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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended March 31, 2007
or
¨ | 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 000-50952
EDUCATE, INC.
(Exact name of registrant as specified in its charter)
Delaware | 37-1465722 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
1001 Fleet Street, Baltimore, Maryland | 21202 | |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: 410-843-8000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The registrant had 43,191,541 shares of common stock outstanding as of May 8, 2007.
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EDUCATE, INC.
Page No. | ||||
PART I – FINANCIAL INFORMATION | ||||
Item 1. | Financial Statements. | 1 | ||
Consolidated Balance Sheets – March 31,2007 (Unaudited) and December 31, 2006 | 1 | |||
Consolidated Statements of Income (Unaudited) – For the three months ended March 31,2007 and 2006 | 3 | |||
4 | ||||
6 | ||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. | 17 | ||
Item 3. | 25 | |||
Item 4. | 26 | |||
PART II – OTHER INFORMATION | ||||
Item 1. | 27 | |||
Item 1A. | 27 | |||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. | 27 | ||
Item 3. | 27 | |||
Item 4. | 27 | |||
Item 5. | 27 | |||
Item 6. | 28 | |||
29 |
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Educate, Inc.
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
(Dollar amounts in thousands)
March 31, 2007 | December 31, 2006 | |||||||
(unaudited) | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 381 | $ | 535 | ||||
Receivables: | ||||||||
Accounts receivable | 60,733 | 53,891 | ||||||
Notes receivable | 148 | 183 | ||||||
60,881 | 54,074 | |||||||
Allowances | (5,225 | ) | (4,949 | ) | ||||
55,656 | 49,125 | |||||||
Finished goods inventory | 14,913 | 14,885 | ||||||
Prepaid expenses | 4,313 | 3,313 | ||||||
Other current assets | 952 | 818 | ||||||
Other receivables | 874 | 3,224 | ||||||
Deferred income taxes | 2,169 | 2,169 | ||||||
Total current assets | 79,258 | 74,069 | ||||||
Property and equipment: | ||||||||
Furniture and fixtures | 6,348 | 6,398 | ||||||
Education materials | 4,810 | 4,918 | ||||||
Computer equipment and software | 15,051 | 14,751 | ||||||
Leasehold improvements | 19,485 | 19,481 | ||||||
45,694 | 45,548 | |||||||
Accumulated depreciation and amortization | (24,147 | ) | (22,677 | ) | ||||
21,547 | 22,871 | |||||||
Intangible assets: | ||||||||
Goodwill | 91,124 | 93,148 | ||||||
Tradenames | 148,598 | 148,489 | ||||||
Franchise license rights | 91,960 | 91,914 | ||||||
Other intangible assets | 25,746 | 23,951 | ||||||
357,428 | 357,502 | |||||||
Accumulated amortization | (7,161 | ) | (6,254 | ) | ||||
350,267 | 351,248 | |||||||
Other assets | 20,856 | 16,589 | ||||||
Total assets | $ | 471,928 | $ | 464,777 | ||||
See notes to consolidated financial statements (unaudited).
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Educate, Inc.
Consolidated Balance Sheets (continued)
(Dollar amounts in thousands)
March 31, 2007 | December 31, 2006 | |||||
(unaudited) | ||||||
Liabilities and stockholders’ equity | ||||||
Current liabilities: | ||||||
Accounts payable and accrued expenses | $ | 31,318 | $ | 31,914 | ||
Accrued compensation and related benefits | 11,953 | 10,967 | ||||
Income taxes payable | 1,310 | 1,063 | ||||
Current portion of long-term debt | 174,239 | 176,597 | ||||
Deferred revenue | 28,077 | 23,271 | ||||
Other current liabilities | 234 | 260 | ||||
Total current liabilities | 247,131 | 244,072 | ||||
Long-term debt, less current portion | 1,271 | 1,760 | ||||
Other long-term liabilities | 7,160 | 5,900 | ||||
Deferred income taxes | 9,320 | 8,064 | ||||
Total liabilities | 264,882 | 259,796 | ||||
Commitments and contingencies | — | — | ||||
Stockholders’ equity: | ||||||
Common stock, par value $0.01, 120,000,000 shares authorized, 43,191,541 and 43,154,123 shares issued and outstanding as of March 31, 2007 and December 31, 2006, respectively | 432 | 432 | ||||
Additional paid-in capital | 196,008 | 195,639 | ||||
Retained earnings | 7,724 | 6,323 | ||||
Accumulated other comprehensive income | 2,882 | 2,587 | ||||
Total stockholders’ equity | 207,046 | 204,981 | ||||
Total liabilities and stockholders’ equity | $ | 471,928 | $ | 464,777 | ||
See notes to consolidated financial statements (unaudited).
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Educate, Inc.
Consolidated Statements of Income
(Dollar amounts in thousands, except per share data)
(unaudited)
Three months ended March 31, | ||||||||
2007 | 2006 | |||||||
Revenues | ||||||||
Service revenues | $ | 91,692 | $ | 87,902 | ||||
Net product sales | 5,491 | 5,023 | ||||||
Total revenues | 97,183 | 92,925 | ||||||
Costs and expenses | ||||||||
Instructional and franchise operations costs (1) | 72,593 | 68,081 | ||||||
Marketing and advertising | 7,852 | 8,552 | ||||||
Cost of goods sold (1) | 3,693 | 4,155 | ||||||
Depreciation and amortization (1) | 2,197 | 2,015 | ||||||
(Gain) on sale of Company-Owned centers | (1,797 | ) | — | |||||
General and administrative expenses | 4,235 | 4,207 | ||||||
Total costs and expenses | 88,773 | 87,010 | ||||||
Operating income | 8,410 | 5,915 | ||||||
Other income (expense) | ||||||||
Interest income | 186 | 55 | ||||||
Interest expense | (4,033 | ) | (2,613 | ) | ||||
Other financing costs | (24 | ) | (1,066 | ) | ||||
Foreign exchange losses and other | (486 | ) | (61 | ) | ||||
Income from continuing operations before income taxes | 4,053 | 2,230 | ||||||
Income tax expense | (1,702 | ) | (870 | ) | ||||
Income from continuing operations | 2,351 | 1,360 | ||||||
Income from discontinued operations, net of income tax benefit of $1,360 in 2006 | — | 1,973 | ||||||
Net income | $ | 2,351 | $ | 3,333 | ||||
Earnings per common share –basic and diluted | ||||||||
Income from continuing operations | $ | 0.05 | $ | 0.03 | ||||
Income from discontinued operations, net of tax | — | 0.05 | ||||||
Net income | $ | 0.05 | $ | 0.08 | ||||
(1) Amount of depreciation and amortization directly attributed to generation of revenue excluded from: | ||||||||
Instructional and franchise operations costs | $ | 1,807 | $ | 1,561 | ||||
Cost of goods sold | 22 | 27 | ||||||
Total | $ | 1,829 | $ | 1,588 | ||||
See notes to consolidated financial statements (unaudited).
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Educate, Inc.
Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
(unaudited)
Three months ended March 31, | ||||||||
2007 | 2006 | |||||||
Operating activities | ||||||||
Net income | $ | 2,351 | $ | 3,333 | ||||
Income from discontinued operations | — | (1,973 | ) | |||||
Income from continuing operations | 2,351 | 1,360 | ||||||
Adjustments to reconcile income from continuing operations to net cash provided by continuing operations: | ||||||||
Depreciation | 2,003 | 1,829 | ||||||
Amortization | 194 | 186 | ||||||
Bad debt expense | 513 | 275 | ||||||
Deferred income taxes | 1,240 | 964 | ||||||
Amortization of copyrights and software and media intangible assets | 953 | 627 | ||||||
Non-cash stock compensation | 220 | 204 | ||||||
Gain on disposal of Company-owned centers | (1,797 | ) | — | |||||
Other financing costs | 24 | 1,066 | ||||||
Other non-cash items | 80 | — | ||||||
Payment of merger-related costs | (4,493 | ) | — | |||||
Changes in operating assets and liabilities: | ||||||||
Receivables | (7,140 | ) | (4,301 | ) | ||||
Prepaid expenses and other current assets | (1,134 | ) | 132 | |||||
Inventory | (24 | ) | 517 | |||||
Other assets | 448 | (883 | ) | |||||
Accounts payable, accrued expenses, and other current liabilities | (639 | ) | 10,445 | |||||
Income taxes payable | 2,583 | 1,019 | ||||||
Deferred revenue | 5,658 | 7,112 | ||||||
Accrued compensation and related benefits | 982 | (1,386 | ) | |||||
Net cash provided by continuing operations | 2,022 | 19,166 | ||||||
Adjustments for discontinued operations to reconcile net cash provided by continuing operations to net cash provided by operating activities: | ||||||||
Income from discontinued operations | — | 1,973 | ||||||
Changes in operating assets and liabilities | — | (11,661 | ) | |||||
Depreciation and other non-cash items | — | 15 | ||||||
Net cash used in discontinued operations | — | (9,673 | ) | |||||
Net cash provided by operating activities | 2,022 | 9,493 |
(continued on the following page)
See notes to consolidated financial statements (unaudited).
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Educate, Inc.
Consolidated Statements of Cash Flows (continued)
(Dollar amounts in thousands)
(unaudited)
Three months ended March 31, | ||||||||
2007 | 2006 | |||||||
Investing activities | ||||||||
Cash paid for acquired businesses, net of cash acquired (including acquisition costs of $39 in 2006) | $ | — | $ | (689 | ) | |||
Proceeds from sale of Company-owned centers, net | 3,561 | — | ||||||
Cash paid for internally developed software and media | (1,795 | ) | (1,643 | ) | ||||
Purchases of property and equipment | (1,482 | ) | (3,968 | ) | ||||
Net investing activities of discontinued operations | — | (470 | ) | |||||
Change in other assets | (182 | ) | (741 | ) | ||||
Net cash provided by (used in) investing activities | 102 | (7,511 | ) | |||||
Financing activities | ||||||||
Proceeds from exercises of stock options | 149 | 304 | ||||||
Borrowings on revolving credit facility | 6,000 | 6,000 | ||||||
Payments on revolving credit facility | (6,000 | ) | (21,050 | ) | ||||
Cash received upon issuance of debt | — | 21,050 | ||||||
Payments on debt | (2,868 | ) | (692 | ) | ||||
Deferred financing costs | (275 | ) | (922 | ) | ||||
Change in other long-term liabilities | 317 | 196 | ||||||
Net cash (used in) provided by financing activities | (2,677 | ) | 4,886 | |||||
Effect of exchange rate changes on cash | 399 | (154 | ) | |||||
Net change in cash and cash equivalents | (154 | ) | 6,714 | ) | ||||
Cash and cash equivalents at beginning of period | 535 | 2,414 | ||||||
Cash and cash equivalents at end of period | $ | 381 | $ | 9,128 | ||||
See notes to consolidated financial statements (unaudited).
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Educate, Inc.
March 31, 2007
Notes to Consolidated Financial Statements (unaudited)
(Dollars in thousands, except per share data)
1. Organization, Basis of Presentation, and Summary of Significant Accounting Policies
Description of Business
Educate, Inc. and subsidiaries (the “Company”, “Educate” or “we”) is a leading pre-K-12 education company delivering supplemental education services and products to students and their families. For over 25 years, we have provided trusted, personalized instruction to millions of students improving their academic achievement and helping them experience the joy of learning.
We provide supplemental, remedial and enrichment instruction through Sylvan Learning—North America’s largest network of tutoring centers. We are also the leading provider of educational services to public and non-public schools through our school partnership business, Catapult Learning. We also deliver educational products, including the highly regarded Hooked on Phonics early reading, math and study skills programs through our Educate Products business. See Note 9 for further discussion of the Company’s business segments.
Basis of Presentation
The unaudited interim financial information as of March 31, 2007 and for the three month period then ended, and for the comparable period of the prior year, has been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, it does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2006.
The accompanying consolidated financial statements represent the consolidated financial position, results of operations and cash flows of the Company prepared in accordance with accounting principles generally accepted in the United States. The Company’s management has made estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. All significant intercompany transactions and balances have been eliminated in consolidation.
Due principally to the timing of school semesters and holiday schedules, the Company is subject to seasonality of reported revenues and expenses that affect reported results of operations. The Company’s Franchise Services and Company-Owned Centers segments generally experience lower revenues in the fourth quarter. Franchisees pay royalties to the Company based on a percentage of cash receipts. Since customers of these franchisees frequently make payments for services in advance, royalty revenues earned by the Company are higher in periods of increased enrollment, particularly in the spring months prior to commencement of peak summer service periods. In addition, the Company’s Catapult Learning segment generates a disproportionate amount of revenues during the first six months of the calendar year. This occurs because many school districts are on break during the summer months and use the first semester which occurs primarily in the fourth calendar quarter to evaluate the specific needs of individual students prior to enrolling students into the Company’s supplemental education programs. As a result of these factors, quarter-to-quarter comparisons of results of operation may not be indicative of future results of operations.
The Company consolidates investments where it has a controlling financial interest. The usual condition for a controlling financial interest is ownership of a majority of the voting interest and, therefore, as a general rule ownership, directly or indirectly, of over fifty percent of the outstanding voting shares is a condition for consolidation. For investments in variable interest entities, the Company consolidates when it is determined to be the primary beneficiary of the variable interest entity. The Company is not the primary beneficiary of any variable interest entity.
Merger Agreement
On September 25, 2006, we announced that our Board of Directors had received a nonbinding proposal from a management group led by R. Christopher Hoehn-Saric, our Chairman and Chief Executive Officer, and other investors to acquire all of the Company’s outstanding shares for $8.00 per share in cash.
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Educate, Inc.
March 31, 2007
Notes to Consolidated Financial Statements (unaudited, continued)
(Dollars in thousands, except per share data)
On January 28, 2007, we entered into a definitive Agreement and Plan of Merger (the “Merger Agreement”) with Edge Acquisition, LLC, a Company affiliated with Sterling Partners and Citigroup Private Equity, and with Mr Hoehn-Saric (the “Merger”). Under the terms of the Merger Agreement, our stockholders will receive $8.00 in cash for each share of Educate common stock they own. Completion of the Merger is subject to customary closing conditions, including, among others, approval by our stockholders and the absence of any order or injunction prohibiting the consummation of the Merger. The Company expects the Merger to close during June, 2007.
The Merger Agreement was filed on a Current Report on Form 8-K filed with the Securities and Exchange Commission on January 29, 2007. The foregoing description of the Merger Agreement is qualified in its entirety by reference to the full text of the Merger Agreement. In connection with the Merger, the Company capitalized certain due diligence and other transaction-related costs, totaling $4,743 at March 31, 2007, which are ultimately expected to be reimbursed by Sterling Partners. These merger-related costs are classified within other assets in the March 31, 2007 balance sheet.
New Accounting Pronouncements
In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 (“SFAS 159”). This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective for fiscal years beginning after November 15, 2007, which the Company intends to adopt on January 1, 2008. SFAS 159 requires prospective application, unless early adoption is selected, which requires retrospective application. The Company is still evaluating the impact of this pronouncement on its financial statements.
In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and states that a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and the Company intends to adopt the pronouncement on January 1, 2008. SFAS 157 requires prospective application, with limited exceptions for certain financial instruments not currently held by the Company. The Company is still evaluating the impact of this pronouncement on its financial statements, however, based on information currently available, we believe that the impact of adopting SFAS 157 will be immaterial to our financial condition.
As more fully described in Note 6, the Company adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48,Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”) effective January 1, 2007.
2. Sales of Company-Owned Centers
During the first quarter of 2007, the Company sold ten Company-owned Sylvan Learning Center territories (including ten centers) in six separate transactions with franchisees. The assets of these centers were reported within the Company-Owned Centers operating segment. The aggregate sales price of these territories, which excludes franchise fees, was $3,561, consisting of cash and notes receivable.
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Educate, Inc.
March 31, 2007
Notes to Consolidated Financial Statements (unaudited, continued)
(Dollars in thousands, except per share data)
As a result of these sales, the Company recorded a gain of $1,797 (or $0.04 per diluted common share) which represented the difference between the fair value of the net proceeds received and the net assets sold. The net assets sold consisted of accounts receivable of $61, net property and equipment of $341, and deferred revenue of $852. Goodwill totaling $2,214, representing a portion of the Company-Owned Centers reporting unit goodwill, was assigned to the sold centers and included in the net assets sold in determining the gain on disposal.
3. Debt
Debt consists of the following:
March 31, 2007 | December 31, 2006 | |||||||
Senior term loan payable to a bank (“2005 Term Loan”) in quarterly installments through March 2012. The loan bears interest at the bank’s prime rate or the Eurodollar rate, plus specified margins, as elected by the Company (aggregating to 9.35% per annum at March 31, 2007). | $ | 156,551 | $ | 158,844 | ||||
Revolving loan payable to a bank (under the “2005 Term Loan”) maturing April 27, 2009. The loan bears interest at the bank’s prime rate or the Eurodollar rate, plus specified margins, as elected by the Company (aggregating to 9.35% per annum at March 31, 2007). | 17,000 | 17,000 | ||||||
Note payable, due in semi-annual installments through June 30, 2009. The note does not bear interest, and is recorded net of a discount of $103 and $121 at March 31, 2007 and December 31, 2006, respectively. | 1,109 | 1,089 | ||||||
Various notes payable bearing interest at fixed rates ranging from 5.75% to 8.25% per annum, with maturity dates ranging from June 2007 to October 2014. | 850 | 1,424 | ||||||
175,510 | 178,357 | |||||||
Less: current portion of long-term debt | (174,239 | ) | (176,597 | ) | ||||
Total long-term debt | $ | 1,271 | $ | 1,760 | ||||
On March 15, 2007, in connection with the Fourth Amendment to the 2005 Term Loan, the Company obtained a waiver from its bank syndicate for violations of certain financial covenants within the 2005 Term Loan for the March 31, 2007 reporting period. The Fourth Amendment also provides consent for the sale of certain Company-owned learning centers, modifies the required prepayments of the facility from the net cash proceeds from such sales, and restricts certain acquisition and new center opening expenditures. During the three months ended March 31, 2007, the Company capitalized $251 and expensed $24 related to the Fourth Amendment. The Company made a required principal repayment of $1,486 during the quarter ended March 31, 2007 as a result of the ten Company-owned learning centers sold during the quarter.
As a result of deteriorating operating results and the fact that the financial covenants are calculated using a rolling four quarter adjusted EBITDA measure, it is likely that the Company will be required to obtain waivers or amend the Term Loan facility in the June 30, 2007 and subsequent quarters to remain in compliance with the covenants prescribed in the facility and avoid the facility’s demand repayment provisions. As a result, the Company classified all of the outstanding debt of $173,551 under the 2005 Term Loan as a current liability in the consolidated balance sheet as of March 31, 2007. Management considered negotiating with the lenders under the 2005 Term Loan to obtain, for the next four quarterly reporting periods, covenant amendments that were achievable based on the projected operating results of the Company. Such amendments would provide for the classification of the debt as long-term or current under the maturity provisions of the facility. However, due to the proposed sale of the Company as evidenced by a January 2007 definitive merger agreement, the Company chose to obtain a waiver for the March 31, 2007 violations without negotiating amendments as to future periods. The merger is expected to close during the second quarter of 2007. However, there can be no assurance that lenders will waive their right to demand repayment of outstanding borrowings upon the likely default of the credit facility’s provisions in the June 30, 2007 and subsequent quarterly reporting periods, and in the event of demanded repayment, that the Company can refinance the loans on acceptable terms or meet its obligations in the ordinary course of business. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
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Educate, Inc.
March 31, 2007
Notes to Consolidated Financial Statements (unaudited, continued)
(Dollars in thousands, except per share data)
At the Company’s election, the 2005 Term Loan bears interest at the base rate or Eurodollar rate plus a margin, which was 400 basis points at March 31, 2007. Pursuant to the 2005 Term Loan, quarterly principal payments based upon a 100-year amortization schedule are due through September 30, 2011 with two balloon payments in equal amounts due at the end of each of the following quarters. The obligations under the 2005 Term Loan are guaranteed by the Company and certain direct and indirect subsidiaries of the Company. These obligations are secured by a senior interest in substantially all of the assets of the consolidated subsidiaries of the Company.
The 2005 Term Loan includes customary covenants for transactions of this type, including covenants limiting liens on assets of certain of the Company’s subsidiaries, certain asset sales, payment of dividends, incurrence of additional indebtedness, and mergers or fundamental business changes. The 2005 Term Loan also required compliance with financial covenants and otherwise restricted certain payments to the Company.
Of the $30,000 revolving credit facility, $11,740 was available to the Company due to outstanding revolving loan borrowings of $17,000 and standby letters of credit totaling $1,260 as of March 31, 2007.
4. Commitments and Contingencies
In connection with the 2003 acquisition of the pre-K-12 business from Laureate Education, Inc. (“Laureate”), the Company and Laureate entered into a three-year shared services agreement that expired June 30, 2006. Under the terms of the shared service agreement, the Company provided certain support services including, but not limited to, specified accounting, benefits, information technology, human resources, purchasing and payroll services to Laureate. Conversely, Laureate provided certain support services, primarily in the areas of tax, treasury, and facilities administration to the Company. Laureate and the Company are considered related parties because two individuals, one of whom is the Company’s CEO, serve on the Board of Directors of both companies.
On July 1, 2006, the Company and Laureate extended its shared service agreement through December 31, 2007 for a portion of the originally contracted services. Under the extended agreement, the Company will continue to provide specified accounting, benefits, human resources, purchasing and payroll services to Laureate through the end of 2007. Laureate also provided certain facilities administration functions to the Company through the end of the first quarter of 2007.
The shared services agreement provides for the Company to receive net payments consisting of a base fee plus specified volume-based increases to the fees attributable to the services. The net base fees to be received by the Company under the extended agreement are approximately $383 each quarter. These payments are accounted for as a reduction of general and administrative expenses.
The Company is subject to legal actions arising in the ordinary course of its business. In management’s opinion, the Company has adequate legal defenses and/or insurance coverage with respect to the eventuality of such actions and does not believe any settlement would materially affect the Company’s financial position.
The Company maintains a number of standby letters of credit totaling $1,260 as of March 31, 2007 to guarantee certain of its insurance programs and the potential payment under a franchisee acquisition through 2008.
The Company has guaranteed certain bank loans of franchisees related to financing the purchase of educational programs and other purchased instructional material. Of the $680 of available credit under this program, $113 was outstanding at March 31, 2007. These guarantees are secured by the assets of the business of the individual franchisee utilizing this financing arrangement.
The Company has guaranteed a bank loan of the Sylvan National Advertising Fund (“Fund”) in the amount of $2.0 million, which expires in May 2007. All Sylvan Learning Centers pay advertising fees into the Fund, which coordinates national advertising campaigns for the benefit of the Learning Center network. The Fund is a separate legal entity, which the Company does not control. Provision of the guarantee allowed the Fund to obtain external financing at more favorable terms. The Company would be required to perform under the guarantee in the event of default on the loan by the Fund. An event of default under the 2005 Term Loan would be an event of default under this loan to the Fund.
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Educate, Inc.
March 31, 2007
Notes to Consolidated Financial Statements (unaudited, continued)
(Dollars in thousands, except per share data)
5. Share-Based Payments
Description of Plans
2003 Omnibus Stock Incentive Plan
During 2003, the Company adopted a stock option plan that provides for the granting of options to purchase up to 4,360,000 shares of common stock to selected employees and directors of the Company. Options to purchase 3,898,800 shares of common stock were granted under this plan. Of this amount, 104,000 shares immediately vested with the remainder vesting ratably over thirty-six or forty-eight months. Options under this plan expire 10 years after the grant date. Options to purchase 374,000 shares of common stock were granted in 2004 under this plan with an exercise price less than the estimated fair value of the Company’s common stock at the grant date. The Company can no longer grant options under this plan.
2004 Omnibus Stock Incentive Plan
During 2004, the Company adopted a stock option plan that provides for the granting to selected employees and directors of the Company of options to purchase up to 700,000 shares of common stock plus an annual increase added automatically on the first day of the fiscal year equal to the lesser of (i) 400,000 shares or (ii) one percent of the number of outstanding shares on the last day of the immediately preceding fiscal year. Options under this plan expire 10 years after the grant date, and vest ratably over a forty-eight month period.
The annual automatic increase on January 1, 2007 resulted in 400,000 additional shares of common stock available for issuance under the 2004 stock option plan, and after taking into account shares already granted, 1,314,394 shares of common stock are available for issuance as of March 31, 2007. However, as stipulated in the Merger Agreement, the Company is prohibited from granting any additional stock options, with limited exceptions.
Restricted Common Stock Awards
In June 2004, the Company issued 604,000 shares of restricted common stock for $0.01 per share to certain employees that vested immediately. These shares of common stock are restricted as to resale over a three to five-year period. The Company estimated that due to the restrictions on resale, the common stock had an estimated fair value of $12.60 at the grant date, or 90% of the estimated fair value of an unrestricted share of common stock. The Company recorded aggregate compensation expense of $7,604 in June 2004 related to these common stock grants.
The Company did not grant any options during the three months ended March 31, 2007 and 2006.
The following tables summarize the Company’s stock option activity (options in thousands):
Options | Weighted Average Exercise | Weighted Average Remaining Contractual Term (in Years) | Aggregate Intrinsic Value | ||||||||
Outstanding – December 31, 2006 | 3,381 | $ | 4.88 | ||||||||
Granted | — | — | |||||||||
Exercised | (38 | ) | 3.99 | ||||||||
Forfeited | (106 | ) | 5.11 | ||||||||
Outstanding – March 31, 2007 | 3,237 | $ | 4.88 | 6.8 | $ | 10,222 | |||||
Vested and expected to vest – March 31, 2007 | 3,142 | $ | 4.79 | 6.6 | $ | 10,118 | |||||
Exercisable – March 31, 2007 | 2,776 | $ | 4.34 | 6.5 | $ | 9,858 | |||||
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Educate, Inc.
March 31, 2007
Notes to Consolidated Financial Statements (unaudited, continued)
(Dollars in thousands, except per share data)
The aggregate intrinsic value in the table above represents the difference between the Company’s closing stock price on the last trading day of the quarter (March 30, 2007) and the exercise price, multiplied by the number of in-the-money options outstanding, whether vested or not vested.
The total intrinsic value of stock options exercised, based on the difference between the Company’s stock price at the time of exercise and the related exercise price, was $139 and $193 during the three months ended March 31, 2007 and 2006, respectively.
The total fair value of stock options vested was $220 and $204 during the three months ended March 31, 2007 and 2006, respectively. The related income tax benefit recognized during the three months ended March 31, 2007 was $93. At March 31, 2007, unrecognized compensation cost related to stock options outstanding as of March 31, 2007 was $1,815 ($1,089 after income taxes), which is expected to be recognized over a weighted average remaining vesting period of 2.6 years. According to provisions in the Merger Agreement, all outstanding options, except for options held by certain members of the Company’s management, will be canceled at the effective time of the Merger and option holders will receive cash for the excess, if any, of $8.00 over the exercise price for each option held, less any required tax withholding.
6. Income Taxes
At the end of each interim period, the Company makes its best estimate of the effective tax rate expected to be applicable for the full fiscal year. The rate so determined is used in providing for income taxes on a current year-to-date basis. The effective tax rate reflects anticipated investment tax credits, foreign tax rates, capital gains rates, and other available tax-planning alternatives. It also includes the effect of any valuation allowance expected to be necessary at the end of the year for deferred tax assets related to originating deductible temporary differences and carryforwards during the year. Estimates of the annual effective tax rate at the end of interim periods are, of necessity, based on evaluations of possible future events and transactions and may be subject to subsequent refinement or revision.
In arriving at this effective tax rate, no effect is included for the tax related to significant, unusual, or extraordinary items that will be separately reported or reported net of their related tax effect in financial statements for the interim period or for the year. The effective tax rate excludes the effects of changes in judgment about beginning-of-year valuation allowances and reversals of a prior-year reserve related to a tax loss contingency. Rather, these items are recorded as adjustments to tax expense in the interim period they are determined, and are not allocated to future interim periods.
The Company’s income tax provisions for all periods consist of federal, state and foreign income taxes. The tax provision for the three month period ended March 31, 2007 is based on the estimated effective tax rate applicable for the full year. Currently, the effective tax rate for the Company for the year ending December 31, 2007 is expected to be 42%. Due to potential changes in the mix of earnings between tax jurisdictions, the Company’s consolidated effective tax rate may fluctuate during 2007.
The Company adopted the provisions of FIN 48 effective January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109,Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Only tax positions that meet a more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized.
In accordance with FIN 48, the Company recognized a cumulative effect adjustment of $950, which increased the liability for unrecognized tax benefits, interest, and penalties and reduced the January 1, 2007 balance of retained earnings.
As of January 1, 2007, the Company had unrecognized tax benefits totaling $2,363, all of which, if recognized, would impact the effective tax rate. These unrecognized tax benefits did not significantly change during the three months ended March 31, 2007, and the Company does not expect them to significantly change within the next twelve months.
The Company classifies interest on underpayment of taxes and penalties as income tax expense, which is consistent with prior years. The total amount of interest and penalties recognized in the income statement was immaterial for the three months ended March 31, 2007 and 2006, respectively. The total amount of accrued interest and penalties recognized on the balance sheet was immaterial as of March 31, 2007 and December 31, 2006, respectively.
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Educate, Inc.
March 31, 2007
Notes to Consolidated Financial Statements (unaudited, continued)
(Dollars in thousands, except per share data)
As of January 1 and March 31, 2007, tax years 2003 through 2006 remain subject to examination by U.S. federal and state tax authorities, and tax years 2002 through 2006 remain subject to examination by German tax authorities.
7. Stockholders’ Equity and Comprehensive Income
Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income | Total Stockholders’ Equity | ||||||||||||||
Balance at December 31, 2006, as previously reported | $ | 432 | $ | 195,639 | $ | 6,323 | $ | 2,587 | $ | 204,981 | ||||||||
Cumulative effect of change in accounting principle | — | — | (950 | ) | — | (950 | ) | |||||||||||
Balance at December 31, 2006, as adjusted | 432 | $ | 195,639 | $ | 5,373 | $ | 2,587 | $ | 204,031 | |||||||||
Options exercised for purchase of 37,418 shares of common stock | — | 149 | — | — | 149 | |||||||||||||
Non-cash stock compensation expense | — | 220 | — | — | 220 | |||||||||||||
Comprehensive income: | ||||||||||||||||||
Net income for the three months ended March 31, 2007 | — | — | 2,351 | — | 2,351 | |||||||||||||
Other comprehensive income: | ||||||||||||||||||
Change in fair value of derivative financial instrument | — | — | — | (99 | ) | (99 | ) | |||||||||||
Foreign currency translation adjustment | — | — | — | 394 | 394 | |||||||||||||
Total comprehensive income | 2,646 | |||||||||||||||||
Balance at March 31, 2007 | $ | 432 | $ | 196,008 | $ | 7,724 | $ | 2,882 | $ | 207,046 | ||||||||
The components of comprehensive income, net of related taxes, are as follows:
Three months ended March 31, | |||||||
2007 | 2006 | ||||||
Net income | $ | 2,351 | $ | 3,333 | |||
Change in fair value of derivative financial instruments | (99 | ) | 2 | ||||
Foreign currency translation adjustment | 394 | 489 | |||||
Comprehensive income | $ | 2,646 | $ | 3,824 | |||
Income tax expense (benefit) related to the derivative financial instrument in the table above was $(68) and $35 for the three months ended March 31, 2007 and 2006, respectively.
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Educate, Inc.
March 31, 2007
Notes to Consolidated Financial Statements (unaudited, continued)
(Dollars in thousands, except per share data)
The components of accumulated other comprehensive income are summarized as follows:
Foreign Currency Translation Adjustment | Derivative Financial Instruments | Total | ||||||||
Balance at December 31, 2006 | $ | 2,358 | $ | 229 | $ | 2,587 | ||||
Gains (losses) recorded in other comprehensive income, net of tax | 394 | (99 | ) | 295 | ||||||
Balance at March 31, 2007 | $ | 2,752 | $ | 130 | $ | 2,882 | ||||
8. Earnings Per Share
Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per common share include the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
A reconciliation of the numerators and denominators for basic and diluted earnings per common share is as follows:
Three months ended March 31, | ||||||
2007 | 2006 | |||||
Numerator | ||||||
Income from continuing operations | $ | 2,351 | $ | 1,360 | ||
Income from discontinued operations, net of tax | — | 1,973 | ||||
Net income | $ | 2,351 | $ | 3,333 | ||
Denominator(shares in thousands) | ||||||
Basic: | ||||||
Weighted-average shares outstanding | 43,166 | 42,751 | ||||
Diluted: | ||||||
Weighted-average shares outstanding | 43,166 | 42,751 | ||||
Dilutive effect of stock options | 659 | 1,093 | ||||
Total | 43,825 | 43,844 | ||||
Earnings per common share - basic | ||||||
Income from continuing operations | $ | 0.05 | $ | 0.03 | ||
Income from discontinued operations, net of tax | — | 0.05 | ||||
Net income | $ | 0.05 | $ | 0.08 | ||
Earnings per common share - diluted | ||||||
Income from continuing operations | $ | 0.05 | $ | 0.03 | ||
Income from discontinued operations, net of tax | — | 0.05 | ||||
Net income | $ | 0.05 | $ | 0.08 | ||
Since their exercise price exceeded the market value of the Company’s common stock, options to purchase 577,918 and 289,354 shares of common stock were excluded from the 2007 and 2006 computations, respectively, because the effect was antidilutive.
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Educate, Inc.
March 31, 2007
Notes to Consolidated Financial Statements (unaudited, continued)
(Dollars in thousands, except per share data)
9. Businesses and Geographic Segment Information
The Company is primarily organized on the basis of educational services or products provided. The Company operates through seven business segments that offer distinct supplemental education services and products from which revenues are earned. The following describes the Company’s reportable segments:
• | Franchise Services - manages our system of franchised Sylvan Learning territories |
• | Catapult Learning - provides tutoring and other supplemental education services, to eligible students in public and private schools through government-funded contracts |
• | European - operates a network of company-owned and franchised centers providing tutoring in Germany and Austria |
• | Company-Owned Centers - manages our network of company-owned Sylvan Learning territories |
• | Educate Products - creates, manufactures, and sells educational products including the Hooked on Phonics early reading, math and study skills programs |
• | Progressus - provides pediatric therapies such as physical, occupational and speech therapies to K-12 children with special education needs under contracts with school districts |
• | Educate Online - provides online tutoring to students in the third through ninth functional grades |
The Company evaluates performance and allocates resources based on operating income. In the following tables, revenue of the Franchise Services segment and operating income of the Company-Owned Centers segment includes an intercompany royalty and other service fees from the Company-Owned Centers segment to the Franchise Services segment which were $3,717 and $3,757 during the three months ended March 31, 2007 and 2006, respectively. The “Corporate and Eliminations” column combines the elimination of intercompany transactions and general and administrative expenses that are not allocated to segments, which are necessary to reconcile the respective line items to the consolidated financial statements. All other significant intercompany sales or transfers are eliminated.
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Educate, Inc.
March 31, 2007
Notes to Consolidated Financial Statements (unaudited, continued)
(Dollars in thousands, except per share data)
The following tables set forth information on the Company’s reportable segments:
Three months ended March 31,
Franchise Services | Catapult Learning | European | Subtotal-Educate Services | Company-Owned Centers | Educate Products | Progressus | Educate Online | Corporate & Eliminations | Total | |||||||||||||||||||||||||||||||
2007 | ||||||||||||||||||||||||||||||||||||||||
Revenues | $ | 17,053 | $ | 22,069 | $ | 10,524 | $ | 49,646 | $ | 32,614 | $ | 3,701 | $ | 7,171 | $ | 7,768 | $ | (3,717 | ) | $ | 97,183 | |||||||||||||||||||
Operating income before depreciation and amortization | 10,062 | 4,328 | 1,810 | 16,200 | 667 | (2,880 | ) | 694 | 162 | (4,236 | ) | 10,607 | ||||||||||||||||||||||||||||
Depreciation and amortization (1) | (142 | ) | (163 | ) | (129 | ) | (434 | ) | (1,178 | ) | (93 | ) | (12 | ) | (111 | ) | (369 | ) | (2,197 | ) | ||||||||||||||||||||
Operating income (loss) | $ | 9,920 | $ | 4,165 | $ | 1,681 | $ | 15,766 | $ | (511 | ) | $ | (2,973 | ) | $ | 682 | $ | 51 | $ | (4,605 | ) | $ | 8,410 | |||||||||||||||||
2006 | ||||||||||||||||||||||||||||||||||||||||
Revenues | $ | 18,041 | $ | 20,075 | $ | 8,806 | $ | 46,922 | $ | 35,873 | $ | 2,733 | $ | 6,120 | $ | 5,034 | $ | (3,757 | ) | $ | 92,925 | |||||||||||||||||||
Operating income before depreciation and amortization | 11,148 | 4,288 | 1,524 | 16,960 | (2,388 | ) | (2,506 | ) | 624 | (553 | ) | (4,207 | ) | 7,930 | ||||||||||||||||||||||||||
Depreciation and amortization (1) | (139 | ) | (194 | ) | (108 | ) | (441 | ) | (1,013 | ) | (46 | ) | (12 | ) | (76 | ) | (427 | ) | (2,015 | ) | ||||||||||||||||||||
Operating income (loss) | $ | 11,009 | $ | 4,094 | $ | 1,416 | $ | 16,519 | $ | (3,401 | ) | $ | (2,552 | ) | $ | 612 | $ | (629 | ) | $ | (4,634 | ) | $ | 5,915 | ||||||||||||||||
(1) | excludes amortization of copyrights and computer software and media intangible assets |
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Educate, Inc.
March 31, 2007
Notes to Consolidated Financial Statements (unaudited, continued)
(Dollars in thousands, except per share data)
The following tables reconcile operating income in the table above to income from continuing operations before income taxes reported in the consolidated statements of operations and segment assets to total assets reported on the consolidated balance sheets:
Three months ended March 31, | ||||||||
2007 | 2006 | |||||||
Total operating income | $ | 8,410 | $ | 5,915 | ||||
Interest income | 186 | 55 | ||||||
Interest expense | (4,033 | ) | (2,613 | ) | ||||
Other financing costs | (24 | ) | (1,066 | ) | ||||
Foreign exchange losses and other | (486 | ) | (61 | ) | ||||
Income from continuing operations before income taxes | $ | 4,053 | $ | 2,230 | ||||
March 31, 2007 | ||||||||
Franchise Services segment assets | $ | 238,365 | ||||||
Catapult Learning segment assets | 29,931 | |||||||
European segment assets | 33,401 | |||||||
Total Educate Services | 301,697 | |||||||
Company-Owned Centers segment assets | 90,851 | |||||||
Educate Products segment assets | 40,663 | |||||||
Progressus segment assets | 9,564 | |||||||
Educate Online segment assets | 12,732 | |||||||
Total assets for reportable segments | $ | 455,507 | ||||||
Unallocated corporate assets | 16,421 | |||||||
Total assets | $ | 471,928 | ||||||
Revenues by geographic area are as follows:
Three months ended March 31, | ||||||
2007 | 2006 | |||||
United States | $ | 85,308 | $ | 82,540 | ||
Germany | 10,412 | 8,721 | ||||
Other | 1,463 | 1,665 | ||||
Consolidated total | $ | 97,183 | $ | 92,925 | ||
Revenues are attributed to countries based on the location of the customer. Revenues attributed to Germany represent approximately 11% of consolidated revenues for the three month period ended March 31, 2007. Substantially all long-lived assets are located in the United States.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and related notes to those statements in Part I, Item 1 of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2006.
Information Regarding Forward-Looking Statements
The statements contained herein include forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include information about possible or assumed results of operations, business strategies, financing plans, competitive position and potential growth opportunities. Forward-looking statements include all statements that are not historical facts and are generally accompanied by words such as “may,” “will,” “intend,” “anticipate,” “believe,” “estimate,” “expect,” “should” or similar expressions or the negative of such words or expressions. These statements also relate to our contingent payment obligations relating to acquisitions, future capital requirements, and our future development plans and are based on current expectations. Forward-looking statements involve various risks, uncertainties and assumptions. Our actual results may differ materially from those expressed in these forward-looking statements.
Future events and actual results could differ materially from those set forth in the forward-looking statements as a result of many factors. The following factors are some of the factors that might cause such a difference: the occurrence of any event, change or other circumstances that could give rise to the termination of the merger agreement; the outcome of any legal proceedings that have been or may be instituted against the Company and others following announcement of the proposal or the merger agreement; the inability to complete the merger due to the failure to obtain stockholder approval or the failure to satisfy other conditions to the completion of the merger, including receipt of required regulatory approvals; risks that the proposed transaction disrupts current plans and operations and the potential difficulties in employee retention as a result of the merger; the amount of the costs, fees, expenses and charges related to the merger and the actual terms of certain financings that will be obtained for the merger; the development and expansion of the Sylvan Learning franchise system; changes in the relationships among Sylvan Learning and its franchisees; our ability to effectively manage business growth; changes in our ability to effectively integrate recently acquired companies; increased competition from other educational service providers; changes in laws and government policies and programs; changes in the acceptance of our services and products by institutional customers and consumers; changes in customer relationships; acceptance of new programs, services and products by institutional customers and consumers; the seasonality of operating results; global economic conditions, including interest and currency rate fluctuations and inflation rates; fluctuations in our consolidated effective tax rate due to potential changes in the mix of earnings; and the other factors described in this Form 10-Q. Additional information regarding these and other risk factors and uncertainties are set forth from time to time in our filings with the Securities and Exchange Commission, available for viewing on our website atwww.educate-inc.com. These forward-looking statements are based on estimates, projections, beliefs and assumptions of management and speak only as of the date made and are not guarantees of future performance. We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events, except as may be required under applicable securities law.
Overview
We are a leading pre-K-12 education company delivering supplemental education services and products to students and their families. We operate through seven business segments that offer distinct supplemental education services and products from which we earn revenues:
• | Our Franchise Services segment manages our system of franchised Sylvan Learning territories |
• | Our Catapult Learning segment provides tutoring and other supplemental education services to students in public and private schools through government-funded contracts |
• | Our European segment operates a network of company-owned and franchised centers providing tutoring in Germany and Austria |
• | Our Company-Owned Centers segment manages our network of company-owned Sylvan Learning territories |
• | Our Educate Products segment creates, manufactures, and sells educational products including the Hooked on Phonics early reading, math and study skills programs |
• | Our Progressus segment provides pediatric therapies such as physical, occupational and speech therapies to K-12 children with special education needs under contracts with school districts |
• | Our Educate Online segment provides online tutoring to students in the third through ninth functional grades |
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Our consolidated financial statements reflect our financial position as of March 31, 2007 and December 31, 2006, and our results of operations and cash flows for the quarter ended March 31, 2007 and 2006.
Merger Agreement
On September 25, 2006, we announced that our Board of Directors had received a nonbinding proposal from a management group led by R. Christopher Hoehn-Saric, our Chairman and Chief Executive Officer, and other investors to acquire all of the Company’s outstanding shares for $8.00 per share in cash.
On January 28, 2007, we entered into a definitive Agreement and Plan of Merger (the “Merger Agreement”) with Edge Acquisition, LLC, a Company affiliated with Sterling Partners and Citigroup Private Equity, and with Mr Hoehn-Saric (the “Merger”). Under the terms of the Merger Agreement, our stockholders will receive $8.00 in cash for each share of Educate common stock they own. Completion of the Merger is subject to customary closing conditions, including, among others, approval by our stockholders and the absence of any order or injunction prohibiting the consummation of the Merger. The Company expects the Merger to close during June, 2007.
The Merger Agreement was filed on a Current Report on Form 8-K filed with the Securities and Exchange Commission on January 29, 2007. The foregoing description of the Merger Agreement is qualified in its entirety by reference to the full text of the Merger Agreement.
Seasonality and Other Quarterly Fluctuations
Our revenues and operating income are characterized by significant seasonal fluctuations as described below. The following table sets forth selected information related to these fluctuations:
2007 | 2006 | |||||||||||||||||||||
(Dollars in millions) | First Quarter | First Quarter | Second Quarter | Third Quarter | Fourth Quarter | |||||||||||||||||
Revenues: | ||||||||||||||||||||||
Franchise Services | $ | 17.0 | $ | 18.0 | $ | 18.0 | $ | 15.1 | $ | 12.5 | ||||||||||||
Catapult Learning | 22.1 | 20.1 | 21.2 | 11.2 | 21.0 | |||||||||||||||||
European | 10.5 | 8.8 | 9.5 | 8.1 | 8.7 | |||||||||||||||||
Company-Owned Centers | 32.6 | 35.9 | 41.7 | 39.4 | 26.8 | |||||||||||||||||
Educate Products | 3.7 | 2.7 | 1.8 | 9.9 | 3.8 | |||||||||||||||||
Progressus | 7.2 | 6.1 | 5.4 | 4.3 | 6.2 | |||||||||||||||||
Educate Online | 7.8 | 5.0 | 6.1 | 1.3 | 1.9 | |||||||||||||||||
Eliminations | (3.7 | ) | (3.7 | ) | (4.7 | ) | (4.5 | ) | (3.0 | ) | ||||||||||||
Total revenues | $ | 97.2 | $ | 92.9 | $ | 99.0 | $ | 84.8 | $ | 77.9 | ||||||||||||
Percentage of annual revenues | N/A | 26 | % | 28 | % | 24 | % | 22 | % | |||||||||||||
Operating income (loss) | $ | 8.4 | $ | 5.9 | $ | 10.5 | $ | 1.8 | $ | (12.3 | ) | |||||||||||
Income (loss) from continuing operations | $ | 2.4 | $ | 1.4 | $ | 4.4 | $ | (3.8 | ) | $ | (10.6 | ) |
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Educate, Inc.
Like other companies that provide tutoring and other supplemental education services and products, we are subject to seasonality in our revenue streams that can affect our results of operations. This seasonality arises from a number of factors, primarily driven by the timing of school semester cycles. Our quarterly results are also affected by our license agreements with franchisees that require the payment of royalties to us based on a percentage of their cash receipts, a significant portion of which consist of prepayments by customers for services to be provided by our franchisees more than a month in the future.
First Quarter. In our Company-Owned Centers segment, we generally experience increased enrollments as a result of the initiation of more intensive advertising and increased parental focus on their children’s performance associated with the receipt of academic results from the first part of the school year. In our Franchise Services segment our royalties increase as our franchisees begin to receive advance payment for services to be provided during the second half of the school year. Our Educate Products segment may experience a slowdown in revenue due to softness in retailers’ sales in this post holiday period. In our Catapult Learning, Progressus, and Educate Online segments, we deliver services under school-based programs during this quarter.
Second Quarter. In our Sylvan Learning Center network, we generally experience a higher level of revenues as we benefit from our continued investment in advertising, delivery of services in our company-owned territories and increased receipts of franchise royalties due to prepayment for summer programs. In our Catapult Learning segment, we complete delivery of our institutional services in conjunction with the ending of the school year. The Educate Online segment experiences its highest quarterly revenue of the year as the sessions delivered to students under Catapult Online increase with the number of active school district programs during the quarter.
Third Quarter. The third quarter is a significant service delivery period in our Sylvan Learning Centers. We recognize revenue as we deliver these services in our company-owned territories. However, with respect to our franchised territories, our royalties decline as the cash receipts our franchisees receive from their customers decline from peak second quarter levels. Our product sales are expected to modestly increase in this quarter as retailers purchase more educational products in preparation for back to school sales. Due to summer recess, we provide limited summer school services in our Catapult Learning segment during this period, which results in the lowest segment revenue for the year. However, we gain visibility for the upcoming year because the majority of our institutional contracts are renewed during the third quarter. In our Educate Online segment, the second half of the year generally reflects an emphasis on marketing and student enrollment activities within Catapult Online, resulting in the lowest quarterly revenue activity of the year.
Fourth Quarter. In our Company-Owned Centers segment, enrollments are at their lowest levels of the year as a result of lower advertising expenditures, students taking a greater number of vacations during the holiday season and parental optimism towards their children’s improved school performance associated with the beginning of a new school year. Additionally, we experience lower revenues from franchise royalties in the fourth quarter as a result of prepayments by our franchisees’ customers in earlier quarters. In our products business, we believe that we may experience relatively higher revenues in this quarter due to new product introductions and as retailers restock in expectation of higher sales during the holiday period. The period reflects increased revenues in Catapult Learning and Progressus as schools are back in session and programs begin.
Other. The timing of school year services, advertising spending, critical enrollment periods, changes in consumer behavior, and new product introductions can affect our revenues at any time during the year.
As a result of the foregoing factors, we believe that quarter-to-quarter comparisons of our results of operations may not be a fair indicator and should not be relied upon as a measure of our future performance.
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Results of Operations
Comparison of results for the three months ended March 31, 2007 and 2006.
Three months ended March 31, | |||||||||||
2007 | 2006 | % Increase (Decrease) | |||||||||
(Dollars in millions) | |||||||||||
Revenues | |||||||||||
Franchise Services (1) | $ | 17.0 | $ | 18.0 | (6 | )% | |||||
Catapult Learning | 22.1 | 20.1 | 10 | % | |||||||
European | 10.5 | 8.8 | 19 | % | |||||||
Total Educate Services | 49.6 | 46.9 | 6 | % | |||||||
Company-Owned Centers | 32.6 | 35.9 | (9 | )% | |||||||
Educate Products | 3.7 | 2.7 | 37 | % | |||||||
Progressus | 7.2 | 6.1 | 18 | % | |||||||
Educate Online | 7.8 | 5.0 | 56 | % | |||||||
Eliminations (1) | (3.7 | ) | (3.7 | ) | 0 | % | |||||
Total | $ | 97.2 | $ | 92.9 | 5 | % | |||||
Business Metrics | |||||||||||
Sylvan Learning same territory revenue growth: (2) | |||||||||||
Franchise Services | (4 | )% | 0 | % | |||||||
Company-Owned Centers | (9 | )% | (5 | )% | |||||||
Number of Sylvan Learning Territories as of March 31: | |||||||||||
Franchisee-owned | 748 | 729 | 3 | % | |||||||
Company-owned | 166 | 178 | (7 | )% | |||||||
Total | 914 | 907 | 1 | % | |||||||
Number of Sylvan Learning Centers as of March 31: | |||||||||||
Franchisee-owned | 898 | 881 | 2 | % | |||||||
Company-owned | 236 | 255 | (7 | )% | |||||||
Total | 1,134 | 1,136 | 0 | % | |||||||
(1) | Franchise Services revenue includes intercompany royalty and other service fees from Company-Owned Centers segment to Franchise Services segment of $3.7 million during the three months ended March 31, 2007 and 2006. The “eliminations” line presents the elimination of intercompany transactions in consolidation. |
(2) | “Same Territory” amounts, for both company-owned and franchised territories, include the results of territories for the identical months for each period presented in the comparison, commencing with the 13th full month the territory has been operating as either a company-owned or franchised territory, as the case may be. Same territory growth is presented as the aggregate growth for franchise or company-owned territory, as the case may be, during the period. Franchise Services revenue includes royalties and other services revenue earned in the territories. A territory reflects the geographically specified area where an operator controls rights to provision of services under the Sylvan franchise agreement. |
Revenues. Revenues for the quarter ended March 31, 2007 increased $4.3 million or 5% over the same period in 2006 to $97.2 million, driven primarily by growth in the Educate Online segment of $2.8 million, Catapult Learning segment of $2.0 million, European segment of $1.7 million, Progressus segment of $1.1 million, and Educate Products segment of $1.0 million partially offset by declines in the Company-Owned Centers segment of $3.3 million and the Franchise Services segment of $1.0 million.
Franchise Services— North American franchise services revenues declined by $1.0 million due primarily to a decrease in product sales compared to the prior year of $0.7 million. First quarter 2007 sales of the new Advanced Math educational program that was released to the Sylvan Learning network in the fourth quarter of 2006 were exceeded by sales of the Beginning Reading and Study Skills educational programs during the first quarter of 2006. The remaining decrease of $0.3 million was primarily due to a decrease in assessment testing revenue resulting from a decline in inquiries from the prior year and a slight change in the mix of new enrollments
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during the quarter ended March 31, 2007 toward newer programs not requiring the Company’s traditional diagnostic assessments. Inquiries decreased 17% from the same quarter in the prior year, which correlated with the overall learning center advertising spending level decrease of 19% during the quarter. The Company’s plans for 2007 are to change the timing and mix of the advertising spend from last year in an attempt to maximize the efficiency of the advertising dollars spent. The planned advertising spend for the second quarter of 2007 is higher than what was incurred in the second quarter of the prior year.
Catapult Learning— Revenues increased $2.0 million, or 10% to $22.1 million in the first quarter of 2007 primarily due to increases in services provided under federal government funded Title I programs of $1.8 million, primarily in New Jersey, Louisiana and Wisconsin. New Orleans based contracts accounted for approximately $0.8 million of this increase as the prior year’s services were negatively impacted by storm-related damages.
European— European revenues, which include both company-owned and franchise territory results, increased $1.7 million to $10.5 million for the quarter ended March 31, 2007. The increase was due primarily to increased enrollment and growth in the number of Company-owned and franchised centers. Total Company-owned centers revenue grew by $0.5 million primarily because of the opening of 24 new corporate centers during the past year. Total franchise revenues grew by $0.3 million due to the number of franchised centers increasing by 16 during this period. The remaining increase of $0.9 million was due to exchange rate changes as the euro strengthened against the dollar compared to the prior year.
Company-Owned Centers— Revenues decreased $3.3 million, or 9% to $32.6 million, due primarily to an 18% decrease in inquiries and a 5% decline in enrollments. While the enrollment to inquiry conversion ratio improved compared to the prior year, enrollments were for lower per student revenue amounts. Additionally, ten company-owned territories were re-franchised to new franchisees during the quarter. Revenue from these centers was $1.1 million less than the same quarter of last year due to the timing of the refranchising.
Educate Products— Revenues increased $1.0 million, or 37% to $3.7 million due to increases in net product sales of $1.3 million as the business expanded its number of retail distribution customers and product line. This increase was offset by a $0.3 reduction in royalty revenue due to the non-renewal of a royalty contract in the fourth quarter of 2006.
Progressus— Revenue for Progressus increased $1.1 million or 18% to $7.2 million during the quarter ended March 31, 2007 compared to the same quarter of the prior year. The increase was primarily due to an increased number of therapists fulfilling school outsource needs combined with higher overall billing rates. The average bill rate increased $4 per hour and an additional 8,000 hours of service were delivered in 2007 compared to 2006.
Educate Online— The $2.8 million increase in revenue during the quarter ended March 31, 2007 compared to the same period of the prior year was primarily due to growth in the Catapult Online channel. The increase is primarily due to the delivery of an increased number of online tutoring sessions to students by increasing enrollments in school districts where we have had contracts in a prior year combined, to a lesser extent, with an increase in the number of school district contracts. Additionally, Catapult Online has accelerated the start of services in many school districts in the current year to achieve a higher program completion rate, since student session completion rates have historically declined later in the school year.
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Three months ended March 31, | |||||||||||
2007 | 2006 | % Increase (Decrease) | |||||||||
(Dollars in millions) | |||||||||||
Segment Operating Costs | |||||||||||
Franchise Services | $ | 7.1 | $ | 7.0 | 1 | % | |||||
Catapult Learning | 17.9 | 16.0 | 12 | % | |||||||
European | 8.8 | 7.4 | 19 | % | |||||||
Total Educate Services | 33.8 | 30.4 | 11 | % | |||||||
Company-Owned Centers (1) (2) | 33.1 | 39.3 | (16 | )% | |||||||
Educate Products | 6.7 | 5.3 | 26 | % | |||||||
Progressus | 6.5 | 5.5 | 18 | % | |||||||
Educate Online | 7.8 | 5.6 | 39 | % | |||||||
Eliminations (1) | (3.7 | ) | (3.7 | ) | 0 | % | |||||
Total Segment Operating Costs | $ | 84.2 | $ | 82.4 | 2 | % | |||||
Segment Operating Income | |||||||||||
Franchise Services | $ | 9.9 | $ | 11.0 | (10 | )% | |||||
Catapult Learning | 4.2 | 4.1 | 2 | % | |||||||
European | 1.7 | 1.4 | 21 | % | |||||||
Total Educate Services | 15.8 | 16.5 | (4 | )% | |||||||
Company-Owned Centers (2) | (0.5 | ) | (3.4 | ) | (85 | )% | |||||
Educate Products | (3.0 | ) | (2.6 | ) | 15 | % | |||||
Progressus | 0.7 | 0.6 | 17 | % | |||||||
Educate Online | — | (0.6 | ) | (100 | )% | ||||||
Total Segment Operating Income | $ | 13.0 | $ | 10.5 | 24 | % | |||||
Corporate Expenses | |||||||||||
Corporate depreciation and amortization expenses | $ | 0.4 | $ | 0.4 | 0 | % | |||||
General and administrative expenses | 4.2 | 4.2 | 0 | % | |||||||
Interest expense, net | 3.8 | 2.5 | 52 | % | |||||||
Other financing costs | — | 1.1 | (100 | )% | |||||||
Foreign exchange losses and other | 0.5 | — | N/A | ||||||||
Income tax expense | 1.7 | 0.9 | 89 | % | |||||||
Total Corporate Expenses | 10.6 | 9.1 | 16 | % | |||||||
Income from continuing operations | $ | 2.4 | $ | 1.4 | 71 | % | |||||
Business Metrics | |||||||||||
Segment Operating Margin (3) | |||||||||||
Franchise Services | 58 | % | 61 | % | |||||||
Catapult Learning | 19 | % | 20 | % | |||||||
European | 16 | % | 16 | % | |||||||
Company-Owned Centers | (2 | )% | (10 | )% | |||||||
Educate Products | (81 | )% | (96 | )% | |||||||
Progressus | 10 | % | 10 | % | |||||||
Educate Online | 0 | % | (12 | )% |
(1) | Company-Owned Centers operating costs includes intercompany royalty and other service fees from Company-Owned Centers segment to Franchise Services segment of $3.7 million during the three months ended March 31, 2007 and 2006. The “eliminations” line presents the elimination of intercompany transactions in consolidation. |
(2) | Includes $1.8 million gain on sale of 10 Company-owned centers in 2007. |
(3) | Segment operating margin is calculated by dividing segment operating income by segment revenue. |
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Segment Operating Income. The increase in segment operating income during the quarter ended March 31, 2007 of $2.5 million compared to the same period of the prior year was due to improvements in the Company-Owned Centers segment of $2.9 million, the Educate Online segment of $0.6 million, the European segment of $0.3 million, and $0.1 million in the Catapult Learning segment and Progressus segment, partially offset by declines in the Franchise Services segment of $1.1 million and the Educate Products segment of $0.4 million.
Franchise Services— Segment operating income decreased $1.1 million, or 10% to $9.9 million in the first quarter of 2007 due to decreased profit of $0.4 million on lower product sales, a decrease in the amount of testing revenue resulting from a decrease in the number of inquiries, and higher segment operating costs incurred to provide higher service levels to the franchise community.
Catapult Learning— Segment operating income increased $0.1 million, or 2% to $4.2 million during the first quarter of 2007 compared to the first quarter of 2006 due to the increase in revenue of $2.0 million, which was largely offset by an increased investment in sales, marketing and operations personnel to prepare the business for future growth.
European— Segment operating income increased $0.3 million, or 21% to $1.7 million in the first quarter of 2007. The increase was due to revenue growth of $1.7 million, offset by increases in operating expenses primarily driven by an increase of 24 company-owned centers and 16 additional franchise centers. Exchange rates also favorably impacted segment operating income by $0.1 million for the quarter ended March 31, 2007 compared to the same quarter in the prior year.
Company-Owned Centers— Segment operating results improved by $2.9 million during the quarter ended March 31, 2007 compared to the same quarter of the prior year from an operating loss of $3.4 million to a loss of $0.5 million. The improvement was primarily due to gains of $1.8 million recorded on the sale of 10 company-owned centers during the quarter and reductions in operating expenses exceeding reductions in revenue compared to the first quarter of the prior year by $1.1 million. Labor and other variable costs were well controlled as revenue declined during the quarter, and advertising costs were also reduced during the quarter. Overhead costs were also lower during the current quarter as the first quarter of the prior year included costs to identify and implement operational best practices and to improve conversions of inquiries into enrollments and to improve the efficiency of advertising expenditures. The first quarter of 2006 also included new center opening expenses, as eight new centers were opened in that quarter compared to none in the first quarter of 2007.
Educate Products— Educate Products’ operating loss increased $0.4 million, or 15% to $3.0 million primarily as a result of an increase in infrastructure costs to expand production and distribution in anticipation of increased revenues throughout 2007 and beyond. Additionally, the high margin royalty contract that was not renewed in the fourth quarter of 2006 resulted in a decrease in segment operating income of $0.3 million in the first quarter of 2007 compared to the first quarter of 2006.
Progressus— Segment operating income increased 17% to $0.7 million in the quarter ended March 31, 2007 compared to the same quarter of the prior year. This $0.1 million increase is primarily related to the $1.1 million increase in revenue, offset by increased operating costs of $1.0 million, that can primarily be attributed to higher wage costs associated with the additional hours worked.
Educate Online— Educate Online broke even for the three months ended March 31, 2007, compared to an operating loss of $0.6 million in the prior year. The improvement in operating results is primarily related to the revenue growth in the Catapult Online channel, partially offset by expenses related to the higher session volumes, and marketing and advertising costs.
Corporate Expenses— Corporate general and administrative and depreciation and amortization expenses of $4.6 million for the quarter ended March 31, 2007 was comparable with the same quarter of the prior year. Net interest expense increased by $1.3 million, which was primarily a result of higher debt levels and higher short-term interest rates on the credit facility. Other financing costs decreased by $1.1 million due to fewer costs attributable to the credit facility debt refinanced in 2007 compared to debt refinanced in 2006. Our income tax expense increased to $1.7 million for the quarter ended March 31, 2007 from $0.9 million in 2006, due to an increase in pretax income in 2007 along with a higher effective tax rate in the 2007 quarter. Our effective tax rate was 42% and 39% for the quarters ended March 31, 2007 and 2006, respectively.
Liquidity and Capital Resources
The following table summarizes major changes in our cash position during the three months ended:
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March 31, | ||||||||
2007 | 2006 | |||||||
(Dollars in millions) | ||||||||
Beginning cash balance | $ | 0.5 | $ | 2.4 | ||||
Operating activities – continuing operations | 2.0 | 19.2 | ||||||
Operating activities – discontinued operations | — | (9.7 | ) | |||||
Investing activities | 0.1 | (7.5 | ) | |||||
Financing activities | (2.6 | ) | 4.9 | |||||
Effect of exchange rates | 0.4 | (0.2 | ) | |||||
Ending cash balance | $ | 0.4 | $ | 9.1 | ||||
Historically, we have generated significant cash flows from our operations which have allowed us to meet our working capital needs and provide the cash we require to make investments in property and equipment, develop new products and services, and to expand our business.
Our working capital requirements are favorably impacted by the fact that our largest segments, the Franchise Services and Company-Owned Centers segments, typically generate positive working capital even during growth periods. In our Sylvan Learning businesses, customers must pay in advance of services, which contributes to our cash position. Company-owned territories benefit from customer prepayment and, in connection with franchised territories, we receive royalty payments from franchisees based upon net cash collected in the prior month.
Our working capital needs are greater in our Catapult Learning and Progressus segments because our customers are primarily public school districts that pay us in arrears, often 60 days or longer after we perform our services. Customers in our Educate Products segment are granted payment terms customary in the industry, which may extend up to 240 days. The Products segment has also used cash to develop new products and to finance production and growth in inventory levels during the current and prior years.
For the quarters ended March 31, 2007 and 2006, our cash flows from continuing operations were $2.0 million and $19.2 million, respectively. The decrease of $17.2 million was attributed primarily to a decrease in working capital of $11.9 million as well as a decrease in income from continuing operations before non-cash charges of $5.2 million, which included payments of $4.5 million in merger-related costs.
Cash used in operating activities of discontinued operations was $9.7 million in 2006. We completed the sale of our Education Station business in the third quarter of 2006, therefore, there is no comparable current year amount.
Our investing activities have historically consisted of investments in property and equipment and internally developed software and media. During the quarter ended ended March 31, 2007, we sold 10 Company-owned learning center territories to franchisees for $3.6 million in order to focus Company-owned operations on maximizing system revenue and profit potential in strategic markets. See Note 2 to our consolidated financial statements for more information regarding these sales. We expect to sell additional Company-owned territories in connection with this initiative during the remainder of 2007.
As described more fully in the Note 3 to our consolidated financial statements, we amended our term loan facility during the first quarter of 2007 to obtain waivers for certain financial covenants for the March 31, 2007 quarterly reporting period. The Company believes it will fail to comply with these same financial covenants at subsequent quarterly reporting dates in 2007, and accordingly, will need to obtain waivers or amend the terms of the credit facility to avoid triggering the facility’s demand repayment provisions. As a result, the Company classified the $173.6 million of outstanding borrowings under the credit facility at March 31, 2007 as a current liability in the accompanying March 31, 2007 consolidated balance sheet, resulting in a working capital deficit of $167.9 million.
Management considered attempting to negotiate revised financial covenants to allow for compliance in 2007 based on projected operating results. However, because the Company has entered into a definitive merger agreement for the sale of the Company and expects to close that transaction by June 30, 2007, the Company determined it was not prudent to negotiate new terms and incur additional costs to amend its credit facility. However, there can be no assurance that lenders will waive their right to demand repayment of outstanding borrowings upon the likely default of the credit facility’s provisions in the June 30, 2007 and subsequent quarterly reporting periods, and in the event of demanded repayment, that the Company can refinance the loans on acceptable terms. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
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Assuming that our existing credit facility and planned acquisition financing are available as we anticipate, we believe that cash flows from operations, available cash and these credit facilities will be sufficient to meet our operating requirements, including expansion of our existing business, funding of program and software development and operating costs for the next year. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of sales and marketing activities, the timing of introductions of new services and enhancements to existing programs and products. If our existing credit facility is not available and we are unable to refinance the indebtedness, obtain a waiver or complete the merger, then we may be unable to continue as a going concern.
Contractual Obligations
There has been no material change in the information provided in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2006.
International Exposure
Our Franchise Services, European and Company-Owned Centers segments have operations outside the United States, primarily in Germany and Canada. These international operations subject us to political uncertainties, currency devaluations and national regulations affecting the provision of educational services. Accordingly, our revenues and income in any period may be impacted by international developments outside our control.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue, intangible assets and contingencies. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Our critical accounting policies and estimates are described in Management’s Discussion and Analysis of Financial Condition and Results of Operations and our significant accounting policies are described in Note 1 to our consolidated financial statements, both in our Annual Report on Form 10-K for the year ended December 31, 2006.
New Accounting Pronouncements
As more fully described in Note 1 to our consolidated financial statements, the FASB issued Statement of Financial Accounting Standards No. 157,Fair Value Measurements (“SFAS 157”) in September 2006. We are still evaluating the impact of this pronouncement on our financial statements.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk. |
We are exposed to certain market risks, which exist as part of our ongoing business operations. We use derivative financial instruments, where appropriate, to manage these risks. As a matter of policy, we do not engage in trading or speculative transactions. See Note 1 to our consolidated financial statements in this Form 10-K for further information on accounting policies related to derivative financial instruments.
Foreign Currency Risk
During the quarter ended March 31, 2007, approximately 12% of our revenues were derived from customers outside the United States. Most of this business is transacted through international subsidiaries, generally in the local currency that is considered the functional
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currency of that foreign subsidiary. Expenses are also incurred in the foreign currencies to match revenues earned and minimize the exchange rate exposure of our operating margins. We are vulnerable to changes in U.S. dollar / euro and U.S. dollar / Canadian dollar exchange rates. A hypothetical 10% adverse change in average annual foreign currency movements would have decreased both net income and cash flows for the quarter ended March 31, 2007 by approximately $0.1 million. We are also exposed to fluctuations in the value of foreign currency investments in subsidiaries and cash flows related to repatriation of these investments. We generally view our equity investment in foreign subsidiaries, comprised of Schülerhilfe, located in Germany, and Sylvan Canada, as long-term. The effects of a change in foreign currency exchange rates on our net investment in foreign subsidiaries are reflected in other comprehensive income. A hypothetical 10% average change in depreciation in functional currencies relative to the U.S. dollar would have resulted in a decrease in our net investment in foreign subsidiaries of approximately $2.7 million at March 31, 2007.
Interest Rate Risk
We hold cash and cash equivalents in high quality, short-term, fixed income securities. Consequently, the fair value of our cash and cash equivalents would not be significantly impacted by either a 100 basis point increase or decrease in interest rates.
We are exposed to interest rate volatility with regard to future issuances of fixed rate debt and existing and future issuance of variable rate debt. Primary exposures include movements in U.S. Treasury rates, London Interbank Offered Rates (LIBOR) and commercial paper. We currently have interest rate swaps in place to reduce interest rate volatility associated with our secured credit facility, and to achieve a desired proportion of variable versus fixed rate debt.
Note 3 to our consolidated financial statements provides information on our significant indebtedness and on our interest rate swap agreements. The total notional amount of interest rate swaps as of March 31, 2007 was $50.0 million, representing a settlement asset of $0.2 million. Assuming average variable rate debt levels, a one percentage point increase in interest rates would have increased interest expense by approximately $0.3 million for the quarter ended March 31, 2007.
All the potential impacts noted above are based on sensitivity analysis performed on our financial position at March 31, 2007. Actual results may differ materially.
Item 4. | Controls and Procedures. |
(a) | Disclosure controls and procedures |
As previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006, management identified a material weakness in our internal control over financial reporting. The material weakness was disclosed as follows:
We identified certain transactions recorded as revenue by our Educate Products division in 2006 that did not meet the criteria for revenue recognition in such period. The year ended December 31, 2006 was the initial year that Educate Products was subject to the provisions of Section 404 of the Sarbanes Oxley Act of 2002 concerning the effectiveness of the design and operation of its internal control over financial reporting. The errors identified were the result of a deficiency in the operation of controls requiring the supervisory review of transaction documentation to ensure proper revenue cutoff at period end. Specifically, key contract terms specifying when title to products shipped was transferred to the customer and related shipping documents were not properly reviewed and evaluated by responsible officials of the Company prior to recording revenue in the accounting records. The errors associated with these transactions resulted in an audit adjustment to correct an overstatement of recorded revenue of approximately $2.3 million, and an understatement of loss from continuing operations of approximately $1.1 million for the year ended December 31, 2006.
During the quarter ended March 31, 2007 the Company took the following actions to remediate this weakness:
• | Management conducted a review of sales terms with all customers and improved training and communication between all relevant personnel involved in sales transactions to enable a fuller understanding of proper revenue recognition accounting |
• | Management implemented improved procedures to obtain and review sales terms documentation and to perform accounting reviews designed to ensure that all sales transactions are recorded in accordance with proper revenue recognition accounting. |
• | Management implemented a procedure for the review of all new sales agreements by responsible Company officials prior to recording revenue in the accounting records. |
In connection with the filing of this Quarterly Report on Form 10-Q for the quarter ended March 31, 2007, the Company’s management, with the participation of our principal executive and principal financial officers, has re-evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended
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(the “Exchange Act”)) as of March 31, 2007. Disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in reports that the Company files or submits under the Exchange Act has been appropriately recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, to allow timely decisions regarding required disclosure. In conducting their re-evaluation, our Chief Executive Officer and Chief Financial Officer considered the nature and timing of our successful remediation of the material weakness in internal control over financial reporting as discussed above. Our Chief Executive Officer and Chief Financial Officer concluded that the remediation efforts completed effectively remediated the material weakness that did not prevent or timely detect the errors described above. Based on such re-evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective at the reasonable assurance level.
(b) Changes in Internal Control over Financial Reporting
The Company’s management, including the principal executive and principal financial officers, has evaluated any changes in the internal controls over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act that occurred during the quarter ended March 31, 2007, and has concluded that, except as discussed above, there was no change that occurred during the quarter ended March 31, 2007 that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.
Item 1. | Legal Proceedings. |
There has been no material change in the information provided in Part I, Item 3 of our Annual Report on Form 10-K for the year ended December 31, 2006.
Item 1A. | Risk Factors. |
There has been no material change in the information provided in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2006.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
None.
Item 3. | Defaults Upon Senior Securities. |
None.
Item 4. | Submission of Matters to a Vote of Security Holders. |
None.
Item 5. | Other Information. |
None.
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Item 6. | Exhibits. |
Exhibit | Description | |
2.3 | Agreement and Plan of Merger, dated as of January 28, 2007, by and among Edge Acquisition, LLC, Edge Acquisition Corporation and Educate, Inc. (1) | |
3.1 | Amended and Restated Certificate of Incorporation of Educate, Inc., a Delaware corporation. (2) | |
3.2 | Amended and Restated By-Laws of Educate Inc., a Delaware corporation. (3) | |
4.1 | Form of Registration Rights Agreement, by and among Educate, Inc., and certain of its stockholders. (3) | |
10.27 | Fourth Amendment, dated as of March 15, 2007, to the Amended and Restated Credit Agreement, dated as of April 28, 2005, among Educate Operating Company, LLC, the several banks and other financial institutions party thereto, Merrill Lynch Capital, as documentation agent, and JPMorgan Chase Bank, N.A., as administrative agent. (4) | |
31(i).1 | Certification of R. Christopher Hoehn-Saric pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31(i).2 | Certification of Kevin E. Shaffer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of R. Christopher Hoehn-Saric pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 | Certification of Kevin E. Shaffer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
(1) | Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on January 29, 2007. |
(2) | Incorporated by reference to the Registrant’s Registration Statement on Form 8-A filed on September 22, 2004. |
(3) | Incorporated by reference to our Registration Statement on Form S-1 (File No. 333-115496). |
(4) | Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on March 19, 2007. |
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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, thereunto duly authorized.
EDUCATE, INC. | ||
By: | /s/ Kevin E. Shaffer | |
Name: | Kevin E. Shaffer | |
Title: | Chief Financial Officer | |
Date: | May 10, 2007 |
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