<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 SEPTEMBER 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 30,334,370 shares of Common Stock outstanding as of November
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
September 30, 1997........................................... 3
Statements of Income - Three months ended
September 30, 1996, three months ended September 30, 1997.... 5
Statements of Income - Nine months ended September 30, 1996,
nine months ended September 30, 1997......................... 6
Statements of Cash Flows - Nine months ended
September 30, 1996, nine months ended September 30, 1997..... 7
Notes to Unaudited Financial Statements - September 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............................... 21
SIGNATURES................................................................ 21
</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, SEPTEMBER 30,
1996 1997
(RESTATED) (UNAUDITED)
------------ -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 11,198 $ 29,624
Available-for-sale securities 16,449 80,523
Receivables:
Accounts receivable 36,431 46,819
Costs and estimated earnings in excess of billings
on uncompleted contracts 3,565 3,153
Notes receivable 3,008 3,978
------------ -------------
43,004 53,950
Allowance for doubtful accounts (1,379) (1,465)
------------ -------------
41,625 52,485
Inventory 4,470 5,786
Deferred income taxes 620 625
Prepaid expenses 3,125 3,255
------------ -------------
Total current assets 77,487 172,298
Notes receivable, less current portion 563 2,668
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 550 274
Property and equipment:
Furniture and equipment 37,952 43,936
Leasehold improvements 5,544 6,883
------------ -------------
43,496 50,819
Accumulated depreciation (15,578) (16,145)
------------ -------------
27,918 34,674
Intangible assets:
Goodwill 103,986 104,671
Contract rights 13,881 13,973
Other 2,570 2,522
------------ -------------
120,437 121,166
Accumulated amortization (10,736) (15,161)
------------ -------------
109,701 106,005
Deferred contract costs, net of accumulated amortization
of $2,067 as of December 31, 1996 and $4,961 as of
September 30, 1997 13,230 10,647
Investments in affiliates 3,896 10,355
Other investments 24,220 25,752
Other assets 2,025 5,943
------------ -------------
Total assets $ 259,590 $ 368,616
============ =============
</TABLE>
3
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(RESTATED) (UNAUDITED)
<S> <C> <C>
Liabilities and stockholders' equity
Current liabilities:
Accounts payable and accrued expenses $ 28,576 $ 28,538
Bank lines of credit 1,000 -
Current portion of long-term debt 3,182 572
Due to former shareholders of Wall Street Institute 4,921 250
Deferred revenue 9,543 9,666
Other current liabilities 661 350
------------- -------------
Total current liabilities 47,883 39,376
Long-term debt, less current portion 2,170 -
Deferred income taxes 2,338 2,304
Due to former shareholders of Drake 8,143 -
Due to former shareholders of Wall Street Institute 15,150 -
Due to former shareholders of ICST & Inroads 3,233 -
Other long-term liabilities 350 354
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 September 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 28,887,292
as of September 30, 1997 240 289
Additional paid-in capital 168,547 299,186
Foreign currency translation adjustments (4) (779)
Unrealized holding losses on available for sale securities (11) -
Retained earnings 11,551 27,886
------------- -------------
Total stockholders' equity 180,323 326,582
------------- -------------
Total liabilities and stockholders' equity $ 259,590 $ 368,616
============= =============
</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
SEPTEMBER 30,
-----------------------
1996 1997
----------- -----------
(Unaudited) (Unaudited)
(Restated)
<S> <C> <C>
Revenues $ 41,482 $ 58,464
Cost and expenses:
Direct costs 32,141 44,013
General and administrative expenses 2,332 3,664
----------- -----------
Total expenses 34,473 47,677
----------- -----------
Operating income 7,009 10,787
Investment income 232 1,267
Interest expense (198) (13)
Equity in net income (loss) of
unconsolidated subsidiaries 196 (461)
----------- -----------
Income before income taxes 7,239 11,580
Income taxes (2,897) (4,053)
----------- -----------
Net income $ 4,342 $ 7,527
=========== ===========
Per common and common equivalent share
Net income $ 0.17 $ 0.25
=========== ===========
</TABLE>
See accompanying notes.
5
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
1996 1997
----------- -----------
(Unaudited) (Unaudited)
(Restated)
<S> <C> <C>
Revenues $ 130,196 $ 168,003
Cost and expenses:
Direct costs 108,281 149,573
General and administrative expenses 7,308 16,538
Loss on impairment of assets - 4,000
----------- -----------
Total expenses 115,589 170,111
----------- -----------
Operating income (loss) 14,607 (2,108)
Investment income 974 2,819
Income, net of transaction costs for termination
of acquisition - 28,500
Interest expense (637) (426)
Equity in net income (loss) of unconsolidated
subsidiaries 449 (848)
----------- -----------
Income before income taxes 15,393 27,937
Income taxes (6,240) (10,268)
----------- -----------
Net income $ 9,153 $ 17,669
=========== ===========
Per common and common equivalent share
Net income $ 0.36 $ 0.61
=========== ===========
</TABLE>
See accompanying notes.
6
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
($ IN THOUSANDS)
<TABLE>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
1996 1997
----------- ----------
(Unaudited) (Unaudited)
(Restated)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 9,153 $ 17,669
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 3,941 5,588
Amortization 5,287 7,319
Non-cash issuance of common stock - 18,500
Loss on impairment of assets - 4,000
Provision for doubtful accounts 159 179
Deferred income taxes - (34)
Equity in net loss (income) of unconsolidated subsidiaries (450) 848
Changes in operating assets and liabilities:
Accounts and notes receivable (4,752) (13,557)
Cost and estimated earnings in excess of billings
on uncompleted contracts - 688
Inventory (251) (1,317)
Prepaid expenses (532) (221)
Other assets (1,149) (2,406)
Accounts payable and accrued expenses 1,581 (1,384)
Billings in excess of costs and estimated earnings
on uncompleted contracts (251) 46
Other current liabilities (342) -
Deferred revenue and other long-term liabilities 261 203
--------- ----------
Net cash provided by operating activities 12,655 36,121
--------- ----------
INVESTING ACTIVITIES
Purchase of available-for-sale securities (30,243) (75,269)
Proceeds from sale of available-for-sale securities 44,571 11,194
Increase in investments in and advances to affiliates - (6,907)
Increase in other investments - (1,870)
Purchase of property and equipment (5,256) (17,787)
Proceeds from sale of property and equipment 116 1,254
Contract termination fee paid to
Drake Authorized Testing Centers (4,433) -
Purchase of contract rights (4,872) -
Cash paid for intangible assets - (665)
Expenditures for deferred contract costs and other
assets (3,244) (1,671)
--------- ----------
Net cash used in investing activities (3,361) (91,721)
--------- ----------
FINANCING ACTIVITIES
Payments to former shareholders of WSI - (4,671)
Payments to former shareholders of Pace - (369)
Proceeds from exercise of options and warrants 2,171 12,304
Proceeds from issuance of long term debt 338 -
Proceeds from issuance of common stock 440 73,430
Payments on long-term debt and capital lease obligations (2,452) (4,893)
Paydown of line of credit (3,500) (1,000)
--------- ----------
Net cash provided by (used in) financing activities (3,003) 74,801
--------- ----------
Effects of exchange rate changes on cash (164) (775)
--------- ----------
Net increase in cash and cash equivalents 6,127 18,426
Cash and cash equivalents at beginning of period 2,903 11,198
--------- ----------
Cash and cash equivalents at end of period $ 9,030 $ 29,624
========= =========
</TABLE>
See accompanying notes.
7
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SEPTEMBER 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 nine months ended September 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 nine month periods ended September 30, 1997 and 1996
are based on the estimated effective tax rates applicable for the full years.
The Company's income tax provision of $10,268 for the nine month period ended
September 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 September 30, 1997 and 1996 was 29,360,284 and 25,115,151,
respectively. The weighted average number of shares used for the nine month
periods ended September 30, 1997 and 1996 was 27,780,887 and 25,038,781,
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 September 30, 1997 and 1996
of $0.01 and $0.02 per share, respectively and for the nine month periods ended
September 30, 1997 and 1996 of $0.03 and $0.03, respectively. The impact of
Statement 128 on the calculation of fully diluted earnings per share for these
periods is not expected to be material.
NOTE D - RECLASSIFICATIONS
-----------------
Certain amounts in the 1996 financial statements have been reclassified to
conform with the 1997 presentation.
NOTE E - ACQUISITIONS
------------
On May 30, 1997, the Company acquired by merger all of the outstanding
stock of I-R, Inc. and Independent Child Study Teams, Inc. (collectively,
"Educational Inroads") in exchange for 1,414,000 shares of common stock. I-R,
Inc. and Independent Child Study Teams, Inc. were commonly owned by two
shareholders. The acquisition was accounted for as a pooling-of-interests and
accordingly, the Company's consolidated financial statements for periods prior
to the merger have been restated to include the combined results of operations,
financial position and cash flows of Educational Inroads.
Educational Inroads provides remedial and special education services to
public and non-public school systems, with current contracts in New Jersey,
Maryland, Louisiana, Washington, D.C. and other school districts.
Combined and separate results of operations of Sylvan and Educational
Inroads during the periods prior to the acquisition are as follows:
9
<PAGE>
<TABLE>
<CAPTION>
Sylvan Independent
Learning Child Study
Systems, Inc. I-R, Inc. Teams, Inc. Combined
------------- ------------- ------------- -------------
($ in thousands, except per share amounts)
<S> <C> <C> <C> <C>
THREE MONTHS ENDED
SEPTEMBER 30, 1996
Revenues $ 38,685 $ 1,453 $ 1,344 $ 41,482
Net income $ 4,342 $ -- $ -- $ 4,342
Net income per share $ 0.18 $ 0.17
NINE MONTHS ENDED
SEPTEMBER 30, 1996
Revenues $ 112,812 $ 7,124 $ 10,260 $ 130,196
Net income $ 9,153 $ -- $ -- $ 9,153
Net income per share $ 0.38 $ 0.36
</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 $187,500, and it is expected that the aggregate duties and
responsibilities of these two individuals will not be diminished to the extent
that other costs will be incurred. In addition, both Sylvan and Educational
Inroads incurred legal and transaction costs which are non-recurring in nature.
The following supplemental pro forma information for the three-month and nine-
month periods ended September 30, 1997 and 1996 is presented solely as a result
of the changed circumstances that exist following the consummation of the
merger, and is necessary to realistically assess the impact of the combination.
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1996 1997 1996 1997
----------- ----------- ----------- -----------
($ in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Combined net income $ 4,342 $ 7,527 $ 9,153 $ 17,669
Contractual reduction to be made in (611) -- 858 800
compensation
Legal and transactions costs -- -- -- 400
Related income taxes (at 40%) 244 -- (343) (480)
----------- ----------- ----------- -----------
(367) -- 515 720
----------- ----------- ----------- -----------
Pro forma net income after contractual
reduction in compensation $ 3,975 $ 7,527 $ 9,668 $ 18,389
=========== =========== =========== ===========
Pro forma net income per share $ 0.16 $ 0.25 $ 0.38 $ 0.64
=========== =========== =========== ===========
</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 1,121,530 shares of common
stock, including income tax benefit of 12,951
$8,342 11 12,940
Issuance of 357,143 Revenue Escrow
Shares of common stock in connection
with the acquisition of Drake 4 8,139 8,143
Issuance of 714,884 shares of 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 common
stock to NAC 2 4,998 5,000
Issuance of 2,062,292 shares of common
stock in secondary stock offering -
net of offering costs 20 73,410 73,430
Forgiveness of debt of former
shareholders of Educational Inroads 2,811 2,811
Distributions to former shareholders of
Educational Inroads (1,334) (1,334)
Foreign currency translation adjustment (775) (775)
Unrealized holding gain 11 11
Net income for the nine months ended
September 30 1997 17,669 17,669
----------- ----------- ----------- ----------- ----------- -------------
Balance at September 30, 1997 $ 289 $ 299,186 $ 0 $ (779) $ 27,886 $ 326,582
=========== =========== =========== =========== =========== =============
</TABLE>
11
<PAGE>
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 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 the third quarter of 1997, the Company completed a secondary stock offering
and issued 2,062,292 shares of its Common Stock for net proceeds of $73.4
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
12
<PAGE>
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.
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 nine
month periods ended September 30, 1996 and 1997 is derived from the Company's
consolidated financial statements.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1996 1997 1996 1997
------- ------- ------- -------
(In thousands)
<S> <C> <C> <C> <C>
Operating Revenue:
Core educational services...... $ 9,850 $11,207 $ 25,107 $ 31,192
Contract educational services.. 8,563 9,917 40,962 45,817
Testing services............... 23,069 37,340 64,127 90,994
------- ------- -------- --------
Total revenue............... $41,482 $58,464 $130,196 $168,003
======= ======= ======== ========
Direct costs:
Core educational services...... $ 6,742 $ 7,749 $ 17,607 $ 27,185
Contract educational services.. 7,954 7,855 38,002 39,736
Testing services............... 17,445 28,409 52,672 82,652
------- ------- -------- --------
Total direct costs.......... $32,141 $44,013 $108,281 $149,573
======= ======= ======== ========
</TABLE>
13
<PAGE>
RESULTS OF OPERATIONS
Comparison of results for the quarter and nine months ended September 30, 1997
to results for the quarter and nine months ended September 30, 1996.
Revenue. Total revenues increased by $17.0 million, or 41% to $58.5 million for
the quarter ended September 30, 1997 and increased by $37.8 million or 29%, to
$168.0 million for the nine months ended September 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 $1.4 million, or 14%, to
$11.2 million during the third quarter of 1997 and by $6.1 million, or 24%, to
$31.2 million for the first nine months of 1997 compared to the comparable 1996
periods. Franchise royalties increased by $300,000, or 9.0%, to $3.4 million
for the quarter ended September 30, 1997 and by $1.4 million, or 16%, to $10.0
million for the first nine months of 1997 compared to the comparable 1996
periods. This increase in franchise royalties was due to the net increase of 41
new Centers in new territories and 11 new satellite Centers (Centers operating
within existing franchise territories) opened during the first nine months of
1997, combined with an overall 12% increase in revenues at existing Learning
Centers open for more than one year. Franchise sales fees increased $500,000 to
$1.0 million for the quarter ended September 30, 1997 and increased $1.3 million
to $2.2 million for the first nine months of 1997, compared to the same periods
in 1996. For the nine months ended September 30, 1997, there were 32 franchise
Center licenses and three area development agreements totaling $1.1 million
sold, compared to 22 franchise Center licenses and two area development
agreements totaling $530,000 sold in the first nine months of 1996.
Revenue from Company-owned Learning Centers increased by $500,000, or 10%,
to $5.9 million during the third quarter of 1997 and by $3.5 million, or 28%, to
$16.3 million during the first nine months of 1997 compared to the comparable
periods in 1996. Substantially all of this increase for the third quarter and
$1.7 million of the increase for the nine month period was generated from the
acquisition of eight centers which occurred after September 30, 1996. The
remaining increase in revenues for the nine month period related to increased
student enrollments in centers which existed in both nine month periods.
Contract educational services revenue increased by $1.4 million, or 16%, to
$9.9 million for the quarter ended September 30, 1997, and by $4.9 million, or
12%, to $45.8 million for the nine months ended September 30, 1997. Revenue
from Public/Non-public school contracts decreased by $300,000 for the quarter
ended September 30, 1997, and increased by $600,000 for the nine months ended
September 30, 1997. Revenue from PACE training services increased by $1.7
million for the quarter ended September 30, 1997, and increased $4.3 million for
the nine months ended September 30, 1997,
14
<PAGE>
primarily the result of services provided to new customers. Revenue from
Public/Non-public school contracts decreased for the quarter ended September 30,
1997 compared to the 1996 quarter primarily due to revenues earned from one time
summer contracts in the 1996 period. Revenue from Public/Non-public school
contracts increased for the nine months ended September 30, 1997 compared to the
1996 period, as a result of expansion of services to existing districts and
contracts obtained with new districts after September 30, 1996 partially offset
by the reduction due to the one time 1996 contracts discussed above.
Testing services revenue increased by $14.3 million or 62% to $37.3 million
during the third quarter of 1997 and by $26.9 million, or 42% to $91.0 million
during the first nine months of 1997 compared to the same periods in 1996. The
increase in testing services revenue for the third quarter and nine months ended
September 30, 1997 resulted mainly from increased services under Educational
Testing Service (ETS) contracts, which included the cost-plus international
contract, GRE, TOEFL and PRAXIS, and certain volume-based pricing adjustments.
In addition, the Wall Street Institute International, B.V. and its commonly
controlled affiliates (collectively, "WSI"), which the Company acquired during
the fourth quarter 1996, and increased testing services by the Armed Services
Vocational Aptitude Battery (ASVAB) contributed to the increased revenues.
Cost and Expenses. Total direct costs increased 37% from $32.1 million in the
third quarter of 1996 to $44.0 million in the third quarter of 1997 but
decreased as a percentage of total revenues from 77% in the third quarter of
1996 to 75% in the third quarter of 1997. Total direct costs increased 38% from
$108.3 million in the first nine months of 1996 to $149.6 million in the first
nine months of 1997 and increased as a percentage of total revenues from 83% in
the 1996 period to 89% 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 80% for the nine months ended
September 30, 1997.
Core educational services expenses increased by $1.0 million to $7.7
million, or 69% of core educational services revenue for the quarter ended
September 30, 1997, compared to $6.7 million or 68% of core educational services
revenue for the quarter ended September 30, 1996. Core educational services
expenses increased by $9.6 million to $27.2 million, or 87% of core educational
services revenue for the nine months ended September 30, 1997, compared to $17.6
million or 70% of core educational services revenue for the nine months ended
September 30, 1996. Included in core educational services expense for the nine
month 1997 period 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. Excluding these non-
recurring charges, total core educational services expenses as a percentage of
core educational services revenue would be 71% for the nine months ended
September 30, 1997.
15
<PAGE>
Company-owned Learning Center expenses increased 12%, from $4.4 million in the
third quarter of 1996 to $5.0 million in the third quarter of 1997. Company-
owned Learning Center expenses increased 28%, from $10.8 million for the first
nine months of 1996 to $13.7 million for the first nine months of 1997. $600,000
of the third quarter expense increase and $1.5 million of the year to date
increase relates to the acquisition of eight Centers from three franchisees. The
remaining increase in expenses was primarily related to advertising and labor
associated with increases in Center enrollment. As a percentage of revenue,
expenses for Company-owned Centers increased from 82% of revenues to 84% of
revenues for the third quarter, but held constant at 84% of revenue for the nine
month period ended September 30, 1997 compared to the same period in 1996.
Contract educational services expense decreased by $100,000 to $7.9
million, or 79% of contract educational services revenue for the quarter ended
September 30, 1997, compared to $8.0 million or 93% of contract services revenue
for the third quarter of 1996, and increased by $1.7 million to $39.8 million,
or 87% of contract educational services revenue during the nine months ended
September 30, 1997, compared to $38.0 million or 93% of contract educational
services revenue during the first nine months of 1996. The decrease in contract
educational services expense as a percentage of revenue for the quarter and nine
month period ended September 30, 1997 versus the comparable periods of 1996 is
the result of increased profit margins for PACE and Public/Non-public school
contract services in 1997, as well as a higher mix of revenue from PACE
contracts in 1997 which generate a higher profit margin than Public/Non-public
school contract services.
Testing services expenses for the third quarter of 1997 increased by $11.0
million to $28.4 million, or 76% of total testing services revenue, compared to
$17.4 million, or 76% of total testing services revenue for the third quarter of
1996. Testing services expense for the first nine months of 1997 increased by
$30.0 million to $82.7 million, or 91% of total testing revenue, compared to
$52.7 million, or 82% of total testing services revenue for the same period in
1996. During the first nine months of 1997, the increase in testing services
expenses as a percentage of testing services revenues was predominantly a result
of the marketing expenditures and contributions of $10 million after the breakup
of the NEC acquisition. The 1996 expenses include $2.4 million of non-recurring
charges related to the Drake acquisition, incurred during the first and second
quarter of 1996. Therefore, the recurring expenses as a percentage of total
testing services revenue for the first nine months for 1997 and 1996 were 80%
and 78%, respectively. This increase in recurring expenses as a percentage of
testing services revenue was primarily due to lower margins on higher revenues
earned on the cost-plus ETS International contract and by increased salary and
other operating costs resulting from the expected growth in business volumes in
1997, offset in part by revenue increases from volume-based pricing adjustments
in the 1997 third quarter.
16
<PAGE>
General and administrative expenses increased by $1.3 million to $3.7
million during the third quarter of 1997 compared to the third quarter of 1996
but remained at 6% of revenue. General and administrative expenses increased by
$9.2 million to $16.5 million during the first nine months of 1997 compared to
the same period in 1996 and increased as a percentage of revenue from 6% to 10%.
Included in general and administrative expenses for the nine months ended
September 30, 1997 is a non-recurring expense 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 nine months ended September 30, 1997. The expenses did
not decrease as a percentage of revenues as a result of increased administrative
staff, leased space costs 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, net of $1.5 million of transaction
costs, is included as a separate component of non-operating income.
The Company's effective tax rate has decreased from 41% during the first
nine months of 1996 to 37% during the first nine 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 $36.1 million for the nine months
ended September 30, 1997 as compared to $12.7 million provided in the comparable
period of 1996. Cash flow from operations before working capital changes
increased from $18.1 million in the 1996 period to $54.1 million in the 1997
period, primarily as a result of the $30.0 million in cash received from the NEC
break up fee offset by the $1.5 million of transaction costs paid and the $3.0
million cash payment to a non-profit corporation formed to fund the Sylvan
Prometric division marketing programs, 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 29%
for the nine months ended September 30, 1997 compared to the same period in
1996. Specifically, of the $13.6 million operating cash flow reduction
attributable to an increase in accounts and notes receivable, $6.8 million is
attributable to increased revenues in the testing services business segment,
$2.6 million of which represents amounts owed the Company
17
<PAGE>
by the former shareholders of an acquired entity secured by the Company's stock
held in escrow 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 the core
educational services and contract educational services 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 nine months of 1997, the Company used a portion of the
proceeds of the secondary stock offering to purchase a net of $64.1 million of
available for sale securities.
The Company continues to incur expenditures for additions to property and
equipment, which totaled $17.8 million in the first nine 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 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 (6.81% at September 30, 1997). The Company had no outstanding balance on
the credit line at September 30, 1997.
During the first nine months of 1997, the Company received $12.3 million as
a result of the exercise of stock options and warrants to purchase 1,121,530
shares of Common Stock.
During the first nine months of 1997, the Company paid $4.7 million for the
purchase of WSI.
In the third quarter of 1997, the Company completed a secondary stock
offering and issued 2,062,292 shares of its Common Stock for net proceeds of
$73.4 million after underwriting costs and expenses. Also, in connection with
this offering, 453,888 options
18
<PAGE>
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.
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 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
19
<PAGE>
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.
20
<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 third quarter of 1997, the Company filed a report on Form 8-K,
dated July 15, 1997, with respect to the filing of restated audited
financial statements for the years ended December 31, 1994, 1995 and 1996
and restated unaudited financial statements for the three months ended
March 31, 1996 and 1997 related to 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: November 13, 1997 /s/ B. Lee McGee
----------------------------
B. Lee McGee, Vice President
and Chief Financial Officer
21
<PAGE>
EXHIBIT 11 - STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
SYLVAN LEARNING SYSTEMS, INC.
($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
QUARTERS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- -----------------------
1996 1997 1996 1997
-------------------------- -----------------------
<S> <C> <C> <C> <C>
PRIMARY:
AVERAGE SHARES OUTSTANDING 22,768,240 27,702,811 27,715,552 26,164,157
DILUTIVE EFFECT OF STOCK OPTIONS - Based on the treasury
stock method using the average market price. 2,249,726 1,343,173 2,226,044 1,172,682
COMMON STOCK CONTINGENTLY ISSUABLE 97,185 165,364 97,185 165,364
----------- ----------- ----------- -----------
TOTAL 25,115,151 29,211,348 25,038,781 27,502,203
=========== =========== =========== ===========
NET INCOME $ 4,342 $ 7,527 $ 9,153 $ 17,669
CONTINGENT GOODWILL AMORTIZATION FOR ACQUISITIONS 77 237 230 710
----------- ----------- ----------- -----------
SUPPLEMENTAL NET INCOME $ 4,265 $ 7,290 $ 8,923 $ 16,959
=========== =========== =========== ===========
PER SHARE AMOUNTS $ 0.17 $ 0.25 $ 0.36 $ 0.62
=========== =========== =========== ===========
FULLY DILUTED:
AVERAGE SHARES OUTSTANDING 22,768,240 27,702,812 22,715,554 26,164,157
DILUTIVE EFFECT OF STOCK OPTIONS - Based on the treasury
stock method using the average market price. 2,378,976 1,492,108 2,362,088 1,451,366
COMMON STOCK CONTINGENTLY ISSUABLE 97,185 165,364 97,185 165,364
----------- ----------- ----------- -----------
TOTAL 25,244,401 29,360,284 25,174,827 27,780,887
=========== =========== =========== ===========
NET INCOME $ 4,342 $ 7,527 $ 9,153 $ 17,669
CONTINGENT GOODWILL AMORTIZATION FOR ACQUISITIONS 77 237 230 710
----------- ----------- ----------- -----------
SUPPLEMENTAL NET INCOME $ 4,265 $ 7,290 $ 8,923 $ 16,959
=========== =========== =========== ===========
PER SHARE AMOUNTS $ 0.17 $ 0.25 $ 0.35 $ 0.61
=========== =========== =========== ===========
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997
<PERIOD-START> JUL-01-1997 JAN-01-1997
<PERIOD-END> SEP-30-1997 SEP-30-1997
<CASH> 29,624 29,624
<SECURITIES> 80,523 80,523
<RECEIVABLES> 53,950 53,950
<ALLOWANCES> 1,465 1,465
<INVENTORY> 5,786 5,786
<CURRENT-ASSETS> 172,298 172,298
<PP&E> 50,819 50,819
<DEPRECIATION> 16,145 16,145
<TOTAL-ASSETS> 368,616 368,616
<CURRENT-LIABILITIES> 39,376 39,376
<BONDS> 0 0
0 0
0 0
<COMMON> 289 289
<OTHER-SE> 326,293 326,293
<TOTAL-LIABILITY-AND-EQUITY> 368,616 368,616
<SALES> 0 0
<TOTAL-REVENUES> 58,464 168,003
<CGS> 0 0
<TOTAL-COSTS> 47,677 170,111
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 13 426
<INCOME-PRETAX> 11,580 27,937
<INCOME-TAX> 4,053 10,268
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 7,527 17,669
<EPS-PRIMARY> 0.25 0.61
<EPS-DILUTED> 0 0
</TABLE>
