SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
CURRENT REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of Earliest Event Reported): September 2, 2003
EDUCATION MANAGEMENT CORPORATION
(Exact Name of Registrant as Specified in Charter)
| Pennsylvania | 000-21363 | 25-1119571 | ||
| (State or Other Jurisdiction of incorporation) | (Commission File Number) | (IRS Employer Identification No.) |
| 210 Sixth Avenue, Pittsburgh, Pennsylvania | 15222 | |
| (Address of Principal Executive Offices) | (Zip Code) |
Registrant’s telephone number, including area code: (412) 562-0900
| ITEM 2. | ACQUISITION OR DISPOSITION OF ASSETS. |
On September 2, 2003, Education Management Corporation (“EDMC”) announced that it had closed its purchase of all of the outstanding shares (the “Shares”) of American Education Centers, Inc., Asher School of Business Education Corporation, Brown Mackie Education Corporation, Commonwealth Business College Education Corporation, Michiana College Education Corporation, and Stautzenberger College Education Corporation. In addition, Southern Ohio College, LLC, a wholly-owned subsidiary of the entities listed above, was acquired in this purchase. Collectively, these entities are referred to as American Education Centers (“AEC”). The acquisition of AEC was pursuant to the terms and conditions of a Stock Purchase Agreement dated as of June 24, 2003. The Shares were beneficially owned by certain individuals and trusts. The aggregate cash purchase price for the Shares was $112.5 million (which amount included approximately $70 million paid by EDMC two business days after the closing date); EDMC also assumed $3.5 million of debt. The purchase price for the Shares was determined in arms’ length negotiations.
EDMC funded the stock purchase by borrowings under its credit facility with National City Bank as agent for a syndicate of lenders.
AEC, with approximately 5,800 students currently, offers diploma and associate’s degree programs. AEC is headquartered in a suburb of Cincinnati, Ohio and operates 18 education institutions in eight states. Its academic programs include medical assisting, licensed practical nursing, occupational therapy assisting, physical therapy assisting, business management, accounting, network engineering, computer applications, computer programming, electronics engineering, paralegal studies, criminal justice, audio-video production and computer-aided design. EDMC intends to continue AEC’s programs.
| ITEM 7. | FINANCIAL STATEMENTS AND EXHIBITS |
| Page | ||||
(a) Financial Statements of Businesses Acquired | ||||
(i) | American Education Centers, Inc. | |||
Independent Auditor’s Report | F-1 | |||
Balance Sheet as of December 31, 2002 | F-2 | |||
Statement of Income for the year ended December 31, 2002 | F-4 | |||
Statement of Stockholders’ Equity for the year ended December 31, 2002 | F-5 | |||
Statement of Cash Flows for the year ended December 31, 2002 | F-6 | |||
Notes to Financial Statements | F-7 | |||
Supplementary Information | F-14 | |||
Independent Auditors’ Report | F-17 | |||
(ii) | Asher School of Business Education Corporation | |||
Independent Auditor’s Report | F-18 | |||
Balance Sheet as of December 31, 2002 | F-19 | |||
Statement of Income for the year ended December 31, 2002 | F-20 | |||
Statement of Stockholders’ Equity for the year ended December 31, 2002 | F-21 | |||
Statement of Cash Flows for the year ended December 31, 2002 | F-22 | |||
Notes to Financial Statements | F-23 | |||
Supplementary Information | F-28 | |||
Independent Auditors’ Report | F-31 | |||
(iii) | Brown Mackie Education Corporation | |||
Independent Auditor’s Report | F-32 | |||
Balance Sheet as of December 31, 2002 | F-33 | |||
Statement of Income for the year ended December 31, 2002 | F-35 | |||
Statement of Stockholders’ Equity for the year ended December 31, 2002 | F-36 | |||
Statement of Cash Flows for the year ended December 31, 2000 | F-37 | |||
Notes to Financial Statements | F-38 | |||
Supplementary Information | F-45 | |||
Independent Auditors’ Report | F-48 | |||
(iv) | Commonwealth Business College Education Corporation | |||
Independent Auditor’s Report | F-49 | |||
Balance Sheet as of December 31, 2002 | F-50 | |||
Statement of Income for the year ended December 31, 2002 | F-51 | |||
Statement of Stockholders’ Equity for the year ended December 31, 2002 | F-52 | |||
Statement of Cash Flows for the year ended December 31, 2002 | F-53 | |||
Notes to Financial Statements | F-54 | |||
Supplementary Information | F-60 | |||
Independent Auditors’ Report | F-63 | |||
(v) | Michiana College Education Corporation | |||
Independent Auditor’s Report | F-64 | |||
Balance Sheet as of December 31, 2002 | F-65 | |||
Statement of Income for the year ended December 31, 2002 | F-66 | |||
Statement of Stockholders’ Equity for the year ended December 31, 2002 | F-67 | |||
Statement of Cash Flows for the year ended December 31, 2002 | F-68 | |||
Notes to Financial Statements | F-69 | |||
Supplementary Information | F-75 | |||
Independent Auditors’ Report | F-78 | |||
(vi) | Southern Ohio College, LLC | |||
Independent Auditor’s Report | F-79 | |||
Balance Sheet as of December 31, 2002 | F-80 | |||
Statement of Income for the year ended December 31, 2002 | F-81 | |||
Statement of Stockholders’ Equity for the year ended December 31, 2002 | F-82 | |||
Statement of Cash Flows for the year ended December 31, 2002 | F-83 | |||
Notes to Financial Statements | F-87 | |||
Supplementary Information | F-89 | |||
Independent Auditors’ Report | ||||
| Page | ||||
(vii) | Stautzenberger College Education Corporation | |||
Independent Auditor’s Report | F-90 | |||
Balance Sheet as of December 31, 2002 | F-91 | |||
Statement of Income for the year ended December 31, 2002 | F-92 | |||
Statement of Stockholders’ Equity for the year ended December 31, 2002 | F-93 | |||
Statement of Cash Flows for the year ended December 31, 2002 | F-94 | |||
Notes to Financial Statements | F-95 | |||
Supplementary Information | F-100 | |||
Independent Auditors’ Report | F-103 | |||
(viii) | American Education Centers, Inc. | |||
Condensed Balance Sheet as of June 30, 2003 (unaudited) | F-104 | |||
Condensed Statements of Income for the years ended June 30, 2002 and 2003 (unaudited) | F-105 | |||
Condensed Statements of Cash Flows for the years ended June 30, 2002 and 2003 (unaudited) | F-106 | |||
Notes to Condensed Financial Statements | F-107 | |||
(ix) | Asher School of Business Education Corporation | |||
Condensed Balance Sheet as of June 30, 2003 (unaudited) | F-108 | |||
Condensed Statements of Income for the years ended June 30, 2002 and 2003 (unaudited) | F-109 | |||
Condensed Statements of Cash Flows for the years ended June 30, 2002 and 2003 (unaudited) | F-110 | |||
Notes to Condensed Financial Statements | F-111 | |||
(x) | Brown Mackie Education Corporation | |||
Condensed Balance Sheet as of June 30, 2003 (unaudited) | F-112 | |||
Condensed Statements of Income for the years ended June 30, 2002 and 2003 (unaudited) | F-113 | |||
Condensed Statements of Cash Flows for the years ended June 30, 2002 and 2003 (unaudited) | F-114 | |||
Notes to Condensed Financial Statements | F-115 | |||
(xi) | Commonwealth Business College Education Corporation | |||
Condensed Balance Sheet as of June 30, 2003 (unaudited) | F-116 | |||
Condensed Statements of Income for the years ended June 30, 2002 and 2003 (unaudited) | F-117 | |||
Condensed Statements of Cash Flows for the years ended June 30, 2002 and 2003 (unaudited) | F-118 | |||
Notes to Condensed Financial Statements | F-119 | |||
(xii) | Michiana College Education Corporation | |||
Condensed Balance Sheet as of June 30, 2003 (unaudited) | F-120 | |||
Condensed Statements of Income for the years ended June 30, 2002 and 2003 (unaudited) | F-121 | |||
Condensed Statements of Cash Flows for the years ended June 30, 2002 and 2003 (unaudited) | F-122 | |||
Notes to Condensed Financial Statements | F-123 | |||
(xiii) | Southern Ohio College, LLC | |||
Condensed Balance Sheet as of June 30, 2003 (unaudited) | F-124 | |||
Condensed Statements of Income for the years ended June 30, 2002 and 2003 (unaudited) | F-125 | |||
Condensed Statements of Cash Flows for the years ended June 30, 2002 and 2003 (unaudited) | F-126 | |||
Notes to Condensed Financial Statements | F-127 | |||
(xiv) | Stautzenberger College Education Corporation | |||
Condensed Balance Sheet as of June 30, 2003 (unaudited) | F-128 | |||
Condensed Statements of Income for the years ended June 30, 2002 and 2003 (unaudited) | F-129 | |||
Condensed Statements of Cash Flows for the years ended June 30, 2002 and 2003 (unaudited) | F-130 | |||
Notes to Condensed Financial Statements | F-131 | |||
(b) Pro forma financial information (unaudited) | ||||
Pro forma financial statements of Education Management Corporation | ||||
(i) | Pro forma background and introduction | F-132 | ||
(ii) | Pro forma Condensed Consolidated Balance Sheet as of June 30, 2003 | F-133 | ||
(iii) | Pro forma Consolidated Statement of Income for the year ended June 30, 2003 | F-134 | ||
(c) Exhibit Index | ||||
| Exhibit No. | Description | |
| 2.1 | Stock Purchase Agreement dated as of June 24, 2003 by and among Education Management Corporation and Russell E. Palmer, Bradley C. Palmer, The Stephen R. Palmer Living Trust, The Russell E. Palmer III Living Trust, The Karen J. Korfmann Living Trust, Michael Masin, Connie Walter, Technology Leaders L.P., Technology Leaders First Corp., J. William Brooks, Gerard Francois, Danny Finuf, The Companies Signatory Thereto and Sellers’ Representative, incorporated by reference to Exhibit 2.1 to the Report on Form 8-K filed by Education Management Corporation on September 17, 2003 (the “September 2003 8-K”). | |
| 4.1 | Second Amended and Restated Credit Agreement dated as of August 18, 2003 by and among Education Management Corporation as the Borrower, The Banks Party Thereto as the Banks and National City Bank of Pennsylvania as the Agent and Wachovia Bank, National Association, as Syndication Agent, Suntrust Bank, as Syndication Agent, Fleet National Bank, as Documentation Agent, and JPMorgan Chase Bank, as Documentation Agent, incorporated by reference to Exhibit 4.1 to the September 2003 8-K. | |
| 23.1 | Consent of Almich & Associates, independent auditors for American Education Centers, Inc., filed herewith. | |
To the Board of Directors and
Stockholders of American Education Centers, Inc.:
We have audited the accompanying balance sheet of American Education Centers, Inc. (a Delaware corporation) as of December 31, 2002, and the related statements of income, stockholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America andGovernment Auditing Standards, issued by the Comptroller General of the 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of American Education Centers, Inc. as of December 31, 2002, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying supplementary information on page 15 on American Education Centers, Inc.’s calculation of its Title IV 90/10 revenue test and on related party transactions are required by the U.S. Department of Education and are presented for purposes of additional analysis and are not a required part of the basic financial statements. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.
In accordance withGovernment Auditing Standards, we have also issued our report dated February 14, 2003 on our consideration of American Education Centers, Inc.’s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grants.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
website: www.almichcpa.com • email: info@almichcpa.com
AMERICAN EDUCATION CENTERS, INC.
Balance Sheet
December 31, 2002
Assets
Current assets: | |||
Cash | $ | 1,393,424 | |
Accounts receivable, net of allowance for doubtful accounts of $1,023,900 | 1,049,274 | ||
Secured related party receivables | 1,570,000 | ||
Prepaid expenses and other | 716,132 | ||
Deferred initial direct costs | 890,100 | ||
Total current assets | 5,618,930 | ||
Property, equipment and improvements, net of accumulated depreciation and amortization of $2,142,478 | 3,980,852 | ||
Due from related parties, net | 248,611 | ||
Investment in affiliate | 420,000 | ||
Deposits and other | 91,323 | ||
| $ | 10,359,716 | ||
See notes to financial statements
F-2
AMERICAN EDUCATION CENTERS, INC.
Balance Sheet
December 31, 2002
Liabilities and Stockholders’ Equity
Current liabilities: | ||||
Accounts payable | $ | 344,584 | ||
Accrued expenses | 1,173,480 | |||
Unearned tuition | 2,093,009 | |||
Current portion of notes and debentures payable | 180,000 | |||
Total current liabilities | 3,791,073 | |||
Notes and debentures payable, net of current portion | 2,264,402 | |||
Total liabilities | 6,055,475 | |||
Stockholders’ equity: | ||||
Class A common stock, $.01 par value, 10,000 shares authorized | 10 | |||
Class B nonvoting common stock, $.01 par value, 10,000 shares authorized | 10 | |||
Additional paid-in capital | 1,879,909 | |||
Retained earnings | 4,156,614 | |||
| 6,036,543 | ||||
Treasury stock, at cost | (1,732,302 | ) | ||
Total stockholders’ equity | 4,304,241 | |||
| $ | 10,359,716 | |||
See notes to financial statements
F-3
AMERICAN EDUCATION CENTERS, INC.
Statement of Income
For The Year Ended December 31, 2002
Revenues | $ | 22,612,741 | ||
Costs and expenses: | ||||
Course materials, services and instruction | 7,450,007 | |||
Selling and promotion | 4,447,173 | |||
General and administrative | 3,537,690 | |||
Facilities | 2,717,862 | |||
Depreciation and amortization | 1,097,257 | |||
Total costs and expenses | 19,249,989 | |||
Income from operations | 3,362,752 | |||
Other income (expense): | ||||
Loss on disposal of fixed assets | (1,824 | ) | ||
Interest income | 87,700 | |||
Interest expense | (132,921 | ) | ||
Other income (expense): | 943 | |||
Total other income (expense) | (46,102 | ) | ||
Income before provision for income taxes | 3,316,650 | |||
Provision for income taxes | — | |||
Net income | $ | 3,316,650 | ||
See notes to financial statements
F-4
AMERICAN EDUCATION CENTERS, INC.
Statement of Stockholders’ Equity
For The Year Ended December 31, 2002
| Class A Common Stock | Class B Nonvoting Common Stock | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Total Stockholders' Equity | ||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | ||||||||||||||||||||||
Balance, beginning of year | 521.21 | $ | 10 | 443.42 | $ | 10 | $ | 1,701,759 | $ | 2,641,364 | 435.36 | $ | (1,732,302 | ) | $ | 2,610,841 | |||||||||||
Net income | — | — | — | — | — | 3,316,650 | — | — | 3,316,650 | ||||||||||||||||||
Distributions to stockholders for payment of income taxes | — | — | — | — | — | (1,693,400 | ) | — | — | (1,693,400 | ) | ||||||||||||||||
Distributions to stockholders | — | — | — | — | — | (108,000 | ) | — | — | (108,000 | ) | ||||||||||||||||
Stock compensation expense | — | — | — | — | 96,025 | — | — | — | 96,025 | ||||||||||||||||||
Recognition of restricted stock compensation | — | — | — | — | 82,125 | — | — | — | 82,125 | ||||||||||||||||||
Balance, end of year | 521.21 | $ | 10 | 443.42 | $ | 10 | $ | 1,879,909 | $ | 4,156,614 | 435.36 | $ | (1,732,302 | ) | $ | 4,304,241 | |||||||||||
See notes to financial statements
F-5
AMERICAN EDUCATION CENTERS, INC.
Statement of Cash Flows
For The Year Ended December 31, 2002
Cash flows from operating activities: | ||||
Net income | $ | 3,316,650 | ||
Adjustments to reconcile net income to net cash provided by operating activities - | ||||
Depreciation and amortization | 1,097,257 | |||
Stock compensation expense | 96,025 | |||
Recognition of restricted stock compensation | 82,125 | |||
Loss on disposal of fixed assets | 1,824 | |||
Changes in operating assets and liabilities - | ||||
Accounts receivable, net | 71,833 | |||
Prepaid expenses and other | (13,767 | ) | ||
Deferred initial direct costs | 37,000 | |||
Deposits and other | 1,072 | |||
Accounts payable | 14,222 | |||
Accrued expenses | (168,106 | ) | ||
Unearned tuition | 319,383 | |||
Net cash provided by operating activities | 4,855,518 | |||
Cash flows from investing activities: | ||||
Purchases of property, equipment and improvements | (1,032,367 | ) | ||
Investment in affiliate | (420,000 | ) | ||
Net cash used by investing activities | (1,452,367 | ) | ||
Cash flows from financing activities: | ||||
Payments on note payable | (180,000 | ) | ||
Principal payments on capital lease obligation | (10,391 | ) | ||
Increase in secured related party receivables | (770,000 | ) | ||
Increase in amounts due from related parties, net | (15,168 | ) | ||
Distributions to stockholders for payment of income taxes | (1,693,400 | ) | ||
Distributions to stockholders | (108,000 | ) | ||
Net cash used by financing activities | (2,776,959 | ) | ||
Increase in cash | 626,192 | |||
Cash, beginning of year | 767,232 | |||
Cash, end of year | $ | 1,393,424 | ||
Supplemental cash flows information: | ||||
Cash paid for - | ||||
Interest expense | $ | 130,049 | ||
Income taxes | $ | — | ||
See notes to financial statements
F-6
AMERICAN EDUCATION CENTERS, INC.
Notes to Financial Statements
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
American Education Centers, Inc. (the Company) was incorporated on June 2, 1993, in the state of Delaware and is engaged in the business of operating private two year colleges. The Company provides career training for business, medical and technical professions.
The Company’s eight campuses are located in Akron and Cincinnati, Ohio, Ft. Mitchell, Hopkinsville and Louisville, Kentucky, Pittsburgh, Pennsylvania, as well as Garland and Hurst, Texas.
Basis of Presentation
The accompanying financial statements include the accounts of the Company, as well as its 20% equity interest in the earnings of Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $420,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002.
Property, Equipment and Improvements
Property, equipment and improvements are stated at cost. Depreciation and amortization are provided for using the straight-line basis over the following estimated useful lives.
Furniture and equipment | 3 to 7 years | |
Buildings | 30 years | |
Leasehold improvements | Shorter of lease term or useful life |
When property, equipment and improvements are sold or otherwise disposed of, the asset and related depreciation and amortization are removed from the accounts and any resulting gain or loss is recorded in income for the period.
Revenue Recognition
Revenues are derived primarily from tuition on courses taught in the Company’s career schools. Tuition revenue is recognized on a straight-line basis over the term of instruction. Deferred initial direct costs, consisting primarily of marketing expenses, are deferred and amortized over a period not to exceed the term of instruction. Unearned tuition results when cash collected on a student’s account exceeds tuition revenue recognized at the balance sheet date.
Accounts Receivable
Accounts receivable are recorded at the net realizable value expected to be received from students or third-party payors. Management continually monitors and adjusts its allowances associated with the Company’s receivables to address any credit risks associated with the accounts receivable. When uncertainty exists as to the collection of receivables, the Company records an allowance for doubtful accounts and a corresponding charge to bad debt expense.
F-7
Income Taxes
The Company operates as a Subchapter S Corporation. As such, the income and expenses of the Company pass through directly to the stockholders and are reported on their individual income tax returns. Accordingly, no provision for income taxes is recorded in the accompanying financial statements.
Stock-Based Compensation
The Company follows Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation”, which establishes a fair value based method of accounting for stock-based compensation plans.
Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.
NOTE 2 - PROPERTY, EQUIPMENT AND IMPROVEMENTS
Property, equipment and improvements consisted of the following as of December 31, 2002:
Land | $ | 79,809 | ||
Buildings and improvements | 422,971 | |||
Furniture and equipment | 3,813,905 | |||
Leasehold improvements | 1,462,754 | |||
Construction in progress | 343,891 | |||
| 6,123,330 | ||||
Less: accumulated depreciation and amortization | (2,142,478 | ) | ||
| $ | 3,980,852 | |||
Depreciation and amortization expense related to property, equipment and improvements was $1,097,257 for the year ended December 31, 2002.
NOTE 3 - NOTES AND DEBENTURES PAYABLE
Notes and debentures payable consisted of the following as of December 31, 2002:
Note payable to a bank, originating during the year ended December 31, 2000, due to the purchase of fixed assets for facility renovations, equipment, furniture and fixtures, collateralized by all assets of the Company and other educational corporations owned by the Company’s stockholders, payable in monthly principal installments of $15,000 plus accrued interest at the bank’s prime rate (4.25% at December 31, 2002), with any remaining principal balance and all accrued interest due on June 1, 2006. | $ | 1,090,000 | ||
5.5% Senior Subordinated Debentures, related to the purchase of the net assets of the institution, due March 31, 2004, with interest payable semi-annually. The debentures include non-detachable Series A, Series B and Series C warrants to purchase in the aggregate up to 148.48, 21.45 and 6.5359 shares, respectively, of the Company’s Class A common stock and Class B common stock. | 1,212,701 | |||
5.5% Senior Subordinated Debentures, related to the purchase of the net assets of the institution, due March 31, 2004, with interest payable semi-annually. The debentures include non-detachable Series D, Series E and Series F warrants to purchase in the aggregate up to 59.39, 8.58 and 2.61 shares, respectively, of the Company’s Class A common stock and Class B common stock. | 141,701 | |||
| 2,444,402 | ||||
Less: current portion | (180,000 | ) | ||
| $ | 2,264,402 | |||
F-8
Future maturities under the terms of the above described agreements as of December 31, 2002, are as follows:
Year Ending | |||
2003 | $ | 180,000 | |
2004 | 1,534,402 | ||
2005 | 180,000 | ||
2006 | 550,000 | ||
| $ | 2,444,402 | ||
The Company and other educational corporations owned by the stockholders of the Company have a line of credit with a bank which expires June 1, 2003. As of December 31, 2002, borrowing capacity under the line of credit was $1,735,100 and there were no outstanding borrowings. Borrowings bear interest at the bank’s prime rate (4.25% at December 31, 2002) and are collateralized by all assets of the Company and the other educational corporations owned by the Company’s stockholders.
As of December 31, 2002, the Company was co-guarantor and its assets secured outstanding credit facilities of $3,335,760 of another educational corporation owned by the stockholders of the Company. In addition, the Company guarantees $940,000 of notes payable of related educational institutions.
The bank debt contains certain financial covenants, among others, as to maintenance of deposits with a combined balance of $75,000, limitations on additional indebtedness, dispositions of assets, transactions with related entities, as well as maintenance of a specified capital base and level of earnings, as defined in the agreement. As of December 31, 2002, the Company was in compliance with such financial covenants.
F-9
NOTE 4 - CAPITAL LEASE OBLIGATION
The Company had leased equipment under the terms of a non-cancelable capital lease agreement. The capital lease was paid in full during the year ended December 31, 2002.
NOTE 5 - RELATED PARTY TRANSACTIONS
As of December 31, 2002, the Company had $1,570,000 in secured receivables from three educational corporations owned by the stockholders of the Company. Such receivables were under the terms of a Security Agreement, were secured and collateralized by all assets of the educational corporations, and were to be repaid by January 31, 2003. These $1,570,000 in secured receivables were fully repaid subsequent to December 31, 2002.
The Company advances and receives funds with other educational corporations owned by the stockholders of the Company. Net amounts advanced as of December 31, 2002, amounted to $248,611. These amounts are non-interest bearing, secured by the educational corporations’ assets and have no stipulated repayment provisions.
During the year ended December 31, 2002, the Company paid management fees of $189,996, to an entity owned by one of the Company’s stockholders. The Company also charged administrative fees of $2,050,000 to its eight campuses, as well as $2,350,000 to other educational corporations owned by the stockholders of the Company. Such fees are reflected within general and administrative expenses in the accompanying statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
The Company leases certain equipment from an entity which is owned by one of the stockholders and an officer of the Company. The lease has a stipulated term of 10 years, but may be cancelled by the Company with 90 days notice. Base monthly lease payments constructively paid to this related entity during the year ended December 31, 2002, amounted to $212,271, and are reflected within general and administrative expense in the accompanying statement of income. In addition to the base monthly lease payments, the Company is also responsible for the maintenance and operating costs of the equipment.
F-10
Investment In Affiliate
Summarized financial position and results of operations for the Company’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity
Effective August 7, 2001, the Company entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 84.76 shares of the Company’s restricted Class A common stock with a fair market value of $4,844 per share as consideration for providing certain consultancy and advisory services to the Company. The restricted stock will be held by the Company until terms and conditions specified by the Company are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $82,125 during the year ended December 31, 2002.
The Company has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Company, subject to adjustment for changes in the Company’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accompanying financial statements for these options as vesting is contingent upon the Company achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and become vested and exercisable ratably over a five year period. The option price is $10 for all shares, regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Company’s stock at the grant date was immaterial. Vested options at December 31, 2001 were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been recognized in the accompanying statement of income within general and administrative expense as well as within additional paid-in capital.
NOTE 6 – COMMITMENTS AND CONTINGENCIES
Commitments
The Company leases its operating facilities under noncancelable agreements expiring at various dates through July 2007. The leases generally require the Company to pay certain operating expenses of the facilities in addition to base monthly rent. Certain of the leases contain renewal options and rent escalation clauses. Rent escalation clauses require either fixed increases or increases tied to the consumer price index.
F-11
The following is a schedule by year of future minimum rental payments required under noncancelable operating leases as of December 31, 2002:
Year Ending | |||
2003 | $ | 1,957,758 | |
2004 | 1,979,386 | ||
2005 | 1,807,453 | ||
2006 | 1,143,866 | ||
2007 | 555,545 | ||
Thereafter | 97,703 | ||
| $ | 7,541,711 | ||
Rent expense for the year ended December 31, 2002, amounted to approximately $2,063,000 and is included in facilities expense on the accompanying statement of income.
Contingencies
The Company has irrevocable standby letters of credit totaling $245,300 in favor of the U.S. Department of Education (ED) due to late refunds. As of December 31, 2002, the letters of credit have never been drawn upon.
NOTE 7 - 401(K) PLAN
The Company has a 401(k) plan covering substantially all of its employees. The Company matches 100% of the first 3% of employee contributions to the plan. Company contributions vest according to a schedule, become fully vested after six years and amounted to approximately $104,800 for the year ended December 31, 2002. The Company may elect to contribute additional amounts to the Plan as determined by the board of directors. Company discretionary contributions during the year ended December 31, 2002 amounted to $184,800.
NOTE 8 - CONCENTRATION OF CREDIT RISK AND REGULATORY CONSIDERATIONS
The Company had cash balances with a bank in excess of the federally insured amount of $100,000 as of December 31, 2002.
The Company participates in Government Student Financial Assistance Programs (Title IV) administered by ED for the payment of student tuitions. Substantial portions of the revenue and collection of ending accounts receivable as of December 31, 2002, are dependent upon the Company’s continued participation in the Title IV programs. Institutions participating in Title IV programs may not receive more than 90% of tuition collections (90/10 revenue test as defined in regulation) from Title IV sources in order to maintain eligibility for participation in such programs. For the year ended December 31, 2002, the Company complied with ED’s standards pertaining to the 90/10 eligibility calculations. ED requires an institution to provide additional information with respect to its 90/10 revenue test. Reference is made to the accompanying Supplementary Information on page 15 with respect to additional disclosures required by ED.
F-12
Institutions participating in Title IV programs are also required by ED to demonstrate financial responsibility. ED determines an institution’s financial responsibility through the calculation of a composite score based upon certain financial ratios as defined in regulations. Institutions receiving a composite score of 1.5 or greater are considered fully financially responsible. Institutions receiving a composite score between 1.0 and 1.4 are subject to additional monitoring and institutions receiving a score below 1.0 are required to submit financial guarantees in order to continue participation in the Title IV programs. As of December 31, 2002, and for the year then ended, the Company’s composite score was 2.6.
F-13
AMERICAN EDUCATION CENTERS, INC.
SUPPLEMENTARY INFORMATION
(Information Required by the U.S. Department of Education)
December 31, 2002
Institution’s Calculation of 90/10 Revenue Test
American Education Centers, Inc. (the Institution) derives a substantial portion of its revenues from Student Financial Aid (SFA) received by its students under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). To continue to participate in the SFA programs the Institution must comply with the regulations promulgated under HEA. The regulations restrict the proportion of cash receipts for tuition and fees from eligible programs to not more than 90 percent from the Title IV programs. The failure of the Institution to meet the 90 percent limitation will result in the loss of the Institution’s ability to participate in SFA programs. For the year ended December 31, 2002, the Institution’s 90/10 revenue test percentages were computed as follows:
Southern Ohio College - OPE ID No. 005127 | ||||
Title IV Funds | $ | 13,571,432 | ||
Total Funds | $ | 17,635,339 | ||
Percent Title IV | 77.0 | % | ||
RETS Electronic Institute - OPE ID No. 021082 | ||||
Title IV Funds | $ | 4,362,365 | ||
Total Funds | $ | 5,248,905 | ||
Percent Title IV | 83.1 | % |
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
Related Party Transactions
American Education Centers, Inc. (the Institution) participates in Student Financial Aid (SFA) under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). The Institution must comply with the regulations promulgated under HEA. Those regulations require that all related party transactions be disclosed, regardless of their materiality to the financial statements.
Distributions to Stockholders – During the year ended December 31, 2002, the Institution made distributions of $1,801,400 to its stockholders, of which $1,693,400 was for the payment of income taxes.
Management and Administrative Fees – During the year ended December 31, 2002, the Institution paid management fees of $189,996 to an entity owned by one of the Institution’s stockholders. The Institution also charged administrative fees of $2,050,000 to its eight campuses, as well as $2,350,000 to other educational corporations owned by the stockholders of the Institution. The amounts charged represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support and were as follows:
Asher School of Business Education Corporation | $ | 150,000 | |
Brown Mackie Education Corporation | 150,000 | ||
Commonwealth Business College Education Corporation | 700,000 | ||
Michiana College Education Corporation | 1,000,000 | ||
Stautzenberger College Education Corporation | 250,000 | ||
Southern Ohio College, LLC | 100,000 | ||
| $ | 2,350,000 | ||
F-14
Secured Related Party Receivables - As of December 31, 2002, the Institution had $1,570,000 in secured receivables from three educational corporations owned by the stockholders of the Institution. Such receivables were under the terms of a Security Agreement, were secured and collateralized by all assets of the educational corporations, and were to be repaid by January 31, 2003. These $1,570,000 in secured receivables were fully repaid subsequent to December 31, 2002. The secured receivables at December 31, 2002, were from the following corporations:
Michiana College Education Corporation | $ | 430,000 | |
Commonwealth Business College Education Corporation | 680,000 | ||
Brown Mackie Education Corporation | 460,000 | ||
| $ | 1,570,000 | ||
Due From Related Parties, net - The Institution advances and receives funds with other educational corporations owned by the stockholders of the Institution. These amounts are non-interest bearing, secured by the educational corporations’ assets and have no stipulated repayment provisions. Amounts advanced as of December 31, 2002, were due from (to) the following corporations:
Asher School of Business Education Corporation | $ | 187,751 | ||
Brown Mackie Education Corporation | 6,583 | |||
Commonwealth Business College Education Corporation | 690 | |||
Michiana College Education Corporation | 7,879 | |||
Stautzenberger College Education Corporation | (142,014 | ) | ||
Southern Ohio College, LLC | 187,722 | |||
| $ | 248,611 | |||
Equipment Rental - The Institution leases certain equipment from an entity which is owned by one of the stockholders and an officer of the Institution. The lease has a stipulated term of 10 years, but may be cancelled by the Institution with 90 days notice. Base monthly lease payments constructively paid to this related entity during the year ended December 31, 2002, amounted to $212,271, and are reflected within general and administrative expense in the accompanying statement of income. In addition to the base monthly lease payment the Institution is also responsible for the maintenance and operating costs of the equipment.
Contingency - As of December 31, 2002, the Institution was co-guarantor and its assets secured outstanding credit facilities of $3,335,760 of Brown Mackie Education Corporation, another educational corporation owned by the stockholders of the Institution. In addition, the Institution guarantees $100,000 of a note payable of Michiana College Education Corporation and a $840,000 note payable of Southern Ohio College, LLC.
F-15
Investment In Affiliate - The accompanying financial statements include the accounts of the Institution, as well as its 20% interest in Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Institution’s investment in SOC is accounted for using the equity method of accounting as the Institution exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $420,000, adjusted for the Institution’s proportionate share of earnings or losses. The Institution’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002. Summarized financial position and results of operations for the Institution’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity
Effective August 7, 2001, the Institution entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 84.76 shares of the Institution’s restricted Class A common stock with a fair market value of $4,844 per share as consideration for providing certain consultancy and advisory services to the Institution. The restricted stock will be held by the Institution until terms and conditions specified by the Institution are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $82,125 during the year ended December 31, 2002.
The Institution has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Institution, subject to adjustment for changes in the Institution’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accompanying financial statements for these options as vesting is contingent upon the Institution achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and become vested and exercisable ratably over a five year period. The option price is $10 for all shares, regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Institution’s stock at the grant date was immaterial. Vested options at December 31, 2002 were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been recognized in the accompanying statement of income within general and administrative expenses as well as within additional paid-in capital.
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
F-16
INDEPENDENT AUDITORS’ REPORT ON COMPLIANCE AND
ON INTERNAL CONTROL OVER FINANCIAL REPORTING BASED ON
AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE
WITHGOVERNMENT AUDITING STANDARDS
To the Board of Directors and
Stockholders of American Education Centers, Inc.:
We have audited the financial statements of American Education Centers, Inc. as of and for the year ended December 31, 2002, and have issued our report thereon dated February 14, 2003. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained inGovernment Auditing Standards, issued by the Comptroller General of the United States.
Compliance
As part of obtaining reasonable assurance about whether American Education Centers, Inc.’s financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grants, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance that are required to be reported underGovernment Auditing Standards.
Internal Control Over Financial Reporting
In planning and performing our audit, we considered American Education Centers, Inc.’s internal control over financial reporting in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on internal control over financial reporting. Our consideration of internal control over financial reporting would not necessarily disclose all matters in internal control over financial reporting that might be material weaknesses. A material weakness is a condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. We noted no matters involving internal control over financial reporting and its operation that we consider to be material weaknesses.
This report is intended solely for the information and use of the board of directors, management, and the U.S. Department of Education and is not intended to be and should not be used by anyone other than these specified parties.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
website: www.almichcpa.com • email: info@almichcpa.com
F-17
To the Board of Directors and Stockholders of
Asher School of Business Education Corporation:
We have audited the accompanying balance sheet of Asher School of Business Education Corporation (a Delaware corporation) as of December 31, 2002, and the related statements of income, stockholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America andGovernment Auditing Standards, issued by the Comptroller General of the 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Asher School of Business Education Corporation as of December 31, 2002, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying supplementary information on page 11 on Asher School of Business Education Corporation’s calculation of its Title IV 90/10 revenue test and on related party transactions are required by the U.S. Department of Education and are presented for purposes of additional analysis and are not a required part of the basic financial statements. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.
In accordance withGovernment Auditing Standards, we have also issued our report dated February 14, 2003, on our consideration of Asher School of Business Education Corporation’s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts and grants.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
website: www.almichcpa.com • email: info@almichcpa.com
F-18
ASHER SCHOOL OF BUSINESS EDUCATION CORPORATION
Balance Sheet
December 31, 2002
Assets
Current assets: | ||||
Cash | $ | 257,909 | ||
Accounts receivable, net of allowance for doubtful accounts of $77,600 | 80,067 | |||
Prepaid expenses and other | 53,298 | |||
Deferred initial direct costs | 168,100 | |||
Total current assets | 559,374 | |||
Furniture, equipment and improvements, net of accumulated depreciation and amortization of $128,166 | 65,693 | |||
Other assets: | ||||
Investment in affiliate | 210,000 | |||
Goodwill | 316,208 | |||
Total other assets | 526,208 | |||
| $ | 1,151,275 | |||
| Liabilities and Stockholders’ Equity | ||||
Current liabilities: | ||||
Accounts payable | $ | 8,943 | ||
Accrued expenses | 77,497 | |||
Unearned tuition | 166,671 | |||
Total current liabilities | 253,111 | |||
Advances from related party | 187,751 | |||
Senior subordinated debentures | 90,000 | |||
Total liabilities | 530,862 | |||
Stockholders’ equity: | ||||
Class A common stock, $.01 par value, 1,000 shares authorized | 5 | |||
Class B nonvoting common stock, $.01 par value, 1,000 shares authorized | 5 | |||
Additional paid-in capital | 1,603,228 | |||
Accumulated deficit | (698,245 | ) | ||
| 904,993 | ||||
Treasury stock, at cost | (284,580 | ) | ||
Total stockholders’ equity | 620,413 | |||
| $ | 1,151,275 | |||
See notes to financial statements
F-19
ASHER SCHOOL OF BUSINESS EDUCATION CORPORATION
Statement of Income
For The Year Ended December 31, 2002
Revenues | $ | 1,857,546 | ||
Costs and expenses: | ||||
Course materials, service and instruction | 606,939 | |||
Selling and promotion | 445,191 | |||
General and administrative | 510,633 | |||
Facilities | 186,852 | |||
Depreciation and amortization | 32,927 | |||
Total costs and expenses | 1,782,542 | |||
Income from operations | 75,004 | |||
Other income (expense): | ||||
Loss on disposal of fixed assets | (420 | ) | ||
Interest expense | (4,951 | ) | ||
Other income (expense) | 63 | |||
Total other income (expense) | (5,308 | ) | ||
Income before provision for income taxes | 69,696 | |||
Provision for income taxes | — | |||
Net income | $ | 69,696 | ||
See notes to financial statements
F-20
ASHER SCHOOL OF BUSINESS EDUCATION CORPORATION
Statement of Stockholders’ Equity
For The Year Ended December 31, 2002
| Class A Common Stock | Class B Nonvoting Common Stock | Additional Paid-in Capital | Accumulated Deficit | Treasury Stock | Total Stockholders’ Equity | ||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | ||||||||||||||||||||||
Balance, beginning of year | 331.18 | $ | 5 | 365 | $ | 5 | $ | 1,524,696 | $ | (663,857 | ) | 303.82 | $ | (284,580 | ) | $ | 576,269 | ||||||||||
Net income | — | — | — | — | — | 69,696 | — | — | 69,696 | ||||||||||||||||||
Distributions to stockholders for payment of income taxes | — | — | — | — | — | (66,080 | ) | — | — | (66,080 | ) | ||||||||||||||||
Distributions to stockholders | — | — | — | — | — | (38,004 | ) | — | — | (38,004 | ) | ||||||||||||||||
Recognition of restricted stock compensation | — | — | — | — | 59,294 | — | — | — | 59,294 | ||||||||||||||||||
Stock compensation expense | — | — | — | — | 19,238 | — | — | — | 19,238 | ||||||||||||||||||
Balance, end of year | 331.18 | $ | 5 | 365 | $ | 5 | $ | 1,603,228 | $ | (698,245 | ) | 303.82 | $ | (284,580 | ) | $ | 620,413 | ||||||||||
See notes to financial statements
F-21
ASHER SCHOOL OF BUSINESS EDUCATION CORPORATION
Statement of Cash Flows
For The Year Ended December 31, 2002
Cash flows from operating activities: | ||||
Net income | $ | 69,696 | ||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||
Depreciation and amortization | 32,927 | |||
Recognition of restricted stock compensation | 59,294 | |||
Stock compensation expense | 19,238 | |||
Changes in operating assets and liabilities: | ||||
Accounts receivable, net | 19,796 | |||
Other accounts receivable | 21,548 | |||
Prepaid expenses and other | (12,796 | ) | ||
Deferred initial direct costs | 22,000 | |||
Accounts payable | 4,431 | |||
Accrued expenses | 6,527 | |||
Unearned tuition | (139,682 | ) | ||
Net cash provided by operating activities | 102,979 | |||
Cash flows from investing activities: | ||||
Purchases of furniture and equipment | (12,911 | ) | ||
Investment in affiliate | (210,000 | ) | ||
Net cash used by investing activities | (222,911 | ) | ||
Cash flows from financing activities: | ||||
Increase in advances from related party | 40,096 | |||
Distributions to stockholders | (38,004 | ) | ||
Distributions to stockholders for payment of income taxes | (66,080 | ) | ||
Net cash used by financing activities | (63,988 | ) | ||
Decrease in cash | (183,920 | ) | ||
Cash, beginning of year | 441,829 | |||
Cash, end of year | $ | 257,909 | ||
Supplemental cash flows information: | ||||
Cash paid for - | ||||
Interest expense | $ | 4,951 | ||
Income taxes | $ | — | ||
See notes to financial statements
F-22
ASHER SCHOOL OF BUSINESS EDUCATION CORPORATION
Notes to Financial Statements
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Asher School of Business Education Corporation (the Company) was incorporated on September 25, 1996, in the state of Delaware. The Company operates a private career school located in Norcross, Georgia. The Company provides career training for business and health related professions and offers diploma and degree programs.
Basis of Presentation
The accompanying financial statements include the accounts of the Company, as well as its 10% equity interest in the earnings Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $210,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002.
Furniture, Equipment and Improvements
Furniture, equipment and leasehold improvements are stated at cost and are being depreciated and amortized utilizing the straight-line method over the following estimated useful lives:
Furniture and equipment | 3 to 7 years | |
Buildings | 5 years | |
Leasehold improvements | Shorter of lease term or useful life |
Goodwill
Goodwill represents the excess of the purchase price over the fair market value of the net assets acquired in connection with the purchase of the college.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 142 “Goodwill and Other Intangible Assets.” As a result of SFAS No. 142, all existing and newly acquired goodwill will no longer be amortized but will be tested for impairment annually and written down only when impaired. The Company adopted the provisions of SFAS No. 142 effective January 1, 2002. Management does not believe that the Company’s existing goodwill is impaired.
Revenue Recognition
Revenues are derived primarily from tuition on courses taught in the Company’s career school. Tuition revenue is recognized on a straight-line basis over the term of instruction. Deferred initial direct costs, consisting primarily of marketing expenses, are deferred and amortized over a period not to exceed the term of instruction. Unearned tuition results when cash collected on a student’s account exceeds tuition revenue recognized at the balance sheet date.
F-23
Accounts Receivable
Accounts receivable are recorded at the net realizable value expected to be received from students or third-party payors. Management continually monitors and adjusts its allowances associated with the Company’s receivables to address any credit risks associated with the accounts receivable. When uncertainty exists as to the collection of receivables, the Company records an allowance for doubtful accounts and a corresponding charge to bad debt expense.
Income Taxes
The Company operates as a Subchapter S Corporation. As such, the income and expenses of the Company pass through directly to the stockholders and are reported on their individual income tax returns. Accordingly, no provision for income taxes is recorded in the accompanying financial statements.
Stock-Based Compensation
The Company follows Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation”, which establishes a fair value based method of accounting for stock-based compensation plans.
Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.
NOTE 2 - FURNITURE, EQUIPMENT AND IMPROVEMENTS
Furniture, equipment and improvements consisted of the following as of December 31, 2002:
Equipment | $ | 59,583 | ||
Furniture | 47,282 | |||
Library | 14,465 | |||
Leasehold improvements | 60,743 | |||
Construction in progress | 11,786 | |||
| 193,859 | ||||
Less: accumulated depreciation and amortization | (128,166 | ) | ||
| $ | 65,693 | |||
Depreciation and amortization expense associated with furniture, equipment and improvements was $32,927 for the year ended December 31, 2002.
F-24
NOTE 3 - COMMITMENTS AND CONTINGENCIES
Commitments
The Company leases its operating facility under the terms of a non-cancelable operating lease which expires in 2005. The lease requires the Company to pay various operating expenses of the facility in addition to base monthly lease payments. The Company’s performance under this lease is guaranteed by other educational institutions owned by the stockholders of the Company.
Future minimum lease payments over the remaining terms of the above described lease are as follows:
Year Ending | |||
2003 | $ | 117,873 | |
2004 | 121,360 | ||
2005 | 72,002 | ||
| $ | 311,235 | ||
Rent expense for the year ended December 31, 2002, was approximately $136,400 and is reflected within facilities expense in the accompanying statement of income.
Contingencies
The Company and other educational corporations owned by the stockholders of the Company have a $1,735,100 line of credit with a bank which expires June 1, 2003. Borrowings bear interest at the bank’s prime rate (4.25% at December 31, 2002), and are collateralized by all assets of the Company and the other educational corporations owned by the Company’s stockholders. As of December 31, 2002, there were no outstanding balances under this agreement.
As of December 31, 2002, the Company was a co-guarantor and its assets secured outstanding credit facilities of $4,425,760 of other educational corporations owned by the stockholders of the Company.
The Company has a $42,100 irrevocable standby letter of credit in favor of the U.S. Department of Education due to an incidence of late refunds. As of December 31, 2002, the letter of credit has never been drawn upon.
NOTE 4 - SENIOR SUBORDINATED DEBENTURES
The senior subordinated debentures as of December 31, 2002, are related to the purchase of the net assets of the college and consist of 5.5% Senior Subordinated Debentures due March 31, 2004. The debentures include nondetachable Series A warrants to purchase in the aggregate up to 77.10 shares of each of the Company’s Class A common stock and Class B common stock. The agreement also contains provisions to issue Series B warrants to purchase up to an additional 11.14 shares of each of the Company’s Class A and Class B common stock. All accrued interest was payable on or before October 14, 2000, and semi-annually thereafter. Accrued interest on the debentures was $1,238 as of December 31, 2002 and is reflected within accrued expenses.
F-25
NOTE 5 - RELATED PARTY TRANSACTIONS
The Company advances and receives funds with an educational corporation owned by the stockholders of the Company. Net amounts received at December 31, 2002, amounted to $187,751. The advances are non-interest bearing, have no stipulated repayment provisions and are subordinated to all other third-party obligations.
During the year ended December 31, 2002, the Company paid $21,000 in management fees to an entity owned by one of the Company’s stockholders. The Company was also charged $150,000 in administrative fees by an educational corporation owned by the stockholders of the Company. The fees have been included in general and administrative expense on the accompanying statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
Investment In Affiliate
Summarized financial position and results of operations for the Company’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity
Effective August 7, 2001, the Company entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 63.62 shares of the Company’s restricted Class A common stock with a fair market value of $4,660 per share as consideration for providing certain consultancy and advisory services to the Company. The restricted stock will be held by the Company until terms and conditions specified by the Company are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $59,294 during the year ended December 31, 2002.
F-26
The Company has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Company, subject to adjustment for changes in the Company’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accompanying financial statements for these options as vesting is contingent upon the Company achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and become vested and exercisable ratably over a five year period. The option price is $10 for all shares, regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Company’s stock at the grant date was immaterial. Vested options at December 31, 2002 were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been included in the $150,000 administrative fee discussed above, as well as within additional paid-in capital.
NOTE 6 - 401(K) SAVINGS PLAN
The Company has a 401(k) plan covering substantially all of its employees. The Company matches 100% of the first 3% of employee contributions to the Plan. The Company may elect to contribute additional amounts to the Plan as determined by the board of directors. No Company discretionary contributions were made during the year ended December 31, 2002. Company contributions vest according to a schedule, become fully vested after six years and amounted to approximately $8,400 for the year ended December 31, 2002.
NOTE 7 - CONCENTRATION OF CREDIT RISK AND REGULATORY CONSIDERATIONS
At December 31, 2002, the Company had cash balances with a bank in excess of the federally insured amount of $100,000.
The Company participates in Government Student Financial Assistance Programs (Title IV) administered by the U.S. Department of Education (ED) for the payment of student tuitions. Substantial portions of the revenue and collection of ending accounts receivable as of December 31, 2002, are dependent upon the Company’s continued participation in the Title IV programs. Institutions participating in Title IV programs may not receive more than 90% of tuition collections (90/10 revenue test as defined in regulation) from Title IV sources in order to maintain eligibility for participation in such programs. For the year ended December 31, 2002, the Company’s tuition cash collections from Title IV programs were 78.9%. ED requires an institution to provide additional information with respect to its 90/10 revenue test. Reference is made to the accompanying Supplementary Information on page 11 with respect to additional disclosures required by ED.
Institutions participating in Title IV programs are also required by ED to demonstrate financial responsibility. ED determines an institution’s financial responsibility through the calculation of a composite score based upon certain financial ratios as defined in regulations. Institutions receiving a composite score of 1.5 or greater are considered fully financially responsible. Institutions receiving a composite score between 1.0 and 1.4 are subject to additional monitoring and institutions receiving a score below 1.0 are required to submit financial guarantees in order to continue participation in the Title IV programs. As of December 31, 2002, and for the year then ended, the Company’s composite score was 2.4.
F-27
ASHER SCHOOL OF BUSINESS EDUCATION CORPORATION
SUPPLEMENTARY INFORMATION
(Information Required by the U.S. Department of Education)
December 31, 2002
Institution’s Calculation of 90/10 Revenue Test
Asher School of Business Education Corporation (the Institution) derives a substantial portion of its revenues from Student Financial Aid (SFA) received by its students under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). To continue to participate in the SFA programs the Institution must comply with the regulations promulgated under HEA. The regulations restrict the proportion of cash receipts for tuition and fees from eligible programs to not more than 90 percent from the Title IV programs. The failure of the Institution to meet the 90 percent limitation will result in the loss of the Institution’s ability to participate in SFA programs. For the year ended December 31, 2002, the Institution’s 90/10 revenue test percentages were computed as follows:
Title IV funds received | $ | 1,392,335 | ||
Total eligible cash receipts | $ | 1,765,285 | ||
Percentage Title IV | 78.9 | % |
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
Related Party Transactions
Asher School of Business Education Corporation (the Institution) participates in Student Financial Aid (SFA) under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). The institution must comply with the regulations promulgated under HEA. Those regulations require that all related party transactions be disclosed, regardless of their materiality to the financial statements.
Contingency – As of December 31, 2002, the Institution was a co-guarantor and its assets secured outstanding credit facilities of $1,090,000 of American Education Centers, Inc. (AEC) and $3,335,760 of Brown Mackie Education Corporation, which are entities owned by the stockholders of the Institution.
Distributions to Stockholders – During the year ended December 31, 2002, the Institution made $104,084 of distributions to its stockholders, of which $66,080 was for the payment of income taxes.
Advances From Related Party – The Institution had net advances from AEC as of December 31, 2002, of $187,751. The advances are non-interest bearing, have no stipulated repayment provisions and are subordinated to all other third-party obligations.
Management and administrative fees – During the year ended December 31, 2002, the Institution paid $21,000 in management fees to an entity owned by one of the Institution’s stockholders. The Institution was also charged $150,000 in administrative fees by an educational corporation owned by the stockholders of the Institution. The fees have been included in general and administrative expense on the accompanying statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
F-28
Investment In Affiliate – The accompanying financial statements include the accounts of the Institution, as well as its 10% interest in Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Institution’s investment in SOC is accounted for using the equity method of accounting as the Institution exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $210,000, adjusted for the Institution’s proportionate share of earnings or losses. The Institution’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002. Summarized financial position and results of operations for the Institution’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity - Effective August 7, 2001, the Institution entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 63.62 shares of the Institution’s restricted Class A common stock with a fair market value of $4,660 per share as consideration for providing certain consultancy and advisory services to the Institution. The restricted stock will be held by the Institution until terms and conditions specified by the Institution are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $59,294 during the year ended December 31, 2002.
The Institution has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Institution, subject to adjustment for changes in the Institution’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accompanying financial statements for these options as vesting is contingent upon the Institution achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and become vested and exercisable ratably over a five year period. The option price is $10 for all shares, regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Institution’s stock at the grant date
F-29
was immaterial. Vested options at December 31, 2002 were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been included in the $150,000 administrative fee discussed above, as well as within additional paid-in capital.
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
F-30
INDEPENDENT AUDITORS’ REPORT ON COMPLIANCE AND
ON INTERNAL CONTROL OVER FINANCIAL REPORTING BASED ON
AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE
WITHGOVERNMENT AUDITING STANDARDS
To the Board of Directors and
Stockholders of Asher School of Business Education Corporation:
We have audited the financial statements of Asher School of Business Education Corporation as of and for the year ended December 31, 2002, and have issued our report thereon dated February 14, 2003. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained inGovernment Auditing Standards, issued by the Comptroller General of the United States.
Compliance
As part of obtaining reasonable assurance about whether Asher School of Business Education Corporation’s financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grants, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance that are required to be reported underGovernment Auditing Standards.
Internal Control Over Financial Reporting
In planning and performing our audit, we considered Asher School of Business Education Corporation’s internal control over financial reporting in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on internal control over financial reporting. Our consideration of internal control over financial reporting would not necessarily disclose all matters in internal control over financial reporting that might be material weaknesses. A material weakness is a condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. We noted no matters involving internal control over financial reporting and its operation that we consider to be material weaknesses.
This report is intended solely for the information and use of the board of directors, management, and the U.S. Department of Education and is not intended to be and should not be used by anyone other than these specified parties.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
website: www.almichcpa.com • email: info@almichcpa.com
F-31
To the Board of Directors and
Stockholders of Brown Mackie Education Corporation:
We have audited the accompanying balance sheet of Brown Mackie Education Corporation (a Delaware corporation) as of December 31, 2002, and the related statements of income, stockholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America andGovernment Auditing Standards, issued by the Comptroller General of the 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Brown Mackie Education Corporation as of December 31, 2002, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying supplementary information on page 14 on Brown Mackie Education Corporation’s calculation of its Title IV 90/10 revenue test and on related party transactions are required by the U.S. Department of Education and are presented for purposes of additional analysis and are not a required part of the basic financial statements. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.
In accordance withGovernment Auditing Standards, we have also issued our report dated February 14, 2003, on our consideration of Brown Mackie Education Corporation’s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts and grants.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
website: www.almichcpa.com • email: info@almichcpa.com
F-32
BROWN MACKIE EDUCATION CORPORATION
Balance Sheet
December 31, 2002
Assets | |||
Current assets: | |||
Cash | $ | 491,385 | |
Accounts receivable, net of allowance for doubtful accounts of $313,600 | 401,647 | ||
Prepaid expenses and other | 50,496 | ||
Deferred initial direct costs | 449,333 | ||
Total current assets | 1,392,861 | ||
Property, equipment and improvements, net of accumulated depreciation and amortization of $773,425 | 4,024,902 | ||
Other assets: | |||
Other amounts receivable | 117,567 | ||
Goodwill | 78,952 | ||
Investment in affiliate | 315,000 | ||
Deposits | 28,126 | ||
Total other assets | 539,645 | ||
| $ | 5,957,408 | ||
See notes to financial statements
F-33
BROWN MACKIE EDUCATION CORPORATION
Balance Sheet
December 31, 2002
Liabilities and Stockholders’ Equity | ||||
Current liabilities: | ||||
Accounts payable | $ | 11,961 | ||
Accrued expenses | 441,415 | |||
Current portion of notes and debentures payable | 483,920 | |||
Unearned tuition | 541,188 | |||
Total current liabilities | 1,478,484 | |||
Notes and debentures payable, net of current portion | 3,196,830 | |||
Advances from related party | 466,583 | |||
Total liabilities | 5,141,897 | |||
Stockholders’ equity: | ||||
Class A common stock, $.01 par value, 1,000 shares authorized | 5 | |||
Class B nonvoting common stock, $.01 par value, 1,000 shares authorized | 5 | |||
Additional paid-in capital | 681,711 | |||
Retained earnings | 647,870 | |||
| 1,329,591 | ||||
Treasury stock, at cost | (514,080 | ) | ||
Total stockholders’ equity | 815,511 | |||
| $ | 5,957,408 | |||
See notes to financial statements
F-34
BROWN MACKIE EDUCATION CORPORATION
Statement of Income
For The Year Ended December 31, 2002
Revenues | $ | 5,170,525 | ||
Costs and expenses: | ||||
Course materials, services and instruction | 1,739,862 | |||
Selling and promotion | 951,171 | |||
General and administrative | 1,139,111 | |||
Facilities | 543,176 | |||
Depreciation and amortization | 283,225 | |||
Total costs and expenses | 4,656,545 | |||
Income from operations | 513,980 | |||
Other income (expense): | ||||
Gain on sale of fixed assets | 7,514 | |||
Interest expense | (87,713 | ) | ||
Total other income (expense) | (80,199 | ) | ||
Income before provision for income taxes | 433,781 | |||
Provision for income taxes | — | |||
Net income | $ | 433,781 | ||
See notes to financial statements
F-35
BROWN MACKIE EDUCATION CORPORATION
Statement of Stockholders’ Equity
For The Year Ended December 31, 2002
| Class A Common Stock | Class B Nonvoting Common Stock | Additional Capital | Retained Earnings | Treasury Stock | Total Equity | ||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | ||||||||||||||||||||||
Balance, beginning of year | 331.18 | $ | 5 | 365 | $ | 5 | $ | 597,130 | $ | 398,535 | 303.82 | $ | (514,080 | ) | $ | 481,595 | |||||||||||
Net income | — | — | — | — | — | 433,781 | — | — | 433,781 | ||||||||||||||||||
Distributions to stockholders for payment of income taxes | — | — | — | — | — | (184,446 | ) | — | — | (184,446 | ) | ||||||||||||||||
Recognition of restricted stock compensation | — | — | — | — | 59,294 | — | — | — | 59,294 | ||||||||||||||||||
Stock compensation expense | — | — | — | — | 25,287 | — | — | — | 25,287 | ||||||||||||||||||
Balance, end of year | 331.18 | $ | 5 | 365 | $ | 5 | $ | 681,711 | $ | 647,870 | 303.82 | $ | (514,080 | ) | $ | 815,511 | |||||||||||
See notes to financial statements
F-36
BROWN MACKIE EDUCATION CORPORATION
Statement of Cash Flows
For The Year Ended December 31, 2002
Cash flows from operating activities: | ||||
Net income | $ | 433,781 | ||
Adjustments to reconcile net income to net cash provided by operating activities - | ||||
Depreciation and amortization | 283,225 | |||
Recognition of restricted stock compensation | 59,294 | |||
Stock compensation expense | 25,287 | |||
Changes in assets and liabilities - | ||||
Accounts receivable, net | 17,052 | |||
Prepaid expenses and other | 45,938 | |||
Deferred initial direct costs | 1,000 | |||
Other amounts receivable | 38,820 | |||
Deposits | (12,084 | ) | ||
Accounts payable | (3,792 | ) | ||
Accrued expenses | 243,441 | |||
Deferred rent | (9,326 | ) | ||
Unearned tuition | (13,573 | ) | ||
Net cash provided by operating activities | 1,109,063 | |||
Cash flows from investing activities: | ||||
Purchases of property, equipment and improvements | (3,209,982 | ) | ||
Investment in affiliate | (315,000 | ) | ||
Net cash used by investing activities | (3,524,982 | ) | ||
Cash flows from financing activities: | ||||
Principal borrowings on notes payable | 2,700,000 | |||
Principal payments on notes payable | (202,443 | ) | ||
Increase in advances from related party | 319,672 | |||
Distributions to stockholders for payment of income taxes | (184,446 | ) | ||
Net cash provided by financing activities | 2,632,783 | |||
Increase in cash | 216,864 | |||
Cash, beginning of year | 274,521 | |||
Cash, end of year | $ | 491,385 | ||
Supplemental cash flows information: | ||||
Cash paid for - | ||||
Interest | $ | 87,713 | ||
Income taxes | $ | — | ||
See notes to financial statements
F-37
BROWN MACKIE EDUCATION CORPORATION
Notes to Financial Statements
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Brown Mackie Education Corporation (the Company) was incorporated on March 24, 1994, in the state of Delaware and is engaged in the business of operating a private junior college with two campuses located in Salina and Lenexa, Kansas. The Company provides education in the business, legal and medical professions resulting in associate degrees.
Basis of Presentation
The accompanying financial statements include the accounts of the Company, as well as its 15% equity interest in the earnings of Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $315,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002.
Property, Equipment and Improvements
Property and equipment are recorded at cost and are depreciated over their estimated useful lives (3 to 30 years) using the straight-line method.
Leasehold improvements are stated at cost and are amortized over the shorter of the lease term or their estimated useful lives.
Revenue Recognition
Revenues are derived primarily from tuition on courses taught in the Company’s junior college. Tuition revenue is recognized on a straight-line basis over the term of instruction. Deferred initial direct costs, consisting primarily of marketing expenses, are deferred and amortized over a period not to exceed the term of instruction. Unearned tuition results when cash collected on a student’s account exceeds tuition revenue recognized at the balance sheet date.
Accounts Receivable
Accounts receivable are recorded at the net realizable value expected to be received from students or third-party payors. Management continually monitors and adjusts its allowances associated with the Company’s receivables to address any credit risks associated with the accounts receivable. When uncertainty exists as to the collection of receivables, the Company records an allowance for doubtful accounts and a corresponding charge to bad debt expense.
Goodwill
Goodwill is comprised of the excess of the purchase price over the fair market value of the net assets acquired in connection with the purchase of the college.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets.” As a result of SFAS No. 142, goodwill will no longer be amortized but will be tested for impairment annually and written down only when impaired. The Company adopted the provisions of SFAS No. 142 effective January 1, 2002. Management does not believe that the Company’s goodwill is impaired.
F-38
Income Taxes
The Company operates as a Subchapter S Corporation. As such, the income and expenses of the Company pass through to the stockholders and are reported on their individual income tax returns. Accordingly, no provision for income taxes is recorded in the accompanying financial statements.
Stock-Based Compensation
The Company follows Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation”, which establishes a fair value based method of accounting for stock-based compensation plans.
Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.
NOTE 2 - PROPERTY, EQUIPMENT AND IMPROVEMENTS
Property, equipment and improvements consisted of the following as of December 31, 2002:
Land | $ | 1,390,000 | ||
Buildings | 1,200,808 | |||
Leasehold improvements | 251,835 | |||
Furniture and equipment | 1,046,468 | |||
Transportation equipment | 11,238 | |||
Library | 111,911 | |||
Construction in progress | 786,067 | |||
| 4,798,327 | ||||
Less: accumulated depreciation and amortization | (773,425 | ) | ||
| $ | 4,024,902 | |||
Depreciation and amortization expense related to property, equipment and improvements was $283,225 for the year ended December 31, 2002.
NOTE 3 - RELATED PARTY TRANSACTIONS
The Company advances and receives funds with an educational corporation owned by the stockholders of the Company. Net amounts received at December 31, 2002, amounted to $466,583, of which $460,000 was under the terms of a Security Agreement whereby all of the Company’s assets secured and collateralized this portion of the net advances, which were to be repaid by January 31, 2003. The remaining advances are non-interest bearing, have no stipulated repayment provisions and are subordinated to all other third-party obligations. Subsequent to December 31, 2002, the advances of $466,583 were fully repaid.
During the year ended December 31, 2002, the Company paid $42,000 in management fees to an entity owned by one of the Company’s stockholders. The Company was also charged $150,000 in administrative fees by an educational corporation owned by the stockholders of the Company. Such fees are reflected in general and administrative expenses in the accompanying statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
F-39
Investment In Affiliate
Summarized financial position and results of operations for the Company’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity
Effective August 7, 2001, the Company entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 63.62 shares of the Company’s restricted Class A common stock with a fair market value of $4,660 per share as consideration for providing certain consultancy and advisory services to the Company. The restricted stock will be held by the Company until terms and conditions specified by the Company are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $59,294 during the year ended December 31, 2002.
The Company has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Company, subject to adjustment for changes in the Company’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accompanying financial statements for these options as vesting is contingent upon the Company achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and become vested and exercisable ratably over a five year period. The option price is $10 for all shares, regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Company’s stock at the grant date was immaterial. Vested options at December 31, 2002 were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been included in the $150,000 administrative fee discussed above, as well as within additional paid-in capital.
F-40
NOTE 4 - NOTES AND DEBENTURES PAYABLE
Notes and debentures payable consisted of the following as of December 31, 2002:
| Mortgage note payable to a bank, originating during the year ended December 31, 2002, and due to the purchase of land, building and facility renovations pertaining to the Lenexa campus, collateralized by all assets of the Company and other educational corporations owned by the Company’s stockholders, payable in monthly principal and interest installments of $15,330, bearing interest at 5.658% per annum, with any remaining principal balance and all accrued interest due on October 1, 2012 | $ | 2,190,760 | ||
| Note payable to a bank, originating during the year ended December 31, 2002, related to facility renovations pertaining to the Lenexa campus, collateralized by all assets of the Company and other educational corporations owned by the Company’s stockholders, payable in monthly principal installments of $13,889 plus accrued interest at the bank’s prime rate (4.25% at December 31, 2002), with any remaining principal balance and all accrued interest due on December 26, 2005 | 500,000 | |||
| Note payable to a bank, originating during the year ended December 31, 2000, and due to the purchase of fixed assets for facility renovations, equipment, furniture and fixtures, collateralized by all assets of the Company and other educational corporations owned by the Company’s stockholders, payable in monthly principal installments of $15,000 plus accrued interest at the bank’s prime rate (4.25% at December 31, 2002), with any remaining principal balance and all accrued interest due on June 1, 2006 | 645,000 | |||
| Mortgage note payable due to the purchase of land and building, secured by land and building, requiring monthly principal and interest installments of $1,416, bearing interest at 2.5% per annum above the Federal Home Loan Bank Rate (5.625% at December 31, 2002) | 73,891 | |||
| Mortgage note payable due to the purchase of land and building, secured by land and building, requiring monthly principal and interest installments of $523, bearing interest at 2.7% per annum above the three year monthly Treasury constant maturity rate (6.860% at December 31, 2002) | 50,343 | |||
| 5.5% Senior Subordinated Debentures, related to the purchase of the net assets of the college, due March 31, 2004, with interest payable semi-annually. The debentures include nondetachable Series A warrants to purchase in the aggregate up to 77.10 shares of each of the Company’s Class A common stock and Class B common stock. The agreement also contains provisions to issue Series B warrants to purchase up to an additional 11.14 shares of each of the Company’s Class A and Class B common stock. Accrued interest on the debentures was $3,034 as of December 31, 2002 and is reflected within accrued expenses. | 145,809 | |||
| Demand notes payable related to the purchase of the net assets of the college, unsecured, bearing interest at 5.5% per annum payable semi-annually. If no demand is made, the notes are due March 31, 2004 | 74,947 | |||
| 3,680,750 | ||||
Less: current portion | (483,920 | ) | ||
| $ | 3,196,830 | |||
F-41
Future maturities of notes and debentures payable as of December 31, 2002, are as follows:
Year Ending December 31, | |||
2003 | $ | 483,920 | |
2004 | 572,831 | ||
2005 | 446,010 | ||
2006 | 195,510 | ||
2007 | 94,448 | ||
Thereafter | 1,888,031 | ||
| $ | 3,680,750 | ||
The Company and other educational corporations owned by the stockholders of the Company have a $1,735,100 line of credit with a bank which expires June 1, 2003. Borrowings bear interest at the bank’s prime rate (4.25% at December 31, 2002), and are collateralized by all assets of the Company and the other educational corporations owned by the Company’s stockholders. As of December 31, 2002, there were no outstanding balances under this agreement.
The bank debt contains certain financial convenants, among others, as to maintenance of deposits with a combined balance of $75,000, limitations on additional indebtedness, dispositions of assets, transactions with related entities, as well as maintenance of a specified capital base and level of earnings, as defined in the agreement. As of December 31, 2002, the Company was in compliance with such financial covenants.
F-42
NOTE 5 - 401(K) SAVINGS PLAN
The Company has a 401(K) plan covering substantially all of its employees. The Company matches 100% of the first 3% of employee contributions to the plan. The Company may elect to contribute additional amounts to the Plan as determined by the board of directors. No Company discretionary contributions were made during the year ended December 31, 2002. Company contributions vest according to a schedule, become fully vested after six years and amounted to approximately $24,200, for the year ended December 31, 2002.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
Commitments
The lease on the Salina operating facility is non-cancellable, commenced in July 2000, is for a term of six years, with an option to extend for an additional six years. The lease requires payment of various operating expenses in addition to base monthly rent.
Future minimum payments over the remaining term of the above described lease as of December 31, 2002, are as follows:
Year Ending | |||
2003 | $ | 247,200 | |
2004 | 247,200 | ||
2005 | 247,200 | ||
2006 | 61,800 | ||
| $ | 803,400 | ||
Rent expense for the year ended December 31, 2002, was approximately $395,200, and is reflected in facilities expense in the accompanying statement of income.
Contingencies
The Company has a $224,200 irrevocable standby letter of credit in favor of the U.S. Department of Education due to an incidence of late refunds. As of December 31, 2002, the letter of credit has never been drawn upon.
As of December 31, 2002, the Company was a co-guarantor and its assets secured outstanding credit facilities of $1,090,000 of another entity owned by the stockholders of the Company.
The Company is subject to claims and legal actions in the ordinary course of its business. The Company has insurance policies in varying amounts covering certain of the outstanding lawsuits and claims. In the event a judgment was awarded in excess of the insurance coverage, the burden would fall on the Company. The Company does not expect that the ultimate outcome of an unfavorable judgment in any of the legal matters would result in a material adverse effect on the Company’s financial position.
F-43
NOTE 7 - CONCENTRATION OF CREDIT RISK AND REGULATORY CONSIDERATIONS
At December 31, 2002, the Company had cash balances with a bank in excess of the federally insured amount of $100,000.
The Company participates in Government Student Financial Assistance Programs (Title IV) administered by the U.S. Department of Education (ED) for the payment of student tuitions. Substantial portions of the revenue and collection of ending accounts receivable as of December 31, 2002, are dependent upon the Company’s continued participation in the Title IV programs. Institutions participating in Title IV programs may not receive more than 90% of tuition collections (90/10 revenue test as defined in regulation) from Title IV sources in order to maintain eligibility for participation in such programs. For the year ended December 31, 2002, the Company’s tuition cash collections from Title IV programs were 87.2%. ED requires an institution to provide additional information with respect to its 90/10 revenue test. Reference is made to the accompanying Supplementary Information on page 14 with respect to additional disclosures required by ED.
Institutions participating in Title IV programs are also required by ED to demonstrate financial responsibility. ED determines an institution’s financial responsibility through the calculation of a composite score based upon certain financial ratios as defined in regulations. Institutions receiving a composite score of 1.5 or greater are considered fully financially responsible. Institutions receiving a composite score between 1.0 and 1.4 are subject to additional monitoring and institutions receiving a score below 1.0 are required to submit financial guarantees in order to continue participation in the Title IV programs. As of December 31, 2002, and for the year then ended, the Company’s composite score was 1.7.
F-44
BROWN MACKIE EDUCATION CORPORATION
SUPPLEMENTARY INFORMATION
(Information Required by the U.S. Department of Education)
December 31, 2002
Institution’s Calculation of 90/10 Revenue Test
Brown Mackie Education Corporation (the Institution) derives a substantial portion of its revenues from Student Financial Aid (SFA) received by its students under the Title IV programs administered by the U.S. Department of Education (ED) pursuant to the Higher Education Act of 1965, as amended (HEA). To continue to participate in the SFA programs the Institution must comply with the regulations promulgated under HEA. The regulations restrict the proportion of cash receipts for tuition and fees from eligible programs to not more than 90 percent from the Title IV programs. The failure of the Institution to meet the 90 percent limitation will result in the loss of the Institution’s ability to participate in SFA programs.
For the year ended December 31, 2002, the Institution’s 90/10 revenue test percentages were computed as follows:
Title IV funds received | $ | 4,409,380 | ||
Total eligible cash receipts | $ | 5,057,063 | ||
Percentage Title IV | 87.2 | % |
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
Related Party Transactions
Brown Mackie Education Corporation (the Institution) participates in Student Financial Aid (SFA) under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). The Institution must comply with the regulations promulgated under HEA. Those regulations require that all related party transactions be disclosed, regardless of their materiality to the financial statements.
Distributions - During the year ended December 31, 2002, the Institution made $184,446 of distributions to its stockholders for the payment of income taxes.
Management and Administrative Fees - During the year ended December 31, 2002, the Institution paid management fees of $42,000 to an entity owned by one of the Institution’s stockholders. The Institution was also charged $150,000 in administrative fees by American Education Centers, Inc. (AEC), an entity owned by the Institution’s stockholders. Such fees are reflected in general and administrative expense in the statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
Advances From Related Party - At December 31, 2002, the Institution had received net advances of $466,583 from AEC, of which $460,000 was under the terms of a Security Agreement whereby all of the Institution’s assets secured and collateralized this portion of the net advances, which were to be repaid by January 31, 2003. The remaining advances are non-interest bearing, have no stipulated repayment provisions and are subordinated to all other third-party obligations. Subsequent to December 31, 2002, the advances of $466,583 were fully repaid.
F-45
Contingency - As of December 31, 2002, the Institution was a co-guarantor and its assets secured outstanding credit facilities of $1,090,000 of AEC.
Investment In Affiliate- The accompanying financial statements include the accounts of the Institution, as well as its 15% interest in Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Institution’s investment in SOC is accounted for using the equity method of accounting as the Institution exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $315,000, adjusted for the Institution’s proportionate share of earnings or losses. The Institution’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002. Summarized financial position and results of operations for the Institution’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity - Effective August 7, 2001, the Institution entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 63.62 shares of the Institution’s restricted Class A common stock with a fair market value of $4,660 per share as consideration for providing certain consultancy and advisory services to the Institution. The restricted stock will be held by the Institution until terms and conditions specified by the Institution are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $59,294 during the year ended December 31, 2002.
The Institution has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Institution, subject to adjustment for changes in the Institution’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accompanying financial statements for these options as vesting is contingent upon the Institution achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and
F-46
become vested and exercisable ratably over a five year period. The option price is $10 for all shares, regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Institution’s stock at the grant date was immaterial. Vested options at December 31, 2002 were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been included in the $150,000 administrative fee discussed above, as well as within additional paid-in capital.
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
F-47
INDEPENDENT AUDITORS’ REPORT ON COMPLIANCE AND
ON INTERNAL CONTROL OVER FINANCIAL REPORTING BASED ON
AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE
WITHGOVERNMENT AUDITING STANDARDS
To the Board of Directors and
Stockholders of Brown Mackie Education Corporation:
We have audited the financial statements of Brown Mackie Education Corporation as of and for the year ended December 31, 2002, and have issued our report thereon dated February 14, 2003. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained inGovernment Auditing Standards, issued by the Comptroller General of the United States.
Compliance
As part of obtaining reasonable assurance about whether Brown Mackie Education Corporation’s financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grants, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance that are required to be reported underGovernment Auditing Standards.
Internal Control Over Financial Reporting
In planning and performing our audit, we considered Brown Mackie Education Corporation’s internal control over financial reporting in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on internal control over financial reporting. Our consideration of internal control over financial reporting would not necessarily disclose all matters in internal control over financial reporting that might be material weaknesses. A material weakness is a condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. We noted no matters involving internal control over financial reporting and its operation that we consider to be material weaknesses.
This report is intended solely for the information and use of the board of directors, management, and the U.S. Department of Education and is not intended to be and should not be used by anyone other than these specified parties.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
website: www.almichcpa.com • email: info@almichcpa.com
F-48
To the Board of Directors and Stockholders
of Commonwealth Business College Education Corporation:
We have audited the accompanying balance sheet of Commonwealth Business College Education Corporation (a Delaware corporation) as of December 31, 2002, and the related statements of income, stockholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America andGovernment Auditing Standards, issued by the Comptroller General of the 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Commonwealth Business College Education Corporation as of December 31, 2002, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying supplementary information on page 12 on Commonwealth Business College Education Corporation’s calculation of its Title IV 90/10 revenue test and on related party transactions are required by the U.S. Department of Education and are presented for purposes of additional analysis and are not a required part of the basic financial statements. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.
In accordance withGovernment Auditing Standards, we have also issued our report dated February 14, 2003, on our consideration of Commonwealth Business College Education Corporation’s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts and grants.
Irvine, California
February 14, 2003
F-49
COMMONWEALTH BUSINESS COLLEGE EDUCATION CORPORATION
Balance Sheet
December 31, 2002
| Assets | ||||
Current assets: | ||||
Cash | $ | 244,808 | ||
Accounts receivable, net of allowance for doubtful accounts of $329,500 | 746,463 | |||
Prepaid expenses and other | 99,223 | |||
Deferred initial direct costs | 264,453 | |||
Total current assets | 1,354,947 | |||
Furniture, equipment and improvements, net of accumulated depreciation and amortization of $308,770 | 891,401 | |||
Other assets: | ||||
Deposits | 4,560 | |||
Investment in affiliate | 420,000 | |||
Goodwill | 181,684 | |||
Total other assets | 606,244 | |||
| $ | 2,852,592 | |||
| Liabilities and Stockholders’ Equity | ||||
Current liabilities: | ||||
Accounts payable | $ | 9,241 | ||
Accrued expenses | 347,304 | |||
Unearned tuition | 35,620 | |||
Current portion of note payable | 6,757 | |||
Total current liabilities | 398,922 | |||
Advances from related party | 680,690 | |||
Senior subordinated debentures | 90,000 | |||
Note payable, net of current portion | 15,826 | |||
Total liabilities | 1,185,438 | |||
Stockholders’ equity: | ||||
Class A common stock, $.01 par value, 1,000 shares authorized | 5 | |||
Class B nonvoting common stock, $.01 par value, 1,000 shares authorized | 5 | |||
Additional paid-in capital | 840,701 | |||
Retained earnings | 2,275,353 | |||
| 3,116,064 | ||||
Treasury stock, at cost | (1,448,910 | ) | ||
Total stockholders’ equity | 1,667,154 | |||
| $ | 2,852,592 | |||
See notes to financial statements
F-50
COMMONWEALTH BUSINESS COLLEGE EDUCATION CORPORATION
Statement of Income
For The Year Ended December 31, 2002
Revenues | $ | 6,499,579 | ||
Costs and expenses: | ||||
Course materials, services and instruction | 1,766,610 | |||
Selling and promotion | 932,158 | |||
General and administrative | 1,607,209 | |||
Facilities | 472,953 | |||
Depreciation and amortization | 103,306 | |||
Total costs and expenses | 4,882,236 | |||
Income from operations | 1,617,343 | |||
Other expense - interest | (7,936 | ) | ||
Income before provision for income taxes | 1,609,407 | |||
Provision for income taxes | — | |||
Net income | $ | 1,609,407 | ||
See notes to financial statements
F-51
COMMONWEALTH BUSINESS COLLEGE EDUCATION CORPORATION
Statement of Stockholders’ Equity
For The Year Ended December 31, 2002
| Class A Common Stock | Class B Nonvoting Common Stock | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Total Stockholders’ Equity | ||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | ||||||||||||||||||||||
Balance, beginning of year | 331.18 | $ | 5 | 365 | $ | 5 | $ | 729,712 | $ | 1,461,504 | 303.82 | $ | (1,448,910 | ) | $ | 742,316 | |||||||||||
Net income | — | — | — | — | — | 1,609,407 | — | — | 1,609,407 | ||||||||||||||||||
Distributions to stockholders for payment of income taxes | — | — | — | — | — | (687,558 | ) | — | — | (687,558 | ) | ||||||||||||||||
Distributions to stockholders | — | — | — | — | — | (108,000 | ) | — | — | (108,000 | ) | ||||||||||||||||
Recognition of restricted stock compensation | — | — | — | — | 59,294 | — | — | — | 59,294 | ||||||||||||||||||
Stock compensation expense | — | — | — | — | 51,695 | — | — | — | 51,695 | ||||||||||||||||||
Balance, end of year | 331.18 | $ | 5 | 365 | $ | 5 | $ | 840,701 | $ | 2,275,353 | 303.82 | $ | (1,448,910 | ) | $ | 1,667,154 | |||||||||||
See notes to financial statements
F-52
COMMONWEALTH BUSINESS COLLEGE EDUCATION CORPORATION
Statement of Cash Flows
For The Year Ended December 31, 2002
Cash flows from operating activities: | ||||
Net income | $ | 1,609,407 | ||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||
Depreciation and amortization | 103,306 | |||
Recognition of restricted stock compensation | 59,294 | |||
Stock compensation expense | 51,695 | |||
Changes in assets and liabilities: | ||||
Accounts receivable, net | (401,854 | ) | ||
Prepaid expenses and other | (5,527 | ) | ||
Deferred initial direct costs | 29,000 | |||
Accounts payable | (8,843 | ) | ||
Accrued expenses | 129,482 | |||
Unearned tuition | (219,812 | ) | ||
Net cash provided by operating activities | 1,346,148 | |||
Cash flows from investing activities: | ||||
Purchases of furniture, equipment and improvements | (740,755 | ) | ||
Investment in affiliate | (420,000 | ) | ||
Net cash used by investing activities | (1,160,755 | ) | ||
Cash flows from financing activities: | ||||
Distributions to stockholders for payment of income taxes | (687,558 | ) | ||
Distributions to stockholders | (108,000 | ) | ||
Increase in advances from related party | 269,006 | |||
Principal payments on note payable | (6,089 | ) | ||
Net cash used by financing activities | (532,641 | ) | ||
Decrease in cash | (347,248 | ) | ||
Cash, beginning of year | 592,056 | |||
Cash, end of year | $ | 244,808 | ||
Supplemental cash flows information: | ||||
Cash paid for: | ||||
Interest expense | $ | 7,316 | ||
Income taxes | $ | — | ||
See notes to financial statements
F-53
COMMONWEALTH BUSINESS COLLEGE EDUCATION CORPORATION
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Commonwealth Business College Education Corporation (the Company) was incorporated on September 7, 1995, in the state of Delaware. The Company operates a private career school with three campuses located in Merrillville and Michigan City, Indiana, as well as Moline, Illinois. The Company provides career training for business and health related professions.
Basis of Presentation
The accompanying financial statements include the accounts of the Company, as well as its 20% equity interest in the earnings of Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $420,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002.
Furniture, Equipment and Improvements
Furniture, equipment and improvements are stated at cost. Depreciation and amortization are provided for utilizing the straight-line method over the following estimated useful lives:
| Furniture and equipment | 3 to 7 years | |
| Leasehold improvements | Shorter of lease term or useful life |
When furniture, equipment and improvements are sold or otherwise disposed of, the asset and related accumulated depreciation are removed from the accounts with any resulting gain or loss recorded in income for the period.
Goodwill
Goodwill represents the excess of the purchase price over the fair market value of the net assets acquired in connection with the acquisition of the three campuses.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 142 “Goodwill and Other Intangible Assets.” As a result of SFAS No. 142, all existing and newly acquired goodwill will no longer be amortized but will be tested for impairment annually and written down only when impaired. The Company adopted the provisions of SFAS No. 142 effective January 1, 2002. Management does not believe that the Company’s existing goodwill is impaired.
Revenue Recognition
Revenues are derived primarily from tuition on courses taught in the Company’s career school. Tuition revenue is recognized on a straight-line basis over the term of instruction. Deferred initial direct costs, consisting primarily of marketing expenses, are deferred and amortized over a period not to exceed the term of instruction. Unearned tuition results when cash collected on a student’s account exceeds tuition revenue recognized at the balance sheet date.
F-54
Accounts Receivable
Accounts receivable are recorded at the net realizable value expected to be received from students or third-party payors. Management continually monitors and adjusts its allowances associated with the Company’s receivables to address any credit risks associated with the accounts receivable. When uncertainty exists as to the collection of receivables, the Company records an allowance for doubtful accounts and a corresponding charge to bad debt expense.
Income Taxes
The Company operates as a Subchapter S corporation. As such, the income and expenses of the Company pass through directly to the stockholders and are reported on their individual income tax returns. Accordingly, no provision for income taxes is recorded in the accompanying financial statements.
Stock-Based Compensation
The Company follows Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation”, which establishes a fair value based method of accounting for stock-based compensation plans.
Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.
NOTE 2 – FURNITURE, EQUIPMENT AND IMPROVEMENTS
Furniture, equipment and improvements consisted of the following as of December 31, 2002:
Equipment | $ | 217,243 | ||
Furniture | 205,268 | |||
Leasehold improvements | 193,701 | |||
Construction in progress | 583,959 | |||
| 1,200,171 | ||||
Less: accumulated depreciation and amortization | (308,770 | ) | ||
| $ | 891,401 | |||
Depreciation and amortization expense associated with furniture, equipment and improvements for the year ended December 31, 2002, was $103,306.
NOTE 3 - COMMITMENTS AND CONTINGENCIES
Commitments
The Company initially entered into lease agreements with the seller associated with the operating facilities for the career schools. As of December 31, 2002, only the Moline operating facility remains leased under these terms. The lease requires the Company to pay various operating expenses of the facility in addition to base monthly rental payments, expires on September 30, 2005 and contains annual incremental increases in base monthly rental payments which approximate the consumer price index.
F-55
The Michigan City operating facility lease requires the Company to pay various operating expenses of the facility in addition to base monthly rental payments. The lease expired November 2001 and was extended for 11 months until certain leasehold improvements were completed, at which time the option to renew the lease for seven years was exercised. The lease commenced in November 2002 with base rent of $10,390 per month and contains annual incremental increases in base monthly rental payments which approximate the consumer price index.
The Merrillville operating facility lease requires the Company to pay various operating expenses of the facility in addition to base monthly rental payments. The lease expires September 2004, with two three year renewal options. The lease contains annual incremental increases in base monthly rental payments which approximate the consumer price index.
Future minimum lease payments over the remaining terms of the above described leases as of December 31, 2002, are as follows:
Year Ending | |||
2003 | $ | 399,123 | |
2004 | 362,891 | ||
2005 | 202,578 | ||
2006 | 141,183 | ||
2007 | 146,830 | ||
Thereafter | 284,170 | ||
| $ | 1,536,775 | ||
Rent expense for the year ended December 31, 2002, was approximately $353,000, and is reflected in facilities expense in the accompanying statement of income.
Contingencies
The Company and other educational corporations owned by the stockholders of the Company have a $1,735,100 line of credit with a bank which expires June 1, 2003. Borrowings bear interest at the bank’s prime rate (4.25% at December 31, 2002), and are collateralized by all assets of the Company and the other educational corporations owned by the Company’s stockholders. As of December 31, 2002, there were no outstanding balances under this agreement.
As of December 31, 2002, the Company was a co-guarantor and its assets secured outstanding credit facilities of $4,425,760 of other educational corporations owned by the stockholders of the Company.
The Company has a $92,200 irrevocable standby letter of credit in favor of the U.S. Department of Education due to an incidence of late refunds. As of December 31, 2002, the letter of credit has never been drawn upon.
NOTE 4 - RELATED PARTY TRANSACTIONS
The Company advances and receives funds with an educational corporation owned by the stockholders of the Company. Net amounts received at December 31, 2002, amounted to $680,690, of which $680,000 was under the terms of a Security Agreement whereby all of the Company’s assets secured and collateralized this portion of the net advances, which were to be repaid by January 31, 2003. The remaining advances are non-interest bearing, have no stipulated repayment provisions and are subordinated to all other third-party obligations. Subsequent to December 31, 2002, the advances of $680,690 were fully repaid.
F-56
During the year ended December 31, 2002, the Company paid $63,000 in management fees to an entity owned by one of the Company’s stockholders. The Company was also charged $700,000 in administrative fees by an educational corporation owned by the stockholders of the Company. The fees are reflected in general and administrative expenses in the accompanying statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
Investment In Affiliate
Summarized financial position and results of operations for the Company’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity
Effective August 7, 2001, the Company entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 63.62 shares of the Company’s restricted Class A common stock with a fair market value of $4,660 per share as consideration for providing certain consultancy and advisory services to the Company. The restricted stock will be held by the Company until terms and conditions specified by the Company are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $59,294 during the year ended December 31, 2002.
The Company has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Company, subject to adjustment for changes in the Company’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accompanying financial statements for these options as vesting is contingent upon the Company achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and become vested and exercisable ratably over a five year period. The option price is $10 for all shares,
F-57
regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Company’s stock at the grant date was immaterial. Vested options at December 31, 2002, were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been included in the $700,000 administrative fee discussed above, as well as within additional paid-in capital.
NOTE 5 - NOTE PAYABLE
As of December 31, 2002, the note payable consisted of the following:
Note payable to seller, related to the purchase of the net assets of the college, secured by all assets of the Company, discounted at an interest rate of 11.0% per annum, payable in annual principal and interest payments of $9,241 | $ | 22,583 | ||
Less: current portion | (6,757 | ) | ||
| $ | 15,826 | |||
Future maturities of the note payable as of December 31, 2002, are as follows:
Year Ending | |||
2003 | $ | 6,757 | |
2004 | 7,501 | ||
2005 | 8,325 | ||
| $ | 22,583 | ||
NOTE 6 - SENIOR SUBORDINATED DEBENTURES
The senior subordinated debt as of December 31, 2002, relates to the purchase of the net assets of the college and consists of 5.5% Senior Subordinated Debentures due March 31, 2004. The debentures include nondetachable Series A warrants to purchase in the aggregate up to 77.10 shares of each of the Company’s Class A common stock and Class B common stock. The agreement also contains provisions to issue Series B warrants to purchase up to an additional 11.14 shares of each of the Company’s Class A and Class B common stock. Interest is payable semi-annually in arrears on September 30 and March 31 of each year. Accrued interest at December 31, 2002, amounted to $1,238, and is reflected in accrued expenses.
NOTE 7- 401(K) PLAN
The Company has a 401(K) plan covering substantially all of its employees. The Company matches 50% of the first 4% of employee contributions to the plan. The Company may elect to contribute additional amounts to the Plan as determined by the board of directors. No Company discretionary contributions were made during the year ended December 31, 2002. Company contributions vest according to a schedule, become fully vested after six years and amounted to approximately $20,900 for the year ended December 31, 2002.
F-58
NOTE 8 - CONCENTRATION OF CREDIT RISK AND REGULATORY CONSIDERATIONS
At December 31, 2002, the Company had cash balances with a bank in excess of the federally insured balance of $100,000.
The Company participates in Government Student Financial Assistance Programs (Title IV) administered by the U.S. Department of Education (ED) for the payment of student tuitions. Substantial portions of the revenue and collection of ending accounts receivable as of December 31, 2002, are dependent upon the Company’s continued participation in the Title IV programs. Institutions participating in Title IV programs may not receive more than 90% of tuition collections (90/10 revenue test as defined in regulation) from Title IV sources in order to maintain eligibility for participation in such programs. For the year ended December 31, 2002, the Company’s tuition cash collections from Title IV programs were 86.9%. ED requires an institution to provide additional information with respect to its 90/10 revenue test. Reference is made to the accompanying Supplementary Information on page 12 with respect to additional disclosures required by ED.
Institutions participating in Title IV programs are also required by ED to demonstrate financial responsibility. ED determines an institution’s financial responsibility through the calculation of a composite score based upon certain financial ratios as defined in regulations. Institutions receiving a composite score of 1.5 or greater are considered fully financially responsible. Institutions receiving a composite score between 1.0 and 1.4 are subject to additional monitoring and institutions receiving a score below 1.0 are required to submit financial guarantees in order to continue participation in the Title IV programs. As of December 31, 2002, and for the year then ended, the Company’s composite score was 3.0.
F-59
COMMONWEALTH BUSINESS COLLEGE EDUCATION CORPORATION
SUPPLEMENTARY INFORMATION
(Information Required by the U.S. Department of Education)
December 31, 2002
Institution’s Calculation of 90/10 Revenue Test
Commonwealth Business College Education Corporation (the Institution) derives a substantial portion of its revenues from Student Financial Aid (SFA) received by its students under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). To continue to participate in the SFA programs the Institution must comply with the regulations promulgated under HEA. The regulations restrict the proportion of cash receipts for tuition and fees from eligible programs to not more than 90 percent from the Title IV programs. The failure of the Institution to meet the 90 percent limitation will result in the loss of the Institution’s ability to participate in SFA programs. For the year ended December 31, 2002 the Institution’s 90/10 revenue test percentages were computed as follows:
Title IV funds received | $ | 5,219,794 | ||
Total eligible cash receipts | $ | 6,008,708 | ||
Percentage Title IV | 86.9 | % |
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
Related Party Transactions
Commonwealth Business College Education Corporation (the Institution) participates in Student Financial Aid (SFA) under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). The institution must comply with the regulations promulgated under HEA. Those regulations require that all related party transactions be disclosed, regardless of their materiality to the financial statements.
Distributions to Stockholders – During the year ended December 31, 2002, the Institution made $795,558 of distributions to its stockholders, of which $687,558 was for the payment of income taxes.
Contingency – As of December 31, 2002, the Institution was a co-guarantor and its assets secured outstanding credit facilities of $1,090,000 of American Education Centers, Inc. (AEC) and $3,335,760 of Brown Mackie Education Corporation, which are entities owned by the stockholders of the Institution.
Advances From Related Party – As of December 31, 2002, the Institution had received net advances of $680,690 from AEC, of which $680,000 was under the terms of a Security Agreement whereby all of the Institution’s assets secured and collateralized this portion of the net advances, which were to be repaid by January 31, 2003. The remaining advances are non-interest bearing, have no stipulated repayment provisions and are subordinated to all other third-party obligations. Subsequent to December 31, 2002, the advances of $680,690 were fully repaid.
Management and administrative fees - During the year ended December 31, 2002, the Institution paid $63,000 in management fees to an entity owned by one of the Institution’s stockholders. The Institution was also charged $700,000 in administrative fees by an educational corporation owned by the stockholders of the Institution. The fees are reflected in general and administrative expenses in the accompanying statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
F-60
Investment In Affiliate - The accompanying financial statements include the accounts of the Institution, as well as its 20% interest in Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Institution’s investment in SOC is accounted for using the equity method of accounting as the Institution exercises significant influence over operating and financial policies of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $420,000, adjusted for the Institution’s proportionate share of earnings or losses. The Institution’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002. Summarized financial position and results of operations for the Company’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity - Effective August 7, 2001, the Institution entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 63.62 shares of the Institution’s restricted Class A common stock with a fair market value of $4,660 per share as consideration for providing certain consultancy and advisory services to the Institution. The restricted stock will be held by the Institution until terms and conditions specified by the Institution are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $59,294 during the year ended December 31, 2002.
The Institution has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Institution, subject to adjustment for changes in the Institution’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accompanying financial statements for these options as vesting is contingent upon the Institution achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and become vested and exercisable ratably over a five year period. The option price is $10 for all shares, regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Institution’s stock at the grant date
F-61
was immaterial. Vested options at December 31, 2002, were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been included in the $700,000 administrative fee discussed above, as well as within additional paid-in capital.
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
F-62
INDEPENDENT AUDITORS’ REPORT ON COMPLIANCE AND
ON INTERNAL CONTROL OVER FINANCIAL REPORTING BASED ON
AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE
WITHGOVERNMENT AUDITING STANDARDS
To the Board of Directors and
Stockholders of Commonwealth Business College Education Corporation:
We have audited the financial statements of Commonwealth Business College Education Corporation as of and for the year ended December 31, 2002, and have issued our report thereon dated February 14, 2003. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained inGovernment Auditing Standards, issued by the Comptroller General of the United States.
Compliance
As part of obtaining reasonable assurance about whether Commonwealth Business College Education Corporation’s financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grants, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance that are required to be reported underGovernment Auditing Standards.
Internal Control Over Financial Reporting
In planning and performing our audit, we considered Commonwealth Business College Education Corporation’s internal control over financial reporting in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on internal control over financial reporting. Our consideration of internal control over financial reporting would not necessarily disclose all matters in internal control over financial reporting that might be material weaknesses. A material weakness is a condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. We noted no matters involving internal control over financial reporting and its operation that we consider to be material weaknesses.
This report is intended solely for the information and use of the board of directors, management, and the U.S. Department of Education and is not intended to be and should not be used by anyone other than these specified parties.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
website: www.almichcpa.com • email:info@almichcpa.com
F-63
To the Board of Directors and Stockholders
of Michiana College Education Corporation:
We have audited the accompanying balance sheet of Michiana College Education Corporation (a Delaware corporation) as of December 31, 2002, and the related statements of income, stockholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America andGovernment Auditing Standards, issued by the Comptroller General of the 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Michiana College Education Corporation as of December 31, 2002, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying supplementary information on page 12 on Michiana College Education Corporation’s calculation of its Title IV 90/10 revenue test and on related party transactions are required by the U.S. Department of Education and are presented for purposes of additional analysis and are not a required part of the basic financial statements. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.
In accordance withGovernment Auditing Standards, we have also issued our report dated February 14, 2003, on our consideration of Michiana College Education Corporation’s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts and grants.
Irvine, California
February 14, 2003
F-64
MICHIANA COLLEGE EDUCATION CORPORATION
Balance Sheet
December 31, 2002
| Assets | ||||
Current assets: | ||||
Cash | $ | 1,406,031 | ||
Accounts receivable, net of allowance for doubtful accounts of $343,900 | 873,245 | |||
Prepaid expenses and other | 87,780 | |||
Deferred initial direct costs | 256,000 | |||
Total current assets | 2,623,056 | |||
Furniture and equipment, net of accumulated depreciation of $336,956 | 253,633 | |||
Other assets: | ||||
Investment in affiliate | 420,000 | |||
Goodwill | 1,067,581 | |||
Total other assets | 1,487,581 | |||
| $ | 4,364,270 | |||
| Liabilities and Stockholders’ Equity | ||||
Current liabilities: | ||||
Accounts payable | $ | 12,749 | ||
Accrued expenses | 201,037 | |||
Unearned tuition | 67,101 | |||
Current portion of note payable | 94,637 | |||
Total current liabilities | 375,524 | |||
Advances from related party | 437,879 | |||
Note payable, net of current portion | 99,208 | |||
Senior subordinated debentures | 240,000 | |||
Total liabilities | 1,152,611 | |||
Stockholders’ equity: | ||||
Class A common stock, $.01 par value, 1,000 shares authorized | 5 | |||
Class B nonvoting common stock, $.01 par value, 1,000 shares authorized | 5 | |||
Additional paid-in capital | 1,543,576 | |||
Retained earnings | 2,571,283 | |||
| 4,114,869 | ||||
Treasury stock, at cost | (903,210 | ) | ||
Total stockholders’ equity | 3,211,659 | |||
| $ | 4,364,270 | |||
See notes to financial statements
F-65
MICHIANA COLLEGE EDUCATION CORPORATION
Statement of Income
For The Year Ended December 31, 2002
Revenues | $ | 7,759,899 | ||
Costs and expenses: | ||||
Course materials, services and instruction | 2,080,911 | |||
Selling and promotion | 1,003,908 | |||
General and administrative | 1,956,816 | |||
Facilities | 646,666 | |||
Depreciation and amortization | 166,091 | |||
Total costs and expenses | 5,854,392 | |||
Income from operations | 1,905,507 | |||
Other expense: | ||||
Loss on sale of fixed assets | (18,483 | ) | ||
Interest expense | (25,424 | ) | ||
Total other expense | (43,907 | ) | ||
Income before provision for income taxes | 1,861,600 | |||
Provision for income taxes | — | |||
Net income | $ | 1,861,600 | ||
See notes to financial statements
F-66
MICHIANA COLLEGE EDUCATION CORPORATION
Statement of Stockholders’ Equity
For The Year Ended December 31, 2002
| Class A Common Stock | Class B Nonvoting Common Stock | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Total Stockholders’ Equity | ||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | ||||||||||||||||||||||
Balance, beginning of year | 331.18 | $ | 5 | 365 | $ | 5 | $ | 1,384,696 | $ | 1,604,216 | 303.82 | $ | (903,210 | ) | $ | 2,085,712 | |||||||||||
Net income | — | — | — | — | — | 1,861,600 | — | — | 1,861,600 | ||||||||||||||||||
Distributions to stockholders for payment of income taxes | — | — | — | — | — | (786,533 | ) | — | — | (786,533 | ) | ||||||||||||||||
Distributions to stockholders | — | — | — | — | — | (108,000 | ) | — | — | (108,000 | ) | ||||||||||||||||
Recognition of restricted stock compensation | — | — | — | — | 59,294 | — | — | — | 59,294 | ||||||||||||||||||
Stock compensation expense | — | — | — | — | 99,586 | — | — | — | 99,586 | ||||||||||||||||||
Balance, end of year | 331.18 | $ | 5 | 365 | $ | 5 | $ | 1,543,576 | $ | 2,571,283 | 303.82 | $ | (903,210 | ) | $ | 3,211,659 | |||||||||||
See notes to financial statements
F-67
MICHIANA COLLEGE EDUCATION CORPORATION
Statement of Cash Flows
For The Year Ended December 31, 2003
Cash flows from operating activites: | ||||
Net income | $ | 1,861,600 | ||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||
Depreciation and amortization | 166,091 | |||
Recognition of restricted stock compensation | 59,294 | |||
Stock compensation expense | 99,586 | |||
Changes in assets and liabilities: | ||||
Accounts receivable, net | (526,169 | ) | ||
Prepaid expenses and other | 71,355 | |||
Deferred initial direct costs | 41,000 | |||
Deposits | 18,867 | |||
Accounts payable | (26,393 | ) | ||
Accrued expenses | 22,776 | |||
Unearned tuition | (271,456 | ) | ||
Net cash provided by operating activities | 1,516,551 | |||
Cash flows from investing activities: | ||||
Investment in affiliate | (420,000 | ) | ||
Purchases of furniture and equipment | (63,250 | ) | ||
Net cash used by investing activities | (483,250 | ) | ||
Cash flows from financing activities: | ||||
Accrued interest on senior subordinated debentures | (15,334 | ) | ||
Increase in advances from related party | 198,187 | |||
Principal payments on note payable | (90,278 | ) | ||
Distributions to stockholders for payment of income taxes | (786,533 | ) | ||
Distributions to stockholders | (108,000 | ) | ||
Net cash used by financing activities | (801,958 | ) | ||
Increase in cash | 231,343 | |||
Cash, beginning of year | 1,174,688 | |||
Cash, end of year | $ | 1,406,031 | ||
Supplemental cash flows information: | ||||
Cash paid for - | ||||
Interest | $ | 10,090 | ||
Income taxes | $ | — | ||
Supplemental schedule of non-cash investing and financing activities: | ||||
Transfer of fixed assets from Cherry Hill campus | $ | 211,384 | ||
See notes to financial statements
F-68
MICHIANA COLLEGE EDUCATION CORPORATION
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Michiana College Education Corporation (the Company) was incorporated on February 16, 1999, in the state of Delaware. The Company was organized to acquire and operate a private career college with campuses located in South Bend and Ft. Wayne, Indiana. During the year ended December 31, 2001, the Company opened an additional location in Cherry Hill, New Jersey; this location was closed during the year ended December 31, 2002. The Company provides career training for business, medical and technical professions and offers diploma and degree programs.
Basis of Presentation
The accompanying financial statements include the accounts of the Company, as well as its 20% equity interest in the earnings of Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $420,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002.
Furniture, Equipment and Improvements
Furniture, equipment and leasehold improvements are stated at cost and are being depreciated and amortized utilizing the straight-line method over the following estimated useful lives:
Furniture and equipment | 5 to 7 years | |
Leasehold improvements | Shorter of lease term or useful life |
Revenue Recognition
Revenues are derived primarily from tuition on courses taught in the Company’s career school. Tuition revenue is recognized on a straight-line basis over the term of instruction. Deferred initial direct costs, consisting primarily of marketing expenses, are deferred and amortized over a period not to exceed the term of instruction. Unearned tuition results when cash collected on a student’s account exceeds tuition revenue recognized at the balance sheet date.
Accounts Receivable
Accounts receivable are recorded at the net realizable value expected to be received from students or third-party payors. Management continually monitors and adjusts its allowances associated with the Company’s receivables to address any credit risks associated with the accounts receivable. When uncertainty exists as to the collection of receivables, the Company records an allowance for doubtful accounts and a corresponding charge to bad debt expense.
F-69
Goodwill
Goodwill is comprised of the excess of the purchase price over the fair market value of the net assets acquired in connection with the purchase of the college.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards SFAS No. 142 “Goodwill and Other Intangible Assets.” As a result of SFAS No. 142, goodwill will no longer be amortized but will be tested for impairment annually and written down only when impaired. The Company adopted the provisions of SFAS No. 142 effective January 1, 2002. Management does not believe that the Company’s goodwill is impaired.
Income Taxes
The Company operates as a Subchapter S Corporation. As such, income and expenses of the Company pass through directly to the stockholders and are reported on their individual income tax returns. Accordingly, no provision for income taxes is recorded in the accompanying financial statements.
Stock-Based Compensation
The Company follows Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation”, which establishes a fair value based method of accounting for stock-based compensation plans.
Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.
NOTE 2 - FURNITURE, EQUIPMENT AND IMPROVEMENTS
Furniture, equipment and improvements consisted of the following as of December 31, 2002:
Furniture and equipment | $ | 532,136 | ||
Leasehold improvements | 18,351 | |||
Construction in progress | 40,102 | |||
| 590,589 | ||||
Less: accumulated depreciation | (336,956 | ) | ||
| $ | 253,633 | |||
Depreciation and amortization expense associated with furniture, equipment and improvements for the year ended December 31, 2002, was $166,091.
F-70
NOTE 3 - COMMITMENTS AND CONTINGENCIES
Commitments
The Company has non-cancelable operating lease agreements expiring in March 2004 for its South Bend and Ft. Wayne facilities. The lease agreements are with the shareholder of the seller and contain one five-year renewal option. The leases require the Company to pay all operating expenses of the facilities in addition to base monthly rent. The Ft. Wayne lease provides for stipulated increases in the base rent beginning in the third year.
The Cherry Hill facility was leased under the terms of a non-cancelable agreement expiring in February 2007. The lease required the Company to pay certain operating expenses associated with the facility. The Company had the option of renewing this lease for two additional five-year terms. During the year ended December 31, 2002, the Company negotiated a lease termination agreement dated May 21, 2002, the Company closed the Cherry Hill campus, and exercised the lease termination agreement, effective August 2002.
Future minimum lease payments over the remaining terms of the leases are as follows:
Year Ending | |||
2003 | $ | 350,500 | |
2004 | 87,625 | ||
| $ | 438,125 | ||
Rent expense for the year ended December 31, 2002, was approximately $474,000 and is reflected within facilities expense in the accompanying statement of income.
Contingencies
The Company and other educational corporations owned by the stockholders of the Company have a $1,735,100 line of credit with a bank which expires June 1, 2003. Borrowings bear interest at the bank’s prime rate (4.25% at December 31, 2002), and are collateralized by all assets of the Company and the other educational corporations owned by the Company’s stockholders. As of December 31, 2002, there were no outstanding balances under this agreement.
As of December 31, 2002, the Company was a co-guarantor and its assets secured outstanding credit facilities of $4,425,760 of other educational corporations owned by the stockholders of the Company.
The Company has a $161,100 irrevocable standby letter of credit in favor of the U.S. Department of Education due to an incidence of late refunds. As of December 31, 2002, the letter of credit has never been drawn upon.
F-71
NOTE 4 - NOTE PAYABLE
The note payable consisted of the following as of December 31, 2002:
Note payable to seller, related to the purchase of the net assets of the college, bearing interest at 4.83%, guaranteed in an amount not to exceed $250,000 by an educational corporation owned by the stockholders of the Company, with such guarantee reduced by $50,000 per year on the anniversary of the closing date (remaining guarantee of $100,000 at December 31, 2002). Payable in an initial principal payment of $20,000 on the closing date and thereafter in annual principal and interest installments of $104,000 on the anniversary of the closing date | $ | 193,845 | ||
Less: current portion | (94,637 | ) | ||
| $ | 99,208 | |||
Maturities of the note payable for the remainder of its term are as follows:
Year Ending December 31, | |||
2003 | $ | 94,637 | |
2004 | 99,208 | ||
| $ | 193,845 | ||
NOTE 5 - SENIOR SUBORDINATED DEBENTURES
The senior subordinated debentures as of December 31, 2002, are related to the purchase of the net assets of the college and consist of 5.5% Senior Subordinated Debentures due March 31, 2005. The debentures include nondetachable Series A warrants to purchase in the aggregate up to 77.10 shares of each of the Company’s Class A common stock and Class B common stock. The agreement also contains provisions to issue Series B warrants to purchase up to an additional 11.14 shares of each of the Company’s Class A and Class B common stock. All accrued interest is payable on or before March 31, 2003. Accrued interest as of December 31, 2002 was $54,133 and is included within accrued expenses.
NOTE 6 - 401(K) SAVINGS PLAN
The Company has a 401(K) plan covering substantially all of its employees. The Company matches 50% of the first 4% of employee contributions to the plan. The Company may elect to contribute additional amounts to the plan as determined by the board of directors. No Company discretionary contributions were made during the year ended December 31, 2002. Company contributions vest according to a schedule, become fully vested after six years and amounted to $20,764 for the year ended December 31, 2002.
F-72
NOTE 7 - RELATED PARTY TRANSACTIONS
The Company advances and receives funds with an educational corporation owned by the stockholders of the Company. Net amounts received at December 31, 2002, amounted to $437,879, of which $430,000 was under the terms of a Security Agreement whereby all of the Company’s assets secured and collaterlized this portion of the net advances, which were to be repaid by January 31, 2003. The remaining advances are non-interest bearing, have no stipulated repayment provisions and are subordinated to all other third-party obligations. Subsequent to December 31, 2002, the advances of $437,879 were fully repaid.
During the year ended December 31, 2002, the Company paid $52,500 in management fees to an entity owned by one of the Company’s stockholders. The Company was also charged $1,000,000 in administrative fees by an educational corporation owned by the stockholders of the Company. The fees are reflected within general and administrative expenses in the accompanying statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
Investment In Affiliate
Summarized financial position and results of operations for the Company’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity
Effective August 7, 2001, the Company entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 63.62 shares of the Company’s restricted Class A common stock with a fair market value of $4,660 per share as consideration for providing certain consultancy and advisory services to the Company. The restricted stock will be held by the Company until terms and conditions specified by the Company are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $59,294 during the year ended December 31, 2002.
F-73
The Company has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Company, subject to adjustment for changes in the Company’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accompanying financial statements for these options as vesting is contingent upon the Company achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and become vested and exercisable ratably over a five year period. The option price is $10 for all shares, regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Company’s stock at the grant date was immaterial. Vested options at December 31, 2002 were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been included in the $1,000,000 administrative fee discussed above, as well as within additional paid-in capital.
NOTE 8 - CONCENTRATION OF CREDIT RISK AND REGULATORY CONSIDERATIONS
As of December 31, 2002, the Company had cash balances with a bank in excess of the federally insured limit of $100,000.
The Company participates in Government Student Financial Assistance Programs (Title IV) administered by the U.S. Department of Education (ED) for the payment of student tuitions. Substantial portions of the revenue and collection of ending accounts receivable as of December 31, 2002, are dependent upon the Company’s continued participation in the Title IV programs. Institutions participating in Title IV programs may not receive more than 90% of tuition collections (90/10 revenue test as defined in regulation) from Title IV sources in order to maintain eligibility for participation in such programs. For the year ended December 31, 2002, the Company’s tuition cash collections from Title IV programs were 85.8%. ED requires an institution to provide additional information with respect to its 90/10 revenue test. Reference is made to the accompanying Supplementary Information on page 12 with respect to additional disclosures required by ED.
Institutions participating in Title IV programs are also required by ED to demonstrate financial responsibility. ED determines an institution’s financial responsibility through the calculation of a composite score based upon certain financial ratios as defined in regulations. Institutions receiving a composite score of 1.5 or greater are considered fully financially responsible. Institutions receiving a composite score between 1.0 and 1.4 are subject to additional monitoring and institutions receiving a score below 1.0 are required to submit financial guarantees in order to continue participation in the Title IV programs. As of December 31, 2002, and for the year then ended, the Company’s composite score was 3.0.
F-74
MICHIANA COLLEGE EDUCATION CORPORATION
SUPPLEMENTARY INFORMATION
(Information Required by the U.S. Department of Education)
December 31, 2002
Institution’s Calculation of 90/10 Revenue Test
Michiana College Education Corporation (the Institution) derives a substantial portion of its revenues from Student Financial Aid (SFA) received by its students under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). To continue to participate in the SFA programs the Institution must comply with the regulations promulgated under HEA. The regulations restrict the proportion of cash receipts for tuition and fees from eligible programs to not more than 90 percent from the Title IV programs. The failure of the Institution to meet the 90 percent limitation will result in the loss of the Institution’s ability to participate in SFA programs. For the year ended December 31, 2002, the Institution’s 90/10 revenue test percentages were computed as follows:
Title IV funds received | $ | 6,155,548 | ||
Total eligible cash receipts | $ | 7,171,820 | ||
Percentage Title IV | 85.8 | % |
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
Related Party Transactions
Michiana College Education Corporation (the Institution) participates in Student Financial Aid (SFA) under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). The institution must comply with the regulations promulgated under HEA. Those regulations require that all related party transactions be disclosed, regardless of their materiality to the financial statements.
Distributions to Stockholders – During the year ended December 31, 2002, the Institution made $894,533 of distributions to its stockholders, of which $786,533 was for the payment of income taxes.
Contingency – As of December 31, 2002, the Institution was a co-guarantor and its assets secured outstanding credit facilities of $1,090,000 of American Education Centers, Inc. (AEC) and $3,335,760 of Brown Mackie Education Corporation, which are entities owned by the stockholders of the Institution.
Advances From Related Party – As of December 31, 2002, the Institution had received net advances of $437,879 from AEC, of which $430,000 was under the terms of a Security Agreement whereby all of the Institution’s assets secured and collaterlized this portion of the net advances, which were to be repaid by January 31, 2003. The remaining advances are non-interest bearing, have no stipulated repayment provisions and are subordinated to all other third-party obligations. Subsequent to December 31, 2002, the advances of $437,879 were fully repaid.
F-75
Management and Administrative Fees – During the year ended December 31, 2002, the Institution paid $52,500 in management fees to an organization owned by one of the Institution’s stockholders. The Institution was also charged $1,000,000 in administrative fees by AEC. Such fees have been reflected within general and administrative expense in the statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
Investment In Affiliate - The accompanying financial statements include the accounts of the Institution, as well as its 20% interest in Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Institution’s investment in SOC is accounted for using the equity method of accounting as the Institution exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $420,000, adjusted for the Institution’s proportionate share of earnings or losses. The Institution’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002. Summarized financial position and results of operations for the Institution’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity - Effective August 7, 2001, the Institution entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 63.62 shares of the Institution’s restricted Class A common stock with a fair market value of $4,660 per share as consideration for providing certain consultancy and advisory services to the Institution. The restricted stock will be held by the Institution until terms and conditions specified by the Institution are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $59,294 during the year ended December 31, 2002.
F-76
The Institution has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Institution, subject to adjustment for changes in the Institution’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accompanying financial statements for these options as vesting is contingent upon the Institution achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and become vested and exercisable ratably over a five year period. The option price is $10 for all shares, regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Institution’s stock at the grant date was immaterial. Vested options at December 31, 2002 were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been included in the $1,000,000 administrative fee discussed above, as well as within additional paid-in capital.
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
F-77
INDEPENDENT AUDITORS’ REPORT ON COMPLIANCE AND
ON INTERNAL CONTROL OVER FINANCIAL REPORTING BASED ON
AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE
WITHGOVERNMENT AUDITING STANDARDS
To the Board of Directors and Stockholders
of Michiana College Education Corporation:
We have audited the basic financial statements of Michiana College Education Corporation as of and for the year ended December 31, 2002, and have issued our report thereon dated February 14, 2003. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained inGovernment Auditing Standards, issued by the Comptroller General of the United States.
Compliance
As part of obtaining reasonable assurance about whether Michiana College Education Corporation’s financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grants, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance that are required to be reported underGovernment Auditing Standards.
Internal Control Over Financial Reporting
In planning and performing our audit, we considered Michiana College Education Corporation’s internal control over financial reporting in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on internal control over financial reporting. Our consideration of internal control over financial reporting would not necessarily disclose all matters in internal control over financial reporting that might be material weaknesses. A material weakness is a condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. We noted no matters involving internal control over financial reporting and its operation that we consider to be material weaknesses.
This report is intended solely for the information and use of the board of directors, management, and the U.S. Department of Education and is not intended to be and should not be used by anyone other than these specified parties.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
F-78
To the members
of Southern Ohio College, LLC:
We have audited the accompanying balance sheet of Southern Ohio College, LLC (a Delaware limited liability company) as of December 31, 2002, and the related statements of income and members’ equity and cash flows for the period from inception (June 13, 2002) through December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America andGovernment Auditing Standards, issued by the Comptroller General of the 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Southern Ohio College, LLC as of December 31, 2002, and the results of its operations and its cash flows for the initial period then ended in conformity with accounting principles generally accepted in the United States of America.
Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying supplementary information on page 9 on Southern Ohio College, LLC’s calculation of its Title IV 90/10 revenue test and on related party transactions are required by the U.S. Department of Education and are presented for purposes of additional analysis and are not a required part of the basic financial statements. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.
In accordance withGovernment Auditing Standards, we have also issued our report dated February 14, 2003, on our consideration of Southern Ohio College, LLC’s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grants.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
F-79
Balance Sheet
December 31, 2002
| Assets | |||
Current assets: | |||
Cash | $ | 841,849 | |
Accounts receivable, net of allowance for doubtful accounts of $116,000 | 255,938 | ||
Prepaid expenses and other | 62,490 | ||
Total current assets | 1,160,277 | ||
Furniture and equipment, net of accumulated depreciation of $53,466 | 280,375 | ||
Other assets: | |||
Deposits | 14,062 | ||
Intangible asset: non-compete agreement, net of accumulated amortization of $5,000 | 45,000 | ||
Goodwill | 1,760,222 | ||
Total other assets | 1,819,284 | ||
| $ | 3,259,936 | ||
| Liabilities and Members’ Equity | |||
Current liabilities: | |||
Accounts payable | $ | 13,803 | |
Accrued expenses | 86,878 | ||
Unearned tuition | 42,587 | ||
Current portion of note payable | 151,723 | ||
Total current liabilities | 294,991 | ||
Advances from related party | 187,722 | ||
Note payable, net of current portion and unamortized discount | 643,775 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
See notes to financial statements
F-80
Statement of Income and Members’ Equity
For The Period From Inception (June 13, 2002) Through December 31, 2002
Revenues | $ | 1,379,575 | ||
Costs and expenses: | ||||
Course materials, services and instruction | 512,705 | |||
Selling and promotion | 256,482 | |||
General and administrative | 358,363 | |||
Facilities | 140,245 | |||
Depreciation and amortization | 58,466 | |||
Total costs and expenses | 1,326,261 | |||
Income from operations | 53,314 | |||
Other expense - interest | (19,866 | ) | ||
Income before provision for income taxes | 33,448 | |||
Provision for income taxes | — | |||
Net income | 33,448 | |||
Members’ equity, beginning of period | 2,100,000 | |||
Members’ equity, end of period | $ | 2,133,448 | ||
See notes to financial statements
F-81
Statement of Cash Flows
For The Period From Inception (June 13, 2002) Through December 31, 2002
Cash flows from operating activities: | ||||
Net income | $ | 33,448 | ||
Adjustments to reconcile net income to net cash used by operating activities - | ||||
Depreciation and amortization | 58,466 | |||
Amortization of discount on note payable | 8,823 | |||
Changes in operating assets and liabilities - | ||||
Accounts receivable, net | (132,329 | ) | ||
Prepaid expenses and other | 691 | |||
Accounts payable | (30,437 | ) | ||
Accrued expenses | 57,223 | |||
Unearned tuition | (23,929 | ) | ||
Net cash used by operating activities | (28,044 | ) | ||
Cash flows from investing activities: | ||||
Purchases of furniture and equipment | (101,607 | ) | ||
Net cash used by investing activities | (101,607 | ) | ||
Cash flows from financing activities: | ||||
Increase in advance from related party | 187,722 | |||
Net cash provided by financing activities | 187,722 | |||
Increase in cash | 58,071 | |||
Cash, beginning of period | 783,778 | |||
Cash, end of period | $ | 841,849 | ||
Supplemental cash flows information: | ||||
Cash paid for - | ||||
Interest expense | $ | — | ||
Income taxes | $ | — | ||
See notes to financial statements
F-82
Notes to Financial Statements
From the Period From Inception (June 13, 2002) Through December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Basis of Presentation
Southern Ohio College, LLC (the Company) is a Delaware limited liability company organized on May 8, 2002. The duration of the limited liability company is perpetual. The members of the Company are American Education Centers, Inc., Asher School of Business Education Corporation, Brown Mackie Education Corporation, Commonwealth Business College Education Corporation, Michiana College Education Corporation, and Stautzenberger College Education Corporation. There is one class of members’ equity, and each member has the same rights, preferences and privileges. Each of the members have common ownership.
The Company was formed to purchase certain assets and assume certain liabilities of Career Options, Inc. (Career Options), an Ohio corporation. Career Options operated a private career school known as ETI Technical College with one campus located in Canton, Ohio which provided training for the medical and technical industries.
The accompanying financial statements include only the accounts of the Company. Operations for the Company commenced on June 13, 2002.
Depreciation and Amortization
Furniture and equipment are stated at cost and will be depreciated utilizing the straight-line method over the estimated useful lives of the assets, which range from 2 to 5 years.
The non-compete agreement will be amortized over its five year term using the straight-line method (see Note 2).
Depreciation and amortization commenced with operations on June 13, 2002.
Goodwill
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets.” As a result of SFAS No. 142, goodwill will no longer be amortized but will be tested for impairment annually and written down only when impaired. Management does not believe that the Company’s goodwill is impaired.
Revenue Recognition
Revenues are derived primarily from tuition on courses taught in the Company’s career school. Tuition revenue is recognized on a straight-line basis over the term of instruction. Unearned tuition results when cash collected on a student’s account exceeds tuition revenue recognized at the balance sheet date.
Accounts Receivable
Accounts receivable are recorded at the net realizable value expected to be received from students or third-party payors. Management continually monitors and adjusts its allowances associated with the Company’s receivables to address any credit risks associated with the accounts receivable. When uncertainty exists as to the collection of receivables, the Company records an allowance for doubtful accounts and a corresponding charge to bad debt expense.
F-83
Income Taxes
As a limited liability company, the Company is not required to pay federal or state income taxes. Accordingly, no provision for income taxes are reflected in the Company’s financial statements.
Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.
NOTE 2 - BUSINESS ACQUISITION
On June 13, 2002, the Company entered into an Asset Purchase Agreement (the Agreement) to acquire certain assets and to assume certain liabilities of Career Options (the Seller). The purchase price was $2,155,000, of which $2,105,000 pertains to the tangible and intangible assets acquired and $50,000 to a non-compete agreement. The Agreement provides for the purchase price to be adjusted only to the extent that cash transferred by the Seller at closing of $21,278 plus net student accounts receivable is less than student advance payments, as defined in the Agreement; there was no such purchase price adjustment.
The purchase price was as follows:
Cash payment at closing | $ | 1,315,000 | |
Note payable, net of discount | 786,675 | ||
Direct costs of acquisition | 13,972 | ||
| $ | 2,115,647 | ||
The acquisition of the Company has been accounted for by the purchase method of accounting and accordingly, the purchase price has been allocated to the assets acquired and liabilities assumed based on the estimated fair market values at the date of acquisition.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The allocation of the purchase price is subject to refinement due to estimates associated with the valuation of certain assets and liabilities as well as the direct costs of the acquisition.
Current assets | $ | 199,630 | |
Furniture and equipment | 232,234 | ||
Total assets acquired | 431,864 | ||
Current liabilities assumed | 126,439 | ||
Net assets acquired | 305,425 | ||
Purchase price | 2,101,675 | ||
Direct costs of acquisition | 13,972 | ||
Total purchase price | 2,115,647 | ||
Excess of total purchase price over net assets acquired | $ | 1,810,222 | |
Of the $1,810,222 excess of total purchase price over net assets acquired, $50,000 was assigned to the non-compete agreement. This intangible asset will be amortized over its five year term. The remaining $1,760,222 of the excess of total purchase price over net assets acquired has been assigned to goodwill and is expected to be fully deductible for tax purposes.
F-84
NOTE 3 - FURNITURE AND EQUIPMENT
Furniture and equipment consisted of the following as of December 31, 2002:
Furniture | $ | 200,387 | ||
Equipment | 133,454 | |||
| 333,841 | ||||
Less: accumulated depreciation | (53,466 | ) | ||
| $ | 280,375 | |||
Depreciation expense associated with furniture and equipment for the initial period ended December 31, 2002, was $53,466.
NOTE 4 - NOTE PAYABLE
The note payable at December 31, 2002, had the following terms:
Note payable to Seller, related to the purchase of the net assets of the college, with a principal amount of $840,000, payable in five annual principal installments plus accrued interest at 2.5% per annum, with a maturity date of June 12, 2007. The note has been discounted using an interest rate of 4.75% per annum, which represents the prime interest rate at June 13, 2002. The note is collateralized by substantially all assets acquired from the Seller, as well as a guaranty from one of the Company’s members. | $ | 840,000 | ||
Less: unamortized discount | (44,502 | ) | ||
current portion | (151,723 | ) | ||
| $ | 643,775 | |||
Future maturities of the note payable as of December 31, 2002 are as follows:
Year Ending | |||
2003 | $ | 159,781 | |
2004 | 163,738 | ||
2005 | 167,879 | ||
2006 | 172,125 | ||
2007 | 176,477 | ||
| $ | 840,000 | ||
NOTE 5 - COMMITMENTS
The Company leases its operating facility under the terms of a non-cancellable lease agreement which expires June 13, 2007. The lease contains two renewal options of five years each.
F-85
Future minimum lease payments over the remaining terms of the lease as of December 31, 2002, are as follows:
Year Ending | |||
2003 | $ | 168,750 | |
2004 | 168,750 | ||
2005 | 168,750 | ||
2006 | 168,750 | ||
2007 | 70,313 | ||
| $ | 745,313 | ||
Rent expense for the initial period ended December 31, 2002, was approximately $94,300 and is reflected within facilities expense in the accompanying statement of income.
NOTE 6 - RELATED PARTY TRANSACTIONS
The Company advances and receives funds with one of its members. Net amounts received at December 31, 2002, amounted to $187,722. The advances are non-interest bearing, have no stipulated repayment provisions and are subordinated to all other third-party obligations.
During the initial period ended December 31, 2002, the Company paid $10,500 in management fees to an entity owned by a stockholder of one of its members. The Company was also charged $100,000 in administrative fees by one of its members. The fees are reflected within general and administrative expenses in the accompanying statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
NOTE 7 - CONCENTRATION OF CREDIT RISK AND REGULATORY CONSIDERATIONS
As of December 31, 2002, the Company had cash balances with a bank in excess of the federally insured limit of $100,000.
The Company participates in Government Student Financial Assistance Programs (Title IV) administered by the U.S. Department of Education (ED) for the payment of student tuitions. Substantial portions of the revenue and collection of ending accounts receivable as of December 31, 2002, are dependent upon the Company’s continued participation in the Title IV programs. Institutions participating in Title IV programs may not receive more than 90% of tuition collections (90/10 revenue test as defined in regulation) from Title IV sources in order to maintain eligibility for participation in such programs. For the year ended December 31, 2002, the Company’s tuition cash collections from Title IV programs were 84.8%. ED requires an institution to provide additional information with respect to its 90/10 revenue test. Reference is made to the accompanying Supplementary Information on page 9 with respect to additional disclosures required by ED.
Institutions participating in Title IV programs are also required by ED to demonstrate financial responsibility. ED determines an institution’s financial responsibility through the calculation of a composite score based upon certain financial ratios as defined in regulations. Institutions receiving a composite score of 1.5 or greater are considered fully financially responsible. Institutions receiving a composite score between 1.0 and 1.4 are subject to additional monitoring and institutions receiving a score below 1.0 are required to submit financial guarantees in order to continue participation in the Title IV programs. As of December 31, 2002, and for the initial period then ended, the Company’s composite score was 2.0.
F-86
Supplementary Information
(Information Required by the U.S. Department of Education)
From the Period From Inception (June 13, 2002) Through December 31, 2002
Title IV 90/10 Revenue Test
Southern Ohio College, LLC (the Institution) derives a substantial portion of its revenues from Student Financial Aid (SFA) received by its students under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). To continue to participate in the SFA programs the Institution must comply with the regulations promulgated under HEA. The regulations restrict the proportion of cash receipts for tuition and fees from eligible programs to not more than 90 percent from the Title IV programs. The failure of the Institution to meet the 90 percent limitation will result in the loss of the Institution’s ability to participate in SFA programs. For the year ended December 31, 2002, the Institution’s 90/10 revenue test percentages were computed as follows:
Title IV funds received | $ | 2,147,876 | ||
Total eligible cash receipts | $ | 2,532,440 | ||
Percentage Title IV | 84.8 | % |
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
Related Party Transactions
Southern Ohio College, LLC (the Institution) is a Delaware limited liability company organized on May 8, 2002. The duration of the limited liability company is perpetual. The members of the Institution are American Education Centers, Inc., Asher School of Business Education Corporation, Brown Mackie Education Corporation, Commonwealth Business College Education Corporation, Michiana College Education Corporation, and Stautzenberger College Education Corporation. There is one class of members’ equity, and each member has the same rights, preferences and privileges. Each of the members have common ownership.
With respect to the December 31, 2002 balance sheet, members’ equity, as reflected on the balance sheet, has been contributed as follows:
American Education Centers, Inc. (AEC) | $ | 420,000 | |
Asher School of Business Education Corporation | 210,000 | ||
Brown Mackie Education Corporation | 315,000 | ||
Commonwealth Business College Education Corporation | 420,000 | ||
Michiana College Education Corporation | 420,000 | ||
Stautzenberger College Education Corporation | 315,000 | ||
| $ | 2,100,000 | ||
Advances From Related Party – As of December 31, 2002, the Institution had received net advances of $187,722 from AEC. The advances are non-interest bearing, have no stipulated repayment provisions and are subordinated to all other third-party obligations.
F-87
Management and Administrative Fees – During the initial period ended December 31, 2002, the Institution paid $10,500 in management fees to an organization owned by a stockholder of one of its members. The Institution was also charged $100,000 in administrative fees by AEC. The management fees have been reflected within general and administrative expense in the statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
F-88
INDEPENDENT AUDITORS’ REPORT ON COMPLIANCE AND
ON INTERNAL CONTROL OVER FINANCIAL REPORTING BASED ON
AN AUDIT OF THE FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE
WITHGOVERNMENT AUDITING STANDARDS
To the members of
Southern Ohio College, LLC:
We have audited the financial statements of Southern Ohio College, LLC as of and for the initial period ended December 31, 2002, and have issued our report thereon dated February 14, 2003. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained inGovernment Auditing Standards, issued by the Comptroller General of the United States.
Compliance
As part of obtaining reasonable assurance about whether Southern Ohio College, LLC’s financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grants, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance that are required to be reported underGovernment Auditing Standards.
Internal Control Over Financial Reporting
In planning and performing our audit of the financial statements, we considered Southern Ohio College, LLC’s internal control over financial reporting in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on internal control over financial reporting. Our consideration of internal control over financial reporting would not necessarily disclose all matters in internal control over financial reporting that might be material weaknesses. A material weakness is a condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. We noted no matters involving internal control over financial reporting and its operation that we consider to be material weaknesses.
This report is intended solely for the information and use of the members, management, and the U.S. Department of Education and is not intended to be and should not be used by anyone other than these specified parties.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
website: www.almichcpa.com • email: info@almichcpa.com
F-89
To the Board of Directors and
Stockholders of Stautzenberger College Education Corporation:
We have audited the accompanying balance sheet of Stautzenberger College Education Corporation (a Delaware corporation) as of December 31, 2002, and the related statements of income, stockholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America andGovernment Auditing Standards,issued by the Comptroller General of the 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Stautzenberger College Education Corporation as of December 31, 2002, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying supplementary information on page 11 on Stautzenberger College Education Corporation’s calculation of its Title IV 90/10 revenue test and on related party transactions are required by the U.S. Department of Education and are presented for purposes of additional analysis and are not a required part of the basic financial statements. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.
In accordance withGovernment Auditing Standards,we have also issued our report dated February 14, 2003, on our consideration of Stautzenberger College Education Corporation’s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts and grants.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
website: www.almichcpa.com • email: info@almichcpa.com
F-90
STAUTZENBERGER COLLEGE EDUCATION CORPORATION
Balance Sheet
December 31, 2002
| Assets | ||||
Current assets: | ||||
Cash | $ | 446,385 | ||
Accounts receivable, net of allowance for doubtful accounts of $88,400 | 149,808 | |||
Deferred initial direct costs | 69,200 | |||
Prepaid expenses and other | 33,614 | |||
Total current assets | 699,007 | |||
Furniture, equipment and improvements, net of accumulated depreciation and amortization of $53,716 | 36,732 | |||
Other assets: | ||||
Deposits | 4,958 | |||
Advances to related party | 142,014 | |||
Investment in affiliate | 315,000 | |||
Goodwill | 134,233 | |||
Total other assets | 596,205 | |||
| $ | 1,331,944 | |||
| Liabilities and Stockholders’ Equity | ||||
Current liabilities: | ||||
Accounts payable | $ | 3,404 | ||
Accrued expenses | 66,400 | |||
Unearned tuition | 295,747 | |||
Total current liabilities | 365,551 | |||
Senior subordinated debentures | 57,818 | |||
Total liabilities | 423,369 | |||
Stockholders’ equity: | ||||
Class A common stock, $.01 par value, 1,000 shares authorized | 5 | |||
Class B nonvoting common stock, $.01 par value, 1,000 shares authorized | 5 | |||
Additional paid-in capital | 839,801 | |||
Retained earnings | 340,084 | |||
| 1,179,895 | ||||
Treasury stock, at cost | (271,320 | ) | ||
Total stockholders’ equity | 908,575 | |||
| $ | 1,331,944 | |||
See notes to financial statements
F-91
STAUTZENBERGER COLLEGE EDUCATION CORPORATION
Statement of Income
For The Year Ended December 31, 2002
Revenues | $ | 2,641,070 | ||
Costs and expenses: | ||||
Course materials, services and instruction | 838,753 | |||
Selling and promotion | 245,667 | |||
General and administrative | 621,037 | |||
Facilities | 189,947 | |||
Depreciation and amortization | 25,258 | |||
Total costs and expenses | 1,920,662 | |||
Income from operations | 720,408 | |||
Other income (expense): | ||||
Other income | 53 | |||
Loss on sale of fixed assets | (946 | ) | ||
Interest expense | (3,181 | ) | ||
Total other income (expense) | (4,074 | ) | ||
Income before provision for income taxes | 716,334 | |||
Provision for income taxes | — | |||
Net income | $ | 716,334 | ||
See notes to financial statements
F-92
STAUTZENBERGER COLLEGE EDUCATION CORPORATION
Statement of Stockholders’ Equity
For The Year Ended December 31, 2002
| Class A Common Stock | Class B Nonvoting Common Stock | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Total Stockholders’ Equity | ||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | ||||||||||||||||||||||
Balance, beginning of year | 331.18 | $ | 5 | 365 | $ | 5 | $ | 752,334 | $ | 30,628 | 303.82 | $ | (271,320 | ) | $ | 511,652 | |||||||||||
Net income | — | — | — | — | — | 716,334 | — | — | 716,334 | ||||||||||||||||||
Distributions to stockholders for payment of income taxes | — | — | — | — | — | (368,874 | ) | — | — | (368,874 | ) | ||||||||||||||||
Distributions to stockholders | — | — | — | — | — | (38,004 | ) | — | — | (38,004 | ) | ||||||||||||||||
Recognition of restricted stock compensation | — | — | — | — | 59,294 | — | — | — | 59,294 | ||||||||||||||||||
Stock compensation expense | — | — | — | — | 28,173 | — | — | — | 28,173 | ||||||||||||||||||
Balance, end of year | 331.18 | $ | 5 | 365 | $ | 5 | $ | 839,801 | $ | 340,084 | 303.82 | $ | (271,320 | ) | $ | 908,575 | |||||||||||
See notes to financial statements
F-93
STAUTZENBERGER COLLEGE EDUCATION CORPORATION
Statement of Cash Flows
For The Year Ended December 31, 2002
Cash flows from operating activities: | ||||
Net income | $ | 716,334 | ||
Adjustments to reconcile net income to net cash provided by operating activities - | ||||
Depreciation and amortization | 25,258 | |||
Recognition of restricted stock compensation | 59,294 | |||
Stock compensation expense | 28,173 | |||
Changes in assets and liabilities - | ||||
Accounts receivable, net | (77,639 | ) | ||
Deferred initial direct costs | 12,000 | |||
Prepaid expenses and other | (1,556 | ) | ||
Accounts payable | (20,742 | ) | ||
Accrued expenses | 19,829 | |||
Unearned tuition | 77,683 | |||
Net cash provided by operating activities | 838,634 | |||
Cash flows from investing activities: | ||||
Purchases of furniture, equipment and improvements | (17,786 | ) | ||
Investment in affiliate | (315,000 | ) | ||
Net cash used by investing activities | (332,786 | ) | ||
Cash flows from financing activities: | ||||
Distributions to stockholders for payment of income taxes | (368,874 | ) | ||
Distributions to stockholders | (38,004 | ) | ||
Increase in advances to related party | (18,131 | ) | ||
Net cash used by financing activities | (425,009 | ) | ||
Increase in cash | 80,839 | |||
Cash, beginning of year | 365,546 | |||
Cash, end of year | $ | 446,385 | ||
Supplemental cash flows information: | ||||
Cash paid for - | ||||
Interest | $ | 3,181 | ||
Income taxes | $ | — | ||
See notes to financial statements
F-94
STAUTZENBERGER COLLEGE EDUCATION CORPORATION
Notes to Financial Statements
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Stautzenberger College Education Corporation (the Company) was incorporated on July 22, 1997, in the state of Delaware. The Company operates a private career school located in Findlay, Ohio. The Company provides career training for business and health related professions and offers diploma and degree programs.
Basis of Presentation
The accompanying financial statements include the accounts of the Company, as well as its 15% equity interest in the earnings of Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $315,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002.
Furniture, Equipment and Improvements
Furniture, equipment and improvements are stated at cost and are being depreciated or amortized utilizing the straight-line method over the following estimated useful lives:
Furniture | 7 years | |
Equipment | 3 to 5 years | |
Leasehold improvements | Shorter of lease term or useful life |
Goodwill
Goodwill represents the excess of the purchase price over the fair market value of the net assets acquired in connection with the purchase of the college.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 142 “Goodwill and Other Intangible Assets.” As a result of SFAS No. 142, all existing and newly acquired goodwill will no longer be amortized but will be tested for impairment annually and written down only when impaired. The Company adopted the provisions of SFAS No. 142 effective January 1, 2002. Management does not believe that the Company’s goodwill is impaired.
Revenue Recognition
Revenues are derived primarily from tuition on courses taught in the Company’s career school. Tuition revenue is recognized on a straight-line basis over the term of instruction. Deferred initial direct costs, consisting primarily of marketing expenses, are deferred and amortized over a period not to exceed the term of instruction. Unearned tuition results when cash collected on a student’s account exceeds tuition revenue recognized at the balance sheet date.
F-95
Accounts Receivable
Accounts receivable are recorded at the net realizable value expected to be received from students or third-party payors. Management continually monitors and adjusts its allowances associated with the Company’s receivables to address any credit risks associated with the accounts receivable. When uncertainty exists as to the collection of receivables, the Company records an allowance for doubtful accounts and a corresponding charge to bad debt expense.
Income Taxes
The Company operates as a Subchapter S Corporation. As such, the income and expenses of the Company pass through to the stockholders and are reported on their individual income tax returns. Accordingly, no provision for income taxes is recorded in the accompanying financial statements.
Stock-Based Compensation
The Company follows Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation”, which establishes a fair value based method of accounting for stock-based compensation plans.
Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.
NOTE 2 - FURNITURE, EQUIPMENT AND IMPROVEMENTS
Furniture, equipment and improvements consisted of the following as of December 31, 2002:
Furniture and equipment | $ | 79,178 | ||
Leasehold improvements | 11,270 | |||
| 90,448 | ||||
Less: accumulated depreciation and amortization | (53,716 | ) | ||
| $ | 36,732 | |||
Depreciation and amortization expense associated with furniture, equipment and improvements for the year ended December 31, 2002 was $25,258.
NOTE 3 - COMMITMENTS AND CONTINGENCIES
Commitments
The Company had a five-year non-cancelable operating lease agreement for its facilities. The lease contained one five-year renewal option. The lease expired in August 2002. The lease required the Company to pay all operating expenses of the facility and provided for annual increases in the base rent based on the consumer price index.
F-96
During the year ended December 31, 2002, the Company entered into a new non-cancelable operating lease agreement for its facilities. The lease contains one ten-year renewal option, commences in January 2003 and will expire in December 2012. The lease requires monthly lease payments of $6,773 for the first year, $8,119 for years two through five, $10,835 for year six and $11,658 for the remaining four years. In addition, the lease requires the Company to pay all operating expenses of the facility as well as common area fees.
Future minimum payments over the remaining terms of the above described leases as of December 31, 2002 are as follows:
Year Ending | |||
2003 | $ | 81,276 | |
2004 | 97,432 | ||
2005 | 97,432 | ||
2006 | 97,432 | ||
2007 | 130,022 | ||
Thereafter | 699,497 | ||
| $ | 1,203,091 | ||
Rent expense for the year ended December 31, 2002, was approximately $134,900. Rent expense is reflected within facilities expenses in the accompanying statement of income.
Contingencies
The Company and other educational corporations owned by the stockholders of the Company have a $1,735,100 line of credit with a bank which expires June 1, 2003. Borrowings bear interest at the bank’s prime rate (4.25% at December 31, 2002), and are collateralized by all assets of the Company and the other educational corporations owned by the Company’s stockholders. As of December 31, 2002, there were no outstanding balances under this agreement.
As of December 31, 2002, the Company was a co-guarantor and its assets secured outstanding credit facilities of $4,425,760 of other educational corporations owned by the stockholders of the Company.
NOTE 4 - RELATED PARTY TRANSACTIONS
The Company advances and receives funds with an educational corporation owned by the stockholders of the Company. Net amounts advanced at December 31, 2002, amounted to $142,014. The advances are non-interest bearing, secured by the corporation’s assets and have no stipulated repayment provisions.
During the year ended December 31, 2002, the Company paid $21,000 in management fees to an entity owned by one of the Company’s stockholders. The Company was also charged $250,000 in administrative fees by an educational corporation owned by the stockholders of the Company. The fees have been reflected within general and administrative expenses in the accompanying statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
F-97
Investment In Affiliate
Summarized financial position and results of operations for the Company’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity
Effective August 7, 2001, the Company entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 63.62 shares of the Company’s restricted Class A common stock with a fair market value of $4,660 per share as consideration for providing certain consultancy and advisory services to the Company. The restricted stock will be held by the Company until terms and conditions specified by the Company are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $59,294 during the year ended December 31, 2002.
The Company has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Company, subject to adjustment for changes in the Company’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accompanying financial statements for these options as vesting is contingent upon the Company achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and become vested and exercisable ratably over a five year period. The option price is $10 for all shares, regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Company’s stock at the grant date was immaterial. Vested options at December 31, 2002 were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been included within the $250,000 administrative fee discussed above, as well as within additional paid-in capital.
F-98
NOTE 5 - SENIOR SUBORDINATED DEBENTURES
The senior subordinated debentures as of December 31, 2002, are related to the purchase of the net assets of the college and consist of 5.5% Senior Subordinated Debentures due March 31, 2004. The debentures include nondetachable Series A warrants to purchase in the aggregate up to 77.10 shares of each of the Company’s Class A common stock and Class B common stock. The agreement also contains provisions to issue Series B warrants to purchase up to an additional 11.14 shares of each of the Company’s Class A and Class B common stock. All accrued interest is payable on or before March 31, 2002. Accrued interest on the debentures was $795 as of December 31, 2002 and is reflected within accrued expenses.
NOTE 6 - 401(K) SAVINGS PLAN
The Company has a 401(K) plan covering substantially all of its employees. The Company matches 100% of the first 3% of employee contributions to the plan. The Company may elect to contribute additional amounts to the plan as determined by the board of directors. No Company discretionary contributions were made during the year ended December 31, 2002. Company contributions vest according to a schedule, become fully vested after six years and amounted to approximately $4,500 during the year ended December 31, 2002.
NOTE 7 - CONCENTRATION OF CREDIT RISK AND REGULATORY CONSIDERATIONS
At December 31, 2002, the Company had cash balances with a bank in excess of the federally insured amount of $100,000.
The Company participates in Government Student Financial Assistance Programs (Title IV) administered by the U.S. Department of Education (ED) for the payment of student tuitions. Substantial portions of the revenue and collection of ending accounts receivable as of December 31, 2002, are dependent upon the Company’s continued participation in the Title IV programs. Institutions participating in Title IV programs may not receive more than 90% of tuition collections (90/10 revenue test as defined in regulation) from Title IV sources in order to maintain eligibility for participation in such programs. For the year ended December 31, 2002, the Company’s tuition cash collections from Title IV programs were 68.8%. ED requires an institution to provide additional information with respect to its 90/10 revenue test. Reference is made to the accompanying Supplementary Information on page 11 with respect to additional disclosures required by ED.
Institutions participating in Title IV programs are also required by ED to demonstrate financial responsibility. ED determines an institution’s financial responsibility through the calculation of a composite score based upon certain financial ratios as defined in regulations. Institutions receiving a composite score of 1.5 or greater are considered fully financially responsible. Institutions receiving a composite score between 1.0 and 1.4 are subject to additional monitoring and institutions receiving a score below 1.0 are required to submit financial guarantees in order to continue participation in the Title IV programs. As of December 31, 2002, and for the year then ended, the Company’s composite score was 3.0.
F-99
STAUTZENBERGER COLLEGE EDUCATION CORPORATION
SUPPLEMENTARY INFORMATION
(Information Required by the U.S. Department of Education)
December 31, 2002
Institution’s Calculation of 90/10 Revenue Test
Stautzenberger College Education Corporation (the Institution) derives a substantial portion of its revenues from Student Financial Aid (SFA) received by its students under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). To continue to participate in the SFA programs the Institution must comply with the regulations promulgated under HEA. The regulations restrict the proportion of cash receipts for tuition and fees from eligible programs to not more than 90 percent from the Title IV programs. The failure of the Institution to meet the 90 percent limitation will result in the loss of the Institution’s ability to participate in SFA programs. For the year ended December 31, 2002, the Institution’s 90/10 revenue test percentages were computed as follows:
Title IV funds received | $ | 1,873,726 | ||
Total eligible cash receipts | $ | 2,723,810 | ||
Percentage Title IV | 68.8 | % |
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
Related Party Transactions
Stautzenberger College Education Corporation (the Institution) participates in Student Financial Aid (SFA) under the Title IV programs administered by the U.S. Department of Education pursuant to the Higher Education Act of 1965, as amended (HEA). The institution must comply with the regulations promulgated under HEA. Those regulations require that all related party transactions be disclosed, regardless of their materiality to the financial statements.
Distributions to Stockholders - During the year ended December 31, 2002, the Institution made $406,878 of distributions to its stockholders, of which $368,874 was for the payment of income taxes.
Contingency - As of December 31, 2002, the Institution was a co-guarantor and its assets secured outstanding credit facilities of $1,090,000 of American Education Centers, Inc. (AEC) and $3,335,760 of Brown Mackie Education Corporation, which are entities owned by the stockholders of the Institution.
Advances to Related Party - At December 31, 2002, the Institution had advanced $142,014 to AEC. The advances are non-interest bearing, secured by AEC’s assets and have no stipulated repayment provisions.
Management and Administrative Fees - During the year ended December 31, 2002, the Institution paid management fees of $21,000 to an organization owned by one of the Institution’s stockholders. The Institution was also charged $250,000 in administrative fees by AEC. Such fees are reflected within general and administrative expenses in the accompanying statement of income, and represent various services including marketing, accounting, compliance and financial aid, as well as information systems and support.
F-100
Investment In Affiliate - The accompanying financial statements include the accounts of the Institution, as well as its 15% interest in Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Institution’s investment in SOC is accounted for using the equity method of accounting as the Institution exercises significant influence over operating and financial policies of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $315,000, adjusted for the Institution’s proportionate share of earnings or losses. The Institution’s proportionate share of SOC’s earnings were not material during the year ended December 31, 2002. Summarized financial position and results of operations for the Institution’s equity method affiliate SOC is as follows as of December 31, 2002:
Current assets | $ | 1,160,277 | |
Furniture, equipment and improvements | 280,375 | ||
Goodwill | 1,760,222 | ||
Other assets | 59,062 | ||
| $ | 3,259,936 | ||
Current liabilities | $ | 294,991 | |
Non-current liabilities | 831,497 | ||
Total liabilities | 1,126,488 | ||
Members’ equity | 2,133,448 | ||
| $ | 3,259,936 | ||
Revenues | $ | 1,379,575 | |
Net income | $ | 33,448 | |
Stockholders’ Equity - Effective August 7, 2001, the Institution entered into a Restricted Stock Agreement and a Consulting Agreement (the Agreements) with one of its stockholders. Under the terms of the Agreements, the stockholder was granted 63.62 shares of the Institution’s restricted Class A common stock with a fair market value of $4,660 per share as consideration for providing certain consultancy and advisory services to the Institution. The restricted stock will be held by the Institution until terms and conditions specified by the Institution are satisfied. Except for the right of disposal and the right to receive distributions, the holder of the restricted stock has full stockholders’ rights during the period of restriction. The restricted shares vest in full five years after the date of the Agreements, are nontransferable, and are subject to forfeiture and accelerated vesting in certain instances, as defined. Consulting expense related to the restricted stock is based upon fair market value at the date of grant and is being charged to earnings on a straight-line basis over the period of restriction. Consulting expense related to restricted stock was $59,294 during the year ended December 31, 2002.
The Institution has agreements with certain individuals under which the individuals may purchase collectively 6% of the issued and outstanding common stock of the Institution, subject to adjustment for changes in the Institution’s capitalization, as defined. Options for 2% have an exercise price of $.01 per share, become 100% vested and may only be exercised upon the consummation of a qualified public offering or a sale of control, as defined. No compensation cost has been recognized in the accounting financial statements for these options as vesting is contingent upon the Institution achieving the above described performance condition. Options for the remaining 4% were granted in February 1998 and become vested and exercisable ratably over a five year period. The option price is $10 for all shares, regardless of number, that become vested during any calendar year. Management believes that any difference between the option price and the fair market value of the Institution’s stock at the grant date
F-101
was immaterial. Vested options at December 31, 2002 were 3.2%. In addition, repurchase provisions apply to the sale of stock acquired by option, the effects of which have been included within the $250,000 administrative fee discussed above, as well as within additional paid-in capital.
This information is required by the U.S. Department of Education and is presented for purposes of additional analysis and is not a required part of the basic financial statements.
F-102
INDEPENDENT AUDITORS’ REPORT ON COMPLIANCE AND
ON INTERNAL CONTROL OVER FINANCIAL REPORTING BASED ON
AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE
WITHGOVERNMENT AUDITING STANDARDS
To the Board of Directors and
Stockholders of Stautzenberger College Education Corporation:
We have audited the financial statements of Stautzenberger College Education Corporation as of and for the year ended December 31, 2002, and have issued our report thereon dated February 14, 2003. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained inGovernment Auditing Standards,issued by the Comptroller General of the United States.
Compliance
As part of obtaining reasonable assurance about whether Stautzenberger College Education Corporation’s financial statements are free of material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grants, noncompliance with which could have a direct and material effect on the determination of financial statement amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance that are required to be reported underGovernment Auditing Standards.
Internal Control Over Financial Reporting
In planning and performing our audit, we considered Stautzenberger College Education Corporation’s internal control over financial reporting in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on internal control over financial reporting. Our consideration of internal control over financial reporting would not necessarily disclose all matters in internal control over financial reporting that might be material weaknesses. A material weakness is a condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. We noted no matters involving internal control over financial reporting and its operation that we consider to be material weaknesses.
This report is intended solely for the information and use of the board of directors, management, and the U.S. Department of Education and is not intended to be and should not be used by anyone other than these specified parties.
/s/ Almich & Associates
Irvine, California
February 14, 2003
19000 MacArthur Blvd • Suite 610 • Irvine, CA 92612 • (949) 475-5410 • Fax (949) 475-5412
website: www.almichcpa.com • email: info@almichcpa.com
F-103
AMERICAN EDUCATION CENTERS, INC.
CONDENSED BALANCE SHEET
As of June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash | $ | 3,940,557 | $ | 5,498,565 | ||||
Accounts receivable, net of allowance | 1,518,597 | 2,223,990 | ||||||
Inventories | 110,763 | 107,104 | ||||||
Prepaid expenses | 366,426 | 742,590 | ||||||
Deferred initial direct costs | 927,100 | 890,100 | ||||||
Total current assets | 6,863,444 | 9,462,350 | ||||||
Property and equipment, net | 3,736,765 | 3,984,572 | ||||||
Other assets: | ||||||||
Deposits and other | 91,321 | 91,321 | ||||||
Investment in affiliate | 2,000,000 | 2,420,000 | ||||||
Intercompany transfers | (2,897,472 | ) | (5,533,095 | ) | ||||
Total other assets | (806,151 | ) | (3,021,774 | ) | ||||
Total assets | $ | 9,794,058 | $ | 10,425,148 | ||||
Liabilities and shareholders’ investment | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 175,144 | $ | 285,562 | ||||
Accrued expenses | 1,209,973 | 1,164,404 | ||||||
Unearned tuition | 2,197,522 | 2,227,933 | ||||||
Current portion of notes and debenture payable | 183,958 | 180,000 | ||||||
Total current liabilities | 3,766,596 | 3,857,899 | ||||||
Long-term liabilities: | ||||||||
Notes payable, net of current portion | 2,415,762 | 2,203,082 | ||||||
Total long-term liabilities | 2,415,762 | 2,203,082 | ||||||
Equity: | ||||||||
Common Stock | 20 | 20 | ||||||
Additional paid-in capital | 3,902,824 | 4,000,970 | ||||||
Retained earnings | 1,441,158 | 2,095,479 | ||||||
Treasury stock | 1,732,302 | 1,732,302 | ||||||
Total stockholder’s equity | 3,611,700 | 4,364,167 | ||||||
Total liabilities and equity | $ | 9,794,058 | $ | 10,425,148 | ||||
F-104
AMERICAN EDUCATION CENTERS, INC.
CONDENSED INCOME STATEMENTS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | |||||||
Net revenues | $ | 11,877,651 | $ | 12,332,985 | ||||
Costs and expenses: | ||||||||
Course materials, services and instruction | 4,334,500 | 4,321,362 | ||||||
Selling and promotion | 2,219,223 | 2,542,296 | ||||||
General and administrative | 3,281,599 | 3,559,370 | ||||||
Facilities | 1,320,164 | 1,434,281 | ||||||
Depreciation and amortization | 528,831 | 607,140 | ||||||
Total costs and expenses | 11,684,317 | 12,464,449 | ||||||
Income from operations | 193,334 | (131,464 | ) | |||||
Other income (expense) | ||||||||
Interest income | 40,581 | 44,031 | ||||||
Interest expense | 61,456 | 62,225 | ||||||
Other income (expense) | (287 | ) | (636 | ) | ||||
Total Other income (expense) | (21,162 | ) | (18,830 | ) | ||||
Net income | $ | 172,746 | $ | (149,021 | ) | |||
F-105
AMERICAN EDUCATION CENTERS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| Cash Flows from Operating Activities | 2002 | 2003 | ||||||
Net Income | $ | 172,746 | $ | (149,021 | ) | |||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 528,831 | 607,140 | ||||||
Changes in operating assets and liabilities | ||||||||
Accounts Receivable | 57,832 | (827,713 | ) | |||||
Prepaid expenses and other | 169,013 | (150,339 | ) | |||||
Deposits and other | 5,560 | (936 | ) | |||||
Accounts Payable | (150,384 | ) | (59,023 | ) | ||||
Accrued expenses and other | (437 | ) | 41,636 | |||||
Unearned Tuition | (54,405 | ) | (216,398 | ) | ||||
Net cash provided (used) by operating activities | 728,755 | (754,653 | ) | |||||
| Cash Flows from Investing Activities | ||||||||
Purchases of Property, Equipment & Improvements | (218,028 | ) | (610,860 | ) | ||||
Net cash provided (used) by investing activities | (218,028 | ) | (610,860 | ) | ||||
| Cash Flows from Financing Activities | ||||||||
Payments on notes payable | (96,434 | ) | (90,000 | ) | ||||
Increase in advances from (to) related parties | 3,930,914 | 7,351,708 | ||||||
Capital contribution from stockholders | 201,065 | 121,061 | ||||||
Distribution to shareholders for payment of income tax obligation | (1,372,947 | ) | (1,912,114 | ) | ||||
Net cash provided (used) by financing activities | 2,662,598 | 5,470,654 | ||||||
Increase (decrease) in cash | 3,173,325 | 4,105,141 | ||||||
Cash, beginning of year | 767,232 | 1,393,425 | ||||||
Cash, end of year | $ | 3,940,557 | $ | 5,498,565 | ||||
Supplemental cash flows information: | ||||||||
Cash paid for – | ||||||||
Interest expense | $ | 61,456 | $ | 62,225 | ||||
Income taxes | $ | — | $ | — | ||||
F-106
AMERICAN EDUCATION CENTERS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
| 1. | NATURE OF OPERATIONS: |
American Education Centers, Inc. (the Company) was incorporated on June 2, 1993, in the state of Delaware and is engaged in the business of operating private two year colleges. The Company provides career training for business, medical and technical professions.
The Company’s eight campuses are located in Akron and Cincinnati, Ohio, Ft. Mitchell, Hopkinsville and Louisville, Kentucky, Pittsburgh, Pennsylvania, as well as Garland and Hurst, Texas.
| 2. | BASIS OF PRESENTATION: |
The accompanying unaudited condensed financial statements include the accounts of the Company, as well as its 20% equity interest in the earnings of Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $420,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s proportionate share of SOC’s earnings were not material during the period ended June 30, 2003.
The preparation of 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, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.
| 3. | GUARANTEES: |
As of June 30, 2003, the Institution was co-guarantor and its assets secured outstanding credit facilities of $3,335,760 of Brown Mackie Education Corporation, another educational corporation owned by the stockholders of the Institution. In addition, the Institution guarantees $100,000 of a note payable of Michiana College Education Corporation and a $840,000 note payable of Southern Ohio College, LLC.
| 4. | SUBSEQUENT EVENTS: |
On September 2, 2003, Education Management Corporation (“EDMC”) acquired 100 percent of the outstanding stock of American Education Centers, Inc. and related companies (“AEC”). The acquisition is subject to receipt of final regulatory approvals.
F-107
ASHER SCHOOL OF BUSINESS EDUCATION CORPORATION
CONDENSED BALANCE SHEET
As of June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash | $ | 196,636 | $ | (10,868 | ) | |||
Accounts receivable, net of allowance | 120,459 | 91,324 | ||||||
Inventories | 19,258 | 14,759 | ||||||
Prepaid expenses | 16,776 | 40,868 | ||||||
Deferred initial direct costs | 190,100 | 168,100 | ||||||
Total current assets | 543,229 | 304,183 | ||||||
Property and equipment, net | 70,422 | 51,202 | ||||||
Other assets: | ||||||||
Goodwill – net | 316,208 | 316,208 | ||||||
Investment in affiliate | — | 210,000 | ||||||
Intercompany transfers | 157,478 | 43,041 | ||||||
Total other assets | 473,686 | 569,249 | ||||||
Total assets | $ | 1,087,336 | $ | 924,634 | ||||
Liabilities and shareholders’ investment | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 1,149 | $ | 13,781 | ||||
Accrued expenses | 82,624 | 64,937 | ||||||
Unearned tuition | 237,292 | 122,439 | ||||||
Total current liabilities | 321,064 | 201,157 | ||||||
Long-term liabilities: | ||||||||
Notes payable, net of current portion | 93,708 | 91,238 | ||||||
Total long-term liabilities | 93,708 | 91,238 | ||||||
Equity: | ||||||||
Common Stock | 10 | 10 | ||||||
Additional paid-in capital | 1,554,343 | 1,632,874 | ||||||
Retained earnings | (597,209 | ) | (716,065 | ) | ||||
Treasury stock | 284,580 | 284,580 | ||||||
Total stockholder’s equity | 672,563 | 632,240 | ||||||
Total liabilities and equity | $ | 1,087,336 | $ | 924,634 | ||||
F-108
ASHER SCHOOL OF BUSINESS EDUCATION CORPORATION
CONDENSED INCOME STATEMENTS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | |||||||
Net revenues | $ | 1,002,584 | $ | 774,807 | ||||
Costs and expenses: | ||||||||
Course materials, services and instruction | 361,152 | 303,759 | ||||||
Selling and promotion | 218,206 | 192,863 | ||||||
General and administrative | 184,059 | 171,300 | ||||||
Facilities | 91,920 | 84,843 | ||||||
Depreciation and amortization | 16,145 | 15,266 | ||||||
Total costs and expenses | 871,481 | 768,031 | ||||||
Income from operations | 131,103 | 6,777 | ||||||
Other income (expense) | ||||||||
Interest expense | 2,471 | 2,475 | ||||||
Other income (expense) | (25 | ) | — | |||||
Total Other income (expense) | (2,496 | ) | (2,475 | ) | ||||
Net income | $ | 128,657 | $ | 4,302 | ||||
F-109
ASHER SCHOOL OF BUSINESS EDUCATION CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| Cash Flows from Operating Activities | 2002 | 2003 | ||||||
Net Income | $ | 128,657 | $ | 4,302 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 16,145 | 15,266 | ||||||
Changes in operating assets and liabilities | ||||||||
Accounts Receivable | 27,970 | 10,667 | ||||||
Prepaid expenses and other | (10,794 | ) | (2,329 | ) | ||||
Deposits and other | 317 | (1,403 | ) | |||||
Accounts Payable | 7,947 | 4,837 | ||||||
Accrued expenses and other | 14,239 | (9,752 | ) | |||||
Unearned Tuition | (93,793 | ) | (66,323 | ) | ||||
Net cash provided (used) by operating activities | 90,687 | (44,736 | ) | |||||
| Cash Flows from Investing Activities | ||||||||
Purchases of Property, Equipment & Improvements | (857 | ) | (774 | ) | ||||
Net cash provided (used) by investing activities | (857 | ) | (774 | ) | ||||
| Cash Flows from Financing Activities | ||||||||
Payments on notes payable | 2,471 | 0 | ||||||
Increase in advances from (to) related parties | (305,132 | ) | (230,793 | ) | ||||
Capital contribution from stockholders | 29,647 | 29,647 | ||||||
Distribution to shareholders for payment of income tax obligation | (62,009 | ) | (22,122 | ) | ||||
Net cash provided (used) by financing activities | (335,023 | ) | (223,267 | ) | ||||
Increase (decrease) in cash | (245,193 | ) | (268,777 | ) | ||||
Cash, beginning of year | 441,829 | 257,909 | ||||||
Cash, end of year | $ | 196,636 | $ | (10,868 | ) | |||
Supplemental cash flows information: | ||||||||
Cash paid for – | ||||||||
Interest expense | $ | 2,471 | $ | 2,475 | ||||
Income taxes | $ | — | $ | — | ||||
F-110
ASHER SCHOOL OF BUSINESS EDUCATION CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
| 1. | NATURE OF OPERATIONS: |
Asher School of Business Education Corporation (the Company) was incorporated on September 25, 1996, in the state of Delaware. The Company operates a private career school located in Norcross, Georgia. The Company provides career training for business and health related professions and offers diploma and degree programs.
| 2. | BASIS OF PRESENTATION: |
The accompanying financial statements include the accounts of the Company, as well as its 10% equity interest in the earnings Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $210,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s proportionate share of SOC’s earnings were not material during the period ended June 30, 2003.
The preparation of 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, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.
| 3. | GUARANTEES: |
As of June 30, 2003, the Company was a co-guarantor and its assets secured outstanding credit facilities of $4,425,760 of other educational corporations owned by the stockholders of the Company.
| 4. | SUBSEQUENT EVENTS: |
On September 2, 2003, Education Management Corporation (“EDMC”) acquired 100 percent of the outstanding stock of American Education Centers, Inc. and related companies (“AEC”). The acquisition is subject to receipt of final regulatory approvals.
F-111
BROWN MACKIE EDUCATION CORPORATION
CONDENSED BALANCE SHEET
As of June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash | $ | (41,134 | ) | $ | (14,559 | ) | ||
Accounts receivable, net of allowance | 468,359 | 379,730 | ||||||
Inventories | 18,501 | 17,624 | ||||||
Prepaid expenses | 56,861 | 43,414 | ||||||
Deferred initial direct costs | 450,333 | 449,333 | ||||||
Total current assets | 952,919 | 875,542 | ||||||
Property and equipment, net | 965,998 | 3,894,163 | ||||||
Other assets: | ||||||||
Deposits and other | 138,036 | 107,690 | ||||||
Goodwill – net | 78,952 | 78,952 | ||||||
Investment in affiliate | — | 315,000 | ||||||
Intercompany transfers | 205,615 | (370,377 | ) | |||||
Total other assets | 422,602 | 131,265 | ||||||
Total assets | $ | 2,341,520 | $ | 4,900,970 | ||||
Liabilities and shareholders’ investment | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | (17,244 | ) | $ | 5,563 | |||
Accrued expenses | 117,218 | 163,092 | ||||||
Unearned tuition | 563,553 | 430,661 | ||||||
Current portion of notes and debenture payable | 180,000 | 392,635 | ||||||
Total current liabilities | 843,527 | 991,950 | ||||||
Long-term liabilities: | ||||||||
Notes payable, net of current portion | 910,395 | 3,075,150 | ||||||
Total long-term liabilities | 910,395 | 3,075,150 | ||||||
Equity: | ||||||||
Common Stock | 10 | 10 | ||||||
Additional paid-in capital | 626,777 | 711,358 | ||||||
Retained earnings | 474,892 | 636,582 | ||||||
Treasury stock | 514,080 | 514,080 | ||||||
Total stockholder’s equity | 587,598 | 833,869 | ||||||
Total liabilities and equity | $ | 2,341,520 | $ | 4,900,970 | ||||
F-112
BROWN MACKIE EDUCATION CORPORATION
CONDENSED INCOME STATEMENTS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | |||||||
Net revenues | $ | 2,882,573 | $ | 2,802,058 | ||||
Costs and expenses: | ||||||||
Course materials, services and instruction | 1,180,699 | 1,097,749 | ||||||
Selling and promotion | 443,542 | 449,121 | ||||||
General and administrative | 564,518 | 472,193 | ||||||
Facilities | 275,271 | 245,613 | ||||||
Depreciation and amortization | 134,943 | 232,157 | ||||||
Total costs and expenses | 2,589,972 | 2,495,605 | ||||||
Income from operations | 283,600 | 306,454 | ||||||
Other income (expense) | ||||||||
Interest income | 196 | — | ||||||
Interest expense | 30,563 | 91,059 | ||||||
Other income (expense) | (2,923 | ) | 35,689 | |||||
Total Other income (expense) | (33,290 | ) | (55,370 | ) | ||||
Net income | $ | 256,156 | $ | 179,706 | ||||
F-113
BROWN MACKIE EDUCATION CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| Cash Flows from Operating Activities | 2002 | 2003 | ||||||
Net Income | $ | 256,156 | $ | 179,706 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 134,943 | 232,157 | ||||||
Changes in operating assets and liabilities | ||||||||
Accounts Receivable | 28,702 | 128,013 | ||||||
Prepaid expenses and other | (2,189 | ) | (10,542 | ) | ||||
Deposits and other | 32,574 | 38,002 | ||||||
Accounts Payable | 7,410 | (6,399 | ) | |||||
Accrued expenses and other | (57,456 | ) | (274,016 | ) | ||||
Unearned Tuition | (114,492 | ) | (217,897 | ) | ||||
Net cash provided (used) by operating activities | 285,648 | 69,025 | ||||||
| Cash Flows from Investing Activities | ||||||||
Purchases of Property, Equipment & Improvements | (5,720 | ) | (102,432 | ) | ||||
Gain (loss) on sale of assets | 2,923 | 1,015 | ||||||
Net cash provided (used) by investing activities | (2,797 | ) | (101,417 | ) | ||||
| Cash Flows from Financing Activities | ||||||||
Payments on notes payable | (95,830 | ) | (215,999 | ) | ||||
Increase in advances from (to) related parties | (352,525 | ) | (96,206 | ) | ||||
Capital contribution from stockholders | 29,647 | 29,647 | ||||||
Distribution to shareholders for payment of income tax obligation | (179,798 | ) | (190,995 | ) | ||||
Net cash provided (used) by financing activities | (598,506 | ) | (473,553 | ) | ||||
Increase (decrease) in cash | (315,655 | ) | (505,944 | ) | ||||
Cash, beginning of year | 274,521 | 491,385 | ||||||
Cash, end of year | $ | (41,134 | ) | $ | (14,559 | ) | ||
Supplemental cash flows information: | ||||||||
Cash paid for - | ||||||||
Interest expense | $ | 30,563 | $ | 91,059 | ||||
Income taxes | $ | — | $ | — | ||||
F-114
BROWN MACKIE EDUCATION CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
| 1. | NATURE OF OPERATIONS: |
Brown Mackie Education Corporation (the Company) was incorporated on March 24, 1994, in the state of Delaware and is engaged in the business of operating a private junior college with two campuses located in Salina and Lenexa, Kansas. The Company provides education in the business, legal and medical professions resulting in associate degrees.
| 2. | BASIS OF PRESENTATION: |
The accompanying financial statements include the accounts of the Company, as well as its 15% equity interest in the earnings of Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $315,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s proportionate share of SOC’s earnings were not material during the period ended June 30, 2003.
The preparation of 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, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.
| 3. | GUARANTEES: |
As of June 30, 2003, the Company was a co-guarantor and its assets secured outstanding credit facilities of $1,090,000 of another entity owned by the stockholders of the Company.
| 4. | SUBSEQUENT EVENTS: |
On September 2, 2003, Education Management Corporation (“EDMC”) acquired 100 percent of the outstanding stock of American Education Centers, Inc. and related companies (“AEC”). The acquisition is subject to receipt of final regulatory approvals.
F-115
COMMONWEALTH BUSINESS COLLEGE EDUCATION CORPORATION
CONDENSED BALANCE SHEET
As of June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | ||||||
Assets | |||||||
Current assets: | |||||||
Cash | $ | 417,242 | $ | (5,761 | ) | ||
Accounts receivable, net of allowance | 404,940 | 413,690 | |||||
Inventories | 30,098 | 34,660 | |||||
Prepaid expenses | 42,506 | 55,155 | |||||
Deferred initial direct costs | 293,453 | 264,453 | |||||
Total current assets | 1,188,240 | 762,198 | |||||
Property and equipment, net | 213,453 | 787,448 | |||||
Other assets: | |||||||
Deposits and other | 4,560 | 4,560 | |||||
Goodwill – net | 181,684 | 181,684 | |||||
Investment in affiliate | — | 420,000 | |||||
Intercompany transfers | 775,742 | 1,083,938 | |||||
Total other assets | 961,986 | 1,690,182 | |||||
Total assets | $ | 2,363,679 | $ | 3,239,828 | |||
Liabilities and shareholders’ investment | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 12,045 | $ | 1,871 | |||
Accrued expenses | 179,946 | 219,500 | |||||
Unearned tuition | 642,862 | 765,421 | |||||
Current portion of notes and debenture payable | 6,088 | 8,621 | |||||
Total current liabilities | 840,941 | 995,412 | |||||
Long-term liabilities: | |||||||
Notes payable, net of current portion | 118,662 | 107,064 | |||||
Total long-term liabilities | 118,662 | 107,064 | |||||
Equity: | |||||||
Common Stock | 10 | 10 | |||||
Additional paid-in capital | 759,359 | 870,347 | |||||
Retained earnings | 2,093,618 | 2,715,905 | |||||
Treasury stock | 1,448,910 | 1,448,910 | |||||
Total stockholder’s equity | 1,404,076 | 2,137,352 | |||||
Total liabilities and equity | $ | 2,363,679 | $ | 3,239,828 | |||
F-116
COMMONWEALTH BUSINESS COLLEGE EDUCATION CORPORATION
CONDENSED INCOME STATEMENTS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | |||||||
Net revenues | $ | 3,357,184 | $ | 3,684,098 | ||||
Costs and expenses: | ||||||||
Course materials, services and instruction | 1,118,898 | 1,162,589 | ||||||
Selling and promotion | 437,593 | 479,000 | ||||||
General and administrative | 384,818 | 445,237 | ||||||
Facilities | 213,520 | 276,996 | ||||||
Depreciation and amortization | 47,648 | 125,443 | ||||||
Total costs and expenses | 2,202,476 | 2,489,265 | ||||||
Income from operations | 1,154,707 | 1,194,833 | ||||||
Other income (expense) | ||||||||
Interest income | — | — | ||||||
Interest expense | 4,052 | 3,717 | ||||||
Other income (expense) | — | — | ||||||
Total Other income (expense) | (4,052 | ) | (3,717 | ) | ||||
Net income | $ | 1,150,655 | $ | 1,191,116 | ||||
F-117
COMMONWEALTH BUSINESS COLLEGE EDUCATION CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| Cash Flows from Operating Activities | 2002 | 2003 | ||||||
Net Income | $ | 1,150,655 | $ | 1,191,116 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 47,648 | 125,443 | ||||||
Changes in operating assets and liabilities | ||||||||
Accounts Receivable | 267,002 | 850,915 | ||||||
Prepaid expenses and other | (5,308 | ) | 9,409 | |||||
Deposits and other | (1,356 | ) | 3,632 | |||||
Accounts Payable | (32,632 | ) | (7,369 | ) | ||||
Accrued expenses and other | (22,918 | ) | (125,505 | ) | ||||
Unearned Tuition | 105,800 | 207,584 | ||||||
Net cash provided (used) by operating activities | 1,508,893 | 2,255,224 | ||||||
| Cash Flows from Investing Activities | ||||||||
Purchases of Property, Equipment & Improvements | (7,148 | ) | (21,492 | ) | ||||
Net cash provided (used) by investing activities | (7,148 | ) | (21,492 | ) | ||||
| Cash Flows from Financing Activities | ||||||||
Increase in advances from (to) related parties | (1,187,426 | ) | (1,764,628 | ) | ||||
Capital contribution from stockholders | 29,647 | 29,647 | ||||||
Distribution to shareholders for payment of income tax obligation | (518,779 | ) | (750,563 | ) | ||||
Net cash provided (used) by financing activities | (1,676,559 | ) | (2,484,302 | ) | ||||
Increase (decrease) in cash | (174,814 | ) | (250,570 | ) | ||||
Cash, beginning of year | 592,056 | 244,809 | ||||||
Cash, end of year | $ | 417,242 | $ | (5,761 | ) | |||
Supplemental cash flows information: | ||||||||
Cash paid for - | ||||||||
Interest expense | $ | 4,052 | $ | 3,717 | ||||
Income taxes | $ | — | $ | — | ||||
F-118
COMMONWEALTH BUSINESS COLLEGE EDUCATION CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
| 1. | NATURE OF OPERATIONS: |
Commonwealth Business College Education Corporation (the Company) was incorporated on September 7, 1995, in the state of Delaware. The Company operates a private career school with three campuses located in Merrillville and Michigan City, Indiana, as well as Moline, Illinois. The Company provides career training for business and health related professions.
| 2. | BASIS OF PRESENTATION: |
The accompanying financial statements include the accounts of the Company, as well as its 20% equity interest in the earnings of Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $420,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s proportionate share of SOC’s earnings were not material during the period ended June 30, 2003.
The preparation of 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, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.
| 3. | GUARANTEES: |
As of June 30, 2003, the Company was a co-guarantor and its assets secured outstanding credit facilities of $4,425,760 of other educational corporations owned by the stockholders of the Company.
| 4. | SUBSEQUENT EVENTS: |
On September 2, 2003, Education Management Corporation (“EDMC”) acquired 100 percent of the outstanding stock of American Education Centers, Inc. and related companies (“AEC”). The acquisition is subject to receipt of final regulatory approvals.
F-119
MICHIANA COLLEGE EDUCATION CORPORATION
CONDENSED BALANCE SHEET
As of June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | ||||||
Assets | |||||||
Current assets: | |||||||
Cash | $ | 386,531 | $ | (28,458 | ) | ||
Accounts receivable, net of allowance | 367,039 | 510,223 | |||||
Inventories | 40,923 | 25,625 | |||||
Prepaid expenses | 28,643 | 48,937 | |||||
Deferred initial direct costs | 297,000 | 256,000 | |||||
Total current assets | 1,120,136 | 812,327 | |||||
Property and equipment, net | 263,407 | 199,935 | |||||
Other assets: | |||||||
Goodwill – net | 1,067,581 | 1,067,581 | |||||
Investment in affiliate | 600,000 | 420,000 | |||||
Intercompany transfers | 2,006,596 | 2,888,934 | |||||
Total other assets | 3,674,176 | 4,376,515 | |||||
Total assets | $ | 5,057,719 | $ | 5,388,777 | |||
Liabilities and shareholders’ investment | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 3,331 | $ | 9,965 | |||
Accrued expenses | 123,043 | 143,241 | |||||
Unearned tuition | 663,622 | 817,590 | |||||
Current portion of notes and debenture payable | 97,758 | 1,597 | |||||
Total current liabilities | 887,755 | 972,393 | |||||
Long-term liabilities: | |||||||
Notes payable, net of current portion | 385,674 | 342,508 | |||||
Total long-term liabilities | 385,674 | 342,508 | |||||
Equity: | |||||||
Common Stock | 10 | 10 | |||||
Additional paid-in capital | 1,414,343 | 1,573,222 | |||||
Retained earnings | 3,273,147 | 3,403,853 | |||||
Treasury stock | 903,210 | 903,210 | |||||
Total stockholder’s equity | 3,784,290 | 4,073,876 | |||||
Total liabilities and equity | $ | 5,057,719 | $ | 5,388,777 | |||
F-120
MICHIANA COLLEGE EDUCATION CORPORATION
CONDENSED INCOME STATEMENTS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | |||||||
Net revenues | $ | 3,934,654 | $ | 4,488,113 | ||||
Costs and expenses: | ||||||||
Course materials, services and instruction | 1,233,489 | 1,357,419 | ||||||
Selling and promotion | 405,330 | 467,543 | ||||||
General and administrative | 376,702 | 422,891 | ||||||
Facilities | 263,593 | 270,969 | ||||||
Depreciation and amortization | 53,664 | 51,265 | ||||||
Total costs and expenses | 2,332,777 | 2,570,088 | ||||||
Income from operations | 1,601,878 | 1,918,026 | ||||||
Other income (expense) | ||||||||
Interest income | — | — | ||||||
Interest expense | 13,075 | (47,675 | ) | |||||
Other income (expense) | — | — | ||||||
Total Other income (expense) | (13,075 | ) | 47,675 | |||||
Net income | $ | 1,588,803 | $ | 1,965,701 | ||||
F-121
MICHIANA COLLEGE EDUCATION CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| Cash Flows from Operating Activities | 2002 | 2003 | ||||||
Net Income | $ | 1,168,775 | $ | 1,965,701 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 101,565 | 51,265 | ||||||
Changes in operating assets and liabilities | ||||||||
Accounts Receivable | 328,034 | 956,806 | ||||||
Prepaid expenses and other | 28,012 | 13,219 | ||||||
Deposits and other | (800 | ) | (800 | ) | ||||
Accounts Payable | (1,967 | ) | (2,783 | ) | ||||
Accrued expenses and other | 940 | (43,102 | ) | |||||
Unearned Tuition | 4,506 | 153,912 | ||||||
Net cash provided (used) by operating activities | 1,629,065 | 3,094,218 | ||||||
| Cash Flows from Investing Activities | ||||||||
Purchases of Property, Equipment & Improvements | (16,702 | ) | 2,433 | |||||
Net cash provided (used) by investing activities | (16,702 | ) | 2,433 | |||||
| Cash Flows from Financing Activities | ||||||||
Payments on notes payable | (90,925 | ) | (100,842 | ) | ||||
Increase in advances from (to) related parties | (1,837,701 | ) | (3,326,814 | ) | ||||
Capital contribution from stockholders | 29,647 | 29,647 | ||||||
Distribution to shareholders for payment of income tax obligation | (499,125 | ) | (1,133,131 | ) | ||||
Net cash provided (used) by financing activities | (2,398,104 | ) | (4,531,140 | ) | ||||
Increase (decrease) in cash | (785,741 | ) | (1,434,489 | ) | ||||
Cash, beginning of year | 1,174,688 | 1,406,032 | ||||||
Cash, end of year | $ | 388,947 | $ | (28,458 | ) | |||
Supplemental cash flows information: | ||||||||
Cash paid for - | ||||||||
Interest expense | $ | 13,075 | $ | — | ||||
Income taxes | $ | — | $ | — | ||||
F-122
MICHIANA COLLEGE EDUCATION CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
| 1. | NATURE OF OPERATIONS: |
Michiana College Education Corporation (the Company) was incorporated on February 16, 1999, in the state of Delaware. The Company was organized to acquire and operate a private career college with campuses located in South Bend and Ft. Wayne, Indiana. During the year ended December 31, 2001, the Company opened an additional location in Cherry Hill, New Jersey; this location was closed during the year ended December 31, 2002. The Company provides career training for business, medical and technical professions and offers diploma and degree programs.
| 2. | BASIS OF PRESENTATION: |
The accompanying financial statements include the accounts of the Company, as well as its 20% equity interest in the earnings of Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial polices of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $420,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s proportionate share of SOC’s earnings were not material during the period ended June 30, 2003.
The preparation of 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, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.
| 3. | GUARANTEES: |
As of June 30, 2003, the Company was a co-guarantor and its assets secured outstanding credit facilities of $4,425,760 of other educational corporations owned by the stockholders of the Company.
| 4. | SUBSEQUENT EVENTS: |
On September 2, 2003, Education Management Corporation (“EDMC”) acquired 100 percent of the outstanding stock of American Education Centers, Inc. and related companies (“AEC”). The acquisition is subject to receipt of final regulatory approvals.
F-123
SOUTHERN OHIO COLLEGE
CONDENSED BALANCE SHEET
As of June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash | $ | 1,008,402 | $ | (27,453 | ) | |||
Accounts receivable, net of allowance | 123,609 | 342,330 | ||||||
Inventories | 9,949 | 47,858 | ||||||
Prepaid expenses | 84,533 | 47,182 | ||||||
Total current assets | 1,226,493 | 409,917 | ||||||
Property and equipment, net | 232,234 | 238,604 | ||||||
Other assets: | ||||||||
Deposits and other | 64,062 | 54,062 | ||||||
Goodwill – net | 1,760,222 | 1,760,222 | ||||||
Intercompany transfers | (303,239 | ) | 1,235,793 | |||||
Total other assets | 1,521,045 | 3,050,077 | ||||||
Total assets | $ | 2,979,772 | $ | 3,698,597 | ||||
Liabilities and shareholders’ investment | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 44,414 | $ | 11,169 | ||||
Accrued expenses | 59,786 | 76,165 | ||||||
Unearned tuition | 78,456 | 302,453 | ||||||
Current portion of notes and debenture payable | 142,900 | (8,058 | ) | |||||
Total current liabilities | 325,557 | 381,729 | ||||||
Long-term liabilities: | ||||||||
Notes payable, net of current portion | 643,775 | 643,775 | ||||||
Total long-term liabilities | 643,775 | 643,775 | ||||||
Equity: | ||||||||
Additional paid-in capital | 2,100,000 | 2,100,000 | ||||||
Retained earnings | (89,560 | ) | 573,093 | |||||
Total stockholder’s equity | 2,010,440 | 2,673,093 | ||||||
Total liabilities and equity | $ | 2,979,772 | $ | 3,698,597 | ||||
F-124
SOUTHERN OHIO COLLEGE
CONDENSED INCOME STATEMENTS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | |||||||
Net revenues | $ | — | $ | 1,860,517 | ||||
Costs and expenses: | ||||||||
Course materials, services and instruction | 28,554 | 664,862 | ||||||
Selling and promotion | 40,855 | 284,018 | ||||||
General and administrative | 6,652 | 148,044 | ||||||
Facilities | 13,500 | 144,867 | ||||||
Depreciation and amortization | — | 62,250 | ||||||
Total costs and expenses | 89,560 | 1,297,698 | ||||||
Income from operations | (89,560 | ) | 562,819 | |||||
Other income (expense) | ||||||||
Interest income | — | — | ||||||
Interest expense | — | 16,816 | ||||||
Other income (expense) | — | 6,361 | ||||||
Total Other income (expense) | — | (10,455 | ) | |||||
Net income | $ | (89,560 | ) | $ | 539,643 | |||
F-125
SOUTHERN OHIO COLLEGE
CONDENSED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| Cash Flows from Operating Activities | 2002 | 2003 | ||||||
Net Income | $ | (89,560 | ) | $ | 539,643 | |||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | — | 62,250 | ||||||
Changes in operating assets and liabilities | ||||||||
Accounts Receivable | (123,609 | ) | (25,277 | ) | ||||
Prepaid expenses and other | (144,482 | ) | (27,549 | ) | ||||
Deposits and other | (14,062 | ) | 0 | |||||
Accounts Payable | 44,414 | (2,634 | ) | |||||
Accrued expenses and other | 59,786 | 5,159 | ||||||
Unearned Tuition | 78,456 | 193,940 | ||||||
Net cash provided (used) by operating activities | (189,056 | ) | 745,532 | |||||
| Cash Flows from Investing Activities | ||||||||
Purchases of Property, Equipment & Improvements | (1,992,456 | ) | (20,478 | ) | ||||
Net cash provided (used) by investing activities | (1,992,456 | ) | (20,478 | ) | ||||
| Cash Flows from Financing Activities | ||||||||
Payments on notes payable | 786,675 | (170,842 | ) | |||||
Increase in advances from (to) related parties | 303,239 | (1,423,514 | ) | |||||
Capital contribution from stockholders | 2,100,000 | 0 | ||||||
Net cash provided (used) by financing activities | 3,189,914 | (1,594,356 | ) | |||||
Increase (decrease) in cash | 1,008,402 | (869,302 | ) | |||||
Cash, beginning of year | 0 | 841,849 | ||||||
Cash, end of year | $ | 1,008,402 | $ | (27,453 | ) | |||
| Supplemental cash flows information: | ||||||||
Cash paid for — | ||||||||
Interest expense | $ | — | $ | 16,816 | ||||
Income taxes | $ | — | $ | — | ||||
F-126
SOUTHERN OHIO COLLEGE, LLC
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
| 1. | NATURE OF OPERATIONS: |
American Education Centers, Inc. (AEC or the Company) was incorporated on June 2, 1993 in the state of Delaware and is engaged in the business of operating private two year colleges. The Company provides career training for business, medical and technical professions. The Company’s campuses are located in Akron and Cincinnati, Ohio, Ft. Mitchell, Hopkinsville and Louisville, Kentucky, Pittsburgh, Pennsylvania, as well as Garland and Hurst, Texas. Southern Ohio College (SOC) has campuses located in Ft. Mitchell, Kentucky, Cincinnati and Akron, Ohio, as well as Garland and Hurst, Texas.
| 2. | BASIS OF PRESENTATION: |
The accompanying financial statements include only the accounts of SOC, a division of the Company.
The preparation of 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, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.
| 3. | GUARANTEES: |
As of June 30, 2003, SOC was a co-guarantor and its assets secured outstanding credit facilities of $1,090,000 of the Company and $3,335,760 of another educational corporation owned by the stockholders of the Company.
| 4. | SUBSEQUENT EVENTS: |
On September 2, 2003, Education Management Corporation (“EDMC”) acquired 100 percent of the outstanding stock of American Education Centers, Inc. and related companies (“AEC”). The acquisition is subject to receipt of final regulatory approvals.
F-127
STAUTZENBERGER COLLEGE EDUCATION CORPORATION
CONDENSED BALANCE SHEET
As of June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | ||||||
Assets | |||||||
Current assets: | |||||||
Cash | $ | 24,409 | $ | (11,039 | ) | ||
Accounts receivable, net of allowance | 107,880 | 232,944 | |||||
Inventories | 2,783 | 6,309 | |||||
Prepaid expenses | 17,035 | 20,924 | |||||
Deferred initial direct costs | 81,200 | 69,200 | |||||
Total current assets | 233,306 | 318,338 | |||||
Property and equipment, net | 32,433 | 272,799 | |||||
Other assets: | |||||||
Deposits and other | 4,958 | 4,958 | |||||
Goodwill – net | 134,233 | 134,233 | |||||
Investment in affiliate | — | 315,000 | |||||
Intercompany transfers | 675,251 | 651,403 | |||||
Total other assets | 814,442 | 1,105,594 | |||||
Total assets | $ | 1,080,181 | $ | 1,696,730 | |||
Liabilities and shareholders’ investment | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 1,830 | $ | 11,638 | |||
Accrued expenses | 45,346 | 115,470 | |||||
Unearned tuition | 271,153 | 343,196 | |||||
Total current liabilities | 318,329 | 470,304 | |||||
Long-term liabilities: | |||||||
Notes payable, net of current portion | 60,203 | 58,613 | |||||
Total long-term liabilities | 60,203 | 58,613 | |||||
Equity: | |||||||
Common Stock | 5 | 5 | |||||
Additional paid-in capital | 781,986 | 869,452 | |||||
Retained earnings | 190,979 | 569,676 | |||||
Treasury stock | 271,320 | 271,320 | |||||
Total stockholder’s equity | 701,650 | 1,167,814 | |||||
Total liabilities and equity | $ | 1,080,181 | $ | 1,696,730 | |||
F-128
STAUTZENBERGER COLLEGE EDUCATION CORPORATION
CONDENSED INCOME STATEMENTS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| 2002 | 2003 | |||||||
Net revenues | $ | 1,276,178 | $ | 1,897,210 | ||||
Costs and expenses: | ||||||||
Course materials, services and instruction | 440,406 | 623,088 | ||||||
Selling and promotion | 105,531 | 145,988 | ||||||
General and administrative | 195,634 | 223,051 | ||||||
Facilities | 92,737 | 199,231 | ||||||
Depreciation and amortization | 12,627 | 10,531 | ||||||
Total costs and expenses | 846,898 | 1,201,889 | ||||||
Income from operations | 429,280 | 695,321 | ||||||
Other income (expense) | ||||||||
Interest income | — | 201 | ||||||
Interest expense | 1,590 | 1,590 | ||||||
Other income (expense) | 20 | (76 | ) | |||||
Total Other income (expense) | (1,570 | ) | (1,465 | ) | ||||
Net income | $ | 427,670 | $ | 694,008 | ||||
F-129
STAUTZENBERGER COLLEGE EDUCATION CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2002 and 2003
UNAUDITED
| Cash Flows from Operating Activities | 2002 | 2003 | ||||||
Net Income | $ | 427,670 | $ | 694,008 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 12,627 | 10,531 | ||||||
Changes in operating assets and liabilities | ||||||||
Accounts Receivable | 6,877 | (36,037 | ) | |||||
Prepaid expenses and other | 10,011 | 6,382 | ||||||
Deposits and other | 0 | 19,517 | ||||||
Accounts Payable | (22,364 | ) | 8,234 | |||||
Accrued expenses and other | 2,359 | 33,317 | ||||||
Unearned Tuition | 11,577 | (1,619 | ) | |||||
Net cash provided (used) by operating activities | 448,757 | 734,333 | ||||||
| Cash Flows from Investing Activities | ||||||||
Purchases of Property, Equipment & Improvements | (855 | ) | (246,598 | ) | ||||
Net cash provided (used) by investing activities | (855 | ) | (246,598 | ) | ||||
| Cash Flows from Financing Activities | ||||||||
Increase in advances from (to) related parties | (551,368 | ) | (509,390 | ) | ||||
Capital contribution from stockholders | 29,647 | 29,647 | ||||||
Distribution to shareholders for payment of income tax obligation | (267,318 | ) | (464,416 | ) | ||||
Net cash provided (used) by financing activities | (789,040 | ) | (944,159 | ) | ||||
Increase (decrease) in cash | (341,137 | ) | (456,424 | ) | ||||
Cash, beginning of year | 365,546 | 445,385 | ||||||
Cash, end of year | $ | 24,409 | $ | (11,039 | ) | |||
| Supplemental cash flows information: | ||||||||
Cash paid for — | ||||||||
Interest expense | $ | 1,590 | $ | 1,590 | ||||
Income taxes | $ | — | $ | — | ||||
F-130
STAUTZENBERGER COLLEGE EDUCATION CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
| 1. | NATURE OF OPERATIONS: |
Stauntzenberger College Education Corporation (the Company) was incorporated on July 22, 1997, in the state of Delaware. The Company operates a private career school located in Findlay, Ohio. The Company provides career training for business and health related professions and offers diploma and degree programs.
| 2. | BASIS OF PRESENTATION: |
The accompanying financial statements include the accounts of the Company, as well as its 15% equity interest in the earnings of Southern Ohio College, LLC (SOC), which began operations on June 13, 2002. The Company’s investment in SOC is accounted for using the equity method of accounting as the Company exercises significant influence over operating and financial policies of SOC. Under the equity method of accounting, the investment in SOC is carried at cost, $315,000, adjusted for the Company’s proportionate share of earnings or losses. The Company’s share of SOC’s earnings were not material during the period ended June 30, 2003.
The preparation of 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, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.
| 3. | GUARANTEES: |
As of June 30, 2003, the Company was a co-guarantor and its assets secured outstanding credit facilities of $4,425,760 of other education corporations owned by the stockholders of the Company.
| 4. | SUBSEQUENT EVENTS: |
On September 2, 2003, Education Management Corporation (“EDMC”) acquired 100 percent of the outstanding stock of American Education Centers, Inc. and related companies (“AEC”). The acquisition is subject to receipt of final regulatory approvals.
F-131
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Background and Introduction
On September 2, 2003, Education Management Corporation (“EDMC”) announced that it had closed its purchase of all of the outstanding shares (the “Shares”) of American Education Centers, Inc., Asher School of Business Education Corporation, Brown Mackie Education Corporation, Commonwealth Business College Education Corporation, Michiana College Education Corporation, and Stautzenberger College Education Corporation. In addition, Southern Ohio College, LLC, a wholly-owned subsidiary of the entities listed above, was acquired in this purchase. Collectively, these entities are referred to as American Education Centers (“AEC”). The acquisition of AEC was pursuant to the terms and conditions of a Stock Purchase Agreement dated as of June 24, 2003. The Shares were beneficially owned by certain individuals and trusts. The aggregate cash purchase price for the Shares was $112.5 million (which amount included approximately $70 million paid by EDMC two business days after the closing date); EDMC also assumed $3.5 million of debt. The purchase price for the Shares was determined in arms’ length negotiations.
The unaudited pro forma condensed consolidated statement of income combines EDMC’s and AEC’s historical consolidated statements of income, giving effect to the acquisition as if it had occurred on the first day of the period for which the statement is presented, July 1, 2002. The unaudited pro forma condensed consolidated balance sheet combines EDMC’s and AEC’s historical consolidated balances, giving effect to the acquisition as if it occurred on June 30, 2003.
The pro forma financial information reflects the purchase method of accounting for the acquisition of AEC, and accordingly is based upon estimated purchase accounting adjustments that are subject to further revision depending on completion of third-party appraisals of the fair values of AEC’s assets and liabilities.
This information should be read in conjunction with:
| • | The accompanying notes to the unaudited pro forma condensed consolidated financial statements; and |
| • | the separate historical audited financial statements of AEC as of and for the year ended December 31, 2002; and |
| • | the separate historical unaudited interim condensed financial statements of AEC as of and for the six-month periods ended June 30, 2002 and 2003. |
The pro forma data is not necessarily indicative of the results of operations and financial position that would have been achieved had the acquisition been completed on the dates indicated or of future operations of the combined company.
F-132
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED INCOME STATEMENT
For the year ended June 30, 2003
(Dollars in thousands, except per share amounts)
| EDMC | AEC(1) | Acquisition Adjustments | Pro Forma Consolidated EDMC & AEC | |||||||||||||
Net revenues | $ | 640,027 | $ | 54,125 | $ | — | $ | 694,152 | ||||||||
Operating expenses | 542,851 | 44,669 | — | 587,520 | ||||||||||||
Amortization of intangible assets | 4,443 | 10 | 1,944 | (2 | ) | 6,397 | ||||||||||
Income before interest and taxes | 92,733 | 9,446 | (1,944 | ) | 100,235 | |||||||||||
Interest expense, net | 1,282 | 208 | 2,600 | (3 | ) | 4,090 | ||||||||||
Income before income taxes | 91,451 | 9,238 | (4,544 | ) | 96,145 | |||||||||||
Provision for income taxes | 35,174 | — | 1,807 | (4 | ) | 36,981 | ||||||||||
Net income | $ | 56,277 | $ | 9,238 | $ | (6,351 | ) | $ | 59,164 | |||||||
Earnings per share: | ||||||||||||||||
Basic | $ | 1.59 | $ | 1.67 | ||||||||||||
Diluted | $ | 1.54 | $ | 1.62 | ||||||||||||
Weighted average number of shares outstanding (in 000’s): | ||||||||||||||||
Basic | 35,478 | 35,478 | ||||||||||||||
Diluted (5) | 36,509 | 36,509 | ||||||||||||||
| (1) | The AEC results have been reclassified to conform to EDMC’s presentation of these statements. |
| (2) | EDMC’s pro forma results of operations have been adjusted to reflect twelve months of amortization of intangibles based upon the new values and useful lives assigned at the time of the AEC acquisition. These amounts are subject to the finalization of a third-party appraisal, the excess of the purchase price over the value of AEC’s tangible assets has been assigned to goodwill and intangibles. These intangible assets have a value of approximately $4.6 million and have an average useful life of 2.3 years. |
| (3) | EDMC’s pro forma results of operations have been adjusted to reflect the additional interest expense related to the AEC acquisition at an interest rate of 2.15%, the weighted average interest rate paid on borrowings under the credit facility and 3.11% on the notes payable to sellers, during the twelve months ended June 30, 2003. |
| (4) | A 38.5% combined state and federal statutory rate was assumed in calculating the income tax effect of the pro forma adjustments. As AEC filed its returns as a Subchapter S Corporation, the provision for income tax adjustment reflects the net impact of the tax provision for the historical income before income taxes of AEC and the acquisition adjustments. |
| (5) | The weighted average shares outstanding for the diluted earnings per share calculation include the impact of outstanding options, where dilutive. |
F-133
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
June 30, 2003
(Dollars in thousands, except share and per share data)
| EDMC | AEC (1) | Acquisition Adjustments(2)(3) | Pro Forma Consolidated EDMC & AEC | ||||||||||
Assets | |||||||||||||
Current assets: | |||||||||||||
Cash and cash equivalents | $ | 80,491 | $ | 5,400 | $ | — | $ | 85,891 | |||||
Receivables, net | 39,709 | 4,194 | — | 43,903 | |||||||||
Other current assets | 30,829 | 3,351 | — | 34,180 | |||||||||
Total current assets | 151,029 | 12,945 | — | 163,974 | |||||||||
Property and equipment, net | 230,749 | 9,429 | (434 | ) | 239,744 | ||||||||
Other long-term assets | 11,202 | 4,324 | — | 15,526 | |||||||||
Intangible assets | 16,892 | 38 | 4,464 | 21,394 | |||||||||
Goodwill | 156,701 | 3,539 | 92,500 | 252,740 | |||||||||
Total assets | $ | 566,573 | $ | 30,275 | $ | 96,530 | $ | 693,378 | |||||
Liabilities and shareholders’ investment | |||||||||||||
Current liabilities: | |||||||||||||
Current portion of long-term debt | $ | 35,074 | $ | 575 | $ | 13,925 | $ | 49,574 | |||||
Accounts payable | 16,301 | 340 | — | 16,641 | |||||||||
Accrued liabilities | 28,461 | 1,947 | — | 30,408 | |||||||||
Advance payments | 50,372 | 5,010 | — | 55,382 | |||||||||
Total current liabilities | 130,208 | 7,872 | 13,925 | 152,005 | |||||||||
Long-term debt, less current portion | 3,426 | 6,521 | 98,487 | 108,434 | |||||||||
Other long-term liabilities | 5,160 | — | — | 5,160 | |||||||||
Shareholders’ investment | 427,779 | 15,882 | (15,882 | ) | 427,779 | ||||||||
Total liabilities and shareholders’ investment | $ | 566,573 | $ | 30,275 | $ | 96,530 | $ | 693,378 | |||||
| (1) | The AEC results of operations have been reclassified to conform to EDMC’s presentation. |
| (2) | The preliminary allocation of the estimated purchase price to assets acquired and liabilities assumed as of June 30, 2003 is as follows (in thousands): |
Purchase price | $ | 114,520 | ||
Estimated acquisition costs | 1,488 | |||
| $ | 116,008 | |||
Net book value of assets acquired | 15,882 | |||
Debt not assumed | 3,596 | |||
Intangible assets of AEC | (3,577 | ) | ||
Adjustments to fair value: | ||||
Identifiable intangible assets | 4,502 | |||
Goodwill | 96,039 | |||
Property and equipment | (434 | ) | ||
| $ | 116,008 | |||
| (3) | Borrowings include the $11.0 million in notes payable to the sellers. |
F-134
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
| EDUCATION MANAGEMENT CORPORATION | ||
| By: | /s/ ROBERT T. MCDOWELL | |
Robert T. McDowell Executive Vice President and Chief Financial Officer | ||
Dated: November 10, 2003
EXHIBIT INDEX
| Exhibit No. | Description | |
| 2.1 | Stock Purchase Agreement dated as of June 24, 2003 by and among Education Management Corporation and Russell E. Palmer, Bradley C. Palmer, The Stephen R. Palmer Living Trust, The Russell E. Palmer III Living Trust, The Karen J. Korfmann Living Trust, Michael Masin, Connie Walter, Technology Leaders L.P., Technology Leaders First Corp., J. William Brooks, Gerard Francois, Danny Finuf, The Companies Signatory Thereto and Sellers’ Representative, incorporated by reference to Exhibit 2.1 to the Report on Form 8-K filed by Education Management Corporation on September 17, 2003 (the “September 2003 8-K”). | |
| 4.1 | Second Amended and Restated Credit Agreement dated as of August 18, 2003 by and among Education Management Corporation as the Borrower, The Banks Party Thereto as the Banks and National City Bank of Pennsylvania as the Agent and Wachovia Bank, National Association, as Syndication Agent, Suntrust Bank, as Syndication Agent, Fleet National Bank, as Documentation Agent, and JPMorgan Chase Bank, as Documentation Agent, incorporated by reference to Exhibit 4.1 to the September 2003 8-K. | |
| 23.1 | Consent of Almich & Associates, independent auditors for American Education Centers, Inc. filed herewith. | |
