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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001
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or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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Commission file number: 333-42530
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eSylvan, Inc.
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(Exact name of registrant as specified in its charter)
Maryland 52-2257470
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer
Identification No.)
506 South Central Avenue, Baltimore, Maryland 21202
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(Address of principal executive offices) (ZIP Code)
(410) 843-2622
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name Of Each Exchange
Title Of Each Class On Which Registered
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None None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
On March 25, 2002, the aggregate value of the voting stock held by
non-affiliates of the Registrant, based upon the price at which the Common Stock
was sold, was none (affiliates being, for these purposes only, directors,
executive officers and holders of more than 5% of the Registrant's Common
Stock.)
As of March 25, 2002, the registrant had 14,000,000 outstanding shares of
Common Stock and 2,452,484 outstanding shares of Class A Convertible Common
Stock.
ESYLVAN, INC.
2001 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I. PAGE
ITEM 1. Business .................................................................................. 3
ITEM 2. Properties ................................................................................ 17
ITEM 3. Legal Proceedings ......................................................................... 18
ITEM 4. Submission of Matters to a Vote of Securities Holders ..................................... 18
PART II.
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters ................. 18
ITEM 6. Selected Financial Data ................................................................... 18
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................................................. 20
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk ................................ 24
ITEM 8. Financial Statements and Supplementary Data ............................................... 25
ITEM 9. Changes In and Disagreements with Accountants and Accounting
and Financial Disclosure .................................................................. 25
PART III.
ITEM 10. Directors and Executive Officers of the Registrant ........................................ 25
ITEM 11. Executive Compensation .................................................................... 27
ITEM 12. Security Ownership of Certain Beneficial Owners and Management ............................ 31
ITEM 13. Certain Relationships and Related Transactions ............................................ 31
PART IV.
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ........................... 34
PART I.
ITEM 1: BUSINESS
Overview
eSylvan, Inc., (the Company") was incorporated by Sylvan Learning Systems,
Inc. ("Sylvan") on February 3, 2000 under the laws of the state of Maryland for
the purpose of delivering high quality supplemental education programs to
students through internet-based applications. Prior to incorporation and upon
inception on October 1, 1999, the Company operated as an unincorporated division
of Sylvan. On June 30, 2000, Sylvan contributed substantially all of its
ownership in the Company to a newly formed majority-owned subsidiary of Sylvan,
Sylvan Ventures, LLC ("Sylvan Ventures").
We are a development stage company that delivers individualized
supplemental education to families and children via applications on the
Internet. Through our fee-based services, we deliver diagnostic and prescriptive
instruction in real time. Our services are comparable to services that Sylvan
provides in its traditional bricks and mortar learning center environment. Since
our inception, we have focused on leveraging our licensed right to use Sylvan
intellectual property, including the Sylvan instructional methodology, the
Sylvan brand, and our marketing partnership with Sylvan to create various
referral opportunities between eSylvan and Sylvan Learning Centers. Using these
assets as a foundation, we have made substantial investments in technology and
education resources and have developed the capability to provide these services
over the internet. In addition to delivering our tutoring services to individual
students, we are also conducting a pilot offering of these services to school
districts.
We have launched our website, commenced delivering services to the public
and started recognizing revenue in October 2000. Until October 2000, our
operations consisted primarily of organizational and capital raising activities,
research and analysis with respect to Internet education industry opportunities,
and the development of our technical and operational infrastructure.
We maintain our corporate offices at 506 South Central Avenue, Baltimore,
Maryland 21202. Our telephone number is (410) 843-2622. Our Internet Web Site
address is http://www.esylvan.com
K through 12 Distance Learning Through the Internet
We believe that the broad accessibility of the Internet and its real-time
interactive nature make it an ideal platform for K through12 distance learning.
Learning online encourages students to participate in classes and activities at
times that are convenient for them from a variety of geographic locations,
particularly their own homes. Online learning allows both students and parents
additional flexibility by eliminating transportation requirements. According to
a Nielsen/Net Ratings report issued in January 2002, consumers now spend 2.3
billion hours online each month. We believe that growth in internet usage
provides a rapidly expanding market for distance learning. In order to meet this
demand, we believe that education providers face several challenges in
delivering education over the Internet. We believe that effective online
learning requires that students receive:
. Comparable experience and results to in-person learning
. Access to content
. Access to qualified teachers and tutors
. The ability to track results
The eSylvan solution
We offer two- or three-to-one, diagnostic and prescriptive instruction over
the Internet for students who are seeking a highly individualized and convenient
program of supplemental academic help. By providing instructional services at
home, eSylvan makes the tutoring process more convenient for both the student
and the parent, because instructional sessions are conducted without the need to
drive. Modeled after Sylvan's center-based program, our Internet-based program
requires from four to six months to complete and generally comprises 40 to 60
hours of instruction. We provide instruction on average twice a week in one-hour
sessions, and our Academic Directors schedule parent conferences periodically
during the program. Throughout a student's course of study, we test
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students using specially designed mastery tests, and we share the results with
parents on an ongoing basis. We offer our online tutoring programs at prices
that are comparable to the prices of similar programs offered by most private
tutors and learning centers.
Each of our teachers is a certified teacher who completes a formalized
training program prior to teaching their initial student session. This ensures
that the quality of our services are consistent from teacher to teacher and
allows us to offer our parents a guarantee. eSylvan guarantees that each math
and reading student will progress one full grade-level equivalent in 36 hours of
instruction, or we will provide 12 additional hours of instruction at no
additional charge.
Content
We use tutoring content for our core reading and math programs based upon
Sylvan's Individual Learning Objectives (ILO) tutoring curricula. The ILO
tutoring curricula provide a measurable academic outcome from a series of
activities or curriculum based programs and has been tested and proven to be
effective through 22 years in the market covering more than one million
students. We have spent a significant portion of our efforts to date in
converting the ILO curricula into an internet-deliverable format. Given the
breadth of the offerings available from Sylvan and the expansion of these
offerings that we have done to date we are not dependent upon other third
parties for educational content.
Marketing
Our customer acquisition and retention strategy includes the following
marketing activities:
. Direct Response Marketing. The majority of our students currently come
to us through our on-line marketing campaigns. Utilizing knowledge
gained through our efforts to date and through Sylvan's experiences,
we have established a network of providers of web based advertising
and are constantly working to refine this network to ensure that we
are obtaining the highest quality audience at the lowest possible
cost. We may expand our sources of students in the future through
efforts in other media areas that may include radio, television and
print as well as direct mail. We also believe that as we expand our
student population that we will see significant numbers of referrals
from our current and former students.
. Sylvan Referrals and Cross Marketing. We intend to capitalize upon the
distribution strengths of Sylvan to pursue referrals from Sylvan's
system of products and services. We intend to pursue cross-promotion
opportunities with existing and former Sylvan customers in
cross-referral relationships developed with Sylvan's franchised
learning centers.
. Marketing Relationships. We believe that we have an opportunity to
establish ourselves as the educational services provider of choice for
other websites that also target the K through 12th grade market, our
selected demographic. We can work with potential partners to provide a
revenue sharing or referral fee based payment for students referred to
us from the partners' web sites. We believe this will result in a
mutually beneficial relationship as our partners can expand the nature
of services provided to their visitors and receive a fee for referrals
while we gain highly desirable leads for potential customers.
Technology
Our service offerings are supported by a technical infrastructure developed
to provide effective interaction over the Internet for students and instructors
and an operational support environment for effective business operation. Our
technical infrastructure includes commercial technologies that have been
integrated by our technology staff with some outsourcing to consulting firms.
The primary interface to our learning environment is a personal computer
equipped with a 56K modem connection to the Internet. We supply each student and
instructor with an audio headset, a microphone and a special pen-shaped mouse.
All these components are commonly available retail products. Students gain
access to our online program by entering our website where information on
learning programs is presented. When registered for a learning program, students
interact with instructors in real time through an audio/visual session, where
existing
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technologies permit simultaneous voice and data transmission over the Internet
connection. This learning environment permits the instructor to control a
tutoring session for up to three students per session. Instructors can present
curriculum associated content on a whiteboard on the student's computer, which
both parties can simultaneously reference and markup or annotate. The whiteboard
may also be used without content so that either party in the session can use
freeform drawing tools for illustration purposes. In addition to our technical
infrastructure, we also have licensed access to technology based solutions
developed by Sylvan. Included in this licensed technology are the following key
items:
. Teach 2000. The Teach 2000 software delivers content on demand in the
learning center environment and tracks the instructional delivery
process as teachers and students work through a personalized
instruction plan. Based on this software, we have developed an
application to provide a complete learning environment for students
and instructors that can be accessed through the Internet.
. Shortcut to Success/Sylvan Automated Assessment System. STS/SAAS
delivers and scores a variety of tests for students that enroll at
Sylvan. These software systems are seamlessly integrated to deliver
diagnostic and prescriptive tests that pinpoint a student's skill
gaps, analyze a student's test results to prepare a personalized
instruction profile and create initial and on-going parent conference
reports to monitor progress. We have licensed this program from Sylvan
and adopted it for use on the Internet.
Together, these two pieces of software allow us to create unique programs
for each student and to track student progress as the programs are delivered to
students. U.S. patents are pending for these proprietary software programs.
Sylvan will hold the patents and the software will be used under license from
Sylvan.
We have also developed and continue to develop several administrative
applications to support our learning environment. Our customer relationship
management system permits us to retrieve student-specific data including
specific tutoring session schedules.
Competition
We believe that the key competitive factors in our market are:
. Technology, expertise and capabilities
. Brand recognition
. Content and instructional methodology
. Access to capital
We compete in the tutoring market against both traditional bricks and mortar
providers of educational services and companies that are implementing an online
business plan.
. Individual Tutors. We compete with individual home tutors who serve
high-income families. In most geographic areas, individual tutors form
the largest share of the tutoring market. We may also compete with
state and local education agencies that fund individual tutoring. Our
experience to date indicates we do not substantially compete with
traditional Sylvan Learning Centers who serve a segment of the market
highly desirous of face-to-face services.
. Online Providers. We compete with several companies that currently
participate in the online tutoring market. Further, we expect that
many existing bricks and mortar tutoring companies, and others, will
begin to distribute their services over the Internet in the near
future. We believe that our services differ significantly from those
currently offered by these companies. Other online providers currently
provide a portion of our services, but we are not aware of any other
companies that provide the full range of services that we provide.
Current competitors generally provide either a chat-only homework help
service, or provide only a whiteboard for instruction with no
available assessment, content or measurable results. Others may
provide a synchronous access to content, but no live instruction. A
variety of models like these, though they differ from ours, will
compete with us for market share.
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. New Entrants. As Internet and broadband services become more widely
deployed in the K through 12 market, we believe new and as yet
unidentified companies will enter the market. Traditional media
companies and rapidly expanding Internet companies represent potential
new competition.
Many of our current and potential competitors have longer operating
histories and greater customer or user bases, brand recognition and greater
financial, marketing and other resources than we do. In addition, many of these
competitors can devote substantially greater resources to product development,
marketing and promotional campaigns and website and systems development than we
can.
Relationship with Sylvan and Sylvan Ventures
Sylvan has created eSylvan as a stand-alone corporation to separate its
online educational services business plan from Sylvan's other businesses and to
facilitate capital raising. Although we have hired a seasoned management team
and built a staff, we will continue to be dependent for the foreseeable future
upon the resources provided by Sylvan and Sylvan Ventures for the execution of
our business plan. Currently, 100% of our funding requirements are derived from
commitments from Sylvan Ventures.
Sylvan Learning Centers
Sylvan seeks to provide educational services with consistent, quantifiable
results, and has delivered its core educational services to more than 1.2
million students primarily in grades three through eight over the past 22 years.
In 2001, Sylvan provided services to over 140,000 students through its nearly
900 centers in North America. Sylvan offers programs for students of all ages
and skill-levels who want to catch up, keep up or get ahead. Sylvan's range of
programs includes beginning, academic and accelerated reading; basic math,
algebra I and II and geometry; writing and composition; study skills; and
SAT/ACT preparation. In addition, Sylvan offers certified high school courses
for credit in geometry, algebra I and II, trigonometry, pre-calculus and English
9, 10 and 11.
Services provided to us by Sylvan
Professional Services Agreement
Student Referrals. We may elect to participate in a cross referral program
whereby we and Sylvan receive payments for each student referred to each other.
Under the referral program, we will receive or pay amounts equal to five
percent, up to a maximum of $100, of all revenues received by Sylvan or us,
respectively, for the programs to which each referred student initially
subscribes, including testing and registration fees. For each student enrollment
a Sylvan franchisee generates for us, we will pay Sylvan a sales commission of
five percent, up to a maximum of $100, of the revenues we receive for the first
programs to which such student initially subscribes through the franchisee's
center.
Professional Services. Prior to assigning a diagnostic and prescriptive
instructor to a referred student, we must request Sylvan to provide an
instructor for a committed period. In the event Sylvan does not provide an
instructor, we may use instructors that are not provided by Sylvan. In the event
Sylvan makes personnel available for committed periods, we shall reimburse
Sylvan for the salary of such instructors or other personnel at an hourly rate
based on the base compensation such person receives from Sylvan. In addition to
salary reimbursement, Sylvan shall receive a 30% management fee for each hour of
direct instruction or test administration, including some specified preparation
time, or parent conferences (calculated as a salary reimbursement multiplied by
30%). Additional services to be provided to us by center personnel and
corresponding fees may be arranged subsequently. If Sylvan refers instructors to
us on an independent contractor basis, we will pay Sylvan a referral fee of
$100.
Co-Marketing. We have agreed with Sylvan that we will provide a link to
Sylvan's website on our website and Sylvan will provide a link to our website on
its website. Sylvan has agreed to adhere to our reasonable directives concerning
promotion of our business including displaying posters or other promotional
materials in Sylvan-owned centers and requesting its franchisees to display
posters or other promotional materials in their centers.
License Agreement
We have entered into a license agreement with Sylvan under which we have
licensed certain of the materials that we believe are necessary to implement our
business plan as follows:
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. "eSYLVAN," "eSYLVAN.COM", and the associated Internet domain name,
"1-800-eSylvan", "SYLVAN", "SYLVAN LEARNING CENTER," "SYLVAN LEARNING
CENTERS," "SYLVAN LEARNING SYSTEMS" and such other trade names,
trademarks, service marks, associated logos and symbols as may be
designated by Sylvan in writing.
. The Sylvan system, which includes, but is not limited to, Sylvan's
proprietary programs, systems and techniques and certain copyrighted
materials, all software and computer programs necessary to offer the
online educational services and such other content as may be
designated by Sylvan in writing.
. New materials, modifications, enhancements and improvements related to
the above (subject to an additional license fee).
The licenses of Sylvan's trademarks and content as described in the bullets
above are limited to use in connection with our Internet business in the United
States and Canada. For the duration of this agreement and for one year
thereafter, we have agreed not, directly or indirectly, to engage in or compete
with any of Sylvan's site based businesses or centers offering certain
educational services. For the duration of this agreement and for one year
thereafter, Sylvan has agreed not, directly or indirectly, to engage in or
compete with any of our fee-based educational services that are provided online
to students, other than those services provided online to students at any of
Sylvan's site based businesses or centers.
Under this agreement, we have agreed to co-develop with Sylvan a
confidential operations manual, which may be revised by Sylvan from time to
time, to govern the use of Sylvan's intellectual property in our business. We
have agreed that in order to promote Sylvan's intellectual property in
connection with our business, we will expend quarterly at least six percent of
our prior quarter's gross revenues on advertising approved by Sylvan.
Under this agreement, we have the right to modify Sylvan's intellectual
property or create derivative works and Sylvan has the right to modify any
software or materials that we create or develop for our business or create
derivative works from our software and materials. We will own any copyright in
the derivative works created by us and we have agreed to license to Sylvan these
derivative works for no additional consideration. We have agreed that Sylvan
will own any copyright in the derivative works created by it from our
intellectual property and that Sylvan will license to us these derivative works
for no additional consideration. With respect to certain other intellectual
property that we develop for our business, including software and other
materials, Sylvan will have 30 days from the date it receives notice that we
have developed this material to notify us of its desire to license it. Any
license will be for a reasonable fee designed to permit us to recoup our
development costs on a proportional basis across all the products or services in
which we will commercialize the material. We will have 30 days from the date we
receive notice that Sylvan has developed or created any new intellectual
property, including software or other materials, related to its learning center
business to notify Sylvan if we desire to obtain a license of that content. Any
license will be for a fee based on financial terms offered to all of its
franchise licensees.
We have paid Sylvan an initial license fee of $1 million and we have agreed
to pay Sylvan a periodic, running royalty equal to four percent of our net
revenues (gross revenues less discounts and refunds) and an additional amount
equal to any sales, gross receipts or similar tax imposed on Sylvan. The initial
license fee of $1 million was agreed to be an initial capital contribution by
Sylvan, and no cash was paid for the initial license fee. During 2001 there will
be no guaranteed minimum royalty, but for each calendar year thereafter, there
will be a guaranteed minimum royalty equal to 120% of the prior year's minimum
royalty, with the guaranteed minimum royalty for calendar year 2002 of $400,000.
As part of our arrangement with Sylvan, Sylvan has agreed to reduce future
royalty payments due under the terms of the license agreement by the amounts
that we paid to Sylvan franchisees who received shares of our Class A
Convertible Common Stock. We have accounted for the payments to Sylvan
franchises as prepaid royalties under our agreement with Sylvan.
This agreement has an initial term of five years and it will terminate on
the fifth anniversary of the effective date; provided, however, that the license
with respect to content is for the duration of the applicable copyrights and
will not otherwise terminate. We have the option to serially renew the agreement
for unlimited consecutive five-year terms and no initial license fee will be
owned for such renewal terms.
We have agreed to cooperate with Sylvan for the protection of the
intellectual property licensed to us. Sylvan has agreed, at its expense, to
defend and indemnify us from certain claims brought against us in the United
States based upon any infringement of United States intellectual property rights
with respect to only the licensed
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trademarks and service marks and not the licensed content; provided, however,
that Sylvan's liability is limited to the amount of royalties paid by us within
the one year preceding the date upon which we make a demand for indemnification.
We have agreed to defend any action, suit or proceeding brought against Sylvan
based upon or arising out of our operation of our business.
Services Agreement
Sylvan has agreed to provide management services, MIS support services,
corporate accounting services, PeopleSoft (database management) services, human
resources/payroll services and legal services to us on an independent contractor
basis at fees that are fair and reasonable, as jointly determined by us and
Sylvan for the services provided based on our utilization of such services. Fees
that have been billed but that have not been paid within 30 days shall accrue
simple interest at the prime rate plus one percent per annum. This agreement,
which had an initial term of one-year, has been extended through June 30, 2002
and can be terminated at any time on 60 days notice.
Facility Use Agreement
Sylvan has agreed to provide us with the use of its facilities for a
monthly use fee based upon Sylvan's good faith estimate of our use of such
facilities. In the event Sylvan owns a facility, the use fee is based on market
rent. In the event Sylvan leases a facility, the use fee is based on Sylvan's
lease payments. We currently occupy office space pursuant to this agreement.
This agreement, which had an initial term of one-year, has been extended through
June 30, 2002 and can be terminated at any time on 60 days notice.
Sylvan Ventures, LLC
Founded in February 2000, Sylvan Ventures develops and invests in
educational technology companies, providing them with access to brands, content
and resources of its parent company Sylvan.
Funding provided to us by Sylvan Ventures includes:
. A revolving line of credit in the amount of $10 million, which
originally terminated on December 31, 2001, and has been extended
through December 31, 2002. Sylvan Ventures and the Company have agreed
that the balance outstanding under the line of credit on December 31,
2001 will be repaid from the proceeds of the sale of Series A
preferred stock discussed below.
. An investment of $20 million in return for 10,526,316 shares of our
Series A preferred stock as of December 31, 2001. In February 2002,
Sylvan Ventures purchased an additional 4,947,368 shares of our Series
A preferred stock for $9.4 million.
Sylvan Learning Center Franchisees
During December 2000, we filed a Registration Statement on form S-1 for the
registration of up to 3,000,000 shares of our Class A Convertible Common Stock
to be issued to Sylvan Learning Center franchisees participating in the
offering. On March 30, 2001, we issued 2,452,484 shares of Class A Common Stock
pursuant to the receipt of executed participation agreements from certain Sylvan
Learning Center franchisees that provide for support of the delivery of our
services to students living in the relevant franchisees territory. In connection
with this offering, we were obligated to pay an amount in cash to each Class A
Convertible Common Stock shareholder equal to $0.35 multiplied by the number of
shares received. In April 2001, we paid an aggregate amount of $858,385 to the
shareholders. These payments have been recorded as prepaid royalties to Sylvan
as the license agreement with Sylvan provides for the offset of this payment
against any future royalties due Sylvan. We are not able to deliver our services
to students in territories for which the relevant franchisee has elected not to
participate.
Government Regulation And Legal Uncertainties
There are an increasing number of laws and regulations pertaining to the
Internet. In addition, a number of legislative and regulatory proposals are
under consideration by federal, state and local governments and agencies.
Recently, the United States Congress enacted Internet legislation regarding
children's privacy, copyrights and taxation. Other laws or regulations may be
adopted with respect to online content regulation, user privacy, pricing,
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taxation and quality of products and services. Any new legislation or
regulation, or the application or interpretation of existing laws, may decrease
the growth in the use of the Internet, which could in turn decrease the demand
for our service, increase our cost of doing business or otherwise have a
material adverse effect on our prospects and revenues.
Liability for information retrieved from our website and other websites
Content may be accessed on our website or on other Internet sites that
are linked to our website. This content may be downloaded by users and
subsequently transmitted to others over the Internet. By providing those links,
we may be exposed to claims that we are liable for wrongful actions by the
owners of these sites. Claims of this nature have been brought, sometimes
successfully, against providers of Internet services. We could also be exposed
to liability with respect to third-party content that may be posted by users in
chat rooms or bulletin boards, which may be offered on our website. We also may
be subject to claims, alleging that we, by directly or indirectly providing
links to other websites, are liable for copyright or trademark infringement or
the wrongful actions of third parties through their respective websites. The
Digital Millennium Copyright Act of 1998 established limited liability for
online copyright infringement by online service providers for listing or linking
to third party websites that include copyright-infringing materials. Although we
hold general liability insurance, that insurance may not cover all potential
claims to which we are exposed and may not be adequate to indemnify us for all
liability that may be imposed. Any imposition of liability that is not covered
by insurance or is in excess of insurance coverage could result in significant
expense and cash demands, which would adversely affect operating results and
financial condition. Even to the extent that these claims do not result in
liability, we could incur significant costs in investigating and defending
against these claims, which would also adversely affect our operating results
and financial condition.
Privacy Concerns
The Children's Online Privacy Protection Act of 1998 makes it unlawful
for an operator of a website or online service directed to children under 13 to
collect, use or distribute personal information from a child under 13 in a
manner which violates regulations to be proscribed by the Federal Trade
Commission (FTC). The FTC has issued final regulations, which concern the scope
of this Act's parental consent requirements. The FTC is also considering
adopting regulations regarding the collection and use of personal identifying
information obtained from individuals when accessing websites. Further, the FTC
has conducted investigations into the privacy practices of companies that
collect information on the Internet. The Children's Online Privacy Protection
Act may apply to our business if we collect personal information on persons
under the age of 13. Accordingly, we may be required to obtain verifiable
parental consent for such collection activities and provide parental access to
personal information we maintain about their children. While we believe we will
be able to comply with the regulations that have been promulgated by the FTC to
implement that Act, the present regulations are subject to clarification through
administrative implementation and amendment and the specific means for complying
remain to be developed. The costs of compliance could be a significant element
of our costs of doing business.
Internet Taxation
A number of legislative proposals have been made at the federal, state
and local level that would impose additional taxes on the sale of goods and
services over the Internet and some states have taken measures to tax
Internet-related activities. Although Congress recently placed a three-year
moratorium on state and local taxes on Internet access or on discriminatory
taxes on electronic commerce, existing state or local laws were expressly
excepted from this moratorium. Further, once this moratorium is lifted, some
type of federal and/or state taxes may be imposed upon Internet commerce. This
legislation, or other attempts at regulating commerce over the Internet, may
substantially impede the growth of commerce on the Internet and, as a result,
adversely affect our opportunity to derive financial benefit from those
activities.
Jurisdictions
It is possible that, although our transmissions over the Internet will
originate primarily in Maryland, the governments of other states might attempt
to regulate our transmissions or prosecute us for violations of their laws.
These laws may be modified, or new laws enacted, in the future. Any of these
developments could have a material adverse effect on our prospects, operating
results and financial condition. In addition, as we expect to offer our services
in multiple states and Canada, these jurisdictions may claim that we are
required to qualify to do business as
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a foreign corporation in each of these states or Cananda. As of the date of this
filing, we are not qualified to do business in any state other than Maryland and
California, and our failure to qualify as a foreign corporation in a
jurisdiction where we are required to do so could subject us to taxes and
penalties and could result in our inability to enforce contracts in these
jurisdictions. Any new legislation or regulation, the application of laws and
regulations from jurisdictions whose laws do not currently apply to our
business, or the application of existing laws and regulations to the Internet
and other online services could have a material adverse effect on our prospects,
operating results and financial condition.
Employees
We have approximately 45 full-time and 120 part-time employees. We
expect to hire additional full-time employees as we grow our business. Although
the competition for skilled employees in the Internet and education industries
is intense, we do not now foresee problems in hiring qualified employees to meet
our needs. None of our employees is represented by a union. We consider our
relations with our employees to be good.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Risks and factors described below are not the only ones we face.
Additional risks not presently known to us or that we currently deem immaterial
may also impair our business operations.
Risks Related to Our Business
Our technology for the online delivery of tutoring services is new.
Our online program includes live, voice-based, interactive, three
student to one teacher instruction with tutoring curriculum individualized to
the student based upon a needs assessment supplemented by rewards for student
participation. Although some other companies delivering tutoring services over
the Internet have programs that rely on chat or message board homework help,
these companies generally do not have programs that include one or more of the
key features of our online program. This is primarily because the companies'
existing technology is not sufficiently developed to support our program. The
key features of our technology are new and have been internally developed. This
new technology includes our voice-based interactive instruction, our diagnostic
and assessment software and our content search engine. If we fail to integrate
such technology to provide reliable service to our customers, if our technology
remains incompatible with some of our customer's technology, or if the
reliability of our technology decreases as the number of customers in our
program increases, we may fail to become profitable.
We have only recently commenced recognizing revenues, our accumulated operating
loss since inception is $24.8 million as of December 31, 2001, and we expect to
generate significant operating losses and continue to experience negative cash
flow for the foreseeable future.
We launched our website, commenced delivering services to the public
and started recognizing revenue in October 2000. As of December 31, 2001, we
have generated approximately $476,000 in revenues, and we have incurred expenses
and an accumulated net loss of approximately $24.8 million from inception,
consisting primarily of research and development, sales and marketing, legal,
accounting, consulting, personnel and facilities costs. Our ability to generate
revenue will depend on our ability to attract customers to our online
educational services and improve our content and technology. We believe that our
expenditures for marketing and advertising and personnel will substantially
increase over the next year as we shift from organizational activities, the
development of our technology and initial market testing to the broad based sale
of tutoring services to the public. We also expect to incur substantial expenses
in software and computer hardware, tutoring content and professional fees and
other areas. Because we are a new entrant to the Internet market, these
expenditures may be significantly higher than we anticipate. These expenses are
substantially dependent upon the success of our business plan and marketing and
advertising efforts and factors outside of our control such as lawsuits,
unexpected technical difficulties with our on-line tutoring infrastructure, our
need for additional financing and other factors discussed in this section. Our
expenses generally will precede revenues. If these expenses are not followed by
sufficient revenues, our business
10
may not become profitable. If online tutoring fails to gain acceptance, it is
unlikely that eSylvan will become a viable business.
We have operated as a separate entity for less than two years, and for the
foreseeable future we will remain dependent upon our majority stockholder for
operational support and financing.
From inception on October 1, 1999 through February 2, 2000, we operated
as an unincorporated division of Sylvan, from February 3, 2000 to June 29, 2000,
we operated as a subsidiary of Sylvan. Since June 30, 2000, we have operated as
a majority-owned subsidiary of Sylvan Ventures. Pursuant to separate agreements,
Sylvan provides us with facilities, management services, intellectual property,
including the eSylvan name, marketing referrals and a website link to the Sylvan
website. Our facilities agreement with Sylvan had an initial term of one-year,
has been extended through June 30, 2002 and can be terminated at any time with
60 days notice. Our services agreement with Sylvan had an initial term of
one-year, has been extended through June 30, 2002 and can be terminated at any
time with 60 days notice. Our license agreement with Sylvan has an initial term
of five years; provided, however, that the license with respect to content is
for the duration of the applicable copyrights. We have the option to serially
renew the license agreement for unlimited additional five-year terms. Our
professional services agreement with Sylvan terminates upon the termination or
expiration of the license agreement. Sylvan Ventures has met our financing needs
through December 31, 2001, with a $10 million line of credit, which has been
extended through December 31, 2002, and the purchase of 10,526,316 shares of our
Series A preferred stock for $20 million. In addition, Sylvan Ventures purchased
an additional 4,947,368 shares of our Series A preferred stock in February 2002
for $9.4 million. We believe that we cannot replace the services and
intellectual property that Sylvan provides to us on reasonable terms, if at all.
Accordingly, if Sylvan or Sylvan Ventures terminates its support of our business
plan, we may not be able to continue operations, or if we continue operations,
we may not become profitable. The terms and conditions of these agreements were
not negotiated on an arms-length basis with Sylvan or Sylvan Ventures and,
accordingly, we expect that these terms and conditions may be less favorable to
us than the terms and conditions that might have been negotiated on an
arms-length basis with an unaffiliated third party. We currently have one
independent member of our board of directors.
Fees for diagnostic and prescriptive tutoring services provided to us by Sylvan
may be higher than the cost of such services otherwise available.
Prior to assigning a diagnostic and prescriptive instructor to a
student, we must request Sylvan to provide an instructor for a committed period.
In the event Sylvan does not provide an instructor, we may use instructors that
are not provided by Sylvan. In the event Sylvan makes personnel available for
committed periods, we shall reimburse Sylvan for the salary of such instructors
or other personnel at an hourly rate based on the base compensation such person
receives from Sylvan. In addition to salary reimbursement, Sylvan shall receive
a 30% management fee for each hour of direct instruction or test administration,
including some specified preparation time, or parent conferences. Additional
services to be provided to us by center personnel and corresponding fees may be
arranged subsequently. If Sylvan refers instructors to us on an independent
contractor basis, we will pay Sylvan a referral fee of $100. The terms and
conditions of this agreement were not negotiated on an arms-length basis with
Sylvan and we believe that the terms and conditions are less favorable to us
than the terms and conditions that might have been negotiated on an arms-length
basis with an unaffiliated party. If the cost of tutoring services under our
agreement with Sylvan is greater than can be obtained on the open market, our
higher expenses could affect our ability to compete with other companies that
can obtain tutoring services at lower costs.
We will need additional financing.
We expect to experience negative cash flow from operations for the
foreseeable future. We expect that our available funds will be insufficient to
meet our needs for working capital and capital expenditures prior to July 2002.
Accordingly, we will need to raise additional funds prior to July 31, 2002. We
are unable to predict the exact amount of additional financing we will need
because such amount is substantially dependent upon the success of our business
plan and marketing and advertising efforts and factors outside our control such
as lawsuits, unexpected technical difficulties with our on-line tutoring
infrastructure and other factors discussed under this section. We cannot be
certain that additional financing will be available to us on favorable terms
when required or at all. If we fail to secure the necessary financing, we may
not be able to continue operations.
11
Our business strategy is new, evolving, unproven and subject to change and may
not generate sufficient revenue opportunities.
Our business objective is to become the premier provider of online
tutoring services to the K through 12 market. Our business strategy is new,
evolving and unproven. Due to the rapidly changing nature of the Internet, we
are continuously modifying our business strategy and expect to continue to
modify our strategy in the future. Our business model assumes that we will be
able to attract students and their parents to our fee-based internet tutoring
services. Our current business strategy may not be scalable and, if it is not
scalable, we may not be able to modify it in a timely and successful manner. In
addition, we may not be able to develop successful business strategies to
capitalize on opportunities in new and unproven areas.
Consumers may not accept an online source for tutoring services.
Our success depends on attracting and retaining online consumers. Some
factors that could prevent consumer acceptance of online tutoring services, and
consequently our ability to generate our revenues, include:
. student or parent preference for in-person tutoring relationships,
. pricing that does not meet consumer expectations of finding "the
lowest price on the Internet," and
. lack of consumer awareness of our online presence.
We may fail to retain and integrate key personnel.
Our success depends upon the key members of our management team. Loss
of the services of key members of our senior management team would harm our
business. Our senior management may not perform effectively as individuals or
work together as a team. If we were to lose members of our management team we
may not be able to achieve profitability or raise sufficient capital to allow us
to continue our operations.
We may fail to attract qualified employees.
Our success also depends on our ability to attract, retain and motivate
skilled employees, including trained instructors and information technology
specialists. Competition for these skilled employees is intense. We expect to
experience difficulty in hiring and retaining skilled employees. We have no
employment contracts with our employees.
If we do not establish, maintain and strengthen our brand we may not attract
customers for our services or generate revenue opportunities.
We must expend resources to establish the eSylvan brand and promote our
services. We are in competition with a number of Internet companies currently
seeking to establish their names as dominant brands in the online tutoring
market. As such, we face competition for placement of our advertising on web
sites that attract the appropriate prospects for our services and will also face
additional expenses should we decide to expand our marketing efforts to radio,
television and print media.
We will pursue an aggressive web based direct response marketing
campaign to establish, maintain and grow our brand. Our other advertising
efforts will also be designed to strengthen our brand. Although we commenced
operations in October 2000, we have incurred $3.3 million in sales and marketing
expenses to date through December 31, 2001. In addition, we expect substantial
increases in such expenditures to support our business plan. We expect that the
funds for these efforts will be provided through the sale of our Series A
preferred stock to Sylvan Ventures. See "Management's Discussion and Analysis of
Financial Condition and Plan of Operation-Liquidity and Capital Resources." If
our promotional efforts are unsuccessful, we may fail to generate sufficient
revenues to become profitable.
We face intense competition.
12
We compete with numerous providers of tutoring services, including
other online companies as well as traditional bricks and mortar tutoring
providers. Sylvan Ventures, our majority stockholder, is controlled by Sylvan, a
bricks and mortar provider of tutoring services through company-owned and
franchised learning centers, and, to the extent that Sylvan's customers find
online tutoring to be more convenient, we may compete with Sylvan. Some of our
competitors have greater access to capital than we do and may use these
resources to engage in aggressive advertising and promotion campaigns such as
offering free services to attract new consumers. The current practice of such
aggressive advertising and promotion may generate pricing pressures to which we
must respond.
We expect that competition will continue to increase because of the
relative ease with which new websites may be developed. Individual tutors, for
example, can easily and at low cost establish a rudimentary web presence and
compete with us on the Internet in their local markets. Traditional media
companies and existing bricks and mortar companies can also establish a web
presence with relative ease. The nature of the Internet as an electronic
delivery medium for services, which may, among other things, facilitate
competitive entry and price comparisons, may also render it inherently more
competitive than traditional formats of service delivery. Increased competition
may reduce our gross margins, cause us to lose market share, decrease the value
of the eSylvan brand and prevent us from generating revenues and becoming
profitable.
We may lose users if we do not adapt to rapid technological change and provide
tools and features which meet the changing demands of our users.
The Internet market is characterized by rapidly changing technology,
evolving industry standards and frequent new service announcements. We must
adopt to our rapidly changing market by continuing to improve the performance,
features and reliability of our website and, in particular, its functionality
with new versions of web browsers and other platforms. We also could incur
substantial costs if we need to modify our services or infrastructure in order
to adopt to these changes. If we fail to keep pace with technological
advancements, our consumers may not use our services and instead may use
competitive services. In addition, we must provide informational content,
interactive tools and other features that consumers demand in order to continue
to attract and retain our consumer audiences. We have allocated significant
resources to improve our software and computer hardware and tutoring content.
However, we must properly anticipate, identify and respond to changes in
consumer demands. Notwithstanding these planned expenditures, if we fail to
respond to changes in consumer demand, expand the scope of our content and
services, introduce new services quickly and efficiently, or if our content and
services fail to achieve market acceptance, our ability to retain customers and
generate revenues could be materially and adversely affected.
We may incur expenses for compensation paid to Sylvan for participating in our
program.
We may incur significant expenses for the consideration we are required
to pay to Sylvan if Sylvan provides us with instructors, education developers
and other professionals. Specifically, prior to assigning a tutor to a referred
student for a diagnostic and prescriptive program, we must request Sylvan to
provide a tutor for a committed period for which we reimburse Sylvan for the
salary of such tutor at an hourly rate based on the base compensation such
person receives, and pay Sylvan a 30% management fee per hour of service. If
Sylvan refers instructors to us, we will pay Sylvan a $100 referral fee. The
amount of these fees was not determined through arms-length negotiation and such
fees may be in excess, perhaps substantially so, of the cost to retain such
professionals on the open market from unaffiliated third parties.
Our computer and communications systems may fail or experience delays.
Our success, and in particular our ability to provide quality customer
service, depends on the efficient and uninterrupted operation of our computer
systems. Systems interruptions may result from fire, power loss, water damage,
telecommunications failures, vandalism and other malicious acts and problems
related to our software and equipment. Our website may also experience
disruptions or interruptions in service due to failures by third-party
communications providers. We will depend on communications providers and our
website host to provide our consumers with access to our website. In addition,
our consumers depend on their own Internet service providers for access to our
website. Periodic systems interruptions will occur. These occurrences may cause
consumers to
13
perceive our website as not functioning properly and therefore cause them to
stop using our services. Systems interruptions that last more than a few hours
would harm our business.
We are substantially dependent upon Sylvan for our use of the eSylvan brand.
Sylvan licensed us the right to use the eSylvan name and its other
trademarks and various tutoring content for an initial license fee of $1 million
and a periodic, running royalty equal to four percent of our net revenues and an
additional amount equal to any sales, gross receipts or similar tax imposed on
Sylvan. The initial license fee of $1 million was agreed to be an initial
capital contribution by Sylvan, and no cash was paid for the initial license
fee. During 2001, there was no guaranteed minimum royalty, but for each calendar
year thereafter, there will be a guaranteed minimum royalty equal to 120% of the
prior year's minimum royalty, with the guaranteed minimum royalty for calendar
year 2002 of $400,000. Sylvan has agreed to reduce future royalty payments due
under the terms of the license agreement by the amounts that we paid to Sylvan
franchisees who received shares of our Class A Convertible Common Stock. This
agreement has an initial term of five years and it will terminate on the fifth
anniversary of the effective date; provided, however, that the license with
respect to content is for the duration of the applicable copyrights and will not
otherwise terminate. We have the option to renew the agreement for unlimited
additional five-year terms and no initial license fee will be owed for such
renewal terms. We believe that we cannot replace the intellectual property that
Sylvan has licensed to us under this agreement on reasonable terms, if at all.
Accordingly, if Sylvan terminates the license agreement, we may not become
profitable. The terms and conditions of this agreement were not negotiated on an
arms-length basis with Sylvan and, accordingly, we expect that these terms and
conditions may be less favorable to us than the terms and conditions that might
have been negotiated on an arms-length basis with an unaffiliated third party.
Others may infringe upon or misappropriate our intellectual property rights.
The intellectual property rights that we license from Sylvan for use on
the Internet are critical to our success. These intellectual property rights
include the use of the eSylvan name, the eSylvan.com website and the Sylvan
tutoring content that we have adapted for the online delivery of tutoring
services. We believe that our ability to leverage Sylvan's existing reputation
with respect to the provision of tutoring services in bricks and mortar centers
to generate brand recognition and loyalty for our online tutoring business is
the key to our marketing plans. We will rely on trademark and copyright law,
trade secret protection and confidentiality, license and other agreements with
customers, other companies and others to protect our proprietary rights. The
steps taken to protect this intellectual property may not be adequate, and third
parties may infringe upon or misappropriate our intellectual property rights.
Our efforts to protect our intellectual property rights may result in
litigation. Intellectual property litigation is expensive and can divert
management's attention from the operation of our business.
The market data upon which we have based our business plan may not be accurate
and has not been verified independently.
Much of the market and related data upon which we have based our
business plan including our estimates of future revenues, expenses and required
financing, was obtained from industry publications and reports prepared by
independent sources. We have not independently verified the accuracy of such
information. We have not independently generated or verified this market data
because we do not currently have the capacity to do so, nor do we currently have
the resources to acquire the capacity to do so. The methodology typically used
in compiling market and related data, including the fact that such data are
usually based upon a selected sampling of the market or population rather than a
survey of the market or population as a whole, means that the data are subject
to uncertainties and estimations. If the market data upon which we have relied
in developing our business plan is materially inaccurate our estimates with
respect to future revenues, the expenses necessary to generate future revenues,
need for and timing of future financing and profitability are likely to be
inaccurate which, depending on the nature of such inaccuracies, could affect the
viability of our business plan.
Sylvan Ventures' ownership of over 70% of our outstanding voting stock on a
fully diluted basis and the presence of interlocking directors and officers
could prevent a change of control.
Sylvan Ventures owns a substantial majority of our outstanding voting
stock on a fully diluted basis. Sylvan Ventures is a majority-owned subsidiary
of Sylvan. Christopher Hoehn-Saric, our chairman, chief executive
14
officer and director is a director and former co-chief executive officer and
chairman of Sylvan and chairman, president and a manager of Sylvan Ventures. B.
Lee McGee, our senior vice president, treasurer, assistant secretary and
director is a managing director, chief financial officer and treasurer of Sylvan
Ventures. Robert Zentz, our secretary, assistant treasurer and director is
senior vice president and general counsel of Sylvan and secretary of Sylvan
Ventures. Peter Cohen, our director and assistant secretary, is president of
Sylvan. Susannah Bennett, our assistant secretary, is vice president of Sylvan.
As a result, the directors and officers of Sylvan and Sylvan Ventures will be
able to control our day-to-day operations and the outcome of substantially all
matters submitted to our stockholders for approval, including the election of
directors and any proposed merger, liquidation, transfer or encumbrance of a
substantial portion of our assets, or amendment to our charter to change our
authorized capitalization. This concentration of ownership may also have the
effect of delaying or preventing a change in control of our company.
Our control by Sylvan Ventures and Sylvan and the presence of interlocking
directors and officers could create potential conflicts of interest.
Christopher Hoehn-Saric, our chairman, chief executive officer and director is a
director and former co-chief executive officer and chairman of Sylvan and
chairman, president and a manager of Sylvan Ventures. B. Lee McGee, our senior
vice president, treasurer, assistant secretary and director is a managing
director, chief financial officer and treasurer of Sylvan Ventures. Robert
Zentz, our secretary, assistant treasurer and director is vice president and
general counsel of Sylvan and secretary of Sylvan Ventures. Peter Cohen, our
director and assistant secretary, is president of Sylvan, Susannah Bennett, our
assistant secretary, is vice president of Sylvan. Mr. Hoehn-Saric beneficially
owns less than five percent and three percent of the outstanding equity
securities of Sylvan and Sylvan Ventures, respectively. Each of Messrs. Graves,
Offutt, McGee, Zentz and Cohen and Ms. Bennett beneficially owns less than one
percent of the outstanding equity securities of Sylvan. Because of these
relationships, equity interests and the fact that we currently have only one
independent member on our board of directors, our directors and officers have
conflicts of interest when making decisions related to transactions between us
and Sylvan Ventures or Sylvan. These conflicts of interest include possible
competition between Sylvan and us for tutoring customers, the demands for
management attention placed upon our executive team by the other companies they
serve, whether another company or we should be presented business or financing
opportunities that present themselves to our management team and the extent of
Sylvan resources that will be made available to us under our agreements with
Sylvan for implementation of our business plan. The ability of Sylvan Ventures
and Sylvan to control the outcome of matters submitted to stockholders together
with the potential conflicts of interest of their affiliates who also serve as
our executive officers could adversely affect the operation of our business. In
addition, those persons serving as both our officers and key employees and those
of Sylvan Ventures and Sylvan have not committed to devote any specific
percentage of their business time to us. The competing claims upon each
officer's time and energies could divert attention from our affairs, placing
additional demands on our resources. The efforts of all or any of these
individuals may not be sufficient to meet both our needs and those of Sylvan
Ventures and/or Sylvan. If we were deprived of access to the members of our
management team, or other personnel, or lost access to these services
altogether, we may not be able to meet the objectives set forth in our business
plan.
Risks Related to the Internet
We depend on continued growth in use of the Internet and online commerce.
Our success depends upon the ability of the Internet infrastructure to
support increased use. The performance and reliability of the Internet may
decline as the number of online users grows or bandwidth requirements increase.
The Internet has experienced a variety of outages due to equipment malfunctions,
human error and physical damage to portions of its infrastructure. If outages or
delays frequently occur in the future, Internet usage, including usage of our
website, could grow slowly or decline. Concerns about inadequate Internet
infrastructure, security, reliability, accessibility, privacy and the
availability of cost-effective, high-speed service also may inhibit growth in
Internet usage. Even if the necessary infrastructure or technologies develop, we
may incur significant costs to adapt our operating strategy.
We may be sued due to privacy or security concerns.
15
Consumer concerns over the security of transactions conducted on the
Internet or the privacy of users may inhibit the growth of the Internet and
online service delivery. To transmit confidential information securely, we will
rely on encryption and authentication technology licensed to us by third
parties. Events or developments may result in a compromise or breach of the
encryption software that we use to protect consumer transaction data. Any
penetration of our network security or misappropriation of our consumers'
personal information could subject us to liability.
Furthermore, our servers may be vulnerable to computer viruses,
physical or electronic break-ins and similar disruptions. We may need to expend
significant additional capital and other resources to protect against a security
breach or to alleviate problems caused by any breaches. Our business may be
harmed if our security measures do not prevent security breaches.
Claims may be based on other misuses of personal information, such as
for unauthorized marketing purposes. Websites typically place identifying data
"cookies" on a user's computer hard drive without the user's express consent. We
may use cookies for a variety of reasons, including the collection of data
derived from the user's Internet activity. Any reduction or limitation in the
use of cookies could limit the effectiveness of our sales and marketing efforts.
Most currently available Internet browsers allow users to remove cookies at any
time or to prevent cookies from being stored on their computer hard drives. In
addition, some commentators, privacy advocates and governmental bodies have
suggested that the use of cookies be limited or eliminated. The FTC and several
states have investigated the use of personal information by online companies. We
may incur expense if regulations regarding the use of personal information are
introduced or if our privacy practices were investigated. Any claims that may be
brought against us would be expensive to defend even if these claims are
determined to be without merit. The Children's Online Privacy Protection Act may
apply to our business if we collect personal information on persons under the
age of 13. Accordingly, we may be required to obtain verifiable parental consent
for such collection activities and provide parental access to personal
information we maintain about their children. While we believe we will be able
to comply with the regulations that have been promulgated by the FTC to
implement that Act, the present regulations are subject to clarification through
administrative implementation and amendment and the specific means for complying
remain to be developed. The costs of compliance could be a significant element
of our costs of doing business.
Government regulation and legal uncertainties could add additional burdens to
doing business on the Internet.
Laws and regulations applicable to Internet communications, commerce
and advertising are becoming more prevalent. Online commerce is new and rapidly
changing, and federal, state and foreign regulations relating to the Internet
and online commerce are evolving. Due to the increasing popularity of the
Internet, it is probable that new laws and regulations will be enacted to
address issues such as user privacy, pricing, content, copyrights, distribution,
antitrust matters and the qualify of products and services. The adoption of
these laws or regulations could reduce the rate of growth of the Internet, which
could potentially decrease the usage of our website and could otherwise harm our
business. In addition, many existing laws governing issues such as advertising,
property ownership, copyrights and other intellectual property issues, libel,
obscenity and personal privacy are now being applied to the Internet. Most of
these laws were adopted prior to the advent of the Internet and do not
necessarily apply easily to the unique issues of the Internet. New laws
applicable to the Internet may impose substantial burdens on companies
conducting business over the Internet. In addition, the growth and development
of online commerce has already prompted calls for more stringent consumer
protection laws in the United States and abroad. As one example, the European
Union has adopted a privacy directive that may well have an effect on websites
in the United States. Compliance with that directive, or other regulatory
activities of foreign governments, could have a significant effect on our
business.
Several telecommunications carriers have asked the Federal
Communications Commission (FCC) to regulate telecommunications over the
Internet. Due to the increasing use of the Internet and the burden it has placed
on the telecommunications infrastructure, telephone carriers have requested the
FCC to regulate Internet and online service providers and to impose access fees
on those providers. If the FCC imposes access fees, the costs of using the
Internet could increase dramatically. In this event, our business could be
negatively impacted.
16
The FTC has already promulgated a number of regulations and proposed
regulations that are designed specifically to deal with e-commerce and has
several on-going industry studies that might result in further regulation.
The Children's Online Privacy Protection Act may apply to our business
if we collect personal information on persons under the age of 13. Accordingly,
we may be required to obtain verifiable parental consent for such collection
activities and provide parental access to personal information we maintain about
their children. While we believe we will be able to comply with the regulations
that have been promulgated by the FTC to implement that Act, the present
regulations are subject to clarification through administrative implementation
and amendment and the specific means for complying remain to be developed. The
costs of compliance could be a significant element of our costs of doing
business.
Historically the use of encryption on the Internet has provoked
national security concerns among certain governments. While the current posture
of the United States is to permit the use and export of strong encryption, law
enforcement agencies here and abroad are pressing for changes that could have an
adverse effect on our ability to protect customer privacy through encryption.
We may be liable for information displayed on and communicated through our
website.
We may be subjected to claims for defamation, negligence, copyright or
trademark infringement or other theories relating to the information that we
publish on our website. These claims have been brought against online companies
as well as print publications in the past. Based on hyperlinks that we provide
to other websites, we may also be subjected to claims based upon online content
that we do not control but that is accessible from our website. Any claims that
may be brought against us would be expensive to defend even if these claims are
determined to be without merit.
Registration of similar domain names may result in a diversion of our potential
customers to other websites.
For the foreseeable future, we will substantially rely on the
eSylvan.com domain name as a significant means of attracting potential customers
to our website. Domain names are registered by a growing number of organizations
around the world. Governing authorities could establish additional top-level
domains, appoint additional domain name registrars or modify the requirements
for holding domain names. As a result, we may not be able to prevent others from
adopting and using domain names that might result in a diversion of our
potential customers to competing websites. While there is a growing number of
cases in which "domain name piracy" has been redressed, the law in this area is
evolving and not totally effective in preventing use of confusingly similar
domain names. While it is possible that others might claim that our own domain
name `eSylvan.com' infringes on their rights, we are not aware of any such claim
and believe we have the right to maintain and use that domain name. However, if
we were subsequently unable to continue using that domain name, we might
experience a significant loss of business.
FORWARD-LOOKING STATEMENTS
Many statements made in this filing under the headings "Business,"
"Management's Discussion and Analysis of Financial Condition and Plan of
Operation" and elsewhere are forward-looking statements that are not based on
historical facts. Because these forward-looking statements involve risks and
uncertainties, there are important factors that could cause actual results to
differ materially from those expressed or implied by these forward-looking
statements, including those discussed under "Factors that May Affect Future
Results."
ITEM 2: PROPERTIES
Our headquarters is located in Baltimore, Maryland. We currently lease
our facilities from Sylvan pursuant to a facilities use agreement. See
"Business - Services Provided to us by Sylvan." We expect to expand our
facilities as our operations grow. We believe that additional space will be
available on commercially acceptable terms.
17
ITEM 3: LEGAL PROCEEDINGS
We are not party to any material legal proceedings.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted to be voted on by securities holders during
the fourth quarter ended December 31, 2001.
PART II.
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
There is no established public trading market for our common stock.
10,526,316 shares of our common stock are subject to outstanding options or
warrants to purchase, or securities convertible into, our common stock. None of
the shares of our common stock are available for sale under Rule 144. We have
agreed to register 70,000,000 shares of our common stock under the Securities
Act for sale by our stockholders.
As of March 25, 2002, there were 14,000,000 shares of our common stock
and 2,452,484 shares of Class A Convertible Common Stock outstanding, held by
approximately 466 holders of record. We have never declared or paid any cash
dividends on our common stock and presently intend to retain our future
earnings, if any, to fund the development and growth of our business and,
therefore, do not anticipate paying any cash dividends in the foreseeable
future.
On June 30, 2000, 14,000,000 shares of common stock were sold to Sylvan
for cash of $5 million. Subsequent to the purchase of the 14,000,000 shares of
common stock, 13,714,286 of those shares were contributed to Sylvan Ventures. On
June 30, 2000, 10,526,316 shares of Series A preferred stock was subscribed for
purchase by Sylvan Ventures for aggregate proceeds of $20 million issuable and
payable equally over the subsequent six quarters beginning September 30, 2000.
As of December 31, 2001, all of the shares had been fully paid and were issued
and outstanding. During February 2002, Sylvan Ventures purchased an additional
4,947,368 shares of Series A preferred stock for $9.4 million. A portion of the
proceeds of this issuance was used to pay the balance outstanding under the line
of credit agreement between Sylvan Ventures and the Company.
Through December 31, 2001, we incurred approximately $880,000 in
expenses in connection with the offering of our Class A Convertible common stock
to holders of Sylvan franchise license agreements or area development
agreements. Through the time of conclusion of this offering, 359 franchisees
executed participation agreements, and we were obligated to issue 2,452,484
shares of Class A Convertible common stock and remit $858,385 in exchange for
the franchisees' participation in this offering. We issued these shares and paid
this amount on March 2, 2001. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
ITEM 6: SELECTED FINANCIAL DATA
The following table presents the selected financial data of our
business. The financial data for all periods presented have been derived from
and are qualified by reference to, our audited financial statements included
elsewhere in this report.
18
Period October 1,
Period October 1, 1999 (date of
1999 (date of inception)
Year Ended Year Ended inception) through through
December 31, December 31, December 31, December 31,
2001 2000 1999 2001
----------------------------------------------------------------------------
Statements of Operations:
Revenues $ 460,331 $ 15,921 $ - $ 476,252
Costs and expenses:
Direct costs of services
provided 1,144,375 151,247 - 1,295,622
Sales and marketing 2,249,905 1,082,431 - 3,332,336
General and administrative 6,698,547 5,890,081 376,204 12,964,832
Research and development 2,326,315 4,883,521 51,690 7,261,526
Management services and
facilities usage charges
from Sylvan 1,263,587 529,286 - 1,792,873
Allocated indirect overhead
costs - 205,196 219,622 424,818
----------------------------------------------------------------------------
Total operating costs and
expenses 13,682,729 12,741,762 647,516 27,072,007
----------------------------------------------------------------------------
Loss from operations (13,2225,398) (12,725,841) (647,516) (26,595,755)
Non-operating expenses
(income), net (122,362) 127,600 - 5,238
----------------------------------------------------------------------------
Loss accumulated during
development stage (13,100,036) (12,853,441) (647,516) (26,600,993)
Allocated income tax benefit - 1,516,117 252,337 1,768,454
----------------------------------------------------------------------------
Net loss accumulated during
development stage $ (13,100,036) $(11,337,324) $ (395,179) $(24,832,539)
============================================================================
Basic and diluted loss per
common share $ (0.82) $ (1.62) $ n/a $ (2.42)
============================================================================
As of December 31,
2001 2000 1999
-------------------------------------------
Balance Sheet Data:
Cash and cash
equivalents $ 250,880 $ - $ -
Working capital deficit (4,735,359) (6,189,540) (49,595)
Total assets 5,703,097 4,478,448 13,083
Current liabilities 6,038,323 6,312,739 49,595
Deficiency of assets (335,226) (1,834,291) (36,512)
19
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Financial Statements and related Notes thereto included elsewhere in this Annual
Report on Form 10-K.
Results of Operation
We are a development stage business that delivers individualized
supplemental education to families and children via applications on the
Internet. We launched our website, commenced delivering services to the public
and started recognizing revenue in October 2000. Our lack of operating history
makes it difficult to evaluate our business and prospects. You must consider our
prospects in light of the risks, expenses and difficulties frequently
encountered by companies in their early stage of development, particularly
companies dependent upon the relatively new and rapidly evolving Internet
environment. We have no assurance that we will be successful in addressing these
or any other risks, and our failure to do so could have a material adverse
effect on our business, financial condition and results of operations.
From inception on October 1, 1999 through February 2, 2000, we operated
as an unincorporated division of Sylvan, from February 3, 2000 to June 29, 2000,
we operated as a subsidiary of Sylvan and since June 30, 2000, we have operated
as a majority owned subsidiary of Sylvan Ventures. Until October 2000, our
operations consisted of organizational activities, research and analysis with
respect to the Internet educational services industry, development of our
website and identifying and testing key technology. As of December 31, 2001, we
have generated minimal revenues, our financial statements show a net loss, and
we have incurred expenses and an accumulated operating loss of approximately
$24.8 million from inception, consisting primarily of research and development,
sales and marketing, legal, accounting, consulting, personnel and facilities
costs. Since our inception, Sylvan has provided us with a significant portion of
the administrative personnel and services that we have required.
During 2002, the expenses we expect to incur in connection with the
implementation of our business plan include:
. Improvement of our website,
. Improvement of technical infrastructure for online delivery of
tutoring services,
. Improvement of online tutoring content,
. Direct marketing, advertising and promotion of the eSylvan brand,
. Recruiting and retention of executive, marketing, technical and
tutoring personnel,
. Administration, and
. Legal, accounting and investment related fees.
As of March 25, 2002, we estimate that we will incur $12 to $15 million
in expenditures for marketing and advertising, personnel, professional fees,
software, computer hardware, tutoring content, costs of delivering services and
other expenses during the year ending December 31, 2002. Because we are a
development stage company that commenced operations in October 2000, this
estimate is not based on our historical experience. Instead, it is based upon
the experience of our management team in the tutoring services industry, our
internally developed business plan and strategy and publicly available research
concerning our proposed market. Because we have only recently commenced
operations, we are updating our business plan, and our internal estimate of the
expenses we may incur in the next year, on a weekly and even daily basis to
reflect our operating experience. Since this estimate is based upon less than
eighteen months of operating experience in a limited market, we believe that we
are unable to predict the exact amount of any specific expense and the aggregate
amount of such expenses may exceed our estimated range by $5 million or more.
For example, though we believe that our expenditures for personnel,
marketing and advertising will substantially increase over the next year as we
shift from organizational activities and the development of our technology to
the sale of tutoring services to the public, the actual level of expenditures
will depend upon the success of our marketing and advertising efforts. If our
marketing and advertising efforts were to raise a demand for our services that
exceeded our capacity, our personnel and infrastructure expense would likely
increase.
20
Alternatively, if our marketing and advertising are unsuccessful in generating
demand for our services, these efforts would likely be increased beyond our
current plans. Further, unforeseen legal issues, technical difficulties,
problems with our tutoring content and other risks set forth under the heading
"Factors That May Affect Future Results" could require a reallocation of our
resources to cover more urgent items of expense and heavier reliance upon the
funding commitment of Sylvan and Sylvan Ventures than we currently expect.
Under our professional services agreement with Sylvan, we may elect to
participate in a cross referral program whereby we and Sylvan receive payments
for each student referred to each other. Under the referral program, we will
receive or pay amounts equal to 5%, up to a maximum of $100, of all revenues
received by Sylvan or us, respectively, for the programs to which each referred
student initially subscribes, including testing and registration fees. For each
student enrollment a Sylvan franchisee generates for us, we will pay Sylvan a
sales commission of 5%, up to a maximum of $100, of the revenues we receive for
the first programs to which such student initially subscribes through the
franchisee's center. Also under this agreement, before we assign a diagnostic
and prescriptive instructor to a student, we must request Sylvan to provide an
instructor for a committed period. If Sylvan makes personnel available for
committed periods, we shall reimburse Sylvan for the salary of such instructors
or other personnel at an hourly rate based on the base compensation such person
receives from Sylvan. In addition to salary reimbursement, Sylvan shall receive
a 30% management fee for each hour of direct instruction or test administration,
including some specific preparation time, or parent conferences. If Sylvan
refers instructors to us on an independent contractor basis, we will pay Sylvan
a referral fee of $100.
We anticipate that, for the foreseeable future, we will incur
substantial operating losses and negative cash flow as we execute our business
plan and acquire and integrate the necessary technology, systems and supporting
infrastructure, enroll students in our service, develop our brand name, hire
employees and contract personnel and expand our business. The extent of these
loses will depend, in part, on the amount and rates of growth in our revenue
from enrolled students.
Revenue is charged on an hourly basis for diagnostic/prescriptive
instructional programs. Revenue from these services are recognized as hours of
instruction are completed.
To the extent that revenue does not grow at anticipated rates or that
increases in our operating expenses precede or are not subsequently followed by
commensurate increases in revenue, our business, results of operations and
financial condition will be materially and adversely affected. There can be no
assurance that our operating losses will not increase in the future or that we
will ever achieve or sustain profitability.
Comparison of results for the year ended December 31, 2001 to results
for the year ended December 31, 2000
We incurred net losses of $13.1 and $11.3 million for the years ended
December 31, 2001 and 2000, respectively.
Revenues for the year ended December 31, 2001 were $460,000. We had
revenues of $16,000 during the year ended December 31, 2000, as we did not
commence delivering services until October 2000.
During the years ended December 31, 2001 and 2000, we incurred $13.7
and $12.7 million, respectively, in operating and other expenses in implementing
our business plan.
Direct costs of services provided increased by $993,000 to $1.1 million
for the year ended December 31, 2001 from $151,000 for the year ended December
31, 2000. These costs consist primarily of labor for instructional, technical
and operations support related to providing instructional services to our
students. The increase was a direct result of the increase in revenues.
Sales and marketing expenses increased by $1.1 million to $2.2 million
for the year ended December 31, 2001 from $1.1 million for the year ended
December 31, 2000. Sales and marketing costs are incurred to establish and grow
the "eSylvan" brand. The primary costs incurred were related to advertising on
various third-party web sites and internet-based newsletters and labor costs
related to converting the leads generated from the advertising
21
campaigns into enrollments. The increase in sales and marketing costs was a
result of promoting our product for a the full year in 2001 versus a partial
year in 2000.
General and administrative expenses increased by $800,000 to $6.7
million for the year ended December 31, 2001 from $5.9 million for the year
ended December 31, 2000. General and administrative expenses consist of
personnel costs, professional fees, maintenance expenses, depreciation and other
expenses. The increase in general and administrative expenses resulted from
additional personnel and other costs incurred to develop and expand
administrative and operations support systems and services.
Research and development expenses decreased by $2.6 million to $2.3
million for the year ended December 31, 2001 from $4.9 million for the year
ended December 31, 2000. The decrease in research and development expenses is
attributable to the fact that the development of our online tutoring technical
infrastructure was more intensive during the period prior to the initial launch
of our tutoring services in late 2000.
Management services and facility usage charges from Sylvan increased by
$734,000 to $1.3 million for the year ended December 31, 2001 from $529,000 for
the year ended December 31, 2000. Under a services agreement with Sylvan, which
commenced in July 2000, Sylvan provides management services, information systems
support services, corporate accounting services, database management services,
human resources and payroll services, general liability insurance and legal
services to us. During 2001, the agreements were in place for the full year,
versus six months in the prior year. Additionally, as our business activities
have expanded, we have increased our utilization of these services thereby
resulting in an increase in the charges.
Allocated indirect overhead costs from Sylvan decreased by $200,000 to
none for the year ended December 31, 2001 from $200,000 for the year ended
December 31, 2000. Beginning June 30, 2000, upon the transfer of ownership of
the Company from Sylvan to Sylvan Ventures and the adoption of the management
services agreement with Sylvan, indirect overhead costs were no longer allocated
to us.
During the period October 1, 1999 through June 30, 2000, the Company
and Sylvan operated under a tax sharing agreement that provided for the
allocation to us of any tax benefits realized by Sylvan as a result of including
our operations in its consolidated income tax return. Commencing July 1, 2000,
Sylvan could not realize income tax benefits attributable to our operations as a
result of the transfer of Sylvan's ownership in us to Sylvan Ventures. For the
year ended December 31, 2000, we recorded tax benefits of $1.5 million under
this agreement, related to the period from January 1, 2000 to June 30, 2000. For
the periods subsequent to June 30, 2000, we have not reported a tax benefit from
operating losses because of an increase in the valuation allowance for deferred
tax assets. This results primarily from the inability to determine the
realization of the net operation loss carryforwards generated in those periods.
Liquidity And Capital Resources
Net cash used in operating activities was $12.6 million in 2001
compared to $9.1 million in 2000. The 2001 cash used in operating activities
resulted primarily from the net loss of $13.1 million, the reduction in accounts
payable and accrued expenses of $1.7 million and the payment of certain fees to
Sylvan totaling $300,000. These items were partially offset by non-cash
depreciation and amortization expense of $2.2 million. The 2000 cash used in
operating activities resulted primarily from the net loss of $11.1 million
partially offset by an increase in accounts payable and accrued expenses of $2.7
million.
Capital expenditures during 2001 and 2000 were $900,000 and $4.3
million, respectively consisting primarily of increases in software and
educational content during 2001. Expenditures during 2000 consisted primarily of
increases in software and educational content of $2.4 million and computer
equipment and furnishings of $1.7 million.
Our operations and capital requirements were funded by Sylvan from
inception to June 30, 2000 and by Sylvan Ventures from July 1, 2000 to December
31, 2001.
22
On June 30, 2000, we entered into a revolving credit note with Sylvan
Ventures pursuant to which we may borrow up to $10 million. The revolving credit
note expires on December 31, 2002. As of December 31, 2001, $4.5 million was due
under this note. The note is non-interest bearing.
On June 30, 2000, we also entered into an agreement with Sylvan
Ventures under which we agreed to issue an aggregate of 10,526,316 shares of
Series A preferred stock in six closings. These closings were held on the last
day of each fiscal quarter through December 31, 2001, for an aggregate price of
$20 million, which represents a price per share of $1.90. As of December 31,
2000, we had issued 3,508,772 shares of Series A preferred stock to Sylvan
Ventures for aggregate proceeds of $6.7 million and as of December 31, 2001 we
have issued 10,526,316 shares of Series A preferred stock to Sylvan Ventures for
aggregate proceeds of $20 million. Subsequent to December 31, 2001, the Company
and Sylvan Ventures entered into an additional agreement under which Sylvan
Ventures would acquire an additional 4,947,368 shares of our Series A preferred
stock for $9.4 million which also represents a price per share of $1.90. A
portion of the proceeds from this sale will be used to repay the balance
outstanding on the revolving credit note discussed above, with the balance
available to fund operations.
We lease certain equipment from Sylvan under an operating lease dated
October 1, 2000. The lease expires on September 30, 2003. Future minimum
payments under this arrangement are $270,127 for 2002 and $202,954 for 2003.
We have authorized the issuance of 10,000,000 shares of $.001 par value
Class A Convertible Common Stock. On December 14, 2000, we filed a Form S-1
Registration Statement with the Securities and Exchange Commission in connection
with the offering of up to 3,000,000 shares of Class A Convertible Common Stock
to certain holders of Sylvan franchise license agreements or area development
agreements. On March 2, 2001 the offer to issue shares was finalized and on
March 30, 2001 we issued 2,452,484 shares of Class A Convertible Common Stock to
Sylvan franchisees and remitted $858,385 to the holders of the Class A shares.
We received no cash consideration for the Class A Convertible Common Stock
issued to franchisees, instead the investors received a cash payment of $0.35
per share in exchange for execution of the participation agreement, which
requires that the franchisee support our business plan. On March 2, 2001, we
closed on this offering upon receipt of participation agreements and requests to
issue an aggregate of 2,452,484 shares of Class A Convertible Common Stock to
franchisees and the related payment of $858,385.
We expect to incur significant negative cash flow from operations for
the foreseeable future. Although we believe that the closings on our sale of
Series A preferred stock to Sylvan Ventures will satisfy the majority of our
cash needs through July 31, 2002, we do not expect that our current resources
will be sufficient to support our growth and operations until we are profitable.
We expect that we will need to raise additional capital or other financing prior
to July 31, 2002. We cannot guarantee that we will be able to raise additional
funds, or, if we can, that we will be able to do so on terms that we deem
acceptable. In particular, potential investors may be unwilling to invest in us
due to Sylvan Venture's voting control over us. We are unable to predict the
amount of additional financing we will need prior to July 31, 2002 because such
amount is substantially dependent upon the success of our business plan and
marketing and advertising efforts and factors outside our control such as
lawsuits, unexpected technical difficulties with our on-line tutoring
infrastructure and other factors discussed herein and under the heading "Factors
That May Affect Future Results." Our failure to raise the funds necessary to
establish and grow our business would have a material adverse effect on our
business and our ability to generate and grow revenues. If we raise funds
through the issuance of equity, equity-related or debt securities, these
securities will likely have rights, preferences or privileges senior to those of
the rights of our existing Common stock, and our current Common stockholders may
experience dilution.
Our current and projected operating losses and limited funding raises
substantial doubt about our ability to continue as a going concern. The
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
23
In August 2001, the Financial Standards Board issued Statement No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. Statement No.144 Supercedes Statement
No.121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, and provides a single accounting model for long-lived
assets to be disposed of. We will apply the new rules on accounting for the
impairment or disposal of long-lived assets beginning in the first quarter of
2002. Statement No. 144 retains the requirements of Statement No. 121 to
recognize an impairment loss only if the carrying amount of a long-lived asset
is not recoverable from its undiscounted cash flows and to measure the
impairment loss as the difference between the carrying amount and the fair value
of the asset. We do not believe that the adoption of the new standard will have
a material impact on its financial position or results of operations.
CRITICAL ACCOUNTING POLICIES
Our accounting policies are more fully described in Note 1 of the Notes to
Financial Statements. As discussed in this note, the preparation of financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions about future
events that affect the amounts reported in the financial statements and
accompanying notes. Future events and their effects cannot be determined with
absolute certainty; therefore, the determination of estimates requires the
exercise of judgment. Actual results inevitably will differ from those
estimates, and such differences may be material to the financial statements.
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Valuation of Participation Agreements
The fair value of the participation agreements was determined based on the
fair value of the underlying Class A Convertible Common Stock that we issued in
exchange for the executed agreements. The assumptions used to calculate the fair
value of these securities included estimates of future operating results and
cash flows as well as discount rates based on specifically identified risks and
assumptions about our weighted average cost of capital. The assigned useful life
of the participation agreements of six years is based upon the estimated
weighted-average useful five of the agreements, which was determined based on an
analysis of the historical useful life of Sylvan franchise agreements.
If we used different assumptions and estimates in the calculation of the
fair value of the underlying securities and the estimation of the related useful
life, the amounts allocated to this asset, as well as the related amortization
expense, would have been significantly different than the amounts recorded.
Impairment of Participation Agreements
In assessing the recoverability of the participation agreements, we must
make assumptions regarding estimated future cash flows and other factors to
determine its current fair value. If these estimates or their related
assumptions change in the future, we may be required to record an impairment
charge for this asset not previously recorded.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET AND INTEREST RATE
RISK
Market risk is the risk of loss to future earnings, to fair values or to
future cash flows that may result from changes in the price of financial
instruments. We are exposed to market risks primarily through changes in
24
interest rates. We do not utilize derivatives and therefore exposure to market
risks is managed through our regular operating and financing activities.
The Company's revolving credit facility with Sylvan Ventures represents its
only significant financial instrument and does not bear interest.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) 1. Financial Statements.
The information required by this Item is set forth on pages
F-1 to F-26.
(b) 2. Supplementary Data.
Not Applicable.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III.
ITEM 10: DIRECTORS AND OFFICERS OF THE REGISTRANT
Our directors and executive officers are as follows:
Name Age Principal Positions
- ---- --- -------------------
R. Christopher Hoehn-Saric 39 Chairman and Co-Chief Executive Officer
David S. Graves 44 President and Chief Operating Officer
Barry C. Offutt 40 Vice President and Chief Financial Officer
B. Lee McGee 46 Senior Vice President, Treasurer, Assistant
Secretary and Director
Robert W. Zentz 47 Secretary, Assistant Treasurer and Director
Anna T. Parmer 32 Vice President of Technology
Catherine Killian 43 Vice President of Sales
Stuart A. Finnigan 51 Vice President of Operations
Susannah Bennett 36 Assistant Secretary
Peter Cohen 47 Assistant Secretary and Director
Barry E. Miller 52 Director
Beth J. Kaplan 43 Director
R. Christopher Hoehn-Saric has served as our chairman since inception and
as a director since June 30, 2000. He has been president, chief executive
officer and director of Sylvan Ventures, LLC, our majority stockholder, since
2000, and a principal in Sterling Capital, Ltd. ("Sterling"), the investment
partnership that led the 1986 acquisition of the predecessor to Sylvan Learning
Systems, Inc. since prior to 1986. Mr. Hoehn-Saric was co-chief executive
officer of Sylvan Learning Systems, Inc. from 1993 to June 2000 and was
president of Sylvan from 1988 to 1992. Before becoming Sylvan's president, Mr.
Hoehn-Saric was involved in Sterling's acquisition of several distribution,
broadcasting and photography businesses. Mr. Hoehn-Saric also serves as a
director of Sylvan Learning Systems, Inc. Mr. Hoehn-Saric serves as an officer
and director at the request of Sylvan Ventures under our services agreement with
Sylvan.
25
David S. Graves has been our president since inception. From 1997 to 2000,
he was vice president of marketing for Sylvan. In that role, he served as
president of the SLC National Advertising Fund, Inc., a cooperative advertising
fund managed with the input and support of Sylvan franchisees. Until 2000, he
also served as executive director of Book Adventure, launching this new
interactive, online reading program (www.bookadventure.com) with his team in
1999. From 1996 to 1997, he was vice president/general manager for the Franklin
Mint jewelry and collector plates divisions. From 1988 to 1996, he held
positions of increasing responsibility in brand marketing for Colgate-Palmolive
Company's Hill's Pet Foods division (Science Diet brand), including marketing
manager for US marketing, director of marketing for Europe, and managing
director/general manager of northern European subsidiaries (UK, Ireland,
Belgium, Luxembourg, and Netherlands). He began his marketing career at the
Quaker Oats Company, working on the Gatorade brand and Quaker frozen foods.
Barry C. Offutt has been our vice president and chief financial officer
since September 1, 2001. He also serves as chief financial officer of MindSurf
Inc., a company partially owned by Sylvan Ventures, and has served in that role
since May 2001. He previously served as chief financial officer of Nexus
Communications from June 2000 until joining Mindsurf. From 1992 to 2000 he was
chief financial officer of HCIA Inc., a publicly traded health care information
provider. During his tenure as CFO at HCIA, the Company acquired ten companies
and completed its Initial Public Offering and three follow-on offerings.
B. Lee McGee has been our senior vice president, treasurer and assistant
secretary since inception and a director since June 30, 2000. He served as our
chief financial officer from inception through August 2001. He served as chief
financial officer of Sylvan Learning Systems, Inc. or its predecessor entities
from 1987 to 2000 and executive vice president from 1997 to 2000. Mr. McGee has
been a managing director, chief financial officer and treasurer of Sylvan
Ventures, LLC, our majority stockholder, since 2000. Mr. McGee serves as an
officer and director at the request of Sylvan and Sylvan Ventures under our
services agreement with Sylvan.
Robert W. Zentz has been our secretary, assistant treasurer and director
since inception. He has been secretary of Sylvan Ventures, LLC, our majority
stockholder since 2000, and since 1998, has been vice president and general
counsel to Sylvan Learning Systems, Inc. From 1997 to 1998, Mr. Zentz was a
partner of the law firm of Frank & Kraft. From 1996 to 1997, Mr. Zentz served as
campaign manager in the political campaign of Jack O'Malley. From 1990 to 1996,
he was vice president and general counsel of A.C. Nielsen, Inc., a marketing
research firm. Mr. Zentz serves as an officer and director at the request of
Sylvan and Sylvan Ventures under our services agreement with Sylvan.
Anna T. Parmer has been our vice president of technology since September
2001 and since April 2000 our Director of Information Technology. For the prior
nine years, she held positions of increasing responsibility related to
applications development, information systems architecture and management of
information systems personnel with the Procter & Gamble Company.
Catherine Killian has been our vice president of sales since February 2001.
From 1994 through February 2001 she was employed by Sylvan, and since 1995 held
the position of Western regional vice president for Sylvan. In this position,
she was responsible for overseeing daily operations, developing local and
regional management teams, planning local advertising and territory expansion
for 50 locations in six corporate markets. Prior to 1994, she held a series of
sales and operations positions of increasing responsibility at Nutri/Sytems,
Inc.
Stuart A. Finnigan has been our vice president of operations since August
2000. From 1998 to 2000, he was vice president of operations for Sylvan's ASPECT
language schools, responsible for global operations of 26 immersion ESL (English
as second language) schools in five countries. Prior to ASPECT, he held the
positions of vice president - Europe and vice president of test center
operations for Sylvan's Prometric division from 1993 to 1998. In this position,
he oversaw testing center growth from 80 centers to over 2,000 centers in 130
countries, with direct responsibility for operations in Europe, the Middle East
and Africa.
Peter Cohen has been our assistant secretary and a director since
inception. He has been president of Sylvan Learning Systems, Inc. since February
2000. From 1996 to February 2000, Mr. Cohen was president of the learning center
division of Sylvan. Prior to joining Sylvan, he was the chief executive officer
of The Pet Practice, an 85 hospital veterinary business. He also served as vice
president of sales for National Media Corporation and senior
26
vice president of corporate operations for Nutri-System Weight Loss Centers. Mr.
Cohen serves as a director at the request of Sylvan under our services agreement
with Sylvan.
Susannah Bennett has been our assistant secretary since June 30, 2000. Ms.
Bennett has been vice president and assistant general counsel of Sylvan Learning
Systems, Inc. since 1999 and 1995, respectively. Ms. Bennett serves as an
officer at the request of Sylvan under our services agreement with Sylvan.
Barry E. Miller has been a member of our board of directors since February
2001. Mr. Miller has served as president of NBM Management, a company which owns
and operates Sylvan Learning Centers and Thomson Prometric, Computer Based
Testing Centers in Northeast Ohio and Western Pennsylvania since 1985. Since
1991 Mr. Miller has served four terms as president of Sylvan Franchise Owners
Association, Inc. (FOA) and was a founding director and officer of SLC National
Advertising Fund, Inc. Mr. Miller is currently a director of Sylvan Franchise
Owners Association, Inc., and has been elected to serve as president of the
board in 2002. He also serves as a director of the Sylvan National Advertising
Fund. Mr. Miller was designated by the FOA and approved by Sylvan as the FOA's
representative to our board of directors under the program agreement between
Sylvan and the FOA.
Beth J. Kaplan has been a member of our board of directors since March
2001. In May 2001, she founded Axcel Partners, LLC, a venture capital fund
focused on early state start-ups with a focus on retail and consumer good
technology. From 1996 through 1999, she was senior executive vice president of
Rite Aid Drugstores, a national chain of over 4,000 drugstores with $13 billion
in revenue. She was responsible for marketing , merchandising, category
management, store design and logistics. In 1998 she was named Drugstore Marketer
of the Year and identified as "one of the top 20 women to watch" by Advertising
-----------
Age. From 1981 through 1996 she held positions of increasing responsibility with
- ---
Proctor & Gamble, including President of Noxell.
ITEM 11: EXECUTIVE COMPENSATION
Compensation of Executive Officers and Directors
Compensation of Executive Officers. The following table sets forth
information about the annual and long-term compensation of the four highest paid
executive officers of the Company during the period August 16, 2000 through
December 31, 2001 (collectively, the "Named Executive Officers").
Long Term
Annual Compensation Compensation
------------------------------------------------------- ---------------
Other Awards
Annual Securities
Name Compen- Underlying
And Sation Options/ All Other
Compen-
Principal Position Fiscal Year Salary ($) Bonus ($) ($)(2) SARs (#) sation ($)
- ------------------ ----------- ---------- --------- ------ -------- ---------
David S. Graves (1) .............. 2001 $ 190,000 $ 31,063 $ 6,600 180,000 $ 4,301(3)
President and 2000 73,208 - 1,750 - -
Chief Operating Officer
Anna T. Parmer ................... 2001 $ 140,209 $ 15,358 $ 1,925 50,000 $ -
Vice President of Technology 2000 - - - - -
Catherine Killian ................ 2001 $ 122,150 $ 8,000 $ 5,500 85,000 $ 11,028(4)
Vice President of Sales 2000 - - - - -
Stuart A. Finnigan ............... 2001 $ 128,333 $ 27,525 $ 6,600 100,000 $ 1,365(3)
Vice President of Operations 2000 - - - - -
27
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(1) Mr. Graves became a full-time employee of the Company on August 16,
2000.
(2) This amount represents automobile allowance for each officer.
(3) This amount represents the Company match on employee 401(k)
contributions.
(4) All other compensation represents taxable expenses in connection with
Ms. Killian's relocation.
During 2001, our current directors and executive officers, except our
president and chief operating officer, vice president of technology, vice
president of sales and vice president of operations, were employees of Sylvan or
Sylvan Ventures and were not separately compensated by us for services. Ms.
Kaplan, one of our directors, is a consultant to the Company and received
compensation of $135,000 in 2001. Mr. Offutt, our vice president and chief
financial officer, who also serves as vice president and chief financial officer
of another Sylvan Venture company, Mindsurf, Inc., was hired in September 2001.
We pay a portion of his compensation and benefits and Mindsurf, Inc. pays the
remainder. Our portion did not exceed $100,000 for 2001. No other officers'
compensation exceeded $100,000 in 2001. Sylvan did not allocate any of its
corporate overhead for salaries to us during 2001.