<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, 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)
<TABLE>
<CAPTION>
<S> <C>
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)
</TABLE>
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 48,451,459 shares of Common Stock outstanding as of July 31,
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
June 30, 1998...................................... 3
Statements of Operations - Three months ended
June 30, 1997, three months ended June 30, 1998.... 5
Statements of Income - Six months ended
June 30, 1997, six months ended June 30, 1998.... 6
Statements of Cash Flows - Six months ended
June 30, 1997, six months ended June 30, 1998.... 7
Notes to Unaudited Financial Statements -
June 30, 1998.................................... 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 14
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, JUNE 30,
1997 1998
------------ ------------
(Restated) (Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 29,650 $ 26,721
Available-for-sale securities 82,926 38,021
Receivables:
Accounts receivable 62,431 63,946
Costs and estimated earnings in excess of billings
on uncompleted contracts 3,900 3,992
Notes receivable 2,943 6,647
Other receivables 7,000 -
--------- ---------
76,274 74,585
Allowance for doubtful accounts (2,508) (3,370)
--------- ---------
73,766 71,215
Inventory 4,999 8,570
Deferred income taxes 3,738 3,719
Prepaid expenses and other current assets 6,550 7,821
--------- ---------
Total current assets 201,629 156,067
Notes receivable, less current portion 6,232 6,179
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 352 -
Property and equipment:
Land and building 5,710 8,626
Furniture and equipment 58,709 85,970
Leasehold improvements 7,985 9,116
--------- ---------
72,404 103,712
Accumulated depreciation (21,160) (26,936)
--------- ---------
51,244 76,776
Intangible assets:
Goodwill 183,004 207,665
Contract rights 13,973 13,973
Other 2,522 4,777
--------- ---------
199,499 226,415
Accumulated amortization (16,714) (22,309)
--------- ---------
182,785 204,106
Deferred contract costs, net of accumulated amortization
of $6,205 as of December 31, 1997 and $8,889
as of June 30, 1998 10,324 11,565
Investments in and advances to affiliates 12,464 14,697
Other investments 28,017 29,049
Other assets 3,266 3,987
--------- ---------
Total assets $496,313 $502,426
========= =========
</TABLE>
3
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
------------ -----------
(Restated) (Unaudited)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 40,707 $ 45,206
Income taxes payable 5,590 2,047
Current portion of long-term debt 1,213 1,550
Current portion of due to shareholders of
acquired companies 13,794 -
Deferred revenue 26,289 31,074
Other current liabilities 1,281 994
--------- ---------
Total current liabilities 88,874 80,871
Long-term debt, less current portion 2,303 4,234
Deferred income taxes 7,620 7,605
Due to shareholders of acquired companies,
less current portion 56,366 -
Other long-term liabilities 902 312
Commitments and contingent liabilities - -
--------- ---------
Total liabilities 156,065 93,022
--------- ---------
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 June 30, 1998 - -
Common stock, par value $.01 per share--authorized
90,000,000 shares, issued and outstanding shares of
45,450,447 as of December 31, 1997 and 48,342,029
as of June 30, 1998 455 483
Additional paid-in capital 301,897 368,155
Retained earnings 39,057 42,121
Foreign currency translation adjustments (1,161) (1,355)
--------- ---------
Total stockholders' equity 340,248 409,404
--------- ---------
Total liabilities and stockholders' equity $ 496,313 $ 502,426
========= =========
</TABLE>
See accompanying notes.
4
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
------------------------
1997 1998
------------------------
(Restated)
<S> <C> <C>
REVENUES $ 68,928 $ 99,328
COST AND EXPENSES
Direct costs 73,383 85,026
General and administrative expense 9,913 4,358
Transaction costs related to pooling of interests - 5,000
Restructuring costs - 3,730
Loss on impairment of assets 4,000 -
-------- --------
Total expenses 87,296 98,114
-------- --------
Operating income (loss) (18,368) 1,214
OTHER INCOME (EXPENSE)
Investment and other income 964 1,607
Termination fee, net of transaction costs 28,500 -
Interest expense (332) (333)
Equity in net loss of affiliates (198) (1,127)
-------- --------
Income before income taxes 10,566 1,361
Income taxes (3,917) (2,839)
-------- --------
Net income (loss) $ 6,649 $ (1,478)
======== ========
Earnings (loss) per common share, basic $ 0.17 $ (0.03)
======== ========
Earnings (loss) per common share, diluted $ 0.16 $ (0.03)
======== ========
</TABLE>
See accompanying notes.
5
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------
1997 1998
----------------------
(Restated)
<S> <C> <C>
REVENUES $129,749 $185,651
COST AND EXPENSES
Direct costs 126,968 161,808
General and administrative expense 12,874 7,684
Transaction costs relating to pooling of interests - 5,000
Restructuring costs - 3,730
Loss on impairment of assets 4,000 -
-------- --------
Total expenses 143,842 178,222
-------- --------
Operating income (loss) (14,093) 7,429
OTHER INCOME (EXPENSE)
Investment and other income 1,700 3,273
Termination fee, net of transaction costs 28,500 -
Interest expense (623) (420)
Equity in net loss of affiliates (308) (2,338)
-------- --------
Income before income taxes 15,176 7,944
Income taxes (5,872) (5,155)
-------- --------
Net income $ 9,304 $ 2,789
======== ========
Earnings per common share, basic $ 0.23 $ 0.06
======== ========
Earnings per common share, diluted $ 0.22 $ 0.06
======== ========
</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,
-----------------------
1997 1998
-----------------------
(Unaudited) (Unaudited)
(Restated)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 9,304 $ 2,789
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 4,211 5,706
Amortization 4,588 7,843
Non-cash issuance of common stock 18,500 -
Non-cash dividend received (1,000) (1,000)
Loss on impairment of assets 4,000 -
Provision for doubtful accounts 180 864
Deferred income taxes (724) 4
Equity in net loss of unconsolidated subsidiaries 308 2,338
Changes in operating assets and liabilities:
Accounts and notes receivable (8,410) 2,142
Cost and estimated earnings in excess
of billings on uncompleted contracts 1,598 259
Inventory (542) (2,290)
Prepaid expenses 372 (1,179)
Other assets (229) (569)
Accounts payable and accrued expenses (5,000) 2,528
Notes payable - 1,449
Billings in excess of costs and estimated earnings
on uncompleted contracts 871 (2)
Deferred revenue and other long-term liabilities 1,754 3,471
-------- --------
Net cash provided by operating activities 29,781 24,353
-------- --------
INVESTING ACTIVITIES
Purchase of available-for-sale securities (4,828) (1,627)
Proceeds from sale of available-for-sale securities 11,195 46,532
Increase in investments in and advances to affiliates (3,073) (4,572)
Increase in other investments (556) (31)
Purchase of property and equipment (10,182) (30,338)
Proceeds from sale of property and equipment 1,254 -
Cash paid for intangible assets (554) (1,374)
Expenditures for deferred contract costs and other assets (1,428) (1,633)
Acquisition of Canter Group, net of cash received - (24,262)
-------- --------
Net cash used in investing activities (8,172) (17,305)
-------- --------
FINANCING ACTIVITIES
Payments to former shareholders of WSI (4,670) (262)
Payments to former shareholders of Pace (158) (13,547)
Proceeds from exercise of options and warrants 6,265 3,532
Proceeds from issuance of long-term debt - 858
Payments on long-term debt and capital lease obligations (4,979) -
Cash paid for fractional shares of common stock - (58)
Repayment of distributions to shareholders - 238
Paydown of line of credit (1,000) (544)
-------- --------
Net cash used in financing activities (4,542) (9,783)
-------- --------
Effects of exchange rate changes on cash (766) (194)
-------- --------
Net increase (decrease) in cash and cash equivalents 16,301 (2,929)
Cash and cash equivalents at beginning of period 18,564 29,650
-------- --------
Cash and cash equivalents at end of period $ 34,865 $ 26,721
======== ========
</TABLE>
See accompanying notes.
7
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
JUNE 30, 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 and six months ended June
30, 1998 are not necessarily indicative of the results that may be expected for
the year ended December 31, 1998. As discussed in Note E, on May 6, 1998, the
Company consummated its acquisition of all of the outstanding stock of Aspect
International Language Schools, B.V. and subsidiaries ("ASPECT"). The
acquisition has been accounted for as a pooling-of-interests and accordingly,
the Company's financial statements have been restated to include the results of
ASPECT for all periods presented. For further information, refer to the restated
annual financial statements and footnotes thereto included in the Company's
report on Form 8-K filed on July 29, 1998.
NOTE B - INCOME TAXES
------------
The tax provisions for the three and six month periods ended June 30, 1998
and 1997 are based on the estimated effective tax rates applicable for the full
years, and after giving effect to significant unusual items related
specifically to the interim periods. The Company's income tax provisions for all
periods consist of federal, state, and foreign income taxes. The Company's
effective tax rate has increased from 39% during the first six months of 1997 to
65% during the first six months of 1998 due to significant transaction costs
related to the acquisition of ASPECT in May 1998 which are expensed for
financial reporting purposes but are non-deductible for income tax purposes. The
Company estimates that its effective income tax rate for the year ended December
31, 1998 will be 38%.
8
<PAGE>
NOTE C - EARNINGS PER SHARE
------------------
The following table summarizes the computations of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
1997 1998 1997 1998
------------ -------------- ------------ -----------
<S> <C> <C> <C> <C>
Numerator used in basic and diluted
earnings per common share:
Net income(loss) $ 6,649 $(1,478) $ 9,304 $ 2,789
======= ======= ======= =======
Denominator:
Denominator for basic earnings per
common share--weighted average
shares 40,252 48,185 40,165 47,850
Effect of dilutive securities:
Employee stock options 2,155 - 2,100 2,193
Common stock contingently issuable 260 - 260 -
------- ------- ------- -------
Total dilutive potential common shares 2,415 - 2,360 2,193
------- ------- ------- -------
Denominator for diluted earnings per
common share--weighted average
shares and assumed conversions 42,667 48,185 42,525 50,043
======= ======= ======= =======
Earnings(loss) per common share, basic $ 0.17 $ (0.03) $ 0.23 $ 0.06
Earnings(loss) per common share, diluted $ 0.16 $ (0.03) $ 0.22 $ 0.06
</TABLE>
The effect of employee stock options on the diluted computation for the
three months ended June 30, 1998 is antidilutive and these options are therefore
not considered in the computation.
NOTE D - RECLASSIFICATIONS AND STOCK SPLIT
---------------------------------
Certain amounts in the 1997 financial statements have been reclassified to
conform with the 1998 presentation.
In February 1998, the Company declared a 3 for 2 stock split of its common
stock effective in the form of a stock dividend which was distributed on May
22, 1998 to shareholders of record at the close of business on April 1, 1998.
Accordingly, all share and per share data information have been restated to
retroactively reflect the stock split.
9
<PAGE>
NOTE E - ACQUISITIONS AND RESTRUCTURING CHARGES
--------------------------------------
ASPECT
Effective May 6, 1998 the Company acquired all of the common stock of
privately held ASPECT in exchange for 2,004,030 shares of Sylvan common stock
valued at $65 million. 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 results of
operations, financial position and cash flows of ASPECT.
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.
Combined and separate results of operations of Sylvan and ASPECT during the
periods prior to the acquisition are as follows:
<TABLE>
<CAPTION>
Sylvan
Learning
Systems, Inc. ASPECT Combined
------------- -------- --------
<S> <C> <C> <C>
Three Months Ended June 30, 1997
Revenues $ 57,596 $11,332 $ 68,928
Net income (loss) $ 6,694 $ (45) $ 6,649
Earnings per common share - diluted $ 0.16 $ 0.16
Six Months Ended June 30, 1997
Revenues $109,540 $20,209 $129,749
Net income (loss) $ 10,142 $ (838) $ 9,304
Earnings per common share - diluted $ 0.25 $ 0.22
</TABLE>
In connection with the acquisition of ASPECT, Sylvan expects to incur
certain restructuring charges of $3.7 million, with an after-tax effect of $3.4
million. These pre-tax charges, which have been accrued in the quarter ended
June 30, 1998, include costs associated with termination benefits of certain
employees of ASPECT of $340,000 and costs associated with the consolidation and
restructuring of the combined operations of $3.4 million. Consolidation and
restructuring charges consist mainly of estimated obligations resulting from the
merger. These estimated obligations relate to contract cancellation costs and
the closing of duplicate facilities. A pre-tax charge related to the
cancellation of certain contracts of $2.6 million is expected to result from the
repurchase of certain franchise rights previously sold for territories where
ASPECT locations in existence will violate the terms of master franchise
agreements previously entered into by the Company and certain master
franchisees. A pre-tax charge of $790,000 will result from the consolidation of
duplicate facilities, lease termination costs and the sale of certain facilities
which will no longer be used by the Company.
Also included in operating expenses for the quarter and six months ended
June 30, 1998 are $6.2 million of shareholder non-recurring expenses and
transaction-related costs. Transaction-related charges of approximately $5.0
million recorded include legal, accounting and
10
<PAGE>
advisory fees. The shareholder non-recurring expenses of $1.2 million recorded
represent shareholder compensation and related expenses of ASPECT.
CANTER
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 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.
11
<PAGE>
NOTE F - 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 $455 $301,897 $39,057 $(1,161) $340,248
Options exercised for purchase
of 373 shares of common stock,
including income tax benefit
of $3,459 4 6,528 6,532
Issuance of 964 shares of
common stock in connection
with the acquisition of
NAI/Block 10 25,706 25,716
Issuance of 110 shares of
common stock in connection
with other acquisitions 1 929 37 967
Issuance of 24 shares of common
stock in connection with the
Employee Stock Purchase Plan 502 502
Issuance of 345 shares of
common stock to ex-PACE
shareholders 3 11,305 11,308
Issuance of 1,071 shares of
common stock in connection
with contingent consideration
related to the acquisition of
Drake 10 20,046 20,056
Cash paid for fractional shares (58) (58)
Capital contribution by ASPECT
partners 1,300 1,300
Foreign currency translation
adjustment (194) (194)
Repayment of distributions 238 238
Net income for the six months
ended June 30, 1998 2,789 2,789
------------ ------------ ------------ -------------- ---------------
Balance at June 30, 1998 $483 $368,155 $42,121 $(1,355) $409,404
============ ============ ============ ============== ===============
</TABLE>
NOTE G - CONTINGENCIES
-------------
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 acquisition of 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,
12
<PAGE>
contractual and quasi-contractual, with the NASD, that the Company 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. If ACT
were awarded significant compensatory or punitive damages, it could materially
adversely affect the Company's results of operations and financial condition.
Additionally, if ACT were granted significant injunctive relief, the Company may
be reqired to dispose of, limit expansion or curtail existing operations of its
Sylvan Prometric division, which, in turn, would materially adversely affect the
Company's results of operations, financial condition and prospects for growth.
In February 1998, the Court ruled that ACT may proceed only on three of its five
antitrust theories and otherwise narrowed the scope of ACT's antitrust claims.
In March 1998, the Court denied the Company's motion to dismiss ACT's state law
claims. Discovery has recently commenced and is expected to continue at least
through the end of 1998. The Company believes that all of ACT's claims are
without merit but is unable to predict the outcome of the ACT litigation at this
time.
NOTE H - BUSINESS SEGMENT INFORMATION
----------------------------
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
1997 1998 1997 1998
-------------- ------------- ------------- -----------
<S> <C> <C> <C> <C>
Operating Revenues:
Learning Centers $10,755 $15,470 $ 19,985 $ 27,605
Contract Educational Services 18,326 25,649 35,900 52,269
Sylvan Prometric 39,847 58,209 73,864 105,777
------- ------- -------- --------
$68,928 $99,328 $129,749 $185,651
======= ======= ======== ========
Segment profit(loss):
Learning Centers $(1,852) $ 4,538 $ 549 $ 7,243
Contract Educational Services 2,613 3,524 4,019 7,331
Sylvan Prometric (9,216) (2,490) (5,787) 539
------- ------- -------- --------
$(8,455) $ 5,572 $ (1,219) $ 15,113
======= ======= ======== ========
Segment assets:
Learning Centers $ 18,853 $ 31,989
Contract Educational Services 27,017 91,024
Sylvan Prometric 172,436 281,694
-------- --------
$218,306 $404,707
======== ========
</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 and
six months ended June 30, 1997 and 1998:
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
1997 1998 1997 1998
--------------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
Total profit(loss) for reportable segments $(8,455) $ 5,572 $ (1,219) $15,113
Corporate general and administrative
expense (9,913) (4,358) (12,874) (7,684)
Other income(expense) 28,934 147 29,269 515
------- ------- -------- -------
Income before income taxes $10,566 $ 1,361 $ 15,176 $ 7,944
======= ======= ======== =======
</TABLE>
NOTE I - COMPREHENSIVE INCOME
--------------------
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standard No. 130, Reporting Comprehensive Income. Statement 130
established new rules for the reporting and display of comprehensive income and
its components, however, this Statement has no impact on the Company's net
income or stockholders' equity. Statement 130 requires foreign currency
translation adjustments, which prior to adoption were reported separately in
shareholders' equity, to be included in other comprehensive income. Prior
period financial statements have been reclassified to conform to the
requirements of Statement 130.
The components of comprehensive income, net of related tax, for the three
and six month periods ended June 30, 1998 and 1997 are as follows:
<PAGE>
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
1997 1998 1997 1998
-------------- ------------- ------------- -----------
<S> <C> <C> <C> <C>
Net income/(loss) $ 6,649 $ (1,478) $ 9,304 $ 2,789
Foreign currency translation
adjustments (19) (428) (373) (194)
-------- -------- -------- --------
Comprehensive income $ 6,630 $ (1,906) $ 8,931 $ 2,595
======== ======== ======== ========
</TABLE>
13
<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: Learning
Centers, which primarily consists of franchise royalties, franchise sales fees
and Company-owned Learning Center revenues; Sylvan Prometric, which consists of
computer-based testing fees paid to the Company and the operations of the Wall
Street Institute ("WSI") and ASPECT; and Contract Educational Services, which
consists 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 three months and six months ended June 30, 1997 and 1998 is derived from
the Company's unaudited consolidated financial statements.
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
1997 1998 1997 1998
------------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Operating Revenue:
Learning Centers $10,755 $15,470 $ 19,985 $ 27,605
Contract Educational Services 18,326 25,649 35,900 52,269
Sylvan Prometric 39,847 58,209 73,864 105,777
------- ------- -------- --------
Total revenue $68,928 $99,328 $129,749 $185,651
======= ======= ======== ========
Direct costs:
Learning Centers $12,607 $10,932 $ 19,436 $ 20,362
Contract Educational Services 15,713 22,125 31,881 44,938
Sylvan Prometric 45,063 51,969 75,651 96,508
------- ------- -------- --------
Total direct costs $73,383 $85,026 $126,968 $161,808
======= ======= ======== ========
</TABLE>
14
<PAGE>
RESULTS OF OPERATIONS
Comparison of results for the quarter and six months ended June 30, 1998 to
results for the quarter and six months ended June 30, 1997.
Revenue. Total revenues increased by $30.4 million, or 44% to $99.3 million for
the quarter ended June 30, 1998 and increased by $55.9 million, or 43% to $185.7
million for the six months ended June 30, 1998, compared to the same periods in
1997. These increases resulted from higher revenues in all business segments -
Learning Centers, Contract Educational Services and Sylvan Prometric.
Learning Centers revenue increased by $4.7 million, or 44% to $15.5
million for the quarter ended June 30, 1998 and by $7.6 million, or 38% to $27.6
million for the six months ended June 30, 1998, compared to the same periods in
1997. Overall, franchise royalties increased by $445,000, or 12%, for the
quarter ended June 30, 1998 and $1.0 million, or 15%, for the six months ended
June 30, 1998, compared to the same periods in 1997. The increase in royalties
was reduced by the Company's acquisition of 19 franchised Centers during the
last twelve months. Excluding the effect of the Center acquisitions, franchise
royalties increased 16% for the quarter ended June 30, 1998 and 19% for the six
months ended June 30, 1998, compared to the same periods in 1997. The six month
increase in franchise royalties was due to the net increase of 38 new Centers
opened after June 30, 1997, combined with same center revenue increases of 13%.
Franchise sales fees increased $37,000 to $560,000 for the quarter ended
June 30, 1998 and decreased $400,000 to $800,000 for the first six months of
1998, compared to the same periods in 1997. The six month decrease is primarily
due to a significant area development agreement that was sold for $500,000 in
the first quarter of 1997.
Revenue from Company-owned Learning Centers increased $3.4 million, or 59%,
to $9.1 million during the quarter ended June 30, 1998, and by $5.4 million, or
50%, to $16.1 million during the six months ended June 30, 1998, compared to the
same periods in 1997. The acquisition of 19 Centers from several franchisees
during the past twelve months accounted for $2.3, million or 68%, of the
increase for the quarter ended June 30, 1998 and $3.8 million, or 70%, of the
increase for the six months ended June 30, 1998, compared to the same periods in
1997. Same center revenues increased by $1.1 million, or 19%, for the quarter
ended June 30, 1998 and $1.6 million, or 15%, for the six months ended June 30,
1998, compared to the same periods in 1997.
Contract Educational Services Revenue increased by $7.3 million, or 40%, to
$25.6 million for the quarter ended June 30, 1998, and by $16.4 million, or 46%,
to $52.3 million for the six months ended June 30, 1998, compared to the same
periods in 1997. The revenue increase for the quarter ended June 30, 1998 was
the result of $5.6 million in revenue from Canter, a provider of teacher
training services which was acquired in January 1998, a $1.7 million increase in
revenue from public and nonpublic school contracts and adult training services.
The revenue increase for the six months ended June 30, 1998 was the result of
$12.3
15
<PAGE>
million in revenue from Canter, a $4.1 million increase in revenue from public
and nonpublic school contracts and adult training services.
The $1.7 million increase in revenue from public and nonpublic schools and
adult training services for the quarter ended June 30, 1998 compared to the 1997
quarter was reduced by the fact that the quarter ended June 30, 1997 included
revenue of $1.7 million from a non-education related segment of Educational
Inroads, which was a non-related business activity that was disposed of after it
was acquired in 1997. The $4.1 million increase in revenue from public and
nonpublic schools and adult training services for the six months ended June 30,
1998 compared to the 1997 six month period was reduced by revenue of $2.6
million included in the 1997 six month period from a segment of Educational
Inroads, which was a non-related business activity that was disposed of after it
was acquired in 1997.
Sylvan Prometric revenue increased by $18.4 million, or 46%, to $58.2
million during the quarter ended June 30, 1998 and by $31.9 million, or 43%, to
$105.8 million during the six months ended June 30, 1998, compared to the same
periods in 1997. The fourth quarter 1997 acquisition of NAI/Block accounted for
$3.5 million of the revenue growth for the second quarter of 1998 and $6.6
million of the revenue growth for the first six months of 1998. Academic
admissions testing revenues increased 148% compared to the second quarter of
1997 and 125% compared to the first six months of 1997, primarily due to volume
increases under Educational Testing Service (ETS) contracts, which included the
cost-plus international contract, the Graduate Record Examinations (GRE),
Graduate Management Admission Test (GMAT), and The Test of English as a Foreign
Language (TOEFL). Information Technology and professional licensure and
certification testing revenues increased 36% and 17%, respectively, in the
second quarter of 1998, over the comparable 1997 period mainly due to volume
increases. Revenues in 1998 from the Wall Street Institute International, B.V.
and its commonly controlled affiliates (collectively, "WSI"), Sylvan's
international chain of English language centers, decreased compared to the
second quarter of 1997 and compared to the first six months of 1997 as a result
of master franchise sales recorded in 1997, with none recognized in 1998.
Revenues from ASPECT increased $1.8 million, or 17%, and $4.1 million, or 20%,
for the quarter and the six months ended June 30, 1998, respectively, compared
to the same periods in 1997.
Cost and Expenses. Total direct costs increased 16% from $73.4 million in the
second quarter of 1997 to $85.0 million in the second quarter of 1998, and
decreased as a percentage of total revenues from 106% to 86%. Direct costs
increased 27% from $127.0 million for the six months ended June 30, 1997, to
$161.8 million for the six months ended June 30, 1998 and decreased as a
percentage of total revenues from 98% to 87%.
Learning Centers expenses decreased by $1.7 million to $10.9 million, or
71% of Learning Centers revenue for the quarter ended June 30, 1998 compared to
$12.6 million, or 117% of Learning Centers revenue for the quarter ended June
30, 1997. Learning Centers expenses increased $926,000 to $20.4 million, or 74%,
of Learning Centers revenue for the six months ended June 30, 1998 compared to
$19.4 million or 97% of Learning Centers revenue for
16
<PAGE>
the six months ended June 30, 1997. Included in Learning Centers expenses for
the 1997 period is a non-recurring $5.0 million contribution of the Company's
common stock to a corporation whose sole purpose is to develop and fund
advertising programs for Sylvan Learning Centers. Excluding this contribution,
Learning Centers expenses increased by $3.3 million during the quarter ended
June 30, 1998 and increased by $5.9 million during the six months ended June 30,
1998. Excluding this contribution, recurring expenses as a percentage of total
Learning Centers revenue were 71% and 71% for the second quarter of 1998 and
1997, respectively, and 74% and 72% for the first six months of 1998 and 1997,
respectively. Approximately $2.8 million of the increase for the quarter and
$4.4 million of the increase for the first six months was due to the acquisition
of franchised Learning Centers and costs associated with higher revenues at
existing centers. As a percentage of revenues, expenses for Company-owned
Learning Centers decreased from 84% for the six months ended June 30, 1997 to
82% for the six months ended June 30, 1998. The Company incurred $209,000 of
expenses in the second quarter of 1998 and $608,000 of expenses in the first six
months of 1998 for the development of certain educational programs. These
expenses were not incurred in the first six months of 1997 and are not expected
to continue during 1998. The remaining cost increases for both the quarter and
six months ended June 30, 1998 relate to franchise support costs, which
decreased as a percentage of franchise royalty revenue.
Contract Educational Services expense increased by $6.4 million, to $22.1
million, or 86% of Contract Educational Services revenue for the quarter ended
June 30, 1998, compared to $15.7 million or 86% of contract services revenue for
the quarter ended June 30, 1997. Contract educational services expense increased
by $13.1 million to $44.9 million, or 86% of Contract Educational Services
revenue during the six months ended June 30, 1998, compared to $31.9 million or
89% of Contract Educational Services revenue during the six months ended June
30, 1997. The increase in Contract Educational Services margins for the six
months ended June 30, 1998 compared to the 1997 period is a result of
significant officers' salaries for the two former owners of Educational Inroads
as well as certain non-recurring transaction costs related to that merger being
included in the results of operations for the six months ended June 30, 1997.
Sylvan Prometric expenses for the quarter ended June 30, 1998 increased by
$6.9 million to $52.0 million, or 89% of total Sylvan Prometric revenue,
compared to $45.1 million, or 113% of total Sylvan Prometric revenue for the
quarter ended June 30, 1997. Sylvan Prometric expense for the six months ended
June 30, 1998 increased by $20.8 million to $96.5 million, or 91% of total
Sylvan Prometric revenue, compared to $75.7 million, or 102% of total Sylvan
Prometric revenue for the same period in 1997. During the second quarter of
1997, Sylvan Prometric expenses included non-recurring marketing expenditures
related to contributions of $10 million in cash and common stock to an
independent marketing fund to be used for development of the information
technology testing business. The second quarter and six months ended June 30,
1998 contain $1.2 million of non-recurring expenses related to the acquisition
of ASPECT as further described in Note E to the financial statements. Excluding
these expenditures, recurring expenses as a percentage of total Sylvan Prometric
revenue were 87% and 88% for the second quarter of 1998 and 1997, respectively,
and 90% and 89% for the first six months of 1998 and 1997, respectively.
In the three and six months ended June 30, 1998, Sylvan incurred $5.0
million of non-recurring transaction-related costs relating to the
pooling-of-interest with ASPECT. The transaction costs include legal, accounting
and advisory fees, as further described in Note E to the financial statements.
In connection with the acquisition of ASPECT, Sylvan expects to incur
certain restructuring charges of $3.7 million, with an after-tax effect of $3.4
million. These pre-tax charges, which have been accrued in the quarter ended
June 30, 1998, include costs associated with termination benefits of certain
employees of ASPECT of $340,000 and costs associated
17
<PAGE>
with the consolidation and restructuring of the combined operations of
$3.4 million. Consolidation and restructuring charges consist mainly of
estimated obligations resulting from the merger. These estimated obligations
relate to contract cancellation costs and the closing of duplicate facilities.
A pre-tax charge related to the cancellation of certain contracts of
$2.6 million is expected to result from the repurchase of certain franchise
rights previously sold in territories where existing ASPECT locations will
violate the terms of master franchise agreements previously entered into by the
Company and certain master franchisees. A pre-tax charge of $790,000 will result
from the consolidation of duplicate facilities, lease termination costs and the
sale of certain facilities which will no longer be used by the Company.
The quarter ended June 30, 1997 included an asset impairment loss of
$4.0 million caused by certain strategic changes contemplated as part of the
planned National Education Corporation merger, and primarily related to computer
equipment and software, whose value was impaired as a result of changes in
technical requirements and specifications of such equipment and software.
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 was recorded, net of $1.5 million
of transaction costs, as a separate component of non-operating income in the
quarter ended June 30, 1997.
General and administrative expenses decreased by $5.5 million to
$4.4 million for the quarter ended June 30, 1998 compared to the quarter ended
June 30, 1997 and decreased as a percentage of revenue from 14% to 4%. General
and administrative expenses decreased by $5.2 million to $7.7 million during the
six months ended June 30, 1998 compared to the six months ended June 30, 1997
and decreased as a percentage of revenue from 10% to 4%. Included in general and
administrative expenses for both the second quarter and six months ended June
30, 1997 are non-recurring expenses related to the contribution of the Company's
common stock valued at $6.5 million to Sylvan Learning Foundation, Inc., a non
profit foundation formed to promote various educational pursuits. Excluding this
1997 non-recurring expense, general and administrative expenses decreased as a
percentage of revenues from 5% of total revenues for both the quarter and six
months ended June 30, 1997 to 4% of total revenues for the quarter and six
months ended June 30, 1998. This decrease in expenses as a percentage of
revenues resulted from increased revenues in all segments without corresponding
proportional increases in overhead.
The Company's effective tax rate has increased from 39% during the first
six months of 1997 to 65% during the first six months of 1998. The increase in
the effective rate is due to $5.0 million of transaction costs related to the
acquisition of ASPECT for which there is no allowable income tax deduction.
18
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $24.4 million for the six months
ended June 30, 1998 as compared to $29.8 million provided in the comparable
period of 1997. Cash flow from operations before working capital changes
decreased by $20.9 million from $39.4 million in the 1997 period to
$18.5 million in the 1998 period, primarily as a result of the $28.5 million
termination fee, net of costs, related to the NEC acquisition and the
$3.0 million cash contribution to the independent marketing fund included in the
1997 period and the $6.2 million of non-recurring expenses in the 1998 period
related to the acquisition of ASPECT as further described in Note E to the
financial statements. Excluding the effects of these items, recurring cash flow
from operations before working capital changes increased from $13.9 million in
the 1997 period to $24.7 million in the 1998 period due to 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. 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 $30.3 million in the six months ended June 30, 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 as the
equipment is depreciated. This reimbursement includes a financing charge over
the reimbursement period.
In connection with the PACE acquisition, the Company recorded a liability
for additional consideration as of December 31, 1997 which was payable $14.5
million in cash and $11.3 million in common stock. The payment, net of amounts
due from the former owners of PACE, and issuance of common stock was made
during the second quarter of 1998, and was funded by the sale of available-for-
sale securities. 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 allowing
the Company to borrow a maximum of $15.0 million. The original credit line
expired on May 31, 1998 but has been extended through September 30, 1998. The
credit line bears interest at a floating rate equal to the 30 day London
Interbank Offered Rate ("LIBOR") plus 1.15% per annum (5.66% at June 30, 1998).
The Company is in the process of obtaining a new line of credit containing
similar terms as the existing credit line.
During the first six months of 1998, the Company received $3.5 million as a
result of the exercise of options to purchase 373,000 shares of Common Stock.
19
<PAGE>
During the first six 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.
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 nonpublic 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.
20
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. REPORTS ON FORM 8-K
-------------------
(A) REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the three months
ended June 30, 1998.
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, 1998 /s/ B. Lee McGee
---------------------------------------
B. Lee McGee, Executive Vice President
and Chief Financial Officer
21
<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> 29,650 29,650
<SECURITIES> 82,926 82,926
<RECEIVABLES> 76,274 76,274
<ALLOWANCES> 2,508 2,508
<INVENTORY> 4,999 4,999
<CURRENT-ASSETS> 201,629 201,629
<PP&E> 72,404 72,404
<DEPRECIATION> 21,160 21,160
<TOTAL-ASSETS> 496,313 496,313
<CURRENT-LIABILITIES> 88,874 88,874
<BONDS> 0 0
0 0
0 0
<COMMON> 455 455
<OTHER-SE> 339,793 339,793
<TOTAL-LIABILITY-AND-EQUITY> 496,313 496,313
<SALES> 0 0
<TOTAL-REVENUES> 68,928 129,749
<CGS> 0 0
<TOTAL-COSTS> 87,296 143,842
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 332 623
<INCOME-PRETAX> 10,566 15,176
<INCOME-TAX> 3,917 5,872
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 6,649 9,304
<EPS-PRIMARY> .17 .23
<EPS-DILUTED> .16 .22
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
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<MULTIPLIER> 1,000
<S> <C> <C>
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<PERIOD-START> APR-01-1998 JAN-01-1998
<PERIOD-END> JUN-30-1998 JUN-30-1998
<CASH> 26,721 26,721
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<DEPRECIATION> 26,936 26,936
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<NET-INCOME> (1,478) 2,789
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</TABLE>
