<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 MARCH 31, 1998 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 29,770,293 shares of Common Stock outstanding as of April 30,
1998.
<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, 1997 and
March 31, 1998........................................... 3
Statements of Income - Three months ended
March 31, 1997, three months ended March 31, 1998........ 5
Statements of Cash Flows - Three months ended
March 31, 1997, three months ended March 31, 1998........ 6
Notes to Unaudited Financial Statements - March 31, 1998.. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 12
PART II. - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K........................... 18
SIGNATURES................................................................ 18
</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, March 31,
1997 1998
-------------- -------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 23,150 $ 25,160
Available-for-sale securities 82,925 57,880
Receivables:
Accounts receivable 56,188 54,329
Costs and estimated earnings in excess of billings
on uncompleted contracts 3,900 6,463
Notes receivable 2,943 3,201
Other receivables 7,000 -
-------------- -------------
70,031 63,993
Allowance for doubtful accounts (1,755) (1,970)
-------------- -------------
68,276 62,023
Inventory 4,777 6,802
Deferred income taxes 3,738 3,719
Prepaid expenses and other current assets 3,675 5,107
-------------- -------------
Total current assets 186,541 160,691
Notes receivable, less current portion 6,232 6,176
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 352 161
Property and equipment:
Furniture and equipment 55,381 67,099
Leasehold improvements 7,650 8,250
-------------- -------------
63,031 75,349
Accumulated depreciation (18,725) (21,602)
-------------- -------------
44,306 53,747
Intangible assets:
Goodwill 182,168 205,750
Contract rights 13,973 13,973
Other 2,522 2,777
-------------- -------------
198,663 222,500
Accumulated amortization (16,649) (18,975)
-------------- -------------
182,014 203,525
Deferred contract costs, net of accumulated amortization
of $6,205 as of December 31, 1997 and $7,500
as of March 31, 1998 10,324 11,767
Investments in and advances to affiliates 12,464 16,024
Other investments 28,017 28,524
Other assets 3,266 4,490
-------------- -------------
Total assets 473,516 485,105
============== =============
</TABLE>
3
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ IN THOUSANDS)
<TABLE>
<CAPTION>
December 31, March 31,
1997 1998
--------------- -------------
<S> <C> <C>
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 36,435 $ 39,367
Income taxes payable 4,876 4,879
Current portion of long-term debt 930 1,318
Current portion of due to shareholders of
acquired companies 13,794 13,870
Deferred revenue 11,752 11,512
Other current liabilities 780 979
--------------- -------------
Total current liabilities 68,567 71,925
Deferred income taxes 7,335 7,335
Due to shareholders of acquired companies,
less current portion 56,366 31,365
Other long-term liabilities 877 359
Commitments and contingent liabilities - -
--------------- -------------
Total liabilities 133,145 110,984
--------------- -------------
Stockholders' equity:
Preferred stock, par value $.01 per share--authorized
10,000,000 shares, no shares issued and
outstanding as of December 31, 1997 and March 31,
1998 - -
Common stock, par value $.01 per share--authorized
40,000,000 shares, issued and outstanding shares of
28,964,278 as of December 31, 1996 and 29,743,660
as of March 31, 1998 290 297
Additional paid-in capital 301,391 329,518
Retained earnings 39,652 45,340
Foreign currency translation adjustments (962) (1,034)
--------------- -------------
Total stockholders' equity 340,371 374,121
--------------- -------------
Total liabilities and stockholders' equity $ 473,516 $ 485,105
=============== =============
</TABLE>
See accompanying notes.
4
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------------
1997 1998
----------------------------------
<S> <C> <C>
REVENUES 51,944 $ 75,356
COST AND EXPENSES
Direct costs 43,630 63,915
General and administrative expense 2,961 3,327
--------------- --------------
Total expenses 46,591 67,242
--------------- --------------
Operating income 5,353 8,114
OTHER INCOME (EXPENSE)
Investment and other income 662 1,594
Interest expense (182) (67)
Equity in net loss of affiliates (128) (1,212)
--------------- --------------
Income before income taxes 5,705 8,429
Income taxes (2,258) (2,782)
--------------- --------------
Net income 3,447 $ 5,647
=============== ==============
Earnings per common share, basic $0.14 $0.19
=============== ==============
Earnings per common share, diluted $0.13 $0.18
=============== ==============
</TABLE>
See accompanying notes.
5
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
($ IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------------
1997 1998
--------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 3,447 $ 5,647
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation 1,860 2,806
Amortization 2,106 3,384
Non-cash dividend income (500) (500)
Provision for doubtful accounts 40 175
Equity in net loss of affiliates 128 1,211
Changes in operating assets and liabilities:
Accounts and notes receivable (3,522) 9,084
Cost and estimated earnings in excess of billings
on uncompleted contracts 953 (2,372)
Inventory 29 (744)
Prepaid expenses and other current assets 813 (1,324)
Other assets (902) (1,224)
Accounts and notes payable and accrued expenses (5,675) 2,654
Billings in excess of costs and estimated earnings
on uncompleted contracts 553 392
Other current liabilities (87) 207
Deferred revenue and other long-term liabilities 618 (1,555)
----------- -------------
Net cash provided by (used in) operating activities (139) 17,841
----------- -------------
INVESTING ACTIVITIES
Purchase of available-for-sale securities (4,827) (4,354)
Proceeds from sale of available-for-sale securities 11,045 29,400
Investment in and advances to affiliates (880) (4,778)
Increase in other investments (742) -
Purchase of property and equipment (2,533) (11,348)
Proceeds from sale of property and equipment 43 -
Cash paid for Canter, net of cash received - (24,262)
Cash paid for other acquired businesses, net of cash received - (24)
Increase in other intangible assets - (255)
Expenditures for deferred contract costs and other assets (11) (193)
----------- -------------
Net cash provided by (used in) investing activities 2,095 (15,814)
----------- -------------
FINANCING ACTIVITIES
Payments on loans from stockholders of acquired companies (4,671) (15)
Proceeds from exercise of options and warrants 922 1,403
Distributions to shareholders of pooled entity (550) -
Payments on long-term debt and capital lease obligations (2,932) (789)
Proceeds from issuance of long-term debt 56 -
Payments on bank lines of credit - (544)
Proceeds from bank lines of credit 7,164 -
----------- -------------
Net cash provided by (used in) financing activities (11) 55
----------- -------------
Effects of exchange rate changes on cash (354) (72)
----------- -------------
Net increase in cash and cash equivalents 1,591 2,010
Cash and cash equivalents at beginning of period 11,198 23,150
----------- -------------
Cash and cash equivalents at end of period $ 12,789 $ 25,160
=========== =============
</TABLE>
See accompanying notes.
6
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
MARCH 31, 1998
NOTE A - BASIS OF PRESENTATION
---------------------
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three months ended March 31, 1998 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 1998. 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, 1997.
NOTE B - INCOME TAXES
------------
The tax provisions for the three month periods ended March 31, 1998 and
1997 are based on the estimated effective tax rates applicable for the full
years. The Company's income tax provision of $2.8 million for the three month
period ended March 31, 1998 consists of federal, state, and foreign income
taxes. The Company's effective tax rate has decreased from 40% during the first
quarter of 1997 to 33% during the first quarter of 1998 mainly due to the effect
of higher earnings levels in certain lower tax jurisdictions.
7
<PAGE>
NOTE C - EARNINGS PER SHARE
------------------
The following table summarizes the computations of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
Three Months ended March 31,
----------------------------
1997 1998
------- -------
<S> <C> <C>
Numerator used in basic and diluted
earnings per common share:
Net income $ 3,447 $ 5,647
======= =======
Denominator:
Denominator for basic earnings per common
share weighted average shares 25,379 30,504
Effect of dilutive securities:
Employee stock options 1,679 1,444
Common stock contingently issuable 193 -
------- -------
Total dilutive potential common shares 1,872 1,444
------- -------
Denominator for diluted earnings per common
share weighted average shares and
assumed conversions 27,251 31,948
======= =======
Earnings per common share, basic $ 0.14 $ 0.19
Earnings per common share, diluted $ 0.13 $ 0.18
</TABLE>
NOTE D - RECLASSIFICATIONS
-----------------
Certain amounts in the 1997 financial statements have been reclassified to
conform with the 1998 presentation.
Note E - ACQUISITIONS
------------
Effective January 1, 1998 the Company acquired all of the outstanding stock
of Canter and Associates, Inc. and Canter Educational Productions, Inc.
(collectively, "Canter"), commonly controlled companies, for an initial purchase
price of $25 million in cash. Additional contingent consideration is payable
over the next three years based upon Canter's meeting certain earnings
thresholds. The acquisition was accounted for using the purchase method of
accounting. During the first quarter of 1998, goodwill of
8
<PAGE>
approximately $23.6 million was recorded and is being amortized over a period of
25 years. Results of operations of Canter are included in the accompanying 1998
consolidated statement of income from January 1, 1998.
Canter develops and markets staff development materials, including books
and videotapes for teachers, as well as graduate level courses for educators
that are delivered primarily through distance learning. The companies provide
courseware for a complete distance learning Master's program offered by five
independent colleges and universities. Additionally, Canter provides courseware
for 11 other graduate level courses that are offered by 14 independent colleges
and universities nationwide.
NOTE F - SUBSEQUENT EVENTS
-----------------
The Company has authorized a 3 for 2 stock split of its Common Stock to be
effective in the form of a stock dividend which will be distributed on May 22,
1998 to shareholders of record at the close of business on April 1, 1998.
Holders of the Company's Common Stock will receive a stock dividend at the rate
of 1/2 share of Common Stock for each share of Common Stock owned. Shareholders
will not be entitled to receive any resulting fractional shares, but will
receive the value of any such fractional shares in cash.
On April 13, 1998, the Company announced it has entered into an agreement
to acquire all of the outstanding stock of privately held ASPECT in a merger
transaction that would be accounted for as a pooling-of-interests, in exchange
for Sylvan common stock valued at $65 million. This transaction was consummated
on May 6, 1998.
ASPECT, which had 1997 revenues of approximately $52 million, is a leading
provider of English as a Second Language programs for college-age students.
Founded in 1992, ASPECT delivers intensive English language programs at 19
schools in five countries.
9
<PAGE>
NOTE G - STOCKHOLDERS' EQUITY
--------------------
The components of stockholders' equity are as follows:
<TABLE>
<CAPTION>
Foreign
Additional Currency Total
Common Paid-In Retained Translation Stockholders'
Stock Capital Earnings Adjustments Equity
------------- --------------- --------------- ------------------ ------------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1998
$290 $301,391 $39,652 $ (962) $340,371
Options exercised for purchase
of 69 shares of common stock,
including income tax benefit
of $458 1 1,860 1,861
Issuance of 643 shares of
common stock in connection
with the acquisition of
NAI/Block 6 25,710 25,716
Issuance of 53 shares of common
stock in connection with other
acquisitions 119 41 160
Issuance of 15 shares of common
stock in connection with the
Employee Stock Purchase Plan 438 438
Foreign currency translation
adjustment (72) (72)
Net income for the three months
ended March 31, 1998 5,647 5,647
--------------- ----------------- ----------------- ----------------- -----------------
Balance at March 31, 1998 $297 $329,518 $45,340 $(1,034) $374,121
=============== ================= ================= ================= =================
</TABLE>
NOTE H - CONTINGENCIES
-------------
From time to time, the Company may be a party to routine litigation
incidental to its business. At this time, the Company is the defendant in a
legal proceeding pending in the United States District Court for the Northern
District of Iowa, Civil Action No. C96-334MJM, filed on November 18, 1996 by
ACT, Inc., an Iowa nonprofit corporation formerly known as American College
Testing Program, Inc. ("ACT"). ACT's claim arises out of the Company's purchase
of contract rights to administer testing services for the National Association
of Securities Dealers, Inc. ("NASD"). ACT has asserted that the Company
tortuously interfered with ACT's relations, contractual and quasi-contractual,
with the NASD, caused ACT to suffer the loss of its advantageous economic
prospects with the NASD and other ACT clients and that the Company has
monopolized and attempted to monopolize the computer-based testing services
market. ACT has claimed unspecified amounts of compensatory, treble and
punitive damages, as well as injunctive relief. The Company believes that all
of ACT's claims are without merit.
10
<PAGE>
NOTE I - BUSINESS SEGMENT INFORMATION
----------------------------
<TABLE>
<CAPTION>
Three months ended March 31,
-----------------------------------
1997 1998
----------- -----------
<S> <C> <C>
Operating revenues:
Learning Centers $ 9,231 $ 12,136
Contract Educational Services 17,574 26,620
Sylvan Prometric 25,139 36,600
-------- --------
$ 51,944 $ 75,356
======== ========
Segment profit:
Learning Centers $ 2,402 $ 2,707
Contract Educational Services 1,406 3,806
Sylvan Prometric 4,506 4,928
-------- --------
$ 8,314 $ 11,441
======== ========
Segment assets:
Learning Centers $ 21,694 $ 27,840
Contract Educational Services 28,820 82,382
Sylvan Prometric 147,894 254,575
-------- --------
$198,408 $364,797
======== ========
</TABLE>
There have been no changes since December 31, 1997 in the Company's method
for identification of reportable segments or for determination of segment profit
or loss. There are no significant intercompany sales or transfers. The following
table reconciles the reported information on segment profit to income before
income taxes reported in the consolidated statements of income for the three
months ended March 31, 1997 and 1998, respectively:
<TABLE>
<CAPTION>
Three months ended March 31,
------------------------------
1997 1998
---------- ----------
<S> <C> <C>
Total profit for reportable segments $ 8,314 $11,441
Corporate general and administrative expense (2,961) (3,327)
Other income (expense) 352 315
------- -------
Income before income taxes $ 5,705 $ 8,429
======= =======
</TABLE>
11
<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 DRAKE ACQUISITION, 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; AMOUNT OF REVENUES EARNED BY THE COMPANY'S TESTING
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 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 the operations of the Wall
Street Institute ("WSI"); 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 as well as providing
teacher training services. The following selected segment data for the quarters
ended March 31, 1997 and 1998 is derived from the Company's unaudited
consolidated financial statements.
<TABLE>
<CAPTION>
Three Months
Ended March 31,
----------------
1997 1998
------- -------
(In thousands)
<S> <C> <C>
Operating Revenue:
Core educational services...... $ 9,231 $12,136
Contract educational services.. 17,574 26,620
Testing services............... 25,139 36,600
------- -------
Total revenue............... $51,944 $75,356
======= =======
Direct costs:
Core educational services...... $ 6,829 $ 9,429
Contract educational services.. 16,168 22,814
Testing services............... 20,633 31,672
------- -------
Total direct costs.......... $43,630 $63,915
======= =======
</TABLE>
12
<PAGE>
RESULTS OF OPERATIONS
Comparison of results for the quarter ended March 31, 1998 to results for the
quarter ended March 31, 1997.
Revenue. Total revenues increased by $23.4 million, or 45% to $75.4 million for
the quarter ended March 31, 1998, compared to the same period in 1997. 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 $2.9 million, or 31%, to
$12.1 million during the first quarter of 1998, compared to the same period in
1997. Franchise royalties increased by $500,000, or 16%, to $3.5 million for
the quarter ended March 31, 1998, compared to the same period in 1997. The
increase in franchise royalties was due to an overall 14% increase in revenues
at existing Learning Centers open for more than one year combined with royalties
generated at a net of 29 new Centers opened after March 31, 1997. Franchise
sales fees decreased $500,000 to $200,000 for the quarter ended March 31, 1998,
compared to the same period in 1997. For the three months ended March 31, 1998,
there were four territory sales and no area development agreements sold,
compared to five territory sales and a $500,000 area development agreement sold
in the first three months of 1997.
Revenue from Company-owned Learning Centers increased by $2.1 million, or
43%, to $7.0 million during the first quarter of 1998, compared to the first
quarter of 1997. Company-owned same center revenues increased 10%, or $600,000,
with the remaining increase of $1.5 million generated from the acquisition of 13
Centers from certain franchisees which occurred after March 31, 1997.
Product sales increased by $500,000, or 73%, to $1.1 million. The remaining
increase in core educational services revenue was generated by other franchise
service income.
Contract educational services revenue increased by $9.0 million, or 51%, to
$26.6 million for the quarter ended March 31, 1998, compared to the first
quarter of 1997. The revenue increase was the result of a $6.7 million increase
in revenue from the Canter Group, a provider of teacher training services which
was acquired in January 1998, a $1.9 million increase in revenue from public
and non-public school contracts and a $400,000 increase in revenue from PACE
services.
Revenue from public and nonpublic school contracts obtained during 1998
contributed $2.9 million to the revenue increase for the first quarter of 1998.
The first quarter of 1997 included $1.0 million of revenue from a segment of
Educational Inroads, which was a non-related business activity, and was disposed
of after it was acquired in
13
<PAGE>
1997. Revenue from existing public and nonpublic school contracts was consistent
with the prior year.
Testing services revenue increased by $11.5 million or 46% to $36.6 million
during the first quarter of 1998 compared to the first quarter of 1997.
NAI/Block, acquired during the fourth quarter of 1997, accounted for $3.1
million of the revenue growth. Without the acquisition, revenue growth would
have been 33% for the quarter. Academic admissions testing revenues increased
97% compared to the first quarter of 1997 primarily due to volume increases
under Educational Testing Service (ETS) contracts, which included the
international cost-plus contract, the Graduate Record Examinations (GRE),
Graduate Management Admission Test (GMAT) and Test of English as a Foreign
Language (TOEFL). Information Technology and professional certification testing
revenues increased 35% and 18%, respectively, over the comparable 1997 period
mainly due to volume increases. Revenues from Wall Street Institute (WSI),
Sylvan's international chain of English language centers, decreased compared to
the first quarter of 1997 as a result of master franchise sales recorded in 1997
with none recognized in the 1998 quarter.
Cost and Expenses. Total direct costs increased 46% from $43.6 million in the
first quarter of 1997 to $63.9 million in the first quarter of 1998 and
increased as a percentage of total revenues from 84% to 85%. The overall margin
reduction was mainly the result of reduced margins in the testing services
division.
Core educational services expenses increased by $2.6 million to $9.4
million, or 78% of core educational services revenue for the quarter ended March
31, 1998, compared to $6.8 million or 74% of core educational services revenue
for the quarter ended March 31, 1997. The Company incurred $400,000 for the
development of certain educational programs that were not incurred in the first
quarter of the prior year which are not expected to continue. Excluding such
non-recurring expenses, core educational services expenses were 74% of core
educational services revenues for the first quarter of 1998. Company-owned
Learning Center expenses increased 37%, from $4.3 million in the first quarter
of 1997 to $5.9 million in the first quarter of 1998. The 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 decreased from 88% of revenues to 85% of revenues for the first quarter
of 1998, compared to the same period in 1997.
Contract educational services expense increased by $6.6 million to $22.8
million, or 86% of contract educational services revenue for the quarter ended
March 31, 1998, compared to $16.2 million or 92% of contract services revenue
for the first quarter of 1997. The increase in contract educational services
expense for the quarter ended March 31, 1998 versus the comparable period of
1997 is the result of a $300,000 increase in costs from public and nonpublic
school contracts and a $6.3 million increase in costs from PACE services and the
Canter Group, which was acquired in January 1998. The
14
<PAGE>
decrease in contract educational expenses as a percentage of revenue for the
first quarter of 1998 versus 1997 is the result of our ability to leverage our
increasing student volumes over the fixed cost infrastructure of this division.
Testing services expenses for the first quarter of 1998 increased by $11.1
million to $31.7 million, or 87% of total testing services revenue, compared to
$20.6 million, or 82% of total testing services revenue for the first quarter of
1997. The first quarter 1998 increase in expense of $11.1 million is directly
attributable to the increase in revenue from the same period in 1997. After
adjusting for the 1997 master franchise sales at WSI, the 1998 expenses and the
1997 expenses are the same at 87% of recurring revenue.
General and administrative expenses increased by $400,000 to $3.3 million
during the first quarter of 1998 compared to the first quarter of 1997 but
decreased as a percentage of revenue from 6% to 4% . The percentage decline
resulted from increased revenues from all business segments without
corresponding increases in administrative expenses.
The Company's effective tax rate has decreased from 40% during the first
quarter of 1997 to 33% during the first quarter of 1998 mainly due to the effect
of higher earnings levels in certain lower tax jurisdictions.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $17.8 million for the three
months ended March 31, 1998 as compared to $139,000 used in the comparable
period of 1997. Cash flow from operations before working capital changes
increased from $7.1 million in the 1997 period to $12.7 million in the 1998
period, primarily as a result of the significant overall growth in income from
Company operations before considering non-cash charges, which primarily consist
of depreciation, amortization and equity in the net losses of affiliates. Of the
$9.1 million operating cash flow increase attributable to a decrease in accounts
and notes receivable, $7.0 million relates to other receivables which was
collected during the first quarter of 1998. 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.
The Company continues to incur expenditures for additions to property and
equipment, which totaled $11.3 million in the first quarter of 1998. These
additions primarily consist of furniture and equipment for general business
expansion, including expenditures related to new public school contracts,
testing center expansions, equipment upgrades, internal software development and
equipment needed for overseas testing centers operated by the Company under the
ETS international testing contract. Under this contract with ETS, the Company
is reimbursed for overseas equipment expenditures
15
<PAGE>
as the equipment is depreciated. This reimbursement includes a financing charge
over the reimbursement period.
In connection with the PACE acquisition, the Company has recorded a
liability for additional consideration which is payable $14.5 million in cash
and $11.3 million in Common Stock. The payment and issuance of common stock will
be made during the second quarter of 1998 and will be recorded as goodwill to be
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 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 (5.69% at March 31, 1998). The Company had no outstanding balance on the
credit line at March 31,1998.
During the first three months of 1998, the Company received $1.4 million as
a result of the exercise of options to purchase 69,131 shares of Common Stock.
During the first three months of 1998, the Company paid $25.0 million for
the purchase of Canter, which was funded by the sale of available-for-sale
securities.
The Company believes that its capital resources will be sufficient on a
short term basis and over the next 24 months to fund continued expansion of the
business, including working capital needs and expected investments in property
and equipment.
CONTINGENT MATTERS
The agreement with Drake provides for future contingent payments based on
achievement of certain specified revenue targets in 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 recorded as goodwill when paid and
amortized over the remaining estimated recovery period.
16
<PAGE>
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.
17
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. REPORTS ON FORM 8-K
-------------------
(A) REPORTS ON FORM 8-K
During the first quarter of 1998, the Company filed a report on Form 8-K,
dated March 11, 1998, with respect to the filing of restated unaudited
financial statements for the quarters ended March 31, June 30 and September
30, 1997 related to the retroactive effect to the Company's adoption of
Statement of Financial Accounting Standards No. 128, Earnings Per Share, as
of December 31, 1997.
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: May 13, 1998
/s/ B. Lee McGee
----------------------------------------------------
B. Lee McGee, Executive Vice President
and Chief Financial Officer
18
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<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
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<SECURITIES> 57,880
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