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, 1999 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 51,957,750 shares of Common Stock outstanding as of August
10, 1999.
<PAGE>
SYLVAN LEARNING SYSTEMS, INC.
<TABLE>
<CAPTION>
INDEX
Page No.
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
<S> <C>
Consolidated Balance Sheets - June 30, 1999 and
December 31, 1998............................................3
Consolidated Statements of Operations - Three months ended
June 30, 1999 and June 30, 1998...............................5
Consolidated Statements of Income - Six months ended
June 30, 1999 and June 30, 1998...............................6
Consolidated Statements of Cash Flows - Six months ended
June 30, 1999 and June 30, 1998...............................7
Notes to Consolidated Financial Statements - June 30, 1999.........8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................14
Item 3. Quantitative and Qualitative Disclosure of Market Risk............24
PART II. - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K .................................25
SIGNATURES..................................................................25
</TABLE>
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
--------- ------------
(UNAUDITED)
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 34,860 $ 33,170
Available-for-sale securities 5,336 6,166
Receivables:
Accounts receivable 73,723 71,248
Costs and estimated earnings in excess of billings
on uncompleted contracts 4,552 7,806
Notes receivable from tuition financing 3,904 2,977
Other notes receivable 9,456 8,922
Other receivables 2,327 2,404
--------- ----------
93,962 93,357
Allowance for doubtful accounts (4,011) (2,963)
--------- ----------
89,951 90,394
Inventory 9,877 9,841
Deferred income taxes 1,832 1,831
Prepaid expenses 10,596 10,093
Other current assets 541 1,843
--------- ----------
Total current assets 152,993 153,338
Notes receivable from tuition financing, less
current portion 4,586 3,415
Other notes receivable, less current portion 11,794 9,882
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 506 637
Property and equipment:
Land and buildings 68,886 9,917
Furniture and equipment 149,611 111,490
Leasehold improvements 15,794 13,156
--------- ----------
234,291 134,563
Accumulated depreciation (47,764) (36,682)
--------- ----------
186,527 97,881
Intangible assets:
Goodwill 320,969 292,693
Contract rights 13,973 13,973
Other 2,878 3,111
--------- ----------
337,820 309,777
Accumulated amortization (33,645) (26,322)
--------- ----------
304,175 283,455
Deferred contract costs, net of accumulated
amortization of $13,982 as of June 30, 1999
and $11,740 as of December 31, 1998 9,110 10,255
Investments in and advances to affiliates 50,441 18,532
Other investments 46,639 44,230
Net assets to be transferred to joint venture - 31,575
Other assets 11,226 6,596
========= ==========
Total assets $ 777,997 $ 659,796
========= ==========
3
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
JUNE 30, DECEMBER 31,
1999 1998
--------- ------------
(UNAUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 68,875 $ 57,177
Income taxes payable 7,487 11,784
Current portion of long-term debt 13,887 1,128
Current portion of due to shareholders of
acquired companies 15,489 40,719
Deferred revenue and other current liabilities 36,053 27,430
--------- ----------
Total current liabilities 141,791 138,238
Long-term debt, less current portion 98,604 12,504
Deferred income taxes 7,064 6,961
Due to shareholders of acquired companies,
less current portion 8,722 12,239
Other long-term liabilities 1,110 1,021
--------- ----------
Total liabilities 257,291 170,963
Minority interest 10,420 -
Stockholders' equity:
Preferred stock, par value $.01 per share-authorized
10,000 shares, no shares issued and outstanding
as of June 30, 1999 and December 31, 1998 - -
Common stock, par value $.01 per share-authorized
90,000 shares, issued and outstanding shares of
51,616 as of June 30, 1999 and 50,952 as of
December 31, 1998 516 510
Additional paid-in-capital 421,088 410,694
Retained earnings 91,216 75,852
Accumulated other comprehensive income (loss) (2,534) 1,777
--------- ----------
Total stockholders' equity 510,286 488,833
--------- ----------
Total liabilities and stockholders' equity $ 777,997 $ 659,796
========= ==========
See notes to consolidated financial statements.
4
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Amounts in thousands, except per share data)
Three months ended
June 30,
-------------------
1999 1998
------- -------
(Unaudited)
Revenues $ 148,460 $ 99,328
Cost and expenses
Direct costs 123,277 85,026
General and administrative expense 5,042 4,358
Transaction costs related to pooling-of-interests - 5,000
Restructuring costs - 3,730
-------- --------
Total expenses 128,319 98,114
-------- --------
Operating income 20,141 1,214
Other income (expense)
Investment and other income 35 1,607
Interest expense (1,393) (333)
Equity in net loss of affiliates (360) (1,127)
Minority interest in income of consolidated
subsidiary (1,174) -
-------- --------
Income before income taxes 17,249 1,361
Income taxes (5,866) (2,839)
-------- --------
Net income (loss) $ 11,383 $ (1,478)
======== ========
Earnings (loss) per common share, basic $ 0.22 $ (0.03)
======== ========
Earnings (loss) per common share, diluted $ 0.21 $ (0.03)
======== ========
See notes to consolidated financial statements.
5
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Amounts in thousands, except per share data)
Six months ended
June 30,
--------------------
1999 1998
----- ------
(Unaudited)
Revenues $ 272,238 $ 185,651
Cost and expenses
Direct costs 231,478 161,808
General and administrative expense 9,766 7,684
Transaction costs related to pooling-of-interests - 5,000
Restructuring costs - 3,730
-------- --------
Total expenses 241,244 178,222
-------- --------
Operating income 30,994 7,429
Other income (expense)
Investment and other income 346 3,273
Interest expense (2,161) (420)
Equity in net loss of affiliates (444) (2,338)
Minority interest in income of consolidated
subsidiary (1,174) -
-------- --------
Income before income taxes and cumulative
effect of accounting change 27,561 7,944
Income taxes (9,371) (5,155)
-------- --------
Income before cumulative effect
of accounting change 18,190 2,789
Cumulative effect of accounting change,
net of income taxes of $682 (1,323) -
-------- --------
Net income $ 16,867 $ 2,789
======== ========
Earnings per common share, basic:
Income before cumulative effect
of accounting change $ 0.35 $ 0.06
Cumulative effect of accounting change 0.02 -
-------- --------
$ 0.33 $ 0.06
======== ========
Earnings per common share, diluted:
Income before cumulative effect
of accounting change $ 0.34 $ 0.06
Cumulative effect of accounting change 0.02 -
-------- --------
$ 0.32 $ 0.06
======== ========
</TABLE>
See notes to consolidated financial statements.
6
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Amounts in thousands)
<TABLE>
<CAPTION>
Six months ended June 30,
---------------------------------
1999 1998
---------------------------------
(Unaudited)
<S> <C> <C>
Operating activities
Net income $ 16,867 $ 2,789
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 11,030 5,706
Amortization 10,066 7,843
Minority interest in income of
consolidated subsidiary 1,174 -
Cumulative effect of accounting change 2,005 -
Non-cash issuance of options to
non-employees 121 -
Non-cash dividend income - (1,000)
Equity in net loss of affiliates 444 2,338
Deferred income taxes (40) 4
Changes in operating assets and
liabilities:
Accounts and notes receivable, net (5,202) 3,006
Cost and estimated earnings in
excess of billings
on uncompleted contracts, net 2,507 257
Inventory (81) (2,290)
Prepaid expenses and other current
assets 1,015 (1,179)
Accounts payable and accrued
expenses (496) 9,567
Income taxes payable (2,123) (5,590)
Deferred revenue and other current
liabilities 4,317 3,471
------------ -----------
Net cash provided by operating activities 41,604 24,922
------------ -----------
Investing activities
Purchase of available-for-sale securities (2,025) (1,627)
Proceeds from sale of available-for-sale
securities 2,855 46,532
Investment in and advances to affiliates (679) (4,572)
Increase in other investments (2,416) (31)
Purchase of property and equipment (22,043) (30,338)
Purchase of Canter, including direct costs of
acquisition, net of cash received - (24,262)
Payment of contingent consideration for prior
period acquisitions (16,475) (13,547)
Purchase of Universidad Europea de Madrid,
including direct costs of acqusition,
net of cash received (25,768) -
Cash paid for other acquired businesses,
net of cash received (16,355) -
Expenditures for deferred contract costs (2,981) (1,633)
Increase in other assets (4,906) (1,943)
------------ -----------
Net cash used in investing activities (90,793) (31,421)
------------ -----------
Financing activities
Proceeds from exercise of options and warrants 2,392 3,532
Proceeds from issuance of common stock 716 -
Repurchase of common stock (7,764) -
Cash paid for fractional shares of common stock - (58)
Repayment of distributions to shareholders - 238
Payments on loans from stockholders of
acquired companies - (262)
Proceeds from issuance of long-term debt 74,760 858
Payments on long-term debt and capital lease
obligations (16,965) (544)
------------ -----------
Net cash provided by financing activities 53,139 3,764
------------ -----------
Effects of exchange rate changes on cash (2,260) (194)
------------ -----------
Net increase (decrease) in cash and cash
equivalents 1,690 (2,929)
Cash and cash equivalents at beginning of
period 33,170 29,650
------------ -----------
Cash and cash equivalents at end of period $ 34,860 $ 26,721
============ ===========
</TABLE>
See notes to consolidated financial statements.
7
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Unaudited
(Amounts in thousands, except per share amounts)
June 30, 1999
Note 1 - 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 month and six month periods ended
June 30, 1999 are not necessarily indicative of the results that may be expected
for the year ended December 31, 1999. The balance sheet at December 31, 1998 has
been derived from the audited financial statements at that date but does not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Sylvan Learning Systems, Inc. and Subsidiaries (the
"Company") annual report on Form 10-K for the year ended December 31, 1998.
During the period ended June 30, 1999, the Company acquired a 54% controlling
interest in the Universidad Europea de Madrid (UEM) (see Note 2). As such, the
unaudited consolidated financial statements for the three month and six month
periods ended June 30, 1999 include the accounts of Sylvan Learning Systems,
Inc., its wholly-owned subsidiaries and its majority-owned and controlled
subsidiary. All intercompany accounts and transactions have been eliminated in
consolidation. Investments in affiliates owned more than 20%, but not in excess
of 50%, and corporate joint ventures are reported using the equity method.
Certain amounts in the 1998 financial statements have been reclassified to
conform with the 1999 presentation.
Note 2 - Commencement of New Division
The Company's newest division, Sylvan International Universities, began
operations in the second quarter of 1999 with the acquisition of UEM. Sylvan
assumed operating control of UEM on April 1, 1999 and finalized the purchase of
a 54% controlling interest in the private, for-profit university on June 22,
1999. The purchase price of the UEM shares, including acquisition costs, was
approximately $28,300. The final purchase price allocation may differ from this
preliminary amount due to adjustments to acquisition related costs. Results of
operations of UEM are included in the accompanying 1999 consolidated statements
of income from April 1, 1999 through June 30, 1999. The acquisition would not
materially change reported 1998 results had it occurred on January 1, 1998.
In conjunction with acquiring the majority interest in UEM, the ownership
interest not acquired by the Company became minority interest ownership.
Minority interest in the accompanying consolidated financial statements relates
to such ownership interest.
8
<PAGE>
Note 3 - Long-term Debt
Long-term debt as of June 30, 1999 consists of the following (amounts in
thousands):
Long-term revolving credit facility
with banks $66,871
Various notes payable bearing interest
at rates ranging from 5.125% to 8.125% 4,693
Debt acquired as part of the UEM
acquisition 40,927
---------
112,491
Less: Current portion of long-term
debt 13,887
---------
Total long-term debt $98,604
=========
The revolving credit facility (the "Facility") with a group of six banks
allows the Company to borrow up to an aggregate of $100,000 at a variable rate.
Outstanding borrowings under the Facility are unconditionally guaranteed by a
pledge of the capital stock of the Company's subsidiaries, and are due on
December 31, 2003. As of June 30, 1999, approximately $66,900 of borrowings are
outstanding under the Facility at rates ranging from 6.00% to 7.75%.
Approximately $40,900 of outstanding borrowings acquired as part of the UEM
acquisition are due between December 1999 and August 2007. These UEM borrowings
bear interest at a blended rate of approximately 5.00% as of June 30, 1999.
Note 4 - Accounting Change
On January 1, 1999, the Company adopted the provisions of AICPA Statement of
Position No. 98-5, Reporting the Costs of Start-up Activities ("SOP 98-5"),
which requires start-up costs capitalized prior to January 1, 1999 to be
written-off and any future start-up costs to be expensed as incurred. The
Company previously capitalized pre-contract costs directly associated with
specific anticipated contracts as well as development costs for new educational
programs that were estimated to be recoverable. The cumulative effect of
adopting SOP 98-5 in 1999 decreased net income by $1,323 (net of $682 in income
taxes), or ($.02) per share.
Note 5 - Income Taxes
The tax provisions for the three and six month periods ended June 30, 1999 and
1998 are based on the estimated effective tax rates applicable for the full
years, 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
was 34% and 65% for the six months ended June 30, 1999 and 1998, respectively.
The effective tax rate for the period ended June 30, 1998 was unusually high due
to significant transaction costs related to the acquisition of Aspect in May
1998 which were expensed for financial reporting purposes but were
non-deductible for income tax purposes. The Company estimates that its effective
income tax rate for the year ending December 31, 1999 will be 34%.
9
<PAGE>
Note 6 - Earnings Per Share
The following table summarizes the computations of basic and diluted earnings
per share:
Three months ended Six months ended
June 30, June 30,
1999 1998 1999 1998
---------------------- ----------------------
Numerator used in basic and
diluted earnings per common share:
Income (loss) before
cumulative effect
of accounting change $ 11,383 $ (1,478) $ 18,190 $ 2,789
Cumulative effect of
accounting change,
net of tax - - (1,323) -
---------- --------- --------- ----------
Net income (loss) $ 11,383 $ (1,478) $ 16,867 $ 2,789
========== ========= ========= ==========
Denominator:
Denominator for basic
earnings per common share -
weighted average shares 51,841 48,185 51,539 47,850
Effect of dilutive
securities:
Stock options and warrants 1,733 - 2,006 2,193
---------- --------- --------- ----------
Denominator for diluted
earnings per common
share - weighted average
shares 53,574 48,185 53,545 50,043
========== ========= ========= ==========
Earnings (loss) per common
share, basic:
Income before cumulative
effect of accounting change 0.22 (0.03) 0.35 0.06
Cumulative effect of
accounting change - - (0.02) -
---------- --------- --------- ----------
$ 0.22 $ (0.03) $ 0.33 $ 0.06
========== ========= ========= ==========
Earnings (loss) per common share,
diluted:
Income before cumulative
effect of accounting change $ 0.21 $ (0.03) $ 0.34 $ 0.06
Cumulative effect of
accounting change - - (0.02) -
---------- --------- --------- ----------
$ 0.21 $ (0.03) $ 0.32 $ 0.06
========== ========= ========= ==========
The effect of stock options and warrants was antidilutive for the three
months ended June 30, 1998 and was therefore not considered in the computation
of dilutive loss per common share.
10
<PAGE>
Note 7 - Stockholders' Equity
The components of stockholders' equity are as follows (amounts in thousands):
<TABLE>
<CAPTION>
Accumulated
Additional Other Total
Common Paid-In Retained Comprehensive Stockholders'
Stock Capital Earnings Income (loss) Equity
------- ---------- ---------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1998 $ 510 $ 410,694 $ 75,852 $ 1,777 $ 488,833
Options exercised for
purchase of 256 shares of
common stock, including
income tax benefit of $1,177 3 3,567 3,570
Stock options granted to
non-employees 121 121
Repurchase of 312 shares
of common stock (3) (7,761) (7,764)
Issuance of 27 shares of
common stock in connection
with the Employee Stock
Purchase Plan 716 716
Issuance of 510 shares of
common stock in connection
with contingent consideration
related to the acquisition of
Canter 5 11,162 11,167
Issuance of 38 shares of
common stock in connection
with consideration related
to the acquisition of PACE 995 995
Issuance of 144 shares of
common stock in connection
with other acquisitions 1 1,594 (1,503) 92
Comprehensive income:
Net income for the six
months ended
June 30, 1999 16,867 16,867
Other comprehensive
income:
Foreign currency
translation adjustment (4,311) (4,311)
----------
Total comprehensive
income 12,556
------- --------- ---------- ---------- ===========
Balance at June 30, 1999 $ 516 $ 421,088 $ 91,216 $ (2,534) $ 510,286
======= ========= ========== =========== ==========
</TABLE>
During the second quarter of 1999, the Company repurchased 312 shares of its
common stock for $7,764. Management intends to use the repurchased shares in
payment of contingent consideration related to acquisitions.
11
<PAGE>
Note 8 - 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, 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 required 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 commenced in 1998 and is now completed. Motions will be heard
by the Court over the next several months. 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 9 - Business Segment Information
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1999 1998 1999 1998
-----------------
Operating revenues:
<S> <C> <C> <C> <C>
Sylvan Prometric $82,511 $58,209 $155,874 $105,777
Sylvan Contract Educational
Services 27,667 25,649 58,258 52,269
Sylvan Learning Centers 23,544 15,470 43,368 27,605
Sylvan International
Universities 14,738 - 14,738 -
========= ========= ========= =========
$148,460 $99,328 $272,238 $185,651
========= ========= ========= =========
Segment profit:
Sylvan Prometric $12,198 $(2,490) $ 19,680 $ 539
Sylvan Contract Educational
Services 3,045 3,524 6,616 7,331
Sylvan Learning Centers 6,889 4,538 11,413 7,243
Sylvan International
Universities 3,051 - 3,051 -
========= ========= ========= =========
$ 25,183 $ 5,572 $ 40,760 $ 15,113
========= ========= ========= =========
June 30,
1999 1998
----------------------
Segment assets:
Sylvan Prometric $424,143 $281,694
Sylvan Contract Educational
Services 121,041 91,024
Sylvan Learning Centers 55,647 31,989
Sylvan International
Universities 75,637 -
========= =========
$676,468 $404,707
========= =========
</TABLE>
12
<PAGE>
Note 9 - Business Segment Information (continued)
With the exception of the second quarter 1999 addition of a segment, Sylvan
International Universities (see Note 2), there have been no changes since
December 31, 1998 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:
Three months ended Six months ended
June 30, June 30,
1999 1998 1999 1998
---------------------- ----------------------
Total profit for reportable
segments $ 25,183 $ 5,572 $ 40,760 $ 15,113
Corporate general and
administrative expense (5,042) (4,358) (9,766) (7,684)
Other income (expense) (2,892) 147 (3,433) 515
---------- --------- --------- ----------
Income before income taxes
and cumulative effect of
accounting change $ 17,249 $ 1,361 $ 27,561 $ 7,944
========== ========= ========= ==========
Note 10 - Comprehensive Income
The components of comprehensive income, net of related tax, are as follows:
Three months ended June 30, Six months end June 30,
1999 1998 1999 1998
----------------------- -----------------------
Net income (loss) $ 11,383 $ (1,478) $ 16,867 $ 2,789
Foreign currency translation
adjustment (3,723) (428) (4,311) (194)
---------- ---------- ---------- ----------
Comprehensive income (loss) $ 7,660 $ (1,906) $ 12,556 $ 2,595
========== ========== ========== ==========
Note 11 - Subsequent Events
On July 14, 1999, the Company sold its entire investment in JLC Learning
Corporation ("JLC"), a company that develops educational software products.
Proceeds from such sale amounted to approximately $15,200 in cash and a five
year purchase credit in the amount of approximately $11,200. The Company intends
to apply this purchase credit to software purchases of various divisions. Full
application of these purchase credits would result in no gain or loss on the JLC
sale.
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Overview
The Company generates revenues from four business segments: Sylvan Prometric,
which earns computer-based testing fees as well as fees from the operations of
an English language instruction business (consisting of the Wall Street
Institute ("WSI") and Aspect International Language Schools ("Aspect"); Sylvan
Contract Educational Services, which earns revenues attributable to providing
supplemental remedial education services to public and non-public schools and
major corporations as well as providing teacher training services; Sylvan
Learning Centers, which earns primarily franchise royalties, franchise sales
fees and Company-owned Learning Center revenues; and Sylvan International
Universities, which earns tuition and fees paid by the students of the
Universidad Europea de Madrid.
The following table sets forth the percentage relationships of operating
revenues and direct costs for each division, as well as certain income statement
line items expressed as a percentage of total revenues for the periods
indicated:
Three months ended Six months ended
June 30, June 30,
1999 1998 1999 1998
------------------- -------------------
Operating revenues:
Sylvan Prometric 56% 59% 57% 57%
Sylvan Contract Education
Services 18% 25% 22% 28%
Sylvan Learning Centers 16% 16% 16% 15%
Sylvan International
Universities 10% 0% 5% 0%
-------- --------- --------- --------
Total revenues 100% 100% 100% 100%
Direct costs:
Sylvan Prometric 47% 52% 50% 51%
Sylvan Contract Education
Services 17% 22% 19% 24%
Sylvan Learning Centers 11% 11% 12% 11%
Sylvan International
Universities 8% 0% 4% 0%
-------- --------- --------- --------
Total direct costs 83% 85% 85% 86%
General and administrative
expenses 3% 4% 4% 4%
Restructuring and transaction
costs related to pooling
of interests 0% 9% 0% 5%
-------- --------- --------- --------
Operating income 14% 2% 11% 5%
Non-operating income (expense) (2%) 0% (1%) 0%
-------- --------- --------- --------
Income before income taxes and
cumulative effect of change
in accounting principle 12% 2% 10% 5%
Income taxes 4% 3% 3% 3%
-------- --------- --------- --------
Net income (loss) 8% (1%) 7% 2%
======== ========= ========= ========
14
<PAGE>
RESULTS OF OPERATIONS
COMPARISON OF RESULTS FOR THE THREE MONTHS ENDED JUNE 30, 1999 TO RESULTS FOR
THE THREE MONTHS ENDED JUNE 30, 1998.
REVENUES. Total revenues increased by $49.1 million, or 49%, to $148.5 million
in 1999 from $99.3 million in 1998. This increase resulted from higher revenues
in all business segments - Sylvan Prometric, Sylvan Contract Educational
Services, Sylvan Learning Centers and Sylvan International Universities.
SYLVAN PROMETRIC revenue increased by $24.3 million, or 42%, to $82.5 million
in 1999, compared to $58.2 million in 1998. Excluding 1998 revenues of $3.5
million from Block Testing Services, L.P. And related entities (collectively,
"NAI/Block"), the net assets of which were contributed to a joint venture in
January 1999, Sylvan Prometric revenue for 1999 increased $27.8 million, or 51%,
compared to 1998. Academic admissions testing revenues increased $3.4 million,
or 103%, compared to the same period in 1998, primarily due to volume based and
cost of living adjustments in the Test of English as a Foreign Language (TOEFL),
Praxis and Regents College exams. Information Technology (IT) testing revenues
increased $7.7 million, or 44%, in 1999 compared to 1998 due primarily to
Microsoft and other IT client volume increases. Professional licensure and
certification testing revenues increased 66%, or $3.8 million, in 1999 compared
to 1998, primarily as a result of increased revenues from the National
Association of Securities Dealers (NASD) testing contract and the addition of
the National Board of Medical Examiners (NBME) and other new testing contracts.
Educational Testing Service cost-plus international contract revenues increased
$2.1 million, or 27%, for 1999 compared to 1998, primarily due to an increase in
testing volume and the cost of center build-out. Revenues from the Company's
English Language instruction business, which represents 33% of 1999 divisional
operating revenues, increased $10.8 million in 1999, primarily as a result of
the operations of several WSI franchise locations acquired after the first
quarter of 1998 and the sale of international area development rights. Operating
revenue for Prometric represents 56% of total revenues of the Company for the
three month period ended June 30, 1999.
SYLVAN CONTRACT EDUCATIONAL SERVICES revenue increased by $2.0 million, or
8%, to $27.7 million in 1999 compared to the same period in 1998. The revenue
increase was the result of a $3.4 million increase in revenue from public and
nonpublic school contracts, offset by a $1.4 million decrease in revenue from
the PACE corporate training business. The $3.4 million increase in revenue from
public and nonpublic schools for 1999 is the result of $3.2 million in revenue
attributable to new contracts obtained after June 30, 1998, as well as an
increase of $.2 million in revenue attributable to existing contracts. Operating
revenue for Contract Educational Services represents 18% of total revenues of
the Company for the three month period ended June 30, 1999.
SYLVAN LEARNING CENTERS revenue increased by $8.1 million, or 52%, to $23.5
million compared to the same period in 1998. Franchise royalties increased by
$1.0 million, or 25%, for 1999 as a result of the net increase of 81 new centers
opened after June 30, 1998 and a 16% increase in same center revenue. Revenues
from Company-owned Learning Centers increased $2.5 million, or 27%, to $11.6
million during 1999. Same center revenues increased 7%, or $.6 million, with the
remaining revenue increase of $1.9 million generated from 16 new company-owned
centers acquired from franchise owners during the past 12 months. On October 31,
1998, the company acquired Schulerhilfe, a tutoring company based in Germany.
this acquisition resulted in an additional $3.9 million in revenue for 1999.
Product sales, franchise sales fees and other franchise service revenues
generated the remaining revenue increase of $.7 million for 1999, as compared to
1998. Operating revenue for Learning Centers represents 16% of total revenues of
the Company for the three month period ended June 30, 1999.
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SYLVAN INTERNATIONAL UNIVERSITIES, The Company's newest division, began
operations in the second quarter of 1999 with the acquisition of a 54%
controlling interest in the Universidad Europea de Madrid (UEM). Sylvan assumed
operating control of UEM on April 1, 1999, at which time results of UEM's
operations began to be consolidated with those of the Company. Total revenues
for International Universities subsequent to April 1, 1999 were $14.7 million,
which represents 10% of total revenues of the Company for the three month period
ended June 30, 1999.
DIRECT COSTS. Total direct costs increased 45% to $123.2 million in 1999 from
$85.0 million in 1998 as a result of business expansion. Direct costs as a
percentage of total revenues decreased to 83% in 1999 from 85% in 1998. This
decrease in costs as a percentage of revenue is primarily due to expanding
revenues while management controls the related direct operating expenses.
SYLVAN PROMETRIC direct costs for 1999 increased by $18.3 million to $70.3
million, or 85% of total Sylvan Prometric revenue, compared to $52.0 million, or
89% of total Prometric revenue for the same period in 1998. Excluding expenses
of $2.2 million for 1998 related to NAI/Block, the net assets of which were
contributed to a joint venture in January 1999, and $1.2 Million of
non-recurring expenses related to the acquisition of Aspect, Prometric expenses
would have been $48.6 million, or 89% of Prometric revenue for 1998. This
decrease in direct costs as a percentage of revenues is due to increased volumes
and revenues from IT, academic admissions, professional licensure and
certificate testing offset in part by increased Year 2000 compliance and
international business development support costs. The increased margins in 1999
compared to the same periods in 1998 are mainly a result of the improvements in
the higher volumes of tests which reduces the cost per test of the division, the
margins on the sale of WSI area development rights in 1999, and increased
margins on the revenues of the WSI franchisees acquired after the first quarter
of 1998.
SYLVAN CONTRACT EDUCATIONAL SERVICES expenses increased by $2.5 million to
$24.6 million, or 89% of Sylvan Contract Educational Services revenue for 1999,
compared to $22.1 million, or 86% of Contract Educational Services revenue for
the same period in 1998. The increase in costs as a percentage of revenue for
1999 is due to costs for new contracts for specialized services, increased sales
costs for selling public and non-public business as well as higher costs as a
percentage of revenue for the PACE corporate training business.
SYLVAN LEARNING CENTERS Expenses increased $5.7 million to $16.7 million, or
71% of Learning Centers revenue for 1999, compared to $10.9 million, or 71% of
Learning Centers revenue for the same period in 1998. Approximately $2.3 million
of the increase for 1999 was related to the acquisition of franchised learning
centers and costs associated with higher revenues at existing company-owned
centers. Expenses as a percentage of revenues did not decline for the period as
a result of the acquisition of more franchise centers which tend to operate at
lower margins. The acquisition of Schulerhilfe resulted in $2.9 million of
increased costs for the three month period ended June 30, 1999. The remaining
cost increase of $0.5 million for 1999 relates to franchise services support
costs due to the growth in franchised Centers over the prior year.
SYLVAN INTERNATIONAL UNIVERSITIES expenses were $11.7 million for the three
month period ended June 30, 1999. These direct expenses consist primarily of
tuition personnel, marketing and advertising, and facility-related costs of UEM.
These expenses represent 79% of the International Universities revenues for the
three month period ended June 30, 1999.
OTHER EXPENSES. General and administrative expenses increased by $0.7 million
during 1999, compared to 1998, but decreased to 3% of revenues for 1999 compared
to 4% of revenues for 1998. This decrease in general and administrative expense
as a percentage of total revenues is primarily due to the expansion of revenues
without a corresponding increase in general and administrative expenses. The
Company's
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centralized infrastructure has been adequate to respond to additional demands
without a corresponding increase in the level of general and administrative
expenses.
In May of 1998, the Company acquired Aspect. Associated with this
acquisition, Sylvan incurred $5.0 million of non-recurring transaction-related
costs, as well as $3.7 million of restructuring charges. The net effect of the
$3.7 million restructuring charge, the $5.0 million of transaction-related
costs, as well as the $1.2 million in compensation paid to Aspect's former
owners which are included in the direct costs of Prometric for 1998, was a
decrease in pre-tax income of $9.9 million and net income of $8.9 million during
the three month period ended June 30, 1998.
Non-operating expenses incurred by the Company increased $3.0 million as
compared to the same period in 1998. This increase is largely attributable to
the $1.2 million minority interest in income of consolidated subsidiary recorded
during 1999 related to UEM, as well as an increase of $1.1 million in interest
expense related to additional borrowings made during the three month period
ended June 30, 1999, and debt obligations of UEM assumed by the Company as part
of the acquisition. The remaining $.7 million increase in non-operating expenses
is attributable to charges related to the equity in the net loss of affiliates,
as well as normal fluctuations in other income and expense.
The Company's effective tax rate has decreased from 209% during 1998 to 34%
during 1999. This decrease is a result of an increase in income earned during
1999 in jurisdictions with lower tax rates as well as the fact that the
effective tax rate for 1998 includes the effect of $5.0 million of transaction
costs related to the acquisition of Aspect for which there was no allowable
income tax deduction. The company estimates that its effective tax rate for the
year ending December 31, 1999 will be 34%.
NET INCOME. Net income increased by $12.9 million to $11.4 million for the three
month period ended June 30, 1999, compared to a net loss of $1.5 million in the
same period in 1998. Excluding the total $8.9 million of non-recurring expenses,
net of tax, related to Aspect from the results of operations for 1998, net
income would have increased by $4.0 million, or 54%, for 1999. This increase is
a result of increased revenue from all divisions, improved margins and
management's efforts to control costs.
COMPARISON OF RESULTS FOR THE SIX MONTHS ENDED JUNE 30, 1999 TO RESULTS FOR
THE SIX MONTHS ENDED JUNE 30, 1998.
REVENUES. Total revenues increased by $86.6 million, or 47%, to $272.2 million
for the six months ended June 30, 1999 from $185.7 million for the same period
in 1998. This increase resulted from higher revenues in all business segments -
Sylvan Prometric, Sylvan Contract Educational Services, Sylvan Learning Centers
and Sylvan International Universities.
SYLVAN PROMETRIC revenue increased by $50.1 million, or 47%, to $155.9
million in 1999, compared to 1998. Excluding 1998 revenues of $6.6 million from
Block Testing Services, L.P. and related entities (collectively, "NAI/Block"),
the net assets of which were contributed to a joint venture in January 1999,
Prometric revenue for 1999 increased $56.7 million, or 57%, compared to 1998.
Academic admissions testing revenues increased $5.0 million, or 68%, compared to
the same period in 1998, primarily due to volume based and cost of living
adjustments in the Test of English as a Foreign Language (TOEFL), Praxis and
Regents College exams. Information Technology (IT) testing revenues increased
$16.4 million, or 50%, in 1999 due primarily to Microsoft and other it client
volume increases. Professional licensure and certification testing revenues
increased 57%, or $6.0 million, in 1999 compared to 1998, primarily as a result
of increased revenues from the National Association of Securities Dealers (NASD)
testing contract and the addition of the National Board of Medical Examiners
(NBME) and other new testing contracts. Educational
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Testing Service cost-plus international contract revenues increased $10.0
million, or 92% for 1999 compared to 1998, primarily due to an increase in
testing volume and the cost of center build-out. Revenues from the Company's
English language instruction business, which represents 32% of 1999 divisional
operating revenues, increased $18.3 million in 1999 primarily as a result of the
operations of several WSI franchise locations acquired after the first quarter
of 1998 and the sale of international area development rights. The remaining
$1.0 million increase in revenue is related to various other fees and media
based testing revenue. Operating revenue for Prometric represents 57% of total
revenues of the Company for the six month period ended June 30, 1999.
SYLVAN CONTRACT EDUCATIONAL SERVICES revenue increased by $6.0 million, or
11%, to $58.3 in 1999 compared to the same period in 1998. The revenue increase
was the result of a $7.4 million increase in revenue from public and nonpublic
school contracts, offset by a $1.4 million decrease in revenue from the PACE
corporate training business. The $7.4 million increase in revenue from public
and nonpublic schools for 1999 is the result of $7.0 million in revenue
attributable to new contracts obtained after June 30, 1998, as well as an
increase of $.4 million in revenue attributable to existing contracts. Operating
revenue for Contract Educational Services represents 22% of total revenues of
the Company for the six month period ended 1999.
SYLVAN LEARNING CENTERS revenues for 1999 increased by $15.8 million, or 57%,
to $43.4 million compared to 1998. Franchise royalties increased by $1.7
million, or 22%, for 1999 as a result of the net increase of 81 new Centers
opened after June 30, 1998 and a 16% increase in same center revenue. Revenues
from Company-owned Learning Centers increased $4.9 million, or 30%, to $20.9
million during 1999. Same center revenues increased 11%, or $1.7 million, with
the remaining revenue increase of $3.2 million generated from 16 new
company-owned centers from franchise owners during the past 12 months. On
October 31, 1998, the Company acquired Schulerhilfe, a tutoring company based in
Germany. This acquisition resulted in an additional $7.9 million in revenue for
the six month period ended 1999. Product sales, franchise sales fees and other
franchise service revenues generated the remaining revenue increase of $1.3
million for 1999, as compared to 1998. Operating revenues for Learning Centers
represents 16% of total revenues of the Company for the six months ended 1999.
SYLVAN INTERNATIONAL UNIVERSITIES, The Company's newest division, began
operations in the second quarter of 1999 with the acquisition of a 54%
controlling interest in the Universidad Europea de Madrid (UEM). Sylvan assumed
operating control of UEM on April 1, 1999, at which time results of UEM's
operations began to be consolidated with those of the Company. Total revenues
for International Universities subsequent to April 1, 1999, were $14.7 million,
which represent 5% of total revenue of the Company for the six month period
ended 1999.
DIRECT COSTS. Total direct costs increased 43% to $231.5 million in 1999 from
$161.8 million in 1998 as a result of business expansion. Direct costs as a
percentage of total revenues decreased to 85% in 1999 from 86% in 1998. This
decrease in costs as a percentage of revenues is primarily due to expanding
revenues while management controls the related direct operating expenses.
SYLVAN PROMETRIC direct costs for 1999 increased by $39.7 million to $136.2
million, or 89% of total Prometric revenue, compared to $96.5 million, or 91% of
total Prometric revenue for the same period in 1998. Excluding expenses of $5.5
million for 1998 related to NAI/Block, the net assets of which were contributed
to a joint venture in January 1999, and $1.2 million of non-recurring expenses
related to the acquisition of Aspect, Prometric direct costs would have been
$89.8 million, or 91% of Prometric revenue for 1998. This decrease in direct
costs as a percentage of revenues is due to increased volumes and revenues from
IT, academic admissions, professional licensure and certificate testing offset
in part by increased Year
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2000 compliance and international business development support costs. The
increased margins in 1999 compared to the same periods in 1998 are mainly a
result of improvements in higher volumes of tests which reduces the cost per
test of the division, the margins on the sale of WSI area development rights in
1999, and increased margins on the revenues of the WSI franchisees acquired
after the first quarter of 1998.
SYLVAN CONTRACT EDUCATIONAL SERVICES expenses increased by $6.7 million to
$51.6 million, or 89% of Sylvan Contract Educational Services revenue for 1999,
compared to $44.9 million, or 86% of Contract Educational Services revenue for
1998. The increase in costs as a percentage of revenue for 1999 is due to costs
for new contracts for specialized services, increased sales costs for selling
public and non-public business as well as higher costs as a percentage of
revenue for the PACE corporate training business.
SYLVAN LEARNING CENTERS expenses increased $11.6 million to $32.0 million, or
74% of Learning Centers revenue for 1999, compared to $20.4 million, or 74% of
Learning Centers revenue for the same period in 1998. Approximately $4.5 million
of the increase for 1999 was related to the acquisition of franchised learning
centers and costs associated with higher revenues at existing company-owned
centers. Expenses as a percentage of revenues did not decline for the period as
a result of the acquisition of more franchise centers which tend to operate at
lower margins. The acquisition of Schulerhilfe resulted in $6.3 million of
increased costs for six month period ended June 30, 1999. The remaining cost
increase of $0.8 million for 1999 relates to franchise services support costs
due to the growth in franchised Centers over the prior year.
SYLVAN INTERNATIONAL UNIVERSITIES expenses were $11.7 million for the six
month period ended June 30, 1999. These direct expenses consist primarily of
tuition personnel, marketing and advertising, and facility-related costs of UEM.
These expenses represent 79% of the International Universities revenues for the
six month period ended June 30, 1999.
OTHER EXPENSES. General and administrative expenses increased by $2.1 million
during 1999, compared to 1998, but remained constant at 4% of revenues. This
constant percentage in general and administrative expenses as a percentage of
total revenues is primarily due to the expansion of revenues without a
corresponding increase in general and administrative expenses.
In May 1998, the company acquired Aspect. Associated with this acquisition,
the Company incurred $5.0 million of non-recurring transaction-related costs, as
well as $3.7 million of restructuring charges. The net effect of the $3.7
million restructuring charge, the $5.0 million of transaction-related costs, as
well as the $1.2 million in compensation paid to Aspect's former owners which
are included in the direct costs of Prometric for 1998, was a decrease in
pre-tax income of $9.9 million and net income of $8.9 million during the six
month period ended June 30, 1998.
Non-operating expenses incurred by the Company increased $3.9 million, as
compared to the same period in 1998. This net increase in expenses is
attributable to a $2.9 decrease in interest and other income, a $1.7 million
increase in interest expense related to increased borrowings outstanding during
the period, and a $1.2 million minority interest in income of consolidated
subsidiary recorded in 1999 associated with UEM, offset by a $1.9 million
decrease in charges related to equity in net loss of affiliates.
The Company's effective tax rate has decreased from 65% during 1998 to 34%
during 1999. This decrease is a result of an increase in income earned during
1999 in jurisdictions with lower tax rates as well as the fact that the
effective tax rate for 1998 includes the effect of $5.0 million of transaction
costs related to the acquisition of Aspect for which there was no allowable
income tax deduction. The company estimates that its effective tax rate for the
year ending December 31, 1999 will be 34%.
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NET INCOME. Net income increased by $14.1 million to $16.9 million in 1999,
compared to $2.8 million in 1998. Excluding the $8.9 million of non-recurring
costs, net of tax, related to Aspect from the results of operations for 1998 and
the $1.3 million charge related to a change in accounting principle from the
adoption of the provisions of AICPA Statement of Position No. 98-5, net income
would have increased by $6.5 million, or 56%, for 1999. This increase is a
result of increased revenue from all divisions, improved margins and
management's efforts to control costs.
LIQUIDITY AND CAPITAL RESOURCES
The Company generated $41.6 million of cash flow from operations for the six
month period ended June 30, 1999, an increase of $16.7 million as compared to
the six months ended June 30, 1998. The cash flow from operations consists
primarily of $41.1 million related to net income excluding non-cash charges
(principally depreciation and amortization) for the six month period ended June
30, 1999. Although accounts and notes receivable increased during the period as
a result of revenue increases, the percentage increase was significantly less
than the rate of increase in revenues. The Company believes that uncollectible
accounts receivable will not have a significant effect on future liquidity, as a
large portion of the accounts receivable are due from enterprises with
substantial financial resources. Other operating assets decreased during the
period, offsetting the receivable increase, and when combined with the cash flow
from net income resulted in the $41.6 million cash flow from operations for the
six months period ended June 30, 1999.
Cash used in investing activities increased to $90.8 million in 1999 from $31.4
million in 1998. This increase was primarily due to the acquisition of the UEM,
the acquisition of other businesses and franchise centers, and the purchase of
property and equipment. These investments were made to begin the new
International Universities division, to acquire existing successful Sylvan
Learning and WSI Centers and to invest in furniture and equipment for the
Company's general business expansion.
The Company funded investing activity through operating cash flows as well as
funds provided through financing activities. The Company received net proceeds
of $56.9 million from borrowings on the revolving line of credit during the
period ended June 30, 1999. These proceeds were used to fund acquisitions,
fulfill payment obligations to shareholders of previously acquired companies and
for share repurchase activity. Borrowings under the revolving credit facility
are due December 31, 2003. At June 30, 1999 the Company has remaining
availability under the revolving credit facility of $33.1 million.
The Company expects that available cash, cash flow from operations and existing
lines of credit will be sufficient to meet its operating requirements, including
the expected expansion of its existing business, over the near term. The Company
continues to examine opportunities in the educational services or computer-
based testing industries for potential acquisitions. Additional capital
resources may be necessary to acquire and thereafter operate additional
businesses.
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YEAR 2000 ISSUES
The Year 2000 issue is the result of computer programs written using two
digits (rather than four) to define the applicable year. Absent corrective
actions, programs with date-sensitive logic may recognize "00" as 1900 rather
than 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, production
difficulties, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company has established a corporate-wide Year 2000 task force with
representatives from all divisions. The task force has conducted a comprehensive
review of the Company's information technology and non-information technology
systems affected by the Year 2000 issue and has developed an implementation plan
to resolve them. The Company measures its progress towards completion based on
the level of efforts completed to date compared to the total expected. The
process involves five phases:
Phase I - Inventory and Data Collection. This phase involves conducting a
comprehensive inventory of the Company's information systems which includes but
is not limited to telecommunications systems, computer hardware, software and
networks as well as building infrastructure such as HVAC, elevators and security
systems. The identification of key third party vendors is also involved. During
this phase, all new systems are required to have passed Year 2000 compliance
tests before being purchased and implemented. The Company commenced this phase
in the first quarter of 1998 and the phase is complete.
Phase II - Assessment / Date Impact. In this phase, systems identified during
Phase I are reviewed to determine what impact, if any, the Year 2000 Issue has
on the operation of these systems. This phase also identifies the effects of
Year 2000 being a leap year. This phase has been completed.
Phase III - Remediation. This phase involves modifying, replacing or
upgrading the systems that have failed during Phase II. The remediation phase is
95% complete and is expected to be completed by the end of the third quarter of
1999.
Phase IV - Testing. This phase involves review of systems for compliance and
re-testing as necessary. The testing phase is 90% complete and is expected to be
completed by the end of the third quarter of 1999.
Phase V - Implementation. This phase involves implementing the systems after
they have been successfully remediated and tested. This is the final step in
assuring that the systems are Year 2000 compliant. The phase is 80% complete and
is expected to be completed by the end of the third quarter of 1999, with the
exception of certain third party service providers already identified as not
Year 2000 compliant.
The Company believes the cost to remedy Year 2000 issues to be $4.5 million.
The Company has expended $1.0 million in 1998 and $2.9 million during the first
six months of 1999. The Company is not aware of any material non-compliance that
would have a material effect on its financial position. As part of the Year 2000
issue process, formal communication with the Company's suppliers, customers and
other support services has been initiated and efforts will continue until
positive statements of readiness have been received from all third parties. The
Company has identified certain service suppliers that are not Year 2000
compliant. It is working with the suppliers to ensure efforts are taken to
correct the situation and the Company is establishing contingency plans to
ensure no material service interruption. Therefore, the Company does not believe
that the non-compliance by the service suppliers will have a material impact on
the Company's business. Nevertheless, there can be no assurance that
unanticipated non-compliance will not occur, and such non-compliance could
require material costs to repair or could cause material disruptions if
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not repaired. The Company is in the process of developing a strategy to address
these potential consequences that may result from unresolved Year 2000 issues,
which will include the development of one or more contingency plans by mid 1999.
EURO CONVERSION
On January 1, 1999, certain countries of the European Union established fixed
conversion rates between their existing currencies and one common currency, the
euro. The euro is now traded on currency exchanges and may be used in business
transactions. Beginning in January 2002, new euro-denominated currencies will be
issued and the existing currencies will be withdrawn from circulation. The
Company is currently evaluating the systems and business issues raised by the
euro conversion. These issues include the need to adapt computer and other
business systems and equipment and the competitive impact of cross-border
transparency. The Company has not yet completed its estimate of the potential
impact likely to be caused by the euro conversion; however, at present the
Company has no reason to believe the euro conversion will have a material impact
on the Company's financial condition or results of operations.
CONTINGENT MATTERS
In connection with the Company's acquisition of Canter and based on Canter's
earnings in 1998, the Company paid additional consideration during the second
quarter of 1999 to the seller in cash of $14.9 million and shares of restricted
common stock which were valued at $11.2 million. Additional variable amounts of
contingent consideration are also payable to the seller if specified levels of
earnings are achieved in 1999 and 2000, payable in equal amounts of cash and
stock. The Company will record the contingent consideration when the
contingencies are resolved and the additional consideration is payable.
In connection with the Company's acquisition of Schulerhilfe, the Company may
be obligated to pay the sellers up to an additional $13.3 million of
consideration in February 2000 (payable in either cash or common stock at the
discretion of the Company) based on the amount of 1999 franchise fees which have
been collected by Schulerhilfe on or before January 31, 2000. The Company will
record this contingent consideration when the contingencies are resolved and the
additional consideration is payable.
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EFFECTS OF INFLATION
Inflation has not had a material effect on Sylvan's revenues and income from
continuing operations in the past three years. Inflation is not expected to have
a material future effect.
QUARTERLY FLUCTUATIONS
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 Title I or similar programs. Based on the Company's experience, revenues
generated by computer-based testing services may vary based on the frequency or
timing of delivery of individual tests and the speed of test administrators'
conversion of tests to computer-based format. The Company's English language
instruction businesses experience seasonal fluctuations based on the timing of
delivery of instruction to individuals. The International Universities Division
experiences seasonality in operating results as a result of the school term
which extends from September through May with limited summer classes.
Additionally, franchise license fees earned by the Company in its Sylvan
Learning Centers and testing services segments may vary significantly from
quarter to quarter. Revenues or profits in any period will not necessarily be
indicative of results in subsequent periods.
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 ACQUISITIONS, FUTURE CAPITAL REQUIREMENTS, POTENTIAL
ACQUISITIONS, THE FAILURE TO REMEDIATE OR THE COST OF REMEDIATING YEAR 2000
ISSUES 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 TUTORIAL AND TEACHER TRAINING OPERATIONS; THE
AVAILABILITY OF SUFFICIENT CAPITAL TO FINANCE THE COMPANY'S BUSINESS PLAN ON
TERMS SATISFACTORY TO THE COMPANY; THE FAILURE TO REMEDIATE OR THE COST OF
REMEDIATING YEAR 2000 ISSUES; 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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The Company is exposed to market risk from changes in interest rates and foreign
currency exchange rates, which could affect its future results of operations and
financial condition. The Company manages its exposure to these risks through its
regular operating and financing activities.
FOREIGN CURRENCY RISK
The Company derives approximately 35% of its revenues from customers outside of
the United States. This business is transacted through a network of
international subsidiaries, generally in the local currency that is considered
the functional currency of that foreign subsidiary. The Company generally views
its investment in the majority of its foreign subsidiaries as long-term. The
functional currencies of these foreign subsidiaries are principally denominated
in the Spanish peseta, the British pound sterling, and the Australian dollar.
The effects of a change in foreign currency exchange rates on the Company's net
investment in foreign subsidiaries are reflected in other comprehensive income.
A 10% depreciation in functional currencies relative to the U.S. dollar would
result in a decrease in consolidated stockholders' equity at June 30, 1999 and
1998 of approximately $9.8 million and $3.3 million, respectively.
INTEREST RATE RISK
The Company's long-term debt bears interest at variable rates, and the fair
value of this debt is not significantly affected by changes in market interest
rates. A 100 basis point increase in interest rates would reduce pretax income
for the six months ended June 30, 1999 and 1998 by approximately $1.1 million
and $.2 million, respectively.
24
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the three months
ended June 30, 1999.
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 10, 1999 /s/ B. Lee McGee
---------------------------
B. Lee McGee, Executive Vice President
and Chief Financial Officer
25
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