SYLVAN LEARNING SYSTEMS INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[X] Annual Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 for the fiscal year ended DECEMBER 31, 1997
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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
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SYLVAN LEARNING SYSTEMS, INC.
-----------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

Maryland 52-1492296
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(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
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
- --------------------------------------------- ------------------------
COMMON STOCK, PAR VALUE $.01 NASDAQ

SECURITIES REGISTERED PURSUANT TO THE SECTION 12(g) OF THE ACT: NONE
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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 [ ].

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The aggregate market value of voting Common Stock held by non-affiliates of
the registrant was approximately $1.2 billion as of March 17, 1998.

The registrant had 29,670,910 shares of Common Stock outstanding as of March 17,
1998.

DOCUMENTS INCORPORATED BY REFERENCE
-----------------------------------

Certain information in Sylvan Learning Systems, Inc.'s definitive Proxy
Statement for its 1998 Annual Meeting of Shareholders, which will be filed with
the Securities and Exchange Commission pursuant to Regulation 14A no later than
April 30, 1998 is incorporated by reference in Part III of this Form 10-K.

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INDEX
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PAGE NO.
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PART I.

Item 1. Business............................................. 3
Item 2. Properties........................................... 10
Item 3. Legal Proceedings.................................... 10
Item 4. Submission of Matters to a Vote of Security Holders.. 10

PART II.

Item 5. Market for Registrant's Common
Equity and Related Stockholder Matters............. 11
Item 6. Selected Financial Data.............................. 11
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations...... 16
Item 8. Financial Statements and Supplementary Data.......... 23
Item 9. Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure............. 23

PART III.

Items 10., 11., 12. and 13. are incorporated by reference from
Sylvan Learning Systems, Inc.'s definitive Proxy
Statement which will be filed with the Securities
and Exchange Commission, pursuant to Regulation 14A,
not later than April 30, 1998........................ 24

PART IV.

Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K............................ 24

SIGNATURES

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PART I.
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ITEM 1. BUSINESS

Sylvan Learning Systems, Inc. ("the Company" or "Sylvan") is the leading
provider of educational services to families, schools and industry. The Company
provides lifelong educational services through three lines of business: the
Sylvan Prometric division delivers computer-based testing for academic
admissions and professional certification programs, and includes the operations
of Wall Street Institute, a European based franchisor and operator of learning
centers for English language instruction that will also administer certain
computer-based testing programs throughout Europe and Latin America; the Sylvan
Learning Centers division provides personalized instructional services to
students of all ages and skill levels and the Sylvan Contract Educational
Services division provides educational services and professional development
through contracts with school systems and other organizations. Sylvan's services
are delivered through its network of more than 3,000 educational and testing
centers around the globe. In 1997, total system-wide revenues were
approximately $395.5 million, composed of $193.6 million from core educational
services ($162.4 million from franchised Learning Centers and $31.2 million from
Company-owned Learning Centers, product sales, franchise sales fees and other
franchise service revenues), $135.3 million from testing services and $66.6
million from contract educational services. Note 21 of the 1997 audited
financial statements contains additional disclosures regarding the Company's
business and geographic segments.

CORE EDUCATIONAL SERVICES: SYLVAN LEARNING CENTERS

Sylvan is widely recognized as providing high quality educational services
with consistent, quantifiable results, and has delivered its core educational
service to more than 1.1 million students primarily in grades three through
eight over the past 18 years. The Company's core educational service segment
provides supplemental instruction in reading, mathematics and reading readiness,
featuring an extensive series of standardized diagnostic tests, individualized
instruction, a student motivational system and continued involvement from both
parents and the child's regular school teacher.

Typically, a parent contacts a Sylvan Learning Center because the parent
believes that his or her child may have insufficient reading or mathematics
skills. Parents learn about Sylvan from the Company's media advertising, from a
referral from another parent or from school personnel. Learning Center
personnel ask the parent to bring the student to the Learning Center to complete
a series of standardized diagnostic tests and to receive educational
consultation. Approximately 35% of phone inquiries result in a visit to a
Learning Center. The Learning Center's Sylvan-trained educators use test results
to diagnose students' weaknesses and to design an individual learning program
for each student. After the initial testing and consultation, the Company
estimates that more than 90% of parents enroll the student in a full course of
study. The program typically requires four to six months to complete and
comprises approximately 36 to 60 hours of instruction. Instruction is generally
given twice a week for one hour per visit. Sylvan requires that all instructors
be certified teachers. The cost of the tests and initial consultation ranges
from $95 to $250, and fees average $35 per hour. The Company estimates that the
typical program costs approximately $1,500.

Learning Centers range from 1,000 to 3,500 square feet. Instruction is given
at U-shaped tables designed to ensure that teachers work with no more than three
students at a time. The student's individualized one hour lesson includes a five
segment mastery approach. There are special incentives, such as tokens
redeemable for novelties and toys, to motivate the student to achieve the
program's objectives and to strengthen the student's enthusiasm for learning.
Personal computers at each Learning Center are used by the student as a
supplemental learning tool. The Learning Center's Director of Education monitors
the progress of each student after each hour of instruction.

Instructors schedule parent conferences after every 12 hours of a student's
program. Throughout a student's course of study, the Learning Center tests the
student using the same standardized diagnostic tests, and the results are shared
with the parents in personal conferences, during which the student's
continuation in a Sylvan program is discussed.

Franchise Operations. As of December 31, 1997, there were a total of 670
Learning Centers in 49 states, five

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Canadian provinces, Hong Kong, South Korea and Guam operated by the Company or
its franchisees. As of that date, there were 460 franchisees operating 622
Sylvan Learning Centers. During 1997, 60 franchised Learning Centers were opened
and five were closed. In addition, during 1997, 13 franchisee-owned Learning
Centers were acquired by the Company. Fewer than 2% of franchisees are currently
more than three months in arrears in the payment of franchise royalties, and the
Company does not believe that the closing of any or all of the Learning Centers
of these franchisees would have a material adverse effect on the Company because
the royalties earned from these franchisees only represented approximately 1% of
total franchise royalties earned by the Company in 1997.

The Company licenses franchisees to operate Sylvan Learning Centers in a
specified territory, the size of which depends on the number of school-age
children and average household incomes in the area. Franchisees must obtain the
Company's approval for the location and design of the Learning Center and of all
advertising, and must operate the Learning Center in accordance with the
Company's methods, standards and specifications. Most Learning Centers are
located in suburban areas and have approximately 10 employees, two of which are
typically full-time employees and eight of which are part-time instructors. The
cost to open a typical franchised Learning Center ranges from approximately
$79,000 to $145,000, including the franchise license fee, furniture, equipment
and an initial supply of certain items required under the Company's franchise
agreement.

The Company actively manages its franchise system. The Company requires
franchisees and their employees to attend two weeks of initial training in
Learning Center operations and Sylvan's educational programs. The Company also
offers franchisees continuing training each year. The Company employs field
operations managers that act as "consultants" to provide assistance to
franchisees in technology implementation, business development, marketing,
education and operations. These employees also facilitate regular communications
between franchisees and the Company.

Sylvan operates a quality assurance review program to maintain the quality of
Sylvan Learning Centers. Sylvan's field operations managers confirm franchisee
compliance with the Company's standards, including training requirements,
exclusive use of approved educational materials and programs, correct
administration of testing materials, proper execution of supervisory procedures,
sufficient time spent in parent/teacher conferences, staffing and Learning
Center appearance. Sylvan's field managers counsel franchisees that fail to meet
the Company's quality or financial performance standards and assist these
franchisees in developing a plan to improve their Learning Centers' performance.
When necessary, the Company assists franchisees in selling their franchises.

The Company believes there is significant potential for additional franchised
Learning Centers both domestically and internationally. A number of territories
with only one Learning Center could support one or more additional Learning
Centers based upon the number of school-age children in the market area. The
Company is actively encouraging existing franchisees in these territories to
open additional Learning Centers. In addition, management has identified at
least 234 territories in North America, primarily in smaller markets, in which
there are no Learning Centers. The Company is actively seeking franchisees for a
number of these territories. Forty-two new territories were sold in 1997.

The Company has sold franchise rights for the operation of Learning Centers in
South Korea, Hong Kong, China, the United Kingdom, Spain and the Philippines.
In pricing international franchise rights, the Company takes into account
estimates of the number of centers that could be opened in an area.

The Company's typical franchise agreement (the "License Agreement") grants a
license to operate a Sylvan Learning Center and to use Sylvan's trademarks
within a specified territory. The franchisee is required to purchase from Sylvan
certain diagnostic and instructional materials, student record forms, parental
information booklets and explanatory and promotional brochures developed by the
Company. Sylvan specifies requirements for other items necessary for operation
of a Learning Center, such as computers, instructional materials and furniture.
The Company currently offers a License Agreement with an initial term of ten
years, subject to unlimited additional ten year extensions at the franchisee's
option on the same terms and conditions. The initial license fee ranges from
$34,000 to $42,000, depending on factors such as the number of school-age
children in the territory. Royalties are either 8% or 9% of gross revenues of
the Learning Center, and the royalty rate depends upon the demographics of the
territory and is specified in the License Agreement. Advertising spending
requirements range from $1,000 to $3,500 per month, or up to 6% of gross
revenues, whichever is greater. The License Agreement has been revised
periodically, and several franchisees are operating under older agreements with
variations from the above terms. Approximately 10% of

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franchisees operate under older agreements with royalties as low as 6% and
without any requirement to contribute to the national advertising fund. The
remaining 90% of the franchisees are required to contribute a minimum of 1.0% to
1.5% of gross revenues to the national advertising fund. The fund is
administered by the SLC National Advertising Fund, Inc. ("SNAF"). The Franchise
Owners Association ("FOA") owns the SNAF. The FOA is an association whose
members consist of Sylvan franchise owners. Franchisees must submit monthly
financial data to the Company.

Company-owned Learning Centers. As of December 31, 1997, Sylvan owned and
operated 48 Learning Centers: five in Baltimore, seven in Dallas, six in Los
Angeles, five in Orange County, California, six in the greater Philadelphia
area, six in South Florida, eight in the greater Washington, D.C. area and five
in the greater Minneapolis area. The Company's operation of Learning Centers
enables it to test new educational programs, marketing plans and Learning Center
management procedures. As of December 31, 1997, eleven of the Company-owned
Learning Centers contained Technology Centers for computer-based testing.
Company-owned Learning Centers give the Company a local presence in key markets,
which has been helpful in marketing the Company's services to school districts
utilizing Title I funds and to employers interested in the Sylvan-At-Work and
PACE programs (see "Contract Educational Services" on page 7). The Company may
consider selected acquisitions of additional Learning Centers now operated by
franchisees.

SYLVAN PROMETRIC

The Company conducts its testing business through 1,981 testing centers, 1,125
of which are located in the United States and Canada and the remainder of which
are located in 103 foreign countries. These centers are classified as either
Sylvan Technology Centers ("STCs") or Authorized Prometric Testing Centers
("APTCs"). STCs are generally located in certain existing franchisee and
Company-owned and operated sites. During 1997, the Company added 691 testing
centers, of which 617 were APTCs. The Company believes that it can increase
capacity by adding workstations at existing testing centers, as well as by
opening new testing centers. Opening a new testing center can take up to 120
days. Computer-based tests, which can be offered during regular school hours
and on weekends at STCs, increase the utilization of Learning Centers. Testing
also increases the public awareness of Sylvan Learning Centers and the Company's
core educational services.

For STCs, Sylvan provides the supporting infrastructure and administration,
including computer equipment and software systems in each testing center and
where appropriate, registration and scheduling of candidates, downloading of
individual tests and training and certification of STC personnel in accordance
with procedures established by the sponsoring testing organization. The
franchisee provides the space and staffing for the testing center. The Company
enters into contracts directly with the testing organization, such as
Educational Testing Service ("ETS"), under which Sylvan receives a fee based
upon the number of tests given. The Company has entered into a separate
agreement with each franchisee that operates a testing center, whereby the
franchisee receives a fee per test that decreases as the volume of the tests
delivered increases.

APTCs must meet certain criteria established by the Company for administering
computer-based testing and are required to furnish the space, equipment and
personnel needed for their operation and receive compensation for test delivery
in various forms including marketing assistance for their core business.

Principal customers in the information technology ("IT") industry are
Microsoft Corporation and Novell, Inc.. IT customers sponsor worldwide
certification programs for various professionals such as network administrators
and engineers, service technicians, instructors, application specialists and
developers, and system administrators, operators and engineers. Certification
testing for Microsoft and Novell accounted for $39.3 million, or 29%, of Sylvan
Prometric's revenues in fiscal 1997.

ETS, a leading educational testing firm, develops and administers more than
9.0 million tests each year, including the Graduate Record Exam ("GRE"), the
Graduate Management Admissions Test ("GMAT"), The Test of English as a Foreign
Language ("TOEFL"), the National Teachers Exam ("NTE") and the Advanced
Placement Program, sponsored by organizations such as the College Board. The
largest tests administered by ETS are the SAT, of which 2.3 million are given
annually to college-bound students, and the PSAT, of which 1.9 million are given
annually to all students in grade 10 or 11. As one of the largest and most
influential test developers and administrators, ETS is leading the conversion of
tests to computer-based format from pencil and paper versions.

The Company developed a working relationship with ETS as a result of a joint
venture between ETS and a

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predecessor of the Company in the late 1980s. This relationship facilitated the
Company's entering into a master agreement with ETS (the "ETS Agreement"), under
which the Company is the exclusive commercial provider of computer-based tests
administered by ETS. This exclusivity provision does not apply to the SAT, PSAT
and Achievement Tests that are sponsored by the College Board.

During 1997, the Company recognized approximately $33.2 million, or 25% of
Sylvan Prometric's revenues in fiscal 1997, from services for ETS. The Company
provides testing services through two contracts with ETS to provide services
both in North America and internationally. Sylvan initially signed a contract
for computer-based test delivery in North America in 1993 with a term expiring
in 1999. This North American contract was renegotiated in 1997 and now extends
through 2005. The North American contract continues to provide that Sylvan will
be ETS's exclusive commercial provider of computer-based testing services in
North America, provided Sylvan can provide sufficient capacity to meet candidate
testing demand, in accordance with the criteria set forth in the contract.
Further, the contract provides that the Company will deliver not less than 50%
of ETS's computer-based testing volume (excluding College Board tests) in North
America.

The North American contract also provides that ETS may establish computer-
based test sites (subject to the requirement for 50% of the computer-based
testing volume being delivered by the Company) at three specific ETS locations,
at ETS client specific locations and at test centers located in colleges,
universities and similar institutions. At present, there are approximately 40
ETS operated test sites.

ETS and the Company entered into an international contract for delivery of ETS
computer-based tests in 1994. The terms of the contract stipulate that the
Company will be compensated for its services through a fee equal to approved
costs, plus 10 percent, and the Company recognizes revenue accordingly. The
Company also is reimbursed for its cost of capital and any foreign exchange
losses. During 1997, the Company recognized revenues of approximately $17.7
million under this contract. In return for the cost plus compensation, the
Company is required to establish a network of international computer-based
testing sites and to deliver ETS's computer-based tests. The contract provides
that the Company shall be the exclusive provider of computerized commercial
testing capacity to ETS for all secure testing programs outside North America.
ETS may establish its own test sites only where Sylvan fails to provide
sufficient capacity as defined by the contract or where the Company's costs of
providing the service would be prohibitive. There are no ETS sites for computer-
based testing operated internationally. During 1997, the Company expanded
international testing for ETS to a total of 116 permanent and 30 temporary sites
in 79 countries.

Under the ETS agreements, the Company offers computer-based versions of ETS'
PRAXIS examination, which is used to license beginning teachers, the GRE, which
is used by graduate schools to evaluate applicants, and through a contract with
the National Council of State Boards of Nursing, a computer-based licensing
examination (NCLEX) for registered and practical nurses. In October 1997,
Sylvan and ETS converted the GMAT examination to computer-based delivery on a
world-wide basis.

In addition to the tests offered through its partnership with ETS, the Company
is one of three entities licensed by the FAA to deliver computer-based versions
of various pilot and mechanical licensing tests for private aviation. In
addition to FAA testing, the Company provides testing services for organizations
in many other fields, such as for computer professionals, medical laboratory
technicians and military candidates.

The Company, in December 1996, purchased Wall Street Institute International,
B.V. and it's commonly controlled affiliates (collectively, "WSI"), a European
based franchisor and operator of learning centers where English is taught
through a combination of computer-based and live instruction. Typically, the
instructional programs are approximately nine months to one year in duration.
WSI has more than 200 company-owned and franchised centers in operation
throughout Europe and Latin America.

The 1996 acquisition of WSI is an important step in Sylvan's strategy to
increase its services to the adult education marketplace and to expand
internationally. Sylvan began building a global network for the delivery of
computer-based testing services in early 1994 through an exclusive international
alliance with ETS. In addition to offering the English language programs, WSI
locations will be utilized by Sylvan to administer certain computer-based
testing programs throughout Europe and Latin America, and accordingly is
considered part of the Company's Sylvan Prometric testing division.

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WSI has 82 centers in Spain with the remainder in France, Germany, Italy,
Portugal, Switzerland, Mexico, Chile, and Venezuela. WSI's international
expansion was accomplished by selling Master Licensing agreements, with each
Master Licensor obtaining franchisees to open centers in their development
areas. Sylvan plans to continue this strategy to expand WSI's presence
globally, with a focus on the Middle East, Africa and the Pacific Rim region.

Effective December 1, 1997, the Company purchased Block Testing Services L.P.,
Block State Testing Services L.P. and National Assessment Institute, Inc.,
(collectively "NAI/Block"), commonly-controlled companies engaged in the
business of designing, marketing, selling, distributing and administering paper
and pencil tests for the licensing of individuals. NAI/Block operates 12
regional offices that develop and administer licensing examinations on the
state, county and local municipality level for various industries, including but
not limited to the construction, cosmetology, real estate and medical
industries. These 12 regional offices provide examinations for 41 states, the
District of Columbia and the Virgin Islands. With the acquisition of NAI/Block,
the Company is now providing services to a market that it had not previously
serviced.

CONTRACT EDUCATIONAL SERVICES: PUBLIC AND NON-PUBLIC SCHOOL BASED PROGRAMS
FUNDED BY FEDERAL TITLE I AND STATE-BASED PROGRAMS; EDUCATIONAL INROADS, PACE
AND SYLVAN-AT-WORK

Title I and state-based programs. The federal government and various state and
local governmental agencies allocate funds to local school districts to provide
supplemental remedial education to academically and economically disadvantaged
students. The main program is the Title I (formerly Chapter I) program,
administered by the U.S. Department of Education. Federal law now contains
minimum student performance standards for each school district receiving Title I
funds. The Company believes that because of its proven record of achieving
measurable improvement in the reading and mathematics skills of its students
nationwide, it is positioned to provide supplemental educational services to
school districts receiving Title I and similar state funds. As of December 31,
1997, the Company had contracts to provide supplemental remedial educational
services to the following public schools: 45 Baltimore schools, 12 Chicago
schools, 10 Detroit schools, eight Washington D.C. schools, five St. Paul
schools, four Richmond schools and 25 schools in twelve other school districts.

In January 1998, the Company was awarded a contract to provide supplemental
remedial education services in eight public schools in the district of Compton,
California.

Using Company personnel, Sylvan offers virtually the same core educational
services to students in schools as is offered at Sylvan Learning Centers. The
school designates a classroom to be the Learning Center for the duration of the
contract and modifies the classroom to resemble a typical Learning Center.
Sylvan personnel administer standardized diagnostic tests and, based on the
results, prescribe an individualized learning program for each child. Students
typically receive two hours of instruction per week, which includes the use of
personal computers as in a Learning Center. The Company can provide these
services to students after school, on Saturdays, during the summer or as a
"pullout" program during the regular school day, which is the method currently
prescribed by most current contracts. There is a high degree of individual
attention, with student to teacher ratios of no more than three to one. The
program is designed to include a high degree of parental involvement, and
teachers make a special effort to have the parents involved.

Under most of its contracts, the Company has guaranteed that each student who
receives instruction in the Sylvan program and meets prescribed attendance
requirements will achieve some minimum measure of improvement required by the
school districts, as measured by standardized tests. Improvement is measured
using various standardized measures, including normal curve equivalents
("NCE's") a generally accepted statistical measure of student performance. The
typical minimum improvement required is two NCE's per year. If a student does
not achieve the required improvement, the Company will provide 12 hours of
remedial instruction to that student during the following summer or school year
without charge. The Company has not incurred significant expense related to
this guarantee. Under the contracts, the school districts pay the Company a set
fee for all services, materials and equipment. The contracts have terms of one
to three years, with the latest expiring in June 2001. All of the contracts
contain provisions for cancellation by school district officials based on
funding constraints.

The Company is actively seeking contracts to provide its core educational
program to other school systems, offering to tailor its program to the system's
specific needs, and is in discussions with several other major school districts.
In addition to serving public school students, Sylvan can provide its service to
parochial or private school

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students through contracts with public school districts. Public school districts
are responsible for administering the Title I funding for the non-public
schools. Because government-funded services to any parochial school students
generally cannot legally be provided in the parochial school, Sylvan offers the
flexibility of conducting the program at a nearby Learning Center, or providing
temporary facilities.

Educational Inroads. On May 30, 1997 the Company acquired by merger all of
the outstanding stock of I-R, Inc. and Independent Child Study Teams, Inc.
(collectively, "Educational Inroads") in exchange for 1,414,000 shares of common
stock. I-R, Inc. and Independent Child Study Teams, Inc. were commonly owned by
two shareholders. Educational Inroads provides remedial and special education
services to public and non-public school systems, with current contracts in New
Jersey, Maryland, Louisiana, Washington D.C. and other school districts.

PACE. In March 1995, the Company acquired The PACE Group ("PACE"), a provider
of educational and training services to large corporations throughout the United
States. Services offered by PACE include racial and gender workplace diversity
training and skills improvement programs such as writing, advanced reading,
listening and public speaking. This acquisition compliments the Company's
Sylvan-At-Work program and extends the core educational services the Company
offers to adults in the corporate workplace. PACE provides educational and
training services, typically on-site, to businesses throughout the United States
and generated $15.6 million in revenues for the year ended December 31, 1997.
Management believes PACE is capitalizing on the trend toward outsourcing of
training services by large corporations. PACE licenses most of these programs
from the individuals who developed them and pays royalties ranging from 5% to
15% of the revenues generated from the programs. These programs are typically
offered on-site from one to several days at a time and are conducted by trained
instructors employed by PACE, or, in some cases, PACE will train the customer's
employees to conduct the programs. Additionally, a corporation may purchase a
site license to offer a particular PACE program. PACE currently has 26 sales
offices throughout the United States and markets the programs locally through
its sales force. PACE customers include Ford Motor Company, IBM, BankOne,
General Motors and AT&T.

Sylvan-At-Work. The Company's Sylvan-At-Work program is a modified version of
Sylvan's core educational service provided to businesses on-site. Programs are
currently offered for Motorola, Inc., at one site in Austin, Texas; for Texas
Instruments Incorporated, at three sites in the Dallas area; and for Lockheed
Martin Energy Systems, Inc., at one site in Tennessee.

The Canter Group. In January 1998, the Company acquired Canter and
Associates, Inc. and Canter Educational Productions, Inc. (collectively, "The
Canter Group" or "Canter"), a leading provider of training, staff development
and graduate courseware for educators. The Canter Group had revenues of
approximately $20.0 million in 1997. This acquisition will allow Sylvan to
continue to expand into the college and university market with a proven course
curriculum.

MARKETING

The Company and its franchisees market Sylvan's core educational service to
parents of school-aged children at all grade levels and academic abilities. Far
beyond tutoring, Sylvan Learning Centers' supplemental education utilizes a
diagnostic and prescriptive approach to address the specific needs of each and
every student. A portion of Sylvan's advertising includes spots on morning and
evening news on the national networks. Sylvan's advertising campaign
demonstrates the benefits of its personalized educational services through
testimonials of actual parents and Sylvan teachers. It positions Sylvan as the
leader in supplemental education and emphasizes Sylvan's high quality
curriculum, personalized attention and positive results: better grades and
improved self-esteem. Franchisees form local cooperatives to collectively
purchase local television and radio advertising and usually supplement their
efforts with local newspaper and direct mail. The company also has additional
marketing support for specific programs, including Reading, Math, Algebra,
Geometry, Study Skills, SAT/ACT College Prep, and Writing.

The Company is actively involved in marketing computer-based testing services
to national and international academic testing organizations, such as ETS, and
licensing and professional certification organizations. The Company's network of
testing centers, centralized registration capability and computer-based testing
experience offers important competitive advantages. The Company markets its
school-based educational services to several public school systems and state
education departments. This marketing effort has been expanded to seek
contracts for both public and non-public schools, where both are administered by
the local public school district.

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Marketing efforts for the PACE programs are focused on large corporations
seeking to outsource their training and educational programs, through PACE's 26
sales offices throughout the United States. PACE's strategy is to offer
solutions to the customer's training needs rather than marketing specific
products.

COMPETITION

The Company is aware of only two direct national corporate competitors in its
core educational services segment: Huntington Learning Centers, Inc. and Kumon
Educational Institute. The Company believes these competitors operate fewer
centers than Sylvan and that these firms concentrate their services within a
smaller geographic area. In most areas served by Sylvan Learning Centers, the
primary competition is from individual tutors. State and local education
agencies also fund tutoring by individuals, which competes with the Company's
core educational services segment.

The Company's contract educational services segment's most significant
competitor remains the public school system itself. Given the unique position of
public education in the United States, the Company believes that educational
reforms implemented directly by school officials will not face the same degree
of public resistance that the Company may face. The Company also competes with
school reform efforts sponsored by private organizations and universities and
with consultants hired by school districts to provide assistance in the
identification of problems and implementation of solutions. The Company is aware
of several entities that currently provide Title I and state-based programs for
students attending parochial and private schools on a contract basis.

Sylvan Prometric also has a small number of direct competitors. These
competitors include organizations that have opened centers to offer specific
computer-based tests under contracts with the administrators of those tests.

GOVERNMENT REGULATION

Title I. Title I school districts are responsible for implementing Title I in
carrying out their educational programs. Title I regulations, as well as
provisions of Title I itself, direct Title I school districts to satisfy
obligations including involving parents in their children's education,
evaluating and reporting on student progress, providing equitable services and
other benefits to eligible non-public school students in the district and other
programmatic and fiscal requirements. In contracting with school districts to
provide Title I services, the Company has become and will continue to be,
subject to various Title I requirements and may become responsible to the school
district for carrying out specific functions required by law. For example, under
the Baltimore City Schools' contract, Sylvan has responsibility for soliciting
parental involvement, introducing program content adequate to achieve certain
educational gains and maintaining the confidentiality of student records. The
Company's failure to adhere to Title I requirements or to carry out regulatory
responsibilities undertaken by contract may result in contract termination,
financial liability, or other sanctions.

Franchise. The sales of franchises are regulated by various state authorities
as well as the Federal Trade Commission (the "FTC"). The FTC requires that
franchisors make extensive disclosure to prospective franchisees but does not
require registration. A number of states require registration and prior approval
of the franchise offering document. In addition, several states have "franchise
relationship laws" or "business opportunity laws" that limit the ability of a
franchisor to terminate franchise agreements or to withhold consent to the
renewal or transfer of these agreements. While the Company's franchising
operations have not been materially adversely affected by such existing
regulation, the Company cannot predict the effect of any future legislation or
regulation.

Trademarks

The Company has a federal trademark registration for the words "Sylvan
Learning Center" and distinctive logo (a reading child), a service mark for the
words "Sylvan Prometric" and various other trademarks and service marks and has
applications pending for a number of other distinctive phrases. The Company also
has obtained foreign registrations of a number of the same trademarks. The
Company's License Agreement grants the franchisee the right to use the Company's
trademarks in connection with operation of the franchisee's Learning Center.

9

EMPLOYEES

As of December 31, 1997, the Company had approximately 3,600 employees, 2,000
of whom were classified as full-time and 1,600 of whom were classified as part-
time. Most of the Company's part-time employees are teachers in school-based
programs, Company-owned Learning Centers and Sylvan-At-Work programs. None of
the Company's employees are represented by a union and the Company considers its
relationship with its employees to be good.

EFFECT OF ENVIRONMENTAL LAWS

The Company is in compliance with all environmental laws. Future compliance
with environmental laws is not expected to have a material effect on the
business.

ITEM 2. PROPERTIES

The Company leases all of its facilities, consisting principally of
administrative office space and Learning Centers and testing sites. The Company
leases approximately 108,000 square feet of space in Baltimore, Maryland for its
administrative offices. In addition, the Company leases approximately 55,000
square feet in Minneapolis, Minnesota for general office space and a
registration center, 27,000 square feet in Woodlawn, Maryland for a registration
center and 14,600 square feet in Baltimore, Maryland for a Logistics Center.
The Company also leases space for the 48 Company-owned Learning Centers in
Maryland, Texas, California, Pennsylvania, Delaware, New Jersey, Florida,
Minnesota and Virginia, ranging from 1,500 to 3,500 square feet per Learning
Center. The Company also leases space for 80 testing centers in areas where
there is no Learning Center franchise. These spaces range from 500 to 3,500
square feet. The Company leases space for 54 international testing sites
ranging from 500 to 5,000 square feet, with the lease terms from three to five
years.

ITEM 3. LEGAL PROCEEDINGS

From time to time, the Company may be a party to routine litigation incidental
to its business. At this time, the Company is the defendant in a legal
proceeding pending in the United States District Court for the Northern District
of Iowa, Civil Action No. C96-334MJM, filed on November 18, 1996 by ACT, Inc.,
an Iowa nonprofit corporation formerly known as American College Testing
Program, Inc. ("ACT"). ACT's claim arises out of the Company's purchase of
contract rights to administer testing services for the National Association of
Securities Dealers, Inc. ("NASD"). ACT has asserted that the Company tortuously
interfered with ACT's relations, contractual and quasi-contractual, with the
NASD, caused ACT to suffer the loss of its advantageous economic prospects with
the NASD and other ACT clients and that the Company has monopolized and
attempted to monopolize the computer-based testing services market. ACT has
claimed unspecified amounts of compensatory, treble and punitive damages, as
well as injunctive relief. The Company believes that all of ACT's claims are
without merit.

At this time the Company is not a party, either as plaintiff or defendant, in
any other material litigation.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter ended December 31, 1997.

10

PART II.
--------

ITEM 5. MARKET FOR REGISTRANTS'S COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock has traded on the NASDAQ Stock Market since its
initial public offering on December 9, 1993. The Company's trading symbol is
SLVN. The high and low trade prices for 1996 and 1997 for the Company's common
stock are set out in the following table. These prices are as reported by
NASDAQ, and reflect inter-dealer price quotations, without retail mark-up, mark
down or commission and may not necessarily represent actual transactions.

1996 High Low
--------------- ------ ------

1st Quarter $26.17 $18.00
2nd Quarter $27.50 $21.33
3rd Quarter $27.50 $18.67
4th Quarter $33.00 $24.25

1997 High Low
--------------- ------ ------

1st Quarter $37.75 $24.25
2nd Quarter $37.38 $23.88
3rd Quarter $44.50 $32.75
4th Quarter $46.25 $38.00

No dividends were declared on the Company's Common Stock during the years
ended December 31, 1996 and 1997, and the Company does not anticipate paying
dividends in the future.

The number of registered shareholders of record as of March 17,1998 was 326.

During the year ended December 31, 1997, the Company issued 1,104,104 shares
of its common stock that were not registered under the Securities Act of 1933.
On January 28, 1997, the Company issued 434,340 shares to Dr. Luigi T. Peccenini
pursuant to the acquisition of WSI. On February 3, 1997, the Company issued
39,552 shares to Carter Holdings, Inc. for the purchase of six franchised
learning centers. On June 30, 1997, the Company issued 214,000 shares to Sylvan
Learning Foundation as a charitable contribution. On June 30, 1997, the Company
contributed 205,882 shares to IT Training Marketing Company. On June 30, 1997,
the Company contributed 149,059 shares to SLC National Advertising Fund, Inc. On
September 30, 1997, the Company issued 2,450 shares to Harold A. Sakayan for the
purchase of one franchised learning center. On September 30, 1997, the Company
issued 15,557 shares to the shareholders of PMZ Inc. for the purchase of nine
franchised learning centers. On December 10, 1997, the Company issued 21,632
shares to Ralph Celidonio and 21,632 shares to Vince Donohue for the purchase of
a business.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

On February 1, 1991, Sylvan Learning Corporation (a predecessor to the
Company) and KEE, Incorporated ("KEE"), a computer training software development
business owned by a group of investors including Messrs. Hoehn-Saric and Becker,
the Co-CEOs of Sylvan, entered into a joint venture by contributing
substantially all of their assets to Sylvan KEE Systems, a Maryland general
partnership (the "Partnership"), each in exchange for a 50% interest in the
Partnership. Messrs. Hoehn-Saric and Becker assumed management responsibility
for the Partnership. The Partnership operated the business through January 26,
1993, when KEE purchased all of Sylvan Learning Corporation's outstanding common
stock.

Following KEE's purchase of the stock of Sylvan Learning Corporation, the
Partnership was dissolved, and all of its assets and liabilities were
transferred to KEE. KEE changed its name to Sylvan KEE Systems, Inc. and later
to Sylvan Learning Systems, Inc., in contemplation of the disposition of the
assets of the KEE division. During 1993, Sylvan sold all of KEE's assets and
liabilities for $2.2 million to Computer Innovations Distribution Inc., which
operates under the name Computerland of Canada and is a subsidiary of SHL
Systemhouse Inc. KEE's business had generated operating losses for all periods
and is presented in the Statements of Operations as a discontinued operation.

The selected statement of operations data for the year ended December 31, 1993
consists of the results of the Partnership for the month of January 1993, plus
the results of Sylvan for the eleven months ended December 31, 1993.

11

The selected financial data for the years ended December 31, 1994, 1995, 1996
and 1997 have been derived from Sylvan's financial statements which have been
audited by Ernst & Young LLP. The financial data should be read in conjunction
with the historical Consolidated Financial Statements and Notes thereto.

On May 30, 1997, the Company acquired by merger all of the outstanding stock
of Educational Inroads. Educational Inroads provided contract educational
services to school districts in New Jersey and several other states. On February
17, 1995, the Company acquired by merger all of the outstanding stock of
Remedial Education and Diagnostic Services, Inc. and READS, Inc. (collectively,
"READS"). READS is based in Philadelphia, Pennsylvania and provides remedial and
education services, psychological, diagnostic and counseling services, career
awareness training, and a variety of consulting services. Services are delivered
under contracts with school districts, county-wide educational agencies and
municipalities in the Eastern United States. During 1994, the Company acquired
by merger all of the outstanding stock of Learning Services, Inc. "LSI") and all
of the outstanding stock of Loralex Corporation ("Loralex"). These companies
owned and operated a total of nine Sylvan Learning Centers located in the
Northeast United States and Florida, respectively. All of these acquisitions
have been accounted for by the Company as poolings-of-interests and,
accordingly, the Company's financial statements have been restated for all
periods prior to these acquisitions to include the results of operations of
Educational Inroads, READS, LSI and Loralex. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Background." The
selected statements of operations data include the operations of certain
acquired businesses accounted for using the purchase method of accounting from
the date of the respective acquisition, as further described in the notes to the
accompanying schedule of Selected Consolidated Financial Data.

12

SELECTED CONSOLIDATED FINANCIAL DATA (1)

PARTNERSHIP
AND SYLVAN
COMBINED SYLVAN
--------------- ------------------------------------------------------
YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1993 1994 1995 1996 1997
-------------- ------------ ------------ ------------ ------------
(THOUSANDS, EXCEPT PER SHARE DATA)

STATEMENTS OF OPERATIONS DATA:

Revenues:......................................... $51,519 $ 68,748 $ 111,059 $ 181,936 $ 246,212

Cost and expenses:
Direct costs.................................... 44,056 60,388 96,708 150,449 206,621
General and administrative expense.............. 6,255 4,998 6,206 8,755 20,468
Loss on impairment of assets.................... -- -- 3,316 -- 4,000
------- ------- -------- -------- --------
Total cost and expenses...................... 50,311 65,386 106,230 159,204 231,089
------- ------- -------- -------- --------
Operating income................................ 1,208 3,362 4,829 22,732 15,123
Non-operating income (expense).................. (116) 224 391 363 27,974
Interest income (expense), net.................. (1,290) (62) (1,440) 551 2,401
------- ------- -------- -------- --------
Income (loss) from continuing operations
before income taxes and extraordinary
items.......................................... (198) 3,524 3,780 23,646 45,498
Income taxes.................................... (7) (76) (209) (8,850) (16,064)
------- ------- -------- -------- --------
Income (loss) from continuing
operations before extraordinary items.......... (205) 3,448 3,571 14,796 29,434
Discontinued operations (2):
Loss from operations, net of tax.............. (375) -- -- -- --
Gain on disposal.............................. 580 -- -- -- --
------- ------- -------- -------- --------
Income from discontinued operations........... 205 -- -- -- --
------- ------- -------- -------- --------
Net income before extraordinary items........... -- 3,448 3,571 14,796 29,434
Extraordinary items (3)......................... (177) -- -- -- --
------- ------- -------- -------- --------
Net income(loss).............................. $ (177) $ 3,448 $ 3,571 $ 14,796 $ 29,434
======= ======= ======== ======== ========

Earnings (loss) per common share, basic (4):
Income (loss) from continuing operations
before extraordinary items.................... $(0.03) $0.24 $0.24 $0.64 $1.09
Income from discontinued operations............ 0.03 -- -- -- --
Extraordinary items............................ (0.03) -- -- -- --
------ ----- ----- ----- -----
Earnings (loss) per common share, basic.......... $(0.03) $0.24 $0.24 $0.64 $1.09
====== ===== ===== ===== =====

Earnings (loss) per common share, diluted (4):
Income (loss) from continuing operations
before extraordinary items..................... $(0.03) $0.21 $0.21 $0.60 $1.03
Income from discontinued operations............. 0.03 -- -- -- --
Extraordinary items............................. (0.03) -- -- -- --
------ ----- ----- ----- -----
Earnings (loss) per common share, diluted........ $(0.03) $0.21 $0.21 $0.60 $1.03
====== ===== ===== ===== =====

Shares used in computation (4):

Basic........................................... 6,448 14,522 15,132 23,029 26,886
======== ====== ====== ====== =======

Diluted......................................... 6,448 16,286 17,079 24,586 28,538
======== ====== ====== ====== =======

BALANCE SHEET DATA (AT PERIOD END):
Cash and cash equivalents......................... $11,499 $ 4,366 $ 2,903 $ 11,198 $ 23,150
Available-fore-sale securities.................... 1,248 2,537 30,735 16,449 82,926
Net working capital............................... 12,665 13,166 39,407 29,603 113,453
Intangible assets and deferred contract costs..... 7,000 7,932 82,849 122,932 194,576
Total assets...................................... 42,003 50,046 174,070 259,590 475,754
Long-term debt and capital leases................. 6,640 9,814 9,854 32,228 73,328
Stockholders' equity.............................. 24,563 32,481 137,148 180,323 340,371

(footnotes on next page)

13

(1) Prior to February 1, 1991, the Sylvan Learning Centers business was
conducted by Sylvan Learning Corporation (the "Predecessor"). On February 1,
1991, the Predecessor contributed the Sylvan Learning Centers business to
Sylvan KEE Systems, a Maryland general partnership (the "Partnership") in
exchange for a 50% partnership interest, and Sylvan contributed its computer
training software development business to the Partnership in exchange for
the other 50% partnership interest. On January 26, 1993, Sylvan acquired the
Predecessor and dissolved the Partnership. On September 3, 1993, Sylvan sold
its computer training software development business.

During 1994, Sylvan acquired by merger all of the outstanding stock of
Learning Services, Inc. ("LSI") and all of the outstanding stock of Loralex
Corporation ("Loralex"). These companies owned and operated a total of nine
Sylvan Learning Centers located in the Northeast United States and Florida.
On February 17, 1995, Sylvan acquired by merger all of the outstanding stock
of Remedial Education and Diagnostic Services, Inc. and READS, Inc.
(collectively, "READS"), a Philadelphia-based provider of remedial,
education and a variety of consulting services to school districts, county-
wide educational agencies and municipalities in the Eastern United States.
The READS, Loralex and LSI acquisitions have been accounted for by Sylvan as
poolings-of-interests and, accordingly, Sylvan's financial statements have
been restated for all periods presented to include the results of operations
of READS, Loralex and LSI.

Effective September 30, 1995, Sylvan acquired Drake Prometric, L.P.
("Drake"), a leading provider of computer-based certification, licensure and
assessment testing. The transaction was accounted for using the purchase
method of accounting, and Sylvan's results of operations from October 1,
1995 include the operations of Drake.

Effective December 1, 1996, Sylvan acquired Wall Street International, B.V.,
and its commonly controlled affiliates (collectively "Wall Street"), a
European-based franchisor and operator of learning centers that teach the
English language. This transaction was accounted for using the purchase
method of accounting and Sylvan's results of operations from December 1,
1996 include the operations of Wall Street. Sylvan paid $4.9 million of the
$20.1 million purchase price in cash and the remainder in 714,884 shares of
Common Stock.

On May 30, 1997, the Company consummated its acquisition by merger of all
the outstanding common stock of Educational Inroads. Educational Inroads
provides contract educational services to school districts in New Jersey and
several other states. The Educational Inroads acquisition has been accounted
for by Sylvan as a pooling-of-interests and, accordingly, Sylvan's financial
statements have been restated for all periods prior to the acquisition to
include the results of operations of Educational Inroads. Educational
Inroads generated revenues of $24.8 million in 1996.

Effective December 1, 1997, the Company purchased the assets and liabilities
of Block Testing Services L.P. and Block State Testing Services L.P. and
also acquired all of the outstanding common stock of National Assessment
Institute, Inc., (collectively, "NAI/Block"), commonly controlled companies
engaged in the business of designing, marketing, selling, distributing and
administering paper and pencil tests for the licensing of individuals. The
acquisition, which was paid for by issuing 642,901 shares of common stock
valued at $24.6 million in January 1998, was accounted for using the
purchase method of accounting, and Sylvan's results of operations from
December 1, 1997 include the operations of NAI/Block.

(2) Represents Sylvan's computer training software development business which
was sold in September 1993 and a Canadian computer testing business, 80.1%
of which was sold in 1992.

(3) Represents the $350,000 gain on extinguishment of a $3.5 million debt to
Learning Centers, Inc., and a $527,000 loss on an extinguishment of $5.0
million of notes payable to stockholders, each recorded in 1993.

(4) In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings Per Share ("Statement No. 128"). Statement No. 128 replaced the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic
earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully-diluted earnings per share. Earnings per share
amounts for all periods have been

14

presented, and where appropriate, restated to conform to the Statement No.
128 requirements.

In February 1998, the SEC issued Staff Accounting Bulletin No. 98 ("SAB No.
98"), which redefined "cheap stock" for registrants completing initial
public offerings of their common stock. The 1993 earnings per share amount
has been restated to conform to the requirements of SAB No. 98.

15

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

ALL STATEMENTS CONTAINED HEREIN THAT ARE NOT HISTORICAL FACTS, INCLUDING BUT NOT
LIMITED TO, STATEMENTS REGARDING THE ANTICIPATED IMPACT OF UNCOLLECTIBLE
ACCOUNTS RECEIVABLE ON FUTURE LIQUIDITY, EXPENDITURES TO DEVELOP LICENSING AND
CERTIFICATION TESTS UNDER EXISTING CONTRACTS, THE COMPANY'S CONTINGENT PAYMENT
OBLIGATIONS RELATING TO THE DRAKE ACQUISITION, FUTURE CAPITAL REQUIREMENTS,
POTENTIAL ACQUISITIONS AND THE COMPANY'S FUTURE DEVELOPMENT PLANS ARE BASED ON
CURRENT EXPECTATIONS. THESE STATEMENTS ARE FORWARD LOOKING IN NATURE AND INVOLVE
A NUMBER OF RISKS AND UNCERTAINTIES. ACTUAL RESULTS MAY DIFFER MATERIALLY. AMONG
THE FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY ARE THE
FOLLOWING: CHANGES IN THE FINANCIAL RESOURCES OF THE COMPANY'S CLIENTS; TIMING
AND EXTENT OF TESTING CLIENTS CONVERSIONS TO COMPUTER-BASED TESTING; AMOUNT OF
REVENUES EARNED BY THE COMPANY'S TESTING OPERATIONS; THE AVAILABILITY OF
SUFFICIENT CAPITAL TO FINANCE THE COMPANY'S BUSINESS PLAN ON TERMS SATISFACTORY
TO THE COMPANY; GENERAL BUSINESS AND ECONOMIC CONDITIONS; AND OTHER RISK FACTORS
DESCRIBED IN THE COMPANY'S REPORTS FILED FROM TIME TO TIME WITH THE COMMISSION.
THE COMPANY WISHES TO CAUTION READERS NOT TO PLACE UNDUE RELIANCE ON ANY SUCH
FORWARD LOOKING STATEMENTS, WHICH STATEMENTS ARE MADE PURSUANT TO THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995 AND, AS SUCH, SPEAK ONLY AS OF THE
DATE MADE.

OVERVIEW

Sylvan generates revenues from three business segments: core educational
services which primarily consist of franchise sales, royalties and Sylvan-owned
Learning Center revenues; testing services, which consist of computer-based
testing fees paid to Sylvan and the operations of WSI; and contract educational
services, which consist of revenues attributable to providing supplemental
remedial education services to public and non-public schools and major
corporations. The following selected segment data is derived from the Company's
audited consolidated financial statements.

YEAR YEAR YEAR
ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1997
------------ ------------ ------------

Operating revenue:
Core educational services.................. $ 26,063 $ 36,799 $ 44,289
Contract educational services.............. 50,430 58,186 66,582
Testing services........................... 34,566 86,951 135,341
-------- -------- --------
Total revenue............................. 111,059 181,936 246,212
-------- -------- --------

Direct costs:
Core educational services.................. 18,675 25,557 36,708
Contract educational services.............. 47,685 53,373 56,057
Testing services........................... 30,348 71,519 113,856
-------- -------- --------
Total direct costs........................ 96,708 150,449 206,621
-------- -------- --------

RESULTS OF OPERATIONS

Comparison of results for the year ended December 31, 1997 to the year ended
December 31, 1996.

Revenues. Total revenues increased by $64.3 million, or 35%, to $246.2
million for the year ended December 31, 1997, compared to the same period in
1996. This increase resulted from higher revenues in all business segments --
core educational services, testing services and contract educational services.

Core educational services revenues increased by $7.5 million, or 20%, to
$44.3 million for 1997. Franchise royalties increased $1.9 million or 17%, for
1997. This increase in franchise royalties was due to an overall 10%

16

increase in revenues at existing Learning Centers open for more than one year
combined with a net increase of 60 new Learning Centers opened in 1997.

Franchise sales fees increased by $1.3 million, or 43%, to $4.5 million for
the year ended December 31, 1997 compared to the same period in 1996. For the
year ended December 31, 1997, there were six area development agreements sold
for $2.9 million and 42 franchise Center licenses sold, as compared to 38
franchise Center licenses and four area development agreements sold for $1.7
million in the same period in 1996. Product sales decreased by $190,000, or 5%,
to $3.7 million for 1997.

Revenues from Company-owned Learning Centers increased by $4.2 million, or
22%, to $22.7 million during 1997. Revenue growth related to student enrollment
increases for Centers operating over 12 months as of December 31, 1997 resulted
in $4.0 million, or 24%, of the increase for 1997 compared to 1996.
Approximately $1.1 million of the revenue increase resulted from the acquisition
of thirteen centers from five franchisees.

Contract educational services revenue increased by $8.4 million, or 14%, to
$66.6 million for the year ended December 31, 1997. Revenue from public and
non-public contracts increased by $2.2 million for the year ended December 31,
1997, primarily the result of contracts with new school districts. Revenue
from PACE contracts accounted for $6.2 million of the increase for 1997. The
PACE increase resulted primarily from contracts with new customers.

Revenue from new public and non-public contracts obtained after December 31,
1996 contributed $5.3 million to revenue for 1997. Revenue from existing
public and non-public contracts obtained before December 31, 1996 decreased by
$3.1 million in 1997, primarily related to reduced funding in certain school
districts and certain contracts expiring in 1997.

Testing services revenue increased by $48.3 million, or 56%, to $135.3
million during the year ended December 31, 1997, compared to the year ended
December 31, 1996. The increase in testing services revenues resulted mainly
from increased services under Educational Testing Service (ETS) contracts,
which included the cost-plus international contract, GRE, GMAT, and TOEFL, and
certain volume-based pricing adjustments, testing in the information technology
and professional licensure businesses. WSI, acquired in December 1996,
contributed $19.0 million of the revenue increase.

Cost and Expenses. Total direct costs increased 37%, from $150.4 million in
1996 to $206.6 million in 1997 and increased as a percentage of total revenues
from 83% in 1996 to 84% in 1997 as a result of non-recurring expenses of $21.5
million being included in direct costs in 1997, as discussed below. Excluding
the non-recurring expenses, total direct costs as a percentage of total
revenues would be 75% for the year ended December 31, 1997.

Core educational services expense increased 44% from $25.6 million in 1996 to
$36.7 million in 1997. Included in core educational services expense for the
1997 period is advertising expense related to a non-recurring $5.0 million
contribution of the Company's common stock to a non-profit corporation whose
sole purpose is to develop and fund advertising programs for the Sylvan
Learning Centers. Franchise services expense increased by $8.0 million, to
$17.5 million or 82% of franchise related revenues for the year ended December
31, 1997, compared to $9.5 million, or 52% of franchise related revenues for
the year ended December 31, 1996. The lower margin in franchise services was
primarily due to the non-recurring expense discussed above, as well as to costs
incurred for development of new financing and after-school programs and
additional management staff for the Learning Center division.

Company-owned Learning Center expense increased by $3.1 million, to $19.2
million or 85% of Company-owned Learning Center services revenues for the year
ended December 31, 1997, compared to $16.1 million, or 87% of Company-owned
Learning Center services revenues for the year ended December 31, 1996. The
increase resulted from $1.1 million of expenses associated with 13 acquired
Learning Centers, and increases in advertising, labor and general overhead
associated with increased Center enrollment. Expenses for Centers operating
over 12 months as of December 31, 1997 accounted for $2.0 million of the
increase for 1997.

17

Contract educational services expense increased by $2.7 million to $56.1
million, or 84% of contract educational services revenues during 1997, compared
to $53.4 million, or 92% of contract educational services revenues during 1996.
Operating expenses for public and non-public schools decreased $1.3 million,
while operating expenses for PACE increased by $3.5 million for the year ended
December 31, 1997. The decrease in contract educational services expense as a
percentage of revenue for 1997 versus 1996 is the result of increased profit
margins for PACE and public and non-public services in 1997, as well a higher
mix of revenue from PACE contracts which generate a higher profit margin than
public and non-public services. In March 1998, the additional contingent
consideration payable to the former shareholders of PACE resulting from the
purchase of PACE in 1995 was determined to be $25.8 million, which was
recorded as additional goodwill and is being amortized over the estimated
remaining useful life of 22 years. This amount will increase the amount of
amortization associated with the contract educational services segment by
$1.2 million in 1998.

Testing service expenses for the year ended December 31, 1997 increased by
$42.4 million to $113.9 million, or 84% of total testing services revenue,
compared to $71.5 million, or 82% of total testing services revenue for the
year ended December 31, 1996. The increase in testing services expense as a
percentage of testing services revenues was predominantly a result of a non-
recurring marketing expense of $10.0 million related to a contribution to IT
Training Marketing Company, a nonprofit corporation whose sole purpose is to
fund promotional and channel support programs for the Sylvan Prometric
distribution channel. The 1996 expense includes $2.4 million of non-recurring
charges related to the Drake acquisition, incurred during the first and second
quarter of 1996. Excluding these effects, expenses as a percentage of total
testing revenue for 1997 and 1996 were 77% and 79%, respectively. This
decrease in recurring expenses as a percentage of testing services revenue was
primarily due to the fixed expenses of the division being spread over a higher
revenue base as well as the effects of a full year of results of WSI, at higher
incremental margins, being included in 1997 compared to only one month in the
1996 period.

General and administrative expenses increased by $11.7 million to $20.5
million during 1997 and increased as a percentage of revenues from 4.8% to
8.3%. Included in general and administrative expenses is a non-recurring
expense related to a contribution of the Company's common stock valued at $6.5
million to Sylvan Learning Foundation, Inc., a nonprofit foundation formed to
promote various educational pursuits. Excluding this non-recurring expense,
general and administrative expenses are 5.7% of total revenues for 1997. The
expenses did not decrease as a percentage of revenues as a result of increased
administrative staff, leased space costs and other expenses which were added to
support the current and expected growth in the Company's three divisions.

In March 1997, the Company and National Education Corporation ("NEC")
executed a definitive agreement pursuant to which the Company was to acquire
NEC. In May 1997, NEC accepted a competing offer which resulted in the
termination of NEC's agreement with the Company. As a result, NEC paid the
Company a $30.0 million termination fee, which has been recorded, net of $1.5
million of transaction costs, as a separate component of non-operating income.

In May 1997, the Company determined that certain assets of Sylvan Prometric
were impaired as a result of certain strategic changes that were made as a
result of pursuing the NEC acquisition. During and after the acquisition
negotiations with NEC, the Company developed certain plans that resulted in
required changes in both software systems and hardware currently utilized in
Sylvan Prometric's network of centers. The plans continued to be valid for the
Company even after the NEC acquisition was terminated. The impaired assets,
consisting of computer equipment and software, were impaired as a result of
changes in the technical requirements and specifications of certain computer
hardware and software. The amount of the impairment loss was determined by
evaluating the likely sales proceeds from the disposition of the assets
compared to their book value. The Company determined that it was unlikely that
the net cash proceeds from the sale of any assets would be significant, and
therefore recorded an impairment loss equal to the net book value of the assets
of $4.0 million.

Investment and other income increased by $2.9 million to $4.5 million during
1997, primarily due to the $2.0 million non-cash dividend income received from
the Company's investment in JLC Holdings, Inc. and the higher

18

cash and investment balances resulting from the NEC termination fee and the
proceeds received from the sale of the Company's common stock during 1997. The
Company's interest expense decreased by $0.5 million due to the repayment of all
outstanding Educational Inroads debt in the second quarter of 1997.

The Company reported losses of $2.1 million in 1997 from its investment in
affiliates, consisting primarily of $1.4 million attributable to Caliber
Learning Network, Inc., in which the Company has an equity investment. The
Company and MCI Communications Corp. organized Caliber in November of 1996.

The Company's effective tax rate has decreased from 37% during the 1996 to
35% during 1997 mainly due to the effect of proportionately higher earnings
levels attributable to foreign countries with lower tax rates than the U.S.

19

Comparison of results for the year ended December 31, 1996 to the year ended
December 31, 1995.

Revenues. Total revenues increased 64%, from $111.1 million in 1995 to $181.9
million in 1996. This increase resulted from greater revenues in all business
segments--core educational services, testing services and contract educational
services.

Core educational services revenues increased 41%, from $26.1 million in 1995
to $36.8 million in 1996. Franchise royalties increased 21%, from $9.2 million
in 1995 to $11.2 million in 1996. This increase in franchise royalties was due
to an overall 19% increase in revenues at Learning Centers that had been
operating for more than one year as of December 31, 1996 combined with a net
increase of 49 Learning Centers opened during 1996.

Franchise sales fees increased 49%, from $2.1 million in 1995 to $3.2 million
in 1996. During 1996, there were four area development agreements sold for $1.7
million and 38 franchise Learning Center licenses sold, compared to two area
development agreements sold for $550,000 and 43 Learning Center licenses sold
during 1995.

Revenues from Company-owned Learning Centers increased 61%, from $11.5
million in 1995 to $18.5 million in 1996. Revenue growth related to increased
student enrollment at Learning Centers that had been operating for more than
one year as of December 31, 1996, resulted in $3.4 million, or 30%, of the
increase from 1995 to 1996. Approximately $3.2 million of the revenue increase
resulted from the acquisition of 11 Learning Centers from two franchisees. The
opening of one new Learning Center during 1996 resulted in an additional
$350,000 of revenues during 1996. Product sales increased 23%, from $3.2
million in 1995 to $3.9 million in 1996. This increase resulted from overall
student enrollment increases at franchised Learning Centers.

Contract educational services revenues increased 15%, from $50.4 million in
1995 to $58.2 million in 1996. Revenues from public and non-public school
contracts accounted for $5.9 million of the increase, and greater revenues from
PACE accounted for $1.9 million of the increase. The PACE increase primarily
resulted from the fact that the acquisition, accounted for as a purchase, was
effective February 28, 1995, and as such the 1995 revenues of Sylvan only
reflect ten months of PACE revenues.

Revenues from public and non-public school contracts executed during 1996
contributed $2.2 million to 1996 revenues. Revenues from public and non-public
school contracts executed during 1995 increased by $4.6 million in 1996,
primarily because a full year of revenues were generated under these contracts
during 1996.

Testing services revenues increased 152%, from $34.6 million in 1995 to $87.0
million in 1996. The significant increase in testing services revenues resulted
primarily from the September 1995 acquisition of Drake, which provided
increased revenues from IT clients. Increased services under ETS contracts,
including the cost-plus international contract and the Graduate Record Exam
(the "GRE"), and other professional testing revenue increases, including NASD
testing, which began in February 1996, also contributed to the increase in
testing services revenues.

Cost and Expenses. Total direct costs increased 56%, from $96.7 million in
1995 to $150.4 million in 1996, but decreased as a percentage of total revenues
from 87% in 1995 to 83% in 1996. Core educational services expense increased
37%, from $18.7 million in 1995 to $25.6 million in 1996. Franchise services
expense increased 11%, from $5.9 million in 1995 to $6.5 million in 1996 but
decreased as a percentage of franchise royalties and sales revenues from 52% in
1995 to 46% in 1996. The increased margin in 1996 primarily related to the
effects of leveraging the fixed costs of supporting this line of business over
a larger revenue base. Company-owned Learning Center expense increased 55%,
from $10.4 million in 1995 to $16.1 million in 1996 but decreased as a
percentage of Company-owned Learning Center services revenues from 90% in 1995
to 87% in 1996. Of the increase, $3.1 million related to the acquisition of 11
Learning Centers. The remaining increase is primarily from advertising, labor
and general overhead expense associated with increased enrollment at Learning
Centers that had been operating prior to 1996.

20

Contract educational services expense increased 12%, from $47.7 million in
1995 to $53.4 million in 1996 but decreased as a percentage of contract
educational services revenues from 95% in 1995 to 92% in 1996. The decline in
these expenses as a percentage of contract educational services revenues
resulted from increased revenues without corresponding increases in overhead.
Operating expenses for public and non-public school contracts increased $4.6
million during 1996, while operating expenses for PACE increased $1.1 million
during the same period. The PACE increase resulted from the fact that the
acquisition, accounted for as a purchase, was effective February 28, 1995, and
as such the 1995 results only reflect ten months of PACE results.

Testing services expense increased 136%, from $30.3 million in 1995 to $71.5
million in 1996 but decreased as a percentage of testing services revenue from
88% in 1995 to 82% in 1996. The increased expense resulted primarily from the
acquisition of Drake and the increased registration and delivery costs
associated with an increased volume of tests. Testing services expense in 1996
included $2.4 million of amortization of contract rights related to the Drake
acquisition. Testing services expense in 1995 included $4.1 million of
amortization of contract rights, imputed interest and salary termination
charges related to the Drake acquisition. Excluding non-recurring charges,
testing services expense, as a percentage of testing services revenues,
increased from 76% in 1995 to 79% in 1996. The principal reasons for this
percentage increase in 1996 are the full year amortization of goodwill
associated with the Drake acquisition and increased staffing levels required to
meet the growth in business volumes that occurred during 1996 and expected
growth in business activity in 1997.

General and administrative expense increased 41%, from $6.2 million in 1995
to $8.8 million in 1996, but decreased as a percentage of total revenues, from
6% in 1995 to 5% in 1996. The percentage decline resulted from increased
revenues in all segments without corresponding increases in overhead.

There was $1.4 million of net interest expense in 1995 and $0.6 million of
net interest income in 1996. This change resulted primarily from the $1.1
million of interest expense imputed on the purchase of Drake and an increase in
the average invested cash amounts in 1996 compared to 1995.

The Company's effective tax rate increased from 6% in 1995 to 37% in 1996.
This increase was the primarily the result of a 1995 decrease in the amount of
the valuation allowance for deferred tax assets, consisting principally of net
operating loss carryforwards.

LIQUIDITY AND CAPITAL RESOURCES

Cash provided by operating activities increased $31.9 million, from $23.6
million in 1996 to $55.5 million in 1997. This increase is attributable to a
variety of factors, the most significant of which was a $35.5 million increase
in operating income before non-cash charges.

Sylvan's investment in working capital continues to reduce net cash flow from
operations, particularly as a result of the growth in accounts and notes
receivable. The $26.4 million increase in accounts and notes receivable is
principally the result of a 35% increase in revenue during 1997. Of the $26.4
million cash flow reduction attributable to an increase in accounts and notes
receivable, $12.3 million is related to Sylvan's expanding testing contracts
and $3.8 million is related to new and expanded public school contracts. The
increase in amounts due from expanding testing contracts resulted from higher
domestic testing volumes and a significant increase in billings under the
international contract with ETS to establish overseas testing capacity. ETS
typically makes monthly payments for domestic activity and quarterly payments
for international services. Accounts receivable from public school-based
programs have increased due to billings under new contracts obtained in 1996
and 1997. Notes receivable for new area development agreements accounted for
$3.2 million of the increase in 1997 and a note receivable from one of the
former owners of WSI accounted for another $2.0 million. Increases in revenue
for all business segments contributed to the remaining accounts and note
receivable increase of $5.1 million. Sylvan believes that uncollectible
accounts receivable will not have a significant effect on future liquidity, as
a significant portion of its accounts receivable are due from enterprises with
substantial financial resources, such as ETS and governmental units.

21

Cash flow from operations in 1997 was favorably impacted by an increase in
accounts payable, accrued expenses and income taxes payable of $16.3 million.
This increase relates to the overall increase in expenses, including income
taxes, of $79.4 million.

The Company's investing activities include the investment of excess cash in
available-for-sale securities. During 1997, the Company's investments
increased $66.5 million to $82.9 million. These investments are readily
marketable and available for use in current operations. The Company also made
$9.3 million of additional investments or loans to affiliates accounted for
using the equity method, consisting primarily of additional investments and
loans to Caliber Learning Network, Inc., in the amount of $7.2 million. In
January 1997, the Company completed the acquisition of WSI and paid cash to the
sellers and incurred acquisition costs totaling $4.7 million.

Sylvan continues to incur expenditures for additions to property and
equipment, which totaled $28.7 million in 1997. These additions consist
primarily of furniture and equipment for general business expansion, including
expenditures for the headquarters facility, new public school-based programs'
classrooms, and equipment needed for overseas testing centers operated by
Sylvan. Under the international testing contract with ETS, Sylvan is reimbursed
for overseas equipment expenditures as the equipment is depreciated. This
reimbursement includes a financing charge over the reimbursement period.

The Company has entered into a loan agreement with a bank, (hereinafter the
"credit line") that provides an unsecured revolving line of credit. The credit
line allows the Company to borrow a maximum of $15.0 million through the
expiration date of May 31, 1998, at which time the total outstanding principal
balance can be converted into a term loan, at the option of the Company. The
term loan would be repaid over 24 months from the date of issuance. The credit
line and the term loan both bear interest at a floating rate equal to the 30
day London Interbank Offered Rate ("LIBOR") plus 1.15% per annum. The credit
line had no outstanding borrowings at December 31, 1997.

In the third quarter of 1997, the Company issued 2,062,292 shares of its
common stock for net proceeds of $73.7 million, after underwriting costs and
expenses. The Company also received $5.0 million of cash as a result of the
exercise of stock options and warrants to purchase 1,137,245 shares of common
stock in 1997.

The Company will be required to make cash payments of $13.5 million in 1998
to the former shareholders of PACE in settlement of contingent consideration
arising from the 1995 acquisition of PACE. This amount has been classified as a
current liability in the consolidated balance sheet at December 31, 1997. Also,
as of December 31, 1997, the Company is obligated to issue directly to certain
shareholders of acquired companies common stock with a value of $56.4 million.
This amount is classified as a long-term liability in the consolidated balance
sheet at December 31, 1997. The Company has nominal amounts of long-term debt
outstanding at December 31, 1997.

Sylvan believes that its capital resources will be sufficient over the next
12 to 24 months to fund expected expansion of its business, including working
capital needs and expected investments in property and equipment.

Sylvan continues to review other companies in the education or computer-based
testing industries for potential acquisitions. Additional capital resources
may be necessary to acquire and thereafter operate additional businesses.

CONTINGENT MATTERS

In connection with the PACE acquisition, Sylvan will be required to make a
contingent payment equal to 6.5 times PACE's 1997 earnings before interest and
income taxes ("EBIT"). EBIT in 1997 was $4.0 million, resulting in additional
consideration of $25.8 million. The contingent payment is payable $13.5 million
in cash ($14.5 million offset by $1.0 million of amounts owed the Company by the
former owners of PACE) and the remainder in shares of common stock. The Company
has recorded this additional consideration as a liability and increased
goodwill and will amortize that amount over the remaining estimated recovery
period.

22

Upon the acquisition of Drake in September 1995, the Company entered into two
contingent payment obligations related to the acquisition. The first related
to 1,785,714 shares of common stock (the "Revenue Escrow Shares") that were
placed in escrow to be released to the sellers provided certain revenue targets
relating to portions of the computer-based testing business are achieved from
1996 through 1998. Based on testing revenues earned by the Company in 1996 and
1997, 60% of the Revenue Escrow Shares (1,071,429 shares) have been earned
through December 31, 1997. As of December 31, 1997, an additional $28.2
million of goodwill related to the earned shares was recorded and will be
amortized over the remaining estimated useful life. The 714,286 Revenue Escrow
Shares earned in 1997 will be released to the sellers in 1998.

The sellers of Drake may receive up to an additional $40.0 million (payable
12.5% in cash and the balance in either cash or restricted shares of common
stock, at the Company's option) as a second component of contingent
consideration. This component will be earned if other revenue targets relating
to portions of the combined computer-based testing business are achieved in
1998 or 1999 (with the measuring year selected by the sellers).

Sylvan has put in place a corporate-wide Year 2000 task force with
representatives for each business segment. This task force has conducted a
comprehensive review of Sylvan's computer systems to identify the systems that
would be affected by the Year 2000 issue and is developing an implementation
plan to resolve the issues. The Company is also surveying critical suppliers
and customers to determine the status of their Year 2000 compliance programs.
The Company presently believes that, with modifications to the existing systems
and implementation of new hardware and software, the Year 2000 project will not
pose any significant operational problems. The Company anticipates completing
the Year 2000 project by June of 1999. The future and total costs relating to
the Year 2000 issue are not expected to have a material impact on the Company's
consolidated financial position, results of operations or cash flow.

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

Sylvan'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 Sylvan's limited 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. In addition,
franchise license fees earned by the Company in its core educational services
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.

ITEM 8. FINANCIAL STATEMENTS

The financial statements of the Company are included on pages 29 through 63
of the report as indicated on page 28.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

There were no changes in accountants, disagreements, or other events
requiring reporting under this Item.

23

PART III.
---------

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF SYLVAN LEARNING SYSTEMS, INC.

Information required is set forth under the caption "Election of Directors"
in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders,
which is incorporated by reference.

Information required pertaining to compliance with Section 16 (a) of the
Securities and Exchange Act of 1934 is set forth under the caption "Election of
Directors" in the Proxy Statement relating to the 1998 Annual Meeting of
Shareholders, which is incorporated by reference.

ITEM 11. EXECUTIVE COMPENSATION

Information required is set forth under the caption "Executive Compensation"
in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders,
which is incorporated by reference.

ITEM 12. SECURITY OWNERSHIP AND CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information required is set forth under the caption "Security Ownership" in
the Proxy Statement relating to the 1998 Annual Meeting of Shareholders, which
is incorporated by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information required is set forth under the caption "Certain Transactions" in
the Proxy Statement relating to the 1998 Annual Meeting of Shareholders, which
is incorporated by reference.

PART IV.
--------

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) The following documents are filed as a part of this report:

1. FINANCIAL STATEMENTS

The response to this portion of Item 14 is submitted as a separate section
of this Report.

2. FINANCIAL STATEMENT SCHEDULES

All schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are inapplicable or
immaterial and therefore have been omitted.

(b) Reports on Form 8-K:

The Registrant did not file any reports on Forms 8-K and 8-K/A during the
fourth quarter ended December 31, 1997.

3. EXHIBITS

24

(a) Exhibits:

Exhibit
Number Description
- ------------ -----------

3.01 Articles of Amendment and Restatement of the Charter.(b)
3.03 Amended and Restated Bylaws dated September 27, 1996.(n)
4.01 Specimen Common Stock Certificate.(b)
4.02 Form of Warrant to Purchase Common Stock of Sylvan KEE Systems, Inc. dated January 26, 1993.(b)
4.03 Form of Warrant to Purchase Common Stock of Sylvan KEE Systems, Inc. dated July 14, 1993.(b)
4.07 Rights Agreement by and between Registrant and State Street Bank & Trust Company dated as of October 1,
1996.(i)
5.01 Opinion of Piper & Marbury L.L.P.(a)
10.01 Agreement of Lease by and between Rouse & Associates-Quarry and KEE Systems, Inc. dated May 15, 1990.(b)
10.02 Agreement of Lease by and between Rouse & Associated-Quarry and KEE Systems, Inc. dated May 6, 1990.(b)
10.03 Lease Agreement between Harbor East Parcel G-Office, LLC and Sylvan Learning Systems, Inc. dated August
24, 1995(c)
10.04 Master Agreement Between Educational Testing Service and Sylvan Learning Systems, Inc. for
Computer-Based Testing Services at Sylvan Technology Centers dated September 1, 1993. (Portions of this
document have been omitted pursuant to a request for confidential treatment.)(b)
10.05 Term Lease Master Agreement between Sylvan Learning Systems and IBM Credit Corporation dated March 31,
1992.(b)
10.06 Director Stock Option Plan.(b)
10.07 Employee Stock Option Plan.(b)
10.08 Management Stock Option Plan.(b)
10.19 KEE, Incorporated Non-Qualified Stock Option Plan.(b)
10.10 Sylvan Employee Confidentiality and Non-Disclosure Agreement and Covenant Not to Compete.(b)
10.11 $2.5 Million Revolving Loan, $3.76 Million Term Loan and $5.0 Million Revolving Loan with NationsBank.(d)
10.12 Indemnification Agreement by and between Sylvan KEE Systems, Tom D. Wippman and David H. Jacobson dated
September 17, 1992.(b)
10.13 Guaranty Agreement by Sylvan KEE Systems in favor of Encyclopedia Britannica, Inc. dated October 1,
1992.(b)
10.14 Form of Non-Competition Agreement by and between Sylvan KEE Systems, Inc. and Douglas L. Becker dated
January 26, 1993.(b)
10.15 Certification and Testing Services Agreement by and between TRO Learning, Inc. and
Sylvan Learning Systems, Inc. dated August 31, 1993.(b)
10.16 Plato Educational Products Purchase and License Agreement by and between TRO Learning, Inc. and Sylvan
Learning Systems, Inc. dated August 31, 1993.(b)
10.17 Form of Franchise Agreement.(b)
10.18 Form of Technology Center Agreement.(b)
10.19 Agreement and Plan of Reorganization dated July 14, 1994 by and between Registrant and Learning
Services, Inc.(e)
10.20 Agreement and Plan of Reorganization dated July 14, 1994 by and between Registrant and Loralex Learning,
Inc.(e)
10.21 Agreement and Plan of Reorganization dated February 17, 1995 by and between Registrant and Remedial
Education and Diagnostic Services, Inc.(f)
10.22 Agreement and Plan of Reorganization dated as of March 1, 1995, by and between Registrant and the PACE
Group.(g)
10.23 Agreement and Plan of Reorganization dated as of July 28, 1995, by and between Registrant and Drake
Prometric, L.P.(h)

25

10.24 Lease Agreement dated August 24, 1995, First Amendment dated May 13, 1996 and Second Amendment dated
November 11, 1996 by and between Registrant and Harbor East, LLC.(n)
10.25 Revolving Credit Note to NationsBank, N.A. dated December 31, 1996.(n)
10.26 Senior Management Option Plan dated March 29, 1996.(n)
10.27 Securities Purchase Agreement by and between Registrant and JLC Holdings, Inc., Software Systems
Corporation and JLC Learning Corporation dated November 1, 1996.(j)
10.28 Agreement and Plan of Reorganization dated January 28, 1997 by and between Registrant and Wall Street
Institute.(k)
10.29 Agreement and Plan of Reorganization dated May 30, 1997 among Registrant and I-R, Inc. and Independent
Child Study Teams, Inc.(l)
10.30 Sylvan Learning Systems, Inc. Employee Stock Purchase Plan.(m)
21.00 Subsidiaries of the Registrant.(n)
23.01 Consent of Ernst & Young LLP.
23.02 Consent of Deloitte & Touche L.L.P.
27.01 Financial Data Schedule for the year ended December 31, 1997.
27.02 Financial Data Schedule for the years ended December 31, 1995 and 1996.
27.03 Financial Data Schedule for the three months ended March 31, 1997 and 1996.
27.04 Financial Data Schedule for the three months ended June 30, 1997 and 1996.
27.05 Financial Data Schedule for the six months ended June 30, 1997 and 1996.
27.06 Financial Data Schedule for the three months ended September 30, 1997 and 1996.
27.07 Financial Data Schedule for the nine months ended September 30, 1997 and 1996.
99.01 Opinion of Deloitte & Touche L.L.P.
99.02 Opinion of Deloitte & Touche L.L.P.

(a) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-1 dated February 26, 1996.
(b) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-1 (Registration No. 33-69558).
(c) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-3 as amended by a Registration Statement on Form S-1
(No. 33-97870).
(d) Incorporated by reference from the Exhibits to the Company's Quarterly
Report for the Quarter ended September 30, 1995.
(e) Incorporated by reference to the Company's Current Report on Form 8-K dated
July 20, 1994.
(f) Incorporated by reference to the Company's Current Report on Form 8-K dated
February 27, 1995.
(g) Incorporated by reference to the Company's Current Report on Form 8-K dated
May 5, 1995.
(h) Incorporated by reference to the Company's Current Report on Form 8-K dated
July 21, 1995.
(i) Incorporated by reference to the Company's Current Report on Form 8-K dated
September 27, 1996.
(j) Incorporated by reference to the Company's Current Report on Form 8-K dated
November 1, 1996.
(k) Incorporated by reference to the Company's Current Report on Form 8-K dated
January 28, 1997.
(l) Incorporated by reference to the Company's Current Report on Forms 8-K and
Form 8-K/A dated April 17, 1997 and May 30, 1997.
(m) Incorporated by reference from the Exhibits to the Company's Registration
Statement on Form S-8 dated February 18, 1997.
(n) Incorporated by reference from the Exhibits to the Company's Form 10-K
filed March 31, 1997.

26

SIGNATURES
----------

Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
of the undersigned, thereunto duly authorized on March 31, 1998.

SYLVAN LEARNING SYSTEMS, INC.
(Registrant)

By: /s/ R. Christopher Hoehn-Saric
------------------------------------
R. Christopher Hoehn-Saric
Chairman of the Board

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on March 31, 1998

SIGNATURE CAPACITY
- --------- --------

/s/ R. Christopher Hoehn-Saric Director and Chairman of the Board
- ------------------------------------------
R. Christopher Hoehn-Saric

/s/ Douglas L. Becker Secretary
- ------------------------------------------
Douglas L. Becker

/s/ B. Lee McGee Vice President and Chief
- ------------------------------------------ Financial Officer
B. Lee McGee

/s/ Donald Berlanti Director
- ------------------------------------------
Donald Berlanti

/s/ Phillip Samper Director
- ------------------------------------------
Phillip Samper

/s/ James H. McGuire Director
- ------------------------------------------
James H. McGuire

/s/ Rick Inatome Director
- ------------------------------------------
Rick Inatome

/s/ R. William Pollock Director
- ------------------------------------------
R. William Pollock

/s/ Nancy S. Cole Director
- ------------------------------------------
Nancy S. Cole

27

ITEM 14 (A) (1)

INDEX TO FINANCIAL STATEMENTS

PAGE
----
THE COMPANY:

Report of Independent Auditors............................................................... 29
Consolidated Balance Sheets as of December 31, 1996 and December 31, 1997.................... 30
Consolidated Statements of Income for the years ended December 31, 1995, 1996 and 1997....... 32
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996
and 1997................................................................................... 33
Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997... 34
Notes to Consolidated Financial Statements................................................... 35

28

Report of Independent Auditors

The Board of Directors and Stockholders
Sylvan Learning Systems, Inc.

We have audited the consolidated balance sheets of Sylvan Learning Systems, Inc.
as of December 31, 1997 and 1996, and the related consolidated statements of
income, stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
financial statements of I-R, Inc. and Independent Child Study Teams, Inc., which
statements reflect combined total assets constituting 3% of 1996 consolidated
total assets, and which reflect combined revenues constituting 14% and 21% of
consolidated total revenues for the years ended December 31, 1996 and 1995.
Those statements were audited by other auditors whose reports have been
furnished to us, and our opinion, insofar as it relates to data included for
I-R, Inc. and Independent Child Study Teams, Inc., is based solely on the
reports of the other auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of other auditors provide a
reasonable basis for our opinion.

In our opinion, based on our audits and the reports of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Sylvan Learning Systems, Inc. at December
31, 1997 and 1996, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.

/s/ Ernst & Young LLP

Baltimore, Maryland
February 25, 1998

29

SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

December 31, December 31,
1996 1997
--------------- ---------------

ASSETS
Current assets:
Cash and cash equivalents $ 11,198,106 $ 23,150,106
Available-for-sale securities 16,448,759 82,925,569

Receivables:
Accounts receivable 36,431,363 56,187,522
Costs and estimated earnings in excess of billings
on uncompleted contracts 3,565,201 3,899,760
Notes receivable 3,007,473 2,942,861
Other receivables - 7,000,000
--------------- ---------------
43,004,037 70,030,143
Allowance for doubtful accounts (1,378,854) (1,754,682)
--------------- ---------------
41,625,183 68,275,461

Inventory 4,469,577 4,777,542
Deferred income taxes 619,553 3,737,831
Prepaid expenses and other current assets 3,124,802 3,674,563
--------------- ---------------
Total current assets 77,485,980 186,541,072

Notes receivable, less current portion 562,989 6,231,651
Costs and estimated earnings in excess of billings
on uncompleted contracts, less current portion 549,448 351,712

Property and equipment:
Furniture and equipment 37,952,268 55,381,518
Leasehold improvements 5,543,726 7,649,845
--------------- ---------------
43,495,994 63,031,363
Accumulated depreciation (15,577,693) (18,725,260)
--------------- ---------------
27,918,301 44,306,103

Intangible assets:
Goodwill 103,986,427 182,167,949
Contract rights 13,881,337 13,972,800
Other 2,570,091 2,522,391
--------------- ---------------
120,437,855 198,663,140
Accumulated amortization (10,736,219) (16,649,374)
--------------- ---------------
109,701,636 182,013,766

Deferred contract costs, net of accumulated amortization
of $2,066,893 as of December 31, 1996 and $6,205,393
as of December 31, 1997 13,230,340 10,323,898

Investments in and advances to affiliates 5,895,602 12,463,729
Other investments 22,219,888 28,017,457
Other assets 2,025,337 3,266,176
--------------- ---------------
Total assets $ 259,589,521 $ 473,515,564
=============== ===============

30

SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

December 31, December 31,
1996 1997
------------------- -------------------

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 28,575,931 $ 36,435,373
Income taxes payable - 4,876,458
Current portion of long-term debt 3,182,197 930,231
Current portion of due to shareholders of
acquired companies 4,920,565 13,794,195
Deferred revenue 9,542,578 11,751,722
Other cu