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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2002

OR

Commission file number: 333-42530

eSylvan, Inc.

(Exact name of registrant as specified in its charter)

(410) 843-2622

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

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.  ¨

Indicate by a check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes  ¨  No  x

On June 28, 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 last sold, was $2,450,000.

As of March 26, 2003, the registrant had 14,000,000 outstanding shares of Common Stock and 2,517,984 outstanding shares of Class A Convertible Common Stock.

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ESYLVAN, INC.

2002 ANNUAL REPORT ON FORM 10-K

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PART I.

ITEM 1: BUSINESS

FORWARD-LOOKING STATEMENTS

Many statements we make in this Annual Report on Form 10-K under the headings “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” 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 the heading “Factors that May Affect Future Results.”

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”). Through December 31, 2001, we were considered a development stage company.

We deliver 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 Learning Centers, a division of Sylvan, provide in their 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 and to create various referral opportunities between eSylvan and Sylvan Learning Centers. Using these rights 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 pilot offerings of these services to a limited number of school districts.

We launched our web site, 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 web site address is http://www.esylvan.com. Information contained on our web site is not part of this Annual Report on Form 10-K.

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 through 12 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. We believe that growth in Internet usage should provide 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:

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The eSylvan solution

We offer two or three-to-one diagnostic and prescriptive instruction over the Internet for students 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. Modeled after Sylvan’s Learning 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 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 fully certified and has completed a formalized training program prior to his or her 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. We guarantee that each math and reading student will progress one full grade-level equivalent after 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 which is 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 and more than one million students. We spent a significant portion of our efforts through 2001 in converting the ILO curricula into an Internet-deliverable format. We believe students’ academic progress through our on-line program approximates that of Sylvan’s Learning Center programs. 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:

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 pen-shaped mouse. All these components are commonly available retail products. Students, and begining in 2002 our instructors, gain access to our online program by entering our web site where information on learning programs is presented. Once registered for a learning program, students interact with instructors in real time through an

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audio/visual session, where existing 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 that appears on the student’s computer, and that 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 have licensed access to technology-based solutions developed by Sylvan. Included in this licensed technology are the following key items:

Together, these two pieces of software allow us to create unique programs for each student and to track student progress as our 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:

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.

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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 web site and systems development than we can.

Relationship with Sylvan and Sylvan Ventures

Sylvan created us as a stand-alone business to separate our online educational services business from Sylvan’s other businesses and to facilitate our 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. See “Factors That May Affect Future Results – Pending Transaction Affecting Sylvan, Sylvan Ventures and eSylvan” for information regarding the proposed separation of Sylvan’s K through 12 businesses, including eSylvan, from its international and online university business.

Sylvan Learning Centers

Sylvan seeks to provide educational services with consistent, quantifiable results, and has delivered its core educational services to more than 1.6 million students in grades K-12 over the past 20 years. In 2002, Sylvan provided services to approximately 150,000 students through 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 amounts equal to five percent, up to a maximum of $100, of all revenues received by Sylvan 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 a sales commission of $300.

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 that teacher 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 per instructor.

Co-Marketing. We have provided a link to Sylvan’s web site on our web site, and Sylvan has provided a link to our web site on its web site. 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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The licenses of Sylvan’s trademarks and content as described 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 we provide 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 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 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 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. The guaranteed minimum royalty for calendar year 2002 was $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 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 owed for such renewal terms.

We have agreed to cooperate with Sylvan in protecting 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 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.

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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, 2003 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, 2003 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:

See “Factors That May Affect Future Results – Pending Transaction Affecting Sylvan, Sylvan Ventures and eSylvan” for information regarding the proposed separation of Sylvan’s K through 12 businesses (including eSylvan) from its international and online university business.

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 various Sylvan Learning Center franchisees that provide for support of the delivery of our services to students living in a particular 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, restrictions on email solicitations (i.e. spam), 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,

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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 web site and other web sites

Content may be accessed on our web site or on other Internet sites that are linked to our web site. This content maybe 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 web site. We also may be subject to claims, alleging that we, by directly or indirectly providing links to other web sites, are liable for copyright or trademark infringement or the wrongful actions of third parties through their respective web sites. 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 web sites 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 web site 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 adopted by the Federal Trade Commission (FTC). The FTC’s regulations require us to obtain parental consent before we obtain personal information from a child under the age of 13. The FTC also has regulations regarding the collection and use of personal identifying information obtained from individuals when accessing web sites. Accordingly, we are 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 comply with the FTC’s regulations, 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 levels 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. Congress’ three-year moratorium on state and local taxes on Internet access or on discriminatory taxes on electronic commerce has expired. Therefore, we cannot predict whether some type of federal and/or state taxes may be imposed in the future upon Internet commerce. Attempts to regulate or impose taxes on commerce over the Internet may substantially impede further growth of commerce on the Internet and adversely affect our business.

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 a foreign corporation in each of these states or Canada. As of the date of this filing, we are qualified to do business in 44 states. 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.

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Employees

We have approximately 48 full-time and 168 part-time employees. We expect to hire additional full-time employees as we grow our business. We do not now foresee problems in hiring qualified employees to meet our needs. None of our employees are 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.

Pending Transaction Affecting Sylvan, Sylvan Ventures and eSylvan

On March 10, 2003, Sylvan announced that it will focus exclusively on its international and online university business by selling its K-12 education operating units and disbanding Sylvan Ventures. Under the pending transaction, the Sylvan Learning Center and Sylvan Education Solutions divisions of Sylvan, the ownership interest in eSylvan held by Sylvan Ventures and other assets will be sold to Educate, Inc., a newly formed entity associated with Apollo Management LP. Additionally, Sylvan Ventures will be disbanded. We cannot predict how this transaction, if consummated, will impact our business, particularly our access to Sylvan management, the services provided to us under various management services agreements or our ability to obtain the working capital and /or equity capital we will need to continue to operate our business. This transaction is subject to the approval of various regulatory bodies and third parties.

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 was $37.4 million as of December 31, 2002, and we expect to generate significant operating losses and continue to experience negative cash flow for the foreseeable future.

We launched our web site, commenced delivering services to the public and started recognizing revenue in October 2000. As of December 31, 2002, we have generated approximately $3.2 million in revenues, and we have incurred an accumulated net loss of approximately $37.4 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 expect to reduce the size of our annual operating loss and cash flow requirements by enrolling and servicing fewer students in 2003 than we did in 2002, by enrolling and servicing those students on a more economical basis and by reducing our personnel and other overhead costs. By reducing our enrollments and the number of students served in 2003, we believe we can develop certain software applications and operational processes that will enable us to operate more efficiently as we increase our enrollments in future periods. Because we are relatively inexperienced in operating in the Internet market, our expenditures and cash requirements 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

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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 may not become profitable. If online tutoring fails to gain acceptance, it is unlikely that eSylvan will become a viable business.

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 web site link to the Sylvan web site. Our facilities agreement with Sylvan had an initial term of one-year, has been extended through June 30, 2003 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, 2003 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, 2002, with a $10 million line of credit, which was extended through, but which expired on December 31, 2002, and the purchase of 15,473,684 shares of our Series A preferred stock for $29.4 million. In addition, Sylvan Ventures purchased an additional 3,578,947 shares of our Series A preferred stock in February 2003 for $6.8 million, which was used to pay off the line of credit at that date, without penalty, and in March 2003 agreed to purchase an additional 1,157,895 shares of our Series A preferred stock for $2.2 million. We do not expect these amounts to be sufficient to meet our cash needs through 2003. We believe that we could not replace the services and intellectual property that Sylvan provides to us on reasonable terms, if at all, and we do not know whether we could obtain capital from any other source. 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 our agreements with Sylvan 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.

If the proposed transaction affecting Sylvan, Sylvan Ventures and eSylvan is consummated, we anticipate that we will have adequate access to Sylvan and Sylvan Ventures management for a sufficient period of time to affect a transition. However, there can be no assurances that this will be the case. Neither Sylvan nor Apollo Management LLP has made any commitment to continue to finance development of our business, and we cannot predict whether we can obtain the necessary financing in the future. As we expect to experience negative cash flow from operations for the forseeable future, we may be unable to continue to operate if we do not continue to receive financial support from Sylvan Ventures or its successor.

We currently have two independent members 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.

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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:

We may fail to retain and integrate key personnel.

Our success depends upon the continued services from key members of our management team. Loss of the services of these key persons 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. 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 be unable to attract customers for our services or generate revenue opportunities.

We must continue to 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. We have incurred a total of $7.6 million in sales and marketing expenses to date through December 31, 2002. We expect substantial additional such expenditures to support our business plan and will require additional funds for these efforts from our parent company. We do not have any financing commitments from our parent company. See “Management’s Discussion and Analysis of Financial Condition and Plan of Operation-Liquidity and Capital Resources.” If our promotional efforts are unsuccessful, we are unlikely to generate sufficient revenues to become profitable.

We face intense competition.

We compete with numerous providers of tutoring services, including other online companies as well as traditional bricks and mortar tutoring providers. Sylvan is a bricks and mortar provider of tutoring services through company-owned and franchised learning centers. Therefore, to the extent that Sylvan’s customers find online tutoring to be more convenient, we may actually compete with Sylvan. Some of our competitors have greater access

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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 web sites 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 web site 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.

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 web site may also experience disruptions or interruptions in service due to failures by third-party communications providers. We will depend on communications providers and our web site host to provide our consumers with access to our web site. In addition, our consumers depend on their own Internet service providers for access to our web site. Periodic systems interruptions will occur. These occurrences may cause consumers to perceive our web site 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. Commencing in calendar year 2002, there was a guaranteed minimum royalty of $400,000. 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 2003 of $480,000. Sylvan has agreed to reduce 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

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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. See the section “Pending transaction affecting Sylvan, Sylvan Ventures and eSylvan”.

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 web site 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.

Sylvan’s 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 owns a substantial majority of our outstanding voting stock on a fully diluted basis. Sylvan Ventures is a majority-owned subsidiary of Sylvan. Most of our officers and directors also have relationships with Sylvan. As a result, Sylvan controls 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. If the proposed transaction to separate Sylvan’s K through 12 business from its university business is consummated, the successor to Sylvan’s K through 12 business will continue to control us.

Our control by Sylvan and the presence of interlocking directors and officers could create potential conflicts of interest.

Because of the many relationships we have with Sylvan, and the fact that we currently have only two independent directors, our directors and officers have conflicts of interest when making decisions related to transactions between us and 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 its 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 as officers of 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. 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. Even if the proposed transaction to separate Sylvan’s K through 12 business from Sylvan’s university business is consummated, eSylvan will continue to be controlled by the successor to Sylvan’s K through 12 business. Therefore, the potential conflict of interest described above will continue to exist.

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

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error and physical damage to portions of its infrastructure. If outages or delays frequently occur in the future, Internet usage, including usage of our web site, 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.

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. Web sites 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 probabl