-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OyBAZpBN/wTj9nOZ3ik893YuvfnRp+ntxV7hUhbOz26RT6BpBWmgsy8e/NfPCFRK Ug1B7r6VptW/SqAnazkiXA== 0000950131-99-001197.txt : 19990302 0000950131-99-001197.hdr.sgml : 19990302 ACCESSION NUMBER: 0000950131-99-001197 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 19990301 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAREER EDUCATION CORP CENTRAL INDEX KEY: 0001046568 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-EDUCATIONAL SERVICES [8200] IRS NUMBER: 393932190 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-70747 FILM NUMBER: 99553522 BUSINESS ADDRESS: STREET 1: 2800 WEST HIGGINS ROAD, SUITE 790 CITY: HOFFMAN ESTATES STATE: IL ZIP: 60195 BUSINESS PHONE: 8477813600 MAIL ADDRESS: STREET 1: 2800 WEST HIGGINS ROAD STREET 2: SUITE 790 CITY: HOFFMAN ESTATES STATE: IL ZIP: 60195 S-1/A 1 AMENDMENT NO. 1 TO FORM S-1 As filed with the Securities and Exchange Commission on March 1, 1999 Registration No. 333-70747 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------- Amendment No. 1 to FORM S-1 REGISTRATION STATEMENT Under The Securities Act of 1933 -------------- CAREER EDUCATION CORPORATION (Exact name of registrant as specified in its charter) -------------- Delaware 8200 39-3932190 (State or other (Primary Standard (I.R.S. Employer jurisdiction of Industrial Classification Identification No.) incorporation or Code No.) organization) 2800 West Higgins Road, Suite 790 Hoffman Estates, Illinois 60195 (847) 781-3600 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) -------------- JOHN M. LARSON President and Chief Executive Officer Career Education Corporation 2800 West Higgins Road, Suite 790, Hoffman Estates, Illinois 60195, (847) 781- 3600 (Name, address, including zip code, and telephone number, including area code, of agent for service) Copies to: LAWRENCE D. LEVIN, ESQ. DENNIS V. OSIMITZ, ESQ. Katten Muchin & Zavis Sidley & Austin 525 West Monroe Street, Suite 1600 One First National Plaza Chicago, Illinois 60661 Chicago, Illinois 60603 (312) 902-5200 (312) 853-7000 -------------- Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box: [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: [_] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: [_] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box: [_] CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
Proposed Amount Proposed maximum Amount of Title of each class of to be maximum aggregate registration securities to be registered registered offering price offering price fee - ------------------------------------------------------------------------------------------------------------ 2,127,500 shares $29.375 per share Common Stock, $.01 par value..... (1) (2) $62,495,313 (2) $17,374 (3) - ------------------------------------------------------------------------------------------------------------ 172,500 shares $28.00 per share Common Stock, $.01 par value..... (4) (2) $ 4,830,000 (2) $ 1,343 - ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------- (1) Includes 277,500 shares to be offered upon exercise of the Underwriters' over-allotment option. (2) Estimated solely for purposes of calculating the registration fee pursuant to Rule 457 of Regulation C under the Securities Act of 1933, as amended. (3) Previously paid. (4) Includes 22,500 shares to be offered upon exercise of the Underwriters' over-allotment option. -------------- The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to Section 8(a), may determine. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +The information in this prospectus is not complete and may be changed. We and + +the Selling Stockholders may not sell these securities until the registration + +statement filed with the Securities and Exchange Commission is effective. + +This prospectus is not an offer to sell these securities, and it is not + +soliciting an offer to buy these securities in any state where the offer or + +sale is not permitted. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION, DATED MARCH 1, 1999 2,000,000 Shares [LOGO OF CAREER EDUCATION] Common Stock -------- Of the shares of common stock in this offering, 250,000 shares are being sold by us and 1,750,000 shares are being sold by the selling stockholders named under "Principal and Selling Stockholders." We will not receive any of the proceeds from the shares of common stock sold by the selling stockholders. The Underwriters have an option to purchase a maximum of 300,000 additional shares to cover over-allotments of shares. Our common stock is traded on The Nasdaq National Market under the symbol "CECO." On February 26, 1999, the last reported sales price of our common stock on The Nasdaq National Market was $28.12. Investing in the common stock involves material risks. See "Risk Factors" on page 7.
Price Underwriting Proceeds to to Discounts and Proceeds Selling Public Commissions to Us Stockholders ------ ------------- -------- ------------ Per Share............................ $ $ $ $ Total................................ $ $ $ $
Delivery of the shares of common stock will be made on or about , 1999, against payment in immediately available funds. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Credit Suisse First Boston Salomon Smith Barney BancBoston Robertson Stephens Prospectus dated , 1999 [INSIDE FRONT COVER] CAREER EDUCATION CORPORATION LOGO BUILDING THE FUTURE OF PRIVATE POST- SECONDARY EDUCATION Photograph of five students from Allentown Business School walking on campus. INFORMATION TECHNOLOGIES VISUAL COMMUNICATION AND DESIGN TECHNOLOGIES BUSINESS STUDIES CULINARY ARTS TABLE OF CONTENTS
Page ---- Prospectus Summary.................. 1 Risk Factors........................ 7 Use of Proceeds..................... 14 Dividend Policy..................... 14 Price Range of Common Stock......... 14 Capitalization...................... 15 Unaudited Pro Forma Condensed Consolidated Financial Data........ 16 Selected Historical Consolidated Financial and Other Data........... 20 Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 22
Page ---- Business............................ 30 Financial Aid and Regulation........ 42 Management.......................... 53 Principal and Selling Stockholders.. 62 Description of Capital Stock........ 64 Shares Eligible for Future Sale..... 65 Underwriting........................ 67 Notice to Canadian Residents........ 69 Legal Matters....................... 70 Experts............................. 70 Where You Can Find More Information. 70 Index to Financial Statements....... F-1
---------------- Notes to Readers of this Prospectus You should keep in mind the following points as you read this prospectus: . The term "school" means a campus or group of campuses known by a single brand name, such as The Katharine Gibbs Schools or the Al Collins Graphic Design School. The term "campus" means a single location of any school, such as the New York campus of The Katharine Gibbs Schools or the Al Collins Graphic Design School in Tempe, Arizona. The term "institution" means a main campus and its additional locations, as such are defined under regulations of the U.S. Department of Education. . This offering is for 2,000,000 shares; however, the underwriters have a 30-day option to purchase up to 300,000 additional shares to cover over- allotments. Some of the disclosures in this prospectus would be different if the underwriters exercise the option. Unless we tell you otherwise, the information in this prospectus assumes that the underwriters will not exercise the option. ---------------- Special Note Regarding Forward-Looking Statements This prospectus contains "forward-looking" statements that have been made pursuant to the Private Securities Litigation Reform Act of 1995 which reflect our expectations regarding our future growth, results of operations, performance and business prospects and opportunities. Wherever possible, words such as "anticipate," "believe," "plan," "expect" and similar expressions have been used to identify these forward-looking statements. These statements reflect our current beliefs and are based on information currently available to us. Accordingly, these statements are subject to risks and uncertainties, including those listed under "Risk Factors," which could cause our actual growth, results, performance and business prospects and opportunities to differ from those expressed in, or implied by, these statements. Except as otherwise required by federal securities law, we are not obligated to update or revise these forward-looking statements to reflect new events or circumstances. ---------------- You should rely only on the information contained in this document or to which we have referred you. We have not authorized anyone to provide you with information that is different. This document may only be used where it is legal to sell these securities. The information in this document may only be accurate on the date of this document. (i) PROSPECTUS SUMMARY This summary highlights some of the information in this prospectus. It may not contain all of the information that is important to you. To understand this offering fully, you should read the entire prospectus carefully, including the risk factors and the financial statements. The Company Career Education Corporation is one of the largest providers of private, for-profit postsecondary education in North America, with approximately 15,900 students enrolled as of October 31, 1998. We operate 12 schools, with 21 campuses located in 13 states and two Canadian provinces. Our schools enjoy long operating histories and offer a variety of bachelor's degree, associate degree and non-degree programs in career-oriented disciplines within our core curricula of: . information technologies . visual communication and design technologies . business studies . culinary arts We have experienced significant growth both internally and through acquisitions with our net revenue increasing from $7.5 million in 1994 to $144.2 million in 1998. In addition, our net income increased to $4.3 million in 1998 from a net loss of $1.6 million in 1994. CEC was founded in January 1994 by John M. Larson, our President and Chief Executive Officer, who has over 24 years of experience in the career-oriented education industry. We were formed to capitalize on opportunities in the large and highly fragmented postsecondary school industry. Since our inception, we have completed 12 acquisitions. We have acquired schools that we believe possess strong curricula, leading reputations and broad marketability but that have been undermanaged from a marketing and financial standpoint. We seek to apply our expertise in operations, marketing and curricula development, as well as our financial strength, to improve the performance of these schools. Our Acquisition History
Number of Year Month School Campuses Founded Acquired ------ --------- ------- -------- Al Collins Graphic Design School..................... 1 1978 1/94 Brooks College....................................... 1 1970 6/94 Allentown Business School............................ 1 1869 7/95 Brown Institute...................................... 1 1946 7/95 Western Culinary Institute........................... 1 1983 10/96 School of Computer Technology........................ 2 1967 2/97 The Katharine Gibbs Schools.......................... 7 1911 5/97 International Academy of Merchandising & Design...... 2 1977 6/97 International Academy of Design...................... 2 1983 6/97 Southern California School of Culinary Arts.......... 1 1994 3/98 Scottsdale Culinary Institute........................ 1 1986 7/98 Harrington Institute of Interior Design.............. 1 1931 1/99
1 Our Business and Operating Strategy Our company was founded based on a business and operating strategy which we believe has enabled us to achieve significant improvements in the performance of our schools. We believe this strategy will enable us to continue to capitalize on the favorable economic, demographic and social trends which are driving demand for career-oriented education. These trends include greater technological skills required for entry-level jobs, increasing numbers of high school graduates and a greater recognition of the value of higher education. The key elements of our strategy are: . Focusing on Core Curricula. Our schools offer educational programs principally in four career-related fields of study identified by us as areas with highly interested and motivated students, strong entry-level employment opportunities and ongoing career and salary advancement potential. . Adapting and Expanding Educational Programs. Each of our schools strives to meet the changing needs of its students and the employment markets by regularly refining and adapting its existing educational programs, selectively duplicating successful programs offered elsewhere in our school system and introducing entirely new programs of study. . Investing for Future Growth. We make substantial investments in our infrastructure to prepare us for continued growth. We devote particular attention to attracting and retaining both corporate and campus-level management, and we focus on employee development to facilitate internal promotions. Our investments in facilities and classroom technologies help us attract and retain students and prepare them for the increasing technical demands of the workplace. . Emphasizing School Management Autonomy and Accountability. We provide significant operating autonomy and appropriate performance-based incentives to our campus-level managers. We believe these policies create an important sense of personal responsibility for achieving campus performance objectives and provide us with a significant advantage in recruiting and retaining highly-motivated, entrepreneurial individuals. . Direct Response Marketing. We seek to increase school enrollment and profitability through intensive local, regional and national direct response marketing programs specifically crafted for each school to maximize its market penetration. We also use the Internet to attract potential students and believe this medium will be an increasingly important marketing tool. . Improving Student Retention. We focus substantial attention on student retention, as modest improvements in student retention can result in meaningful increases in school revenue and profitability. We strive to improve retention by treating students as valued customers. . Emphasizing Employment of Graduates. We devote significant resources to graduate placement efforts because we believe that maintaining high employment rates for graduates of our schools enhances the overall reputation of the schools and their ability to attract new students. Approximately 92.5% of our students graduating during the 1998 academic year, which is July 1, 1997 to June 30, 1998, obtained employment related to their program of study within six months of graduation. 2 Our Growth Strategy We believe we can continue to achieve superior long-term growth in revenue and profitability through: . Expanding Existing Operations. We intend to achieve continued growth at our existing campuses by executing our business and operating strategy. . Acquiring Additional North American Schools. We continually evaluate opportunities to acquire schools in the U.S. and Canada that have leading reputations, broad marketability and demonstrated compliance with regulatory requirements and accreditation standards. In March 1998, we hired a Director of Strategic Planning and Development to proactively identify and evaluate these opportunities. We seek to acquire schools which we believe will benefit from the implementation of our business and operating strategy. . Establishing New Campuses. We expect to open new campuses, most likely as additional locations of existing institutions, to capitalize on new markets or geographic regions that exhibit strong enrollment potential or the opportunity to establish a successful school operation in one of our core curricula areas. . Entering New Service Areas. We plan to develop new services, such as distance learning, which we believe offer strong long-term growth potential. Distance learning offers educational products and services through video, Internet and other distribution channels. We also plan to expand our contract training operations, which provide customized training on a contract basis for business and government organizations. . Expanding Internationally. We may also acquire or establish operations outside North America where we believe significant opportunities exist. Our Address CEC was incorporated in Delaware on January 5, 1994. Our principal executive offices are located at 2800 West Higgins Road, Suite 790, Hoffman Estates, Illinois 60195 and our telephone number is (847) 781-3600. Our web site is located at http://www.careered.com. Web sites for our schools can be accessed through hyperlinks at our web site. Information contained in our web site is not a part of this prospectus. The Offering Common stock offered by us....................... 250,000 shares Common stock offered by the selling stockholders. 1,750,000 shares Common stock outstanding after the offering...... 7,447,445 shares (1) Use of proceeds.................................. We will use the net proceeds to us from the sale of the shares offered by us in this offering for general corporate purposes. See "Use of Proceeds." We will not receive any proceeds from the sale of shares by the selling stockholders. Nasdaq National Market symbol.................... CECO
- -------- (1) Excludes 909,384 shares of common stock issuable upon the exercise of stock options outstanding at December 31, 1998 at a weighted average exercise price of $16.38 per share and 187,774 shares reserved for issuance under our stock plans. 3 Recent Developments Acquisitions On January 4, 1999, we acquired Harrington for $3.3 million, subject to adjustment. Harrington was founded in 1931 and provides degree and diploma programs in interior design and related fields at its campus in Chicago, Illinois. Harrington had a student population of approximately 425 as of September 30, 1998 and is accredited by the National Association of Schools of Art and Design. On December 29, 1998, we entered into an agreement to acquire the Brooks Institute of Photography. Brooks Institute was founded in 1945 which is located in Santa Barbara, California. As of June 30, 1998, the school had a student population of approximately 290, approximately 40% of which was foreign students. The completion of the proposed acquisition is subject to a number of conditions, including approval by California state regulators. We cannot assure you that this acquisition will be completed. Brooks Institute is accredited by the Accrediting Council for Independent Colleges and Schools. On December 3, 1998, we entered into a letter of intent to acquire Briarcliffe College. Briarcliffe College was founded in 1966 and provides diploma, associate degree and bachelor's degree programs in business, information technology, visual communications, graphic design technologies and other fields at its campuses in Bethpage and Patchogue, New York. Briarcliffe College had a student population of approximately 1,400 as of October 15, 1998 and is accredited by Middle States Association of Colleges and Schools. We cannot assure you that this acquisition will be completed. Strategic Relationships On October 29, 1998, we entered into an agreement with Le Cordon Bleu Limited granting us exclusive rights to use the "Le Cordon Bleu" name in the U.S. and Canada in connection with our culinary education programs. We are developing a curriculum with Le Cordon Bleu for use at our culinary schools, and the agreement will not take effect until this curriculum is completed and approved by both of us. We do not expect to implement this curriculum until late in our second quarter of this year. The initial term of this agreement expires on December 31, 2008. In January 1999, we began offering professional education loans to students at our U.S. campuses pursuant to an agreement with Sallie Mae, a student loan marketing association. Sallie Mae designed a private loan program for our students to supplement federal, state and other private financial aid programs. This program offers variable interest rate loans tied to the prime rate, determination of eligibility within 24 hours, repayment deferral until students have been out of school for six months and a single billing statement with other federal student loans serviced by Sallie Mae. 4 Summary Consolidated Financial and Other Data You should read the consolidated financial and other operating data below in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this prospectus. See "Unaudited Pro Forma Condensed Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Year Ended December 31, ---------------------------------------------- 1998 -------------------------- Pro Forma 1996 1997 Historical As Adjusted (1) -------- -------- ---------- --------------- (Dollars in thousands, except per share data) Statement of Operations Data: Revenue: Tuition and registration fees, net................. $ 29,269 $ 74,842 $132,926 $135,458 Other, net................. 4,311 7,756 11,306 11,778 -------- -------- -------- -------- Total net revenue........ 33,580 82,598 144,232 147,236 Depreciation and amortization (2)........... 2,134 8,121 12,163 12,357 Compensation expense related to the initial public offering................... -- -- 1,961 1,961 Income from operations...... 2,420 2,315 9,101 9,645 Net income (loss) (3)....... $ 1,495 $ (880) $ 4,296 $ 5,108 ======== ======== ======== ======== Net income (loss) attributable to common stockholders (4). $ 137 $ (9,307) $ 1,869 $ 5,010 ======== ======== ======== ======== Net income per diluted share attributable to common stockholders (5). $ 0.67 ======== Other Data: EBITDA (6).................. $ 4,554 $ 10,436 $ 21,264 $ 22,002 EBITDA margin (6)........... 13.6% 12.6% 14.7% 14.9% Cash flow provided by (used in): Operating activities....... 5,275 (194) 22,227 Investing activities....... (9,518) (45,214) (12,356) Financing activities....... 8,076 56,659 (4,897) Capital expenditures, net... 1,231 3,822 6,383 Student population (7)...... 4,537 10,889 15,900 Number of campuses (8)...... 5 18 20
December 31, 1998 ----------------------- Actual As Adjusted(1) -------- -------------- (Dollars in thousands) Balance Sheet Data: Cash.................................................... $ 23,548 $23,548 Working capital......................................... 15,994 15,994 Total assets............................................ 132,887 132,887 Long-term debt.......................................... 22,617 16,722 Total stockholders' investment.......................... 84,636 90,531
- -------- (1) Gives effect to (a) our acquisition of Scottsdale Culinary, (b) the use of proceeds from our initial public offering of common stock to retire indebtedness, (c) the conversion of all classes of preferred stock into common stock and the exercise of warrants in connection with our initial public offering as if they had occurred on January 1, 1998, and is adjusted for our sale of 250,000 shares of common stock in this offering and the application of the estimated net proceeds therefrom as described in "Use of Proceeds," as if it had occurred as of the beginning of the year. See "Unaudited Pro Forma Condensed Consolidated Financial Data" and Note 2 of the Notes to our Consolidated Financial Statements. 5 (2) Includes depreciation of property and equipment, amortization of goodwill and covenants not-to-compete and excludes the amortization of debt discount and deferred financing costs. (3) For the year ended December 31, 1997, net income includes an extraordinary loss of $418, which is net of a $233 tax benefit, resulting from the early extinguishment of debt. See Note 6 of the Notes to our Consolidated Financial Statements. For the year ended December 31, 1998, net income includes a charge of $205, net of taxes of $149, related to the cumulative effect of a change in accounting principle, in connection with the adoption of Statement of Position 98-5 "Reporting on the Costs of Start-up Activities." See Note 4 of the Notes to our Consolidated Financial Statements. (4) Includes reductions to net income (loss) for dividends paid or added to the redemption value of preferred stock and the accretion to redemption value of preferred stock and warrants. See Note 3 of the Notes to our Consolidated Financial Statements. (5) Pro forma net income per diluted share is based upon the weighted average number of common and common stock equivalent shares outstanding totalling 7,514,000 for the year ended December 31, 1998. This number includes (a) outstanding shares of common stock and common stock equivalents, (b) 275,000 shares of common stock assumed to have been issued in our initial public offering to repay indebtedness as if our initial public offering occurred at the beginning of the year, (c) approximately 292,000 additional weighted average shares of common stock related to the conversion of preferred stock and the exercise of warrants which occurred in connection with our initial public offering, as if such conversion occurred at the beginning of the year, and (d) approximately 210,000 shares of common stock assumed to be issued in this offering, to repay indebtedness as if the offering occurred at the beginning of the year. (6) For any period, EBITDA equals earnings before interest expense, taxes, depreciation and amortization, including amortization of debt discount and deferred financing costs. EBITDA margin equals EBITDA as a percentage of net revenue. We have included information concerning EBITDA and EBITDA margin because we believe they allow for a more complete analysis of our results of operations. EBITDA and EBITDA margin should not be considered as alternatives to, nor is there any implication that they are more meaningful than, any measure of performance or liquidity as promulgated under generally accepted accounting principles. (7) Represents the total number of students attending our schools as of October 31. (8) Represents the total number of campuses operated by us as of the end of the period. 6 RISK FACTORS Before you invest in our common stock, you should be aware that there are various risks, including those described below. You should carefully consider these risk factors, and all of the other information included in this prospectus before you decide whether to purchase shares of our common stock. Any of the following risks could materially adversely affect our business, results of operations or financial condition and could result in a complete loss of your investment. Risks Associated with our Substantial Dependence on Financial Aid Our U.S. schools are extensively regulated. We derive a majority of our revenue from U.S. federal student financial aid programs. To participate in such programs, a U.S. institution must obtain and maintain authorization by the appropriate state education agencies, accreditation by an accrediting agency recognized by the Department of Education, and certification by the Department of Education. As a result, our U.S. schools are subject to extensive regulation by these agencies. These regulations cover virtually all phases of our operations, including our educational programs, facilities, instructional and administrative staff, administrative procedures, financial operations and financial strength. They also affect our ability to acquire or open additional schools or change our corporate structure. These regulatory agencies periodically revise their requirements and modify their interpretations of existing requirements. If one of our schools were to violate any of these regulatory requirements, we could suffer a financial penalty. The regulatory agencies could also place limitations on or terminate our schools' operations, including our receipt of federal student financial aid funds, which could have a material adverse effect on our business, results of operations or financial condition. We believe that we substantially comply with the requirements of these regulatory agencies, but we cannot predict with certainty how all of these requirements will be applied, or whether we will be able to comply with all of the requirements in the future. Some of the most significant regulatory requirements and risks that apply to our U.S. schools are described in the following paragraphs. Please see "Financial Aid and Regulation" for more detailed information on the regulations and other requirements that apply to us. The U.S. Congress may change the law or reduce funding for federal student financial aid programs. The U.S. Congress regularly reviews and revises the laws governing the federal student financial aid programs and annually determines the funding level for each of these programs. Any action by Congress that significantly reduces funding for the federal student financial aid programs or the ability of our schools or students to participate in these programs could have a material adverse effect on our business, results of operations or financial condition. Legislative action may also increase our administrative costs and burden and require us to modify our practices in order for our schools to comply fully with applicable requirements, which could have a material adverse effect on our business, results of operations or financial condition. Please see "Financial Aid and Regulation--Nature of Federal Support for Postsecondary Education in the U.S." and "--Regulation of Federal Student Financial Aid Programs for U.S. Schools--Legislative Action" for more information regarding legislative action that could affect our funding. We must meet financial responsibility standards to participate in federal student financial aid programs. To participate in the federal student financial aid programs, an institution must either satisfy numeric standards of financial responsibility, or post a letter of credit in favor of the Department of Education and possibly accept other conditions on its participation in the federal student financial aid programs. The Department of Education has determined that we and some of our institutions did not satisfy the numeric standards based on our audited financial statements for 1996 and 1997 and our February 1998 balance sheet, which reflects the results of our initial public offering. Currently, we have posted letters of credit for eleven of our institutions totalling approximately $17.6 million. The Department of Education has also placed a limit on 7 the total amount of federal student financial aid available to students at the Southern California School of Culinary Arts. We filed our 1998 financial statements with the Department of Education in February 1999 and asked it to release most, if not all, of our outstanding letters of credit and to increase or eliminate the funding cap for the Southern California School of Culinary Arts. We cannot assure you that we or our institutions will satisfy the numeric standards or that the Department of Education will take any action with respect to the letters of credit or funding limitation. For more information on our compliance with these standards, please see "Financial Aid and Regulation-- Regulation of Federal Student Financial Aid Programs for U.S. Schools-- Financial Responsibility Standards." Our schools may lose eligibility to participate in federal student financial aid programs if their student loan default rates are too high. An institution may lose its eligibility to participate in some or all of the federal student financial aid programs, if defaults by its students on their federal student loans exceed specified rates. If any of our institutions, depending on its size, loses eligibility to participate in federal student financial aid programs because of high student loan default rates, it could have a material adverse effect on our business, results of operations or financial condition. For information regarding our default rates and other requirements, please see "Financial Aid and Regulation--Regulation of Federal Student Financial Aid Programs for U.S. Schools--Cohort Default Rates." Our schools may lose eligibility to participate in federal student financial aid programs if the percentage of their revenue derived from those programs is too high. A proprietary institution loses its eligibility to participate in the federal student financial aid programs if it derives more than 85% of its revenue from these programs in any fiscal year ending before October 1998 or 90% of its revenue from these programs in any fiscal year ending after October 1998. If any of our institutions, depending on its size, loses eligibility to participate in federal student financial aid programs, it could have a material adverse effect on our business, results of operations or financial condition. Please see "Financial Aid and Regulation--Regulation of Federal Student Financial Aid Programs for U.S. Schools--The "85/15 Rule"' for a discussion of the percentage of our institutions' revenues derived from federal student financial aid programs. Regulators must approve acquisitions that we make. When we acquire an institution, the Department of Education and most applicable state education agencies and accrediting agencies consider that a change of ownership or control of the institution has occurred. A change of ownership or control of an institution under the standards of the Department of Education generally results in the suspension of the institution's participation in the federal student financial aid programs until the Department of Education reviews and recertifies the institution. If we were unable to reestablish the state authorization, accreditation or Department of Education certification of an institution we acquired, depending on the size of that acquisition, that failure could have a material adverse effect on our business, results of operations or financial condition. Regulators need to approve transactions involving a change of control of us or our schools. If there is a change of control of us or of any of our institutions under the standards of applicable state education agencies or accrediting agencies or the Department of Education, the affected institutions must seek the approval of the relevant agencies. The failure of any of our institutions to reestablish its state authorization, accreditation or Department of Education certification could result in a suspension or loss of federal student financial aid funding, which could have a material adverse effect on our business, results of operations or financial condition. We have been advised by the Department of Education that this offering will not be a change of control under its standards. We believe that this offering will be considered a change of control by the state education agency in Arizona and one of the state education agencies in Illinois, based on the numeric thresholds that 8 these agencies apply in determining whether a transfer of stock is a change of control. As a result, three of our campuses will be required to apply to be reauthorized by the applicable state agency. We do not believe that this offering will be considered a change of control by other applicable state education agencies or applicable accrediting agencies, based on our review of their standards and our familiarity with their procedures. The Department of Education, applicable state education agencies or applicable accrediting agencies may consider other transactions or events to constitute a change of control. Some of these transactions or events, such as a significant acquisition or disposition of our common stock, may be beyond our control. Our schools must receive state authorizations and be accredited to operate and participate in federal student financial aid programs. An institution that grants degrees, diplomas or certificates must be authorized by the relevant education agencies of the state in which it is located and, in some cases, other states. Requirements for authorization vary substantially among the states. State authorization and accreditation by an accrediting agency recognized by the Department of Education are also required for an institution to participate in the federal student financial aid programs. Loss of state authorization or accreditation by any of our campuses, depending on the size of the campus, could have a material adverse effect on our business, results of operations or financial condition. For a more detailed discussion of the requirements of state education agencies and accrediting bodies, please see "Financial Aid and Regulation--State Authorization for U.S. Schools" and "--Accreditation for U.S. Schools." Our Canadian schools are also extensively regulated. Approximately 70% of students enrolled at our Canadian schools receive assistance from Canadian governmental financial aid programs. Depending on their province of residence, Canadian students may receive loans under the Canada Student Loan Program, the Ontario Student Loans Plan and the Quebec Loans and Bursaries Program. Our Canadian schools must meet the eligibility standards to administer these programs and must comply with extensive statutes, regulations and other requirements. Our International Academy of Design school in Toronto may be required to share the cost of student loan defaults if defaults by its students on their Ontario Student Assistance Plan loans exceed specified rates. Our Toronto school currently does not have a default rate that exceeds the applicable threshold. If our Canadian schools cannot meet these and other eligibility standards or fail to comply with applicable requirements, it could have a material adverse effect on our business, results of operations or financial condition. The Canadian, Ontario and Quebec governments are currently in the process of changing the legislative, regulatory and other requirements relating to student financial assistance programs due to political and budgetary pressures. Although we do not anticipate a significant reduction in the funding for these programs, any change that significantly reduces funding or the ability of our schools to participate in these programs could have a material adverse effect on our business, results of operations or financial condition. Risks Associated with Our Business We must effectively manage our growth. We have grown rapidly since our incorporation in January 1994. Our rapid growth could place a strain on our management, operations, employees or resources. We cannot assure you that we will be able to maintain or accelerate our current growth rate, effectively manage our expanding operations or achieve planned growth on a timely or profitable basis. If we are unable to manage our growth effectively, our business, results of operations or financial condition could be materially adversely affected. 9 We have a history of losses. Since our inception in 1994, we have experienced a net loss for 1994 and 1997; and a net loss attributable to common stockholders for 1994, 1995 and 1997. To the extent that we earned net income or income attributable to common stockholders for any prior periods, the amounts earned were not substantial. See "Selected Historical Consolidated Financial and Other Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our Consolidated Financial Statements and the related notes thereto appearing elsewhere in this prospectus. We cannot assure you that we will be profitable in the future. Acquisitions are a key component of our growth strategy. We expect to continue to rely on acquisitions as a key component of our growth. From time to time, we engage in, and we are currently engaged in, evaluations of, and discussions with, possible acquisition candidates, including those discussed under "Prospectus Summary--Recent Developments." We cannot assure you that we will continue to be able to identify suitable acquisition opportunities or to acquire any such schools on favorable terms. Furthermore, we cannot assure you that any acquired schools can be successfully integrated into our operations or be operated profitably. Acquisitions involve a number of special risks and challenges, including the diversion of management's attention, assimilation of the operations and personnel of acquired schools, adverse short-term effects on reported operating results, possible loss of key employees and difficulty of presenting a unified corporate image. Continued growth through acquisition may also subject us to unanticipated business or regulatory uncertainties or liabilities. We cannot assure you that any potential acquisition will enhance our business and will not ultimately have a material adverse effect on us. When we acquire an existing school, we typically allocate a significant portion of the purchase price to fixed assets, curriculum, goodwill and intangibles, such as covenants not-to-compete. For our acquisitions to date, we have amortized goodwill over a period of 40 years and intangible assets over periods of three to five years. In addition, our acquisition of a school in the U.S. would be a change of ownership, which may result in the suspension of that school's participation in the federal student financial aid programs until it obtains the Department of Education's approval. If we fail to manage our acquisition program effectively, it could have a material adverse effect on our business, results of operations or financial condition. We may seek to expand by opening new schools or by adding new services. To date, we have added new schools only through acquisitions. However, in the future we expect to open and operate new schools, most likely as additional locations of existing schools, but possibly also as separate, freestanding institutions. Establishing new schools poses unique challenges and would require us to make investments in management, capital expenditures, marketing expenses and other resources different, and in some cases greater, than those required with respect to the operation of acquired schools. To open a new school, we would be required to obtain appropriate state or provincial and accrediting agency approvals. In addition, to be eligible for federal student financial aid programs, such a school would have to be certified by the Department of Education. We have never established a new school, and we cannot assure you that we will be able to do so successfully or profitably. While we expect that our career-oriented school business will continue to provide the substantial majority of our revenue in the near term, we plan to expand our contract training business, currently offered to a limited extent by a few of our schools, and may also decide to provide other education-related services, such as distance learning. We cannot be certain which, if any, new service areas we will decide to enter or whether we will succeed in markets beyond our current career-oriented school business. 10 Our failure to effectively manage the operations of newly established schools or service areas, or any diversion of management's attention from our core career-oriented school operating activities, could have a material adverse effect on our business, results of operations or financial condition. For a more detailed description of our growth strategy and the related regulatory concerns, please see "Business--Growth Strategy" and "Financial Aid and Regulation--Regulation of Federal Student Financial Aid Programs for U.S. Schools--Opening Additional Schools and Adding Educational Programs." We must keep pace with changing market needs and technology. Prospective employers of our graduates increasingly demand that their entry- level employees possess appropriate technological skills. Educational programs at our schools, particularly programs in information technologies and visual communications, must keep pace with these evolving requirements. If we cannot respond to changes in industry requirements, it could have a material adverse effect on our business, results of operations or financial condition. Our financial results fluctuate. Our results of operations fluctuate primarily as a result of changes in the level of student enrollment at our schools. Our schools experience a seasonal increase in new enrollments in the fall, traditionally when the largest numbers of new high school graduates begin postsecondary education. We anticipate that these seasonal trends will continue. For more detailed information on our quarterly operating results, please see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Seasonality." We are in a highly competitive business. The postsecondary education market is highly competitive. Our schools compete with traditional public and private two-year and four-year colleges and universities and other proprietary schools. Some public and private colleges and universities, as well as other private career-oriented schools, may offer programs similar to those of our schools. Although tuition at private nonprofit institutions is, on average, higher than tuition at our schools, some public institutions are able to charge lower tuition than our schools, due in part to government subsidies, government and foundation grants, tax-deductible contributions and other financial sources not available to proprietary schools. Some of our competitors in both the public and private sectors have substantially greater financial and other resources than us. Expansion outside of the U.S. and Canada may involve special risks. Although we currently operate only in the U.S. and Canada, we intend to explore opportunities outside those markets. There may be difficulties and complexities associated with our expansion into international markets, and we cannot assure you that our strategies will succeed beyond the U.S. and Canada. International operations present inherent risks, including currency fluctuations, varying political and economic conditions, unanticipated changes in regulation, trade barriers, staffing and management problems and adverse tax consequences. Also, in expanding internationally, we would be required to comply with different, and potentially more onerous, regulatory requirements. We cannot assure you that such factors will not have a material adverse effect on our business, results of operations or financial condition in the future. We may need additional capital in the future to implement our growth strategy. We believe that funds from operations, cash, investments and borrowings under our $60 million credit facility pursuant to our credit agreement will be adequate to fund our current operating plans for the foreseeable future. However, we may need additional debt or equity financing in order to carry out our strategy of growth through acquisitions. For this reason, we are in the process of amending our credit agreement to increase the amount of the credit facility from $60 million to $90 million. We cannot assure you that the credit facility will be increased. We may also need additional debt or equity financing in the future to carry out our growth 11 strategy. The amount and timing of such additional financing will vary principally depending on the timing and size of acquisitions and the sellers' willingness to provide financing themselves. To the extent that we require additional financing in the future and are unable to obtain such additional financing, we may not be able to fully implement our growth strategy. We are subject to limitations under our credit agreement. Our credit agreement limits our ability to take certain actions, including paying dividends, disposing of assets and incurring certain additional indebtedness. Accordingly, we may be restricted from taking certain actions which management believes would be desirable and in the best interests of us and our stockholders. The credit agreement also requires us to maintain specified financial ratios and satisfy certain financial tests. We were in compliance with all ratios and financial tests as of December 31, 1998, and believe that we remain in compliance. However, a breach of any covenants contained in the credit agreement could result in an event of default under that agreement and allow the lenders to accelerate the indebtedness, which could have a material adverse effect on our business, results of operations or financial condition. We are dependent on our key personnel, including John M. Larson and William A. Klettke. Our success to date has depended, and will continue to depend, largely on the skills and efforts of John M. Larson, our President and Chief Executive Officer, William A. Klettke, our Senior Vice President and Chief Financial Officer, and our other key personnel. Our success also depends, in large part, upon our ability to attract and retain highly qualified faculty, school presidents and administrators and corporate management. Due to the nature of our business, we may have difficulty locating and hiring qualified personnel, and retaining such personnel once hired. None of our employees is subject to an employment or noncompetition agreement other than Mr. Larson. We do not maintain life insurance on any of our employees. The loss of the services of any of our key personnel, or our failure to attract and retain other qualified and experienced personnel on acceptable terms, could have a material adverse effect on our business, results of operations or financial condition. If we fail to be Year 2000 compliant, it could harm our business. Most companies face potentially serious problems because many information technology ("IT") hardware and software systems and non-IT systems containing embedded technology may not properly recognize calendar dates beginning in the year 2000. This problem could force systems to either shut down or provide incorrect data and information. We began the process of identifying the necessary changes to our computer programs and hardware as well as assessing the progress of our significant vendors in their remediation efforts in late 1997. We are unable at this time to fully assess the possible impact on our business, results of operations and financial condition that may result from any disruptions to our business caused by Year 2000 problems in any systems controlled by us or any third party with whom we have a material relationship. These third parties primarily include the Department of Education, state education agencies, accrediting agencies, guaranty agencies and student loan lenders. We do not believe that the cost to remedy our internal Year 2000 problems will have a material adverse effect on our business, results of operations or financial condition. We cannot assure you, however, that our systems or those of third parties with whom we interact will be free of Year 2000 problems. Please see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Year 2000 Compliance" for detailed information on our state or readiness, potential risk and contingency plan regarding the Year 2000 issue. Anti-takeover provisions in our charter documents and Delaware law could make an acquisition of us difficult. Our Certificate of Incorporation, our by-laws and Delaware law contain provisions that may delay, defer or inhibit a future acquisition of us not approved by our board of directors. These provisions are intended to encourage any person interested in acquiring us to negotiate with and obtain the approval of our board of directors in connection with the transaction. Our Certificate of Incorporation also permits our board of directors to issue shares of preferred stock with such voting, conversion and other rights as it determines, without any 12 further vote or action by our stockholders. By using preferred stock, we could (1) discourage a proxy contest, (2) make the acquisition of a substantial block of our common stock more difficult or (3) limit the price investors may be willing to pay in the future for shares of our common stock. In addition, our by-laws provide that (1) special meetings of our stockholders may be called only by our board of directors and (2) only two of our six Directors may be elected at such special meetings. These provisions also could discourage bids for your shares of common stock at a premium and could have a material adverse effect on the market price of your shares. Please see "Description of Capital Stock" for more detailed information on these provisions. Risks Related to this Offering Heller Equity Capital Corporation can exercise significant influence over us. After the offering Heller Equity Capital Corporation will own approximately 21.0% of our common stock. Heller is currently entitled to designate, and has designated, two members of our board of directors. Beginning on the date of our next annual meeting of stockholders, Heller will be entitled to designate one member of our board of directors. However, we have nominated the second Heller representative to our board for re-election at our next annual meeting of stockholders. As a result, Heller can exercise considerable influence over our operations and business strategy. For more information regarding our relationship with Heller, please see "Management--Arrangements for Nomination as Director," "Principal and Selling Stockholders" and "Description of Capital Stock." Our stock price is volatile. The market price for our common stock has fluctuated significantly. Factors such as quarterly variations in our operating results, announcements of acquisitions by us or our competitors, new regulations or interpretations of regulations applicable to our schools, changes in accounting treatments or principles and changes in earnings estimates by securities analysts, as well as general political economic and market conditions, could cause the market price of our common stock to fluctuate significantly. The market price for our common stock may also be affected by our ability to meet or exceed analysts' or "street" expectations, and any failure to meet such expectations, even if minor, could have a material adverse effect on the market price of our common stock. In addition, the stock market has from time to time experienced significant price and volume fluctuations that have particularly affected the market prices of equity securities of many companies and that have often been unrelated to the operating performance of such companies. The number of shares eligible for public sale after this offering could cause our stock price to decline. The sale of a substantial number of shares of our common stock, or the perception that such sales could occur, could adversely affect prevailing market prices for our common stock. We currently have approximately 7,167,445 shares of common stock outstanding. Substantially all of these shares are eligible for immediate sale in the public market without restriction unless such shares are held by persons who are deemed to be our "affiliates" because they, directly or indirectly through one or more intermediaries, control, or are controlled by, or are under common control, with us. Upon completion of the offering, 1,719,567 shares will be held by our affiliates. 2,027,320 shares of common stock are subject to lock-up agreements between the holders of our shares and the representatives of the underwriters, pursuant to which the holders have agreed that they will not, directly or indirectly, sell or otherwise dispose of any shares of common stock, or securities or other rights convertible into or exchangeable or exercisable for any shares of common stock, for 90 days after the date of the offering without the prior written consent of Credit Suisse First Boston Corporation. Upon expiration of this period substantially all of the shares subject to the lock-up agreements will be eligible for sale under Rule 144, subject to volume and other limitations, other than the holding period requirement, of such rule. An additional 909,384 shares of common stock are issuable at various dates upon exercise of options granted to certain of our employees, officers, directors and consultants pursuant to stock option agreements. After the offering, our affiliates holding 1,562,007 shares of our common stock have been granted registration rights. We cannot predict the effect, if any, that future sales of shares, or the availability of shares for future sales, will have on the market price of the common stock prevailing from time to time or on our ability to raise capital through an offering of our equity securities. 13 USE OF PROCEEDS The net proceeds to us from the sale of the shares of common stock offered by us in this offering, after deduction of the estimated discounts, commissions and offering expenses payable by us, are estimated to be approximately $5.9 million. If the underwriters exercise in full the over-allotment option granted to them by us, the net proceeds to us from the sale of the shares of common stock offered by us in this offering, after deduction of the estimated discounts, commissions and offering expenses payable by us, are estimated to be approximately $13.3 million. We will not receive any of the proceeds from the sale of common stock by the selling stockholders. We will use our net proceeds from this offering for general corporate purposes. DIVIDEND POLICY We have never paid a cash dividend on our common stock. We do not anticipate paying any cash dividends on our common stock in the foreseeable future and we plan to retain our earnings to finance future growth. The declaration and payment of dividends on our common stock are subject to the discretion of our board of directors. Our board's decision to pay future dividends will depend on general business conditions, the effect on our financial condition and other factors our board may consider to be relevant. Our ability to pay dividends on our common stock is limited if we are not in compliance with the terms of our credit agreement or we fail to meet a specified leverage ratio. PRICE RANGE OF COMMON STOCK The following table sets forth the range of high and low sales prices per share for our common stock as reported on The Nasdaq National Market, where the stock trades under the symbol " CECO," for the periods indicated. The initial public offering price of our common stock on January 28, 1998 was $16.00 per share.
Price Range of Common Stock ------------- High Low ------ ------ 1998: First Quarter (from January 28, 1998).......................... $22.12 $17.62 Second Quarter................................................. 27.50 21.50 Third Quarter.................................................. 26.75 17.37 Fourth Quarter................................................. 30.00 14.12 1999: First Quarter (through February 26, 1999)...................... $30.62 $28.00
On February 26, 1999, the last sale price of the common stock as reported on The Nasdaq National Market was $28.12 per share. As of February 25, 1999, there were 27 holders of record of the common stock. 14 CAPITALIZATION The following table sets forth our cash and capitalization consisting of long-term debt plus stockholders' investment: (1) as of December 31, 1998 and (2) as adjusted to reflect the proceeds from our sale of 250,000 shares of common stock in this offering, net of estimated underwriting discounts and commissions and offering expenses. We will not receive any of the proceeds of the sale of common stock by the selling stockholders. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our financial statements and the related notes thereto included elsewhere in this prospectus.
December 31, 1998 -------------------------- Actual As Adjusted ----------- ------------- (Dollars in thousands) Cash................................................ $ 23,548 $ 23,548 =========== =========== Long-term debt...................................... $ 22,617 $ 16,722 Stockholders' investment: Common stock, $.01 par value, 50,000,000 shares authorized; 7,152,896 shares issued and outstanding (1)...... 72 74 Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued and outstanding.................................. -- -- Additional paid-in capital........................ 95,481 101,374 Foreign currency translation...................... (822) (822) Accumulated deficit............................... (10,095) (10,095) ----------- ----------- Total stockholders' investment.................. 84,636 90,531 ----------- ----------- Total capitalization............................ $ 107,253 $ 107,253 =========== ===========
- -------- (1) Does not include (a) 909,384 shares of common stock issuable upon the exercise of outstanding options at a weighted average exercise price of $16.38 per share and (b) 187,774 shares of common stock reserved for issuance under our stock plans. See "Management--Stock Plans," "Description of Capital Stock" and Notes 10 and 15 of the Notes to our Consolidated Financial Statements. 15 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA The unaudited pro forma condensed consolidated statement of operations of Career Education Corporation for the year ended December 31, 1998 gives effect to (1) the acquisition of Scottsdale Culinary, (2) events occurring at the time of our initial public offering of common stock, including the use of proceeds to retire indebtedness and (3) our sale of 250,000 shares of common stock in this offering, as if they had occurred at the beginning of the year. The historical results of operations of Scottsdale Culinary are for the period from January 1, 1998 to the date of acquisition, July 31, 1998. The unaudited pro forma condensed consolidated statement of operations for the year ended December 31, 1998 was prepared from the audited historical statement of operations of Career Education Corporation for the year ended December 31, 1998 and the unaudited statement of operations of Scottsdale Culinary for the seven months ended July 31, 1998, the date of acquisition. The unaudited pro forma condensed consolidated balance sheet gives effect to our sale of 250,000 shares of common stock in this offering and the application of the estimated net proceeds therefrom to retire outstanding indebtedness. All unaudited pro forma condensed consolidated financial data includes all adjustments necessary (consisting only of normal recurring entries) for a fair presentation thereof and, in the opinion of management, have been prepared on the same basis as the audited financial statements. The unaudited pro forma financial data are a presentation of historical results with accounting and other adjustments. The unaudited pro forma financial data do not reflect the effects of any anticipated changes to be made by us to the historical operations, are presented for informational purposes only and should not be construed to be indicating (1) the results of our operations or financial position that actually would have occurred had the acquisitions and the initial public offering been consummated as of the date indicated or (2) the results of our operations or our financial position in the future. The unaudited pro forma condensed consolidated financial data reflect the Scottsdale Culinary acquisition using the purchase method of accounting. The acquired assets and assumed liabilities of Scottsdale Culinary are stated at values representing an allocation of the purchase price based upon the estimated fair market value at the date of the acquisition. The following unaudited pro forma condensed consolidated financial statements and accompanying notes are qualified in their entirety by reference to, and should be read in conjunction with, "Management's Discussion and Analysis of Financial Condition and Results of Operations," the financial statements and notes thereto of Career Education Corporation and Scottsdale Culinary and the other historical financial information included elsewhere in this prospectus. 16 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS For the Year Ended December 31, 1998 (In thousands, except per share amounts)
Historical ----------------------------- Scottsdale (preacquisition, January 1, 1998 through Pro Forma Offering Pro Forma CEC July 31, 1998) Adjustments Pro Forma Adjustments As Adjusted -------- ---------------- ----------- --------- ----------- ----------- Revenue: Tuition and registration fees, net.................. $132,926 $ 2,532 $ -- $135,458 $-- $135,458 Other, net............ 11,306 472 -- 11,778 -- 11,778 -------- ------- ------- -------- ---- -------- Total net revenue... 144,232 3,004 -- 147,236 -- 147,236 Operating Expenses: Educational services and facilities....... 57,151 1,445 -- 58,596 -- 58,596 General and administrative....... 63,856 821 -- 64,677 -- 64,677 Depreciation and amortization......... 12,163 54 140 (1) 12,357 -- 12,357 Compensation expense related to the initial public offering............. 1,961 -- -- 1,961 -- 1,961 -------- ------- ------- -------- ---- -------- Total operating expenses........... 135,131 2,320 140 137,591 -- 137,591 -------- ------- ------- -------- ---- -------- Income from operations.. 9,101 684 (140) 9,645 -- 9,645 Interest (expense) income, net............ (1,250) 12 (131)(2) (1,369) 531(8) (838) -------- ------- ------- -------- ---- -------- Income before provision for income taxes....... 7,851 696 (271) 8,276 531 8,807 Provision (benefit) for income taxes........... 3,350 -- 126 (3) 3,476 223(3) 3,699 -------- ------- ------- -------- ---- -------- Net Income ............. 4,501 (4) 696 (397) 4,800 308 5,108 Dividends paid or accrued on preferred stock................ (274) -- 274 (5) -- -- -- Accretion to redemption value of preferred stock and warrants......... (2,153) -- 2,055 (5) (98) -- (98) -------- ------- ------- -------- ---- -------- Net income attributable to common stockholders.... $ 2,074 (4) $ 696 $ 1,932 $ 4,702 $308 $ 5,010 ======== ======= ======= ======== ==== ======== Net income per share attributable to common stockholders: Basic................. $ 0.32 $ 0.66 $ 0.69 ======== ======== ======== Diluted............... $ 0.30 $ 0.64 $ 0.67 ======== ======== ======== Weighted average number of shares outstanding: Basic................. 6,521 567 (6) 7,088 210(9) 7,298 ======== ======= ======== ==== ======== Diluted............... 6,797 507 (6)(7) 7,304 210(9) 7,514 ======== ======= ======== ==== ========
17 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET As of December 31, 1998 (In thousands)
Offering Pro Assets Historical Adjustments Forma ------ ---------- ----------- -------- Current assets............................... $ 40,928 $ -- $ 40,928 Property and equipment, net.................. 46,403 -- 46,403 Other assets: Intangibles, net........................... 42,645 -- 42,645 Other noncurrent assets.................... 2,911 -- 2,911 -------- ------- -------- Total other assets......................... 45,556 -- 45,556 -------- ------- -------- Total assets................................. $132,887 $ -- $132,887 ======== ======= ======== Liabilities and Stockholders' Investment ---------------------------------------- Current liabilities.......................... $ 24,934 $ -- $ 24,934 Long-term debt, net.......................... 22,300 (5,895)(8) 16,405 Other long term liabilities.................. 1,017 -- 1,017 -------- ------- -------- Total liabilities.......................... 48,251 (5,895) 42,356 Stockholders' investment..................... 84,636 5,895 (8) 90,531 -------- ------- -------- Total liabilities and stockholders' investment................................ $132,887 $ -- $132,887 ======== ======= ========
18 NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA The following notes identify the pro forma adjustments made to the historical amounts in the unaudited pro forma condensed consolidated financial data: (1) Depreciation of property and equipment, based on appraised values and estimated useful lives, which range from five to 31 years, in excess of the historical amounts, which was only recorded from the date of the acquisitions to the end of each period, is recorded as an adjustment. The adjustment also gives effect to the amortization of goodwill and covenants not-to-compete. Intangible assets recorded in conjunction with the acquisition of Scottsdale Culinary relate to goodwill of approximately $7.9 million. Goodwill is amortized on a straight-line basis over its estimated useful life of 40 years. Amortization expense, reflecting the amortization of goodwill for the entire year presented in excess of historical amounts, has been recorded as an adjustment. (2) Reflects (a) additional interest expense at an imputed average interest rate of 9% of approximately $0.5 million associated with debt incurred to finance the Scottsdale Culinary acquisition and (b) a reduction of interest expense of approximately $0.3 million associated with proceeds from our initial public offering used to repay outstanding indebtedness, at an assumed weighted average interest rate of 9.0%. (3) Reflects an adjustment to record a provision for federal and state income taxes at an effective income tax rate of 42%. (4) Excludes the cumulative effect of change in accounting principle of $205, which is net of a $149 tax benefit. (5) Shares of redeemable preferred stock, including accrued paid-in-kind dividends, were converted into common stock and substantially all warrants were exercised in connection with our initial public offering. Accrued dividends and any accretion to redemption value related to those shares of preferred stock and warrants, assumed to have been issued at the beginning of each period presented to consummate the acquisition, have been added back to net income attributable to common stockholders to derive pro forma income attributable to common stockholders. Therefore, such amounts are eliminated. (6) Represents an adjustment of (a) approximately 275,000 shares of common stock assumed to have been issued in our initial public offering to repay indebtedness and (b) approximately 292,000 additional shares of common stock related to the conversion of preferred stock and exercise of warrants which occurred in connection with our initial public offering as if both events occurred at the beginning of the year. (7) Includes an adjustment for common stock equivalents of 216,000 shares. (8) Net proceeds from the offering, estimated to be $5.9 million, net of fees and expenses, are assumed to repay outstanding indebtedness which existed during 1998. Accordingly, debt assumed to be repaid with proceeds from the offering and related interest expense of $0.5 million have been eliminated. (9) Represents an adjustment of common stock assumed to have been issued in this offering to repay indebtedness. 19 SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OTHER DATA The following selected historical consolidated financial and other data are qualified by reference to, and should be read in conjunction with, our consolidated financial statements and the related notes thereto appearing elsewhere in this prospectus and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The selected statement of operations data set forth below for the years ended December 31, 1996, 1997 and 1998 and the balance sheet data as of December 31, 1997 and 1998 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The statement of operations data for the years ended December 31, 1994 and 1995 and the balance sheet data as of December 31, 1994, 1995 and 1996 are derived from audited financial statements which are not included in this prospectus.
Year Ended December 31, ----------------------------------------------- 1994(1) 1995 1996 1997 1998 ------- -------- -------- -------- -------- (Dollars in thousands) Statement of Operations Data: Revenue: Tuition and registration fees, net............... $ 5,794 $ 16,330 $ 29,269 $ 74,842 $132,926 Other, net............... 1,692 3,066 4,311 7,756 11,306 ------- -------- -------- -------- -------- Total net revenue....... 7,486 19,396 33,580 82,598 144,232 Operating Expenses: Educational services and facilities.............. 3,074 8,565 14,404 34,620 57,151 General and administrative.......... 4,887 9,097 14,622 37,542 63,856 Depreciation and amortization............ 980 1,330 2,134 8,121 12,163 Compensation expense related to the initial public offering......... -- -- -- -- 1,961 ------- -------- -------- -------- -------- Total operating expenses.............. 8,941 18,992 31,160 80,283 135,131 ------- -------- -------- -------- -------- Income (loss) from operations............... (1,455) 404 2,420 2,315 9,101 Interest expense.......... 134 311 717 3,108 1,250 ------- -------- -------- -------- -------- Income (loss) before provision for taxes, extraordinary item and cumulative effect of change in accounting principle................ (1,589) 93 1,703 (793) 7,851 Provision (benefit) for income taxes............. -- 24 208 (331) 3,350 ------- -------- -------- -------- -------- Income (loss) before extraordinary item and cumulative effect of change in accounting principle................ (1,589) 69 1,495 (462) 4,501 Extraordinary loss on early extinguishment of debt (net of taxes of $233).................... -- -- -- (418) -- ------- -------- -------- -------- -------- Income (loss) before cumulative effect of change in accounting principle................ (1,589) 69 1,495 (880) 4,501 Cumulative effect of change in accounting principle (net of taxes of $149)................. -- -- -- -- (205) ------- -------- -------- -------- -------- Net income (loss)......... $(1,589) $ 69 $ 1,495 $ (880) $ 4,296 ======= ======== ======== ======== ======== Income (loss) attributable to common stockholders: Income (loss) before extraordinary item and cumulative effect of change in accounting principle............... $(1,589) $ 69 $ 1,495 $ (462) $ 4,501 Dividends on preferred stock (2)............... (393) (777) (1,128) (2,159) (274) Accretion to redemption value of preferred stock and warrants (3)........ -- (96) (230) (6,268) (2,153) ------- -------- -------- -------- -------- Income (loss) before extraordinary item and cumulative effect of change in accounting principle, attributable to common stockholders... (1,982) (804) 137 (8,889) 2,074 Extraordinary loss, net... -- -- -- (418) -- Cumulative effect of change in accounting principle, net........... -- -- -- -- (205) ------- -------- -------- -------- -------- Net income (loss) attributable to common stockholders............. $(1,982) $ (804) $ 137 $ (9,307) $ 1,869 ======= ======== ======== ======== ======== Net income (loss) per share attributable to common stockholders: Basic.................... $ (1.06) $ 0.18 $ (12.12) $ 0.29 ======== ======== ======== ======== Diluted.................. $ (1.06) $ 0.13 $ (12.12) $ 0.27 ======== ======== ======== ========
20
Year Ended December 31, ------------------------------------------ 1994(1) 1995 1996 1997 1998 ------- ------ ------ ------- ------- (Dollars in thousands) Other Data: EBITDA (4).................... $ (475) $1,734 $4,554 $10,436 $21,264 EBITDA margin (4)............. (6.3)% 8.9% 13.6% 12.6% 14.7% Cash flow provided by (used in): Operating activities......... (1,000) 235 5,275 (194) 22,227 Investing activities......... (2,372) (3,478) (9,518) (45,214) (12,356) Financing activities......... 6,014 4,566 8,076 56,659 (4,897) Capital expenditures, net..... 153 897 1,231 3,822 6,383 Student population (5)........ 1,131 3,347 4,537 10,889 15,900 Number of campuses (6)........ 2 4 5 18 20
December 31, --------------------------------------------- 1994 1995 1996 1997 1998 ------- ------- ------- -------- -------- (Dollars in thousands) Balance Sheet Data: Cash and cash equivalents........ $ 2,642 $ 3,965 $ 7,798 $ 18,906 $ 23,548 Working capital.................. 578 1,314 1,379 13,806 15,994 Total assets..................... 11,704 23,584 36,208 117,617 132,887 Long-term debt................... 2,313 8,034 16,459 64,035 22,617 Redeemable preferred stock and warrants........................ 8,243 13,628 14,561 40,160 -- Total stockholders' investment... (1,982) (2,756) (2,589) (7,404) 84,636
- -------- (1) Commencing January 5, 1994, the date of our incorporation. (2) Represents the dividends paid on, or added to, the redemption value of outstanding preferred stock. See Note 3 of the Notes to our Consolidated Financial Statements. (3) See Note 3 of the Notes to our Consolidated Financial Statements. (4) For any period, EBITDA equals earnings before interest expense, taxes, depreciation and amortization, including amortization of debt discount and deferred financing costs. EBITDA margin equals EBITDA as a percentage of net revenue. We have included information concerning EBITDA and EBITDA margin because we believe they allow for a more complete analysis of our results of operations. EBITDA and EBITDA margin should not be considered as alternatives to, nor is there any implication that they are more meaningful than, any measure of performance or liquidity as promulgated under generally accepted accounting principles. (5) Represents the total student population at our schools as of October 31. (6) Represents the total number of campuses operated by us as of the end of the period. 21 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion together with the financial statements and related notes included elsewhere in this prospectus. The results discussed below are not necessarily indicative of the results to be expected in any future periods. This discussion contains forward-looking statements. See "Special Note Regarding Forward-Looking Statements." Background and Overview We are one of the largest providers of private, for-profit postsecondary education in North America, with approximately 15,900 students enrolled as of October 31, 1998. We operate 12 schools, with 21 campuses located in 13 states and two Canadian provinces. Our schools enjoy long operating histories and offer a variety of bachelor's degree, associate degree and non-degree programs in career-oriented disciplines within our core curricula of: . information technologies, . visual communication and design technologies, . business studies, and . culinary arts. We have experienced significant growth both internally and through acquisitions. Net revenue and EBITDA have increased in each of the years we have operated. Our net revenue increased to $144.2 million in 1998, from $7.5 million in 1994 and EBITDA increased to $21.3 million in 1998, from a loss of $0.5 million in 1994. We have invested significant amounts of capital in the hiring of additional personnel and increased marketing and capital improvements at each of the schools we have acquired. We have also hired additional corporate staff to support our continued growth. The increased costs of personnel and marketing are expensed as incurred and are reflected in general and administrative expenses. Additional depreciation and amortization is reflected as a result of the capital improvements. We believe that EBITDA, while not a substitute for generally accepted accounting principles' measures of operating results, is an important measure of our financial performance and that of our schools. Our management believes that EBITDA is particularly meaningful due principally to the role acquisitions have played in our development. Our rapid growth through acquisitions has resulted in significant non-cash depreciation and amortization expense, because a significant portion of the purchase price of a school acquired by us is generally allocated to fixed assets, goodwill and other intangible assets. As a result of our ongoing acquisition strategy, non-cash amortization expense may continue to be substantial. Our principal source of revenue is tuition collected from our students. The academic year is at least 30 weeks in length, but varies both by individual school and program of study. The academic year is divided by term, which is determined by start dates which vary by school and program. Payment of each term's tuition may be made by full cash payment, financial aid and/or an installment payment plan. If a student withdraws from school prior to the completion of the term, we refund the portion of tuition already paid which is attributable to the period of the term that is not completed. Revenue is recognized ratably over the period of the student's program. Our campuses charge tuition at varying amounts, depending not only on the particular school, but also upon the type of program and the specific curriculum. Each of our campuses typically implements one or more tuition increases annually. Other revenue consists of bookstore sales, placement fees, dormitory and cafeteria fees and restaurant revenue. Other revenue is recognized during the period services are rendered. Educational services and facilities expense includes costs directly attributable to the educational activity of our schools, including salaries and benefits of faculty, academic administrators and student support personnel. 22 Educational services and facilities expense also includes costs of educational supplies and facilities (including rents on school leases), certain costs of establishing and maintaining computer laboratories, costs of student housing and all other physical plant and occupancy costs, with the exception of costs attributable to our corporate offices. General and administrative expense includes salaries and benefits of personnel in recruitment, admissions, accounting, personnel, compliance and corporate and school administration. Costs of promotion and development, advertising and production of marketing materials, and occupancy of the corporate offices are also included in this expense category. Depreciation and amortization includes costs associated with the depreciation of purchased computer laboratories, equipment, furniture and fixtures, courseware, owned facilities, capitalized equipment leases and amortization of intangible assets, primarily goodwill and non-competition agreements with the previous owners of our schools. Acquisitions On February 28, 1997, we acquired all of the outstanding capital stock of the School of Computer Technology for a purchase price of approximately $4.9 million. In addition, we paid approximately $1.8 million to the former owners of the School of Computer Technology pursuant to non-competition agreements. Effective May 31, 1997, we acquired all of the outstanding capital stock of Gibbs for a purchase price of approximately $19.0 million. In addition, we paid $7.0 million to the former owner of Gibbs pursuant to a non-competition agreement. On June 30, 1997, we acquired all of the outstanding capital stock of the International Academy of Merchandising & Design for an initial purchase price of $3.0 million, which amount was further increased by $4.7 million during 1998, based on the results of the International Academy of Merchandising & Design operations and the calculation of the final purchase price adjustment. In addition, we paid $2.0 million to the former owners of the International Academy of Merchandising & Design pursuant to covenants not-to-compete. Also on June 30, 1997, we acquired all of the capital stock of International Academy of Design for a purchase price of $6.5 million. In addition, we paid $2.0 million to the former owners of International Academy of Design pursuant to covenants not-to-compete. On March 13, 1998, we acquired all of the outstanding capital stock of Southern California School of Culinary Arts for a purchase price of approximately $1.0 million. On July 31, 1998, we acquired certain assets and assumed certain liabilities of Scottsdale Culinary. The purchase price was approximately $9.9 million. On January 4, 1999, we acquired all of the outstanding capital stock of Harrington for a purchase price of approximately $3.3 million, subject to adjustment. 23 Results of Operations The following table summarizes our operating results as a percentage of net revenue for the periods indicated.
Year Ended December 31, -------------------- 1996 1997 1998 ----- ----- ----- Revenue: Tuition and registration, net........................... 87.2% 90.6% 92.2% Other, net.............................................. 12.8 9.4 7.8 ----- ----- ----- Net revenue............................................ 100.0 100.0 100.0 ----- ----- ----- Operating expenses: Educational services and facilities..................... 42.9 41.9 39.6 General and administrative.............................. 43.5 45.5 44.3 Depreciation and amortization........................... 6.4 9.8 8.4 Compensation expense related to the initial public offering............................................... -- -- 1.4 ----- ----- ----- Total operating expenses............................... 92.8 97.2 93.7 ----- ----- ----- Income (loss) from operations............................ 7.2 2.8 6.3 Interest expense, net.................................... 2.1 3.8 0.9 ----- ----- ----- Income (loss) before provision for taxes, extraordinary item and cumulative effect of change in accounting principle............................................... 5.1 (1.0) 5.4 Provision (benefit) for income taxes..................... 0.6 (0.4) 2.3 ----- ----- ----- Income (loss) before extraordinary item and cumulative effect of change in accounting principle................ 4.5 (0.6) 3.1 Extraordinary loss on early extinguishment of debt, net.. -- (0.5) -- Cumulative effect of change in accounting principle, net. -- -- (0.1) ----- ----- ----- Net income (loss)........................................ 4.5 (1.1) 3.0 ===== ===== ===== Net income (loss) attributable to common stockholders.... 0.4% (11.3)% 1.3% ===== ===== =====
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997 Revenue. Net tuition revenue increased 78%, from $74.8 million in 1997 to $132.9 million in 1998, due to an approximately 20.5% increase in the average number of students attending the schools which were owned by us during 1997 and tuition increases effective in 1998 for these schools, as well as added net tuition revenue of $42.8 million for schools acquired during and after 1997. Other net revenue increased 46%, from $7.8 million in 1997 to $11.3 million in 1998, due to an increase in student population for schools owned during the 1997 period. Educational Services and Facilities Expense. Educational services and facilities expense increased 65%, from $34.6 million in 1997 to $57.2 million in 1998. Of this increase, $5.9 million was attributable to the increase in student population for schools owned during 1997 and $16.6 million was attributable to the addition of educational services and facilities for schools acquired during and after 1997. General and Administrative Expense. General and administrative expense increased 70%, from $37.5 million in 1997 to $63.9 million in 1998. The increase was primarily attributable to $11.9 million of expenses for schools acquired during and after 1997, costs totalling $3.9 million related to increased personnel at the corporate level to enhance our infrastructure, and increased advertising and marketing (including admissions) of $8.8 million for schools owned during 1997. The increase in advertising and marketing expenses reflected, in part, the fact that the former owners of the acquired schools had reduced their expenditures in these areas prior to our acquisition of the schools. Depreciation and Amortization Expense. Depreciation and amortization expense increased 50%, from $8.1 million in 1997 to $12.2 million in 1998. The increase was due to increased capital expenditures for schools 24 owned during 1997 and related increased depreciation expense of $0.3 million in 1998. Additionally, depreciation expense increased $2.2 million due to the depreciation expense for schools acquired during and after 1997. Amortization expense increased from $3.5 million in 1997 to $5.1 million in 1998, primarily due to additional amortization of non-competition agreements and goodwill for the acquisition of schools after 1997. Compensation Expense Related to the Initial Public Offering. Pursuant to amended stock option agreements with two stockholders, compensation expense totalling approximately $2.0 million was recognized upon consummation of our initial public offering in February 1998. Interest Expense. Interest expense decreased 60%, from $3.1 million in 1997 to $1.3 million in 1998. The decrease was primarily due to a reduction of indebtedness resulting from the application of the net proceeds of our initial public offering in February 1998. Provision (Benefit) for Income Taxes. The provision (benefit) for income taxes increased from a $0.3 million benefit in 1997 to a $3.4 million provision in 1998 as a result of changes in pretax income (loss). Net Income (Loss) before Extraordinary Item and Cumulative Effect of Change in Accounting Principle. Net income (loss) before extraordinary item and cumulative effect of change in accounting principle increased to a net income of $4.5 million in 1998 from a net loss of $0.5 million in 1997. Extraordinary Item. During 1997, we recorded an extraordinary expense of $0.4 million, net of tax, due to the early retirement of debt related to a credit facility which was terminated and replaced by our current credit facility. Cumulative Effect of Change in Accounting Principle. During 1998, we adopted Statement of Position 98-5, "Reporting on the Costs of Start-up Activities." In connection therewith, we recorded a charge of $0.2 million, net of tax. Net Income (Loss). Net income (loss) increased to a net income of $4.3 million in 1998 from a net loss of $0.9 million in 1997, due to the factors noted above. Net Income (Loss) Attributable to Common Stockholders. Net income (loss) attributable to common stockholders increased from a loss of $9.3 million in 1997 to net income of $1.9 million in 1998. The primary reason for this increase was due to the increase in net income (loss) discussed above and decreases in dividends on preferred stock and accretion to redemption value of preferred stock and warrants in connection with our initial public offering. Year Ended December 31, 1997 Compared to Year Ended December 31, 1996 Revenue. Net tuition revenue increased 156% from $29.3 million in 1996 to $74.8 million in 1997, due to an approximately 18% increase in the average number of students attending the schools which were owned by us during 1996 and tuition increases effective in 1997 for these schools, as well as added net tuition revenue of $34.2 million for schools acquired after 1996. Other net revenue increased 80%, from $4.3 million in 1996 to $7.8 million in 1997, due to an increase in student population for schools owned during 1996 and the addition of $2.0 million from schools acquired after 1996. Educational Services and Facilities Expense. Educational services and facilities expense increased 140%, from $14.4 million in 1996 to $34.6 million in 1997. Of this increase, $5.2 million was attributable to the increase in student population and associated facility costs for schools owned during 1996 and $15.0 million was attributable to the addition of educational services and facilities for schools acquired after 1996. General and Administrative Expense. General and administrative expense increased 157%, from $14.6 million in 1996 to $37.5 million in 1997. The increase was primarily attributable to costs totalling $1.1 million related to increased personnel at the corporate level to enhance our infrastructure and increased advertising and 25 marketing, including admissions, of $1.9 million for schools owned during 1996, as well as the addition of $17.9 million of expenses for schools acquired after 1996. The increase in advertising and marketing expenses reflected, in part, the fact that the former owners of the acquired schools had reduced their expenditures in these areas prior to their acquisition by us. Depreciation and Amortization Expense. Depreciation and amortization expense increased 281%, from $2.1 million in 1996 to $8.1 million in 1997. The increase was due to increased capital expenditures for schools owned during 1996 and related increased depreciation expense of $0.2 million in 1997. Additionally, depreciation expense increased $2.3 million due to the depreciation expense for schools acquired after 1996. Amortization expense increased from an immaterial amount in 1996 to $3.5 million in 1997, primarily due to additional amortization of non-competition agreements for the acquisition of schools after 1996. Interest Expense. Interest expense increased 333% from $0.7 million in 1996 to $3.1 million in 1997. The increase was primarily due to interest expense on borrowings used to finance the acquisition of schools after 1996. Provision (Benefit) for Income Taxes. The benefit for income taxes increased from a provision in 1996 of $0.2 million to a benefit of $0.3 benefit in 1997. Income (Loss) before Extraordinary Item. Net income (loss) before extraordinary item decreased to a net loss of $0.5 million in 1997 from net income before extraordinary item of $1.5 million in 1996, due to the factors noted above. Extraordinary Item. During 1997, we recorded an extraordinary expense of $0.4 million, net of tax, due to the early retirement of debt related to a credit facility which was terminated and replaced by our current credit facility. Net Income (Loss). Net income (loss) decreased to a net loss of $0.9 million in 1997 from net income of $1.5 million in 1996, due to the factors noted above. Net Income (Loss) Attributable to Common Stockholders. Net income attributable to common stockholders decreased from $0.1 million in 1996 to a loss of $9.3 million in 1997. The primary reasons for this decrease were the extraordinary item referred to above; increased dividends on preferred stock, primarily due to the issuance of additional shares; and increased accretion in the redemption value of preferred stock and warrants as a result of our growth. All outstanding preferred stock converted into common stock and all outstanding warrants were exercised prior to the consummation of our initial public offering. Seasonality Our results of operations fluctuate primarily as a result of changes in the level of student enrollment at our schools. Our schools experience a seasonal increase in new enrollments in the fall, traditionally when the largest numbers of new high school graduates begin postsecondary education. Furthermore, although we encourage year-round attendance at all schools, some schools have summer breaks for some of their programs. As a result of these factors, total student enrollment and net revenue are typically highest in the fourth quarter, which is October through December, and lowest in the second quarter, which is April through June, of our fiscal year. Our costs and expenses do not, however, fluctuate as significantly on a quarterly basis. We anticipate that these seasonal trends will continue. Liquidity and Capital Resources On February 4, 1998, we sold 3,277,500 of our shares of common stock at $16.00 per share pursuant to our initial public offering. We used net proceeds from that offering totalling $45.6 million to repay borrowings of $41.5 million under our former credit facility and amounts owed to former owners of acquired businesses of 26 $4.1 million which were outstanding at that time. Prior to that offering, we financed our operating activities through cash generated from operations, and we financed acquisitions through a combination of additional equity investments and credit facilities. Net cash provided by operating activities increased to $22.2 million in 1998 from net cash used of $0.2 million in 1997, due primarily to increases in net income and depreciation and amortization and the result of the non-cash compensation expense related to options. Capital expenditures increased to $6.4 million in 1998 from $3.8 million in 1997. These increases were primarily due to investments in capital equipment as a result of increasing student population. We expect capital expenditures to continue to increase as new schools are acquired, student population increases and current facilities and equipment are upgraded and expanded. Our net receivables as a percentage of net revenue decreased to 9% in 1998 from 15% in 1997. This change was primarily due to increased revenues at schools acquired during 1997. Based upon past experience and judgment, we establish an allowance for doubtful accounts with respect to tuition receivables. When a student withdraws, the receivable balance attributable to such student is charged to this allowance for doubtful accounts. Our historical bad debt expense as a percentage of revenue for the years ended December 31, 1996, 1997 and 1998 has ranged from 1.8% to 3.6%. In October 1998, we refinanced our credit agreement. We can borrow up to $60 million under a revolving credit facility ($10 million of which may be drawn in Canadian Dollars), such amount is reduced by outstanding letters of credit. We can obtain up to $35 million in letters of credit. The credit agreement matures on October 26, 2003. Our borrowings under the credit agreement bear interest, payable quarterly, at either (1) the bank's base or prime rate depending on whether the particular loan is denominated in U.S. or Canadian dollars, plus a specified number of basis points, ranging from 0 to 75, based upon our leverage ratio or (2) LIBOR, plus a specified number of basis points, ranging from 75 to 200 based upon our leverage ratio. Under the credit agreement, we are required, among other things, to maintain (1) financial ratios with respect to debt to EBITDA and interest coverage and (2) a specified level of net worth. We are also subject to limitations on, among other things, payment of dividends, disposition of assets and incurrence of additional indebtedness. We are required to pledge the stock of our subsidiaries as collateral for the repayment of our obligations under the credit agreement. At December 31, 1998, we had approximately $28.9 million of outstanding letters of credit and $11.3 million of outstanding borrowings under our credit facility. As a result, at December 31, 1998, our remaining credit availability under the credit agreement was approximately $19.8 million. We are currently in the process of amending the credit agreement to increase the credit facility from $60 million to $90 million. We cannot assure you that the credit facility will be increased. Market Risk We are exposed to the impact of interest rate changes, foreign currency fluctuations and changes in the market value of our investments. We have not entered into interest rate caps or collars or other hedging instruments. Our exposure to changes in interest rates is limited to borrowings under revolving credit agreements, which have variable interest rates tied to the prime and LIBOR rates. The weighted average annual interest rate of these credit agreements and bank note payables was 8.25% at December 31, 1998. In addition, we had debt with fixed annual rates of interest of 7.0% totaling $10.8 million at December 31, 1998. We estimate that the fair value of each of our debt instruments approximated its market value at December 31, 1998. We are subject to fluctuations in the value of the Canadian dollar vis-a-vis the U.S. dollar. Our investment in our Canadian operations is not significant and the fair value of the assets and liabilities of these operations at December 31, 1998 approximated their fair value. 27 Year 2000 Compliance The Year 2000 Problem. Many IT hardware and software systems and non-IT systems containing embedded technology, such as microcontrollers and microchip processors, can only process dates with six digits (for example, 03/17/98), instead of eight digits (for example, 03/17/1998). This limitation may cause IT systems and non-IT systems to experience problems processing information with dates after December 31, 1999 (for example, 01/01/00 could be processed as 01/01/2000 or 01/01/1900) or with other dates, such as September 9, 1999, which was a date traditionally used as a default date by computer programmers. These problems may cause IT systems and non-IT systems to suffer miscalculations, malfunctions or disruptions. These problems are commonly referred to as "Year 2000" problems. In late 1997, we began our audit, testing and remediation project to assess our exposure to Year 2000 problems both because of our own IT systems and non-IT systems and because of the systems of our significant vendors, including those who process and disburse student financial aid for us. The discussion below details our efforts to ensure Year 2000 compliance. Our State of Readiness. Through our audit, test and remediation project, we have identified and evaluated the readiness of our IT systems and non-IT systems, which, if not Year 2000 compliant, could have a material adverse effect on us. We held planning strategy sessions in the first quarter of 1998 and conducted our Year 2000 audits, upgrade assessments and budget alignments during the remainder of 1998. Our evaluation indicated that our administrative IT systems are Year 2000 compliant, but identified the following areas of concern: . our accounting and financial reporting system, . our student database system, . the systems of third party vendors which process student financial aid applications and loans for us, . the Department of Education's systems for processing and disbursing student financial aid and . financial institutions which provide loans to our students. Based on our assessment and vendors' representations, we believe that the financial and accounting systems, including those necessary for financial aid, of our significant third party vendors will be Year 2000 compliant by mid-year 1999. We believe that the material non-IT systems that we control are Year 2000 compliant and have begun the process of surveying our landlords, utility providers and other providers of non-IT systems to confirm that such systems are compliant. We expect to complete this process in the second quarter of 1999. We also expect that all of our Year 2000 testing will be completed by the second quarter of 1999. The Risks Associated with Our Year 2000 Issues. Although we are unable at this time to quantify with certainty our internal costs resulting from our Year 2000 problems, we do not believe that the cost of remediating our internal Year 2000 problems or the lost opportunity costs arising from any necessary diversion of our personnel to Year 2000 problems will have a material adverse effect on our business, results of operations or financial condition. We estimate that the cost of replacing non-compliant servers and desktop computers to be approximately $200,000. Alternatively, we estimate that the cost of upgrading such servers and desktop computers to be approximately $100,000. The choice to replace or upgrade these servers and computers will be made on a case-by-case basis. We believe the greatest Year 2000 compliance risk, in terms of magnitude, is that the Department of Education may fail to complete its remediation efforts in a timely manner and federal student financial aid funding for our students could be interrupted for a period of time. During any such time, students may not be able to pay their tuition in a timely matter. Because we derive a majority of our revenue from U.S. federal student financial aid programs, such delay is likely to have a material adverse effect on our business, results of 28 operations and financial condition. Other than public comments provided by the Department of Education that contingency plans have been drafted and will be tested by March 31, 1999, we are unable to predict the likelihood of this risk occurring. According to the Department of Education, its systems should be brought into certifiable compliance by the end of March, 1999. Contingency Plans. At this time, we expect to be Year 2000 compliant and are satisfied that our significant vendors are or will be compliant. However, to avoid interruptions of our operations, we have begun developing contingency plans in the event that we experience any Year 2000 problems. With respect to IT-systems, we have distributed guidelines to each of our campuses regarding data backup practices to store the information for our critical business processes in case any of them experience Year 2000 problems. Our contingency plan with respect to the material non-IT systems that we control includes, among other things, investigating the availability and replacement cost of such non-IT systems that have Year 2000 problems, isolating such systems that are not Year 2000 compliant so that they do not affect other systems and adjusting the clocks on such non-IT systems that are not date sensitive. We do not believe that the total costs of such Year 2000 compliance activities will be material. 29 BUSINESS The discussion below contains certain forward-looking statements (as such term is defined in Section 21E of the Securities Exchange Act of 1934) that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Our actual growth, results, performance and business prospects and opportunities could differ materially from those expressed in, or implied by, any such forward-looking statements. See "Special Note Regarding Forward-Looking Statements" and "Risk Factors." Overview We are one of the largest providers of private, for-profit postsecondary education in North America, with approximately 15,900 students enrolled as of October 31, 1998. We operate 12 schools, with 21 campuses located in 13 states and two Canadian provinces. Our schools enjoy long operating histories and offer a variety of bachelor's degree, associate degree and non-degree programs in career-oriented disciplines. We have experienced significant growth both internally and through acquisitions with our net revenue increasing from $7.5 million in 1994 to $144.2 million in 1998. In addition, our net income increased to $4.3 million in 1998 from a net loss of $1.6 million in 1994. Career Education Corporation was founded in January 1994 by John M. Larson, our President and Chief Executive Officer, who has over 24 years of experience in the career-oriented education industry. We were formed to capitalize on opportunities in the large and highly fragmented postsecondary school industry. Since our inception, we have completed 12 acquisitions. We have acquired schools that we believe possess strong curricula, leading reputations and broad marketability but that have been undermanaged from a marketing and financial standpoint. We seek to apply our expertise in operations, marketing and curricula development, as well as our financial strength, to improve the performance of these schools. Our schools offer educational programs principally in the following four career-related fields of study--identified by us as areas with highly interested and motivated students, strong entry-level employment opportunities and ongoing career and salary advancement potential: . Information Technologies: These programs include PC/LAN, PC/Net, computer technical support, computer network operation, computer information management and computer programming. . Visual Communication and Design Technologies: These programs include desktop publishing, graphic design, fashion design, interior design, graphic imaging, webpage design and animation. . Business Studies: These programs include business administration and business operations. . Culinary Arts: These programs include culinary arts, culinary arts and restaurant management and pastry arts. 30 The schools acquired by us are summarized in the following table:
Year Month Principal Degree School Founded Acquired Curricula(1) Granting ------ ------- -------- ------------ -------- Al Collins Graphic Design School 1978 1/94 IT, VC Yes Tempe, AZ Brooks College 1970 6/94 VC Yes Long Beach, CA Allentown Business School 1869 7/95 B, IT, Yes Allentown, PA S, VC Brown Institute 1946 7/95 CA, E, Yes Mendota Heights, MN IT, RTB, VC Western Culinary Institute 1983 10/96 CA No Portland, OR School of Computer Technology 1967 2/97 CA, IT Yes Fairmont, WV Pittsburgh, PA The Katharine Gibbs Schools 1911 5/97 B, IT, Yes Boston, MA S, VC Melville, NY Montclair, NJ New York, NY Norwalk, CT (2) Piscataway, NJ (3) Providence, RI (3) International Academy of Merchandising & Design 1977 6/97 VC Yes Chicago, IL Tampa, FL International Academy of Design 1983 6/97 VC No Montreal, PQ Toronto, ON Southern California School of Culinary Arts 1994 3/98 CA No South Pasadena, CA Scottsdale Culinary Institute 1986 7/98 CA Yes Scottsdale, AZ Harrington Institute of Interior Design 1931 1/99 VC Yes Chicago, IL
- -------- (1) The programs offered by our schools include business ("B"), culinary arts ("CA"), electronics ("E"), information technologies ("IT"), radio and television broadcasting ("RTB"), secretarial studies ("S") and visual communication and design technologies ("VC"). (2) The Gibbs campus in Norwalk, Connecticut is now using the name Gibbs College. (3) Does not offer degree programs. 31 Industry Background Based on estimates for 1996 by the Department of Education's National Center for Education Statistics, postsecondary education is a $225 billion industry in the U.S., with over 14 million students obtaining some form of postsecondary education. Of this total, approximately 3.2 million students are enrolled in approximately 4,500 private, degree-granting schools. Federal funds available to support postsecondary education exceed $40 billion each year and have grown steadily over the last two decades. Additionally, the federal government guaranteed over $44 billion in student loans in 1997 and is expected to guarantee loans at comparable levels in the future. State, local and private funds for career-oriented training are also available. Several national economic, demographic and social trends are converging to contribute to growing demand for career-oriented school education: Changes in Workplace Demands. The workplace is becoming increasingly knowledge-intensive. Rapid advances in technology have increased demands on employers and their employees, requiring many new workers to have some form of training or education beyond the high school level. The increasing technological skills required for entry level jobs are spurring demand for specialized training which, in many cases, is not provided by traditional two and four year colleges. The U.S. Department of Labor projects that jobs requiring some form of postsecondary training are expected to increase approximately 19% between 1996 and 2006. Furthermore, career-oriented schools generally have the ability to react quickly to the changing needs of the nation's business and industrial communities. Additionally, to meet the new workplace demands, many major companies are now using career-oriented institutions to provide customized training for their employees on a contractual basis. Small to medium-sized companies are also using proprietary career-oriented schools to fill their needs for training to maintain or increase the skill levels of their employees. Increasing Numbers of High School Graduates. Currently, U.S. high school graduates represent over 2.6 million new prospective postsecondary students each year, the largest pool of potential enrollees. Over the 18 years prior to 1993, the number of high school graduates had been declining. However, this trend has changed favorably as children of the "baby boom" generation are entering their high school years. These members of the "echo boom," as it is commonly known, are expected to boost enrollment in postsecondary educational programs to as high as 15.8 million students by 2006, an increase of 11% from approximately 14.3 million in the fall of 1996. Growing Demand for Postsecondary Education. High school graduates and adults are seeking postsecondary education in increasing numbers. According to the U.S. Department of Commerce, approximately 65% of all 1996 high school graduates continued their education that same year, compared with 53% a decade earlier. The Department of Labor projects the number of jobs requiring at least an associate degree or higher to grow by more than 14% between 1996 and 2006. In addition, enrollment in postsecondary programs is expected to increase substantially as individuals seek to enhance their skills or re-train for new job requirements. In part because of the recent trend toward corporate downsizing, the National Center for Education Statistics estimates that over the next several years initial enrollments in postsecondary education institutions by working adults will increase more rapidly than initial enrollments by recent high school graduates. The number of adults enrolled in postsecondary education programs in the U.S. is estimated by the National Center for Education Statistics to reach 6.3 million by 2000, or 43% of the total number of people enrolled. Recognition of the Value of Postsecondary Education. We believe that prospective students are increasingly recognizing the income premium and other improvements in career prospects associated with a postsecondary education. On average, a person with an associate's degree earns 25% more than a high school graduate, while a person with a bachelor's degree earns 54% more than a high school graduate. Independent research studies have demonstrated that prospective students consider these benefits in making their education decisions. 32 Reduction in Public Education Funding. The reduction of federal, state or provincial and local funding of public educational institutions in recent years has forced educational institutions to cut back spending on general operations. As a result, some schools have become underfunded and overcrowded. This trend may provide an opportunity for proprietary institutions to serve, at more competitive prices, the postsecondary education needs of individuals who would have otherwise attended public schools. Decreasing Size of Military Forces. Due to defense budget cuts and the corresponding reduction in the U.S. armed forces, the U.S. military, a traditional provider of technical and career-oriented training, is able to provide fewer educational opportunities. According to the U.S. Department of Defense, the aggregate number of military personnel has declined by 32% since 1987, with the aggregate number of individuals on active duty in the military services declining from 2.2 million in 1987 to 1.5 million in 1996. This has left an educational void to be filled by other sources, including proprietary career-oriented schools. We believe that private, for-profit, career-oriented schools are uniquely positioned to take advantage of these national trends. We also believe that similar factors are creating a favorable climate for career-oriented postsecondary education in Canada and other international markets. Business and Operating Strategy We were founded based upon a business and operating strategy which we believe has enabled us to achieve significant improvements in the performance of our schools. We believe this strategy will enable us to continue to capitalize on the favorable economic, demographic and social trends which are driving demand for career-oriented education, thereby strengthening our position as a premier, professionally managed system of career-oriented postsecondary educational institutions. The key elements of our business and operating strategy are as follows: Focusing on Core Curricula. Our schools offer educational programs principally in four career-related fields of study: . information technologies, including Internet and intranet technologies, offered at 12 campuses . visual communication and design technologies, offered at 14 campuses . business studies, offered at eight campuses . culinary arts, offered at five campuses We perceive a growing demand by employers for individuals possessing skills in these particular fields. We also believe there are many entry-level positions and ongoing career and salary advancement potential for individuals who have received advanced training in these areas. We recognize that these employment opportunities have attracted highly interested and motivated students. These students include both recent high school graduates and adults seeking formal training in these fields as well as degrees, diplomas and certificates evidencing their knowledge and skills. Our experience and expertise in these attractive areas of study enable us to differentiate ourself from many of our competitors and to effectively tailor our acquisition and marketing plans. Adapting and Expanding Educational Programs. We strive to meet the changing needs of our students and the employment market. We continually refine and adapt our courses to ensure that both students and employers are satisfied with the quality and breadth of our educational programs. Through various means, including student and employer surveys and curriculum advisory boards comprised of business and community members, our schools regularly evaluate their program offerings and consider revisions to existing classes and programs, as well as the introduction of new courses and programs of study within our core curricula. We selectively duplicate programs that have been successful elsewhere in our school system. In 1998, we successfully duplicated eight programs and plan to continue this curricula transfer in the future. For example, we introduced information technology programs at Gibbs similar to those already offered at Brown and culinary arts programs at Brown like those offered at Western. Investing for Future Growth. We make substantial investments in our people, facilities, management information systems and classroom technologies to prepare our company for continued growth. We devote particular attention to attracting and retaining both corporate and school level management, and focus on employee development in order to facilitate internal promotions. We make substantial investments in facilities 33 and classroom technologies to attract, retain and prepare students for the increasing technical demands of the workplace. Additionally, we have made significant investments in our management information systems to standardize applications and processes across our schools in order to maintain effective and expedient communication between our schools and corporate management, as well as to ensure the smooth integration of newly acquired schools. Emphasizing School Management Autonomy and Accountability. We provide significant autonomy and appropriate performance-based incentives to our campus-level managers, which we believe offers important benefits for the organization. We believe these policies foster an important sense of personal responsibility for achieving campus performance objectives. We also believe our willingness to grant local autonomy provides us and our schools with a significant advantage in recruiting and retaining highly-motivated individuals with an entrepreneurial spirit. Management of each of our campuses is principally directed by a campus president and local managers, who are accountable for the campuses' operations and profitability. Business strategy, finance and consolidation accounting functions are, however, centralized at our executive offices in Hoffman Estates, Illinois. When a new school is acquired, we evaluate the capabilities of existing campus management personnel, and typically retain a significant portion, which contributes to our ability to rapidly integrate acquired schools into our system. We also determine the acquired school's needs for additional or stronger managers in key areas and, where necessary, take appropriate action by hiring new managers or assigning experienced staff to the school's campuses. Direct Response Marketing. We seek to increase school enrollment and profitability through intensive local, regional and national direct response marketing programs designed to maximize each school's market penetration. We also use the Internet to attract potential students and believe that this medium will be an increasingly important marketing tool. Because many of our schools have been significantly undermarketed prior to their acquisition, we believe that major benefits can result from carefully crafted, targeted marketing programs that leverage schools' curriculum strength and brand name recognition. After every school acquisition, we design a marketing program tailored to the particular school to highlight its strengths and to improve student lead generation and student enrollment rates. Our management uses a diversified media, direct response approach, including direct mail, Internet- based advertising, infomercials, other television-based advertising, newspaper advertising and other print media, to attract potential students. We place particular emphasis on high school recruitment because it produces a steady supply of new students. Improving Student Retention. We emphasize the retention of students, from initial enrollment to completion of their courses of study, at each of our schools. Because, as at any postsecondary educational institution, a substantial portion of our students never finish their educational programs for personal, financial or academic reasons, substantial increases in revenue and profitability can be achieved through modest improvements in student retention rates. Our costs to keep current students in school are much less than the expense of the marketing efforts associated with attracting new students; therefore, student retention efforts, if successful, are extremely beneficial to operating results. We strive to improve retention by treating students as valued customers. We consider student retention the responsibility of the entire staff of each school, from admissions to faculty and administration to career counseling services, and provide resources and support for the retention efforts developed by our local school administrators. School personnel typically employ an approach based upon establishing personal relationships with students; for example, students may receive a telephone call from a school counselor or faculty member if they miss classes. In addition, our corporate staff regularly tracks retention rates at each school and provides feedback and support to the efforts of local school administrators. Emphasizing Employment of Graduates. We believe that the high rates of employment for graduates of our schools enhance the overall reputation of the schools as well as their ability to attract new students. High placement rates also lead to low student loan default rates, which are necessary to allow our schools to continue to participate in the federal student financial aid programs. We consider student placement to be a high priority and allocate a significant amount of time and resources to placement services. Due at least in part to this 34 emphasis, 92.5% of our graduates for the 1998 academic year who were available for employment had found employment relating to their fields of study within six months of graduation. We are committed to maintaining or improving these graduate employment rates and newly acquired schools will be expected to meet similar graduate employment success standards. Growth Strategy We believe we can achieve superior long-term growth in revenue and profitability by continuing to expand existing operations and acquire additional schools in attractive North American markets. We believe we can achieve additional growth in the future by establishing new campuses and also by entering new service areas and expanding internationally. Expanding Existing Operations. We believe that our existing 21 campuses can achieve significant internal growth in enrollment, revenue and profitability. We are executing our business and operating strategy, including all of the elements described above, to accomplish this growth. We believe that expansion of operations at our existing schools, along with acquisitions of new schools, will be the primary generators of our growth in the near term. Acquiring Additional North American Schools. To date, we have grown by acquiring new schools in the U.S. and Canada and then applying our expertise in marketing and school management to increase enrollment, revenue and profitability at those schools. We expect that this process will continue to be one of the most important elements of our growth strategy. We have an active acquisition program and from time to time engage in, and are currently engaged in, evaluations of, and discussions with, possible acquisition candidates, including evaluations and discussions relating to acquisitions that may be material in size or scope. See "Prospectus Summary--Recent Developments" and "Management's Discussion and Analysis of Financial Conditions and Results of Operations--Acquisitions." We make selective acquisitions of for-profit, career-oriented schools which have capable faculty and operations staff, as well as quality educational programs, which stand to benefit from our educational focus, marketing and operating strengths. We target schools which we believe have the potential to generate superior financial performance. Generally, such schools demonstrate the following characteristics: . ""Schools of Choice"--Possessing leading reputations in career-oriented disciplines within local, regional and national markets . Success--Demonstrating the ability to attract, retain and place students, while meeting applicable federal and state regulatory criteria and accreditation standards . Marketable Curricula--Offering programs that provide students with relevant training and the skills necessary to obtain attractive jobs and advance in their selected fields . Broad Marketability--Attracting students from each of the high school, adult, foreign and contract training market segments . Attractive Facilities and Geographic Locations--Providing geographically desirable locations and modern facilities to attract and prepare students for the demands of the increasingly competitive workplace We believe that significant opportunities exist for growth through acquisition. Some opportunities result from institutions having limited resources to manage increasingly complex regulations or to fund the significant cost of developing new educational programs necessary to meet changing demands of the employment market. We believe that a substantial number of schools exhibiting the characteristics described above exist in the U.S. and Canadian markets and that such schools can be successfully integrated into our marketing and administrative structure. We believe that competition in Canada is not currently as intense as in the U.S. Few of 35 the largest U.S. operators of postsecondary career-oriented schools presently have a significant Canadian presence. We believe that, given our existing Canadian operations, we are well-positioned to take advantage of these opportunities. We analyze potential acquisition targets for their long-term profit potential, enrollment potential and long-term demographic trends, concentration of likely employers within the region, level of competition, facility costs and availability and quality of management and faculty. We carefully investigate any potential acquisition target for its history of regulatory compliance, both as an indication of future regulatory costs and compliance issues and as an indication of the school's overall condition. Significant regulatory compliance issues in the school's past will generally remove a school from our consideration as an acquisition candidate. After we have completed an acquisition, we immediately begin to apply our business strategy to boost enrollment and improve the acquired schools' profitability. We assist acquired schools in achieving their potential through a highly focused and active management role, as well as through capital contributions. We selectively commit resources to improve marketing, advertising, administration and regulatory compliance at each acquired school. Further resources may also be committed to enhance management depth. We retain acquired schools' brand names to take advantage of their established reputation in local, regional and national markets as "schools of choice." By acquiring new schools, we are also able to realize economies of scale in terms of our management information systems, accounting and audit functions, employee benefits and insurance procurement. We also benefit from the exchange of ideas among school administrators regarding faculty development, student retention programs, recruitment, curriculum, financial aid and student placement programs. Establishing New Campuses. Although, to date, we have added new campuses only through acquisitions, in the future we expect to develop, open and operate new campuses ourselves. These new campuses will most likely be established as additional locations of existing institutions, but also may be established as entirely separate, free-standing institutions. Opening new campuses would enable us to capitalize on new markets or geographic locations that exhibit strong enrollment potential and/or the potential to establish a successful operation in one of our core curricula areas. We believe that this strategy will allow us to continue to grow rapidly even if appropriate acquisition opportunities are not readily available. We have not yet developed specific plans for any new campuses, nor made any determination as to when we will first develop, open and operate a new campus. Entering New Service Areas. While we expect that our current career-oriented school operations will continue to provide the substantial majority of our revenue in the near term, we plan to develop new education-related services which we believe offer strong long-term growth potential. Among the service areas being actively considered is distance learning, which offers educational products and services through video, Internet and other distribution channels. We also plan to expand our contract training business, which provides customized training on a contract basis for business and government organizations, and which is currently a limited part of the operations of a few of our schools. Although we have not yet actively targeted the growing market for contract training services, we believe that contract training can become a much more significant part of our business. Expanding Internationally. Although all of our current operations are located in North America, we believe that trends similar to those impacting the market for career-oriented postsecondary education in the U.S. and Canada are occurring outside of North America. As a result, we believe that there may be significant international opportunities in private, for-profit postsecondary education. To take advantage of these opportunities, we may at some time in the future elect to acquire or establish operations outside North America. Student Recruitment Our schools seek to attract students with both the desire and ability to complete their academic programs. Therefore, to produce interest among potential students, each of our schools engages in a wide variety of marketing activities. 36 We believe that the reputation of our schools in local, regional and national business communities and the recommendations of satisfied former students are important factors contributing to success in recruiting new students. Each school's admissions office is charged with marketing the school's programs through a combination of admissions representatives, direct mailings and radio, Internet, television and print media advertising, in addition to providing the information needed by prospective students to assist them in making their enrollment decisions. As of December 31, 1998, our schools employed approximately 200 admissions representatives, each of whom focuses his or her efforts on the following areas: (1) out-of-area/correspondence recruiting, (2) high school recruiting or (3) in-house/local recruiting. Correspondence representatives work with students who live outside of the immediate school area to generate interest through correspondence with potential enrollees who have learned of the school through regional or national advertising. We believe we are able to significantly boost enrollment by targeting students outside of the local population. High school recruiting representatives conduct informational programs at local secondary schools and follow up with interested students outside of school, either at their homes or on our school campus. The interpersonal relationships formed with high school counselors and faculty may have significant influence over a potential student's choice of school. We believe that the relationships of our schools' representatives with the counseling departments of high schools are good and that the brand awareness and placement rates of our schools assist representatives in gaining access to counselors. In-house representatives are also available to speak with prospective students who visit campuses and to respond to calls generated through the school's advertising campaigns. Representatives interview and advise students interested in specific careers to determine the likelihood of their success in completing their educational programs. The admissions representatives are full-time, salaried employees of the schools. Regulations of the Department of Education prevent us from giving our U.S. employees incentive compensation based, directly or indirectly, upon the number of students recruited. We also engage in significant direct mail campaigns. Mailing lists are purchased from a variety of sources, and brochures are mailed regularly during the course of the year, with frequency determined by the number of school starts in a given year. We believe direct mailings offer a fast and cost- effective way to reach a targeted population. In addition, each school develops advertising for a variety of media, including radio, television and the Internet, which is run locally, regionally and sometimes nationally. While multi-media advertising is generally more appropriate for local markets, some initiatives have been successfully utilized on a national basis. We have found infomercials to be a particularly effective tool nationally because their length enables schools to convey a substantial amount of information about their students, their faculty, their facilities and, most importantly, their course offerings. We also believe that the personal flavor of the presentation typical of infomercials is well-suited to attracting potential applicants. As an additional marketing tool, all of our schools have established web sites, which can be easily accessed for information about these schools and their educational programs. Although we retain independent advertising agencies, we design and produce a portion of our direct marketing and multi-media advertising and communications in-house, through Market Direct, Inc., a wholly-owned subsidiary. While a majority of Market Direct's operations involve designing and producing advertising for us, Market Direct also provides these services to other businesses outside of the postsecondary education industry as opportunities arise. We closely monitor the effectiveness of our marketing efforts. We estimate that, in 1998, admissions representatives were responsible for attracting approximately 37% of student enrollments, direct mailings were responsible for approximately 13%, television, radio and print media advertising were responsible for approximately 37%, and the remaining approximately 13% was attributable to various other methods. Student Admissions and Retention The admissions and entrance standards of each school are designed to identify those students who are best equipped to meet the requirements of their chosen fields of study. The most important qualifications for students include a strong desire to learn, passion for their area of interest, initiative and a high likelihood of 37 successfully completing their programs. These characteristics are generally identified through personal interviews by admissions representatives. We believe that a success-oriented student body results in higher retention and placement rates, increased satisfaction on the part of students and their employers and lower student default rates on government loans. To be qualified for admission to one of our schools, each applicant must have a high school diploma or a General Education Development certificate. Many of our schools also require that applicants obtain certain minimum scores on academic assessment examinations. For 1998, approximately 39% of entering students at our campuses enrolled directly from high school. We recognize that our ability to retain students until graduation is an important indicator of our success and that modest improvements in retention rates can result in meaningful increases in school revenue and profitability. As with other postsecondary educational institutions, many of our students do not complete their programs for a variety of personal, financial or academic reasons. As a result, student retention is considered an entire school's responsibility, from admissions to faculty and administration to career counseling services. To minimize student withdrawals, faculty and staff members at each of our campuses strive to establish personal relationships with students. Each campus devotes staff resources to advising students regarding academic and financial matters, part-time employment and other matters that may affect their success. However, while there may be many contributors, each campus has one administrative employee specifically responsible for monitoring and coordinating the student retention efforts. In addition, our corporate staff regularly tracks retention rates at each campus and provides feedback and support to appropriate local campus administrators. Curriculum Development and Faculty We believe that curriculum is the single most important component of our operations, because students choose, and employers recruit from, career- oriented schools based on the type and quality of technical education offered. The curriculum development efforts of our schools are a product of their operating partnership with students and the business and industrial communities. The relationship of each of our schools with the business community plays a significant role in the development and adaptation of school curriculum. Each school has one or more program advisory boards composed of members of the local and regional business community who are engaged in businesses directly related to the educational offerings provided by the school. These boards provide valuable input to the school's education department, which allows the school to keep our programs current and provide graduates with the training and skills that these employers seek. We also endeavor to enhance and maintain the relevancy of our curricula by soliciting ideas through student and employer surveys and by requiring students in selected programs to complete an internship during their school experience. We have developed a number of techniques designed both to gain valuable industry insight for ongoing curriculum development and enhance the overall student experience. These techniques include (1) classroom discussions with industry executives, (2) part-time job placement within a student's industry of choice, and (3) classroom case studies that are based upon actual industry issues. Our schools are in continuous contact with employers through their faculty, many of whom are industry professionals. The schools hire a significant number of part-time faculty holding positions in business and industry because specialized knowledge is required to teach many of the schools' courses and to provide students with current, industry-specific training. The schedules of business and industry professionals often permit them to teach the many evening courses offered by our schools. Unlike traditional four-year colleges, instructors in our schools are not awarded tenure and are evaluated, in part, based upon student evaluations. As of December 31, 1998, our schools employed approximately 1,460 faculty and staff members, of which approximately 32% were full-time employees and approximately 68% had been hired on a part-time, adjunct basis. School Administration We provide significant operational autonomy and appropriate performance- based compensation to local school administrators who have demonstrated the ability to undertake such responsibility, based on our belief 38 that success is driven by performance at the local level through enrollment growth, student retention rates and placement rates. In addition, each of our schools requires, to a certain extent, different resources and operating tactics due to a variety of factors, including curriculum, demographics, geographic location and size. Management of each of our schools is principally in the hands of a school president who has accountability for the school's operations and profitability. Each of our schools has five primary operating departments: admissions, financial aid, education, placement and accounting. Business strategy, finance and consolidation accounting functions are centralized at our corporate headquarters. Our corporate staff develops long- term and short-term operating strategies for the schools and works closely with local administrators to accomplish their goals and ensure adherence to our strategy. We maintain stringent quality standards and controls at both the corporate and individual school levels. Activities at the corporate level include regular reporting processes which track the vital statistics of each school's operations, including leads, enrollments, retention rates, placements, and financial data. These reports provide real-time data which allow management to monitor the performance of each campus. Each operating department at the campus level is also required to compile quantitative reports at regular intervals, including reports on admissions, financial aid, academic performance and placement. We use a number of quality and financial controls. Information is tracked through an advanced, PC-based management information system, which currently runs on a decentralized basis, but also allows centralized access to account information. Tuition and Fees Currently, total tuition for completion of a diploma/certificate program offered by our schools, assuming full time attendance, ranges from $5,400 to $23,000, for completion of an associate degree program ranges from $13,000 to $23,000, and for completion of a bachelor's degree program ranges from $32,000 to $49,500. In addition to these tuition amounts, students at our schools typically must purchase textbooks and supplies as part of their educational programs. Our institutions bill students for their tuition and other institutional charges based on the specific instructional format or formats of the school's educational programs. Each institution's refund policies must meet the requirements of the Department of Education and such institution's state and accrediting agencies. Generally, under the Department of Education's requirements, if a first-time student ceases attendance before the point in time that is 60% of the period of enrollment for which the student has been charged, the institution will refund institutional charges based on the amount of time for which the student was charged but did not attend. After a student has attended 60% or more of such period of enrollment, the institution will retain 100% of the institutional charges for that period of enrollment. After the student's first enrollment period, the institution refunds institutional charges for subsequent periods of enrollment based on the number of weeks remaining in the period of enrollment in which the student withdrew. In certain circumstances, institutions must apply state refund requirements when determining refunds for students. Graduate Employment We believe that employment of graduates of our schools in occupations related to their fields of studies is critical to the reputation of the schools and their ability to continue to recruit students successfully. We believe that our schools' most successful form of recruiting is through referrals from satisfied graduates. A strong placement office is important to maintain and elevate the school's reputation, as well as managing the rate at which former students default on their loans. We devote a significant amount of time and resources to student placement, which we believe to be the ultimate indicator of our success. We believe that our average placement rate is attractive to prospective students. Student placement is a top priority of each of our schools beginning on the first day of student enrollment. This approach heightens the students' awareness of the placement department and keeps students 39 focused on their goal--job placement within their field of choice. Moreover, each of our schools includes career development instruction in our curricula, which includes the preparation of resumes, cover letters, networking and other essential job-search tools. Placement office resources are regularly available to our graduates. With such assistance, our graduates find employment with a wide variety of businesses located not only in the schools' local markets but also regionally and nationally. Each campus' placement department also plays a role in marketing the campus' curriculum to the business community to produce job leads for graduates. As of December 31, 1998, approximately 65 employees worked in the placement departments of our campuses. Placement counselors participate in professional organizations, advisory boards, trade shows and community events to keep apprised of industry trends and maintain relationships with key employers. Partnerships with local and regional businesses are established through internships and curriculum development programs and facilitate placement of graduates in local and regional businesses. The placement department also assists current students in finding part-time jobs while attending school. These part-time placements often lead to permanent positions. Based on survey information received from graduating students and employers, we believe that of the 6,615 students graduating from our schools during the 1998 academic year, 92.5% of the 6,088 available graduates, which excludes students who are continuing their education, are in active military service or are disabled or deceased, as well as students from foreign countries who are legally ineligible to work in the U.S., obtained employment in fields related to their program of study within six months following their graduation. The reputation of Gibbs allows it to charge fees to employers upon placement of many of its students. Our other schools do not currently receive such placement fees, nor, we believe, do any of our principal proprietary competitors. We believe that, as an additional source of revenue, we may be able to replicate the Gibbs' placement fee program at some of our other schools. Technology We are committed to providing our students access to the technology necessary for developing skills required to succeed in the careers for which they are training. Through regular consultation with business representatives, we ensure that all our schools provide their students with industry-current computer hardware, computer software and equipment meeting industry-specific technical standards. In each program, students use the types of equipment that they will eventually use in their careers of choice. For example, graphic animation students use sophisticated computer multimedia animation and digital video editing equipment and supplies, and visual communication and design technologies students make significant use of technologies for computer-related design and layout and digital pre-press applications. Employees As of December 31, 1998, Career Education Corporation and our schools had a total of approximately 1,200 full-time and 985 part-time employees. Neither Career Education Corporation nor any of our schools has any collective bargaining agreements with our employees. We consider our relations with our employees to be good. Competition The postsecondary education market is highly fragmented and competitive, with no single institution having a significant market share. Our schools compete with traditional public and private two-year and four-year colleges and universities, other proprietary schools and alternatives to higher education such as immediate employment and military service. Private and public colleges and universities may offer courses of study similar to those of our schools. Some public institutions are able to charge lower tuition than our schools due in part to government subsidies, government and foundation grants, tax- deductible contributions and other financial sources not available to proprietary schools. However, tuition at private, non-profit institutions is, on 40 average, higher than the average tuition rates of our schools. Other proprietary career-oriented schools also offer programs that compete with those of our schools. We believe that our schools compete with other educational institutions principally based upon quality of their educational programs, reputation in the business community, costs of programs and graduates' ability to find employment. Some of our competitors in both the public and private sectors may have substantially greater financial and other resources than us. Changes in the regulatory environment have stimulated consolidation in the postsecondary education industry. Regulations adopted in recent years have tightened standards for educational content, established strict standards for student loan default rates, required intensified scrutiny by state education agencies and accrediting agencies and created more stringent standards for the evaluation of an institution's financial responsibility and administrative capability. As a result, career-oriented schools have been forced to close because they lacked sufficient quality or financial resources or could not manage the increased regulatory burden. At the same time, despite increasing demand, potential new entrants face significant barriers to entry due to the highly regulated nature of the industry and the considerable expense of start- up operations. Facilities Our corporate headquarters are located in Hoffman Estates, Illinois, near Chicago, and our 21 campuses are located in 13 states and two Canadian provinces. Each campus contains teaching facilities, including modern classrooms, laboratories and, in the case of the schools with culinary arts programs, large, well-equipped kitchens. Admissions and administrative offices are also located at each campus. Additionally, Brooks' campus includes a dormitory and student cafeteria, and Western and Scottsdale Culinary lease and operate restaurants in conjunction with their culinary arts program. We lease all of our facilities, except the primary Gibbs facility in Montclair, New Jersey, which we own. As of December 31, 1998, we owned approximately 19,000 square feet and leased approximately 809,000 square feet. The leases have remaining terms ranging from less than one year to eleven years. We actively monitor facility capacity in light of our current utilization and projected enrollment growth. We have plans to lease at least 90,000 additional square feet in 1999 to accommodate our growth. We believe that our schools can acquire any necessary additional capacity on reasonably acceptable terms. We devote capital resources to facility improvements and expansions as necessary. Legal Proceedings We and our institutions are subject to occasional lawsuits, investigations and claims arising out of the ordinary conduct of our business, including the following: On February 24, 1997, 30 former and current students in Brown's PC/LAN program brought a suit entitled Peter Alsides, et al. v. Brown Institute, Ltd. in the Fourth Judicial District in Hennepin County, Minnesota against Brown alleging breach of contract, fraud, misrepresentation, violation of the Minnesota Consumer Fraud Act, violation of the Minnesota Deceptive Trade Practices Act and negligent misrepresentation. Plaintiffs allege that Brown failed to provide them with the education for which they contracted and which had been represented to them upon enrollment. There are currently 41 plaintiffs, who are seeking to recover their tuition, interest and costs. Brown believes that all of these claims are frivolous and without merit and is vigorously contesting the allegations. Brown's motion for summary judgment was granted in May 1998. Plaintiffs have appealed the motion and the appeal is pending. Although outcomes cannot be predicted with certainty, we do not believe that the above-described matter or any other legal proceeding to which we are a party will have a material adverse effect on our business, results of operations or financial condition. 41 FINANCIAL AID AND REGULATION Our schools and students in the U.S. and Canada participate in a wide variety of government-sponsored financial aid programs. For this reason, our schools are subject to extensive regulatory requirements imposed by government funding agencies and other bodies. For the 1997-98 award year, which is July 1, 1997 to June 30, 1998, we derived approximately 70% of our total net revenue on a cash basis from such financial aid received by our students. We estimate that over 70% of our students receive government-sponsored financial aid. Our students also finance their education through family contributions and individual resources. Nature of Federal Support for Postsecondary Education in the U.S. While many states support public colleges and universities primarily through direct state subsidies, the federal government provides a substantial part of its support for postsecondary education in the form of grants and loans to students who can use those funds at any institution that has been certified as eligible by the Department of Education. These federal programs are authorized by Title IV of the Higher Education Act of 1965, as amended, and are collectively referred to as the "Title IV Programs." Most aid under the Title IV Programs is awarded on the basis of financial need, generally defined under the Higher Education Act as the difference between the cost of attending the institution and the amount a student can reasonably contribute to that cost. All recipients of Title IV Program funds must maintain a satisfactory grade point average and progress in a timely manner toward completion of their program of study. Students at our schools receive grants, loans and work opportunities to fund their education under the following Title IV Programs, although not every campus participates in all programs: (1) the Federal Family Education Loan ("FFEL") program, (2) the William D. Ford Federal Direct Loan ("FDL") program, (3) the Federal Pell Grant ("Pell") program, (4) the Federal Supplemental Educational Opportunity Grant ("FSEOG") program, (5) the Federal Perkins Loan ("Perkins") program and (6) the Federal Work-Study ("FWS") program . FFEL. Loans made under the FFEL program are federally guaranteed. Loans are made by banks and other lending institutions, but if a student or parent defaults on a loan, payment is guaranteed by a federally recognized guaranty agency, which is then reimbursed by the Department of Education. Students with financial need qualify for interest subsidies while in school and during grace periods. Our schools and their students use a wide variety of lenders and guaranty agencies and have not experienced difficulties in identifying lenders and guaranty agencies willing to make and guarantee FFEL loans. FDL. Under the FDL program, students or their parents may obtain loans directly from the Department of Education rather than from commercial lenders. The conditions on FDL loans are generally the same as on loans made under the FFEL program. Pell. Under the Pell program, the Department of Education makes grants to students who demonstrate financial need. FSEOG. FSEOG awards are designed to supplement Pell grants for the neediest students. An institution is required to make a 25% matching contribution for all federal funds received under this program. Perkins. Perkins loans are made from a revolving institutional account, 75% of which is capitalized by the Department of Education and the remainder by the institution. Each institution is responsible for collecting payments on Perkins loans from its former students and lending those funds to currently enrolled students. FWS. Under the FWS program, federal funds are used to pay up to 75% of the cost of part-time employment of eligible students to perform work for the institution or certain off-campus organizations. The remaining 25% is paid by the institution or the employer. Regulation of Federal Student Financial Aid Programs for U.S. Schools To participate in the Title IV Programs, an institution must be authorized to offer its programs of instruction by the relevant agencies of the state in which it is located, accredited by an accrediting agency 42 recognized by the Department of Education and certified as eligible by the Department of Education. The Department of Education will certify an institution to participate in the Title IV Programs only after the institution has demonstrated compliance with the Higher Education Act and the Department of Education's extensive regulations regarding institutional eligibility. An institution must also demonstrate its compliance to the Department of Education on an ongoing basis. These standards are applied primarily on an institutional basis, with an institution defined as a main campus and its additional locations, if any. Under this definition, each of our U.S. campuses is a separate institution, except for Gibbs-Piscataway, which is an additional location of Gibbs-Montclair, and the School of Computer Technology-Fairmont, which is an additional location of the School of Computer Technology- Pittsburgh. All of our U.S. schools currently participate in the Title IV Programs. The substantial amount of federal funds disbursed through the Title IV Programs coupled with the large numbers of students and institutions participating in those programs have led to instances of fraud, waste and abuse. As a result, Congress has required the Department of Education to increase its level of regulatory oversight of institutions to ensure that public funds are properly used. Under the Higher Education Act, accrediting agencies and state licensing agencies also have responsibilities for overseeing institutions' compliance with Title IV Program requirements. As a result, each of our institutions is subject to frequent reviews and detailed oversight and must comply with a complex framework of laws and regulations. Because the Department of Education periodically revises its regulations and changes its interpretation of existing laws and regulations, we cannot assure you that the Department of Education will agree with our understanding of each Title IV Program requirement. Significant factors relating to the Title IV Programs that could adversely affect us include the following: Legislative Action. Political and budgetary concerns significantly affect the Title IV Programs. Congress must reauthorize the Higher Education Act approximately every six years. The most recent reauthorization in October 1998 reauthorized the Higher Education Act for an additional five years. Congress reauthorized all of the Title IV Programs in which our schools participate, generally in the same form and at funding levels no less than for the prior year. While the 1998 reauthorization of the Higher Education Act made numerous changes to Title IV Program requirements, we believe that these changes will not have a material adverse effect on our business, results of operations or financial condition. Changes made by the 1998 reauthorization of the Higher Education Act include: .expanding the adverse effects on schools of high student loan default rates, . increasing from 85% to 90% the portion of a proprietary school's revenue that may be derived each year from the Title IV Programs, . revising the refund standards that require an institution to return a portion of the Title IV Program funds for students who withdraw from school, . giving the Department of Education flexibility to continue an institution's Title IV participation without interruption in some circumstances following a change of ownership or control, .changing the formula for calculating the interest rate on FFEL and FDL loans, and . modifying the definition of default from 180 days to 270 days past due for loans payable in monthly installments. In addition, Congress reviews and determines federal appropriations for the Title IV Programs on an annual basis. Congress can also make changes in the laws affecting the Title IV Programs in those annual appropriations bills and in other laws it enacts between the Higher Education Act reauthorizations. Since a significant percentage of our revenue is derived from the Title IV Programs, any action by Congress that significantly reduces Title IV Program funding or the ability of our schools or students to participate in the Title IV Programs could have a material adverse effect on our business, results of operations or financial condition. Legislative action may also increase our administrative costs and require us to adjust our practices in order for our schools to comply fully with the Title IV Program requirements. 43 Cohort Default Rates. A significant component of Congress' initiative to reduce abuse in the Title IV Programs has been the imposition of limitations on institutions whose former students default on the repayment of their federally guaranteed or funded student loans above specific rates. All of our institutions have implemented aggressive student loan default management programs aimed at reducing the likelihood of students failing to repay their loans in a timely manner. Those programs emphasize the importance of students meeting loan repayment requirements and provide for extensive loan counseling, methods to increase student persistence and completion rates and graduate employment rates, and proactive borrower contacts after students cease enrollment. An institution's cohort default rate under the FFEL and FDL programs is calculated on an annual basis as the rate at which student borrowers scheduled to begin repayment on their loans in one federal fiscal year default on those loans by the end of the next federal fiscal year. An institution whose cohort default rates equal or exceed 25% for three consecutive years will no longer be eligible to participate in the FFEL or FDL programs, and beginning with fiscal year 1996 cohort default rates, the Pell program, for the remainder of the federal fiscal year in which the Department of Education determines that such institution has lost its eligibility and for the two subsequent federal fiscal years. An institution whose cohort default rate under the FFEL or FDL program for any federal fiscal year exceeds 40% may have its eligibility to participate in all of the Title IV Programs limited, suspended or terminated by the Department of Education. None of our institutions has FFEL or FDL cohort default rates of 25% or greater for three consecutive years. The following table sets forth the FFEL and FDL cohort default rates for our institutions for federal fiscal years 1994, 1995 and 1996, the most recent years for which the Department of Education has published such rates:
FFEL and FDL Cohort Default School Rate ------ ------------------ 1996 1995 1994 ---- ---- ---- Al Collins Graphic Design School Tempe, AZ 15.4% 13.8% 19.3% Allentown Business School Allentown, PA 9.7 10.7 7.1 Brooks College Long Beach, CA 21.1 17.8 18.3 Brown Institute Mendota Heights, MN 17.4 18.1 19.6 Harrington Institute of Interior Design Chicago, IL 8.9 5.6 0.0 International Academy of Merchandising & Design Chicago, IL 13.8 15.5 13.3 Tampa, FL 12.0 13.3 15.0 The Katharine Gibbs Schools Boston, MA 16.2 16.9 16.7 Melville, NY 12.7 15.8 17.7 Montclair, NJ and Piscataway, NJ 14.5 15.8 16.2 New York, NY 17.3 14.5 18.9 Norwalk, CT 16.0 27.0 17.8 Providence, RI 14.9 14.8 13.1 School of Computer Technology Pittsburgh, PA and Fairmont, WV 12.9 11.2 9.3 Scottsdale Culinary Institute Scottsdale, AZ 4.0(1) 6.1 5.6 Western Culinary Institute Portland, OR 9.8 14.3 11.4
- -------- (1) This is a preliminary rate. The Department of Education has not yet published a final 1996 rate for this institution. 44 An institution whose cohort default rate under the FFEL or FDL program equals or exceeds 25% for any one of the three most recent federal fiscal years, or whose cohort default rate under the Perkins program exceeds 15% for any year, may be placed on provisional certification status by the Department of Education for up to four years. Nine of our institutions have Perkins cohort default rates in excess of 15% for students who were scheduled to begin repayment in the 1996-97 federal award year, the most recent year for which such rates have been calculated. The Perkins cohort default rates for these nine institutions ranged from 20.7% to 100.0%. To date, the Department of Education has placed only two of our institutions, Gibbs-Melville and Gibbs- Montclair, on provisional certification for their cohort default rates. Both institutions were placed on provisional certification for their Perkins default rates, either alone or in combination with other reasons. Total Perkins loans disbursed during 1997-98 represented less than 1% of our total net revenue. See "--Eligibility and Certification Procedures." Financial Responsibility Standards. All institutions participating in the Title IV Programs must satisfy specific standards of financial responsibility. The Department of Education evaluates institutions for compliance with these standards each year, based on the institution's annual audited financial statements, and following a change of ownership of the institution. Under new regulations which took effect July 1, 1998, the Department of Education calculates the institution's composite score based on its: . equity ratio, which measures the institution's capital resources, ability to borrow and financial viability, . primary reserve ratio, which measures the institution's ability to support current operations from expendable resources and . net income ratio, which measures the institution's ability to operate at a profit. An institution that does not meet the Department of Education's minimum composite score may demonstrate its financial responsibility by posting a letter of credit in favor of the Department of Education in an amount equal to at least 50% of the Title IV Program funds received by the institution during its prior fiscal year and possibly accepting other conditions on its participation in the Title IV Programs. In periodic reviews of our financial statements for 1997 and prior years, as well as our February 28, 1998 balance sheet reflecting the results of our initial public offering, the Department of Education has questioned certain accounting issues and has found that we and some of our institutions when measured on an individual basis failed the numeric tests under the Department of Education's former and current standards of financial responsibility. To satisfy the Department of Education's concerns, we have posted letters of credit on behalf of all institutions we have acquired since October 1996. The Department of Education reduced the number and amount of our letters of credit in September 1998 following its review of our 1997 financial statements and our February 28, 1998 balance sheet. The Department of Education also noted that the funds derived from our initial public offering, shortly after the close of our 1997 fiscal year, would have a positive effect on our financial responsibility. As a result, we currently have posted letters of credit totaling approximately $17.6 million on behalf of the following schools, which represent 11 institutions as defined by the Department of Education: . Gibbs -- $8.9 million . International Academy of Merchandising & Design -- $3.4 million . Scottsdale Culinary -- $1.3 million . Southern California School of Culinary Arts -- $2.0 million . Western -- $2.0 million
In addition, in December 1998 when the Department of Education certified the Southern California School of Culinary Arts to participate in the Title IV Programs under our ownership, it imposed a condition providing that school may not disburse more than $2.0 million in Title IV Program funds during its initial period of certification ending June 30, 2000. We believe the Department of Education added this condition because the 45 Southern California School of Culinary Arts had not participated in the Title IV Programs under its prior owner. For a period of time during 1997 and 1998, the Department of Education imposed a similar limitation on the total Title IV Program funding at three of our other schools: Gibbs, the School of Computer Technology and the International Academy of Merchandising & Design. In June 1998, the Department of Education removed the limitation on Title IV Program funding for these three schools. We believe our 1998 audited financial statements conform with generally accepted accounting principles and demonstrate that we and most if not all of our institutions satisfy the Department of Education's composite score for financial responsibility, without any conditions. We filed our 1998 financial statements with the Department of Education in February 1999 and asked it to release most, if not all, of our outstanding letters of credit and to increase or eliminate the Title IV Program funding limitation for the Southern California School of Culinary Arts. We cannot assure you that we or our institutions will satisfy the numeric standards or that the Department of Education will take any action with respect to the letters of credit or funding limitation. Under a separate standard of financial responsibility, an institution that has made late student refunds in either of its last two fiscal years must post a letter of credit with the Department of Education in an amount equal to 25% of the total Title IV Program refunds paid by the institution in its prior fiscal year. Based on this standard, we currently have posted a total of $120,000 in letters of credit with respect to two Gibbs campuses and one International Academy of Merchandising & Design campus. Change of Ownership or Control. When we acquire an institution that is eligible to participate in the Title IV Programs, that institution undergoes a change of ownership resulting in a change of control as defined by the Department of Education. Upon such a change of control, an institution's eligibility to participate in the Title IV Programs is generally suspended until it has applied for and been recertified by the Department of Education as an eligible institution under our ownership, which requires that the institution also reestablish its state authorization and accreditation. The time required to act on such an application may vary substantially. Pending recertification by the Department of Education, the institution may receive and disburse Title IV Program funds to its students only if those funds were committed prior to the change of control. If an institution is recertified following a change of control, it will be on a provisional basis. The 1998 reauthorization of the Higher Education Act provides that the Department of Education may provisionally and temporarily certify an institution undergoing a change of control under certain circumstances while the Department of Education reviews the institution's application. The Department of Education has not yet issued regulations regarding how it will interpret or apply this amendment to the Higher Education Act. Each of the U.S. institutions we have acquired has undergone a certification review under our ownership and has been certified to participate in the Title IV Programs, with the exception of Harrington. We acquired Harrington in January 1999 and the Department of Education has granted it temporary and provisional certification, pending a full certification review. Nine of our U.S. institutions are presently participating in Title IV Programs under provisional certification and the remaining eight have been granted regular certification. Some other types of transactions can also cause a change of control. The Department of Education, the state education agencies and the accrediting agencies that accredit our schools have their own definitions of when a transaction is deemed a change of control. With respect to a publicly traded corporation, such as us, Department of Education regulations provide that a change of control occurs when there is an event that would obligate that corporation to file a Current Report on Form 8-K with the Securities and Exchange Commission disclosing a change of control. This standard is subject to interpretation by the Department of Education. We cannot predict how the Department of Education will apply this standard in the future, or whether the Department of Education will change this standard. A significant purchase or disposition of our common stock could be determined by the Department of Education to be a change of control under this standard. Most of the states and accrediting agencies include the sale of a controlling interest of common stock in the definition of a change of control. A change of control under the definition of one of these agencies would require the affected institution to reaffirm its state authorization or accreditation. The requirements to obtain such reaffirmation from the states and accrediting agencies with jurisdiction over our schools vary widely. 46 We have been advised by the Department of Education that this offering will not be a change of control under its standard. We believe that this offering will be a change of control under the standards of the Arizona State Board for Private Postsecondary Education and the Illinois State Board of Education, but will not be a change of control under the standards of any other applicable state education agencies or the accrediting agencies that accredit our schools. As a result, Collins and Scottsdale Culinary, our only campuses in Arizona, and International Academy of Merchandising & Design-Chicago, our only campus authorized by the Illinois State Board, will be required to be reauthorized by the Arizona State Board and the Illinois State Board, respectively. We believe that this offering will not affect the ability of those three campuses to participate in the Title IV Programs unless the Arizona State Board or the Illinois State Board fails to reauthorize any of those campuses in a timely manner. The failure of any of those campuses to reobtain state authorization could have a material adverse effect on our business, results of operations or financial condition. We believe this offering will not affect the ability of our other institutions to participate in the Title IV Programs. The potential adverse effects of a change of control could influence future decisions by us and our stockholders regarding the sale, purchase, transfer, issuance or redemption of our capital stock. Opening Additional Schools and Adding Educational Programs. The Higher Education Act generally requires that proprietary institutions be fully operational for two years before applying to participate in the Title IV Programs. However, an institution that is certified to participate in the Title IV Programs may establish an additional location and apply to participate in the Title IV Programs at that location without reference to the two-year requirement, if such additional location satisfies all other applicable eligibility requirements. Our expansion plans are based, in part, on our ability to open new campuses as additional locations of our existing institutions. Generally, an institution that is eligible to participate in the Title IV Programs may add a new educational program without Department of Education approval if that new program leads to an associate level or higher degree and the institution already offers programs at that level, or if it prepares students for gainful employment in the same or related occupation as an educational program that has previously been designated as an eligible program at that institution and meets minimum length requirements. If an institution erroneously determines that an educational program is eligible for the Title IV Programs, the institution would likely be liable for repayment of the Title IV Program funds provided to students in that educational program. We do not believe that current Department of Education regulations will create significant obstacles to our plans to add new programs. Some of the state education agencies and accrediting agencies with jurisdiction over our campuses also have requirements that may affect schools' ability to open a new campus, acquire an existing campus, establish an additional location of an existing institution or begin offering a new educational program. We do not believe that these standards will have a material adverse effect on our expansion plans. The "85/15 Rule." Under a provision of the Higher Education Act commonly referred to as the "85/15 Rule," a proprietary institution, such as each of our institutions, would cease being eligible to participate in the Title IV Programs if, on a cash accounting basis, it derived more than 85% of its revenue for any fiscal year from the Title IV Programs. Any institution that violates this rule becomes ineligible to participate in the Title IV Programs as of the first day of the fiscal year following the fiscal year in which it exceeds 85%, and is unable to apply to regain its eligibility until the next fiscal year. If one of our institutions violated the 85/15 Rule and became ineligible to participate in the Title IV Programs but continued to disburse Title IV Program funds, the Department of Education would require the institution to repay all Title IV Program funds received by the institution after the effective date of the loss of eligibility. We have calculated that, since this requirement took effect in 1995, none of our institutions has derived more than 83% of its revenue from the Title IV Programs for any fiscal year. The 1998 reauthorization of the Higher Education Act increased the percentage of applicable revenue that a for-profit institution can derive from the Title IV Programs from 85% to 90%. We regularly monitor compliance with this requirement to 47 minimize the risk that any of our institutions would derive more than the maximum percentage of its revenue from the Title IV Programs for any fiscal year. If an institution appeared likely to approach the maximum percentage threshold, we would evaluate making changes in student funding and financing to ensure compliance with the rule. Administrative Capability. The Department of Education assesses the administrative capability of each institution that participates in the Title IV Programs under a series of separate standards. Failure to satisfy any of the standards may lead the Department of Education to find the institution ineligible to participate in the Title IV Programs or to place the institution on provisional certification as a condition of its participation. One standard which applies to programs with the stated objective of preparing students for employment requires the institution to show a reasonable relationship between the length of the program and the entry-level job requirements of the relevant field of employment. We believe we have made the required showing for each of our applicable programs. Short-term educational programs that provide less than 600 clock hours of instruction must demonstrate that 70% of all students who enroll in such programs complete them within a prescribed time and 70% of the graduates of such programs obtain employment in the occupation for which they were trained within a prescribed time. Some of the Gibbs institutions offer such short-term programs, but students enrolled in these programs represent a small percentage of our total enrollment. To date, the applicable institutions have been able to establish that their short-term educational programs meet the required completion and placement percentages. Other standards provide that an institution may be found to lack administrative capability and be placed on provisional certification if its student loan default rate under the FFEL and FDL programs is 25% or greater for any of the three most recent federal fiscal years, or if its Perkins cohort default rate exceeds 15% for any federal award year. Two of our institutions have been placed on provisional certification or determined by the Department of Education to lack administrative capability due to their Perkins default rates, either alone or in conjunction with other reasons. An additional standard prohibits an institution from providing any commission, bonus or other incentive payment based directly or indirectly on success in securing enrollments or financial aid to any person or entity engaged in any student recruitment, admission or financial aid awarding activity. We believe that our current compensation plans are in compliance with the Higher Education Act standards, although the regulations of the Department of Education do not establish clear criteria for compliance. Eligibility and Certification Procedures. The Higher Education Act and its implementing regulations require each institution to apply to the Department of Education for continued certification to participate in the Title IV Programs at least every six years, or when it undergoes a change of control, opens an additional location or raises the highest academic credential it offers. The Department of Education may place an institution on provisional certification status if it finds that the institution does not fully satisfy all of the eligibility and certification standards. The Department of Education may withdraw an institution's provisional certification without advance notice if the Department of Education determines that the institution is not fulfilling all material requirements, and may more closely review an institution that is provisionally certified if it applies for approval to open a new location or make any other significant change. Provisional certification does not otherwise limit an institution's access to Title IV Program funds. An institution seeking certification to participate in the Title IV Programs after a change of control will be provisionally certified for a limited period, following which the institution must reapply for continued certification. If at that time the institution satisfies all conditions for full certification, the Department of Education will recertify the institution and remove the provisional status. Otherwise, the Department of Education may recertify the institution on a continued provisional basis. Each institution that we have acquired was initially certified by the Department of Education for participation in the Title IV Programs under our ownership on a provisional basis. Seven of our institutions remain on provisional certification status because the initial period of their provisional certification has not expired. Two institutions have been recertified by the Department of Education upon the expiration of their initial provisional period, but remain on provisional status 48 for other reasons. Gibbs-Melville is on provisional certification status because its Perkins cohort default rate at the time of the Department of Education's review was above 30%, and the institution was told that it would remain on provisional certification until it reduced its Perkins default rate below 30%. Gibbs-Montclair is on provisional certification status because its Perkins cohort default rate is above 30% and because of other reasons that we believe are now fully resolved. Compliance with Regulatory Standards and Effect of Regulatory Violations. Our schools are subject to audits and program compliance reviews by various external agencies, including the Department of Education, state education agencies, guaranty agencies and accrediting agencies. The Higher Education Act and its implementing regulations also require that an institution's administration of Title IV Program funds be audited annually by an independent accounting firm, and the resulting audit report submitted to the Department of Education for review. If the Department of Education or another regulatory agency determined that one of our institutions improperly disbursed Title IV Program funds or violated a provision of the Higher Education Act or the Department of Education's regulations, that institution could be required to repay such funds, and could be assessed an administrative fine. The Department of Education could also subject the institution to heightened cash monitoring, under which the institution's federal funding requests are more carefully reviewed by the Department of Education, or the Department of Education could transfer the institution from the advance system of receiving Title IV Program funds to the reimbursement system, under which a institution must disburse its own funds to students and document the students' eligibility for Title IV Program funds before receiving such funds from the Department of Education. Violations of Title IV Program requirements could also subject us or our schools to other civil and criminal penalties. Significant violations of Title IV Program requirements by us or any of our institutions could be the basis for a proceeding by the Department of Education to limit, suspend or terminate the participation of the affected institution in the Title IV Programs. Generally, such a termination extends for 18 months before the institution may apply for reinstatement of its participation. There is no proceeding pending to fine any of our institutions or to limit, suspend or terminate any of our institutions' participation in the Title IV Programs, and we have no reason to believe that any such proceeding is contemplated. Any such action that substantially limited our schools' participation in the Title IV Programs could have a material adverse effect on our business, results of operations or financial condition. State Authorization for U.S. Schools We are subject to extensive regulation in each of the 13 states in which we currently operate schools and in other states in which our schools recruit students. Each of our campuses must be authorized by the applicable state agency or agencies to operate and grant degrees or diplomas to its students. In addition, state authorization is required for an institution to become and remain eligible to participate in the Title IV Programs. Currently, each of our U.S. campuses is authorized by the applicable state agency or agencies. The level of regulatory oversight varies substantially from state to state. In some states, the campuses are subject to licensure by an agency that regulates proprietary schools and also by a separate higher education agency. State laws establish standards for instruction, qualifications of faculty, location and nature of facilities, financial policies and other operational matters. State laws and regulations may limit our ability to operate or to award degrees or diplomas or offer new degree programs. Some states prescribe standards of financial responsibility that are different from those prescribed by the Department of Education. We believe that each of our campuses is in substantial compliance with state authorizing and licensure laws. If any one of our campuses lost its state authorization, the campus would be unable to offer its programs and we would be forced to close that campus. Closing one of our campuses for any reason could have a material adverse effect on our business, results of operations or financial condition. Accreditation for U.S. Schools Accreditation is a non-governmental process through which an institution submits to a qualitative review by an organization of peer institutions. Accrediting agencies primarily examine the academic quality of the 49 institution's instructional programs, and a grant of accreditation is generally viewed as confirmation that an institution's programs meet generally accepted academic standards. Accrediting agencies also review the administrative and financial operations of the institutions they accredit to ensure that each institution has the resources to perform its educational mission. Accreditation by an accrediting agency recognized by the Department of Education is required for an institution to be certified to participate in the Title IV Programs. Accrediting agencies must adopt specific standards in connection with their review of postsecondary institutions to be recognized by the Department of Education. All of our U.S. campuses are accredited by an accrediting agency recognized by the Department of Education. Thirteen of our campuses are accredited by the Accrediting Council for Independent Colleges and Schools ("ACICS"), four of our campuses are accredited by the Accrediting Commission of Career Schools and Colleges of Technology ("ACCSCT"), one of our campuses is accredited by the Accrediting Commission for Community and Junior Colleges of the Western Association of Schools and Colleges and one of our campuses is accredited by the National Association of Schools of Art and Design. In addition, four of our campuses' interior design programs are accredited by the Foundation for Interior Design Education Research and two of our campuses' culinary arts programs are accredited by the American Culinary Federation Educational Institute Accrediting Commission, accrediting agencies which are not recognized by the Department of Education. An accrediting agency may place a campus on "reporting" status to monitor one or more specified areas of performance. A campus placed on reporting status is required to report periodically to its accrediting agency on that campus' performance in the specified areas. ACICS has placed five campuses, International Academy of Merchandising & Design-Chicago, International Academy of Merchandising & Design-Tampa, Gibbs-Boston, Gibbs-Melville, and Gibbs- Providence, on financial reporting status, and one campus, Gibbs-Montclair, on placement reporting status. ACCSCT has placed two campuses, Brown and Collins, on completion and placement reporting status. Each of these campuses has submitted all requested data in the identified area to its accrediting agency. The placement of these eight campuses on reporting status by their accrediting agencies has not had a material adverse effect on our business, results of operations or financial condition, and we do not believe that it will have that effect in the future. Canadian Regulation Depending on their province of residence, our Canadian students may receive loans under the Canada Student Loan Program, the Ontario Student Loans Plan and the Quebec Loans and Bursaries Program. Canadian schools must meet eligibility standards to administer these programs and must comply with extensive statutes, rules, regulations and requirements. We believe our Canadian schools currently hold all necessary registrations, approvals and permits and meet all eligibility requirements to administer these governmental financial aid programs. If our Canadian schools cannot meet these and other eligibility standards or fail to comply with applicable requirements, it could have a material adverse effect on our business, results of operations or financial condition. Ontario. The Ontario Ministry of Education and Training provides financial assistance to eligible students through the Ontario Student Assistance Plan ("OSAP"). This plan includes two main components, the Canada Student Loan Program and the Ontario Student Loans Plan. For our International Academy of Design school in Toronto to maintain its right to administer OSAP it must, among other things, be registered and in good standing under the Ontario Private Vocational Schools Act and abide by the rules, regulations and administrative manuals of the Canada Student Loan Program, Ontario Student Loans Plan and other OSAP-related programs. In order to attain initial eligibility, an institution has to establish that it has (1) been in good standing under the Ontario Private Vocational Schools Act for at least 12 months, (2) offers an eligible program for at least 12 months and (3) graduates at least one class in an eligible program that satisfied specific requirements with respect to class size and graduation rate. Pursuant to Ontario Ministry rules, during the first two years of initial eligibility, an institution has its administration of OSAP independently audited, and full eligibility is not granted until these audits confirmed that the school is properly administering OSAP. Our 50 International Academy of Design school in Toronto has been granted full eligibility. Under Ontario Ministry rules, our Toronto school must advise the Ontario Ministry before the school takes any material action that may result in its failure or inability to meet any rules, regulations or requirements related to OSAP. In order for our International Academy of Design school in Toronto to establish a new branch, it must obtain OSAP-designation from the Ontario Ministry. We do not believe that OSAP's requirements will create significant obstacles to our plans to acquire additional institutions or open new branches in Ontario. Our International Academy of Design school in Toronto may submit applications for loans only to students enrolled in educational programs that have been designated as OSAP-eligible by the Ontario Ministry. To be eligible, among other things, a program must be registered with the Private Vocational Schools Unit of the Ontario Ministry, must be of a minimum length and must lead to a diploma or certificate. We do not anticipate that these program approval requirements will create significant problems with respect to our plans to add new educational programs. Under Ontario Ministry rules, an institution cannot automatically acquire OSAP designation through the acquisition of other OSAP-eligible institutions. When there is a change of ownership, including a change in controlling interest, in a non-incorporated OSAP-eligible institution, the Ontario Ministry will require evidence of the institution's continued capacity to properly administer the program before extending OSAP designation to the new owner. We do not believe that this offering will be considered a change of ownership for purposes of OSAP. Given that the Ontario Ministry periodically revises its regulations and other requirements and changes its interpretations of existing laws and regulations, we cannot assure you that the Ontario Ministry will agree with our understanding of each requirement. Our International Academy of Design school in Toronto is required to audit its OSAP administration annually and the Ontario Ministry is authorized to conduct its own audits of our administration of these programs. We have complied with these requirements on a timely basis. Based on the most recent annual compliance audits, our International Academy of Design school in Toronto is in substantial compliance with OSAP requirements and we believe that the school continues to be in substantial compliance with these requirements. The Ontario Ministry has the authority to take any measures it deems necessary to protect the integrity of the administration of OSAP. If the Ontario Ministry deems a failure to comply to be minor, the Ontario Ministry will advise us of the deficiency and provide us with an opportunity to remedy it. If the Ontario Ministry deems the failure to comply to be serious in nature, the Ontario Ministry has the authority to: (1) condition our continued OSAP designation upon our meeting specific requirements during a specific time frame; (2) suspend our OSAP designation; or (3) revoke our OSAP designation. When the Ontario Ministry determines that any non-compliance in our OSAP administration is serious, the Ontario Ministry has the authority to contract with an independent auditor, at our expense, to conduct a full audit in order to quantify the deficiencies and to require repayment of all loan amounts. In addition, the Ontario Ministry may impose a penalty up to the amount of the damages assessed in the independent audit. Adopting a practice similar to that of the U.S. Department of Education, the Ontario Ministry now calculates for each school student loan default rates on the basis of incidences of default and expresses the default rates as a percentage of the total number of loans issued to students attending that school. Beginning with loans issued in the 1998-99 award year, August 1, 1998 to July 31, 1999, institutions with a 1997 default rate which is 15 percentage points or more above the 1997 provincial average of 23.5% will be required to share the cost of defaults. In the 1999-2000 award year, this policy will also apply to institutions with a 1997 default rate 10 percentage points or more above 23.5%. Our International Academy of Design school in Toronto had an average program-wide total default rate for 1998 of 23.8%. We may only operate a private vocational school in Ontario if the school is registered under the Ontario Private Vocational Schools Act. Upon payment of the prescribed fee and satisfaction of the conditions prescribed by the regulations under the Ontario Private Vocational Schools Act and by the Private Vocational 51 Schools Unit of the Ontario Ministry, an applicant or registrant such as our International Academy of Design school in Toronto is entitled to registration or renewal of registration to conduct or operate a private vocational school unless: . the school cannot reasonably be expected to be financially responsible in the conduct of the private vocational school . the past conduct of the officers or directors provides reasonable grounds for belief that the operations of the school will not be carried on in accordance with relevant law and with integrity and honesty . it can reasonably be expected that the course or courses of study or the method of training offered by the school will not provide the skill and knowledge requisite for employment in the vocation or vocations for which the applicant or registrant is offering instruction . the applicant is carrying on activities that are, or will be, if the applicant is registered, in contravention of the Ontario Private Vocational Schools Act or the regulations under that Act. An applicant for registration to conduct or operate a private vocational school is required to submit with the application a bond in an amount determined in accordance with the regulations under the Ontario Private Vocational Schools Act. Our International Academy of Design school in Toronto is currently registered under the Ontario Private Vocational Schools Act for both of its locations, and we do not believe that there will be any impediment to renewal of such registrations on an annual basis. The Ontario Private Vocational Schools Act provides that a "registration" is not transferable. However, the Private Vocational Schools Unit of the Ontario Ministry takes the position that a purchase of shares of a private vocational school does not invalidate the school's registration under the Ontario Private Vocational Schools Act. We do not believe that this offering will invalidate the registrations of our International Academy of Design school in Toronto. If our International Academy of Design school in Toronto is convicted of violating the Ontario Private Vocational Schools Act or the regulations under that Act, the school can be fined up to $25,000 Canadian dollars. Quebec. Our Quebec students may receive loans under the Quebec Loans and Bursaries Program subject to student eligibility criteria. Under an Act Respecting Private Education, our International Academy of Design school in Montreal may not operate as a private educational institution without holding a permit issued by the Quebec Minister of Education. Permits cannot be transferred without the written authorization of the Quebec Minister and we must notify that Minister of any amalgamation, sale or transfer affecting our Quebec school. The Quebec Minister can modify or revoke our permit in certain circumstances, such as if we do not comply with the conditions, restrictions or prohibitions of the permit or if we are to become insolvent. We must be provided with a chance to present our views before our permit can be revoked. We do not believe that this offering will be considered a "sale or transfer" affecting our International Academy of Design school in Montreal, for the purposes of applicable law; however, because the Quebec Minister periodically revises its legal requirements and changes its interpretation of existing law, we cannot assure you that the Quebec Minister will agree with our understanding of each requirement. We also do not believe that there will be any impediment to renewal of the permit issued to our International Academy of Design school in Montreal or that the Quebec Minister's requirements will create significant obstacles to our plans to open new branches or add new educational programs at our International Academy of Design school in Montreal, or to acquire additional schools in Quebec. The Canadian, Ontario and Quebec governments are currently in the process of changing the legislative, regulatory and other requirements relating to student financial assistance programs due to political and budgetary pressures. Although we do not anticipate a significant reduction in the funding for these programs, any change that significantly reduces funding or the ability of our schools to participate in these programs could have a material adverse effect on our business, results of operations or financial condition. 52 MANAGEMENT Directors and Executive Officers The following table sets forth certain information with respect to our executive officers and directors:
Name Age Position ---- --- -------- John M. Larson.......... 47 President, Chief Executive Officer, Secretary and Director William A. Klettke...... 46 Senior Vice President, Chief Financial Officer and Treasurer Robert E. Dowdell....... 53 Director Thomas B. Lally......... 54 Director Wallace O. Laub......... 74 Director Keith K. Ogata.......... 44 Director Patrick K. Pesch........ 42 Director
John M. Larson has served as our President and Chief Executive Officer and one of our Directors since January 1994. From July 1993 until our formation, Mr. Larson served as a consultant to Heller Equity Capital Corporation ("Heller"), working with Heller to establish CEC. From January through May 1993, Mr. Larson served as the Eastern Regional Operating Manager of Educational Medical, Inc., which provides career-oriented postsecondary education. From 1989 until 1993, Mr. Larson served as the Senior Vice President of College Operations of Phillips Colleges, Inc., overseeing a nationwide system of 58 schools, which offered a wide range of academic programs. From March through September 1989, he served as Senior Vice President of Operations for the Geneva Companies, a mergers and acquisitions firm. From 1980 to 1989, Mr. Larson was Vice President of Marketing at National Education Centers, Inc., a subsidiary of National Education Corporation, where he managed the entire admissions program, including marketing and advertising efforts, with a team of approximately 500 employees. Mr. Larson has also served in marketing positions with DeVry Inc., at its Chicago and Kansas City campuses. Mr. Larson received a Bachelor's of Science in Business Administration from the University of California at Berkeley and has completed the Executive Management Program at Stanford University. William A. Klettke has served as our Senior Vice President and Chief Financial Officer since March 1996. From 1987 until 1995, Mr. Klettke was Executive Vice President and Chief Financial Officer for ERO, Inc., a licensed distributor of children's toys. In these positions, Mr. Klettke was responsible for finance, accounting, management information systems, human resources, forecasting, treasury, legal, acquisitions and two operating subsidiaries. From 1976 to 1987, Mr. Klettke served in various positions with The Enterprise Companies, a paint and coatings manufacturer, and a subsidiary of Insilco, starting as an accountant and progressing to Senior Vice President of Finance and Administration. Mr. Klettke is a Certified Public Accountant and holds Bachelor's of Arts degrees in Psychology and Sociology from Baker University, a Bachelor's of Science in Accounting from Illinois State University and a Master's Degree in Management from Northwestern University. Mr. Klettke is also the President and a Director of the Career Education Scholarship Fund, a not- for-profit corporation. Robert E. Dowdell has been one of our Directors since our inception in January 1994. From 1989 to present, Dowdell has served as Chief Executive Officer and director of Marshall & Swift, L.P., a publishing company. Mr. Dowdell is also a director of ADMS, a software provider and LaQuinta Spring, L.P., in which he is the general partner. Thomas B. Lally has been one of our Directors since January 28, 1998. Mr. Lally was designated to be a director by Heller. He has been the President of Heller since 1996 and an Executive Vice President of Heller Financial, Inc. ("HFI"), the parent of Heller, since 1994, with direct responsibility for the asset quality oversight of HFI's portfolio of loan and equity investments. Mr. Lally joined HFI in 1974. Wallace O. Laub has been one of our Directors since October 1994. Mr. Laub was a co-founder of National Education Corporation, Inc., where he served as Executive Vice President and director from 1955 to 1993. From 1981 to 1990, Mr. Laub served as a director of the Distance Education Training Council, a trade association and accrediting agency for distance education companies. Mr. Laub is now retired. 53 Keith K. Ogata has been one of our Directors since January 28, 1998. Mr. Ogata is currently president of, and a private investor in, 3-K Financial Corporation. From 1995 to 1997, Mr. Ogata served as President of National Education Centers, Inc., a subsidiary of National Education Corporation. From 1991 to June 1997, he served as Vice President, Chief Financial Officer and Treasurer of National Education Corporation, with responsibility for finance, accounting, treasury, tax, mergers and acquisitions, human resources, investor and public relations and information systems. Patrick K. Pesch has been one of our Directors since 1995. Mr. Pesch was designated as director by Heller. Since 1992, Mr. Pesch has served as a Senior Vice President of HFI, and also as an officer of Heller, managing a portfolio of loan and equity investments, as well as serving as a credit officer of one of HFI's principle business units. Mr. Pesch also serves as a director of Kimpex, Inc., a Canadian company and as an officer and director of Amersig Graphics, Inc. None of our executive officers or directors are related to one another. Certain Other Significant Employees of the Company The following table sets forth information with respect to some of our other significant employees:
Name Position - ---- -------- J. Patrick Andrews............... Director of Advertising Jon R. Coover.................... National Director of Marketing Mari-Ann Deering................. Director of Human Resources Nick Fluge....................... Managing Director John Fraccaro.................... Director of Information Technology Jacob P. Gruver.................. Managing Director Patricia Kapper.................. Director of Education James R. McEllhiney.............. Director of Regulatory Compliance Carol A. Menck................... Managing Director Robert W. Nachtsheim............. Controller Steve B. Sotraidis............... Managing Director Todd H. Steele................... Director of Strategic Planning and Development Mark J. Tobin.................... Director of Student Finance
J. Patrick Andrews has served as our Director of Advertising since October 1995. From 1994 until he joined our corporate management, Mr. Andrews was Advertising Manager for two of our schools, Collins and Brooks. For approximately 12 years prior to joining us, Mr. Andrews managed the advertising and marketing functions for Spartan, a 2,800 student school in Tulsa, Oklahoma. Mr. Andrews holds a Bachelor's of Arts in Journalism from the University of South Carolina and a Masters in Marketing from the University of Texas. Dr. Jon R. Coover has served as our National Director of Marketing since May 1997, after serving for 14 months as Director of Education at our largest school, Brown. Dr. Coover's background in private career education includes holding positions as Vice President of Marketing for the Rasmussen Business Colleges, Minneapolis, Minnesota; Vice President of Operations at Virginia College, Birmingham, Alabama; President of Dominion College, Roanoke, Virginia; President of Nettle Junior College, Sioux Falls, South Dakota; Co-Director of New York Restaurant School in New York City; and Regional Director with DeVry Institute of Technology. Dr. Coover holds a Bachelor's of Science in Business Administration and an M.B.A. from California Western University and a Ph.D. in Business from California Coast University. Mari-Ann Deering has served as our Director of Human Resources since July 1998. Ms. Deering joined our corporate management with 19 years of human resources experience in the veterinary pharmaceutical industry. Ms. Deering served as the Director of Human Resources--North America for Fort Dodge Animal Health, Overland Park, Kansas, a division of American Home Products, from 1997 until 1998. She was Vice 54 President of Human Resources and Administration of Southwest Technologies, a medical device company, from 1996 until 1997. Her prior experience also includes 16 years in human resource management with Sanofi Animal Health from 1979 until 1995 where her final position was Vice President of Human Resources. Ms. Deering holds a Bachelor's of Science degree in Business Administration from AVILA College, Kansas City, Missouri and an M.B.A. from Rockhurst College, Kansas City, Missouri. Nick Fluge has served as one of our Managing Directors since July 1997. Mr. Fluge has served as Director and President of Western since 1989. From 1984 until 1988, Mr. Fluge was Director of Retail/Restaurants and a member of the management team of Western. With over 20 years of experience in the hospitality/foodservice industry and as a Certified Culinary Educator with the American Culinary Federation, Mr. Fluge has chaired American Culinary Federation Food Salons, judged wine competitions and written columns for various periodicals, including The National Culinary Review. Mr. Fluge has been a Team Leader for the Accrediting Commission of Career Schools and Colleges of Technology (ACCSCT) since 1992. Mr. Fluge is a member of the Oregon Department of Education--Career College Division. Mr. Fluge holds a Bachelor's of Science degree in Political Science from Portland State University. John Fraccaro has served as our Director of Information Technology since March 1998. Mr. Fraccaro has held Consulting and Principal Consulting positions with New Resources Corporation from 1997 until 1998 and with Coopers & Lybrand L.L.C. from 1993 until 1996. Mr. Fraccaro was a Director of Information Technology for Sara Lee Hosiery from 1996 until 1997 and Manager of Database Development and Support for Kraft General Food from 1990 until 1993. Mr. Fraccaro has held several positions with software vendors including ComputerVision, Ingres and CompuGraphic. Mr. Fraccaro holds a Bachelor's of Science in Education from Northern Illinois University. Jacob P. Gruver has served as one of our Managing Directors since May 1997. From August 1994 to May 1997, Mr. Gruver served as our Director of Finance. From 1989 until joining our management team, Mr. Gruver was Vice President and Controller of Wyoming Technical Institute in Laramie, Wyoming, a moderately sized career-oriented school. In such positions, he managed all financial functions, including budgeting and implementation of management information/financial systems. From 1978 to 1989, Mr. Gruver audited career- oriented schools and other clients at a regional public accounting firm in Laramie, Wyoming. Mr. Gruver received a Bachelor's of Science in Accounting from National College. Patricia Kapper, Ed.D, has served as our Director of Education since August 1997. From 1990 until joining our management team, Dr. Kapper was Dean of Academic Affairs (Chief Academic Officer) of DeVry Institute of Technology, Addison, Illinois. From 1986 until 1990, Dr. Kapper held academic management positions with Milwaukee Area Technical College, from 1984 to 1986 as Associate Dean of Business and Graphic and Applied Arts and from 1986 to 1990 as Dean of Business and Graphic Arts. Dr. Kapper holds a Bachelor's of Arts in Business Education from the University of Wisconsin--Eau Claire, a Master's of Science in Teaching from the University of Wisconsin--Whitewater, and a doctorate in Adult Education from Northern Illinois University. James R. McEllhiney has served as our Director of Regulatory Compliance since August 1997. Mr. McEllhiney served as our Director of Education from August 1994 until August 1997. Prior to joining our corporate management in August 1994, Mr. McEllhiney was the Vice President of Academic Affairs for Phillips Colleges, Inc. In this position, Mr. McEllhiney managed regulatory compliance, including processing change of ownership applications for over 60 acquisitions, and oversaw corporate educational administration for this group of 92 schools. From 1975 to 1988, Mr. McEllhiney managed regulatory compliance and served as Chief Academic Officer for MetriData Computing, a 40 unit career- oriented school company. Prior to joining MetriData, Mr. McEllhiney was an instructor and Academic Dean at Northwood Institute. Mr. McEllhiney holds a Bachelor's of Science in Education and a Master's of Science in Psychology from Indiana State University. 55 Carol A. Menck has served as one of our Managing Directors since January 1999. From 1997 to 1999, Ms. Menck served as the President of The School of Computer Technology--Pittsburgh with oversight responsibility over the campus in Fairmont. From 1993 until joining us, Ms. Menck was Director of an ITT Technical Institute. From 1991 until 1993, she served as Director of Phillips Junior College--Spokane, Washington. From 1987 to 1991 she served as President of Bradford School--Portland, Oregon. From 1976 until 1987, she held various positions at Trend Colleges--Vancouver, Washington. Her final position at Trend was Operations Manager. Ms. Menck received a Bachelor's of Arts in Political Science from Gonzaga University in Spokane, Washington and a Juris Doctorate from Gonzaga Law School in Spokane, Washington. Robert W. Nachtsheim has served as our Controller since December 1995. Mr. Nachtsheim joined our corporate management with 19 years of accounting and financial analysis experience in multiple industries. From 1993 until 1995, Mr. Nachtsheim served as Controller for Century 21 North Central, Inc., overseeing the financial performance of 600 midwestern Century 21 franchises. His prior experience includes six years as the Director of Financial Analysis and Reporting for Newark Electronics, a nationwide electronics distributor, and 11 years with Amoco Corporation in various accounting positions. Mr. Nachtsheim holds a Bachelor's of Science in Accountancy from the University of Missouri and an M.B.A. in Finance from DePaul University. Steve B. Sotraidis has served as one of our Managing Directors since July 1, 1997. Mr. Sotraidis joined our administrative management team in June 1994. Mr. Sotraidis joined Brooks College in 1970 and has managed Brooks' overall operations since 1975. Mr. Sotraidis holds a Bachelor's of Science in Psychology and completed two years of graduate work in Industrial Psychology at California State University at Long Beach. Todd H. Steele has served as our Director of Strategic Planning and Development since March 1998. Mr. Steele served as a director from our inception in January 1994 until March 1998. From December 1996 until joining our management team, he served as a Vice President of Baker, Fentress & Co., an investment company, making equity investments in private companies. From May 1990 to November 1996, he served as a Vice President of HFI and Heller, also making equity investments in private companies. Mr. Steele holds a Bachelor's of Arts in Economics from Northwestern University and an M.B.A. in finance from the University of Chicago. Mark J. Tobin has served as our Director of Student Finance since March 1996. Mr. Tobin joined DeVry, Inc., in 1984 and, from 1989 until joining our corporate management, Mr. Tobin was Director of Student Finance for DeVry, Inc. In that position, Mr. Tobin was responsible for student finance policy development, technical and operations assistance and performance monitoring for the DeVry Institutes of Technology and the Keller Graduate School of Management. From 1984 to 1989, Mr. Tobin held corporate financial aid management positions at DeVry, Inc. Prior to his tenure at DeVry, Inc. from 1984 until 1996, Mr. Tobin was Director of Financial Aid at Carthage College from 1978 until 1984 and Marian College from 1973 until 1978. Mr. Tobin holds a Bachelor's of Arts in Psychology from Northeastern Illinois State College and a Master's of Education degree in Student Personnel Work in Higher Education from Loyola University of Chicago. Board of Directors Our board of directors is divided into three classes with staggered three- year terms. The terms of Messrs. Dowdell and Pesch expire at the annual meeting of our stockholders in 1999, the terms of Messrs. Laub and Ogata expire at the annual meeting of our stockholders in 2000, and the terms of Messrs. Lally and Larson expire at the annual meeting of our stockholders in 2001. At each annual meeting of our stockholders, the successors to the directors whose terms expire will be elected for a three-year term. Arrangements for Nomination as Director We have entered into an agreement with Heller pursuant to which Heller is entitled to designate individuals for nomination to our board of directors. Heller is entitled to designate two directors as long as it owns at least 25% of our capital stock. The number of directors that Heller is entitled to designate will be reduced to one when Heller no longer owns 25% of our capital stock, and the agreement terminates when 56 Heller no longer owns at least 10% of our capital stock. This agreement provides that we will cause these Heller designees to be nominated and solicit proxies from our stockholders to vote in favor of them, and will appoint the Heller designees to the Compensation and Audit Committees of the board. Messrs. Pesch and Lally are the current designees of Heller. After this offering, Heller will own approximately 21.0% of our common stock. Accordingly, Heller will not be entitled to designate its second nominee, Mr. Pesch, to the board at our 1999 Annual Meeting of Stockholders. However, the board of directors has nominated Mr. Pesch for re-election to the board. Committees of the Board of Directors The board of directors has established an Audit Committee and a Compensation Committee. Both the Audit Committee and the Compensation Committee are currently composed entirely of directors who are not our officers or employees. The Audit Committee generally has responsibility for recommending independent auditors to the board of directors for selection, reviewing the plan and scope of the annual audit, reviewing our audit and control functions and reporting to the full board of directors regarding all of the foregoing. The members of the Audit Committee are Messrs. Dowdell, Lally, Ogata and Pesch. The Compensation Committee generally has responsibility for recommending to the board guidelines and standards relating to the determination of executive compensation, reviewing our executive compensation policies and reporting to the board of directors regarding the foregoing. The Compensation Committee also has responsibility for administering our incentive compensation plans, determining the number of options to be granted to our executive officers pursuant to such plans and reporting to the board of directors regarding the foregoing. The members of the Compensation Committee are Messrs. Lally, Laub and Pesch. Compensation of Directors All directors who are not employees are paid an annual fee of $6,000 and are paid $1,000 for each board meeting attended and $500 for each board committee meeting attended. Non-employee directors are also reimbursed for their reasonable out-of-pocket expenses incurred in attending board and committee meetings. In addition, the Career Education Corporation 1998 Non-Employee Directors' Stock Option Plan provides for annual option grants to each director who is not an employee. For a more detailed description of our stock plans, please see "--Stock Plans--Career Education Corporation 1998 Non-Employee Directors' Stock Option Plan." Compensation Committee Interlocks and Insider Participation Thomas B. Lally, Wallace O. Laub, Patrick K. Pesch and Scott D. Steele, who resigned as a director on January 23, 1998, served as the members of the Compensation Committee during 1998. Scott Steele resigned due to time constraints imposed by his work for Electra Fleming, Inc., of which Mr. Steele serves as a principal, and because of a general policy of Electra Fleming against its principals serving on the boards of publicly-held corporations in which Electra Fleming or any of its affiliates has an equity interest. We entered into a Registration Rights Agreement with Heller, dated as of February 3, 1998. Under this agreement, Heller is entitled, subject to certain exceptions, to demand that we register shares of common stock held by Heller on up to three occasions and to cause us to register such shares in any registration by us for our own account or for the account of other security holders. Executive Compensation The following table sets forth information with respect to all compensation paid by us for services rendered during the fiscal years ended December 31, 1997 and 1998, to our Chief Executive Officer and our other executive officer (each, a "Named Executive Officer"). 57 SUMMARY COMPENSATION TABLE
Annual Long Term Compensation Compensation ------------------ ------------ Securities Underlying All Other Name and Principal Positions Year Salary($) Bonus($) Options(#) Compensation ---------------------------- ---- --------- -------- ------------ ------------ John M. Larson, President and Chief Executive Officer.......... 1998 $308,333 $201,810 180,000(1) $ 7,659(2) 1997 $229,167 $143,000 21,105 $17,018(3) William A. Klettke, Senior Vice President and Chief Financial Officer..... 1998 $169,167 $ 73,815 45,000 $ 6,491(4) 1997 $152,500 $ 47,580 9,844 $ 6,771(5)
- -------- (1) On February 8, 1999, 80,000 of these options were cancelled and then reissued. The exercise price and vesting terms were not changed. (2) Includes $6,000 in 401(k) matching contributions by us and $1,659 in term life insurance premium payments by us. (3) Includes $8,594 in 401(k) matching contributions by us and $8,424 in term life insurance premium payments by us. (4) Includes $6,400 in 401(k) matching contributions by us and $91 in term life insurance premium payments by us. (5) Includes $6,100 in 401(k) matching contributions by us and $671 in term life insurance premium payments by us. OPTION GRANTS IN 1998 The following table contains information concerning the grant of stock options by us to our Named Executive Officers during 1998.
Percentage Number of of Total Potential Realizable Value Shares Options at Assumed Annual Rates of Underlying Granted to Stock Price Appreciation Options Employees Exercise or for Option Term (2) Granted in Fiscal Base Price Expiration --------------------------- Name (#) (1) Year ($/Sh) Date 5% ($) 10% ($) ---- ---------- ---------- ----------- ---------- ------------ -------------- John M. Larson.......... 60,000 10.2% $16.00 1/28/2008 $ 603,739 $ 1,529,993 120,000(3) 20.3% $26.25 7/28/2008 $ 990,509 $ 2,510,144 William A. Klettke...... 15,000 2.5% $16.00 1/28/2008 $ 150,935 $ 382,498 30,000 5.1% $26.25 7/28/2008 $ 247,627 $ 627,536
- -------- (1) These options were granted under the Career Education Corporation 1998 Employee Incentive Compensation Plan. Each of these options is an incentive stock option and vests in five equal annual installments on each of the first five anniversaries of the date grant. (2) Potential realizable value is presented net of the option exercise price, but before any federal or state income taxes associated with exercise, and is calculated assuming that the fair market value on the date of the grant appreciates at the indicated annual rates, compounded annually, for the term of the option. The 5% and 10% assumed rates of appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent our estimate or projection of future increases in the price of our common stock. Actual gains are dependent on the future performance of our common stock and the option holder's continued employment throughout the vesting periods. The amounts reflected in the table may not necessarily be achieved. (3) On February 8, 1999, 80,000 of these options were cancelled and then reissued. The exercise price and vesting terms were not changed. 58 FISCAL YEAR-END OPTION VALUES The following table contains information regarding the Named Executive Officers' unexercised options as of December 31, 1998. Neither of the Named Executive Officers exercised any options during 1998.
Number of Shares Underlying Unexercised Options Value of Unexercised in-the-Money as of December 31, Options as of December 31, 1998(#) 1998($)(1) ------------------------- --------------------------------- Name Exercisable/Unexercisable Exercisable/Unexercisable ---- ------------------------- --------------------------------- John M. Larson..... 131,878/185,840 $3,689,796/$1,465,142 William A. Klettke. 19,104/51,774 $466,923/$426,074
- -------- (1) The value per option is calculated by subtracting the exercise price of the option from the closing price of our common stock of $30.00 per share on December 31, 1998. Employment Agreement We have entered into an Employment and Non-Competition Agreement with Mr. Larson, dated as of October 9, 1997, which has an initial term ending July 31, 2000. This agreement is subject to successive, automatic employer extensions if we give written notice at least 90 days prior to the expiration date. The agreement provides for an initial base salary of $250,000 plus bonus compensation established by our board of directors. Effective July 29, 1998, Mr. Larson's base salary was increased to $350,000 per annum. The agreement provides for continuation of salary, bonus and benefits for one year following Mr. Larson's termination of employment with us, other than termination by us for "Cause" or termination by Mr. Larson without "Good Reason". Cause is defined under the agreement to include indictment or conviction of Mr. Larson on any felony criminal charges, willful misconduct or malfeasance in the performance of Mr. Larson's duties, and a material breach by Mr. Larson of the terms of the agreement. Good Reason includes a material breach by us of the terms of the agreement, a material change by us in Mr. Larson's duties or responsibilities and a change of control of us. The agreement also prohibits Mr. Larson from disclosing confidential information and prohibits him from engaging in activities competitive with us for a period which includes the term of his employment with us or service as one of our directors and continues for two years thereafter. However, if Mr. Larson's employment with us is terminated by us without "Cause" or by Mr. Larson for "Good Reason," the non-competition period will expire on the later of the termination of Mr. Larson's service as a director with us or six months after the termination of his employment. In such case, we may extend the non-competition period up to an additional 18 months if we pay Mr. Larson's base salary, a portion of his bonus and benefits during this additional period. If the term of the agreement expires and we refuse its renewal or Mr. Larson refuses its renewal for Good Reason, the non-competition period will expire on the later of the termination of Mr. Larson's employment or the termination of his service as a director. In such case, we may extend the non-competition period for up to an additional two years if we pay Mr. Larson's base salary, a portion of his bonus and benefits during this additional period. Stock Plans Career Education Corporation 1995 Stock Option Plan Effective August 1, 1995, our board of directors adopted the Career Education Corporation 1995 Stock Option Plan, pursuant to which options to acquire shares of common stock may be granted to employees, advisors, consultants and non-employee directors as may be determined by the option committee of the board of directors. As of December 31, 1998, options to acquire 145,022 shares of common stock were outstanding under the 1995 Stock Option Plan, and an additional 12,990 shares of common stock were reserved for issuance under the 1995 Stock Option Plan. The compensation committee of the board of directors serves as the option committee and administers the 1995 Stock Option Plan and determines with respect to each grant the number of shares subject to the option, the exercise price, the period of the option and the time at which the option may be exercised, as well as any terms and conditions of the option amount. Exercise prices may not be less than the fair market value of our common stock as determined by the option committee as of the date of issuance of each stock option. Options may be granted as either (1) incentive stock options, as defined in the 59 Internal Revenue Code, for which the option price must be at least 100% of the fair market value of the shares subject to the option on the grant date, or 110% in the case of an option granted to a person holding more than 10% of the voting power of all classes of our stock, and which are not exercisable after ten years from the grant date or five years in the event of an option granted to a 10% holder, or (2) non-qualified stock options, which are not subject to such restrictions. Career Education Corporation 1998 Employee Incentive Compensation Plan Our board of directors has adopted, and our stockholders have approved, the Career Education Corporation 1998 Employee Incentive Compensation Plan. The 1998 Employee Plan is a flexible plan that provides the compensation committee of the board of directors broad discretion to fashion the terms of the awards to provide eligible participants with stock-based and performance-related incentives as the compensation committee deems appropriate. The 1998 Employee Plan permits the issuance of awards in a variety of forms, including: (1) nonqualified and incentive stock options for the purchase of common stock, (2) stock appreciation rights, (3) restricted stock, (4) deferred stock, (5) bonus stock and awards in lieu of obligations, (6) dividend equivalents, (7) other stock-based awards and (8) performance awards and cash incentive awards. Options granted will provide for the purchase of common stock at prices determined by the compensation committee. The persons eligible to participate in the 1998 Employee Plan are officers, employees and consultants of us or any of our subsidiaries who, in the opinion of the compensation committee, contribute to the growth and success. The purpose of the 1998 Employee Plan is to promote our overall financial objectives by motivating eligible participants to achieve long-term growth in stockholder equity and to retain the association of these individuals. The 1998 Employee Plan is administered by the compensation committee. The 1998 Employee Plan provides for the award of up to 600,000 shares of common stock. At the discretion of the compensation committee, shares of common stock subject to an award under the 1998 Employee Plan that remain unissued upon termination of such award, are forfeited or are received by us as consideration for the exercise or payment of an award may be reissued under the 1998 Employee Plan. On February 17, 1999, our board of directors authorized that the total number of shares available under the 1998 Employee Plan be increased from 600,000 to 1,350,000 and that the total number of shares which may be granted to any participant under the 1998 Employee Plan in any fiscal year be increased from 100,000 to 250,000. In the event of a stock dividend, stock split, recapitalization, sale of substantially all of our assets, reorganization or other similar event, the compensation committee will adjust the aggregate number of shares of common stock subject to the 1998 Employee Plan and the number, class and price of shares subject to outstanding awards. Career Education Corporation 1998 Non-Employee Directors' Stock Option Plan Our board of directors has adopted, and our stockholders have approved, the Career Education Corporation 1998 Non-Employee Directors' Stock Option Plan. The 1998 Directors' Plan grants nonqualified stock options for the purchase of common stock to directors who are not our employees. The purpose of the 1998 Directors' Plan is to promote our overall financial objectives by motivating directors to achieve long-term growth in our stockholder equity, to further align the interest of such directors with those of our stockholders and to retain the association of these directors. The 1998 Directors' Plan is administered by the compensation committee. The 1998 Directors' Plan provides for the award of up to 200,000 shares of common stock. The 1998 Directors' Plan provides for (1) the grant of an option to purchase 8,000 shares of common stock to each participant who is a non- employee director on January 28, 1998 or, if after such date, the date such individual is first elected or appointed as a non-employee director and (2) a grant of an option to purchase 3,000 shares of common stock on the date of each regular annual stockholder meeting after the effective date of the 1998 Directors' Plan to each participant who is a non-employee director upon such date and either is continuing as a non-employee director subsequent to the meeting or who is elected at such meeting to serve as a non-employee 60 director, other than a meeting in the year of such participant's initial election or appointment. Options granted under the 1998 Directors' Plan provide for the purchase of common stock at the fair market value on the date of grant and become exercisable in three equal annual installments, commencing on the date of grant. No stock option granted under the 1998 Directors' Plan may be exercisable later than the tenth anniversary date of its grant. Career Education Corporation 1998 Employee Stock Purchase Plan Our board of directors has adopted, and our stockholders have approved, the Career Education Corporation 1998 Employee Stock Purchase Plan, effective as of April 1, 1998. A total of 500,000 shares of common stock have been reserved for issuance under the 1998 Stock Purchase Plan. The Stock Purchase Plan permits our eligible employees to purchase common stock through payroll deductions with all such deductions credited to an account under the Stock Purchase Plan. The 1998 Stock Purchase Plan operates on a calendar year basis. To be eligible to participate in the Stock Purchase Plan, an employee must file all requisite forms prior to a specified due date known as a "grant date." Initially, the first day of each calendar quarter of each year will be a grant date and the last day of each calendar quarter of each year will be an exercise date. However, the determination of the grant dates and the exercise dates are completely within the discretion of the compensation committee of the board of directors. On each exercise date, participants' payroll deductions credited to their accounts will be automatically applied to the purchase price of common stock at a price per share equal to 85% of the fair market value of our common stock on the exercise date. Employees may end their participation in the Stock Purchase Plan at any time during an offering period, and their payroll deductions to date will be refunded. Participation ends automatically upon termination of employment. Payroll deductions may not exceed $5,000 for any employee in any purchase period. No more than 25,000 shares in the aggregate may be issued to all participants in any purchase period. Employees are eligible to participate in the 1998 Stock Purchase Plan if they are customarily employed by us or a designated subsidiary. No person will be able to purchase common stock under the 1998 Stock Purchase Plan if such person, immediately after the purchase, would own stock possessing 5% or more of the total combined voting power or value of all outstanding shares of all classes of our stock. Limitation of Liability and Indemnification Matters Our Certificate of Incorporation contains provision which eliminate the personal liability of our directors to us or our stockholders for monetary damages for breach of their fiduciary duty as a director to the fullest extent permitted by the Delaware General Corporation Law except for liability (1) for any breach of their duty of loyalty to us or our stockholders, (2) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (3) for unlawful payments of dividends or unlawful stock repurchases or redemptions, or (4) for any transaction from which the director derived an improper personal benefit. These provisions will not affect a director's responsibilities under any other laws, such as the federal securities laws or state or federal environmental laws. Our Certificate of Incorporation also contains provisions which require us to indemnify our directors, and permit us to indemnify our officers and employees, to the fullest extent permitted by Delaware law, including those circumstances in which indemnification would otherwise be discretionary, except that we are not obligated to indemnify any such person (1) with respect to proceedings, claims or actions initiated or brought voluntarily by any such person and not by way of defense, or (2) for any amounts paid in settlement of an action indemnified against by us without our prior written consent. We have obtained directors' and officers' liability insurance and has entered into indemnity agreements with each of our directors providing for the indemnification described above. 61 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth information regarding the beneficial ownership of our common stock as of February 1, 1999 and as adjusted to reflect the sale of the shares of common stock being offered hereby by: (1) each person, or group of affiliated persons, known by us to beneficially own more than 5% of the outstanding shares of common stock, (2) each of our directors, (3) each of our Named Executive Officers, (4) each of the selling stockholders and (5) all of our directors and executive officers as a group. Unless otherwise indicated below, the persons in the table have sole voting and investment power with respect to all shares shown as beneficially owned by them.
Shares of Common Number of Stock Beneficially Shares of Shares of Common Stock Owned Prior to the Common Stock Beneficially Owned After Offering (1) Being Offered the Offering (1) ------------------------------------- --------------------------- Number Percent Number Number Percent ----------- ---------------------- -------------- ------------ Heller Equity Capital Corporation (2)........ 2,549,944 35.6 987,937 1,562,007 21.0 Electra Investment Trust P.L.C. and Electra Associates, Inc. (3)... 962,511 13.5 710,000 252,511 3.4 Baron Capital Group, Inc. (4)............... 560,000 7.8 -- 560,000 7.5 BankAmerica Corporation (5).................... 381,000 5.3 -- 381,000 5.1 John M. Larson.......... 165,350(6) 2.3 30,000 135,350 1.8 William A. Klettke (7).. 52,621 * -- 52,621 * Robert E. Dowdell (8)... 101,441 1.4 -- 101,441 1.4 Thomas B. Lally (9)..... 6,333 * -- 6,333 * Wallace O. Laub (10).... 32,151 * -- 32,151 * Keith K. Ogata (9)...... 30,333 * -- 30,333 * Patrick K. Pesch (11)... 10,133 * -- 10,133 * Mark A. Bounds.......... 16,063 * 6,000 10,063 * John M. Goense (12)..... 45,179 * 10,000 35,179 * John H. Underwood (13).. 16,063 * 6,063 10,000 * All directors and executive officers as a group (7 persons)............ 398,362 5.4 30,000 368,362 4.8
- -------- * Less than 1%. (1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. The number of shares beneficially owned by a person and the percentage ownership of that person includes shares of common stock subject to options held by that person that are currently exercisable or exercisable within 60 days of February 1, 1999 (including options that will become exercisable upon consummation of the offering). (2) As reported on a Schedule 13D/A filed with the Securities and Exchange Commission on February 1, 1999 jointly by The Fuji Bank, Limited, Fuji America Holdings, Inc., Heller Financial, Inc. and Heller Equity Capital Corporation ("HECC"). According to the Schedule 13D/A, HECC has sole voting and sole dispositive power with respect to 2,549,944 shares of common stock. The address of HECC is 500 West Monroe Street, Chicago, Illinois 60661. (3) As reported on a Schedule 13G filed with the Securities and Exchange Commission on February 16, 1999 jointly by Electra Investment Trust P.L.C. ("EIT") and Electra Associates, Inc. ("EAI"). According to the Schedule 13G, EIT has sole voting and sole dispositive power with respect to 887,305 shares of 62 common stock and EAI is (a) the nominee for certain foreign investors represented by Selectra Investment and Management Ltd. ("Selectra") and (b) the owner of record of 75,206 shares of common stock owned by such foreign investors. EAI votes and will dispose of such shares in accordance with Selectra's instructions. EIT and EAI are affiliated entities, and their address is c/o Electra Investment Trust P.L.C., 65 Kingsway, London, England WC2B 6QT. (4) As reported on a Schedule 13G filed with the Securities and Exchange Commission on January 22, 1999 jointly by Baron Capital Group, Inc., BAMCO, Inc., Baron Small Cap Fund and Ronald Baron (collectively, the "Baron Entities"). According to the Schedule 13G, each of the Baron Entities have shared voting and shared dispositive power with respect to 560,000 shares of common stock. The address of each of the Baron Entities is (or, in the case of Ronald Baron, is c/o) 767 Fifth Avenue, New York, NY 10153. (5) As reported on a Schedule 13G filed with the Securities and Exchange Commission on January 28, 1999 jointly by BankAmerica Corporation ("BAC"), Bank of America NT&SA ("B of A"), NB Holdings Corp. ("NBHC"), NationsBank NA ("NB"), NationsBanc Advisors Inc. ("NBAI") and TradeStreet Investment Associates ("TSIA"). According to the Schedule 13G, BAC has shared voting and shared dispositive power with respect to 381,100 shares of common stock, B of A has sole voting and sole dispositive power with respect to 13,200 shares of common stock, NBHC has shared voting and shared dispositive power with respect to 367,900 shares of common stock, NB has sole voting and sole dispositive power with respect to 50,300 shares of common stock and shared voting and shared dispositive power with respect to 317,600 shares of common stock, NBAI has shared voting and shared dispositive power with respect to 220,000 shares of common stock and TSIA has sole voting and sole dispositive power with respect to 317,600 shares of common stock. The address of BAC, NBHC, NBAI and TSIA is 100 North Tryon Street, Charlotte, NC 28255. The address of NB is 110 South Tryon Street, Charlotte, NC 28255. The address of B of A is 555 California Street, San Francisco, CA 94104. (6) Includes 149,718 shares of common stock which may be acquired by Mr. Larson upon the exercise of stock options which are currently exercisable or exercisable within sixty (60) days of February 1, 1999. Mr. Larson has also agreed to offer up to 20,000 additional shares in the over-allotment option. (7) Includes 22,104 shares of common stock which may be acquired by Mr. Klettke upon the exercise of stock options which are currently exercisable or exercisable within sixty (60) days of February 1, 1999. (8) Includes 2,834 shares of common stock held by Mr. Dowdell, as Custodian for Brian M. Dowdell under the Uniform Transfers to Minors Act; 2,834 shares of common stock held by Mr. Dowdell, as Custodian for Sharon T. Dowdell under the Uniform Transfers to Minors Act; 3,825 shares of common stock held by Robert E. Dowdell Defined Benefit Plan and Trust, under Agreement dated 12/9/96; 5,000 shares of common stock held by Mr. Dowdell and Grace C. Dowdell, as Trustees under a Trust Agreement dated July 1, 1991; and 42,313 shares of common stock which may be acquired by Mr. Dowdell upon the exercise of stock options which are currently exercisable or exercisable within sixty (60) days of February 1, 1999. (9) Includes 5,333 shares of common stock which may be acquired upon the exercise of stock options which are currently exercisable or exercisable within sixty (60) days of February 1, 1999. (10) Includes 10,668 shares of common stock which may be acquired upon the exercise of stock options which are currently exercisable or exercisable within sixty (60) days of February 1, 1999. (11) Includes 2,700 shares of common stock held by Mr. Pesch's individual retirement account, 1,100 shares of common stock held by Cathy Pesch's individual retirement account (Cathy Pesch is Mr. Pesch's spouse), 1,000 shares of common stock held in a joint account with Cathy Pesch and 5,333 shares of common stock which may be acquired upon the exercise of stock options which are currently exercisable or exercisable within sixty (60) days of February 1, 1999. (12) Represents shares of common stock held by Mr. Goense as Trustee for the John M. Goense Rev. Trust U/A/D 06/19/89. (13) Mr. Underwood was a Senior Vice President of Heller Financial, Inc. from July, 1995 through January, 1997 and a Vice President of Heller Equity Capital Corporation from July, 1989 through January, 1997. 63 DESCRIPTION OF CAPITAL STOCK Our authorized capital stock consists of 50,000,000 shares of common stock, $.01 par value per share, and 1,000,000 shares of preferred stock, $.01 par value per share. The following summarizes the material provisions of our Certificate of Incorporation and by-laws that are included as exhibits to the registration statement of which this prospectus is a part. We believe this summary contains a description of all of the material terms of our capital stock. Common Stock As of February 25, 1999, 7,167,445 shares of common stock were outstanding and held by 26 holders of record. Subject to the rights of holders of preferred stock, the holders of outstanding shares of common stock are entitled to share ratably in dividends declared out of assets legally available therefor at such time and in such amounts as the board of directors may from time to time lawfully determine. Each holder of common stock is entitled to one vote for each share held. Subject to the rights of holders of any outstanding preferred stock, upon our liquidation, dissolution or winding up, any assets legally available for distribution to stockholders as such are to be distributed ratably among the holders of our common stock at that time outstanding. All shares of common stock currently outstanding are, and all shares of common stock offered by hereby when duly issued and paid for will be, fully paid and nonassessable, not subject to redemption and assessment and without conversion, preemptive or other rights to subscribe for or purchase any proportionate part of any new or additional issues of any class or of securities convertible into stock of any class. Preferred Stock Preferred stock may be issued by us in series from time to time with such designations, relative rights, priorities, preferences, qualifications, limitations and restrictions thereof, to the extent that such are not fixed in our Certificate of Incorporation, as the board of directors determines. The rights, preferences, limitations and restrictions of different series of preferred stock may differ with respect to dividend rates, amounts payable on liquidation, voting rights, conversion rights, redemption provisions, sinking fund provisions and other matters. The board of directors may authorize the issuance of preferred stock which ranks senior to our common stock with respect to the payment of dividends and the distribution of assets on liquidation. In addition, the board of directors is authorized to fix the limitations and restrictions, if any, upon the payment of dividends on common stock to be effective while any shares of preferred stock are outstanding. The board of directors, without stockholder approval, may issue preferred stock with voting and conversion rights which could adversely affect the voting power of the holders of common stock. The issuance of preferred stock may have the effect of delaying, deferring or preventing a change in control of us. We have no present intention to issue shares of preferred stock. Certain Corporate Provisions We are subject to the provisions of Section 203 of the Delaware General Corporation Law. In general, this statute prohibits a publicly held Delaware corporation from engaging, under certain circumstances, in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person becomes an interested stockholder, unless either (1) prior to the date at which the stockholder became an interested stockholder the board of directors approved either the business combination or the transaction in which the person becomes an interested stockholder, (2) the stockholder acquires more than 85% of the outstanding voting stock of the corporation (excluding shares held by directors who are officers or held in certain employee stock plans) upon consummation of the transaction in which the stockholder becomes an interested stockholder or (3) the business combination is approved by the board of directors and by two- thirds of the outstanding voting stock of the corporation (excluding shares held by the interested stockholder) at a meeting of the stockholders (and not by written consent) held on or subsequent to the date of the business combination. An "interested stockholder" is a person who, together with affiliates and 64 associates, owns or at any time within the prior three years did own, 15% or more of the corporation's voting stock. Section 203 defines a "business combination" to include, without limitation, mergers, consolidations, stock sales and asset based transactions and other transactions resulting in a financial benefit to the interested stockholder. A business combination by us with Heller or Electra would not be prohibited by Section 203. Our Certificate of Incorporation and by-laws contain a number of provisions relating to corporate governance and to the rights of stockholders. Some of these provisions may be deemed to have a potential "anti-takeover" effect in that such provisions may delay, defer or prevent a change of control of us. These provisions include (1) a requirement that stockholder action may be taken only at stockholder meetings; (2) notice requirements in the by-laws relating to nominations to the board of directors and to the raising of business matters at stockholders meetings; and (3) the classification of the board of directors into three classes, each serving for staggered three year terms. See "Management--Directors and Executive Officers." Transfer Agent and Registrar The transfer agent and registrar for our common stock is Harris Trust and Savings Bank. SHARES ELIGIBLE FOR FUTURE SALE Upon completion of the offering, we will have an aggregate of approximately 7,447,445 shares of common stock outstanding, assuming no exercise of the underwriters' over-allotment option and no exercise of outstanding options. Substantially all of these shares will be freely tradable without restriction or further registration under the Securities Act of 1933, unless held by persons who are deemed to be our "affiliates" because they, directly or indirectly through one or more intermediaries control, or are controlled by, or are under common control, with us. Upon completion of the offering 1,719,567 shares will be held by our affiliates. All selling stockholders, directors, executive officers and some of our other current stockholders have agreed with the underwriters that, for a period of 90 days from the date of this prospectus, they will not offer to sell or otherwise sell, dispose of or grant rights with respect to any shares of common stock, now owned or hereafter acquired directly by such holders or with respect to which they have the power of disposition, otherwise than with the prior written consent of Credit Suisse First Boston Corporation. As a result of these contractual restrictions, notwithstanding possible earlier eligibility for sale under the provisions of Rules 144, 144(k) and 701 of the Securities Act of 1933, shares subject to lock-up agreements will not be salable until the agreements expire or unless prior written consent is received from Credit Suisse First Boston Corporation. Any early waiver of the lock-up agreements by the underwriters, which, if granted, could permit sales of a substantial number of shares and could adversely affect the trading price of our shares, may not be accompanied by an advance public announcement by us. In general, under Rule 144 a person, or persons whose shares are aggregated, who has beneficially owned "restricted shares" for at least one year, including persons who may be deemed our "affiliate," would be entitled to sell within any three-month period a number of shares that does not exceed the greater of one percent of the number of shares of common stock then outstanding or the average weekly trading volume of our common stock during the four calendar weeks preceding the filing of a Form 144 with respect to such sale. Sales under Rule 144 are also subject to manner of sale provisions and notice requirements and to the availability of current public information about us. In addition, a person who is not deemed to have been our affiliate at any time during the 90 days preceding a sale, and who has beneficially owned for at least two years the shares proposed to be sold, would be entitled to sell such shares under Rule 144(k) without regard to the requirements described above. We are unable to estimate accurately the number of restricted shares that will be sold under Rule 144 because this will depend in part on the market price for our common stock, the personal circumstances of the seller and other factors. 65 Upon consummation of the offering, options to purchase 872,384 shares of common stock will be issued and outstanding, of which options to purchase 280,978 shares of common stock will be exercisable. Registration Rights Under a registration rights agreement, Electra is entitled, subject to various exceptions, to demand that we register shares of common stock held by Electra on two or three occasions, depending on the circumstances, and to cause us to register such shares in any registration by us for our own account or for the account of other security holders. Additionally, at any time that we are eligible to use Commission Form S-3 for registration of securities, Electra will be entitled, subject to various exceptions, to cause us to register such shares held by Electra on a registration statement on Form S-3. Upon consummation of the offering, Electra will hold 252,511 shares covered by the registration rights agreement. Under a registration rights agreement, Heller is entitled, subject to various exceptions, to demand that we register shares of common stock held by Heller on up to three occasions and to cause us to register such shares in any registration by us for our own account or for the account of other security holders. Additionally, at any time that we are eligible to use Form S-3 for registration of securities, Heller will be entitled, subject to certain exceptions, to cause us to register such shares held by Heller on a registration statement on Form S-3. Upon consummation of the offering, Heller will hold 1,562,007 shares which will be covered by the registration rights agreement. Under a Stock Transfer and Registration Rights Agreement, Le Cordon Bleu is entitled, subject to certain exceptions, to cause us to register shares issued to them in connection with their license arrangement with us in any registration by us for our own account or for the account of other security holders through October 29, 2000. Le Cordon Bleu will be issued 50,601 shares of common stock upon completion of a program manual in connection with the license arrangement, which is currently expected to be in the first quarter of 1999, and an additional 50,601 shares of common stock one year after the completion of the manual. 66 UNDERWRITING Under the terms and subject to the conditions contained in an Underwriting Agreement dated , 1999, the underwriters named below, for whom Credit Suisse First Boston Corporation, Salomon Smith Barney Inc. and BancBoston Robertson Stephens Inc. are acting as representatives, have severally but not jointly agreed to purchase from the selling stockholders the following respective numbers of shares of common stock. Their obligations are subject to conditions contained in the Underwriting Agreement.
Number of Underwriter Shares ----------- --------- Credit Suisse First Boston Corporation.......................... Salomon Smith Barney Inc........................................ BancBoston Robertson Stephens Inc............................... Legg Mason Wood Walker, Incorporated............................ --------- Total....................................................... 2,000,000 =========
The Underwriting Agreement provides that the underwriters will be obligated to purchase all the shares of common stock in this offering (other than those shares covered by the over-allotment option described below) if any are purchased. The Underwriting Agreement provides that, in the event of a default by an underwriter, in certain circumstances the purchase commitments of non- defaulting underwriters may be increased or the Underwriting Agreement may be terminated. We and Mr. Larson have granted to the underwriters an option, expiring at the close of business on the 30th day after the date of this prospectus, to purchase up to 280,000 additional shares from us and 20,000 additional shares from Mr. Larson at the public offering price less the underwriting discounts and commissions, all as set forth on the cover page of this prospectus. Such option may be exercised only to cover over-allotments in the sale of the shares of common stock. To the extent such option is exercised, each underwriter will become obligated, subject to certain conditions, to purchase approximately the same percentage of such additional shares of common stock as it was obligated to purchase pursuant to the Underwriting Agreement. We and the selling stockholders have been advised by the representatives that the underwriters propose to offer shares of common stock to the public initially at the public offering price set forth on the cover page of this prospectus and, through the representatives, to selling group members at such price less a concession of $ per share, and the underwriters and such selling group members may allow a discount of $ per share on sales to certain other broker-dealers. After the public offering, the public offering price and concession and discount to broker-dealers may be changed by the representatives. The following table summarizes the compensation to be paid to the underwriters by the selling stockholders and us, and the expenses payable by us.
Total ------------------- Without With Per Over- Over- Share allotment allotment -------- --------- --------- Underwriting discounts and commissions paid by CEC.............................................. $ $ $ Expenses payable by CEC........................... $ $ $ Underwriting discounts and commissions paid by selling stockholders............................. $ $ $
We, our executive officers and directors and certain other of our current stockholders have agreed not to offer, sell, contract to sell, announce an intention to sell, pledge or otherwise dispose of, directly or indirectly, or file with the Securities and Exchange Commission a registration statement under the Securities Act of 1933 relating to, any shares of our common stock or securities or other rights convertible into or exchangeable or exercisable for any shares of our common stock without the prior written consent of Credit Suisse First Boston 67 Corporation, for a period of 90 days after the date of this prospectus, except that such restrictions will not apply to (1) our ability to grant employee or director stock options pursuant to the terms of a plan in effect on the date of this prospectus or issuance of common stock pursuant to the exercise of such options and (2) issuances of common stock to Le Cordon Bleu pursuant to its agreement with us. The underwriters have reserved for sale, at the public offering price, up to 60,000 shares of our common stock in this offering for employees, directors and other persons associated with us who have expressed an interest in purchasing such shares of our common stock in this offering. The number of shares available for sale to the general public in this offering will be reduced to the extent such persons purchase such reserved shares. Any reserved shares not so purchased will be offered by the underwriters to the general public on the same terms as the other shares offered hereby. We and the selling stockholders have agreed to indemnify the underwriters against certain liabilities, including civil liabilities under the Securities Act, or to contribute to payments which the underwriters may be required to make in respect thereof. The representatives, on behalf of the underwriters, may engage in over- allotment, stabilizing transactions, syndicate covering transactions, penalty bids and "passive" market making in accordance with Regulation M under the Securities Exchange Act of 1934. Over-allotment involves syndicate sales in excess of the offering size, which creates a syndicate short position. Stabilizing transactions permit bids for and purchases of our common stock so long as the stabilizing bids do not exceed a specified maximum. Syndicate covering transactions involve purchases of our common stock in the open market after the distribution has been completed in order to cover syndicate short positions. Penalty bids permit the underwriters to reclaim a selling concession from a syndicate member when our common stock originally sold by such syndicate member is purchased in a stabilizing transaction or syndicate covering transaction to cover syndicate short positions. In "passive" market making, market makers in our common stock who are underwriters or prospective underwriters may, subject to certain limitations, make bids for or purchases of our common stock until the time, if any, at which a stabilizing bid is made. Such stabilizing transactions, syndicate covering transactions and penalty bids may cause the price of our common stock to be higher than it would otherwise be in the absence of such transactions. These transactions may be effected on The Nasdaq National Market or otherwise and, if commenced, may be discontinued at any time. 68 NOTICE TO CANADIAN RESIDENTS Resale Restrictions The distribution of our common stock in Canada is being made only on a private placement basis exempt from the requirement that the Company and the selling stockholders prepare and file a prospectus with the securities regulatory authorities in each province where trades of common stock are effected. Accordingly, any resale of our common stock in Canada must be made in accordance with applicable securities laws which will vary depending on the relevant jurisdiction, and which may require resales to be made in accordance with available statutory exemptions or pursuant to a discretionary exemption granted by the applicable Canadian securities regulatory authority. Purchasers are advised to seek legal advice prior to any resale of our common stock. Representations of Purchasers Each purchaser of common stock in Canada who receives a purchase confirmation will be deemed to represent to the Company, the selling stockholders and the dealer from whom such purchase confirmation is received that (1) such purchaser is entitled under applicable provincial securities laws to purchase such common stock without the benefit of a prospectus qualified under such securities laws, (2) where required by law, that such purchaser is purchasing as principal and not as agent, and (3) such purchaser has reviewed the text above under "Resale Restrictions." Rights of Action (Ontario Purchasers) The securities being offered are those of a foreign issuer and Ontario purchasers will not receive the contractual right of action prescribed by Ontario securities law. As a result, Ontario purchasers must rely on other remedies that may be available, including common law rights of action for damages or rescission or rights of action under the civil liability provisions of the U.S. federal securities laws. Enforcement of Legal Rights All of the Company's directors and officers as well as the experts named herein and the selling stockholders may be located outside of Canada and, as a result, it may not be possible for Canadian purchasers to effect service of process within Canada upon the Company or such persons. All or a substantial portion of the assets of the Company and such persons may be located outside of Canada and, as a result, it may not be possible to satisfy a judgment against the Company or such persons in Canada or to enforce a judgment obtained in Canadian courts against such Company or persons outside of Canada. Notice to British Columbia Residents A purchaser of common stock to whom the Securities Act (British Columbia) applies is advised that such purchaser is required to file with the British Columbia Securities Commission a report within ten days of the sale of any common stock acquired by such purchaser pursuant to the offering. Such report must be in the form attached to British Columbia Securities Commission Blanket Order BOR #95/17, a copy of which may be obtained from the Company. Only one such report must be filed in respect of common stock acquired on the same date and under the same prospectus exemption. Taxation and Eligibility for Investment Canadian purchasers of common stock should consult their own legal and tax advisors with respect to the tax consequences of an investment in our common stock in their particular circumstances and with respect to the eligibility of our common stock for investment by the purchaser under relevant Canadian legislation. 69 LEGAL MATTERS The validity of our common stock offered hereby and other legal matters will be passed upon for us by Katten Muchin & Zavis, Chicago, Illinois. Certain legal matters in connection with this offering will be passed upon for the underwriters by Sidley & Austin, Chicago, Illinois. EXPERTS The consolidated financial statements and schedule of Career Education Corporation and its subsidiaries as of December 31, 1997 and 1998, and for each of the three years in the period ended December 31, 1998, and the financial statements of Scottsdale Culinary Institute, Inc. as of December 31, 1996 and 1997, and for each of the two years in the period ended December 31, 1997, included in this prospectus and elsewhere in the registration statement, have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their reports with respect thereto, and are included herein in reliance upon the authority of said firm as experts in giving said reports. The statements of consolidated operations and accumulated deficit and of cash flows of The Katharine Gibbs Schools, Inc. for the years ended December 31, 1995 and 1996 included in this prospectus have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report appearing herein and is included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing. WHERE YOU CAN FIND MORE INFORMATION This prospectus is part of a registration statement we filed with the SEC. This prospectus does not contain all of the information contained in the registration statement and all of the exhibits and schedules thereto. For further information about us, please see the complete registration statement. Summaries of agreements or other documents in this prospectus are not necessarily complete. Please refer to the exhibits to the registration statement for complete copies of such documents. We file annual, quarterly and special reports, proxy statements and other information with the SEC under the Exchange Act. The Exchange Act file number for our SEC filings is 0-23245. You may read and copy any document we file at the following SEC public reference rooms: 450 Fifth Street, N.W. Seven World Trade Center Citicorp Center Judiciary Plaza Suite 1300 500 West Madison Street Room 1024 New York, NY 10048 Suite 1400 Washington, D.C. 20549 Chicago, IL 60661 You may also inspect and copy our SEC filings, the complete registration statement and other information at the offices of The Nasdaq Stock Market located at 1735 K Street, N.W., Washington, D.C. 20006-1500. You may obtain information on the operation of the public reference room in Washington, D.C. by calling the SEC at 1-800-SEC-0330. We file information electronically with the SEC. Our SEC filings also are available from the SEC's Internet site at http://www.sec.gov, which contains reports, proxy and information statements, and other information regarding issuers that file electronically. 70 INDEX TO FINANCIAL STATEMENTS
Page ---- Consolidated Financial Statements of Career Education Corporation and Subsidiaries: Report of Independent Public Accountants................................ F-2 Consolidated Balance Sheets as of December 31, 1997 and 1998............ F-3 Consolidated Statements of Operations for the years ended December 31, 1996, 1997 and 1998.................................................... F-6 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998.................................................... F-8 Consolidated Statements of Stockholders' Investment for the years ended December 31, 1996, 1997 and 1998....................................... F-9 Notes to Consolidated Financial Statements.............................. F-11 Consolidated Financial Statements of The Katharine Gibbs Schools, Inc. and Subsidiaries: Independent Auditors' Report............................................ F-31 Statements of Consolidated Operations and Accumulated Deficit for the years ended December 31, 1995 and 1996................................. F-32 Statements of Consolidated Cash Flows for the years ended December 31, 1995 and 1996.......................................................... F-33 Notes to Consolidated Financial Statements.............................. F-34 Unaudited Condensed Consolidated Financial Statements of The Katharine Gibbs Schools, Inc. and Subsidiaries: Unaudited Condensed Consolidated Statements of Operations for the six months ended June 30, 1996 and five months ended May 31, 1997.......... F-37 Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1996 and five months ended May 31, 1997.......... F-38 Notes to Unaudited Condensed Consolidated Financial Statements.......... F-39 Financial Statements of Scottsdale Culinary Institute, Inc.: Report of Independent Public Accountants................................ F-40 Balance Sheets as of December 31, 1996 and 1997 and June 30, 1998 (unaudited)............................................................ F-41 Statements of Operations and Retained Earnings for the years ended December 31, 1996 and 1997 and the six months ended June 30, 1997 (unaudited) and 1998 (unaudited)....................................... F-42 Statements of Cash Flows for the years ended December 31, 1996 and 1997 and for the six months ended June 30, 1997 (unaudited) and 1998 (unaudited)............................................................ F-43 Notes to Financial Statements........................................... F-44
F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders of Career Education Corporation: We have audited the accompanying consolidated balance sheets of CAREER EDUCATION CORPORATION (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1997 and 1998 and the related consolidated statements of operations, stockholders' investment and cash flows for each of the three years in the period ended December 31, 1998. 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 audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Career Education Corporation and Subsidiaries as of December 31, 1997 and 1998 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. As described in Note 4 to the consolidated financial statements, effective January 1, 1998, the Company adopted the provisions of Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities." Arthur Andersen LLP Chicago, Illinois January 29, 1999 F-2 CAREER EDUCATION CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands)
December 31, --------------------- 1997 1998 -------- -------- ASSETS CURRENT ASSETS: Cash................................................... $ 18,906 $ 23,548 Receivables-- Students, net of allowance for doubtful accounts of $1,516 and $2,127 at December 31, 1997 and 1998, respectively........................................ 10,812 11,408 Other................................................ 1,346 999 Inventories, prepaid expenses and other current assets. 2,232 4,514 Deferred offering costs................................ 2,900 -- Deferred income tax assets............................. 406 459 -------- -------- Total current assets............................... 36,602 40,928 -------- -------- PROPERTY AND EQUIPMENT, net ............................. 45,555 46,403 INTANGIBLE ASSETS, net................................... 33,579 42,645 DEFERRED INCOME TAX ASSETS............................... -- 865 OTHER ASSETS............................................. 1,881 2,046 -------- -------- TOTAL ASSETS............................................. $117,617 $132,887 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-3 CAREER EDUCATION CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS--(Continued) (Dollars in thousands)
December 31, ------------------- 1997 1998 ------- ------- LIABILITIES AND STOCKHOLDERS' INVESTMENT CURRENT LIABILITIES: Current maturities of long-term debt..................... $ 3,888 $ 317 Accounts payable......................................... 3,580 2,425 Accrued expenses-- Payroll and related benefits........................... 1,605 2,944 Offering costs......................................... 2,447 -- Other.................................................. 3,800 9,089 Deferred tuition revenue................................. 7,476 10,159 ------- ------- Total current liabilities............................ 22,796 24,934 ------- ------- LONG-TERM DEBT, net of current maturities.................. 60,147 22,300 OTHER LONG-TERM LIABILITIES................................ 703 1,017 DEFERRED INCOME TAX LIABILITIES............................ 1,215 -- COMMITMENTS AND CONTINGENCIES.............................. REDEEMABLE PREFERRED STOCK AND WARRANTS Redeemable Series A preferred stock, $0.01 par value; 50,000 shares authorized; 7,852 shares outstanding at December 31, 1997, at liquidation value (stated value plus accumulated dividends); no shares authorized or outstanding at December 31, 1998........................ 10,112 -- Redeemable Series B preferred stock, $0.01 par value; 1,000 shares authorized; no shares outstanding at December 31, 1997; no shares authorized or outstanding at December 31, 1998.................................... -- -- Redeemable Series C preferred stock, $0.01 par value; 5,000 shares authorized; 4,954 shares outstanding at December 31, 1997, at liquidation value (stated value plus accumulated dividends); no shares authorized or outstanding at December 31, 1998........................ 4,784 -- Redeemable Series D preferred stock, $0.01 par value; 25,000 shares authorized; 22,500 shares outstanding at December 31, 1997, at liquidation value (stated value plus accumulated dividends); no shares authorized or outstanding at December 31, 1998........................ 22,175 -- Warrants exercisable into 202,297 shares of Class D common stock at December 31, 1997, at an exercise price of $0.01 per share, at estimated redemption value; no warrants outstanding at December 31, 1998............... 2,659 -- Warrants exercisable into 32,947 shares of Class E common stock at December 31, 1997, at an exercise price of $0.01 per share, at estimated redemption value; no warrants outstanding at December 31, 1998............... 430 -- ------- ------- Total redeemable preferred stock and warrants........ 40,160 -- ------- -------
The accompanying notes are an integral part of these consolidated financial statements. F-4 CAREER EDUCATION CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS--(Continued) (Dollars in thousands)
December 31, ----------------------- 1997 1998 -------- -------- STOCKHOLDERS' INVESTMENT: Common stock, $0.01 par value; 50,000,000 shares authorized; 7,152,896 shares issued and outstanding at December 31, 1998................................ $ -- $ 72 Class A common stock, $0.01 par value; 5,625,600 shares authorized; 49,224 shares issued and outstanding at December 31, 1997; no shares authorized or outstanding at December 31, 1998...... 1 -- Class B common stock, $0.01 par value; 937,600 shares authorized; 47,818 shares issued and outstanding at December 31, 1997; no shares authorized or outstanding at December 31, 1998.................... 1 -- Class C common stock, $0.01 par value; 937,600 shares authorized; 655,382 shares issued and outstanding at December 31, 1997; no shares authorized or outstanding at December 31, 1998.................... 7 -- Class D common stock, $0.01 par value; 937,600 shares authorized; no shares issued and outstanding at December 31, 1997; no shares authorized or outstanding at December 31, 1998.................... -- -- Class E common stock, $0.01 par value; 1,875,200 shares authorized; 16,380 shares issued and outstanding at December 31, 1997; no shares authorized or outstanding at December 31, 1998...... -- -- Preferred stock, $0.01 par value, 1,000,000 shares authorized, no shares issued and outstanding at December 31, 1998................................... -- -- Warrants............................................. 4,777 -- Additional paid-in capital........................... 71 95,481 Accumulated other comprehensive income............... (297) (822) Accumulated deficit.................................. (11,964) (10,095) -------- -------- Total stockholders' investment................... (7,404) 84,636 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' INVESTMENT......... $117,617 $132,887 ======== ========
The accompanying notes are an integral part of these consolidated statements. F-5 CAREER EDUCATION CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands)
For the Years Ended December 31, ------------------------- 1996 1997 1998 ------- ------- -------- REVENUE: Tuition and registration fees, net................. $29,269 $74,842 $132,926 Other, net......................................... 4,311 7,756 11,306 ------- ------- -------- Total net revenue.............................. 33,580 82,598 144,232 OPERATING EXPENSES: Educational services and facilities................ 14,404 34,620 57,151 General and administrative......................... 14,622 37,542 63,856 Depreciation and amortization...................... 2,134 8,121 12,163 Compensation expense related to the initial public offering.......................................... -- -- 1,961 ------- ------- -------- Total operating expenses....................... 31,160 80,283 135,131 ------- ------- -------- Income from operations......................... 2,420 2,315 9,101 INTEREST EXPENSE.................................... 717 3,108 1,250 ------- ------- -------- Income (loss) before provision for income taxes, extraordinary item and cumulative effect of change in accounting principle...... 1,703 (793) 7,851 PROVISION (BENEFIT) FOR INCOME TAXES................ 208 (331) 3,350 ------- ------- -------- Income (loss) before extraordinary item and cumulative effect of change in accounting principle..................................... 1,495 (462) 4,501 EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT, net of taxes of $233............................... -- (418) -- ------- ------- -------- Income (loss) before cumulative effect of change in accounting principle................ 1,495 (880) 4,501 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, net of taxes of $149............................... -- -- (205) ------- ------- -------- NET INCOME (LOSS)................................... $ 1,495 $ (880) $ 4,296 ======= ======= ========
The accompanying notes are an integral part of these consolidated statements. F-6 CAREER EDUCATION CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS--(continued) (In thousands, except per share amounts)
For the Years Ended December 31, ----------------------- 1996 1997 1998 ------ ------- ------ INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS: Income (loss) before extraordinary item and cumulative effect of change in accounting principle......................................... $1,495 $ (462) $4,501 Dividends on preferred stock....................... (1,128) (2,159) (274) Accretion to redemption value of preferred stock and warrants...................................... (230) (6,268) (2,153) ------ ------- ------ Income (loss) before extraordinary item and cumulative effect of change in accounting principle attributable to common stockholders.. 137 (8,889) 2,074 Extraordinary loss................................. -- (418) -- Cumulative effect of change in accounting principle......................................... -- -- (205) ------ ------- ------ Net income (loss) attributable to common stockholders................................... $ 137 $(9,307) $1,869 ====== ======= ====== INCOME (LOSS) PER SHARE ATTRIBUTABLE TO COMMON STOCKHOLDERS: Basic-- Income (loss) before extraordinary item and cumulative effect of change in accounting principle........................................ $ 0.18 $(11.58) $ 0.32 Extraordinary loss................................ -- (0.54) -- Cumulative effect of change in accounting principle........................................ -- -- (0.03) ------ ------- ------ Net income (loss)............................... $ 0.18 $(12.12) $ 0.29 ====== ======= ====== Diluted-- Income (loss) before extraordinary item and cumulative effect of change in accounting principle........................................ $ 0.13 $(11.58) $ 0.30 Extraordinary loss................................ -- (0.54) -- Cumulative effect of change in accounting principle........................................ -- -- (0.03) ------ ------- ------ Net income (loss)............................... $ 0.13 $(12.12) $ 0.27 ====== ======= ====== WEIGHTED AVERAGE SHARES OUTSTANDING: Basic.............................................. 761 768 6,521 ====== ======= ====== Diluted............................................ 1,030 768 6,797 ====== ======= ======
The accompanying notes are an integral part of these consolidated statements. F-7 CAREER EDUCATION CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
For the Year Ended December 31 -------------------------- 1996 1997 1998 ------- -------- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)................................ $ 1,495 $ (880) $ 4,296 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities-- Depreciation, amortization and debt discount... 2,188 8,239 12,163 Warrants issued to a bank...................... -- 180 -- Deferred income taxes.......................... (208) (1,013) (1,311) Extraordinary loss on early extinguishment of debt.......................................... -- 418 -- Cumulative effect of change in accounting principle..................................... -- -- 205 Compensation expense related to options........ -- -- 2,212 Gain on sale of property and equipment......... -- -- (14) Changes in operating assets and liabilities, net of acquisitions-- Receivables, net............................. 385 (5,208) (4,237) Inventories, prepaid expenses and other current assets.............................. (237) (3,959) 814 Deposits and other non-current assets........ -- -- (352) Accounts payable............................. (138) 4,808 (1,383) Accrued expenses and other liabilities....... 752 392 8,031 Deferred tuition revenue..................... 1,038 (3,171) 1,803 ------- -------- ------- Net cash provided by (used in) operating activities................................ 5,275 (194) 22,227 ------- -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Business acquisitions, net of cash............... (8,250) (39,855) (5,860) Acquisition and financing transaction costs...... -- (1,516) (372) Purchase of property and equipment, net.......... (1,231) (3,822) (6,383) Other assets..................................... (37) (21) (73) Proceeds from sale of property and equipment..... -- -- 332 ------- -------- ------- Net cash used in investing activities...... (9,518) (45,214) (12,356) ------- -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock......................... -- 30 52,765 Issuance of warrants............................. -- 4,789 -- Issuance of redeemable preferred stock and warrants........................................ -- 17,556 -- Dividends paid on preferred stock................ (495) (495) (47) Equity and debt financing costs.................. (553) (1,021) (7,085) Book overdraft................................... 683 (683) -- Payments of long-term debt....................... (1,309) (513) (8,295) Net proceeds (payments on) from revolving credit facility........................................ 1,500 (8,239) -- Proceeds from term loan facility................. 8,250 3,400 -- Repayments of term loan facility................. -- (11,650) -- Net proceeds (payments on) from revolving loans under Credit Agreement.......................... -- 39,985 (28,735) Proceeds from issuance of term loans under Credit Agreement....................................... -- 15,000 -- Payments on term loans under Credit Agreement.... -- (1,500) (13,500) ------- -------- ------- Net cash provided by (used in) financing activities................................ 8,076 56,659 (4,897) ------- -------- ------- EFFECT OF EXCHANGE RATE CHANGES ON CASH............ -- (143) (332) ------- -------- ------- NET INCREASE (DECREASE) IN CASH.................... 3,833 11,108 4,642 CASH, beginning of year............................ 3,965 7,798 18,906 ------- -------- ------- CASH, end of year.................................. $ 7,798 $ 18,906 $23,548 ======= ======== =======
The accompanying notes are an integral part of these consolidated statements. F-8 CAREER EDUCATION CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT
Common Stock ------------------------------------------------------------------------------------------------------------- Class A Class B Class C Class D Class E Common Stock ---------------- ---------------- ------------------ ---------------- ---------------- ------------------ 5,625,600 $0.01 937,600 $0.01 937,600 $0.01 937,600 $0.01 1,875,200 $0.01 50,000,000 $0.01 Shares Par Shares Par Shares Par Shares Par Shares Par Shares Par Authorized Value Authorized Value Authorized Value Authorized Value Authorized Value Authorized Value ---------- ----- ---------- ----- ---------- ------- ---------- ----- ---------- ----- ---------- ------- BALANCE, December 31, 1995........... 49,224 $ 492 47,818 $ 478 655,382 $ 6,554 -- $-- 7,726 $ 78 -- $ -- Net income........ -- -- -- -- -- -- -- -- -- -- -- -- Issuance of stock............. -- -- -- -- -- -- -- -- 7,726 77 -- -- Dividends paid.... -- -- -- -- -- -- -- -- -- -- -- -- Dividends on preferred stock for the year...... -- -- -- -- -- -- -- -- -- -- -- -- Preferred stock and warrant accretion......... -- -- -- -- -- -- -- -- -- -- -- -- ------- ----- ------- ----- -------- ------- --- ---- ------- ----- --------- ------- BALANCE, December 31, 1996........... 49,224 492 47,818 478 655,382 6,554 -- -- 15,452 155 -- -- Net loss.......... -- -- -- -- -- -- -- -- -- -- -- -- Foreign currency translation....... Total comprehensive income.......... Issuance of warrants.......... -- -- -- -- -- -- -- -- -- -- -- -- Exercise of warrants.......... -- -- -- -- -- -- -- -- 928 9 -- -- Dividends paid.... -- -- -- -- -- -- -- -- -- -- -- -- Dividends on preferred stock... -- -- -- -- -- -- -- -- -- -- -- -- Preferred stock and warrant accretion......... -- -- -- -- -- -- -- -- -- -- -- -- ------- ----- ------- ----- -------- ------- --- ---- ------- ----- --------- ------- BALANCE, December 31, 1997........... 49,224 492 47,818 478 655,382 6,554 -- -- 16,380 164 -- -- Net income........ -- -- -- -- -- -- -- -- -- -- -- -- Foreign currency translation....... -- -- -- -- -- -- -- -- -- -- -- -- Total comprehensive income.......... Preferred stock and warrant accretion......... -- -- -- -- -- -- -- -- -- -- -- -- Dividends......... -- -- -- -- -- -- -- -- -- -- -- -- Compensatory options........... -- -- -- -- -- -- -- -- -- -- -- -- Conversion of preferred and common stock...... (49,224) (492) (47,818) (478) (655,382) (6,554) -- -- (16,380) (164) 3,192,037 31,920 Issuance of common stock...... -- -- -- -- -- -- -- -- -- -- 3,288,279 32,883 Warrants exercised......... -- -- -- -- -- -- -- -- -- -- 657,267 6,573 Options exercised......... -- -- -- -- -- -- -- -- -- -- 15,313 153 ------- ----- ------- ----- -------- ------- --- ---- ------- ----- --------- ------- BALANCE, December 31, 1998........... -- $ -- -- $ -- -- $ -- -- $-- -- $ -- 7,152,896 $71,529 ======= ===== ======= ===== ======== ======= === ==== ======= ===== ========= ======= Total Amount ------- BALANCE, December 31, 1995........... $ 7,602 Net income........ -- Issuance of stock............. 77 Dividends paid.... -- Dividends on preferred stock for the year...... -- Preferred stock and warrant accretion......... -- ------- BALANCE, December 31, 1996........... 7,679 Net loss.......... -- Foreign currency translation....... Total comprehensive income.......... Issuance of warrants.......... -- Exercise of warrants.......... 9 Dividends paid.... -- Dividends on preferred stock... -- Preferred stock and warrant accretion......... -- ------- BALANCE, December 31, 1997........... 7,688 Net income........ -- Foreign currency translation....... -- Total comprehensive income.......... Preferred stock and warrant accretion......... -- Dividends......... -- Compensatory options........... -- Conversion of preferred and common stock...... 24,232 Issuance of common stock...... 32,883 Warrants exercised......... 6,573 Options exercised......... 153 ------- BALANCE, December 31, 1998........... $71,529 =======
The accompanying notes are an integral part of these consolidated statements. F-9 CAREER EDUCATION CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT (Continued)
Preferred Stock Warrants ---------------- ----------- Accumulated $0.01 par value, Class E Additional Other Total 1,000,000 shares Common Paid-in Comprehensive Accumulated Stockholders' authorized Stock Capital Income Deficit Investment ---------------- ----------- ----------- ------------- ------------ ------------- BALANCE, December 31, 1995................... $-- $ -- $ 29,904 $ -- $ (2,793,833) $(2,756,327) Net income............ -- -- -- -- 1,494,666 1,494,666 Issuance of stock..... -- -- 29,905 -- -- 29,982 Dividends paid........ -- -- -- -- (495,400) (495,400) Dividends on preferred stock................ -- -- -- -- (632,417) (632,417) Preferred stock and warrant accretion.... -- -- -- -- (229,975) (229,975) ---- ----------- ----------- --------- ------------ ----------- BALANCE, December 31, 1996................... -- -- 59,809 -- (2,656,959) (2,589,471) ---- ----------- ----------- --------- ------------ ----------- Net loss.............. -- -- -- -- (879,608) (879,608) Foreign currency translation.......... -- -- -- (296,602) -- (296,602) ----------- Total comprehensive income............. (1,176,210) Issuance of warrants.. -- 4,788,563 -- -- -- 4,788,563 Exercise of warrants.. -- (11,136) 11,127 -- -- -- Dividends paid........ -- -- -- -- (495,400) (495,400) Dividends on preferred stock................ -- -- -- -- (1,663,137) (1,663,137) Preferred stock and warrant accretion.... -- -- -- -- (6,268,478) (6,268,478) ---- ----------- ----------- --------- ------------ ----------- BALANCE, December 31, 1997................... -- 4,777,427 70,936 (296,602) (11,963,582) (7,404,133) ---- ----------- ----------- --------- ------------ ----------- Net income............ -- -- -- -- 4,296,048 4,296,048 Foreign currency translation.......... -- -- -- (525,238) -- (525,238) ----------- Total comprehensive income............. 3,770,810 Preferred stock and warrant accretion.... -- -- -- -- (2,152,834) (2,152,834) Dividends............. -- -- -- -- (274,424) (274,424) Compensatory options.. -- -- 2,171,635 -- -- 2,171,635 Conversion of preferred and common stock................ -- -- 38,746,072 -- -- 38,770,304 Issuance of common stock................ -- -- 45,786,186 -- -- 45,819,069 Warrants exercised.... -- (4,777,427) 8,540,301 -- -- 3,769,447 Options exercised..... -- -- 165,499 -- -- 165,652 ---- ----------- ----------- --------- ------------ ----------- BALANCE, December 31, 1998................... $-- $ -- $95,480,629 $(821,840) $(10,094,792) $84,635,526 ==== =========== =========== ========= ============ ===========
The accompanying notes are an integral part of these consolidated statements. F-10 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1996, 1997 and 1998 1. DESCRIPTION OF THE COMPANY Career Education Corporation ("CEC", collectively with its subsidiaries "we" or "our") owns and operates companies, which provide private, for-profit postsecondary education in North America. We operate 11 schools with 20 campuses that offer bachelor's degree, associate degree and non-degree programs in information technologies, visual communications and design technologies, business studies and culinary arts. 2. INITIAL PUBLIC OFFERING On February 4, 1998, we sold 3,277,500 shares of our common stock at $16.00 per share pursuant to an initial public offering ("IPO"). The net proceeds from the offering of $45.6 million were used to repay borrowings under the Credit Agreement (Note 6) totaling $41.5 million and amounts owed to former owners of acquired businesses of $4.1 million (Note 6) which were outstanding at that time. Prior to the consummation of the IPO, all outstanding shares of all series of preferred stock and accumulated dividends were converted into 2,423,485 shares of common stock and warrants (except for redeemable warrants exercisable into 32,947 shares of Class E common stock) to purchase 624,320 shares of common stock were exercised. Subsequent to December 31, 1997 and prior to the consummation of the IPO, we also authorized one class of preferred stock and one class of common stock, increased the number of authorized shares of common stock to 50,000,000 and completed a 9.376-for-1 stock split. The effect of the split has been retroactively reflected for all periods presented in the accompanying consolidated financial statements. 3. SIGNIFICANT ACCOUNTING POLICIES a. Principles of Consolidation The consolidated financial statements include the accounts of CEC and our wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in the consolidation. The results of operations of all acquired businesses have been consolidated for all periods subsequent to the date of acquisition. b. Concentration of Credit Risk We extend unsecured credit for tuition to a significant portion of the students who are in attendance at the campuses operated by our subsidiaries. A substantial portion of credit extended to students is repaid through the students' participation in various federally funded financial aid programs under Title IV of the Higher Education Act of 1965, as amended ("Title IV Programs"). The following table presents the amounts and percentages of the Company's U.S. institutions' cash receipts collected from Title IV Programs for the years ended December 31, 1996, 1997 and 1998 (such amounts were determined based upon each U.S. institution's cash receipts for the twelve-month period ended December 31, pursuant to the regulations of the United States Department of Education ("DOE") at 34 C.F.R. (S) 600.5):
For the Years Ended December 31, ------------------------------------ 1996 1997 1998 ----------- ----------- ------------ Total Title IV funding.............. $26,931,030 $54,963,232 $ 90,086,463 Total cash receipts................. $38,036,509 $85,046,951 $132,552,679 Total Title IV funding as a percentage of total cash receipts.. 71% 65% 68%
F-11 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 We generally complete and approve the financial aid packet of each student who qualifies for financial aid prior to the student's beginning class in an effort to enhance the collectibility of our unsecured credit. Transfers of funds from the financial aid programs are made in accordance with DOE requirements. Changes in DOE funding of Title IV Programs could impact our ability to attract students. c. Marketing and Advertising Costs Marketing and advertising costs are expensed as incurred. Marketing and advertising costs included in general and administrative expenses were $3,494,000, $10,640,000 and $16,915,000 for the years ended December 31, 1996, 1997 and 1998, respectively. d. Inventories Inventories consisting principally of program materials, books and supplies are stated at the lower of cost, determined on a first-in, first-out basis, or market. e. Property and Equipment Property and equipment are stated at cost. Depreciation and amortization are recognized utilizing the straight-line method over the useful lives of the related assets. Leasehold improvements and assets recorded under capital leases are amortized on a straight-line basis over their estimated useful lives or lease terms, whichever is shorter. Maintenance, repairs and minor renewals and betterments are expensed; major improvements are capitalized. The estimated cost basis and useful lives of property and equipment at December 31, 1997 and 1998, are as follows (dollars in thousands):
December 31, --------------- 1997 1998 Life ------- ------- ---------- Buildings..................................... $ 1,190 $ 846 31 years Classroom equipment, courseware and other instructional materials...................... 39,518 44,754 3-15 years Furniture, fixtures and equipment............. 7,768 7,722 3-10 years Leasehold improvements........................ 4,325 7,266 1-7 years Vehicles...................................... 17 17 5 years ------- ------- 52,818 60,605 Less--Accumulated depreciation and amortization................................. 7,263 14,202 ------- ------- $45,555 $46,403 ======= =======
The gross cost of assets recorded under capital leases included above amounts to $2,075,000 and $1,291,000 at December 31, 1997 and 1998, respectively. f. Intangible Assets Intangible assets include the excess of cost over fair market value of identifiable assets acquired through the business purchases described in Note 5. Goodwill is being amortized on a straight-line basis over their estimated useful lives. Covenants not-to-compete entered into before 1997 are being amortized on a straight-line basis over their useful lives. Those entered into during and after 1997 are being amortized on an F-12 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 accelerated method over their estimated useful lives. At December 31, 1997 and 1998, the cost basis and useful lives of intangible assets consist of the following (dollars in thousands):
December 31, --------------- Estimated 1997 1998 Lives ------- ------- --------- Goodwill........................................ $24,358 $38,080 40 years Covenants not-to-compete........................ 13,250 13,055 3-5 years ------- ------- 37,608 51,135 Less--Accumulated amortization.................. 4,029 8,490 ------- ------- $33,579 $42,645 ======= =======
On an ongoing basis, we review intangible assets and other long-lived assets for impairment whenever events or circumstances indicate that carrying amounts may not be recoverable. To date, no such events or changes in circumstances have occurred. If such events or changes in circumstances occur, we will recognize an impairment loss if the undiscounted future cash flows expected to be generated by the asset (or acquired business) are less than the carrying value of the related asset. The impairment loss would adjust the asset to its fair value. g. Revenue Recognition Revenue is derived primarily from programs taught at our schools. Tuition revenue is recognized on a straight-line basis over the length of the applicable course. Dormitory and cafeteria revenues charged to students are recognized on a straight-line basis over the length of the students' program. Other dormitory and cafeteria revenues are recognized as earned. Textbook sales and other revenues are recognized as services are performed. If a student withdraws, future revenue is reduced by the amount of the refund due to the student. Refunds are calculated in accordance with federal, state and accrediting agency standards. Deferred tuition revenue represents the portion of payments received but not earned and is reflected as a current liability in the accompanying consolidated balance sheets as such amount is expected to be earned within the next year. h. Management's Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. i. Income Taxes We file a consolidated federal income tax return and provide for deferred income taxes under the asset and liability method of accounting. This method requires the recognition of deferred income taxes based upon the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. F-13 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 j. Fair Value of Financial Instruments The carrying value of current assets and liabilities reasonably approximates their fair value due to their short maturity periods. The carrying value of our debt obligations reasonably approximates their fair value as the stated interest rate approximates current market interest rates of debt with similar terms. k. Accretion to Redemption Value of Preferred Stock and Warrants Accretion to redemption value of redeemable preferred stock and warrants represents the change in the redemption value of outstanding preferred stock and warrants, which is being accreted over the earliest period redemption can occur using the effective interest method. The redemption values are based on the estimated fair market values of the classes of stock and consider the amounts we have received for the sale of equity instruments, prices paid for acquired businesses and our operations. l. Income (Loss) Per Share Attributable to Common Stockholders We compute earnings per share in accordance with Financial Accounting Standard No. 128 "Earnings Per Share" which requires two calculations: basic earnings per share and diluted earnings per share. The calculations primarily differ by excluding dilutive common stock equivalents, convertible securities and contingently issuable securities using the treasury method, when computing basic earnings per share. The weighted average number of common shares used in determining basic and diluted net income (loss) per share attributable to common stockholders for the years ended December 31, 1996, 1997 and 1998 is as follows (in thousands):
For the Years Ended December 31, ---------------- 1996 1997 1998 ----- ---- ----- Common shares outstanding (basic)........................ 761 768 6,521 Common stock equivalents................................. 269 -- 259 Common stock contingently issuable....................... -- -- 17 ----- --- ----- Diluted.................................................. 1,030 768 6,797 ===== === =====
For the year ended December 31, 1997, antidilutive common stock equivalents totaling 568,332 were excluded from diluted weighted average number of common shares outstanding. Supplemental pro forma diluted income (loss) before extraordinary item and cumulative effect of change in accounting principle and net income (loss) per share attributable to common stockholders, had the debt retirement in connection with the consummation of the IPO occurred at the beginning of the year, would have been $(2.59) and $(2.73), respectively, for the year ended December 31, 1997 and $0.33 and $0.30, respectively, for the year ended December 31, 1998. This earnings per share data is computed based upon historical information adjusted for the reduction in interest expense resulting from the application of net proceeds from the IPO to reduce our indebtedness and pro forma weighted average number of shares of common stock outstanding which reflect the assumed sale of common stock in the IPO resulting in net proceeds sufficient to pay indebtedness as described in Note 2. F-14 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 m. Stock-Based Compensation We account for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and have adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," (SFAS No. 123) related to options and warrants issued to employees and directors. Expense associated with stock options and warrants issued to non-employees/non- directors is recorded in accordance with SFAS No. 123. n. Comprehensive Income In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"), which establishes standards for the reporting of comprehensive income. This pronouncement requires that all items recognized under accounting standards as components of comprehensive income, as defined in the pronouncement, be reported in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. We have adopted SFAS No. 130 at December 31, 1998 and have restated the Statements of Stockholders' Investment for all periods presented to reflect comprehensive income and accumulated other comprehensive income. o. Foreign Currency Translation We acquired the International Academy of Design, an entity with operations in Canada, on June 30, 1997. At December 31, 1997 and 1998, revenues and expenses related to these operations have been translated at average exchange rates in effect at the time the underlying transactions occurred. Transaction gains or losses are included in income. Assets and liabilities of this subsidiary have been translated at the year-end exchange rate, with gains and losses resulting from such translation being included in stockholders' investment at December 31, 1997 and 1998. p. Supplemental Disclosures of Cash Flow Information
For the Year Ended December 31 ------------------- 1996 1997 1998 ---- ------ ------- CASH PAID FOR-- Interest.............................................. $407 $3,008 $ 1,534 Taxes, excluding a refund of $900 in 1998............. 80 2,446 1,860 ==== ====== ======= NON-CASH INVESTING AND FINANCING ACTIVITIES: Accretion to redemption value of preferred stock and warrants............................................... $230 $6,268 $(2,153) Dividends on preferred stock added to liquidation value.................................................. 632 1,663 (227) Conversion of all Class A, B, C, and E common stock and all series of redeemable preferred stock into 3,192,037 shares of common stock in connection with the IPO. Value of the redeemable preferred stock at the date of conversion............................................. -- -- 38,776 ==== ====== =======
q. Segment Information We operate in one industry segment. Operations in geographic regions outside the United States are not significant. F-15 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 4. CHANGE IN ACCOUNTING PRINCIPLE In April 1998, the American Institute of Certified Public Accountants issued Statement of Position No. 98-5 ("SOP 98-5"), "Reporting on the Costs of Start- Up Activities." SOP 98-5 requires that all nongovernmental entities expense the costs of start-up activities (which include organization costs) as these costs are incurred. As prescribed by the literature, we adopted the provisions of SOP 98-5 in the fourth quarter of 1998, effective January 1, 1998, and recorded a net of tax charge of $205,000 representing the cumulative effect of the change in accounting principle. 5. BUSINESS ACQUISITIONS Western Culinary Institute (Western) On October 21, 1996, we acquired certain assets and assumed certain liabilities of Western Culinary Institute, a wholly owned subsidiary of Phillips College, Inc. This acquisition was accounted for as a purchase and, accordingly, the purchased assets and assumed liabilities have been recorded at their estimated fair market values at the date of the acquisition. The purchase price, as adjusted, of approximately $7,477,000 exceeded the fair market value of net assets acquired, resulting in goodwill of approximately $646,000. In connection with the purchase, the former owner of the school entered into a four-year covenant not-to-compete agreement with us for a total price of $400,000. At closing, we paid $7,000,000 to the former owner with funds obtained through bank financing, assumed a $150,000 obligation and deposited $1,250,000 into escrow. School of Computer Technology, Inc. (SCT) On February 28, 1997, through SCT Acquisition, Ltd., we acquired 100% of the outstanding shares of capital stock of School of Computer Technology, Inc. This acquisition was accounted for as a purchase and, accordingly, the acquired assets and assumed liabilities have been recorded at their estimated fair market values at the date of the acquisition. The purchase price, as adjusted, of approximately $4,944,000 exceeded the estimated fair market value of net assets acquired and liabilities assumed, resulting in goodwill of approximately $3,111,000. In connection with the purchase, we entered into a three-year covenant not-to-compete agreement with each of the former owners of the school for a total price of $1,750,000. At closing, we paid $400,000 to the former owners, deposited $5,000,000 into escrow, and assumed a $1,800,000 note payable due to the former owners. Funds paid were raised through the issuance of $2,000,000 of Series D preferred stock and warrants and $3,400,000 of bank borrowings. The note was paid subsequent to December 31, 1998. The Katharine Gibbs Schools, Inc. (Gibbs) On May 31, 1997, we acquired 100% of the outstanding shares of capital stock of The Katharine Gibbs Schools, Inc. Gibbs has seven wholly-owned subsidiaries, each of which owns and operates separate campuses. This acquisition was accounted for as a purchase and, accordingly, the acquired assets and assumed liabilities have been recorded at their estimated fair market values at the date of the acquisition. The estimated fair market values of certain assets are based upon preliminary appraisal reports. The purchase price, as adjusted, of approximately $19,029,000 exceeded the fair market value of net assets acquired and liabilities assumed, resulting in goodwill of approximately $8,434,000. In connection with the purchase, we also entered into a covenant not-to-compete agreement with the former owner of the schools in exchange for $7,000,000. The covenant not-to-compete restricts the former owners' ability to own or operate some types of for-profit postsecondary schools for five years. F-16 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 At closing, we paid $5,400,000 to the former owner and deposited $18,850,000 into escrow with borrowings of $12,500,000 from a new bank financing arrangement and $15,000,000 which was raised through the issuance of Series D preferred stock. International Academy of Merchandising & Design (IAMD) On June 30, 1997, through IAMD, Acquisition I, Ltd. we acquired 100% of the outstanding shares of capital stock of International Academy of Merchandising & Design for $3,000,000. Subsequent to the purchase, IAMD Acquisition I, Ltd. merged with and into International Academy of Merchandising & Design and assumed its name. In 1998, the purchase price was increased by approximately $4,700,000, pursuant to the earn-out provision in the purchase agreement. This acquisition was accounted for as a purchase and, accordingly, the acquired assets and assumed liabilities have been recorded at their estimated fair market values at the date of the acquisition. The purchase price exceeded the fair market value of net assets acquired and liabilities assumed, resulting in goodwill of approximately $8,395,000. In connection with the purchase, we also entered into covenant not-to- compete agreements with the former owners of the school in exchange for $2,000,000. The covenant not-to-compete restricts the former owners' ability to own or operate some types of for-profit postsecondary schools for four years. On June 30, 1997, we paid $100,000 to the former owners, issued $1,500,000 in notes payable to the former owners and issued letters of credit totaling $3,400,000 to secure amounts owed to the former owners to consummate these transactions. The funds to consummate these transactions were obtained through the issuance of Series D preferred stock and warrants and bank borrowings. The notes and amounts owed to former owners were paid upon the consummation of the IPO (Note 2). International Academy of Design (IAD) On June 30, 1997, we purchased 100% of the capital stock of International Academy of Design for $6,500,000. This acquisition was accounted for as a purchase and, accordingly, the acquired assets and assumed liabilities have been recorded at their estimated fair market values at the date of the acquisition. The estimated fair market values of certain assets are based upon preliminary appraisal reports. The purchase price, subject to certain modifications, exceeded the fair market value of net assets acquired and liabilities assumed, resulting in goodwill of approximately $5,648,000. In connection with the purchase, we entered into covenant not-to-compete agreements with the former owners of the school in exchange for $2,000,000. The covenant not-to-compete restricts the former owners' ability to own or operate certain types of postsecondary vocational schools for four years. On June 30, 1997, we paid $3,820,000 to the former owners, deposited $2,120,000 into escrow, and issued $2,550,000 in notes payable to the former owners to consummate these transactions. The funds to consummate these transactions were obtained through the issuance of Series D preferred stock and warrants and bank borrowings. The notes were paid upon consummation of the IPO (Note 2). Southern California School of Culinary Arts (SCSCA) On March 13, 1998, we purchased 100% of the outstanding shares of capital stock of Southern California School of Culinary Arts for $1,000,000. The acquisition was accounted for as a purchase and the purchase price exceeded the fair value of assets acquired and liabilities assumed resulting in goodwill of approximately $1,301,000. F-17 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 Scottsdale Culinary Institute, Inc. (SCI) On July 31, 1998, we acquired certain assets and assumed certain liabilities of Scottsdale Culinary Institute, Inc. for approximately $9,900,000. The acquisition was accounted for as a purchase and the purchase price exceeded the fair value of assets acquired and liabilities assumed, resulting in goodwill of approximately $7,900,000. Harrington Institute of Interior Design, Inc. (Harrington) On January 4, 1999, we acquired 100% of the outstanding shares of capital stock of the Harrington Institute of Interior Design, Inc. for $3,300,000, subject to adjustment. The acquisition will be accounted for as a purchase, with the excess of the purchase price over the net assets acquired, currently estimated to be $2,800,000, recorded as goodwill. Pro Forma Results of Operations The following unaudited pro forma results of operations (in thousands, except per share amounts) for the years ended December 31, 1996, 1997 and 1998, assume that the business acquisitions subsequent to January 1, 1996 described above occurred at the beginning of the year preceding the year of the acquisition. The pro forma results below are based on historical results of operations, include adjustments for depreciation, amortization, interest and taxes and do not necessarily reflect actual results that would have occurred.
For the Years Ended December 31, --------------------------- 1996 1997 1998 ------- -------- -------- (Unaudited) Net revenue........................................ $87,476 $111,310 $147,577 Income (loss) before extraordinary item and cumulative effect of change in accounting principle......................................... (5,051) (1,516) 4,565 Net income (loss).................................. (5,051) (1,934) 4,360 Income (loss) before extraordinary item and cumulative effect of change in accounting principle attributable to common stockholders..... (6,409) (9,944) 2,138 Net income (loss) attributable to common stockholders...................................... (6,409) (10,362) 1,933 ======= ======== ======== Basic income (loss) per share attributable to common stockholders-- Income (loss) before extraordinary item and cumulative effect of change in accounting principle....................................... $ (8.42) $ (12.95) $ 0.33 ======= ======== ======== Net income (loss).................................. $ (8.42) $ (13.49) $ 0.30 ======= ======== ======== Diluted income (loss) per share attributable to common stockholders-- Income (loss) before extraordinary item and cumulative effect of change in accounting principle....................................... $ (8.42) $ (12.95) $ 0.31 ======= ======== ======== Net income (loss)................................ $ (8.42) $ (13.49) $ 0.28 ======= ======== ========
F-18 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 6. DEBT Our long-term debt at December 31, 1997 and 1998, consists of the following:
December 31, --------------- 1997 1998 ------- ------- (in thousands) Borrowings under Credit Agreement with a syndicate of banks as discussed below-- Revolving loans............................................. $39,985 $11,250 Term loans.................................................. 13,500 --
Note payable to former owners of SCI, secured by bank letters of credit, bearing annual interest of 7%, currently payable... -- 9,029 Notes payable to former owners of SCT, bearing annual interest of 7%, principal due February 28, 2001, secured by bank letter of credit..................................................... 1,800 1,800 Notes payable to former owners of IAMD, bearing annual interest of 7%, repaid in connection with the IPO...................... 1,500 -- Amounts due to former owners of IAMD non-interest bearing, repaid in connection with the IPO............................. 3,400 -- Notes payable to former owners of IAD bearing annual interest of 7%, repaid in connection with the IPO...................... 2,550 -- Equipment under capital leases, secured by related equipment, discounted at a weighted average interest rate of 10.5%....... 1,279 523 Other.......................................................... 21 15 ------- ------- 64,035 22,617 Less--Current portion.......................................... 3,888 317 ------- ------- $60,147 $22,300 ======= =======
On May 30, 1997, we entered into a new credit agreement (the "Credit Agreement") with a bank (syndicated on September 25, 1997) and prepaid approximately $21,187,000 of outstanding revolving credit notes, term loans and other obligations under our previous credit agreement with borrowings from term loans and revolving credit notes which were permitted under the Credit Agreement at that time. On October 26, 1998, the Credit Agreement was amended. We can borrow, under the amended Credit Agreement, up to $60,000,000 under a revolving credit facility ("Revolving Loans") and can obtain up to $35,000,000 in letters of credit, however, outstanding letters of credit reduce the revolving credit facility availability. The amended Credit Agreement matures on October 26, 2003. Borrowings under the amended Credit Agreement bear interest, payable quarterly, at the bank's prime rate plus 0.50% (8.25% at December 31, 1998) or at LIBOR plus 1.75% (6.85% at December 31, 1998), at our election. Interest rates are subject to change based upon our funded debt levels relative to consolidated earnings before interest, taxes, depreciation and amortization on a pro forma basis for the last four fiscal quarters. We are also required to pay annual commitment fees of 0.25% on unused availability under the revolver and 1.5% for unused letters of credit. At December 31, 1998, we had outstanding, $11,250,000 in revolving credit borrowings and outstanding letters of credit totaling approximately $28,935,000 (to meet certain Department of Education financial responsibility requirements and to guarantee certain purchase price payments) under the Credit Agreement. At December 31, 1998, all borrowings were at the bank's prime rate plus 0.50%. Under our previous bank credit agreement, which we entered into in 1995, (the "Agreement") we were permitted to borrow, on a consolidated basis, $8,000,000 under a revolving credit note and $12,000,000 through a term loan. On May 30, 1997, in connection with entering into the Credit Agreement and prepaying F-19 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 all amounts outstanding under the Agreement, we expensed prepayment penalty fees and unamortized deferred financing costs and recorded an extraordinary loss on the early extinguishment of debt of $651,000, net of related tax benefit of $233,000. CEC and our subsidiaries have collectively guaranteed repayment of amounts outstanding under the Credit Agreement. In addition, we have pledged the stock of our subsidiaries as collateral for repayment of the debt. We may voluntarily make principal prepayments. Mandatory principal prepayments are required if we generate excess cash flows, as defined, sell certain assets, or upon the occurrence of certain other events. Under the Credit Agreement we are limited in our ability to take certain actions, including paying dividends, as defined, selling or disposing of certain assets or subsidiaries, making annual rental payments in excess of 15% of consolidated revenues in any given year, and issuing subordinated debt in excess of $5,000,000, among other things. We are required to maintain certain financial ratios, including a quarterly interest coverage ratio of at least 1.75:1, certain levels of consolidated net worth, and funded debt to consolidated earnings before interest, taxes, depreciation, and amortization of 3.50:1, among others. At December 31, 1998, we were in compliance with the covenants of the Credit Agreement, as amended. We intend to refinance amounts owed to former owners of acquired businesses as noted above through availability under our Credit Agreement and, therefore, such amounts have been classified as long-term. At December 31, 1998, future annual principal payments of long-term debt are as follows (in thousands): 1999............................. $ 317 2000............................. 153 2001............................. 1,861 2002............................. 7 2003............................. 20,279 ------- $22,617 =======
7. STOCKHOLDERS' INVESTMENT In connection with the consummation of the IPO on February 4, 1998, we amended and restated our certificate of incorporation to authorize a total of 50,000,000 shares of common stock ("Common Stock") and authorize 1,000,000 shares of preferred stock, with a par value of $0.01, and converted all classes of common stock described below into one class of Common Stock, with a par value of $0.01, at a rate of 9.376 shares of Common Stock for every share of existing common stock. The shares of common stock disclosed in these financial statements and notes hereto retroactively reflect this split. Prior to the IPO we had Class A, B, C, D, and E common stock. Class A and Class B common stock had voting rights while Class C, D and E common stock was nonvoting. Class B common stock was convertible into shares of Class A common stock at any time at the discretion of the holder at a ratio of 1:1. Class C common stock was convertible into shares of either Class A common stock or Class B common stock at any time at the discretion of the holder at a ratio of 1:1. Class D common stock was convertible into shares of Class A common stock, subject to certain restrictions. Class E common stock could only be converted into shares of Class A common stock upon the occurrence of certain events. 8. Redeemable Preferred Stock In connection with the IPO consummated on February 4, 1998, all classes of redeemable preferred stock described below were converted into 2,423,233 shares of Common Stock by dividing the liquidation value of preferred stock on that date (including all accrued paid-in-kind dividends) by $16.00, the initial public offering price of the common stock. F-20 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 Series A Series A and D preferred stock had a stated value of $1,000 per share, and its holders were entitled to receive dividends at an annual rate of 7% of the liquidation value per share ($1,000 per share plus dividends as defined). Dividends were paid in equal semiannual installments on January 31 and July 31 of each year by increasing the liquidation value of the Series A and D preferred stock. The mandatory redemption value of the Series A and D preferred stock was increased to reflect these dividends. On February 28, 1997, we entered into a securities purchase agreement with existing common and preferred stockholders to raise funds for acquisitions. The securities purchase agreement gave the stockholders the right to purchase up to 7,500 shares of Series D preferred stock for $1,000 per share and receive warrants to purchase 83,671 shares of Class E common stock at an exercise price of $.01 per share. Under this securities purchase agreement, we issued 7,500 shares of Series D preferred stock and warrants to purchase 83,671 shares of Class E common stock to existing stockholders in connection with the acquisition of SCT and Gibbs. The proceeds were allocated to preferred stock and warrants based upon their relative market values after considering issuance costs. On May 30, 1997, we entered into another securities purchase agreement with existing common and preferred stockholders to raise funds for additional acquisitions. The securities purchase agreement gave the stockholders the right to purchase up to an additional 15,000 shares of Series D preferred stock for $1,000 per share and receive warrants to purchase 339,280 shares of Class E common stock at an exercise price of $.01 per share. Under this securities purchase agreement, we issued 15,000 shares of Series D preferred stock and warrants to purchase 339,280 shares of Class E common stock to existing stockholders in connection with the acquisitions of Gibbs, IAMD and IAD. The proceeds were allocated to preferred stock and warrants based upon their relative market values after considering issuance costs. Series B Series B preferred stock had a stated value of $1,000 per share, and its holders were not entitled to any dividends on any outstanding shares. Series C Series C preferred stock had a stated value of $1,000 per share, and its holders were entitled to receive cash dividends at an annual rate of 10% of the liquidation value per share ($1,000 per share plus undeclared dividends as defined). Dividends were payable in equal quarterly installments on each March 31, June 30, September 30 and December 31. To the extent dividends were declared and not paid, they were added to the liquidation value. The Company paid all dividends through December 31, 1997 on Series C preferred stock. In July 1996, we increased the number of authorized shares of Series C preferred stock and completed a 10-for-1 stock split. The stock split has been retroactively reflected in the accompanying financial statements. 9. REDEEMABLE WARRANTS In connection with the issuance of Series C preferred stock during 1995, we issued warrants exercisable into 237,072 shares of Class D common stock. These warrants were subject to adjustment, exercisable at any time, and had an exercise price of $.01 per share. These warrants were adjusted to be 202,297 based upon the results of our operations through December 31, 1997 and were exercised in connection with the IPO (Note 2) during 1998. We accreted the difference between the value of the warrants at the date of issuance and the IPO date using the effective interest method. F-21 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 In connection with our previous credit agreement (Note 6), we issued warrants exercisable into 20,618 shares (subject to adjustment under certain circumstances) of Class D common stock. The warrants were exercisable at any time and had an exercise price of $.01 per share. Based upon the terms and provisions of the credit and warrant agreements, we assigned a value (based upon the relative fair market value of the debt and warrants) of $79,997 to these warrants. The fair market value of the warrants was determined with reference to the exercise price of the warrants, the fair market value of our common stock at the date the warrants were issued (considering its recent sale of stock to third parties) and the period the warrants can be exercised. In connection with the sales of Series D preferred stock through the various securities purchase agreements, the warrants were exchanged for warrants (with similar put and call features) to purchase 20,618 shares of Class E common stock and also increased to include additional warrants to purchase 12,329 shares of Class E common stock. The value of these additional warrants, totaling approximately $180,000 (based upon a Black-Scholes option pricing model with assumptions as described in Note 10) was recorded as interest expense in 1997. The warrant holder exercised the warrants in 1998. 10. STOCK OPTIONS AND WARRANTS Stock Options During 1994, certain stockholders were granted options to purchase up to a total of approximately 13.5% of the outstanding shares of our common stock. These options, which have an exercise price of $.10 per share, were to be earned and become exercisable based upon certain financial returns earned and realized in a cash payment by certain stockholders and are subject to other conditions. In July 1995, the option agreements were amended to reduce the total number of shares of common stock for which the options could be exercised to 11.5% of the outstanding shares, and a supplemental option agreement was entered into entitling one of these stockholders to purchase 20,618 shares of common stock at $0.01 per share. The supplemental option vests over a five year period. Under the supplemental option agreement, additional options to purchase a total of 8,579 shares of common stock at an exercise price of $0.01 per share were issued in 1997. These options vest over the same period as the initial supplemental option. On October 20, 1997, the original option agreements were further amended to fix the number of shares that the stockholders may exercise only upon completion of the IPO. Under these amended agreements, in addition to the options issued under the supplemental option agreement, the stockholders may purchase an aggregate of 122,615 shares of our common stock at any time after the IPO closing, but prior to January 1, 2004. These options fully vested upon the IPO closing. We recorded compensation expense of approximately $2.0 million related to these agreements in 1998. During 1995, we adopted the 1995 Stock Option Plan. Under this plan we can grant up to 160,568 options exercisable into shares of Class E common stock to certain members of management. The options vest and become exercisable in five equal annual installments commencing with the first anniversary of the grant, and expire 10 years from the date of grant, or earlier under certain circumstances. Options issued under the 1995 Stock Option Plan to purchase 92,101 shares of common stock were fully vested upon the consummation of the IPO. During 1998, we approved the 1998 Employee Incentive Compensation Plan. The plan provides for us to grant stock options, stock appreciation rights, restricted stock, deferred stock and other awards which are exercisable into shares of common stock to our directors, officers, employees and consultants. Stock options may be either incentive stock options or nonqualified stock options. No stock option or appreciation right shall be exercisable more than ten years after the date of grant. We have reserved 600,000 shares of common stock for distribution pursuant to awards issued under the plan. F-22 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 During 1998, we approved the 1998 Non-Employee Directors' Stock Option Plan. The plan provides for us to grant options to purchase shares of common stock to directors. Each person who is a non-employee director shall be granted an option to purchase 8,000 shares of common stock upon becoming a director and on an annual basis, as long as such director continues to serve as a director, shall receive an option to purchase 3,000 shares of common stock. Each option becomes exercisable in three equal annual installments and expires ten years from the date of grant. We have reserved 200,000 shares of common stock for issuance under the plan. Stock option activity under all of our stock option plans for the years ended December 31, 1996, 1997 and 1998, was as follows:
Weighted Average Exercise Shares Price Range Price ------- ------------ -------- Outstanding as of December 31, 1995............ 54,334 $ 3.88 $ 3.88 Granted...................................... 30,922 3.88 3.88 ------- Outstanding as of December 31, 1996............ 85,256 3.88 3.88 Granted...................................... 68,782 13.85-14.71 14.59 Cancelled.................................... (2,672) 3.88 3.88 ------- Outstanding as of December 31, 1997............ 151,366 3.88-14.71 8.75 Granted...................................... 638,050 16.00-26.25 22.47 Exercised.................................... (9,313) 3.88-16.00 13.44 Cancelled.................................... (16,531) 14.71-26.25 16.95 ------- Outstanding as of December 31, 1998............ 763,572 $ 3.88-26.25 $19.50 ======= ============ ====== Stock options exercisable at December 31, 1997............................ 26,853 $ 3.88 $ 3.88 ======= ============ ====== December 31, 1998............................ 126,450 $ 3.88-26.25 $ 8.07 ======= ============ ======
The following table summarizes information about all stock options outstanding as of December 31, 1998:
Options Outstanding Options Exercisable ------------------------------------------------- -------------------------------- Number Weighted Number Outstanding Weighted Average Exercisable Weighted as of Average Remaining at Average Exercise Price Ranges December 31, 1998 Exercise Price Contractual Life December 31, 1998 Exercise Price - --------------------- ----------------- -------------- ---------------- ----------------- -------------- $ 0.01-$ 3.88........... 226,520 $ 1.39 6.73 214,681 $ 1.46 $13.85-$16.00........... 301,914 15.70 8.95 43,741 14.98 $19.25-$26.25........... 380,950 25.82 9.55 2,000 26.25 ------- ------ ---- ------- ------ $ 0.01-$26.25........... 909,384 $16.38 8.64 260,422 $ 3.93 ======= ====== ==== ======= ======
F-23 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 The fair value of each option is estimated on the date of grant based on the Black-Scholes option pricing model and assumptions used to value the options. The weighted average fair value of the options granted during the years ended December 31, 1996, 1997 and 1998 and assumptions used to value the options are as follows:
For the Years Ended -------------------- 1996 1997 1998 ----- ----- ------ Dividend yield............................................ -- -- -- Risk-free interest rate................................... 5.7% 6.8% 8.0% Volatility................................................ -- -- 60% Expected life............................................. 10 10 10 Weighted average fair value of options granted............ $1.80 $2.58 $14.48
Warrants During 1997, in connection with the issuance of Class D preferred stock through the various securities purchase agreements, we issued warrants exercisable into a total of 422,951 shares of Class E common stock. These warrants were exercisable at any time, had an exercise price of $.01 per share and were exercised in connection with the consummation of the IPO. A summary of warrant activity, including redeemable warrants, for the years ended December 31, 1996, 1997 and 1998, is as follows:
Shares Under Warrant ------------------------------- Class D Class E Common Stock Common Stock --------------- --------------- Shares Price Shares Price -------- ----- -------- ----- Outstanding as of December 31, 1995.......... 257,690 $0.01 -- $ -- Issued..................................... -- -- -- -- -------- ----- -------- ----- Outstanding as of December 31, 1996.......... 257,690 0.01 -- -- Issued..................................... -- -- 435,281 0.01 Cancelled.................................. (34,776) 0.01 -- -- Exercised.................................. -- -- (928) 0.01 Exchanged.................................. (20,618) 0.01 20,618 0.01 -------- ----- -------- ----- Outstanding as of December 31, 1997.......... 202,296 0.01 454,971 0.01 Exercised.................................. (202,296) 0.01 (454,971) 0.01 -------- ----- -------- ----- Outstanding as of December 31, 1998.......... -- $ -- -- $ -- ======== ===== ======== ===== Warrants exercisable at December 31, 1997.... 202,296 $0.01 454,971 $0.01 ======== ===== ======== =====
The fair value of each warrant is estimated on the date of grant based on the Black-Scholes option pricing model assuming among other things, no dividend yield, a risk-free interest rate of 6.59%, an expected volatility of 0.70 and expected life of 8-10 years. F-24 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 Pro Forma Results Had we accounted for our stock options in accordance with SFAS No. 123, pro forma income (loss) before extraordinary item and cumulative effect of change in accounting principle and net income (loss), and pro forma income (loss) before extraordinary item and cumulative effect of charge in accounting principle and net income (loss) attributable to common stockholders would have been as follows (in thousands, except per share data):
December 31, ----------------------- 1996 1997 1998 ------- ------- ------ Pro forma income (loss) before extraordinary item and cumulative effect of change in accounting principle....................................... $ 1,475 $ (505) $3,754 Pro forma net income (loss)...................... 1,475 (923) 3,549 Pro forma income (loss) before extraordinary item and cumulative effect of change in accounting principle attributable to common stockholders... 117 (8,932) 1,327 Pro forma net income (loss) attributable to common stockholders............................. 117 (9,350) 1,122 ======= ======= ====== Pro forma diluted income (loss) before extraordinary item and cumulative effect of change in accounting principle per share attributable to common stockholders............. $ 0.11 $(11.63) $0.20 ======= ======= ====== Pro forma diluted net income (loss) per share attributable to common stockholders............. $ 0.11 $(12.17) $0.17 ======= ======= ======
The pro forma disclosure is not likely to be indicative of pro forma results which may be expected in future years because of the fact that options vest over several years, pro forma compensation expense is recognized as the options vest and additional awards may also be granted. 11. INCOME TAXES The provision (benefit) for income taxes for the years ended December 31, 1996, 1997 and 1998, consists of the following (in thousands):
For the Year Ended December 31, --------------------- 1996 1997 1998 ---- ------- ------ Current-- Federal.......................................... $150 $ 685 $3,688 State and local.................................. 260 (3) 973 ---- ------- ------ Total current.................................. 410 682 4,661 ---- ------- ------ Deferred-- Federal.......................................... (172) (578) (923) State and local.................................. (30) (76) (182) Foreign.......................................... -- (359) (206) ---- ------- ------ Total deferred................................. (202) (1,013) (1,311) ---- ------- ------ Total provision (benefit) for income taxes......... $208 $ (331) $3,350 ==== ======= ======
F-25 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 A reconciliation of the statutory U.S. federal income tax rate to the effective income tax rate for the years ended December 31, 1996, 1997 and 1998, is as follows:
Year Ended December 31, -------------------- 1996 1997 1998 ----- ----- ---- Statutory U.S. Federal income tax rate.............. 34.0 % (34.0)% 34.0% Foreign taxes....................................... -- (8.7) (0.3) State income taxes, net of Federal benefit.......... 10.0 (6.6) 6.7 Permanent differences and other..................... 4.8 7.6 2.3 Valuation allowance................................. (36.6) -- -- ----- ----- ---- Effective income tax rate........................... 12.2% (41.7)% 42.7% ===== ===== ====
Components of deferred income tax assets and liabilities consist of the following at December 31, 1997 and 1998 (in thousands):
December 31, -------------- 1997 1998 ------ ------ Deferred income tax assets: Tax net operating loss carryforwards.......................... $ 891 $1,788 Stock options................................................. -- 872 Allowance for doubtful accounts............................... 285 320 Amortization on covenants not-to-compete...................... 926 2,086 Other......................................................... 121 488 ------ ------ Total deferred income tax assets............................ 2,223 5,554 ------ ------ Deferred income tax liabilities: Depreciation and amortization................................. 3,032 4,134 Other......................................................... -- 95 ------ ------ Total deferred income tax liabilities....................... 3,032 4,229 ------ ------ Net deferred income tax (liability) asset................... $ (809) $1,325 ====== ======
We have purchased certain tax net operating loss carryforwards in connection with our business acquisitions. At December 31, 1998 we have federal and state net operating loss carryforwards totalling $1.5 million and $8.4 million respectively. We have not recorded a valuation allowance because we believe that deferred income tax assets will be realized in the future. 12. COMMITMENTS AND CONTINGENCIES Litigation We are subject to occasional lawsuits, investigations and claims arising out of the normal conduct of our business. In some cases, claims against acquired businesses relating to events which occurred during the periods we did not own them are indemnified by the former owners. Management does not believe the outcome of any pending claims will have a material adverse impact on our financial position or results of operations. Leases We rent most of our school facilities and certain equipment under non- cancelable operating leases expiring at various dates through 2009. The facility leases require us to make monthly payments covering rent, taxes, insurance and maintenance costs. Rent expense, exclusive of taxes, insurance and maintenance of the facilities and equipment for the years ended December 31, 1996, 1997 and 1998 was approximately $2,649,000, $8,049,000, and $14,304,000, respectively. F-26 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 Future minimum lease payments under these leases as of December 31, 1998, are as follows (in thousands):
Capital Operating Leases Leases Total ------- --------- ------- 1999........................................... $382 $14,375 $14,757 2000........................................... 193 13,468 13,661 2001........................................... 75 11,550 11,625 2002........................................... 9 8,822 8,831 2003........................................... -- 7,833 7,833 2004 and thereafter............................ -- 24,432 24,432 ---- ------- ------- 659 $80,480 $81,139 ======= ======= Less--Portion representing interest at a weighted average rate of 10.5%................ 136 ---- Principal payments............................. 523 Less--Current portion.......................... 302 ---- $221 ====
On October 29, 1998, we entered into an agreement with Le Cordon Bleu Limited granting us exclusive rights to use the "Le Cordon Bleu" name in the United States and Canada in connection with our culinary education programs. We are developing a curriculum with Le Cordon Bleu for use at our culinary schools and upon approval of the curriculum, we will issue Le Cordon Bleu 50,601 shares of Common Stock and one year later an additional 50,601 shares of Common Stock. Under this agreement we will also pay Le Cordon Bleu royalties based on tuition collected from students enrolled in Le Cordon Bleu programs at our schools. The agreement expires on December 31, 2008 but can be renewed for two successive five year terms. 13. REGULATORY CEC and our U.S. schools are subject to extensive regulation by federal and state governmental agencies and accrediting bodies. In particular, the Higher Education Act ("HEA"), and the regulations promulgated thereunder by the U.S. Department of Education ("DOE") subject our U.S. schools to significant regulatory scrutiny on the basis of numerous standards that schools must satisfy in order to participate in the various federal student financial assistance programs under Title IV of the HEA ("Title IV Programs"). To participate in the Title IV Programs, an institution must be authorized to offer its programs of instruction by the relevant agencies of the state in which it is located, accredited by an accrediting agency recognized by the DOE and certified as eligible by the DOE. The DOE will certify an institution to participate in the Title IV Programs only after the institution has demonstrated compliance with the HEA and the DOE's extensive regulations regarding institutional eligibility. An institution must also demonstrate its compliance to the DOE on an ongoing basis. Political and budgetary concerns significantly affect the Title IV Programs. Congress must reauthorize the HEA approximately every six years. The most recent reauthorization in October 1998 reauthorized the HEA for an additional five years (the "1998 HEA Reauthorization"). Congress reauthorized all of the Title IV Programs in which our schools participate, generally in the same form and at funding levels no less than for the prior year. Changes made by the 1998 HEA Reauthorization include (i) expanding the adverse effects on schools of high student loan default rates, (ii) increasing from 85% to 90% the portion of a proprietary school's revenue that may be derived each year from the Title IV Programs, (iii) revising the refund standards that require an F-27 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 institution to return a portion of the Title IV Program funds for students who withdraw from school and (iv) giving the Department of Education flexibility to continue an institution's Title IV participation without interruption in some circumstances following a change of ownership or control. A significant component of Congress' initiative to reduce abuse in the Title IV Programs has been the imposition of limitations on institutions whose former students default on the repayment of their federally guaranteed or funded student loans above specific rates (cohort default rate). An institution whose cohort default rates equal or exceed 25% for three consecutive years will no longer be eligible to participate in the FFEL or FDL programs. An institution whose cohort default rate under certain Title IV programs for any federal fiscal year exceeds 40% may have its eligibility to participate in all of the Title IV Programs limited, suspended or terminated by the DOE. All institutions participating in the Title IV Programs must satisfy specific standards of financial responsibility. The DOE evaluates institutions for compliance with these standards each year, based on the institution's annual audited financial statements and following a change of ownership of the institution. In reviewing our financial statements, it has been the DOE's practice to measure financial responsibilities on the basis of the financial statements of both our institutions and CEC on a consolidated basis. Under new regulations which took effect July 1, 1998, the DOE calculates the institution's composite score based on its (i) equity ratio, which measures the institution's capital resources, ability to borrow and financial viability; (ii) primary reserve ratio, which measures the institution's ability to support current operations from expendable resources; and (iii) net income ratio, which measures the institution's ability to operate at a profit. An institution that does not meet the DOE's minimum composite score may demonstrate its financial responsibility by posting a letter of credit in favor of the DOE in an amount equal to at least 50% of the Title IV Program funds received by the institution during its prior fiscal year and possibly accepting other conditions on its participation in the Title IV Programs. In periodic reviews of our financial statements for 1997 and prior years, as well as our February 28, 1998 balance sheet reflecting the results of our initial public offering, the DOE has questioned certain accounting matters and has found that we and certain of our institutions, when measured on an individual basis failed the numeric tests under the DOE's former and current standards of financial responsibility. To satisfy the DOE's concerns, we have posted letters of credit on behalf of all institutions we have acquired since October 1996 except Harrington. The DOE reduced the number and amount of our letters of credit in September 1998 following its review of our 1997 financial statements and our February 28, 1998 balance sheet. The DOE also noted that the funds derived from our initial public offering, shortly after the close of our 1997 fiscal year, would have a positive effect on our financial responsibility. As a result, we currently have posted letters of credit totaling approximately $17.6 million on behalf of Gibbs, IAMD, Scottsdale, SCSCA, and Western. We intend to file our audited 1998 financial statements with the DOE early in 1999 and to ask it to release most, if not all, of our outstanding letters of credit and to increase or eliminate the Title IV Program funding limitation for SCSCA. At December 31, 1998, we believe, based on our audited 1998 financial statements, that we satisfy each of the DOE's standards of financial responsibility and may participate in Title IV Programs without additional monitoring. However, we believe that two of our institutions, while considered financially responsible, may be subject to additional monitoring by the DOE. In the event that the DOE does not measure the financial responsibility of such institutions on the basis of the financial position of CEC, the DOE may require us to post letters of credit on behalf of such institutions. Such letters of credit, which would be calculated on an institution-specific basis, would be in amounts substantially less than the letters of credit we F-28 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 currently have outstanding. To the extent the outstanding letters of credit are reduced or eliminated based upon the DOE's review, we will have additional availability under the Credit Agreement. The DOE also assesses the administrative capability of each institution that participates in the Title IV Program. In addition, each institution is required to apply to the DOE for continued certification to participate in the Title IV Programs at least every six years, or when it undergoes a change of control, opens an additional location or raises the highest academic credential it offers. When we acquire an institution that is eligible to participate in the Title IV Programs, that institution undergoes a change of ownership resulting in a change of control ("change of control") as defined by the DOE. Upon a change of control, an institution's eligibility to participate in the Title IV Programs is generally suspended until it has applied for and been recertified by the DOE as an eligible institution under our ownership, which requires that the institution also reestablish its state authorization and accreditation. If an institution is recertified following a change of control, it will be on a provisional basis. The 1998 HEA Reauthorization provides that the DOE may provisionally and temporarily certify an institution undergoing a change of control under certain circumstances while the DOE reviews the institution's application. The DOE has not yet issued regulations or guidance regarding how it will interpret or apply this amendment to the HEA. Each of the U.S. institutions we have acquired has undergone a certification review under our ownership and has been certified to participate in the Title IV Programs, with the exception of Harrington, which we acquired in January, 1999. Each of the U.S. institutions we have acquired has undergone a certification review under our ownership and has been certified to participate in the Title IV Programs, with the exception of Harrington, which we acquired in January 1999. In Canada, there are several government programs which provide students attending eligible institutions with government funding. The provisions governing an eligible institution vary by province and generally require an institution's programs qualifying for funding to meet certain rules and regulations and also to have the administration of the program independently audited. 14. RELATED-PARTY TRANSACTIONS We have short-term employment and consulting agreements with certain stockholders. Total expenses under these agreements were approximately $298,000, $367,000 and $493,000, for the years ended December 31, 1996, 1997 and 1998, respectively. 15. EMPLOYEE BENEFIT PLANS We maintain a contributory profit sharing plan established pursuant to the provisions of Section 401(k) of the Internal Revenue Code that provides retirement benefits for our eligible employees. This plan requires matching contributions to eligible employees. Our matching contributions were $279,000, $400,000, and $699,000 for the years ended December 31, 1996, 1997 and 1998, respectively. F-29 CAREER EDUCATION CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 We maintain an employee stock purchase plan which provides for the issuance of up to 500,000 shares of common stock to be purchased by our eligible employees through periodic offerings. Our employees may purchase common stock through payroll deductions (not to exceed $20,000 per person within any calendar year) at 85% of the fair market value. F-30 INDEPENDENT AUDITORS' REPORT To the Board of Directors of Career Education Corporation Hoffman Estates, Illinois We have audited the accompanying statements of consolidated operations and accumulated deficit and of cash flows of The Katharine Gibbs Schools, Inc. and subsidiaries (a wholly-owned subsidiary of PRIMEDIA Inc., formerly K-III Communications Corporation) (the "Company") for the years ended December 31, 1995 and 1996. 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 audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the results of the Company's operations and its cash flows for the years ended December 31, 1995 and 1996 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP New York, New York October 27, 1997 F-31 THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED OPERATIONS AND ACCUMULATED DEFICIT For the Years Ended December 31, 1995 and 1996 (Dollars In Thousands)
1995 1996 ------- ------- REVENUES: Tuition and registration fees, net......................... $22,343 $25,831 Other, net................................................. 2,507 2,932 ------- ------- Total revenues........................................... 24,850 28,763 ------- ------- OPERATING COSTS AND EXPENSES: Instruction................................................ 5,945 6,427 Selling, general and administrative........................ 16,937 18,991 Depreciation and amortization.............................. 2,400 2,235 Management fees charged by PRIMEDIA Inc.................... 354 397 ------- ------- Total operating costs and expenses....................... 25,636 28,050 ------- ------- INCOME (LOSS) FROM OPERATIONS................................ (786) 713 INTEREST EXPENSE............................................. 1,394 1,038 ------- ------- NET LOSS..................................................... (2,180) (325) ACCUMULATED DEFICIT, BEGINNING OF YEAR....................... (256) (2,436) ------- ------- ACCUMULATED DEFICIT, END OF YEAR............................. $(2,436) $(2,761) ======= =======
See notes to consolidated financial statements. F-32 THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS For the Years Ended December 31, 1995 and 1996 (Dollars In Thousands)
1995 1996 ------- ------- OPERATING ACTIVITIES: Net loss.................................................... $(2,180) $ (325) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization.............................. 2,400 2,235 Changes in operating assets and liabilities: (Increase) decrease in: Accounts receivable--students............................ 463 397 Accounts receivable--other............................... (195) (174) Prepaid expenses and other current assets................ (121) 496 Other non-current assets................................. (29) (75) Increase (decrease) in: Accounts payable and accrued expenses.................... 1,087 (209) Advance student payments and other current liabilities... (1,158) 14 Deferred tuition revenue................................. 639 (655) Other non-current liabilities............................ 199 152 ------- ------- Net cash provided by operating activities............. 1,105 1,856 ------- ------- INVESTING ACTIVITIES: Purchases of property and equipment......................... (1,025) (1,157) Investment in Perkins loan program, net..................... 9 21 ------- ------- Net cash used in investing activities................. (1,016) (1,136) ------- ------- FINANCING ACTIVITIES: Principal payments under capital lease obligations.......... (85) (103) Increase in payable to PRIMEDIA Inc......................... 1,666 172 ------- ------- Net cash provided by financing activities............. 1,581 69 ------- ------- NET INCREASE IN CASH......................................... 1,670 789 CASH, BEGINNING OF PERIOD.................................... 3,837 5,507 ------- ------- CASH, END OF PERIOD.......................................... $ 5,507 $ 6,296 ======= ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid............................................... $ 26 $ 16 ======= ======= NON-CASH INVESTING AND FINANCING ACTIVITIES-- Equipment acquired under capital lease obligations.......... $ 57 $ 86 ======= =======
See notes to consolidated financial statements. F-33 THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Years Ended December 31, 1995 and 1996 (Dollars In Thousands) 1. DESCRIPTION OF THE BUSINESS AND GENERAL The Katharine Gibbs Schools, Inc. (which together with its subsidiaries is herein referred to as the "Company") is headquartered in New York, New York, and has wholly-owned subsidiary campuses in New York, New York; Melville, New York; Boston, Massachusetts; Montclair, New Jersey; Piscataway, New Jersey; Norwalk, Connecticut; and Providence, Rhode Island. The schools are private post-secondary vocational schools which are engaged in the instruction of business career education programs leading towards degrees or certificates of completion in secretarial arts, business administration, hospitality management, and hotel and restaurant management. On March 7, 1994, the operating assets and liabilities of the Company were acquired from Phillips Colleges, Inc. by The Katharine Gibbs Schools, Inc. (formerly K-III KG Holdings Corporation), a wholly-owned subsidiary of PRIMEDIA Inc. (formerly K-III Communications Corporation) (the ultimate parent company, "PRIMEDIA"). 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation--The consolidated financial statements include the accounts of The Katharine Gibbs Schools, Inc. and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Concentration of Credit Risk--The Company extends unsecured credit for tuition to a significant portion of the students who are in attendance at the schools. A substantial portion of credit extended to students is repaid through the student's participation in Federally funded financial aid programs. The Company generally completes and approves the financial aid packet of each student who qualifies for financial aid prior to the student's beginning of class in an effort to enhance the collectibility of its unsecured credit. Transfers of funds from the financial aid programs to the Company are made in accordance with the United States Department of Education (the "DOE") requirements. The Company participates in various Federal student financial aid programs under Title IV of the Higher Education Act of 1965, as amended ("Title IV Programs"). Approximately 62% and 63% of the Company's net revenue was collected from funds distributed under these programs for 1995 and 1996, respectively. Marketing and Advertising Costs--Marketing and advertising costs are expensed as incurred. Marketing and advertising costs included in selling, general and administrative expenses were $4,282 and $5,687 for 1995 and 1996, respectively. Property and Equipment, Net--Depreciation and amortization are recognized utilizing the straight-line method over their useful lives. Leasehold improvements are amortized over their useful lives or lease term, whichever is shorter. Improvements are capitalized while maintenance and repairs are expensed as incurred. Intangible Assets--Intangible assets include the excess of purchase price over net assets acquired resulting from the business acquisition described in Note 1. Intangible assets are being amortized on a straight-line basis over their estimated useful life ranging from two to forty years. F-34 THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Years Ended December 31, 1995 and 1996 (Dollars In Thousands) The recoverability of the carrying values of the excess of the purchase price over the net assets acquired and other intangible assets is evaluated quarterly to determine if an impairment in value has occurred. An impairment in value will be considered to have occurred when it is determined that the undiscounted future operating cash flows generated by the acquired business is not sufficient to recover the carrying values of such intangible assets. If it has been determined that an impairment in value has occurred, the excess of the purchase price over the net assets acquired and other intangible assets would be written down to an amount which will be equivalent to the present value of the future operating cash flows to be generated by the acquired business. Revenue Recognition--Revenue is derived primarily from courses taught at the schools. Tuition revenue is recognized ratably over the length of the applicable course. Textbook sales and other revenues are recognized as services are performed. If a student withdraws, future revenue would be reduced by the amount of refund due to the student. Refunds are calculated in accordance with Federal, state and accrediting agency standards. Deferred Rent Obligations--Certain of the schools' facility leases include rental concessions, as defined in the various lease agreements. The Company recognizes rent expense on a straight-line basis over the terms of the various leases, ranging from 7 to 11 years. Rent expense recognized differs from the actual cash payments required to be made under these lease agreements. Use of Estimates--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results may differ from these estimates. In 1996, the Company recorded an adjustment to reduce certain liabilities established in prior periods, which decreased net loss by approximately $341. 3. INCOME TAXES The results of operations of the Company are included in the consolidated Federal income tax return of PRIMEDIA. The income tax provision has been computed as if the Company filed a separate return. At December 31, 1996, the Company, on a stand-alone basis, had aggregate net operating loss carryforwards of approximately $4,200 for Federal and state income taxes. As a result of the disposition of the Company on May 31, 1997, as discussed in Note 7, PRIMEDIA will retain all net operating losses up to the date of disposition. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts for income tax purposes. 4. COMMITMENTS AND CONTINGENCIES Operating Leases--The Company rents seven of its eight administrative and classroom facilities and certain equipment under noncancellable operating leases. The facility leases require the Company to make monthly payments covering rent, taxes, insurance and maintenance costs and expire at various times through 2007. Rent expense under operating leases exclusive of taxes, insurance and maintenance of the facilities and equipment for 1995 and 1996, was approximately $3,418 and $4,098, respectively. F-35 THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Concluded) For the Years Ended December 31, 1995 and 1996 (Dollars In Thousands) Litigation--The Company is subject to occasional lawsuits, investigations and claims arising out of the normal conduct of its business. Management does not believe the outcome of any of these legal actions and claims will have a material adverse impact on the Company's consolidated financial statements. Regulatory--Each of the Company's schools has Federal financial assistance programs which are subject to ongoing program reviews by the DOE, Title IV program audits by external auditors and state program audits by state agencies. Any regulatory violation could be the basis for the initiation of a suspension, limitation or termination proceeding against the Company. To minimize risks associated with noncompliance, the Company conducts periodic reviews of its schools' financial conditions. Changes in DOE funding of Federal student financial aid programs could impact the Company's ability to attract students. Each of the Company's schools is also required to meet certain financial and other standards in order to qualify to participate in Title IV programs. These include maintaining an acid test ratio (defined as cash, cash equivalents and current accounts receivable to current liabilities) of at least 1:1, having a positive tangible net worth at the end of each fiscal year, collecting less than 85% of its education revenues from Title IV funds on an annual basis, not having cumulative net operating losses during its two most recent fiscal years that result in a decline of more than 10% of the individual school's tangible net worth at the beginning of that two-year period, and not having cohort default rates on Federal student loans that equal or exceed 25% for three consecutive federal fiscal years, amongst others. At December 31, 1996, each of the Company's schools was in compliance with such requirements. 5. TRANSACTIONS WITH PARENT COMPANY The note payable to PRIMEDIA accrues interest at PRIMEDIA's weighted average borrowing rate. Interest expense of $1,368 and $1,022 on the note payable to PRIMEDIA has been recorded for 1995 and 1996, respectively. The Company pays PRIMEDIA management fees for costs and expenses incurred by PRIMEDIA on behalf of the Company for certain services, including treasury, consulting, insurance, tax, financing and other services. 6. EMPLOYEE BENEFIT PLANS The Company participates in a PRIMEDIA contributory profit sharing plan, established pursuant to the provisions of Section 401(k) of the Internal Revenue Code, that provides retirement benefits for eligible employees of the Company. This plan requires matching contributions to eligible employees. The Company's matching contributions were $12, and $23 for 1995 and 1996, respectively. 7. SUBSEQUENT EVENTS On May 31, 1997, PRIMEDIA sold 100% of the outstanding shares of capital stock of the Company to Career Education Corporation ("CEC") for approximately $20,000. The sales price is subject to certain adjustments. In connection with the sale, PRIMEDIA also entered into a covenant not-to-compete agreement with CEC for proceeds totaling $7,000. The covenant not-to-compete restricts PRIMEDIA's ability to own or operate certain types of post-secondary vocational schools for a period of five years. F-36 THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS For the Six Months Ended June 30, 1996, and For the Five Months Ended May 31, 1997 (Unaudited, dollars in thousands)
June 30, 1996 May 31, 1997 ------------- ------------ REVENUE: Tuition and registration fees, net................ $12,179 $11,606 Other, net................ 1,316 1,222 ------- ------- Total net revenue....... 13,495 12,828 ------- ------- OPERATING COSTS AND EXPENSES: Instruction............... 3,247 3,029 Selling, general and administrative........... 9,261 8,028 Depreciation and amortization............. 1,199 901 Management fees charged by PRIMEDIA, Inc............ 82 15 ------- ------- Total operating expenses............... 13,789 11,973 ------- ------- Income (loss) from operations............. (294) 855 ------- ------- INTEREST EXPENSE............ 509 242 ------- ------- Income (loss) before provision for income taxes.................. (803) 613 PROVISION FOR INCOME TAXES.. -- -- ------- ------- NET INCOME (LOSS)........... $ (803) $ 613 ======= =======
The accompanying notes are an integral part of these statements. F-37 THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the Six Months Ended June 30, 1996, and For the Five Months Ended May 31, 1997 (Unaudited, dollars in thousands)
June 30, May 31, 1996 1997 ------- ------- CASH FLOWS FROM OPERATING ACTIVITIES.......................... $(1,436) $(1,057) ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment, net.................... (542) (134) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase (decrease) in Payable to PRIMEDIA, Inc............. 2,464 (3,948) ------- ------- NET INCREASE (DECREASE) IN CASH............................... 486 (5,139) CASH, beginning of period..................................... 5,506 6,296 ------- ------- CASH, end of period........................................... $ 5,992 $ 1,157 ======= ======= NONCASH INVESTING AND FINANCING ACTIVITIES: Capital leases entered into for the purchase of equipment... $ 34 $ 158 ======= =======
The accompanying notes are an integral part of these statements. F-38 THE KATHARINE GIBBS SCHOOLS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 1996, and May 31, 1997 1. BASIS OF PRESENTATION The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of financial position and the results of operations and cash flows have been included, and the disclosures made are adequate to prevent the information presented from being misleading. Operating results for the six months ended June 30, 1996, and the five months ended May 31, 1997, are not necessarily indicative of the results that may be expected for the fiscal years ended December 31, 1996 and 1997. These financial statements should be read in conjunction with, and have been prepared in conformity with the accounting principles reflected in the financial statements and related notes of The Katharine Gibbs Schools, Inc. and Subsidiaries (the "Company") as of and for the year ended December 31, 1996. 2. SUBSEQUENT EVENTS On May 31, 1997, PRIMEDIA, Inc. (formerly K-III Communications Corporation) ("PRIMEDIA"), the sole shareholder of the Company, sold 100% of the outstanding shares of capital stock of the Company to Career Education Corporation ("CEC") for approximately $20,000,000. The sales price is subject to certain adjustments. In connection with the sale, PRIMEDIA also entered into a covenant not-to-compete agreement with CEC for proceeds totaling $7,000,000. The covenant not-to-compete restricts PRIMEDIA's ability to own or operate certain types of postsecondary vocational schools for five years. 3. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from these estimates. F-39 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders of Scottsdale Culinary Institute, Inc.: We have audited the accompanying balance sheets of SCOTTSDALE CULINARY INSTITUTE, INC. (a Delaware corporation) as of December 31, 1996 and 1997, and the related statements of operations and retained earnings and cash flows for the years 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 audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Scottsdale Culinary Institute, Inc. as of December 31, 1997 and 1996, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. Arthur Andersen LLP Chicago, Illinois September 25, 1998 (except with respect to the matter discussed in Note 7, as to which the date is December 17, 1998) F-40 SCOTTSDALE CULINARY INSTITUTE, INC. BALANCE SHEETS (Dollars in thousands)
December 31 ----------- June 30 1996 1997 1998 ----- ----- ----------- ASSETS (Unaudited) CURRENT ASSETS: Cash and cash equivalents................................. $ 359 $ 288 $ 766 Receivables, net of allowance for doubtful accounts of $5. 264 388 375 Inventories and other current assets...................... 62 63 64 ----- ----- ------ Total current assets.................................. 685 739 1,205 PROPERTY AND EQUIPMENT, net of accumulated depreciation and amortization............................................... 270 201 187 OTHER ASSETS................................................ 14 15 15 ----- ----- ------ TOTAL ASSETS................................................ $ 969 $ 955 $1,407 ===== ===== ====== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable, accrued expenses and other current liabilities.............................................. $ 251 $ 199 $ 163 Deferred tuition revenue.................................. 355 338 299 ----- ----- ------ Total current liabilities............................. 606 537 462 LONG-TERM DEBT, net of current portion...................... 31 17 15 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Common stock, no par value; 1,000,000 shares authorized; 51,000 shares issued and outstanding at December 31, 1997, December 31, 1996 and June 30, 1998................ 51 51 51 Additional paid-in capital................................ 145 145 145 Retained earnings......................................... 136 205 734 ----- ----- ------ Total shareholders' equity............................ 332 401 930 ----- ----- ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $ 969 $ 955 $1,407 ===== ===== ======
The accompanying notes are an integral part of these statements. F-41 SCOTTSDALE CULINARY INSTITUTE, INC. STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (Dollars in thousands)
For the Years For the Six Months Ended December 31 Ended June 30 ------------------ -------------------- 1996 1997 1997 1998 -------- -------- --------- --------- (Unaudited) REVENUE: Tuition and registration fees, net. $ 3,823 $ 4,428 $ 2,272 $ 2,469 Other, net......................... 408 415 221 232 -------- -------- --------- --------- Total net revenue.............. 4,231 4,843 2,493 2,701 OPERATING EXPENSES: Educational services and facilities........................ 2,445 2,565 1,323 1,168 General and administrative......... 1,097 1,292 565 575 Depreciation and amortization...... 107 94 46 38 Rent paid to related party......... -- 62 -- 162 -------- -------- --------- --------- Total operating expenses....... 3,649 4,013 1,934 1,943 -------- -------- --------- --------- Income from operations......... 582 830 559 758 OTHER INCOME, net.................... 33 62 5 11 -------- -------- --------- --------- NET INCOME........................... 615 892 564 769 Retained earnings, beginning of period.............................. 250 136 136 205 Distributions to shareholders........ (729) (823) (206) (240) -------- -------- --------- --------- RETAINED EARNINGS, END OF PERIOD..... $ 136 $ 205 $ 494 $ 734 ======== ======== ========= =========
The accompanying notes are an integral part of these statements. F-42 SCOTTSDALE CULINARY INSTITUTE, INC. STATEMENTS OF CASH FLOWS (Dollars in thousands)
For the Six For the Years Ended Months December 31 Ended June 30 -------------------- -------------- 1996 1997 1997 1998 --------- --------- ------ ------ (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net income............................. $ 615 $ 892 $ 564 $ 769 Adjustments to reconcile net income to net cash provided by operating activities-- Depreciation and amortization........ 107 94 46 38 Loss on disposal of asset............ 1 3 1 -- Changes in operating assets and liabilities-- Receivables, net................... (21) (124) (69) 13 Inventories and other current assets............................ 7 (1) (2) (1) Accounts payable, accrued expenses and other current liabilities..... 95 (44) (29) (36) Deferred tuition revenue........... (286) (17) 62 (39) --------- --------- ------ ------ Net cash provided by operating activities...................... 518 803 573 744 --------- --------- ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment..... (134) (28) (3) (24) Other assets........................... 2 (1) 1 -- --------- --------- ------ ------ Net cash used in investing activities...................... (132) (29) (2) (24) --------- --------- ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES: Distributions to shareholders.......... (729) (823) (206) (240) Repayments of long-term debt........... (14) (22) (10) (2) Proceeds from issuance of long-term debt.................................. 31 -- -- -- --------- --------- ------ ------ Net cash used in financing activities...................... (712) (845) (216) (242) --------- --------- ------ ------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................. (326) (71) 355 478 CASH AND CASH EQUIVALENTS, beginning of period.................................. 685 359 359 288 --------- --------- ------ ------ CASH AND CASH EQUIVALENTS, end of period. 359 288 714 766 ========= ========= ====== ====== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for interest.............................. 2 2 -- 16 ========= ========= ====== ======
The accompanying notes are an integral part of these statements. F-43 SCOTTSDALE CULINARY INSTITUTE, INC. NOTES TO FINANCIAL STATEMENTS (Information for the Six Months Ended June 30, 1997 and 1998 is Unaudited) 1. DESCRIPTION OF THE BUSINESS Scottsdale Culinary Institute, Inc. (the "Company" or the "School") was incorporated in June 1986 for the purpose of operating a school to provide professional culinary education. The School, located in Scottsdale, Arizona, provides professional culinary education leading to an Associate of Occupational Studies degree in Culinary Arts and Sciences and Restaurant Management. The School also operates a restaurant open to the public. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The financial statements and related notes thereto for the six months ended June 30, 1997 and 1998 are unaudited and have been prepared on the same basis as the audited financial statements included herein. In the opinion of management, such unaudited financial statements include all adjustments (consisting of normal recurring adjustments) necessary to present fairly information set forth herein. Operating results for the six months ended June 30, 1998 are not necessarily indicative of results that may be expected for the fiscal year ending December 31, 1998. The principal accounting policies of the Company are as follows: Concentration of Credit Risk The Company extends unsecured credit for tuition to a significant portion of the students who are in attendance at the School. A substantial portion of credit extended to students is repaid through the students' participation in federally funded financial aid programs under Title IV of the Higher Education Act of 1965, as amended ("Title IV Programs"). Approximately 58%, 55%, 57% and 55% of the Company's net revenue was collected from Title IV Program funds for the years ended December 31, 1996 and 1997 and for the six months ended June 30, 1997 and 1998, respectively. The Company generally completes and approves the financial aid packet of each student who qualifies for financial aid prior to the student's beginning class in an effort to enhance the collectibility of its unsecured credit. Transfers of funds from the financial aid programs to the Company are made in accordance with DOE requirements. Changes in DOE funding of federal student financial aid programs could impact the Company's ability to attract students. Cash and Cash Equivalents Cash and cash equivalents consists of cash in banks and money market funds. Restricted Cash Cash received from the U. S. Government under various student aid grant and loan programs is considered to be restricted. Restricted cash is held in separate bank accounts and does not become available for general use by the Company until the financial aid is credited to the accounts of students and the cash is transferred to an operating account. There is no restricted cash included in the cash and cash equivalents balance at December 31, 1996, December 31, 1997 and June 30, 1998. Inventories Inventories consisting principally of food and beverage, program materials, books and supplies are stated at the lower of cost, determined on a first-in, first-out basis or market. F-44 SCOTTSDALE CULINARY INSTITUTE, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) Property and Equipment Property and equipment are stated at cost. Depreciation and amortization are recognized utilizing the straight-line method over the related assets useful lives. Leasehold improvements and assets recorded under capital leases are amortized on a straight-line basis over the shorter of the estimated useful life of the asset or the lease term. The cost basis and estimated useful lives of property and equipment at December 31, 1996, December 31, 1997 and June 30, 1998, are as follows (dollars in thousands):
December 31 ----------- June 30 Asset Description 1996 1997 1998 Life ----------------- ----- ----- ------- ---------- Classroom equipment and other instructional materials...................................... $ 492 $ 469 $478 5-10 years Leasehold improvements.......................... 266 265 280 3-10 years ----- ----- ---- 758 734 758 Less--Accumulated depreciation and amortization. 488 533 571 ----- ----- ---- $ 270 $ 201 $187 ===== ===== ====
The Company reviews long-lived assets for impairment whenever events or circumstances indicate that carrying amounts may not be recoverable. To date, no such events or changes in circumstances have occurred. If such events or changes in circumstances occur, the Company will recognize an impairment loss if the undiscounted future cash flows expected to be generated by the asset (or acquired business) are less than the carrying value of the related asset. The impairment loss would adjust the asset to its fair value. Revenue Recognition Revenue is derived primarily from courses taught at the School. Tuition revenue is recognized on a straight-line basis during the period of instruction provided by the School. Other revenues consist of restaurant revenues and are recognized as services are performed. If a student withdraws, future revenue is reduced by the amount of refund due to the student. Refunds are calculated in accordance with federal, state and accrediting agency standards. Deferred tuition revenue represents the portion of tuition payments received but not earned and is reflected as a current liability on the balance sheet as such amount is expected to be earned within the next year. Marketing and Advertising Costs Marketing and advertising costs are expensed as incurred. Marketing and advertising costs included in general and administrative expenses were approximately $221,000, $191,000, $93,000 and $113,000 for the years ended December 31, 1996 and 1997 and the six months ended June 30, 1997 and 1998, respectively. Income Taxes The Company has elected to be treated as an S Corporation under the provisions of Subchapter S of the Internal Revenue Code. Accordingly, the shareholders of the Company are responsible for the federal taxes arising from its operations. Therefore, no provision or liability for federal income taxes has been included in these financial statements. Use of Estimates The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reported period. Actual results could differ from these estimates. F-45 SCOTTSDALE CULINARY INSTITUTE, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) 3. LINE OF CREDIT At December 31, 1996 and December 31, 1997, the Company had available a line of credit providing for borrowings of up to $200,000, bearing interest at the bank's reference rate plus 1.5%. The line of credit contains certain financial covenants and is guaranteed by the shareholders. The line of credit was not utilized at December 31, 1996 and December 31, 1997, and expired in April 1998. 4. COMMITMENTS AND CONTINGENCIES Regulatory The Company has federal financial assistance programs that are subject to ongoing program reviews by the DOE and Title IV program audits by external auditors. Based upon the results of such audits and reviews, the Company may have to repay funds previously granted to its students through loans and grants, and pay interest, fines and/or penalties. Management believes such amounts would be minimal and does not expect them to have a material effect on the results of operations of the Company. The Company is also required to meet certain financial and other standards in order to qualify to participate in Title IV programs. These include maintaining an acid test ratio (defined as cash, cash equivalents, and current accounts receivable to current liabilities) of at least 1:1, having a positive tangible net worth at the end of each fiscal year, to collect less than 85% of its education revenues from Title IV funds on an annual basis, not to have cumulative net operating losses during the most recent fiscal years that result in a decline of more than 10% of the Company's tangible net worth at the beginning of that two-year period, and a student default rate on their federal loans of not more than 25% for any three-year consecutive period, amongst others. Leases The Company leases equipment under capital leases expiring at various dates through 2002. In addition, the Company leases its school facility and certain equipment under noncancellable operating leases expiring at various dates through 2008. Rent expense, exclusive of taxes, insurance and maintenance of the facility and equipment for the years ended December 31, 1996 and 1997 and the six months ended June 30, 1997 and 1998 was approximately $369,000, $436,000, $220,000 and $191,000, respectively. Future minimum lease payments under these capital and operating leases as of June 30, 1998 are as follows:
Capital Operating Leases Leases Total ------- ---------- ---------- Remainder of 1998........................... $ 3,153 $ 166,742 $ 169,895 1999........................................ 6,304 320,307 326,611 2000........................................ 6,304 318,792 325,096 2001........................................ 6,304 318,792 325,096 2002........................................ 3,341 318,792 322,133 2003........................................ -- 318,066 318,066 2004 and thereafter......................... -- 1,205,750 1,205,750 ------- ---------- ---------- 25,406 $2,967,241 $2,992,647 ========== ========== Less--portion attributable to interest...... 6,904 ------- Principal payments.......................... 18,502 Less--Current portion....................... 3,527 ------- $14,975 =======
F-46 Litigation The Company is subject to occasional lawsuits, investigations and claims arising out of the normal conduct of its business. At June 30, 1998, the Company is not a party to any material legal action. 5. RELATED-PARTY TRANSACTIONS Effective October 15, 1997, the Company leases its office and school space from an affiliated company operated by the Company's shareholders. Total rent expense under this agreement was approximately $62,000 and $162,000 for the year ended December 31, 1997 and the six months ended June 30, 1998, respectively. In addition, the Company loaned the affiliated company $6,500. This amount is included in receivables at December 31, 1997. As of June 30, 1998, the Company has guaranteed a $750,000 bank loan of an affiliated company. The Company's equipment serves as collateral for the loan. 6. EMPLOYEE BENEFIT PLAN The Company maintains a contributory profit sharing plan established pursuant to the provisions of Section 401(k) of the Internal Revenue Code that provides retirement benefits for eligible employees of the Company. This plan requires matching contributions to eligible employees. The Company's matching contributions were approximately $9,600, $12,500, $0 and $9,300 for the years ended December 31, 1996 and 1997 and the six months ended June 30, 1997 and 1998, respectively. 7. SUBSEQUENT EVENT On July 31, 1998, SCI Acquisition, Ltd., a wholly owned subsidiary of Career Education Corporation ("CEC"), purchased certain assets and assumed certain liabilities of the Company for a sales price of approximately $9,900,000. Subsequent to the purchase, SCI Acquisition, Ltd. changed its name to Scottsdale Culinary Institute, Ltd. F-47 [INSIDE BACK COVER] Map of North America with Logos of the Company and its Schools superimposed on the map indicating the location of each campus. Below the map are the logos, full names and addresses of each of the schools and their campuses. PART II INFORMATION NOT REQUIRED IN THE PROSPECTUS Item 13. Other Expenses of Issuance and Distribution Set forth below is an estimate of the approximate amount of fees and expenses (other than underwriting commissions and discounts) payable by the Registrant in connection with the issuance and distribution of our common stock pursuant to the prospectus contained in this Registration Statement. The Registrant will pay all of these expenses.
Approximate Amount ----------- Securities and Exchange Commission registration fee........... $ 18,717 NASD filing fee............................................... 7,233 Nasdaq National Market application fee........................ 5,000 Accountants' fees and expenses................................ 150,000 Blue Sky fees and expenses.................................... 5,000 Legal fees and expenses....................................... 275,000 Transfer Agent and Registrar fees and expenses................ 10,000 Printing and engraving........................................ 200,000 Miscellaneous expenses........................................ 79,050 -------- Total..................................................... $750,000 ========
All expenses other than the Securities and Exchange Commission registration fee and NASD filing fee are estimated. Item 14. Indemnification of Directors and Officers Article XII of the Registrant's Amended and Restated Certificate of Incorporation provides that the Registrant shall indemnify its directors to the full extent permitted by the General Corporation Law of the State of Delaware and may indemnify its officers and employees to such extent, except that the Registrant shall not be obligated to indemnify any such person (1) with respect to proceedings, claims or actions initiated or brought voluntarily by any such person and not by way of defense, or (2) for any amounts paid in settlement of an action indemnified against by the Registrant without the prior written consent of the Registrant. The Registrant has entered into indemnity agreements with each of its directors. These agreements may require the Registrant, among other things, to indemnify such directors against certain liabilities that may arise by reason of their status or service as directors, to advance expenses to them as they are incurred, provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification and to obtain directors' liability insurance if available on reasonable terms. In addition, Article XII of the Registrant's Amended and Restated Certificate of Incorporation provides that a director of the Registrant shall not be personally liable to the Registrant or its stockholders for monetary damages for breach of his or her fiduciary duty as a director, except for liability (1) for any breach of the director's duty of loyalty to the Registrant or its stockholders, (2) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (3) for willful or negligent conduct in paying dividends or repurchasing stock out of other than lawfully available funds or (4) for any transaction from which the director derives an improper personal benefit. Reference is made to Section 145 of the General Corporation Law of the State of Delaware which provides for indemnification of directors and officers in certain circumstances. The Registrant has purchased a directors' and officers' liability insurance policy. II-1 Under the terms of the Underwriting Agreement, the Underwriters have agreed to indemnify, under certain conditions, the Registrant, its directors, certain of its officers and persons who control the Registrant within the meaning of the Securities Act of 1933, as amended, against certain liabilities. Item 15. Recent Sales of Unregistered Securities Prior to the consummation of our initial public offering in February 1998, the Registrant's outstanding capital stock consisted of (1) four classes of common stock: Class A Voting Common Stock, $.01 par value; Class B Voting Common Stock, $.01 par value; Class C Non-voting Common Stock, $.01 par value; and Class E Non-voting Common Stock, $.01 par value (the Class A Common Stock, Class B Common Stock, Class C Common Stock and Class E Common Stock are collectively referred to as the "Existing Common Stock"); and (2) three classes of preferred stock: preferred stock, Series A, $.01 par value; preferred stock, Series C, $.01 par value; and Series D Preferred Stock, $.01 par value (the Series A Preferred Stock, Series C Preferred Stock and Series D Preferred Stock are collectively referred to as the "Existing Preferred Stock"). The following information reflects a 100-for-one split of the Registrant's common stock effected as of July 31, 1995 and a 10-for-one split of our Series C Preferred Stock effected as of July 26, 1996. It does not reflect the following transactions effected immediately prior to the consummation of the initial public offering: (1) the Amended and Restated Certificate of Incorporation of the Registrant was amended to provide, among other things, for (a) only two classes of capital stock, consisting of our common stock and preferred stock, $.01 par value, (b) the conversion of all shares of Existing Common Stock into Common Stock at the rate of 9.376 shares of Common Stock for every share of Existing Common Stock, and (c) the conversion (the "Preferred Stock Conversion") of all Existing Preferred Stock, including all accrued paid- in-kind dividends thereon, into common stock at a rate determined by dividing the liquidation value of the Existing Preferred Stock, including the liquidation value of the accrued paid-in-kind dividends, by the initial public offering price of our common stock in the initial public offering, converting into 2,423,481 shares of common stock; and then (2) all outstanding warrants to purchase Class D Non-Voting Common Stock, $.01 par value, and Class E Common Stock were exercised for an aggregate of 624,062 shares of common stock. On February 28, 1997, pursuant to a Securities Purchase Agreement dated as of February 28, 1997, the Registrant issued (1) 1,391 shares of Series D Preferred Stock and warrants to purchase 1,655 shares of Class E Common Stock to Heller in exchange for total consideration of $1,391,000, (2) 468 shares of Series D Preferred Stock and warrants to purchase 558 shares of Class E Common Stock to Electra in exchange for total consideration of $468,000, (3) 84 shares of Series D Preferred Stock and warrants to purchase 99 shares of Series E Common Stock to Dowdell in exchange for total consideration of $84,000, (4) 16 shares of Series D Preferred Stock and warrants to purchase 19 shares of Class E Common Stock to Larson in exchange for total consideration of $16,000, (5) 15 shares of Series D Preferred Stock and warrants to purchase 18 shares of Class E Common Stock to Klettke in exchange for total consideration of $15,000 and (6) 26 shares of Series D Preferred Stock and warrants to purchase 31 shares of Class E Common Stock to Laub in exchange for total consideration of $26,000. On May 30, 1997, pursuant to the February 1997 securities purchase agreement, the Registrant issued (1) 3,995 shares of Series D Preferred Stock and warrants to purchase 4,754 shares of Class E Common Stock to Heller in exchange for total consideration of $3,995,000, (2) 1,348 shares of Series D Preferred Stock and warrants to purchase 1,603 shares of Class E Common Stock to Electra in exchange for total consideration of $1,348,000, (3) 44 shares of Series D Preferred Stock and warrants to purchase 52 shares of Class E Common Stock to Mr. Larson in exchange for total consideration of $44,000, (4) 42 shares of Series D Preferred Stock and warrants to purchase 50 shares of Class E Common Stock to Mr. Klettke in exchange for total consideration of $42,000 and (5) 71 shares of Series D Preferred Stock and warrants to purchase 85 shares of Class E Common Stock to Mr. Laub in exchange for total consideration of $71,000. II-2 On May 30, 1997, pursuant to a Securities Purchase Agreement dated as of May 30, 1997, the Registrant issued (1) 11,127 shares of Series D Preferred Stock and warrants to purchase 26,842 shares of Class E Common Stock to Heller in exchange for total consideration of $11,127,000, (2) 2,376 shares of Series D Preferred Stock and warrants to purchase 5,732 shares of Class E Common Stock to Electra in exchange for total consideration of $2,376,000 and (3) 122 shares of Series D Preferred Stock and warrants to purchase 295 shares of Class E Common Stock to Mr. Klettke in exchange for total consideration of $122,000. On June 30, 1997, pursuant to the May 1997 Securities Purchase Agreement, the Registrant issued 1,375 shares of Series D Preferred Stock and warrants to purchase 3,317 shares of Class E Common Stock to Electra in exchange for total consideration of $1,375,000. No underwriters were involved in any of the transactions described above. All of the securities issued in the foregoing transactions were issued by the Registrant in reliance upon the exemption from registration available under Section 4(2) of the Securities Act of 1933, including Regulation D promulgated thereunder. Item 16. Exhibits and Financial Statement Schedules (a) Exhibits. 1++++ Form of Underwriting Agreement. 2.1** Asset Purchase Agreement dated as of September 30, 1996, among the Registrant, WCI Acquisition, Ltd., Phillips Educational Group of Portland, Inc., and Phillips Colleges, Inc. 2.2** Stock Sale Agreement dated as of April 7, 1997, between K-III Prime Corporation, Inc. and the Registrant. 2.3** Stock Purchase Agreement dated as of June 30, 1997, among IAMD Acquisition I, Ltd. and Clem Stein, Jr., Marion Stein, Leonard Rutstein, Barbara Ann Scott King, Thomas V. King, William W. Wirtz and David Powell. 2.4** Share Purchase Agreement dated as of June 30, 1997, among the Registrant and Clem Stein, Jr., Leonard Rutstein, Barbara Ann Scott King and Lawrence N. Gross. 2.5*** Asset Purchase Agreement dated as of July 1, 1998 by and among Scottsdale Institute, Inc., an Arizona corporation, The Frank G. and Elizabeth S. Leite Revocable Trust dated April 14, 1992, Frank G. Leite and Elizabeth S. Leite, and SCI Acquisition I, Ltd., a Delaware Corporation. 3.1+ Amended and Restated Certificate of Incorporation of the Registrant. 3.2+ Amended and Restated By-laws of the Registrant. 4.1** Specimen stock certificate representing common stock. 4.3* Credit Agreement dated as of October 26, 1998 among the Registrant, as borrower, the Co-Borrowers named therein, the lenders named therein, LaSalle National Bank, as administrative agent and The Bank of Nova Scotia as foreign currency agent. 5++++ Opinion of Katten Muchin & Zavis as to the legality of the securities being registered (including consent). 10.1** Career Education Corporation 1995 Stock Option Plan, as amended. 10.2** Form of Option Agreement under the Registrant's 1995 Stock Option Plan. 10.3** Career Education Corporation 1997 Employee Incentive Compensation Plan. 10.4** Form of Option Agreement under the Registrant's 1997 Employee Incentive Compensation Plan.
II-3 10.5** Career Education Corporation 1997 Non-Employee Directors' Stock Option Plan. 10.6** Form of Option Agreement under the Registrant's 1997 Non- Employee Directors' Stock Option Plan. 10.7** Career Education Corporation 1998 Employee Stock Option Plan. 10.8** Amended and Restated Option Agreement dated July 31, 1995, between the Registrant and John M. Larson. 10.9** Supplemental Option Agreement dated July 31, 1995, between the Registrant and John M. Larson. 10.10** Amended and Restated Option Agreement dated July 31, 1995, between the Registrant and Robert E. Dowdell. 10.11** Employment and Non-Competition Agreement as of October 9, 1997 between the Registrant and John M. Larson. 10.12** Form of Indemnification Agreement for Directors and Executive Officers. 10.13** Career Education Corporation Amended and Restated Stockholders' Agreement dated as of July 31, 1995, as amended on February 28, 1997 and May 30, 1997. 10.14** Registration Rights Agreements dated as of July 31, 1995, between the Registrant, Electra Investment Trust P.L.C. and Electra Associates, Inc. 10.15** Securities Purchase Agreement dated as of July 31, 1995 among the Registrant, Electra Investment Trust P.L.C. and Electra Associates, Inc. (the "Electra 1995 Agreement"). 10.16** Securities Purchase Agreement dated as of February 28, 1997, among the Registrant, Heller Equity Capital Corporation, Electra Investment Trust P.L.C., Robert E. Dowdell, John M. Larson, Wallace O. Laub and Constance L. Laub and William A. Klettke (the "February 1997 Agreement"). 10.17** Securities Purchase Agreement dated as of May 30, 1997 among the Registrant, Heller Equity Capital Corporation, Electra Investment Trust P.L.C. and William A. Klettke (the "May 1997 Agreement"). 10.18** Form of Management Fee Agreement between the Registrant and each of its subsidiaries. 10.19** Form of Tax Sharing Agreement between the Registrant and each of its subsidiaries. 10.20+ Registration Rights Agreement between the Registrant Heller Equity Capital Corporation dated as of February 3, 1998. 10.21+ Agreement between the Registrant and Heller Equity Capital Corporation, regarding designation of directors of the Registrant. 10.22++ Stock Purchase Agreement dated as of November 25, 1998 by and between the Registrant, and Robert C. Marks and the Robert C. Marks Trust dated October 9, 1997. 21.1* Subsidiaries of the Registrant. 23.1++++ Consent of Arthur Andersen LLP with respect to financial statements of the Registrant. 23.2++++ Consent of Arthur Andersen LLP with respect to financial statements of Scottsdale Culinary Institute, Inc. 23.3++++ Consent of Deloitte & Touche LLP with respect to financial statements of The Katharine Gibbs Schools, Inc.
II-4 23.6 Consent of Katten Muchin & Zavis (contained in its opinion to be filed as Exhibit 5 hereto). 24* Power of Attorney 27++++ Financial Data Schedule.
- -------- * Previously filed. ** Incorporated by reference to the Exhibit of the same number to our Registration Statement No. 333-37601 on Form S-1, effective as of January 28, 1998. *** Incorporated by reference to our Report on Form 8-K dated August 14, 1998. + Incorporated by reference to the Exhibit of the same number to our Annual Report on Form 10-K for the year ended December 31, 1997. ++ Incorporated by reference to our Report on Form 8-K dated January 15, 1999. +++ Incorporated by reference to the Exhibit of the same number to each of our Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, June 30 and September 30, 1998. ++++ Filed herewith. (b) Financial Statement Schedules.
Page ---- Schedule II--Valuation and Qualifying Accounts....................... S-2
Item 17. Undertakings The Registrant hereby undertakes: (1) To provide to the underwriters at the closing specified in the underwriting agreement, certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser. (2) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue. (3) For purposes of determining any liability under the Securities Act of 1933, (a) the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act of 1933 shall be deemed to be part of this Registration Statement as of the time it was declared effective and (b) each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused Amendment No. 1 to this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Chicago, and State of Illinois on the 26th day of February, 1999. Career Education Corporation /s/ John M. Larson By: ______________________________ John M. Larson President and Chief Executive Officer * * * Pursuant to the requirements of the Securities Act of 1933, Amendment No. 1 to this Registration Statement has been signed below by the following persons in the capacities indicated on February 26, 1999.
Signature Title --------- ----- /s/ John M. Larson President, Chief Executive Officer ___________________________________________ (Principal Executive Officer) and a John M. Larson Director * Senior Vice President and Chief Financial ___________________________________________ Officer (Principal Financial and William A. Klettke Accounting Officer) * Director ___________________________________________ Robert E. Dowdell * Director ___________________________________________ Thomas B. Lally * Director ___________________________________________ Wallace O. Laub * Director ___________________________________________ Keith K. Ogata * Director ___________________________________________ Patrick K. Pesch
* The undersigned, by signing his name hereto, does sign and execute the Amendment No. 1 to this Registration Statement on behalf of the above-named Directors and officers of the Registrant pursuant to a Power of Attorney executed by each such Director and officer and filed with the Securities and Exchange Commission. /s/ John M. Larson By:_____________________________ John M. Larson as Attorney-in-Fact II-6 CAREER EDUCATION CORPORATION AND SUBSIDIARIES FINANCIAL STATEMENT SCHEDULE REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders of Career Education Corporation: We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Career Education Corporation and Subsidiaries and issued our unqualified opinion thereon dated January 29, 1999. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The Valuation and Qualifying Account Schedule is presented for purposes of additional analysis and is not a required part of the basic financial statements. This information has been subjected to the auditing procedures applied in our audits 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. ARTHUR ANDERSEN LLP Chicago, Illinois January 29, 1999 S-1 CAREER EDUCATION CORPORATION AND SUBSIDIARIES FINANCIAL STATEMENT SCHEDULE SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
Balance at Charges to Increase Due Balance at Beginning Operating to Amounts End of of Period Expenses Acquisitions Written-off Period ---------- ---------- ------------ ----------- ---------- (in thousands) Student receivable allowance activity for the year ended December 31, 1996..... 258 760 30 (593) 455 Student receivable allowance activity for the year ended December 31, 1997..... 455 1,400 1,040 (1,379) 1,516 Student receivable allowance activity for the year ended December 31, 1998..... 1,516 4,983 71 (4,443) 2,127
S-2 EX-1 2 FORM OF UNDERWRITING AGREEMENT Exhibit 1 2,000,000 Shares CAREER EDUCATION CORPORATION Common Stock, $.01 par value UNDERWRITING AGREEMENT ---------------------- ____________________, 1999 Credit Suisse First Boston Corporation Salomon Smith Barney Inc. BancBoston Robertson Stephens As Representatives of the Several Underwriters, c/o Credit Suisse First Boston Corporation Eleven Madison Avenue New York, N.Y. 10010-3629 Ladies and Gentlemen: 1. Introductory. Career Education Corporation, a Delaware corporation ("Company"), proposes to issue and sell 250,000 shares of its Common Stock, $.01 par value ("Securities"), and the stockholders listed in Schedule A hereto ("Selling Stockholders") propose to severally sell an aggregate of 1,750,000 outstanding shares of the Securities (such 2,000,000 shares of Securities being hereinafter referred to as the "Firm Securities"). The Company also proposes to sell to the Underwriters, at the option of the Underwriters, an aggregate of not more than 280,000 additional shares of its Securities, and John M. Larson ("Larson"), one of the Selling Stockholders, also proposes to sell to the Underwriters, at the option of the Underwriters, not more than 20,000 additional outstanding shares of the Securities (such 300,000 additional shares being hereinafter referred to as the "Optional Securities"). The Firm Securities and the Optional Securities are herein collectively called the "Offered Securities." The Company and the Selling Stockholders hereby agree with the several Underwriters named in Schedule B hereto ("Underwriters") as follows: 2. Representations and Warranties of the Company and the Selling Stockholders. (a) The Company represents and warrants to, and agrees with, the several Underwriters that: (i) A registration statement (No. 333-70747) relating to the Offered Securities, including a form of prospectus, has been filed with the Securities and Exchange Commission ("Commission") and either (A) has been declared effective under the Securities Act of 1933, as amended ("Act"), and is not proposed to be amended or (B) is proposed to be amended by amendment or post-effective amendment. If such registration statement (the "initial registration statement") has been declared effective, either (A) an additional registration statement (the "additional registration statement") relating to the Offered Securities may have been filed with the Commission pursuant to Rule 462(b) ("Rule 462(b)") under the Act and, if so filed, has become effective upon filing pursuant to such Rule, and the Offered Securities all have been duly registered under the Act pursuant to the initial registration statement and, if applicable, the additional registration statement, or (B) such an additional registration statement is proposed to be filed with the Commission pursuant to Rule 462(b) and will become effective upon filing pursuant to such Rule and, upon such filing, the Offered Securities will all have been duly registered under the Act pursuant to the initial registration statement and such additional registration statement. If the Company does not propose to amend the initial registration statement or if an additional registration statement has been filed and the Company does not propose to amend it, and if any post-effective amendment to either such registration statement has been filed with the Commission prior to the execution and delivery of this Agreement, the most recent amendment (if any) to each such registration statement has been declared effective by the Commission or has become effective upon filing pursuant to Rule 462(c) ("Rule 462(c)") under the Act or, in the case of the additional registration statement, Rule 462(b). For purposes of this Agreement, "Effective Time" with respect to the initial registration statement or, if filed prior to the execution and delivery of this Agreement, the additional registration statement means (A) if the Company has advised the Representatives that it does not propose to amend such registration statement, the date and time as of which such registration statement, or the most recent post-effective amendment thereto (if any) filed prior to the execution and delivery of this Agreement, was declared effective by the Commission or has become effective upon filing pursuant to Rule 462(c), or (B) if the Company has advised the Representatives that it proposes to file an amendment or post-effective amendment to such registration statement, the date and time as of which such registration statement, as amended by such amendment or post-effective amendment, as the case may be, is declared effective by the Commission. If an additional registration statement has not been filed prior to the execution and delivery of this Agreement but the Company has advised the Representatives that it proposes to file one, "Effective Time" with respect to such additional registration statement means the date and time as of which such registration statement is filed and becomes effective pursuant to Rule 462(b). "Effective Date" with respect to the initial registration statement or the additional registration statement (if any) means the date of the Effective Time thereof. The initial registration statement, as amended at its Effective Time, including all information contained in the additional registration statement (if any) and deemed to be a part of the initial registration statement as of the Effective Time of the additional registration statement pursuant to the General Instructions of the Form on which it is filed and including all information (if any) deemed to be a part of the initial registration statement as of its Effective Time pursuant to Rule 430A(b) ("Rule -2- 430A(b)") under the Act, is hereinafter referred to as the "Initial Registration Statement." The additional registration statement, as amended at its Effective Time, including the contents of the initial registration statement incorporated by reference therein and including all information (if any) deemed to be a part of the additional registration statement as of its Effective Time pursuant to Rule 430A(b), is hereinafter referred to as the "Additional Registration Statement." The Initial Registration Statement and the Additional Registration Statement are hereinafter referred to collectively as the "Registration Statements" and individually as a "Registration Statement." The form of prospectus relating to the Offered Securities, as first filed with the Commission pursuant to and in accordance with Rule 424(b) ("Rule 424(b)") under the Act or (if no such filing is required) as included in a Registration Statement, is hereinafter referred to as the "Prospectus." No document has been or will be prepared or distributed in reliance on Rule 434 under the Act. (ii) If the Effective Time of the Initial Registration Statement is prior to the execution and delivery of this Agreement: (A) on the Effective Date of the Initial Registration Statement, the Initial Registration Statement conformed in all material respects to the requirements of the Act and the rules and regulations of the Commission ("Rules and Regulations") and did not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, (B) on the Effective Date of the Additional Registration Statement (if any), each Registration Statement conformed or will conform, in all material respects to the requirements of the Act and the Rules and Regulations and did not include, or will not include, any untrue statement of a material fact and did not omit, or will not omit, to state any material fact required to be stated therein or necessary to make the statements therein not misleading, and (C) on the date of this Agreement, the Initial Registration Statement and, if the Effective Time of the Additional Registration Statement is prior to the execution and delivery of this Agreement, the Additional Registration Statement each conforms, and at the time of filing of the Prospectus pursuant to Rule 424(b) or (if no such filing is required) at the Effective Date of the Additional Registration Statement in which the Prospectus is included, each Registration Statement and the Prospectus will conform, in all material respects to the requirements of the Act and the Rules and Regulations, and none of such documents includes, or will include, any untrue statement of a material fact or omits, or will omit, to state any material fact required to be stated therein or necessary to make the statements therein not misleading. If the Effective Time of the Initial Registration Statement is subsequent to the execution and delivery of this Agreement: on the Effective Date of the Initial Registration Statement, the Initial Registration Statement and the Prospectus will conform in all material respects to the requirements of the Act and the Rules and Regulations, neither of such documents will include any untrue statement of a material fact or will omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, and no Additional Registration Statement has been or will be filed. The two preceding sentences do not apply to statements in or omissions from a Registration -3- Statement or the Prospectus based upon written information furnished to the Company by any Selling Stockholder or by any Underwriter through the Representatives specifically for use therein, it being understood and agreed that the only such information furnished by any Selling Stockholder is that described as such in Section 7(b) hereof and the only such information furnished by any Underwriter is that described as such in Section 7(c) hereof. (iii) The Company has been duly incorporated and is an existing corporation in good standing under the laws of the State of Delaware, with corporate power and authority to own its properties and conduct its business as described in the Prospectus; and the Company is duly qualified to do business as a foreign corporation in good standing in all other jurisdictions in which its ownership or lease of property or the conduct of its business requires such qualification, except for failures to be so qualified and in good standing that, individually or in the aggregate, do not have, and are reasonably likely not to have, a material adverse effect on the condition (financial or other), business, properties or results of operations of the Company and its subsidiaries, taken as a whole (a "Material Adverse Effect"). (iv) Each of the subsidiaries of the Company listed in Schedule C hereto (the "Material Subsidiaries") has been duly incorporated and is an existing corporation in good standing under the laws of the jurisdiction of its incorporation, with corporate power and authority to own its properties and conduct its business as described in the Prospectus; and each Material Subsidiary of the Company is duly qualified to do business as a foreign corporation in good standing in all other jurisdictions in which its ownership or lease of property or the conduct of its business requires such qualification, except for failures to be so qualified or in good standing that, individually or in the aggregate, do not have, and are reasonably likely not to have, a Material Adverse Effect; all of the issued and outstanding capital stock of each Material Subsidiary of the Company has been duly authorized and validly issued and is fully paid and nonassessable; and the capital stock of each Material Subsidiary is owned by the Company, directly or through subsidiaries, free from any mortgage, pledge, lien, security interest, claim, encumbrance or other defect of any kind, except any of the foregoing that has been or will be granted under the Credit Agreement dated as of October 26, 1998, as amended (as described in the Prospectus); and, there are no rights granted to or in favor of any third party (whether acting in an individual, fiduciary or other capacity) other than the Company to acquire such capital stock, any additional capital stock or any other securities of any such Material Subsidiary. (v) The Offered Securities to be sold by the Selling Stockholders and all other outstanding shares of capital stock of the Company have been duly authorized and are validly issued, fully paid and nonassessable and have been issued in compliance with applicable federal and state securities laws. The Offered Securities to be sold by the Company have been duly authorized and will be, when issued and paid for in accordance with this Agreement, validly issued, fully paid and nonassessable, and no further approval -4- or authorization of the stockholders or the Board of Directors of the Company is or will be required for the issuance and sale of the Offered Securities as contemplated by this Agreement on each Closing Date (as defined below). The Offered Securities to be sold by the Selling Stockholders conform and the Offered Securities to be sold by the Company will conform to the descriptions thereof contained in the Prospectus under the captions "Capitalization" and "Description of Capital Stock" and on each Closing Date the stockholders of the Company will have no preemptive or similar rights with respect to the Offered Securities or any other securities of the Company. (vi) Except as described in the Prospectus, there are no contracts, agreements or understandings between the Company and any person that would give rise to a valid claim against the Company or any Underwriter for a brokerage commission, finder's fee or other like payment in connection with this Agreement. (vii) Except as described in the Prospectus, there are no contracts, agreements or understandings between the Company and any person granting such person the right to require the Company to file a registration statement under the Act with respect to any securities of the Company owned or to be owned by such person or to require the Company to include such securities in the securities registered pursuant to a Registration Statement or in any securities being registered pursuant to any other registration statement filed by the Company under the Act. (viii) The Securities have been approved for listing, subject to notice of issuance, on The Nasdaq National Market. (ix) Except as described in the Prospectus, no consent, approval, authorization or order of, or filing with, any governmental agency or body or any court is required to be obtained or made by the Company for the consummation of the transactions contemplated by this Agreement, except such as have been, or will be, obtained or made on or prior to the First Closing Date (as defined below). (x) The execution, delivery and performance by the Company of this Agreement and the consummation by the Company of the transactions contemplated herein have been duly authorized by all necessary corporate action on the part of the Company and, to the extent required, its stockholders and do not and will not conflict with or result in a breach or violation of any of the terms and provisions of, and do not and will not constitute a default (or an event which with the giving of notice or the lapse of time or both would constitute a default) under, and do not and will not result in the creation or imposition of any lien, charge or encumbrance upon any assets, properties or operations of the Company or any of its subsidiaries (including any individual institution within such entity ("subsidiaries")) under, (A) the charter, by-laws or other organizational documents of the Company or any such subsidiary, (B) except as described in the Prospectus, any statute, rule, regulation, requirement, order or decree of any -5- governmental, regulatory or accrediting agency or body or any court having jurisdiction over the Company or any such subsidiary or any of their properties, assets or operations, including, without limitation, The Higher Education Act of 1965, as amended, and the regulations promulgated thereunder (the "HEA"), or (C) any indenture, mortgage, loan or credit agreement, note, lease, permit, license or other agreement or instrument to which the Company or any such subsidiary is a party or by which the Company or any such subsidiary is bound or to which any of the properties, assets or operations of the Company or any such subsidiary is subject, except, in each case, for such conflicts, breaches, violations, defaults, liens, charges or encumbrances that, individually or in the aggregate, do not have, and are reasonably likely not to have, a Material Adverse Effect or that, individually or in the aggregate, do not have, and are reasonably likely not to have, a material adverse effect on the ability of the Company to consummate the transactions contemplated by this Agreement and perform its obligations hereunder. The sale of the Offered Securities or consummation of the other transactions contemplated by this Agreement will not constitute a change of ownership resulting in a "change of control" of the Company as defined in the HEA. (xi) This Agreement has been duly executed and delivered by the Company and constitutes the legal, valid and binding obligation of the Company enforceable against the Company in accordance with its terms, except to the extent that (A) enforceability may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other similar laws relating to creditors' rights generally and by general principles of equity, whether applied by a court of law or equity, and (B) rights to indemnity and contribution may be limited by federal or state securities laws or policies underlying such laws. (xii) Except as described in the Prospectus, the Company and its Material Subsidiaries have good and marketable title to all real properties and all other material properties and assets owned by them, in each case free from any mortgage, pledge, lien, security interest, claim, encumbrance or other defect of any kind, except any of the foregoing that do not have, and are reasonably likely not to have, a Material Adverse Effect; and, except as described in the Prospectus, the Company and its Material Subsidiaries hold any leased real or material personal property under valid and enforceable leases with no exceptions other than any exceptions that do not have, and are reasonably likely not to have, a Material Adverse Effect. (xiii) Except as described in the Prospectus, the Company and its subsidiaries possess all accreditations, approvals, authorizations, certificates, permits and licenses (collectively, "Licenses") issued by appropriate governmental, regulatory or accrediting agencies or bodies, including, without limitation, all authorizations required for participation in federal aid programs under Title IV of the HEA ("Title IV Programs"), as are necessary to own, lease or operate their properties and to conduct the business now operated by them and all such Licenses are in full force and effect, except for failures to possess any such Licenses or failures of any such Licenses to be in full force and effect -6- that, individually or in the aggregate, do not have, and are reasonably likely not to have, a Material Adverse Effect; the Company and its subsidiaries are in compliance with their respective obligations under such Licenses, subject to such qualifications as are described in the Prospectus; and, except as described in the Prospectus, neither the Company nor any of its subsidiaries has received written notice of any proceedings, investigations or inquiries (or has knowledge of any facts that could form a reasonable basis for any proceedings, investigations or inquiries) relating to the revocation, modification, termination or suspension of any such License, except for any such revocations, modifications, terminations or suspensions that, individually or in the aggregate, do not have, and are reasonably likely not to have, a Material Adverse Effect. (xiv) No labor dispute with the employees of the Company or any subsidiary exists or, to the knowledge of the Company, is imminent that is reasonably likely to have a Material Adverse Effect. (xv) The Company and its subsidiaries own, possess or can acquire on reasonable terms, adequate trademarks, trade names and other rights to inventions, know-how, patents, copyrights, confidential information and other intellectual property (collectively, "intellectual property rights") necessary to conduct the business now operated by them, or currently employed by them, and have not received any notice of infringement of or conflict with asserted rights of others with respect to any intellectual property rights that, if determined adversely to the Company or any of its subsidiaries, individually or in the aggregate, would be reasonably likely to have a Material Adverse Effect. (xvi) Except as described in the Prospectus, neither the Company nor any of its subsidiaries is in violation of any statute, rule, regulation, decision or order of any governmental agency or body or any court, domestic or foreign, relating to the use, disposal or release of hazardous or toxic substances or relating to the protection or restoration of the environment or human exposure to hazardous or toxic substances (collectively, "environmental laws"), owns or operates any real property contaminated with any substance that is subject to any environmental laws, is liable for any off-site disposal or contamination pursuant to any environmental laws, or is subject to any claim relating to any environmental laws, which violation, contamination, liability or claim, individually or in the aggregate has, or is reasonably likely to have, a Material Adverse Effect; and the Company is not aware of any pending investigation that is reasonably likely to lead to such a claim. (xvii) Except as described in the Prospectus, there are no pending actions, suits or proceedings against or affecting the Company, any of its subsidiaries or any of their respective properties that, if determined adversely to the Company or any of its subsidiaries, individually or in the aggregate, would be reasonably likely to have a Material Adverse Effect or would materially and adversely affect the ability of the Company to perform its obligations under this Agreement or which are otherwise -7- material in the context of the sale of the Offered Securities; and no such actions, suits or proceedings are, to the Company's knowledge, threatened. (xviii) The financial statements included in each Registration Statement and the Prospectus present fairly the financial position of the entities covered thereby as of the dates shown and their results of operations and cash flows for the periods shown, and such financial statements have been prepared in conformity with the generally accepted accounting principles in the United States of America applied on a consistent basis (except, with respect to unaudited interim financial statements, as otherwise described in the Prospectus); any financial statement schedules included in each Registration Statement present fairly the information required to be stated therein; and the assumptions used in preparing the pro forma financial information included in each Registration Statement and the Prospectus provide a reasonable basis for presenting the significant effects directly attributable to the transactions or events described therein, the related pro forma adjustments give appropriate effect to those assumptions and the pro forma columns therein reflect the proper application of those adjustments to the corresponding historical financial statement amounts. (xix) Except as described in the Prospectus, since the date of the latest financial statements of the Company included in the Prospectus there has been no material adverse change, nor any development or event involving a prospective material adverse change, in the condition (financial or other), business, properties or results of operations of the Company and its subsidiaries taken as a whole, and, except as described in or contemplated by the Prospectus, there has been no dividend or distribution of any kind declared, paid or made by the Company on any class of its capital stock. (xx) Except as described in the Prospectus, there are no outstanding (A) securities or obligations of the Company convertible into or exchangeable for any capital stock of the Company, (B) warrants, rights or options to subscribe for or purchase from the Company any such capital stock or any such convertible or exchangeable securities or obligations or (C) obligations of the Company to issue any such capital stock, convertible or exchangeable securities or obligations, or warrants, rights or obligations. (xxi) The Company and its Material Subsidiaries maintain a system of internal accounting controls sufficient in all material respects for purposes of the prevention or detection of errors or irregularities in amounts that could be expected to be material to the Company's consolidated financial statements and the recording of transactions so as to permit the preparation of such consolidated financial statements in conformity with generally accepted accounting principles. (xxii) Neither the Company nor any of its subsidiaries is in violation of (A) its charter, by-laws or other organizational documents or (B) except as described in the Prospectus, any statute, rule, regulation, requirement, order, decree or judgment of any -8- governmental, regulatory or accrediting agency or body or any court having jurisdiction over the Company or any such subsidiary; and no event of default (or event which with the giving of notice or the lapse of time, or both, would constitute an event of defaults) exists under any indenture, mortgage, loan or credit agreement, note, lease, permit, license or other agreement or instrument to which the Company or any such Subsidiary is a party or by which the Company or any such subsidiary is bound or to which any of the properties, assets or operations of the Company or any such subsidiary is subject, except, in each case, for violations or events of default that, individually or in the aggregate, do not have, and are reasonably likely not to have, a Material Adverse Effect. (xxiii) The Company and its Material Subsidiaries carry or are entitled to the benefits of insurance in such amounts and covering such risks as the Company believes are generally maintained by companies of established repute engaged in the same or a similar business, and all such insurance is in full force and effect. (xxiv) The Company has not taken and will not take, directly or indirectly, any action designed to or that could cause or result in the stabilization or manipulation of the price of the Offered Securities to facilitate the sale or resale of the Offered Securities. (xxv) The Company is not and, after giving effect to the offering and sale of the Offered Securities and the application of the proceeds therefrom as described in the Prospectus, will not be an "investment company" as defined in the Investment Company Act of 1940, as amended. (b) Each Selling Stockholder severally represents and warrants to, and agrees with, the several Underwriters that: (i) Such Selling Stockholder has, and on the Closing Date hereinafter mentioned will have, good, clear and marketable title to the Offered Securities to be delivered by such Selling Stockholder on such Offered Closing Date and full right, power and authority to enter into this Agreement and to sell, assign, transfer and deliver the Offered Securities to be delivered by such Selling Stockholder on such Closing Date hereunder; and upon the delivery of and payment for the Offered Securities on each Closing Date hereunder the several Underwriters will acquire good, clear and marketable title to the Offered Securities to be delivered by such Selling Stockholder on such Closing Date. (ii) If the Effective Time of the Initial Registration Statement is prior to the execution and delivery of this Agreement: (A) on the Effective Date of the Initial Registration Statement, the Initial Registration Statement did not include any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, (B) on the Effective Date of the Additional Registration Statement (if any), each Registration Statement did not include, or will not include, any untrue statement of a material fact and did not omit, or will not omit, to state any material fact required to be stated therein or necessary to make -9- the statements therein not misleading, and (C) on the date of this Agreement, the Initial Registration Statement and, if the Effective Time of the Additional Registration Statement is prior to the execution and delivery of this Agreement, the Additional Registration Statement, each does not include or will not include, any untrue statement of a material fact or omit, or will not omit, to state any material fact required to be stated therein or necessary to make the statements therein not misleading. If the Effective Time of the Initial Registration Statement is subsequent to the execution and delivery of this Agreement: on the Effective Date of the Initial Registration Statement, the Initial Registration Statement and the Prospectus will not include any untrue statement of a material fact or will not omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading. The two preceding sentences apply only to the information in the Registration Statement or the Prospectus under the caption "Principal and Selling Stockholders" which specifically relates to such Selling Stockholder. (iii) This Agreement has been duly authorized, executed and delivered by or on behalf of such Selling Stockholder and constitutes the legal, valid and binding obligations of such Selling Stockholder enforceable against such Selling Stockholder in accordance with its terms, except to the extent that (A) enforceability may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other similar laws relating to creditors' rights generally and by general principles of equity, whether applied by a court of law or equity, and (B) rights to indemnity and contribution may be limited by federal and state securities laws or policies underlying such laws. (iv) Except as described in the Prospectus, no consent, approval, authorization or order of, filing with, any governmental agency or body or any court is required to be obtained or made for the consummation by such Selling Stockholder of the transactions contemplated by this Agreement, except such as have been, or will be, obtained or made on or prior to the First Closing Date. (v) The execution, delivery and performance by such Selling Stockholder of the Power of Attorney, the Custody Agreement and this Agreement, the sale of the Offered Securities to be sold by such Selling Stockholder and the consummation by such Selling Stockholder of any of the other transactions herein and therein contemplated, do not and will not conflict with or result in a breach or violation of any of the terms and provisions of, or constitute or will constitute a default (or an event which with the giving of notice or the lapse of time or both would constitute a default) under, or result in the creation or imposition of any lien, charge or encumbrance upon the Offered Securities under (A) in the case of a corporate Selling Stockholder, the charter, by-laws or other organizational documents of such Selling Stockholder, (B) except as described in the Prospectus, any statute, rule, regulation, requirement, order or decree of any governmental or accrediting agency or body or any court having jurisdiction over such Selling Stockholder or any of its properties, assets or operations or (C) any indenture, mortgage, loan or credit -10- agreement, note, lease, permit, license or other agreement or instrument to which such Selling Stockholder is a party or by which such Selling Stockholder is bound or to which any of the properties, assets or operations of such Selling Stockholder is subject, except, in each case, for such conflicts, breaches, violations, defaults, liens, charges and encumbrances that individually or in the aggregate, do not have, and are reasonably likely not to have, a Material Adverse Effect on the ability of such Selling Stockholder to consummate the transactions contemplated by this Agreement, the Power of Attorney and the Custody Agreement or perform such Selling Stockholder's obligations hereunder and thereunder. (vi) The Power of Attorney and related Custody Agreement with respect to each Selling Stockholder has been duly authorized, executed and delivered by such Selling Stockholder and constitute valid and legally binding obligations of each such Selling Stockholder enforceable in accordance with their terms, subject to bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and similar law of general applicability relating to or affecting creditors' rights and to general equity principles. (vii) Except as described in the Prospectus, there are no contracts, agreements or understandings between such Selling Stockholder and any third party that would give rise to a valid claim against such Selling Stockholder or any Underwriter for a brokerage commission, finder's fee or other like payment in connection with the transactions contemplated by this Agreement. (viii) Such Selling Stockholder has not taken and will not take, directly or indirectly, any action designed to or that could cause or result in the stabilization or manipulation of the price of the Offered Securities to facilitate the sale or resale of the Offered Securities. 3. Purchase, Sale and Delivery of Offered Securities. On the basis of the representations, warranties and agreements herein contained, but subject to the terms and conditions herein set forth, the Company and each Selling Stockholder agree, severally and not jointly, to sell to the Underwriters, and each Underwriter agrees, severally and not jointly, to purchase from the Company and each Selling Stockholder, at a purchase price of $_____ per share, that number of Firm Securities (rounded up or down as determined by Credit Suisse First Boston Corporation ("CSFBC") in its discretion, in order to avoid fractions) obtained by multiplying 250,000 Firm Securities (in the case of the Company) and the number of Firm Securities set forth opposite the name of such Selling Stockholder in Schedule A hereto (in the case of such Selling Stockholder) in each case by a fraction the numerator of which is the number of Firm Securities set forth opposite the name of such Underwriter in Schedule B hereto and the denominator of which is the total number of Firm Securities. Certificates in negotiable form for the Offered Securities to be sold by the Selling Stockholders hereunder have been placed in custody, for delivery pursuant to this Agreement, -11- under those certain Custody Agreements made with Harris Trust and Savings Bank, as custodian ("Custodian"). Each Selling Stockholder agrees that the shares represented by the certificates held in custody for the Selling Stockholders under such Custody Agreements are subject to the interests of the Underwriters hereunder, that the arrangements made by the Selling Stockholders for such custody are, to that extent, irrevocable, and that the obligations of the Selling Stockholders hereunder shall not be terminated by operation of law, whether by the death of any individual Selling Stockholder or the occurrence of any other event, or, in the case of a trust, by the death of any trustee or trustees or the termination of such trust. If any individual Selling Stockholder or any such trustee or trustees should die, or if any other such event should occur, or if any of such trusts should terminate, before the delivery of the Offered Securities to be sold by such Selling Stockholders hereunder, certificates for such Offered Securities shall be delivered by the Custodian in accordance with the terms and conditions of this Agreement as if such death or other event or termination had not occurred, regardless of whether or not the Custodian shall have received notice of such death or other event of termination. The Company and the Custodian will deliver the Firm Securities to the Representatives for the accounts of the Underwriters against payment of the purchase price in Federal (same day) funds by official bank check or checks or wire transfer to an account at a bank designated by the Company and the Selling Stockholders and reasonably acceptable to CSFBC drawn to the order of the Company in the case of the Firm Securities sold by the Company and to each Selling Stockholder in the case of the Firm Securities sold by such Selling Stockholder at the office of Katten Muchin & Zavis, at _____ A.M., New York time, on __________, 1999 or at such other time not later than seven full business days thereafter as CSFBC, the Company and the Custodian determine (such time being herein referred to as the "First Closing Date"). For purposes of Rule 15c6-1 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the First Closing Date (if later than the otherwise applicable settlement date) shall be the settlement date for payment of funds and delivery of securities for all the Offered Securities sold pursuant to this Agreement. The certificates for the Firm Securities so to be delivered will be in definitive form, in such denominations and registered in such names as CSFBC requests and will be made available for checking and packaging at the office of CSFBC, Eleven Madison Avenue, New York, New York 10010, at least 24 hours prior to the First Closing Date. In addition, upon written notice from CSFBC given to the Company and Larson from time to time not more than 30 days subsequent to the date of the Prospectus, the Underwriters may purchase all or less than all of the Optional Securities at the purchase price per share to be paid for the Firm Securities. The Company and Larson agree, severally and not jointly, to sell to the Underwriters the respective numbers of Optional Securities obtained by multiplying the number of Optional Securities specified in such notice by a fraction the numerator of which is 280,000, in the case of the Company, and 20,000, in the case of Larson, respectively, and the denominator of which is the total number of Optional Securities (subject to adjustment by CSFBC to eliminate fractions). Such Optional Securities shall be purchased from the Company and Larson for the account of each Underwriter in the same proportion as the number of Firm Securities set forth opposite such Underwriter's name bears to the total number of Firm Securities -12- (subject to adjustment by CSFBC to eliminate fractions) and may be purchased by the Underwriters only for the purpose of covering over-allotments made in connection with the sale of the Firm Securities. No Optional Securities shall be sold or delivered unless the Firm Securities previously have been, or simultaneously are, sold and delivered. The right to purchase the Optional Securities or any portion thereof may be exercised from time to time and to the extent not previously exercised may be surrendered and terminated at any time upon notice by CSFBC to the Company and Larson. Each time for the delivery of and payment for the Optional Securities, being herein referred to as an "Optional Closing Date," which may be the First Closing Date (the First Closing Date and each Optional Closing Date, if any, being sometimes referred to as a "Closing Date"), shall be determined by CSFBC but shall be not later than five full business days after written notice of election to purchase Optional Securities is given. The Company and the Custodian will deliver the Optional Securities being purchased on each Optional Closing Date to the Representatives for the accounts of the several Underwriters against payment of the purchase price therefor in Federal (same day) funds by official bank check or checks or wire transfer to an account at a bank acceptable to CSFBC drawn to the order of the Company, in the case of Optional Securities sold by the Company, and Larson, in the case of the Optional Securities sold by Larson. The certificates for the Optional Securities being purchased on each Optional Closing Date will be in definitive form, in such denominations and registered in such names as CSFBC requests upon reasonable notice prior to such Optional Closing Date and will be made available for checking and packaging at the office of CSFBC, Eleven Madison Avenue, New York, New York 10010, at a reasonable time in advance of such Optional Closing Date. 4. Offering by Underwriters. It is understood that the several Underwriters propose to offer the Offered Securities for sale to the public as set forth in the Prospectus. 5. Certain Agreements of the Company and the Selling Stockholders. The Company agrees with the several Underwriters and the Selling Stockholders and, with respect to clauses (j) and (k) below, each Selling Stockholder agrees with the Company and the several Underwriters that: (a) If the Effective Time of the Initial Registration Statement is prior to the execution and delivery of this Agreement, the Company will file the Prospectus with the Commission pursuant to and in accordance with subparagraph (1) (or, if applicable and if consented to by CSFBC, subparagraph (4)) of Rule 424(b) not later than the earlier of (A) the second business day following the execution and delivery of this Agreement or (B) the fifteenth business day after the Effective Date of the Initial Registration Statement. The Company will advise CSFBC promptly of any such filing pursuant to Rule 424(b). If the Effective Time of the Initial Registration Statement is prior to the execution and delivery of this Agreement and an additional registration statement is -13- necessary to register a portion of the Offered Securities under the Act but the Effective Time thereof has not occurred as of such execution and delivery, the Company will file the additional registration statement or, if filed, will file a post-effective amendment thereto with the Commission pursuant to and in accordance with Rule 462(b) on or prior to 10:00 P.M., New York time, on the date of this Agreement or, if earlier, on or prior to the time the Prospectus is printed and distributed to any Underwriter, or will make such filing at such later date as shall have been consented to by CSFBC. (b) The Company will advise CSFBC promptly of any proposal to amend or supplement the initial or any additional registration statement as filed or the related prospectus or the Initial Registration Statement, the Additional Registration Statement (if any) or the Prospectus and will not effect such amendment or supplementation without CSFBC's consent, which consent shall not be unreasonably withheld; and the Company will also advise CSFBC promptly of the effectiveness of each Registration Statement (if its Effective Time is subsequent to the execution and delivery of this Agreement) and of any amendment or supplementation of a Registration Statement or the Prospectus and of the institution by the Commission of any stop order proceedings in respect of a Registration Statement and will use its best efforts to prevent the issuance of any such stop order and to obtain as soon as possible its lifting, if issued. (c) If, at any time when a prospectus relating to the Offered Securities is required to be delivered under the Act in connection with sales by any Underwriter or dealer, any event occurs as a result of which the Prospectus as then amended or supplemented would include an untrue statement of a material fact or omit to state any material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if it is necessary at any time to amend the Prospectus to comply with the Act, the Company will promptly notify CSFBC of such event and will promptly prepare and file with the Commission, at its own expense, an amendment or supplement that will correct such statement or omission or an amendment which will effect such compliance. Neither CSFBC's consent to, nor the Underwriters' delivery of, any such amendment or supplement shall constitute a waiver of any of the conditions set forth in Section 6. (d) As soon as practicable, but not later than the Availability Date (as defined below), the Company will make generally available to its security holders an earnings statement covering a period of at least 12 months beginning after the Effective Date of the Initial Registration Statement (or, if later, the Effective Date of the Additional Registration Statement) that will satisfy the provisions of Section 11(a) of the Act. For the purpose of the preceding sentence, "Availability Date" means the 45th day after the end of the fourth fiscal quarter following the fiscal quarter that includes such Effective Date, except that, if such fourth fiscal quarter is the last quarter of the Company's fiscal year, "Availability Date" means the 90th day after the end of such fourth fiscal quarter. -14- (e) The Company will furnish to the Representatives copies of each Registration Statement (three of which will be signed and will include all exhibits), each related preliminary prospectus and, so long as a prospectus relating to the Offered Securities is required to be delivered under the Act in connection with sales by any Underwriter or dealer, the Prospectus and all amendments and supplements to such documents, in each case in such quantities as CSFBC reasonably requests. The Prospectus shall be so furnished on or prior to 5:00 P.M., New York time, on the business day following the later of the execution and delivery of this Agreement or the Effective Time of the Initial Registration Statement. All other such documents shall be so furnished as soon as available. The Company will pay the expenses of printing and distributing to the Underwriters all such documents. (f) The Company will arrange for the qualification of the Offered Securities for sale under the laws of such jurisdictions as CSFBC designates and will continue such qualifications in effect so long as required for the distribution; provided, that the Company shall not be required to file a general consent to service of process or qualify to do business in any jurisdiction in which it is not so qualified. (g) During the period of five years hereafter, the Company will furnish to the Representatives and, upon request, to each of the other Underwriters, as soon as practicable after the end of each fiscal year, a copy of its annual report to stockholders for such year; and the Company will furnish to the Representatives (i) as soon as available, a copy of each report and any definitive proxy statement of the Company filed with the Commission under the Exchange Act or mailed to stockholders, and (ii) from time to time, such other information concerning the Company as CSFBC may reasonably request. (h) For a period of 90 days after the date of the initial public offering of the Offered Securities, the Company will not offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, or file with the Commission a registration statement under the Act relating to, any additional shares of its Securities or securities convertible into or exchangeable or exercisable for any shares of its Securities, or publicly disclose the intention to make any such offer, sale, pledge, disposition or filing, without the prior written consent of CSFBC, except issuances of Securities pursuant to the conversion or exchange of convertible or exchangeable securities or the exercise of warrants or options, in each case outstanding on the date hereof, or grants of employee or director stock options pursuant to the terms of a plan in effect on the date hereof or issuances of Securities pursuant to the exercise of such options. (i) The Company and each Selling Stockholder agree with the several Underwriters that the Company will pay all expenses incident to the performance of the obligations of the Company and such Selling Stockholder, as the case may be, under this Agreement, for any filing fees and other expenses (including fees and disbursements of counsel to the Company) in connection with qualification of the Offered Securities for -15- sale under the laws of such jurisdictions as CSFBC designates and the printing of memoranda relating thereto, for the filing fee incident to, the review by the National Association of Securities Dealers, Inc. (the "NASD") of the Offered Securities, for any travel expenses of the Company's officers and employees and any other expenses of the Company in connection with attending or hosting meetings with prospective purchasers of the Offered Securities and for expenses incurred in distributing preliminary prospectuses and the Prospectus (including any amendments and supplements thereto) to the Underwriters. Each Selling Stockholder will reimburse the Underwriters (if and to the extent incurred by them) for any transfer taxes on the sale by such Selling Stockholder of the Offered Securities to the Underwriters. (j) Each Selling Stockholder agrees to deliver to CSFBC, attention: Transactions Advisory Group, on or prior to the First Closing Date, if any, a properly completed and executed United States Treasury Department Form W- 9 (or other applicable form or statement specified by Treasury Department regulations in lieu thereof). (k) Each Selling Stockholder agrees, for a period of 90 days after the date of the initial public offering of the Offered Securities, not to offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, any additional shares of the Securities or securities convertible into or exchangeable or exercisable for any shares of Securities, or publicly disclose the intention to make any such offer, sale, pledge or disposal, without the prior written consent of CSFBC. 6. Conditions of the Obligations of the Underwriters. The obligations of the several Underwriters to purchase and pay for the Firm Securities on the First Closing Date and the Optional Securities to be purchased on each Optional Closing Date will be subject to the accuracy of the representations and warranties on the part of the Company and the Selling Stockholders herein, to the accuracy of the statements of Company officers made pursuant to the provisions hereof, to the performance by the Company and the Selling Stockholders of their obligations hereunder and to the following additional conditions precedent: (a) The Representatives shall have received a letter, dated the date of delivery thereof (which, if the Effective Time of the Initial Registration Statement is prior to the execution and delivery of this Agreement, shall be on or prior to the date of this Agreement or, if the Effective Time of the Initial Registration Statement is subsequent to the execution and delivery of this Agreement, shall be prior to the filing of the amendment or post-effective amendment to the registration statement to be filed shortly prior to such Effective Time), of Arthur Andersen LLP confirming that they are independent public accountants with respect to the Company within the meaning of the Act and the applicable Rules and Regulations thereunder adopted by the SEC and stating substantially to the effect that: -16- (i) in their opinion the financial statements and schedule of the Company audited by them and included in the Registration Statements comply as to form in all material respects with the applicable accounting requirements of the Act and the related Rules and Regulations adopted by the SEC; (ii) they have performed the procedures specified by the American Institute of Certified Public Accountants for a review of interim financial information as described in Statement of Auditing Standards No. 71, Interim Financial Information, on the unaudited financial statements of The Katharine Gibbs Schools, Inc. and subsidiaries ("Gibbs") and Scottsdale Culinary Institute, Inc. ("Scottsdale Culinary") included in the Registration Statements; (iii) on the basis of the reviews referred to in clause (ii) above, a reading of the latest available interim financial statements of the Company, inquiries of officials of the Company who have responsibility for financial and accounting matters and other specified procedures, nothing came to their attention that caused them to believe that: (A) the unaudited financial statements of Gibbs and Scottsdale Culinary included in the Registration Statements do not comply as to form in all material respects with the applicable accounting requirements of the Act and the related published Rules and Regulations or any material modifications should be made to such unaudited financial statements for them to be in conformity with generally accepted accounting principles; (B) at the date of the latest available balance sheet read by such accountants, and at a subsequent specified date not more than three business days prior to the date of this Agreement, there was any decrease in stockholders' investment or change in the capital stock or any increase in total current liabilities or long term debt of the Company and its consolidated subsidiaries or any decrease in consolidated total current assets or total assets as compared with amounts shown on the latest balance sheet included in the Prospectus; or (C) for the period from the closing date of the latest income statement included in the Prospectus to the closing date of the latest available income statement read by such accountants and at a subsequent specified date not more than three business days prior to the date of this Agreement, there were any decreases, as compared with the corresponding period of the previous year, in consolidated total net revenue or income from operations of the Company or in the total or per share amounts of consolidated total net income of the Company; -17- except in all cases set forth in clauses (B) and (C) above for changes, increases or decreases which the Prospectus discloses have occurred or may occur or which are described in such letter; and (iv) they have read any unaudited pro forma information included in the Prospectus; inquired of certain officials of the Company who have responsibility for financial and accounting matters about the basis for their determination of the pro forma adjustments and whether such unaudited pro forma financial information complies as to form in all material respects with the applicable requirements of Rule 11-02 of Regulation S-X under the Act; and proved the arithmetic accuracy of the application of the pro forma adjustments to the historical amounts in the unaudited pro forma financial information; (v) on the basis of the procedures specified in clause (iv) above, nothing came to their attention that caused them to believe that the unaudited pro forma financial information referred to in clause (iv) above does not comply as to form in all material respects with the applicable accounting requirements of Rule 11-02 of Regulation S-X under the Act and that the pro forma adjustments have not been properly applied to the historical amounts in the compilation of that information; and (vi) they have compared specified dollar amounts (or percentages derived from such dollar amounts) and other financial information contained in the Registration Statements (in each case to the extent that such dollar amounts, percentages and other financial information are derived from the general accounting records of the Company and its subsidiaries subject to the internal controls of the Company's accounting system or are derived directly from such records by analysis or computation) with the results obtained from inquiries, a reading of such general accounting records and other procedures specified in such letter and have found such dollar amounts, percentages and other financial information to be in agreement with such results, except as otherwise specified in such letter. For purposes of this subsection, (i) if the Effective Time of the Initial Registration Statements is subsequent to the execution and delivery of this Agreement, "Registration Statements" shall mean the initial registration statement as proposed to be amended by the amendment or post- effective amendment to be filed shortly prior to its Effective Time, (ii) if the Effective Time of the Initial Registration Statements is prior to the execution and delivery of this Agreement but the Effective Time of the Additional Registration Statement is subsequent to such execution and delivery, "Registration Statements" shall mean the Initial Registration Statement and the additional registration statement as proposed to be filed or as proposed to be amended by the post-effective -18- amendment to be filed shortly prior to its Effective Time, and (iii) "Prospectus" shall mean the prospectus included in the Registration Statements. (b) The Representatives shall have received a letter, dated the date of delivery thereof (which, if the Effective Time of the Initial Registration Statement is prior to the execution and delivery of this Agreement, shall be on or prior to the date of this Agreement or, if the Effective Time of the Initial Registration Statement is subsequent to the execution and delivery of this Agreement, shall be prior to the filing of the amendment or post-effective amendment to the registration statement to be filed shortly prior to such Effective Time), of each of the accounting firms whose report as to audited financial statements of a company other than the Company is included in the Registration Statement to the effect that (i) they are independent public accountants within the meaning of the Act and the applicable published Rules and Regulations thereunder and (ii) in their opinion the financial statements and any schedules examined by them and included in the Registration Statements comply as to form in all material respects with the applicable accounting requirements of the Act and the related published Rules and Regulations. (c) If the Effective Time of the Initial Registration Statement is not prior to the execution and delivery of this Agreement, such Effective Time shall have occurred not later than 10:00 P.M., New York time, on the date of this Agreement or such later date as shall have been consented to by CSFBC. If the Effective Time of the Additional Registration Statement (if any) is not prior to the execution and delivery of this Agreement, such Effective Time shall have occurred not later than 10:00 P.M., New York time, on the date of this Agreement or, if earlier, the time the Prospectus is printed and distributed to any Underwriter, or shall have occurred at such later date as shall have been consented to by CSFBC. If the Effective Time of the Initial Registration Statement is prior to the execution and delivery of this Agreement, the Prospectus shall have been filed with the Commission in accordance with the Rules and Regulations and Section 5(a) of this Agreement. Prior to such Closing Date, no stop order suspending the effectiveness of a Registration Statement shall have been issued and no proceedings for that purpose shall have been instituted or, to the knowledge of the Company or the Representatives, shall be threatened by the Commission. (d) Subsequent to the execution and delivery of this Agreement, there shall not have occurred (i) any change, or any development or event involving a prospective change, in the condition (financial or other), business, properties or results of operations of the Company or its subsidiaries, taken as a whole, which, in the judgment of a majority in interest of the Underwriters (including the Representatives), is material and adverse and makes it impractical or inadvisable to proceed with completion of the public offering or the sale of and payment for the Offered Securities; (ii) any suspension or limitation of trading in securities generally on the New York Stock Exchange, or any setting of minimum prices for trading on such exchange, or any suspension of trading of any -19- securities of the Company on any exchange or in the over-the-counter market; (iii) any banking moratorium declared by U.S. Federal or New York authorities; or (iv) any outbreak or escalation of major hostilities in which the United States of America is involved, any declaration of war by Congress or any other substantial national or international calamity or emergency if, in the judgment of a majority in interest of the Underwriters (including the Representatives), the effect of any such outbreak, escalation, declaration, calamity or emergency makes it impractical or inadvisable to proceed with completion of the public offering or the sale of and payment for the Offered Securities. (e) The Representatives shall have received an opinion, dated such Closing Date, of Katten Muchin & Zavis, counsel for the Company, to the effect that: (i) The Company has been duly incorporated and is an existing corporation in good standing under the laws of the State of Delaware, with corporate power and authority to own its properties and conduct its business as described in the Prospectus; and the Company is qualified to do business as a foreign corporation in good standing in each jurisdiction listed in Schedule D hereto; (ii) The Offered Securities to be sold by the Selling Stockholders on such Closing Date and all other outstanding shares of capital stock of the Company have been duly authorized and are validly issued, fully paid and nonassessable. The Offered Securities to be sold by the Company have been duly authorized and will be, when issued and paid for in accordance with this Agreement, validly issued, fully paid and nonassessable. The Offered Securities conform in all material respects to the descriptions thereof contained in the Prospectus under the captions "Capitalization" and "Description of Capital Stock;" (iii) No consent, approval, authorization or order of, or filing with, any governmental agency or body or any court is required to be obtained or made by the Company for the consummation of the transactions contemplated by this Agreement, other than as required under state securities laws or as have been obtained or made under the Act (it being understood that such counsel need express no opinion as to the matters described in Section 6(g)(ii), as to which Dow, Lohnes & Albertson, PLLC, is providing an opinion to the Underwriters, or Section 6(h)(ii), as to which Fraser Milner is providing an opinion to the Underwriters); (iv) The execution, delivery and performance by the Company of this Agreement and the consummation by the Company of the transactions herein contemplated have been duly authorized by all necessary corporate action on the part of the Company and, to the extent required, its stockholders and do not result in a breach or violation of any of the terms and provisions of, and do not -20- constitute a default (or an event which with the giving of notice or the lapse of time or both would constitute a default) under, and do not result in the creation or imposition of any lien, charge or encumbrance upon any assets, properties or operations of the Company or any of its Material Subsidiaries under, (A) the charter, by-laws or other organizational documents of the Company or any such Material Subsidiary, (B) to the knowledge of such counsel, any statute, rule, regulation, requirement, order or decree of any governmental or regulatory agency or body or any court having jurisdiction over the Company or any such Material Subsidiary or any of their properties, assets or operations or (C) to the knowledge of such counsel, any indenture, mortgage, loan or credit agreement, note, lease, permit, license or other agreement or instrument that is material to the Company and the Material Subsidiaries, taken as a whole, and to which the Company or such Material Subsidiary is a party or by which the Company or any such Material Subsidiary is bound or to which any of the properties, assets or operations of the Company or any such Material Subsidiary is subject (it being understood that, in the case of clause (B) above, such counsel need express no opinion as to the matters described in Section 6(g)(iii), as to which Dow, Lohnes & Albertson, PLLC, is providing an opinion to the Underwriters, or Section 6(h)(iii), as to which Fraser Milner is providing an opinion to the Underwriters); (v) The Initial Registration Statement was declared effective under the Act as of the date and time specified in such opinion, the Additional Registration Statement (if any) was filed and became effective under the Act as of the date and time (if determinable) specified in such opinion, the Prospectus either was filed with the Commission pursuant to the subparagraph of Rule 424(b) specified in such opinion on the date specified therein or was included in the Initial Registration Statement or the Additional Registration Statement (as the case may be), and, to the knowledge of such counsel, no stop order suspending the effectiveness of a Registration Statement or any part thereof has been issued and no proceedings for that purpose have been instituted or are pending or threatened under the Act, and each Registration Statement and the Prospectus, and each amendment or supplement thereto, as of their respective effective or issue dates, complied as to form in all material respects with the requirements of the Act and the Rules and Regulations; the descriptions in the Registration Statements and Prospectus of statutes, legal and governmental proceedings and contracts and other documents are accurate and fairly present the information required to be shown (it being understood that such counsel need express no opinion as to the matters described in Section 6(g)(i), as to which Dow, Lohnes & Albertson, PLLC, is providing an opinion to the Underwriters, or Section 6(h)(i), as to which Fraser Milner is providing an opinion to the Underwriters); and (vi) This Agreement has been duly executed and delivered by the Company and is enforceable against the Company in accordance with its terms, -21- except to the extent that (A) enforceability may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other similar laws relating to creditors' rights generally and by general principles of equity, whether applied by a court of law or equity, and (B) rights to indemnity and contribution may be limited by federal and state securities laws or policies underlying such laws. In addition, such counsel shall state that (A) except as described in the Prospectus, to the knowledge of such counsel, there are no contracts or agreements between the Company and any person granting such person the right to require the Company to file a registration statement under the Act with respect to any securities of the Company owned or to be owned by such person or to require the Company to include such securities in the securities registered pursuant to the Registration Statement or in any securities being registered pursuant to any other registration statement filed by the Company under the Act; (B) such counsel do not know of any legal or governmental proceedings required to be described in a Registration Statement or the Prospectus which are not described as required or of any contracts or documents of a character required to be described in a Registration Statement or the Prospectus or to be filed as exhibits to a Registration Statement which are not described and filed as required; (C) except as described in the Prospectus, to the knowledge of such counsel, there are no pending or threatened actions, suits, proceedings or investigations against or affecting the Company or any of its subsidiaries or any of their respective properties, assets or operations that, if determined adversely to the Company or any of its subsidiaries, individually or in the aggregate, would be reasonably likely to have, a Material Adverse Effect or would be reasonably likely to materially and adversely affect the ability of the Company to perform its obligations under this Agreement; and (D) they have no reason to believe that any part of a Registration Statement or any amendment thereto, as of its effective date or as of such Closing Date, contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading; or that the Prospectus or any amendment or supplement thereto, as of its issue date or as of such Closing Date, contained any untrue statement of a material fact or omitted to state any material fact necessary in order to make the statements therein, the light of the circumstances under which they were made, not misleading (it being understood that for purposes of this subparagraph such counsel need express no opinion as to the financial statements and schedules and other financial and accounting data contained in the Registration Statements or the Prospectus or as to any matters described in Section 6(g), as to which Dow, Lohnes & Albertson, PLLC, is providing an opinion to the Underwriters, or Section 6(h), as to which Fraser Milner is providing an opinion to the Underwriters). -22- In rendering such opinion, such counsel may rely as to matters governed by the laws of jurisdictions other than the laws of jurisdictions in which such counsel is admitted to practice and the federal laws of the United States of America and, to the extent deemed appropriate by such counsel, as to other matters upon the opinions of counsel reasonably satisfactory to the Representatives and counsel for the Underwriters. (f) The Representatives shall have received an opinion, dated such Closing Date, of [Name], counsel for the Selling Stockholders, to the effect that: (i) Immediately prior to the delivery of the Offered Securities being sold by such Selling Stockholder, such Selling Stockholder was the sole registered owner of the Offered Securities and has legal right and power, or, in the case of a corporate Selling Stockholder, corporate power and authority, to enter into this Agreement and to sell, assign, transfer and deliver the Offered Securities delivered by such Selling Stockholder on such Closing Date; and, upon payment for such Offered Securities, delivery to the Underwriters by such Selling Stockholder of such Offered Securities and registration of such Offered Securities in the names of the Underwriters or their nominees, assuming the Underwriters have purchased such Offered Securities for value, in good faith and without notice of any adverse claim as defined in Section 8-105 of the Uniform Commercial Code, the Underwriters will have acquired all the rights of such Selling Stockholder in such Offered Securities free of any adverse claim, any lien in favor of the Company and any restrictions on transfer imposed by the Company; (ii) This Agreement, the Power of Attorney and Custody Agreement have been duly authorized, executed and delivered by or on behalf of such Selling Stockholder and constitutes the legal, valid and binding obligations of such Selling Stockholder enforceable against such Selling Stockholder in accordance with their respective terms, except to the extent that (A) enforceability may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other similar laws relating to creditors' rights generally and by general principles of equity, whether applied by a court of law or equity, and (B) rights to indemnity and contribution may be limited by federal and state securities laws or policies underlying such laws; (iii) No consent, approval, authorization, order of or filing with, any governmental agency or body or any court is required to be obtained or made by such Selling Stockholder for the consummation by such Selling Stockholder of the transactions contemplated by this Agreement (it being understood that such counsel need express no opinion as to the matters described in Section 6(g)(ii), as to which Dow, Lohnes & Albertson, PLLC, is providing an opinion to the Underwriters, or Section 6(h)(ii), as to which Fraser Milner is providing an opinion to the Underwriters); -23- (iv) The execution, delivery and performance by such Selling Stockholder of the Power of Attorney, the Custody Agreement and this Agreement and the consummation of the transactions contemplated herein and therein by such Selling Stockholder do not result in a breach or violation of any of the terms and provisions of, and do not constitute a default (or an event which with the giving of notice or the lapse of time or both would constitute a default) under, or result in the creation or imposition of any lien, charge or encumbrance upon the Offered Securities being sold by such Selling Stockholder under (A) in the case of a corporate Selling Stockholder, the charter, by-laws or other organizational documents of such Selling Stockholder, (B) to the knowledge of such counsel, any statute, rule, regulation, requirement, order or decree of any governmental or regulatory agency or body, or any court having jurisdiction over such Selling Stockholder or any of its properties, assets or operations or (C) to the knowledge of such counsel, any indenture, mortgage, loan or credit agreement, note, lease, permit, license or other agreement or instrument to which such Selling Stockholder is a party or by which such Selling Stockholder is bound or to which any of the properties, assets or operations of such Selling Stockholder is subject, except, in each case, for such breaches, violations, defaults, liens, charges and encumbrances which could not, individually or in the aggregate, have a material adverse effect on the ability of such Selling Stockholder to consummate the transactions contemplated by this Agreement , the Power of Attorney and the Custody Agreement or perform such Selling Stockholder's obligations hereunder and thereunder (it being understood that, in the case of clause (B) above, such counsel need express no opinion as to the matters described in Section 6(g)(iii), as to which Dow, Lohnes & Albertson, PLLC, is providing an opinion to the Underwriters, or Section 6(h)(iii), as to which Fraser Milner is providing an opinion to the Underwriters); (v) The Power of Attorney and related Custody Agreement with respect to each Selling Stockholder has been duly authorized, executed and delivered by such Selling Stockholder and constitute valid and legally binding obligations of such Selling Stockholder enforceable in accordance with its terms, except to the extent that (A) enforceability may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other similar laws relating to creditors' rights generally and by general principles of equity, whether applied by a court of law or equity, and (B) rights to indemnity and contribution may be limited by federal and state securities laws or policies underlying such laws; and (vi) Upon execution and delivery of the Underwriting Agreement by each of the Attorneys (as defined in each Power of Attorney) on behalf of each Selling Stockholder, the Underwriting Agreement will have been duly authorized, executed and delivered by such Selling Stockholder. -24- (g) The Representatives shall have received from Dow, Lohnes & Albertson, PLLC, special United States regulatory counsel to the Company, such opinion or opinions, dated as of such Closing Date, to the effect that: (i) The statements contained in the Prospectus under the caption "Risk Factors -- Our U. S. schools are extensively regulated" to the extent related to educational regulatory matters other than Canadian educational regulatory matters, insofar as such statements constitute a summary of legal matters, documents or proceedings with respect to the operation of postsecondary educational institutions and the offering of programs of postsecondary education in the United States of America (collectively, "U.S. Regulatory Matters"), are accurate in all material respects; (ii) Except as disclosed in the Prospectus, no consent, approval, authorization, order, registration or qualification of, or filing with, the U.S. Department of Education under Title IV of the HEA or any state education agency under any similar state statute governing the authorization to operate postsecondary educational institutions is required for the consummation of the transactions contemplated by this Agreement in connection with the issuance and sale of the Offered Securities. (iii) To the knowledge of such counsel, except as disclosed in the Prospectus, the execution, delivery and performance by the Company of this Agreement and the consummation of the transactions contemplated herein in connection with the issuance and sale of the Offered Securities do not result in a breach or violation of (A) Title IV of the HEA; (B) any rule, regulation or requirement of the U.S. Department of Education promulgated under Title IV of the HEA; or (C) any similar state statute governing the authorization to operate postsecondary educational institutions, except for any such breaches or violations that, individually or in the aggregate, do not have, and are reasonably likely not to have, a Material Adverse Effect; (iv) The consummation of the transactions contemplated by this Agreement in connection with the issuance and sale of the Offered Securities will not constitute a change of ownership resulting in a "change of control" as defined in the HEA; and (v) To the knowledge of such counsel, except as disclosed in the Prospectus, the Company and its subsidiaries have all necessary Licenses required for the Company and such subsidiaries to participate in the Title IV Programs as described in the Registration Statements and the Prospectus, except for any -25- failures to possess any such Licenses that, individually or in the aggregate, do not have, and are not reasonably likely to have, a Material Adverse Effect. Such counsel shall also describe the extent to which they have participated in the preparation of those portions of the Registration Statements and the Prospectus relating to U.S. Regulatory Matters and state that nothing has come to their attention in the course of such participation to cause them to believe that the information relating to U.S. Regulatory Matters contained in any Registration Statement or any amendment thereto (and specifically excluding the financial statements and schedules and other financial and accounting data), as of its effective date or as of such Closing Date, contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading, or that any such information contained in the Prospectus or any amendment or supplement thereto, as of its issue date or as of such Closing Date, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. (h) The Representatives shall have received an opinion, dated such Closing Date, of Fraser Milner, special Canadian regulatory counsel for the Company, to the effect that: (i) The statements contained in the Prospectus under the caption -- "Our Canadian schools are also extensively regulated" in the section "Risk Factors" and the caption "Canadian Regulation" in the section "Financial Aid and Regulation" (collectively, the "Canadian Captions"), in each case, only to the extent related to legislation, regulations and other legal requirements applicable specifically to the regulation of private vocational schools and student financial assistance programs thereat in the Province of Ontario and the regulation of private educational institutions and student financial assistance programs thereat in the Province of Quebec (collectively, "Canadian Educational Regulatory Matters"), insofar as such statements constitute a summary of Canadian Educational Regulatory Matters are, accurate in all material respects; (ii) Except as described in the Prospectus, no prior consent, approval, authorization, order, registration or qualification of, or filing with, any governmental or regulatory agency or body under any legislation or regulation related to Canadian Educational Regulatory Matters ("Canadian Educational Legislation") is required for the consummation of the transactions contemplated by this Agreement; and (iii) The execution, delivery and performance by the Company of this Agreement and the consummation of the transactions contemplated herein do not -26- result in a breach or violation of Canadian Educational Legislation, except for any such breaches or violations that, individually or in the aggregate, do not have, and are reasonably likely not to have, a Material Adverse Effect. Such counsel shall also state that they have no reason to believe that any statements relating to Canadian Educational Regulatory Matters contained in any Registration Statement or any amendment thereto under the Canadian Captions, as of its effective date or as of such Closing Date, contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading, or that any statements relating to Canadian Educational Regulatory Matters contained in the Prospectus or any amendment or supplement thereto under the Canadian Captions, as of its issue date or as of such Closing Date, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. In rendering such opinion, such counsel may rely as to matters governed by the laws of jurisdictions other than the laws of jurisdictions in which such counsel is admitted to practice and the federal laws of the United States of America upon the opinions of counsel reasonably satisfactory to the Representatives and counsel for the Underwriters. Further, Fraser Milner may qualify its opinion in such manner as counsel for the Underwriters may agree. (i) The Company shall have delivered to the Representatives agreements of certain officers, directors and stockholders of the Company and other persons specified by the Representatives to the effect that, for a period of 90 days after the date of the initial public offering of the Offered Securities, such officers, directors and stockholders will not offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, any additional shares of Securities or securities convertible into or exchangeable or exercisable for any shares of Securities, or publicly disclose the intention to make any such offer, sale, pledge or disposition, without the prior written consent of CSFBC. (j) The Representatives shall have received from Sidley & Austin, counsel for the Underwriters, such opinion or opinions, dated such Closing Date, with respect to the incorporation of the Company, the validity of the Offered Securities delivered on such Closing Date, the Registration Statements, the Prospectus and other related matters as the Representatives may require, and the Selling Stockholders and the Company shall have furnished to such counsel such documents as they reasonably request for the purpose of enabling them to pass upon such matters. (k) The Representatives shall have received a certificate of the Company, dated such Closing Date, executed on behalf of the Company by the President or any Vice President and a principal financial or accounting officer of the Company after their -27- reasonable investigation, to the effect that: the representations and warranties of the Company in this Agreement are true and correct; the Company has complied with all agreements and satisfied all conditions on its part to be performed or satisfied hereunder at or prior to such Closing Date; no stop order suspending the effectiveness of any Registration Statement has been issued and no proceedings for that purpose have been instituted or are, to the knowledge of such officers, threatened by the Commission; the Additional Registration Statement (if any) satisfying the requirements of subparagraphs (1) and (3) of Rule 462(b) was filed pursuant to Rule 462(b), including payment of the applicable filing fee in accordance with Rule 111(a) or (b) under the Act, prior to the time the Prospectus was printed and distributed to any Underwriter; and, subsequent to the date of the most recent financial statements in the Prospectus, there has been no material adverse change, nor any development or event involving a prospective material adverse change, in the condition (financial or other), business, properties or results of operations of the Company and its subsidiaries taken as a whole, except as set forth in or contemplated by the Prospectus or as described in such certificate. (l) The Representatives shall have received a certificate, dated such Closing Date, of each Selling Stockholder, which, in the case of a corporate Selling Stockholder, shall be executed on behalf of such Selling Stockholder by a senior executive officer of such Selling Stockholder, after reasonable investigation, to the effect that: the representations and warranties of such Selling Stockholder in this Agreement are true and correct and such Selling Stockholder has complied with all agreements and satisfied all conditions on its part to be performed or satisfied hereunder at or prior to such Closing Date. (m) The Representatives shall have received a letter, dated such Closing Date, of Arthur Andersen LLP, which meets the requirements of subsection (a) of this Section, except that the specified date referred to in such subsection will be a date not more than three business days prior to such Closing Date for the purposes of this subsection. (n) The Representatives shall have received copies of the certificate of incorporation or other equivalent document of each Material Subsidiary, certified as of a date within five days prior to the Closing Date by the secretary of state or other equivalent governmental official of the jurisdiction of incorporation of such Material Subsidiary and certificates of appropriate governmental officials as to the good standing of such Material Subsidiary under the laws of the jurisdiction of its incorporation and as to the qualification of each Material Subsidiary to do business as a foreign corporation in good standing in each jurisdiction listed opposite its name in Schedule C hereto. (o) The Representatives shall have received such other opinions, certificates, letters and other documents from or on behalf of the Company or the Selling Stockholders as the Representatives shall reasonably request. -28- The Selling Stockholders and the Company will furnish the Representatives with such conformed copies of such opinions, certificates, letters and documents as the Representatives reasonably request. CSFBC may in its sole discretion waive on behalf of the Underwriters compliance with any conditions to the obligations of the Underwriters hereunder, whether in respect of an Optional Closing Date or otherwise. 7. Indemnification and Contribution. (a) The Company will indemnify and hold harmless each Underwriter against any losses, claims, damages or liabilities, joint or several, to which such Underwriter may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any Registration Statement, the Prospectus, or any amendment or supplement thereto, or any related preliminary prospectus, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse each Underwriter for any legal or other expenses reasonably incurred by such Underwriter in connection with investigating or defending any such loss, claim, damage, liability or action as such expenses are incurred; provided, however, that the Company will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement in or omission or alleged omission from any of such documents in reliance upon and in conformity with written information furnished to the Company by any Selling Stockholder or by any Underwriter through the Representatives specifically for use therein, it being understood and agreed that the only such information furnished by any Underwriter consists of the information described as such in subsection (c) below; and provided, further, however, that the foregoing indemnity with respect to any untrue statement or alleged untrue statement or omission or alleged omission in any preliminary prospectus or the Prospectus shall not inure to the benefit of any Underwriter (or to the benefit of any person controlling such Underwriter) from whom the person asserting any such losses, claims, damages or liabilities purchased the Offered Securities if a copy of the Prospectus or any amendment or supplement thereto was not sent or given to such person at or prior to the written confirmation of the sale of such Offered Securities to such person if required by the Act and the Prospectus or any amendment or supplement thereto would have cured the defect giving rise to such loss, claim, damage or liability. (b) Each Selling Stockholder will, severally and not jointly, indemnify and hold harmless each Underwriter against any losses, claims, damages or liabilities, to which such Underwriter may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any Registration Statement, the Prospectus, or any amendment or supplement thereto, or any related preliminary prospectus, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement was made in reliance upon and in conformity with written information furnished to the Company -29- or its representatives by or on behalf of such Selling Stockholder specifically for use therein, and will reimburse each Underwriter for any legal or other expenses reasonably incurred by such Underwriter in connection with investigating or defending any such loss, claim, damage, liability or action as such expenses are incurred, it being understood and agreed that the only such information furnished by any Selling Stockholder consists of the information in the Prospectus under the caption "Principal and Selling Stockholders" relating to such Selling Stockholder; provided, however, that the liability of each Selling Stockholder pursuant to this Section 7(b) is limited to the proceeds received (less underwriting discounts and commissions) by such Selling Stockholder, if any, from the sale of the Firm Securities (or in the case of Larson, the sale of the Offered Securities sold by him); and provided, further, however, that the foregoing indemnity with respect to any preliminary prospectus shall not inure to the benefit of any Underwriter (or to the benefit of any person controlling such Underwriter) from whom the person asserting any such losses, claims, damages or liabilities purchased the Offered Securities if a copy of the Prospectus was not sent or given to such person at or prior to the written confirmation of the sale of such Offered Securities to such person if required by the Act and the Prospectus would have cured the defect giving rise to such loss, claim, damage or liability. (c) Each Underwriter will severally and not jointly indemnify and hold harmless the Company and each Selling Stockholder against any losses, claims, damages or liabilities to which the Company or such Selling Stockholder may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any Registration Statement, the Prospectus, or any amendment or supplement thereto, or any related preliminary prospectus, or arise out of or are based upon the omission or the alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company by such Underwriter through the Representatives specifically for use therein, and will reimburse any legal or other expenses reasonably incurred by the Company and each Selling Stockholder in connection with investigating or defending any such loss, claim, damage, liability or action as such expenses are incurred, it being understood and agreed that the only such information furnished by any Underwriter consists of the following information in the Prospectus furnished on behalf of each Underwriter: the last paragraph at the bottom of the cover page concerning the terms of the offering by the Underwriters, the list under the caption "Underwriting" setting forth the names of the Underwriters and the number of Offered Securities to be purchased by each Underwriter, the concession and reallowance figures appearing in the fourth paragraph under the caption "Underwriting," the information responsive to Regulation M under the Act contained in the ninth paragraph under the caption "Underwriting," and the information regarding sales to discretionary accounts and/or passive market making and other transactions contained in the sixth and ninth paragraphs under the caption "Underwriting" and the information contained under the caption "Notice to Canadian Residents." -30- (d) Promptly after receipt by an indemnified party under this Section of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against an indemnifying party under subsection (a), (b) or (c) above, notify the indemnifying party of the commencement thereof; but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party otherwise than under subsection (a), (b) or (c) above. In case any such action is brought against any indemnified party and it notifies an indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party (who shall not, except with the consent of such indemnified party, be counsel to the indemnifying party), and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party will not be liable to such indemnified party under this Section for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation. No indemnifying party shall, without the prior written consent of the relevant indemnified party, effect any settlement of any pending or threatened action in respect of which indemnified party is or could have been a party and indemnity could have been sought hereunder by such indemnified party unless such settlement includes an unconditional release of such indemnified party from all liability on any claims that are the subject matter of such action. (e) If the indemnification provided for in this Section is unavailable or insufficient to hold harmless an indemnified party under subsection (a), (b) or (c) above, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of the losses, claims, damages or liabilities referred to in subsection (a), (b) or (c) above (i) in such proportion as is appropriate to reflect the relative benefits received by the Company and the Selling Stockholders on the one hand and the Underwriters on the other from the offering of the Securities or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the Company and the Selling Stockholders on the one hand and the Underwriters on the other in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities as well as any other relevant equitable considerations. The relative benefits received by the Company and the Selling Stockholders on the one hand and the Underwriters on the other shall be deemed to be in the same proportion as the total net proceeds from the offering of the Securities (before deducting expenses) received by the Company and the Selling Stockholders bear to the total underwriting discounts and commissions received by the Underwriters. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company, the Selling Stockholders or the Underwriters and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such untrue statement or omission. The amount paid by an indemnified party as a result of the losses, claims, damages or liabilities referred to in the first sentence of this subsection (e) shall be deemed to include any -31- legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any action or claim which is the subject of this subsection (e). Notwithstanding the provisions of this subsection (e), no Underwriter shall be required to contribute any amount in excess of the amount by which the total price at which the Securities underwritten by it and distributed to the public were offered to the public exceeds the amount of any damages which such Underwriter has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission, and no Selling Stockholder shall be required to contribute any amount in excess of the amount by which the proceeds received (less underwriting discounts and commissions) by such Selling Stockholder, if any, from the sale of the Offered Securities exceeds the amount of any damages which such Selling Stockholder has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations in this subsection (e) to contribute are several in proportion to their respective underwriting obligations and not joint. (f) The obligations of the Company and the Selling Stockholders under this Section shall be in addition to any liability which the Company and the Selling Stockholders may otherwise have and shall extend, upon the same terms and conditions, to each person, if any, who controls any Underwriter within the meaning of the Act; and the obligations of the Underwriters under this Section shall be in addition to any liability which the respective Underwriters may otherwise have and shall extend, upon the same terms and conditions, to each director of the Company, to each officer of the Company who has signed a Registration Statement and to each person, if any, who controls the Company within the meaning of the Act. 8. Default of Underwriters. If any Underwriter or Underwriters default in their obligations to purchase Offered Securities hereunder on either the First or any Optional Closing Date and the aggregate number of shares of Offered Securities that such defaulting Underwriter or Underwriters agreed but failed to purchase does not exceed 10% of the total number of shares of Offered Securities that the Underwriters are obligated to purchase on such Closing Date, CSFBC may make arrangements satisfactory to the Company and the Selling Stockholders for the purchase of such Offered Securities by other persons, including any of the Underwriters, but if no such arrangements are made by such Closing Date, the non-defaulting Underwriters shall be obligated severally, in proportion to their respective commitments hereunder, to purchase the Offered Securities that such defaulting Underwriters agreed but failed to purchase on such Closing Date. If any Underwriter or Underwriters so default and the aggregate number of shares of Offered Securities with respect to which such default or defaults occur exceeds 10% of the total number of shares of Offered Securities that the Underwriters are obligated to purchase on such Closing Date and arrangements satisfactory to CSFBC, the Company and the Selling Stockholders for the purchase of such Offered Securities by other persons are not made within 36 hours after such default, this Agreement will terminate without liability on the part of any non- defaulting Underwriter, the Company or the Selling Stockholders, except as provided in -32- Section 9 (provided that if such default occurs with respect to Optional Securities after the First Closing Date, this Agreement will not terminate as to the Firm Securities or any Optional Securities purchased prior to such termination). As used in this Agreement, the term "Underwriter" includes any person substituted for an Underwriter under this Section. Nothing herein will relieve a defaulting Underwriter from liability for its default. 9. Survival of Certain Representations and Obligations. The respective indemnities, agreements, representations, warranties and other statements of the Selling Stockholders or their officers (if applicable), of the Company or its officers and of the several Underwriters set forth in or made pursuant to this Agreement will remain in full force and effect, regardless of any investigation, or statement as to the results thereof, made by or on behalf of any Underwriter, any Selling Stockholder, the Company or any of their respective representatives, officers or directors or any controlling person, and will survive delivery of and payment for the Offered Securities. If this Agreement is terminated pursuant to Section 8 or if for any reason the purchase of the Offered Securities by the Underwriters is not consummated, the Company shall remain responsible for the expenses to be paid or reimbursed by it pursuant to Section 5 and the respective obligations of the Company, the Selling Stockholders and the Underwriters pursuant to Section 7 shall remain in effect, and if any Offered Securities have been purchased hereunder the representations and warranties in Section 2 and all obligations under Section 5 shall also remain in effect; provided, however, that the obligations of the Company in Sections 5 and 7 shall not affect any rights of the Company against any defaulting Underwriter. If the purchase of the Offered Securities by the Underwriters is not consummated for any reason other than solely because of the termination of this Agreement pursuant to Section 8 or the occurrence of any event specified in clause (ii), (iii) or (iv) of Section 6(d), the Company will reimburse the Underwriters for all out-of-pocket expenses (including fees and disbursements of counsel) reasonably incurred by them in connection with the offering of the Offered Securities. 10. Notices. All communications hereunder will be in writing and, if sent to the Underwriters, will be mailed or delivered to the Representatives, c/o Credit Suisse First Boston Corporation, Eleven Madison Avenue, New York, N.Y. 10010-3629, Attention: Investment Banking Department - Transactions Advisory Group, or, if sent to the Company, will be mailed or delivered to it at 2800 West Higgins Road, Suite 790, Hoffman Estates, Illinois 60195, Attention: Chief Financial Officer, or, if sent to the Selling Stockholders or any of them, will be mailed or delivered to the addresses set forth in Schedule A hereto; provided, however, that any notice to an Underwriter pursuant to Section 7 will be mailed or delivered, telegraphed and confirmed to such Underwriter. 11. Successors. This Agreement will inure to the benefit of and be binding upon the parties hereto and their respective personal representatives and successors and the officers and directors and controlling persons referred to in Section 7, and no other person will have any right or obligation hereunder. 12. Representation. The Representatives will act for the several Underwriters in connection with the transactions contemplated by this Agreement, and any action under this -33- Agreement taken by the Representatives jointly or by CSFBC will be binding upon all the Underwriters. [_______________ will act for Heller Equity Capital Corporation in connection with such transactions, and any action under or in respect of this Agreement taken by _______________ will be binding upon Heller Equity Capital Corporation. _______________ will act for Electra Investment Trust P.L.C. and Electra Associates, Inc. (" Electra") in connection with such transactions, and any action under or in respect to this Agreement taken by _______________ will be binding on Electra. _______________ will act for Messrs. Bounds, Goense, Jessen and Underwood in connection with such transactions, and any action under or in respect of this Agreement taken by _______________ will be binding on Messrs. Bounds, Goense, Jessen and Underwood.] 13. Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original, but all such counterparts shall together constitute one and the same Agreement. 14. Applicable Law. This Agreement shall be governed by, and construed in accordance with, the laws of the State of New York, without regard to principles of conflict of laws. The Company hereby submits to the non-exclusive jurisdiction of the Federal and state courts in the Borough of Manhattan in The City of New York in any suit or proceeding arising out of or relating to this Agreement or the transactions contemplated hereby. -34- If the foregoing is in accordance with the Representatives' understanding of our agreement, kindly sign and return to the Company one of the counterparts hereof, whereupon it will become a binding agreement among the Selling Stockholders, the Company and the several Underwriters in accordance with its terms. Very truly yours, CAREER EDUCATION CORPORATION By:________________________________ William A. Klettke Senior Vice President Chief Financial Officer and Treasurer SELLING STOCKHOLDERS By:________________________________ [Name] [As attorney-in-fact acting on behalf Heller Equity Capital Corporation] By:________________________________ [Name] [As attorney-in-fact acting on behalf of Electra] By:________________________________ John M. Larson -35- By:________________________________ [Name] [As attorney-in-fact acting on behalf of Messrs. Bounds, Goense and Underwood] The foregoing Underwriting Agreement is hereby confirmed and accepted as of the date first above written. CREDIT SUISSE FIRST BOSTON CORPORATION SALOMON SMITH BARNEY INC. BANCBOSTON ROBERTSON STEPHENS Acting on behalf of themselves and as the Representatives of the several Underwriters. By CREDIT SUISSE FIRST BOSTON CORPORATION By................................... -36- SCHEDULE A
Number of Firm Number of Optional Securities to be Sold Securities to be Sold --------------------- --------------------- Company 250,000 280,000 Selling Stockholders - -------------------- Heller Equity Capital Corporation 987,937 500 West Monroe St. Suite 1900 Chicago, Illinois 60661 Electra Investment Trust P.L.C. 710,000 and Electra Associates, Inc. 65 Kingsway London, England WC2B John M. Larson 30,000 20,000 c/o Career Education Corporation 2800 West Higgins Road - Suite 790 Hoffman Estates, Illinois 60195 Mark A. Bounds 6,000 c/o Allstate Private Equity 3075 Sanders Road - Suite G-5D Northbrook, Illinois 60062 John M. Goense 10,000 c/o Allstate Private Equity 3075 Sanders Road - Suite G-50 Northbrook, Illinois 60062 John H. Underwood 6,063 c/o Pfingsten Partners, LLC 625 S. Burton Place Arlington Heights, Illinois 60005 TOTAL --------- 2,000,000 300,000 ========= =======
A-1 SCHEDULE B
Number of Firm Underwriter Securities to be Purchased ----------- -------------------------- Credit Suisse First Boston Corporation Salomon Smith Barney Inc. BancBoston Robertson Stephens Legg Mason Wood Walker, Incorporated --------- TOTAL 2,000,000 =========
B-1 SCHEDULE C Material Subsidiaries and Foreign Qualifications C-1 SCHEDULE D Foreign Qualifications of the Company D-1 EX-5 3 OPINION OF KATTEN MUCHIN & ZAVIS Exhibit 5 March 1, 1999 Career Education Corporation 2800 West Higgins Road Suite 790 Hoffman Estates, IL 60195 Re: Registration Statement on Form S-1 ---------------------------------- Ladies and Gentlemen: We have acted as counsel for Career Education Corporation, a Delaware corporation (the "Company"), and certain stockholders of the Company (the "Selling Stockholders") in connection with the preparation and filing of a Registration Statement on Form S-1, file No. 333-70747 (the "Registration Statement") with the Securities and Exchange Commission under the Securities Act of 1933, as amended. The Registration Statement relates to a sale by the Company and the Selling Stockholders of up to an aggregate of 2,000,000 shares (2,300,000 shares if the underwriters' over-allotment option is exercised in full) of the Company's Common Stock, $.01 par value per share (the "Common Stock"). In connection with this opinion, we have relied as to matters of fact, without investigation, upon certificates of public officials and others and upon affidavits, certificates and written statements of directors, officers and employees of, and the accountants for, the Company. We have also examined originals or copies, certified or otherwise identified to our satisfaction, of such instruments, documents and records as we have deemed relevant and necessary to examine for the purpose of this opinion, including (a) the Registration Statement, (b) the proposed form of Underwriting Agreement among the Company, the Selling Stockholders and Credit Suisse First Boston Corporation, Salomon Smith Barney Inc. and BancBoston Robertson Stephens Inc., as representatives of the several underwriters to be named therein (the "Underwriting Agreement"), (c) the Amended and Restated Certificate of Incorporation of the Company, (d) the Amended and Restated By-laws of the Company and (e) resolutions adopted by the Board of Directors of the Company. In connection with this opinion, we have assumed the accuracy and completeness of all documents and records that we have reviewed, the genuineness of all signatures, the due authority of the parties signing such documents, the authenticity of the documents submitted to us as Career Education Corporation March 1, 1999 Page 2 as originals and the conformity to authentic original documents of all documents submitted to us as certified, conformed or reproduced copies. Based upon and subject to the foregoing, it is our opinion that up to the 2,300,000 shares of Common Stock covered by the Registration Statement (including up to the 300,000 shares issuable upon exercise of the underwriters' over-allotment option), when sold by the Company and the Selling Stockholders and paid for in accordance with the provisions of the Underwriting Agreement, will be legally issued, fully paid and non-assessable shares of Common Stock. Our opinion expressed above is limited to the General Corporation Law of the State of Delaware, and we do not express any opinion concerning any other laws. This opinion is given as of the date hereof, and we assume no obligation to advise you of changes that may hereafter be brought to our attention. We hereby consent to the reference to our name in the Registration Statement under the caption "Legal Matters" and further consent to the filing of this opinion as Exhibit 5 to the Registration Statement. Very truly yours, KATTEN MUCHIN & ZAVIS EX-23.1 4 CONSENT OF ARTHUR ANDERSEN LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the use in this registration statement of our report dated January 29, 1999 on the consolidated financial statements of CAREER EDUCATION CORPORATION and SUBSIDIARIES included herein and to all references to our Firm included in this registration statement. Arthur Andersen LLP /s/ Arthur Andersen LLP Chicago, Illinois February 26, 1999 EX-23.2 5 CONSENT OF ARTHUR ANDERSEN Exhibit 23.2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the use in this registration statement of our report dated September 25, 1998 (except with respect to the matter discussed in Note 7, as to which the date is December 17, 1998), on the financial statements of SCOTTSDALE CULINARY INSTITUTE, INC. included herein and to all references to our Firm included in this registration statement. Arthur Andersen LLP /s/ Arthur Andersen LLP Chicago, Illinois February 26, 1999 EX-23.3 6 CONSENT OF DELOITTE & TOUCHE Exhibit 23.3 INDEPENDENT AUDITORS' CONSENT We consent to the use in this Amendment No. 1 to Registration Statement No. 333-70747 of Career Education Corporation of our report dated October 27, 1997 on the consolidated financial statements of The Katherine Gibbs Schools, Inc. and Subsidiaries for the year ended December 31, 1995 and 1996, appearing in the Prospectus, which is a part of such Registration Statement. We also consent to the reference to us under the heading "Experts" in such Prospectus. DELOITTE & TOUCHE LLP New York, New York February 26, 1999 EX-27 7 FINANCIAL DATA SCHEDULE
5 1,000 YEAR YEAR DEC-31-1997 DEC-31-1998 JAN-01-1997 JAN-01-1998 DEC-31-1997 DEC-31-1998 18,906 23,548 0 0 13,674 14,534 1,516 2,127 0 0 36,602 40,928 45,555 46,403 7,263 14,202 117,617 132,887 22,796 24,934 0 0 0 0 0 0 9 72 7,413 84,564 117,617 132,887 74,842 132,926 82,598 144,232 34,620 57,151 80,283 135,131 0 0 0 0 3,108 1,250 (793) 7,851 (331) 3,350 (462) 4,501 0 0 (418) 0 0 (205) (880) 4,296 (12.12) 0.29 (12.12) 0.27
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