operating expenses for PACE increased $1.1 million
during the same period. The PACE increase resulted from the fact that the
acquisition, accounted for as a purchase, was effective February 28, 1995, and
as such the 1995 results only reflect ten months of PACE results.
Testing services expense increased 136%, from $30.3 million in 1995 to $71.5
million in 1996 but decreased as a percentage of testing services revenue from
88% in 1995 to 82% in 1996. The increased expense resulted primarily from the
acquisition of Drake and the increased registration and delivery costs
associated with an increased volume of tests. Testing services expense in 1996
included $2.4 million of amortization of contract rights related to the Drake
acquisition. Testing services expense in 1995 included $4.1 million of
amortization of contract rights, imputed interest and salary termination
charges related to the Drake acquisition. Excluding non-recurring charges,
testing services expense, as a percentage of testing services revenues,
increased from 76% in 1995 to 79% in 1996. The principal reasons for this
percentage increase in 1996 are the full year of amortization of goodwill
associated with the Drake acquisition and increased staffing levels required
to meet the growth in business volumes that occurred during 1996 and expected
growth in business activity in 1997.
General and administrative expense increased 41%, from $6.2 million in 1995
to $8.8 million in 1996 but decreased as a percentage of total revenues from
6% in 1995 to 5% in 1996. The percentage decline resulted from increased
revenues from all segments without corresponding increases in overhead.
There was $1.4 million of net interest expense in 1995 and $0.6 million of
net interest income in 1996. This change resulted primarily from the $1.1
million of interest expense imputed on the purchase of Drake and an increase
in the average invested cash amounts in 1996 compared to 1995.
The Company's effective tax rate increased from 6% in 1995 to 37% in 1996.
This increase was primarily caused by a decrease in 1995 in the amount of the
valuation allowance for deferred tax assets, consisting principally of net
operating loss carryforwards.
Comparison of results for the year ended December 31, 1995 to the year ended
December 31, 1994.
Revenues. Total revenues increased 62%, from $68.7 million in 1994 to $111.1
million in 1995. This increase resulted from higher revenues in all business
segments--core educational services, testing services and contract educational
services.
<PAGE>
Core educational services revenues increased 30%, from $20.0 million in 1994
to $26.1 million in 1995. Franchise royalties increased $1.3 million, or 16%,
for 1995. This increase in franchise royalties was due to a net increase of 31
new Learning Centers in new territories and 15 new Learning Centers opened in
existing franchise territories) in 1995, combined with an overall 14% increase
in revenues at existing Learning Centers open for more than one year as of
December 31, 1995.
Franchise sales fees increased 70%, from $1.3 million in 1994 to $2.1
million in 1995. In 1995, there were two area development agreements sold for
$0.6 million and 43 franchise Learning Center licenses sold, as compared to 31
franchise Learning Center licenses and one $0.1 million area development
agreement sold in 1994.
Revenues from Company-owned Learning Centers increased 34%, from $8.6
million in 1994 to $11.5 million in 1995. The increase primarily resulted from
same-Learning Center revenue growth related to student enrollment increases.
Product sales increased $1.0 million or 43%, to $3.2 million for 1995.
Approximately $0.3 million of the increase in product sales was due to sales
of new versions of math and algebra programs (which began in the second half
of 1994) with the remainder resulting from overall increases in student
enrollment.
Contract educational services revenues increased 44%, from $35.1 million in
1994 to $50.4 million in 1995. Revenues from public and non-public school
contracts increased $7.0 million in 1995. This increase was due primarily to
$2.8 million in revenues from public and non-public school contracts obtained
during 1995 and by a $4.2 million increase in revenues from public and non-
public school contracts existing in 1994. Revenues from PACE, acquired
effective February 28, 1995, accounted for $8.4 million of the increase.
Testing services revenues increased 153%, from $13.7 million in 1994 to
$34.6 million in 1995. Revenues from Drake, acquired as of September 30, 1995,
accounted for $11.7 million of the increase and consisted primarily of
revenues from IT clients. Revenues from the ETS international contract
accounted for $3.7 million of the increase resulting primarily from the fact
that the contract was in effect during the entire 1995 period compared to six
months in 1994. During 1995, Sylvan sold the exclusive development rights for
testing centers in India for $0.5 million and in the Middle East for $0.5
million. The remaining increase in testing services revenues for 1995 was
attributable to a $1.7 million increase in revenues from the NCLEX test for
the licensing of registered and practical nurses, which began in April 1994,
$0.8 million of revenue from test development fees for ASVAB (the Armed
Services Vocational Aptitude Battery tests) and other test volume increases in
the GRE, PRAXIS and FAA tests.
Cost and Expenses. Total direct costs increased 60%, from $60.4 million in
1994 to $96.7 million in 1995 but decreased as a percentage of total revenues
from 88% in 1994 to 87% in 1995. Core educational services expense increased
41%, from $13.3 million in 1994 to $18.7 million in 1995. Franchise services
expense increased 53%, from $3.8 million in 1994 to $5.9 million in 1995 and
increased as a percentage of franchise royalties and sales revenues from 42%
in 1994 to 52% in 1995. The reduced margin in 1995 primarily relates to
increased marketing and advertising costs incurred to produce a new national
advertising campaign. Company-owned Learning Center expense increased 35%,
from $7.7 million in 1994 to $10.4 million in 1995 and increased as a
percentage of Company-owned Learning Center services revenues from 89% in 1994
to 90% in 1995. The increased expenses were primarily advertising, labor and
general overhead associated with increased Learning Center enrollment.
Contract educational services expense increased 44%, from $33.1 million in
1994 to $47.7 million in 1995 and increased as a percentage of contract
educational services revenues from 94% in 1994 to 95% in 1995. Operating
expenses for public and non-public school contracts increased $7.1 million
during 1995, while operating expenses for PACE accounted for $7.5 million of
the increase during the same period.
<PAGE>
The increase in contract educational services expense as a percent of related
revenues during 1995 resulted from the following factors: (i) 1994 included
consulting fee revenues of $0.5 million with no associated costs; and (ii)
higher total cost estimates relating to READs contracts.
Testing services expense increased 116%, from $14.0 million in 1994 to $30.3
million in 1995 but decreased as a percentage of total testing service
revenues from 103% in 1994 to 88% in 1995. The decrease in testing services
expense as a percentage of testing services revenues was attributable to
several factors, including the fixed and semi-variable nature of test delivery
and registration costs included in this segment. In addition, Sylvan
recognized $1.0 million of testing revenues in 1995 related to the sale of
exclusive development rights for testing centers in India and the Middle East
and $0.8 million of testing revenues related to the contract to develop the
ASVAB test. These revenues have significantly higher margins than fees for
test delivery and registration services.
Testing services expense during the fourth quarter of 1995 included
amortization expense of $2.1 million related to contract rights recorded upon
the acquisition of Drake and $1.1 million of non-recurring interest expense
imputed on the unpaid purchase price from September 30, 1995 to December 13,
1995, the closing date for the acquisition.
General and administrative expense increased 24%, from $5.0 million in 1994
to $6.2 million in 1995 but decreased as a percentage of total revenues from
7% in 1994 to 6% in 1995. The percentage decline resulted from increased
revenues from all segments without corresponding increases in overhead.
Interest expense of $1.4 million in 1995 was primarily attributable to $1.1
million of interest expense imputed on the purchase of Drake discussed above.
During 1995, Sylvan recorded a non-recurring loss on impairment of assets of
$3.3 million associated with the Drake acquisition. The Drake acquisition and
resulting consolidation of operations resulted in the determination that
certain assets in the Sylvan division were not recoverable and, therefore,
were written down to their realizable value.
During 1995, the Company reduced its valuation allowance relating to
deferred income tax assets by $3.1 million. Approximately $1.1 million of this
reduction was recorded through the allocation of the Drake purchase price. The
remaining decrease of $2.0 million reduced the Company's effective tax rate by
54%.
The Company's effective tax rate in 1995 and 1994 was substantially below
the U. S. statutory income tax rate of 34% due to the recognition of income
tax benefits from net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $0.4 million for the first quarter
of 1997 compared to $1.8 million used by operating activities in the first
quarter of 1996. Cash flow from operations before working capital changes
increased from $5.5 million in the first quarter of 1996 to $7.6 million in
the first quarter of 1997. This increase primarily resulted from significant
overall growth in income from operations before depreciation and amortization
and other non-cash charges. The Company's investment in working capital has
significantly reduced cash flows provided by operations, particularly as a
result of the growth in accounts and notes receivable and reductions in
accounts payable and accrued expenses. The increase in accounts receivable
related to a 25% increase in total revenues in the first quarter of 1997
compared to the first quarter of 1996. The Company expects this trend to
continue as its revenues increase. Of the $3.5 million operating cash flow
reduction attributable to an increase in accounts receivable, $2.4 million was
related to the ETS international testing contract and the remainder to higher
accounts receivable levels in all business segments. The increase in testing
services accounts receivable resulted from an
<PAGE>
increase in billings and longer collection periods under the international
testing contract. The Company experiences varying collection periods for
accounts receivable in its three operating divisions. The Company believes
that uncollectible accounts receivable will not have a significant effect on
future liquidity, as a significant portion of its accounts receivable are due
from enterprises with substantial financial resources and governmental units.
During the first quarter of 1997, the Company generated net proceeds of $6.2
million from the sale of available-for-sale securities. At March 31, 1997, the
Company's portfolio of available for-sale securities had a market value equal
to $10.7 million. The Company continues to incur expenditures for additions to
property and equipment, which totaled $2.5 million in the first quarter of
1997. These additions primarily consist of furniture and equipment for general
business expansion, including expenditures for new public and non-public
school classrooms and equipment needed for Testing Centers operated by the
Company. Under the international ETS testing contract, the Company is
reimbursed for overseas equipment expenditures as that equipment is
depreciated. This reimbursement includes a financing charge over the
reimbursement period.
The Company has a $15.0 million unsecured revolving line of credit which
either expires, or the outstanding balance of which can be converted into a
two year term loan, at the option of the Company on May 31, 1998. The credit
line and the term loan, when converted, both bear interest at a floating rate
equal to the 30 day London Interbank Offered Rate ("LIBOR") plus 1.15% per
annum (6.84% at March 31, 1997). At March 31, 1997, the balance on the credit
line was $7.2 million, and at June 30, 1997, there was no balance outstanding.
During the first quarter of 1997, the Company received $0.9 million as a
result of the exercise of stock options and warrants to purchase 298,608
shares of Common Stock.
During the first quarter of 1997, the Company paid $4.7 million of the $4.9
million cash portion of the Wall Street purchase price. Pursuant to the
Caliber Learning Network stockholders' agreement, Sylvan is obligated to lend
or guarantee up to $3.0 million of debt for Caliber and anticipates investing
up to an additional $8.0 million in Caliber over the next 12 to 24 months.
In March 1997, the Company and NEC executed a definitive agreement pursuant
to which Sylvan was to acquire NEC. In May 1997, NEC accepted the offer of
Harcourt General, Inc. to acquire all of the stock of NEC, resulting in the
termination of its agreement with the Company and the payment by NEC to the
Company of the $30.0 million termination fee required by that agreement. In
connection with the terminated acquisition, the Company incurred approximately
$1.5 million of direct expenses. Therefore, the termination fee resulted in a
$28.5 million net positive impact on the Company's cash resources in the
second quarter of 1997. Subsequent to receipt of the termination fee, Sylvan
invested $3.0 million in cash in a non profit corporation formed to fund the
Sylvan Prometric division marketing programs.
The Company believes that the remaining cash from the termination fee, the
net proceeds of this offering, and cash provided by operations and other
available financial resources will be sufficient on a short-term basis and
over the next 24 months to fund continued expansion of the business, including
working capital needs and expected investments in property and equipment.
CONTINGENT MATTERS
The PACE acquisition agreement requires Sylvan to make a contingent payment
equal to 6.5 times PACE's 1997 earnings before interest and income taxes
("EBIT"); or, if PACE's EBIT is less than $2.7 million in 1997, the PACE
shareholders may elect to have the payment calculation based on EBIT in either
1998 or 1999. Management believes it is likely that the PACE shareholders will
elect to calculate the contingent payment based on PACE's 1997 EBIT. The
contingent payment is payable partially in cash and partially in Common Stock.
The amount of any contingent payment to the PACE shareholders will be
<PAGE>
capitalized as goodwill when paid and amortized over the 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 have
generated positive cash flow from operations.
The Drake acquisition agreement provides for future contingent payments
based on achievement of certain specified revenue targets in 1997 and 1998 (or
1999 at election of the Drake owners). The contingent payment of up to $40.0
million, if earned, is payable at least 12.5% in cash, with the remainder in
shares of Common Stock. The amount of any contingent payment will be
capitalized as goodwill when paid and amortized over the remaining useful life
of the goodwill as estimated when the contingent payment is paid. Based on
testing services revenues generated in 1996, 357, 143 of the 1,785,714 shares
of Common Stock that were placed in escrow at the closing of the acquisition
have been earned and, accordingly, will be released in the third quarter of
1997. At December 31, 1996, $8.1 million of goodwill relating to the earned
shares was recorded and will be amortized over the 24-year remaining life of
the goodwill.
EFFECTS OF INFLATION
Inflation has not had a material effect on Sylvan's revenues and income from
continuing operations in the past three years. Inflation is not expected to
have a material future effect.
QUARTERLY FLUCTUATIONS
Sylvan'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 Title I or similar programs. Based on Sylvan's limited experience,
revenues 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. Revenues or
profits in any period will not necessarily be indicative of results in
subsequent periods.
<PAGE>
EXHIBIT 99.2
SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Auditors............................................................................................. 2
Supplemental Consolidated Balance Sheets as of December 31, 1995 and December 31, 1996..................................... 3
Supplemental Consolidated Statements of Income for the years ended December 31, 1994, 1995 and 1996........................ 5
Supplemental Consolidated Statements of Stockholders' Equity for the years ended December 31, 1994, 1995 and 1996.......... 6
Supplemental Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1995 and 1996.................... 7
Notes to Supplemental Consolidated Financial Statements.................................................................... 8
Financial Statement Schedule:
Supplemental Schedule II -- Valuation and Qualifying Accounts.............................................................. 39
</TABLE>
<PAGE>
Report of Independent Auditors
The Board of Directors and Stockholders
Sylvan Learning Systems, Inc.
We have audited the supplemental consolidated balance sheets of Sylvan Learning
Systems, Inc. (formed as a result of the consolidation of Sylvan Learning
Systems, Inc., I-R, Inc. and Independent Child Study Teams, Inc.) as of December
31, 1996 and 1995, and the related supplemental consolidated statements of
income, shareholders' equity, and cash flows for each of the three years in the
period ended December 31, 1996. Our audits also included the supplemental
financial statement schedule listed in the index. The supplemental consolidated
financial statements and schedule give retroactive effect to the merger of
Sylvan Learning Systems, Inc., I-R, Inc. and Independent Child Study Teams, Inc.
on May 30, 1997, which has been accounted for using the pooling-of-interests
method as described in the notes to the supplemental consolidated financial
statements. These supplemental financial statements and schedule are the
responsibility of the management of Sylvan Learning Systems, Inc. Our
responsibility is to express an opinion on these supplemental financial
statements and schedule based on our audits. We did not audit the financial
statements of I-R, Inc. and Independent Child Study Teams, Inc., which
statements reflect combined total assets constituting 3% for 1996 and 5% for
1995 of supplemental consolidated total assets, and which reflect combined
revenues constituting 14% for 1996, 21% for 1995 and 31% for 1994 of
supplemental consolidated total revenues. Those statements were audited by other
auditors whose reports have been furnished to us, and our opinion, insofar as it
relates to data included for I-R, Inc. and Independent Child Study Teams, Inc.,
is based solely on the reports of the other auditors.
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 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 and the reports of other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the
supplemental financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Sylvan Learning
Systems, Inc. at December 31, 1996 and 1995, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996, after giving retroactive effect to the merger of I-R, Inc.
and Independent Child Study Teams, Inc., as described in the notes to the
supplemental consolidated financial statements, in conformity with generally
accepted accounting principles. Also, in our opinion, the related supplemental
financial statement schedule, when considered in relation to the basic
supplemental financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Baltimore, Maryland
July 10, 1997
2
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Supplemental Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31, December 31,
1995 1996
---------------- --------------
(Restated - Note 1) (Restated - Note 1)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 2,902,657 $ 11,198,106
Available-for-sale securities 30,734,519 16,448,759
Receivables:
Accounts receivable 23,810,001 36,431,363
Costs and estimated earnings in excess of billings
on uncompleted contracts 3,028,558 3,565,201
Notes receivable 1,595,478 3,007,473
------------------------------------------
28,434,037 43,004,037
Allowance for doubtful accounts (1,466,027) (1,378,854)
------------------------------------------
26,968,010 41,625,183
Inventory 3,743,221 4,469,577
Deferred income taxes 1,271,925 619,553
Prepaid expenses 2,554,366 3,124,802
---------------- --------------
Total current assets 68,174,698 77,485,980
Notes receivable, less current portion 1,968,438 562,989
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 673,181 549,448
Property and equipment:
Furniture and equipment 26,862,301 37,952,268
Leasehold improvements 2,062,033 5,543,726
---------------- --------------
28,924,334 43,495,994
Accumulated depreciation (9,707,469) (15,577,693)
---------------- --------------
19,216,865 27,918,301
Intangible assets:
Goodwill 74,653,356 103,986,427
Contract rights 7,857,346 13,881,337
Other 2,451,091 2,570,091
---------------- --------------
84,961,793 120,437,855
Accumulated amortization (4,640,450) (10,736,219)
---------------- --------------
80,321,343 109,701,636
Deferred contract costs, net of accumulated amortization
of $684,177 as of December 31, 1995 and $2,066,893 as of
December 31, 1996 2,528,029 13,230,340
Investments in affiliates 182,320 3,895,602
Other investments 338,681 24,219,888
Other assets 666,706 2,025,337
---------------- --------------
Total assets $ 174,070,261 $ 259,589,521
================ ==============
</TABLE>
3
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Supplemental Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31, December 31,
1995 1996
------------------- -------------------
(Restated - Note 1) (Restated - Note 1)
<S> <C> <C>
Liabilities and stockholders' equity
Current liabilities:
Accounts payable and accrued expenses $ 13,642,085 $ 28,575,931
Bank lines of credit 4,600,000 1,000,000
Current portion of long-term debt 2,584,744 3,182,197
Billings in excess of costs and estimated earnings
on uncompleted contracts 237,644 65,465
Due to former shareholders of Wall Street Institute -- 4,920,565
Deferred revenue 6,907,436 9,542,578
Other current liabilities 795,967 596,311
------------- -------------
Total current liabilities 28,767,876 47,883,047
Long-term debt, less current portion 3,685,691 2,170,101
Deferred income taxes 884,612 2,338,154
Due to former shareholders of Drake -- 8,142,856
Due to former shareholders of Wall Street Institute -- 15,150,115
Due to shareholders 3,216,156 3,232,884
Other long-term liabilities 367,790 349,771
Commitments and contingent liabilities -- --
Stockholders' equity:
Preferred stock, par value $.01 per share--authorized
10,000,000 shares, no shares issued and
outstanding as of December 31, 1996 and 1995 -- --
Common stock, par value $.01 per share--authorized
40,000,000 shares, issued and outstanding shares of
22,344,193 as of December 31, 1995 and 23,980,215 -- --
as of December 31, 1996 223,442 239,802
Additional paid-in capital 139,785,773 168,547,097
Unrealized losses on available-for-sale securities (5,437) (11,043)
Foreign currency translation adjustments 70,000 (4,131)
Retained earnings (accumulated deficit) (2,925,642) 11,550,868
------------- -------------
Total stockholders' equity 137,148,136 180,322,593
------------- -------------
Total liabilities and stockholders' equity $ 174,070,261 $ 259,589,521
============= =============
</TABLE>
See accompanying notes.
4
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Supplemental Consolidated Statements of Income
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------------
1994 1995 1996
------------------- ------------------- -------------------
(Restated - Note 1) (Restated - Note 1) (Restated - Note 1)
<S> <C> <C> <C>
Revenues $ 68,747,971 $ 111,058,550 $ 181,935,961
Cost and expenses
Direct costs 60,387,726 96,708,097 150,448,547
General and administrative expense 4,998,399 6,205,480 8,755,406
Loss on impairment of assets -- 3,315,541 --
------------- -------------- --------------
Total expenses 65,386,125 106,229,118 159,203,953
------------- -------------- --------------
Operating income 3,361,846 4,829,432 22,732,008
Other income (expense)
Investment and other income 818,171 957,169 1,622,240
Interest expense (879,543) (2,396,803) (1,071,323)
Gain on sale of company center 151,214 -- --
Equity in net income of unconsolidated
subsidiaries 72,747 390,692 363,396
------------- -------------- --------------
Income before income taxes 3,524,435 3,780,490 23,646,321
Income taxes (76,249) (209,159) (8,850,000)
------------- -------------- --------------
Net income $ 3,448,186 $ 3,571,331 $ 14,796,321
============= ============== ==============
Earnings per common and common equivalent share $ 0.21 $ 0.21 $ 0.60
============= ============== ==============
Earnings per common share, assuming full dilution $ 0.21 $ 0.21 $ 0.59
============= ============== ==============
</TABLE>
See accompanying notes.
5
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Supplemental Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Additional Unrealized
Common Paid-In Gain
Stock Capital (Loss)
----------------------------------------------------------
(Restated - Note 1)
<S> <C> <C> <C>
Balance at January 1, 1994 $ 139,859 $ 34,374,712 $ (7,254)
Options and warrants exercised for purchase
of 454,935 shares of common stock 4,549 3,048,194
Shares of common stock issued to ETS 1,305 1,498,695
Additional registration costs relating to 1993
stock offering (69,950)
Distributions to shareholders of pooled entity
Unrealized gain (loss) on available-for-sale securities (12,592)
Net income for 1994
------------- ------------- -------------
Balance at December 31, 1994 145,713 38,851,651 (19,846)
Options and warrants exercised for purchase
of 731,871 shares of common stock 7,319 4,210,937
Issuance of 262,446 shares of common stock in
connection with the acquisition of PACE 2,624 3,158,237
Issuance of 3,928,572 shares of common stock
in connection with the acquisition of Drake 39,286 49,460,714
Issuance of 2,850,000 shares of common
stock, net of offering costs of $3,367,266 28,500 44,104,234
Foreign currency translation adjustment
Unrealized gain (loss) on available-for-sale securities 14,409
Net income for 1995
------------- ------------- -------------
Balance at December 31, 1995 223,442 139,785,773 (5,437)
Options and warrants exercised for purchase of 661,700
shares of common stock, including income tax
benefit of $1,887,006 6,617 6,991,426
Issuance of 824,000 shares of common stock in connection
with the investment in Jostens Learning Corporation 8,240 21,209,760
Issuance of 116,605 shares of common stock in
connection with other acquisitions 1,166 27,225
Exercise of underwriter's overallotment option to purchase
33,750 shares of common stock in connection with 1995
public stock offering 337 532,913
Foreign currency translation adjustment
Unrealized gain (loss) on available-for-sale securities (5,606)
Net income for 1996
------------- ------------- -------------
Balance at December 31, 1996 $ 239,802 $ 168,547,097 $ (11,043)
============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
Foreign Retained
Currency Earnings Total
Translation (Accumulated Stockholders'
Adjustments Deficit) Equity
------------------- ---------------- ---------------
(Restated - Note 1)
<S> <C> <C> <C>
Balance at January 1, 1994 $ -- $ (9,940,159) $ 24,567,158
Options and warrants exercised for purchase
of 454,935 shares of common stock 3,052,743
Shares of common stock issued to ETS 1,500,000
Additional registration costs relating to 1993
stock offering (69,950)
Distributions to shareholders of pooled entity (5,000) (5,000)
Unrealized gain (loss) on available-for-sale securities (12,592)
Net income for 1994 3,448,186 3,448,186
------------- ------------- -------------
Balance at December 31, 1994 -- (6,496,973) 32,480,545
Options and warrants exercised for purchase
of 731,871 shares of common stock 4,218,256
Issuance of 262,446 shares of common stock in
connection with the acquisition of PACE 3,160,861
Issuance of 3,928,572 shares of common stock
in connection with the acquisition of Drake 49,500,000
Issuance of 2,850,000 shares of common
stock, net of offering costs of $3,367,266 44,132,734
Foreign currency translation adjustment 70,000 70,000
Unrealized gain (loss) on available-for-sale securities 14,409
Net income for 1995 3,571,331 3,571,331
------------- ------------- -------------
Balance at December 31, 1995 70,000 (2,925,642) 137,148,136
Options and warrants exercised for purchase of 661,700
shares of common stock, including income tax
benefit of $1,887,006 6,998,043
Issuance of 824,000 shares of common stock in connection
with the investment in Jostens Learning Corporation 21,218,000
Issuance of 116,605 shares of common stock in
connection with other acquisitions (319,811) (291,420)
Exercise of underwriter's overallotment option to purchase
33,750 shares of common stock in connection with 1995
public stock offering 533,250
Foreign currency translation adjustment (74,131) (74,131)
Unrealized gain (loss) on available-for-sale securities (5,606)
Net income for 1996 14,796,321 14,796,321
------------- ------------- -------------
Balance at December 31, 1996 $ (4,131) $ 11,550,868 $ 180,322,593
============= ============= =============
</TABLE>
See accompanying notes.
6
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Supplemental Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------------------
1994 1995 1996
------------------- ------------------- -------------------
(Restated - Note 1) (Restated - Note 1) (Restated - Note 1)
<S> <C> <C> <C>
Operating activities
Net income $ 3,448,186 $ 3,571,331 $ 14,796,321
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation 3,098,383 4,112,535 5,986,025
Amortization 1,000,446 4,323,351 7,478,485
Interest imputed on purchase of Drake -- 1,125,000 --
Loss on impairment of assets -- 3,315,541 --
Provision for doubtful accounts 183,628 (42,631) 55,738
Deferred income taxes -- (387,313) 2,105,914
Equity in net income of unconsolidated subsidiaries (72,747) (390,692) (363,396)
Other (268,214) -- --
Changes in operating assets and liabilities:
Accounts and notes receivable (758,437) (10,780,236) (10,709,674)
Cost and estimated earnings in excess of billings -- -- --
on uncompleted contracts (2,528,600) (1,021,779) (412,910)
Inventory (994,685) (1,561,091) (134,483)
Prepaid expenses (435,062) (1,388,445) (273,711)
Other assets (545,510) (109,736) (997,608)
Accounts payable and accrued expenses (1,913,622) (3,132,695) 5,406,434
Billings in excess of costs and estimated earnings
on uncompleted contracts 262,208 (455,600) (233,665)
Deferred revenue and other long-term liabilities 40,954 115,149 922,642
------------ ------------ ------------
Net cash provided by (used in) operating activities 516,928 (2,707,311) 23,626,112
------------ ------------ ------------
Investing activities
Change in advances to unconsolidated subsidiaries (104,291) 287,970 (98,922)
Purchase of available-for-sale securities (17,615,859) (91,759,493) (31,261,415)
Proceeds from sale of available-for-sale securities 13,296,243 66,595,240 45,542,061
Investment in and advances to affiliates 5,770 (1,098) (3,247,147)
Increase in other investments -- -- (2,329,874)
Proceeds from sale of company-owned center 119,084 -- --
Purchase of property and equipment (8,088,810) (6,148,998) (13,580,617)
Refund of deposits on equipment 31,104 -- --
Purchase of contract rights -- -- (4,890,576)
Cash received upon acquisition of PACE -- 682,411 --
Cash received upon acquisition of Wall Street Institute -- -- 2,012,565
Purchase of Drake Prometric, L. P., including direct costs of
acquisition, net of cash acquired -- (16,979,737) --
Cash paid for intangible assets -- (500,000) --
Expenditures for deferred contract costs and other assets (1,779,011) (801,586) (6,941,769)
------------ ------------ ------------
Net cash used in investing activities (14,135,770) (48,625,291) (14,795,694)
------------ ------------ ------------
Financing activities
Payments to stockholders (109,770) (630,533) (37,604)
Proceeds from exercise of options and warrants 2,982,794 4,218,256 5,111,037
Proceeds from issuance of common stock 1,500,000 44,132,734 533,250
Proceeds from issuance of long-term debt 6,944,635 346,195 154,414
Payments on long-term debt and capital lease obligations (4,532,213) (2,867,459) (2,609,866)
Proceeds from bank lines of credit -- 4,600,000 200,000
Payments on bank lines of credit (300,000) -- (3,812,069)
------------ ------------ ------------
Net cash provided by (used in) financing activities 6,485,446 49,799,193 (460,838)
------------ ------------ ------------
Effects of exchange rate changes on cash -- 70,000 (74,131)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (7,133,396) (1,463,409) 8,295,449
Cash and cash equivalents at beginning of period 11,499,462 4,366,066 2,902,657
------------ ------------ ------------
Cash and cash equivalents at end of period $ 4,366,066 $ 2,902,657 $ 11,198,106
============ ============ ============
</TABLE>
See accompanying notes.
7
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
1. Basis of Presentation and Description of Business
Sylvan Learning Systems, Inc. and subsidiaries (the Company) is an international
provider of educational and testing services. The Company conducts operations
in three separate business segments - core educational services, testing
services, and contract educational services. The core educational services
segment designs and delivers individualized tutorial services to school-age
children and adults through a network of 620 franchised and Company-owned Sylvan
Learning Centers in operation in 49 states, five Canadian provinces, Hong Kong,
Guam and South Korea. In addition, in December 1996 the Company acquired Wall
Street Institute International, B.V. and its commonly controlled affiliates.
Wall Street and its affiliates teach the English language in non-English
speaking countries in Europe and Latin America through a network of over 170
franchised and company-owned centers. The Company's testing segment ("Sylvan
Prometric") administers computer-based tests for major corporations,
professional associations and governmental agencies through a network of
certification centers which are located throughout the world. The contract
educational services segment provides educational programs to employees of large
corporations, and to public and non-public school districts through contracts
funded by federal Title I and state-based programs.
The consolidated financial statements include the accounts of Sylvan Learning
Systems, Inc. and its wholly-owned subsidiaries. All intercompany accounts and
transactions have been eliminated in consolidation. Investments in affiliates
owned more than 20%, but not in excess of 50%, and corporate joint ventures are
reported using the equity method.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts and related disclosures. Actual
results could differ from those estimates.
As discussed in Note 3, on May 30, 1997, the Company consummated its acquisition
by merger of all of the outstanding stock of I-R, Inc. and Independent Child
Study Teams, Inc. (collectively, "Educational Inroads"). The acquisition has
been accounted for as a pooling-of-interests and accordingly, the Company's
financial statements have been restated to include the results of Educational
Inroads for all periods presented. As of the date of the issuance of these
financial statements, the Company has not issued financial statements for a
period including the merger date. Therefore, the accompanying consolidated
financial statements are considered "supplemental." Upon the issuance of
financial statements for a period that includes the date of the merger, the
supplemental consolidated financial statements will become the historical
consolidated financial statements of the Company.
8
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
2. Accounting Policies
Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Investments
Available-for-sale securities are carried at fair value, with the unrealized
gains and losses, net of tax, reported in a separate component of stockholders'
equity. The amortized cost of debt securities in this category is adjusted for
amortization of premiums and accretion of discounts to maturity. Such
amortization is included in investment income. Realized gains and losses and
declines in value judged to be other than temporary on available-for-sale
securities are included in investment income. The cost of securities sold is
based on the specific identification method. Interest and dividends on
securities classified as available-for-sale are included in investment income.
Inventory
Inventory, consisting primarily of computer software and educational,
instructional, and marketing materials and supplies, is stated at the lower of
cost (first-in, first-out) or market value.
Accounting For Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of
In 1995, the Company adopted the provisions of Financial Accounting Standards
Board Statement No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of. The Statement prescribes the
accounting for the impairment of long-lived assets, such as property and
equipment and intangible assets, as well as the accounting for long-lived assets
that are held for disposal. The initial adoption of this Statement in 1995 did
not have a material impact on the reported results of operations of the Company.
Property and Equipment
Property and equipment is stated at cost. Depreciation is provided using the
straight-line method over the estimated useful lives of the assets.
9
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
2. Accounting Policies (continued)
Intangible Assets
Goodwill consists of the cost in excess of fair value of the net assets of
entities acquired in purchase transactions, and is amortized over the expected
periods of benefit, which range from 10 to 25 years. At December 31, 1995 and
1996, accumulated amortization of goodwill is $1,110,944 and $4,803,586,
respectively.
Contract rights consist of the allocated cost of acquiring computer-based
testing contracts in business combinations accounted for as purchases.
Contract rights are being amortized using the straight-line method over the term
of the related contract, which range from three months to 10 years. At December
31, 1995 and 1996, accumulated amortization of contract rights is $2,978,112 and
$5,193,199, respectively.
Deferred Contract Costs
Deferred contract costs include costs incurred to develop computer-based tests
under contractual arrangements with customers. Under these arrangements, the
Company incurs certain costs related to the development of new computer-based
tests on behalf of the customer in return for the right to deliver the computer-
based tests and collect a testing fee from either the candidate or the
sponsoring organization. These costs are capitalized and amortized over the
shorter of the estimated utility period of the test or the contractual period
for delivery of the test.
Deferred contract costs also include payments and accruals of approximately
$10,400,000 in 1996 made to non-affiliated computer-based testing centers that
have entered into three-year contracts with Sylvan to deliver information
technology computer-based certification tests. In accordance with the terms of
these contracts, the independent testing centers have received an advance
payment and will receive no additional fees upon delivery of the computer-based
certification tests. These costs are being amortized over the contractual term
of three years.
10
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
2. Accounting Policies (continued)
Stock Options Granted to Employees
The Company records compensation expense for all stock-based compensation plans
using the intrinsic value method prescribed by APB Opinion No. 25, Accounting
for Stock Issued to Employees. In October 1995 the Financial Accounting
Standards Board issued FASB Statement No. 123, Accounting for Stock-Based
Compensation, which encourages companies to recognize expense for stock-based
awards based on their estimated value on the date of grant. Statement No. 123,
effective for 1996, does not require companies to change their existing
accounting for stock-based awards, but if the new fair value method is not
adopted, pro forma income and earnings per share data should be provided in the
notes to the financial statements. The Company has disclosed in Note 14, the
required pro forma information as if the fair value method had been adopted.
Foreign Currency Translation
The financial statements of certain foreign subsidiaries that are measured in
local functional currencies have been translated into U.S. dollars in accordance
with FASB Statement No. 52, Foreign Currency Translation. All balance sheet
accounts have been translated using the rates of exchange at the balance sheet
date. Results of operations have been translated using the average rates
prevailing throughout the year. Translation gains or losses resulting from the
changes in exchange rates from year to year, are accumulated as a separate
component of stockholders' equity.
The financial statements of other foreign subsidiaries, primarily those
subsidiaries providing services overseas to Educational Testing Services (see
Note 18), prepare financial statements using the U.S. dollar as the functional
currency. The transactions of these subsidiaries that are denominated in
foreign currencies have been remeasured in U.S. dollars. Any resulting gain or
loss is recorded as an adjustment of the amount due from ETS as the contract
with ETS requires ETS to bear the risk of realized translation gains or losses.
Reclassifications and Stock Split
Certain amounts in the 1995 and 1994 consolidated financial statements have been
reclassified to conform with the 1996 presentation.
In October 1996, the Company declared a 3-for-2 stock split of its common stock
for stockholders of record on November 7, 1996. Accordingly, all share and per
share data including stock option, warrant and earnings per share information
have been restated in the consolidated financial statements to retroactively
reflect the stock split.
11
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
2. Accounting Policies (continued)
Revenue Recognition
Franchise sales fees relate to single-center and area franchise sales. Revenue
related to these sales is recognized when all material services or conditions
relating to the sales have been substantially performed or satisfied by the
Company. For single-center franchise sales, the criteria for substantial
performance include: (1) receipt of an executed franchise license agreement,
(2) receipt of full payment of the franchise fee, (3) completion of requisite
training by the franchisee or center director, and (4) completion of site
selection assistance and site approval. Area franchise sales generally transfer
to the licensee the right to develop and operate centers in a specified
territory, primarily in a foreign country, and the Company's future obligations
are insignificant. Area franchise fees are recognized upon the signing of the
license agreement and the determination that (1) all material services or
conditions relating to the sale have been satisfied and the fee is non-
refundable, (2) a minimum payment of 50% of the fee is required within 90 days
of the date of the agreement, and (3) the Company has the ability to estimate
the collectibility of any unpaid amounts. Franchise sales fees not meeting the
recognition criteria are recorded as deferred revenue if not refundable, or
deposits from franchisees if refundable. Commissions paid on sales of
franchises are recorded as a current asset until the corresponding revenue is
recognized.
Fixed price contracts with school districts receiving funds under the federal
Title I program and state-based programs are accounted for using the percentage-
of-completion method. Income is recognized based on the percentage of contract
completion determined by the total expenses incurred to date as a percentage of
total estimated expenses at the completion of the contract. Total contract
income is estimated as contract revenue less total estimated costs considering
the most recent cost information. Revenues from cost-plus-fee contracts are
recognized on the basis of costs incurred during the period plus the fee earned.
Franchise royalties are reported as revenue as the royalties are earned and
become receivable, unless collection is not assured or the royalties are 90 days
or more in arrears.
Revenue from the sale of products to franchisees is recognized when shipped.
Testing revenues are recognized upon the completion of tests.
12
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
3. Acquisitions
Educational Inroads
On May 30, 1997, the Company acquired by merger all of the outstanding stock of
I-R, Inc. and Independent Child Study Teams, Inc. (collectively, "Educational
Inroads") in exchange for 1,414,000 shares of common stock. I-R, Inc. and
Independent Child Study Teams, Inc. were commonly owned by two shareholders.
The acquisition was accounted for as a pooling-of-interests and accordingly, the
Company's consolidated financial statements for periods prior to the merger have
been restated to include the combined results of operations, financial position
and cash flows of Educational Inroads (see Note 1).
Educational Inroads provides remedial and special education services to public
and non-public school systems, with current contracts in New Jersey, Maryland,
Louisiana, Washington, D.C. and other school districts.
Combined and separate results of operations of Sylvan and Educational Inroads
during the periods presented are as follows:
<TABLE>
<CAPTION>
Previously Independent
Reported by Child Study
the Company I-R, Inc. Teams, Inc. Combined
-----------------------------------------------------
Year ended
December 31, 1996
<S> <C> <C> <C> <C>
Revenues $157,116,660 $9,825,299 $14,994,002 $181,935,961
Net income $14,743,106 $31,664 $21,551 $14,796,321
Net income per share $0.60 $0.59
Year ended
December 31, 1995
Revenues $ 87,990,818 $9,475,103 $13,592,629 $111,058,550
Net income $3,547,829 $16,882 $6,620 $3,571,331
Net income per share $0.21 $0.21
</TABLE>
13
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
3. Acquisitions (continued)
<TABLE>
<CAPTION>
Previously Independent
Reported by Child Study
the Company I-R, Inc. Teams, Inc. Combined
-----------------------------------------------------
Year ended
December 31, 1994
<S> <C> <C> <C> <C>
Revenues $47,244,063 $8,750,811 $12,753,097 $68,747,971
Net income 3,385,557 $44,053 $18,576 $3,448,186
Net income per share $0.22 $0.21
</TABLE>
The results of operations of Educational Inroads for each of the periods
presented includes significant officers' salaries for the two owners. In
connection with the merger, these two individuals have contracted for annual
compensation totaling $187,500, and it is expected that the aggregate duties and
responsibilities of these two individuals will not be diminished to the extent
that other costs will be incurred. The following 1996 supplemental pro forma
information is presented solely as a result of the changed circumstances that
will exist following the consummation of the merger, and is necessary to
realistically assess the impact of the combination.
<TABLE>
<S> <C>
1996 combined net income $14,796,321
Contractual reduction to be made in compensation 2,448,845
Related income taxes (at 40%) (979,538)
---------------
1,469,307
---------------
Pro forma net income after contractual reduction in compensation $16,265,628
===============
Pro forma net income per share $0.65
===============
</TABLE>
14
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
3. Acquisitions (continued)
Wall Street Institute International, B.V. and Affiliates
Effective December 1, 1996, the Company acquired substantially all of the
operating net assets of Wall Street Institute International, B.V. and its
commonly controlled affiliates (collectively, "WSI"). The Company and the
sellers signed a definitive purchase agreement in December 1996 that provided
for an effective date of the sale of December 1, 1996. The Company's control of
the operations of WSI commenced at the effective date, and the Company recorded
the acquisition using the purchase method of accounting on December 1, 1996.
WSI is a European-based franchisor and operator of learning centers that teach
the English language through a combination of computer-based and live
instruction. WSI has a network of more than 170 franchised centers in operation
throughout Europe and Latin America.
The purchase price of WSI consisted of cash of $4,921,000, 505,364 shares of
restricted common stock valued at $9,250,000, and 209,520 shares of unrestricted
common stock valued at $5,900,000. The restricted stock may not be transferred
by the sellers for a period of three years, unless the Company, in its sole
discretion, removes the restriction. The Company must use its best efforts to
register the 209,520 shares of unrestricted common stock by April 28, 1997. In
the event that the Company is unable to register the common stock by April 28,
1997, the sellers are entitled to interest calculated at an increasing rate (10%
to 15%) on the initial value of the common stock until such time as the
unrestricted common stock is registered. If the unrestricted common stock is
unregistered at any time during the period from October 28, 1997 through
November 12, 1997, the sellers at their option may require the Company to
repurchase the unrestricted common stock for $5,900,000, plus any unpaid
interest. Of the 505,364 shares of restricted common stock issued to the
sellers, 124,292 shares are held in escrow to indemnify the Company against any
subsequent losses resulting from any misrepresentation or breach of certain
covenants. The unrestricted common stock held in escrow will be released in
varying amounts to the sellers through 2001.
In connection with the acquisition of WSI, the Company in January 1997 loaned
the principal stockholder of the seller $2,500,000. The loan is due in lump sum
in January 2000, and bears interest payable quarterly at the rate of prime plus
one percent. The loan is secured by restricted common stock of the Company with
a value of $2,500,000, adjusted annually for changes in the market price of the
Company's common stock.
15
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
3. Acquisitions (continued)
The Company on the closing date of the acquisition entered into option
agreements to purchase two franchisees of WSI, and granted the owners of these
same franchisees put rights that require, in certain circumstances and at the
election by the right holders, the Company to purchase the franchisees. At the
Company's option it may purchase the two franchisees at any time during the
period from September 1, 2001 through September 1, 2005 for an amount equal to
seven times the previous fiscal years' earnings before interest and taxes,
adjusted for certain defined items. The franchisees may require the Company to
purchase substantially all of their net assets during the same four-year period
if defined levels of operating results are met or exceeded at the end of the
most recently completed fiscal year. The purchase price is payable 10% in cash
and 90% in common stock, or at the Company's option, entirely in cash.
The total purchase price of $21,071,000, including $1,000,000 of direct
acquisition costs, was allocated as follows:
<TABLE>
<CAPTION>
<S> <C>
Working capital $ 2,795,000
Fixed assets 1,125,000
Other assets 329,000
Goodwill 19,852,000
-----------
24,101,000
Less liabilities assumed:
Debt 1,417,000
Deferred revenue 1,613,000
-----------
3,030,000
-----------
$21,071,000
===========
</TABLE>
Goodwill is being amortized over its estimated useful life of 25 years. The
cash portion of the purchase price was recorded as a current liability at
December 31, 1996, and the portion of the purchase price represented by common
stock has been recorded as a noncurrent liability at December 31, 1996. Upon
closing of the transaction in January 1997, the Company paid the cash portion of
the purchase price to the sellers of $4,921,000 and recorded the issuance of
714,884 shares of common stock to the sellers through a reduction in the
noncurrent liability of $15,150,115. In December 1996, the Company recorded
$172,000 of imputed interest expense related to the acquisition.
The following unaudited pro forma summary presents the consolidated results of
operations as if the WSI acquisition had occurred at the beginning of the
respective periods presented, and does not purport to be indicative of what
would have occurred had the acquisition been made at that date or of results
which may occur in the future:
16
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
3. Acquisitions (continued)
<TABLE>
<CAPTION>
Year ended December 31,
1995 1996
------------------------
(in thousands)
<S> <C> <C>
Revenues $124,198 $194,597
Net income $5,586 $16,935
Net income per share - fully diluted $0.30 $0.64
</TABLE>
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 262,446 shares of 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 common stock, unless the PACE
shareholders determine that a smaller cash payment is desired for their income
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. At February 28, 1995, goodwill of
approximately $3.5 million was recorded and is being amortized over a period of
25 years. Results of operations of PACE are included in the accompanying
consolidated statements of operations from March 1, 1995. For the year ended
December 31, 1996, PACE EBIT was approximately $1.2 million (unaudited).
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. As of that date, Drake had a
network of 820 testing centers on six continents, 472 of which were located in
North America and the remainder in 69 foreign countries.
17
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
3. Acquisitions (continued)
The Company acquired Drake for an initial purchase price of $20.0 million in
cash and 5,714,286 restricted shares of common stock (the "Initial Shares"). Of
the Initial Shares, 1,785,714 shares (the "Revenue Escrow Shares") were placed
in escrow and will be released to the sellers to the extent that certain revenue
targets relating to portions of the combined computer-based testing business are
achieved from 1996 through 1998. The sellers may receive up to an additional
$40.0 million (payable 12.5% in cash and the balance in either cash or
restricted shares of common stock, at the Company's option) to the extent other
revenue targets relating to portions of the combined computer-based testing
business are achieved in 1998 or 1999 (with the measuring year selected by the
sellers).
The acquisition was accounted for using the purchase method of accounting. The
initial purchase price consisted of the following components, totaling $70.6
million.
<TABLE>
<CAPTION>
<S> <C>
Cash, net of $1,125,000 of imputed interest..................... $18,875,000
Initial Shares, excluding contingently issuable Revenue Escrow
Shares (3,928,572 shares), with an estimated fair
market value of $12.60 per share............................... 49,500,000
Acquisition costs............................................... 1,847,227
Accrued Drake reorganization costs.............................. 422,954
-----------
$70,645,181
===========
</TABLE>
The purchase price includes 714,285 shares of common stock placed in escrow to
indemnify the Company for potential undisclosed liabilities, as these shares are
likely to ultimately be released from escrow. The Company also accrued $422,954
of costs related to estimated Drake employee termination costs resulting from
the integration of the Drake business. The purchase price was adjusted for
imputed interest between the effective date and December 13, 1995, the date the
Drake acquisition was consummated. This amount, calculated using a rate of 8%
per annum, was $1,125,000.
Approximately $4.8 million of contract rights and $69.8 million of goodwill were
recorded. The contract rights are being amortized over their respective terms,
and no term exceeds five years. Goodwill is being amortized over 25 years, its
estimated useful life. The Company will record the contingent consideration
consisting of the 1,785,714 Revenue Escrow Shares and the additional contingent
payment of up to $40.0 million when the contingencies are resolved and the
additional consideration is payable. Based on testing revenues earned by the
Company in 1996, 20% of the Revenue Escrow Shares have been earned. These
357,143 Revenue Escrow Shares will be released to the sellers in the third
quarter of 1997. At December 31, 1996, an additional $8.1 million of goodwill
which relates to the earned shares was recorded which will be amortized over the
remaining life of 24 years.
18
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
3. Acquisitions (continued)
Remedial Education and Diagnostic Services, Inc. and READS, Inc.
On February 17, 1995, the Company acquired by merger all of the outstanding
stock of Remedial Education and Diagnostic Services, Inc. and READS, Inc.
(collectively, "READS") in exchange for 525,108 shares of common stock. The
acquisition was accounted for as a pooling of interests and accordingly, the
Company's financial statements for periods prior to the merger have been
restated to include the results of operations, financial position and cash flows
of READS.
READS is based in Philadelphia, Pennsylvania and provides remedial and education
services, psychological, diagnostic and counseling services, career awareness
training, and a variety of consulting services. Services are delivered under
contracts with school districts, county-wide educational agencies and
municipalities in the eastern United States.
4. Available-For-Sale Securities
The following is a summary of available-for-sale securities (cost approximates
fair value):
<TABLE>
<CAPTION>
December 31,
1995 1996
----------- -----------
<S> <C> <C>
Stock mutual fund $ 150,434 $3,646,361
U.S. Treasury bills and notes 14,210,923 3,002,398
Municipal bonds 16,373,162 9,800,000
----------- ----------
$30,734,519 $16,448,759
=========== ===========
</TABLE>
The Company has not had any significant realized or unrealized gains or losses
on its investments during the periods presented. As of December 31, 1996, the
Company has approximately $6.6 million of investments that mature in 1997, $1.8
million of investments that mature in 2004 and $8.0 million of investments that
mature in 2026. These investments are classified as current as the Company
expects to sell them in 1997.
19
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
5. Acquisition of Contract Rights
In August 1996 the Company acquired the right to provide computer-based tests on
behalf of the National Association of Securities Dealers, Inc. ("the NASD") for
a period of ten years. In addition, Sylvan assumed certain lease obligations of
approximately 50 testing centers previously operated by the NASD, and acquired
equipment and leasehold improvements related to these leased centers. Sylvan
paid the NASD $5,146,000 to acquire these rights and fixed assets, of which
$4,871,832 was recorded as contract rights and $242,841 was recorded as fixed
assets. In addition, as contemplated by the terms of the contract, the Company
will incur in the first six months of 1997 an additional $1,395,000 of costs
related to the acquisition of the contract rights from the NASD. The total
contract rights recorded of $6,266,832 are being amortized over the contract
life of 10 years using the straight-line method.
6. Costs and Estimated Earnings on Uncompleted Contracts
Costs and estimated earnings on uncompleted fixed-price contracts and cost-plus-
fee contracts are as follows:
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------
1995 1996
--------------------------- ---------------------------
Fixed Price Cost-Plus-Fee Fixed Price Cost-Plus-Fee
Contracts Contracts Contracts Contracts
------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
Cost incurred on uncompleted contracts $10,108,393 $5,199,044 $13,420,902 $6,749,577
Estimated earnings 2,592,135 519,265 4,788,132 916,168
----------- ---------- ----------- ----------
12,700,528 5,718,309 18,209,034 7,665,745
Less: Billings to date 11,966,610 3,062,906 17,507,158 4,331,725
----------- ---------- ----------- ----------
$ 733,918 $2,655,403 $ 701,876 $3,334,020
=========== ========== =========== ==========
</TABLE>
Included in the accompanying consolidated balance sheets under the following
captions:
<TABLE>
<S> <C> <C> <C> <C>
Cost and estimated earnings in excess of billings
on uncompleted contracts $ 922,232 $2,106,326 $ 505,787 $3,059,414
Cost and estimated earnings in excess of billings
on uncompleted contracts, less current portion 124,104 549,077 274,842 274,606
Billings in excess of costs and estimated earnings
on uncompleted contracts (237,644) - (65,465) -
Other long-term liabilities (74,774) - (13,288) -
----------- ---------- ----------- ----------
$ 733,918 $2,655,403 $ 701,876 $3,334,020
=========== ========== =========== ==========
</TABLE>
20
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
7. Investments
Investments in Affiliates
At December 31, 1995, the Company's investments in affiliates consists of (i) a
50% interest in Sylvan National Advertising Committee, Inc. ("SNAC") in the
amount of $97,266, which is engaged in purchasing advertising and marketing
services for Sylvan Learning Centers, and (ii) a 34% interest in ADEPT Merger,
Inc. ("ADEPT") in the amount of $85,054, a corporate joint venture formed to
develop a computer-based examination for safe automobile driver certifications.
At December 31, 1996, the Company's investments in affiliates consists of a 50%
interest in SNAC ($559,584), a 10% interest in Caliber Learning Network, Inc.
($2,850,964), a corporate joint venture formed to develop distance learning
programs, and a 34% interest in ADEPT ($485,054).
Consolidated retained earnings at December 31, 1996 includes $644,561 related to
undistributed earnings of equity method investees.
Other Investments
Other investments consist of non-marketable investments in common and preferred
stocks of private companies in which the Company does not exercise significant
influence. These investments are carried at the lower of cost or estimated net
realizable value.
At December 31, 1996, other investments consist primarily of a $21.9 million
non-voting convertible preferred stock investment in Jostens Learning
Corporation, a company that develops educational software products.
8. Bank Lines of Credit
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 $15.0 million through the
expiration date of May 31, 1998, at which time the total outstanding principal
balance can be converted into a term loan, at the option of the Company. The
term loan would be repaid over 24 months from the time of issuance. The credit
line and the term loan both bear interest at a floating rate equal to the 30 day
London Interbank Offered Rate ("LIBOR") plus 1.15% per annum (6.68% at December
31, 1996). The balance on the credit line was $3.5 million at December 31, 1995
and no amounts were outstanding at December 31, 1996.
21
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
8. Bank Lines of Credit (continued)
The Company has also entered into loan agreements with a bank that provides
revolving lines of credit secured by certain assets of the Company. These lines
of credit allow the Company to borrow a maximum of $1.8 million which is
primarily due on demand. The lines bear interest at the bank's prime rate plus
0.25% (8.75% at December 31, 1996). The balance due on these lines of credit
was $1.0 million at December 31, 1996.
9. Long-Term Debt
<TABLE>
<CAPTION>
December 31,
1995 1996
------------------------
<S> <C> <C>
Long-term debt consists of the following:
Note payable to a bank, bearing interest at 1.10%
over the LIBOR (6.63% at December 31, 1996).
The loan is payable in monthly installments of
$80,000 plus interest through May, 1999. $3,280,000 $2,320,000
Other notes payable bearing interest
at rates ranging from 8% to 14%. 2,990,435 3,032,298
---------- ----------
$6,270,435 $5,352,298
========== ==========
</TABLE>
Future maturities of long-term debt as of December 31, 1996 are as follows:
<TABLE>
<CAPTION>
Years ending December 31:
<S> <C>
1997 $3,182,197
1998 1,505,155
1999 510,851
2000 77,384
2001 54,785
Thereafter 21,926
----------
$5,352,298
==========
</TABLE>
22
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
10. Due to Shareholders
Due to shareholders consists of the following:
<TABLE>
<CAPTION>
December 31,
------------------------
1995 1996
------------------------
<S> <C> <C>
Notes payable to certain shareholders,
bearing interest at 12% per annum. The
notes are subject to a subordination
agreement with a bank related to certain
lines of credit (see Note 8) and cannot
be repaid prior to such bank borrowings.
It is the intention of the shareholders
not to require payment prior to
January 1, 1998. $1,591,202 $1,753,254
Deferred salaries payable to certain
management shareholders, bearing
interest at 9% per annum and due on
December 31, 2004. The liability is
payable in monthly installments of
$23,805, including interest. 1,624,954 1,479,630
------------------------
$3,216,156 $3,232,884
========================
</TABLE>
11. Leases
Operating Leases
The Company conducts all of its operations from leased facilities. These
facilities include the Company's corporate headquarters and other office
locations, warehouse space, certain testing sites, and Company-owned learning
centers. The terms of these leases are five years or less, with the exception
of the Company's corporate headquarters, which has a lease term of ten years,
and generally contain renewal options. The Company also leases certain
equipment under operating leases of 36 months or less.
23
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
11. Leases (continued)
Future minimum lease payments at December 31, 1996, by year and in the
aggregate, under all noncancellable operating leases are as follows:
<TABLE>
<CAPTION>
Years ending December 31:
<S> <C>
1997 $ 5,798,967
1998 4,983,154
1999 3,952,500
2000 3,330,013
2001 2,914,455
Thereafter 9,548,518
-----------
$30,527,607
===========
</TABLE>
Rent expense for cancelable and noncancellable leases was $6.5 million, $4.0
million and $2.7 million for the years ended December 31, 1996, 1995 and 1994,
respectively.
12. Contingencies
On November 18, 1996, ACT, Inc. filed suit against the Company alleging that the
Company violated federal antitrust laws and committed various state law torts in
connection with the operations of its computer-based testing operations and in
obtaining a testing services contract from the NASD. The Company believes the
grounds of the lawsuit are without merit and intends to defend the lawsuit
vigorously. Management is unable to predict the ultimate outcome of the
lawsuit, but believes that the ultimate resolution of the matter will not have a
material effect on consolidated financial position.
The Company is subject to other legal actions arising in the ordinary course of
its business. In management's opinion, the Company has adequate legal defenses
and/or insurance coverage with respect to the eventuality of such actions and
does not believe any settlement would materially affect the Company's financial
position.
24
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
13. Fair Value of Financial Instruments
The fair value of the Company's financial instruments, which consist primarily
of cash and cash equivalents, accounts and notes receivable, available-for-sale
investments, accounts payable, and short and long-term debt, approximate their
carrying amounts reported in the consolidated balance sheets.
It was not practical to estimate the fair value of the Company's other
investments because of the lack of quoted market prices of the underlying equity
securities and the inability to determine fair value without incurring excessive
costs. Management does not believe that the value of these investments have
been impaired.
14. Stock Options and Warrants
Stock Options
Under a non-qualified stock option plan for key employees adopted by the
stockholders, the Company has outstanding stock options at December 31, 1996 to
purchase 300,509 shares of common stock for $2.54 per share and options to
purchase 287,947 shares of common stock for $.63 per share. All outstanding
options are fully vested and expire on December 31, 1997, and no additional
options may be granted under this plan.
The Company also has an Employee Stock Option Plan ("the Employee Plan") which
provides for the granting of stock options to purchase up to 3,200,000 shares
of common stock. All options granted under the Employee Plan vest ratably over
a five-year period and expire six years after date of grant. At December 31,
1996, options to purchase 2,984,917 shares of common stock have been granted
under the Employee Plan.
Under a Management Stock Option Plan ("Management Plan"), the Company has
outstanding stock options at December 31, 1996 to purchase 163,500 shares of
common stock for $11.25 per share. All outstanding options are fully vested,
and expire on December 1, 2001. No additional options may be granted under the
Management Plan.
In March 1996, the Company established the Senior Management Stock Option Plan
("the Senior Management Plan") to replace the Management Plan. The Senior
Management Plan provides for the granting of stock options to purchase up to
2,250,000 shares of common stock. At December 31, 1996, options to purchase
1,035,000 shares of common stock have been granted under the Senior Management
Plan. Options granted under this plan expire ten years after the date of grant.
Of this amount, options for 165,000 shares became immediately vested, with the
balance vesting ratably over three years.
25
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
14. Stock Options and Warrants (continued)
In October 1993 the stockholders approved the establishment of the Director
Stock Option Plan ("Director Plan") for all non-employee members of the Board of
Directors. Under the Director Plan, options to purchase 172,500 shares of
common stock may be issued to certain members of the Board of Directors. No
individual is eligible to receive more than 33,750 options under this plan and
options granted under this plan expire at varying times three months after a
director ceases his term on the Board. At December 31, 1996, options to
purchase 168,750 shares of common stock have been granted under the Director
Stock Option Plan.
During 1995 the Board of Directors granted 37,500 options to the former
shareholder of READS at an exercise price of $11.62 per share. These options
vest ratably over a five-year period. In addition, an option to purchase an
aggregate of 75,000 shares of common stock at an exercise price of $13.16 per
share was granted in connection with the purchase of the rights to contracts to
provide remedial education services to certain non-public schools under the
federal Title I Program. All of these options are exercisable at December 31,
1996.
In 1994 the Company sold 130,436 shares of restricted stock and options to
purchase common stock to ETS for $1.5 million. During 1995, the Company
received $2.0 million of cash as a result of the exercise by ETS of options to
purchase 173,913 shares of common stock. Pursuant to the initial option
agreement, upon exercise of the initial option, ETS was granted an additional
one-year option to purchase 121,458 shares at an exercise price of $16.47 per
share. This option was exercised on October 22, 1996.
26
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
14. Stock Options and Warrants (continued)
The following table summarizes the stock option activity of the Company.
<TABLE>
<CAPTION>
Weighted
Options Options Average
Outstanding Outstanding Exercisable Exercise Price
- ----------- ----------- ----------- --------------
<S> <C> <C> <C>
Balances at January 1, 1994 2,540,465 1,115,469
Granted 484,413
Became exercisable 515,159
Exercised (450,147) (450,147)
---------- ----------
Balance at December 31, 1994 2,574,731 1,180,481
Granted 919,083
Became exercisable 573,684
Exercised (258,663) (258,663)
---------- ----------
Balances at December 31, 1995 3,235,151 1,495,502 $ 7.69
Granted 1,847,875 $ 21.92
Became exercisable 765,823
Exercised (384,563) (384,563) $ 10.87
Forfeited (84,450) (84,450) $ 11.24
---------- ----------
Balances at December 31, 1996 4,614,013 1,792,312
========== ==========
Weighted average exercise price at
December 31, 1996 $13.06 $ 6.67
========== ==========
</TABLE>
Exercise prices for options outstanding as of December 31, 1996 ranged from
$0.63 to $26.67 consisting of the following ranges:
<TABLE>
<CAPTION>
Weighted Weighted
Range of Options Average Options Average Weighted Average Remaining
Exercise Prices Outstanding Exercise Prices Exercisable Exercise Prices Contractual Life
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$0.63-$2.54 588,456 $ 1.61 588,456 $ 1.61 1.0 years
$5.22-$9.12 1,416,550 $ 6.17 786,745 $ 6.11 3.2 years
$10.17-$17.00 764,882 $13.23 252,111 $11.31 4.6 years
$17.00-$26.67 1,844,125 $21.92 165,000 $20.33 8.1 years
</TABLE>
27
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
14. Stock Options and Warrants (continued)
Options exercised and the range of related option prices follow:
<TABLE>
<CAPTION>
Year ended Options exercised Exercise Prices Per Share
- --------------------------------------------------------------------------
<S> <C> <C>
1994 450,147 $ 0.63-$7.33
1995 258,663 $0.63-$11.50
1996 384,563 $0.63-$16.47
</TABLE>
For the years ended December 31, 1995 and 1996, pro forma net income and
earnings per share information required by Statement 123 has been determined as
if the Company had accounted for its stock options using the fair value method.
The fair value of these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted average
assumptions for 1995 and 1996 respectively: risk-free interest rate of 6.00% and
6.00%, dividend yield of 0% and 0%, volatility factors of the expected market
price of the Company's common stock of .428 and .399, and an expected life of
granted options which varies from zero to five years depending upon the vesting
period. The weighted-average grant-date fair value of options granted during
1996 was $8.33.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting periods. The Company's pro
forma information follows:
<TABLE>
<CAPTION>
1995 1996
---- ----
<S> <C> <C>
Pro forma net income $2,674,761 $11,938,549
========== ===========
Pro forma earnings per share:
Primary $ 0.16 $ 0.48
========== ===========
Fully diluted $ 0.15 $ 0.48
========== ===========
</TABLE>
28
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
14. Stock Options and Warrants (continued)
The effect of compensation expense from stock options on 1995 pro forma net
income reflects only the vesting of 1995 awards. However, 1996 pro forma net
income reflects the second year of vesting of the 1995 awards and the first year
of vesting of 1996 awards. Because the granted stock options vest over periods
ranging from zero to five years, not until 2001 is the full effect of
recognizing compensation expense for stock options representative of the
possible effects on pro forma net income for future years.
Stock Warrants
In January 1993, the Company issued warrants to purchase 272,721 shares of
Series A Convertible Preferred Stock for $4.39 per share, which approximated
fair market value at the date of issuance. On December 9, 1993 in connection
with the initial public offering, the warrants automatically converted into
common stock warrants which allow holders to purchase 409,085 shares of common
stock for $2.93 per share. During 1996 and 1995, warrants to purchase 134,499
and 235,497 shares were exercised, respectively. The remaining 39,089 warrants
expire in September 1997.
The Company also issued warrants to purchase 205,167 shares of common stock for
$2.93 per share to the placement agent for the January 1993 preferred stock
offering. Warrants to purchase 88,182 and 100,983 shares were exercised in 1996
and 1995, respectively. The remaining 16,002 warrants expire in January 1998.
In July 1993 warrants to purchase 239,364 shares of common stock for $5.22 per
share were issued in connection with a $5.0 million financing. Warrants to
purchase 54,457, 136,728 and 4,788 shares of common stock were exercised in
1996, 1995 and 1994, respectively. The remaining 43,391 warrants expire in July
1998.
15. Impairment Loss
In September 1995 the Company determined that certain assets of the testing
services segment were impaired as a result of the acquisition of Drake. These
assets, consisting of computer equipment, software and other assets, were
impaired because of dissimilar technical requirements for Drake computer-based
tests, or because their use was limited by virtue of the acquisition of similar
productive assets from Drake. The amount of the impairment loss was determined
by evaluating the likely sales proceeds from the disposition of the assets as
compared to their book value.
29
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
16. Income Taxes
Significant components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
December 31,
1994 1995 1996
---------------------------------
<S> <C> <C> <C>
Current:
Federal $ - $250,334 $4,991,497
Foreign - 133,887 372,996
State 76,249 212,251 1,379,593
------ -------- ----------
Total current 76,249 596,472 6,744,086
Deferred (benefit):
Federal - (300,168) 1,773,051
State - (87,145) 332,863
------ -------- ----------
Total deferred - (387,313) 2,105,914
------- -------- ----------
$76,249 $209,159 $8,850,000
======= ======== ==========
</TABLE>
The Company uses the liability method to account for income taxes. Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amount 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 and liabilities are summarized as follows:
30
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
16. Income Taxes (continued)
<TABLE>
<CAPTION>
December 31,
1995 1996
-------------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 3,288,617 $ 2,277,600
Loss on impairment of assets 302,729 71,601
Deferred revenue 427,574 443,618
Allowance for doubtful accounts 163,008 301,205
Amortization of intangible assets 361,537 459,040
Equity share of income from affiliates 19,499 53,841
Inventory reserve 53,050 60,094
Non-deductible reserves - 75,920
Other 9,826 133,056
----------- -----------
Total deferred tax assets 4,625,840 3,875,975
Deferred tax liabilities:
Deferred contract costs - 1,746,807
Contract rights 1,113,887 316,619
Depreciation 252,332 684,508
Amortization of software 202,157 175,183
Unbilled receivables 293,567 266,432
Prepaid expenses 86,080 106,586
Other 12,904 20,841
----------- -----------
Total deferred tax liabilities 1,960,927 3,316,976
----------- -----------
Net future income tax benefits 2,664,913 558,999
Valuation allowance for net deferred
tax assets (2,277,600) (2,277,600)
----------- -----------
Net deferred tax assets (liabilities) $ 387,313 $(1,718,601)
=========== ===========
</TABLE>
The net operating loss carryforwards at December 31, 1996 are related to a
subsidiary of the Company, and are available only to offset future taxable
income of the subsidiary. These net operating loss carryforwards will begin to
expire in 2007.
The reconciliation of the reported income tax expense to the amount that would
result by applying the U.S. federal statutory tax rates to income before income
taxes is as follows:
31
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
16. Income Taxes (continued)
<TABLE>
<CAPTION>
Year ended December 31,
1994 1995 1996
---------- ----------- ----------
<S> <C> <C> <C>
Tax expense at U.S. statutory rate $1,198,000 $ 1,285,000 $8,040,000
Permanent differences - 828,000 813,000
State income tax expense, net of
federal tax effect 216,000 123,000 1,130,000
Reduction for income of pooled entities
operating as S-corporations prior to
date of merger (404,000) (8,000) (18,000)
Tax effect of foreign income taxed at
lower rate - (87,000) (704,000)
Change in valuation allowance affecting
tax expense (912,000) (2,026,000) -
Available tax credits - - (254,000)
Other (22,000) 94,000 (157,000)
---------- ----------- ----------
$ 76,000 $ 209,000 $8,850,000
========== =========== ==========
</TABLE>
Income before income taxes from foreign operations was $2.8 million in 1996 and
$0.6 million in 1995.
17. Earnings Per Share
Income per common and common equivalent share is based upon the average number
of shares of common stock outstanding during each year, adjusted for the
dilutive effect of common stock equivalents determined using the modified
treasury stock method in 1994, and the treasury stock method in 1995 and 1996.
Earnings per common share, assuming full dilution, is calculated on the same
basis as the previously described primary computation, except that the
computations assume that the end-of-year market price of the Company's common
stock (rather than the average market price during the year) is used to
determine the number of shares that would be assumed to be repurchased using the
treasury stock method.
As discussed in Note 3, on May 30, 1997, the Company acquired by merger
Educational Inroads in exchange for 1,414,000 shares of common stock. The
calculation of earnings per common share assumes that these shares had been
issued and outstanding for all periods presented.
32
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
17. Earnings Per Share (continued)
As described more fully in Note 3, the Company may be required to issue
additional shares of common stock in future years in connection with the
acquisition of PACE. The 1995 and 1996 earnings per share calculations assume
that 95,693 and 88,890 shares, respectively, are issuable upon the
determination of the final purchase price. These respective amounts were
calculated assuming that PACE were to achieve its respective current year
operating results in the year of determination. The calculation also assumes
that net income is reduced by $171,000 and $630,000 as a result of the
additional goodwill amortization that would have been recorded in 1995 and 1996,
respectively, if the assumed contingent shares were issued on the date of
acquisition.
The Company may also be required to issue additional shares of common stock as a
result of the Drake acquisition. The 357,143 Revenue Escrow shares to be
released in April 1997 (as discussed in Note 3) are considered outstanding in
1996 for primary and fully diluted earnings per share. The remaining contingent
shares are not considered in the computations since the effect on earnings per
share is antidilutive in 1995 and 1996 if the conditions required for issuance
of the contingent shares are assumed to have been met.
<TABLE>
<CAPTION>
December 31,
1994 1995 1996
----------------------------------
<S> <C> <C> <C>
Per common and common equivalent share:
Weighted average number of shares of common
stock outstanding during the period 14,521,967 15,132,007 23,028,816
Dilutive effect of options and warrants 1,763,895 1,851,103 1,379,485
Common stock contingently issuable - 95,693 446,033
---------- ---------- ----------
Total common and common equivalent shares of
stock considered outstanding during the
year 16,285,862 17,078,803 24,854,334
========== ========== ==========
Per common share, assuming full dilution 16,533,015 17,385,819 24,996,023
========== ========== ==========
</TABLE>
33
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
18. Major Customers and Concentration of Credit Risk
The Company has an agreement with Educational Testing Services ("ETS") to be the
exclusive commercial provider of ETS computer-based tests through the year 2000.
In addition, in 1994 the Company entered into a ten-year contract with ETS to
provide computer-based tests internationally. The international testing
contract with ETS stipulates that the Company will be compensated for its
services for a fee equal to approved costs plus 10 percent, and the Company
recognizes revenues accordingly. Operating costs under the contract will be
paid at cost plus 10 percent on a quarterly basis by ETS. Start-up costs will
be paid ratably over a period not to exceed 10 years. The Company incurs
financing costs to fund the contract and ETS has agreed to reimburse these costs
at the prime rate of interest. Total revenues from ETS represented
approximately 10.8%, 16.2% and 15.0% of consolidated revenues for the years
ended December 31, 1996, 1995 and 1994, respectively.
The testing business acquired upon the acquisition of Drake in September 1995 is
highly concentrated with two customers. These customers contributed
approximately 20% and 24% to consolidated revenues during 1996 and the fourth
quarter of 1995, respectively. The Company expects the contracts with these two
customers to be renewed at the expiration date of the existing contracts. The
failure of these contracts to be renewed under similar terms would have a
detrimental effect on future operating results and significantly impair the
Company's ability to recover the remaining goodwill balance of approximately
$74.0 million related to the acquisition of Drake.
Financial instruments which potentially subject the Company to credit risk are
investments in available-for-sale securities, accounts receivable and notes
receivable. The Company maintains an allowance for losses on receivables based
on the collectibility of all amounts owed. The Company generally does not
require collateral for trade receivables. Notes receivable are generally
collateralized by assets of the debtors. At December 31, 1996, the Company does
not have any significant concentrations of credit risk.
19. Defined Contribution Retirement Plan
The Company sponsors a defined contribution retirement plan under section 401(k)
of the Internal Revenue Code. The provisions of this plan allow for voluntary
employee contributions, subject to certain annual limitations, and discretionary
Company contributions which are allocated to eligible participants based upon
compensation. All employees are eligible after meeting certain service
requirements. The Company made no contributions to this plan in any of the
periods presented.
34
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
20. Business and Geographic Segment Information
The Company's operations are classified into three primary business segments:
core educational services, contract educational services and testing services.
The core educational services segment involves the design and delivery of
personalized tutorial services to individuals through a network of franchised
and Company-owned Sylvan Learning Centers. The contract educational services
segment offers educational services under contract to public and private school
districts receiving funding under the federal Title I and other education
programs and provides contract educational and training services on-site to
employees of large corporations. The testing services segment delivers
computer-based tests both domestically and internationally.
35
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
20. Business and Geographic Segment Information (continued)
Summarized financial information by business segment for the years ended
December 31, 1994, 1995 and 1996 is as follows:
<TABLE>
<CAPTION>
Year ended December 31,
1994 1995 1996
-----------------------------------------------
<S> <C> <C> <C>
Operating revenue:
Core educational services:
Franchise royalties $ 7,920,666 $ 9,222,996 $ 11,159,986
Franchise sales fees 1,255,835 2,131,990 3,183,954
Company-owned learning
center revenues 8,605,254 11,520,024 18,527,854
Product sales 2,233,779 3,188,181 3,927,493
----------- ------------ ------------
20,015,534 26,063,191 36,799,287
Contract educational services 35,067,468 50,429,662 58,185,985
Testing services 13,664,969 34,565,697 86,950,689
----------- ------------ ------------
Total revenue $68,747,971 $111,058,550 $181,935,961
=========== ============ ============
Direct Costs:
Core educational services:
Franchise services $ 3,840,575 $ 5,875,095 $ 6,531,733
Company-owned learning center 7,655,129 10,368,983 16,073,377
Product sales 1,758,857 2,431,156 2,951,771
----------- ------------ ------------
13,254,561 18,675,234 25,556,881
Contract educational services 33,108,499 47,684,580 53,373,185
Testing services 14,024,666 30,348,283 71,518,481
----------- ------------ ------------
$60,387,726 $ 96,708,097 $150,448,547
=========== ============ ============
Operating income (loss):
Core educational services:
Franchise operations $ 4,459,645 $ 4,569,962 $ 6,573,376
Company-owned learning
center 128,394 227,888 854,297
Product sales 261,615 501,541 636,519
----------- ------------ ------------
4,849,654 5,299,391 8,064,192
Contract educational services 1,483,168 2,111,249 3,598,274
Testing services (2,970,976) (2,581,208) 11,069,542
----------- ------------ ------------
Total operating income $ 3,361,846 $ 4,829,432 $ 22,732,008
=========== ============ ============
Total assets:
Core educational services $ 8,051,776 $ 12,863,792 $ 41,744,146
Contract educational services 13,132,055 26,568,393 27,495,706
Testing services 17,329,631 98,200,486 127,651,141
Other -- -- 26,345,435
Corporate 11,531,959 36,437,590 36,353,093
----------- ------------ ------------
Total assets $50,045,421 $174,070,261 $259,589,521
=========== ============ ============
</TABLE>
36
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
20. Business and Geographic Segment Information (continued)
<TABLE>
Year ended December 31,
1994 1995 1996
-------------------------------------
<S> <C> <C> <C>
Depreciation and amortization:
Core educational services $ 591,747 $ 895,430 $ 945,968
Contract educational services 1,088,361 1,584,352 1,939,778
Testing services 2,310,947 5,601,471 9,846,889
Other -- -- 64,673
Corporate 107,774 354,633 667,202
---------- ---------- -----------
Total depreciation and amortization $4,098,829 $8,435,886 $13,464,510
========== ========== ===========
Capital expenditures:
Core educational services $ 809,080 $ 331,022 $ 888,959
Contract educational services 1,058,041 3,685,439 2,690,045
Testing services 6,221,689 1,894,847 5,937,046
Other -- -- --
Corporate -- 237,690 4,064,567
---------- ---------- -----------
Total capital expenditures $8,088,810 $6,148,998 $13,580,617
========== ========== ===========
</TABLE>
There were no significant intersegment sales or transfers during the period.
Operating income or loss by business segment excludes interest income and
expense, earnings and losses on equity investments, and investment and other
income of $162,589 in 1994, ($1,048,942) in 1995 and $914,313 in 1996. Allocated
corporate expenses are applied to each segment based on each segment's
percentage of total revenues. Corporate assets consist principally of cash and
cash equivalents, corporate property and equipment, and other assets.
The Company reports information related to geographic locations based on the
location of the regional service centers, which for the years ended December 31,
1995 and 1996 is as follows:
<TABLE>
<CAPTION>
1995 1996
------------ ------------
<S> <C> <C>
Operating revenue:
North America $100,373,442 $152,912,824
Europe 7,980,827 18,804,612
Asia/Pacific Rim 2,704,281 10,218,525
------------ ------------
Total revenue $111,058,550 $181,935,961
============ ============
Operating income:
North America $ 2,886,831 $ 11,638,694
Europe 1,205,230 8,232,240
Asia/Pacific Rim 737,371 2,861,074
------------ ------------
Total operating income $ 4,829,432 $ 22,732,008
============ ============
</TABLE>
37
<PAGE>
Sylvan Learning Systems, Inc. and subsidiaries
Notes to Supplemental Consolidated Financial Statements
20. Business and Geographic Segment Information (continued)
<TABLE>
1995 1996
------------ ------------
<S> <C> <C>
Identifiable assets:
North America $164,447,963 $217,833,228
Europe 7,440,001 36,563,504
Asia/Pacific Rim 2,182,297 5,192,789
------------ ------------
Total identifiable assets $174,070,261 $259,589,521
============ ============
</TABLE>
There were no reportable geographic segments meeting disclosure criteria for the
year ended December 31, 1994.
21. Supplemental Cash Flow Information
Interest payments were $0.7 million, $2.4 million and $1.0 million for the years
ended December 31, 1996, 1995 and 1994, respectively. The 1995 amount includes
imputed interest payments of $1.1 million related to the acquisition of Drake.
Income tax payments were $4.0 million, $1.8 million and $57,000 for the years
ended December 31, 1996, 1995, and 1994, respectively.
38
<PAGE>
SUPPLEMENTAL SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
COL A COL B COL C COL D COL E
- ------------------------------------------------------------------------------------------------------------------------------------
ADDITIONS
BALANCE AT --------------------------------------- BALANCE AT
DESCRIPTION BEGINNING OF CHARGED TO COSTS CHARGED TO OTHER DEDUCTIONS-DESCRIBED END OF
PERIOD AND EXPENSES ACCOUNTS-DESCRIBE PERIOD
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1996
DEDUCTED FROM ASSET ACCOUNTS:
ALLOWANCE FOR DOUBTFUL ACCOUNTS $1,466,027 $280,444 $0 ($367,617) (1) $1,378,854
INVENTORY RESERVE $132,626 $70,000 $0 ($44,316) (2) $158,310
--------- ------- -- -------- ---------
TOTALS $1,598,653 $350,444 $0 ($411,933) $1,537,164
---------- -------- -- --------- ----------
YEAR ENDED DECEMBER 31, 1995
DEDUCTED FROM ASSET ACCOUNTS:
ALLOWANCE FOR DOUBTFUL ACCOUNTS $490,226 $531,929 $950,000 (3) ($506,128) (1) $1,466,027
INVENTORY RESERVE $228,415 $22,615 $0 ($118,404) (2) $132,626
--------- ------- -------- -------- ---------
TOTALS $718,641 $554,544 $950,000 ($624,532) $1,598,653
---------- -------- -------- --------- ----------
YEAR ENDED DECEMBER 31, 1994
DEDUCTED FROM ASSET ACCOUNTS:
ALLOWANCE FOR DOUBTFUL ACCOUNTS $626,643 $158,621 ($295,038) (1) $490,226
INVENTORY RESERVE $486,471 $20,330 ($278,386) (2) $223,415
--------- ------- -------- ---------
TOTALS $1,113,114 $178,951 ($573,424) $716,641
---------- -------- --------- ----------
</TABLE>
(1) REDUCTION OF RESERVE DUE TO ACTUAL ACCOUNTS RECEIVABLE WRITE-OFFS.
(2) REDUCTION OF RESERVE DUE TO SALES OF RESERVED INVENTORY AND CHANGES IN
ESTIMATES
(3) REPRESENTS THE RESERVE BALANCE ACQUIRED BY THE PURCHASE OF PACE AND DRAKE
DURING 1995 AS FOLLOWS:
PACE $200,000
DRAKE $750,000
39
<PAGE>
EXHIBIT 99.3
SUPPLEMENTAL CONSOLIDATED
FINANCIAL STATEMENTS FOR
THE THREE MONTHS ENDED
MARCH 31, 1996 and MARCH 31, 1997
(UNAUDITED)
-----------------------------
INDEX
-----
Page No.
--------
Financial Statements (Unaudited)
Supplemental Balance Sheets - December 31, 1996 and
March 31, 1997................................................. 2
Supplemental Statements of Income - Three months ended
March 31, 1996, three months ended March 31, 1997.............. 4
Supplemental Statements of Cash Flows - Three months ended
March 31, 1996, three months ended March 31, 1997.............. 5
Notes to Unaudited Supplemental Financial Statements -
March 31, 1997................................................. 6
1
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Supplemental Consolidated Balance Sheets
($ in thousands)
<TABLE>
<CAPTION>
December 31, March 31,
1996 1997
------------------- -------------------
(Restated - Note A) (Restated - Note A)
(Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 11,198 $ 12,789
Available-for-sale securities 16,449 10,730
Receivables:
Accounts receivable 36,431 38,023
Costs and estimated earnings in excess of billings
on uncompleted contracts 3,565 3,228
Notes receivable 3,007 4,427
--------- ---------
43,003 45,678
Allowance for doubtful accounts (1,379) (1,339)
--------- ---------
41,624 44,339
Inventory 4,470 4,441
Deferred income taxes 620 620
Prepaid expenses 3,125 4,003
--------- ---------
Total current assets 77,486 76,922
Notes receivable, less current portion 563 1,110
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 549 334
Property and equipment:
Furniture and equipment 37,952 41,131
Leasehold improvements 5,544 4,874
--------- ---------
43,496 46,005
Accumulated depreciation (15,578) (17,438)
--------- ---------
27,918 28,567
Intangible assets:
Goodwill 103,986 104,005
Contract rights 13,882 13,972
Other 2,570 2,570
--------- ---------
120,438 120,547
Accumulated amortization (10,736) (12,046)
--------- ---------
109,702 108,501
Deferred contract costs, net of accumulated
amortization of $2,067 as of December 31, 1996
and $2,945 as of March 31, 1997 13,230 12,447
Investments in affiliates 3,896 4,747
Other investments 24,220 24,862
Other assets 2,026 2,890
========= =========
Total assets $ 259,590 $ 260,380
========= =========
</TABLE>
21
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Supplemental Consolidated Balance Sheets
($ in thousands)
<TABLE>
<CAPTION>
December 31, March 31,
1996 1997
--------------------- ---------------------
(Restated - Note A) (Restated - Note A)
(Unaudited)
<S> <C> <C>
Liabilities and stockholders' equity
Current liabilities:
Accounts payable and accrued expenses $ 28,576 $ 21,779
Bank lines of credit 1,000 -
Current portion of long-term debt 3,182 3,056
Billings in excess of costs and estimated earnings
on uncompleted contracts 65 989
Due to former shareholders of Wall Street Institute 4,921 250
Deferred revenue 9,543 10,109
Other current liabilities 596 511
--------- ---------
Total current liabilities 47,883 36,694
Long-term debt, less current portion 2,170 9,542
Deferred income taxes 2,338 2,338
Due to former shareholders of Drake 8,143 8,143
Due to former shareholders of Wall Street Institute 15,150 -
Due to shareholders 3,233 1,441
Other long-term liabilities 350 342
Commitments and contingent liabilities
Stockholders' equity:
Preferred stock, par value $.01 per share--authorized
10,000,000 shares, no shares issued and
outstanding as of December 31, 1996 and 1995
Common stock, par value $.01 per share--authorized
40,000,000 shares, issued and outstanding shares of
23,980,215 as of December 31, 1996 and 24,993,707
as of March 31, 1997 240 250
Additional paid-in capital 168,547 187,551
Unrealized losses on available-for-sale securities (11) (11)
Foreign currency translation adjustments (4) (358)
Retained earnings 11,551 14,448
--------- ---------
Total stockholders' equity 180,323 201,880
--------- ---------
Total liabilities and stockholders' equity $ 259,590 $ 260,380
========= =========
</TABLE>
See accompanying notes.
3
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Supplemental Consolidated Statements of Income (Unaudited)
($ in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------------
1996 1997
------------- -------------
(Restated - Note A) (Restated - Note A)
<S> <C> <C>
Revenues $ 41,506 $ 51,944
Cost and expenses
Direct costs 36,423 43,630
General and administrative expense 2,069 2,961
------------- ----------
Total expenses 38,492 46,591
------------- ----------
Operating income 3,014 5,353
Other income (expense)
Investment and other income 406 689
Interest expense (264) (209)
Equity in net income of unconsolidated
subsidiaries 92 (128)
------------- ----------
Income before income taxes 3,248 5,705
Income taxes (1,469) (2,258)
------------- ----------
Net income $ 1,779 $ 3,447
============= ==========
Earnings per common and common equivalent share $ 0.07 $ 0.12
============= ==========
</TABLE>
See accompanying notes.
4
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Supplemental Consolidated Statements of Cash Flows (Unaudited)
($ in thousands)
<TABLE>
<CAPTION>
Three months ended March 31,
------------------------------------------
1996 1997
------------------- -------------------
(Restated - Note A) (Restated - Note A)
<S> <C> <C>
Operating activities
Net income $ 2,516 $ 3,447
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation 1,287 1,860
Amortization 1,776 2,106
Provision for doubtful accounts 36 40
Equity in net income of unconsolidated subsidiaries (92) 128
Changes in operating assets and liabilities:
Accounts and notes receivable (7,681) (3,522)
Cost and estimated earnings in excess of billings
on uncompleted contracts 654 953
Inventory (195) 29
Prepaid expenses (168) 813
Other assets (78) (902)
Accounts payable and accrued expenses (1,241) (5,675)
Billings in excess of costs and estimated earnings
on uncompleted contracts 655 553
Other current liabilities (41) (87)
Deferred revenue and other long-term liabilities 807 618
-------- --------
Net cash provided by (used in) operating activities (1,765) 361
-------- --------
Investing activities
Change in advances to unconsolidated subsidiaries 35 (880)
Purchase of available-for-sale securities (4,826) (4,827)
Proceeds from sale of available-for-sale securities 12,833 11,045
Investment in and advances to affiliates (217) -
Increase in other investments - (1,242)
Proceeds from sale of equipment 11 43
Purchase of property and equipment (1,568) (2,533)
Expenditures for deferred contract costs and other assets (7) (11)
-------- --------
Net cash provided by investing activities 6,261 1,595
-------- --------
Financing activities
Payments to stockholders - (4,671)
Proceeds from exercise of options and warrants 1,022 922
Proceeds from issuance of common stock 533 -
Proceeds from issuance of long-term debt 119 56
Payments on long-term debt and capital lease obligations (896) (2,932)
Proceeds from bank lines of credit 216 7,164
Payments on bank lines of credit (4,100) (550)
-------- --------
Net cash used in financing activities (3,106) (10)
-------- --------
Effects of exchange rate changes on cash (21) (354)
-------- --------
Net increase in cash and cash equivalents 1,369 1,592
Cash and cash equivalents at beginning of period 2,903 11,198
-------- --------
Cash and cash equivalents at end of period $ 4,272 $ 12,789
======== ========
See accompanying notes.
</TABLE>
5
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
Notes to Unaudited Supplemental Consolidated Financial Statements
($ in thousands, except per share amounts)
March 31, 1997
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 ended March 31, 1997 are not necessarily
indicative of the results that may be expected for the year ended December 31,
1997. 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, 1996.
As discussed in Note D, on May 30, 1997, the Company consummated its acquisition
by merger of all of the outstanding stock of I-R, Inc. and Independent Child
Study Teams, Inc. (collectively, "Educational Inroads"). The acquisition has
been accounted for as a pooling-of-interests and accordingly, the Company's
financial statements have been restated to include the results of Educational
Inroads for all periods presented. As of the date of the issuance of these
financial statements, the Company has not issued financial statements for a
period including the merger date. Therefore, the accompanying consolidated
financial statements are considered "supplemental." Upon the issuance of
financial statements for a period that includes the date of the merger, the
unaudited supplemental consolidated financial statements will become the
historical unaudited consolidated financial statements of the Company.
Note B - Income Taxes
------------
The tax provisions for the three month periods ended March 31, 1997 and 1996 are
based on the estimated effective tax rates applicable for the full years. The
Company's income tax provision of $2,258 for the three month period ended March
31, 1997 consists of federal, state, and foreign income taxes.
6
<PAGE>
Note C - Earnings Per Share
------------------
Earnings 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 March 31, 1997 and 1996 was 27,207,356 and 24,901,533,
respectively. The difference between the number of shares used to determine
earnings per common and common equivalent share and earnings per common share
assuming full dilution is immaterial. Common stock equivalents consist of stock
options and warrants (using the treasury stock method).
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings Per Share, which is required to be adopted on December 31,
1997. At that time, the Company will be required to change the method currently
used to compute earnings per share and to restate all prior periods. Under the
new requirements for calculating primary earnings per share, the dilutive effect
of stock options will be excluded. The impact is expected to result in an
increase in primary earnings per share for the quarters ended March 31, 1997 and
1996 of $0.01 and $0.01 per share, respectively. The impact of Statement 128 on
the calculation of fully diluted earnings per share for these quarters is not
expected to be material.
Note D - Acquisition
-----------
On May 30, 1997, the Company acquired by merger all of the outstanding stock of
I-R, Inc. and Independent Child Study Teams, Inc. (collectively, "Educational
Inroads") in exchange for 1,414,000 shares of common stock. I-R, Inc. and
Independent Child Study Teams, Inc. were commonly owned by two shareholders.
The acquisition was accounted for as a pooling-of-interests and accordingly, the
Company's consolidated financial statements for periods prior to the merger have
been restated to include the combined results of operations, financial position
and cash flows of Educational Inroads (see Note A).
Educational Inroads provides remedial and special education services to public
and non-public school systems, with current contracts in New Jersey, Maryland,
Louisiana, Washington, D.C. and other school districts.
7
<PAGE>
Combined and separate results of operations of Sylvan and Educational Inroads
during the periods presented are as follows:
<TABLE>
<CAPTION>
Previously Independent
Reported by Child Study
the Company I-R, Inc. Teams, Inc. Combined
-----------------------------------------------------
<S> <C> <C> <C> <C>
Three months ended
March 31, 1997
Revenues $ 44,850 $ 2,749 $ 4,345 $ 51,944
Net income $ 3,697 $ (125) $ (125) $ 3,447
Net income per share $ 0.14 $ 0.12
Three months ended
March 31, 1996
Revenues $ 34,557 $ 2,771 $ 4,178 $ 41,506
Net income $ 1,779 $ - $ - $ 1,779
Net income per share $ 0.07 $ 0.07
</TABLE>
The results of operations of Educational Inroads for each of the periods
presented includes significant officers' salaries for the two owners. In
connection with the merger, these two individuals have contracted for annual
compensation totaling $187,500, and it is expected that the aggregate duties and
responsibilities of these two individuals will not be diminished to the extent
that other costs will be incurred. In addition, both Sylvan and Educational
Inroads incurred legal and transaction costs which are non-recurring in nature.
The following supplemental pro forma information for the three months ended
March 31, 1997 is presented solely as a result of the changed circumstances that
will exist following the consummation of the merger, and is necessary to
realistically assess the impact of the combination.
<TABLE>
<S> <C>
Combined net income for the three months ended March 31, 1997 $3,447
Contractual reduction to be made in compensation 550
Legal and transactions costs 400
Related income taxes (at 40%) (380)
----------
570
----------
Pro forma net income after contractual reduction in compensation
and elimination of merger costs $4,017
==========
Pro forma net income per share $0.14
==========
</TABLE>
8
<PAGE>
Note E - Reclassifications
-----------------
Certain amounts in the 1996 financial statements have been reclassified to
conform with the 1997 presentation.
Note F - Subsequent Event
----------------
In March 1997, the Company and National Education Corporation "NEC"), executed
a definitive agreement pursuant to which Sylvan was to acquire NEC. In May
1997, NEC accepted the offer of Harcourt General, Inc. to acquire all of the
stock of NEC, resulting in the termination of its agreement with the Company and
the payment by NEC to the Company of the $30 million termination fee required by
that agreement. In connection with the failed acquisition, the Company incurred
approximately $1.5 million of direct expenses. In addition, as a result of
certain strategic actions taken by the Company in anticipation of the merger
with NEC, certain assets of the Sylvan Prometric Division have been impaired,
and an impairment loss of approximately $4 million is expected to be recorded in
the second quarter of 1997. Therefore, the net effect of the termination of the
NEC merger on the results of operations of the Company in the second quarter is
expected to be $24.5 million.
Due to the availability of sufficient capital resources, stemming in part from
the receipt of the NEC termination fee, the Company made in June 1997 non-
recurring expenditures totaling $22 million. These expenditures consisted of
$10 million in promotional expenditures for the Sylvan Prometric Division, a $5
million advertising contribution to the Sylvan National Advertising Committee,
Inc., and a $7 million contribution to a newly-formed Sylvan Foundation, which
is expected to qualify as a 501(c)(3) not-for-profit foundation.
Note G - Bank Loan
---------
The Company has borrowed $7.2 million during the first quarter of 1997 under its
revolving credit line which is described in Note 8 to the 1996 audited
supplemental financial statements.
9
<PAGE>
Note H - Stockholders' Equity
--------------------
The components of stockholders' equity are as follows ($ in thousands):
<TABLE>
<CAPTION>
Foreign
Additional Unrealized Currency Total
Common Paid-In Gain Translation Retained Stockholders'
Stock Capital (Loss) Adjustments Earnings Equity
----- ------- ------ ----------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $ 240 $ 168,547 $ (11) $ (4) $ 11,551 $ 180,323
Options and warrants exercised for
purchase price of 298,608 shares of
common stock, including income tax
benefit of $2,942 3 3,861 3,864
Issuance of 714,884 shares of common
stock in connection with the
acquisition of WSI 7 15,143 15,150
Distributions to shareholders of pooled
entities (550) (550)
Foreign currency translation adjustment (354) (354)
Net income for the three months ended
March 31, 1997 3,447 3,447
--------- ----------- ----------- ------------- ---------- ------------
Balance at March 31, 1997 $ 250 $ 187,551 $ (11) $ (358) $ 14,448 $ $201,880
========= =========== =========== ============= ========== ============
</TABLE>
Note I - Contingencies
-------------
On November 18, 1996, ACT, Inc. filed suit against the Company alleging that the
Company violated federal antitrust laws and committed various state law torts in
connection with the operations of its computer-based testing operations and in
obtaining a testing services contract from the NASD. The Company believes the
grounds of the lawsuit are without merit and intends to defend the lawsuit
vigorously. Management is unable to predict the ultimate outcome of the
lawsuit, but believes that the ultimate resolution of the matter will not have a
material effect on consolidated financial position.
10
