Selling, general and administrative expenses include payroll and payroll related expenses, advertising expenses and office facility expenses, including rent, utilities, telephone and miscellaneous expenditures, which collectively represented approximately 65% of our total selling, general and administrative expenses in 2005. Selling, general and administrative expenses also include costs associated with national advertising campaigns that benefit our company-owned locations as well as our independent franchisees. Finally, the remaining components of selling, general and administrative expenses include professional fees, travel and entertainment, health insurance and depreciation and amortization.
For the three months ended December 31, 2005 total revenue for the Company increased by $4.5 million, or 16.2%, from $27.8 million in 2004 to $32.3 million in 2005.
Test Preparation Services revenue increased by $3.5 million, or 25.7%, from $13.6 million in 2004 to $17.1 million in 2005. This increase is driven by an increase of $2.1 million in retail, institutional and tutoring revenue, reflecting strong enrollment in SAT, LSAT, and MCAT courses and an increase of $1.0 million in SES revenue.
K-12 Services revenue increased by $385,000, or 3.4%, from $11.2 million in 2004 to $11.6 million in 2005. This increase is primarily driven by $2.0 million of growth in assessment services and the receipt of $400,000 in prior year license fees. Reductions are driven primarily by the recognition of a certain professional development contract which combined both third and fourth quarter revenue into the fourth quarter of 2004 driving a year-over-year reduction of $1.7 million. After adjusting for this $1.7 million contract, revenue growth for the quarter would be approximately 22%.
Admissions Services revenues increased by $648,000, or 21.6%, from $3.0 million in 2004 to $3.6 million in 2005. This increase was driven primarily by an increase of $643,000 in counseling contracts entered into during the third quarter of 2005.
Cost of Revenue
For the three months ended December 31, 2005 total cost of revenue for the Company increased by $4.0 million, or 38.1%, from $10.5 million in 2004 to $14.5 million in 2005.
Test Preparation Services cost of revenue increased by $1.5 million, or 29.5%, from $5.1 million in 2004 to $6.6 million in 2005. This increase is driven by a $1.4 million volume increase related to retail enrollments which caused variable costs such as teacher salaries, site rent and course materials to increase. Costs associated with SES also increased by approximately $300,000. Gross margin declined by 1.1% from 62.1% to 61.0% due to higher costs of labor and materials in support of SES institutional based contracts and year end delays.
K-12 Services cost of revenues increased by $2.2 million, or 50.5%, from $4.3 million in 2004 to $6.5 million in 2005. This increase is primarily related to an increase in content development and professional development costs of approximately $2.0 million. Gross margin declined by 17.5% from 61.7% to 44.2%. Adjusting for the additional $1.7 million of revenue during the fourth quarter of 2004 gross margin declines by 10.4% from 54.6% to 44.2% related to higher fourth quarter mix of professional development services and higher content development, production and distribution costs.
Admissions Services cost of revenue increased by $320,000, or 29.8%, from $1.1 million in 2004 to $1.4 million in 2005. This increase is primarily driven by an increase of $378,000 related to counseling labor and related costs. Gross margin declined by 2.4% from 64.3% to 61.9%. This decrease is primarily related to ongoing expenses in support of the new counseling services contracts.
Selling, General & Administration Expenses
Selling, general and administrative expense increased by approximately $890,000 or 4.1%, from 21.6 million in 2004 to $22.5 million in 2005. Primary components of this increase are: increased rent and related costs of $450,000 and $400,000 of advertising expense primarily related to the SES business.
Impairment of goodwill
Our results for the fourth quarter of 2004 included a write-down of approximately $8.2 million of goodwill related to the Embark acquisition.
Comparison of Years Ended December 31, 2005 and 2004
Revenue
For the year ended December 31, 2005 total revenue for the Company increased by $16.7 million, or 14.7%, from $113.8 million in 2004 to $130.5 million in 2005.
Test Preparation Services revenue increased by $12.6 million, or 16.8%, from $74.7 million in 2004 to $87.3 million in 2005. This increase is driven by an increase of $9.3 million in retail, institutional and tutoring revenue, once again reflecting strong enrollment in SAT, LSAT and MCAT courses, and $2.1 million in SES revenue.
For the year, K-12 services revenue increased by $4.0 million or 14.2%, from $28 million in 2004 to approximately $32 million in 2005. This increase is driven by $2.4 million in assessment services, $1.8 million in workbook intervention materials (primarily SideStreets) and $943,000 of professional development services.
For the year, Admissions Services revenue increased by $168,000, or 1.5%, from $11.1 million in 2004 to $11.3 million in 2005. This increase is driven by an increase of approximately $700,000 in revenue from
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counseling services, and a $1.4 million increase in higher education marketing fees. Reductions to revenue include a decrease in higher education technology fees and book related revenues related to timing.
Cost of Revenue
For the year ended December 31, 2005 total cost of revenue for the Company increased by $8.9 million, or 22%, from $40.7 million in 2004 to $49.6 million in 2005.
Test Preparation Services cost of revenue increased by $4.6 million, or 19.3%, from $23.6 million in 2004 to $28.1 million in 2005. This increase is primarily driven by the variable expense increase related to higher retail enrollments, and higher tutoring and institutional revenue. Gross margin declined slightly by 0.6% from 68.4% to 67.8%.
K-12 Services cost of revenue increased by $3.1 million, or 23.0%, from $13.7 million in 2004 to $16.8 million in 2005. This increase is driven by variable expense of approximately $2.1 million on $4.0 million of incremental revenue growth. In addition, there is an increase of $300,000 of web content amortization and approximately $889,000 increase related to incremental content production and labor related expense. Gross margin declined by 3.8% from 51.1% to 47.3% due to revenue timing and content production related costs. The Company expects margins to improve in 2006.
Admissions Services cost of revenue increased by $1.2 million, or 36.3%, from $3.4 million in 2004 to $4.6 million in 2005. This increase is driven by an increase of $500,000 in counseling expense and $700,000 of other related expense in support of both the technology and marketing business. Gross margins declined by 10.5% from 69.5% to 59.0%. The key drivers of this reduction relate to $700,000 in revenue credits driving approximately 6% of the decline, as well as approximately 2% in consulting mix and another 1.5% attributed to the cost base.
Selling, General & Administrative Expenses
Selling, general and administrative expense increased by approximately $6.7 million or 8.6%, from $78.4 million in 2004 to $85.1 million in 2005. This increase is attributed to: salary expense of $2.1 million, office rent and related expense of $730,000, professional fees primarily related to Sarbanes-Oxley of $2.8 million, $400,000 in advertising and recruitment expense and workers compensation fees of $300,000.
Impairment of goodwill
Our 2004 results included a write-down of approximately $8.2 million of goodwill related to the acquisition of Embark.
Sale of Rights to Franchises
During the third quarter of 2005, we sold the right to provide SES programs to four of our independent franchisees for $990,000.
Comparison of Years Ended December 31, 2004 and 2003
Overall, results for 2004 were below expectations in all three divisions. After returning to profitability in 2003, we incurred a net loss of $30.4 million in 2004. In the Test Preparation Services division, weakness in enrollments in LSAT and GMAT courses offset growth in online courses, SES programs and tutoring, resulting in annual revenue growth of only 4%. Despite revenue growth for the year of 30%, the K-12 Services division experienced a longer sales cycle in closing on contracts. The Admissions Services division, despite rolling out a new counseling product, failed to grow revenue for the second year in a row, primarily due to weak demand for subscription-based services from its post-secondary institution customers. Gross margins for the company as a whole slipped from 69.4% in 2003 to 64.3% in 2004, due primarily to higher costs combined with lower enrollment in test preparation services and a less profitable product mix in K-12 services.
On the expense side, professional fees, including those relating to Sarbanes Oxley compliance, were significantly higher than expected, and a bad debt expense relating to the write-off of aged accounts
33
receivable in the Admissions Services and K-12 Services divisions further hurt our bottom line. Additionally, we recorded a valuation allowance relating to our net deferred tax assets as of December 31, 2004, of approximately $22.1 million, resulting in a tax charge of $16.7 million in 2004, and incurred an $8.2 million impairment charge relating to the write-down of goodwill.
Revenue
Our total revenue increased from $104.5 million in 2003 to $113.8 million in 2004, representing a 9% increase.
Test Preparation Services revenue increased from $71.7 million in 2003 to $74.7 million in 2004, representing a 4% increase, comprised primarily of an increase of approximately $2.9 million in revenue from our company-owned operations. The increased revenue from company-owned operations resulted from an increase of approximately $488,000 in revenue attributable to the operations acquired from our former franchisee, Princeton Review of North Carolina, Inc., and an increase of approximately $2.5 million in course and tutoring revenue at our other locations. This $2.5 million increase is attributable to an increase in our tutoring, online course and SES revenue totaling $4.2 million, which was partially offset by a decrease in retail classroom revenue of approximately $2.3 million, primarily due to a drop in LSAT and GMAT course fees.
K-12 Services revenue increased from $21.5 million in 2003 to $28.0 million in 2004, representing a 30% increase. This increase resulted primarily from an increase of approximately $6.8 million in revenue from schools for assessment tests, printed materials, professional development and Homeroom subscriptions, due to additional contracts signed in 2004, as well as increased revenue from contracts signed in 2003 which were in effect for the full year in 2004. The increase in revenue from schools was partially offset by a decrease in fees from McGraw-Hill.
Admissions Services revenue decreased from $11.2 million in 2003 to $11.1 million in 2004, representing a 1% decrease. The approximate $750,000 in sales of college counseling services to high schools, a new product offering in 2004 by this division, was offset by a decrease in revenues from post-secondary institutions.
Cost of Revenue
Our total cost of revenue increased from $32.0 million in 2003 to $40.7 million in 2004, representing a 27% increase.
Test Preparation Services cost of revenue increased from $20.8 million in 2003 to $23.6 million in 2004, representing a 13% increase, primarily as a result of increasing the number of tutoring sessions and SES programs delivered. Cost of revenue as a percentage of revenue increased due to reduction in the average class size due to reduced enrollment, primarily in our LSAT courses, as well as an increase in the relative cost of teachers and course materials.
K-12 Services cost of revenue increased from $8.3 million in 2003 to $13.7 million in 2004, representing a 65% increase. This increase is primarily attributable to an increase in costs incurred to service increasing numbers and increasingly complex contracts with school-based customers. The percentage increase in cost of revenue was significantly higher than the increase in revenue in this division primarily because of the increased revenues from the lower margin professional development services.
Admissions Services cost of revenue increased from $2.8 million in 2003 to $3.4 million in 2004, representing a 21% increase, primarily due to increased customer support costs, including the new high school counseling product.
Operating Expenses
Selling, general and administrative expenses increased from $65.6 million in 2003 to $86.6 million in 2004, representing a 32% increase. This increase resulted from the following:
| • | | a write-down of goodwill related to the acquisition of Embark of approximately $8.2 million; |
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| • | | an increase of approximately $4.7 million in salaries and payroll taxes, resulting primarily from increased headcount; |
| • | | an increase of approximately $2.6 million attributable primarily to personnel related costs, including office rent and expenses, travel and entertainment, employee benefits and recruiting fees; |
| • | | an increase of approximately $2.4 million in professional fees, comprised primarily of legal, accounting and consultant fees, relating to Sarbanes-Oxley compliance, an internal corporate reorganization and other miscellaneous matters; |
| • | | an increase of approximately $2.2 million in web site technology and development expenses; |
| • | | an increase of approximately $1.1 million in bad debt allowance expense primarily due to an increase in aged accounts receivable in the Admissions Services and K-12 Services divisions; and |
| • | | an increase of approximately $725,000 in depreciation and amortization expenses, due primarily to increased amortization expense relating to the K-12 Services division’s web site development costs. |
Liquidity and Capital Resources
Our primary sources of liquidity are cash and cash equivalents on hand and collections from customers. At December 31, 2005, we had $8.0 million of cash and cash equivalents. The $11.2 million decrease in cash from the December 31, 2004 balance is primarily attributed to investing activities of $13.6 million ($8.3 million in furniture, fixtures, equipment and software development and $5.6 million in capitalized content) along with $5.1 million related to financing activity that more than offset the $7.5 million cash increase provided by operating activities. Our Test Preparation Services division has historically generated, and continues to generate, the largest portion of our cash flow from its retail classroom and tutoring courses. These customers usually pay us in advance or contemporaneously with the services we provide, thereby supporting our short-term liquidity needs. Increasingly, however, across all of our divisions, we are generating a greater percentage of our cash from contracts with institutions such as the schools and school districts serviced by our K-12 Services division and the post-secondary institutions serviced by our Admissions Services division, all of which pay us in arrears. Typical payment performance for these institutional customers, once invoiced, ranges from 60 to 90 days. Additionally, the long contract approval cycles and/or delays in purchase order generation with some of our contracts with large institutions or school districts can contribute to the level of variability in the timing of our cash receipts.
Cash provided by operating activities is our net income (loss) adjusted for certain non-cash items and changes in operating assets and liabilities. During 2005, cash provided by operating activities was $7.5 million, compared to $4.0 million for 2004, an increase of $3.5 million. The increase is primarily attributed to the year-over-year increase in accounts payable and accrued expenses of $5.6 million and an increase in net income adjusted for non cash items of $4.8 million. These increases were partially offset by a decrease in deferred income of $1.1 million and an increase in inventory, primarily SideStreets instruction books, of $1.7 million
During 2005, we used $13.6 million in cash for investing activities as compared to $8.3 million used during 2004. This increase is driven by increases of $2.5 million in capital expenditures due primarily to the Oracle implementation, an increase of $4.1 million in content expenditures related to the development of SideStreets content and an increase of $1.8 million in leasehold improvements.
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Financing cash flows consist primarily of transactions related to our debt and equity structure. We used approximately $5.1 million in 2005 compared to net proceeds of $9.6 million during 2004. During 2005, we repaid approximately $2.0 million of the debt we had borrowed in 2004 under a bank credit facility, and we repaid approximately $2.0 million in other debt. In 2004, we raised approximately $9.7 million net of issuance costs, from the sale of Series B-1 Preferred Stock and repaid approximately $2.3 million of other debt.
Our current cash balances and operating cash flow, will be sufficient to cover our normal operating requirements for the next 12 months as we implement a number of restructuring initiatives designed to significantly improve operating cash flow. We also expect to shortly secure a revolving line of credit in an amount of $5 million to $10 million to support any further working capital requirements.
Contractual Obligations and Commercial Commitments
As of December 31, 2005, our principal contractual obligations and commercial commitments consisted of obligations outstanding under our long-term office and classroom leases, obligations under promissory notes entered into in connection with acquisitions, employment agreements and several capital leases of computer equipment. As of December 31, 2005, we operated from leased premises in New York, Alabama, Arizona, California, Colorado, Georgia, Illinois, Kansas, Louisiana, Maryland, Massachusetts, Minnesota, Missouri, New Jersey, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Texas, Virginia, Washington, Washington D.C., and Canada.
The following table summarizes our contractual obligations and other commercial commitments set forth therein as of December 31, 2005.
| | | | Payments due by period
| |
|---|
| | | | ($ in millions)
| |
|---|
Contractual Obligations
| | | | Total
| | Less than
1 year
| | 1–3 years
| | 3–5 years
| | More than
5 years
|
|---|
| Long-term debt obligations | | | | $ | 3.1 | | | $ | 0.7 | | | $ | 2.3 | | | $ | 0.1 | | | $ | — | |
| Capital lease obligations | | | | | 1.2 | | | | 0.8 | | | | 0.4 | | | | — | | | | — | |
| Operating lease obligations | | | | | 28.5 | | | | 5.1 | | | | 9.2 | | | | 6.8 | | | | 7.4 | |
| Purchase obligations (1) | | | | | 6.5 | | | | 3.0 | | | | 3.5 | | | | — | | | | — | |
| Total | | | | $ | 39.3 | | | $ | 9.6 | | | $ | 15.4 | | | $ | 6.9 | | | $ | 7.4 | |
| (1) | | Purchase obligations consist of payments required under employment agreements. |
Adoption of New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R),“Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R) establishes standards for accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS 123(R) requires that the fair value of such equity instruments be recognized as expense in the financial statements as services are performed. Prior to SFAS 123(R), only the pro forma disclosures of fair value were required. In March 2005, the SEC issued Staff Accounting Bulletin No. 107,“TOPIC 14: Share-Based Payment” which addresses the interaction between SFAS 123(R) and certain SEC rules and regulations and provides views regarding the valuation of share-based payment arrangements for public companies. SFAS 123(R) is effective for our first quarter of 2006 and the adoption of this new accounting pronouncement is expected to result in pre-tax stock-based compensation expense of between $0.3 million and $0.5 million in our fiscal year 2006.
In December 2004, the FASB issued SFAS No. 153,“Exchanges of Nonmonetary Assets — An Amendment of APB Opinion No. 29” (“SFAS 153”). This new standard is the result of a broader effort by the FASB to improve financial reporting by eliminating differences between generally accepted accounting principles (“GAAP”) in the U.S. and GAAP developed by the International Accounting
36
Standards Board (“IASB”). As part of this effort, the FASB and the IASB identified opportunities to improve financial reporting by eliminating certain narrow differences between their existing accounting standards. SFAS 153 amends Accounting Principles Board Opinion No. 29,“Accounting for Nonmonetary Transactions” (“APB 29”), that was issued in 1973. The amendments made by SFAS 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have “commercial substance.” Previously, APB 29 required that the accounting for an exchange of a productive asset for a similar productive asset, or an equivalent interest in the same or similar productive asset, should be based on the recorded amount of the asset relinquished. The provisions of SFAS 153 were effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005, and there was no impact on our consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154,“Accounting Changes and Error Corrections — a Replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). SFAS 154 requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also redefines “restatement” as the revising of previously issued financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 (our 2006 fiscal year) and is not expected to have a significant impact on our consolidated financial statements.
Critical Accounting Policies
The estimates, methods and judgments we use in applying our accounting policies significantly impact the results we report in our financial statements. Some of our accounting policies require us to make subjective and difficult judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Our most critical accounting estimates include the assessment of the collectability of our accounts receivable balances, which impacts bad debt write-offs; recoverability of goodwill, which impacts goodwill impairment expense; assessment of recoverability of long-lived assets, which primarily impacts operating margins when we record the impairment of assets or accelerate their depreciation; recognition and measurement of current and deferred income tax assets and liabilities, which impacts our tax provision and, to a lesser extent, revenue recognition requirements, which impacts how and when we recognize revenue from our goods and services. Below, we discuss these policies further, as well as the estimates and judgments involved.
We also have other policies that we consider to be key accounting policies. However, these policies do not meet the definition of critical accounting estimates because they do not generally require us to make estimates or judgments that are difficult or subjective.
Accounts Receivable. We maintain allowances for doubtful accounts for losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances for uncollectible accounts may be required. We review our aged receivables monthly. This review includes discussions with our customers and their account representatives, the customers’ payment history and other factors. Based on these reviews we may increase or decrease our allowance for uncollectible accounts if we determine there is a change in the collectability of our accounts receivable.
Goodwill and Territorial Marketing Rights. We perform an annual goodwill impairment review during the fourth quarter, or more frequently if indicators of potential impairment exist. No impairment was indicated in 2003 or 2005. In 2004, we recorded an impairment expense of $8.2 million against goodwill in our Admissions Services division due to the continued poor performance of this division. Our impairment review process is based on a discounted future cash flow approach that uses our estimates of revenue for the reporting units, driven by assumed market growth rates as well as appropriate discount rates. These estimates are consistent with the plans and estimates that we use to manage the underlying businesses.
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Long-Lived Assets. We assess the impairment of long-lived assets when events or changes in circumstances indicate that the carrying value of the assets or the asset grouping may not be recoverable. Factors we consider in deciding when to perform an impairment review include significant under-performance of a business or product line in relation to expectations, significant negative industry or economic trends and significant changes or planned changes in our use of the assets. Recoverability of assets that will continue to be used in our operations is measured by comparing the carrying amount of the asset grouping to the related total future undiscounted net cash flows. If an asset grouping’s carrying value is not recoverable through those cash flows, the asset grouping is considered to be impaired. The impairment is measured by the difference between the assets’ carrying amount and their fair value, based on the best information available, including market prices or discounted cash flow analysis.
Income Taxes. In determining income for financial statement purposes, we must make certain estimates and judgments. These estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain of the deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense.
We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a reserve, in the form of a valuation allowance, for the deferred tax assets that we estimate will not ultimately be recoverable. At December 31, 2005, we had a net deferred tax asset of approximately $23.7 million, primarily relating to our net operating loss carryforwards of $53.7 million, which expire in varying amounts between 2021 and 2025.
Realization of our deferred tax asset is dependent on generating sufficient taxable income in the United States prior to expiration of these loss carryforwards. As of December 31, 2004, we recorded a valuation allowance for the entire net deferred tax asset because our loss in 2004 and the emphasis placed on cumulative losses under generally accepted accounting principles represented sufficient evidence under SFAS No. 109 “Accounting for Income Taxes” for us to determine that it was appropriate to establish a full valuation allowance. If, in the future, an appropriate level and consistency of profitability is attained, we would reduce the valuation allowance, which could have a significant impact on our consolidated financial statements.
Revenue Recognition. In general our revenue recognition policies do not require us to make estimates or judgments that are difficult or subjective, with the possible exception being the recognition of revenue for separate units of accounting in accordance with EITF No. 00-21, “Revenue Arrangements with Multiple Deliverables.” In accounting for multiple-element arrangements, one of the key judgments to be made is the accounting value that is attributable to the different contractual elements. The appropriate allocation of value not only impacts which segment is credited with the revenue, it also impacts the amount and timing of revenue recorded in the consolidated statement of operations during a given period due to the differing methods of recognizing revenue for each product or service by each of the segments. Revenue is allocated to each element based on the accounting determination of the relative fair value of that element to the aggregate fair value of all elements. The fair values must be reliable, verifiable and objectively determinable. When available, such determination is based principally on the pricing of similar arrangements with unrelated parties that are not part of a multiple-element arrangement.
Impact of Inflation
Inflation has not had a significant impact on our historical operations.
Seasonality in Results of Operations
We experience, and we expect to continue to experience, seasonal fluctuations in our revenue because the markets in which we operate are subject to seasonal fluctuations based on the scheduled dates for standardized admissions tests and the typical school year. These fluctuations could result in volatility or adversely affect our stock price. We typically generate the largest portion of our test preparation revenue in the third quarter. However, as SES revenues increase, we expect to recognize these revenues primarily in the first and fourth quarters. The electronic application revenue recorded in
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our Admissions Services division is highest in the first and fourth quarters, corresponding with the busiest times of year for submission of applications to academic institutions. Our K-12 Services division experiences seasonal fluctuations in revenue, with the first and fourth quarters (corresponding to the school year) expected to have the highest revenue.
Item 7A. | | Quantitative and Qualitative Disclosures about Market Risk |
Our portfolio of marketable securities includes primarily short-term money market funds. The fair value of our portfolio of marketable securities would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due primarily to the short-term nature of the portfolio. All of our currently outstanding long-term debt bears interest at fixed rates. Our Series B-1 Preferred Stock requires the payment of quarterly dividends at the greater of 5% or 1.5% above 90-day LIBOR (4.4% at December 31, 2005). During 2005 and 2004, we paid dividends on the Series B-1 Preferred Stock in an aggregate amount of $534,000 and $374,000, at an average rate of 5.3% and 7.5% in 2005 and 2004, respectively. A 100 basis point increase in the dividend rate would have resulted in a $100,000 increase in dividends paid during this period.
We repaid and terminated our line of credit in February 2005. We do not currently hold or issue derivative financial instruments.
Revenue from our international operations and royalty payments from our international franchisees constitute an insignificant percentage of our revenue. Accordingly, our exposure to exchange rate fluctuations is minimal.
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Item 8. | | Financial Statements and Supplementary Data |
Index to Consolidated Financial Statements and Financial Statement Schedule
| | | | Page
|
|---|
Consolidated Financial Statements:
| | | | | | |
| Report of Independent Registered Public Accounting Firm | | | | | 41 | |
| Consolidated Balance Sheets | | | | | 42 | |
| Consolidated Statements of Operations | | | | | 43 | |
| Consolidated Statements of Stockholders’ Equity | | | | | 44 | |
| Consolidated Statements of Cash Flows | | | | | 45 | |
| Notes to Consolidated Financial Statements | | | | | 46 | |
Financial Statement Schedule:
| | | | | | |
| Schedule II — Valuation And Qualifying Accounts | | | | | 71 | |
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
The Princeton Review, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of The Princeton Review, Inc. and Subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 8. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Princeton Review, Inc. and Subsidiaries as of December 31, 2005 and 2004 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with U.S. generally accepted accounting principles. Also, in our opinion the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of The Princeton Review, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2006 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
New York, NY
March 13, 2006
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THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
| | | | December 31,
| |
|---|
| | | | 2005
| | 2004
|
|---|
| | | | (in thousands, except
share data)
| |
|---|
A S S E T S
|
Current assets:
| | | | | | | | | | |
| Cash and cash equivalents (including $255 restricted cash in 2005) | | | | $ | 8,002 | | | $ | 19,197 | |
Accounts receivable, net of allowance of $1,601 in 2005 and $1,290
in 2004 | | | | | 22,493 | | | | 20,652 | |
| Accounts receivable-related parties | | | | | 1,591 | | | | 1,682 | |
| Other receivables ($789 in 2005 and $1,049 in 2004 from related parties) | | | | | 813 | | | | 1,107 | |
| Inventories | | | | | 2,798 | | | | 1,054 | |
| Prepaid expenses | | | | | 2,229 | | | | 2,019 | |
| Other current assets | | | | | 1,307 | | | | 1,547 | |
| Total current assets | | | | | 39,233 | | | | 47,258 | |
| Furniture, fixtures equipment and software development, net | | | | | 16,155 | | | | 13,380 | |
| Goodwill, net | | | | | 31,506 | | | | 31,511 | |
| Investment in affiliates | | | | | 1,938 | | | | 1,847 | |
| Other intangibles, net | | | | | 13,371 | | | | 10,032 | |
| Other assets | | | | | 3,168 | | | | 3,613 | |
Total assets | | | | $ | 105,371 | | | $ | 107,641 | |
| |
L I A B I L I T I E S A N D S T O C K H O L D E R S’ E Q U I T Y
|
Current liabilities:
| | | | | | | | | | |
| Accounts payable | | | | $ | 10,449 | | | $ | 8,359 | |
| Accrued expenses | | | | | 10,826 | | | | 7,342 | |
| Current maturities of long-term debt | | | | | 1,530 | | | | 3,769 | |
| Deferred income | | | | | 16,548 | | | | 17,637 | |
| Total current liabilities | | | | | 39,353 | | | | 37,107 | |
| Deferred rent | | | | | 2,327 | | | | 1,388 | |
| Long-term debt | | | | | 2,845 | | | | 4,213 | |
| Series B-1 Preferred stock, $.01 par value; 10,000 authorized, issued and outstanding at December 31, 2005 and 2004 respectively (liquidation value of $10,000) | | | | | 10,000 | | | | 9,736 | |
Stockholders’ equity
| | | | | | | | | | |
| Preferred stock, $.01 par value; 4,990,000 shares authorized; none issued and outstanding at December 31, 2005 and 2004 | | | | | — | | | | — | |
| Common stock, $.01 par value; 100,000,000 shares authorized; 27,572,172 and 27,569,764 issued and outstanding at December 31, 2005 and 2004, respectively | | | | | 276 | | | | 276 | |
| Additional paid-in capital | | | | | 116,279 | | | | 116,260 | |
| Accumulated deficit | | | | | (65,430 | ) | | | (61,102 | ) |
| Accumulated other comprehensive (loss) | | | | | (279 | ) | | | (237 | ) |
| Total stockholders’ equity | | | | | 50,846 | | | | 55,197 | |
Total liabilities and stockholders’ equity | | | | | 105,371 | | | $ | 107,641 | |
See accompanying notes.
42
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
| | | | Years Ended December 31,
| |
|---|
| | | | 2005
| | 2004
| | 2003
|
|---|
| | | | (in thousands, except per share data)
| |
|---|
Revenue
| | | | | | | | | | | | | | |
| Test Preparation Services | | | | $ | 87,310 | | | $ | 74,744 | | | $ | 71,719 | |
| K-12 Services | | | | | 31,931 | | | | 27,957 | | | | 21,525 | |
| Admissions Services | | | | | 11,252 | | | | 11,084 | | | | 11,218 | |
| Total revenue | | | | | 130,493 | | | | 113,785 | | | | 104,462 | |
Cost of revenue
| | | | | | | | | | | | | | |
| Test Preparation Services | | | | | 28,144 | | | | 23,584 | | | | 20,809 | |
| K-12 Services | | | | | 16,838 | | | | 13,684 | | | | 8,328 | |
| Admissions Services | | | | | 4,615 | | | | 3,385 | | | | 2,836 | |
| Total cost of revenue | | | | | 49,597 | | | | 40,653 | | | | 31,973 | |
| Gross profit | | | | | 80,896 | | | | 73,132 | | | | 72,489 | |
Operating expenses
| | | | | | | | | | | | | | |
| Selling, general and administrative | | | | | 85,144 | | | | 78,381 | | | | 65,634 | |
| Impairment of goodwill | | | | | — | | | | 8,199 | | | | — | |
| Total operating expenses | | | | | 85,144 | | | | 86,580 | | | | 65,634 | |
Income (loss) from operations | | | | | (4,248 | ) | | | (13,448 | ) | | | 6,855 | |
| Interest expense | | | | | (354 | ) | | | (693 | ) | | | (607 | ) |
| Sale of rights to franchisees | | | | | 990 | | | | — | | | | — | |
| Other income (loss), net | | | | | 138 | | | | 435 | | | | 1,217 | |
Income (loss) before provision from income taxes | | | | | (3,474 | ) | | | (13,706 | ) | | | 7,465 | |
| (Provision) for income taxes | | | | | — | | | | (16,707 | ) | | | (3,156 | ) |
Net income (loss) | | | | | (3,474 | ) | | | (30,413 | ) | | | 4,309 | |
Dividends and accretion on Series B-1 Preferred Stock | | | | | (854 | ) | | | (428 | ) | | | — | |
Net income (loss) attributed to common stockholders | | | | $ | (4,328 | ) | | $ | (30,841 | ) | | $ | 4,309 | |
Basic income (loss) per share | | | | $ | (0.16 | ) | | $ | (1.12 | ) | | $ | 0.16 | |
Diluted income (loss) per share | | | | $ | (0.16 | ) | | $ | (1.12 | ) | | $ | 0.16 | |
Weighted average shares used in computing net income (loss) per share
| | | | | | | | | | | | | | |
| Basic | | | | | 27,570 | | | | 27,468 | | | | 27,306 | |
| Diluted | | | | | 27,570 | | | | 27,468 | | | | 27,467 | |
See accompanying notes.
43
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
(in thousands)
| | | | Stockholders’ Equity (Deficit)
| |
|---|
| | | | Common Stock
| |
|---|
| | | | Shares
| | Amount
| | Additional
Paid-in
Capital
| | Accumulated
Deficit
| | Accumulated
Other
Comprehensive
Income (loss)
| | Total
Stockholders’
Equity
|
|---|
Balance at January 1, 2003 | | | | | 27,261 | | | $ | 273 | | | $ | 113,972 | | | $ | (34,570 | ) | | $ | (377 | ) | | $ | 79,298 | |
| Exercise of stock options | | | | | 124 | | | | 1 | | | | 706 | | | | — | | | | — | | | | 707 | |
| Issuance of non-employee options | | | | | — | | | | — | | | | 151 | | | | — | | | | — | | | | 151 | |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | | | — | | | | — | | | | — | | | | 4,309 | | | | — | | | | 4,309 | |
| Foreign currency gain (loss) | | | | | — | | | | — | | | | — | | | | — | | | | 15 | | | | 15 | |
| Unrealized loss on securities, net of applicable income tax expense of $10 | | | | | — | | | | — | | | | — | | | | — | | | | (13 | ) | | | (13 | ) |
| Comprehensive income | | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 4,311 | |
Balance at December 31, 2003 | | | | | 27,385 | | | $ | 274 | | | $ | 114,829 | | | $ | (30,261 | ) | | $ | (375 | ) | | $ | 84,467 | |
| Exercise of stock options | | | | | 121 | | | | 1 | | | | 834 | | | | — | | | | — | | | | 835 | |
| Shares issued in connection with an equity investment | | | | | 64 | | | | 1 | | | | 499 | | | | — | | | | — | | | | 500 | |
| Stock based compensation | | | | | — | | | | — | | | | 98 | | | | — | | | | — | | | | 98 | |
Dividends and accretion on
Series B-1 Preferred Stock | | | | | — | | | | — | | | | — | | | | (428 | ) | | | — | | | | (428 | ) |
| Comprehensive loss | | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Net loss | | | | | — | | | | — | | | | — | | | | (30,413 | ) | | | — | | | | (30,413 | ) |
| Foreign currency gain (loss) | | | | | — | | | | — | | | | — | | | | — | | | | 138 | | | | 138 | |
| Comprehensive loss | | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (30,703 | ) |
Balance at December 31, 2004 | | | | | 27,570 | | | $ | 276 | | | $ | 116,260 | | | $ | (61,102 | ) | | $ | (237 | ) | | $ | 55,197 | |
| Exercise of stock options | | | | | 2 | | | | — | | | | 19 | | | | — | | | | — | | | | 19 | |
Dividends and accretion on
Series B-1 Preferred Stock | | | | | | | | | | | | | | | | | (854 | ) | | | | | | | (854 | ) |
| Comprehensive loss | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | | | — | | | | — | | | | — | | | | (3,474 | ) | | | — | | | | (3,474 | ) |
| Foreign currency gain (loss) | | | | | — | | | | — | | | | — | | | | — | | | | (42 | ) | | | (42 | ) |
| Comprehensive loss | | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (4,370 | ) |
Balance at December 31, 2005 | | �� | | | 27,572 | | | $ | 276 | | | $ | 116,279 | | | $ | (65,430 | ) | | $ | (279 | ) | | $ | 50,846 | |
See accompanying notes.
44
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
| | | | Years Ended December 31,
| |
|---|
| | | | 2005
| | 2004
| | 2003
|
|---|
| | | | (in thousands)
| |
|---|
Cash flows from operating activities:
| | | | | | | | | | | | | | |
| Net income (loss) | | | | $ | (3,474 | ) | | $ | (30,413 | ) | | $ | 4,309 | |
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
| | | | | | | | | | | | | | |
| Depreciation | | | | | 1,776 | | | | 1,609 | | | | 1,664 | |
| Amortization | | | | | 5,897 | | | | 5,393 | | | | 4,373 | |
| Impairment of goodwill | | | | | — | | | | 8,199 | | | | — | |
| Bad debt expense | | | | | 1,328 | | | | 1,521 | | | | 380 | |
| Write-off of deferred financing costs | | | | | 117 | | | | — | | | | | |
| Deferred income taxes | | | | | (1,520 | ) | | | (5,425 | ) | | | 2,851 | |
| Valuation allowance for deferred tax assets | | | | | 1,520 | | | | 22,132 | | | | — | |
| Stock based compensation | | | | | — | | | | 98 | | | | 151 | |
| Other, net | | | | | 1,241 | | | | 219 | | | | 392 | |
Net change in operating assets and liabilities:
| | | | | | | | | | | | | | |
| Accounts receivable | | | | | (2,785 | ) | | | (3,510 | ) | | | (6,664 | ) |
| Inventory | | | | | (1,744 | ) | | | (153 | ) | | | (262 | ) |
| Prepaid expenses | | | | | (211 | ) | | | 9 | | | | (764 | ) |
| Other assets | | | | | 880 | | | | (93 | ) | | | (1,617 | ) |
| Accounts payable and accrued expenses | | | | | 5,574 | | | | (359 | ) | | | 4,252 | |
| Deferred income | | | | | (1,089 | ) | | | 4,758 | | | | 86 | |
| Net cash provided by operating activities | | | | | 7,510 | | | | 3,985 | | | | 9,151 | |
Cash flows from investing activities:
| | | | | | | | | | | | | | |
| Purchases of furniture, fixtures, equipment and software development | | | | | (8,258 | ) | | | (5,208 | ) | | | (4,272 | ) |
| Investment in affiliates | | | | | — | | | | (850 | ) | | | — | |
| Purchases of franchises and other businesses, net of cash acquired | | | | | — | | | | (130 | ) | | | (568 | ) |
| Payment of related party loan | | | | | 33 | | | | — | | | | — | |
| Note receivable | | | | | 250 | | | | 400 | | | | 717 | |
| Additions to capitalized K-12 content, capitalized course costs | | | | | (5,595 | ) | | | (2,518 | ) | | | (1,706 | ) |
| Net cash used in investing activities | | | | | (13,570 | ) | | | (8,306 | ) | | | (5,829 | ) |
Cash flows from financing activities:
| | | | | | | | | | | | | | |
| Proceeds from the sale of Series B-1 Preferred Stock, net of issuance cost | | | | | — | | | | 9,682 | | | | — | |
| Proceeds (payments) from revolving credit facility | | | | | (2,000 | ) | | | 2,000 | | | | — | |
| Notes issued in connection with sale of rights to franchisees | | | | | (956 | ) | | | | | | | | |
| Long-term debt borrowings | | | | | 367 | | | | — | | | | — | |
| Capital lease payments | | | | | (717 | ) | | | (555 | ) | | | (274 | ) |
| Dividends on Series B-1 Preferred Stock | | | | | (591 | ) | | | (374 | ) | | | — | |
| Notes payable related to acquisitions | | | | | (1,257 | ) | | | (1,779 | ) | | | (1,656 | ) |
| Proceeds from exercise of options | | | | | 19 | | | | 752 | | | | 582 | |
| Payment of credit facility financing costs | | | | | — | | | | (145 | ) | | | — | |
| Net cash (used in) provided by financing activities | | | | | (5,135 | ) | | | 9,581 | | | | (1,348 | ) |
| Net (decrease) increase in cash and cash equivalents | | | | | (11,195 | ) | | | 5,260 | | | | 1,974 | |
| Cash and cash equivalents, beginning of period | | | | | 19,197 | | | | 13,937 | | | | 11,963 | |
| Cash and cash equivalents, end of period | | | | $ | 8,002 | | | $ | 19,197 | | | $ | 13,937 | |
Supplemental cash flow disclosures:
| | | | | | | | | | | | | | |
| Cash paid during the year for interest | | | | $ | 580 | | | $ | 564 | | | $ | 462 | |
Supplemental schedule of noncash financing activities:
| | | | | | | | | | | | | | |
| Equipment acquired through capital leases | | | | $ | 316 | | | $ | 1,276 | | | $ | 595 | |
See accompanying notes.
45
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. | | Nature of Business and Significant Accounting Policies |
Business
The Princeton Review, Inc. and its wholly owned subsidiaries (together, the “Company”), are engaged in the business of providing courses that prepare students for college, graduate school and other admissions tests. The Company, through Princeton Review Operations, LLC, provides these courses in various locations throughout the United States and Canada and over the Internet. As of December 31, 2005, the Company had six franchisees operating approximately 18 offices under the Princeton Review name in the United States and 15 franchises with approximately 38 offices in 19 countries. The Company also sells support materials and equipment to its franchisees, author’s content for various books and software products published by third parties, sells marketing and web-based products to higher education institutions, operates a Web site providing education-related content and provides a number of services to K-12 schools and school districts to help them measurably improve academic performance.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of The Princeton Review, Inc. and its wholly owned subsidiaries. All significant intercompany transactions and balances are eliminated in consolidation.
Use of Estimates
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States 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 revenue and expenses during the reporting period. Significant accounting estimates used include estimates for uncollectible accounts receivable, deferred tax valuation allowances, impairment write downs and amortization lives assigned to intangible assets. Actual results could differ from those estimates.
Reclassifications
Certain prior period balance sheet and cash flow amounts have been reclassified to conform with the current year presentation.
Cash and Cash Equivalents
As of December 31, 2005 and 2004, cash and cash equivalents consist of investments in securities issued or guaranteed by the U.S. government, its agencies or instrumentalities, which have maturities of 90 days or less at the date of purchase. As of December 31, 2005 approximately 90% of the Company’s cash and cash equivalents was on hand at one financial institution. As of December 31, 2004 approximately 90% of the Company’s cash and cash equivalents were on hand at two financial institutions.
Accounts Receivable and Allowance for Doubtful Accounts
The Company provides credit, in the normal course of business, to its customers. The Company maintains an allowance for doubtful customer accounts for estimated losses that may result from the inability of the Company’s customers to make required payments. That estimate is based on a variety of factors, including historical collection experience, current economic and market conditions, and a review of the current status of each customer’s trade accounts receivable. The Company charges actual losses when incurred to this allowance.
46
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
Inventories
Inventories consist of program support equipment, course materials and supplies. All inventories are valued at the lower of cost (first-in, first-out basis) or market.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets principally ranging from three to seven years. Leasehold improvements are amortized using the straight-line method over the lesser of the lease term or its estimated economic useful life. Lease terms used are based upon the initial lease agreement and do not consider potential renewals or extensions until such time that the renewals or extensions are contracted.
Software and Web Site Development
The Company accounts for internal use software development in accordance with the provisions of the American Institute of Certified Public Accountants Statement of Position (“SOP”) 98-1,Accounting for the Costs of Computer Software Developed or Obtained for Internal Use and Emerging Issues Task Force (“EITF”) 00-2,Accounting for Web site Development Costs.
For the years ended December 31, 2005, 2004 and 2003, the Company expensed approximately $2.7 million, $3.8 million and $2.3 million, respectively, of product development costs that were incurred in the preliminary project stage under SOP 98-1. For the years ended December 31, 2005 and 2004, the Company capitalized approximately $5.0 million and $3.2 million, respectively, in product and web site development costs under SOP 98-1 and EITF 00-2. For the years ended December 31, 2005, 2004 and 2003, the Company recorded related amortization expense of approximately $3.1 million, $2.8 million and $2.4 million, respectively. As of December 31, 2005 and 2004, the net book value of these capitalized product and web site development costs were $7.2 million and $5.3 million, respectively. These capitalized costs are amortized using the straight-line method over the estimated useful life of the assets ranging from 12 to 60 months.
Goodwill, Capitalized Course Costs, Capitalized K-12 Content and Other Intangible Assets.
Goodwill represents the excess purchase price of acquired businesses over the estimated fair value of net assets acquired.
Territorial marketing rights represent rights contributed by our independent franchisees to our former subsidiary, Princeton Review Publishing, L.L.C., in 1995 in exchange for membership units of Princeton Review Publishing, L.L.C. to allow the marketing of the Company’s products on a contractually agreed-upon basis within the franchisee territories. Without these rights, the Company would be prohibited from selling its products in these territories due to the exclusivity granted to the franchisees within their territories. Should a franchisee decide not to renew its franchise agreement, which is unlikely unless there is a sale of the franchise back to the Company, these rights would remain with the Company. Since no legal, regulatory, contractual, competitive, or other factors limit the useful life of territorial marketing rights, the Company has deemed these intangible assets to have indefinite lives. Goodwill and territorial marketing rights were amortized on a straight-line basis until December 31, 2001, after which such amortization ceased upon the adoption of Statement of Financial Accounting Standards (“SFAS”) 142. Accordingly, the Company’s goodwill and territorial marketing rights that are deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests.
Capitalized course costs include certain expenditures incurred by our Test Preparation Services division to develop test preparation courses and consist primarily of amounts paid to consultants and
47
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
salaries of employees hired to develop course materials and curriculum. Course costs are capitalized only when a course is first developed or there is a major revision to a course or significant re-write of the course materials or curriculum, for example, when the related test changes. The amortization period for these costs is five years, based upon the average life cycle of the related standardized tests. Amortization of these capitalized course costs commences with the realization of course revenues. The cost of minor enhancements or annual updates to the curriculum and materials is expensed as incurred.
Capitalized K-12 content includes certain expenditures incurred by our K-12 Services division to produce questions and lessons primarily for math, reading and language arts subjects typically taught in grades one through 11 and consist primarily of amounts paid to consultants and salaries of employees hired to produce these questions or lessons. These questions or lessons are used in numerous products sold by the K-12 Services division, including the Homeroom subscription service, printed materials and live instruction products. Only expenditures for questions or lessons that allow the Company to enter into new markets, such as new geographic areas or grades, or that significantly enhance the marketability of the Company’s products, such as a new subject area, are capitalized. The amortization period for these costs is seven years, based on numerous factors, including the average lives of similar products and the cycle of major changes in educational philosophies and methodologies as reflected by the adoption cycles of state tests and textbooks. Amortization of these capitalized K-12 content costs commences when the questions or lessons are available for use. The cost of planning, marketing and maintenance related to this content is expensed as incurred, as is the cost of design and feasibility work.
Publishing rights primarily consist of amounts paid in 1995 to certain co-authors to purchase their rights to future royalties on certain books, includingCracking the SAT/PSAT, Cracking the LSAT, Cracking the GRE, Cracking the GMAT, The Best 361 Colleges andWord Smart. These books are primarily current reference materials that are updated every one or two years. In 2005, the Company collected approximately $1.0 million in royalties from the publisher of these books. Publishing rights are being amortized on a straight-line basis over 25 years.
Franchise costs represent the cost of franchise rights purchased by the Company from third parties and are amortized using the straight-line method over the remaining useful life of the applicable franchise agreement.
Customer lists were purchased by the Company from Embark.com, Inc. (“Embark”) in 2001 and consist primarily of academic institution customers of the Company’s Admissions Service division. At the time of the acquisition, an independent party completed a valuation of the customer list using a discounted cash flow analysis and assumed an eight percent annual loss of customer revenues. Customer lists are amortized on a straight-line basis over 10 years.
Other intangible assets are amortized on a straight-line basis over their useful lives: three to 20 years for trademarks/tradenames and for non-compete agreements.
See Note 5 for further information with respect to the Company’s goodwill and other intangible assets.
Impairment
Goodwill and Territorial Marketing Rights
As noted above, the Company adopted SFAS 142, “Goodwill and Other Intangible Assets,” under which goodwill and territorial marketing rights are no longer amortized but instead goodwill and territorial marketing rights are assessed for impairment annually. In making this assessment, management relies on a number of factors including operating results, business plans, economic projections, anticipated future cash flows, and transactions and market place data. Goodwill is assigned to specific reporting units and is reviewed for possible impairment at least annually or more frequently upon the occurrence of an event or when circumstances indicate that a reporting unit’s carrying amount
48
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
is greater than its fair value. During the fourth quarter of 2005, the Company completed its annual assessment for impairment and determined that there was no such impairment against the current carrying amount. During 2004, the carrying amount of goodwill for one of its reporting units exceeded its fair value. As a result of the second step analysis, a goodwill impairment of approximately $8.2 million was recognized.
Long-Lived Assets
The Company reviews its long-lived assets, which excludes goodwill and territorial marketing rights, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If such review indicates that an asset may not be recoverable, an impairment loss is recognized for the excess of the carrying amount over the fair value of an asset to be held and used or over the fair value less cost to sell an asset to be disposed. During 2005 and 2004, no impairment charge was required.
Investments in Affiliates
The Company values its investments in affiliate companies in which it has a less than 50% ownership interest and can exercise significant influence using the equity method of accounting. Investments in affiliate companies in which the Company has a less than 20% ownership interest and does not have the ability to exercise significant influence are accounted for using the cost method of accounting. The Company has evaluated its investment under FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” and concluded that consolidation is not required.
Deferred Income
Deferred income represents tuition and customer deposits (which are refundable prior to the commencement of the program), college marketing fees and subscription services, professional development fees and fees for printed materials. Tuition is applied to income ratably over the periods in which it is earned, generally the term of the program. College marketing fees and subscription fees are applied to income ratably over the life of the agreements, which typically range from one to two years. Fees for professional development and printed materials are recognized as the services and products are delivered.
Revenue Recognition
The Company recognizes revenue from the sale of products and services as follows:
Course and Tutoring Income
Tuition and tutoring fees are paid to the Company and recognized over the life of the course.
Book, Software and Publication Income and Expenses
The Company recognizes revenue from both performance-based fees such as marketing fees and royalties and delivery-based fees such as advances, copy editing fees, workbook development and test booklet fees and books sold directly to schools. Performance-based fees, which represent royalties on books and software sold, are recognized when sales reports are received from the publishers. Delivery-based fees are recognized upon the completion and acceptance of the product by the publishers and/or customers. Until such time, all costs and revenues related to such delivery-based fees are deferred. Book advances are recorded as liabilities and deferred book expenses are included in other current assets.
49
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
Royalty Service Fees
As consideration of the rights and entitlements granted under franchise agreements, which entitle the franchisees to provide test preparation services utilizing the Princeton Review method in their licensed territories, the franchisees are required to pay to the Company a monthly royalty service fee equal to 8% (9.5% beginning in 2006) of the franchise’s gross receipts collected during the preceding month. In addition, these fees include a 10% fee charged to the Company’s franchisees for use by their students of the Company’s supplemental online course tools. The Company’s franchisees’ contributions to the advertising fund are also recognized by the Company as royalty revenue (see Note 8). Under the terms of the franchise agreements, the Company has the right to perform audits of royalty service fees reported by the franchisees. Any differences resulting from an audit, including related interest and penalties, if any, are recorded upon the completion of the audit when such amounts are determinable.
Course Materials and Other Products
The Company recognizes revenue from the sale of course materials and other products to the independently owned franchises upon shipment.
Lead Generation Fees
The Company recognizes revenue from lead generation fees as the service is delivered to these institutions.
College Marketing and Subscription Fees
The Company recognizes revenue from subscription fees for web-based services over the life of the contract, which is typically one to two years.
Transaction Processing Fees
The Company recognizes revenue from transaction processing fees, such as web-based school application fees, as the transactions are completed.
Multiple-deliverable contracts
Certain of the Company’s customer contracts represent multiple-element arrangements, which may include several of the Company’s products and services. Multiple-element arrangements are assessed to determine whether they can be separated into more than one unit of accounting. A multiple-element arrangement is separated into more than one unit of accounting if all of the criteria in EITF Issue 00-21,“Revenue Arrangements with Multiple Deliverables” are met. If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit’s relative fair value and the revenue policies described above are then applied to each unit of accounting.
Other Revenue
Other revenue consists of miscellaneous fees for other services provided to third parties primarily for assessment tests, authoring questions, advertising, training and professional development fees, which are recognized as the products or services are delivered. Other revenue also includes college marketing fees, such as newsletter or banner ads, which are recognized ratably over the period in which the marketing services are provided, which is typically one year.
50
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
Revenue Components
The following table summarizes the Company’s revenue and cost of revenue for the years ended December 31, 2005, 2004 and 2003:
| | | | Years Ended December 31,
|
|
|---|
| | | | 2005
| | 2004
| | 2003
|
|---|
| | | | (in thousands)
| |
|---|
Revenue
| | | | | | | | | | | | | | |
| Services | | | | $ | 104,283 | | | $ | 92,718 | | | $ | 85,602 | |
| Products | | | | | 18,214 | | | | 14,066 | | | | 11,045 | |
| Other | | | | | 7,996 | | | | 7,001 | | | | 7,815 | |
| Total Revenue | | | | $ | 130,493 | | | $ | 113,785 | | | $ | 104,462 | |
Cost of Revenue
| | | | | | | | | | | | | | |
| Services | | | | $ | 40,354 | | | $ | 33,099 | | | $ | 25,286 | |
| Products | | | | | 8,719 | | | | 6,891 | | | | 6,159 | |
| Other | | | | | 524 | | | | 663 | | | | 528 | |
| Total Cost of Revenue | | | | $ | 49,597 | | | $ | 40,653 | | | $ | 31,973 | |
Foreign Currency Translation
Balance sheet accounts of the Company’s Canadian subsidiary, with the exception of certain historical rate-based assets, are translated using year-end exchange rates. Statement of operations accounts, with the exception of depreciation and amortization, are translated at monthly average exchange rates. The resulting translation adjustment is recorded as a separate component of stockholders’ equity. Foreign exchange gains and losses for all the years presented were not significant. The accumulated balance as a component of comprehensive income, comprised entirely of foreign exchange differences, was approximately $262,000 and $221,000 at December 31, 2005 and 2004, respectively.
Advertising and Promotion
Advertising and promotion costs are expensed in the year incurred. Costs related to producing mailers and other pamphlets are expensed when mailed. Due to the seasonal nature of the business, most advertising costs related to mailers and pamphlets are expensed by the end of the year. Total advertising and promotion expense was approximately $6.8 million, $6.4 million, and $7.6 million for the years ended December 31, 2005, 2004 and 2003, respectively.
Fair Value of Financial Instruments
For financial instruments including cash and cash equivalents, accounts receivable, other receivables and accounts payable, the carrying amount approximated fair value because of their short maturity. The carrying value of the Company’s debt approximated fair value as the interest rates for the debt approximated market rates of interest available to the Company for similar instruments.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentration of credit risk include cash and cash equivalents and accounts receivable arising from its normal business activities. The Company places its cash and cash equivalents with high credit quality financial institutions.
Concentrations of credit risks with respect to accounts receivable are limited due to the large number of entities comprising the payor base, and their dispersion across different states. The Company
51
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
does not require collateral. At December 31, 2004, two customers accounted for approximately 18% and 10% of gross accounts receivable.
Income Taxes
The Company accounts for income taxes based upon the provisions of SFAS No. 109,Accounting for Income Taxes. Under SFAS 109, the liability method is used for accounting for income taxes, and deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities. A valuation allowance is recorded when it is more likely than not that some or all of the deferred tax assets will not be realized.
Income (Loss) Per Share
Basic and diluted net income (loss) per share information for all periods is presented under the requirements of SFAS No. 128,Earnings per Share. Basic net income (loss) per share is computed by dividing net income (loss) applicable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is determined in the same manner as basic net income (loss) per share, except that the number of shares is increased assuming exercise of dilutive stock options, warrants and convertible securities. The calculation of diluted net income (loss) per share excludes potential common shares if the effect is antidilutive.
During certain of the periods presented, stock options and securities convertible into or exercisable for common stock were outstanding that would be dilutive but were excluded because to include them would have been antidilutive (see Note 15).
Stock options
The Company accounts for the issuance of stock options using the intrinsic value method in accordance with Accounting Principles Board (“APB”) No. 25,Accounting for Stock Issued to Employees, and related interpretations. Generally for the Company’s stock option plans, no compensation cost is recognized in the Consolidated Statements of Operations because the exercise price of the Company’s stock options equals the market price of the underlying stock on the date of grant. Had the Company accounted for its employee stock options under the fair-value method of that statement, the Company’s net income per share would have been decreased and net loss per share would have been increased to the pro forma amounts indicated:
| | | | Year Ended December 31,
| |
|---|
| | | | 2005
| | 2004
| | 2003
|
|---|
| | | | (in thousands, except per share amounts)
| |
|---|
Net income (loss) attributed to common stockholders,
as reported | | | | $ | (4,328 | ) | | $ | (30,841 | ) | | $ | 4,309 | |
| Total stock-based employee compensation expense determined under fair-value based method for all awards, net of related tax effects | | | | | (3,467 | ) | | | (1,178 | ) | | | (1,326 | ) |
| Pro forma net income (loss) attributed to common stockholders | | | | $ | (7,795 | ) | | $ | (32,019 | ) | | $ | 2,983 | |
Basic and diluted income (loss) per share:
| | | | | | | | | | | | | | |
| As reported | | | | $ | (0.16 | ) | | $ | (1.12 | ) | | $ | 0.16 | |
| Pro forma | | | | $ | (0.28 | ) | | $ | (1.17 | ) | | $ | 0.11 | |
52
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
After the Company’s initial public offering, these options were valued using a Black-Scholes option pricing model. The following weighted-average assumptions were used under this method:
| | | | Year Ended December 31,
| |
|---|
Assumptions
| | | | 2005
| | 2004
| | 2003
|
|---|
| Expected life (years) | | | | | 5.0 | | | | 5.0 | | | | 4.8 | |
| Risk-free interest rate | | | | | 4.25 | % | | | 4.25 | % | | | 4.50 | % |
| Dividend yield | | | | | 0 | % | | | 0 | % | | | 0 | % |
| Volatility factor | | | | | 41 | % | | | 66 | % | | | 76 | % |
This option-valuation method requires input of highly subjective assumptions. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because change in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing methods do not necessarily provide a reliable single measure of the fair value of its employee stock options. The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts and additional awards in future years are anticipated. For purposes of pro forma disclosure, the estimated fair value of the equity awards is amortized to expense, on a straight-line basis, over the options’ vesting period. The weighted average fair value of options granted during the years ended December 31, 2005, 2004 and 2003 was $5.77, $4.42, and $2.75, respectively. As of December 31, 2005, there were approximately 2,461,000 options exercisable with a weighted average remaining contractual life of approximately 6.4 years.
As of December 23, 2005, the Compensation Committee of the Board of Directors of the Company approved the acceleration of vesting of unvested stock options granted to employees of the Company outstanding as of December 31, 2005 that have an exercise price at or greater than $7.00 and which are scheduled to vest in the 24-month period following December 31, 2005. Options held by the Company’s Chief Executive Officer, Chief Operating Officer, Chief Financial Officer and the Board of Directors are excluded from the vesting acceleration. There are approximately 360,000 options to purchase the Company’s common stock that were accelerated. Options accelerated on behalf of the Company’s Executive Officers are as follows:
Officer
| | | | Title
| | Number of
Accelerated
Options
| | Weighted
Average
Exercise Price
Per Share
|
|---|
| Margot Lebenberg | | | | Executive Vice President, Secretary and General Counsel | | | 27,500 | | | $ | 7.56 | |
| Stephen Quattrociocchi | | | | Executive Vice President | | | 23,019 | | | $ | 7.35 | |
| Young J. Shin | | | | Executive Vice President | | | 10,000 | | | $ | 7.30 | |
The decision to accelerate vesting of these “out-of-the-money” stock options was made primarily to minimize future compensation expense that the Company would otherwise have been required to recognize in its consolidated statements of operations pursuant to Financial Accounting Standards Board Statement No. 123(R) (revised 2004), “Share-Based Payment,” which becomes effective as to the Company beginning in the first fiscal quarter of 2006. The Company believes that the aggregate future expense that will not be included in future consolidated statements of operations as a result of this acceleration of vesting is approximately $1.6 million.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), “Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R) establishes standards for accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS 123(R)
53
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS 123(R) requires that the fair value of such equity instruments be recognized as expense in the financial statements as services are performed. Prior to SFAS 123(R), only the pro forma disclosures of fair value were required. In March 2005, the SEC issued Staff Accounting Bulletin No. 107, “TOPIC 14: Share-Based Payment” which addresses the interaction between SFAS 123(R) and certain SEC rules and regulations and provides views regarding the valuation of share-based payment arrangements for public companies. SFAS 123(R) is effective for our first quarter of 2006 and the adoption of this new accounting pronouncement is expected to result in pre-tax stock-based compensation expense of between $0.3 million and $0.5 million in 2006.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets — An Amendment of APB Opinion No. 29” (“SFAS 153”). This new standard is the result of a broader effort by the FASB to improve financial reporting by eliminating differences between generally accepted accounting principles (“GAAP”) in the U.S. and GAAP developed by the International Accounting Standards Board (“IASB”). As part of this effort, the FASB and the IASB identified opportunities to improve financial reporting by eliminating certain narrow differences between their existing accounting standards. SFAS 153 amends Accounting Principles Board Opinion No. 29, “Accounting for Nonmonetary Transactions” (“APB 29”), that was issued in 1973. The amendments made by SFAS 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have “commercial substance.” Previously, APB 29 required that the accounting for an exchange of a productive asset for a similar productive asset, or an equivalent interest in the same or similar productive asset, should be based on the recorded amount of the asset relinquished. The provisions of SFAS 153 were effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005, and there was no impact on the Company’s consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections — a Replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”). SFAS 154 requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also redefines “restatement” as the revising of previously issued financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and are not expected to have a significant impact on the Company’s consolidated financial statements.
54
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
Other assets (current) consists of the following:
| | | | December 31,
| |
|---|
| | | | 2005
| | 2004
|
|---|
| | | | (in thousands)
| |
|---|
| Deferred book costs | | | | $ | 297 | | | $ | 782 | |
| Deferred financing expenses | | | | | — | | | | 117 | |
| Loans to officers, current portion | | | | | 168 | | | | 190 | |
| Loan receivable | | | | | 781 | | | | 250 | |
| Other | | | | | 61 | | | | 208 | |
| | | | | $ | 1,307 | | | $ | 1,547 | |
Other assets (non-current) consists of the following:
| | | | December 31,
| |
|---|
| | | | 2005
| | 2004
|
|---|
| | | | (in thousands)
| |
|---|
| Security deposits | | | | $ | 655 | | | $ | 701 | |
| Content and software development in progress | | | | | 910 | | | | 1,493 | |
| Loans to officers | | | | | 457 | | | | 1,062 | |
| Loan receivable | | | | | 1,146 | | | | 350 | |
| Other | | | | | — | | | | 8 | |
| | | | | $ | 3,168 | | | $ | 3,614 | |
3. | | Furniture, Fixtures, Equipment and Software Development |
| | | | December 31,
| |
|---|
| | | | 2005
| | 2004
|
|---|
| | | | (in thousands)
| |
|---|
| Computer equipment | | | | $ | 7,019 | | | $ | 5,829 | |
| Furniture, fixtures and equipment | | | | | 2,054 | | | | 1,662 | |
| Computer and phone equipment under capital lease | | | | | 3,258 | | | | 2,902 | |
| Automobiles | | | | | — | | | | 22 | |
| Software and web site development — third party | | | | | 4,648 | | | | 2,540 | |
| Software and web site development — internally developed | | | | | 10,374 | | | | 8,128 | |
| Leasehold improvements | | | | | 6,732 | | | | 5,482 | |
| | | | | | 34,085 | | | | 26,565 | |
| Less accumulated depreciation and amortization, including $1,719 in 2005 and $1,182 in 2004 of accumulated depreciation for assets under capital leases | | | | | 17,930 | | | | 13,185 | |
| | | | | $ | 16,155 | | | $ | 13,380 | |
4. | | Investment in Affiliates |
On June 25, 2004, the Company invested $625,000 and issued 63,562 shares of the Company’s common stock, with an approximate value of $500,000 at the time of issuance, and incurred approximately $162,000 of acquisition costs for an approximate 25% equity interest in Oasis Children’s Services, LLC (“Oasis”), a privately held company. Under the agreement, the Company guaranteed a minimum market value of the shares issued. Oasis sold all of the shares in the open market in December,
55
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
2005. The proceeds from the sale of the shares fell short of the guaranteed amount, requiring the Company to pay an additional $117,000 in cash.
Oasis works with schools, school systems and communities to operate summer and after-school programs. In conjunction with the investment, Oasis and the Company have agreed to, from time to time, jointly develop, market and sell summer programs for the K-12 market that combine recreational and enrichment programs and activities provided by Oasis with educational programs and activities provided by the Company. The Company accounts for its investment in Oasis using the equity method. This investment is carried as a corporate asset.
The Company has an ownership interest of approximately 20% in Student Monitor, LLC, a privately held company. At December 31, 2005 and 2004, as a result of recording its shares of losses, the Company’s investment in this company was recorded as $0.
At December 31, 2005 and 2004, the Company’s net investment in Tutor.com was recorded as $0, as a result of recording its share of Tutor.com losses. Pursuant to an agreement entered into on December 31, 2003, the Company terminated its strategic relationship with Tutor.com and sold preferred stock it held in Tutor.com for $300,000 in cash. As consideration for the termination of certain strategic agreements and the restructuring of certain rights, the Company received an additional $200,000 in cash and $500,000 in notes. The Company retains a common stock position in Tutor.com, representing approximately 2.5% of its outstanding equity, which was recorded as $0 as of December 31, 2005.
During 2001 and 2002, the Company invested $700,000 in SchoolNet, Inc.(“SchoolNet”), a privately held education technology solutions company. The Company currently owns approximately 5% of SchoolNet. The Company maintains a strategic marketing relationship with SchoolNet, through which SchoolNet markets and distributes a version of the Company’s Homeroom product called “Homeroom Inside.” As of December 31, 2005 and 2004, the value of the Company’s investment in SchoolNet was approximately $356,000, net of an impairment writedown of approximately $344,000 in 2002. This investment is carried in the K-12 Services Segment. The Company has also contracted with SchoolNet to provide Enterprise Resource Planning software that monitors the use of the Homeroom.com Web site.
5. | | Goodwill and Other Intangible Assets |
The following table summarizes the components of goodwill which is no longer subject to amortization:
| | | | December 31,
| |
|---|
| | | | 2005
| | 2004
|
|---|
| | | | (in thousands)
| |
|---|
| Gross carrying amount | | | | $ | 33,065 | | | $ | 33,070 | |
| Less accumulated amortization | | | | | 1,559 | | | | 1,559 | |
| | | | | $ | 31,506 | | | $ | 31,511 | |
56
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
The following table summarizes the change in the carrying amount of segment goodwill for the periods indicated:
| | | | Test
Preparation
Services
| | K-12
Services
| | Admissions
Services
| | Total
|
|---|
| | | | (in thousands)
| |
|---|
| Balance as of January 1, 2004 | | | | $ | 30,881 | | | | — | | | $ | 8,699 | | | $ | 39,580 | |
| Net change from acquisitions | | | | | 130 | | | | — | | | | — | | | | 130 | |
| Impairments | | | | | — | | | | — | | | | (8,199 | ) | | | (8,199 | ) |
| Balance as of December 31, 2004 | | | | | 31,011 | | | | — | | | | 500 | | | | 31,511 | |
| Other | | | | | (5 | ) | | | | | | | | | | | (5 | ) |
| Balance as of December 31, 2005 | | | | $ | 31,006 | | | | — | | | $ | 500 | | | $ | 31,506 | |
As a result of the Company’s annual evaluation of the impairment of intangible assets, the Company recorded an $8.2 million charge for the impairment of goodwill related to the 2001 acquisition of Embark. This impairment resulted from the Admission Services division’s operating results in 2004, and while this division continues to operate and expects to generate future cash flows from the sale of its new marketing services, these future cash flows are still uncertain.
The following is a summary of other intangible assets:
| | | | December 31, 2005
| | December 31, 2004
|
|---|
| | | | (in thousands)
|
|---|
Subject to Amortization
| | | | Gross
Carrying
Amount
| | Accumulated
Amortization
| | Net
| | Gross
Carrying
Amount
| | Accumulated
Amortization
| | Net
|
|---|
| Franchise costs | | | | $ | 283 | | | $ | 239 | | | $ | 44 | | | $ | 283 | | | $ | 212 | | | $ | 71 | |
| Publishing rights | | | | | 1,761 | | | | 757 | | | | 1,004 | | | | 1,761 | | | | 684 | | | | 1,077 | |
| Capitalized K-12 content | | | | | 12,867 | | | | 4,617 | | | | 8,250 | | | | 7,732 | | | | 3,180 | | | | 4,552 | |
| Trademark / tradename | | | | | 338 | | | | 254 | | | | 84 | | | | 338 | | | | 193 | | | | 145 | |
| Non-compete agreements | | | | | 1,244 | | | | 1,198 | | | | 46 | | | | 1,244 | | | | 1,067 | | | | 177 | |
| Customer lists | | | | | 2,700 | | | | 1,147 | | | | 1,553 | | | | 2,700 | | | | 878 | | | | 1,822 | |
| Capitalized course costs | | | | | 1,610 | | | | 701 | | | | 909 | | | | 1,151 | | | | 444 | | | | 707 | |
| | | | | $ | 20,803 | | | $ | 8,913 | | | | 11,890 | | | $ | 15,209 | | | $ | 6,658 | | | | 8,551 | |
Not Subject to Amortization
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Territorial marketing rights | | | | | | | | | | | | | 1,481 | | | | | | | | | | | | 1,481 | |
| | | | | | | | | | | | | $ | 13,371 | | | | | | | | | | | $ | 10,032 | |
| | | | (in thousands)
|
|---|
Aggregate amortization expense:
| | | | | | |
Actual:
| | | | | | |
| 2003 | | | | | 1,625 | |
| 2004 | | | | | 2,152 | |
| 2005 | | | | | 2,255 | |
Estimate for fiscal year:
| | | | | | |
| 2006 | | | | | 3,191 | |
| 2007 | | | | | 3,097 | |
| 2008 | | | | | 2,997 | |
| 2009 | | | | | 1,389 | |
| 2010 | | | | | 342 | |
57
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
6. | | Line of Credit and Long-Term Debt |
Line of Credit
On May 21, 2004, the Company entered into a credit agreement with Commerce Bank, N.A. for a three-year revolving credit facility with a maximum aggregate principal amount of $5.0 million. As of December 31, 2004, the effective interest rate was 3.9% and $2.0 million was outstanding. In February 2005, the Company repaid the entire outstanding balance and terminated the facility. The outstanding balance at the time of payment was $2.0 million. Additionally, the Company wrote off unamortized deferred financing costs of approximately $0.1 million.
Notes Payable
On March 2, 2001, the Company completed its acquisition of Princeton Review of New Jersey, Inc. and Princeton Review of Boston, Inc. The Company financed part of this acquisition with notes to the sellers totaling $3,625,000. This balance was comprised of two notes. The first promissory note of $3,125,000 is payable as to principal in 20 equal quarterly installments beginning with the 17th calendar quarter following the closing date of the acquisition and bears interest at the rate of 8.25% per year, payable quarterly. The second promissory note for $500,000 bears interest at the rate of 8.25% per year, payable on a quarterly basis, and is payable as to the entire principal amount four years from its date of issuance. At December 31, 2005 and 2004, $2,500,000 and $3,625,000 was outstanding, respectively.
On July 11, 2003, the Company acquired 77% of Princeton Review of North Carolina, Inc with the balance acquired from the minority shareholders on November 13, 2003. The Company financed part of this acquisition with two notes to the sellers in the amount of $609,000 and $740,000, including imputed interest at 5% per year, which were outstanding as of December 31, 2005 and 2004. The notes are payable in annual installments, including interest, of approximately $121,000 per year in years 2006 through 2010 when the loans are due.
The annual maturities of notes payable as of December 31, 2005 are approximately as follows:
As of December 31,
| | | | Amount
Maturing
|
|---|
| | | | (in thousands)
|
|---|
| 2006 | | | | $ | 744 | |
| 2007 | | | | | 750 | |
| 2008 | | | | | 758 | |
| 2009 | | | | | 765 | |
| 2010 | | | | | 144 | |
| | | | | $ | 3,161 | |
Capital Lease Obligations
At December 31, 2005, the Company has leased approximately $3.3 million of computer and phone equipment under capital leases, all of which are included in fixed assets
58
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
The following is a schedule of the future minimum capital lease obligation payments together with the present value of the minimum lease payments at December 31, 2005:
Year ending December 31,
| | | | (in thousands)
|
|---|
| 2006 | | | | $ | 855 | |
| 2007 | | | | | 390 | |
| 2008 | | | | | 55 | |
| Total | | | | | 1,300 | |
| Less: amounts representing interest (effective interest rate ranges from 6% to 11%) | | | | | (86 | ) |
| Present value of minimum lease payments | | | | | 1,214 | |
| Less: current portion of capital lease obligations | | | | | 786 | |
| Long-term portion of capital lease obligations | | | | $ | 428 | |
Total Long-Term Debt
Long-term debt consists of the following:
| | | | December 31,
| |
|---|
| | | | 2005
| | 2004
|
|---|
| | | | (in thousands)
| |
|---|
| Notes payable | | | | $ | 3,161 | | | $ | 6,365 | |
| Capital lease obligations | | | | | 1,214 | | | | 1,616 | |
| Auto loan | | | | | — | | | | 1 | |
| | | | | | 4,375 | | | | 7,982 | |
| Less current portion | | | | | 1,530 | | | | 3,769 | |
| | | | | $ | 2,845 | | | $ | 4,213 | |
7. | | Series B-1 Preferred Stock |
On June 4, 2004, the Company sold 10,000 shares of its Series B-1 Preferred Stock to Fletcher International, Ltd. (“Fletcher”) for proceeds of $10,000,000. These shares are convertible into common stock at any time. Prior to conversion, each share accrues dividends at an annual rate of the greater of 5% and the 90-day London Interbank Offered Rate (LIBOR) plus 1.5% (4.4% at December 31, 2005), subject to adjustment. Dividends are payable, at the Company’s option, in cash or registered shares of common stock. At the time of issuance of the Series B-1 Preferred Stock to Fletcher, each share of Series B-1 Preferred Stock was convertible into a number of shares of common stock equal to: (1) the stated value of one share of Series B-1 Preferred Stock plus accrued and unpaid dividends, divided by (2) the conversion price of $11.00, subject to adjustment. In accordance with the terms of the agreement with Fletcher, the conversion price was decreased to $9.9275 per share because effectiveness of the registration statement relating to the Fletcher shares was delayed until December 28, 2004.
Fletcher may redeem its shares of the Series B-1 Preferred Stock, in lieu of converting such shares, at any time on or after November 28, 2005, for shares of common stock unless the Company satisfies the conditions for cash redemption. If Fletcher elects to redeem its shares and the Company does not elect to make such redemption in cash, then each share of Series B-1 Preferred Stock will be redeemed for a number of shares of common stock equal to: (1) the stated value of $1,000 per share of Series B-1 Preferred Stock plus accrued and unpaid dividends, divided by (2) 102.5% of the prevailing price of common stock at the time of delivery of a redemption notice (based on an average daily trading price formula). If Fletcher elects to redeem its shares and the Company elects to make such redemption in cash, then Fletcher will receive funds equal to the product of: (1) the number of shares of common stock
59
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
that would have been issuable if Fletcher redeemed its shares of Series B-1 Preferred Stock for shares of common stock; and (2) the closing price of the common stock on the NASDAQ National Market on the date notice of redemption was delivered. As of June 4, 2014 the Company may redeem any shares of Series B-1 Preferred Stock then outstanding. If the Company elects to redeem such outstanding shares, Fletcher will receive funds equal to the product of: (1) the number of shares of Series B-1 Preferred Stock so redeemed, and (2) the stated value of $1,000 per share of Series B-1 Preferred Stock, plus accrued and unpaid dividends.
In addition, the Company granted Fletcher certain rights entitling Fletcher to purchase up to 20,000 shares of additional preferred stock, at a price of $1,000 per share, for an aggregate additional consideration of $20,000,000. The agreement with Fletcher provides that any shares of additional preferred stock will have the same conversion ratio as the Series B-1 Preferred Stock, except that the conversion price will be the greater of (1) $11.00, or (2) 120% of the prevailing price of common stock at the time of exercise of the rights (based on an average daily trading price formula), subject to adjustment upon the occurrence of certain events. Due to the delay in the effectiveness of the registration statement relating to the Series B-1 Preferred Stock, the conversion price for any such additional series of preferred stock was reduced to the greater of (1) $9.9275, or (2) 108.3% of the prevailing price of common stock at the time of exercise of the rights. These rights may be exercised by Fletcher on one or more occasions commencing July 1, 2005, and for the 24-month period thereafter, which period may be extended under certain circumstances. The Agreement with Fletcher also provides that shares of additional preferred stock will also be redeemable upon terms substantially similar to those of the Series B-1 Preferred Stock.
During 2005 and 2004, cash dividends in the amount of $534,200 and $373,600, respectively were paid to the Series B-1 Preferred stockholder.
8. | | Commitments and Contingencies |
Advertising Fund
All domestic franchisees are required to pay a monthly advertising fee to the Company, for contribution to an advertising fund, equal to 2% of their franchises’ gross receipts, as defined, for the preceding month. In accordance with the terms of the franchise agreements, the Company is required to use all advertising fees it receives for the development, placement and distribution of regional and national consumer advertising, designed at its discretion to promote consumer demand for services and products available from the franchises.
The Company is required to keep separate advertising fund accounting records and to maintain the advertising funds collected from the franchisees in a separate bank account. Franchisee payments to the Company for the advertising fund are recorded in the Company’s revenue and advertising expenses of the advertising fund are recorded in the Company’s selling, general and administrative expenses.
60
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
Office and Classroom Leases
The Company has entered into various operating leases in excess of one year, primarily office and classroom site locations. Minimum rental commitments under these leases, including fixed escalation clauses, which are in excess of one year, as of December 31, 2005, are approximately as follows:
Years Ending December 31,
| | | | (in thousands)
|
|---|
| 2006 | | | | $ | 5,137 | |
| 2007 | | | | | 4,861 | |
| 2008 | | | | | 4,364 | |
| 2009 | | | | | 3,655 | |
| 2010 | | | | | 3,066 | |
| Thereafter | | | | | 7,418 | |
| | | | | $ | 28,501 | |
Rent expense for the years ended December 31, 2005, 2004 and 2003 was approximately $9.5 million, $8.6 million, and $7.7 million, respectively. These amounts include rent expense for the rental of space on a month-to-month basis, as well as those amounts incurred under operating leases for longer periods. Certain leases provide for early termination without penalty.
Legal Matters
On September 10, 2003, CollegeNet, Inc. filed suit in Federal District Court in Oregon, alleging that the Company infringed a patent owned by CollegeNet related to the processing of on-line applications. CollegeNet never served the Company and no discovery was ever conducted. However, based on adverse rulings in other lawsuits concerning the same patent, CollegeNet dismissed the 2003 case without prejudice on January 9, 2004 against the Company. Thereafter, on August 2, 2005, the Federal Circuit Court of Appeals issued an opinion favorable to CollegeNet from its appeal from the adverse rulings. Then on August 3, 2005, CollegeNet filed suit again against the Company alleging an infringement of the same CollegeNet patent related to processing on-line applications. The Company was served on November 22, 2005 and filed its answer and counterclaim on January 13, 2006. CollegeNet seeks injunctive relief and unspecified monetary damages. Because this proceeding is at a very preliminary stage, we are unable to predict its outcome with any degree of certainty. However, the Company believes that it has meritorious defenses to CollegeNet’s claims of infringement and intends to vigorously defend. In a related matter, the Company filed a request with the United Stated Patent and Trademark Office (“PTO”) for ex parte reexaminations of the CollegeNet No. 6,460,042 (‘042) patent on September 1, 2005 and the CollegeNet No. 6,910,045 (‘045) patent on December 12, 2005. The PTO granted the Company’s request and ordered reexamination of all claims of the CollegeNet ‘042 patent on October 31, 2005 and the CollegeNet ‘045 patent on January 27, 2006.
On August 29, 2005, Test Services, Inc. (“TSI”), a franchisee of the Company under ten separate franchise agreements, six of which expired on December 31, 2005, filed suit against the Company in the United States District Court for the District of Colorado. TSI alleged that the terms the Company offered for renewal of the franchise relationship did not comply with TSI’s contractual renewal rights. TSI sought declaratory relief and specific performance and unspecified damages as to the alleged breaches of the renewal provisions. TSI’s complaint also included claims that the Company had breached the existing franchise agreements with TSI in ways unrelated to the core renewal dispute. On November 29, 2005, the court granted the Company’s motion to dismiss all of TSI’s claims relating to the core renewal dispute. On December 31, 2005, the Company entered into a settlement in which: (1) TSI agreed to execute a new franchise agreement for each of its ten franchise territories with certain negotiated changes; (2) TSI paid the Company $1 million in cash; (3) the Company, TSI and TSI’s parent company agreed on certain terms regarding competitive activities by the parent company, a potential spin-off of TSI, and a Company option
61
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
to acquire TSI at a formula value in certain circumstances; TSI agreed to increase royalty payments to the Company from 8% to 9-1/2% (beginning January 1, 2006); and (4) all litigation was dismissed with prejudice and the parties exchanged releases as to all matters except amounts payable in the ordinary course of business under the superseded franchise agreements.
In addition to the foregoing, from time to time, the Company is involved in legal proceedings incidental to the conduct of the Company’s business, none of which is likely to have a material adverse effect on the Company.
Co-authorship Agreements
In connection with its publishing agreements, the Company has entered into various co-authorship agreements for the preparation of manuscripts. These agreements require payment of nonrecourse advances for services rendered at various established milestones. The Company did not have any future contractual commitments under the co-authorship agreements for manuscripts not yet delivered for the years ended December 31, 2005 and 2004, however there were approximately $30,000 in commitments as of December 31, 2003. In addition, the co-authors are entitled to a percentage of the future royalties earned by the Company, which are first to be offset against such advances. The total costs incurred under these co-authorship agreements by the Company for advances and royalties were approximately $524,000, $585,000, and $528,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
The expense related to co-author payments is accrued monthly. This expense is adjusted based upon actual expenditures paid to the co-authors. These expenditures are a percentage of the royalties paid to the Company by the publisher. Royalties from the publisher are recorded as revenue with the co-author expenditures recorded as expense.
The (provision) benefit for income taxes consists of the following:
| | | | Year Ended December 31,
| |
|---|
| | | | 2005
| | 2004
| | 2003
|
|---|
| | | | (in thousands)
| |
|---|
Current tax (provision) benefit:
| | | | | | | | | | | | | | |
| U.S. Federal | | | | $ | — | | | $ | — | | | $ | (112 | ) |
| State | | | | | — | | | | — | | | | (67 | ) |
| Foreign | | | | | — | | | | — | | | | — | |
| | | | | | — | | | | — | | | | (179 | ) |
Deferred tax (provision) benefit:
| | | | | | | | | | | | | | |
| U.S. Federal | | | | | — | | | | (14,832 | ) | | | (2,217 | ) |
| State | | | | | — | | | | (1,859 | ) | | | (857 | ) |
| Foreign | | | | | — | | | | (16 | ) | | | 97 | |
| | | | | | — | | | | (16,707 | ) | | | (2,977 | ) |
| Total (provision) benefit for income taxes | | | | $ | — | | | $ | (16,707 | ) | | $ | (3,156 | ) |
62
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
Significant components of the Company’s deferred tax assets and liabilities are as follows at:
| | | | December 31,
| |
|---|
| | | | 2005
| | 2004
|
|---|
| | | | (in thousands)
| |
|---|
Deferred tax assets:
| | | | | | | | | | |
| Net operating loss carryforwards | | | | $ | 22,281 | | | $ | 20,764 | |
| Tax credit carryforwards | | | | | 85 | | | | 85 | |
| Allowance for doubtful accounts | | | | | 663 | | | | 522 | |
| Equity compensation | | | | | 188 | | | | 187 | |
| Capitalized inventory costs | | | | | 168 | | | | 46 | |
| Deferred rent | | | | | 911 | | | | 574 | |
| Unrealized losses | | | | | 147 | | | | 147 | |
| Accumulated amortization including write down of intangibles | | | | | 621 | | | | 1,368 | |
| Other | | | | | 464 | | | | 401 | |
| Total deferred tax assets | | | | | 25,528 | | | | 24,094 | |
Deferred tax liabilities:
| | | | | | | | | | |
| Software development costs | | | | | (1,133 | ) | | | (1,155 | ) |
| Accumulated depreciation | | | | | (743 | ) | | | (807 | ) |
| Total deferred tax liabilities | | | | | (1,876 | ) | | | (1,962 | ) |
| Net deferred tax before valuation allowance | | | | | 23,652 | | | | 22,132 | |
| Valuation allowance | | | | | (23,652 | ) | | | (22,132 | ) |
| | | | | $ | — | | | $ | — | |
The net deferred income tax asset decreased from an asset of $16.7 million at December 31, 2003, to $0 at December 31, 2004 and 2005. The $16.7 million change in the net deferred tax balance is primarily attributable to the establishment of a valuation allowance on the net deferred tax asset. The net deferred tax asset at December 31, 2003 was included in the Company’s consolidated balance sheet as other current assets of approximately $852,000, and noncurrent deferred tax assets of approximately $15.8 million. As of December 31, 2005 the Company has a net operating loss carryforward totaling approximately $53.7 million which expires in the years 2021 through 2025, and other timing differences which will be available to offset regular taxable income during the carryforward period.
Deferred Tax Valuation Allowance
SFAS No. 109,“Accounting for Income Taxes,” requires that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. The cumulative pre-tax loss of $9.7 million incurred in the most recent three years represents sufficient negative evidence under the provisions of SFAS No. 109 for the Company to determine that the establishment of a full valuation allowance against the deferred tax asset is appropriate. This valuation allowance will offset assets associated with future tax deductions as well as carryforward items. Although management expects that these assets will ultimately be fully utilized, future performance cannot be assured.
63
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
A reconciliation setting forth the differences between the effective tax rate of the Company for the years ended December 31, 2005, 2004 and 2003 and the U.S. federal statutory tax rate is as follows:
| | | | Years ended December 31,
| |
|---|
| | | | 2005
| | 2004
| | 2003
| |
|---|
| | | | (in thousands)
| |
|---|
| U.S. Federal income tax benefit (provision) expenses at statutory rate | | | | $ | 1,181 | | | | 34 | % | | $ | 4,660 | | | | 34 | % | | $ | (2,537 | ) | | | 34 | % |
| Effect of permanent differences and other | | | | | 15 | | | | 0 | % | | | 39 | | | | 0 | % | | | (121 | ) | | | 1 | % |
| Effect of state taxes | | | | | 324 | | | | 9 | % | | | 726 | | | | 5 | % | | | (498 | ) | | | 7 | % |
| Valuation allowance | | | | | (1,520 | ) | | | (43 | )% | | | (22,132 | ) | | | (161 | )% | | | 0 | | | | 0 | % |
| | | | | $ | — | | | | 0 | % | | $ | (16,707 | ) | | | (122 | )% | | $ | (3,156 | ) | | | 42 | % |
10. | | Employee Benefits and Contracts |
Retirement Plan
The Company has a defined contribution plan (the “Plan”) under Section 401(k) of the Internal Revenue Code, which provides that eligible employees may make contributions subject to Internal Revenue Code limitations. Employees become eligible to participate in the Plan on the first day of the quarter following the beginning of their full-time employment, but company matching contributions do not begin until one year after full-time employment. Under the provisions of the Plan, contributions made by the Company are discretionary and are determined annually by the trustees of the Plan. The Company’s contributions to the Plan for the years ended December 31, 2005, 2004 and 2003 were $342,000, $230,000, and $200,000, respectively.
Stock Incentive Plan
On April 1, 2000, the Company adopted its 2000 Stock Incentive Plan (the “Stock Incentive Plan”) providing for the authorization and issuance of up to 2,538,000 shares of common stock, as adjusted. On various date, beginning in June 2000 and extending through December 2005, an additional 2,675,744 shares were authorized. The Stock Incentive Plan provides for the granting of incentive stock options, non-qualified stock options, restricted stock and deferred stock to eligible participants. Options granted under the Stock Incentive Plan are for periods not to exceed ten years. Other than for options to purchase 133,445 shares granted in 2000 to certain employees which were vested immediately, options outstanding under the Stock Incentive Plan generally vest quarterly over two to four years. As of December 31, 2005, there were approximately 703,000 shares available for grant.
64
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
A summary of the activity of the Stock Incentive Plan is as follows:
| | | | Options
| | Weighted-Average
Exercise Price
|
|---|
Outstanding at December 31, 2002 | | | | | 2,413,362 | | | $ | 7.32 | |
| Granted at Market | | | | | 429,236 | | | $ | 4.63 | |
| Forfeited | | | | | (170,330 | ) | | $ | 7.79 | |
| Excercised | | | | | (124,205 | ) | | $ | 4.69 | |
Outstanding at December 31, 2003 | | | | | 2,548,063 | | | $ | 6.96 | |
| Granted at Market | | | | | 1,098,473 | | | $ | 7.48 | |
| Forfeited | | | | | (167,107 | ) | | $ | 7.60 | |
| Excercised | | | | | (120,926 | ) | | $ | 6.19 | |
Outstanding at December 31, 2004 | | | | | 3,358,503 | | | $ | 7.13 | |
| Granted at Market | | | | | 224,900 | | | $ | 5.77 | |
| Forfeited | | | | | (282,503 | ) | | $ | 7.57 | |
| Excercised | | | | | (2,406 | ) | | $ | 4.96 | |
Outstanding at December 31, 2005 | | | | | 3,298,494 | | | $ | 7.00 | |
| Exercisable at December 31, 2003 | | | | | 1,790,513 | | | $ | 6.84 | |
| Exercisable at December 31, 2004 | | | | | 2,134,059 | | | $ | 6.99 | |
| Exercisable at December 31, 2005 | | | | | 2,461,129 | | | $ | 7.02 | |
Stock options outstanding at December 31, 2005 are summarized as follows:
Options Outstanding
| | Options Exercisable
| |
|---|
Exercise
Price
| | | | Options
Outstanding
| | Weighted-
Average
Remaining
Contractual Life
| | Weighted-
Average
Exercise Price
| | Options
Exercisable
| | Weighted-
Average
Exercise Price
|
|---|
| $1.73–$2.29 | | | | | 99,904 | | | | 4.25 | | | $ | 1.86 | | | | 99,904 | | | $ | 1.86 | |
| $2.30–$7.31 | | | | | 1,100,715 | | | | 8.04 | | | $ | 6.01 | | | | 556,714 | | | $ | 5.51 | |
| $7.31–$7.39 | | | | | 984,467 | | | | 4.25 | | | $ | 7.39 | | | | 984,467 | | | $ | 7.39 | |
| $7.45–$8.30 | | | | | 900,414 | | | | 7.22 | | | $ | 7.79 | | | | 617,829 | | | $ | 7.82 | |
| $8.31–$11.00 | | | | | 212,994 | | | | 5.43 | | | $ | 9.39 | | | | 202,215 | | | $ | 9.44 | |
| | | | | | 3,298,494 | | | | 6.40 | | | $ | 7.00 | | | | 2,461,129 | | | $ | 7.02 | |
During 2001, the Company granted 116,500 stock options to non-employee advisors and, using the fair value method, recorded expense of approximately $98,000, and $151,000 for the years ended December 31, 2004 and 2003, respectively. Prior to 2005, these options were fully vested, therefore no expense was recorded in 2005.
Publisher
Random House, Inc., a holder of 1,515,353 shares of the Company’s common stock at December 31, 2005, is also the publisher and distributor of substantially all of the Company’s books. For the years ended December 31, 2005, 2004 and 2003, the Company earned $3.3 million, $3.7 million and $3.6 million respectively, of book and publication income from Random House, Inc. Total receivables at December 31, 2005 and 2004 included $2.5 million and $2.8 million, respectively, due from Random House, Inc. for royalties, book advances, copy editing and marketing fees.
65
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
Loans to Officers
As of December 31, 2005 the Company had a loan to one executive officer in the amount of $625,000, while in 2004 the Company had loans to two executive officers of approximately $1.3 million. No loans were made to executive officers after February 2002, although interest continues to accrue. Such amounts and accrued interest are included in “Other Current Assets” and “Other assets” at December 31, 2005 and December 31, 2004. Both loans are payable in four consecutive, equal annual installments with the first payment to be made on the earlier of the fourth anniversary of the loan or 60 days after termination of employment, accrue interest at 7.3% per year and. These loans are secured by shares of the Company’s common stock owned by each of these individuals. At December 31, 2005, the loan was secured by 178,316 shares of the Company’s common stock. At December 31, 2004 the loans were secured by 299,066 shares of the Company’s common stock.
On July 11, 2003, the Company acquired a 77% interest in Princeton Review of North Carolina, Inc. and the remaining 23% was acquired on November 13, 2003. The total purchase price including both transactions was approximately $1,138,000, including imputed interest. The purchase price exceeded the fair value of the net assets acquired resulting in goodwill of approximately $938,000. Princeton Review of North Carolina, Inc. provided test preparation courses in North Carolina under the Princeton Review name through a franchise agreement with the Company. This acquisition has been accounted for as a purchase and has been included in the Company’s operations from the date of the purchase.
Approximately $170,000 of the purchase price was paid in cash at the time of closings. The remaining approximately $968,000 of the purchase price was paid by delivery to the sellers of subordinated promissory notes (see Note 6).
The pro forma effect of the purchase of the Princeton Review of North Carolina, Inc. is not presented in 2003 because its results are not significant.
The operating segments reported below are the segments of the Company for which separate financial information is available and for which operating results as measured by EBITDA are evaluated regularly by executive management in deciding how to allocate resources and in assessing performance. The accounting policies of the business segments are the same as those described in the summary of significant accounting policies (see Note 1).
The following segment results include the allocation of certain information technology costs, accounting services, executive management costs, office facilities expenses, human resources expenses and other shared services which are allocated based on consumption. Corporate consists of unallocated administrative support functions. The Company operates its business through three divisions. The majority of the Company’s revenue is earned by the Test Preparation Services division, which sells a range of services including test preparation, tutoring and academic counseling. Test Preparation Services derives its revenue from Company operated locations and from royalties from and product sales to independently owned franchises. The Admissions Services division earns revenue from subscription, transaction and marketing fees from higher education institutions and from selling advertising and sponsorships. The K-12 Services division earns fees from assessment, remediation and professional development services it renders to K-12 schools and from its content development work. Additionally, each division earns royalties and other fees from sales of its books published by Random House.
The segment results include EBITDA for the periods indicated. As used in this report, EBITDA means earnings before interest, income taxes, depreciation and amortization. The Company believes that EBITDA, a non-GAAP financial measure, represents a useful measure of evaluating its financial
66
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
performance because it reflects earnings trends without the impact of certain non-cash and non-operations-related charges or income. The Company’s management uses EBITDA to measure the operating profits or losses of the business. Analysts, investors and rating agencies frequently use EBITDA in the evaluation of companies, but the Company’s presentation of EBITDA is not necessarily comparable to other similarly titled measures of other companies because of potential inconsistencies in the method of calculation. EBITDA is not intended as an alternative to net income as an indicator of the Company’s operating performance, nor as an alternative to any other measure of performance calculated in conformity with GAAP.
| | | | Year Ended December 31, 2005
| |
|---|
| | | | (in thousands)
| |
|---|
| | | | Test
Preparation
Services
| | K-12 Services
| | Admissions
Services
| | Corporate
| | Total
|
|---|
| Revenue | | | | $ | 87,310 | | | $ | 31,931 | | | $ | 11,252 | | | $ | — | | | $ | 130,493 | |
Operating expenses (including depreciation
and amortization) | | | | $ | 48,457 | | | $ | 19,143 | | | $ | 11,473 | | | $ | 6,071 | | | $ | 85,144 | |
| Segment operating income (loss) | | | | | 10,708 | | | | (4,049 | ) | | | (4,836 | ) | | | (6,071 | ) | | | (4,248 | ) |
| Depreciation & amortization | | | | | 1,853 | | | | 2,853 | | | | 1,725 | | | | 1,251 | | | | 7,682 | |
| Other | | | | | — | | | | 1,191 | | | | (39 | ) | | | (24 | ) | | | 1,128 | |
| Segment EBITDA | | | | $ | 12,561 | | | $ | (5 | ) | | $ | (3,150 | ) | | $ | (4,844 | ) | | $ | 4,562 | |
| Total segment assets | | | | $ | 50,355 | | | $ | 26,870 | | | $ | 13,972 | | | $ | 14,174 | | | $ | 105,371 | |
| Segment goodwill | | | | $ | 31,006 | | | $ | — | | | $ | 500 | | | $ | — | | | $ | 31,506 | |
| Expenditures for long lived assets | | | | $ | 1,275 | | | $ | 8,268 | | | $ | 1,636 | | | $ | 3,142 | | | $ | 14,322 | |
| | | | Year Ended December 31, 2004
| |
|---|
| | | | (in thousands)
| |
|---|
| | | | Test
Preparation
Services
| | K-12 Services
| | Admissions
Services
| | Corporate
| | Total
|
|---|
| Revenue | | | | $ | 74,744 | | | $ | 27,957 | | | $ | 11,084 | | | $ | — | | | $ | 113,785 | |
Operating expenses (including depreciation
and amortization) | | | | $ | 42,858 | | | $ | 17,526 | | | $ | 21,813 | | | $ | 4,383 | | | $ | 86,580 | |
| Segment operating income (loss) | | | | | 8,301 | | | | (3,349 | ) | | | (14,017 | ) | | | (4,383 | ) | | | (13,448 | ) |
| Depreciation & amortization | | | | | 1,804 | | | | 2,161 | | | | 1,898 | | | | 1,139 | | | | 7,002 | |
| Other | | | | | — | | | | — | | | | (67 | ) | | | 171 | | | | 104 | |
| Segment EBITDA | | | | $ | 10,105 | | | $ | (1,188 | ) | | $ | (12,186 | ) | | $ | (3,073 | ) | | $ | (6,342 | ) |
| Total segment assets | | | | $ | 37,419 | | | $ | 21,867 | | | $ | 17,532 | | | $ | 30,823 | | | $ | 107,641 | |
| Segment goodwill | | | | $ | 31,011 | | | $ | — | | | $ | 500 | | | $ | — | | | $ | 31,511 | |
| Expenditures for long lived assets | | | | $ | 2,551 | | | $ | 3,385 | | | $ | 427 | | | $ | 2,639 | | | $ | 9,002 | |
67
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
| | | | Year Ended December 31, 2003
| |
|---|
| | | | (in thousands)
| |
|---|
| | | | Test
Preparation
Services
| | K-12 Services
| | Admissions
Services
| | Corporate
| | Total
|
|---|
| Revenue | | | | $ | 71,719 | | | $ | 21,525 | | | $ | 11,218 | | | $ | — | | | $ | 104,462 | |
Operating expenses (including depreciation
and amortization) | | | | $ | 39,123 | | | $ | 13,986 | | | $ | 10,822 | | | $ | 1,703 | | | $ | 65,634 | |
| Segment operating income (loss) | | | | | 11,787 | | | | (789 | ) | | | (2,440 | ) | | | (1,703 | ) | | | 6,855 | |
| Depreciation & amortization | | | | | 1,522 | | | | 1,594 | | | | 1,760 | | | | 1,161 | | | | 6,037 | |
| Other | | | | | — | | | | — | | | | (32 | ) | | | — | | | | (32 | ) |
| Segment EBITDA | | | | $ | 13,309 | | | $ | 805 | | | $ | (712 | ) | | $ | (542 | ) | | $ | 12,860 | |
| Total segment assets | | | | $ | 41,798 | | | $ | 20,189 | | | $ | 29,728 | | | $ | 29,982 | | | $ | 121,697 | |
| Segment goodwill | | | | $ | 30,881 | | | $ | — | | | $ | 8,699 | | | $ | — | | | $ | 39,580 | |
| Expenditures for long lived assets | | | | $ | 2,103 | | | $ | 2,644 | | | $ | 1,249 | | | $ | 1,493 | | | $ | 7,489 | |
Reconciliation of operating income (loss) to net income (loss)
| | | | Years Ended December 31,
| |
|---|
| | | | 2005
| | 2004
| | 2003
|
|---|
| | | | (in thousands)
| |
|---|
| Total income (loss) for reportable segments | | | | $ | (4,248 | ) | | $ | (13,448 | ) | | $ | 6,855 | |
Unallocated amounts:
| | | | | | | | | | | | | | |
| Interest expense, net | | | | | (354 | ) | | | (693 | ) | | | (607 | ) |
| Other income | | | | | 1,128 | | | | 435 | | | | 1,217 | |
| (Provision) benefit for income taxes | | | | | — | | | | (16,707 | ) | | | (3,156 | ) |
| Net income (loss) | | | | $ | (3,474 | ) | | $ | (30,413 | ) | | $ | 4,309 | |
68
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
14. | | Quarterly Results of Operations (Unaudited) |
The following table presents unaudited statement of operations data for each of the eight quarters in the two-year period ended December 31, 2005. This information has been derived from the Company’s historical consolidated financial statements and should be read in conjunction with the Company’s historical consolidated financial statements and related notes appearing in this Annual Report on Form 10-K.
| | | | Quarter Ended
| |
|---|
| | | | Mar. 31,
2005
| | June 30,
2005
| | Sept. 30,
2005
| | Dec. 31,
2005
| | Mar. 31,
2004
| | June 30,
2004
| | Sept. 30,
2004
| | Dec. 31,
2004
|
|---|
| | | | (in thousands, except per share data)
| |
|---|
Revenue
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Test Preparation Services | | | | $ | 22,885 | | | $ | 20,630 | | | $ | 26,748 | | | $ | 17,047 | | | $ | 18,830 | | | $ | 18,163 | | | $ | 24,185 | | | $ | 13,566 | |
| K-12 Services | | | | | 7,919 | | | | 7,122 | | | | 5,281 | | | | 11,609 | | | | 6,283 | | | | 7,697 | | | | 2,752 | | | | 11,225 | |
| Admissions Services | | | | | 2,794 | | | | 2,045 | | | | 2,767 | | | | 3,646 | | | | 2,834 | | | | 2,587 | | | | 2,665 | | | | 2,998 | |
| Total revenue | | | | | 33,598 | | | | 29,797 | | | | 34,796 | | | | 32,302 | | | | 27,947 | | | | 28,447 | | | | 29,602 | | | | 27,789 | |
Cost of revenue
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Test Preparation Services | | | | | 7,037 | | | | 6,452 | | | | 8,007 | | | | 6,648 | | | | 5,820 | | | | 5,313 | | | | 7,316 | | | | 5,135 | |
| K-12 Services | | | | | 4,245 | | | | 3,183 | | | | 2,934 | | | | 6,476 | | | | 3,664 | | | | 3,005 | | | | 2,711 | | | | 4,304 | |
| Admissions Services | | | | | 861 | | | | 1,080 | | | | 1,283 | | | | 1,391 | | | | 596 | | | | 557 | | | | 1,161 | | | | 1,071 | |
| Total cost of revenue | | | | | 12,143 | | | | 10,715 | | | | 12,224 | | | | 14,515 | | | | 10,080 | | | | 8,875 | | | | 11,188 | | | | 10,510 | |
Gross profit | | | | | 21,455 | | | | 19,082 | | | | 22,572 | | | | 17,787 | | | | 17,867 | | | | 19,572 | | | | 18,414 | | | | 17,279 | |
Operating expenses
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Selling, general and administrative | | | | | 21,265 | | | | 19,460 | | | | 21,910 | | | | 22,509 | | | | 19,003 | | | | 18,600 | | | | 19,161 | | | | 21,617 | |
| Impairment of investment | | | | | — | | | | — | | | | — | | | | — | | | | 0 | | | | 0 | | | | — | | | | 8,199 | |
| Total operating expenses | | | | | 21,265 | | | | 19,460 | | | | 21,910 | | | | 22,509 | | | | 19,003 | | | | 18,600 | | | | 19,161 | | | | 29,816 | |
| Income (loss) from operations | | | | | 190 | | | | (378 | ) | | | 662 | | | | (4,722 | ) | | | (1,136 | ) | | | 972 | | | | (747 | ) | | | (12,537 | ) |
| Net income (loss) attributed to common shareholders | | | | $ | (340 | ) | | $ | (668 | ) | | $ | 1,265 | | | $ | (4,585 | ) | | $ | (706 | ) | | $ | 438 | | | $ | (618 | ) | | $ | (29,955 | ) |
| Basic income (loss) per share (1) | | | | $ | (0.01 | ) | | $ | (0.02 | ) | | $ | 0.05 | | | $ | (0.17 | ) | | $ | (0.03 | ) | | $ | 0.02 | | | $ | (0.02 | ) | | $ | (1.09 | ) |
| Diluted income (loss) per share | | | | $ | (0.01 | ) | | $ | (0.02 | ) | | $ | 0.04 | | | $ | (0.17 | ) | | $ | (0.03 | ) | | $ | 0.02 | | | $ | (0.02 | ) | | $ | (1.09 | ) |
Weighted average shares used in computing net income (loss) per share
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | | | | 27,570 | | | | 27,570 | | | | 27,571 | | | | 27,570 | | | | 27,391 | | | | 27,430 | | | | 27,497 | | | | 27,559 | |
| Diluted | | | | | 27,570 | | | | 27,570 | | | | 28,733 | | | | 27,570 | | | | 27,391 | | | | 28,014 | | | | 27,497 | | | | 27,559 | |
| (1) | | The sum of quarterly earnings (loss) per share does not equal the annual loss per share due to changes in average shares outstanding. |
69
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements—(Continued)
15. | | Earnings (Loss) Per Share |
The following table sets forth the denominators used in computing basic and diluted earnings (loss) per common share for the periods indicated:
| | | | Year Ended December 31,
| |
|---|
| | | | 2005
| | 2004
| | 2003
|
|---|
| | | | (in thousands)
| |
|---|
Weighted Average common shares outstanding
| | | | | | | | | | | | | | |
| Basic | | | | | 27,570 | | | | 27,468 | | | | 27,306 | |
| Net effect of dilutive stock options-based on the treasury stock method | | | | | — | | | | — | | | | 152 | |
| Other | | | | | — | | | | — | | | | 9 | |
| Diluted | | | | | 27,570 | | | | 27,468 | | | | 27,467 | |
For the year ended December 31, 2005 and 2004, the following were excluded from the computation of diluted earnings per common share because of their antidilutive effect.
| | | | Year Ended December 31,
| |
|---|
| | | | 2005
| | 2004
|
|---|
| | | | (in thousands)
| |
|---|
Net effect of dilutive stock options-based on the treasury
stock method | | | | | 132 | | | | 230 | |
| Net effect of convertible preferred stock-based on the if converted method | | | | | 1,007 | | | | 578 | |
| Other | | | | | 9 | | | | 9 | |
| | | | | | 1,148 | | | | 817 | |
70
THE PRINCETON REVIEW, INC. AND SUBSIDIARIES
Schedule II
Valuation and Qualifying Accounts
For the years ended December 31, 2005, 2004 and 2003
| | | | Balance at
Beginning of
Period
| | Additions
Charged to
Expense
| | Deductions
From
Allowance(1)
| | Balance at
End of
Period
|
|---|
| | | | (in thousands)
| |
|---|
Allowance for Doubtful Accounts
| | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2005 | | | | $ | 1,290 | | | $ | 1,328 | | | $ | (1,017 | ) | | $ | 1,601 | |
| Year Ended December 31, 2004 | | | | $ | 302 | | | $ | 1,521 | | | $ | (533 | ) | | $ | 1,290 | |
| Year Ended December 31, 2003 | | | | $ | 527 | | | $ | 380 | | | $ | (605 | ) | | $ | 302 | |
Valuation allowance for deferred tax assets
| | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2005 | | | | $ | 22,132 | | | $ | 1,520 | | | | — | | | $ | 23,652 | |
| Year Ended December 31, 2004 | | | | | — | | | $ | 22,132 | | | | — | | | $ | 22,132 | |
| Year Ended December 31, 2003 | | | | | — | | | | — | | | | — | | | | — | |
| (1) | | Consists primarily of amounts written off during the period. |
71
Item 9. | | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure |
None.
Item 9A. | | Controls and Procedures |
Disclosure Controls and Procedures
We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (“Disclosure Controls”), as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (“Exchange Act”) as of December 31, 2005. The evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), and included a review of the controls’ objectives, design and operating effectiveness with respect to the information generated for use in this Annual Report. In the course of the evaluation, we sought to identify data errors, control problems or acts of fraud and confirm that appropriate corrective actions, including process improvements, were being undertaken. This type of Disclosure Controls evaluation is performed on a quarterly basis so that the conclusions of management, including the CEO and CFO, concerning the effectiveness of controls can be reported in our Quarterly Reports on Form 10-Q and in our Annual Reports on Form 10-K. Many of the components of our Disclosure Controls are also evaluated on an ongoing basis by other personnel in our accounting, finance and legal functions. The overall goals of these various evaluation activities are to monitor our Disclosure Controls and to modify them on an ongoing basis as necessary.
Based upon the evaluation of our Disclosure Controls, our CEO and CFO concluded that the Company’s Disclosure Controls were effective as of December 31, 2005 to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. In making this assessment, management used the criteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2005.
Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included elsewhere herein.
Changes in Internal Control over Financial Reporting
As described in Item 9A of the Company’s Form 10-K/A, dated May 2, 2005, the Company’s management assessed the effectiveness of the Company’s internal control over financial reporting and identified three material weaknesses in internal control over financial reporting as of December 31, 2004. These material weaknesses were identified in the areas of capitalized software development costs, the financial statement close process and revenue recognition. During the period covered by this report,
72
including the most recent quarter, the Company continued its remediation efforts which included the following:
| • | | reorganized the accounting and finance department, with the focus on simplifying our business workflow processes; |
| • | | hired more qualified and experienced accounting personnel to perform the month-end review and closing processes as well as provide additional oversight and supervision within the accounting department; |
| • | | established written policies and procedures along with control matrices to ensure that account reconciliation and amounts recorded, as well as the review of these areas, are substantiated by detailed and contemporaneous documentary support and that reconciling items are investigated, resolved and recorded in a timely manner; and |
| • | | established programs providing ongoing training and professional education and development plans for the accounting department and improving internal communications procedures through the Company. |
As a result of these efforts, the previously identified material weaknesses in internal control over financial reporting have been remediated as of December 31, 2005. We are continuing to actively assess and evaluate our most critical business and accounting processing to identify further enhancements and improvement opportunities.
Attestation Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
The Princeton Review, Inc. and Subsidiaries
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that The Princeton Review, Inc. and Subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only
73
in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005 of The Princeton Review, Inc. and Subsidiaries and our report dated March 13, 2006 expressed an unqualified opinion thereon.
New York, NY
March 13, 2006
Item 9B. | | Other Information |
None
PART III
Item 10. | | Directors and Executive Officers of the Registrant |
Executive Officers
The following table sets forth information with respect to our executive officers as of March 10, 2006.
Name
| | | | Age
| | Position
|
|---|
| John S. Katzman | | | | 46 | | Chairman and Chief Executive Officer |
| Mark Chernis | | | | 39 | | President, Chief Operating Officer |
| Andrew Bonanni | | | | 40 | | Chief Financial Officer and Treasurer |
| Kevin A. Howell | | | | 47 | | Executive Vice President, General Manager K-12
Services Division |
| Margot Lebenberg | | | | 38 | | Executive Vice President, General Counsel and Secretary |
| Stephen Quattrociocchi | | | | 43 | | Executive Vice President, Test Preparation Services Division |
| Young J. Shin | | | | 39 | | Executive Vice President, General Manager Admissions
Services Division |
John S. Katzman, Chairman and Chief Executive Officer, founded our company in 1981. Mr. Katzman has served as our Chief Executive Officer and director since our formation. Mr. Katzman served as our President from 1981 until August 2000. Mr. Katzman is the brother of Richard Katzman, one of the other members of the board of directors. Mr. Katzman received a BA from Princeton University.
Mark Chernis, President, Chief Operating Officer and Secretary, joined us in 1984. Mr. Chernis has served as Chief Operating Officer and Secretary since 1995 and became President in August 2000. From 1989 to 1995, Mr. Chernis served as our Vice President, Operations. From 1984 to 1989, Mr. Chernis served as a systems analyst. Mr. Chernis received a BA from Vassar College.
74
Andrew J. Bonanni, Chief Financial Officer and Treasurer joined us in September 2005. From 2002 to 2005, he served as Senior Vice President & Chief Financial Officer of Bowne Business Solutions where he was responsible for overseeing all financial and IT management functions and presided over several key acquisitions and strategic joint ventures. From 2001 to 2002, Mr. Bonanni was Managing Vice President, Worldwide Business Planning & Corporate Reporting for Gartner, Inc. He began his career in 1992 with Xerox, where he held a series of finance and strategy positions with increasing responsibilities. Mr. Bonanni received a B.S. in Finance and Marketing from Le Moyne College and a M.B.A. in Accounting from Rochester Institute of Technology.
Kevin A. Howell, Executive Vice President, General Manager K-12 Services Division, joined us in October 2005. From 2001 to 2005, Mr. Howell was with the National Education Association’s (NEA) Portal Company, where he served as interim CEO for a subsidiary providing online training for K-12 educators. From 1995 to 2000, Mr. Howell worked for McGraw Hill, rising to the position of Senior Vice President, Technology and New Media. He began his career with Digital Equipment Corporation, where he held various managerial positions of increasing responsibility. He received a B.A. in Economics from Vassar College.
Margot Lebenberg, Executive Vice President, General Counsel and Secretary, joined us in June 2004. From 2003 to 2004, Ms. Lebenberg served as the Executive Vice President and General Counsel and Secretary for SoundView Technology Group, Inc., a research driven securities firm, through its sale to Charles Schwab. From 2001 to 2003, she served as Vice President and Assistant General Counsel of Cantor Fitzgerald, a leading financial services provider, and its subsidiary eSpeed, Inc., a leader in developing and deploying electronic trading. From 1996 to 2000, she served as Senior Vice President, General Counsel and Secretary of SOURCECORP, Incorporated (formerly known as F.Y.I. Incorporated), a business process outsourcing and consulting firm, in Dallas, Texas. Ms. Lebenberg began her career at Morgan, Lewis & Bockius LLP in New York and founded and served as President of Living Mountain Capital LLC, a business advisory consulting firm specializing in corporate development, strategic alliances and restructurings. Ms. Lebenberg received her JD from Fordham University School of Law and her BA from SUNY Binghamton.
Stephen Quattrociocchi, Executive Vice President, Test Preparation Services Division, joined us in 1988. Since 1997, he has served as Executive Vice President of our Test Preparation Services division. From 1991 to 1997, Mr. Quattrociocchi served as Vice President of Course Operations. Mr. Quattrociocchi received a BS from the Massachusetts Institute of Technology and an MBA from the Wharton School.
Young J. Shin, Executive Vice President, General Manager Admissions Services Division, joined us in February 2003. From October 2002 to February 2003, Mr. Shin served as the Chief Executive Officer of eduAdvisors, LLC, an education marketing company. In 1995, Mr. Shin co-founded Embark.com, Inc., a provider of online college and graduate school information and application services, the assets of which we acquired in October 2001. Mr. Shin served as Embark’s Chairman of the Board from 1995 until February 2003, as Embark’s Chief Technology Officer from 2000 to 2001 and its President and Chief Executive Officer from 1995 to 2000. From 1991 to 1994, Mr. Shin was a Technical Specialist and Consulting Practice Manager at Seer Technologies, Inc. a computer aided software company. Mr. Shin received a BS from Massachusetts Institute of Technology and a BS from Massachusetts Institute of Technology’s Sloan School of Management.
The information required by this Item 10, other than information with respect to our executive officers, which is contained above, is incorporated by reference from our definitive proxy statement for our 2006 annual meeting of stockholders, scheduled to be held on June 15, 2006.
Item 11. | | Executive Compensation |
The information required by this Item 11 is incorporated by reference from our definitive proxy statement for our 2006 annual meeting of stockholders, scheduled to be held on June 15, 2006.
75
Item 12. | | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
Information required by this Item 12 is incorporated by reference from our definitive proxy statement for our 2006 annual meeting of stockholders, scheduled to be held on June 15, 2006.
Item 13. | | Certain Relationships and Related Transactions |
The information required by this Item 13 is incorporated by reference from our definitive proxy statement for our 2006 annual meeting of stockholders, scheduled to be held on June 15, 2006.
Item 14. | | Principal Accountant Fees and Services |
The information required by this Item 14 is incorporated by reference from our definitive proxy statement for our 2006 annual meeting of stockholders, scheduled to be held on June 15, 2006.
PART IV
Item 15. | | Exhibits and Financial Statement Schedules |
(a) The following documents are filed as part of this Report:
1. Financial Statements—See Index to Consolidated Financial Statements and Financial Statement Schedule at Item 8 on page 40 of this Annual Report on Form 10-K.
2. Financial Statement Schedules—See Index to Consolidated Financial Statements and Financial Statement Schedule at Item 8 on page 40 of this Annual Report on Form 10-K. All other schedules are omitted because they are not applicable or not required.
3. Exhibits—The following exhibits are filed as part of, or incorporated by reference into, this Annual Report on Form 10-K:
76
Exhibit
Number
| |
| Description
|
|---|
| 2.1 | | — | Conversion and Contribution Agreement, dated as of March 31, 2000, by and among The Princeton Review, Inc., the Non-Voting Members of Princeton Review Publishing L.L.C., John S. Katzman and TPR Holdings, Inc. (1) |
| 2.2 | | — | RH Contribution Agreement, dated as of March 31, 2000, by and among Random House TPR, Inc., Random House, Inc., The Princeton Review, Inc., John S. Katzman, and TPR Holdings, Inc. (1) |
| 2.3 | | — | TPR Contribution Agreement, dated as of March 31, 2000, by and among The Princeton Review, Inc., each of the persons listed on Schedule I attached to the agreement and TPR Holdings, Inc. (1) |
| 2.4 | | — | Option Agreement, dated as of May 30, 2000, by and among Princeton Review Operations, L.L.C., Princeton Review of Boston, Inc. and Princeton Review of New Jersey, Inc. (1) |
| 2.5 | | — | Option Agreement Amendment, dated as of December 14, 2000, by and between Princeton Review Operations, L.L.C., Princeton Review of Boston, Inc. and Princeton Review of New Jersey, Inc. (1) |
| 2.6 | | — | Option Agreement, dated as of October 18, 2000, by and among Princeton Review Operations, L.L.C., T.S.T.S., Inc., Robert O. Case and Kevin D. Campbell. (1) |
| 2.7 | | — | Option Agreement, dated as of December 15, 2000, by and between Princeton Review Operations, L.L.C. and The Princeton Review Peninsula, Inc. (1) |
| 2.8 | | — | Asset Purchase Agreement, dated as of January 18, 2001, by and among Princeton Review Boston, Inc., Princeton Review New Jersey, Inc., Robert L. Cohen, Matthew Rosenthal, Princeton Review Operations, L.L.C., and Princeton Review Management, L.L.C. (1) |
| 2.9 | | — | Closing Agreement, dated as of March 2, 2001, by and among Princeton Review of Boston, Inc., Princeton Review of New Jersey, Inc., Robert L. Cohen, Matthew Rosenthal, Princeton Review Operations, L.L.C. and Princeton Review Management, L.L.C. (incorporated herein by reference to Exhibit 2.8.1 to our Registration Statement on Form S-1 (File No. 333-43874) which was declared effective on June 18, 2001 (the “Form S-1”)). |
| 2.10 | | — | Promissory Note, dated as of March 2, 2001, made by Princeton Review Operations, L.L.C. in favor of Princeton Review of Boston, Inc., in the principal amount of $3,125,000 (incorporated herein by reference to Exhibit 2.9 to our Form S-1). |
| 2.11 | | — | Promissory Note, dated as of March 2, 2001, made by Princeton Review Operations, L.L.C. in favor of Princeton Review of Boston, Inc., in the principal amount of $500,000 (incorporated herein by reference to Exhibit 2.10 to our Form S-1). |
| 2.12 | | — | Asset Purchase Agreement, dated as of March 6, 2001, by and among The Princeton Review Peninsula, Inc., the Hirsch Living Trust, Pamela N. Hirsch, Myles E. Hirsch, Frederick Sliter, Princeton Review Operations, L.L.C. and Princeton Review Management, L.L.C. (incorporated herein by reference to Exhibit 2.11 to our Form S-1). |
| 2.13 | | — | Asset Purchase Agreement, dated June 18, 2001, among Princeton Review Operations, L.L.C., Princeton Review Management, L.L.C., T.S.T.S., Inc., Robert O. Case and Kevin D. Campbell (incorporated herein by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q (File No. 000-32469), filed with the Securities and Exchange Commission on August 8, 2001 (the “2001 Second Quarter Form 10-Q”)). |
| 2.14 | | — | Subordinated Promissory Note, dated June 18, 2001, made by Princeton Review Operations, L.L.C. in favor of T.S.T.S., Inc., in the principal amount of $1,475,000 (incorporated herein by reference to Exhibit 10.2 to our 2001 Second Quarter Form 10-Q). |
| 2.15 | | — | Asset Purchase Agreement, dated as of October 1, 2001, by and among The Princeton Review, Inc., Princeton Review Publishing, L.L.C. and Embark.com, Inc. (incorporated herein by reference to Exhibit 2.1 to our Current Report on Form 8-K (File No. 000-32469), filed with the Securities and Exchange Commission on October 9, 2001 (the “Form 8-K”)). |
77
Exhibit
Number
| |
| Description
|
|---|
| 3.1 | | — | Amended and Restated Certificate of Incorporation (incorporated herein by reference to Exhibit 3.1.2 to our Form S-1). |
| 3.2 | | — | Amended and Restated By-laws (incorporated herein by reference to Exhibit 3.3.1 to our Form S-1). |
| 4.1 | | — | Form of Specimen Common Stock Certificate (1). |
| 4.2 | | — | Certificate of Designation of Series B-1 Cumulative Convertible Preferred Stock of The Princeton Review, Inc. (incorporated herein by reference to Exhibit 4.1 to our Current Report on Form 8-K (File No. 000-32469), filed with the Securities and Exchange Commission on June 9, 2004) |
| 10.1 | | — | Stockholders Agreement, dated as of April 1, 2000, by and among The Princeton Review, Inc., and its stockholders (1). |
| 10.2 | | — | Stock Purchase Agreement, dated April 18, 2000, by and among The Princeton Review, Inc., SG Capital Partners LLC, Olympus Growth Fund III, L.P. and Olympus Executive Fund, L.P. (1). |
| 10.3 | | — | Joinder Agreement, dated April 18, 2000, to the Stockholders Agreement dated April 1, 2000, among stockholders of The Princeton Review, Inc. (1). |
| 10.4 | | — | Investor Rights Agreement, dated April 18, 2000, by and among The Princeton Review, Inc., SG Capital Partners LLC, Olympus Growth Fund III, L.P. and Olympus Executive Fund, L.P. (1). |
| 10.5 | | — | The Princeton Review, Inc. 2000 Stock Incentive Plan, March 2000 (1). |
| 10.6 | | — | Amendment to The Princeton Review, Inc. 2000 Stock Incentive Plan (incorporated herein by reference to Exhibit 10.5.1 to our Form S-1). |
| 10.7 | | — | Form of Incentive Stock Option Agreement (incorporated herein by reference to Exhibit 10.6 to our Form S-1). |
| 10.8 | | — | Software Purchase Agreement, dated as of June 23, 1998, by and between Learning Company Properties and Princeton Review Publishing, L.L.C. (incorporated herein by reference to Exhibit 10.10 to our Form S-1). |
| 10.9 | | — | The Princeton Review Executive Compensation Policy Statement, as amended (incorporated by reference to Exhibit 10.12 of our Annual Report on Form 10-K for the year ended December 31, 2001). |
| 10.10 | | — | Office Lease, dated as of April 23, 1992, as amended, by and between The Princeton Review, Inc. and 2316 Broadway Realty Co. (incorporated herein by reference to Exhibit 10.12 to our Form S-1). |
| 10.11 | | — | Amendment to Office Lease, dated December 9, 1993 (incorporated herein by reference to Exhibit 10.13 to our Form S-1). |
| 10.12 | | — | Second Amendment to Office Lease, dated February 6, 1995 (incorporated herein by reference to Exhibit 10.14 to our Form S-1). |
| 10.13 | | — | Third Amendment to Office Lease, dated April 2, 1996 (incorporated herein by reference to Exhibit 10.15 to our Form S-1). |
| 10.14 | | — | Fourth Amendment to Office Lease, dated July 10, 1998 (incorporated herein by reference to Exhibit 10.16 to our Form S-1). |
| 10.15 | | — | Employment Agreement, dated as of April 11, 2002, by and between The Princeton Review, Inc. and John Katzman (incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q (file No. 000-32469), filed with the Securities and Exchange Commission on May 14, 2002 (the “2002 First Quarter Form 10-Q”). |
| 10.16 | | — | Employment Agreement, dated as of April 10, 2002, by and between The Princeton Review, Inc. and Mark Chernis (incorporated by reference to Exhibit 10.2 to our 2002 First Quarter Form 10-Q). |
| 10.17 | | — | Employment Agreement, dated as of April 10, 2002, by and between The Princeton Review, Inc. and Steve Quattrociocchi (incorporated by reference to Exhibit 10.3 to our 2002 First Quarter Form 10-Q). |
78
Exhibit
Number
| |
| Description
|
|---|
| 10.18 | | — | Employment Agreement, dated as of April 10, 2002, by and between The Princeton Review, Inc. and Bruce Task (incorporated by reference to Exhibit 10.4 to our 2002 First Quarter Form 10-Q). |
| 10.19 | | — | Employment Agreement, dated as of October 15, 2001, by and between The Princeton Review, Inc. and Stephen Melvin (incorporated by reference to Exhibit 10.61 of our Annual Report on Form 10-K for the year ended December 31, 2001). |
| 10.20 | | — | Office Lease by and between The Rector, Church-Wardens and Vestrymen of Trinity Church in the City of New York, as Landlord, and Princeton Review Publishing, L.L.C., as Tenant (incorporated herein by reference to Exhibit 10.35 to our Form S-1). |
| 10.21 | | — | Agreement, dated September 1, 1998, by and between The Educational and Professional Publishing Group, a unit of the McGraw-Hill Companies, Inc., and Princeton Review Publishing, L.L.C. (incorporated herein by reference to Exhibit 10.36 to our Form S-1).(2) |
| 10.22 | | — | Franchise Agreement, dated as of July 1, 1986, by and between The Princeton Review Management Corp. and Lloyd Eric Cotsen (Lecomp Company, Inc.) (incorporated herein by reference to Exhibit 10.39 to our Form S-1). |
| 10.23 | | — | Franchise Agreement, dated as of September 13, 1986, by and between The Princeton Review Management Corp. and Robert Case, Richard McDugald and Kevin Campbell (Test Services, Inc.) (incorporated herein by reference to Exhibit 10.40 to our Form S-1). |
| 10.24 | | — | Addendum to the Franchise Agreement, dated as of May 31, 1995, by and between The Princeton Review Management Corp. and the persons and entities listed on the Franchisee Joinders (incorporated herein by reference to Exhibit 10.41 to our Form S-1). |
| 10.25 | | — | Formation Agreement, dated as of May 31, 1995, by and among The Princeton Review Publishing Company, L.L.C., The Princeton Review Publishing Co., Inc., the Princeton Review Management Corp. and the independent franchisees (incorporated herein by reference to Exhibit 10.42 to our Form S-1). |
| 10.26 | | — | Distance Learning Waiver, dated as of June 21, 2000, by and between Princeton Review Management, L.L.C. and Lecomp, Inc. (incorporated herein by reference to Exhibit 10.44 to our Form S-1). |
| 10.27 | | — | Pledge and Security Agreement, dated as of September 19, 2000, by and between Steven Hodas and The Princeton Review, Inc. (incorporated herein by reference to Exhibit 10.45 to our Form S-1) |
| 10.28 | | — | Promissory Note, dated as of September 19, 2000, made by Steven Hodas in favor of The Princeton Review, Inc. (incorporated herein by reference to Exhibit 10.46 to our Form S-1). |
| 10.29 | | — | Non-Recourse Promissory Note, dated August 15, 2001, made by Bruce Task in favor of The Princeton Review, Inc. (incorporated herein by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q (File No. 000-32469) for the third quarter of 2001, filed with the Securities and Exchange Commission on November 13, 2001 (the “2001 Third Quarter Form 10-Q”)). |
| 10.30 | | — | Pledge and Security Agreement, dated as of August 15, 2001, by and between Bruce Task and The Princeton Review, Inc. (incorporated herein by reference to Exhibit 10.2 to our 2001 Third Quarter Form 10-Q). |
| 10.31 | | — | Non-Recourse Promissory Note, dated November 27, 2001, made by Mark Chernis in favor of The Princeton Review, Inc. (incorporated by reference to Exhibit 10.53 of our Annual Report on Form 10-K for the year ended December 31, 2001). |
| 10.32 | | — | Pledge and Security Agreement, dated as of November 27, 2001, by and between Mark Chernis and The Princeton Review, Inc. (incorporated by reference to Exhibit 10.54 of our Annual Report on Form 10-K for the year ended December 31, 2001). |
79
Exhibit
Number
| | | |
| | Description
|
|---|
| 10.33 | | | | — | | Non-Recourse Promissory Note, dated March 7, 2002, made by Mark Chernis in favor of The Princeton Review, Inc. (incorporated by reference to Exhibit 10.55 of our Annual Report on Form 10-K for the year ended December 31, 2001). |
| 10.34 | | | | — | | Agreement, dated as of May 28, 2004, by and between The Princeton Review, Inc. and Fletcher International, Ltd. (incorporated herein by reference to Exhibit 4.1 to our Current Report on Form 8-K (File No. 000-32469), filed with the Securities and Exchange Commission on June 9, 2004). |
| 10.35 | | | | — | | Lease, dated as of August 1, 2004, by and between The Rector, Church-Wardens and Vestrymen of Trinity Church in the City of New York, as Landlord and The Princeton Review, Inc., as Tenant. (incorporated herein by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q (File No. 000-32469) for the third quarter of 2004, filed with the Securities and Exchange Commission on November 9, 2004). |
| 10.36 | | | | — | | Amendment to Employment Agreement, dated September 12, 2005, between The Princeton Review, Inc. and Stephen Melvin (incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q (File No. 0000-32469) for the third quarter of 2005, filed with the Securities and Exchange Commission on November 9, 2006). |
| 10.37 | | | | — | | Employment Agreement, dated September 9, 2005, between The Princeton Review, Inc. and Andrew Bonanni (incorporated by reference to Exhibit 10.2 to our Quarterly Report on Form 10-Q (File No. 0000-32469) for the third quarter of 2005, filed with the Securities and Exchange Commission on November 9, 2006). |
| 10.38 | | | | — | | Office Lease Extension, dated November 18, 2005, as amended, by and between The Princeton Review, Inc. and 2315 Broadway Realty Co. |
| 21.1 | | | | — | | Subsidiaries of the Registrant. (Incorporated by reference to Exhibit 21.1 of our Annual Report on Form 10-K for the year ended December 31, 2004) |
| 23.1 | | | | — | | Consent of Ernst & Young LLP. |
| 24.1 | | | | — | | Powers of Attorney (included on the signature pages hereto). |
| 31.1 | | | | — | | Certification of CEO Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2 | | | | — | | Certification of CFO Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1 | | | | — | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| (1) | | Incorporated herein by reference to the exhibit with the same number to our Registration Statement on Form S-1 (File No. 333-43874), which was declared effective on June 18, 2001. |
| (2) | | Confidential portions of this document are omitted pursuant to a request for confidential treatment that has been granted by the Commission, and have been filed separately with the Commission. |
80
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 16, 2006.
| | | | | THE PRINCETON REVIEW, INC.
|
| | | | | By: /s/ ANDREW J. BONANNI
|
| | | | | Andrew J. Bonanni
Chief Financial Officer and
Treasurer |
POWER OF ATTORNEY
Each individual whose signature appears below constitutes and appoints each of John S. Katzman, Mark Chernis and Andrew Bonanni, such person’s true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, for such person and in such person’s name, place and stead, in any and all capacities, to sign any and all amendments to this report on Form 10-K, and to file the same, with all exhibits thereto, and all documents in connection therewith, with the Securities and Exchange Commission, granting unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as such person might or could do in person, hereby ratifying and confirming all that any said attorney-in-fact and agent, or any substitute or substitutes of any of them, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
| | | | Title
| | Date
|
|---|
/s/ JOHN S. KATZMAN
(John S. Katzman) | | | | Chairman and Chief Executive Officer (Principal Executive Officer) | | March 16, 2006 |
| |
/s/ ANDREW J. BONANNI
(Andrew J. Bonanni) | | | | Chief Financial Officer (Principal Financial and Accounting Officer) | | March 16, 2006 |
| |
/s/ ROBERT E. EVANSON
(Robert E. Evanson) | | | | Director | | March 16, 2006 |
| |
/s/ RICHARD KATZMAN
(Richard Katzman) | | | | Director | | March 16, 2006 |
| |
/s/ JOHN C. REID
(John C. Reid) | | | | Director | | March 16, 2006 |
| |
/s/ RICHARD SARNOFF
(Richard Sarnoff) | | | | Director | | March 16, 2006 |
| |
/s/ SHEREE T. SPEAKMAN
(Sheree T. Speakman) | | | | Director | | March 16, 2006 |
| |
/s/ HOWARD A. TULLMAN
(Howard A. Tullman) | | | | Director | | March 16, 2006 |
81
