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PART I
ITEM 1--BUSINESS
This Annual Report on Form 10-K contains statements that may be
forward-looking statements within the meaning of the U.S. Private Securities
Litigation Reform Act of 1995. Those statements can be identified by the use of
forward-looking terminology such as "believes," "estimates," "anticipates,"
"continues," "contemplates," "expects," "may," "will," "could," "should" or
"would" or the negatives thereof or other variations thereon or comparable
terminology. Those statements are based on the intent, belief or expectation of
Education Management Corporation ("EDMC" or the "Company") as of the date of
this Annual Report. Any such forward-looking statements are not guarantees of
future performance and may involve risks and uncertainties that are outside the
control of the Company. Actual results may vary materially from the
forward-looking statements contained herein as a result of changes in United
States or international economic conditions, governmental regulations and other
factors, including those factors described at the end of the responses to this
Item 1. The Company expressly disclaims any obligation or understanding to
release publicly any updates or revisions to any forward-looking statement
contained herein to reflect any change in the Company's expectations with regard
thereto or any change in events, conditions or circumstances on which any such
statement is based. The following discussion should be read in conjunction with
the Consolidated Financial Statements and Notes thereto filed in response to
Item 8 of this Annual Report.
GENERAL
EDMC is among the largest providers of proprietary postsecondary education
in the United States, based on student enrollments and revenues. Through its
operating units, the Art Institutes ("The Art Institutes"), The New York
Restaurant School ("NYRS"), NCPT, and The National Center for Professional
Development ("NCPD"), the Company offers associate's and bachelor's degree
programs and non-degree programs in the areas of design, media arts and
technology, culinary arts, fashion and professional development. The Company has
provided career-oriented education programs since 1962, and its schools have
graduated over 100,000 students. In the fall quarter of fiscal 1998, beginning
October 1997, EDMC's schools had approximately 18,800 students enrolled,
representing all 50 states and over 85 countries.
The Company's main operating unit, The Art Institutes, consists of 15
schools in 14 cities throughout the United States and accounted for
approximately 93% of the Company's net revenues in fiscal 1998. Art Institute
programs are designed to provide the knowledge and skills necessary for
entry-level employment in various fields, including graphic design, multimedia,
computer animation, video production, culinary arts, interior design, industrial
design, photography, fashion marketing and fashion design. Those programs
typically are completed in 18 to 27 months and culminate in an associate's
degree. Eight Art Institutes currently offer bachelor's degree programs, and
EDMC expects to continue to introduce bachelor's degree programs at schools in
states that permit proprietary postsecondary institutions to offer such
programs.
In fiscal 1998, the Company opened The Art Institute of Los Angeles, which
began offering classes in October 1997. In December 1997, the Company acquired
the assets of the Louise Salinger School in San Francisco, California and
renamed the school The Art Institutes International at San Francisco. In
February 1998, the Company acquired the assets of Bassist College in Portland,
Oregon and renamed the school The Art Institutes International at Portland.
The Company offers a culinary arts curriculum at nine Art Institutes,
including The Art Institute of Los Angeles, which began culinary arts classes in
June 1998, and The Art Institutes International Minnesota, which will begin
culinary arts classes in October 1998. In addition, in August 1996, the Company
acquired NYRS, a well-known culinary arts and restaurant management school
located in New York City. NYRS offers an associate's degree program and
certificate programs. NYRS accounted for approximately 5% of the Company's net
revenues in fiscal 1998.
The Company offers paralegal training at NCPT, a leading source of
paralegals in the southeastern United States. NCPT, located in Atlanta, offers
certificate programs that generally are completed in four to nine months. NCPD
maintains consulting relationships with six colleges and universities to assist
in the development,
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marketing and delivery of paralegal, legal nurse consultant and financial
planning certificate programs for college graduates and working adults. In
fiscal 1998, the Company derived less than 2% of its net revenues from NCPT and
NCPD combined.
EDMC's primary objective is to provide career-focused education that
maximizes employment opportunities for its students after graduation. EDMC's
graduates are employed by a broad range of employers nationwide. Approximately
87.3% of the calendar year 1997 graduates of all programs at EDMC's schools who
were available for employment obtained positions in fields related to their
programs of study within six months of graduation.
The Company believes that demand for postsecondary education will generally
increase due to (i) an increase of approximately 26% in the number of new high
school graduates per year from approximately 2.5 million in 1996 to
approximately 3.2 million in 2008 (as projected by the Western Interstate
Commission for Higher Education), (ii) the growing interest of working adults in
enhancing their marketable skills, (iii) the income premium attributable to
higher education degrees, and (iv) employers' continuing demand for entry-level
workers with appropriate technical skills.
The Company believes the experience of its management team and the
substantial equity ownership of its employees are significant factors
contributing to its success. EDMC's senior management has an average of nine
years with EDMC and 19 years of experience in the education industry.
Approximately two-thirds of the employees of EDMC, including a substantial
majority of the management team, has an ownership interest in the Company
through direct holdings, participation in the Company's Employee Stock Ownership
Plan and Trust (the "ESOP") or both.
COMPANY HISTORY
The Company was organized as a Pennsylvania corporation in 1962. In 1971,
Robert B. Knutson (currently its Chairman and Chief Executive Officer) became
President of the Company. At that time, EDMC consisted primarily of The Art
Institute of Pittsburgh, which was acquired in 1970. Between 1971 and the
present, the Company opened three schools and acquired 13 others. The Company's
net revenues have increased from approximately $1.9 million in 1971 to
approximately $221.7 million in fiscal 1998.
In November 1996, the Company and certain shareholders sold shares of the
Company's common stock, $.01 par value (the "Common Stock"), to the public in an
initial public offering (the "IPO"). In November 1997, those shareholders and
other shareholders sold additional shares of Common Stock in a secondary public
offering.
INDUSTRY OVERVIEW
According to The National Center for Education Statistics, education is the
second largest sector of the U.S. economy, accounting for approximately 7.4% of
gross domestic product in the 1996/1997 school year, or over $560 billion, of
which amount approximately $225 billion was spent for postsecondary education.
EDMC's schools are part of the postsecondary education market. Of the
approximately 6,600 postsecondary schools that are eligible to participate in
federal financial aid programs ("Title IV Programs") under Title IV of the
Higher Education Act of 1965, as amended (the "HEA"), approximately 600 are
proprietary degree-granting institutions such as EDMC's schools. The United
States Department of Education (the "U.S. Department of Education") estimates
that by the year 2001 the number of students enrolled in higher education
institutions will increase by more than 1.5 million to over 16 million students.
The Company believes that a significant portion of the growth in the
postsecondary education market will result from an increase in the number of new
high school graduates. According to the Western Interstate Commission for Higher
Education, the number of new high school graduates per year is expected to
increase by approximately 26%, from approximately 2.5 million graduates in 1996
to approximately 3.2 million graduates in 2008. Significant growth is also
expected to result from increased enrollment by working adults. The U.S.
Department of Education estimates that, over the next several years, initial
enrollments in postsecondary
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education institutions by working adults will increase more rapidly than initial
enrollments by recent high school graduates.
The postsecondary education industry is also expected to benefit from the
public's increased recognition of the value of a postsecondary education.
According to The National Center for Education Statistics, the percentage of
recent high school graduates who continued their education after graduation
increased from approximately 54% in 1986 to approximately 65% in 1996. The
Company believes that the income premium associated with a postsecondary
education has been a significant factor contributing to this trend. The Bureau
of the Census of the United States Department of Commerce has reported that, in
1995, a full-time male worker aged 25 years or older with an associate's degree
earned an average of 42% more per year than a comparable worker with only a high
school diploma, and a full-time male worker with a bachelor's degree earned an
average of approximately 83% more per year than a comparable worker with only a
high school diploma. In addition, employment in technical occupations is
expected to increase over the next several years as the demand for technically
skilled labor increases.
The Company believes that private degree-granting institutions, such as The
Art Institutes and NYRS, will have an advantage over their principal
competitors, the public two-year and four-year institutions, in capitalizing on
the trends in the postsecondary education market. Well-capitalized companies,
such as EDMC, should benefit from their ability to absorb the increasing costs
of regulatory compliance and capital expenditure requirements through their
economies of scale and national marketing presence.
BUSINESS STRATEGY
EDMC intends to capitalize on the trends in the postsecondary education
market, creating an opportunity for increased revenues and profitability, by (i)
enhancing growth at its current schools, (ii) opening or acquiring schools in
attractive markets, (iii) expanding program offerings, and (iv) improving
student outcomes.
ENHANCING GROWTH AT THE COMPANY'S SCHOOLS
EDMC believes that it will continue to benefit from trends relating to the
growing number of potential students, particularly new high school graduates and
working adults. EDMC augmented its efforts to recruit high school students by
enlarging its high school admissions staff by approximately 33% from fiscal 1995
to fiscal 1998 and by increasing the number of high schools visited to
approximately 9,350 in fiscal 1998 (an increase of approximately 34% over fiscal
1995) and the number of high schools at which presentations were made to
approximately 8,100 in fiscal 1998 (an increase of approximately 35% over fiscal
1995). The Company believes that, due in part to these efforts, applications
from high school seniors in fiscal 1998 (for education programs starting in
fiscal 1998 or fiscal 1999) were approximately 11% greater than in fiscal 1997.
The Company also believes it can penetrate the growing working adult market by
introducing and augmenting evening programs. The first introduction of such
programs was at The Art Institute of Dallas in fiscal 1993. Currently, twelve of
The Art Institutes offer evening programs. The total number of students
participating in such programs at The Art Institutes increased 23% to
approximately 2,600 students in the spring quarter of fiscal 1998 from
approximately 2,100 in the spring quarter of fiscal 1997.
In addition, the Company actively seeks international students for The Art
Institutes. The Company both employs admissions personnel with international
experience and contracts with independent recruiters abroad. To accommodate the
special needs of international students, staff members are assigned to act as
international student advisors. Average international student enrollments in
fiscal 1998 were approximately 29% greater than in fiscal 1997, and
international students currently constitute approximately 6% of the total
enrollments at The Art Institutes.
TARGETING EXPANSION OPPORTUNITIES IN A FRAGMENTED MARKET
To further its national presence and to take advantage of the highly
fragmented postsecondary education industry, EDMC plans to open new schools and
to acquire existing schools in favorable locations. The Company regularly
analyzes potential new markets for enrollment potential, positive long-term
demographic trends, the
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concentration of likely employers, the level of competition, facility costs, the
availability of faculty and management talent, and the regulatory approval
process.
Establishing New Schools. In the near term, new schools will be
established primarily as Art Institutes, such as The Art Institute of Phoenix
(which opened in fiscal 1996) and The Art Institute of Los Angeles (which opened
in fiscal 1998), allowing the Company to use its accumulated knowledge and
experience in Art Institute operations. In recent years, the Company has
developed a financial and operational model to analyze prospective start-up
investments, which takes into account, among other things, enrollment
projections, pre-opening expenditures, and the marketing expenses necessary to
build interest in a school.
Acquiring Existing Schools. The Company also believes that significant
opportunities exist for growth through acquisitions. In particular, many smaller
institutions have limited resources to manage the increasingly complex
regulatory environment or to fund the high costs of developing the new programs
required to meet the changing demands of the employment market. The Company's
acquisition focus will be on schools that (i) can be integrated efficiently into
its existing operations, (ii) will benefit from EDMC's expertise and scale in
marketing and administration, and (iii) possess a strong, established
reputation. In August 1996, the Company acquired the assets of NYRS, a culinary
arts and restaurant management school located in New York City. In January 1997,
the Company acquired the assets of Lowthian College in Minneapolis, Minnesota
(renamed The Art Institutes International Minnesota). In December 1997, the
Company acquired the assets of the Louise Salinger School in San Francisco,
California (renamed The Art Institutes International at San Francisco). In
February 1998, the Company acquired the assets of Bassist College in Portland,
Oregon (renamed The Art Institutes International at Portland).
EXPANDING EDUCATION PROGRAMS
EDMC currently offers education programs in a variety of fields and
continually seeks to optimize its portfolio of programs to meet the needs of
both its students and the employment market. The Company believes that
developing programs that balance the opportunities in the job market and the
interests of students will increase enrollment and expand the Company's revenue
base. In addition to the acquisition of NYRS, the Company has introduced its
culinary arts program at nine Art Institutes, including The Art Institute of Los
Angeles, which began culinary arts classes in June 1998, and The Art Institutes
International Minnesota, which will begin culinary arts classes in October 1998.
The Company also offers bachelor's degree programs in several fields of
study which are designed to reflect the needs of the employment market and to
appeal to students seeking enhanced career preparation and credentials.
Bachelor's degree programs benefit the Company by providing a longer revenue
stream than two-year associate's degree programs. The Company will seek to
introduce additional bachelor's degree programs at schools in states that permit
proprietary postsecondary institutions, such as The Art Institutes, to offer
such programs. In fiscal 1997, the Company introduced or enhanced its bachelor's
degree programs in the areas of computer animation, graphic design, interior
design and industrial design. In fiscal 1998, the Company introduced a
bachelor's degree program in interactive multimedia programming. The average
number of students enrolled in bachelor's degree programs at The Art Institutes
in fiscal 1998 increased approximately 109% from fiscal 1997 to approximately
1,200. See "The Business of Education--Programs of Study."
IMPROVING STUDENT OUTCOMES
EDMC intends to continue to improve student persistence and graduate
starting salaries in order to enhance the reputation of its schools and their
education programs and increase student enrollments. Measures implemented by the
Company include higher admissions standards, academic placement testing,
remediation courses, improved faculty training, and increased administrative
resources dedicated to placement assistance. The Art Institutes' average net
quarterly persistence rate, which measures the number of students that are
enrolled during an academic quarter and advance to the next academic quarter,
increased from 89.6% in fiscal 1996 to 89.7% in fiscal 1997 to 90.1% for the
first three quarters of fiscal 1998. The Art Institutes' annual persistence
rate, which measures the number of students who are enrolled during a fiscal
year and either graduate or advance to the next fiscal year, was 67.5% in fiscal
1997 and 66.4% in fiscal 1998. The Company's schools are adopting
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an annual persistence rate measurement to replace the net quarterly persistence
rate measure because the Company believes that the annual measure is closer to
the methodology used by accrediting agencies and remains an effective tool to
manage the delivery of educational services. From calendar year 1993 to calendar
year 1997, The Art Institutes' placement rate for all graduates available for
employment, who completed any program, improved from 83.1% to 89.0% and average
starting salaries rose 40.5% from approximately $15,600 to approximately
$21,900.
THE BUSINESS OF EDUCATION
EDMC's primary mission is to maximize student success by providing students
with the education necessary to meet employers' current and anticipated needs.
To achieve this objective, the Company focuses on (i) marketing to a broad
universe of potential students, (ii) admitting students who possess the relevant
interests and capabilities, (iii) providing students with programs of study
taught by industry professionals, and (iv) assisting students with job placement
prior to graduation.
STUDENT RECRUITMENT AND MARKETING
EDMC seeks to attract students with both the motivation and ability to
complete the programs offered by its schools. To generate interest, the Company
engages in a broad range of activities to inform potential students and their
parents about its schools and programs of study.
The general reputation of The Art Institutes and referrals from current
students, alumni and employers are the largest sources of new students. The
Company also employs marketing tools such as television and print media
advertising, the World Wide Web, high school visits and recruitment events, and
utilizes its internal advertising agency to create publications, television and
radio commercials, videos and other promotional materials for the Company's
schools. The Company estimates that in fiscal 1998 referrals accounted for 39%
of new student enrollments at The Art Institutes, high school recruitment
programs accounted for 21%, broadcast advertising accounted for 20%, print media
accounted for 10%, the Company's web site accounted for 4%, international
marketing accounted for 3%, and the remaining 3% was classified as
miscellaneous. The goal of the Company's recruitment efforts is to increase
awareness of the Company's schools among potential applicants in a
cost-effective manner.
The Company carefully monitors the effectiveness of its marketing efforts.
In fiscal 1998, The Art Institutes' marketing efforts generated inquiries from
approximately 198,000 qualified prospective students. The Art Institutes'
inquiry-to-application conversion ratio increased from 6.5% in fiscal 1992 to
10.2% in fiscal 1998, and the applicant-to-new student ratio increased from
55.8% in fiscal 1992 to 66.0% in fiscal 1998.
To capitalize on the growing number of new high school graduates, the
Company employs approximately 65 high school representatives and utilizes a
variety of strategies. These high school representatives make presentations at
high schools, during which student artwork, videos and a multimedia
demonstration are shown to students and educators to promote The Art Institutes.
Each Art Institute also conducts college preview seminars at which prospective
students can meet with a representative, view artwork and videos, and receive
enrollment information. Summer teenager and teacher workshops are held to inform
students and educators of the education programs offered by The Art Institutes.
The Company's marketing efforts to reach young adults and working adults who may
be attracted to evening programs are conducted through local newspaper
advertising, direct mail campaigns and broadcast advertising.
NYRS relies on local television and referrals as its primary marketing
tools and also uses high school representatives and presentations at high
schools in the New York metropolitan area. NCPT uses direct mail, print media
and advertisements in related national trade periodicals to generate interest.
Referrals, especially from employers, are an important source of new students
for NCPT. In addition, NCPT conducts recruitment programs at colleges, featuring
college visits, participation in college career fairs, posters and advertising
in college newspapers.
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STUDENT ADMISSION AND RETENTION
Each applicant for admission to an Art Institute is required to have a high
school diploma or a recognized equivalent and submit a written essay.
Prospective students are interviewed to assess their qualifications, their
interest in the programs offered by the applicable Art Institute and their
commitment to their education. In addition, the curricula, student services,
education cost, available financial resources and student housing are reviewed
during interviews, and tours of the facilities are conducted for prospective
students.
At each Art Institute, student admissions is overseen by a committee,
comprised principally of members of the faculty, that reviews each application
and makes admissions decisions. Art Institute students are of varying ages and
backgrounds. For fiscal 1998, approximately 32% of the entering students
matriculated directly from high school, approximately 28% were between the ages
of 19 and 21, approximately 29% were 22 to 29 years of age and approximately 11%
were 30 years old or older.
The Company recognizes that the ability to retain students until graduation
is an important indicator of the success of its schools and that early academic
intervention is crucial to improve student persistence and completion rates. As
with other postsecondary institutions, students at the Company's schools may
fail to finish their programs for a variety of personal, financial or academic
reasons. To reduce the risk of student withdrawals, each Art Institute devotes
staff resources to advise students regarding academic and financial matters,
part-time employment and housing. Remedial courses are mandated for students
with low academic skill levels and tutoring is encouraged for students
experiencing academic difficulties. The average student-to-faculty ratio at the
Company's schools was approximately 18.3:1 during fiscal 1998.
At The Art Institutes, the average net quarterly persistence rate, which
measures the number of students that are enrolled during an academic quarter and
advance to the next academic quarter, improved from 88.4% in fiscal 1994 to
90.1% for the first three quarters of fiscal 1998. The Company believes that it
has been able to improve its average net quarterly persistence rate, in part,
due to its investment in academic programs, student academic testing and
placement, remediation programs and faculty training initiatives, the increased
availability of supplemental student financing and orientation and socialization
programs designed to provide transition assistance to incoming students.
The Company's schools bill students for their tuition and other
institutional charges by the term of instruction, typically an academic quarter.
Each school's refund policies must meet the requirements of the U.S. Department
of Education and the requirements of such school's state and accrediting
agencies (which are not uniform). Generally, if a student ceases attendance
during the first 60% of his or her first term, the applicable school will refund
institutional charges based on the number of weeks remaining in that term. After
a student has attended 60% of that term, the school will retain 100% of the
institutional charges. After a student's first term, the school refunds
institutional charges based on the number of weeks attended in the quarter in
which the student withdraws. Generally, after six weeks of a term, the school
will retain 100% of the institutional charges for that academic quarter.
PROGRAMS OF STUDY
EDMC's programs are designed to provide career-oriented education to
students. The Company believes that the educational needs of students are served
through curricula and a teaching/learning model that support the development of
problem-solving, interpersonal and team skills, as well as technical and
professional skills. The Art Institutes attempt to serve students through
education provided by industry-experienced faculty, a low student-to-faculty
ratio and an interactive learning methodology. Classes at The Art Institutes and
NCPT are scheduled throughout the year with quarterly start dates for the
convenience of students. Classes at NYRS begin eight times throughout the year.
The development of new education programs at any postsecondary institution
demands a substantial commitment of human resources and capital. Most new
programs at The Art Institutes are currently approved on a system-wide basis and
are made available to each of The Art Institutes for implementation as
determined by that school's administration and its Board of Trustees, where
applicable. Faculty, employment assistance specialists, curricula advisory
boards, industry experts, industry literature and employers are the most common
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sources for new program offerings. Approximately 560 employers and industry
experts are represented on local curricula advisory boards for the Company's
schools. Generally, proposed education programs are referred to a series of
system-wide administrative bodies that decide whether to proceed with
development of those programs. As part of such process, an independent
contractor, or internal analyst where appropriate, may be retained to develop
and compile data for the purpose of identifying both potential student interest
in a program and the skills required of a graduate upon program completion. Such
research is then used to produce a curriculum model for final review. The goals
of the curriculum development process are to provide new program opportunities
and to revise existing curricula to be consistent with changing industry needs.
The Art Institutes offer the following degree programs, among others. Not
all programs are offered at each Art Institute. (For internal purposes, the
Company classifies its degree programs according to four "schools" or areas of
study.)
THE SCHOOL OF DESIGN
Associate's Degree Programs
Computer Animation
Graphic Design
Interior Design
Industrial Design Technology
Computer-Aided Drafting &
Design
Bachelor's Degree Programs
Computer Animation
Graphic Design
Interior Design
Industrial Design
THE SCHOOL OF CULINARY ARTS
Associate's Degree Programs
Culinary Arts
Travel and Tourism
Restaurant and Catering
Management
Bachelor's Degree Programs
Culinary Management
THE SCHOOL OF MEDIA ARTS AND TECHNOLOGY
Associate's Degree Programs
Multimedia
Photography
Video Production
Web Site Administration
Audio Production
Broadcasting
Music Business
Bachelor's Degree Programs
Interactive Multimedia Programming
Multimedia Communications
THE SCHOOL OF FASHION
Associate's Degree Programs
Fashion Design
Fashion Marketing
Visual Merchandising
Bachelor's Degree Programs
Fashion Design
Fashion Marketing and Management
NYRS offers associate's degree programs in culinary arts and restaurant
management and certificate programs in culinary arts, pastry arts, and culinary
skills.
Approximately 9% of the average quarterly student enrollments at the
Company's schools in fiscal 1998 were in specialized diploma programs. Academic
credits from all of the specialized diploma programs at the Art Institutes and
NYRS are fully transferable into associate's and bachelor's degree programs at
those schools. Diploma programs are designed for working adults who seek to
supplement their education or are interested in enhancing their marketable
skills.
The Company expects to continue to add additional bachelor's degree
programs at schools in states that permit proprietary postsecondary institutions
to offer such programs. Certain Art Institutes that are undergoing review to
obtain regional accreditation have determined not to offer such programs at this
time. See "Accreditation."
GRADUATE EMPLOYMENT
The Company believes that employment of its graduates in occupations
related to their fields of study is critical to the ability of its schools to
continue to recruit students successfully. Based on information received
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from graduating students and employers, the Company believes that students
graduating from The Art Institutes during the five calendar years ended December
31, 1997 obtained employment in fields related to their programs of study as
follows:
PERCENT OF AVAILABLE
GRADUATES WHO OBTAINED
NUMBER OF EMPLOYMENT RELATED
GRADUATING CLASSES AVAILABLE TO PROGRAM OF
(CALENDAR YEAR) GRADUATES(1)(2) STUDY(2)(3)
- ------------------ ---------------- ----------------------
1997....................................... 3,811 89.0%
1996....................................... 3,676 86.8
1995....................................... 3,734 87.4
1994....................................... 3,495 86.4
1993....................................... 3,580 83.1
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(1) The term "Available Graduates" refers to all graduates except those pursuing
further education, who are deceased, who are in active military service, who
have medical conditions that prevent such graduates from working or who are
international students no longer residing in the United States.
(2) If the graduates of NCPT and NYRS (since its acquisition in August 1996)
were included in this table, then the numbers and percentages for 1996 and
1997 would have been 4,167 and 4,749 and 86.4% and 87.3%, respectively.
(3) For calendar years 1997, 1996, 1995 and 1994, the information presented
reflects employment in fields related to graduates' programs of study within
six months after graduation. Prior to calendar year 1994, the Company
tracked graduate employment data based on employment rates within nine
months after graduation.
For calendar year 1997, the approximate average starting salaries of
graduates of degree and diploma programs at The Art Institutes were as follows:
The School of Culinary Arts--$21,200; The School of Design--$23,200; The School
of Fashion--$20,400; and The School of Media Arts and Technology--$20,300.
Each Art Institute offers career-planning services to all graduating
students through its employment assistance department. Specific career advice is
provided during the last two quarters of a student's education. Interviewing
techniques and resume-writing skills are developed, and students receive
portfolio counseling where appropriate. The Art Institutes maintain contact with
approximately 40,000 employers nationwide. Employment assistance advisors
educate employers about the programs at The Art Institutes and the caliber of
their graduates. Employment assistance advisors participate in professional
organizations, trade shows and community events to keep apprised of industry
trends and maintain relationships with key employers. The Company believes that
the ability of employment assistance advisors to generate job leads and match
employers' needs with graduates' skills and the active role of graduates in
their own job searches are major reasons for the percentage of Art Institute
graduates employed in their fields throughout the country.
Employers of Art Institute graduates include numerous small and
medium-sized companies (such as radio and television stations), as well as
better-known larger companies. The following companies are representative of the
larger companies that employ Art Institute graduates: Bell Atlantic Corporation,
The Boeing Company, Eddie Bauer, Inc., Ethan Allen Interiors Inc., Flight Safety
International, The Home Depot, Inc., Humongous Entertainment, Inc., J. C. Penney
Company, Inc., Kinko's Corporation, Marriott International, Inc., The May
Department Stores Company, Microsoft Corporation, The Neiman Marcus Group, Inc.,
Nintendo of America, Nordstrom, Inc., The Ritz-Carlton, Sears Roebuck and Co.,
Sierra On-Line, Inc., Take2 Interactive Software, Inc., Tele-Communications,
Inc., Time Warner Inc., Turner Broadcasting System, Inc., and The Walt Disney
Company.
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SCHOOLS
The following table shows the location of each of EDMC's schools, the name
under which it operates, the date of its establishment, the date EDMC opened or
acquired it, and the number of students enrolled as of the beginning of the
second quarter of fiscal 1998.
CALENDAR FISCAL YEAR
YEAR EDMC
SCHOOL LOCATION ESTABLISHED ACQUIRED/OPENED ENROLLMENT(1)
------ -------- ----------- --------------- -------------
The Art Institute of Atlanta.... Atlanta, GA 1949 1971 1,544
The Art Institute of Dallas..... Dallas, TX 1964 1985 1,193
The Art Institute of Fort
Lauderdale.................... Fort Lauderdale, FL 1968 1974 2,307
The Art Institute of Houston.... Houston, TX 1974 1979 1,425
The Art Institute of Los
Angeles....................... Los Angeles, CA 1997 1998 100
The Art Institute of
Philadelphia.................. Philadelphia, PA 1971 1980 2,145
The Art Institute of Phoenix.... Phoenix, AZ 1995 1996 593
The Art Institute of
Pittsburgh.................... Pittsburgh, PA 1921 1970 2,581
The Art Institute of Seattle.... Seattle, WA 1946 1982 2,655
The Art Institutes International
at Portland................... Portland, OR 1963 1998 N/A
The Art Institutes International
at San Francisco.............. San Francisco, CA 1939 1998 N/A
The Art Institutes International
Minnesota..................... Minneapolis, MN 1964 1997 214
The Colorado Institute of Art... Denver, CO 1952 1976 1,696
The Illinois Institute of Art at
Chicago....................... Chicago, IL 1916 1996 608
The Illinois Institute of Art at
Schaumburg.................... Schaumburg, IL 1983 1996 364
NCPT............................ Atlanta, GA 1973 1973 361
New York Restaurant School...... New York, NY 1980 1997 977
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(1) Enrollments are as of October 1997 (i.e., the start of the fall quarter at
The Art Institutes), prior to the acquisition of The Art Institutes
International at Portland and The Art Institutes International at San
Francisco.
GOVERNANCE OF THE ART INSTITUTES
EDMC believes that the three-tier governance structure for The Art
Institutes differs from governance structures at other proprietary school
systems and possesses several advantages. One of these advantages is that the
structure permits each of EDMC's schools to be recognized by regulatory
authorities and accrediting agencies on an individual basis, thereby enabling
the school to be accredited in its geographic region.
The Art Institutes International, Inc. ("AII") is the parent corporation
for all of The Art Institutes other than The Art Institute of Pittsburgh, which
is a division of AII. The Board of Directors of AII approves the annual and
long-range operating plans of The Art Institutes, including their annual
budgets. The AII Board of Directors also appoints the members of the AII System
Coordinating Board, the primary focus of which is AII system-wide education
policy and quality. The AII System Coordinating Board coordinates education
research, academic programming, development and planning. It also communicates
with external governmental and corporate entities on behalf of AII, approves new
education programs, reviews existing programs and assists The Art Institutes in
developing policies and procedures.
At most of The Art Institutes, Boards of Trustees are vested with the
authority to manage the schools' business and affairs. Thus, each such Art
Institute puts its own imprint on the academic programs it offers, consistent
with applicable state laws, regulations and licensure requirements and
accreditation standards, while
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maintaining compatibility among The Art Institutes. Each Board of Trustees is
empowered to select the president and adopt institutional policies and
procedures to achieve the mission of its Art Institute.
In addition, in calendar year 1994, AII organized an International Advisory
Board (the "IAB"). The IAB is comprised of renowned artists, designers, chefs
and entertainment professionals who provide advice and support to AII. Members
of the IAB also review curricula as requested and provide other services as
agreed upon by the IAB members.
TECHNOLOGY
EDMC is committed to providing its students access to the technology
necessary for developing the skills required by their education programs. To
help fulfill this commitment, as of June 30, 1998, The Art Institutes had
approximately 2,280 desktop and workstation computers with applicable software
in classroom laboratories, largely operating on a seven-day per week basis. Each
Art Institute monitors the utilization of these classroom laboratories to ensure
that students have sufficient and appropriate equipment and software. Animation
students use powerful desktop and workstation computer technologies to create,
animate, color and render two-dimensional and three-dimensional projects.
Multimedia students integrate digital audio, screen-layout and motion content
into their productions. Design students make significant use of technologies for
computer-aided design and layout, photo composition and digital prepress
applications. Video production students use computer technologies for digital
non-linear editing and special effects. Photography students utilize computers
to translate traditional silver-based images into digital forms, where
composition, perspective, sharpness and color can be manipulated. Interior and
industrial design students learn to use computer-aided drafting and
visualization technology and equipment.
The Art Institutes have implemented a process to systematize the
specification and acquisition of equipment, computer hardware and software based
upon present and proposed curricula. Through its director of technology and a
technology committee comprised of key faculty and technology staff, each Art
Institute researches and monitors changing market and technological
requirements. These efforts, conducted in each school's market area and
coordinated on a national basis, are used to develop a system-wide, unified
strategy for the purchase and implementation of classroom technology.
MANAGEMENT AND EMPLOYEES
EDMC is led by a senior management team possessing an average of more than
19 years of experience in the education industry and nine years with the
Company. A substantial majority of the management team has an ownership interest
in the Company through direct holdings, participation in the ESOP or both. As of
June 30, 1998, EDMC had 1,804 full-time and 608 part-time staff and faculty. The
staff and faculty are experienced in assessing the needs of the employment
markets and designing and updating education programs to prepare students for
employment opportunities. Many faculty members are or have been successful
professionals in their respective fields.
ADMINISTRATIVE SUPPORT SYSTEMS
During the last five years, EDMC has centralized many of its administrative
functions to permit the staff at its schools to devote more of their efforts to
attracting new students and promoting student success. Centralized
administrative functions include aspects of: accounting, marketing, finance,
real estate, student financial aid, curricula research and development,
purchasing, human resource management, legal, regulatory and legislative
affairs, information systems and technology support services. The Company
believes that this centralization has contributed to operating efficiencies and
has positioned the Company to control general and administrative costs more
effectively during its planned expansion.
The Company has invested substantial resources in its integrated,
customized information network designed to assist Company personnel in
maximizing internal efficiency. The Company believes that this system has
improved its ability to recruit new students, administer student financial aid,
prepare and track student academic schedules, monitor part-time and full-time
employment opportunities for its students and graduates, perform general and
student accounting and manage human resources. The Company believes that its
investment in
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technology also facilitates the integration of newly acquired and newly
established schools into the Company's operations.
NCPT
NCPT is one of the leading sources of paralegals in the southeastern United
States. NCPT offers certificate programs to recent college graduates,
employer-sponsored students and adults interested in changing careers. Programs
offered by NCPT include paralegal studies, legal nurse consultant and legal
administrative assistant. NCPT paralegal and legal administrative assistant
graduates are employed in law firms and corporations. Legal nurse consultants
typically are employed on a project basis and are trained to be independent
contractors.
NATIONAL CENTER FOR PROFESSIONAL DEVELOPMENT
NCPD maintains consulting relationships with six colleges and universities.
NCPD offers a wide range of services to its college and university clients,
including assistance with curricula development, the formulation and execution
of marketing strategies for the program offerings, training for admissions
staff, program directors and faculty, preparation of annual program budgets,
establishment of instructor evaluation guidelines and development of strategies
for employment assistance and consultation on other academic issues as requested
by a client institution. Certificate programs, developed by NCPD and offered by
its client institutions, are paralegal studies, legal nurse consultant and
financial planning. In the fall of fiscal 1998, NCPD client institutions had
approximately 1,000 students enrolled in these programs.
COMPETITION
The postsecondary education market is highly competitive. The Art
Institutes compete with traditional public and private two-year and four-year
colleges and universities and other proprietary schools. Certain public and
private colleges and universities may offer programs similar to those of The Art
Institutes. Public institutions are often able to charge lower tuition than The
Art Institutes due in part to government subsidies, government and foundation
grants, tax-deductible contributions and other financial sources not available
to proprietary schools. However, tuition at private non-profit institutions is,
on average, higher than The Art Institutes' tuition.
EDMC believes its students are well served by its student-centered
education environment, career-oriented curricula developed with employer input,
the effectiveness of its employment assistance activities and its national
reputation and market presence. The Company believes that its students also
should benefit from its investments in technology, including modern facilities
with well-equipped classrooms, programs that permit attendance year-round
thereby facilitating early graduation, and the Company's commitment to selecting
faculty with appropriate academic credentials and relevant employment
experience. Another competitive strength of EDMC's schools is the ability to
address evolving regulatory and accreditation requirements.
SEASONALITY IN RESULTS OF OPERATIONS
EDMC has experienced seasonality in its results of operations primarily due
to the pattern of student enrollments. Historically, EDMC's lowest quarterly
revenues and income have been in the first quarter (July to September) of its
fiscal year due to fewer students being enrolled during the summer months and
the expenses incurred in preparation for the peak in enrollment in the fall
quarter (October to December). EDMC expects that this seasonal trend will
continue.
ACCREDITATION
Accreditation is a process through which an institution submits itself to
qualitative review by an organization of peer institutions. Accrediting agencies
primarily examine the academic quality of the instructional programs of an
institution, and a grant of accreditation is generally viewed as certification
that an institution's programs meet generally accepted academic standards.
Accrediting agencies also review the administrative and financial operations of
the institutions they accredit to ensure that each institution has the resources
to perform its educational mission.
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Pursuant to provisions of the HEA, the U. S. Department of Education relies
on accrediting agencies to determine whether institutions' educational programs
qualify them to participate in Title IV Programs. The HEA specifies certain
standards that all recognized accrediting agencies must adopt in connection with
their review of postsecondary institutions. Accrediting agencies that meet U.S.
Department of Education standards are recognized as reliable evaluators of
educational quality. All of EDMC's schools are accredited by one or more
accrediting agencies recognized by the U.S. Department of Education. Five of the
Company's schools are either accredited, or are candidates for accreditation, by
one of the six regional accrediting agencies that accredit virtually all of the
public and private non-profit colleges and universities in the United States.
The accrediting agencies for each of the Company's schools are set forth in
the following table (for schools accredited by more than one recognized
accrediting agency, the primary accrediting agency is listed first):
SCHOOL ACCREDITING AGENCY
- ------ ------------------
The Art Institute of Atlanta................ Commission on Colleges of the Southern
Association of Colleges and Schools ("SACS")
The Art Institute of Dallas................. Accrediting Commission of Career Schools and
Colleges of Technology ("ACCSCT")
SACS
The Art Institute of Fort Lauderdale........ ACCSCT
The Art Institute of Houston................ ACCSCT
SACS (Candidate)
The Art Institute of Los Angeles............ ACCSCT, as an additional location of The Art
Institute of Pittsburgh
The Art Institute of Philadelphia........... ACCSCT
The Art Institute of Phoenix................ ACCSCT, as an additional location of The
Colorado Institute of Art
The Art Institute of Pittsburgh............. ACCSCT
The Art Institute of Seattle................ ACCSCT
Commission on Colleges of the Northwest
Association of Schools and Colleges
("NWASC") (Candidate)
The Art Institutes International at NWASC
Portland..................................
The Art Institutes International at San ACCSCT
Francisco.................................
The Art Institutes International Accrediting Council for Independent Colleges
Minnesota................................. and Schools ("ACICS")
The Colorado Institute of Art............... ACCSCT
The Illinois Institute of Art at Chicago.... ACCSCT
The Illinois Institute of Art at ACCSCT, as an additional location of The
Schaumburg................................ Illinois Institute of Art at Chicago
NCPT........................................ ACICS
New York Restaurant School.................. ACCSCT
New York State Board of Regents
The HEA requires each recognized accrediting agency to submit to a periodic
review of its procedures and practices by the U.S. Department of Education as a
condition of its continued recognition. Each of the accrediting agencies listed
above has been reviewed within the past three years and has had its recognition
extended.
Accrediting agencies monitor each institution's performance in specific
areas. In the event that the information provided by a school to an accrediting
agency indicates that such school's performance in one or more areas falls below
certain parameters, the accrediting agency may require that school to supply it
with supplemental reports on the accrediting agency's specific areas of concern
until that school meets the accrediting agency's performance guideline or
standard. A school that is subject to this heightened monitoring must seek the
prior approval of its accrediting agency in order to open or commence teaching
at new locations. The accrediting agencies do not consider requesting that a
school provide supplemental reports to be a negative action.
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As of September 1998, ACCSCT had notified eight of the Company's schools
that, due to concerns regarding student completion rates for certain programs at
each of those schools, such schools were required to provide certain
supplemental reports to ACCSCT. ACCSCT's standards define a program's completion
rate as the percentage of the students who started that program during a
twelve-month period and who have either graduated from that program within a
period of time equal to 150% of that program's length or withdrawn from that
program during the same period in order to accept full-time employment in the
occupation or job category for which the program was offered. Because that
calculation can only be performed after a student's scheduled completion date,
it does not provide a timely basis for a school to take action to affect student
outcomes. For that reason, for internal purposes, the Company uses the net
annual persistence rate as a method to track the retention rate of students.
At the time that the Company purchased the assets of Bassist College in
Portland, Oregon, the school was on probation status with NWASC due to concerns
that NWASC had with the financial stability of the school's previous owner.
NWASC approved the change of ownership of that school to the Company while
continuing its probation status. NWASC has stated that it will monitor the
transition to the Company's new ownership and the expected growth of the school
(now named The Art Institutes International at Portland), and will review the
school's status at its spring 1999 meeting.
STUDENT FINANCIAL ASSISTANCE
As is the case at most postsecondary institutions, many students enrolled
at one of EDMC's schools must rely, at least in part, on financial assistance to
pay the cost of their education. The largest source of such support is the
federal programs of student financial assistance under Title IV of the HEA.
Additional sources of funds include other federal grant programs, state grant
and loan programs, private loan programs and institutional grants and
scholarships.
To provide students access to financial assistance resources available
through Title IV Programs, a school must be (i) authorized to offer its programs
of instruction by the relevant agency of the state in which it is located, (ii)
accredited by an accrediting agency recognized by the U.S. Department of
Education, and (iii) certified as an eligible institution by the U.S. Department
of Education. In addition, that school must ensure that Title IV Program funds
are properly accounted for and disbursed in the correct amounts to eligible
students.
Under the HEA and its implementing regulations, each of the Company's
schools that participates in Title IV Programs must comply with certain
standards on an institutional basis. For purposes of these standards, the
regulations define an institution as a main campus and its additional locations
(formerly called branch campuses), if any. Under this definition, each of the
Company's schools is a separate institution, except for The Art Institute of
Phoenix, which is an additional location of The Colorado Institute of Art, The
Illinois Institute of Art at Schaumburg, which is an additional location of The
Illinois Institute of Art at Chicago, and The Art Institute of Los Angeles,
which is an additional location of The Art Institute of Pittsburgh.
All Art Institutes and NYRS participate in Title IV Programs. NCPT has not
applied to participate in Title IV Programs.
NATURE OF FEDERAL SUPPORT FOR POSTSECONDARY EDUCATION
While the states support public colleges and universities primarily through
direct state subsidies, the federal government provides a substantial part of
its support for postsecondary education in the form of grants and loans to
students who can use this support at any institution that has been certified as
eligible by the U.S. Department of Education. Title IV Programs have provided
aid to students for more than 30 years and, since the mid-1960s, the scope and
size of such programs have steadily increased. Since 1972, Congress has expanded
the scope of the HEA to provide for the needs of the changing national student
population by, among other things, providing that students at proprietary
schools are eligible for assistance under Title IV Programs, establishing a
program for loans to parents of eligible students, opening Title IV Programs to
part-time students, increasing maximum loan limits and eliminating the
requirement that students demonstrate financial need to obtain federally
guaranteed student loans. Most recently, the Federal Direct Student Loan
("FDSL") program was enacted, enabling students to obtain loans from the federal
government rather than from commercial lenders. The total grants and loans
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available to students under Title IV Programs increased from approximately $43
billion for the federal fiscal year ended September 30, 1997 to an estimated $48
billion for the federal fiscal year ending September 30, 1998. The volume of
federally guaranteed student loans (and, more recently, loans issued under the
FDSL program) has increased from $17.9 billion in the federal fiscal year ended
September 30, 1993 to $32.4 billion in the federal fiscal year ended September
30, 1997.
Students at EDMC's schools receive grants, loans and work-study funding to
fund their education under several Title IV Programs, of which the two largest
are the Federal Pell Grant ("Pell") program and the Federal Family Education
Loan ("FFEL") program. The Company's schools also participate in the Federal
Supplemental Educational Opportunity Grant ("FSEOG") program, the Federal
Perkins Loan ("Perkins") program, and the Federal Work-Study ("FWS") program.
All of the Company's schools which participate in Title IV Programs are approved
to participate in the FDSL program.
Pell. Pell grants are the primary component of the Title IV Programs under
which the U.S. Department of Education makes grants to students who demonstrate
financial need. Every eligible student is entitled to receive a Pell grant;
there is no institutional allocation or limit. During fiscal 1998, Pell grants
ranged from $400 to $2,700 per year; beginning on July 1, 1998, the limit was
increased to $3,000 per year. Amounts received by students enrolled in the
Company's schools in fiscal 1998 under the Pell program equaled approximately 6%
of the Company's net revenues.
FSEOG. FSEOG awards are designed to supplement Pell grants for the neediest
students. FSEOG grants generally range in amount from $100 to $4,000 per year;
however, the availability of FSEOG awards is limited by the amount of those
funds allocated to an institution under a formula that takes into account the
size of the institution, its costs and the income levels of its students. At
most of the Company's schools, FSEOG awards generally do not exceed $1,200 per
eligible student per year. The Company is required to make a 25% matching
contribution for all FSEOG program funds disbursed. Resources for this
institutional contribution may include institutional grants and scholarships
and, in certain states, portions of state grants and scholarships. In fiscal
1998, the Company's required 25% institutional match was approximately $750,000.
Amounts received by students in the Company's schools under the FSEOG program in
fiscal 1998 equaled approximately 1% of the Company's net revenues.
FFEL. The FFEL program consists of two types of loans, Stafford loans,
which are made available to students regardless of financial need, and PLUS
loans, which are made available to parents of students classified as dependents.
Under the Stafford loan program, a student may borrow up to $2,625 for the first
academic year, $3,500 for the second academic year and, in some educational
programs, $5,500 for each of the third and fourth academic years. Students with
significant financial need qualify for interest subsidies while in school and
during grace periods. Students who are classified as independent can increase
their borrowing limits and receive additional unsubsidized Stafford loans. Such
students can obtain an additional $4,000 for each of the first and second
academic years and, depending upon the educational program, an additional $5,000
for each of the third and fourth academic years. The obligation to begin
repaying Stafford loans does not commence until six months after a student
ceases enrollment as at least a half-time student. Amounts received by students
in the Company's schools under the Stafford loan program in fiscal 1998 equaled
approximately 38% of the Company's net revenues. PLUS loans may be obtained by
the parents of a dependent student in an amount not to exceed the difference
between the total cost of that student's education (including allowable
expenses) and other aid to which that student is entitled. Amounts received by
parents of students in the Company's schools under the PLUS loan program in
fiscal 1998 equaled approximately 15% of the Company's net revenues.
Perkins. Eligible undergraduate students may borrow up to $3,000 under the
Perkins program during each academic year, with an aggregate maximum of $15,000,
at a 5% interest rate and with repayment delayed until nine months after a
student ceases enrollment as at least a half-time student. Perkins loans are
made available to those students who demonstrate the greatest financial need.
Perkins loans are made from a revolving account, with 75% of new funding
contributed by the U.S. Department of Education, and the remainder by the
applicable school. Subsequent federal capital contributions, which must be
matched by school funds, may be received if an institution meets certain
requirements. Each school collects payments on Perkins loans from its former
students and reloans those funds to currently enrolled students. Collection and
disbursement of Perkins loans is the
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responsibility of each participating institution. During fiscal 1998, the
Company collected approximately $1.9 million from its former students. In fiscal
1998, the Company's required matching contribution was approximately $200,000.
The Perkins loans disbursed to students in the Company's schools in fiscal 1998
were less than 2% of the Company's net revenues.
Federal Work-Study. Under the FWS program, federal funds are made available
to pay up to 75% of the cost of part-time employment of eligible students, based
on their financial need, to perform work for the institution or for off-campus
public or non-profit organizations. At least 5% of an institution's FWS
allocation must be used to fund student employment in community service
positions. In fiscal 1998, FWS funds accounted for less than 0.5% of the
Company's net revenues.
FDSL. Under the FDSL program, students may obtain loans directly from the
U.S. Department of Education rather than commercial lenders. The conditions on
FDSL loans are generally the same as on loans made under the FFEL program. All
of the Company's schools currently eligible to participate in Title IV Programs
are also approved by the U.S. Department of Education to participate in the FDSL
program, but all have deferred participation since their respective students'
loan needs continue to be satisfied under the FFEL program.
OTHER FINANCIAL ASSISTANCE SOURCES
Students at several of the Company's schools participate in state grant
programs. In fiscal 1998, approximately 2% of the Company's net revenues was
derived from state grant programs. In addition, certain students at some of the
Company's schools receive financial aid provided by the United States Department
of Veterans Affairs, the United States Department of the Interior (Bureau of
Indian Affairs) and the Rehabilitative Services Administration of the U.S.
Department of Education (vocational rehabilitation funding). In fiscal 1998,
financial assistance from such federal and state programs equaled less than 3%
of the Company's net revenues. The Art Institutes also provide institutional
scholarships to qualified students. In fiscal 1998, institutional scholarships
had a value equal to approximately 3% of the Company's net revenues. In
September 1995, the Company negotiated access to a supplemental loan program
with a commercial bank that allows students to repay loans over ten years after
graduation and allows students with lower than average credit ratings to obtain
loans. The primary objective of such loan program is to lower the monthly
payments required of students. Such loans are without recourse to the Company or
its schools.
AVAILABILITY OF LENDERS
During fiscal 1998, six lending institutions provided over 81% of all
federally guaranteed loans to students attending the Company's schools. While
the Company believes that other lenders would be willing to make federally
guaranteed student loans to its students if loans were no longer available from
its current lenders, there can be no assurances in this regard. In addition, the
HEA requires the establishment of lenders of last resort in every state to make
certain loans to students at any school that cannot otherwise identify lenders
willing to make federally guaranteed loans to its students.
One student loan guaranty agency (USA Group Guarantee Services, formerly
United Student Aid Funds) currently guarantees approximately 85% of all
federally guaranteed student loans made to students enrolled at the Company's
schools. The Company believes that other guaranty agencies would be willing to
guarantee loans to the Company's students if that agency ceased guaranteeing
those loans or reduced the volume of those loans it guaranteed.
FEDERAL OVERSIGHT OF TITLE IV PROGRAMS
The substantial amount of federal funds disbursed through Title IV
Programs, coupled with the large numbers of students and institutions
participating in them, have led to instances of fraud, waste and abuse. As a
result, the United States Congress (the "U.S. Congress") has required the U.S.
Department of Education to increase its level of regulatory oversight of schools
to ensure that public funds are properly used. Each institution must annually
submit to the U.S. Department of Education an audit by an independent accounting
firm of that school's compliance with Title IV Program requirements, as well as
audited financial statements. The U.S. Department of Education also conducts
compliance reviews, which include on-site evaluations, of several
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hundred institutions each year, and directs student loan guaranty agencies to
conduct additional reviews relating to student loan programs. In addition, the
Office of the Inspector General of the U.S. Department of Education conducts
audits and investigations in certain circumstances. Under the HEA, accrediting
agencies and state licensing agencies also have responsibilities for overseeing
institutions' compliance with certain Title IV Program requirements. As a
result, each participating institution is subject to frequent and detailed
oversight and must comply with a complex framework of laws and regulations or
risk being required to repay funds or becoming ineligible to participate in
Title IV Programs.
Largely as a result of this increased oversight, more than 900 institutions
have either ceased to be eligible for, or have voluntarily relinquished their,
participation in some or all Title IV Programs since October 1, 1992. This has
reduced competition among institutions with respect to certain markets and
education programs. Due to the specialized nature of their education programs,
the reduction in the number of participating institutions has had no substantial
effect on The Art Institutes.
Cohort Default Rates. A significant component of the Congressional
initiative aimed at reducing fraud, waste and abuse was the imposition of
limitations on participation in Title IV Programs by institutions whose former
students defaulted at an "excessive" rate on the repayment of federally
guaranteed student loans and, more recently, of FDSL loans. Since the U.S.
Department of Education began to impose sanctions on institutions with cohort
default rates above certain levels, more than 700 institutions have lost their
eligibility to participate in some or all Title IV Programs for this reason.
However, many institutions that participate in Title IV Programs, including The
Art Institutes, have responded by implementing aggressive student loan default
management programs aimed at reducing the likelihood of students failing to
repay their loans in a timely manner.
A school's cohort default rate under the FFEL program is calculated on an
annual basis as the rate at which student borrowers scheduled to begin repayment
on their loans in one federal fiscal year default on those loans by the end of
the next federal fiscal year. Any institution whose FFEL cohort default rate
equals or exceeds 25% for three consecutive years will no longer be eligible to
participate in that program or the FDSL program for the remainder of the federal
fiscal year in which the U.S. Department of Education determines that such
institution has lost its eligibility and for the two subsequent federal fiscal
years. In addition, an institution whose FFEL cohort default rate for any
federal fiscal year exceeds 40% may have its eligibility to participate in all
Title IV Programs limited, suspended or terminated. Since the calculation of
FFEL cohort default rates involves the collection of data from many
non-governmental agencies (i.e., lenders and non-federal guarantors), as well as
the U.S. Department of Education, the HEA provides a formal process for the
review and appeal of the accuracy of FFEL cohort default rates before the U.S.
Department of Education takes any action against an institution based on its
FFEL cohort default rates. As part of that process, the U.S. Department of
Education provides each institution with its FFEL cohort default rate on a
preliminary basis for review. Preliminary cohort default rates are subject to
revision by the U.S. Department of Education based on information that schools
and guaranty agencies identify and submit to the U.S. Department of Education
for review in order to correct any errors in the data previously provided to the
U.S. Department of Education.
None of the Company's schools has had an FFEL cohort default rate of 25% or
greater for the last three consecutive federal fiscal years. For federal fiscal
year 1995, the most recent year for which such rates have been published, the
average FFEL cohort default rate for borrowers at all proprietary institutions
was 19.9%. For that year, the combined preliminary FFEL cohort default rate for
all borrowers at the Company's schools was 17.7%. When the FFEL cohort default
rates were originally published in November 1997, the combined FFEL cohort
default rate for all borrowers at the Company's schools was 17.5%. EDMC filed
appeals concerning the published rates at some of its schools with the U.S.
Department of Education, resulting in a final combined FFEL cohort default rate
of 16.9% for all borrowers at the Company's schools and a range of rates for the
individual schools of 7.4% to 21.0% for federal fiscal year 1995. For federal
fiscal year 1996, the combined preliminary FFEL cohort default rate for all
borrowers at the Company's schools was 17.5% and its individual schools'
preliminary rates ranged from 7.2% to 21.5%, although only two such schools had
preliminary rates that exceeded 20%. EDMC has submitted information to the U.S.
Department of Education with respect to the preliminary FFEL cohort default
rates for federal fiscal year 1996 for most of its schools and believes that the
published FFEL cohort default rates for such year for one or more of its schools
will be less than such schools' preliminary rates. Any
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such adjustment would be made by the U.S. Department of Education at the time
that official rates for federal fiscal year 1996 are published, which is
expected to occur in 1998.
If an institution's FFEL cohort default rate equals or exceeds 25% in any
of the three most recent federal fiscal years, or if its cohort default rate for
loans under the Perkins program exceeds 15% for the most recent federal award
year (i.e., July 1 through June 30), that institution may be placed on
provisional certification status for up to four years. Provisional certification
does not limit an institution's access to Title IV Program funds, but does
subject that institution to closer review by the U.S. Department of Education
and possible summary adverse action if that institution commits a material
violation of Title IV Program requirements. To EDMC's knowledge, the U.S.
Department of Education reviews an institution's compliance with the cohort
default rate thresholds described in this paragraph only when that school is
otherwise subject to a U.S. Department of Education certification review. As a
result of such a certification review in 1997, The Art Institute of Houston was
placed on provisional certification status because of its FFEL cohort default
rates for federal fiscal years 1993 and 1994. Five of the Company's schools had
Perkins cohort default rates in excess of 15% for students who were to begin
repayment during the federal award year ending June 30, 1997, the most recent
year for which such rates have been calculated. For each of those school, funds
from the Perkins program equaled less than 2% of the school's net revenues in
fiscal 1998. To date, none of those schools has been placed on provisional
certification status for this reason. If an institution is placed on such status
for this reason and that institution reduced its Perkins cohort default rate
below 15% in a subsequent year, that institution could ask the U.S. Department
of Education to remove the provisional status.
Each of the Company's schools has adopted a student loan default management
plan. Those plans provide for extensive loan counseling, methods to increase
student persistence and completion rates and graduate employment rates,
strategies to increase graduate salaries and, for most schools, the use of
external agencies to assist the school with loan counseling and loan servicing
if a student ceases attending that school. Those activities are in addition to
the loan servicing and collection activities of FFEL lenders and guaranty
agencies.
Increased Regulatory Scrutiny. The 1992 reauthorization of the HEA expanded
the role of accrediting agencies in the oversight of institutions participating
in Title IV Programs. As a result, the accrediting agencies of which the
Company's schools are members have increased the depth and intensity of reviews
and have expanded examinations in such areas as financial responsibility and
timeliness of student refunds. The HEA also requires each accrediting agency
recognized by the U.S. Department of Education to undergo comprehensive periodic
review by the U.S. Department of Education to ascertain whether such accrediting
agency is adhering to required standards. Each accrediting agency that accredits
any of the Company's schools has been reviewed by the U.S. Department of
Education within the past three years and reapproved for continued recognition
by the U.S. Department of Education.
The 1992 reauthorization of the HEA also tightened the standards to be
applied by the U.S. Department of Education in evaluating the financial
responsibility and administrative capability of institutions participating in
Title IV Programs, and mandated that the U.S. Department of Education
periodically review the eligibility and certification to participate in Title IV
Programs of every such eligible institution. By law, all institutions were
required to undergo such a recertification review by the U.S. Department of
Education by 1997 and are required to undergo such review every four years
thereafter. Under these standards, each of the Company's schools that
participates in Title IV Programs would be evaluated by the U.S. Department of
Education more frequently than in the past. All of the Company's schools that
participate in Title IV Programs have been reviewed and recertified due to their
acquisition by EDMC or recertified by the U.S. Department of Education during
1996, 1997 or 1998. A denial of recertification would preclude a school from
continuing to participate in Title IV Programs.
As is true for any institution that is recertified following a change of
ownership, The Illinois Institute of Art at Chicago and its additional location,
The Illinois Institute of Art at Schaumburg, were provisionally certified to
participate in Title IV Programs following their acquisition by EDMC in November
1995. The period of their provisional certification is scheduled to expire on
December 31, 1998 and, in accordance with the requirements of the U.S.
Department of Education, they filed an application in September 1998 for
recertification by the U.S. Department of Education. Similarly, NYRS and The Art
Institutes International Minnesota are scheduled to
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file applications by June 30, 1999 to be recertified by the U.S. Department of
Education. None of the Company's other schools are scheduled to apply for
recertification during fiscal 1999.
Financial Responsibility Standards. All institutions participating in Title
IV Programs must satisfy a series of specific standards of financial
responsibility. Institutions are evaluated for compliance with those
requirements as part of the U.S. Department of Education's quadrennial
recertification process and also annually as each institution submits its
audited financial statements to the U.S. Department of Education. Under
regulations that took effect on July 1, 1998, the U.S. Department of Education
has adopted new standards (replacing the former "acid test" ratio test, tangible
net worth test and two-year operating loss test) to determine an institution's
financial responsibility so that it will be permitted to participate in Title IV
Programs without additional constraints or costs. The regulations establish
three new tests: (i) the equity ratio, measuring an institution's capital
resources, ability to borrow and financial viability; (ii) the primary reserve
ratio, measuring an institution's ability to support current operations from
expendable resources; and (iii) the net income ratio, measuring an institution's
profitability. Each ratio is to be calculated separately, based on an
institution's most recent annual audited financial statements, and then weighted
and combined to arrive at a single composite score.
Under those standards, such composite score must be at least 1.5 for an
institution to be deemed financially responsible without any conditions or the
imposition of additional oversight. If an institution's composite score is below
1.5, the institution may nonetheless continue to participate in Title IV
Programs by agreeing to one or a combination of several alternatives that
include: (i) receiving Title IV Program funding under the cash monitoring or
reimbursement system of payment, which would entail additional oversight and
potential delay in receipt of such funds; (ii) filing additional reports with
and submitting to additional monitoring by the U.S. Department of Education; and
(iii) accepting provisional certification and posting a letter of credit in an
amount equal to at least 10% of the Title IV Program funding it received in its
most recent fiscal year. Regardless of its composite score, an institution may
establish its financial responsibility and continue to participate in Title IV
Programs without additional constraints if it posts a letter of credit in an
amount equal to at least 50% of the Title IV Program funding it received in its
most recent fiscal year. For the first year that those new financial
responsibility regulations are in effect, which is fiscal 1998 for the Company's
schools, an institution that has a composite score of less than 1.5 may elect to
have its financial responsibility measured under the U.S. Department of
Education's former standards.
Historically, the U.S. Department of Education has evaluated the financial
condition of the Company's schools on an institution-by-institution basis,
although recently the U.S. Department of Education has requested, and the
Company has provided, financial information concerning The Art Institutes on a
consolidated basis at the level of their parent company, AII, as well as EDMC.
When they were acquired, The Illinois Institute of Art at Chicago (combined with
its additional location, The Illinois Institute of Art at Schaumburg), NYRS, The
Art Institutes International Minnesota, The Art Institutes International at
Portland and The Art Institutes International at San Francisco satisfied the
financial responsibility standards by filing and relying on the consolidated
financial statements of AII. For the year ended June 30, 1998, the Company
believes that, on an individual institution basis, each of its schools then
participating in Title IV Programs satisfied the former financial responsibility
standards and had a composite score of at least 1.5 under the new financial
responsibility standards (pursuant to regulation, The Illinois Institute of Art
at Schaumburg, The Art Institute of Phoenix and The Art Institute of Los Angeles
would be combined with their main campuses, The Illinois Institute of Art at
Chicago, The Colorado Institute of Art, and The Art Institute of Pittsburgh,
respectively, for that purpose).
Restrictions on Operating Additional Schools. The HEA generally requires
that certain institutions, including proprietary schools, be in full operation
for two years before applying to participate in Title IV Programs. However,
under the HEA and applicable regulations, an institution that is certified to
participate in Title IV Programs may establish an additional location and apply
to participate in Title IV Programs at that location without reference to the
two-year requirement, if such additional location satisfies all other applicable
requirements. In addition, a school which undergoes a change of ownership
resulting in a change in control (as defined under the HEA) must be reviewed and
recertified for participation in Title IV Programs under its new ownership.
Pending recertification, the U.S. Department of Education suspends Title IV
Program funding to that school's students. If that school is recertified, it
will be on a provisional basis. During the time a school is provisionally
certified, it may be subject to summary adverse action for a material violation
of Title IV Program
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requirements, but provisional certification does not otherwise limit an
institution's access to Title IV Program funds. The Company's expansion plans
are based, in part, on its ability to add additional locations and acquire
schools that can be recertified.
The Illinois Institute of Art at Chicago, The Illinois Institute of Art at
Schaumburg, NYRS, The Art Institutes International Minnesota, The Art Institutes
International at San Francisco and The Art Institutes International at Portland
are provisionally certified by the U.S. Department of Education due to their
recent acquisition by the Company. None of the Company's other schools that are
participating in Title IV Programs are on provisional certification status,
except The Art Institute of Houston which in the course of the normal
recertification process was provisionally recertified in 1997 because of its
FFEL cohort default rates.
Certain of the state authorizing agencies and accrediting agencies with
jurisdiction over the Company's schools also have requirements that may, in
certain instances, limit the ability of the Company to open a new school,
acquire an existing school or establish an additional location of an existing
school. The Company does not believe that those standards will have a material
adverse effect on the Company or its expansion plans.
The "85/15 Rule." Under a provision of the HEA commonly referred to as the
"85/15 Rule," a proprietary institution, such as each of EDMC's schools, would
cease being eligible to participate in Title IV Programs if, on a cash
accounting basis, more than 85% of its revenues for the prior fiscal year was
derived from Title IV Programs. Any school that violates the 85/15 Rule
immediately becomes ineligible to participate in Title IV Programs and is unable
to apply to regain its eligibility until the following fiscal year. For fiscal
1998, the range for the Company's schools was from approximately 30% to
approximately 70%. The Company regularly monitors compliance with this
requirement in order to minimize the risk that any of its schools would derive
more than 85% of its revenues from Title IV Programs in any fiscal year. If a
school appears likely to approach the 85% threshold, the Company would evaluate
the appropriateness of making changes in student funding and financing to ensure
compliance.
Restrictions on Payment of Bonuses, Commissions or Other Incentives. The
HEA prohibits an institution from providing any commission, bonus or other
incentive payment based directly or indirectly on success in securing
enrollments or financial aid to any person or entity engaged in any student
recruitment, admission or financial aid awarding activity. EDMC believes that
its current compensation plans are in compliance with HEA standards, although
the regulations of the U.S. Department of Education do not establish clear
criteria for compliance.
Legislative Action. The HEA was most recently reauthorized by the U.S.
Congress in 1992, at which time funding for Title IV Programs was authorized
through September 30, 1997, with an automatic one-year extension if the HEA was
not reauthorized by that date. The U.S. Congress has commenced the
reauthorization process, which is expected to be completed during 1998. If the
U.S. Congress has not completed the reauthorization process by September 30,
1998, it is likely that the U.S. Congress, following normal practices, would
extend the HEA for some period of time. At this time it is not possible to
predict whether current funding levels will be maintained for any or all Title
IV Programs or how current requirements for institutional participation and
student eligibility may be changed.
In addition, in August 1997, the Taxpayer Relief Act of 1997 became law.
The law contains a number of provisions relating to students attending
postsecondary education institutions, including various tax credits, tax
deductions and provisions liberalizing the use of individual retirement accounts
to meet educational expenses. The provisions of this new law have been phased in
beginning in calendar 1998 and are intended by the U.S. Congress to assist
students and their families in paying for their postsecondary education
programs.
STATE AUTHORIZATION
Each of EDMC's schools is authorized to offer education programs and grant
degrees or diplomas by the state in which such school is located. The level of
regulatory oversight varies substantially from state to state. In some states,
the schools are subject to licensure by the state education agency and also by a
separate higher education agency. State laws establish standards for
instruction, qualifications of faculty, location and nature of facilities,
financial policies and responsibility and other operational matters. State laws
and regulations may limit
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the ability of the Company to obtain authorization to operate in certain states
or to award degrees or diplomas or offer new degree programs. Certain states
prescribe standards of financial responsibility that are different from those
prescribed by the U.S. Department of Education. The Company believes that each
of the Company's schools is in substantial compliance with state authorizing and
licensure laws.
RISK FACTORS
The Company wishes to caution readers that, in addition to the important
factors described elsewhere in this Annual Report on Form 10-K, the following
factors, among others, could affect the Company's business, results of
operations, financial condition and prospects in fiscal 1999 and later years:
(i) the perceptions of the U.S. Congress, the U.S. Department of Education and
the public concerning proprietary postsecondary education institutions to the
extent those perceptions could result in changes in the HEA in connection with
its reauthorization; (ii) EDMC's ability to comply with federal and state
regulations and accreditation standards, including any changes therein or
changes in the interpretation thereof; (iii) the Company's capability to foresee
changes in the skills required of its graduates and to design new courses and
programs to develop those skills; (iv) the ability of the Company to gauge
successfully the markets which are underserved in the skills that the Company's
schools teach; (v) the Company's ability to gauge appropriate acquisition and
start-up opportunities and to manage and integrate them successfully; and (vi)
competitive pressures from other educational institutions.
ITEM 2--PROPERTIES
EDMC's schools are located in major metropolitan areas in twelve states.
Typically, the schools occupy an entire building or several floors or portions
of floors in a building. The Company and its subsidiaries currently lease almost
all of their facilities. Such leases have remaining terms ranging from less than
one year to 16 years and typically include options for renewal. Most school
leases are guaranteed by EDMC. In fiscal 1998, the Company and its subsidiaries
paid approximately $14.9 million in rent for educational and administrative
facilities. In Denver, one building with 44,495 square feet is owned by the
Company. In addition, the Company has entered into contracts to purchase two
properties and expects to close both transactions in late September or early
October 1998. One property is The Art Institute of Seattle's main facility,
which has 71,627 square feet and has been leased by the school since 1990. The
other property is a 99,400 square foot building in Denver that will enable The
Colorado Institute of Art to consolidate operations that now occupy three
facilities (two leased, one owned) into one building.
New leases entered into for schools typically are for ten years to 15
years, with two to four five-year renewal options. Currently, the Company
expects to spend $40 to $50 per square foot, in addition to any allowance
provided by the landlord, to make improvements necessary for the facility to
meet the Company's operating standards. For new or rapidly growing schools, a
lease typically provides for expansion rights within a building in order to
accommodate increases in student enrollment.
The majority of schools lease facilities for student parking and housing.
These arrangements generally are intended to assist only a limited number of a
school's students, are designed to be flexible, are for terms of one to five
years and usually do not involve an EDMC guarantee. Annual rent for
school-sponsored housing arrangements ranges from approximately $41,000 to $2.1
million per school, depending on the number of housing units and local market
conditions. EDMC has executed a contract to purchase a dormitory facility in
Fort Lauderdale and believes that it will consummate the transaction in late
September or early October 1998. The facility has been leased by The Art
Institute of Ft. Lauderdale for the past six years and contains 144 two-student
units.
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The following table sets forth certain information as of June 30, 1998 with
respect to the principal properties leased by the Company and its subsidiaries:
LOCATION (CITY/STATE) SQUARE FEET
--------------------- -----------
Phoenix, AZ.................. 55,500
Los Angeles, CA.............. 37,899
San Francisco, CA............ 37,102
Denver, CO................... 59,755
Ft. Lauderdale, FL(1)........ 118,500
Atlanta, GA.................. 88,929
Atlanta, GA(2)............... 13,796
Chicago, IL.................. 51,528
Chicago, IL.................. 3,025
Schaumburg, IL............... 26,722
LOCATION (CITY/STATE) SQUARE FEET
--------------------- -----------
Minneapolis, MN.............. 40,835
New York, NY................. 30,500
Portland, OR................. 27,000
Philadelphia, PA(3).......... 113,900
Pittsburgh, PA............... 26,115
Pittsburgh, PA(2)............ 126,500
Dallas, TX................... 75,250
Houston, TX.................. 79,345
Seattle, WA.................. 114,750
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(1) One of the properties occupied by The Art Institute of Fort Lauderdale is
owned by a limited partnership that includes among its limited partners one
current member of EDMC's management who is also a director.
(2) These leases expire in the year 2000 with no renewal options.
(3) One of the properties occupied by The Art Institute of Philadelphia is owned
indirectly by a limited partnership that includes among its limited partners
one current member of EDMC's management who is also a director and another
current director of EDMC.
ITEM 3--LEGAL PROCEEDINGS
EDMC is subject to litigation in the ordinary course of its business. While
there can be no assurance as to the ultimate outcome of any litigation involving
the Company, the Company does not believe that any pending legal proceeding is
likely to result in a judgment or settlement that would have a material adverse
effect on the Company's financial condition, results of operations or liquidity.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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PART II
ITEM 5-- MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
The Common Stock is traded on the Nasdaq National Market System under the
symbol "EDMC." As of September 18, 1998, there were 14,592,530 shares of Common
Stock outstanding held by approximately 532 holders of record. The prices set
forth below reflect the high and low sales prices for the Common Stock for the
periods indicated, as reported in the consolidated transaction reporting system
of the Nasdaq National Market System.
1997 1998
---------------- ----------------
THREE MONTHS ENDED HIGH LOW HIGH LOW
------------------ ---- --- ---- ---
September 30.................... N/A N/A $29.00 $24.25
December 31..................... $21.00 $15.50 32.00 24.50
March 31........................ 23.25 18.00 35.25 27.25
June 30......................... 26.75 21.50 38.13 31.66
EDMC has not declared or paid any cash dividends on its capital stock
during the last ten years other than on the shares of its Series A 10.19%
Convertible Preferred Stock, $.0001 par value (the "Series A Preferred Stock"),
none of which is currently outstanding. EDMC currently intends to retain future
earnings, if any, to fund the development and growth of its business and does
not anticipate paying any cash dividends in the foreseeable future. The payment
of dividends by EDMC was subject to certain restrictions under the terms of the
Amended and Restated Credit Agreement, dated March 16, 1995, as previously
amended (the "Revolving Credit Agreement"). This agreement was further amended,
effective June 30, 1998, eliminating the restriction relating to payment of
dividends.
During fiscal 1997, the Company sold 1,500 shares of Common Stock to N.G.
Temnick on August 9, 1996 for $3.50 per share ($5,250 in the aggregate) pursuant
to the exercise of stock options in a transaction which was intended to be
exempt from the registration requirements of the Securities Act of 1933, as
amended, by virtue of Section 4(2) thereof.
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ITEM 6--SELECTED FINANCIAL DATA
The following summary consolidated financial and other data should be read
in conjunction with the Company's Consolidated Financial Statements and Notes
thereto filed in response to Item 8 and the information included in response to
Item 7 below. Certain of the summary consolidated financial data presented below
are derived from the Company's consolidated financial statements audited by
Arthur Andersen LLP, independent public accountants, whose report covering the
financial statements as of June 30, 1997 and 1998 and for each of the three
years in the period ended June 30, 1998 also is filed in response to Item 8
below. The summary consolidated income statement data for the years ended June
30, 1994 and 1995 and the summary consolidated balance sheet data as of June 30,
1994, 1995 and 1996 are derived from audited financial statements not included
herein.
YEAR ENDED JUNE 30,
------------------------------------------------------
1994(7) 1995(8)(9) 1996(9) 1997(9) 1998
------- ---------- ------- ------- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
INCOME STATEMENT DATA:
Net revenues.............................. $122,549 $131,227 $147,863 $182,849 $221,732
Amortization of intangibles(1)............ 6,599 1,937 1,060 2,076 1,611
ESOP expense(2)........................... 4,759 7,086 1,366 -- --
Income (loss) before extraordinary
item(3)................................. (1,702) 1,513 6,846 9,985 14,322
Net income (loss)......................... (1,702) 1,513 5,920 9,985 14,322
Dividends on Series A Preferred
Stock(4)................................ 2,249 2,249 2,249 83 --
Other Series A Preferred Stock
transactions(4)......................... -- -- -- 403 --
PER SHARE DATA:
Basic:
Income (loss) before extraordinary item... (.57) (.11) .66 .80 .99
Net income (loss)......................... (.57) (.11) .53 .80 .99
Weighted average number of shares
outstanding, in thousands(5)............ 6,926 6,890 6,913 11,939 14,454
Diluted:
Income (loss) before extraordinary item... (.57) (.11) .39 .72 .96
Net income (loss)......................... (.57) (.11) .31 .72 .96
Weighted average number of shares
outstanding, in thousands(5)............ 6,926 6,890 11,874 13,671 14,926
OTHER DATA:
Capital expenditures...................... 6,289 11,640 14,981 18,487 17,951
Enrollments at beginning of fall quarter
during period(6)........................ 12,592 12,749 13,407 15,838 18,763
AS OF JUNE 30,
------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(IN THOUSANDS)
BALANCE SHEET DATA:
Total cash and cash equivalents........... $ 20,487 $ 39,623 $ 27,399 $ 33,227 $ 47,310
Current assets............................ 30,705 49,662 39,858 48,886 65,623
Total assets.............................. 78,527 102,303 101,412 126,292 148,783
Current liabilities....................... 30,129 34,718 27,264 36,178 38,097
Long-term debt (including current
portion)................................ 63,112 69,810 65,919 34,031 38,382
Shareholders' investment (deficit)........ (7,724) 1,855 9,656 57,756 73,325
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(1) Includes the amortization of goodwill and intangibles resulting from the
application of purchase accounting to the establishment and financing of the
ESOP and the related leveraged transaction in 1989. See Note 2 of Notes to
Consolidated Financial Statements. The majority of the intangible assets
related to student enrollments and applications, accreditation and contracts
with colleges and universities and were written off
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over two to five year periods. The excess of the investment in EDMC and
other acquisitions over the fair market value of the net assets acquired has
been assigned to goodwill and is being amortized over 40 years.
(2) ESOP expense equals the sum of the payments on the senior term loan obtained
for the ESOP's acquisition of securities from EDMC (the "ESOP Term Loan"),
plus repurchases of shares from participants in the ESOP, less the dividends
paid on the shares of Series A Preferred Stock previously held by the ESOP.
In fiscal 1995, the Company made a voluntary prepayment of $2.1 million on
the ESOP Term Loan. In fiscal 1996, the ESOP Term Loan was repaid in full.
Therefore, there will be no future ESOP expense resulting from the repayment
of such loan or, so long as the Common Stock is publicly traded, from
repurchases of shares.
(3) In fiscal 1996, the $25.0 million aggregate principal amount of the
Company's 13.25% Senior Subordinated Notes due 1999 (the "Subordinated
Notes") was prepaid in full. The resulting $1.5 million prepayment penalty
is classified as an extraordinary item, net of the related income tax
benefit.
(4) Dividends on the outstanding shares of Series A Preferred Stock, dividends
accrued but not paid on outstanding shares of Series A Preferred Stock and a
redemption premium paid upon redemption of 75,000 shares of Series A
Preferred Stock have been deducted from net income (loss) in calculating net
income (loss) per share of Common Stock.
(5) The weighted average shares outstanding used to calculate basic income
(loss) per share does not include potentially dilutive securities (such as
stock options, warrants and convertible preferred stock). Diluted income
(loss) per share includes, where dilutive, the equivalent shares of Common
Stock calculated under the treasury stock method for the assumed exercise of
options and warrants and conversion of shares of Series A Preferred Stock.
(6) Excludes students enrolled in programs at colleges and universities having
consulting agreements with NCPD.
(7) A special charge of $3.0 million was recorded in fiscal 1994 for unusual
items, including the early write-off of equipment, program termination
expenses, severance compensation, expenses related to the settlement of a
lease and various legal expenses. Such special charge was included in
educational services and general and administrative expenses.
(8) Results for fiscal 1995 include a $1.1 million nonrecurring credit for the
refund of state and local business and occupation taxes.
(9) Charges of $1.1 million, $0.5 million and $0.4 million are reflected in
1995, 1996 and 1997, respectively, to account for non-cash compensation
expense related to the performance-based vesting of nonstatutory stock
options.
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ITEM 7-- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the Company's results of operations and
financial condition should be read in conjunction with the information filed in
response to Item 6 and Item 8. Unless otherwise specified, any reference to a
"year" is to a fiscal year ended June 30.
BACKGROUND
EDMC is among the largest providers of proprietary postsecondary education
in the United States, based on student enrollments and revenues. Through its
operating units, The Art Institutes, NYRS, NCPT and NCPD, the Company offers
associate's and bachelor's degree programs and non-degree programs in the areas
of design, media arts and technology, culinary arts, fashion and professional
development. The Company has provided career-oriented education programs since
1962, and its schools have graduated over 100,000 students. The Company's main
operating unit, The Art Institutes, consists of 15 schools in 14 major
metropolitan areas throughout the United States and accounted for approximately
93% of the Company's net revenues in 1998.
Net revenues, income before interest and taxes and net income increased in
each of the last two years. Net revenues are presented after deducting refunds,
scholarships and other adjustments. Net revenues increased 50.0% to $221.7
million in 1998 from $147.9 million in 1996. Income before interest and taxes
increased 73.2% to $24.7 million in 1998 from $14.3 million in 1996. Net income
increased by 141.9% to $14.3 million in 1998 from $5.9 million in 1996. Average
quarterly student enrollments at the Company's schools were 17,002 in 1998
compared to 12,079 in 1996. The increase in average enrollments relates to,
among other factors, new education programs and additional school locations,
along with expanded bachelor's degree and evening degree program offerings.
The Company's revenues consist of tuition and fees, student housing fees
and student supply store and restaurant sales. In 1998, the Company derived
87.7% of its net revenues from net tuition and fees paid by, or on behalf of,
its students. Tuition revenue generally varies based on the average tuition
charge per credit hour and the average student population. Student supply store
and housing revenue is largely a function of the average student population. The
average student population is influenced by the number of continuing students
attending school at the beginning of a fiscal period and by the number of new
students entering school during such period. New students enter The Art
Institutes and NCPT at the beginning of each academic quarter, which typically
commence in January, April, July and October. Programs at NYRS start eight times
throughout the year. The Company believes that the size of its student
population is influenced by the number of graduating high school students, the
attractiveness of its program offerings, the effectiveness of its marketing
efforts, the strength of employment markets, the persistence of its students,
the length of its education programs and general economic conditions. The
introduction of additional program offerings at existing schools and the
establishment of new schools (through acquisition or start-up) are important
factors influencing the Company's average student population.
Tuition increases have been implemented in varying amounts in each of the
past several years. Historically, the Company has been able to pass along cost
increases through increases in tuition. The Company believes that it can
continue to increase tuition as educational costs at other postsecondary
institutions, both public and private, continue to rise. The Company's schools
implemented tuition rate increases averaging approximately 5% for the fall
quarter of 1998. Tuition rates have generally been consistent across the
Company's schools and programs. However, as the Company enters more markets in
different geographic regions, tuition rates across Company schools might not
remain consistent.
The majority of students at The Art Institutes and NYRS rely on funds
received under various government sponsored student financial aid programs,
especially Title IV Programs, to pay a substantial portion of their tuition and
other education-related expenses. For the year ended June 30, 1998,
approximately 62% of the Company's net revenues was indirectly derived from
Title IV Programs.
Educational services expense consists primarily of costs related to the
development, delivery and administration of the Company's education programs.
Major cost components are faculty compensation, administrative salaries, costs
of educational materials, facility leases and school occupancy costs,
information systems costs, bad
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debt expense and depreciation and amortization of property and equipment. During
1998, The Art Institutes' faculty comprised approximately 45% full-time and
approximately 55% part-time employees. In 1997, these same percentages were 44%
and 56%, respectively.
General and administrative expense consists of marketing and student
admissions expenses and certain central staff departmental costs such as
executive management, finance and accounting, legal and corporate development
and other departments that do not provide direct services to the Company's
students. The Company has centralized many of these services to gain consistency
in management reporting, efficiency in administrative effort and control of
costs. All marketing and student admissions costs are expensed in the fiscal
year incurred.
Amortization of intangibles relates to the values assigned to student
enrollment agreements and applications, accreditation, contracts with colleges
and universities and goodwill. These intangible assets arose principally from
the application of purchase accounting to the establishment and financing of the
ESOP and the related leveraged transaction in October 1989 and the acquisitions
of the schools discussed below. See Note 2 of Notes to Consolidated Financial
Statements.
ESOP expense equals the sum of the payments on the ESOP Term Loan, plus
repurchases of shares from participants in the ESOP, less the dividends paid on
the Series A Preferred Stock that was held by the ESOP. As of June 30, 1996, the
entire ESOP Term Loan was repaid and, in November 1996, the IPO was consummated.
As a result, there was no ESOP expense in 1997 or 1998. Coincident with the IPO,
the ESOP converted its shares of Series A Preferred Stock into shares of Common
Stock and, therefore, dividends are no longer payable on the Series A Preferred
Stock.
In November 1995, the Company purchased the assets of the two schools of
Ray College of Design for $1.1 million in cash and the assumption of specified
liabilities. The Company acquired accounts receivable, property and equipment
and certain other assets. The schools, which regained eligibility as of March
1996 to participate in Title IV Programs, were renamed The Illinois Institute of
Art at Chicago and The Illinois Institute of Art at Schaumburg.
In 1996, the Company established The Art Institute of Phoenix, at which
classes commenced in January 1996. The school became eligible to participate in
Title IV Programs in August 1996. During 1996, the Company deferred
approximately $0.4 million of certain pre-opening non-marketing and admissions
costs associated with The Art Institute of Phoenix start-up. All of the costs
deferred in 1996 were expensed in 1997.
In August 1996, the Company purchased certain assets of NYRS for
approximately $9.5 million. The Company acquired current assets net of specified
current liabilities, property and equipment, student enrollment agreements,
curriculum, trade names and certain other assets. The school regained its
eligibility as of November 1996 to participate in Title IV Programs.
In January 1997, the Company acquired the assets of Lowthian College in
Minneapolis, Minnesota for $0.4 million, which included the assumption of
certain liabilities. The school, which regained eligibility as of April 1997 to
participate in Title IV Programs, has been renamed The Art Institutes
International Minnesota.
In March 1997, the Company established The Art Institute of Los Angeles, at
which classes began in October 1997. The school became eligible to participate
in Title IV Programs in February 1998. In connection with this start-up,
marketing and student recruiting activities commenced in April 1997. The $0.4
million of pre-opening costs were expensed as incurred in 1997.
In December 1997, the Company purchased certain assets of the Louise
Salinger School in San Francisco, California for $0.6 million in cash. The
Company also entered into a consulting agreement with its former president in
exchange for an option to purchase 10,000 shares of Common Stock. The school was
renamed The Art Institutes International at San Francisco and regained its
eligibility to participate in Title IV Programs in April 1998.
In February 1998, the Company acquired certain assets of Bassist College in
Portland, Oregon, from Bassist Corporation, for approximately $0.9 million in
cash. The purchase agreement provides for additional consideration based upon a
specified percentage of gross revenues over the next five years. The school
regained its
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eligibility to participate in Title IV Programs in April 1998 and was renamed
The Art Institutes International at Portland.
Start-up schools and smaller acquisitions are expected to incur operating
losses during the first two to three years following their opening or purchase.
The combined operating losses of the Company's newer schools in California,
Minnesota and Oregon were approximately $4.1 million in 1998.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage
relationships of certain income statement items to net revenues.
YEAR ENDED JUNE 30,
---------------------------
1996 1997 1998
---- ---- ----
Net revenues.................................... 100.0% 100.0% 100.0%
Costs and expenses:
Educational services.......................... 66.8 66.1 66.4
General and administrative.................... 21.9 22.4 21.7
Amortization of intangibles................... 0.7 1.1 0.7
ESOP expense.................................. 0.9 -- --
----- ----- -----
90.4 89.7 88.9
----- ----- -----
Income before interest and taxes................ 9.6 10.3 11.1
Interest expense, net........................... 2.3 0.9 --
----- ----- -----
Income before income taxes...................... 7.4 9.4 11.1
Provision for income taxes...................... 2.7 4.0 4.7
----- ----- -----
Income before extraordinary item................ 4.6 5.5 6.5
Extraordinary item.............................. 0.6 -- --
----- ----- -----
Net income...................................... 4.0% 5.5% 6.5%
===== ===== =====
YEAR ENDED JUNE 30, 1998 COMPARED WITH YEAR ENDED JUNE 30, 1997
NET REVENUES
Net revenues increased by 21.3% to $221.7 million in 1998 from $182.8
million in 1997. The revenue increase was primarily due to an increase in
average quarterly student enrollments ($25.5 million) and an approximate 5%
tuition price increase ($7.4 million) at schools owned by EDMC prior to 1998,
and the addition of three schools ($2.0 million). The average academic year
(three academic quarters) tuition rate for a student attending classes at an Art
Institute on a recommended full schedule increased to $10,350 in 1998 from
$9,860 in 1997. The Art Institute of Los Angeles was established in March 1997
and commenced classes in October 1997. The Company acquired the Louise Salinger
School in December 1997 (renamed The Art Institutes International at San
Francisco) and Bassist College in February 1998 (renamed The Art Institutes
International at Portland).
Net housing revenues increased by 24.3% to $12.9 million in 1998 from $10.4
million in 1997 and revenues from the sale of educational materials in 1998
increased by 20.3% to $10.4 million. Both increased primarily as a result of
higher average student enrollments.
Refunds for 1998 increased from $6.0 million in 1997 to $7.1 million in
1998. As a percentage of gross revenue, refunds decreased slightly from 1997.
EDUCATIONAL SERVICES
Educational services expense increased by $26.4 million, or 21.8%, to
$147.3 million in 1998 from $120.9 million in 1997. The increase was primarily
due to additional costs required to service higher student enrollments,
accompanied by normal cost increases for wages and other services at the schools
owned by EDMC prior to 1997
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($16.8 million) and schools added in 1997 and 1998 ($7.6 million). H