<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 for the quarter ended JUNE 30, 1997 or
-------------
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from __________ to
__________.
COMMISSION FILE NUMBER 0-22844
-------
SYLVAN LEARNING SYSTEMS, INC.
-----------------------------
(Exact name of registrant as specified in its charter)
Maryland 52-1492296
- ------------------------------- -------------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1000 Lancaster Street, Baltimore, Maryland 21202
- ------------------------------------------- -----
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (410) 843-8000
---------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X]. No [ ].
The registrant had 27,696,431 shares of Common Stock outstanding as of August 1,
1997.
<PAGE>
SYLVAN LEARNING SYSTEMS, INC.
-----------------------------
INDEX
-----
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Balance Sheets - December 31, 1996 and
June 30, 1997............................. 3
Statements of Income - Three months ended
June 30, 1996, three months ended June 30,
1997...................................... 5
Statements of Income - Six months ended
June 30, 1996, six months ended June 30,
1997...................................... 6
Statements of Cash Flows - Six months ended
June 30, 1996, six months ended June 30,
1997...................................... 7
Notes to Unaudited Financial Statements -
June 30, 1997............................. 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................ 13
PART II. - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ........... 20
SIGNATURES .......................................... 20
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- ----------------------------
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
($ in thousands)
<TABLE>
<CAPTION>
December 31, June 30,
1996 1997
-------------- ------------
(Restated) (Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 11,198 $ 29,883
Available-for-sale securities 16,449 10,081
Receivables:
Accounts receivable 36,431 39,415
Costs and estimated earnings in excess of billings
on uncompleted contracts 3,565 2,190
Notes receivable 3,008 5,003
-------------- ------------
43,004 46,608
Allowance for doubtful accounts (1,379) (1,510)
-------------- ------------
41,625 45,098
Inventory 4,470 4,985
Deferred income taxes 620 620
Prepaid expenses 3,125 2,277
-------------- ------------
Total current assets 77,487 92,944
Notes receivable, less current portion 563 2,876
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 550 327
Property and equipment:
Furniture and equipment 37,952 37,065
Leasehold improvements 5,544 5,690
-------------- ------------
43,496 42,755
Accumulated depreciation (15,578) (14,485)
-------------- ------------
27,918 28,270
Intangible assets:
Goodwill 103,986 104,560
Contract rights 13,881 13,973
Other 2,570 2,522
-------------- ------------
120,437 121,055
Accumulated amortization (10,736) (13,490)
-------------- ------------
109,701 107,565
Deferred contract costs, net of accumulated amortization
of $2,067 as of December 31, 1996 and $3,898 as of
June 30, 1997 13,230 11,466
Investments in affiliates 3,896 6,172
Other investments 24,220 25,438
Other assets 2,025 3,771
-------------- ------------
Total assets $ 259,590 $ 278,829
============= ============
</TABLE>
3
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
($ in thousands)
<TABLE>
<CAPTION>
December 31, June 30,
1996 1997
------------ ------------
(Restated) (Unaudited)
<S> <C> <C>
Liabilities and stockholders' equity
Current liabilities:
Accounts payable and accrued expenses $ 28,576 $ 25,002
Bank lines of credit 1,000 -
Current portion of long-term debt 3,182 764
Billings in excess of costs and estimated earnings
on uncompleted contracts 65 922
Due to former shareholders of Wall Street Institute 4,921 250
Deferred revenue 9,543 10,199
Other current liabilities 596 438
--------- ---------
Total current liabilities 47,883 37,575
Long-term debt, less current portion 2,170 -
Deferred income taxes 2,338 1,628
Due to former shareholders of Drake 8,143 6,128
Due to former shareholders of Wall Street Institute 15,150 -
Due to former shareholders of ICST & Inroads 3,233 -
Other long-term liabilities 350 248
Stockholders' equity:
Preferred stock, par value $.01 per share--authorized
10,000,000 shares, no shares were issued and
outstanding as of December 31, 1996 and June 30, 1997 - -
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 25,894,977
as of June 30, 1997 240 259
Additional paid-in capital 168,547 211,675
Foreign currency translation adjustments (4) (377)
Unrealized holding losses on available for sale
securities (11) -
Retained earnings 11,551 21,693
--------- ---------
Total stockholders' equity 180,323 233,250
--------- ---------
Total liabilities and stockholders' equity $ 259,590 $ 278,829
========= =========
</TABLE>
See accompanying notes
4
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Statements of Income
($ in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three months ended
June 30,
-----------------------
1996 1997
----------- -----------
(Unaudited) (Unaudited)
(Restated)
<S> <C> <C>
Revenues $ 47,212 $ 57,597
Cost and expenses:
Direct costs 39,721 61,931
General and administrative expenses 2,907 9,913
Loss on impairment of assets - 4,000
-------- --------
Total expenses 42,628 75,844
-------- --------
Operating income 4,584 (18,247)
Investment income 346 889
Income, net of transaction costs for termination
of acquisition - 28,500
Interest expense (185) (231)
Equity in net income (loss) of unconsolidated
subsidiaries 161 (259)
-------- --------
Income before income taxes 4,906 10,652
Income taxes (1,874) (3,957)
-------- --------
Net income $ 3,032 $ 6,695
======== ========
Per common and common equivalent share
Net income $ 0.12 $ 0.24
======== ========
</TABLE>
See accompanying notes.
5
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Statements of Income
($ in thousands, except per share amounts)
<TABLE>
<CAPTION>
Six months ended
June 30,
-------------------------
1996 1997
----------- -----------
(Unaudited) (Unaudited)
(Restated)
<S> <C> <C>
Revenues $ 88,717 $ 109,540
Cost and expenses:
Direct costs 76,142 105,560
General and administrative expenses 4,976 12,874
Loss on impairment of assets - 4,000
----------- -----------
Total expenses 81,118 122,434
----------- -----------
Operating income 7,599 (12,894)
Investment income 742 1,551
Income, net of transaction costs for
termination of acquisition - 28,500
Interest expense (440) (413)
Equity in net income (loss) of
unconsolidated subsidiaries 253 (387)
----------- -----------
Income before income taxes 8,154 16,357
Income taxes (3,343) (6,215)
Net income $ 4,811 $ 10,142
=========== ===========
Per common and common equivalent share
Net income $0.19 $0.36
=========== ===========
</TABLE>
See accompanying notes.
6
<PAGE>
Sylvan Learning Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
($ in thousands)
<TABLE>
<CAPTION>
Six months ended
June 30,
----------------------------
1996 1997
----------------------------
(Unaudited) (Unaudited)
(Restated)
<S> <C> <C>
Operating activities
Net income $ 4,811 $ 10,142
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 2,590 3,927
Amortization 3,755 4,585
Non-cash issuance of common stock - 18,500
Loss on impairment of assets - 4,000
Provision for doubtful accounts 60 165
Deferred income taxes - (710)
Equity in net loss (income) of unconsolidated subsidiaries (253) 387
Changes in operating assets and liabilities:
Accounts and notes receivable (5,621) (7,326)
Cost and estimated earnings in excess of billings
on uncompleted contracts (854) 1,598
Inventory (375) (515)
Prepaid expenses (640) 756
Other assets (189) (229)
Accounts payable and accrued expenses 4,181 (5,358)
Billings in excess of costs and estimated earnings
on uncompleted contracts (312) 871
Other current liabilities (28) -
Deferred revenue and other long-term liabilities 881 628
---------- ----------
Net cash provided by operating activities 8,006 31,421
---------- ----------
Investing activities
Purchase of available-for-sale securities (12,819) (4,828)
Proceeds from sale of available-for-sale securities 24,973 11,195
Increase in investments in and advances to affiliates (26) (2,663)
Increase in other investments - (1,556)
Purchase of property and equipment (3,044) (9,322)
Proceeds from sale of property and equipment 46 1,254
Contract termination fee paid to
Drake Authorized Testing Centers (4,178) -
Purchase of contract rights (4,774) -
Cash paid for intangible assets - (554)
Expenditures for deferred contract costs and other assets (186) (1,428)
---------- ----------
Net cash used in investing activities (8) (7,902)
---------- ----------
Financing activities
Payments to former shareholders of WSI - (4,670)
Payments to former shareholders of Pace - (158)
Proceeds from exercise of options and warrants 2,214 6,265
Proceeds from issuance of common stock 440 -
Payments on long-term debt and capital lease obligations (2,628) (4,898)
Paydown of line of credit (3,500) (1,000)
---------- ----------
Net cash used in financing activities (3,474) (4,461)
---------- ----------
Effects of exchange rate changes on cash (38) (373)
---------- ----------
Net increase in cash and cash equivalents 4,486 18,685
Cash and cash equivalents at beginning of period 2,903 11,198
---------- ----------
Cash and cash equivalents at end of period $ 7,389 $ 29,883
========== ==========
</TABLE>
See accompanying notes.
7
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
JUNE 30, 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 and six months ended June 30, 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.
NOTE B - INCOME TAXES
------------
The tax provisions for the six month periods ended June 30, 1997 and 1996 are
based on the estimated effective tax rates applicable for the full years. The
Company's income tax provision of $6,215 for the six month period ended June 30,
1997 consists of federal, state, and foreign income taxes.
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 June 30, 1997 and 1996 was 27,125,406 and 25,153,317, respectively.
The weighted average number of shares used for the six month periods ended June
30, 1997 and 1996 was 27,063,919 and 25,005,742, 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
8
<PAGE>
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 June 30, 1997 and
1996 of $0.01 and $0.01 per share, respectively and for the six month periods
ended June 30, 1997 and 1996 of $0.02 and $0.02, respectively. The impact of
Statement 128 on the calculation of fully diluted earnings per share for these
periods is not expected to be material.
NOTE D - RECLASSIFICATIONS
-----------------
Certain amounts in the 1996 financial statements have been reclassified to
conform with the 1997 presentation.
NOTE E - ACQUISITIONS
------------
On May 30, 1997, the Company acquired by merger all of the outstanding
stock of I-R, Inc. and Independent Child Study Teams, Inc. (collectively,
"Educational Inroads") in exchange for 1,414,000 shares of common stock. I-R,
Inc. and Independent Child Study Teams, Inc. were commonly owned by two
shareholders. The acquisition was accounted for as a pooling-of-interests and
accordingly, the Company's consolidated financial statements for periods prior
to the merger have been restated to include the combined results of operations,
financial position and cash flows of Educational Inroads.
Educational Inroads provides remedial and special education services to
public and non-public school systems, with current contracts in New Jersey,
Maryland, Louisiana, Washington, D.C. and other school districts.
Combined and separate results of operations of Sylvan and Educational
Inroads during the periods prior to the acquisition are as follows:
9
<PAGE>
<TABLE>
<CAPTION>
Sylvan Independent
Learning Child Study
Systems, Inc. I-R, Inc. Teams, Inc. Combined
-----------------------------------------------------
<S> <C> <C> <C> <C>
($ in thousands, except per share amounts)
THREE MONTHS ENDED
JUNE 30, 1996
Revenues $39,570 $2,902 $4,740 $47,212
Net income $ 3,032 $ -- $ -- $ 3,032
Net income per share $ 0.19 $ 0.12
SIX MONTHS ENDED
JUNE 30, 1996
Revenues $74,127 $5,673 $8,917 $88,717
Net income $ 4,811 $ -- $ -- $ 4,811
Net income per share $ 0.30 $ 0.19
</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 $187,500, and it is expected that the aggregate duties and
responsibilities of these two individuals will not be diminished to the extent
that other costs will be incurred. In addition, both Sylvan and Educational
Inroads incurred legal and transaction costs which are non-recurring in nature.
The following supplemental pro forma information for the three-month and six-
month periods ended June 30, 1997 and 1996 is presented solely as a result of
the changed circumstances that will exist following the consummation of the
merger, and is necessary to realistically assess the impact of the combination.
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
1996 1997 1996 1997
-----------------------------------------------------------
<S> <C> <C> <C> <C>
($ in thousands, except per share amounts)
Combined net income $3,032 $6,695 $4,811 $10,141
Contractual reduction to be made in 966 250 1,469 800
compensation
Legal and transactions costs -- -- -- 400
Related income taxes (at 40%) (386) (100) (588) (480)
-----------------------------------------------------------
580 150 881 720
-----------------------------------------------------------
Pro forma net income after contractual
reduction in compensation $3,612 $6,845 $5,692 $10,861
===========================================================
Pro forma net income per share $0.14 $0.25 $0.22 $0.39
===========================================================
</TABLE>
10
<PAGE>
NOTE F - STOCKHOLDERS' EQUITY
--------------------
The components of stockholders' equity are as follows ($ in thousands):
<TABLE>
<CAPTION>
Foreign
Additional Unrealized Currency Total
Common Paid-In Holding Translation Retained Stockholders'
Stock Capital Losses Adjustments Earnings Equity
------ ---------- ----------- ------------ --------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997
(Restated) $240 $168,547 $(11) $ (4) $11,551 $180,323
Options and warrants exercised for
purchase of 549,941 shares of common
stock, including income tax benefit of
$5,675 5 9,789 9,794
Issuance of 714,884 shares of
restricted common stock in connection
with the acquisition of WSI 7 14,846 14,853
Issuance of 269,118 shares of
restricted common stock in connection
with the creation of Sylvan Learning
Foundation 3 6,497 6,500
Issuance of 205,882 shares of common
stock to ITT 2 6,998 7,000
Issuance of 176,470 shares of
restricted common stock to NAC 2 4,998 5,000
Foreign currency translation adjustment (373) (373)
Unrealized gains on available for sale
investments 11 11
Net income for the six months ended
June 30 1997 10,142 10,142
------ ---------- ----------- ------------ --------- -------------
Balance at June 30, 1997 $259 $211,675 $ 0 $(377) $21,693 $233,250
====== ========== =========== ============ ========= =============
</TABLE>
In the second quarter of 1997, Sylvan made certain cash expenditures and Common
Stock contributions resulting in an aggregate expense to the Company of
approximately $21.5 million. The $21.5 million of recorded expense was
attributable to Sylvan's contributions of (i) approximately $3.0 million in cash
and Common Stock valued at $7.0 million to a nonprofit special purpose
corporation whose sole purpose is to fund promotional and channel support
programs for the Information Technology training and testing business (which
contribution was recorded as a direct cost of the Testing services division),
(ii) Common Stock valued at $5.0 million to a non-profit special purpose
corporation whose sole purpose is to develop and fund advertising programs for
the Sylvan Learning Centers (which contribution was recorded as a direct cost of
the Core
11
<PAGE>
Educational services division) and (iii) Common Stock valued at $6.5
million to Sylvan Learning Foundation, Inc., a newly-formed, non-profit
foundation formed to promote various educational pursuits (which contribution
was recorded as a general and administrative expense).
In August 1997, the Company completed a secondary stock offering and issued
1,612,292 shares of its Common Stock for net proceeds of $57.5 million after
underwriting costs and expenses. Also, in connection with this offering, 453,888
options and warrants to purchase the Company's Common Stock were exercised,
resulting in $1.5 million of proceeds to the Company.
NOTE G - 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 outcome of the lawsuit, but
believes that the ultimate resolution of the matter will not have a material
effect on consolidated financial position.
NOTE H - IMPAIRMENT LOSS
---------------
In May of 1997 the Company determined that certain assets of the Testing
Division were impaired as a result of certain strategic changes that were made
as a result of pursuing the National Education Corporation acquisition. During
and after the acquisition negotiations with NEC, the Company developed certain
plans that resulted in required changes in both software systems and hardware
currently utilized in the Testing division's network of centers. The plans
continue to be valid for the Company even after the NEC acquisition was
terminated. The impaired assets, consisting of computer equipment and software,
are impaired as a result of changes in the technical requirements and
specifications of certain computer hardware and software. The amount of the
impairment loss was determined by evaluating the likely sales proceeds from the
disposition of the assets compared to their book value. The Company determined
that it was unlikely that the net cash proceeds from the sale of any assets
would be significant, and therefore recorded an impairment loss equal to the net
book value of the assets of $4.0 million.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
All statements contained herein that are not historical facts, including
but not limited to, statements regarding the anticipated impact of uncollectible
accounts receivable on future liquidity, expenditures to develop licensing and
certification tests under existing contracts, 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 Company wishes to
caution readers not to place undue reliance on any such forward looking
statements, which statements are made pursuant to the Private Securities
Litigation Reform Act of 1995 and, as such, speak only as of the date made.
OVERVIEW
The Company generates revenues from three business segments: core
educational services which primarily consist of franchise sales, royalties and
Company-owned Learning Center revenues; testing services, which consist of
computer-based testing fees paid to the Company; 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 segment data for the quarter and six month
periods ended June 30, 1996 and 1997 is derived from the Company's consolidated
financial statements.
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
---------------- -----------------
1996 1997 1996 1997
------- ------- ------- --------
(In thousands)
<S> <C> <C> <C> <C>
Operating Revenue:
Core educational services...... $ 8,045 $10,755 $15,257 $ 19,985
Contract educational services.. 15,908 18,326 32,401 35,900
Testing services............... 23,259 28,516 41,059 53,655
------- ------- ------- --------
Total revenue............... $47,212 $57,597 $88,717 $109,540
======= ======= ======= ========
Direct costs:
Core educational services...... $ 5,263 $12,607 $10,867 $ 19,436
Contract educational services.. 14,717 15,713 30,048 31,881
Testing services............... 19,741 33,611 35,227 54,243
------- ------- ------- --------
Total direct costs.......... $39,721 $61,931 $76,142 $105,560
======= ======= ======= ========
</TABLE>
RESULTS OF OPERATIONS
Comparison of results for the quarter and six months ended June 30, 1997 to
results for the quarter and six months ended June 30, 1996.
13
<PAGE>
Revenue. Total revenues increased by $10.4 million, or 22% to $57.6 million for
the quarter ended June 30, 1997 and increased by $20.8 million or 23%, to $109.5
million for the six months ended June 30, 1997 compared to the same periods in
1996. This increase resulted from higher revenues in all business segments -
core educational services, testing services, and contract educational services.
Core educational services revenue increased by $2.7 million, or 34%, to
$10.8 million during the second quarter of 1997 and by $4.7 million, or 31%, to
$20.0 million for the first six months of 1997 compared to the comparable 1996
periods. Franchise royalties increased by $600,000, or 21.0%, for the quarter
ended June 30, 1997 and by $1.1 million, or 20%, to $6.6 million for the first
six months of 1997 compared to the comparable 1996 periods. This increase in
franchise royalties was due to the net increase of 25 new Centers in new
territories and 9 new satellite Centers (Centers operating within existing
franchise territories) opened during the first six months of 1997, combined with
an overall 14% increase in revenues at existing Learning Centers open for more
than one year. Franchise sales fees increased $400,000 to $500,000 for the
quarter ended June 30, 1997 and increased $865,000 to $1.2 million for the first
six months of 1997, compared to the same periods in 1996. For the six months
ended June 30, 1997, there were 19 franchise Center licenses and a $500,000 area
development agreement sold, compared to nine franchise Center licenses sold in
the first six months of 1996.
Revenue from Company-owned Learning Centers increased $1.5 million, or 38%,
to $5.6 million during the second quarter of 1997 and by $3.0 million, or 41%,
to $10.4 million during the first six months of 1997 compared to the comparable
periods in 1996. The acquisition of thirteen Centers from four franchisees
which occurred during the last twelve months accounted for $1.1 million, or 73%
of the revenue increase for the quarter ended June 30, 1997 and $2.0 million, or
67% of the increase for the first six months of 1997, compared to the comparable
1996 periods. Revenue growth related to student enrollment increases for
Centers operating for more than one year as of June 30, 1997 resulted in
$400,000, or 27%, of the increase for the quarter ended June 30, 1997 and $1
million, or 33%, of the increase for the first six months of 1997 compared to
the comparable 1996 periods.
Contract educational services revenue increased by $2.4 million, or 15%, to
$18.3 million for the quarter ended June 30, 1997, and by $3.5 million, or 11%,
to $35.9 million for the six months ended June 30, 1997. The revenue increase
results from contracts with new customers.
Testing services revenue increased by $5.3 million, or 23% to $28.5 million
during the second quarter of 1997 and by $12.6 million, or 31%, to $53.7 million
during the first six months of 1997 compared to the same periods in 1996. The
increase in testing services revenues resulted primarily from the Company's
acquisition of the Wall Street Institute International, B.V. and its commonly
controlled affiliates (collectively,
14
<PAGE>
"WSI") during the fourth quarter of 1996, increased volumes worldwide from
Information Technology and professional licensure and certification clients and
increased volumes and services under the Educational Testing Service domestic
and international contracts.
Cost and Expenses. Total direct costs increased 56% from $39.7 million in the
second quarter of 1996 to $61.9 million in the second quarter of 1997 and
increased as a percentage of total revenues from 84% in the second quarter of
1996 to 108% in the second quarter of 1997, as a result of non-recurring costs
of $21.5 million being included in direct costs for the second quarter of 1997,
as discussed below. Total direct costs increased 39% from $76.1 million in the
first six months of 1996 to $105.6 million in the first six months of 1997 and
increased as a percentage of total revenues from 86% in the 1996 period to 96%
in the 1997 period, as a result of the non-recurring expenses discussed below.
Excluding the non-recurring expenses, total direct costs as a percentage of
total revenues would be 70% and 77% for the second quarter and six months ended
June 30, 1997, respectively.
Core educational services expense increased 140% from $5.3 million to $12.6
million in the second quarter of 1997. Core educational services expense
increased 79% from $10.9 million to $19.4 million in the first six months of
1997. Included in core educational services expense for the second quarter and
six month 1997 periods is a non-recurring $5.0 million contribution of the
Company's Common Stock to a non-profit corporation whose sole purpose is to
develop and fund advertising programs for the Sylvan Learning Centers. Company-
owned Learning Center expenses increased 36%, from $3.3 million in the second
quarter of 1996 to $4.5 million in the second quarter of 1997 but decreased as a
percentage of Company-owned Learning Center revenues from 82% in the second
quarter of 1996 to 80% in the second quarter of 1997. Company-owned Learning
Center expenses increased 39%, from $6.3 million for the first six months of
1996 to $8.8 million for the first six months of 1997 but decreased as a
percentage of Company-owned Learning Center revenues from 85% for the first six
months of 1996 to 84% for the first six months of 1997. $900,000 of the second
quarter expense increase and $1.8 million of the year to date increase relates
to the acquisition of thirteen Centers from four franchisees. The remaining
increase in expenses was primarily related to advertising and labor associated
with increases in Center enrollment
Contract educational services expense increased 7%, from $14.7 million in
the second quarter of 1996 to $15.7 million in the second quarter of 1997 but
decreased as a percentage of contract educational services revenues from 93% in
the second quarter of 1996 to 86% in the second quarter of 1997. Contract
educational services expense increased 6%, from 30.0 million for the first six
months of 1996 to $31.9 million for the first six months of 1997 but decreased
as a percentage of contract educational services revenues from 93% for the first
six months of 1996 to 89% for the first six months of 1997. The decrease in
contract educational services expense as a percentage of revenue for the quarter
and six month period ended June 30, 1997 versus the comparable periods
15
<PAGE>
of 1996 is the result of leveraging the fixed costs for PACE and
Public/nonpublic School services against revenue growth in 1997.
Testing services expense increased 70%, from $19.7 million in the second
quarter of 1996 to $33.6 million in the second quarter of 1997 and increased as
a percentage of testing services revenues from 85% in the first quarter of 1996
to 118% in the first quarter of 1997. Testing services expense increased 54%,
from $35.2 million for the first six months of 1996 to $54.2 million for the
first six months of 1997 and increased as a percentage of testing services
revenues from 86% for the first six months of 1996 to 101% for the first six
months of 1997. The 1997 expenses for both the three month and six month
periods included a $10.0 million non-recurring expense from cash and Common
Stock contributed to an independent marketing fund to be used for development of
the information technology testing business. The 1996 expenses included $1.2
million and $2.4 million of non-recurring expenses related to the Drake
acquisition, incurred in the second quarter and first six-months of 1996,
respectively. Excluding the 1997 and the 1996 non-recurring expenses, expenses
as a percentage of total testing services revenue were 83% and 80% for the
second quarter of 1997 and 1996, respectively, and 82% and 80% for the first six
months of 1997 and 1996, respectively. The increase in testing services expense
as a percentage of testing services revenues was primarily a result of increased
salary and other operating costs resulting from the expected growth in business
volumes in 1997.
General and administrative expenses increased by $7.0 million to $9.9
million during the second quarter of 1997 compared to the second quarter of 1996
and increased as a percentage of revenue from 6% to 17%. General and
administrative expenses increased by $7.9 million to $12.9 million during the
first six months of 1997 compared to the same period in 1996 and increased as a
percentage of revenue from 6% to 12%. Included in general and administrative
expenses for both the second quarter and six months ended June 30, 1997 are non-
recurring expenses related to a contribution of the Company's Common Stock
valued at $6.5 million to Sylvan Learning Foundation, Inc., a nonprofit
foundation formed to promote various educational pursuits. Excluding this non-
recurring expense, general and administrative expenses are 6% of total revenues
for both the quarter and six months ended June 30, 1997 compared to 6% for the
quarter and six months ended June 30, 1996. The expenses did not decrease as a
percentage of revenues as a result of increased administrative staff and leased
space and other expenses which were added to support the growth in the Company's
three divisions.
In March 1997, the Company and National Education Corporation ("NEC")
executed a definitive agreement pursuant to which the Company was to acquire
NEC. In May 1997, NEC accepted a competing offer which resulted in the
termination of NEC's agreement with the Company. As a result, NEC paid the
Company a $30 million termination fee, which has been recorded, net of $1.5
million of transaction costs, as a separate component of non-operating income.
16
<PAGE>
The Company's effective tax rate has decreased from 41% during the first
six months of 1996 to 38% during the first six months of 1997 mainly due to the
effect of higher earnings levels in certain lower tax jurisdictions.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $31.4 million for the six months
ended June 30, 1997 as compared to $8.0 million provided in the comparable
period of 1996. Cash flow from operations before working capital changes
increased from $13.4 million in the 1996 period to $41.0 million in the 1997
period, primarily as a result of non-cash issuances of common stock totaling
$18.5 million, the $4.0 million loss on impairment of assets as well as
significant overall growth in income from Company operations before considering
non-cash charges, which primarily consist of depreciation and amortization. The
Company's investment in working capital has significantly reduced cash flow,
particularly as a result of the growth in accounts receivable and reductions in
accounts payable and accrued expenses. The increase in accounts and notes
receivable relates to an overall increase in revenue of 23% for the six months
ended June 30, 1997 compared to the same period in 1996. Specifically, of the
$7.3 million operating cash flow reduction attributable to an increase in
accounts and notes receivable, $1.8 million is related to a note receivable
resulting from the Education Inroads transaction that will be paid prior to
December 31, 1997 and $2.0 million represents a loan for the development of WSI
in Italy and Germany secured by the Company's stock and a call option, not
expected to be exercised for 3 to 5 years, to purchase the business. The
remainder results from revenue growth and higher accounts receivable levels in
all business segments. The average collection period for accounts receivable
has been approximately 60 days. 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, such as large corporations and governmental
units.
During the first six months of 1997, the Company sold a net of $6.4 million
of available for sale securities, the proceeds of which were used to reduce
accounts payable and accrued expenses by $5.4 million.
The Company continues to incur expenditures for additions to property and
equipment, which totaled $9.3 million in the first six months 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 overseas testing centers operated by the
Company. Under the international testing contract with ETS, the Company is
reimbursed for overseas equipment expenditures as the equipment is depreciated.
This reimbursement includes a financing charge over the reimbursement period.
The Company 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
17
<PAGE>
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 conversion. 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 (6.87% at June 30,
1997). The Company had no outstanding balance on the credit line at June 30,
1997.
During the first six months of 1997, the Company received $6.3 million as a
result of the exercise of stock options and warrants to purchase 549,941 shares
of Common Stock.
During the first six months of 1997, the Company paid $4.7 million for the
purchase of WSI.
In August 1997, the Company completed a secondary stock offering and issued
1,612,292 shares of its Common Stock for net proceeds of $57.5 million after
underwriting costs and expenses. Also, in connection with this offering,
453,888 options and warrants to purchase the Company's Common Stock were
exercised, resulting in $1.5 million of proceeds to the Company. The proceeds
of the offering will be used for general corporate purposes, which may include
funding selected future acquisitions.
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 the secondary stock 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
In connection with the PACE acquisition, the Company will be required to
make a contingent payment equal to 6.5 times PACE's 1997 earnings before
interest and income taxes ("EBIT"). If PACE's EBIT is less than $2.7 million
for 1997, the PACE
18
<PAGE>
shareholders may elect to have the payment calculation based on EBIT for either
calendar year 1998 or 1999. The contingent payment is payable partially in cash
and partially in Common Stock. The amount of any contingent payment to the PACE
Stockholders will be capitalized as goodwill when paid and amortized over the
remaining estimated recovery period. PACE is expected to meet its cash needs
from its operations. PACE provides most of its services to large corporations
with favorable credit histories. PACE operations are not capital intensive and
historically PACE has generated positive cash flow from operations.
The agreement with Drake provides for future contingent payments based on
achievement of certain specified revenue targets between 1997 and 1998 (or 1999
at election of the Sellers) which, if earned would be paid in the first quarter
of 1999 or 2000. The contingent payments of up to $40 million are payable 12.5%
in cash (or more at the discretion of the Company) with the remainder in shares
of Common Stock. The amount of any contingent payments will be capitalized as
goodwill when paid and amortized over the remaining estimated recovery period.
EFFECTS OF INFLATION
Inflation has not had a material effect on the Company's revenue and income
from continuing operations in the past three years. Inflation is not expected
to have a material future effect.
QUARTERLY FLUCTUATIONS
The Company's revenues and operating results have varied substantially from
quarter to quarter and may continue to vary, depending upon the timing of
implementation of new computer-based testing contracts and contracts funded
under the Public and Non-public school or similar programs. Based on the
Company's limited experience, revenue generated by computer-based testing
services may vary based on the frequency or timing of delivery of individual
tests and the speed of test administrators' conversion of tests to computer-
based format. Revenue or profits in any period will not necessarily be
indicative of results in subsequent periods.
19
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(A) EXHIBITS:
The following exhibits are included herein:
(11) Statement re: Computation of Per Share Earnings
(B) REPORTS ON FORM 8-K
During the second quarter of 1997, the Company filed a report on Form 8-
K/A dated April 4, 1997 with respect to the filing of the WSI audited
financial statements; a report on Form 8-K/A dated April 9, 1997, with
respect to the filing of WSI pro forma financial statements; a report on
Form 8-K dated April 29, 1997, with respect to the Educational Inroads
acquisition; a report on Form 8-K/A dated May 20, 1997, with respect to the
termination of the NEC acquisition; and a report on Form 8-K dated June 11,
1997, with respect to the consummation of the Educational Inroads
acquisition.
SIGNATURES
- ----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on behalf by the undersigned
thereunto duly authorized.
Sylvan Learning Systems, Inc.
Date: August 13, 1997 /s/ B. Lee McGee
----------------------------
B. Lee McGee, Vice President
and Chief Financial Officer
20
<PAGE>
EXHIBIT 11 - STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
SYLVAN LEARNING SYSTEMS, INC.
($ in thousands, except per share amounts)
<TABLE>
<CAPTION>
QUARTERS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ -----------------------
1996 1997 1996 1997
------------------------ -----------------------
<S> <C> <C> <C> <C>
PRIMARY:
AVERAGE SHARES OUTSTANDING 22,734,650 25,455,500 22,689,460 25,397,101
DILUTIVE EFFECT OF STOCK OPTIONS - Based on the treasury
stock method using the average market price. 2,352,861 1,436,714 2,250,475 1,400,304
COMMON STOCK CONTINGENTLY ISSUABLE 65,806 173,385 65,806 173,385
------------------------ -----------------------
TOTAL 25,153,317 27,065,599 25,005,741 26,970,790
NET INCOME $3,032 $6,695 $4,811 $10,142
CONTINGENT GOODWILL AMORTIZATION FOR ACQUISITIONS $50 $192 $99 $384
------------------------ -----------------------
SUPPLEMENTAL NET INCOME $2,982 $6,503 $4,712 $9,758
PER SHARE AMOUNTS $0.12 $0.24 $0.19 $0.36
FULLY DILUTED:
AVERAGE SHARES OUTSTANDING 22,734,650 25,455,500 22,689,460 25,397,101
DILUTIVE EFFECT OF STOCK OPTIONS - Based on the treasury
stock method using the market price at the end of the year. 2,352,861 1,496,521 2,333,840 1,493,433
COMMON STOCK CONTINGENTLY ISSUABLE 65,806 173,385 65,806 173,385
------------------------ -----------------------
TOTAL 25,153,317 27,125,406 25,089,106 27,063,919
NET INCOME $3,032 $6,695 $4,811 $10,142
CONTINGENT GOODWILL AMORTIZATION FOR ACQUISITIONS $50 $192 $99 $384
------------------------ -----------------------
SUPPLEMENTAL NET INCOME $2,982 $6,503 $4,712 $9,758
PER SHARE AMOUNTS $0.12 $0.24 $0.19 $0.36
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997
<PERIOD-START> APR-01-1997 JAN-01-1997
<PERIOD-END> JUN-30-1997 JUN-30-1997
<CASH> 29,883 29,883
<SECURITIES> 10,081 10,081
<RECEIVABLES> 46,608 46,608
<ALLOWANCES> 1,510 1,510
<INVENTORY> 4,985 4,985
<CURRENT-ASSETS> 92,944 92,944
<PP&E> 42,755 42,755
<DEPRECIATION> 14,485 14,485
<TOTAL-ASSETS> 278,829 278,829
<CURRENT-LIABILITIES> 37,575 37,575
<BONDS> 0 0
259 259
0 0
<COMMON> 0 0
<OTHER-SE> 232,991 232,991
<TOTAL-LIABILITY-AND-EQUITY> 278,829 278,829
<SALES> 0 0
<TOTAL-REVENUES> 57,597 109,540
<CGS> 0 0
<TOTAL-COSTS> 75,844 122,434
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 231 413
<INCOME-PRETAX> 10,652 16,357
<INCOME-TAX> 3,957 6,215
<INCOME-CONTINUING> 6,695 10,142
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 0 0
<EPS-PRIMARY> .24 .36
<EPS-DILUTED> 0 0
</TABLE>
