10-Q 1 q306.txt DEVRY INC. FISCAL 2006 3RD QTR FORM 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _______________________ FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly and nine month period ended March 31, 2006 Commission file number 1-13988 DeVry Inc. ---------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 36-3150143 ------------------------------- ------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) One Tower Lane, Oakbrook Terrace, Illinois 60181 -------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (630) 571-7700 ---------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X ---- Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. (as defined in Rule 12b-2 of the Exchange Act). X LARGE ACCELERATED FILER ---- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). NO X ---- Number of shares of Common Stock, $0.01 par value, outstanding on April 28, 2006: 70,740,311 Total number of pages: 47 2 DeVry Inc. FORM 10-Q INDEX For the Quarter and Nine Months Ended March 31, 2006 Page No. -------- PART I. Financial Information Item 1. Financial Statements: Consolidated Balance Sheets at March 31, 2006, June 30, 2005, and March 31, 2005 3-4 Consolidated Statements of Income for the Quarter and Nine months ended March 31, 2006 and 2005 5 Consolidated Statements of Cash Flows for the Nine months ended March 31, 2006 and 2005 6 Notes to Consolidated Financial Statements 7-24 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 25-36 Item 3. Quantitative and Qualitative Disclosures About Market Risk 36-37 Item 4. Controls and Procedures 37 PART II. Other Information Item 1. Legal Proceedings 38-39 Item 1A. Risk Factors 39-40 Item 6. Exhibits 41 SIGNATURES 42 3 PART I - Financial Information Item 1 - Financial Statements DEVRY INC. CONSOLIDATED BALANCE SHEETS (Dollars in Thousands) (Unaudited)
March 31, June 30, March 31, 2006 2005 2005 --------- --------- --------- Restated Restated ASSETS Current Assets Cash and Cash Equivalents $162,355 $161,823 $138,187 Restricted Cash 52,523 13,935 33,175 Accounts Receivable, Net 90,089 39,226 119,012 Inventories 104 164 160 Deferred Income Taxes 19,811 17,142 9,395 Prepaid Expenses and Other 13,154 10,048 9,974 ------- ------- ------- Total Current Assets 338,036 242,338 309,903 ------- ------- ------- Land, Buildings and Equipment Land 67,653 68,013 64,583 Buildings 219,899 212,428 205,042 Equipment 241,736 234,201 233,133 Construction In Progress 7,207 15,813 21,475 ------- ------- ------- 536,495 530,455 524,233 Accumulated Depreciation (262,871) (243,688) (237,651) ------- ------- ------- Land, Buildings and Equipment, Net 273,624 286,767 286,582 ------- ------- ------- Other Assets Intangible Assets, Net 65,956 73,699 76,350 Goodwill 291,113 289,308 289,863 Perkins Program Fund, Net 13,290 13,290 12,847 Other Assets 4,180 4,633 4,871 ------- ------- ------- Total Other Assets 374,539 380,930 383,931 ------- ------- ------- TOTAL ASSETS $986,199 $910,035 $980,416 ======= ======= =======
The accompanying notes are an integral part of these consolidated financial statements. 4 DEVRY INC. CONSOLIDATED BALANCE SHEETS (Dollars in Thousands) (Unaudited)
March 31, June 30, March 31, 2006 2005 2005 --------- --------- --------- Restated Restated LIABILITIES Current Liabilities Current Maturities of Debt $ 50,000 $ 50,000 $ - Accounts Payable 30,016 30,681 22,433 Accrued Salaries, Wages & Benefits 31,679 34,071 32,551 Accrued Expenses 35,521 34,462 30,002 Advance Tuition Payments 8,533 14,685 10,238 Deferred Tuition Revenue 151,413 22,823 149,729 ------- ------- ------- Total Current Liabilities 307,162 186,722 244,953 ------- ------- ------- Other Liabilities Revolving Loan - 50,000 70,000 Senior Notes 95,000 125,000 125,000 Deferred Income Taxes 14,628 15,949 18,384 Accrued Post-employment Agreements 6,382 6,352 5,618 Deferred Rent and Other 12,742 12,629 12,614 ------- ------- ------- Total Other Liabilities 128,752 209,930 231,616 ------- ------- ------- TOTAL LIABILITIES 435,914 396,652 476,569 ------- ------- ------- SHAREHOLDERS' EQUITY Common Stock, $0.01 par value, 200,000,000 Shares Authorized, 70,661,000, 70,475,000 and 70,378,000, Shares Issued and Outstanding at March 31, 2006, June 30, 2005 and March 31, 2005, Respectively 708 706 705 Additional Paid-in Capital 119,566 113,571 104,318 Retained Earnings 430,082 398,840 398,614 Accumulated Other Comprehensive Income (Loss) (71) 266 210 ------- ------- ------- TOTAL SHAREHOLDERS' EQUITY 550,285 513,383 503,847 ------- ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $986,199 $910,035 $980,416 ======= ======= =======
The accompanying notes are an integral part of these consolidated financial statements. 5 DEVRY INC. CONSOLIDATED STATEMENTS OF INCOME (Dollars in Thousands Except for Per Share Amounts) (Unaudited)
For The Quarter For The Nine Months Ended March 31, Ended March 31, --------------------- ---------------------- 2006 2005 2006 2005 --------------------- ---------------------- Restated Restated REVENUES: Tuition $203,299 $190,713 $582,384 $552,824 Other Educational 15,771 11,068 42,477 31,731 Interest 1,136 149 1,994 293 ------- ------- ------- ------- Total Revenues 220,206 201,930 626,855 584,848 ------- ------- ------- ------- COSTS AND EXPENSES: Cost of Educational Services 115,483 111,014 338,209 329,968 Student Services and Administrative Expense 80,999 74,341 238,776 227,235 Interest Expense 2,490 2,309 7,751 6,391 ------- ------- ------- ------- Total Costs and Expenses 198,972 187,664 584,736 563,594 ------- ------- ------- ------- Income Before Income Taxes and Cumulative Effect of Change in Accounting 21,234 14,266 42,119 21,254 Income Tax Provision 5,552 3,385 10,877 5,381 ------- ------- ------- ------- Income Before Cumulative Effect of Change in Accounting 15,682 10,881 31,242 15,873 Cumulative Effect of Change in Accounting, Net of Tax - - - 1,810 ------- ------- ------- ------- NET INCOME $ 15,682 $ 10,881 $ 31,242 $ 17,683 ======= ======= ======= ======= EARNINGS PER COMMON SHARE Basic Income Before Cumulative Effect of Change in Accounting $0.22 $0.15 $0.44 $0.23 Cumulative Effect of Change in Accounting - - - 0.02 ----- ----- ----- ----- Net Income $0.22 $0.15 $0.44 $0.25 ===== ===== ===== ===== Diluted Income Before Cumulative Effect of Change in Accounting $0.22 $0.15 $0.44 $0.23 Cumulative Effect of Change in Accounting - - - 0.02 ----- ----- ----- ----- Net Income $0.22 $0.15 $0.44 $0.25 ===== ===== ===== =====
The accompanying notes are an integral part of these consolidated financial statements. 6 DEVRY INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited)
For The Nine Months Ended March 31, 2006 2005 -------- -------- Restated CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 31,242 $ 17,683 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Share-Based Compensation Charge 3,286 5,134 Depreciation 28,043 30,369 Amortization 8,104 11,735 Provision for Refunds and Uncollectible Accounts 39,570 31,538 Deferred Income Taxes (4,025) 1,780 (Gain) Loss on Disposals of Land, Buildings and Equipment (390) 638 Changes in Assets and Liabilities, net of Effects from Acquisition of Business: Restricted Cash (38,649) (19,652) Accounts Receivable (90,802) (121,618) Inventories 66 3,137 Prepaid Expenses and Other (2,881) 765 Accounts Payable (460) (5,403) Accrued Salaries, Wages, Expenses and Benefits (313) 5,979 Advance Tuition Payments (6,126) (6,761) Deferred Tuition Revenue 128,713 126,946 ------- ------- NET CASH PROVIDED BY OPERATING ACTIVITIES 95,378 82,270 ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital Expenditures (16,283) (30,561) Net Proceeds from Sale of Land and Building 1,798 - Payments for Purchases of Businesses, net of Cash Acquired (2,530) (4,861) ------- ------- NET CASH USED IN INVESTING ACTIVITIES: (17,015) (35,422) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from Exercise of Stock Options 2,433 261 Excess Tax Benefit from Share-Based Payments - 190 Proceeds From Revolving Credit Facility - 10,000 Repayments Under Revolving Credit Facility (80,000) (65,000) ------- ------- NET CASH USED IN FINANCING ACTIVITIES (77,567) (54,549) Effects of Exchange Rate Differences (264) (339) ------- ------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 532 (8,040) Cash and Cash Equivalents at Beginning of Period 161,823 146,227 ------- ------- Cash and Cash Equivalents at End of Period $162,355 $138,187 ======= ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest Paid During the Period $ 6,951 $4,920 Income Tax Payments During the Period, Net 14,861 4,760
The accompanying notes are an integral part of these consolidated financial statements. 7 DEVRY INC. Notes to Consolidated Financial Statements For the Quarter and Nine Months Ended March 31, 2006 ---------- NOTE 1: INTERIM FINANCIAL STATEMENTS The interim consolidated financial statements include the accounts of DeVry Inc. (the Company) and its wholly-owned subsidiaries. These financial statements are unaudited but, in the opinion of management, contain all adjustments, consisting only of normal, recurring adjustments, necessary to present fairly the financial condition and results of operations of the Company. The June 30, 2005 data, which is presented, is derived from audited financial statements. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2005 and in conjunction with the Company's quarterly reports on Form 10-Q for the quarters ended September 30, 2005 and December 31, 2005, each as filed with the Securities and Exchange Commission. The results of operations for the three and nine months ended March 31, 2006, are not necessarily indicative of results to be expected for the entire fiscal year. The consolidated financial statements that are presented for the fiscal year ended June 30, 2005 and the three and nine months ended March 31, 2005, have been restated to reflect the adjustments necessary under the provisions of the modified retrospective application method of Statement of Financial Accounting Standards No. 123(R), "Share-Based Payments" ("SFAS 123(R)"). SFAS123(R) was adopted in the first quarter of fiscal 2006 (See Note 3). NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Derivative Instruments and Hedging Activities --------------------------------------------- The Company uses derivative financial instruments to manage its exposure to movements in interest rates. The use of these financial instruments modifies the exposure of these risks with the intent to reduce the risk to the Company. The Company does not use financial instruments for trading purposes, nor does it use leveraged financial instruments. Credit risk related to the derivative financial instruments is considered minimal and is managed by requiring high credit standards for its counterparties and periodic settlements. All derivative contracts are reported at fair value, with changes in fair value reported in earnings or deferred, depending on the nature and effectiveness of the offset or hedging relationship. Any ineffectiveness in a hedging relationship is recognized immediately into earnings. During the first quarter of fiscal 2004, the Company entered into several interest rate cap agreements to protect approximately $100,000,000 of its outstanding borrowings from sharp increases in short-term interest rates upon which its borrowings are based. These agreements expired in the first quarter of fiscal 2006. The Company intends to periodically evaluate the need for 8 NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued Derivative Instruments and Hedging Activities, continued -------------------------------------------------------- interest rate protection in light of projected changes in interest rates and borrowing levels. These interest rate cap agreements were designated as cash flow hedging instruments and were intended to protect the portion of the Company's debt that is covered by these agreements from short-term interest rates above 3.5%. These cap agreements were purchased at fair market values totaling $568,000. This cost was capitalized and amortized to earnings and recorded as interest expense over the 24-month term of the agreements. Differences between the changes in fair value of the interest rate caps and the amount being amortized to earnings were reported as a component of Other Comprehensive Income. These amounts were reclassified and recognized into earnings over the 24- month term of the agreements. As of March 31, 2006, these cap agreements had expired so there is no effect on Accumulated Other Comprehensive Income in the Consolidated Balance Sheets. As of March 31, 2005, $8,000 was recorded as Other Comprehensive Income in the Consolidated Balance Sheet. This represents the cumulative difference between the decline in the fair market value of the interest rate caps of $312,000 and the $320,000 expensed as interest. For the nine months ended March 31, 2006, a gain of $12,000 was recorded as Other Comprehensive Income. For the nine months ended March 31, 2005, a loss of $10,000 was recorded as Other Comprehensive Income. Interest expense of $73,000 and $230,000 was charged to earnings for these interest rate caps for the nine months ended March 31, 2006 and 2005, respectively. For the nine months ended March 31, 2006 and 2005, there was no ineffectiveness related to these agreements. Internal Software Development Costs ----------------------------------- The Company capitalizes certain internal software development costs that are amortized using the straight line method over the estimated useful lives of the software, not to exceed five years. Capitalized costs include external direct costs of materials and services consumed in developing or obtaining internal-use software and payroll and payroll related costs for employees who are directly associated with the internal software development project. Capitalization of such costs ceases no later than the point at which the project is substantially complete and ready for its intended purpose. Capitalized software development costs for projects not yet complete, which are included as Equipment in the Land, Buildings and Equipment section of the Consolidated Balance Sheets, were $557,000 as of March 31, 2005. As of March 31, 2006 and June 30, 2005 there were no capitalized costs for projects not yet completed. The gross capitalized software development costs for completed projects, which are also included as Equipment in the Land, Building and Equipment section of the Consolidated Balance Sheets, were $20,605,000 at March 31, 2006, June 30, 2005, and March 31, 2005. 9 NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued Post-employment Benefits ------------------------ The Company's employment agreements with its Chairman of the Board of Directors and Chief Executive Officer provide certain post-employment benefits that require accrual over the expected future service period beginning with the second quarter of fiscal 2003. For the nine months ended March 31, 2006 and 2005, the Company recognized expense of approximately $31,000 and $1,939,000, respectively, related to these agreements. The amounts provided are based on recording, over the period of active service that ended June 30, 2005, the amount that represents the present value of the obligation, discounted using a 6.00% rate as of March 31, 2006, and using the sinking fund accrual method. Earnings Per Common Share ------------------------- Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Shares used in this computation were 70,604,000 and 70,374,000 for the third quarters ended March 31, 2006 and 2005, respectively and 70,550,000 and 70,364,000 for the nine months ended March 31, 2006 and 2005, respectively. Diluted earnings per share is computed by dividing net income by the weighted average number of shares assuming dilution. Dilutive shares are computed using the Treasury Stock Method and reflect the additional shares that would be outstanding if dilutive stock options were exercised during the period. Shares used in this computation were 70,913,000 and 70,547,000 for the third quarters ended March 31, 2006 and 2005, respectively and 70,739,000 and 70,567,000 for the nine months ended March 31, 2006 and 2005, respectively. Excluded from the computations of diluted earnings per share were options to purchase 1,719,000 and 2,711,000 shares of common stock for the third quarter and nine months ended March 31, 2006, respectively, and 2,203,000 and 2,201,000 shares of common stock, for the third quarter and nine months ended March 31, 2005, respectively. These outstanding options were excluded because the option exercise prices were greater than the average market price of the common shares during these periods and therefore, their effect would be anti-dilutive. Comprehensive Income -------------------- The differences between changes in the fair values of the cash flow hedging instruments described above in "Derivative Instruments and Hedging Activities", and the amount of these instruments being amortized to earnings are reported as a component of Comprehensive Income. The amounts recorded in Other Comprehensive Income are a gain of $12,000 for the nine months ended March 31, 2006 and a loss of $10,000 for the nine months ended March 31, 2005. The Company's only other item that meets the definition for adjustment to arrive at Comprehensive Income is the change in cumulative translation adjustment. The amounts recorded in Other Comprehensive Income for the changes in translation rates were a gain of $2,000 and a loss of $17,000, for the quarters ended March 31, 2006 and 2005, respectively, and losses of $349,000 and $500,000 for nine months ended March 31, 2006 and 2005, respectively. 10 NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued Comprehensive Income, continued ------------------------------- The Accumulated Other Comprehensive Income balance at March 31, 2006 is composed entirely of a cumulative translation loss of $71,000. This balance at March 31, 2005, is composed of a $8,000 gain related to the cash flow hedge and a cumulative translation gain of $202,000. NOTE 3: STOCK-BASED COMPENSATION The Company maintains six stock-based award plans: the Amended and Restated Stock Incentive Plan, established in 1988, the 1991 Stock Incentive Plan, the 1994 Stock Incentive Plan, the 1999 Stock Incentive Plan, the 2003 Stock Incentive Plan and the 2005 Incentive Plan. Under these plans, directors, key executives and managerial employees are eligible to receive incentive stock or nonqualified options to purchase shares of the Company's common stock. The 2005 Incentive Plan also permits the award of stock appreciation rights, restricted stock, performance stock and other stock and cash based compensation. The Amended and Restated Stock Incentive Plan, the 1994, 1999, and 2003 Stock Incentive Plans and the 2005 Incentive Plan are administered by a Plan Committee of the board of directors. Plan Committee members are granted automatic, nondiscretionary annual options. The 1991 Stock Incentive Plan is administered by the board of directors. Options under all six plans are granted for terms of up to 10 years and can vest immediately or over periods of up to five years. The requisite service period is equal to the vesting period. The option price under the plans is the fair market value of the shares on the date of the grant. The Company accounts for options granted to retirement eligible employees that vest upon an employees' retirement under the non- substantive vesting period approach to these options. Under this approach, compensation cost is recognized at the grant date for options issued to retirement eligible employees where the options vest upon retirement. At March 31, 2006, 7,551,615 authorized but unissued shares of common stock were reserved for issuance under the Company's stock incentive plans. Effective July 1,2005, the Company adopted the provisions of SFAS 123(R). SFAS 123(R) establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employee requisite service period. The Company previously applied Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB 25")and related Interpretations and provided the required pro forma disclosures of SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). The Company elected to adopt the modified retrospective application method as provided by SFAS 123(R) and accordingly, financial statement amounts for the prior periods presented in this Form 10-Q have been restated to reflect the fair value method of expensing options as prescribed by SFAS 123(R). 11 NOTE 3: STOCK-BASED COMPENSATION, continued The following is a summary of options activity for the nine months ended March 31, 2005:
Weighted Weighted Average Aggregate Average Remaining Intrinsic Options Exercise Contractual Value Outstanding Price Life ($000) ----------- -------- ----------- --------- Outstanding at July 1, 2005 3,814,339 $22.37 Options Granted 86,500 $21.73 Options Exercised (182,661) $12.87 Options Canceled (170,744) $25.04 --------- Outstanding at March 31, 2006 3,547,434 $22.72 6.42 $4,172 ========= ====== Exercisable at March 31, 2006 2,504,306 $22.75 6.63 $3,282 ========= ======
The total intrinsic value of options exercised for the nine months ended March 31, 2006 and 2005 was $1,690,000 and $690,000, respectively. Prior to fiscal 2005, the fair value of the Company's stock-based awards was estimated as of the date of grant using the Black- Scholes option pricing model ("Black-Scholes model"). The Black- Scholes model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. This model also requires highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly affect the calculated grant date fair value. Beginning with all options granted in the first quarter of fiscal 2005, the fair value of the Company's stock-based awards is estimated using a binomial model. This model uses historical cancellation and exercise experience of the Company to determine the option value. It also takes into account the illiquid nature of employee options during the vesting period, something that the Black-Scholes model does not consider. For these reasons, Company management believes that the binomial model provides a fair value that is more representative of actual experience and future expected experience than the value calculated in previous years, using the Black-Scholes model. The weighted average estimated grant date fair values, as defined by SFAS 123(R), for options granted at market price under the Company's stock option plans during the first nine months of fiscal 2006 and 2005 were $10.13 and $9.92, per share, respectively. The fair values of the Company's stock option awards for the first nine months of fiscal 2006 and 2005, were estimated assuming no expected dividends and the following weighted average assumptions: Fiscal Year, 2006 2005 ---- ---- Expected Life (in Years) 4.38 6.69 Expected Volatility 41.30% 41.41% Risk-free Interest Rate 3.80% 3.83% Pre-vesting Forfeiture Rate 4.00% 4.00% 12 NOTE 3: STOCK-BASED COMPENSATION, continued The expected life of the options granted is based on the weighted average exercise life with age and salary adjustment factors from historical exercise behavior. For fiscal 2006, to date, the expected life of newly granted options is based on projections more heavily weighted to current exercise patterns. The Company's expected volatility is computed by combining and weighting the implied market volatility, the Company's most recent volatility over the expected life of the option grant, and the Company's long-term historical volatility. The following table shows total stock-based compensation expense included in the Consolidated Statement of Earnings:
(Dollars in thousands) For the Quarter For the Nine Months Ended March 31, Ended March 31, 2006 2005 2006 2005 ---- ---- ---- ---- Cost of Educational Services $ 335 $ 409 $1,051 $1,642 Student Services and Administrative Expense 712 869 2,235 3,492 Income Tax Benefit 274 212 848 714 ---- ----- ----- ----- Net Stock-based Compensation Expense $ 773 $1,066 $2,438 $4,420 ==== ===== ===== =====
As of March 31, 2006, $8.46 million of total pre-tax unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted average period of 2.7 years. The total fair value of options vested during the nine months ended March 31, 2006 and 2005 was $3,529,000 and $4,551,000, respectively. There were no capitalized stock-based compensation costs at March 31, 2006 and 2005. The Company has a policy of issuing new shares of common stock to satisfy share option exercises. As previously discussed, the Company elected to adopt SFAS 123(R) under the modified retrospective application method. The Company believes that the modified retrospective application of this standard achieves the highest level of clarity and comparability among the presented periods. Accordingly, financial statement amounts for the prior periods presented in this Form 10-Q have been restated to reflect the fair value method of expensing prescribed by SFAS 123(R). 13 NOTE 3: STOCK-BASED COMPENSATION, continued The following table details the retroactive application impact of SFAS 123(R) on previously reported results, (dollars in thousands except per share amounts):
For the Quarter For the Nine Months ended ended March 31, 2005 March 31, 2005 -------------------- -------------------- As As Previously Previously Restated Reported Restated Reported -------------------- -------------------- CONSOLIDATED STATEMENTS OF INCOME: Total Costs and Expenses $187,664 $186,386 $563,594 $558,460 Income before Income Taxes and Cumulative Effect of Change In Accounting 14,266 15,544 21,254 26,388 Income Tax Provision 3,385 3,597 5,381 6,095 Income before Cumulative Effect Of Change in Accounting 10,881 11,947 15,873 20,293 Net Income 10,881 11,947 17,683 22,103 EARNINGS PER COMMON SHARE: Basic Income before Cumulative Effect Of Change in Accounting $0.15 $0.17 $0.23 $0.29 Net Income $0.15 $0.17 $0.25 $0.31 Diluted Income before Cumulative Effect Of Change in Accounting $0.15 $0.17 $0.23 $0.29 Net Income $0.15 $0.17 $0.25 $0.31
14 NOTE 3: STOCK-BASED COMPENSATION, continued For the Nine Months Ended March 31, 2005 ------------------------- As Previously Restated Reported -------------------- CASH FLOW RELATED TO NINE MONTHS ENDED MARCH 31, 2005 Net Income $ 17,683 $ 22,103 Share Based Compensation Charge 5,134 - Deferred Income Taxes 1,108 2,684 Net Cash Provided by Operating Activities 82,270 82,460 Excess Tax Benefits from Share Based Payments 190 - Net Cash Used in Financing Activities (54,549) (54,739) June 30, 2005 -------------------- As Previously Restated Reported -------------------- CONSOLIDATED BALANCE SHEETS Deferred Income Taxes $ 15,949 $ 21,408 Total Non-current Liabilities 209,930 215,389 Total Liabilities 396,652 402,111 Additional Paid-in Capital 113,571 73,372 Retained Earnings 398,840 433,580 Total Shareholders' Equity 513,383 507,924 NOTE 4: CHANGE IN ACCOUNTING - CHANGED FISCAL YEAR OF SUBSIDIARY Prior to July 1, 2004, the accounts of Becker Professional Review were consolidated based on an April 30 fiscal year end, which management believed was its natural year-end based on its then business cycle. As a result of a change in the CPA exam schedule, the Company has aligned the Becker fiscal year end to that of DeVry Inc. The results of operations for the two-month period from May 1, 2004 through June 30, 2004, are included as a cumulative effect of change in accounting in the Consolidated Statements of Income for the first quarter of fiscal 2005. The cumulative effect of this change in accounting added $1,810,000, or $0.02 per share to net income for the first quarter ended September 30, 2004 and the nine months ended March 31, 2005. This amount is net of income tax expense of $1,189,000. 15 NOTE 4: CHANGE IN ACCOUNTING - CHANGED FISCAL YEAR OF SUBSIDIARY, continued Net Income and basic and diluted earnings per share for the three and nine months ended March 31, 2005 is set forth below as if the consolidation of the Becker operations had been accounted for in the same manner for all periods presented. These amounts have been restated to reflect the fair value method of expensing stock-based compensation as prescribed by SFAS 123(R). Proforma Three Months Ended Nine Months Ended March 31, March 31, 2005 2005 ---- ---- Net Income $10,881,000 $15,873,000 Earnings per Share Basic $0.15 $0.23 Diluted $0.15 $0.23 NOTE 5: BUSINESS COMBINATIONS Gearty CPE ---------- In July 2005, the Company signed a definitive agreement to acquire Gearty CPE for $2.0 million in cash. Gearty CPE, which operates in the New York/New Jersey metro area, is a provider of continuing professional education (CPE) programs and seminars in accounting and finance predominantly serving chief financial officers and controllers of Fortune 500 companies. There is no pro forma presentation of prior year operating results related to this acquisition due to the insignificant effect on consolidated operations. Deaconess College of Nursing ---------------------------- On March 24, 2005, Ross University School of Nursing and Health Sciences, a newly formed, wholly owned subsidiary of the Company, acquired the operations of Deaconess College of Nursing (Deaconess) for $5,391,000 in cash. Funding was provided from the Company's existing operating cash balances. The results of Deaconess' operations have been included in the consolidated financial statements of the Company since the date of acquisition. Located in St. Louis, Missouri, Deaconess had approximately 450 students enrolled at the date of purchase and offers associate and bachelor's degree programs in nursing. In addition, Deaconess offers a bachelor's degree completion program designed for registered nurses who have previously completed an associate degree program. Classes are offered days, evenings and weekends with non-clinical coursework offered both on campus and online. The addition of Deaconess has further diversified the Company's curricula. 16 NOTE 5: BUSINESS COMBINATION, continued Deaconess College of Nursing, continued --------------------------------------- The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. These amounts were finalized along with the purchase price during the third quarter of fiscal 2006. This resulted in no change to the purchase price; however, Current Assets decreased by $460,000, Current Liabilities Assumed decreased by $655,000, and goodwill was reduced by $195,000. At March 24, 2005 (In Thousands) Current Assets $ 199 Property and Equipment 37 Intangible Assets 1,470 Goodwill 4,716 ----- Total Assets Acquired 6,422 Current Liabilities Assumed 1,031 ----- Net Assets Acquired $5,391 ----- Of the $1,470,000 of acquired intangible assets, $470,000 was assigned to the value of the Deaconess Title IV financial aid eligibility and $730,000 was assigned to accreditations, both of which have been determined to not be subject to amortization, and $270,000 was assigned to student relationships that have an average useful life of approximately 3 years. The Company determined this allocation based upon a number of factors, including a valuation analysis prepared by an independent professional valuation specialist. The $4,716,000 of goodwill was all assigned to the Medical & Healthcare operating segment. There is no pro forma presentation of prior year operating results related to this acquisition due to the insignificant effect on consolidated operations. 17 NOTE 6: INTANGIBLE ASSETS Intangible assets consist of the following: As of March 31, 2006 -------------------------------- Gross Carrying Accumulated Amount Amortization -------------------------------- Amortized Intangible Assets: Student Relationships $47,770,000 $(35,623,000) License and Non Compete Agreements 2,650,000 (2,591,000) Class Materials 2,900,000 (1,050,000) Trade Names 110,000 (69,000) Other 620,000 (618,000) ---------- ----------- Total $54,050,000 $(39,951,000) ========== =========== Unamortized Intangible Assets: Trade Names $20,972,000 Trademark 1,645,000 Ross Title IV Eligibility And Accreditations 14,100,000 Intellectual Property 13,940,000 Deaconess Title IV Eligibility and Accreditations 1,200,000 ---------- Total $51,857,000 ========== As of March 31, 2005 -------------------------------- Gross Carrying Accumulated Amount Amortization -------------------------------- Amortized Intangible Assets: Student Relationships $47,760,000 $(25,068,000) License and Non Compete Agreements 2,650,000 (2,454,000) Class Materials 2,900,000 (850,000) Trade Names 110,000 (41,000) Other 620,000 (589,000) ---------- ----------- Total $54,040,000 $(29,002,000) ========== =========== Unamortized Intangible Assets: Trade Names $20,972,000 Trademark 1,645,000 Ross Title IV Eligibility And Accreditations 14,100,000 Deaconess Title IV Eligibility and Accreditations 655,000 Intellectual Property 13,940,000 ---------- Total $51,312,000 ========== 18 NOTE 6: INTANGIBLE ASSETS, continued Amortization expense for amortized intangible assets was $2,582,000 and $7,743,000 for the quarter and nine months ended March 31, 2006, respectively, and $3,637,000 and $10,911,000 for the quarter and nine months ended March 31, 2005, respectively. Estimated amortization expense for amortized intangible assets for the next five fiscal years ending June 30, is as follows: Fiscal Year 2006 $10,036,000 2007 6,807,000 2008 3,598,000 2009 203,000 2010 200,000 The weighted-average amortization period for amortized intangible assets is three and five years for Deaconess and Ross Student Relationships, respectively, six years for License and Non-compete Agreements, 14 years for Class Materials, four years for Trade Names and six years for Other. These intangible assets, except for the Ross Student Relationships, are being amortized on a straight- line basis. The amount being amortized for the Ross Student Relationships is based on the estimated progression of the students through the respective medical and veterinary programs, giving consideration to the revenue and cash flow associated with both existing students and new applicants. This results in the basis being amortized at an annual rate for each of the five years of estimated economic life, beginning with May 2003, as follows: Year 1 27.4% Year 2 29.0% Year 3 21.0% Year 4 14.5% Year 5 8.1% Indefinite-lived intangible assets related to Trademarks, Trade Names, Title IV Eligibility, Accreditation and Intellectual Property are not amortized as there are no legal, regulatory, contractual, economic or other factors that limit the useful life of these intangible assets to the reporting entity. As of the end of fiscal year 2005, there was no impairment loss associated with these indefinite-lived intangible assets as fair value exceeds the carrying amount. The Company determined that as of the end of fiscal 2005, there was no impairment in the value of the Company's goodwill for any reporting units. This determination was made after considering a number of factors including a valuation analysis prepared by an independent professional valuation specialist. The carrying amount of goodwill related to the DeVry University reportable segment at March 31, 2006 and June 30, 2005 was unchanged at $22,195,000. The carrying amount of goodwill related to Professional and Training reportable segment was $24,716,000 at March 31, 2006 and $22,716,000 at June 30, 2005. The increase of $2,000,000 is the result of the allocation of the purchase price for 19 NOTE 6: INTANGIBLE ASSETS, continued Gearty CPE as described in Note 5 above. The carrying amount of goodwill related to the Medical & Healthcare segment was $244,202,000 at March 31, 2006 and $244,397,000 June 30, 2005. The decrease of $195,000 was the result of purchase price allocation adjustments recorded in the second and third quarters of fiscal 2006. NOTE 7: SALE OF FACILITY In November 2005, a Company owned building in the Denver, Colorado area was sold for $1,798,000. As a result of this sale, the Company realized a gain of approximately $450,000. This building was acquired in 1999 with the acquisition of Denver Technical College. Although still used partly as classrooms and offices, this facility was no longer essential to the Company operations in the Denver-area, having been largely replaced by a new and larger DeVry University campus serving the Denver market. This gain is classified as Cost of Educational Services in the Consolidated Statements of Income and related to the DeVry University reportable segment. In December 2005, the Company announced that it plans to offer for sale its campus located in West Hills, California. DeVry University plans to remain in the San Fernando Valley area and is considering other new facilities in the vicinity to meet current and future student demand. There is no anticipated impairment loss with this building as its market value exceeds its net book value. NOTE 8: REDUCTION IN WORKFORCE CHARGES During the second quarter of fiscal 2005, the Company offered a voluntary separation plan to its employees with more than 20 years of service. In the third quarter of fiscal 2005, the Company implemented an involuntary reduction in force that reduced its workforce at its educational facilities and corporate office. In the fourth quarter of fiscal 2005, the Company offered another voluntary separation plan for its DeVry University faculty employees with more than 15 years of service and implemented an involuntary reduction in force of its faculty employees. These voluntary and involuntary separation plans resulted in workforce reductions of approximately 230 employees. In addition to these separation and reduction in force plans, the Company experienced other involuntary separations during fiscal 2005. In relation to all of these voluntary and involuntary reductions in force, the Company recorded pre-tax charges of approximately $8.4 million in fiscal 2005. These charges consist of severance pay and in some cases, extended medical and dental benefits coverage. These charges were classified as Cost of Educational Services and Student Services and Administrative Expense in the Consolidated Statements of Income and are related to the DeVry University and Medical & Healthcare reportable segments. Cash payments for the voluntary separation plans and all involuntary reductions in force were approximately $250,000 the third quarter of fiscal 2006 and $2,550,000 for the nine months ended March 31, 2006. Of the total amount accrued for these events, approximately $800,000 remained to be paid as of March 31, 2006. Payments will continue into the fourth quarter of fiscal 2006. 20 NOTE 9: INCOME TAXES The principal operating subsidiaries of DMI are Ross University School of Medicine (the Medical School) incorporated under the laws of the Commonwealth of Dominica and Ross University School of Veterinary Medicine (the Veterinary School), incorporated under the laws of the Federation of St. Christopher Nevis, St. Kitts in the West Indies. Both operating companies have agreements with the respective governments that exempt them from local income taxation through the years 2043 and 2023, respectively. Accordingly no current provision for foreign income taxes was recorded in the quarter or nine months ended March 31, 2006 for the Medical or Veterinary Schools. The Company has not recorded a tax provision for the undistributed earnings of the Medical and Veterinary Schools for the period after the acquisition. It is the Company's intention to indefinitely reinvest post-acquisition undistributed earnings and profits to service debt, improve the facilities and operations of the Schools and pursue future opportunities outside of the United States. As of March 31, 2006 and 2005, cumulative undistributed earnings were approximately $52.0 million and $27.9 million, respectively. It is the Company's intention for the foreseeable future to use accumulated cash balances at the Medical and Veterinary Schools plus subsequent earnings and cash flow to service outstanding debt, and reinvest remaining balances to improve and expand facilities and operations of the schools and pursue future business opportunities outside the United States. In accordance with this plan, cash held by Ross University will not be available for general Company purposes such as at DeVry University and will not be subject to U.S. taxation. NOTE 10: LONG-TERM DEBT All of the Company's borrowings and letters of credit under its long-term debt agreements are through DeVry Inc. and Global Education International, Inc. (GEI). This long-term debt consists of the following at March 31, 2006: Effective Outstanding Interest Rate at Debt March 31, 2006 ------------ ---------------- Revolving Credit Agreement: DeVry Inc. as borrower $ 20,000,000 6.07% GEI as borrower - ----------- Total $ 20,000,000 6.07% ----------- Senior Notes: DeVry Inc. as borrower $ 75,000,000 5.92% GEI as borrower 50,000,000 5.92% ----------- Total $125,000,000 5.92% ----------- Total outstanding debt $145,000,000 5.94% Current Maturities of Debt $ 50,000,000 5.98% ----------- Total Long-term debt $ 95,000,000 5.92% ----------- 21 NOTE 11: COMMITMENTS AND CONTINGENCIES The Company is subject to occasional lawsuits, administrative proceedings, regulatory reviews associated with financial assistance programs and other claims arising in the normal conduct of its business. The following information updates the status of claims and litigation previously disclosed. In January 2002, a graduate of one of DeVry University's Los Angeles-area campuses, filed a class-action complaint against DeVry Inc. and DeVry University, Inc. in the Superior Court of the State of California, County of Los Angeles, on behalf of all students enrolled in the post-baccalaureate degree program in Information Technology. The suit alleges that the program offered by DeVry did not conform to the program as it was presented in the advertising and other marketing materials. In March 2003, the complaint was dismissed by the court with limited right to amend and re-file. The complaint was subsequently amended and re-filed. During the first quarter of the Company's fiscal year 2004, a new complaint was filed in the same court by another plaintiff with the same general allegations and by the same plaintiffs' attorneys. This subsequent action was stayed pending the outcome of the initial matter. The parties have now reached an agreement in principle and a settlement is in the process of being finalized and subject to judicial approval. The Company has accrued $0.75 million representing the estimated amount agreed upon to resolve this claim. In November 2000, three graduates of one of DeVry University's Chicago-area campuses filed a class-action complaint in the Circuit Court for Cook County, Illinois that alleges DeVry graduates do not have appropriate skills for employment in the computer information systems field. The complaint was subsequently dismissed by the court, but was amended and re-filed to include as a plaintiff, a then-current student in another curriculum from a second Chicago-area campus. In September 2005, the court denied the plaintiff's motion for class action certification in its entirety. However, pending claims remain by each of the named defendants in this action which the court may attempt to resolve by mediation. A former student of Ross University Veterinary School of Medicine was dismissed from the school and denied re-enrollment. In June 2005, the student claims that the dismissal was based upon her handicap and is seeking compensatory damages for economic and non- economic harm, punitive damages, cost of the suit, attorney's fees and other relief deemed appropriate by the Court. The Company filed a motion to dismiss the suit. The Plaintiff has agreed to stay discovery until the motion to dismiss is denied. Plaintiff has also filed a motion to add an additional party to the suit. In April 2006, the general contractor that built the student dormitory building on the DeVry University Fremont, California, campus has placed a lien on the site and filed a counterclaim to the Company's claim for contract breach, alleging that the Company has failed to pay for extra work done in building the dormitory. In addition, some of the sub-contractors have also filed liens on the site, seeking additional payments owed to them by the general contractor. 22 NOTE 11: COMMITMENTS AND CONTINGENCIES, continued The amount claimed by the general contractor for the alleged extra work is approximately $2.8 million. Additional costs of construction, if any, would generally be capitalized as a part of the cost of the building and would not result in any immediate additional expense. No accrual has been made for the resolution of this claim. The total accrual for the resolution of all pending legal claims at the end of the third quarter was $1.4 million. While the ultimate outcome of these and other contingencies is difficult to estimate at this time, the Company does intend to vigorously defend itself with respect to the pending claims. At this time, the Company does not believe that the outcome of current claims, regulatory reviews and lawsuits will have a material effect on its cash flows, results of operations or financial position. NOTE 12: SEGMENT INFORMATION The Company's principal business is providing post-secondary education. The services of our operations are described in more detail under "Nature of Operations" in Note 1 to the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2005. The Company presents three reportable segments: the DeVry University undergraduate and graduate operations (DeVry University), the professional examination review and training operations including Becker Professional Review and Center for Corporate Education (Professional and Training) and the Ross University medical and veterinary school and Deaconess School of Nursing operations (Medical & Healthcare). These segments are based on the method by which management evaluates performance and allocates resources. Such decisions are based, in part, upon each segment's operating income, which is defined as income before interest expense, amortization and income taxes. Intersegment sales are accounted for at amounts comparable to sales to nonaffiliated customers, and are eliminated in consolidation. The accounting policies of the segments are the same as those described in Note 1 - Summary of Significant Accounting Policies to the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2005. The consistent measure of segment profit excludes interest expense, amortization and certain corporate related depreciation. As such, these items are reconciling items in arriving at income before income taxes. The consistent measure of segment assets excludes deferred income tax assets and certain depreciable corporate assets. Additions to long-lived assets have been measured in this same manner. Reconciling items are included as corporate assets. Following is a tabulation of business segment information for the quarters and nine months ended March 31, 2006 and 2005. Where applicable, the March 31, 2005, information has been restated to reflect the adoption of SFAS 123(R) under the modified retrospective application method. These amounts have been restated to reflect the fair value method of expensing stock-based compensation as 23 NOTE 12: SEGMENT INFORMATION, continued prescribed by SFAS 123(R). Corporate information is included where it is needed to reconcile segment data to the consolidated financial statements.
For the Quarter For the Nine Months Ended March 31, Ended March 31, ------------------- ------------------- 2006 2005 2006 2005 ---- ---- ---- ---- Revenues: DeVry University $174,504 $167,977 $506,899 $486,668 Professional and Training 15,063 10,785 37,296 31,738 Medical & Healthcare 30,639 23,168 82,660 66,442 ------- ------- ------- ------- Total Consolidated Revenues $220,206 $201,930 $626,855 $584,848 ------- ------- ------- ------- Operating Income: DeVry University $ 8,492 $8,195 $15,155 $ 6,772 Professional and Training 5,707 3,002 12,612 8,228 Medical & Healthcare 12,360 9,262 30,612 24,333 Reconciling Items: Amortization Expense (2,582) (3,637) (7,743) (10,911) Interest Expense (2,490) (2,309) (7,751) (6,391) Depreciation and Other (253) (247) (766) (777) ------ ------ ------ ------ Total Consolidated Income before Income Taxes and Cumulative Effect of Change in Accounting $21,234 $14,266 $42,119 $21,254 ------ ------ ------ ------ Segment Assets: DeVry University $485,131 $509,541 $485,131 $509,541 Professional and Training 82,025 70,883 82,025 70,883 Medical & Healthcare 390,318 380,695 390,318 380,695 Corporate 28,725 19,297 28,725 19,297 ------- ------- ------- ------- Total Consolidated Assets $986,199 $980,416 $986,199 $980,416 ------- ------- ------- ------- Additions to Long-lived Assets: DeVry University $3,311 $ 6,644 $10,703 $25,398 Professional and Training 31 89 179 291 Medical & Healthcare 2,095 7,263 7,401 9,733 ----- ------ ------ ------ Total Consolidated Additions to Long-lived Assets $5,437 $13,996 $18,283 $35,422 ----- ------ ------ ------ Depreciation Expense: DeVry University $8,067 $ 9,094 $24,045 $26,700 Professional and Training 120 133 348 399 Medical & Healthcare 981 958 2,909 2,529 Corporate 247 247 741 741 ----- ------- ------ ------ Total Consolidated Depreciation $9,415 $10,432 $28,043 $30,369 ----- ------ ------ ------ Intangible Asset Amortization Expense: DeVry University $ - $ - $ - $ - Professional and Training 67 193 200 580 Medical & Healthcare 2,515 3,444 7,543 10,331 ----- ----- ----- ------ Total Consolidated Amortization $2,582 $3,637 $7,743 $10,911 ----- ----- ----- ------
24 NOTE 12: SEGMENT INFORMATION, continued The Company conducts its educational operations in the United States, Canada, the Caribbean countries of Dominica and St. Kitts/Nevis, Europe, the Middle East and the Pacific Rim. Other international revenues, which are derived principally from Canada were less than 5% of total revenues for the quarters and six months ended March 31, 2006 and 2005. Revenues and long-lived assets by geographic area are as follows:
Revenues from Unaffiliated Customers: Domestic Operations $184,450 $175,878 $537,368 $508,885 International Operations: Dominica and St. Kitts/Nevis 32,748 23,168 81,176 66,442 Other 3,008 2,884 8,311 9,521 ------- ------- ------- ------- Total International 35,756 26,052 89,487 75,963 ------- ------- ------- ------- Consolidated $220,206 $201,930 $626,855 $584,848 ------- ------- ------- ------- Long-lived Assets: Domestic Operations $341,495 $352,259 $341,495 $352,259 International Operations: Dominica and St. Kitts/Nevis 306,371 317,621 306,371 317,621 Other 297 628 297 628 ------- ------- ------- ------- Total International 306,668 318,249 306,668 318,249 ------- ------- ------- ------- Consolidated $648,163 $670,508 $648,163 $670,508 ------- ------- ------- -------
Sales are attributable to geographic areas based on location of customer. No one customer accounted for more than 10% of the Company's consolidated revenues. 25 Item 2 - Management's Discussion and Analysis of Results of Operations and Financial Condition -------------------------------------------------- Forward-Looking Statements -------------------------- Certain information contained in this quarterly report on Form 10-Q may constitute forward-looking statements relating to DeVry's future financial results and strategies, business plans or objectives and beliefs about future events. They are often identified by the use of qualifiers in their description such as "expects", "believes", "is likely", "intends", "estimates", "forecast", "assumption" or other similar expressions. Such statements are inherently uncertain and may involve risks and uncertainties that could cause future results to differ materially from the forward-looking statements. All forward-looking statements included in this Report are based upon information presently available, and the Company assumes no obligation to update any forward-looking statements. Copies of the Company's annual and quarterly reports on Form 10- K, Form 10-Q and other reports filed with the Securities and Exchange Commission may be obtained without charge at the Company's website, www.devryinc.com. The following discussion of the Company's results of operations and financial condition should be read in conjunction with the consolidated financial statements of the Company and the notes thereto as included in the Company's annual report on Form 10-K for the fiscal year ended June 30, 2005, and in the Company's quarterly report on Form 10-Q for the quarters ended September 30, 2005 and December 31, 2005. The Company's annual report on Form 10-K includes a detailed description of critical accounting policies and estimates and assumptions used in the preparation of the Company's financial statements. These include, but are not limited to, revenue and expense recognition, useful lives of equipment and facilities, valuation of goodwill and indefinite- lived intangible assets, valuation and useful lives of acquired finite-lived intangible assets, pattern of amortization of finite- lived intangible assets over their economic lives, losses on the collection of student receivable balances, costs associated with pending legal matters, health care costs for incurred but not yet paid medical services and stock based compensation expense. The somewhat seasonal pattern of the Company's enrollments and its educational program starting dates affect the results of operations and the timing of cash flows. Therefore, the Company's management believes that comparisons of its results of operations should be made to the corresponding period in the preceding year. Comparisons of financial position should be made to both the end of the previous fiscal year and to the end of the corresponding quarterly period in the preceding year. 26 Results of Operations --------------------- The following table presents information with respect to the relative size to revenue of each item in the statement of income for the third quarter and first nine months of both the current and prior year. Percents may not add due to rounding.
Quarter Ended Nine Months Ended ------------- ----------------- March 31 ------------------------------------- 2006 2005 1 2006 2005 1 (Restated) (Restated) ---------------- --------------- Revenue 100.0% 100.0% 100.0% 100.0% Cost of Educational Services 52.4% 55.0% 53.9% 56.4% Student Services & Admin. Ex 36.8% 36.8% 38.1% 38.9% Interest Expense 1.1% 1.1% 1.2% 1.1% ------ ------ ------ ------ Total Costs and Expenses 90.4% 92.9% 93.3% 96.4% Income Before Income Taxes and Cumulative Effect of Change in Accounting 9.6% 7.1% 6.7% 3.6% Income Tax Provision 2.5% 1.7% 1.7% 0.9% ------ ------ ------ ------ Income Before Cumulative Effect of Change in Accounting 7.1% 5.4% 5.0% 2.7% Cumulative Effect of Change in Accounting - - - 0.3% ------ ------ ------ ------ NET INCOME 7.1% 5.4% 5.0% 3.0% ------ ------ ------ ------ 1 Quarter and nine months ended March 31, 2005, restated for the adoption of SFAS 123R using the modified retrospective approach.
The Company's financial performance in both the third quarter and nine months of this year improved from the results in the corresponding periods of the previous fiscal year. Fiscal 2005 financial results have been restated for the adoption of Statement of Financial Accounting Standard 123R, Share - Based Payments ("SFAS 123R"), using the modified retrospective approach. Factors contributing to the improved revenue and net income performance compared to last year were continued total enrollment growth in both DeVry University's graduate and undergraduate programs, increased tuition rates for both undergraduate and graduate programs, an increase in new student enrollments and higher tuition rates at Ross University, an increase in 27 enrollments in the Professional and Training segment's Becker Professional Review operations, wage savings from the workforce reductions implemented last year and continued cost control in spending in other areas of operation. Total DeVry University undergraduate enrollments in fall 2005 were 38,546, or 2.3% lower than enrollments a year ago. Although total undergraduate enrollments were lower than in the previous year, the fall term marked the third consecutive term in which new undergraduate student enrollments increased from the year-ago level, contributing to a lesser rate of year-over-year decline in total enrollments. For spring 2006, total DeVry University undergraduate enrollments were 38,523 or 1.2% higher than enrollments a year ago. Spring marked the fourth consecutive term in which new undergraduate student enrollments increased from the year ago level and was also the first term since spring of 2002 that total undergraduate student enrollments increased from the prior year. Third quarter financial results include revenue from both the fall and spring enrollment periods. The Company believes that the increasing new student enrollments are the result of better integration of marketing and recruiting functions, an improved overall marketing communication plan and better management of lead flow. Also, the Company believe that demand for technology graduates continues to improve, positively influencing career decisions of new students towards this field of study. Further diversification of programs has offered another avenue for enrollment growth. DeVry University announced a new online specialty within its bachelor of science in technical management degree program, called Health Information Management ("HIT"). This new specialty provides an opportunity for those who hold an associate degree in health information, such as graduates of DeVry's HIT program, to move seamlessly to a bachelor's degree and advance within this field. Coursetaker enrollments at DeVry University's Keller Graduate School of Management increased 9.4% in the January session and increased 12.3% for the March session compared to the same sessions in the previous year. The Company believes that efforts at Keller to create new brand awareness through improved messaging have produced positive results and will continue to focus on further improvements in the future. At Ross University in the Medical and Healthcare segment, for the term that started in January, new student enrollments increased to 387, up 67.5% from last year, and total student enrollments increased to 3,264, an increase of 4.5% from last year. The Company's total consolidated revenue increased by $18.3 million, or 9.1%, in the third quarter compared to last year. Revenue growth in the third quarter improved when compared to lesser rates of increase of 7.9% and 4.5% in the second and first quarters, respectively. Tuition revenue, which is the largest component of total revenue, represented over 92% of total revenue for both the third quarter and first nine months of fiscal 2006. All three of the Company's segments: DeVry University, Medical and Healthcare and the Professional and Training segment, contributed to the increased revenue for the quarter and year-to- date periods. DeVry University ---------------- At DeVry University, total third quarter revenues increased by approximately $6.5 million, after increasing by approximately $9.7 million and $4.0 million in the second and first quarters, 28 respectively. As discussed above, contributing to the higher revenues in both the third quarter and nine months were the higher DeVry University total student enrollments in spring 2006 and the lessening rate of decline in the total student enrollment in the fall. Third quarter revenues for the undergraduate operations reflect two months of revenue from the fall term (January and February 2006) and one month of revenue from the spring term (March 2006). Further contributing to the increased segment revenues were increased coursetaker enrollments at Keller Graduate School in the January and March sessions that began in the third quarter. Also, higher tuition rates were in effect for both the undergraduate and graduate programs compared to last year. Undergraduate program tuition increased by approximately 5% in July 2005 following a similar tuition increase in November 2004. For graduate school programs, tuition increased by approximately 5% for the September 2005 session following a similar increase in January 2005. Contributing to higher Total Revenues in this segment, Other Educational Revenue increased by approximately $2.8 million in the third quarter and $6.7 million in the first nine months of the year, partly from sales of electronic textbook materials ("eBooks"). In the first quarter of fiscal 2005, the Company completed an agreement with Follett Higher Education Group ("Follett") to manage the nine remaining U.S. DeVry University campus bookstores not already managed by Follett. As a result, reported bookstore sales revenue was lower than it had been in previous periods. However, DeVry University sales of eBooks in selected graduate and undergraduate online and on-site courses beginning in the latter part of fiscal 2005 has more than offset the reduction in revenues from the bookstores previously managed by the Company. The Company reports the sale of eBooks at their full selling price which is a higher unit price sale than the commission income it reports on book and supply sales by Follett. Further contributing to the increase in Other Educational Revenue was a higher interest charge on undergraduate student accounts receivable. These receivables are generally subject to a monthly interest charge of one percent under the Company's EDUCARD revolving charge plan for financing students' education. While these charges generated approximately $0.2 million more in student financing charges in the third quarter, for the year-to- date period they generated approximately $2.3 million more income than in the year-to-date period last year. Partly offsetting the increases in revenue from improved enrollments and higher tuition rates is a growing proportion of working adult undergraduate students who typically enroll for less than a full-time academic load. These students are primarily enrolled in online programs and at programs offered at DeVry University Centers. These part-time students pay a lesser average tuition amount each term than do full-time students at the undergraduate campus locations. Therefore, the higher revenue per student resulting from tuition increases has been partially offset by a greater proportion of part-time students. Professional and Training ------------------------- In the Professional and Training segment, third quarter revenues increased by approximately $4.3 million from the third quarter of last year. For the first nine months, revenues continued to grow, rising $5.6 million above those of the previous year. The Company believes that higher revenues from increased enrollment, primarily in the Becker Professional Review's CPA review courses, reflects the market recovery from the effects of the CPA exam changes in fiscal 2004 and from an increased demand for CPA's by public accounting and consulting firms. Not only have on-site course enrollments increased, but demand for the review courses online and on CD-ROM have increased, contributing approximately 29 $1.9 million of the total Company increase in Other Educational Revenues in the third quarter and $4.6 million for the first nine months of the year. Further contributing to the year-to-date revenue growth in this segment was increased enrollment in the Stalla CFA review course in preparation for the December administration of the Level 1 exam. This is only the second year in which Level 1 of the exam has been offered in December. Third quarter results also reflect increasing Stalla CFA review course revenues as candidates prepare for the June exam. To further strengthen Becker Professional Review results in future periods, the Company hired a new director of international operations and two directors of business operations responsible for sales and marketing of all Becker products in Canada and in the heavily populated east coast market. In July 2005, which is the first quarter of the current fiscal year, the Company completed the acquisition of Gearty CPE. Gearty CPE is a provider of continuing professional education programs and seminars in accounting and finance, predominantly serving customers in the New York/New Jersey metro area. The acquisition complements the Becker Professional Review CPA exam review business. The acquisition is being integrated into the Becker operations in other appropriate markets across the country but has not yet contributed significantly to the revenues or operating income of the Professional and Training segment. Medical and Healthcare ---------------------- In the Medical and Healthcare segment, revenues increased by approximately $7.5 million, or 32.2%, in the third quarter and $16.2 million, or 24.4%, in the first three quarters compared to last year. Included in this segment are $1.5 million in revenues for the third quarter and $4.1 million for the first nine months at Deaconess College of Nursing. Deaconess was not acquired by the Company until the latter part of fiscal 2005 and did not contribute revenues or income during this period last year. At Ross University, although total enrollments during the first and second quarter of this year were lower than a year ago, a tuition price increase of approximately 5% effective with the September 2005 semester, and a price increase of slightly less than 8% in January 2005, fully offset the effects of the decline in enrollment and contributed to the revenue increase during the first six months. However, for the Ross class that began in January, the start of the fiscal third quarter, both new and total student enrollments increased from the year-ago level as described above and revenue growth for the third quarter was at a faster pace than in the first half. To prepare for future enrollment growth, medical school student capacity is being expanded with the leasing of additional space adjacent to the campus to be used as another auditorium for approximately 400 students. SFAS 123R --------- The Company adopted Statement of Financial Accounting Standards 123R effective with the start of the first quarter of fiscal 2006. Financial results for the third quarter and first nine months of fiscal 2005 have been restated to reflect the modified retrospective approach of adoption. Accordingly, expenses relating to share-based awards have been included in the various expense categories for both years as appropriate. SFAS 123R establishes the accounting for stock-based awards issued in exchange for employee services. To-date, all of the Company's stock-based awards have been granted in the form of 30 stock options. Stock based compensation is measured at the grant date of the option, based on the fair value of the award. The fair value is recognized as expense over the employee's requisite service period which is the period over which these options vest. From the beginning of fiscal 2005, the Company's stock-based awards were valued using a binomial model. Previously, these awards were valued using the Black-Scholes model for purposes of pro forma disclosure pursuant to SFAS 123 and SFAS 148. The binomial model requires estimates of several important factors, e.g. expected life of an option, stock price volatility, risk- free rate of return, forfeiture rate for options granted and the stock dividend yield. The expected life of an option takes into account the contractual term of the option and the effects of the employees' expected exercise and post-vesting employment termination behavior. The Company has granted stock options to hundreds of employees over a period of time that extends back longer than the maximum ten-year contractual life of most of its option awards and, therefore, has a history upon which estimates of the expected life of the option and the forfeiture rate can be based. The Company's stock has been publicly traded since 1991 and, therefore, there is a history upon which estimates of future stock price volatility can be determined. In making its determination of the appropriate estimates, and for computing the actual valuation in a binomial model, the Company engaged the assistance of an independent professional actuarial service. Cost of Educational Services ---------------------------- The Company's Cost of Educational Services increased by $4.4 million, or 4.0%, from the third quarter of last year. For the first three quarters of the year, these costs increased by $8.2 million, or 2.5%, from last year. Contributing most of the higher cost for the year-to-date was an increase of $5.6 million in the provision for doubtful accounts, primarily in the DeVry University undergraduate operations, as student receivables increased from last year through the summer and fall semesters. However, at the start of the spring semester in March, the timeliness of receivable collections improved from prior periods as the result of internal process improvements and student receivables at the end of the quarter were lower than they were at this time last year. Also, cost increases were incurred in support of the higher number of DeVry University Centers and expanding online program enrollments. For the March session, courses were being offered at eight new DeVry University locations compared to a year ago. The number of online coursetakers enrolled in courses for summer 2005 was 21,068, increasing to 24,357 for the November session and increasing further in the March 2006 session to 28,912, up 46.3% from last year. Cost of Educational Services is now included in the Company's financial statements from Deaconess College of Nursing which was not included in the Company results through the first three quarters of last year. Partly offsetting these increases were the wage savings from workforce reductions implemented last year and continued spending restraint in operations during the current year. In the third quarter of last year, the Company recognized a $2.8 million pre- tax charge, of which approximately $2.0 million was included in Cost of Educational Services, as the first of several work force reductions was being implemented. Last year-to-date, these charges included in Cost of Educational Services totaled approximately $3.6 million. There are no corresponding charges for work force reduction in the current year. 31 Also, lower capital spending during each of the past several years has resulted in $28.0 million of depreciation expense for the first nine months compared to $30.4 million last year, producing a $2.4 million savings. Most depreciation expense is included in the Cost of Educational Services. Further savings in Cost of Educational Services were generated by lower expense attributed to share-based awards as fewer new option grants have been issued this year compared to the comparable period last year. For the first three quarters this expense was approximately $1.1 million compared to approximately $1.6 million last year. Student Services and Administrative Expense ------------------------------------------- Student Services and Administrative Expense increased by $6.7 million, or 9.0%, from the third quarter of last year. For the first nine months, these costs increased by $11.5 million, or 5.1%, from the first nine months of a year ago. The increased cost primarily reflects efforts to generate higher new student enrollments in all of the Company's educational programs through improved and more efficient advertising and student recruiting. Admissions advisors have been added to support the growing online program enrollments and newly opened DeVry University Centers and at Ross University to offset the previous declines in new student enrollments. Costs were also recognized for the Deaconess College of Nursing that were not included in the Company's financial results last year. Increased new student enrollments, as described above, at DeVry University, Becker Professional Review and Ross University are believed to be, in part, attributable to the higher level and effectiveness of this spending. Largely offsetting these increases in student recruiting expense was lower amortization of finite-lived intangible assets related to acquisitions of businesses including, most recently, Ross University and Deaconess College of Nursing. Amortization expense is included entirely in the Student Services and Administrative Expense category. For the third quarter, amortization expense for finite-lives intangible assets was $2.6 million compared to $3.6 million in the third quarter of a year ago. For the first nine months, this amortization expense was $7.7 million compared to $10.9 million last year. Work force reduction costs included in the Student Services and Administrative Expense category, as discussed above in Cost of Educational Services, totaled $0.8 million in the third quarter of last year and $1.4 million for the first nine months of last year. There are no corresponding work force reduction programs or charges in the current year. Lower expense attributed to share-based awards, as described above, that is included in the Student Services expense category helped to partially offset the increases in student recruitment spending. Share-based award expense in the third quarter was approximately $0.7 million for the current year, compared to approximately $0.9 million in the third quarter of last year. Share-based award expense declined from $3.5 million in the first nine months of last year to $2.2 million in the first nine months of this year. In addition, there was less than $0.1 million of post-employment benefit cost in the first three quarters of this year relating to agreements with each of the Company's Chairman and CEO, compared to approximately $1.9 million of expense accrued for these agreements in the first three quarters of last year. The required period of active service, over which the present value cost of these future benefits were recognized, was fully met at the end of fiscal 2005. 32 DeVry University ---------------- After a loss of approximately $0.1 million in the first quarter of this year, the DeVry University segment generated operating income of approximately $6.7 million in the second quarter, increasing to $8.5 million in the third quarter. For the first nine months, this segment had operating income of $15.2 million compared to $6.8 million last year. The improvement in operating income was the result of improving enrollments, higher tuition rates and lower spending described above. The Company realized additional savings from the consolidation of its online operations into a building in Naperville, Illinois, a nearby suburb to the Company's headquarters location. The acquisition of this building in fiscal 2005 has permitted the Company to relinquish some of its higher cost office space at the headquarters site. In addition, DeVry University's Canadian operation, which included the teach out cost for the former undergraduate Toronto-area campuses last year, is no longer incurring further charges for the teach out activity. In the first three quarters of last year, DeVry University incurred operating losses of approximately $2.6 million at its Canadian operation. In the current year, the Canadian operations had a reduced operating loss of approximately $0.3 million. Professional and Training ------------------------- As a result of record revenues for the first quarter, operating income in the Professional and Training segment for the first half of the year increased from $5.2 million last year to $6.9 million in the first half of the current year. Revenues and operating income increased again in the third quarter, up approximately $4.3 million and $2.7 million, respectively. The exam review course continues to be updated and improved with good student response, which, in conjunction with increasing demand for CPA's by accounting and consulting firms, we believe is attracting more students than before. Although a small part of the total segment operations, Stalla Review for the CFA Exam also continues to increase its enrollments. Declining CFA exam taker pass rates may be attracting more students to take review courses rather than rely on self-study as many have done in the past. Medical and Healthcare ---------------------- The Medical and Healthcare segment increased its third quarter operating income by $3.1 million, or 33.4%, from last year. At Ross University, which is the dominant portion of this segment, an increase in student enrollments in January 2006 and tuition increases combined to produce the higher revenues and operating income for the quarter and nine months compared to last year even as faculty, staff and facilities are being added to accommodate future enrollment growth. Deaconess College of Nursing contributed approximately $1.5 million of revenue to the segment in the third quarter and approximately $0.1 million of operating income. Deaconess College was acquired by the Company in the latter part of fiscal 2005 and its results were not included through this period last year. At Deaconess, the position of division general manager was filled to focus on expansion opportunities. Deaconess College of Nursing has received approval from the State of Ohio to offer associate and bachelor's degree programs in nursing. The College plans to co-locate its Ohio programs with the Columbus campus of DeVry University. 33 For the past three years, Deaconess has offered an online associate degree in nursing ("ASN"). This program has been reviewed annually by the Missouri State Board of Nursing, and has operated on interim approval status since inception. In its most recent review in December, the Board withdrew its approval. The decision was based on test performance by students who entered the program prior to DeVry's acquisition of Deaconess. The Company appealed this determination and this program now has conditional approval status pending final approval, and the program continues to be offered. The State Board decision only affects the ASN Online program and does not affect the ASN on-site or other online or on- site programs. The contribution to revenues and operating income from the ASN online program is not a material part of the Company's overall financial results. Interest Expense ---------------- Interest expense on the Company's borrowings in the third quarter was $2.5 million compared to $2.3 million in the third quarter of last year. For the first three quarters, interest expense has increased from $6.4 million last year to $7.8 million this year. Although borrowings have been reduced, the interest rates on the Company's borrowings is based upon short-term interest rates, which increased significantly over the past year. For example, at the end of this March, the interest rate on the Company's Revolving Loan was approximately 6.1% compared to 4.30% last March. Taxes on Income --------------- Taxes on income for the third quarter of this fiscal year were 26.1% of pre-tax income compared to 23.7% in the third quarter of last year. The effective tax rate reflects the Company's current estimates of the proportion of earnings attributable to Ross University offshore operations compared to Company earnings from its DeVry University and Becker Professional Review operations that are fully taxable at the appropriate federal and state income tax rates. Changes to this proportion as the year progresses could result in a somewhat higher or lower effective tax rate in future periods. During the third quarter of fiscal 2006, the Internal Revenue Service began an audit of the Company's consolidated federal income tax returns for the fiscal years 2003 and 2004 and certain refund claims for prior years. No deficiencies have been proposed through the date of this report. In addition, two states in which the Company has operations have proposed assessments for prior tax years still open to statute. The Company believes these proposed assessments to be in error and is currently appealing both at the respective administrative levels of appeal. The Company intends to vigorously defend itself if agreements can not be reached at the current level of appeal. Based upon the most current information, the Company believes that it has sufficient reserves to adequately settle these claims with no material effect on the Company's results of operations or liquidity and capital resources should these claims be settled adversely. Cumulative Effect of Change in Accounting ----------------------------------------- In the first quarter of last year, the Company recognized $1.8 million of income, net of taxes, from a Cumulative Effect of Change in Accounting for the alignment of the Professional and 34 Training segment's fiscal year to the same June-end fiscal year as the rest of the Company. Because of the change to the CPA exam schedule from a twice a year November and May schedule to a nearly continuous exam administration, the Company believes that the historical Becker Professional Review operating year that ended in April is no longer the most appropriate fiscal year-end. Effective with the start of the Company's fiscal 2005, the Becker fiscal year was aligned to the June 30th year-end of DeVry Inc. and the cumulative effect of this change in accounting, representing the months of May and June 2004, was reported in the first quarter of fiscal 2005. Liquidity and Capital Resources ------------------------------- Cash generated from operations for the first nine months was $95.4 million, compared to $82.3 million in the same period last year. Contributing to the higher cash flow was a $13.6 million increase in net income and an approximately $19.9 million reduction in accounts receivable, net of increases in the related Restricted Cash and Provision for Refunds and Uncollectible Accounts. Partly offsetting these gains was a $7.8 million reduction in non-cash charges contributing to the higher Net Income. The lower non-cash charges were for share-based compensation, depreciation and amortization. Also partly offsetting some of the higher cash flow was an approximately $5.0 million use of cash compared to last year for changes in levels of Prepaid Expenses, Accounts Payable and Accrued Expenses. Variations in the levels of accrued expenses and accounts payable are caused, in part, by the timing of the quarter-end relative to the Company's payroll and bill payment cycles. Capital spending for the first three quarters of fiscal 2006 was $16.3 million, compared to $30.6 million in the first three quarters of last year. There are no major capital projects underway or currently planned. For the total year, capital spending is expected to remain below the level of the past several years. In addition to spending on capital additions and improvements, the Company paid $2.0 million for the acquisition of Gearty CPE and in the third quarter of this year made the final payment completing the 2005 acquisition of Deaconess College of Nursing. During the second quarter of this year, the Company completed the sale of a Denver educational facility that had previously been offered for sale. Cash proceeds from the sale totaled approximately $1.8 million. Also during the second quarter, the Company announced that it had offered for sale its campus located in West Hills California. Proceeds from a sale would be used for general corporate purposes and further debt reduction. DeVry University plans to continue offering educational programs in the San Fernando Valley area and is evaluating other new facilities in the vicinity to meet current and future student demand. During the first nine months of this fiscal year, the Company repaid $80 million in borrowings from its revolving loan agreement using existing cash balances and cash flow generated from operations. During the first nine months of last year, the Company repaid a net of $55 million of its borrowings. In April 2006, the Company prepaid without penalty $10 million of its Senior Note borrowings. All of the Company's borrowings are based upon a floating rate, generally LIBOR at the Company's option. In the first quarter of fiscal 2004, the Company entered into several interest rate cap agreements to protect approximately $100,000,000 of its borrowings from sharp increases in short-term interest rates upon which its borrowings are based. These interest rate cap agreements expired during the first quarter of this fiscal year. 35 The company intends to periodically evaluate the need for future interest rate protection in light of projected changes in interest rates and expected borrowing levels. In November 2005, the Company's revolving loan agreement was amended to exclude from the financial covenant computations, the non-cash effects of accounting for share-based awards in accordance with SFAS 123R. This amendment was initiated at the Company's request in accordance with terms of the original agreement. The Company's primary long-term contractual obligations consist of its revolving line of credit and senior notes, operating leases on facilities and equipment, and agreements for various services. There are no required payments under the Company's borrowing agreements prior to their maturities in 2009 and 2010. The Company is not a party to any off-balance sheet financing or contingent payment agreements, nor are there any unconsolidated subsidiaries of the Company. There are no loans extended to any officer, director or other person affiliated with the Company. The Company has not entered into any derivative, swap, futures contract, put, call, hedge or non-exchange traded contract except for the interest rate cap agreements discussed above. The Company's primary source of liquidity is the cash received from payments for student tuition, books, educational supplies and fees. These payments include funds originating as student and family educational loans; other financial aid from various federal, state and provincial loan and grant programs; and student and family financial resources. The Company is highly dependent upon the timely receipt of financial aid funds at DeVry University, Ross University and Deaconess College of Nursing. The Company estimates that more than 60% of its DeVry University undergraduate students' tuition, book and fee revenues were financed by government-provided financial aid to students. At Keller Graduate School, approximately 70% of student revenues are financed by government- provided financial assistance. At Ross University, collections from student participation in federal loan programs are approximately 70% of its revenues. The financial aid and assistance programs in which the Company's students participate are subject to political and budgetary considerations. There is no assurance that such funding will be maintained in the future. Extensive and complex regulations in the United States and Canada govern all of the government funded financial assistance programs in which the company's students participate. The Company's administration of these programs is periodically reviewed by various regulatory agencies. Any regulatory violation could be the basis for disciplinary action, including initiation of a suspension, limitation or termination proceeding against the Company. Such program reviews may be conducted at any educational institution at any time and have been conducted in the past at the Company's educational facilities and headquarters location. Previous Department of Education and state regulatory agency program reviews have not resulted in material findings or adjustments. Included in the Company's consolidated cash balances at the end of the quarter is approximately $66 million attributable to Ross University offshore operations. For the foreseeable future, it is the Company's intention to reinvest this cash and subsequent earnings and cash flow to service the remainder of the outstanding debt of Global Education International (the Corporate parent of Ross University) to improve and expand facilities and operations of the Ross schools and pursue future business opportunities outside the United States. Therefore, cash held by 36 Ross University will not be available for general Company purposes such as at DeVry University or Becker Professional Review. The Company believes that current balances of unrestricted cash, cash generated from operations and, if necessary, borrowings under the revolving loan facility will be sufficient to fund both its current operations and growth plans for the foreseeable future, unless future investment opportunities should arise that are similar in size or nature to the acquisition of Ross University. Item 3 - Qualitative and Quantitative Disclosures About Market Risk ------------------------------------------------------ The nature of the Company's operations does not subject it to a concentration of risk or dependency upon the price levels or fluctuations in pricing of any one particular or group of commodities. The financial position and results of operations of Ross University's Caribbean operations are measured using the U.S. dollar as the functional currency. Substantially all Ross University financial transactions are transacted in the U.S. dollar. The financial position and results of operations for the Company's Canadian educational programs are measured using the local currency as the functional currency. The Canadian operations have not entered into any material long-term contracts to purchase or sell goods and services, other than a lease agreement on its principal teaching facility in Calgary, Alberta. The Company does not have any foreign exchange contracts or derivative financial instruments related to protection from changes in the value of the Canadian dollar. Because the assets and liabilities of the Company's Canadian operations are small relative to those of the total Company (Canadian assets are currently less than 2.5% of total Company assets) changes in currency value within the range of changes recently experienced would not have a material effect on the Company's results of operations or financial position. Based upon the current value of the net assets in the Canadian operations, a change of $0.01 in the value of the Canadian dollar relative to the U.S. dollar would result in a pre-tax translation adjustment of less than $100,000. The Company's customers are principally individual students enrolled in its various educational programs. Accordingly, concentration of accounts receivable credit risk is small relative to total revenues or accounts receivable. Increasingly, DeVry University students receive tuition reimbursement benefits from their employers but the underlying responsibility for the tuition payment remains with the student. Becker Professional Review courses for CPA exam candidates are being sold in increasing number to the larger, national practice public accounting firms. The Company believes that the financial stability of these firms poses little risk of non-payment for courses taken by employees of these firms. The Company's cash is held in accounts at various financial institutions in the United States, Canada and the Caribbean. The Company selects the financial institutions with which it maintains deposits from amongst only those that are the largest and most financially secure. Therefore, although the amount on deposit at a given institution will typically exceed amounts subject to guarantee, the Company has not experienced any deposit losses to date nor does it expect to incur such losses in the future. The interest rate on the Company's debt is based upon LIBOR interest rates for periods typically ranging from one to three months. Based upon the level of Company borrowings at March 31, 37 2006, a 1.0% increase in short-term interest rates would result in $1.45 million of additional annual interest expense. However, future investment opportunities and cash flow generated from operations may affect the level of outstanding borrowings and the effect of changes in interest rates in future periods. In the first quarter of fiscal 2004, the Company entered into several interest rate cap agreements to protect a portion of its borrowings from sharp increases in short-term interest rates. These agreements had expired by the end of the first quarter of fiscal year 2006 and no longer afford any protection from changes in interest rates. The Company intends to periodically review further debt repayment and the need for additional interest rate protection agreements in light of projected changes in working capital, investment requirements and expectations about future period interest rates. Item 4 - Controls and Procedures ----------------------- CEO and CFO Certificates ------------------------ The required compliance certificates signed by the Company's CEO and CFO are included as Exhibits 31 and 32 of this Quarterly Report on Form 10-Q. Disclosure Controls and Procedures ---------------------------------- Disclosure controls and procedures are designed to help ensure that all the information required to be disclosed in our reports filed with the SEC is recorded, processed, summarized and reported within the time periods specified by the appropriate rules. Evaluations required by Rule 13a - 15 of the Securities Exchange Act of 1934 of the effectiveness of the Company's disclosures and controls and procedures as of the end of the period covered by this Report have been carried out under the supervision and with the participation of the Company's management, including its Chief Executive Officer and its Chief Financial Officer. Based upon these evaluations, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures were effective as required, and have attested to this in Exhibit 31 of this Report. Changes In Internal Control Over Financial Reporting ---------------------------------------------------- There were no changes in internal control over financial reporting that occurred during the third quarter and first nine months of fiscal year 2006 that materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 38 Part II - Other Information --------------------------- Item 1 - Legal Proceedings -------------------------- The Company is subject to occasional lawsuits, administrative proceedings, regulatory reviews associated with financial assistance programs and other claims arising in the normal conduct of its business. The following information updates the status of claims and litigation previously disclosed. In January 2002, Royal Gardner, a graduate of one of DeVry University's Los Angeles-area campuses, filed a class-action complaint against DeVry Inc. and DeVry University, Inc. in the Superior Court of the State of California, County of Los Angeles, on behalf of all students enrolled in the post-baccalaureate degree program in Information Technology. The suit alleges that the program offered by DeVry did not conform to the program as it was presented in the advertising and other marketing materials. In March 2003, the complaint was dismissed by the court with limited right to amend and re-file. The complaint was subsequently amended and re-filed. During the first quarter of the Company's fiscal year 2004, a new complaint was filed in the same court by Gavino Teanio with the same general allegations and by the same plaintiffs' attorneys. This subsequent action was stayed pending the outcome of the Gardner matter. The parties have now reached an agreement in principle and a settlement is in the process of being finalized and subject to judicial approval. The Company has accrued $0.75 million representing the estimated amount agreed upon to resolve this claim. In November 2000, Afshin Zarinebaf, Ali Mousavi and another graduate of one of DeVry University's Chicago-area campuses filed a class-action complaint in the Circuit Court for Cook County, Illinois that alleges DeVry graduates do not have appropriate skills for employment in the computer information systems field. The complaint was subsequently dismissed by the court, but was amended and re-filed to include as a plaintiff Mark Macenas, a then-current student in another curriculum from a second Chicago- area campus. In September 2005, the court denied the plaintiff's motion for class action certification in its entirety. However, pending claims remain by each of the named defendants in this action which the court may attempt to resolve by mediation. Brigette Dean Hines, a former student of Ross University Veterinary School of Medicine was dismissed from the school and denied re-enrollment. The student claims that the dismissal was based upon her handicap and she is seeking compensatory damages for economic and non-economic harm, punitive damages, cost of the suit, attorney's fees and other relief deemed appropriate by the Court. The Company filed a motion to dismiss the suit. The Plaintiff has agreed to stay discovery until the motion to dismiss is denied. Plaintiff has also filed a motion to add an additional party to the suit. Sierra Bay Contractors, the contractor that built the student dormitory building on the DeVry University Fremont, California, campus has placed a lien on the site and filed a counterclaim to the Company's claim for contract breach, alleging that the Company has failed to pay for extra work done in building the dormitory. In addition, some of the sub-contractors have also filed liens on the site, seeking additional payments owed to them by the general contractor. The amount claimed by the general contractor for the alleged extra work is approximately $2.8 million. Additional costs of construction, if any are owed, would generally be capitalized as a 39 part of the cost of the building and would not result in any immediate additional expense. Accordingly, no accrual has been made for the resolution of this claim. The total accrual for the resolution of all pending legal claims at the end of the third quarter was $1.4 million. While the ultimate outcome of these and other contingencies is difficult to estimate at this time, the Company does intend to vigorously defend itself with respect to the pending claims. At this time, the Company does not believe that the outcome of current claims, administrative proceedings, regulatory reviews and lawsuits will have a material effect on its cash flows, results of operations or financial position. Item 1A - Risk Factors ---------------------- Potential risks and uncertainties related to various aspects of the Company's business include, but is not limited to: Shifts in applicant career interests away from the concentration of the Company's undergraduate programs in selected areas of technology, healthcare and business that the Company does not adequately anticipate or to which it does not adequately respond. Increased competition in recruiting of new students and retaining students already enrolled. Reductions in student financial aid, upon which the Company is highly dependent for the collection of its billings, because of changes to program regulations affecting student eligibility or reductions to federal and state funding levels. Failure of DeVry University, Ross University or Deaconess College of Nursing to maintain eligibility for student participation in financial aid programs. Reductions in the amount of corporate employee tuition reimbursement because of changes to tax laws or a lower level of corporate earnings that affects employee educational benefit plans. Loss or limitations in accreditations and licensing approvals affecting DeVry University, Ross University or Deaconess College of Nursing. Changes to laws and regulations that adversely affect the Company's eligibility to participate in government financial aid programs, current operations or future growth opportunities. Ability to hire and retain faculty with appropriate qualifications such as education and experience. Reductions in tuition pricing by other educational institutions that affect the Company's current competitive position and its ability to maintain and increase tuition rates in the future. Business interruption resulting from inclement weather such as hurricanes, tornadoes or winter storms that cause school closings and/or loss of student recruiting opportunities in these regions. 40 Some of these risks and uncertainties are described more fully in the sections of the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2005 filed with the SEC September 13, 2005, especially in the section entitled "Forward Looking Statements" at the beginning of Part 1 and in the subsections of "Item 1 - Business" entitled "Competition," "Student Recruiting," "Accreditation and Approvals," "Tuition and Fees," "Financial Aid and Financing Student Education," "Career Services," and "Faculty". 41 Item 6 - Exhibits ----------------- Exhibits Sequentially Exhibit # Description Numbered Page --------- ----------- ------------- 31 Rule 13a-14(a)/15d-14(a)Certifications 43 - 46 32 Section 1350 Certifications 47 42 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: May 9, 2006 /s/Ronald L. Taylor ----------------------- Ronald L. Taylor Chief Executive Officer Date: May 9, 2006 /s/Norman M. Levine ------------------------- Norman M. Levine Senior Vice President and Chief Financial Officer