1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ending March 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number: 000-21363 EDUCATION MANAGEMENT CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) PENNSYLVANIA 25-1119571 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 300 SIXTH AVENUE, PITTSBURGH, PENNSYLVANIA 15222 (Address of principal executive offices, including zip code) (412) 562-0900 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK As of March 31, 1998 Common Stock: 14,462,850 shares 2 INDEX PART I -- FINANCIAL INFORMATION PAGE ---- Item 1. Financial Statements...................................................................................3-7 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition..........................................................8-10 PART II -- OTHER INFORMATION Item 1. Legal Proceedings......................................................................................11 Item 2. Changes in Securities..................................................................................11 Item 3. Defaults Upon Senior Securities........................................................................11 Item 4. Submission of Matters to a Vote of Security Holders....................................................11 Item 5. Other Information......................................................................................11 Item 6. Exhibits and Reports on Form 8-K.......................................................................11 SIGNATURES ......................................................................................................13 3 PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS) MARCH 31, JUNE 30, MARCH 31, ASSETS 1997 1997 1998 - ------ ---- ---- ---- (Unaudited) (Unaudited) CURRENT ASSETS: Cash and cash equivalents $ 11,592 $ 32,646 $ 20,634 Restricted cash 1,958 581 1,370 -------- -------- -------- Total cash and cash equivalents 13,550 33,227 22,004 Receivables: Trade, net of allowances 7,683 8,706 7,623 Notes, advances and other 4,398 1,841 2,679 Inventories 1,541 1,356 1,802 Deferred income taxes 381 1,509 1,509 Other current assets 3,908 2,247 4,674 -------- -------- -------- Total current assets 31,461 48,886 40,291 -------- -------- -------- PROPERTY AND EQUIPMENT, NET 49,179 52,571 55,999 OTHER ASSETS 6,525 6,381 6,271 GOODWILL, NET OF AMORTIZATION 18,580 18,454 19,716 -------- -------- -------- $105,745 $126,292 $122,277 ======== ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY - ------------------------------------ CURRENT LIABILITIES: Current portion of long-term debt $ 3,551 $ 3,637 $ 2,878 Accounts payable 1,691 6,931 2,574 Accrued liabilities 10,683 9,778 11,862 Advance payments 26,902 15,832 30,694 -------- -------- -------- Total current liabilities 42,827 36,178 48,008 -------- -------- -------- LONG-TERM DEBT, LESS CURRENT PORTION 4,418 30,394 1,409 DEFERRED INCOME TAXES AND OTHER LONG-TERM LIABILITIES 2,505 1,964 1,937 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Capital stock: Common stock, par value $.01 per share, 14,462,850 outstanding as of March 31, 1998 144 144 145 Additional paid-in capital 87,368 87,893 88,576 Treasury stock 39,401 shares at cost (354) (354) (354) Stock subscriptions receivable (171) (122) (8) Accumulated deficit (30,992) (29,805) (17,436) -------- -------- -------- TOTAL SHAREHOLDERS' EQUITY 55,995 57,756 70,923 -------- -------- -------- $105,745 $126,292 $122,277 ======== ======== ======== The accompanying notes to consolidated financial statements are an integral part of these statements. -3- 4 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) THREE MONTHS ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, --------- --------- 1997 1998 1997 1998 ---- ---- ---- ---- (unaudited) (unaudited) NET REVENUES $ 50,696 $ 59,807 $ 136,120 $ 166,051 COSTS AND EXPENSES: Educational services 32,346 39,318 87,320 107,601 General and administrative 11,409 12,191 30,562 35,727 Amortization of intangibles 540 294 1,533 1,317 ----------- ----------- ----------- ----------- 44,295 51,803 119,415 144,645 ----------- ----------- ----------- ----------- INCOME BEFORE INTEREST AND TAXES 6,401 8,004 16,705 21,406 Interest expense, net 96 (15) 1,647 84 ----------- ----------- ----------- ----------- INCOME BEFORE INCOME TAXES 6,305 8,019 15,058 21,322 Provision for income taxes 2,650 3,368 6,329 8,955 ----------- ----------- ----------- ----------- NET INCOME $ 3,655 $ 4,651 $ 8,729 $ 12,367 =========== =========== =========== =========== EARNINGS PER SHARE: BASIC $ .25 $ .32 $ .74 $ .86 ----------- ----------- ----------- ----------- DILUTED $ .25 $ .31 $ .65 $ .83 ----------- ----------- ----------- ----------- WEIGHTED AVERAGE SHARES OUTSTANDING: BASIC 14,389,343 14,454,942 11,117,102 14,441,108 ----------- ----------- ----------- ----------- DILUTED 14,748,633 14,913,229 13,287,647 14,876,516 ----------- ----------- ----------- ----------- The accompanying notes to consolidated financial statements are an integral part of these statements. -4- 5 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS) NINE MONTHS ENDED MARCH 31, 1997 1998 ---- ---- (unaudited) (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: NET INCOME $ 8,729 $ 12,367 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FLOWS FROM OPERATING ACTIVITIES- Depreciation and amortization 9,120 10,542 Vesting of compensatory stock options 375 -- Changes in current assets and liabilities- Restricted cash (721) (789) Receivables (3,890) 291 Inventories (269) (446) Other current assets (1,268) (2,419) Accounts payable (3,085) (3,508) Accrued liabilities 3,369 1,892 Advance payments 15,658 14,769 -------- -------- Total adjustments 19,289 20,332 -------- -------- Net cash flows from operating activities 28,018 32,699 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of subsidiaries (9,753) (1,488) Expenditures for property and equipment (12,089) (13,839) Other items, net (175) (322) -------- -------- Net cash flows from investing activities (22,017) (15,649) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from public stock offering, net 44,969 -- Principal payments on debt, net (57,950) (29,783) Dividends paid to ESOP (83) -- Capital stock transactions, net (7,507) 721 -------- -------- Net cash flows from financing activities (20,571) (29,062) -------- -------- NET CHANGE IN CASH AND CASH EQUIVALENTS (14,570) (12,012) -------- -------- CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 26,162 32,646 -------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 11,592 $ 20,634 ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the period for: Interest $ 1,975 $ 564 Income taxes $ 4,766 $ 9,389 The accompanying notes to consolidated financial statements are an integral part of these statements. 5 6 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. The interim consolidated financial statements consist of the accounts of Education Management Corporation (the "Company") and its wholly owned subsidiaries, which include The Art Institutes International ("AII") and The National Center for Professional Development ("NCPD"). The Company's schools offer associate's and bachelor's degree programs and non-degree programs in the areas of design, technology, culinary arts, fashion and professional development. The Company has provided career-oriented education programs for over 35 years. Unless otherwise noted, references to the fiscal years 1997 and 1998 are to the periods ended March 31, 1997 and 1998, respectively. 2. The results of operations for the three and nine-month periods ended March 31, 1997 and 1998 are not necessarily indicative of the results to be expected for the entire fiscal year. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended June 30, 1997 included in the Company's Annual Report on Form 10-K as filed with the Securities and Exchange Commission. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the disclosures for complete financial statements. This financial information reflects all adjustments, consisting only of normal recurring adjustments, that are, in the opinion of management, necessary to present fairly the financial condition and results of operations for the interim periods presented. Third quarter fiscal year 1997 and 1998 interim financial information was reviewed by Arthur Andersen LLP as set forth in their report included in this document. 3. The Company's authorized and outstanding capital stock was as follows: MARCH 31, 1998 -------------- CAPITAL STOCK AUTHORIZED OUTSTANDING ------------- ---------- ----------- Preferred Stock 10,000,000 -- Common Stock 60,000,000 14,462,850 JUNE 30, 1997 ------------- CAPITAL STOCK AUTHORIZED OUTSTANDING ------------- ---------- ----------- Preferred Stock 10,000,000 -- Common Stock 60,000,000 14,417,874 4. Effective August 1, 1996, the Company acquired certain net assets of The New York Restaurant School ("NYRS") for $9.5 million in cash. The Company acquired principally current assets net of specified current liabilities, property and equipment, student enrollment agreements, curriculum and trade names. The excess of the purchase price over the fair value of the assets acquired has been assigned to goodwill. This transaction was accounted for as a purchase. On January 30, 1997, the Company acquired the assets of Lowthian College, located in Minneapolis, Minnesota, for $200,000 in cash and approximately $200,000 of assumed liabilities. The Company acquired principally accounts receivable, equipment and student enrollment agreements. The excess of the purchase price over the fair value of the assets acquired has been assigned to goodwill. The school was renamed The Art Institute of Minnesota ("AIM"). This transaction was accounted for as a purchase. The Art Institute of Los Angeles ("AILA") became licensed in the State of California in March 1997. AILA began student recruiting and school startup activities in April 1997. Classes commenced in AILA in October 1997. All costs associated with AILA's startup have been expensed as incurred and are reflected in the results of operations. -6- 7 On December 19, 1997, the Company acquired the assets of The Louise Salinger Academy of Fashion located in San Francisco, California, for $600,000 in cash. The Company also entered into a consulting agreement with the former president in exchange for an option to purchase 10,000 shares of Common Stock of the Company at an exercise price of $25.93, the closing price of the Common Stock on December 19, 1997. The Company acquired principally accounts receivable and equipment. The excess of the purchase price over the fair value of the assets acquired has been assigned to goodwill. The school was renamed The Art Institutes International at San Francisco. This transaction was accounted for as a purchase. The Art Institutes International at San Francisco received U.S. Department of Education approval in April 1998. On February 26, 1998, the Company acquired the assets of Bassist College in Portland, Oregon, for $888,000 in cash. The Company, as further consideration for the net assets acquired, has agreed to pay Bassist Corporation a percentage of gross revenues over the next five fiscal years. The Company acquired principally accounts receivable and equipment. The excess of the purchase price over the fair value of the assets acquired has been assigned to goodwill. The school was renamed The Art Institutes International at Portland. This transaction was accounted for as a purchase. The Art Institutes International at Portland received U.S. Department of Education approval in April 1998. 5. In fiscal 1997, the net income allocable to common shareholders was reduced by dividends and a redemption premium on the Company's Series A 10.19% Convertible Preferred Stock, $.0001 par value (the "Series A Preferred Stock"), in the computation of earnings per share. Dividends accrued but not payable that reduced the net income applicable to common shareholders were not paid because the Series A Preferred Stock was converted into Common Stock immediately prior to the consummation of the initial public offering of the Common Stock of the Company, which closed on November 5, 1996. Reconciliation of net income available for common shareholders (Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, 1997 1998 1997 1998 ---- ---- ---- ---- Net income $3,655 $4,651 $8,729 $12,367 Redemption premium on Series A Preferred Stock -- -- (107) -- ------- ------- ------- ------- Net Income Available to common shareholders for diluted earnings per share $3,655 $4,651 $8,622 $12,367 ------ ------ ------ ------- Dividends paid on Series A Preferred Stock -- -- (83) -- Dividends accrued, but not payable on Series A Preferred Stock -- -- (296) -- ------- ------- ------- ------- Net income available to common shareholders for basic earnings per share $3,655 $4,651 $8,243 $12,367 ====== ====== ====== ======= On December 31, 1997, the Company adopted Financial Accounting Standards Board Statement #128. Accordingly, all prior period earnings per share amounts have been restated using the new computation method. Reconciliation of Diluted Shares: THREE MONTHS ENDED NINE MONTHS ENDED MARCH 31, MARCH 31, 1997 1998 1997 1998 ---- ---- ---- ---- Basic shares 14,389,343 14,454,942 11,117,102 14,441,108 Dilution for stock options 359,290 458,287 293,399 435,408 Dilution for warrants and Series A Preferred Stock -- -- 1,877,146 -- ---------- ---------- ---------- ---------- Diluted Shares 14,748,633 14,913,229 13,287,647 14,876,516 ========== ========== ========== ========== -7- 8 PART I - FINANCIAL INFORMATION ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following discussion of the Company's results of operations and financial condition should be read in conjunction with the interim unaudited consolidated financial statements of the Company and the notes thereto. Unless otherwise noted, references to the fiscal years 1997 and 1998 are to the periods ended March 31, 1997 and 1998, respectively. RESULTS OF OPERATIONS For the three months ended March 31, 1998 compared to the three months ended March 31, 1997: Net revenues increased by 18.0% to $59.8 million in the third quarter of fiscal 1998 from $50.7 million in the third quarter of fiscal 1997 due primarily to a 14.6% increase in student enrollments at Company-owned schools, accompanied by an approximate 5.0% tuition price increase. Total student enrollment at the Company's schools increased from 15,746 at the start of the third quarter of fiscal 1997 to 18,041 at the start of the third quarter of fiscal 1998, including growth of approximately 13.0% at the twelve Company-owned schools that, as of the start of the quarter, had been operated by the Company for 24 months or more. In addition, the Company had three more schools in the third quarter when compared to the prior year's quarter. The Art Institute of Los Angeles ("AILA") commenced classes in October 1997. The Louise Salinger Academy of Fashion in San Francisco, California was acquired in December 1997 and renamed the Art Institutes International at San Francisco ("AISF"). Bassist College in Portland, Oregon was acquired in February 1998 and renamed the Art Institutes International at Portland ("AIPD"). Educational services expense increased by $7.0 million, or 21.6%, to $39.3 million in the third quarter of fiscal 1998 from $32.3 million in the third quarter of fiscal 1997. The increase was primarily the result of the additional costs required to service higher student enrollments at The Art Institutes, the addition of AILA, AISF, and AIPD and normal cost increases for wages, supplies expense and other services. Educational services expense in the third quarter of fiscal 1998 was 65.7% of net revenues, compared to 63.8% in the same period last year. Educational services expense, as a percentage of net revenue for new schools, such as AILA, AIPD and AISF is higher than the overall consolidated percentage. General and administrative expense increased by $782,000, or 6.9%, to $12.2 million in the third quarter of fiscal 1998 from $11.4 million in the third quarter of fiscal 1997 primarily because of higher marketing and student admissions expense, including normal cost increases for wages and media advertising. General and administrative expense as a percentage of net revenues decreased to 20.4% in the third quarter of fiscal 1998, compared to 22.5% in the same period last year, principally because corporate and centralized administrative expense grew more slowly than net revenues. Amortization of intangibles decreased by 45.6%, to $294,000 in the third quarter of fiscal 1998 from $540,000 in the third quarter of fiscal 1997. The decrease in amortization expense primarily resulted from certain intangible assets becoming fully amortized during the third quarter of fiscal 1998. The Company had net interest income in the third quarter of fiscal 1998 compared to net expense in the third quarter of fiscal 1997 due to higher average cash balances (invested in short-term instruments) and lower average outstanding indebtedness. The Company's effective tax rate has remained constant at 42.0% for fiscal 1998 and fiscal 1997. Net income for the quarter increased 27.3% to $4.7 million in fiscal 1998 compared to $3.7 million in fiscal 1997. The increase was primarily the result of increased revenues and improved margins. -8- 9 RESULTS OF OPERATIONS For the nine months ended March 31, 1998 compared to the nine months ended March 31, 1997: Net revenues increased by 22.0% to $166.1 million in fiscal 1998 from $136.1 million in fiscal 1997 due primarily to an 18.0% increase in average student enrollments at Company-owned schools, accompanied by an approximate 5.0% tuition price increase. In addition, the Company's revenues and earnings reflect an increase in the number of schools during all or part of the nine-month period compared to the prior year period. Average starting student enrollment at the Company's schools increased from 14,296 in fiscal 1997 to 16,860 in fiscal 1998. The New York Restaurant School was acquired in August 1996. In January, 1997, a Minneapolis school was acquired and renamed The Art Institute of Minnesota ("AIM"). A new school, The Art Institute of Los Angeles, commenced classes in October 1997. In December 1997, a school was acquired and renamed The Art Institutes International at San Francisco. In February 1998, a school was acquired and renamed The Art Institutes International at Portland. Educational services expense increased by $20.3 million, or 23.2%, to $107.6 million in fiscal 1998 from $87.3 million in fiscal 1997. The increase was primarily the result of the additional costs required to service higher student enrollments at The Art Institutes, normal cost increases for wages, supplies expense and other services and the addition of AIM, AILA, AISF and AIPD. Educational services expense, as a percentage of net revenues was 64.8% in fiscal 1998 compared to 64.1% in fiscal 1997. General and administrative expense increased by $5.1 million, or 16.9%, to $35.7 million in fiscal 1998 from $30.6 million in fiscal 1997 primarily because of higher marketing and student admissions expense, including the addition of approximately $1.6 million of such expenses at AIM, AILA, AIPD and AISF and normal cost increases for wages and media advertising. General and administrative expense as a percentage of net revenues decreased to 21.5% for fiscal 1998, compared to 22.5% for fiscal 1997. Amortization of intangibles decreased by 14.1% to $1.3 million in fiscal 1998 from $1.5 million in fiscal 1997 because certain intangible assets became fully amortized in the third quarter. Net interest expense decreased to $84,000 in fiscal 1998 from $1.6 million in fiscal 1997. The lower interest expense was primarily attributable to a decrease in the average outstanding indebtedness from $27.3 million in fiscal 1997 to $5.7 million in fiscal 1998. The Company's effective tax rate has remained constant at 42.0% for fiscal 1998 and fiscal 1997. Net income for the period increased by $3.7 million or 41.7% to $12.4 million in fiscal 1998 from $8.7 million in fiscal 1997. This increase is primarily the result of greater revenues at Company-owned schools, slightly higher margins and lower interest expense. SEASONALITY AND OTHER FACTORS AFFECTING QUARTERLY RESULTS The Company's quarterly revenues and income fluctuate primarily as a result of the pattern of student enrollments. The Company experiences a seasonal increase in new enrollments in the fall (fiscal year second quarter), which is traditionally when the largest number of new high school graduates begin postsecondary education. Some students choose not to attend classes during summer months, although The Art Institutes and NYRS encourage year-round attendance. As a result, total student enrollments at the Company's schools are highest in the fall quarter and lowest in the summer months (fiscal year first quarter). The Company's costs and expenses, however, do not fluctuate as significantly as revenues on a quarterly basis. LIQUIDITY AND CAPITAL RESOURCES The Company generated positive cash flow from operating activities of $32.7 million and $28.0 million for the nine months ended March 31, 1998 and 1997, respectively. The Company had a working capital deficit of $7.7 million as of March 31, 1998, compared to $12.7 million of working capital as of June 30, 1997. The decrease in working capital was due primarily to $29.7 million in debt repayments on revolving credit borrowings and capitalized leases. -9- 10 Effective October 13, 1997, in accordance with the terms of the Company's revolving credit agreement, the amount of the facility thereunder was reduced from $70.0 million to $65.0 million. Borrowings under the revolving credit agreement bear interest at one of three rates set forth in the revolving credit agreement at the election of the Company. Available borrowing capacity is reduced by outstanding letters of credit. As of March 31, 1998, the Company was in compliance with all covenants and had $64.0 million of borrowing capacity available under the revolving credit agreement. Borrowings under the revolving credit agreement are used by the Company primarily to fund its capital investment program, finance acquisitions and meet seasonal working capital needs. The pattern of cash receipts is seasonal throughout the year. The level of accounts receivable reaches a peak immediately after the billing of tuition and fees at the beginning of each academic quarter. Collection of these receivables is heaviest at the start of each academic quarter. The Company believes that cash flow from operations, supplemented from time to time by borrowings under its revolving credit agreement, will provide adequate funds for ongoing operations, planned expansion of new locations, and planned capital expenditures and debt service during the term of the revolving credit agreement. The Company's capital expenditures were $12.1 million and $13.8 million for the nine months ended March 31, 1997 and 1998, respectively. The Company anticipates a slight increase in capital spending for 1998, principally related to the continued investment in schools acquired or opened during fiscal 1996, 1997 and 1998, additional investment in classroom technology and the introduction and expansion of culinary arts and other education programs. The Company leases nearly all of its facilities. Future commitments on existing leases will be paid from cash provided by operating activities. -10- 11 PART II - OTHER INFORMATION Item 1. Legal Proceedings.......................................Not Applicable Item 2. Changes in Securities...................................Not Applicable Item 3. Defaults Upon Senior Securities.........................Not Applicable Item 4. Submission of Matters to a Vote of Security Holders.....Not Applicable Item 5. Other Information.......................................Not Applicable Item 6. Exhibits and reports on Form 8-K (a) Exhibits: (15) Report of Independent Public Accountants (27) Financial Data Schedules (b) Reports on Form 8-K No reports on Form 8-K were filed during the three months ended March 31, 1998 -11- 12 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 thereunto duly authorized. EDUCATION MANAGEMENT CORPORATION (Registrant) Date: May 15, 1998 /s/ ROBERT B. KNUTSON ------------------------------------- Robert B. Knutson Chairman and Chief Executive Officer /s/ ROBERT T. McDOWELL ------------------------------------- Robert T. McDowell Senior Vice President and Chief Financial Officer -12-