Attached files
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EXCEL - IDEA: XBRL DOCUMENT - EDUCATION MANAGEMENT CORPORATION | Financial_Report.xls |
EX-32.2 - EXHIBIT 32.2 - EDUCATION MANAGEMENT CORPORATION | c10713exv32w2.htm |
EX-32.1 - EXHIBIT 32.1 - EDUCATION MANAGEMENT CORPORATION | c10713exv32w1.htm |
EX-31.2 - EXHIBIT 31.2 - EDUCATION MANAGEMENT CORPORATION | c10713exv31w2.htm |
EX-31.1 - EXHIBIT 31.1 - EDUCATION MANAGEMENT CORPORATION | c10713exv31w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: December 31, 2010 |
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period From to
Commission File Number: 001-34466
EDUCATION MANAGEMENT CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania (State or other jurisdiction of incorporation or organization) |
25-1119571 (I.R.S. Employer Identification No.) |
|
210 Sixth Avenue, Pittsburgh, PA, 33rd Floor | 15222 | |
(Address of principal executive offices) | (Zip Code) |
Registrants telephone number, including area code: (412) 562-0900
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer þ | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act.): Yes o No þ
As of February 11, 2011, there were 135,519,085 shares of the registrants common stock outstanding.
Table of Contents
INDEX
1
Table of Contents
EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31, | June 30, | December 31, | ||||||||||
2010 | 2010 | 2009 | ||||||||||
(Unaudited) | (Unaudited) | |||||||||||
Assets |
||||||||||||
Current assets: |
||||||||||||
Cash and cash equivalents |
$ | 393,412 | $ | 373,546 | $ | 310,037 | ||||||
Restricted cash |
18,388 | 12,842 | 16,006 | |||||||||
Total cash, cash
equivalents and
restricted cash |
411,800 | 386,388 | 326,043 | |||||||||
Student receivables, net of allowances
of $171,143, $124,242 and $108,576
(Note 4) |
108,784 | 167,857 | 80,863 | |||||||||
Notes, advances and other receivables |
4,209 | 20,680 | 11,024 | |||||||||
Inventories |
11,643 | 11,655 | 12,572 | |||||||||
Deferred income taxes |
65,410 | 65,410 | 45,164 | |||||||||
Other current assets |
45,993 | 40,971 | 48,130 | |||||||||
Total current assets |
647,839 | 692,961 | 523,796 | |||||||||
Property and equipment, net (Note 5) |
692,293 | 678,846 | 618,953 | |||||||||
Other long-term assets (Note 7) |
92,924 | 93,441 | 66,857 | |||||||||
Intangible assets, net (Note 6) |
464,643 | 467,188 | 469,546 | |||||||||
Goodwill (Note 6) |
2,579,131 | 2,579,131 | 2,579,131 | |||||||||
Total assets |
$ | 4,476,830 | $ | 4,511,567 | $ | 4,258,283 | ||||||
Liabilities and shareholders equity |
||||||||||||
Current liabilities: |
||||||||||||
Current portion of long-term debt (Note
9) |
$ | 12,076 | $ | 12,103 | $ | 12,281 | ||||||
Accounts payable |
31,598 | 71,211 | 47,053 | |||||||||
Accrued liabilities (Note 8) |
156,982 | 178,085 | 147,176 | |||||||||
Accrued income taxes |
37,438 | 17,851 | 16,836 | |||||||||
Unearned tuition |
65,065 | 155,746 | 48,913 | |||||||||
Advance payments |
93,171 | 72,154 | 81,325 | |||||||||
Interest rate swap liability (Note 10) |
18,592 | | | |||||||||
Total current liabilities |
414,922 | 507,150 | 353,584 | |||||||||
Long-term debt, less current portion (Note 9) |
1,520,504 | 1,526,635 | 1,554,049 | |||||||||
Deferred income taxes |
179,174 | 180,934 | 177,396 | |||||||||
Deferred rent |
188,876 | 165,808 | 146,187 | |||||||||
Other long-term liabilities |
22,042 | 54,345 | 94,289 | |||||||||
Shareholders equity: |
||||||||||||
Common stock, at par |
1,431 | 1,429 | 1,198 | |||||||||
Additional paid-in capital |
1,755,269 | 1,749,456 | 1,743,616 | |||||||||
Treasury stock |
(65,487 | ) | (2,207 | ) | | |||||||
Retained earnings |
471,999 | 350,273 | 217,803 | |||||||||
Accumulated other comprehensive loss |
(11,900 | ) | (22,256 | ) | (29,839 | ) | ||||||
Total shareholders equity |
2,151,312 | 2,076,695 | 1,932,778 | |||||||||
Total liabilities and
shareholders equity |
$ | 4,476,830 | $ | 4,511,567 | $ | 4,258,283 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
2
Table of Contents
EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands except per share amounts)
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands except per share amounts)
For the Three Months | For the Six Months | |||||||||||||||
Ended December 31, | Ended December 31, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Net revenues |
$ | 771,866 | $ | 655,469 | $ | 1,437,898 | $ | 1,189,868 | ||||||||
Costs and expenses: |
||||||||||||||||
Educational services |
374,141 | 315,266 | 731,681 | 610,979 | ||||||||||||
General and administrative |
186,979 | 170,305 | 373,749 | 317,162 | ||||||||||||
Management fees paid to affiliates |
| 30,805 | | 32,055 | ||||||||||||
Depreciation and amortization |
35,349 | 29,401 | 70,400 | 58,228 | ||||||||||||
Total costs and expenses |
596,469 | 545,777 | 1,175,830 | 1,018,424 | ||||||||||||
Income before loss on extinguishment of debt, interest
and income taxes |
175,397 | 109,692 | 262,068 | 171,444 | ||||||||||||
Interest expense, net |
28,602 | 30,390 | 56,052 | 66,719 | ||||||||||||
Loss on extinguishment of debt |
8,363 | 44,762 | 8,363 | 44,762 | ||||||||||||
Income before income taxes |
138,432 | 34,540 | 197,653 | 59,963 | ||||||||||||
Provision for income taxes |
53,154 | 14,266 | 75,927 | 23,927 | ||||||||||||
Net income |
$ | 85,278 | $ | 20,274 | $ | 121,726 | $ | 36,036 | ||||||||
Earnings per share: (Note 2) |
||||||||||||||||
Basic |
$ | 0.61 | $ | 0.14 | $ | 0.86 | $ | 0.27 | ||||||||
Diluted |
$ | 0.61 | $ | 0.14 | $ | 0.86 | $ | 0.27 | ||||||||
Weighted average number of shares outstanding: (Note 2) |
||||||||||||||||
Basic |
139,598 | 142,387 | 141,021 | 131,079 | ||||||||||||
Diluted |
140,256 | 143,143 | 141,597 | 131,457 |
The accompanying notes are an integral part of these consolidated financial statements.
3
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
For the Six Months | ||||||||
Ended December 31, | ||||||||
2010 | 2009 | |||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 121,726 | $ | 36,036 | ||||
Adjustments to reconcile net income to net cash flows
from operating activities: |
||||||||
Depreciation and amortization of property and equipment |
66,406 | 53,659 | ||||||
Amortization of intangible assets |
3,994 | 4,569 | ||||||
Bad debt expense |
73,612 | 50,565 | ||||||
Fair value adjustment to loans held for sale |
7,496 | | ||||||
Amortization of debt issuance costs |
3,833 | 4,113 | ||||||
Loss on extinguishment of debt |
8,363 | 44,762 | ||||||
Share-based compensation |
5,399 | 17,476 | ||||||
Non cash adjustments related to deferred rent |
(1,237 | ) | 1,436 | |||||
Changes in assets and liabilities: |
||||||||
Restricted cash |
(5,546 | ) | (5,634 | ) | ||||
Receivables |
5,397 | (1,288 | ) | |||||
Reimbursements for tenant improvements |
14,138 | 7,421 | ||||||
Inventory |
25 | (3,193 | ) | |||||
Other assets |
(10,478 | ) | (17,236 | ) | ||||
Purchase of
EFL loans (Note 7) |
(18,410 | ) | (22,643 | ) | ||||
Accounts payable |
(26,403 | ) | (1,373 | ) | ||||
Accrued liabilities |
(4,046 | ) | (12,415 | ) | ||||
Unearned tuition |
(90,681 | ) | (69,828 | ) | ||||
Advance payments |
20,782 | 13,997 | ||||||
Total adjustments |
52,644 | 64,388 | ||||||
Net cash flows provided by operating activities |
174,370 | 100,424 | ||||||
Cash flows from investing activities: |
||||||||
Expenditures for long-lived assets |
(69,676 | ) | (69,826 | ) | ||||
Reimbursements for tenant improvements |
(14,138 | ) | (7,421 | ) | ||||
Net cash flows used in investing activities |
(83,814 | ) | (77,247 | ) | ||||
Cash flows from financing activities: |
||||||||
Payments under revolving credit facility |
| (100,000 | ) | |||||
Retirement of senior subordinated notes |
| (355,465 | ) | |||||
Issuance of common stock |
416 | 387,824 | ||||||
Common stock repurchased for treasury |
(59,598 | ) | | |||||
Principal payments on long-term debt |
(6,158 | ) | (6,343 | ) | ||||
Debt issuance costs |
(5,411 | ) | (2,400 | ) | ||||
Net cash flows used in financing activities |
(70,751 | ) | (76,384 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents |
61 | (74 | ) | |||||
Net change in cash and cash equivalents |
19,866 | (53,281 | ) | |||||
Cash and cash equivalents, beginning of period |
373,546 | 363,318 | ||||||
Cash and cash equivalents, end of period |
$ | 393,412 | $ | 310,037 | ||||
Cash paid during the period for: |
||||||||
Interest (including swap settlement) |
$ | 54,483 | $ | 64,168 | ||||
Income taxes |
63,113 | 23,011 |
The accompanying notes are an integral part of these consolidated financial statements.
4
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
(Dollars in thousands)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
(Dollars in thousands)
Accumulated | ||||||||||||||||||||||||
Common | Additional | Other | ||||||||||||||||||||||
Stock at | Paid-in | Treasury | Retained | Comprehensive | ||||||||||||||||||||
Par Value (c) | Capital | Stock (c) | Earnings | Loss | Total | |||||||||||||||||||
Balance at June 30, 2009 |
$ | 1,198 | $ | 1,338,316 | $ | | $ | 181,767 | $ | (35,628) | (b) | $ | 1,485,653 | |||||||||||
Issuance of common stock |
231 | 389,210 | | | 389,441 | |||||||||||||||||||
Share-based compensation |
| 21,670 | | | 21,670 | |||||||||||||||||||
Excess tax benefit from share-based
compensation |
| 260 | | | 260 | |||||||||||||||||||
Common stock repurchased for treasury |
| | (2,207 | ) | | | (2,207 | ) | ||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||
Net income |
| | | 168,506 | | 168,506 | ||||||||||||||||||
Foreign currency translation |
| | | | 458 | 458 | ||||||||||||||||||
Reclassification into
earnings on interest rate
swaps, net of tax of $14,005 |
| | | | 23,795 | 23,795 | ||||||||||||||||||
Periodic revaluation of
interest rate swaps, net of
tax of $6,430 |
| | | | (10,881 | ) | (10,881 | ) | ||||||||||||||||
Net change in interest rate
swaps |
| | | | 12,914 | 12,914 | ||||||||||||||||||
Comprehensive income |
| | | | | 181,878 | (a) | |||||||||||||||||
Balance at June 30, 2010 |
$ | 1,429 | $ | 1,749,456 | $ | (2,207 | ) | $ | 350,273 | $ | (22,256) | (b) | $ | 2,076,695 | ||||||||||
Issuance of common stock |
2 | 414 | | | | 416 | ||||||||||||||||||
Share-based compensation |
| 5,399 | | | | 5,399 | ||||||||||||||||||
Common stock repurchased for treasury |
| | (63,280 | ) | | | (63,280 | ) | ||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||
Net income |
| | | 121,726 | | 121,726 | ||||||||||||||||||
Foreign currency translation |
| | | | 709 | 709 | ||||||||||||||||||
Reclassification into
earnings on interest rate
swaps, net of tax of $6,917 |
| | | | 11,778 | 11,778 | ||||||||||||||||||
Periodic revaluation of
interest rate swaps, net of
tax of $1,224 |
| | | | (2,131 | ) | (2,131 | ) | ||||||||||||||||
Net change in interest rate
swaps |
| | | | 9,647 | 9,647 | ||||||||||||||||||
Comprehensive income |
| | | | | 132,082 | ||||||||||||||||||
Balance at December 31, 2010 |
$ | 1,431 | $ | 1,755,269 | $ | (65,487 | ) | $ | 471,999 | $ | (11,900) | (b) | $ | 2,151,312 | ||||||||||
(a) | During the six months ended December 31, 2009, other comprehensive income consisted of an $11.7 million reclassification into earnings, net of tax, a $(6.7) million reduction on interest rate swaps due
to a periodic revaluation, net of tax and a $0.8 million foreign currency translation gain. |
|
(b) | The balance in accumulated other comprehensive loss at December 31, 2010, June 30, 2010 and December 31, 2009 is comprised of $11.7 million, $21.4 million and $29.2 million of a net
change in interest rate swaps, net of tax, respectively and $0.2 million, $0.9 million and $0.6 million of cumulative foreign currency translation losses, respectively. |
|
(c) | There were 600,000,000 authorized shares of par value $0.01 common stock at December 31, 2010, June 30, 2010 and December 31, 2009. Common stock of 142,823,731 shares was issued and outstanding at
December 31, 2009. Common stock and treasury stock balances and activity were as follows for the periods indicated. |
Treasury | Outstanding | |||||||
Balance at June 30, 2009 |
| 119,770,277 | ||||||
Repurchased for treasury |
123,000 | (123,000 | ) | |||||
Public offering |
| 23,000,000 | ||||||
Issued for stock-based compensation plans |
| 205,141 | ||||||
Balance at June 30, 2010 |
123,000 | 142,852,418 | ||||||
Repurchased
for treasury |
5,056,872 | (5,056,872 | ) | |||||
Issued for stock-based compensation plans |
| 84,630 | ||||||
Balance at December 31, 2010 |
5,179,872 | 137,880,176 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
5
Table of Contents
EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Basis of presentation
The accompanying unaudited consolidated financial statements of Education Management
Corporation and its subsidiaries (the Company) have been prepared by the Companys management in
accordance with generally accepted accounting principles for interim financial information and
applicable rules and regulations of the Securities Exchange Act of 1934, as amended. Accordingly,
they do not include all of the information and footnotes required by generally accepted accounting
principles in the United States for annual financial statements. The unaudited consolidated
financial statements included herein contain all adjustments (consisting of normal recurring
adjustments) which are, in the opinion of management, necessary to present fairly the financial
position as of December 31, 2010 and 2009, the consolidated statements of operations for the three and six months ended December 31, 2010 and 2009 and
the statements of cash flows for the six months ended December 31, 2010 and 2009.
The consolidated statements of
operations for the three and six months ended December 31, 2010 and 2009 are not necessarily
indicative of the results to be expected for future periods. These consolidated financial
statements should be read in conjunction with the audited consolidated financial statements and
notes thereto included in the Companys Annual Report on Form 10-K for the fiscal year ended June
30, 2010 as filed with the Securities and Exchange Commission (SEC). The accompanying
consolidated balance sheet at June 30, 2010 has been derived from the consolidated audited balance
sheet included in the Annual Report on Form 10-K.
Nature of operations
The Company is among the largest providers of post-secondary education in North America, with
approximately 158,300 enrolled students as of October 2010. The Company offers education through
four different education systems (The Art Institutes, Argosy University, Brown Mackie Colleges and
South University) and through online platforms at three of the four education systems. The Company
offers academic programs to its students through campus-based and online instruction, or through a
combination of both. The Company is committed to offering quality academic programs and
continuously strives to improve the learning experience for its students. The curriculum is
designed with a distinct emphasis on applied career-oriented content and is primarily taught by
faculty members that possess practical and relevant professional experience in their respective
fields.
Going Private Transaction
On June 1, 2006, the Company was acquired by a consortium of private equity investment funds
led by Providence Equity Partners, Goldman Sachs Capital Partners and Leeds Equity Partners
(collectively, the Sponsors). The acquisition was accomplished through the merger of EM
Acquisition Corporation into the Company, with the Company surviving the merger (the
Transaction). The Sponsors, together with certain other investors, became the owners of the
Company.
The acquisition of the Company was financed by equity invested in EM Acquisition Corporation
by the Sponsors and other investors, cash on hand, borrowings under a new senior secured credit
facility by Education Management LLC (EM LLC) and the issuance by EM LLC and Education Management
Finance Corp. (a wholly-owned subsidiary of EM LLC) of 8.75% senior notes due 2014 (the Senior
Notes) and 10.25% senior subordinated notes due 2016 (the Senior Subordinated Notes and,
together with the Senior Notes, the Notes).
6
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Initial Public Offering
In October 2009, the Company completed an initial public offering of 23.0 million shares of
common stock, $0.01 par value, at a per share price of $18.00 (the initial public offering). Net
proceeds to the Company, after transaction costs, totaled approximately $387.3 million. No
Sponsor-owned shares were sold in connection with the initial public offering. Of the net proceeds
from the initial public offering, $355.5 million was used to purchase $316.0 million of the Senior
Subordinated Notes in a tender offer and $29.6 million was used to pay a termination fee under a
management agreement entered into with the Sponsors in connection with the Transaction. In
addition, the availability for borrowing under EM LLCs revolving credit facility increased from
$388.5 million to $442.5 million effective upon the closing of the initial public offering.
Seasonality
The Companys quarterly net revenues and income fluctuate primarily as a result of the pattern
of student enrollments. The seasonality of the Companys business has decreased over the last
several years due to an increased percentage of students enrolling in online programs, which
generally experience less seasonal fluctuations than campus-based programs. The Companys first
fiscal quarter is typically its lowest revenue recognition quarter due to student vacations.
Reclassifications
Certain reclassifications of December 31, 2009 data have been made to conform to the December
31, 2010 presentation.
2. EARNINGS PER SHARE
Basic earnings per share (EPS) is computed using the weighted average number of shares
outstanding during the period. The Company uses the treasury stock method to compute diluted EPS,
which assumes that vested restricted stock was converted into common stock and certain outstanding
stock options were exercised and the resultant proceeds were used to acquire shares of common stock
at its average market price during the reporting period.
7
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Basic and diluted EPS were calculated as follows (in thousands, except per share amounts):
For the Three Months | For the Six Months | |||||||||||||||
Ended December 31, | Ended December 31, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Net income |
$ | 85,278 | $ | 20,274 | $ | 121,726 | $ | 36,036 | ||||||||
Weighted average number of shares
outstanding: |
||||||||||||||||
Basic |
139,598 | 142,387 | 141,021 | 131,079 | ||||||||||||
Effect of stock-based awards |
658 | 756 | 576 | 378 | ||||||||||||
Diluted |
140,256 | 143,143 | 141,597 | 131,457 | ||||||||||||
Earnings per share: |
||||||||||||||||
Basic |
$ | 0.61 | $ | 0.14 | $ | 0.86 | $ | 0.27 | ||||||||
Diluted |
$ | 0.61 | $ | 0.14 | $ | 0.86 | $ | 0.27 |
Because certain performance and market conditions have not been met with respect to the
Companys performance-based options, as further described in Note 3, the Company has determined
these options to be contingently issuable at December 31, 2010 and 2009 and has excluded them from the
computation of diluted EPS in the three and six month periods ended December 31, 2010 and 2009.
Additionally, time-based options to purchase 4.0 million and 1.6 million shares of common stock
were outstanding for the three-month and six-month periods ended December 31, 2010 and 2009,
respectively, but were not included in the computation of diluted EPS because the effect of
applying the treasury stock method would have been antidilutive. As a result, time-based options
that have a dilutive effect were the only options included in the diluted EPS calculation for the
three-month and six month periods ended December 31, 2010 and 2009.
3. SHARE-BASED COMPENSATION AND STOCK REPURCHASE PROGRAM
Share-Based Compensation
In August 2006, the Companys Board of Directors approved the 2006 Stock Option Plan (the
2006 Plan) for executive management and key personnel. Under the 2006 Plan, certain of the
Companys employees were granted a combination of time-based and performance-based options to
purchase the Companys common stock. In April 2009, the Companys Board of Directors adopted the
Omnibus Long-Term Incentive Plan (the Omnibus Plan), which became effective upon the completion
of the initial public offering. Under the Omnibus Plan, the Company may issue stock options,
stock appreciation rights, restricted stock, restricted stock units and other forms of
long-term incentive compensation.
Upon completion of the initial public offering in October 2009, the Company recognized $15.2
million of previously deferred stock-based compensation costs due to the removal of certain
conditions that existed related to the inability of option holders to obtain fair market value for
stock options granted under the 2006 Plan. The Company also granted stock options and restricted
stock under the Omnibus Plan in connection with the initial public offering. The Company recognized
$3.2 million and $5.4 million of share-based compensation expense related to outstanding time-based
stock options, restricted stock and other awards during the three and six month periods ended
December 31, 2010, respectively. The Company recognized $17.5 million of share-based compensation expense during
the three and six month periods ended December 31, 2009.
The Company continues to defer compensation expense on performance-based options granted under
the 2006 Plan, which have elements of both performance and market conditions, because the
performance conditions are not probable of being met at December 31, 2010.
8
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
During the six month period ended December 31, 2010,
the Company granted 2.5 million time-based stock options, which vest
over a four year period and have a weighted average exercise price of $14.65 per share. Using key assumptions of
44% for stock price volatility and 6.25 years for expected option term, these options had an
estimated fair value of $6.65 per option using the Black-Scholes method of estimating fair value.
Stock option exercise activity was not significant during the six month period ended December 31,
2010. Net of estimated forfeitures, the Company had $26.2 million of unrecognized compensation cost
relating to time-based stock options and $8.6 million of unrecognized compensation cost related to
performance-based awards at December 31, 2010.
Long Term Incentive Compensation Plan
In fiscal 2007, the Company adopted the Long-Term Incentive Compensation Plan (the LTIC
Plan). The LTIC Plan consists of a bonus pool that is valued based on returns to the Principal
Shareholders in connection with a change in control of the Company. Out of a total of 1,000,000
units authorized, approximately 672,000 units were outstanding under the LTIC Plan at December 31,
2010. Each unit represents the right to receive a payment based on the value of the bonus pool. As
the contingent future events that would result in value to the unit-holders are less than probable,
no compensation expense has been recognized by the Company during any of the periods following the
Transaction. The plan is being accounted for as an equity-based plan as the units may be settled in
stock or cash at the Companys discretion, and it is the Companys intent to settle any future
payment out of the LTIC Plan in stock. The total amount of unrecognized compensation cost over the
vesting periods of all units, net of estimated forfeitures, is approximately $2.5 million at
December 31, 2010.
Stock Repurchase Program
On December 8, 2010, the Companys Board of Directors approved an increase in the size of its
stock repurchase program from $50.0 million to $150.0 million. The Company also extended the date
through which the purchases may occur from June 30, 2011 to December 31, 2011. Under the terms of
the program, the Company may make repurchases in the open market, in privately negotiated
transactions, through accelerated repurchase programs or in structured share repurchase programs.
The program does not obligate the Company to acquire any particular amount of common stock, and it
may be modified or suspended at any time at the Companys discretion. The Company has repurchased
5.2 million shares of its common stock for $65.5 million under the program from its inception in
June 2010 through December 31, 2010, of which $3.7 million settled after December 31, 2010. At
December 31, 2010, approximately $84.5 million remained available under the program to be used for
future stock repurchases.
4. STUDENT RECEIVABLES
The Company records student receivables at cost less an estimated allowance for doubtful
accounts. The Company determines its allowance for doubtful accounts
by categorizing gross receivables based upon the enrollment status of the student. The reserve is
established based on the likelihood of collection considering the
Companys historical experience, which is updated on a frequent
basis. The reserve methodology results in a higher reserve rate for out-of-school students compared to in-school students. Student
accounts are monitored through an aging process whereby past due accounts are pursued. When certain
criteria are met, which is generally when receivables age past the due date by more than four
months, and internal collection measures have been taken without success, the accounts of former
students are placed with an outside collection agency. Student accounts that are in collection are
reserved for at a high rate and are written off after repeated attempts have been unsuccessful.
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CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following amounts (in thousands):
December 31, | June 30, | December 31, | ||||||||||
Asset Class | 2010 | 2010 | 2009 | |||||||||
Land |
$ | 17,630 | $ | 17,655 | $ | 17,657 | ||||||
Buildings and improvements |
75,215 | 74,764 | 73,683 | |||||||||
Leasehold improvements and capitalized lease costs |
463,440 | 446,992 | 372,578 | |||||||||
Furniture and equipment |
135,897 | 128,411 | 110,470 | |||||||||
Technology and other equipment |
250,425 | 226,587 | 193,148 | |||||||||
Software |
61,830 | 56,350 | 49,622 | |||||||||
Library books |
37,140 | 35,051 | 32,484 | |||||||||
Construction in progress |
49,830 | 29,850 | 57,178 | |||||||||
Total |
1,091,407 | 1,015,660 | 906,820 | |||||||||
Less accumulated depreciation |
(399,114 | ) | (336,814 | ) | (287,867 | ) | ||||||
Property and equipment, net |
$ | 692,293 | $ | 678,846 | $ | 618,953 | ||||||
Depreciation and amortization of property and equipment was $33.3 million and $27.2 million,
respectively, for the three months ended December 31, 2010 and 2009. Depreciation and amortization
of property and equipment was $66.4 million and $53.6 million, respectively, for the six month
periods ended December 31, 2010 and 2009.
6. GOODWILL AND INTANGIBLE ASSETS
Goodwill
As a result of the Transaction, the Company recorded approximately $2.6 billion of goodwill.
Goodwill is recognized as an asset in the financial statements and is initially measured as the
excess of the purchase price of the acquired company over the amounts assigned to net assets
acquired. In connection with the Transaction, property, equipment, intangible assets other than
goodwill and other assets and liabilities were recorded at fair value. The remaining value was
assigned to goodwill and represents the intrinsic value of the Company beyond its net tangible and
identifiable intangible assets. This is evidenced by the excess of the amount paid to acquire the
Company over the values of these respective net assets.
The Company formally evaluates the carrying amount of goodwill for impairment on April 1 of
each year. During interim periods, the Company reviews forecasts, its market
capitalization, business plans, regulatory and legal matters and other activities necessary to
identify events that may trigger more frequent impairment tests. During the six month period ended
December 31, 2010, the Company identified no such triggering events, and as a result, no
impairments were recorded.
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CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Intangible Assets
Intangible assets consisted of the following amounts (in thousands):
December 31, 2010 | June 30, 2010 | December 31, 2009 | ||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Carrying | Accumulated | Carrying | Accumulated | Carrying | Accumulated | |||||||||||||||||||
Amount | Amortization | Amount | Amortization | Amount | Amortization | |||||||||||||||||||
Tradename-Art Institute |
$ | 330,000 | $ | | $ | 330,000 | $ | | $ | 330,000 | $ | | ||||||||||||
Licensing, accreditation and Title
IV program participation |
112,179 | | 112,179 | | 112,179 | | ||||||||||||||||||
Curriculum and programs |
33,391 | (20,974 | ) | 31,948 | (18,412 | ) | 30,172 | (16,007 | ) | |||||||||||||||
Student contracts, applications
and
relationships |
39,511 | (34,604 | ) | 39,511 | (34,048 | ) | 39,511 | (33,284 | ) | |||||||||||||||
Favorable leases and other |
19,435 | (14,295 | ) | 19,403 | (13,393 | ) | 19,409 | (12,434 | ) | |||||||||||||||
Total intangible assets |
$ | 534,516 | $ | (69,873 | ) | $ | 533,041 | $ | (65,853 | ) | $ | 531,271 | $ | (61,725 | ) | |||||||||
Tradenames are often considered to have useful lives similar to that of the overall business,
which generally means such assets are assigned an indefinite life for accounting purposes.
State licenses and accreditations of the Companys schools as well as their eligibility for
Title IV program participation are periodically renewed in cycles ranging from every year to up to
every ten years depending upon government and accreditation regulations. Since the Company
considers these renewal processes to be a routine aspect of the overall business, these assets were
assigned indefinite lives.
Amortization of intangible assets for the three months ended December 31, 2010 and 2009 was
$2.0 million and $2.2 million, respectively. Amortization of intangible assets for the six month
periods ended December 31, 2010 and 2009 was $4.0 million and $4.6 million, respectively.
Total estimated amortization on the Companys existing intangible assets at December 31,
2010 for each of the years ending June 30, 2011 through 2015 and thereafter is as follows (in
thousands):
Amortization | ||||
Fiscal years | Expense | |||
2011 (remainder) |
$ | 4,377 | ||
2012 |
7,719 | |||
2013 |
5,372 | |||
2014 |
3,604 | |||
2015 |
1,187 | |||
Thereafter |
205 |
7. OTHER LONG-TERM ASSETS
Other long-term assets consisted of the following amounts (in thousands):
December 31, | June 30, | December 31, | ||||||||||
2010 | 2010 | 2009 | ||||||||||
EFL loans |
$ | 53,789 | $ | 49,529 | $ | 18,147 | ||||||
Deferred financing fees |
18,751 | 25,536 | 29,862 | |||||||||
Other |
20,384 | 18,376 | 18,848 | |||||||||
Total other long-term assets |
$ | 92,924 | $ | 93,441 | $ | 66,857 | ||||||
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(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
In August 2008, the Company introduced the Education Finance Loan program with a private
lender, which enables students who have exhausted all available government-sponsored or other aid
and have been denied a private loan to borrow funds to finance a portion of their tuition and other
educational expenses. Under the Education Finance Loan program, the Company purchases loans that
are originated by a private lender (EFL loans). The Company anticipates only awarding aid under the
Education Finance Loan program in fiscal 2011 to students who had received aid under the program
before June 30, 2010. As of December 31, 2010, the Company is committed to purchase approximately
$8.6 million of EFL loans during the remainder of
fiscal 2011. The Company does not expect to make any purchases or award any aid under the program
beyond June 30, 2011.
Prior to the quarter ended December 31, 2010,
EFL loans were classified as held for investment, and the
Company recognized bad debt expense related to these loans for estimated losses on the pro-rata
portion of the academic term that had been completed. Bad debt expense was determined using a
projected default rate based on information received from a private loan provider that included
historical default rate data for former students that attended the Companys institutions.
This data was further analyzed to apply projected default rates by credit score and was supplemented to
include consideration of current economic factors. The allowance for loan losses was recorded in
other long-term assets or other long-term liabilities, depending on whether the loan had been
purchased from the originating bank.
In December 2010, EFL loans were redesignated from
held for investment to held for sale as the Company no longer intends to hold the loans to
maturity. Accordingly, the Company recorded the loans at the lower of cost or fair market value. During the quarter
ended December 31, 2010, the Company recorded a loss of $7.5 million in educational services
expense as a fair value adjustment. In future periods, changes in the fair value of these loans
will be included in educational services expense to the extent that fair value falls below carrying
value.
The Company determines the fair value of
EFL loans using an income-based and a market-based approach using
level 3 inputs. In determining the fair value using the income-based
approach, the Company considers interest rate, credit and market
factors. In determining the fair value using the market-based
approach, the Company includes transaction prices of comparable loan
portfolios, to the extent available, or other market indicators. The following table summarizes changes to the EFL loans during the six months ended December 31, 2010 (in thousands):
EFL loans held for investment at June 30, 2010 |
$ | 49,529 | ||
Purchases of EFL loans |
18,410 | |||
Accrued interest |
4,287 | |||
Bad debt reserve |
(9,499 | ) | ||
Fair value adjustment |
(7,496 | ) | ||
Payments received |
(1,442 | ) | ||
EFL loans held for sale at December 31, 2010 |
$ | 53,789 | ||
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(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
8. ACCRUED LIABILITIES
Accrued liabilities consisted of the following amounts (in thousands):
December 31, | June 30, | December 31, | ||||||||||
2010 | 2010 | 2009 | ||||||||||
Payroll and related taxes |
$ | 35,592 | $ | 67,803 | $ | 35,449 | ||||||
Capital expenditures |
11,869 | 10,020 | 22,904 | |||||||||
Advertising |
36,804 | 32,474 | 33,230 | |||||||||
Interest |
12,859 | 12,732 | 13,007 | |||||||||
Benefits |
12,749 | 12,014 | 9,842 | |||||||||
Other |
47,111 | 43,042 | 32,744 | |||||||||
Total accrued liabilities |
$ | 156,984 | $ | 178,085 | $ | 147,176 | ||||||
9. SHORT-TERM AND LONG-TERM DEBT
Senior Secured Credit Facilities Amendment:
On December 7, 2010, EM LLC entered into an agreement to amend and extend its senior
secured credit facilities, which include a $442.5 million revolving credit facility and a $1.1
billion term loan. Under the agreement, lenders providing $328.3 million, or 74%, of the current
capacity under the revolving credit facility extended their commitments from June 1, 2012 to June
1, 2015, at a new interest rate of LIBOR + 4.0%. In addition, holders of an aggregate $758.7
million, or 68%, of the term loan agreed to extend the maturity date from June 1, 2013 to June 1,
2016 and increase the interest rate on these borrowings from LIBOR + 1.75% to LIBOR + 4.0%.
Lenders who did not extend will continue to be paid interest based on the margin spreads in place
prior to the amendment.
The lenders also approved amendments to the senior secured credit facilities, including a
springing maturity of March 1, 2014 for the term loans in the event that EM LLC does not
refinance, extend or pay in full the Senior Notes due 2014 on or prior to March 1, 2014. The
amendments also included an increase to the covenant basket amount for capital expenditures and
certain restricted payments, a tightening of the leverage ratio requirements through the remainder
of fiscal 2011, an increase in the amount of the revolving credit line available for letters of
credit to $425.0 million and the ability to use cash to collateralize letters of credit.
The amendment of the term loan was accounted for as an extinguishment of the original term
loan, which resulted in a loss on extinguishment of debt of $8.4 million. This loss included $5.1
million of previously deferred financing fees that were being amortized through the original
maturity date and $3.3 million in cash paid to lenders in connection with the amendment.
Short-Term Debt:
EM LLC had no borrowings under its $442.5 million credit facility at December 31, 2010, June
30, 2010 or December 31, 2009. EM LLC is obligated to pay a per annum commitment fee on undrawn
amounts under the revolving credit facility, which is currently 0.375% and varies based on certain
leverage ratios. The revolving credit facility is secured by certain of EM LLCs assets and is
subject to the Companys satisfaction of certain covenants and financial ratios described in Item 2
Managements Discussion and Analysis of Financial Condition and Results of Operations Covenant
Compliance.
EM LLC had outstanding letters of credit of $281.7 million at December 31, 2010. The U.S.
Department of Education requires the Company to maintain a letter of credit due to the Companys
failure to satisfy certain regulatory financial ratios after giving effect to the Transaction. The
amount of the letter of credit was $259.8 million at December 31, 2010 and is set at 10% of
projected Title IV aid to be received by students attending the Companys institutions in fiscal
2011. The majority of the remainder of the outstanding letters of credit relate to obligations to
purchase loans under the Education Finance Loan program, which is described in Note 7. The
outstanding letters of credit reduced the amount available for borrowings under the revolving
credit facility to $160.8 million at December 31, 2010.
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CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Long-Term Debt:
The Companys long-term debt consisted of the following amounts (in thousands):
December 31, | June 30, | December 31, | ||||||||||
2010 | 2010 | 2009 | ||||||||||
Senior secured term loan facility, due 2013 |
$ | 352,386 | $ | 1,114,977 | $ | 1,120,902 | ||||||
Senior secured term loan facility, due 2016 |
756,666 | | | |||||||||
Senior notes
due 2014 at 8.75% |
375,000 | 375,000 | 375,000 | |||||||||
Senior
subordinated notes due 2016 at 10.25% |
47,680 | 47,680 | 69,032 | |||||||||
Other |
848 | 1,081 | 1,396 | |||||||||
Total long-term debt |
1,532,580 | 1,538,738 | 1,566,330 | |||||||||
Less current portion |
12,076 | 12,103 | 12,281 | |||||||||
Total long term debt, less current portion |
$ | 1,520,504 | $ | 1,526,635 | $ | 1,554,049 | ||||||
The interest rate on the senior secured term loan facility due in 2013, which equals
three-month LIBOR plus a margin spread of 1.75% was 2.1% at December 31, 2010, 2.3% at June 30,
2010 and 2.1% at December 31, 2009. The interest rate on the senior secured term loan facility
due in 2016, which equals three-month LIBOR plus a margin spread of 4.00% was 4.3% at December 31,
2010.
In connection with the initial public offering, the Company purchased Senior Subordinated
Notes with a face value of approximately $316.0 million. The Company recorded a loss of $44.8
million on the extinguishment of a portion of the Senior Subordinated Notes in the quarter ended
December 31, 2009, which was comprised of a premium to repurchase the debt over face value of $39.5
million and accelerated amortization on the prorated portion of deferred financing costs related to
the Senior Subordinated Notes of $5.3 million. In the third quarter of fiscal 2010, the Company
extinguished an additional $21.3 million of the Senior Subordinated Notes.
10. DERIVATIVE INSTRUMENTS
EM LLC utilizes interest rate swap agreements, which are contractual agreements to exchange
payments based on underlying interest rates, to manage the floating rate portion of its term loan
facility. Currently, EM LLC has two five-year interest rate swaps outstanding through July 1, 2011,
each for a notional amount of $375.0 million. The interest rate swaps effectively convert a portion
of the variable interest rate on the senior secured term loan to a fixed rate. EM LLC receives
payments based on the three-month LIBOR and makes payments based on a fixed rate of 5.4%.
The fair value of the interest rate swaps was $18.6 million at December 31, 2010, which was
recorded as part of current liabilities on the consolidated balance sheet since the agreements
mature within one year. The fair value of the interest rate swaps was $33.9 million and $46.5
million at June 30, 2010 and December 31, 2009, respectively, which was recorded in other long-term
liabilities on the consolidated balance sheets.
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CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
During the three and six months ended December 31, 2010 and 2009, the Company reclassified
approximately $6.0 million and $11.7 million, net of tax, respectively, from accumulated other
comprehensive loss to the consolidated statement of operations, all of which was paid due to
regularly recurring quarterly settlements of the interest rate swaps. The Company recorded an
unrealized after-tax loss of $0.4 million and $1.9 million for the three months ended December 31,
2010 and 2009, respectively, and $2.1 million and $6.7 million for the six months ended December
31, 2010 and 2009, respectively, in other comprehensive loss related to the change in market value
of the swap agreements. Additionally, at December 31, 2010, there was a cumulative unrealized loss
of $11.7 million, net of tax,
related to these interest rate swaps included in accumulated other comprehensive loss on the
Companys consolidated balance sheet that will be reclassified to the consolidated statement of
operations over the remaining six months of the term of the interest rate swaps based on current
interest rates and underlying debt obligations at December 31, 2010. This loss would be immediately
recognized in the consolidated statement of operations if these instruments fail to meet certain
cash flow hedge requirements
The Company used level two inputs to value its interest rate swaps. These inputs are
defined as other than quoted prices in active markets that are either directly or indirectly
observable, including obtaining quotes from counterparties, which are based on three-month LIBOR
forward curves, and assessing non-performance risk based upon published market data.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and fair values of financial instruments (in
thousands):
December 31, 2010 | June 30, 2010 | December 31, 2009 | ||||||||||||||||||||||
Carrying | Carrying | Carrying | ||||||||||||||||||||||
Value | Fair Value | Value | Fair Value | Value | Fair Value | |||||||||||||||||||
Variable rate debt |
$ | 1,109,052 | $ | 1,087,947 | $ | 1,114,977 | $ | 1,036,929 | $ | 1,120,902 | $ | 1,048,043 | ||||||||||||
Fixed rate debt |
423,528 | 434,246 | 423,761 | 426,979 | 445,428 | 458,749 | ||||||||||||||||||
Total debt |
$ | 1,532,580 | $ | 1,522,193 | $ | 1,538,738 | $ | 1,463,908 | $ | 1,566,330 | $ | 1,506,792 |
The fair values of cash and cash equivalents, accounts receivable, accounts payable and
accrued expenses approximate carrying values due to the short-term nature of these instruments. The
derivative financial instruments are carried at fair value, which is based on the framework
discussed in Note 10. The fair values of the Companys debt instruments are generally determined
based on each instruments trading value at the dates presented.
The following table summarizes the level of the fair value hierarchy for assets and
liabilities that are measured at fair value on a recurring basis (in thousands):
December 31, 2010 | June 30, 2010 | December 31, 2009 | ||||||||||||||||||||||||||||||||||
Total fair | Total fair | Total fair | ||||||||||||||||||||||||||||||||||
Level 2 | Level 3 | value | Level 2 | Level 3 | value | Level 2 | Level 3 | value | ||||||||||||||||||||||||||||
EFL loans held for sale |
$ | | $ | 53,789 | $ | 53,789 | $ | | $ | | $ | | $ | | $ | | $ | | ||||||||||||||||||
Interest rate swap liability |
18,592 | | 18,592 | 33,932 | | 33,932 | 46,511 | | 46,511 |
As
described in Note 7, EFL loans under the Education Finance Loan program were
redesignated from held for investment to held for sale, as the Company no longer intends to hold
these loans to maturity. These loans were transferred to the held for sale category at the
lower of cost or fair market value during the quarter ended December 31, 2010. These loans were
recorded at cost less an allowance for estimated loan losses in past periods.
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CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
As described in Note 10, the interest rate swap liability was recorded as part of current
liabilities on the consolidated balance sheet at December 31, 2010 since the agreements mature
within one year. In past periods, the interest rate swap liability was recorded as part of other
long-term liabilities on the consolidated balance sheets.
12. INCOME TAXES
The Company accounts for income taxes by the asset and liability method. Under this method,
deferred tax assets and liabilities result from (i) temporary differences in the recognition of
income and expense for financial and federal income tax reporting requirements, and (ii)
differences between the recorded value of assets acquired in business combinations accounted for as
purchases for financial reporting purposes and their corresponding tax bases. The Company regularly
evaluates deferred income tax assets for recoverability and records a valuation allowance if it is
more-likely-than-not that some portion of the deferred income tax asset will not be realized.
The Companys effective tax rate was 38.4% for the three and six months ended December 31,
2010 and 41.3% and 39.9% for the three and six months ended December 31, 2009. The effective rates
differed from the combined federal and state statutory rates primarily due to valuation allowances,
expenses that are non-deductible for tax purposes, and accounting for uncertain tax positions.
There have been no material adjustments to liabilities relating to uncertain tax positions
since the last annual disclosure for the fiscal year ended June 30, 2010.
13. CONTINGENCIES
Securities Class Action
On August 11, 2010, a securities class action complaint captioned Gaer v. Education Management
Corp., et. al was filed against the Company, certain of its executive officers and directors, and
certain underwriters of the Companys initial public offering. The complaint alleges violations of
Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the
Exchange Act of 1934 due to allegedly false and misleading statements in connection with the
Companys initial public offering and the Companys subsequent press releases and filings with the
Securities and Exchange Commission. The Company believes that the lawsuit is without merit and
intends to vigorously defend itself.
On
November 10, 2010, the Court granted the Oklahoma Police Pension and Retirement Systems motion to serve
as lead plaintiff in the lawsuit. On January 10, 2011, the lead plaintiff and the Southeastern Pennsylvania Transportation Authority filed an Amended Class Action Complaint with the Court on
January 14, 2011 alleging similar violations of Section 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) and 20(a) of the
Exchange Act of 1934 and adding one additional individual
defendant and other underwriters from the Companys initial public offering.
Incentive Compensation Matters
On May 6, 2010, a qui tam action captioned Buchanan v. South University Online and Education
Management Corporation filed under the False Claims Act in July 2007 was unsealed due to the U.S.
Department of Justices decision to not intervene in the action at this time. The case, which is
pending in the United States District Court for the Western District of Pennsylvania, relates to
whether the defendants compensation plans for admission representatives violated the Higher
Education Act, as amended (HEA) and U.S. Department of Education regulations prohibiting an
institution participating in Title IV Programs from providing any commission, bonus or other
incentive payment based directly or indirectly on success in securing enrollments to any person or
entity engaged in any student recruitment or admissions activity. A number of similar lawsuits have
been filed in recent years against educational institutions that receive Title IV funds. The
complaint, which was filed by a former admissions representative for the online programs offered by
South University, outlines a theory of damages based upon Title IV funding disbursements to the
Company over a number of years and asserts the plaintiff is entitled to recover treble the amount
of actual damages allegedly sustained by the federal government as a result of the alleged
activity, plus civil monetary penalties. The Company believes the claims to be without merit and
intends to defend this action vigorously.
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(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
In December 2010, the Department of Justice, Civil Division, requested that the Company voluntarily furnish
documents and other information regarding its policies and practices with respect to recruiter
compensation and performance evaluation in connection with a second qui tam action that is also
pending in United States
District Court for the Western District of Pennsylvania but that is currently under seal. The
request was made in order to examine allegations that the Company may have submitted or caused the
submission of false claims or false statements to the U.S. Department of Education. The Company
has provided documents and other information to the Office of the U.S. Attorney for the Western
District of Pennsylvania, which is working with the Department of Justice, and intends to continue
to cooperate with the inquiry and furnish requested information and documents.
Buirkle APA Program Accreditation Lawsuit
In August 2009, a petition was filed in the District Court for Dallas County, Texas in the
case of Capalbo et al. v. Argosy Education Group, Inc. University, Education Management LLC, Education Management
Corporation and Marilyn Powell-Kissinger by 15 former students in the Clinical Psychology program
offered by the Dallas campus of Argosy University. In September 2009, the defendants removed the
case to the United States District Court for the Northern District of Texas, Dallas division. The
case was remanded back to state court in November 2009 by agreement after the plaintiffs amended
their pleadings to specify their allegations and agreed to dismiss Ms. Powell-Kissinger as a
defendant. The plaintiffs filed an amended petition in state court in January 2010 under the name
of Buirkle et al. v. Argosy Education Group, Inc., Education Management LLC and Education
Management Corporation and included three new plaintiffs. The petition alleges that, prior to the
plaintiffs enrollment and/or while the plaintiffs were enrolled in the program, the defendants
violated the Texas Deceptive Trade Practices and Consumer Protection Act and made material
misrepresentations regarding the importance of accreditation of the program by the Commission on
Accreditation, American Psychological Association, the status of the application of the Dallas
campus for such accreditation, the availability of loan repayment options for the plaintiffs, and
the quantity and quality of the plaintiffs career options. Plaintiffs seek unspecified monetary
compensatory and punitive damages. In March 2010, claims filed by three of the plaintiffs who
signed arbitration agreements with Argosy University were compelled to binding arbitration. The
remaining lawsuits in the case were stayed pending the resolution of the three arbitrations.
In May 2010, those three plaintiffs and a fourth former student in the Clinical Psychology
program offered by the Dallas campus of Argosy University filed a demand for arbitration. The first of four separate arbitrations is currently scheduled to be heard in September 2011.
Also in May 2010, three additional former students in the Clinical Psychology program offered by the Dallas campus of
Argosy University filed a new action in the District Court for Dallas County,
Texas in the case of Adibian et al. v. Argosy Education Group, Inc., Education Management LLC, and
Education Management Corporation alleging the same claims made in the previous lawsuits. Defendants filed a
motion to stay the new action pending the resolution of the arbitration proceedings.
Prior to the hearing on the motion, plaintiffs filed a notice of non-suit without prejudice.
The court signed the order of non-suit in August 2010, and this case was closed. The Company believes the claims in the lawsuits and the arbitrations to be without merit
and intends to vigorously defend itself.
State Attorney General Investigations
In October 2010, Argosy University received a subpoena from the Florida Attorney Generals
office seeking a wide range of documents related to the Companys institutions, including the nine
institutions located in Florida, from January 2, 2006 to the present. The Florida Attorney General
has announced that it is investigating potential misrepresentations in recruitment, financial aid
and other areas. The Company is cooperating with the investigation, but have also filed a suit to
quash or limit the subpoena and to protect information sought that constitutes proprietary or trade
secret information. We cannot predict the eventual scope, duration or outcome of the investigation
at this time.
In October 2010, the Company received a request for documents from the Illinois State Attorney
Generals office requesting information in connection with an investigation by the Attorney General
under the Illinois False Claims Act of whether incentive compensation was paid to employees in
violation of the U.S. Department of Educations prohibition on the payment of incentive
compensation. The Company has provided documents to the Attorney General in response to its
request and intends to cooperate with the Attorney General in connection with its investigation.
17
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
In December 2010, the Company received a subpoena from the Office of Consumer Protection of
the Attorney General of the Commonwealth of Kentucky requesting documents and detailed information
for the time period of January 1, 2008 through December 31, 2010. The Company has three Brown
Mackie College locations in Kentucky. The Kentucky Attorney General has announced an investigation
of the business practices of for-profit postsecondary schools and that subpoenas had been issued to
six proprietary colleges that do business in Kentucky in connection with the investigation. The
Company intends to continue to cooperate with the investigation. However, we cannot predict the
eventual scope, duration or outcome of the investigation at this time.
In June 2007, The New England Institute of Art (NEIA) received a civil investigative demand
letter from the Massachusetts State Attorney General requesting information in connection with the
Attorney Generals review of alleged submissions of false claims by NEIA to the Commonwealth of
Massachusetts and alleged unfair and deceptive student lending and marketing practices engaged in
by the school. In February 2008, the Attorney General informed NEIA that it does not plan to
further pursue its investigation of the false claims and deceptive marketing practices. NEIA
intends to fully cooperate with the Attorney General in connection with its investigation of NEIAs
student lending practices to the extent further cooperation is required.
Other
In addition to the matters described above, the Company is a defendant in certain legal
proceedings arising out of the conduct of its business. In the opinion of management, based upon an
investigation of these claims and discussion with legal counsel, the ultimate outcome of such legal
proceedings, individually and in the aggregate, is not expected to have a material adverse effect
on the Companys consolidated financial position, results of operations or liquidity.
14. RELATED PARTY TRANSACTIONS
In connection with the debt amendment described in Note 9, the Company paid an arranger fee of
$1.1 million to an affiliate of one of the Sponsors.
In connection with the Transaction and under the terms of an agreement between the Company and
the Sponsors, the Company agreed to pay annual advisory fees of $5.0 million to the Sponsors. This
agreement included customary exculpation and indemnification provisions in favor of the Sponsors
and their affiliates. Upon the completion of the initial public offering, the Company terminated
the agreement with the Sponsors and paid a non-recurring fee of $29.6 million. This has been
included in management fees paid to affiliates in the accompanying consolidated statements of
operations for the three and six months ended December 31, 2009.
In June 2006, the Company entered into a five-year interest rate swap agreement in the amount
of $375.0 million with an affiliate of one of the Sponsors. The terms of this agreement are
discussed in Note 10.
15. GUARANTOR SUBSIDIARIES FINANCIAL INFORMATION
On June 1, 2006, in connection with the Transaction, EM LLC and Education Management Finance
Corp. issued the Notes. The Notes are fully and unconditionally guaranteed by all of EM LLCs
existing direct and indirect domestic restricted subsidiaries, other than any subsidiary that
directly owns or operates a school, or has been formed for such purposes, and subsidiaries that
have no material assets (collectively, the Guarantors). All other subsidiaries of EM LLC, either
direct or indirect, do not guarantee the Notes (Non-Guarantors).
18
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
In November 2009, Education Management Corporation (EDMC) guaranteed the indebtedness of EM
LLC and Education Management Finance Corp. under the Notes.
The following tables present the condensed consolidated financial position of EM LLC, the
Guarantor Subsidiaries, the Non-Guarantor Subsidiaries and EDMC as of December 31, 2010, June 30,
2010 and December 31, 2009. The statements of operations for the three and six month periods ended
December 31, 2010 and 2009 and of condensed cash flows for the six month periods ended December 31,
2010 and 2009 are presented for EM LLC, the Guarantor Subsidiaries, the Non-Guarantor Subsidiaries
and EDMC.
CONDENSED CONSOLIDATED BALANCE SHEET
December 31, 2010 (In thousands)
December 31, 2010 (In thousands)
Guarantor | Non-Guarantor | EM LLC | EDMC | |||||||||||||||||||||||||||||
EM LLC | Subsidiaries | Subsidiaries | Eliminations | Consolidated | EDMC | Eliminations | Consolidated | |||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||||||
Current: |
||||||||||||||||||||||||||||||||
Cash and cash equivalents |
$ | 311,400 | $ | 9,334 | $ | 23,884 | $ | | $ | 344,618 | $ | 48,794 | $ | | $ | 393,412 | ||||||||||||||||
Restricted cash |
438 | | 17,950 | | 18,388 | | | 18,388 | ||||||||||||||||||||||||
Student and other receivables, net |
(172 | ) | 72 | 113,088 | | 112,988 | 5 | | 112,993 | |||||||||||||||||||||||
Inventories |
(355 | ) | 105 | 11,893 | | 11,643 | | | 11,643 | |||||||||||||||||||||||
Other current assets |
27,874 | 533 | 82,996 | | 111,403 | | | 111,403 | ||||||||||||||||||||||||
Total current assets |
339,185 | 10,044 | 249,811 | | 599,040 | 48,799 | | 647,839 | ||||||||||||||||||||||||
Property and equipment, net |
71,328 | 7,205 | 613,760 | | 692,293 | | | 692,293 | ||||||||||||||||||||||||
Intangible assets, net |
2,551 | 57 | 462,035 | | 464,643 | | | 464,643 | ||||||||||||||||||||||||
Goodwill |
7,328 | | 2,571,803 | | 2,579,131 | | | 2,579,131 | ||||||||||||||||||||||||
Intercompany balances |
973,077 | (102,869 | ) | (1,213,810 | ) | | (343,602 | ) | 343,602 | | | |||||||||||||||||||||
Other long-term assets |
33,800 | 53,789 | 5,337 | | 92,926 | (2 | ) | | 92,924 | |||||||||||||||||||||||
Investment in subsidiaries |
2,043,812 | | | (2,043,812 | ) | | 1,758,651 | (1,758,651 | ) | | ||||||||||||||||||||||
Total assets |
$ | 3,471,081 | $ | (31,774 | ) | $ | 2,688,936 | $ | (2,043,812 | ) | $ | 4,084,431 | $ | 2,151,050 | $ | (1,758,651 | ) | $ | 4,476,830 | |||||||||||||
Liabilities and shareholders equity (deficit) |
||||||||||||||||||||||||||||||||
Current: |
||||||||||||||||||||||||||||||||
Current portion of long-term debt |
$ | 11,850 | $ | | $ | 226 | $ | | $ | 12,076 | $ | | $ | | $ | 12,076 | ||||||||||||||||
Other current liabilities |
147,905 | 1,953 | 252,990 | | 402,848 | (2 | ) | | 402,846 | |||||||||||||||||||||||
Total current liabilities |
159,755 | 1,953 | 253,216 | | 414,924 | (2 | ) | | 414,922 | |||||||||||||||||||||||
Long-term debt, less current portion |
1,519,882 | | 622 | | 1,520,504 | | | 1,520,504 | ||||||||||||||||||||||||
Other long-term liabilities |
44,916 | 2,563 | 163,439 | | 210,918 | | | 210,918 | ||||||||||||||||||||||||
Deferred income taxes |
(12,123 | ) | (18,642 | ) | 210,199 | | 179,434 | (260 | ) | | 179,174 | |||||||||||||||||||||
Total liabilities |
1,712,430 | (14,126 | ) | 627,476 | | 2,325,780 | (262 | ) | | 2,325,518 | ||||||||||||||||||||||
Total shareholders equity (deficit) |
1,758,651 | (17,648 | ) | 2,061,460 | (2,043,812 | ) | 1,758,651 | 2,151,312 | (1,758,651 | ) | 2,151,312 | |||||||||||||||||||||
Total liabilities and shareholders
equity (deficit) |
$ | 3,471,081 | $ | (31,774 | ) | $ | 2,688,936 | $ | (2,043,812 | ) | $ | 4,084,431 | $ | 2,151,050 | $ | (1,758,651 | ) | $ | 4,476,830 | |||||||||||||
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED CONSOLIDATED BALANCE SHEET
June 30, 2010 (In thousands)
June 30, 2010 (In thousands)
Guarantor | Non-Guarantor | EM LLC | EDMC | |||||||||||||||||||||||||||||
EM LLC | Subsidiaries | Subsidiaries | Eliminations | Consolidated | EDMC | Eliminations | Consolidated | |||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||||||
Current: |
||||||||||||||||||||||||||||||||
Cash and cash equivalents |
$ | 11,522 | $ | 314 | $ | 313,403 | $ | | $ | 325,239 | $ | 48,307 | $ | | $ | 373,546 | ||||||||||||||||
Restricted cash |
387 | | 12,455 | | 12,842 | | | 12,842 | ||||||||||||||||||||||||
Student and other receivables, net |
99 | 90 | 188,342 | | 188,531 | 6 | | 188,537 | ||||||||||||||||||||||||
Inventories |
| 182 | 11,473 | | 11,655 | | | 11,655 | ||||||||||||||||||||||||
Other current assets |
26,741 | 576 | 79,064 | | 106,381 | | | 106,381 | ||||||||||||||||||||||||
Total current assets |
38,749 | 1,162 | 604,737 | | 644,648 | 48,313 | | 692,961 | ||||||||||||||||||||||||
Property and equipment, net |
64,814 | 6,956 | 607,076 | | 678,846 | | | 678,846 | ||||||||||||||||||||||||
Intangible assets, net |
2,737 | 65 | 464,386 | | 467,188 | | | 467,188 | ||||||||||||||||||||||||
Goodwill |
7,328 | | 2,571,803 | | 2,579,131 | | | 2,579,131 | ||||||||||||||||||||||||
Intercompany balances |
1,285,257 | (76,041 | ) | (1,611,040 | ) | | (401,824 | ) | 401,824 | | | |||||||||||||||||||||
Other long-term assets |
38,474 | 49,529 | 5,440 | | 93,443 | (2 | ) | | 93,441 | |||||||||||||||||||||||
Investment in subsidiaries |
1,883,576 | | | (1,883,576 | ) | | 1,626,483 | (1,626,483 | ) | | ||||||||||||||||||||||
Total assets |
$ | 3,320,935 | $ | (18,329 | ) | $ | 2,642,402 | $ | (1,883,576 | ) | $ | 4,061,432 | $ | 2,076,618 | $ | (1,626,483 | ) | $ | 4,511,567 | |||||||||||||
Liabilities and shareholders equity (deficit) |
||||||||||||||||||||||||||||||||
Current: |
||||||||||||||||||||||||||||||||
Current portion of long-term debt |
$ | 11,850 | $ | | $ | 253 | $ | | $ | 12,103 | $ | | $ | | $ | 12,103 | ||||||||||||||||
Other current liabilities |
114,396 | 4,827 | 375,641 | | 494,864 | 183 | | 495,047 | ||||||||||||||||||||||||
Total current liabilities |
126,246 | 4,827 | 375,894 | | 506,967 | 183 | | 507,150 | ||||||||||||||||||||||||
Long-term debt, less current portion |
1,525,807 | | 828 | | 1,526,635 | | | 1,526,635 | ||||||||||||||||||||||||
Other long-term liabilities |
58,397 | 3,172 | 158,584 | | 220,153 | | | 220,153 | ||||||||||||||||||||||||
Deferred income taxes |
(15,998 | ) | (13,393 | ) | 210,585 | | 181,194 | (260 | ) | | 180,934 | |||||||||||||||||||||
Total liabilities |
1,694,452 | (5,394 | ) | 745,891 | | 2,434,949 | (77 | ) | | 2,434,872 | ||||||||||||||||||||||
Total shareholders equity (deficit) |
1,626,483 | (12,935 | ) | 1,896,511 | (1,883,576 | ) | 1,626,483 | 2,076,695 | (1,626,483 | ) | 2,076,695 | |||||||||||||||||||||
Total liabilities and shareholders
equity (deficit) |
$ | 3,320,935 | $ | (18,329 | ) | $ | 2,642,402 | $ | (1,883,576 | ) | $ | 4,061,432 | $ | 2,076,618 | $ | (1,626,483 | ) | $ | 4,511,567 | |||||||||||||
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED CONSOLIDATED BALANCE SHEET
December 31, 2009 (In thousands)
December 31, 2009 (In thousands)
Guarantor | Non-Guarantor | EM LLC | EDMC | |||||||||||||||||||||||||||||
EM LLC | Subsidiaries | Subsidiaries | Eliminations | Consolidated | EDMC | Eliminations | Consolidated | |||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||||||
Current: |
||||||||||||||||||||||||||||||||
Cash and cash equivalents |
$ | 245,086 | $ | 2,301 | $ | 16,544 | $ | | $ | 263,931 | $ | 46,106 | $ | | $ | 310,037 | ||||||||||||||||
Restricted cash |
531 | | 15,475 | | 16,006 | | | 16,006 | ||||||||||||||||||||||||
Student and other receivables, net |
63 | 53 | 91,767 | | 91,883 | 4 | | 91,887 | ||||||||||||||||||||||||
Inventories |
| 90 | 12,482 | | 12,572 | | | 12,572 | ||||||||||||||||||||||||
Other current assets |
29,377 | 624 | 63,293 | | 93,294 | | | 93,294 | ||||||||||||||||||||||||
Total current assets |
275,057 | 3,068 | 199,561 | | 477,686 | 46,110 | | 523,796 | ||||||||||||||||||||||||
Property and equipment, net |
52,434 | 6,481 | 560,038 | | 618,953 | | | 618,953 | ||||||||||||||||||||||||
Intangible assets, net |
2,952 | 68 | 466,526 | | 469,546 | | | 469,546 | ||||||||||||||||||||||||
Goodwill |
7,328 | | 2,571,803 | | 2,579,131 | | | 2,579,131 | ||||||||||||||||||||||||
Intercompany balances |
1,144,441 | (36,215 | ) | (1,508,694 | ) | | (400,468 | ) | 400,468 | | | |||||||||||||||||||||
Other long-term assets |
43,046 | 18,147 | 5,664 | | 66,857 | | | 66,857 | ||||||||||||||||||||||||
Investment in subsidiaries |
1,712,211 | | | (1,712,211 | ) | | 1,486,386 | (1,486,386 | ) | | ||||||||||||||||||||||
Total assets |
$ | 3,237,469 | $ | (8,451 | ) | $ | 2,294,898 | $ | (1,712,211 | ) | $ | 3,811,705 | $ | 1,932,964 | $ | (1,486,386 | ) | $ | 4,258,283 | |||||||||||||
Liabilities and shareholders equity (deficit) |
||||||||||||||||||||||||||||||||
Current: |
||||||||||||||||||||||||||||||||
Current portion of long-term debt |
$ | 11,851 | $ | | $ | 430 | $ | | $ | 12,281 | $ | | $ | | $ | 12,281 | ||||||||||||||||
Other current liabilities |
118,130 | 2,620 | 220,367 | | 341,117 | 186 | | 341,303 | ||||||||||||||||||||||||
Total current liabilities |
129,981 | 2,620 | 220,797 | | 353,398 | 186 | | 353,584 | ||||||||||||||||||||||||
Long-term debt, less current portion |
1,553,084 | | 965 | | 1,554,049 | | | 1,554,049 | ||||||||||||||||||||||||
Other long-term liabilities |
87,512 | 11,785 | 141,179 | | 240,476 | | | 240,476 | ||||||||||||||||||||||||
Deferred income taxes |
(19,494 | ) | (9,521 | ) | 206,411 | | 177,396 | | | 177,396 | ||||||||||||||||||||||
Total liabilities |
1,751,083 | 4,884 | 569,352 | | 2,325,319 | 186 | | 2,325,505 | ||||||||||||||||||||||||
Total shareholders equity (deficit) |
1,486,386 | (13,335 | ) | 1,725,546 | (1,712,211 | ) | 1,486,386 | 1,932,778 | (1,486,386 | ) | 1,932,778 | |||||||||||||||||||||
Total liabilities and shareholders
equity (deficit) |
$ | 3,237,469 | $ | (8,451 | ) | $ | 2,294,898 | $ | (1,712,211 | ) | $ | 3,811,705 | $ | 1,932,964 | $ | (1,486,386 | ) | $ | 4,258,283 | |||||||||||||
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONSOLIDATED STATEMENT OF OPERATIONS
For the Three Months Ended December 31, 2010 (In thousands)
For the Three Months Ended December 31, 2010 (In thousands)
Guarantor | Non-Guarantor | EM LLC | EDMC | |||||||||||||||||||||||||||||
EM LLC | Subsidiaries | Subsidiaries | Eliminations | Consolidated | EDMC | Eliminations | Consolidated | |||||||||||||||||||||||||
Net revenues |
$ | | $ | 545 | $ | 771,321 | $ | | $ | 771,866 | $ | | $ | | $ | 771,866 | ||||||||||||||||
Costs and expenses: |
||||||||||||||||||||||||||||||||
Educational services |
19,301 | 10,227 | 344,614 | | 374,142 | | | 374,142 | ||||||||||||||||||||||||
General and administrative |
(29,708 | ) | (929 | ) | 217,559 | | 186,922 | 57 | | 186,979 | ||||||||||||||||||||||
Depreciation and amortization |
5,988 | 85 | 29,276 | | 35,349 | | | 35,349 | ||||||||||||||||||||||||
Total costs and expenses |
(4,419 | ) | 9,383 | 591,449 | | 596,413 | 57 | | 596,470 | |||||||||||||||||||||||
Income (loss) before loss on extinguishment
of debt, interest and income taxes |
4,419 | (8,838 | ) | 179,872 | | 175,453 | (57 | ) | | 175,396 | ||||||||||||||||||||||
Interest (income) expense, net |
28,942 | (963 | ) | 636 | | 28,615 | (14 | ) | | 28,601 | ||||||||||||||||||||||
Loss on extinguishment of debt |
8,363 | | | | 8,363 | | | 8,363 | ||||||||||||||||||||||||
Equity in earnings of subsidiaries |
(105,587 | ) | | | 105,587 | | (85,321 | ) | 85,321 | | ||||||||||||||||||||||
Income (loss) before income taxes |
72,701 | (7,875 | ) | 179,236 | (105,587 | ) | 138,475 | 85,278 | (85,321 | ) | 138,432 | |||||||||||||||||||||
Provision for (benefit from) income taxes |
(12,620 | ) | (3,023 | ) | 68,798 | | 53,155 | | | 53,155 | ||||||||||||||||||||||
Net income (loss) |
$ | 85,321 | $ | (4,852 | ) | $ | 110,438 | $ | (105,587 | ) | $ | 85,320 | $ | 85,278 | $ | (85,321 | ) | $ | 85,277 | |||||||||||||
CONSOLIDATED STATEMENT OF OPERATIONS
For the Three Months Ended December 31, 2009 (In thousands)
For the Three Months Ended December 31, 2009 (In thousands)
Guarantor | Non-Guarantor | EM LLC | EDMC | |||||||||||||||||||||||||||||
EM LLC | Subsidiaries | Subsidiaries | Eliminations | Consolidated | EDMC | Eliminations | Consolidated | |||||||||||||||||||||||||
Net revenues |
$ | | $ | (3,254 | ) | $ | 658,723 | $ | | $ | 655,469 | $ | | $ | | $ | 655,469 | |||||||||||||||
Costs and expenses: |
||||||||||||||||||||||||||||||||
Educational services |
17,201 | (2,000 | ) | 300,065 | | 315,266 | | | 315,266 | |||||||||||||||||||||||
General and administrative |
(14,895 | ) | (29 | ) | 185,171 | | 170,247 | 58 | | 170,305 | ||||||||||||||||||||||
Management fees paid to affiliates |
30,805 | | | | 30,805 | | | 30,805 | ||||||||||||||||||||||||
Depreciation and amortization |
4,449 | 64 | 24,888 | | 29,401 | | | 29,401 | ||||||||||||||||||||||||
Total costs and expenses |
37,560 | (1,965 | ) | 510,124 | | 545,719 | 58 | | 545,777 | |||||||||||||||||||||||
Income (loss) before loss on
extinguishment of debt, interest and
income taxes |
(37,560 | ) | (1,289 | ) | 148,599 | | 109,750 | (58 | ) | | 109,692 | |||||||||||||||||||||
Interest expense, net |
29,612 | 85 | 722 | | 30,419 | (29 | ) | | 30,390 | |||||||||||||||||||||||
Loss on extinguishment of debt |
44,762 | | | | 44,762 | | | 44,762 | ||||||||||||||||||||||||
Equity in earnings of subsidiaries |
(86,942 | ) | | | 86,942 | | (20,291 | ) | 20,291 | | ||||||||||||||||||||||
Income (loss) before income taxes |
(24,992 | ) | (1,374 | ) | 147,877 | (86,942 | ) | 34,569 | 20,262 | (20,291 | ) | 34,540 | ||||||||||||||||||||
Provision for (benefit from)
income taxes |
(45,283 | ) | (546 | ) | 60,107 | | 14,278 | (12 | ) | | 14,266 | |||||||||||||||||||||
Net income (loss) |
$ | 20,291 | $ | (828 | ) | $ | 87,770 | $ | (86,942 | ) | $ | 20,291 | $ | 20,274 | $ | (20,291 | ) | $ | 20,274 | |||||||||||||
22
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONSOLIDATED STATEMENT OF OPERATIONS
For the Six Months Ended December 31, 2010 (In thousands)
For the Six Months Ended December 31, 2010 (In thousands)
Guarantor | Non-Guarantor | EM LLC | EDMC | |||||||||||||||||||||||||||||
EM LLC | Subsidiaries | Subsidiaries | Eliminations | Consolidated | EDMC | Eliminations | Consolidated | |||||||||||||||||||||||||
Net revenues |
$ | | $ | 1,696 | $ | 1,436,202 | $ | | $ | 1,437,898 | $ | | $ | | $ | 1,437,898 | ||||||||||||||||
Costs and expenses: |
||||||||||||||||||||||||||||||||
Educational services |
35,107 | 12,283 | 684,291 | | 731,681 | | | 731,681 | ||||||||||||||||||||||||
General and administrative |
(49,646 | ) | (1,031 | ) | 424,312 | | 373,635 | 114 | | 373,749 | ||||||||||||||||||||||
Depreciation and amortization |
11,648 | 166 | 58,586 | | 70,400 | | | 70,400 | ||||||||||||||||||||||||
Total costs and expenses |
(2,891 | ) | 11,418 | 1,167,189 | | 1,175,716 | 114 | | 1,175,830 | |||||||||||||||||||||||
Income (loss) before loss on
extinguishment of debt, interest
and income taxes |
2,891 | (9,722 | ) | 269,013 | | 262,182 | (114 | ) | | 262,068 | ||||||||||||||||||||||
Interest (income) expense, net |
56,903 | (2,072 | ) | 1,249 | | 56,080 | (28 | ) | | 56,052 | ||||||||||||||||||||||
Loss on extinguishment of debt |
8,363 | | | | 8,363 | | | 8,363 | ||||||||||||||||||||||||
Equity in earnings of
subsidiaries |
(160,236 | ) | | | 160,236 | | (121,812 | ) | 121,812 | | ||||||||||||||||||||||
Income (loss) before income taxes |
97,861 | (7,650 | ) | 267,764 | (160,236 | ) | 197,739 | 121,726 | (121,812 | ) | 197,653 | |||||||||||||||||||||
Provision for (benefit from)
income taxes |
(23,951 | ) | (2,937 | ) | 102,815 | | 75,927 | | | 75,927 | ||||||||||||||||||||||
Net income (loss) |
$ | 121,812 | $ | (4,713 | ) | $ | 164,949 | $ | (160,236 | ) | $ | 121,812 | $ | 121,726 | $ | (121,812 | ) | $ | 121,726 | |||||||||||||
CONSOLIDATED STATEMENT OF OPERATIONS
For the Six Months Ended December 31, 2009 (In thousands)
For the Six Months Ended December 31, 2009 (In thousands)
Guarantor | Non-Guarantor | EM LLC | EDMC | |||||||||||||||||||||||||||||
EM LLC | Subsidiaries | Subsidiaries | Eliminations | Consolidated | EDMC | Eliminations | Consolidated | |||||||||||||||||||||||||
Net revenues |
$ | | $ | (3,459 | ) | $ | 1,193,327 | $ | | $ | 1,189,868 | $ | | $ | | $ | 1,189,868 | |||||||||||||||
Costs and expenses: |
||||||||||||||||||||||||||||||||
Educational services |
26,174 | (2,526 | ) | 587,331 | | 610,979 | | | 610,979 | |||||||||||||||||||||||
General and administrative |
(34,706 | ) | 391 | 351,363 | | 317,048 | 114 | | 317,162 | |||||||||||||||||||||||
Management fees paid to affiliates |
32,055 | | | | 32,055 | | | 32,055 | ||||||||||||||||||||||||
Depreciation and amortization |
8,902 | 127 | 49,199 | | 58,228 | | | 58,228 | ||||||||||||||||||||||||
Total costs and expenses |
32,425 | (2,008 | ) | 987,893 | | 1,018,310 | 114 | | 1,018,424 | |||||||||||||||||||||||
Income (loss) before loss on
extinguishment of debt, interest and
income taxes |
(32,425 | ) | (1,451 | ) | 205,434 | | 171,558 | (114 | ) | | 171,444 | |||||||||||||||||||||
Interest (income) expense, net |
65,523 | (208 | ) | 1,442 | | 66,757 | (38 | ) | | 66,719 | ||||||||||||||||||||||
Loss on extinguishment of debt |
44,762 | | | | 44,762 | | | 44,762 | ||||||||||||||||||||||||
Equity in earnings of subsidiaries |
(121,847 | ) | | | 121,847 | | (36,082 | ) | 36,082 | | ||||||||||||||||||||||
Income (loss) before income taxes |
(20,863 | ) | (1,243 | ) | 203,992 | (121,847 | ) | 60,039 | 36,006 | (36,082 | ) | 59,963 | ||||||||||||||||||||
Provision for (benefit from)
income taxes |
(56,945 | ) | (496 | ) | 81,398 | | 23,957 | (30 | ) | | 23,927 | |||||||||||||||||||||
Net income (loss) |
$ | 36,082 | $ | (747 | ) | $ | 122,594 | $ | (121,847 | ) | $ | 36,082 | $ | 36,036 | $ | (36,082 | ) | $ | 36,036 | |||||||||||||
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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
For the Six Months Ended December 31, 2010 (In thousands)
For the Six Months Ended December 31, 2010 (In thousands)
Guarantor | Non-Guarantor | EM LLC | EDMC | |||||||||||||||||||||
EM LLC | Subsidiaries | Subsidiaries | Consolidated | EDMC | Consolidated | |||||||||||||||||||
Net cash flows provided by (used in) operations |
$ | 5,376 | $ | (12,395 | ) | $ | 180,902 | $ | 173,883 | $ | 487 | $ | 174,370 | |||||||||||
Cash flows from investing activities: |
||||||||||||||||||||||||
Expenditures for long-lived assets |
(7,179 | ) | (725 | ) | (61,772 | ) | (69,676 | ) | | (69,676 | ) | |||||||||||||
Other investing activities |
| | (14,138 | ) | (14,138 | ) | | (14,138 | ) | |||||||||||||||
Net cash flows used in investing activities |
(7,179 | ) | (725 | ) | (75,910 | ) | (83,814 | ) | | (83,814 | ) | |||||||||||||
Cash flows from financing activities: |
||||||||||||||||||||||||
Net repayments of debt and other |
(11,336 | ) | | (233 | ) | (11,569 | ) | | (11,569 | ) | ||||||||||||||
Common stock repurchased and stock
option exercises |
| | | | (59,182 | ) | (59,182 | ) | ||||||||||||||||
Intercompany transactions |
313,017 | 22,140 | (394,339 | ) | (59,182 | ) | 59,182 | | ||||||||||||||||
Net cash flows provided by (used in) financing
activities |
301,681 | 22,140 | (394,572 | ) | (70,751 | ) | | (70,751 | ) | |||||||||||||||
Effect of exchange rate changes on cash and
cash equivalents |
| | 61 | 61 | | 61 | ||||||||||||||||||
Increase (decrease) in cash and cash equivalents |
299,878 | 9,020 | (289,519 | ) | 19,379 | 487 | 19,866 | |||||||||||||||||
Beginning cash and cash equivalents |
11,522 | 314 | 313,403 | 325,239 | 48,307 | 373,546 | ||||||||||||||||||
Ending cash and cash equivalents |
$ | 311,400 | $ | 9,334 | $ | 23,884 | $ | 344,618 | $ | 48,794 | $ | 393,412 | ||||||||||||
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Table of Contents
EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
For the Six Months Ended December 31, 2009 (In thousands)
For the Six Months Ended December 31, 2009 (In thousands)
Guarantor | Non-Guarantor | EM LLC | EDMC | |||||||||||||||||||||
EM LLC | Subsidiaries | Subsidiaries | Consolidated | EDMC | Consolidated | |||||||||||||||||||
Net cash flows provided by (used in) operations |
$ | (33,830 | ) | $ | (3,542 | ) | $ | 137,635 | $ | 100,263 | $ | 161 | $ | 100,424 | ||||||||||
Cash flows from investing activities |
||||||||||||||||||||||||
Expenditures for long-lived assets |
(5,915 | ) | (731 | ) | (63,180 | ) | (69,826 | ) | | (69,826 | ) | |||||||||||||
Other investing activities |
| | (7,421 | ) | (7,421 | ) | | (7,421 | ) | |||||||||||||||
Net cash flows used in investing activities |
(5,915 | ) | (731 | ) | (70,601 | ) | (77,247 | ) | | (77,247 | ) | |||||||||||||
Cash flows from financing activities |
||||||||||||||||||||||||
Net repayments of debt and other |
(463,792 | ) | | (416 | ) | (464,208 | ) | | (464,208 | ) | ||||||||||||||
Net proceeds from issuance of common
stock, including stock-based
compensation |
| | | | 387,824 | 387,824 | ||||||||||||||||||
Intercompany transactions |
732,834 | 6,093 | (355,287 | ) | 383,640 | (383,640 | ) | | ||||||||||||||||
Net cash flows provided by (used in) financing
activities |
269,042 | 6,093 | (355,703 | ) | (80,568 | ) | 4,184 | (76,384 | ) | |||||||||||||||
Effect of exchange rate changes on cash and
cash equivalents |
| | (74 | ) | (74 | ) | | (74 | ) | |||||||||||||||
Increase (decrease) in cash and cash equivalents |
229,297 | 1,820 | (288,743 | ) | (57,626 | ) | 4,345 | (53,281 | ) | |||||||||||||||
Beginning cash and cash equivalents |
15,789 | 481 | 305,287 | 321,557 | 41,761 | 363,318 | ||||||||||||||||||
Ending cash and cash equivalents |
$ | 245,086 | $ | 2,301 | $ | 16,544 | $ | 263,931 | $ | 46,106 | $ | 310,037 | ||||||||||||
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ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS |
Results of Operations
The following table sets forth for the periods indicated the percentage relationship of
certain statements of operations items to net revenues.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months | For the Six Months | |||||||||||||||
Ended December 31, | Ended December 31, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Net revenues |
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Costs and expenses: |
||||||||||||||||
Educational services |
48.5 | % | 48.1 | % | 50.9 | % | 51.3 | % | ||||||||
General and administrative |
24.2 | % | 26.0 | % | 26.0 | % | 26.7 | % | ||||||||
Management fees paid to affiliates |
0.0 | % | 4.7 | % | 0.0 | % | 2.7 | % | ||||||||
Depreciation and amortization |
4.6 | % | 4.5 | % | 4.9 | % | 4.9 | % | ||||||||
Total costs and expenses |
77.3 | % | 83.3 | % | 81.8 | % | 85.6 | % | ||||||||
Income before loss on extinguishment of
debt, interest and income taxes |
22.7 | % | 16.7 | % | 18.2 | % | 14.4 | % | ||||||||
Interest expense, net |
3.7 | % | 4.6 | % | 3.9 | % | 5.6 | % | ||||||||
Loss on extinguishment of debt |
1.1 | % | 6.8 | % | 0.6 | % | 3.8 | % | ||||||||
Income before income taxes |
17.9 | % | 5.3 | % | 13.7 | % | 5.0 | % | ||||||||
Provision for income taxes |
6.9 | % | 2.2 | % | 5.2 | % | 2.0 | % | ||||||||
Net income |
11.0 | % | 3.1 | % | 8.5 | % | 3.0 | % | ||||||||
Three months ended December 31, 2010 (current period) compared to the three months ended December
31, 2009 (prior period)
All basis point changes are presented as a percentage of net revenues in each period of
comparison.
Net revenues
Our quarterly net revenues and net income fluctuate primarily as a result of the pattern of
student enrollments at our schools. The seasonality of our business has decreased over the last
several years due to an increased percentage of students enrolling in online programs, which
generally experience less seasonal fluctuations than campus-based programs. Our first fiscal
quarter is typically our lowest revenue recognition quarter due to student vacations.
The largest component of our net revenues is tuition collected from our students, which is
presented in our statements of operations after deducting refunds, scholarships and other
adjustments. Net revenues consist of tuition and fees, student housing fees, bookstore sales,
restaurant sales in connection with culinary programs, workshop fees, finance charges related to
credit extended to students and sales of related study materials. We recognize revenue on a pro
rata basis over the term of instruction or occupancy or when cash is received in the case of
certain point-of-sale revenues. The amount of tuition revenue received from students varies based
on the average tuition charge per credit hour, average credit hours taken per student, type of
program, specific curriculum and average student population. Bookstore and housing revenues are
largely a function of the average student population.
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The two main drivers of our net revenues are average student population and tuition rates.
Factors affecting our average student population include the number of continuing students
and new students attending our schools at the beginning of a period. We believe that the size of our student population at our campuses is
influenced by a number of factors. These
include the number of individuals seeking post-secondary education, the attractiveness of our
program offerings, the quality of the student experience, the effectiveness of our marketing
efforts to reach existing demand for post-secondary education, the
persistence of our students, the number of credit hours taken by our
students, the
length of the education programs and our overall educational reputation. We seek to grow our
average student population by offering new programs at existing schools and by establishing
new school locations, whether through new facility start-up or acquisition. Historically, we have
been able to pass along the rising cost of providing quality education through increases in
tuition. Our ability to raise tuition in the future may be limited by the gainful employment
regulation proposed by the U.S. Department of Education which is described below and limits the
ability of students to obtain financing for tuition and fees in excess of their ability to obtain
federally guaranteed loans, private loans, or make cash payments. Total tuition and fees typically exceed the amounts
of financial aid available for students under all available government-sponsored aid,
including Title IV programs. We have increased our lending activity to students over the last
several years due to significant decreases in availability of private loans for students to cover
this financing gap. We recently extended the repayment period for some of the financing we make
available to students to include periods of up to 36 months, which may result in higher bad debt
expense as a percentage of our net revenues.
Net revenues for the three months ended December 31, 2010 increased 17.8% to $771.9 million,
compared to $655.5 million in the same period a year ago. Average student enrollment increased
16.4% in the current quarter compared to the prior year quarter primarily due to the opening of new
school locations, the growth in our fully online programs and the introduction of new academic
programs. In addition, tuition rates increased approximately 4% in the current quarter compared to
the prior year quarter. These factors were partially offset by a lower average credit load taken by
students due to an increase in the number of students enrolled in fully online programs, who
typically take a lesser average credit load than onground students. None of the increase in student
enrollment was due to acquisitions of schools since December 31, 2009.
Educational services expense
Educational services expense consists primarily of costs related to the development, delivery
and administration of our education programs. The major cost components include faculty
compensation, salaries of administrative and student services staff, costs of educational
materials, facility occupancy costs, information systems costs, loan fees and bad debt expense.
Educational services expense increased by $58.9 million, or 18.7%, to $374.1 million in the
current quarter due primarily to the incremental costs incurred to support higher student
enrollment. As a percentage of net revenues, educational services expense increased by 37 basis
points from the quarter ended December 31, 2009 to the current quarter.
Bad debt expense was $37.1 million, or 4.8% of net revenues, in the current quarter compared
to $27.4 million, or 4.2% of net revenues, in the prior year quarter, which represented an increase
of 63 basis points. The increase in bad debt expense as a percentage of net revenues was primarily
due to larger receivable balances as a result of our assistance with students cost of education
through extended credit terms, higher delinquency rates and an increase in the proportion of our
receivables from out-of-school students, which are reserved for at a higher rate than receivables
from in-school students. The extension of our credit terms to students may result in higher bad
debt expense as a percentage of net revenues in future periods. Additionally, loans purchased
under the Education Finance Loan program were redesignated from held for investment to held for
sale during the current quarter resulting in a $7.5 million fair value adjustment that accounted
for an increase of 97 basis points in educational services expense from the prior year quarter. The fair value
adjustment due to the reclassification of these loans as held for sale includes $1.5 million
that would have been recorded in bad debt expense if the loans had not been reclassified.
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Salaries and benefits expense decreased by 64 basis points from the prior year quarter. This
decrease was primarily due to operating leverage at existing onground campuses and $2.2 million in
non-recurring stock-based compensation costs recognized in the prior year quarter in connection
with the initial public offering, partially offset by an increase in these costs for our fully
online programs. We also experienced operating leverage on rent associated with our schools, which
decreased by 41 basis points as a percentage of net revenues, totaling $46.2 million in the current
quarter compared to $41.9 million in the prior year quarter. We also experienced a decrease of 16 basis
points from the prior year quarter in fees paid to private lenders to originate loans obtained by
our students. The remaining net decrease in educational services expense in the current quarter was
the result of a net decrease in other costs, none of which were individually significant.
General and administrative expense
General and administrative expense consists of marketing and student admissions expenses and
certain central staff departmental costs such as executive management, finance and accounting,
legal, corporate development and other departments that do not provide direct services to our
students.
General and administrative expense was $187.0 million for the current quarter, an increase of
9.8% from $170.3 million in the prior year quarter. As a percentage of net revenues, general and
administrative expense decreased 176 basis points compared to the quarter ended December 31, 2009.
During the three months ended December 31, 2009, we incurred non-cash equity-based compensation
expense of $13.1 million in connection with the initial public offering. This expense was
previously deferred due to the existence of certain conditions associated with outstanding stock
options which were removed upon the completion of the initial public offering. We also incurred
costs of $0.9 million associated with the repurchase of the Senior Subordinated Notes in the prior
year quarter.
After adjusting for the costs incurred in connection with the initial public offering and
repurchase of the Senior Subordinated Notes, general and administrative expense increased by 38
basis points in the current quarter compared to the prior year quarter. The majority of the
increase was due to a 30 basis point increase in legal and consulting costs compared to the prior
year quarter, which were higher due primarily to the current regulatory environment. We also
experienced an increase of ten basis points in marketing and admissions costs, which were $160.0
million in the current quarter compared to $135.2 million in the prior year quarter. The remaining
net decrease of two basis points in the current quarter was the result of decreases in other costs,
none of which were individually significant.
Management fees paid to affiliates
In the quarter ended December 31, 2009, management fees paid to affiliates consisted of the
pro-rata portion of the $5.0 million annual fee paid to the Sponsors through December 31, 2009
under an agreement executed in connection with the Transaction and a non-recurring fee of $29.6
million to terminate the agreement which was paid at the time of the initial public offering. No
management fees were paid in fiscal 2011.
Depreciation and amortization expense
Depreciation and amortization expense on long-lived assets was $35.3 million in the current
period, an increase of 20.2% from the prior year quarter. As a percentage of net revenues,
depreciation and amortization expense remained relatively flat, increasing by nine basis points
compared to the prior year quarter.
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Interest expense, net
Net interest expense was $28.6 million in the current quarter, a decrease of $1.8 million from
the
prior year quarter. The decrease in net interest expense is primarily related to a lower
principal amount outstanding on the Senior Subordinated Notes as a result of the early retirement
of $337.3 million of these notes in fiscal 2010, partially offset by a $1.5
million increase in interest expense due to a higher interest rate on the $758.7 million principal
balance of the term loan held by lenders who consented to the amendment and extension of the senior
secured credit facility in December 2010.
Loss on extinguishment of debt
On December 7, 2010, we finalized an agreement to amend and extend our senior secured credit
facilities. The amendment was accounted for as an extinguishment of the original term loan. As a
result, we recorded a loss on extinguishment of debt of $8.4 million. This loss included $5.1
million of previously deferred financing fees that were being amortized through the original
maturity date and $3.3 million in fees paid to lending institutions to complete the debt amendment.
In connection with the initial public offering in the prior period, we retired $316.0 million
of Senior Subordinated Notes in a tender offer at a premium of $39.5 million. We also accelerated
recognition of $5.3 million of amortization on the deferred financing fees related to these notes.
Provision for income taxes
Our effective tax rate was 38.4% for the three months ended December 31, 2010 as compared to
41.3% for the same period in the prior year. The effective tax rates differed from the combined
federal and state statutory rates due primarily to valuation allowances, expenses that are
non-deductible for tax purposes, and accounting for uncertain tax positions. The reduction in the
effective tax rate from the same period in the prior year is primarily due to the impact of the
establishment of certain reserves for uncertain tax positions in the same period in the prior year.
Six months ended December 31, 2010 (current period) compared to the six months ended December 31,
2009 (prior period)
All basis point changes are presented as a percentage of net revenues in each period of
comparison.
Net revenues
Net revenues for the six months ended December 31, 2010 increased 20.8% to $1,437.9 million,
compared to $1,189.9 million in the same period a year ago. Average student enrollment increased
16.1% in the current period compared to the prior period primarily due to the opening of new school
locations, the growth in our fully online programs and the introduction of new academic programs.
In addition, tuition rates increased approximately 4% in the current period compared to the prior
period. These factors were partially offset by a lower average credit load taken by students due to
an increase in the number of students enrolled in fully online programs, who typically take a
lesser average credit load than onground students. None of the increase in student enrollment was
due to acquisitions of schools since December 31, 2009. Tuition revenue generally varies based on
the average tuition charge per credit hour, average credits per student and the average student
population.
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Table of Contents
Educational services expense
Educational services expense increased by $120.7 million, or 19.8%, to $731.7 million in the
current period due primarily to the incremental costs incurred to support higher student
enrollment. As a percentage of net revenues, educational services expense decreased by 46 basis
points in the current period compared to the prior period.
Salaries and benefits expense decreased by 101 basis points from the prior year six month
period. This decrease was primarily due to operating leverage at existing onground campuses,
partially offset by an increase in these costs for our fully online programs. We also experienced
operating leverage on rent associated with our schools, which decreased 60 basis points as a
percentage of net revenues, totaling $90.9 million in the current period compared to $82.3 million in the prior
period. We also experienced a decrease of 19 basis points from the prior period in fees paid to
private lenders to originate loans obtained by our students.
Bad debt expense was $73.6 million, or 5.1% of net revenues, in the current six month period
compared to $50.6 million, or 4.2% of net revenues, in the prior period, which represented an
increase of 87 basis points. The increase in bad debt expense as a percentage of net revenues was
primarily due to larger receivable balances as a result of our assistance with students cost of
education through extended credit terms, higher delinquency rates and an increase in the proportion
of our receivables from out-of-school students, which are reserved for at a higher rate than
receivables from in-school students. The extension of our credit terms to students may result in
higher bad debt expense as a percentage of net revenues in future
periods. Additionally, loans
purchased under the Education Finance Loan program were redesignated from held for investment to
held for sale during the current period resulting in a $7.5 million fair value adjustment that
accounted for an increase of 52 basis points in educational services
expense from the prior year period. The fair value adjustment
due to the reclassification of these loans as held for sale includes $1.5 million of bad debt
expense that would have been recorded if the loans had not been reclassified.
The remaining net decrease of five basis points in educational services expense in the current
period was the result of a net decrease in other costs, none of which were individually
significant.
General and administrative expense
General and administrative expense was $373.7 million for the current six month period, an
increase of 17.9% from $317.1 million in the prior year period. As a percentage of net revenues,
general and administrative expense decreased 66 basis points compared to the prior year period.
During the six month period ended December 31, 2009, we incurred non-cash equity-based compensation
expense of $13.1 million in connection with the initial public offering. This expense was
previously deferred due to the existence of certain conditions associated with outstanding stock
options which were removed upon the completion of the initial public offering. We also incurred
costs of $0.9 million associated with the repurchase of the Senior Subordinated Notes in the prior
year period.
After adjusting for the costs incurred in connection with the initial public offering and
repurchase of the Senior Subordinated Notes, general and administrative expense increased by 52
basis points in the current six-month period compared to the prior year period. The majority of the
increase was due to a 49 basis point increase in legal and consulting costs compared to the prior
year period, which were higher due primarily to the current regulatory environment.
This increase was partially offset by a decrease in total marketing and admissions costs of
five basis points, which were approximately 22.1% of net revenues in both periods presented. The
remaining net increase of eight basis points in the current six month period was the result of net
increases in other costs, none of which were individually significant.
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Table of Contents
Management fees paid to affiliates
In the six month period ended December 31, 2009, management fees paid to affiliates consisted
of the pro-rata portion of the $5.0 million annual fee paid to the Sponsors through December 31,
2009 under an agreement executed in connection with the Transaction and a non-recurring fee of
$29.6 million to terminate the agreement which was paid at the time of the initial public offering.
No management fees were paid in fiscal 2011.
Depreciation and amortization expense
Depreciation and amortization expense on long-lived assets was $70.4 million in the current
period, an increase of 21.6% from the prior period. As a percentage of net revenues, depreciation
and amortization expense remained flat compared to the prior year six-month period.
Interest expense, net
Net interest expense was $56.1 million in the current period, a decrease of $10.7 million from
the prior year period. The decrease in net interest expense is primarily related to a lower
principal amount outstanding on the Senior Subordinated Notes as a result of the early retirement
of $337.3 million of these notes during fiscal 2010, partially offset by a $1.5 million increase in
interest expense due to a higher interest rate on the $758.7 million principal balance of the term
loan held by lenders who consented to the amendment and extension of the senior credit facility in
December 2010.
Loss on extinguishment of debt
On December 7, 2010, we finalized an agreement to amend and extend our senior secured credit
facilities. The amendment was accounted for as an extinguishment of the original term loan. As a
result, we recorded a loss on extinguishment of debt of $8.4 million. This loss included $5.1
million of previously deferred financing fees that were being amortized through the original
maturity date and $3.3 million in fees paid to lending institutions to complete the debt amendment.
In connection with the initial public offering in the prior period, we retired $316.0 million
of Senior Subordinated Notes in a tender offer at a premium of $39.5 million. We also accelerated
recognition of $5.3 million of amortization on the deferred financing fees related to these notes.
Provision for income taxes
Our effective tax rate was 38.4% for the six months ended December 31, 2010 as compared to
39.9% for the same period in the prior year. The effective tax rates differed from the combined
federal and state statutory rates primarily due to valuation allowances, expenses that are
non-deductible for tax purposes, and accounting for uncertain tax positions. The reduction in the
effective tax rate from the same period in the prior year is primarily due to the impact of the
establishment of certain reserves for uncertain tax positions in the same period in the prior year.
Liquidity and Funds of Capital Resources
We had cash and cash equivalents of $393.4 million at December 31, 2010, all of which was
invested in highly liquid investments with maturities of three months or less. Our cash balances
tend to be higher at the end of our first and third fiscal quarters than at the end of our second
and fourth fiscal quarters due to the timing of receipts of students federal aid. We finance our
operating activities primarily from cash generated from operations. Our primary source of cash is
tuition collected from our students. We believe that cash flow from operations, supplemented from
time to time with borrowings under our $442.5 million revolving credit facility, will provide
adequate funds for ongoing operations, planned expansion to new locations, planned capital
expenditures, debt service and acquisitions during the next twelve months.
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Operating cash flows
Cash flow from operations for the six month period ended December 31, 2010 was $174.4
million, compared to $100.4 million in the prior year period, which included a non-recurring $29.6
million outflow to terminate a management agreement with Sponsors in connection with the initial
public offering. The increase in operating cash flows as compared to the prior year period was
primarily related to improved operating performance and a reduction of $9.7 million in the amount
of interest paid on our debt compared to the prior year period as a result of $337.3 million of
debt repurchases since September 30, 2009.
We calculate days sales outstanding (DSO) by dividing net student and other receivables at
period end by average daily net revenues for the most recently completed quarter. DSO in net
receivables increased slightly to 13.4 days for the quarter ended December 31, 2010 compared to
12.8 days in the quarter ended December 31, 2009 due primarily to our increased assistance with
students cost of education through extended credit terms. We extend credit to our students to help
fund the difference between our total tuition and fees and the amount covered by government sponsored aid,
including amounts awarded under Title IV programs, private loans obtained by students, and cash payments by students. We have increased our lending activity to students over the last several years due to significant
decreases in availability of private loans for students to cover this financing gap. We recently
extended the repayment period for some of the financing we make available to students to include
periods of up to 36 months, which may result in higher bad debt expense as a percentage of our net
revenues and an increase in our DSO if students continue to utilize this funding source. Since the extended payment plans are not federal student aid
loans, these plans will not directly affect our published student loan default rates; however,
there may be an indirect negative impact to default rates as students may have more total debt upon
graduation.
The level of accounts receivable reaches a peak immediately after the billing of tuition and
fees at the beginning of each academic period. Collection of these receivables is heaviest at the
start of each academic period. Additionally, federal financial aid proceeds for continuing students
can be received up to ten days prior to the start of an academic term, which can result in
fluctuations in quarterly cash receipts due to the timing of the
start of academic terms. Net accounts receivable can be affected significantly by the changes in the start dates
of academic terms from reporting period to reporting period. There were no significant changes to
the start dates of academic terms in session as compared to the prior
year period.
We introduced the Education Finance Loan program in August 2008, which enables students who
have exhausted all available government-sponsored or other aid and have been denied a private loan
to borrow a portion of their tuition and other educational expenses at our schools if they or a
co-borrower meet certain eligibility and underwriting criteria. We purchased loans totaling $18.4
million during the six-month period ended December 31, 2010 related to the Education Finance Loan
program.
We have accrued a total of $9.2 million as of December 31, 2010 for uncertain tax positions,
excluding interest and the indirect benefits associated with state income taxes. We may have cash
payments in future periods relating to the amount accrued if we are ultimately unsuccessful in
defending these uncertain tax positions. However, we cannot reasonably predict at this time the
future period in which these payments may occur, if at all.
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Investing cash flows
Capital expenditures were $69.7 million, or 4.8% of net revenues, for the six month period
ended December 31, 2010, compared to $69.8 million, or 5.9% of net revenues, for the prior year
period. We expect capital expenditures in fiscal 2011 to approximate 5.0% of net revenues, compared
to 7.0% of net revenues in fiscal 2010. The anticipated decrease in capital expenditures is
primarily due to a reduced number of new schools opening in the current year as a result of
uncertainty in the regulatory environment.
Reimbursements for tenant improvements represent cash received from lessors based on the terms
of lease agreements to be used for leasehold improvements and reduce capital expenditures. We lease
most of our facilities under operating lease agreements. We anticipate that future commitments on
existing leases will be satisfied from cash provided from operating activities. We also expect to
extend the terms of leases that will expire in the near future or enter into similar long-term
commitments for comparable space.
Financing cash flows
As a result of the Transaction, we are highly leveraged and our debt service requirements are
significant. At December 31, 2010, we had $1,532.6 million in aggregate indebtedness outstanding.
We expect our cash flows from operations, combined with availability under our revolving credit
facility, to
provide sufficient liquidity to fund our current obligations, projected working capital
requirements and capital spending over the next twelve months.
On December 7, 2010, we finalized an agreement to amend and extend our senior secured credit
facilities, which include a $442.5 million revolving credit facility and a $1.1 billion term loan.
Under the agreement, lenders providing $328.3 million, or 74% of the current capacity, under the
revolving credit facility extended their commitments from June 1, 2012 to June 1, 2015 at a new
interest rate of LIBOR + 4.0%. In addition, holders of an aggregate $758.7 million, or 68%, of the
term loan agreed to extend the maturity date from June 1, 2013 to June 1, 2016 and increase the
interest rate on these borrowings from LIBOR + 1.75% to LIBOR + 4.0%. Lenders who did not extend
will continue to be paid interest based on the margin spreads in place prior to the amendment.
We may borrow up to $442.5 million on our revolving credit facility in order to fund working
capital needs that may result from the seasonal pattern of cash receipts that occur throughout the
year, issue letters of credit and, when necessary, satisfy certain year-end regulatory
requirements. We did not draw on the revolving credit facility in fiscal 2010 or in the six month
period ended December 31, 2010.
We may issue up to $425.0 million of letters of credit under the revolving credit facility,
which reduce our availability to borrow funds under the facility. At December 31, 2010, an
aggregate of $281.7 million in letters of credit were outstanding. The U.S. Department of Education
requires us to maintain a letter of credit due to our failure to satisfy certain regulatory
financial ratios after giving effect to the Transaction. The amount of the letter of credit, which
was $259.8 million at December 31, 2010, is currently set at 10% of the projected Title IV aid to
be received by students attending our institutions in fiscal 2011. The majority of the remainder of
the outstanding letters of credit relate to obligations to purchase loans under the Education
Finance Loan program. We had $160.8 million of additional borrowings available under the revolving
credit facility at December 31, 2010 after giving effect to outstanding letters of credit.
In June 2010, our Board of Directors approved a $50.0 million stock repurchase program which
was increased to $150.0 million in December 2010. The stock repurchase program terminates on
December 31, 2011 if the amount allocated to the program is not used to repurchase shares prior to
such date. Under the terms of the program, we may make repurchases in the open market, in privately
negotiated transactions, through accelerated repurchase programs or in structured share repurchase
programs. We are not obligated to acquire any particular amount of common stock, and the program
may be modified or suspended at any time at our discretion. We have repurchased 5.2 million shares
of our common stock for $65.5 million through December 31, 2010. Approximately $84.5 million
remained available under the program for future stock repurchases at December 31, 2010.
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In November 2009, EDMC guaranteed the Indentures issued in connection with the Notes
issued by EM LLC and Education Management Finance Corp. At December 31, 2010, total indebtedness
issued under the Indentures was $422.7 million. We do not expect the guarantee will adversely
affect our liquidity within the next twelve months or restrict our ability to declare dividends or
incur additional indebtedness in the future.
In October 2009, we consummated an initial public offering of 23.0 million shares of our
common stock for net proceeds of approximately $387.3 million. The proceeds were primarily used to
purchase a face value of $316.0 million of the Senior Subordinated Notes in a tender offer for
$355.5 million and to pay a termination fee of $29.6 million under a management agreement entered
into with the Sponsors in connection with the Transaction. In addition, we purchased Senior
Subordinated Notes with a face value of approximately $21.3 million through a tender offer during
the quarter ended March 31, 2010.
We may from time to time use cash on hand to retire or purchase our outstanding debt through
open market purchases, privately negotiated transactions or otherwise. Such repurchases, if any,
will depend on prevailing market conditions, our liquidity requirements, contractual restrictions
and other factors. The amounts involved may be material.
Federal Family Education Loan Program, Direct Loans and Private Student Loans
Approximately 89.3% and 4.5% of our net revenues were indirectly derived from Title IV
programs under the HEA and private loan programs, respectively, in fiscal 2010 compared to 81.3%
and 13.0% from Title IV programs and private loan programs, respectively, in fiscal 2009.
The reliance by students attending our schools on private loans decreased substantially during
the last two fiscal years due to the increased availability of federal aid and adverse market
conditions for consumer student loans. However, this trend was partially offset by increased
extension of credit to our students as well as the introduction of the Education Finance Loan
program described below.
In August 2008, we introduced the Education Finance Loan program, which enables students who
have exhausted all available government-sponsored or other aid and have been denied a private loan
to borrow a portion of their tuition and other educational expenses at our schools not covered by
other financial aid sources if they or a co-borrower meet certain eligibility and underwriting
criteria. Under the program, we purchase loans made by a private lender to students who attend our
schools. We do not anticipate awarding aid under the Education Finance Loan program in fiscal 2011
to students who had not received aid under the program as of June 30, 2010. We estimate that total
aid awarded under the program during the remainder of fiscal 2011 will be approximately $3.2
million, and we will purchase approximately $8.6 million in loans under the program during the
remainder of fiscal 2011. We do not expect to make any purchases or
award any aid under the program beyond June 30, 2011. During fiscal 2010, loans to students under the Education Finance Loan
program represented approximately 2.6% of our net revenues.
The Education Finance Loan program adversely impacts our liquidity and exposes us to greater
credit risk because we own long-term loans to our students. This financing program provides for
payments to us by our students over a term as long as 20 years, which could have a material adverse
effect on our cash flows from operations. In addition, we have the risk of collection with respect
to these loans, which has resulted in an increase to our bad debt expense as a percentage of net
revenues compared to prior fiscal years. In December 2010, loans held under the Education Finance
Loan program were redesignated from held for investment to held for sale because the Company no
longer intends to hold the loans to maturity and recorded the loans at the lower of cost or fair
market value.
While we are taking steps to address the private loan needs of our students, the consumer
lending market could worsen. The inability of our students to finance their education could cause
our student population to decrease, which could have a material adverse effect on our financial
condition, results of operations and cash flows.
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Regulatory Environment
The U.S. Department of Education published Notices of Proposed Rulemaking (NPRM)in the
Federal Register on June 18, 2010 and July 26, 2010 pursuant to which it proposed to amend certain
regulations under the HEA governing federal student financial assistance programs under Title IV of
the HEA (Title IV programs), including the William D. Ford Federal Direct Loan (Direct Loan)
program and the Federal Pell Grant (Pell) program. The NPRMs were preceded by negotiated
rulemaking sessions in which the U.S. Department of Education consulted with members of the higher
education community to discuss issues and attempt to agree on regulatory revisions to address those
issues. The public comment period for the NPRM published June 18, 2010 expired on August 2, 2010
and the public comment period for the NPRM published July 26, 2010 expired on September 9, 2010.
The NPRMs addressed 14 program integrity areas, including, among other things, eliminating the
current safe harbors addressing types of activities and payment arrangements of certain persons and
entities involved in student recruiting and other activities, implementing a definition of gainful
employment with which each educational program offered by for-profit institutions would be
required to comply in order to participate in Title IV programs, revising and expanding the
activities that constitute a substantial misrepresentation, requiring states to legally authorize
institutions through a state governmental agency or entity and requiring those authorizations to
meet certain minimum requirements, imposing limitations on agreements between related institutions,
and defining a credit hour.
The U.S. Department of Education published final regulations in the Federal Register on
October 29, 2010 for all areas addressed by the NRPMs except for the eligibility of existing
programs portion of the proposed gainful employment regulation. With respect to gainful employment,
the final regulations only addressed requirements for approvals of new educational programs and
disclosure and reporting required for educational programs. The majority of the new regulations
take effect on July 1, 2011. The U.S. Department of Education has indicated that the final gainful
employment regulation establishing new criteria for Title IV program eligibility will likely be
published in early 2011, with an effective date of July 1, 2012, which is consistent with the date
published in the gainful employment NPRM. The proposed gainful employment regulation included in
the second NPRM would result in the ineligibility of any program in which (i) students who attended
the program have annual loan repayment rates on Federal Family Education Loan Program loans and
Direct loans of less than 35%, and (ii) students who completed the program have an assumed
debt-to-income ratio that is greater than 30% of their discretionary income and greater than 12% of
their assumed average annual earnings. The proposed regulation would also impose growth
restrictions and warning requirements and employer affirmation restrictions for programs that do
not meet certain minimum debt-to-income ratios and Direct loan repayment rates.
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The final regulations adopted by the U.S. Department of Education make significant changes to
certain of the current regulatory requirements, including the following:
| Elimination of the 12 safe harbors for types of activities and
payment arrangements of certain persons and entities involved in
student recruiting and other activities that an institution may carry
out without violating the HEAs prohibition on the payment of
incentive compensation to these persons and entities. The regulation
prohibits an institution from providing a commission, bonus or other
incentive payment, defined as a sum of money or something of value,
other than a fixed salary or wages, to any person or entity engaged in
any student recruitment or admission activity or in making decisions
regarding the awarding of Title IV program funds, if the commission,
bonus or incentive payment is based directly or indirectly, in whole
or in part, upon success in securing enrollments or the award of
financial aid. Merit-based adjustments to employee compensation are
permitted provided that the adjustments are not based directly or
indirectly upon success in securing student enrollments or the award
of financial aid. We are in the process of revising our compensation
plan for our admissions representatives in response to the new
regulations and anticipate implementing the new plan across our
organization by the end of the third quarter of fiscal 2011. The U.S.
Department of Education also has stated that it will not review
individual schools compensation plans prior to their implementation.
The new compensation plan for our admissions representatives could
adversely affect our ability to compensate our admissions
representatives and other employees in a manner that appropriately
reflects their job performance, which in turn could reduce their
effectiveness and make it more difficult to recruit students and
attract and retain qualified and competent admissions representatives. |
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| Requiring notice to the U.S. Department of Education at least 90 days
prior to the first day of class for a new academic program, including
an accompanying application describing how the institution determined
the need for the program, how the program was designed to meet local
market needs (or regional or national market needs for online
programs), how the program was reviewed, approved or developed by or
with business advisory committees or other listed entities,
documentation of accrediting approval, and the anticipated first day
of class. An institution that provides at least 90 days prior notice
is permitted to offer the new program to students unless the U.S.
Department of Education informs the institution at least 30 days prior
to the start of the first class that it must approve the new program
before it may be added to the institutions Title IV Program
eligibility. If it decides it must approve the new programs, the U.S.
Department of Education may require additional information to be
submitted by the institution. Factors considered by the U.S.
Department of Education when determining whether to approve the new
programs include the financial responsibility and administrative
capacity of the institution, whether the new program is one of several
new programs that will replace programs currently offered by the
institution, whether the number of additional educational programs
being added is inconsistent with the institutions historic program
offerings, growth, and operations, and the sufficiency of the process
undertaken by the institution to determine whether the new program
will lead to gainful employment in a recognized occupation. During
fiscal 2010, we developed eight new
academic programs and introduced over 230 new or existing academic
programs to locations that had not previously offered them. Under the new regulation, all of the new
academic programs and the introduction of most of the new or existing
academic programs to a new location would
require notice to the U.S. Department of Education. Any delay
in obtaining program approvals from the U.S. Department of Education
could adversely impact our ability to serve new students and revise
our programs to meet new areas of interest and respond to changing
regulatory requirements, which could have a material adverse effect on
our business, financial condition and results of operations. |
||
| Revising the provisions regarding misrepresentation to expand what may
constitute substantial misrepresentation by an institution, including
statements about the nature of its educational programs, its financial
charges or the employability of its graduates. Under the new
regulations, any false, erroneous, or misleading statement, or
statement that has the likelihood or tendency to deceive or confuse,
that an institution, one of its representatives, or person or entity
with whom the institution has an agreement to provide educational
programs, marketing, advertising, recruiting or admissions services,
makes directly or indirectly to a student, prospective student, any
member of the public, an accrediting agency, a state licensing agency
or the U.S. Department of Education could constitute a
misrepresentation by the institution. In the event that the U.S.
Department of Education determines that an institution engaged in a
substantial misrepresentation, it can revoke the institutions program
participation agreement, impose limitations on the institutions
participation in Title IV programs, deny participation applications on
behalf of the institution, or seek to fine, suspend or terminate the
institutions participation in Title IV programs. The new regulation
could create an expanded role for the U.S. Department of Education in
monitoring and enforcing prohibitions on misrepresentation, as well as
encourage private litigants to seek to enforce the expanded
regulations through False Claims Act litigation, which could have a
material adverse effect on our business, financial condition and
results of operations. |
||
| Requiring an institution of higher education to be legally authorized
in the state in which it is physically located and establishing new
requirements for establishing the adequacy of the authorization
through one of several prescribed options, including, for example,
demonstrating that the institution is established by name as an
educational institution by the state through a charter, statute,
constitutional provision or other action issued by a state
governmental agency or entity, provided that the state has a process
to review and act on complaints concerning institutions and enforce
applicable state laws and that the institution complies with any
applicable state approval or licensure requirements. The new state
authorization regulations also require institutions offering fully
online classes to students in a state where it is not physically
located to meet any state requirements for it to legally offer
postsecondary education in that state. We currently offer fully online
programs through three of our institutions to students located across
the country. In January 2011, 43,900 students, or 27.9% of all
students attending our schools, were enrolled in fully online
programs. |
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We are reviewing existing authorizations and operations in all states
to ensure all of our institutions comply with the new expectations for
both onground schools and fully online programs. Although we cannot
predict with certainty how all of the regulations will be interpreted
and implemented by the U.S. Department of Education, agency
representatives have clarified that the intent of the new regulations
is not to require postsecondary institutions to be licensed in every
state and states are not required to create new regulatory structures
to regulate all onground and online programs. Instead, the U.S.
Department of Education will defer to the states to determine what
types of approvals are necessary and an institution may be required to
provide documentation to the U.S. Department of Education, upon
request, to confirm they have received the necessary approval or
exemption from a particular state, or that the regulations do not
apply. |
|||
As a result, these new regulations may require some of our schools
and/or programs to secure additional state consents or modify existing
offerings as of July 1, 2011. Furthermore, certain states that
previously approved or exempted some of our schools may be required to
revise existing oversight and licensure processes to ensure existing
approvals and exemptions comply with the U.S. Department of
Educations new expectations. Schools can apply for an extension of
the July 1 deadline to allow states to revise existing processes
and/or requirements to comply with the regulations, but cannot request
extensions of the implementation date to provide documentation, if
requested by the U.S. Department of Education, to confirm
authorization, exemption, or inapplicability of jurisdiction.
Accordingly, we have been seeking written confirmation from states
regarding the applicability of standards based on current or expected
conduct, submitting additional applications for authorization or
exemption, and identifying states with oversight and/or approval
processes that may not meet the the U.S. Department of Educations
expectations for state authorization after July 1, 2011. We
anticipate that this project will be completed in advance of the July
1 implementation date. We cannot predict with certainty how all of
the new state authorization regulations will be interpreted and
implemented, but if we are unable to satisfactorily document the
necessary state authorizations, or if states are unable or unwilling
to revise existing processes to comply with new requirements by the
U.S. Department of Education, certain programs or campuses may no
longer be eligible for participation in Title IV programs, which could
have a material adverse effect on our business, financial condition
and results of operations. |
| Limiting the percentage of an enrolling institutions (the home
institution) program that could be provided by another institution if
the institutions have a common, for-profit parent. The new regulations
prohibit students who attend a home institution which is not
authorized to offer online programs from taking more than 50% of their
program from one of our three institutions that offer fully online
programs even if an agreement exists between the two schools that has
been approved by the
home institutions accrediting agency. We are assessing the impact of
this new regulation on our Art Institutes, some of which have students
who take online classes offered by The Art Institute of Pittsburgh,
which is authorized to offer fully online programs. |
In addition to the new regulations addressed above, the final regulations issued by the U.S.
Department of Education include provisions regarding the definition of a credit hour; the
administration of ability-to-benefit examinations; student attendance requirements; proof of high
school graduation; requirements regarding an institutions return of Title IV program funds; and
certain other issues pertaining to a students eligibility to receive Title IV program funds. We
are in the process of reviewing all of the final regulations issued on October 29, 2010. We cannot
predict with certainty how the recently released or any other resulting regulations will be
interpreted. Our inability to comply with the final regulations by the effective date of the
regulations could have a material adverse effect on our business. Uncertainty surrounding the
application of the final rules, interpretive regulations, and guidance from the U.S. Department of
Education may continue for some period of time and could reduce our enrollment, increase our cost
of doing business, adversely impact our stock price due to investor uncertainty, and have a
material adverse effect on our business, financial condition, results of operations and cash flows.
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Regulatory Oversight
The U.S. Department of Education is required to conduct periodic program reviews to determine
whether to renew the eligibility and certification of every institution participating in Title IV
programs. Generally such reviews occur every six years, although it typically occurs after three
years for an institution on provisional certification. A denial of renewal of certification precludes a school from
continuing to participate in Title IV programs. Currently all of our schools are operating under a
Provisional Program Participation Agreement with the U.S. Department of Education due to the change
of control of the Company which occurred in connection with the Transaction.
During
fiscal 2010, the U.S. Department of Education performed reviews of
three of our 29
institutions, two of which remained open at June 30, 2010. Additional
program reviews were performed at four of our institutions during the
first six months of fiscal 2011. We have received final reports for
three program reviews during the
first six months of fiscal 2011 with no findings of material
noncompliance and have not received final reports from the U.S. Department of Education for
the other three program reviews. In
addition, we received notice from the U.S. Department of Education in
January 2011 that it intends to perform a program review at one of our
institutions during the third quarter of fiscal 2011.
We are in the process of reviewing the proposed regulations to determine their potential
impacts on the Company, our institutions, and the academic programs we offer. As part of this
review, we are considering whether the goodwill at any of our reporting units has been impaired.
Based on all information currently available to us, including the significant excess of estimated
fair value over carrying value at our last annual impairment testing date of April 1, 2010, we do
not believe that it is more likely than not that any of our reporting units has a fair value below
its carrying value at December 31, 2010. Consequently, we do not believe a triggering event has
occurred, and we have not completed an interim impairment analysis. If we determine, based on
additional information, that the regulatory matters described above or the market value of our
common stock result in a triggering event, we will perform an interim goodwill impairment analysis,
which may result in a material impairment charge. For additional information refer to Item 7
Managements Discussion and Analysis of Financial Condition and Results of Operations Use of
Estimates and Critical Accounting Policies Impairment of Goodwill and Indefinite-Lived
Intangible Assets contained within our Annual Report on Form 10-K
for the fiscal year ended June 30, 2010.
Contingencies
Refer to Item 1 Financial Statements Note 13, Contingencies.
New Accounting Standards Not Yet Adopted
None.
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Non-GAAP Financial Measures
EBITDA, a measure used by management to measure operating performance, is defined as net
income (loss) plus interest (income) expense, net, provision for (benefit from) income taxes and
depreciation and amortization, including amortization of intangible assets. EBITDA is not a
recognized term under GAAP and does not purport to be an alternative to net income as a measure of
operating performance or to cash flows from operating activities as a measure of liquidity.
Additionally, EBITDA is not intended to be a measure of free cash flows available for managements
discretionary use, as it does not consider certain cash requirements such as interest payments, tax
payments and debt service requirements. Our obligations to make interest payments and our other
debt service obligations have increased substantially as a result of the indebtedness incurred to
finance the Transaction and to pay related expenses in June 2006. Management believes EBITDA is
helpful in highlighting trends because EBITDA excludes the results of decisions that are outside
the control of operating management and can differ significantly from company to company depending
on long-term strategic decisions regarding capital structure, the tax jurisdictions in which
companies operate and capital investments. Management compensates for the limitations of using
non-GAAP financial measures by using them to supplement GAAP results to provide a more complete
understanding of the factors and trends affecting the business than GAAP results alone. Because not
all companies use identical calculations, these presentations of EBITDA may not be comparable to other similarly titled measures of other companies. EBITDA is calculated as
follows (in millions):
For the Three Months | For the Six Months | |||||||||||||||
Ended December 31, | Ended December 31, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Net income |
$ | 85.3 | $ | 20.3 | $ | 121.7 | $ | 36.0 | ||||||||
Interest expense, net |
28.6 | 30.4 | 56.1 | 66.7 | ||||||||||||
Loss on extinguishment of debt (1) |
8.4 | 44.8 | 8.4 | 44.8 | ||||||||||||
Provision for income taxes |
53.1 | 14.2 | 75.9 | 24.0 | ||||||||||||
Depreciation and amortization |
35.3 | 29.4 | 70.4 | 58.2 | ||||||||||||
EBITDA |
$ | 210.7 | $ | 139.1 | $ | 332.5 | $ | 229.7 | ||||||||
(1) | On December 7, 2010, we finalized an agreement to amend and extend our senior secured credit
facilities. The amendment was accounted for as an extinguishment of the original term loan. As
a result, we expensed $5.1 million of previously deferred financing fees that were being amortized
through the original maturity date. In addition, we recorded $3.3 million as a loss on
extinguishment of debt for fees paid to lenders in connection with the amendment. |
In connection with the initial public offering in the prior year period, we retired $316.0 million
of Senior Subordinated Notes in a tender offer at a premium of $39.5 million. We also accelerated
amortization on the deferred financing fees that related to these notes for $5.3 million. |
Covenant Compliance
Under its senior secured credit facilities, our subsidiary, Education Management LLC, is
required to satisfy a maximum total leverage ratio, a minimum interest coverage ratio and other
financial conditions tests. As of December 31, 2010, it was in compliance with the financial and
non-financial covenants. Its continued ability to meet those financial ratios and tests can be
affected by events beyond our control, and we cannot assure you that it will meet those ratios and
tests in the future.
Adjusted EBITDA is a non-GAAP measure used to determine our compliance with certain covenants
contained in the indentures governing the Notes and in the credit agreement governing our senior
secured credit facilities. Adjusted EBITDA is defined as EBITDA further adjusted to exclude unusual
items and other adjustments permitted in calculating covenant compliance under our senior secured
credit facilities and the indentures governing the Notes. We believe that the inclusion of
supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA is appropriate to provide
additional information to investors to demonstrate compliance with our financing covenants.
The breach of covenants in the credit agreement governing our senior secured credit
facilities that are tied to ratios based on Adjusted EBITDA could result in a default under that
agreement, in which case the lenders could elect to declare all borrowed amounts immediately due
and payable. Any such acceleration also would result in a default under our indentures governing
the Notes. Additionally, under the credit agreement governing our senior secured credit facilities
and the indentures governing the Notes, our subsidiaries ability to engage in activities, such as
incurring additional indebtedness, making investments and paying dividends or other distributions,
is also tied to ratios based on Adjusted EBITDA.
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Adjusted EBITDA does not represent net income or cash flows from operations as those terms are
defined by GAAP and does not necessarily indicate whether cash flows will be sufficient to fund
cash needs. In addition, unlike GAAP measures such as net income and earnings per share, Adjusted
EBITDA does not reflect the impact of our obligations to make interest payments on our other debt
service obligations, which have increased substantially as a result of the indebtedness incurred in
June 2006 to finance the Transaction and related expenses. While Adjusted EBITDA and similar
measures frequently are used as measures of operations and the ability to meet debt service
requirements, these terms are not necessarily comparable to other similarly titled captions of
other companies due to the potential inconsistencies in the method of calculation. Adjusted EBITDA
does not reflect the impact of earnings or charges resulting from matters that we may consider not
to be indicative of our ongoing operations. In particular, the definition of Adjusted EBITDA in our
senior credit facilities and the indentures governing the Notes allows us to add back certain
non-cash, extraordinary, unusual or non-recurring charges that are deducted in calculating net
income. However, these are expenses that may recur, vary greatly and are difficult to predict.
Further, our debt instruments require that Adjusted EBITDA be calculated for the most recent four
fiscal quarters. As a result, the measure can be affected disproportionately by a particularly
strong or weak quarter. Further, it may not be comparable to the measure for any subsequent
12-month period or any complete fiscal year.
The following is a reconciliation of net income, which is a GAAP measure of operating results,
to Adjusted EBITDA for Education Management LLC as defined in its debt agreements. The terms and
related calculations are defined in the senior secured credit agreement (in millions).
For the 12 month | ||||
period ended | ||||
December 31, | ||||
2010 | ||||
Net income |
$ | 254.3 | ||
Interest expense, net |
110.8 | |||
Loss on extinguishment of debt |
10.9 | |||
Provision for income taxes |
133.7 | |||
Depreciation and amortization |
135.5 | |||
EBITDA |
645.2 | |||
Reversal of impact of unfavorable leases (1) |
(0.6 | ) | ||
Severance and relocation |
7.5 | |||
Capital taxes |
2.5 | |||
Non-cash compensation (2) |
9.3 | |||
Other |
5.4 | |||
Adjusted EBITDA Covenant Compliance |
$ | 669.3 | ||
(1) | Represents non-cash reduction to rent expense due to the amortization on $7.3 million of
unfavorable lease liabilities resulting from fair value adjustments required under purchase
accounting as part of the Transaction. |
|
(2) | Represents non-cash expense for stock options and restricted stock. |
Our covenant requirements and actual ratios for the year ended December 31, 2010 are as follows:
Covenant | Actual | ||||
Senior secured credit facility | Requirements | Ratios | |||
Adjusted EBITDA to Consolidated Interest Expense ratio
|
Minimum of 2.20x | 5.85 | x | ||
Consolidated Total Debt to Adjusted EBITDA ratio
|
Maximum of 4.50x | 1.77 | x |
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Certain Risks and Uncertainties
Certain of the matters we discuss in this report may constitute forward-looking statements.
Forward-looking statements contain words such as believes, expects, may, will, should,
seeks, approximately, intends, plans, estimates, or anticipates or similar expressions
which concern our strategy, plans or intentions. All statements we make relating to estimated and
projected earnings, margins, costs, expenditures, cash flows, growth rates and financial results
are forward-looking statements. In addition, from time to time we make forward-looking public
statements concerning our expected future operations and performance and other developments. All of
these forward-looking statements are subject to risks and uncertainties that may change at any
time, and, therefore, our actual results may differ materially from those that we expected. We
derive most of our forward-looking statements from our operating budgets and forecasts, which are
based upon many detailed assumptions. While we believe that our assumptions are reasonable, we
caution that it is very difficult to predict the impact of known factors, and, of course, it is impossible for us to anticipate all factors that could affect our actual
results. Some of the factors that we believe could affect our results include:
| compliance with extensive federal, state and accrediting agency regulations and
requirements; |
| our ability to maintain eligibility to participate in Title IV programs; |
| government and regulatory changes including revised interpretations of regulatory
requirements that affect the postsecondary education industry and new regulations
currently proposed by the U.S. Department of Education; |
| regulatory and accrediting agency approval of transactions involving a change of
ownership or control or a change in our corporate structure; |
| damage to our reputation or our regulatory environment caused by actions of other
for-profit institutions; |
| availability of private loans for our students; |
| loans provided to students under our Education Finance Loan program with a private
lender; |
| effects of a general economic slowdown or recession in the United States or abroad; |
| disruptions in the credit and equity markets worldwide; |
| difficulty in opening additional schools and expanding online academic programs; |
| our ability to improve existing academic programs or to develop new programs on a
timely basis and in a cost effective manner; |
| failure to effectively market and advertise to new students; |
| decline in the overall growth of enrollment in post-secondary institutions; |
| our ability to manage our substantial leverage; |
| compliance with restrictions and other terms in our debt agreements, some of which
are beyond our control; |
| our ability to keep pace with changing market needs and technology; |
| our ability to raise additional capital in the future in light of our substantial
leverage; |
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| our ability to effectively manage our growth; |
| capacity constraints or system disruptions to our online computer networks; |
| the vulnerability of our online computer networks to security risks; |
| failure to attract, retain and integrate qualified management personnel; |
| our ability to integrate acquired schools; |
| inability to operate schools due to a natural disaster; |
| competitors with greater resources; |
||
| risks inherent in non-domestic operations; and |
| the other factors set forth under Risk Factors in our Annual Report on Form 10-K. |
We caution you that the foregoing list of important factors may not contain all of the material
factors that are important to you. In addition, in light of these risks and uncertainties, the
matters referred to in the forward-looking statements contained in this Form 10-Q may not in fact
occur. We undertake no obligation to publicly update or revise any forward-looking statement as a
result of new information, future events or otherwise, except as otherwise required by law.
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ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
We are exposed to market risks in the ordinary course of business that include fluctuations in
the value of the Canadian dollar relative to the U.S. dollar. Due to the size of our Canadian
operations relative to our total business, we do not believe we are subject to material risks from
reasonably possible near-term changes in exchange rates and do not utilize forward or option
contracts on foreign currencies.
The fair values of cash and cash equivalents, accounts receivable, borrowings under our
revolving credit facility, accounts payable and accrued expenses approximate carrying values
because of the short-term nature of these instruments.
At December 31, 2010, we had total debt obligations of $1,532.6 million, including $1,109.1
million of variable rate debt under the senior secured credit facility, at a weighted average
interest rate of 7.6%. A hypothetical change of 1.25% in interest rates from December 31, 2010
levels would have increased or decreased interest expense by approximately $2.2 million for the
variable rate debt in the six month period ended December 31, 2010.
Two five-year interest rate swap agreements fix the interest rate on $750.0 million of our
variable rate debt through July 1, 2011. At December 31, 2010, we had variable rate debt of $359.1
million that was subject to market rate risk, as our interest payments fluctuated as a result of
market changes. Under the terms of the interest rate swaps, we receive variable payments based on
the three-month LIBOR and make payments based on a fixed rate of 5.4%. The net receipt or payment
from the interest rate swap agreements is recorded in interest expense. The interest rate swaps are
designated as and qualify as cash flow hedges. The derivative financial instruments are carried at
fair value, which is based on the framework discussed in Note 10 to the accompanying consolidated
financial statements. We do not use derivative instruments for trading or speculative purposes.
For the six-month period ended December 31, 2010, we recorded a net change in interest rate
swaps of $9.6 million, net of tax, in other comprehensive income consisting of an $18.7 million
reclassification into earnings partially offset by a reduction of $9.1 million due to a periodic
revaluation. The cumulative unrealized loss of $11.7 million, net of tax, at December 31, 2010
related to the swaps may be recognized in the consolidated statement of operations if these
instruments fail to meet certain cash flow hedge requirements, which include a change in certain
terms of the senior secured credit facilities or the extinguishment or termination of the senior
secured credit facilities or swap agreements prior to maturity.
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ITEM 4. | CONTROLS AND PROCEDURES |
The Company, under the supervision and participation of its management, which include the
Companys chief executive officer and chief financial officer, evaluated the effectiveness of its
disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Act of
1934, as amended (the Exchange Act). This evaluation was conducted as of the end of the period
covered by this Form 10-Q. Based on that evaluation, our chief executive officer and chief
financial officer have concluded that the Companys disclosure controls and procedures are
effective. Effective controls are designed to ensure that information required to be disclosed by
the Company in reports that it files under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in Securities and Exchange Commissions rules and forms.
These controls and procedures are designed to ensure that information required to be disclosed by
the Company in such reports are accumulated and communicated to our management, including our chief
executive officer and chief financial officer, as appropriate, to allow timely decisions regarding
required disclosure.
There were no changes that occurred during the fiscal quarter covered by this Quarterly Report
on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting.
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PART II
OTHER INFORMATION
OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS |
Information relating to legal proceedings is included in Note 13, Contingencies, to the
Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form
10-Q, which is incorporated herein by reference.
ITEM 1A. | RISK FACTORS |
There have been no material changes to our Risk Factors
as previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year
ended June 30, 2010 and Part II, Item 1A of our Quarterly Report on
Form 10-Q for the quarter ended September 30, 2010.
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
The following table sets forth information with respect to shares of Education Management
Corporation common stock purchased by us during the three months ended December 31, 2010:
Total Number of Shares | Approximate Dollar Value | |||||||||||||||
Purchased as Part of | of Shares that May Yet Be | |||||||||||||||
Total Number of | Average Price Paid | Publicly Announced | Purchased Under the | |||||||||||||
Period | Shares Purchased | per Share | Plans or Programs (a) | Plans or Programs (a) | ||||||||||||
October 1 - October 31 |
| $ | | | $ | 21,721,405 | ||||||||||
November 1 - November 30 |
1,505,300 | $ | 14.42 | 1,505,300 | $ | 11,657 | ||||||||||
December 1 - December 31 |
1,016,000 | $ | 15.25 | 1,016,000 | $ | 84,513,433 | ||||||||||
Total quarter ended
December 31, 2010 |
2,521,300 | $ | 14.76 | 2,521,300 | $ | 84,513,433 |
(a) | On December 8, 2010, the Companys Board of Directors approved an increase in the size of its
stock repurchase program from $50.0 million to $150.0 million. The Company also extended the date
through which the purchases may occur from June 30, 2011 to December 31, 2011. Under the terms of
the program, the Company may make repurchases in the open market, in privately negotiated
transactions, through accelerated repurchase programs or in structured share repurchase programs.
The program does not obligate the Company to acquire any particular amount of common stock, and it
may be modified or suspended at any time at the Companys discretion. |
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None.
ITEM 4. | REMOVED AND RESERVED |
ITEM 5. | OTHER INFORMATION |
None.
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ITEM 6. | EXHIBITS |
Number | Document | |||
10.1 | Amendment and Restatement Agreement dated December 7, 2010 among Education Management LLC, Education Management Holdings LLC,
certain Subsidiaries of Education Management Holdings LLC, the
designated Subsidiary Borrowers referred to therein, each lender thereto, BNP Paribas
(BNP), as Administrative Agent and Collateral Agent, and BNP, Bank of America, N.A., JPMorgan Chase Bank, N.A., and PNC Bank National Association,
each as Issuing Bank (previously filed as Exhibit 10.1 to the
Current Report on Form 8-K filed on December 8, 2010). |
|||
31.1 | Certification of Todd S. Nelson required by
Rule 13a-14(a) or Rule 15d-14(a) and Section 302
of the Sarbanes-Oxley Act of 2002. |
|||
31.2 | Certification of Edward H. West required by
Rule 13a-14(a) or Rule 15d-14(a) and Section 302
of the Sarbanes-Oxley Act of 2002. |
|||
32.1 | Certification of Todd S. Nelson required by
Rule 13a-14(b) or Rule 15d-14(b) and Section 906
of the Sarbanes-Oxley Act of 2002. |
|||
32.2 | Certification of Edward H. West required by
Rule 13a-14(b) or Rule 15d-14(b) and Section 906
of the Sarbanes-Oxley Act of 2002. |
|||
101 | Interactive Data File |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned hereunto duly authorized.
Date: February 11, 2011
EDUCATION MANAGEMENT CORPORATION | ||||
/s/ Edward H. West | ||||
Edward H. West | ||||
President and Chief Financial Officer |
48