UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 for the quarter ended SEPTEMBER 30, 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 50,954,650 shares of Common Stock outstanding as of November
1, 1999.
<PAGE>
SYLVAN LEARNING SYSTEMS, INC.
-----------------------------
INDEX
-----
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets - September 30, 1999 and
December 31, 1998............................................................3
Consolidated Statements of Operations - Three months ended
September 30, 1999 and September 30, 1998....................................5
Consolidated Statements of Income - Nine months ended
September 30, 1999 and September 30, 1998....................................6
Consolidated Statements of Cash Flows - Nine months ended
September 30, 1999 and September 30, 1998....................................7
Notes to Consolidated Financial Statements - September 30, 1999.................8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.........................................15
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>
SEPTEMBER 30, DECEMBER 31,
1999 1998
--------------- --------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 27,860 $ 33,170
Available-for-sale securities 4,408 6,166
Receivables:
Accounts receivable 86,444 71,248
Costs and estimated earnings in excess of billings
on uncompleted contracts 8,911 7,806
Notes receivable from tuition financing 4,359 2,977
Other notes receivable 16,246 8,922
Other receivables 2,475 2,404
--------------- --------------
118,435 93,357
Allowance for doubtful accounts (5,073) (2,963)
--------------- --------------
113,362 90,394
Inventory 10,030 9,841
Deferred income taxes 1,828 1,831
Prepaid expenses 15,311 10,093
Other current assets 3,668 1,843
Net current assets of discontinued operations 1,060 -
--------------- --------------
Total current assets 177,527 153,338
Notes receivable from tuition financing, less current portion 5,004 3,415
Other notes receivable, less current portion 10,523 9,882
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 721 637
Property and equipment:
Land and buildings 71,084 9,917
Furniture, computer equipment and software 166,612 111,490
Leasehold improvements 18,303 13,156
--------------- --------------
255,999 134,563
Accumulated depreciation (54,344) (36,682)
--------------- --------------
201,655 97,881
Intangible assets:
Goodwill 310,245 292,693
Contract rights 13,973 13,973
Other 2,675 3,111
--------------- --------------
326,893 309,777
Accumulated amortization (34,938) (26,322)
--------------- --------------
291,955 283,455
Deferred contract costs, net of accumulated amortization
of $15,039 as of September 30, 1999 and $11,740
as of December 31, 1998 10,836 10,255
Investments in and advances to affiliates 50,728 18,532
Other investments 19,104 44,230
Net assets to be transferred to joint venture - 31,575
Other assets 17,630 6,596
Net non-current assets of discontinued operations 8,000 -
--------------- --------------
Total assets $ 793,683 $ 659,796
=============== ==============
</TABLE>
3
<PAGE>
SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Amounts in thousands, except per share data)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
--------------- --------------
(Unaudited)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 62,111 $ 57,177
Income taxes payable 18,436 11,784
Current portion of long-term debt 16,831 1,128
Current portion of due to shareholders of
acquired companies 2,492 40,719
Deferred revenue and other current liabilities 50,872 27,430
--------------- --------------
Total current liabilities 150,742 138,238
Long-term debt, less current portion 125,444 12,504
Deferred income taxes 7,045 6,961
Due to shareholders of acquired companies,
less current portion - 12,239
Other long-term liabilities 1,783 1,021
--------------- --------------
Total liabilities 285,014 170,963
Minority interest 10,219 -
Stockholders' equity:
Preferred stock, par value $.01 per share--authorized
10,000 shares, no shares issued and outstanding
as of September 30, 1999 and December 31, 1998 - -
Common stock, par value $.01 per share--authorized
90,000 shares, issued and outstanding shares of
50,983 as of September 30, 1999 and 50,952
as of December 31, 1998 510 510
Additional paid-in capital 414,967 410,694
Retained earnings 83,470 75,852
Accumulated other comprehensive income (loss) (497) 1,777
--------------- --------------
Total stockholders' equity 498,450 488,833
--------------- --------------
Total liabilities and stockholders' equity $ 793,683 $ 659,796
=============== ==============
</TABLE>
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)
<TABLE>
<CAPTION>
Three months ended
September 30,
---------------------------------------
1999 1998
---------------------------------------
(Unaudited)
<S> <C> <C>
REVENUES $ 136,660 $ 106,512
COST AND EXPENSES
Direct costs 104,987 82,591
General and administrative expense 5,518 3,637
---------------- -----------------
Total expenses 110,505 86,228
---------------- -----------------
Operating income 26,155 20,284
OTHER INCOME (EXPENSE)
Investment and other income (expense) 408 (58)
Interest expense (1,955) (346)
Equity in net loss of affiliates (371) (281)
Minority interest in loss of consolidated subsidiary 523 -
---------------- -----------------
Income from continuing operations before income taxes 24,760 19,599
Income taxes (8,402) (6,662)
---------------- -----------------
Income from continuing operations 16,358 12,937
---------------- -----------------
DISCONTINUED OPERATIONS
(Loss) income from discontinued operations, net of tax (426) 15
Loss on disposal of discontinued operations, after tax (25,082) -
---------------- -----------------
Net (loss) income $ (9,150) $ 12,952
================ =================
Earnings (loss) per common share, basic:
Income from continuing operations $ 0.31 $ 0.27
Loss from discontinued operations (0.01) -
Loss from disposal of discontinued operations (0.48) -
---------------- -----------------
Earnings (loss) per common share, basic $ (0.18) $ 0.27
================ =================
Earnings (loss) per common share, diluted:
Income from continuing operations $ 0.31 $ 0.26
Loss from discontinued operations (0.01) -
Loss from disposal of discontinued operations (0.47) -
---------------- -----------------
Earnings (loss) per common share, diluted $ (0.17) $ 0.26
================ =================
</TABLE>
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)
<TABLE>
<CAPTION>
Nine months ended
September 30,
---------------------------------------
1999 1998
---------------------------------------
(Unaudited)
<S> <C> <C>
REVENUES $ 402,219 $ 284,624
COST AND EXPENSES
Direct costs 329,517 237,192
General and administrative expense 15,284 11,321
Transaction costs related to pooling-of-interests - 5,000
Restructuring costs - 3,730
---------------- -----------------
Total expenses 344,801 257,243
---------------- -----------------
Operating income 57,418 27,381
OTHER INCOME (EXPENSE)
Investment and other income 754 3,112
Interest expense (4,053) (796)
Equity in net loss of affiliates (815) (2,603)
Minority interest in income of consolidated subsidiary (651) -
---------------- -----------------
Income from continuing operations before income taxes
and cummulative effect of change in accounting principle 52,653 27,094
Income taxes (17,902) (11,642)
---------------- -----------------
Income from continuing operations before cummulative
effect of change in accounting principle 34,751 15,452
---------------- -----------------
DISCONTINUED OPERATIONS
(Loss) income from discontinued operations, net of tax (629) 292
Loss on disposal of discontinued operations, after tax (25,082) -
---------------- -----------------
Income before cumulative effect of change in
accounting principle 9,040 15,744
Cumulative effect of change in accounting principle (1,323) -
---------------- -----------------
Net income $ 7,717 $ 15,744
================ =================
Earnings per common share, basic:
Income from continuing operations $ 0.67 $ 0.32
Income (loss) from discontinued operations (0.01) 0.01
Loss from disposal of discontinued operations (0.48) -
Cumulative effect of accounting change (0.03) -
---------------- -----------------
Earnings per common share, basic $ 0.15 $ 0.33
================ =================
Earnings per common share, diluted:
Income from continuing operations $ 0.65 $ 0.30
Income (loss) from discontinued operations (0.01) 0.01
Loss from disposal of discontinued operations (0.47) -
Cumulative effect of accounting change (0.03) -
---------------- -----------------
Earnings per common share, diluted $ 0.14 $ 0.31
================ =================
</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>
Nine months ended September 30,
---------------------------------------
1999 1998
---------------------------------------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 7,717 $ 15,744
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 17,506 10,071
Amortization 12,591 11,829
Loss on disposal of discontinued operations 25,082 -
Minority interest in income of consolidated subsidiary 651 -
Cumulative effect of accounting change 1,323 -
Non-cash issuance of options to non-employees 162 -
Non-cash dividend income - (1,000)
Non-cash compensation expense - 1,300
Equity in net loss of affiliates 815 2,603
Deferred income taxes (80) (21)
Changes in operating assets and liabilities:
Accounts and notes receivable, net (18,172) (3,693)
Cost and estimated earnings in excess of billings
on uncompleted contracts, net (1,188) (2,480)
Inventory (327) (1,905)
Prepaid expenses and other current assets (6,443) (3,887)
Accounts payable and accrued expenses (6,794) 1,953
Income taxes payable 7,661 984
Deferred revenue and other current liabilities 17,700 11,122
---------------- -----------------
Net cash provided by operating activities 58,204 42,620
---------------- -----------------
INVESTING ACTIVITIES
Purchase of available-for-sale securities (1,097) (2,105)
Proceeds from sale of available-for-sale securities 2,855 56,010
Investment in and advances to affiliates (1,339) (5,016)
Increase in other investments (1,245) (32)
Proceeds from sale of investment in JLC Learning Corporation 15,211 -
Purchase of property and equipment (41,140) (46,765)
Purchase of Canter, including direct costs of
acquisition, net of cash received - (24,262)
Purchase of WSI franchises, net of cash received (34,503) (14,643)
Payment of contingent consideration for prior period acquisitions (16,660) (13,809)
Purchase of Universidad Europea de Madrid, including direct
costs of acqusition, net of cash received (26,377) -
Cash paid for other acquired businesses, net of cash received (1,003) (1,998)
Expenditures for deferred contract costs (5,815) (717)
Increase in other assets (956) (6,381)
---------------- -----------------
Net cash used in investing activities (112,069) (59,718)
---------------- -----------------
FINANCING ACTIVITIES
Proceeds from exercise of options and warrants 2,885 9,052
Proceeds from issuance of common stock 962 -
Repurchase of common stock (36,213) -
Cash paid for fractional shares of common stock - (58)
Repayment of distributions to shareholders - 237
Proceeds from issuance of long-term debt 115,401 5,615
Payments on long-term debt and capital lease obligations (32,460) (544)
---------------- -----------------
Net cash provided by financing activities 50,575 14,302
---------------- -----------------
Effects of exchange rate changes on cash (2,020) 2,785
---------------- -----------------
Net decrease in cash and cash equivalents (5,310) (11)
Cash and cash equivalents at beginning of period 33,170 29,650
---------------- -----------------
Cash and cash equivalents at end of period $ 27,860 $ 29,639
================ =================
</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)
SEPTEMBER 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 nine month periods
ended September 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 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 nine month periods
ended September 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 a 54%
controlling interest in UEM, a private, for-profit university. The purchase
price of the UEM shares, including acquisition costs, was approximately $27,000,
net of cash received. The final purchase price allocation may differ from the
preliminary amounts due to adjustments to estimated fair value of acquired
assets. Results of operations of UEM are included in the accompanying 1999
consolidated statements of operations from April 1, 1999 through September 30,
1999. The acquisition would not have materially changed 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 - SALE OF OTHER INVESTMENTS
-------------------------
On July 14, 1999, JLC Learning Corporation ("JLC") redeemed the Company's
investment. Proceeds from the redemption amounted to approximately $15,200 in
cash and a four year purchase credit in the amount of approximately $11,200. The
purchase credit can be used by the Company as partial payment of the purchase
price of certain educational software products sold by JLC. The Company must use
at least one-quarter of the purchase credit during each of the first three years
of the agreement or forfeit that portion of the credit. The Company intends to
apply this purchase credit to software purchases of various divisions. The
Company has included this credit in "other assets" in the accompanying
consolidated balance sheet.
NOTE 4 - LONG-TERM DEBT
--------------
Long-term debt as of September 30, 1999 consists of the following (amounts in
thousands):
Long-term revolving credit facility with banks $ 95,552
Various notes payable bearing interest at rates
ranging from 4.6875% to 6.5625% 4,358
Mortgages, notes payable, and lines of credit
related to UEM 42,365
-------------
142,275
Less: Current portion of long-term debt (16,831)
-------------
Total long-term debt $ 125,444
=============
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 September 30, 1999, approximately $95,600 of borrowings
are outstanding under the Facility at rates ranging from 6.06% to 8.25%.
Approximately $42,000 of outstanding borrowings acquired as part of the UEM
acquisition are due between November 1999 and August 2007. These UEM borrowings
bear interest at a blended rate of approximately 5.00% as of September 30, 1999.
NOTE 5 - DISCONTINUED OPERATIONS
-----------------------
On September 30, 1999, the Company adopted a formal plan to dispose of the PACE
Group ("PACE") corporate training business. Management anticipates that a sale
will be consumated by the end of the first half of 2000. The impact of the
decision to sell PACE is the recognition of an estimated loss on disposal
totaling approximately $25,100, which includes an income tax provision of $2,400
related to a taxable gain expected to be realized upon the sale. The Company
also recorded a loss of $670 related to the estimated results of operations for
the period from the measurement date to the estimated date of disposal. For the
nine month period ended September 30, 1999 revenues and losses from operations
of the discontinued business were $9,566 and $629, respectively. For the nine
month period ended September 30, 1998, revenues and losses from operations of
the discontinued business were $10,729 and $292, respectively.
9
<PAGE>
NOTE 5 - DISCONTINUED OPERATIONS (CONTINUED)
-----------------------------------
The net assets of the discontinued operations in the September 30, 1999
consolidated balance sheet include (amounts in thousands):
Account receivable, net $2,294
Accounts payable and accrued expenses (510)
Accrued disposal costs and operating losses (970)
Other, net 246
-----------
Net current assets of discontinued operations $1,060
===========
Property and equipment, net 259
Goodwill, at estimated net realizable value 7,284
Other, net 457
-----------
Net non-current assets of discontinued operations $8,000
===========
NOTE 6 - 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 for the nine months ended
September 30, 1999 by $1,323 (net of $682 in income taxes), or ($.03) per share.
10
<PAGE>
NOTE 7 - EARNINGS PER SHARE
------------------
The following table summarizes the computations of basic and diluted earnings
per common share:
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
1999 1998 1999 1998
-------------------------------- --------------------------------
<S> <C> <C> <C> <C>
Numerator used in basic and diluted
Earnings per common share:
Income from continuing operations $ 16,358 $ 12,937 $ 34,751 $ 15,452
Income (loss) from discontinued
operations, net of tax (426) 15 (629) 292
Loss on disposal of discontinued
operations, after tax (25,082) - (25,082) -
Cumulative effect of change in accounting
principle, net of tax - - (1,323) -
-------------- -------------- -------------- --------------
Net income (loss) $ (9,150) $ 12,952 $ 7,717 $ 15,744
============== ============== ============== ==============
Denominator:
Denominator for basic earnings per common
share - weighted average shares 51,897 48,534 51,642 48,147
Effect of dilutive securities:
Stock options and warrants 1,387 2,062 1,799 2,143
-------------- -------------- -------------- --------------
Denominator for diluted earnings per
Common share - weighted average shares 53,284 50,596 53,441 50,290
============== ============== ============== ==============
Earnings (loss) per common share, basic:
Income from continuing operations $ 0.31 $ 0.27 $ 0.67 $ 0.32
Income (loss) from discontinued
operations, net of tax (0.01) - (0.01) 0.01
Loss on disposal of discontinued
operations, after tax (0.48) - (0.48) -
Cumulative effect of change in accounting
principle, net of tax - - (0.03) -
-------------- -------------- -------------- --------------
Earnings (loss) per common share, basic $ (0.18) $ 0.27 $ 0.15 $ 0.33
============== ============== ============== ==============
Earnings per common share, diluted:
Income from continuing operations $ 0.31 $ 0.26 $ 0.65 $ 0.30
Income (loss) from discontinued
operations, net of tax (0.01) - (0.01) 0.01
Loss on disposal of discontinued
operations, after tax (0.47) - (0.47) -
Cumulative effect of change in accounting
principle, net of tax - - (0.03) -
-------------- -------------- -------------- --------------
Earnings (loss) per common share, diluted $ (0.17) $ 0.26 $ 0.14 $ 0.31
============== ============== ============== ==============
</TABLE>
11
<PAGE>
NOTE 8 - INCOME TAXES
------------
The tax provisions for the three and nine month periods ended September 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 43% for the nine months ended September 30, 1999 and 1998,
respectively. The effective tax rate for the period ended September 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%.
NOTE 9 - 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 303
shares of common stock, including
income tax benefit of $1,441 3 4,322 4,325
Stock options granted to non-employees 162 162
Repurchase of 1,730 shares of common
stock (17) (36,195) (36,212)
Issuance of 41 shares of common stock
in connection with the Employee Stock
Purchase Plan 961 961
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 45 shares of common stock
in connection with consideration
related to the acquisition of PACE 1,180 1,180
Issuance of 720 shares of common
stock in connection with contingent
consideration related to the
acquisition of Drake 7 21,343 21,350
Issuance of 144 shares of common
stock in connection with other
acquisitions 2 1,338 (99) 1,241
Comprehensive income:
Net income for the nine months
ended September 30, 1999 7,717 7,717
Other comprehensive income:
Foreign currency translation
adjustment (2,274) (2,274)
-------------
Total comprehensive income
5,443
--------- ------------ ---------- -------------- -------------
Balance at September 30, 1999 $ 510 $ 414,967 $ 83,470 $ (497) $ 498,450
========= ============ ========== ============== =============
</TABLE>
During the third quarter of 1999, the Company repurchased 1,419 shares of its
common stock for $28,449. Management intends to use repurchased shares to
satisfy contingent consideration related to certain acquisitions.
12
<PAGE>
NOTE 10 - 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 have been
heard by the Court which is expected to rule on the motions in the fourth
quarter of 1999. 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 11 - BUSINESS SEGMENT INFORMATION
----------------------------
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
1999 1998 1999 1998
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating revenues:
Sylvan Prometric $ 89,790 $ 77,347 $245,664 $183,124
Sylvan Contract Educational Services 18,415 12,722 69,994 57,451
Sylvan Learning Centers 27,014 16,443 70,382 44,049
Sylvan International Universities 1,441 - 16,179 -
============= ============= ============= =============
$136,660 $106,512 $402,219 $284,624
============= ============= ============= =============
Segment profit:
Sylvan Prometric $ 17,453 $ 17,687 $ 37,133 $ 18,229
Sylvan Contract Educational Services 6,500 1,362 13,385 8,357
Sylvan Learning Centers 11,010 4,872 22,423 12,116
Sylvan International Universities (3,290) - (239) -
============= ============= ============= =============
$ 31,673 $23,921 $ 72,702 $ 38,702
============= ============= ============= =============
September 30,
1999 1998
--------------------------------
Segment assets:
Sylvan Prometric $456,107 $321,362
Sylvan Contract Educational Services 104,936 92,813
Sylvan Learning Centers 63,098 24,581
Sylvan International Universities 99,679 -
============= =============
$723,820 $438,756
============= =============
</TABLE>
13
<PAGE>
NOTE 11 - 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:
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
1999 1998 1999 1998
-------------------------------- --------------------------------
<S> <C> <C> <C> <C>
Total profit for reportable segments $ 31,673 $ 23,921 $ 72,702 $ 38,702
Corporate general and administrative expense (5,518) (3,637) (15,284) (11,321)
Other income (expense) (1,395) (685) (4,765) (287)
------------- -------------- -------------- -------------
Income from continuing operations before
income taxes and cumulative effect of
accounting change $ 24,760 $ 19,599 $ 52,653 $ 27,094
============== ============== ============== =============
</TABLE>
NOTE 12 - COMPREHENSIVE INCOME
--------------------
The components of comprehensive income, net of related tax, are as follows:
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
1999 1998 1999 1998
--------------------------------- ----------------------------------
<S> <C> <C> <C> <C>
Net income (loss) $ (9,150) $ 12,952 $ 7,717 $ 15,744
Foreign currency translation adjustment 2,037 2,979 (2,274) 2,785
--------------- -------------- --------------- --------------
Comprehensive income (loss) $ (7,113) $ 15,931 $ 5,443 $ 18,529
=============== ============== =============== ==============
</TABLE>
14
<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 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:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
Operating revenues:
Sylvan Prometric 66% 73% 61% 64%
Sylvan Contract Education Services 13% 12% 17% 20%
Sylvan Learning Centers 20% 15% 18% 16%
Sylvan International Universities 1% 0% 4% 0%
------------- ------------ ------------- ------------
Total revenues 100% 100% 100% 100%
Direct costs:
Sylvan Prometric 53% 56% 52% 55%
Sylvan Contract Education Services 9% 11% 14% 17%
Sylvan Learning Centers 12% 11% 12% 11%
Sylvan International Universities 3% 0% 4% 0%
------------- ------------ ------------- ------------
Total direct costs 77% 78% 82% 83%
General and administrative expense 4% 3% 4% 4%
Transaction costs
related to pooling of interests 0% 0% 0% 3%
------------- ------------ ------------- ------------
Operating income 19% 19% 14% 10%
Other income (expense) (1%) (1%) (1%) (0%)
------------- ------------ ------------- ------------
Income from continuing operations before
income taxes and cumulative effect of
change in accounting principle 18% 18% 13% 10%
Income taxes 6% 6% 5% 4%
------------- ------------ ------------- ------------
Income from continuing operations 12% 12% 8% 6%
------------- ------------ ------------- ------------
Loss from discontinued business after tax (19%) 0% (6%) 0%
============= ============ ============= ============
Net income (loss) (7%) 12% 2% 6%
============= ============ ============= ============
</TABLE>
15
<PAGE>
RESULTS OF OPERATIONS
COMPARISON OF RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1999 TO RESULTS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998.
REVENUES. Total revenues increased by $30.1 million, or 28%, to $136.7 million
in 1999 from $106.5 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 $12.4 million, or 16%, to $89.8
million in 1999, compared to $77.3 million in 1998. Excluding 1998 revenues of
$3.3 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 $15.7
million, or 20%, compared to 1998. Academic admissions testing revenues
increased $0.9 million, or 19%, compared to the same period in 1998, primarily
due to volume increases in GRE, the Test of English as a Foreign Language
(TOEFL), Praxis and Regents College exams. Information Technology (IT) testing
revenues increased $5.6 million, or 25%, in 1999 compared to 1998 due primarily
to Microsoft, CompTIA and other IT client volume increases. Professional
licensure and certification testing revenues increased 29%, or $2.3 million, in
1999 compared to 1998, primarily as a result of increased performance based
pricing and 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 decreased $0.4 million, or 4%, for 1999 compared
to 1998, primarily due to a reduction of costs associated with the build-out
phase of the testing centers, which was substantially completed by the middle of
the second quarter of 1999. Revenues from the Company's English language
instruction business, which represents 37% of divisional operating revenues for
the three months ended September 30, 1999, increased $7.1 million in 1999,
primarily as a result of the operations of several WSI franchise locations
acquired after the third quarter of 1998 and the sale of international area
development rights for China, Brazil and Columbia. Operating revenue for
Prometric represents 66% of total revenues of the Company for the three month
period ended September 30, 1999.
SYLVAN CONTRACT EDUCATIONAL SERVICES revenue increased by $5.7 million, or
45% to $18.4 million for the quarter ended September 30, 1999. The revenue
increase for the quarter ended September 30, 1999 was the result of a $5.8
million increase in revenue from Canter, offset by a $0.1 million decrease in
revenue from public and nonpublic school contracts. The revenue increase at
Canter was due to increasing demand for domestic teacher training as well as the
sale of a license to apply the Canter teachers master degree program in Mexico
for a licensing fee of $3.5 million. The $0.1 million decrease in revenue from
public and nonpublic schools for the three months ended September 30, 1999 is
the result of $1.7 million in revenue from new contracts obtained after
September 30, 1998, and a decrease of $1.8 million in revenue from contracts
that have not been renewed. Operating revenue for Contract Educational Services
represents 13% of total revenues of the Company for the three month period ended
September 30, 1999.
SYLVAN LEARNING CENTERS revenue increased by $10.6 million, or 64%, to
$27.0 million compared to the same period in 1998. Franchise services fees
increased by $5.3 million primarily due to the sale of a master franchise
agreement for France for $5.0 million. Franchise royalties increased by $0.6
million, or 14%, for 1999 as a result of the net increase of 76 new Centers
opened after September 30, 1998, and a 9% increase in same center revenue.
Revenues from Company-owned learning centers increased $1.5 million, or 15%, to
$11.5 million during 1999. Same center revenues increased 7%, or $0.7 million,
with the remaining revenue increase of $0.8 million generated from 13 new
Company-owned centers acquired from franchise owners during the past 12 months.
On October 31, 1998, the Company acquired Schulerhilfe, a tutoring company
16
<PAGE>
based in Germany. This acquisition resulted in an additional $3.0 million in
revenue for 1999. Operating revenue for Learning Centers represents 20% of total
revenues of the Company for the three month period ended September 30, 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. The three month
period ended September 30, 1999 is traditionally a slow period since classes are
not in session during July, August and September. Total revenues for
International Universities during the quarter ended September 30, 1999 were $1.4
million, which represents 1% of total revenues of the Company for the three
month period ended September 30, 1999.
DIRECT COSTS. Total direct costs increased 27% to $105 million in 1999 from
$82.6 million in 1998 as a result of business expansion. Direct costs as a
percentage of total revenues decreased to 77% in 1999 from 78% in 1998. This
decrease in direct costs as a percentage of revenues is primarily due to certain
higher margin transactions and management of direct operating expenses.
SYLVAN PROMETRIC direct costs for 1999 increased by $12.7 million to $72.3
million, or 81% of total Prometric revenue, compared to $59.7 million, or 77% of
total Prometric revenue for the same period in 1998. This increase in direct
costs as a percentage of revenues is primarily due to increased channel
promotional and support costs, international business development support costs,
volume based price reductions in IT testing and the increased costs of the
Aspect English language business.
SYLVAN CONTRACT EDUCATIONAL SERVICES expenses increased by $0.5 million
to $11.9 million, or 65% of Contract Educational Services revenue for the
quarter ended September 30, 1999, compared to $11.4 million or 89% of contract
services revenue for the third quarter of 1998. The reduction in expenses as a
percentage of revenue for the three months ended September 30, 1999 is primarily
due to the margin of the sale of a license agreement to provide Canter's masters
degree program in Mexico.
SYLVAN LEARNING CENTERS expenses increased $4.4 million to $16.0 million,
or 59% of Learning Centers revenue for 1999, compared to $11.6 million, or 70%
of Learning Centers revenue for the same period in 1998. Expenses as a
percentage of revenues in 1999 decreased primarily as a result of a margin of
the sale of a master franchise agreement for France. Approximately $1.4 million
of the increase for 1999 relates to expenses incurred in Company-owned centers
due to the acquisition of franchised learning centers and costs associated with
higher revenues at existing Company-owned centers. Expenses as a percentage of
revenues in Company-owned learning centers increased for the period as a result
of the acquisition of more franchise centers which tend to operate at lower
margins. The acquisition of Schulerhilfe in October 1998 resulted in $2.9
million of increased costs for the three month period ended September 30, 1999.
SYLVAN INTERNATIONAL UNIVERSITIES expenses were $4.7 million for the three
month period ended September 30, 1999. These direct expenses consist primarily
of personnel, marketing and advertising, and facility-related costs of UEM.
These expenses exceeded the International Universities revenues for the three
month period ended September 30, 1999 because of the seasonality of the
business. Classes are not in session for July, August and September however
certain fixed expenses are incurred year round.
OTHER EXPENSES. General and administrative expenses increased by $1.9 million
during 1999, compared to 1998. These costs increased to 4.0% of revenues for
1999, compared to 3.4% of revenues for 1998. This increase in general and
administrative expense as a percentage of total revenues is primarily due to
increasing business management costs and professional fees to operate the
Company.
17
<PAGE>
Other expense increased $.7 million as compared to the same period in 1998.
This increase is largely attributable to an increase of $1.6 million in interest
expense related to additional borrowings made subsequent to the third quarter of
1998. Investment and other income increased $0.5 million, principally as a
result of favorable exchange gains. During the third quarter, the Company
recorded a $0.5 million minority interest in loss of consolidated subsidiary
related to UEM.
The Company's effective tax rate has remained constant at 34% during the
quarters ended September 30, 1999 and 1998. The Company estimates that its
effective tax rate for the year ending December 31, 1999 will remain at 34%.
INCOME FROM CONTINUING OPERATIONS. Income from continuing operations increased
by $3.4 million, or 26%, to $16.4 million for the three months ended September
30, 1999. This increase is a result of increased revenue from all divisions
while maintaining operating margins.
LOSS ON DISCONTINUED OPERATIONS. At September 30, 1999 the Company approved a
formal plan to dispose of the PACE Group. Losses from PACE operations, net of
tax, for the three month period ended September 30, 1999 were $0.4 million. The
loss on the disposal of PACE is anticipated to be approximately $25.0 million,
including a tax expense of $2.4 million.
COMPARISON OF RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 TO RESULTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998.
REVENUES. Total revenues increased by $117.6 million, or 41%, to $402.2 million
for the nine months ended September 30, 1999 from $284.6 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 $62.5 million, or 34%, to $245.6
million in 1999, compared to 1998. Excluding 1998 revenues of $9.9 million from
NAI/Block, the net assets of which were contributed to a joint venture in
January 1999, Prometric revenue for 1999 increased $72.4 million, or 42%,
compared to 1998. Academic admissions testing revenues increased $5.8 million,
or 42%, compared to the same period in 1998, primarily due to increased volumes
and volume based and cost of living adjustments in the Test of English as a
Foreign Language (TOEFL), Praxis, GRE, and Regents College exams. Information
Technology (IT) testing revenues increased $23.0 million, or 40%, in 1999 due
primarily to Microsoft, CompTIA and other IT client volume increases.
Professional licensure and certification testing revenues increased 44%, or $8.3
million, in 1999 compared to 1998, primarily as a result of increased
performance based pricing and 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 $9.5
million, or 46%, for 1999 compared to 1998, primarily due to an increase in
testing volume and the earlier cost of center build-out during the first half of
1999. Revenues from the Company's English language instruction business, which
represents 36% of 1999 divisional operating revenues, increased $25.4 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 61% of total
revenues of the Company for the nine month period ended September 30, 1999.
SYLVAN CONTRACT EDUCATIONAL SERVICES revenue increased by $12.5 million, or
22%, to $70.0 in 1999 compared to the same period in 1998. The revenue increase
was the result of a $6.8 million increase in revenue from public and nonpublic
school contracts and a $5.7 increase in Canter revenue. The $6.8 million
increase in revenue from public and nonpublic schools for 1999 is the result of
$7.2 million in revenue attributable to new contracts obtained after September
30, 1998, as well as an increase of $0.2 million in
18
<PAGE>
revenue attributable to existing contracts and a decrease of $0.6 million in
revenues from Sylvan at Work. The revenue increase at Canter was due to
increasing demand for domestic teacher training as well as the sale of a
license to apply the Canter teachers masters degree program in Mexico for a
licensing fee of $3.5 million. Operating revenue for Contract Educational
Services represents 17% of total revenues of the Company for the nine month
period ended 1999.
SYLVAN LEARNING CENTERS revenues for 1999 increased by $26.3 million, or
60%, to $70.4 million compared to 1998. Franchise services fees increased by
$5.7 million primarily due to the sale of a master franchise agreement for
France for $5.0 million. Franchise royalties increased by $2.3 million, or 19%,
for 1999 as a result of the net increase of 76 new Centers opened after
September 30, 1998 and a 13% increase in same center revenue. Revenues from
Company-owned Learning Centers increased $6.2 million, or 24%, to $32.4 million
during 1999. Same center revenues increased 9%, or $1.9 million, with the
remaining revenue increase of $4.3 million generated from 13 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 $11.0 million in revenue for the nine
month period ended September 30, 1999. Product sales and other franchise service
revenues generated the remaining revenue increase of $1.1 million for 1999, as
compared to 1998. Operating revenues for Learning Centers represents 18% of
total revenues of the Company for the nine months ended September 30, 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 $16.2 million,
which represent 4% of total revenue of the Company for the nine month period
ended 1999. Revenues and operating results of the International Universities
division are particularly seasonal due to a limited class schedule during June,
July, August and a portion of September.
DIRECT COSTS. Total direct costs increased 40% to $329.5 million in 1999 from
$236.0 million in 1998 as a result of business expansion. Direct costs as a
percentage of total revenues decreased to 82% in 1999 from 83% in 1998. This
decrease in costs as a percentage of revenues is primarily due to expanding
revenues without a corresponding increase in the related direct operating
expenses.
SYLVAN PROMETRIC direct costs for 1999 increased by $53.5 million to $208.5
million, or 85% of total Prometric revenue, compared to $155.0 million, or 85%
of total Prometric revenue for the same period in 1998. Excluding expenses of
$8.2 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 direct
costs would have been $145.6 million, or 84% of Prometric revenue for 1998. This
increase in direct costs as a percentage of revenues is primarily due to
increased costs of Year 2000 compliance, channel promotional and support costs,
international business development support costs, volume based price reductions
in IT testing and increasing costs of the Aspect English language business.
SYLVAN CONTRACT EDUCATIONAL SERVICES expenses increased by $7.5 million to
$56.6 million, or 81% of Contract Educational Services revenue for 1998. The
decrease in expenses as a percentage of revenue for 1999 is due to the high
margin sale of a license agreement to provide Canter's masters degree program in
Mexico.
SYLVAN LEARNING CENTERS expenses increased $16.0 million to $48.0 million,
or 68% of Learning Centers revenue for 1999, compared to $31.9 million, or 73%
of Learning Centers revenue for the same period in 1998. Expenses as a
percentage of revenues in 1999 decreased primarily as a result of a high margin
sale of a master franchise agreement for France. Approximately $5.8 million of
the increase for 1999 relates to expenses incurred in Company-owned learning
centers due to the acquisition of franchised learning centers
19
<PAGE>
and costs associated with higher revenues at existing Company-owned centers.
Expenses as a percentage of revenues in Company-owned centers increased for
the period as a result of the acquisition of more franchise centers which tend
to operate at lower margins. The acquisition of Schulerhilfe in October, 1998
resulted in $9.1 million of increased costs for nine month period ended
September 30, 1999. The remaining cost increase of $1.1 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 $16.4 million for the nine
month period ended September 30, 1999. These direct expenses consist primarily
of personnel, marketing and advertising, and facility-related costs of UEM.
These expenses exceed the International Universities revenues for the period
from acquisition through September 30, 1999 because of the seasonality of the
business. Classes are not in session for June, July, August and September,
however, certain fixed expenses are incurred year round.
OTHER EXPENSES. General and administrative expenses increased by $4.0 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 with 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 nine
month period ended September 30, 1998.
Other expense increased $4.5 million, as compared to the same period in
1998. This net increase is attributable to a $2.4 decrease in other investment
income, a $3.3 million increase in interest expense related to increased
borrowings outstanding during the period, a $0.6 million minority interest in
income of consolidated subsidiary recorded in 1999 associated with UEM, and a
$1.8 million decrease equity in net loss of affiliates.
The Company's effective tax rate has decreased from 43% during 1998 to 34%
during 1999. This reduction is a result of a proportionally greater increase in
income earned in lower-taxed international jurisdictions during 1999.
Additionally, the effective rate for 1998 was unusually high as a result 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%.
INCOME FROM CONTINUING OPERATIONS. Income from continuing operations increased
by $19.3 million, or 125%, to $34.8 million for the nine months ended September
30, 1999. After removing the effect of the non-recurring Aspect related
transaction and restructuring costs in 1998, income from continuing operations
for the nine months ended September 30, 1999 increased $10.4, or 42% over the
same period in 1998. This increase is a result of increased revenue and margins
from all divisions.
LOSS ON DISCONTINUED OPERATIONS. At September 30, 1999 the Company approved a
formal plan to dispose of the PACE Group. Losses from PACE operations, net of
tax, for the nine month period were $0.6 million and the loss on the disposal of
PACE is anticipated to be approximately $25.0 million including a tax expense of
$2.4 million.
20
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company generated $58.2 million of cash flow from operations for the nine
month period ended September 30, 1999, an increase of $15.6 million as compared
to the nine months ended September 30, 1998. The cash flow from operations
consists primarily of $65.8 million related to income from continuing operations
excluding non-cash charges (principally depreciation and amortization) and the
non-cash loss on discontinued operations for the nine month period ended
September 30, 1999. Although accounts and notes receivable increased during the
period as a result of revenue increases, the percentage increase was 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. The growth of net operating assets of $7.6
million during the period offset the cash generated by operations. The
combination of operating activities and operating asset increases resulted in
the $59.2 million cash flow from operations for the nine month period ended
September 30, 1999.
Cash used in investing activities, net of securities investment transactions,
was $113.8 million in 1999 and $113.6 million in 1998. The 1999 investment
activity was primarily due to business expansion through the acquisition of the
UEM, the acquisition of other businesses and franchise centers, the payment of
contingent consideration for prior period acquisitions and the purchase of
property and equipment offset by the cash received on an investment redemption.
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, computer equipment and software development 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 $82.9 million from borrowings during the period ended September 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
September 30, 1999 the Company has remaining availability under the revolving
credit facility of $4.4 million.
The Company expects that available cash, cash flow from operations and expansion
of existing credit facilities 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 to provide
financial flexibility to fund growth of the core business. The Company continues
to examine opportunities in the educational services or computer- based testing
industries for potential acquisitions. Additional capital resources will be
necessary to acquire and thereafter operate additional businesses.
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:
21
<PAGE>
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 this 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 is complete.
Phase III - Remediation. This phase involves modifying, replacing or
upgrading the systems that have failed during Phase II. The remediation phase is
complete.
Phase IV - Testing. This phase involves review of systems for compliance
and re-testing as necessary. The testing phase is complete.
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 95% complete
and is expected to be completed by the middle of the fourth 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 $3.1 million during
the first nine 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 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
fourth quarter 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.
22
<PAGE>
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.
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 a number of factors
including, 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.
23
<PAGE>
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 40% 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 September 30, 1999
and 1998 of approximately $9.2 million and $4.4 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 nine months ended September 30, 1999 and 1998 by approximately $1.4
million and $0.6 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 September 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: November 12, 1999 /s/B. Lee McGee
--------------------------------------
B. Lee McGee, Executive Vice President
and Chief Financial Officer
25
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