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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: JUNE 30, 1999 COMMISSION FILE NUMBER: 000-21363
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EDUCATION MANAGEMENT CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
PENNSYLVANIA 25-1119571
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
300 SIXTH AVENUE, PITTSBURGH, PA 15222
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (412) 562-0900
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(TITLE OF CLASS)
PREFERRED SHARE PURCHASE RIGHTS
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the definitive proxy statement incorporated
by reference in Part III of this Form 10-K or any amendment to this Form
10-K. __
The aggregate market value of the voting common stock held by non-affiliates of
the registrant as of September 20, 1999 was approximately $292,128,379. The
number of shares of Common Stock outstanding on September 20, 1999 was
29,318,522 shares.
Documents incorporated by reference: Portions of the definitive Proxy Statement
of the registrant for the annual meeting of shareholders to be held on November
4, 1999 ("Proxy Statement") are incorporated by reference into Part III of this
Form 10-K. The incorporation by reference herein of portions of the Proxy
Statement shall not be deemed to incorporate by reference the information
referred to in Item 402(a)(8) of Regulation S-K.
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PART I
Forward-Looking Statements: 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 their use of terms 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. 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 Item 7 under
the heading "Risk Factors." 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.
ITEM 1--BUSINESS
BUSINESS OVERVIEW
EDMC is among the largest providers of proprietary postsecondary education
in the United States, based on student enrollments and revenues. The Company was
organized as a Pennsylvania corporation in 1962 and completed its initial public
offering (the "IPO") in 1996. Through its main operating unit, the Art
Institutes ("The Art Institutes"), the Company offers associate's and bachelor's
degree programs and non-degree programs in the areas of design, media arts,
culinary arts and fashion. The Company's schools have graduated over 100,000
students. In the fall quarter beginning October 1998, EDMC's schools had 21,518
students enrolled, representing all 50 states and over 85 countries.
The Company's main operating unit, The Art Institutes, consisted on June
30, 1999 of 18 schools in 16 cities throughout the United States. Art Institute
programs are designed to provide the knowledge and skills necessary for
entry-level employment in various fields, including graphic design, multimedia
and web design, computer animation, video production, culinary arts, interior
design, industrial design, photography, fashion marketing and fashion design.
Those programs typically are completed in 18 to 48 months and culminate in a
bachelor's or 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 August 1999, the Company acquired the
American Business & Fashion Institute in Charlotte, North Carolina and
Massachusetts Communications College in Boston.
The Company offers a culinary arts curriculum at ten Art Institutes,
including The Art Institute of Los Angeles, The Art Institutes International
Minnesota and The Art Institute of Dallas, which began culinary arts classes in
July 1998, October 1998 and April 1999, respectively. The Company also owns the
New York Restaurant School ("NYRS"), a culinary arts and restaurant management
school located in New York City. NYRS offers an associate's degree program and
certificate programs.
The Company also owns NCPT (The National Center for Paralegal Training),
which offers paralegal certificate programs, and The National Center for
Professional Development, which maintains consulting relationships with five
colleges and universities to assist in the development, marketing and delivery
of paralegal, legal nurse consultant and financial planning certificate
programs.
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
90.9% of the calendar year 1998 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.
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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 marketing to a broad range of
potential students, admitting students who possess the relevant interests and
capabilities, providing students with programs of study taught by industry
professionals, and assisting students with job placement.
STUDENT RECRUITMENT AND MARKETING
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
uses 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 1999 referrals accounted for 36%
of new student enrollments at The Art Institutes, high school recruitment
programs accounted for 21%, broadcast advertising accounted for 22%, print media
accounted for 9%, the Company's web sites accounted for 7%, and international
marketing accounted for 2%. The remainder was classified as miscellaneous.
In fiscal 1999, The Art Institutes' marketing efforts generated inquiries
from approximately 215,000 qualified prospective students. The Art Institutes'
inquiry-to-application conversion ratio has increased from 9.0% in fiscal 1996
to 10.9% in fiscal 1999, and the applicant-to-new student ratio has decreased
slightly from 66.7% in fiscal 1996 to 66.6% in fiscal 1999.
The Company also employs approximately 80 representatives who make
presentations at high schools 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. In fiscal 1999, representatives visited over 9,000 high schools and
attended approximately 1,600 career events. 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.
STUDENT ADMISSIONS AND RETENTION
Each applicant for admission to an Art Institute is required to have a high
school diploma or a recognized equivalent and to 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.
Art Institute students are of varying ages and backgrounds. For fiscal
1999, approximately 26% of the entering students matriculated directly from high
school, approximately 31% were between the ages of 19 and 21, approximately 31%
were 22 to 29 years of age and approximately 12% were 30 years old or older.
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 Art Institutes' net 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 66.4% in fiscal 1998 and 65.4% in fiscal
1999.
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EDUCATION PROGRAMS
The Art Institutes offer the following degree programs. Certain programs
are offered only at select Art Institutes. (For internal purposes, the Company
classifies its degree programs according to four "schools" or areas of study.)
THE SCHOOL OF DESIGN THE SCHOOL OF MEDIA ARTS
Associate's Degree Programs Associate's Degree Programs
Computer-Aided Drafting & Design Audio Production
Computer Animation Broadcasting
Graphic Design Multimedia & Web Design
Interior Design Photography
Industrial Design Technology Video Production
Web Site Administration
Bachelor's Degree Programs
Computer Animation Bachelor's Degree Programs
Game Art and Design
Graphic Design Interactive Multimedia Programming
Interior Design Online Media & Marketing
Industrial Design
THE SCHOOL OF FASHION
THE SCHOOL OF CULINARY ARTS
Associate's Degree Programs
Associate's Degree Programs
Fashion Design
Culinary Arts Fashion Marketing
Restaurant and Catering Management Visual Merchandising
Bachelor's Degree Programs
Bachelor's Degree Programs
Fashion Design
Culinary Management Fashion Marketing and Management
NYRS offers associate's degree programs in culinary arts and restaurant
management and certificate programs in culinary arts, pastry arts, culinary
skills and restaurant management.
Approximately 7% of the average quarterly student enrollments at the
Company's schools in fiscal 1999 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.
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GRADUATE EMPLOYMENT
Based on information received from graduating students and employers, the
Company believes that students graduating from The Art Institutes during the
five calendar years ended December 31, 1998 obtained employment in fields
related to their programs of study as follows:
PERCENT OF AVAILABLE
NUMBER OF GRADUATES WHO OBTAINED
GRADUATING CLASSES AVAILABLE EMPLOYMENT RELATED TO
(CALENDAR YEAR) GRADUATES(1)(2) PROGRAM OF STUDY(2)(3)
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1998............................................ 3,941 90.5%
1997............................................ 3,811 89.0
1996............................................ 3,676 86.8
1995............................................ 3,734 87.4
1994............................................ 3,495 86.4
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(1) The term "Available Graduates" refers to all graduates except those who are
pursuing further education, deceased, in active military service, have
medical conditions that prevent such graduates from working or 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 number of graduates and placement
rates for 1996, 1997 and 1998 would have been 4,167, 4,749 and 4,719, and
86.4%, 87.3%, and 90.9%, respectively. In addition, the data for 1999
exclude graduates of programs in teach-out status. Had these 230 graduates
been included, the total number of graduates available for employment would
have been 4,949 with a placement rate of 90.9%.
(3) The information presented reflects employment in fields related to
graduates' programs of study within six months after graduation.
For calendar year 1998, the approximate average starting salaries of
graduates of degree and diploma programs at The Art Institutes were as follows:
The School of Culinary Arts--$23,300; The School of Design--$24,500; The School
of Fashion--$21,900; and The School of Media Arts--$22,800.
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 and also participate in professional organizations, trade shows
and community events to keep apprised of industry trends and maintain
relationships with key employers.
Employers of Art Institute graduates include numerous small and
medium-sized companies, 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.
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 Higher Education Act of 1965 ("HEA"), the
U.S. Department of Education relies on accrediting agencies to determine whether
institutions' educational programs qualify them to participate in federal
financial aid programs under Title IV of the HEA ("Title IV Programs"). The HEA
specifies certain standards that all recognized accrediting agencies must adopt
in connection with their review of postsecondary institutions. 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 following table shows the location of each of EDMC's schools, the name
under which it operates, the year of its establishment, the date EDMC opened or
acquired it, the number of students enrolled as of the beginning of the second
(fall) quarter of fiscal 1999, and the accrediting agencies (for schools
accredited by more than one recognized accrediting agency, the primary
accrediting agency is listed first).
FISCAL YEAR
CALENDAR EDMC
YEAR ACQUIRED/
SCHOOL LOCATION ESTABLISHED OPENED ENROLLMENT ACCREDITING AGENCY
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The Art Institute of
Atlanta.................... Atlanta, GA 1949 1971 1,699 Commission on Colleges of the
Southern Association of
Colleges and Schools ("SACS")
The Art Institute of
Dallas..................... Dallas, TX 1964 1985 1,334 SACS
The Art Institute of Fort
Lauderdale................. Fort Lauderdale, FL 1968 1974 2,645 Accrediting Commission of
Career Schools and Colleges
of Technology ("ACCSCT")
The Art Institute of
Houston.................... Houston, TX 1974 1979 1,690 ACCSCT, SACS (Candidate)
The Art Institute of Los
Angeles.................... Los Angeles, CA 1997 1998 407 ACCSCT, as an additional
location of The Art Institute
of Pittsburgh
The Art Institute of
Philadelphia............... Philadelphia, PA 1971 1980 2,361 ACCSCT
The Art Institute of
Phoenix.................... Phoenix, AZ 1995 1996 834 ACCSCT, as an additional
location of The Colorado
Institute of Art
The Art Institute of
Pittsburgh................. Pittsburgh, PA 1921 1970 2,585 ACCSCT
The Art Institute of
Seattle.................... Seattle, WA 1946 1982 2,700 ACCSCT
Commission on Colleges of the
Northwest Association of
Schools and Colleges
("NWASC") (Candidate)
The Art Institutes
International at
Portland................... Portland, OR 1963 1998 205 NWASC
The Art Institutes
International at San
Francisco.................. San Francisco, CA 1939 1998 77 ACCSCT
The Art Institutes
International Minnesota.... Minneapolis, MN 1964 1997 531 Accrediting Council for
Independent Colleges and
Schools ("ACICS")
The Colorado Institute of
Art........................ Denver, CO 1952 1976 1,748 ACCSCT
The Illinois Institute of Art
at Chicago................. Chicago, IL 1916 1996 804 ACCSCT
The Illinois Institute of Art
at Schaumburg.............. Schaumburg, IL 1983 1996 507 ACCSCT, as an additional
location of The Illinois
Institute of Art at Chicago
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FISCAL YEAR
CALENDAR EDMC
YEAR ACQUIRED/
SCHOOL LOCATION ESTABLISHED OPENED ENROLLMENT ACCREDITING AGENCY
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NCPT: The National Center for
Paralegal Training......... Atlanta, GA 1973 1973 385 ACICS
The New York Restaurant
School..................... New York, NY 1980 1997 1,006 ACCSCT, New York State Board
of Regents
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.
ACCSCT has notified three 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
the agency. 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 removed the school (now named The Art
Institutes International at Portland) from probation status at its spring 1999
meeting.
STUDENT FINANCIAL ASSISTANCE
Many students at 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 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, the school must ensure that Title IV Program funds
are properly accounted for and disbursed in the correct amounts to eligible
students. All Art Institutes and NYRS 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. Students at EDMC's schools receive
loans, grants and work-study funding to fund their education under several Title
IV Programs, of which the two largest are the Federal Family Education Loan
("FFEL") program and the Federal Pell Grant ("Pell") 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.
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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 certain educational
programs, $5,500 for each of the third and fourth academic years. Students who
are classified as independent 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. Amounts
received by students in the Company's schools under the Stafford loan program in
fiscal 1999 equaled approximately 37% 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 1999 equaled approximately 15% of the Company's net revenues.
Under the Federal Direct Student Loan Program ("FDSL"), 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.
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 1999, Pell grants
ranged from $400 to $3,000 per year; beginning on July 1, 1999, the limit was
increased to $3,125 per year. Amounts received by students enrolled in the
Company's schools in fiscal 1999 under the Pell program equaled approximately 7%
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
1999, the Company's required 25% institutional match was approximately $840,000.
Amounts received by students in the Company's schools under the FSEOG program in
fiscal 1999 equaled approximately 1% of the Company's net revenues.
Perkins. Eligible undergraduate students may borrow up to $4,000 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 relends those funds to currently enrolled students. Collection and
disbursement of Perkins loans is the responsibility of each participating
institution. During fiscal 1999, the Company collected approximately $2.5
million from its former students. In fiscal 1999, the Company's required
matching contribution was approximately $190,000. The Perkins loans disbursed to
students in the Company's schools in fiscal 1999 were less than 1% of the
Company's net revenues. Ten of the Company's schools participate in the Perkins
program.
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
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must be used to fund student employment in community service positions. In
fiscal 1999, FWS funds accounted for less than 0.5% of the Company's net
revenues.
OTHER FINANCIAL ASSISTANCE SOURCES
Students at several of the Company's schools participate in state grant
programs. In fiscal 1999, approximately 3% 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 1999,
financial assistance from such federal and state programs equaled less than 2%
of the Company's net revenues. The Art Institutes also provide institutional
scholarships to qualified students. In fiscal 1999, institutional scholarships
had a value equal to approximately 3% of the Company's net revenues. The Company
has also arranged alternative supplemental loan programs that allow students to
repay a portion of their loans after graduation and allow students with lower
than average credit ratings to obtain loans. The primary objective of these loan
programs 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 1999, five 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 87% 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
Each institution that participates in Title IV Programs 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 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.
Cohort Default Rates. The U.S. Department of Education may impose sanctions
on institutions whose former students default at an "excessive" rate on the
repayment of federally guaranteed student loans. 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,
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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.
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 1996, the most recent year for which such rates have been published, the
average FFEL cohort default rate for borrowers at all proprietary institutions
was 18.2%. For that year, the combined preliminary FFEL cohort default rate for
all borrowers at the Company's schools was 16.6%. For federal fiscal year 1997,
the combined preliminary FFEL cohort default rate for all borrowers at the
Company's schools was 14.7% and its individual schools' preliminary rates ranged
from 4.4% to 22.6%, 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 1997 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 greater or
less than such schools' preliminary rates.
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, 1998, the most recent
year for which such rates have been calculated. For each of those schools, funds
from the Perkins program equaled less than 4% of the school's net revenues in
fiscal 1999. 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 the institution reduces its Perkins cohort default rate to
below 15% in a subsequent year, the institution can 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 to attend that school. Those activities are in addition to
the loan servicing and collection activities of FFEL lenders and guaranty
agencies.
Regulatory Oversight. The U.S. Department of Education is required to
conduct periodic reviews of the eligibility and certification of every
institution participating in Title IV Programs. A denial of recertification
precludes a school from continuing to participate in Title IV Programs.
The Art Institutes International Minnesota, The Illinois Institute of Art
at Chicago and The Illinois Institute of Art at Schaumburg applied for
recertification by the U.S. Department of Education during fiscal 1999, and each
has received recertification. During fiscal 2000, eight of the Company's schools
are scheduled to apply for recertification.
NYRS, 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
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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 1993 and 1994 FFEL cohort default rates.
The HEA 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 four years
and re-approved for continued recognition by the U.S. Department of Education.
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. For the year
ended June 30, 1999, the Company believes that, on an individual institution
basis, each of its schools then participating in Title IV Programs satisfied the
financial responsibility standards. The Illinois Institute of Art at Schaumburg,
The Art Institute of Phoenix and The Art Institute of Los Angeles are 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 that 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.
Previously, if a school was awaiting recertification, the U.S. Department of
Education would suspend Title IV Program funding to that school's students.
Recently, a mechanism was developed that allows most of a school's change of
ownership application to be reviewed prior to the change of ownership. If the
application is considered to be substantially complete, the U.S. Department of
Education may generate a temporary Provisional Program Participation Agreement
allowing the school's students to continue to receive federal funding, subject
to certain conditions. After the change of ownership and the remainder of the
application is submitted, if the school is recertified, it is recertified 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 requirements and may not establish additional locations without prior
approval from the U.S. Department of Education. However, 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.
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 "90/10 Rule." Under a provision of the HEA commonly referred to as the
"90/10 Rule" (formerly known as the "85/15 Rule"), a proprietary institution
such as each of EDMC's schools will cease to be eligible to participate in Title
IV Programs if, on a cash accounting basis, more than 90% of its revenues for
the prior fiscal year was derived from Title IV Programs. Any school that
violates the 90/10 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 1999, the range for the Company's schools was from
approximately 52% to approximately 72%.
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
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financial aid awarding activity. EDMC believes that its current compensation
plans are in compliance with HEA standards.
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 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.
EMPLOYEES
As of June 30, 1999, EDMC employed 1,998 full-time and 782 part-time staff
and faculty.
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 often receive government subsidies, government
and foundation grants, tax-deductible contributions and other financial
resources generally not available to proprietary schools. Accordingly, public
institutions may have facilities and equipment, which are superior to those of
the private sector, and can offer lower tuition prices. However, tuition at
private non-profit institutions is, on average, higher than The Art Institutes'
tuition.
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.
ITEM 2--PROPERTIES
As of June 30, 1999, EDMC's schools were located in major metropolitan
areas in 12 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 the majority of their facilities. In fiscal 1999, the Company
acquired the 71,627 square foot main facility of The Art Institute of Seattle, a
99,400 square foot building in Denver to be occupied by The Colorado Institute
of Art, a 51,545 square foot dormitory facility in Fort Lauderdale and a 177,600
square foot building in Pittsburgh, which will house The Art Institute of
Pittsburgh after renovations currently anticipated to be completed in June 2000.
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\The following table sets forth certain information as of June 30, 1999 with
respect to the principal properties leased by the Company and its subsidiaries:
LOCATION (CITY/STATE) SQUARE FEET
--------------------- -----------
Phoenix, AZ................... 58,635
Los Angeles, CA............... 45,835
San Francisco, CA............. 53,095
Denver, CO.................... 59,755
Ft. Lauderdale, FL(1)......... 118,590
Atlanta, GA(2)................ 106,197
Atlanta, GA................... 119,375
Chicago, IL................... 54,553
Schaumburg, IL................ 39,970
LOCATION (CITY/STATE) SQUARE FEET
--------------------- -----------
Minneapolis, MN............... 67,750
New York, NY.................. 64,697
Portland, OR.................. 27,115
Philadelphia, PA(3)........... 116,375
Pittsburgh, PA(2)............. 36,930
Pittsburgh, PA(2)............. 128,200
Dallas, TX.................... 96,190
Houston, TX................... 83,600
Seattle, WA................... 149,755
- ---------
(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 fiscal 2000 (Atlanta) and fiscal 2001 (Pittsburgh).
(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
The Company and its wholly-owned subsidiaries The Art Institutes
International, Inc. and The Art Institute of Houston, Inc. are defendants in a
suit filed in the District Court of Harris County, Texas on June 30, 1999. The
lawsuit was brought by 145 former and current students of The Art Institute of
Houston who allege being misled about the benefits or quality of educational
services provided to them. The complaint was subsequently amended to add claims
by an additional 90 plaintiffs. The complaint does not specify the amount of
damages being sought. The Company is also a defendant in other legal proceedings
in the ordinary course of business. While there can be no assurance as to the
ultimate outcome of any litigation involving the Company, in the opinion of
management, based upon its investigation of these claims and discussion with
legal counsel, the ultimate outcome of such legal proceedings, individually and
in the aggregate, will not have a material adverse effect on the Company's
consolidated financial position, 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 20, 1999, there were 29,318,522 shares of Common
Stock outstanding held by approximately 480 holders of record. The prices set
forth below reflect the high and low sales prices, adjusted for a two-for-one
stock split effected in the form of a stock dividend in December 1998, for the
Company's Common Stock, as reported in the consolidated transaction reporting
system of the Nasdaq National Market System.
1998 1999
---------------- ----------------
THREE MONTHS ENDED HIGH LOW HIGH LOW
------------------ ---- --- ---- ---
September 30.................... $14.50 $12.13 $20.13 $14.50
December 31..................... 16.00 12.25 24.00 15.63
March 31........................ 17.63 13.63 31.75 21.75
June 30......................... 19.06 15.83 30.75 14.56
EDMC has not declared or paid any cash dividends on its capital stock
during the past two years. 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.
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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, 1998 and 1999 and for each of the three
years in the period ended June 30, 1999 also is filed in response to Item 8
below. The summary consolidated income statement data for the years ended June
30, 1995 and 1996 and the summary consolidated balance sheet data as of June 30,
1995, 1996 and 1997 are derived from audited financial statements not included
herein.
YEAR ENDED JUNE 30,
------------------------------------------------------
1995(7)(8) 1996(8) 1997(8) 1998 1999
---------- ------- ------- ---- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
INCOME STATEMENT DATA:
Net revenues.............................. $131,227 $147,863 $182,849 $221,732 $260,805
ESOP expense(1)........................... 7,086 1,366 -- -- --
Income before extraordinary item(2)....... 1,513 6,846 9,985 14,322 18,752
Net income................................ 1,513 5,920 9,985 14,322 18,752
Dividends on Series A Preferred
Stock(3)................................ 2,249 2,249 83 -- --
Other Series A Preferred Stock
transactions(3)......................... -- -- 403 -- --
PER SHARE DATA(3):
Basic:
Income (loss) before extraordinary
item................................. $ (.05) $ .33 $ .40 $ .50 $ .64
Net income (loss)....................... $ (.05) $ .27 $ .40 $ .50 $ .64
Weighted average number of shares
outstanding, in thousands(4)......... 13,780 13,826 23,878 28,908 29,314
Diluted:
Income (loss) before extraordinary
item................................. $ (.05) $ .19 $ .36 $ .48 $ .61
Net income (loss)....................... $ (.05) $ .15 $ .36 $ .48 $ .61
Weighted average number of shares
outstanding, in thousands(4)......... 13,780 23,748 27,342 29,852 30,615
OTHER DATA:
Capital expenditures(5)................... $ 11,640 $ 14,981 $ 18,487 $ 17,951 $ 54,933
Enrollments at beginning of fall
quarter(6).............................. 12,749 13,407 15,838 18,763 21,518
AS OF JUNE 30,
------------------------------------------------------
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
(IN THOUSANDS)
BALANCE SHEET DATA:
Total cash and cash equivalents........... $ 39,623 $ 27,399 $ 33,227 $ 47,310 $ 32,871
Receivables, net.......................... 7,414 8,172 10,547 11,678 15,333
Current assets............................ 49,662 39,858 48,886 65,623 55,709
Total assets.............................. 102,303 101,412 126,292 148,783 178,746
Current liabilities....................... 34,718 27,264 36,178 38,097 45,188
Long-term debt (including current
portion)................................ 69,810 65,919 34,031 38,382 37,231
Shareholders' investment.................. 1,855 9,656 57,756 73,325 96,805
- ---------
(1) Expenses incurred in connection with the Education Management Corporation
Employee Stock Ownership Plan and Trust (the "ESOP") equal 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
10.19% Convertible Preferred Stock, $.0001 par value (the "Series A
Preferred Stock"), previously held by the ESOP. In fiscal 1995, the Company
made
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a voluntary prepayment of $2.1 million on the ESOP Term Loan. In fiscal 1996,
the ESOP Term Loan was repaid in full. Therefore, subsequent thereto there has
not been, nor will there be in the future ESOP expense resulting from the
repayment of such loan or, so long as the Common Stock is publicly traded,
from repurchases of shares.
(2) 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.
(3) 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.
(4) 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.
(5) Capital expenditures for fiscal 1999 reflect approximately $5.1 million
included in accounts payable at year-end.
(6) Excludes students enrolled in programs at those colleges and universities
with which the Company has consulting arrangements.
(7) Results for fiscal 1995 include a $1.1 million nonrecurring credit for the
refund of state and local business and occupation taxes.
(8) 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 nonqualified 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 above and Item 8 below. Unless otherwise specified, any
reference to a "year" is to a fiscal year ended June 30.
BACKGROUND
EDMC is one of the largest providers of proprietary postsecondary education
in the United States, based on student enrollments and revenues. Through its
operating units, primarily The Art Institutes, the Company offers bachelor's and
associate's degree programs and non-degree programs in the areas of design,
media arts, culinary arts, fashion and paralegal studies. The Company has
provided career-oriented education programs for over 35 years, and its schools
have graduated more than 100,000 students. As of June 30, 1999, the Company
operated 18 schools in 15 major metropolitan areas throughout the United States.
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 42.6% to $260.8
million in 1999 from $182.8 million in 1997. Income before interest and taxes
increased 68.4% to $31.7 million in 1999 from $18.8 million in 1997. Net income
increased by 87.8% to $18.8 million in 1999 from $10.0 million in 1997. Average
quarterly student enrollments at the Company's schools were 19,325 in 1999
compared to 14,490 in 1997. 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 1999, the Company derived
88.0% 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 at the beginning of each academic quarter, which typically commence
in January, April, July and October. 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, changes in technology, 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 6% during 1999.
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 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, 1999, approximately 66%
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 and school occupancy costs, information
systems costs, bad debt expense and depreciation and amortization of property
and equipment. During 1999, the Company's faculty
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comprised approximately 46% full-time and approximately 54% part-time employees.
In 1998, these same percentages were 45% and 55%, 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.
Amortization of intangibles relates to the values assigned to identifiable
intangible assets 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.
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 and certain other intangible assets.
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 was 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.
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 20,000 shares of Common Stock. The school was
renamed The Art Institutes International at San Francisco.
In February 1998, the Company acquired certain assets related to the
operations of Bassist College in Portland, Oregon, 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 was renamed The Art Institutes International at Portland.
In October 1998, the Company acquired the assets of Socrates Distance
Learning Technologies Group for approximately $0.5 million in cash. This
acquisition was made to further the development of the Company's distance
learning capabilities. The Company employs the previous owners under two-year
employment and non-compete arrangements.
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 were approximately
$6.0 million in 1999.
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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,
---------------------------
1997 1998 1999
---- ---- ----
Net revenues.................................... 100.0% 100.0% 100.0%
Costs and expenses:
Educational services............................ 66.1 66.4 65.5
General and administrative...................... 22.4 21.7 21.9
Amortization of intangibles..................... 1.1 0.7 0.5
----- ----- -----
89.7 88.9 87.8
----- ----- -----
Income before interest and taxes................ 10.3 11.1 12.2
Interest expense (income), net.................. 0.9 -- --
----- ----- -----
Income before income taxes...................... 9.4 11.1 12.2
Provision for income taxes...................... 4.0 4.7 5.0
----- ----- -----
Net income...................................... 5.5% 6.5% 7.2%
===== ===== =====
YEAR ENDED JUNE 30, 1999 COMPARED WITH YEAR ENDED JUNE 30, 1998
NET REVENUES
Net revenues increased by 17.6% to $260.8 million in 1999 from $221.7
million in 1998. The revenue increase was primarily due to an increase in
average quarterly student enrollments ($23.2 million) and tuition increases of
approximately 6% ($12.5 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 $11,262 in 1999 from $10,350 in 1998.
Net housing revenues increased by 13.4% to $14.7 million in 1999 from $12.9
million in 1998 and revenues from the sale of educational materials in 1999
increased by 17.3% to $12.3 million. Both increased primarily as a result of
higher average student enrollments. Refunds increased from $7.1 million in 1998
to $8.0 million in 1999. As a percentage of gross revenue, refunds decreased
slightly from 1998.
EDUCATIONAL SERVICES
Educational services expense increased by $23.4 million, or 15.9%, to
$170.7 million in 1999 from $147.3 million in 1998. 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 1998 ($15.8 million) and schools added in 1998 and 1999
($6.0 million). Higher costs associated with establishing and supporting new
schools and developing new education programs contributed to the increase. As a
percentage of net revenues, educational services expense decreased from 66.4% in
1998 to 65.5% in 1999, reflecting leverage on fixed costs.
GENERAL AND ADMINISTRATIVE
General and administrative expense increased by 18.9% to $57.2 million in
1999 from $48.1 million in 1998 due to the incremental marketing and student
admissions expenses incurred to generate higher student enrollments at the
schools owned by EDMC prior to 1998 ($4.8 million), and additional marketing and
student admissions expenses at the schools added in 1998 and 1999 ($2.9
million). General and administrative expense increased slightly as a percentage
of net revenues in 1999 compared to 1998 as a result of increased advertising
expenditures designed to promote awareness of and generate inquiries about the
newer locations and new program offerings.
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AMORTIZATION OF INTANGIBLES
Amortization of intangibles decreased by $.4 million, or 25.3%, to $1.2
million in 1999 from $1.6 million in 1998, as a result of certain intangible
assets becoming fully amortized.
INTEREST EXPENSE (INCOME), NET
The Company had net interest income of $113,000 in 1999 as compared to
$3,000 in 1998. The average outstanding debt balance decreased from $5.6 million
in 1998 to $4.6 million in 1999. Accordingly, less interest cost on borrowings
has been offset against interest earned on investments.
PROVISION FOR INCOME TAXES
The Company's effective tax rate decreased to 41.1% in 1999 from 42.0% in
1998. This reduction reflects a more favorable distribution of taxable income
among the states in which the Company operates and a decrease in non-deductible
expenses as a percentage of taxable income. The effective rates differed from
the combined federal and state statutory rates due to expenses that are
nondeductible for tax purposes.
NET INCOME
Net income increased by $4.4 million or 30.9% to $18.8 million in 1999 from
$14.3 million in 1998. The increase resulted from improved operations at the
Company's schools owned prior to 1998, reduced amortization of intangibles and a
lower effective income tax rate.
YEAR ENDED JUNE 30, 1998 COMPARED WITH YEAR ENDED JUNE 30, 1997
NET REVENUE
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 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 ($16.8 million) and schools added in 1997 and 1998
($7.6 million). Higher costs associated with establishing and supporting new
schools and developing new education programs contributed to the increase.
GENERAL AND ADMINISTRATIVE
General and administrative expense increased by 17.2% to $48.1 million in
1998 from $41.0 million in 1997 due to the incremental marketing and student
admissions expenses incurred to generate higher student enrollments at the
schools owned by EDMC prior to 1997 ($4.5 million), and additional marketing and
student admissions expenses at the schools added in 1997 and 1998 ($3.0
million). General and administrative expense decreased slightly as a percentage
of net revenues in 1998 compared to 1997 as a result of a reduction of expenses
incurred by the Company's central staff organization.
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AMORTIZATION OF INTANGIBLES
Amortization of intangibles decreased by $0.5 million, or 22.4%, to $1.6
million in 1998 from $2.1 million in 1997, as a result of certain intangible
assets becoming fully amortized.
INTEREST EXPENSE (INCOME), NET
The Company had net interest income of $3,000 in 1998 as compared to
interest expense of $1.6 million in 1997. The lower interest expense was
primarily attributable to a decrease in the average outstanding debt balance
from $22.4 million in 1997 to $5.6 million in 1998.
PROVISION FOR INCOME TAXES
The Company's effective tax rate was 42.0% in 1998 and 1997, and differed
from the combined federal and state statutory rates due to expenses that are
nondeductible for tax purposes.
NET INCOME
Net income increased by $4.3 million or 43.4% to $14.3 million in 1998 from
$10.0 million in 1997. The increase resulted from improved operations at the
Company's schools owned prior to 1997 and reduced net interest expense,
partially offset by a higher provision for income taxes.
SEASONALITY AND OTHER FACTORS AFFECTING QUARTERLY RESULTS
The Company's quarterly revenues and income fluctuate primarily as a result
of the pattern of student enrollments. The Company experiences a seasonal
increase in new enrollments in the fall (fiscal year second quarter), which is
traditionally when the largest number of new high school graduates begin
postsecondary education. Some students choose not to attend classes during
summer months, although the Company's schools encourage year-round attendance.
As a result, total student enrollments at the Company's schools are highest in
the fall quarter and lowest in the summer months (fiscal year first quarter).
The Company's costs and expenses, however, do not fluctuate as significantly as
revenues on a quarterly basis. The Company anticipates that the seasonal pattern
in revenues and earnings will continue in the future.
QUARTERLY FINANCIAL RESULTS (UNAUDITED)
The following table sets forth the Company's quarterly results for 1998 and
1999.
1998
-----------------------------------------------
SEPT. 30 DEC. 31 MAR. 31 JUNE 30
(SUMMER) (FALL) (WINTER) (SPRING)
-------- ------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net revenues..................................... $43,176 $63,068 $59,807 $55,681
Income before interest and taxes................. $ 228 $13,174 $ 8,004 $ 3,285
Income before income taxes....................... $ 181 $13,120 $ 8,019 $ 3,374
Net income....................................... $ 105 $ 7,610 $ 4,651 $ 1,956
Net income per share
--Basic........................................ $ .00 $ .26 $ .16 $ .07
--Diluted...................................... $ .00 $ .26 $ .16 $ .06
1999
-----------------------------------------------
SEPT. 30 DEC. 31 MAR. 31 JUNE 30
(SUMMER) (FALL) (WINTER) (SPRING)
-------- ------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Net revenues..................................... $50,079 $74,986 $70,575 $65,165
Income before interest and taxes................. $ 698 $16,646 $10,249 $ 4,105
Income before income taxes....................... $ 732 $16,543 $10,365 $ 4,171
Net income....................................... $ 425 $ 9,749 $ 6,105 $ 2,473
Net income per share
--Basic........................................ $ .01 $ .33 $ .21 $ .08
--Diluted...................................... $ .01 $ .32 $ .20 $ .08
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LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
The Company's cash flow from operations has been the primary source of
financing for capital expenditures and growth. Cash flow from operations was
$28.2 million, $28.6 million and $35.7 million for 1997, 1998 and 1999,
respectively. For the year ended June 30, 1999, cash flow from operations and
cash flow from investing activities are reflected net of approximately $5.1
million of capital expenditures included in accounts payable as of June 30,
1999. As a result of the significant increase in capital expenditures, the
Company had net working capital of $10.5 million as of June 30, 1999, down from
$27.5 million as of June 30, 1998.
As of June 30, 1999, gross trade accounts receivable increased by $3.5
million, or 21.6%, to $19.5 million from the prior year as a result of the
increased net revenues. The allowance for doubtful accounts increased by $1.0
million, or 12.6%, to $9.4 million in 1999 from $8.3 million in 1998.
DEBT SERVICE
The Company's Amended and Restated Credit Agreement, dated March 16, 1995,
as amended (the "Revolving Credit Agreement"), currently allows for maximum
borrowings of $60 million, reduced annually by $5 million, through its
expiration on October 13, 2000. Borrowings under the Revolving Credit Agreement
bear interest at one of three rates set forth in the Revolving Credit Agreement
at the election of the Company. Certain outstanding letters of credit reduce the
facility. As of June 30, 1999, the Company had approximately $22.5 million of
additional borrowing capacity available under the Revolving Credit Agreement.
The Revolving Credit Agreement contains customary covenants that, among
other matters, require the Company to maintain specified levels of consolidated
net worth and meet specified interest, leverage and fixed charge ratio
requirements, and restrict repurchases of Common Stock and the incurrence of
certain additional indebtedness. As of June 30, 1999, the Company was in
compliance with all covenants under the Revolving Credit Agreement.
Borrowings under the Revolving Credit Agreement are used by the Company
primarily to fund its occasional working capital needs, arising from the
seasonal pattern of cash receipts throughout the year. The level of accounts
receivable reaches a peak immediately after the billing of tuition and fees at
the beginning of each academic quarter. Collection of these receivables is
heaviest at the start of each academic quarter.
FUTURE FINANCING AND CASH FLOWS
The Company believes that cash flow from operations, supplemented from time
to time by borrowings under the Revolving Credit Agreement, will provide
adequate funds for ongoing operations, planned expansion to new locations,
planned capital expenditures and debt service during the term of the Revolving
Credit Agreement.
CAPITAL EXPENDITURES
Capital expenditures made during the three years ended June 30, 1999
reflect the implementation of the Company's initiatives emphasizing the addition
of new schools and programs and investment in classroom technology. During 1999,
the Company purchased buildings in Denver, Ft. Lauderdale, Pittsburgh and
Seattle. The buildings in Ft. Lauderdale and Seattle were previously leased. The
real estate purchases in Denver and Pittsburgh will become, after completion of
renovations, the new facilities of The Colorado Institute of Art and The Art
Institute of Pittsburgh. The aggregate purchase price and costs of subsequent
improvements made during the fiscal year related to the buildings acquired was
approximately $29.1 million. The Company's capital expenditures were $18.5
million, $18.0 million and $54.9 million for 1997, 1998 and 1999, respectively.
Exclusive of the real estate purchases and related improvements, the Company
expects that total capital spending for 2000 will increase as a percentage of
net revenues, as compared to 1999. The anticipated expenditures relate
principally to the introduction and expansion of culinary programs, further
investment in schools acquired or started during the previous four years and
anticipated to be added in 2000, continued improvements to the facilities
currently under construction, additional or replacement school and housing
facilities and classroom technology.
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The Company leases the majority of its facilities. Future commitments on
existing leases will be paid from cash provided by operating activities.
REGULATION
The Company indirectly derived approximately 66% of its net revenues from
Title IV Programs in 1999. U.S. Department of Education regulations prescribe
the timing of disbursements of funds under Title IV Programs. Students must
apply for a new loan for each academic year. Lenders in multiple disbursements
each academic year generally provide loan funds. For first-time students in
their first academic quarter, the initial loan disbursement is generally
received at least 30 days after the commencement of that academic quarter.
Otherwise, the first loan disbursement is received, at the earliest, 10 days
before the commencement of the student's academic quarter.
U.S. Department of Education regulations require Title IV Program funds
received by the Company's schools in excess of the tuition and fees owed by the
relevant students at that time to be, with these students' permission,
maintained and classified as restricted until they are billed for the portion of
their education program related to those funds. Funds transferred through
electronic funds transfer programs are held in a separate cash account and
released when certain conditions are satisfied. These restrictions have not
significantly affected the Company's ability to fund daily operations.
Effective July 1997, postsecondary education institutions became subject to
changes in the delivery of FFEL program proceeds. Prior to July 1997, certain
schools delivered FFEL proceeds for an academic year (typically three quarters)
to students in two equal disbursements. The change resulted in FFEL proceeds
being delivered equally in each of the academic quarters. Some of the Company's
schools began to deliver loan proceeds in this manner prior to the change in
regulation becoming effective.
Education institutions participating in Title IV Programs must satisfy a
series of specific standards of financial responsibility. Under regulations that
took effect in July 1998, the U.S. Department of Education has adopted standards
(replacing the former "acid test," tangible net worth test and two-year
operating loss test) to determine an institution's financial responsibility to
participate in Title IV Programs. The regulations establish three ratios: (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 calculated separately, based on the figures in the institution's most
recent annual audited financial statements, and then weighted and combined to
arrive at a single composite score. Such composite score must be at least 1.5
for the institution to be deemed financially responsible without conditions or
additional oversight.
Regulations promulgated under the HEA also require all proprietary
education institutions to comply with the "90/10 Rule," (previously referred to
as the "85/15 Rule"), which prohibits participating schools from deriving 90% or
more of total revenue from Title IV Programs in any year.
If an institution fails to meet any of these requirements, it may be deemed
to be not financially responsible by the U.S. Department of Education, or
otherwise ineligible to participate in Title IV Programs. The Company believes
that all of its participating schools met these requirements as of June 30,
1999.
EFFECT OF INFLATION
The Company does not believe its operations have been materially affected
by inflation.
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," was issued. The statement establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value.
Additionally, SFAS No. 133 requires that changes in a derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. This statement has been amended by SFAS No. 137 "Accounting for Derivative
Instruments and Hedging Activities - Deferral
23
24
of the effective date of SFAS No. 133." SFAS No. 137 will be effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. The Company does
not anticipate that these standards will have a significant impact on its
financial statements.
YEAR 2000 ISSUES
THE PROBLEM
The Year 2000 problem arises from the fact that many existing information
technology ("IT") hardware and software systems and non-information technology
("non-IT") products containing embedded microchip processors were originally
programmed to represent any date with six digits (e.g., 12/31/99), as opposed to
eight digits (e.g., 12/31/1999). Accordingly, problems may arise for many such
products and systems when attempting to process information containing dates
that fall after December 31, 1999. As a result, many such products and systems
could experience miscalculations, malfunctions or disruptions. This problem is
commonly referred to as the "Year 2000" problem, and the acronym "Y2K" is
commonly substituted for the phrase "Year 2000."
At this time, the Company believes that all of the significant internal IT
and non-IT systems with potential Y2K problems have been repaired, replaced or
upgraded in order to avoid any major business interruption from Y2K issues.
THE COMPANY'S STATE OF READINESS FOR ITS YEAR 2000 ISSUES
As a result of the Company's software upgrades and computer system
purchases over the past few years, a substantial number of EDMC's computer
systems should not have a Y2K problem (i.e., are "Y2K-compliant") or have been
warranted to be Y2K-compliant by third-party vendors. The Company created a task
force (the "Y2K Task Force") which has members from the Company's significant
operating areas. The Y2K Task Force implemented a program, the goal of which was
to assess the potential exposure of each such area to the Y2K problem, the first
phase of EDMC's overall Y2K program, and, as the second phase thereof, designed
a coordinated plan to determine whether any such potential exposure would result
in a problem that would require some remediation. As each such area's Y2K
problems have been identified, the third phase has been to formulate proposals
to determine the best course of action to address each such problem, implement
the solution and develop contingency plans to the extent possible and necessary.
The final phase of the overall Y2K program is both independent and coordinated
testing to ensure Y2K compliance in each operating area.
The Y2K Task Force has the responsibility for addressing any Y2K problems
in either IT or non-IT systems. The Company has completed the
assessment/inventory phase for its IT systems, including its accounting, human
resources, admissions, education, student financial services and student
services systems. The Y2K Task Force reports that testing of EDMC's most
critical IT systems is substantially completed. The Y2K Task Force has also
substantially finished its identification of non-IT systems that may have Y2K
problems, and has sent inquiries to the entities that own or control any of
those non-IT systems, including elevators, electricity, telephones, security
systems and HVAC systems, that could have a material impact on the Company's
operations, such as the owners of the buildings and other facilities that house
or service the Company's schools and administrative offices. The Y2K Task Force
has also identified those third parties, such as governmental and other
regulatory agencies, guaranty agencies, software and hardware suppliers,
telephone companies, significant vendors and external file exchange system
providers, whose Y2K compliance or lack thereof may pose problems for the
Company. Pursuant to the Y2K Task Force's plan, inquiries have been sent to
those third parties. All entities have responded with Y2K compliance plans that
appear to be adequate. However, the Company can not independently verify each
agency.
THE COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES
To date, the Company has incurred approximately $150,000 of costs directly
associated with its efforts to address its Y2K issues. This amount does not
include an allocation of salaries of EDMC personnel participating in this
effort. Nor does it include recent hardware, software, or systems purchases
which are, or have been, warranted to be Y2K-compliant. Based upon its current
understanding of the Company's Y2K issues, the Y2K Task Force anticipates
additional direct costs ranging from $250,000 to $350,000, will be incurred to
address
24
25
these issues. This represents a reduction from previous estimates ranging to
$750,000. Of the remaining cost to be incurred, approximately $150,000 will be
used, if necessary, to replace technology hardware and software at Company
schools; $100,000 is budgeted for contingency plan implementation, if necessary.
The Company plans to charge its direct Y2K expenses to its information systems
budget. All Y2K-related expenditures are expensed as incurred.
RISKS RELATED TO THE COMPANY'S YEAR 2000 ISSUES
The Company has identified several possible worst-case scenarios that could
arise because of Y2K issues; however, at this time, the Company does not have
sufficient information to make an assessment of the likelihood of any of these
worst-case scenarios. It should be noted that the Company's schools will not be
in session on December 31, 1999 or January 1, 2000, with classes resuming in
mid-January 2000.
The Company has shifted resources to the resolution of Y2K issues. This has
resulted in the deferral of some existing or contemplated projects, particularly
computer-system oriented projects. Although the Company is unable at this time
to quantify its internal, indirect costs resulting from such changes, with its
resultant deferral of projects, management believes that the cost of remediating
the Company's internal Y2K problems will not have a material adverse impact upon
its business, results of operations, liquidity or financial condition.
Because the Company is in a regulated industry and relies, indirectly, on
only a few sources for a substantial portion of its revenues, EDMC's business is
very dependent upon those entities' efforts to address their own Y2K issues. The
Y2K Task Force has identified those third parties whose failure to resolve their
own Y2K issues could have a material impact upon the Company's operations, and
is taking steps it currently believes appropriate to analyze both such parties'
Y2K status and the Company's options in the event that any such party is not
Y2K-compliant in sufficient time prior to December 31, 1999. Should any such
third parties experience Y2K-related disruptions, it could have a material
adverse impact on the Company's business, results of operations, liquidity or
financial condition.
For example, as with all postsecondary education-oriented businesses whose
students receive governmental financial aid, the Company's operations and
liquidity depend upon the student funding provided by Title IV Programs for its
students. The U.S. Department of Education's computer systems handle processing
of applications for this funding. The U.S. Department of Education has stated
that its systems are Y2K-compliant. The Company has successfully completed file
exchange tests with the U.S. Department of Education. Any problems with the U.S.
Department of Education's systems could result in an interruption in the funding
for students nationwide, including the Company's students. Any prolonged
interruption could have a material adverse impact upon the education industry
and, accordingly, upon the Company's business, results of operations, liquidity
and financial condition.
Similarly, the Company's schools are licensed by one or more agencies in
the states in which they are based and accredited by one or more accrediting
bodies that are recognized by the U.S. Department of Education. The Company
continues to assess the Y2K-readiness of these agencies and bodies. In the event
that any of these entities are unable, due to Y2K problems, to renew a school's
license or accreditation, an interruption in such school's operations could
occur. Depending upon the school involved, a prolonged interruption could have a
material adverse impact upon the Company's business, results of operations,
liquidity and financial condition.
Five guaranty agencies provide the vast majority of the guarantees for the
loans issued to the Company's students under Title IV Programs. The Company has
completed file exchange tests successfully with the agency that accounts for
approximately 85% of those guarantees. The Company is investigating all these
agencies to determine whether they will be Y2K-compliant or whether contingency
plans need to be made with respect thereto. As with the U.S. Department of
Education, the Company is unable to assess independently the readiness of any of
these agencies at the present time, although all such agencies have reported
that they are Y2K-compliant. The majority of the Title IV Program loans to the
Company's students are funded through six banks, five of which work with the
Company's primary guaranty agency. The five lenders that work with that agency
use an affiliate of that agency to disburse and service their loans, and the
Company has successfully completed file exchange tests with the affiliated
agency. The Company is exploring as a contingency plan the availability of other
lenders that have stated that they expect to be Y2K-compliant.
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The Company has also reviewed the Y2K compliance efforts of its transfer
agent and of the NASDAQ National Market System and does not anticipate any
serious disruptions in service from these providers.
The Y2K Task Force has made inquiries of the major financial institutions
and utilities that provide services to the Company and continues to assess the
potential effects of those entities' failures to become Y2K-compliant within the
time remaining. If, notwithstanding any such entity's representations that it
will be Y2K-compliant in time, it is not compliant, the Company's business,
results of operations, liquidity and financial condition could be adversely
affected.
CONTINGENCY PLANS
The Y2K Task Force's responsibilities include developing contingency plans
for each of EDMC's significant operating areas. These contingency plans would be
utilized in the event that, despite the Company's best efforts, or due to the
Company's lack of control over certain third parties, a system is not
Y2K-compliant and EDMC's business is adversely affected. Each operating area is
preparing a contingency plan to operate for up to three consecutive days without
standard computer support. In addition, the Company maintains a "hot site"
contract with Hewlett-Packard that allows it to run its day-to-day central
computer operations from a remote location in Washington State. The "hot site"
is a contingency against a regional Y2K failure that would cause business
interruptions at the Company's corporate offices in Pittsburgh, Pennsylvania.
The Y2K Task Force expects to have substantially all of its contingency plans in
place by December 1, 1999.
RISK FACTORS
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 2000 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 which markets 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; (vi) the Company's ability to defend litigation successfully; and
(vii) competitive pressures from other educational institutions.
ITEM 7A-- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The fair values and carrying amounts of the Company's financial
instruments, primarily accounts receivable and debt, are approximately
equivalent. The debt instruments bear interest at floating rates based upon
market rates or at fixed rates that approximate market rates. All other
financial instruments are classified as current and will be utilized within the
next operating cycle.
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ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES:
We have audited the accompanying consolidated balance sheets of Education
Management Corporation (a Pennsylvania corporation) and Subsidiaries as of June
30, 1998 and 1999, and the related consolidated statements of income,
shareholders' investment and cash flows for each of the three years in the
period ended June 30, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Education Management
Corporation and Subsidiaries as of June 30, 1998 and 1999, and their results of
operations and their cash flows for each of the three years in the period ended
June 30, 1999 in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Pittsburgh, Pennsylvania,
July 28, 1999
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
AS OF JUNE 30,
--------------------
1998 1999
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents, including restricted balances
of $777 and $725....................................... $ 47,310 $ 32,871
Receivables:
Trade, net of allowances of $8,318 and $9,367.......... 7,689 10,100
Notes, advances and other.............................. 3,989 5,233
Inventories............................................... 1,933 2,038
Deferred income taxes..................................... 2,361 2,476
Other current assets...................................... 2,341 2,991
-------- --------
Total current assets................................. 65,623 55,709
-------- --------
PROPERTY AND EQUIPMENT, NET................................. 57,420 96,081
DEFERRED INCOME TAXES AND OTHER LONG-TERM ASSETS............ 6,287 7,614
GOODWILL, NET OF AMORTIZATION OF $3,873 AND $4,484.......... 19,453 19,342
-------- --------
TOTAL ASSETS......................................... $148,783 $178,746
======== ========
LIABILITIES AND SHAREHOLDERS' INVESTMENT
CURRENT LIABILITIES:
Current portion of long-term debt......................... $ 2,615 $ 731
Accounts payable.......................................... 6,982 12,110
Accrued liabilities....................................... 10,162 11,438
Advance payments.......................................... 18,338 20,909
-------- --------
Total current liabilities............................ 38,097 45,188
-------- --------
LONG-TERM DEBT, LESS CURRENT PORTION........................ 35,767 36,500
DEFERRED INCOME TAXES AND OTHER LONG-TERM LIABILITIES....... 1,594 253
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' INVESTMENT:
Common Stock, par value $.01 per share; 60,000,000 shares
authorized; 28,998,892 and 29,546,833 shares issued.... 290 295
Additional paid-in capital................................ 88,880 93,736
Treasury stock, 78,802 and 85,646 shares at cost.......... (354) (495)
Stock subscriptions receivable............................ (8) --
Retained earnings (accumulated deficit)................... (15,483) 3,269
-------- --------
TOTAL SHAREHOLDERS' INVESTMENT....................... 73,325 96,805
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' INVESTMENT....... $148,783 $178,746
======== ========
The accompanying notes to consolidated financial statements are an integral
part of these statements.
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE YEARS ENDED JUNE 30,
--------------------------------
1997 1998 1999
---- ---- ----
NET REVENUES............................................... $182,849 $221,732 $260,805
COSTS AND EXPENSES:
Educational services..................................... 120,918 147,336 170,742
General and administrative............................... 41,036 48,094 57,162
Amortization of intangibles.............................. 2,076 1,611 1,203
-------- -------- --------
164,030 197,041 229,107
-------- -------- --------
INCOME BEFORE INTEREST AND TAXES........................... 18,819 24,691 31,698
Interest expense (income), net........................... 1,603 (3) (113)
-------- -------- --------
INCOME BEFORE INCOME TAXES................................. 17,216 24,694 31,811
Provision for income taxes............................... 7,231 10,372 13,059
-------- -------- --------
NET INCOME................................................. $ 9,985 $ 14,322 $ 18,752
======== ======== ========
INCOME AVAILABLE TO COMMON SHAREHOLDERS:
Dividends paid on Series A Preferred Stock................. $ (83) $ -- $ --
Redemption premium paid on Series A Preferred Stock........ (107) -- --
Dividends accrued on Series A Preferred Stock, but not
paid..................................................... (296) -- --
-------- -------- --------
Net income available to common shareholders -- basic....... $ 9,499 $ 14,322 $ 18,752
Net income available to common shareholders -- diluted..... $ 9,878 $ 14,322 $ 18,752
INCOME PER SHARE:
Basic................................................. $ .40 $ .50 $ .64
Diluted............................................... $ .36 $ .48 $ .61
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (IN 000'S):
Basic................................................. 23,878 28,908 29,314
Diluted............................................... 27,342 29,852 30,615
The accompanying notes to consolidated financial statements are an integral
part of these statements.
29
30
EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
FOR THE YEARS ENDED JUNE 30,
--------------------------------
1997 1998 1999
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 9,985 $ 14,322 $ 18,752
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FLOWS FROM
OPERATING ACTIVITIES:
Depreciation and amortization........................ 12,343 14,316 16,766
Vesting of compensatory stock options................ 375 -- --
Deferred credit for income taxes..................... (1,613) (1,184) (1,992)
Changes in current assets and liabilities:
Receivables....................................... (158) (1,084) (3,655)
Inventories....................................... (73) (577) (105)
Other current assets.............................. 443 (87) (650)
Accounts payable.................................. 1,993 1 57
Accrued liabilities............................... 2,269 473 3,940
Advance payments.................................. 2,715 2,413 2,571
-------- -------- --------
Total adjustments............................... 18,294 14,271 16,932
-------- -------- --------
Net cash flows from operating activities.......... 28,279 28,593 35,684
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of subsidiaries, net of cash acquired......... (9,753) (1,488) (500)
Expenditures for property and equipment................... (18,487) (17,951) (49,862)
Other items, net........................................