-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SZCzhoa65IT3QlTKBBkJvVpmdXI/CJhVNyr/aFlFqwGlUhFa9gzBJg1HTOBemzp7 bpq0tVEtdC6LfSbG+8X7yw== 0000950128-99-001008.txt : 19991227 0000950128-99-001008.hdr.sgml : 19991227 ACCESSION NUMBER: 0000950128-99-001008 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990928 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EDUCATION MANAGEMENT CORPORATION CENTRAL INDEX KEY: 0000880059 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-EDUCATIONAL SERVICES [8200] IRS NUMBER: 251119571 FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21363 FILM NUMBER: 99719077 BUSINESS ADDRESS: STREET 1: 300 SIXTH AVENUE CITY: PITTSBURGH STATE: PA ZIP: 15222 BUSINESS PHONE: 4125620900 MAIL ADDRESS: STREET 1: 300 SIXTH AVE CITY: PITTSBURGH STATE: PA ZIP: 15222 10-K 1 EDUCATION MANAGEMENT CORPORATION 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED: JUNE 30, 1999 COMMISSION FILE NUMBER: 000-21363 ------------------------ EDUCATION MANAGEMENT CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) PENNSYLVANIA 25-1119571 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 300 SIXTH AVENUE, PITTSBURGH, PA 15222 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (412) 562-0900 SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $.01 PAR VALUE (TITLE OF CLASS) PREFERRED SHARE PURCHASE RIGHTS (TITLE OF CLASS) 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 No __ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in the definitive proxy statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. __ The aggregate market value of the voting common stock held by non-affiliates of the registrant as of September 20, 1999 was approximately $292,128,379. The number of shares of Common Stock outstanding on September 20, 1999 was 29,318,522 shares. Documents incorporated by reference: Portions of the definitive Proxy Statement of the registrant for the annual meeting of shareholders to be held on November 4, 1999 ("Proxy Statement") are incorporated by reference into Part III of this Form 10-K. The incorporation by reference herein of portions of the Proxy Statement shall not be deemed to incorporate by reference the information referred to in Item 402(a)(8) of Regulation S-K. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I Forward-Looking Statements: This Annual Report on Form 10-K contains statements that may be forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Those statements can be identified by their use of terms such as "believes," "estimates," "anticipates," "continues," "contemplates," "expects," "may," "will," "could," "should" or "would" or the negatives thereof or other variations thereon or comparable terminology. Those statements are based on the intent, belief or expectation of Education Management Corporation ("EDMC" or the "Company") as of the date of this Annual Report. Such forward-looking statements are not guarantees of future performance and may involve risks and uncertainties that are outside the control of the Company. Actual results may vary materially from the forward-looking statements contained herein as a result of changes in United States or international economic conditions, governmental regulations and other factors, including those factors described at the end of the responses to Item 7 under the heading "Risk Factors." The Company expressly disclaims any obligation or understanding to release publicly any updates or revisions to any forward-looking statement contained herein to reflect any change in the Company's expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto filed in response to Item 8 of this Annual Report. ITEM 1--BUSINESS BUSINESS OVERVIEW EDMC is among the largest providers of proprietary postsecondary education in the United States, based on student enrollments and revenues. The Company was organized as a Pennsylvania corporation in 1962 and completed its initial public offering (the "IPO") in 1996. Through its main operating unit, the Art Institutes ("The Art Institutes"), the Company offers associate's and bachelor's degree programs and non-degree programs in the areas of design, media arts, culinary arts and fashion. The Company's schools have graduated over 100,000 students. In the fall quarter beginning October 1998, EDMC's schools had 21,518 students enrolled, representing all 50 states and over 85 countries. The Company's main operating unit, The Art Institutes, consisted on June 30, 1999 of 18 schools in 16 cities throughout the United States. Art Institute programs are designed to provide the knowledge and skills necessary for entry-level employment in various fields, including graphic design, multimedia and web design, computer animation, video production, culinary arts, interior design, industrial design, photography, fashion marketing and fashion design. Those programs typically are completed in 18 to 48 months and culminate in a bachelor's or associate's degree. Eight Art Institutes currently offer bachelor's degree programs, and EDMC expects to continue to introduce bachelor's degree programs at schools in states that permit proprietary postsecondary institutions to offer such programs. In August 1999, the Company acquired the American Business & Fashion Institute in Charlotte, North Carolina and Massachusetts Communications College in Boston. The Company offers a culinary arts curriculum at ten Art Institutes, including The Art Institute of Los Angeles, The Art Institutes International Minnesota and The Art Institute of Dallas, which began culinary arts classes in July 1998, October 1998 and April 1999, respectively. The Company also owns the New York Restaurant School ("NYRS"), a culinary arts and restaurant management school located in New York City. NYRS offers an associate's degree program and certificate programs. The Company also owns NCPT (The National Center for Paralegal Training), which offers paralegal certificate programs, and The National Center for Professional Development, which maintains consulting relationships with five colleges and universities to assist in the development, marketing and delivery of paralegal, legal nurse consultant and financial planning certificate programs. EDMC's primary objective is to provide career-focused education that maximizes employment opportunities for its students after graduation. EDMC's graduates are employed by a broad range of employers nationwide. Approximately 90.9% of the calendar year 1998 graduates of all programs at EDMC's schools who were available for employment obtained positions in fields related to their programs of study within six months of graduation. 2 3 THE BUSINESS OF EDUCATION EDMC's primary mission is to maximize student success by providing students with the education necessary to meet employers' current and anticipated needs. To achieve this objective, the Company focuses on marketing to a broad range of potential students, admitting students who possess the relevant interests and capabilities, providing students with programs of study taught by industry professionals, and assisting students with job placement. STUDENT RECRUITMENT AND MARKETING The general reputation of The Art Institutes and referrals from current students, alumni and employers are the largest sources of new students. The Company also employs marketing tools such as television and print media advertising, the World Wide Web, high school visits and recruitment events, and uses its internal advertising agency to create publications, television and radio commercials, videos and other promotional materials for the Company's schools. The Company estimates that in fiscal 1999 referrals accounted for 36% of new student enrollments at The Art Institutes, high school recruitment programs accounted for 21%, broadcast advertising accounted for 22%, print media accounted for 9%, the Company's web sites accounted for 7%, and international marketing accounted for 2%. The remainder was classified as miscellaneous. In fiscal 1999, The Art Institutes' marketing efforts generated inquiries from approximately 215,000 qualified prospective students. The Art Institutes' inquiry-to-application conversion ratio has increased from 9.0% in fiscal 1996 to 10.9% in fiscal 1999, and the applicant-to-new student ratio has decreased slightly from 66.7% in fiscal 1996 to 66.6% in fiscal 1999. The Company also employs approximately 80 representatives who make presentations at high schools to promote The Art Institutes. Each Art Institute also conducts college preview seminars at which prospective students can meet with a representative, view artwork and videos, and receive enrollment information. In fiscal 1999, representatives visited over 9,000 high schools and attended approximately 1,600 career events. Summer teenager and teacher workshops are held to inform students and educators of the education programs offered by The Art Institutes. The Company's marketing efforts to reach young adults and working adults who may be attracted to evening programs are conducted through local newspaper advertising, direct mail campaigns and broadcast advertising. NYRS relies on local television and referrals as its primary marketing tools and also uses high school representatives and presentations at high schools in the New York metropolitan area. STUDENT ADMISSIONS AND RETENTION Each applicant for admission to an Art Institute is required to have a high school diploma or a recognized equivalent and to submit a written essay. Prospective students are interviewed to assess their qualifications, their interest in the programs offered by the applicable Art Institute and their commitment to their education. In addition, the curricula, student services, education cost, available financial resources and student housing are reviewed during interviews, and tours of the facilities are conducted for prospective students. Art Institute students are of varying ages and backgrounds. For fiscal 1999, approximately 26% of the entering students matriculated directly from high school, approximately 31% were between the ages of 19 and 21, approximately 31% were 22 to 29 years of age and approximately 12% were 30 years old or older. Students at the Company's schools may fail to finish their programs for a variety of personal, financial or academic reasons. To reduce the risk of student withdrawals, each Art Institute devotes staff resources to advise students regarding academic and financial matters, part-time employment and housing. Remedial courses are mandated for students with low academic skill levels and tutoring is encouraged for students experiencing academic difficulties. The Art Institutes' net annual persistence rate, which measures the number of students who are enrolled during a fiscal year and either graduate or advance to the next fiscal year, was 66.4% in fiscal 1998 and 65.4% in fiscal 1999. 3 4 EDUCATION PROGRAMS The Art Institutes offer the following degree programs. Certain programs are offered only at select Art Institutes. (For internal purposes, the Company classifies its degree programs according to four "schools" or areas of study.) THE SCHOOL OF DESIGN THE SCHOOL OF MEDIA ARTS Associate's Degree Programs Associate's Degree Programs Computer-Aided Drafting & Design Audio Production Computer Animation Broadcasting Graphic Design Multimedia & Web Design Interior Design Photography Industrial Design Technology Video Production Web Site Administration Bachelor's Degree Programs Computer Animation Bachelor's Degree Programs Game Art and Design Graphic Design Interactive Multimedia Programming Interior Design Online Media & Marketing Industrial Design THE SCHOOL OF FASHION THE SCHOOL OF CULINARY ARTS Associate's Degree Programs Associate's Degree Programs Fashion Design Culinary Arts Fashion Marketing Restaurant and Catering Management Visual Merchandising Bachelor's Degree Programs Bachelor's Degree Programs Fashion Design Culinary Management Fashion Marketing and Management NYRS offers associate's degree programs in culinary arts and restaurant management and certificate programs in culinary arts, pastry arts, culinary skills and restaurant management. Approximately 7% of the average quarterly student enrollments at the Company's schools in fiscal 1999 were in specialized diploma programs. Academic credits from all of the specialized diploma programs at the Art Institutes and NYRS are fully transferable into associate's and bachelor's degree programs at those schools. Diploma programs are designed for working adults who seek to supplement their education or are interested in enhancing their marketable skills. The Company expects to continue to add additional bachelor's degree programs at schools in states that permit proprietary postsecondary institutions to offer such programs. 4 5 GRADUATE EMPLOYMENT Based on information received from graduating students and employers, the Company believes that students graduating from The Art Institutes during the five calendar years ended December 31, 1998 obtained employment in fields related to their programs of study as follows:
PERCENT OF AVAILABLE NUMBER OF GRADUATES WHO OBTAINED GRADUATING CLASSES AVAILABLE EMPLOYMENT RELATED TO (CALENDAR YEAR) GRADUATES(1)(2) PROGRAM OF STUDY(2)(3) - ------------------ ---------------- ---------------------- 1998............................................ 3,941 90.5% 1997............................................ 3,811 89.0 1996............................................ 3,676 86.8 1995............................................ 3,734 87.4 1994............................................ 3,495 86.4
- --------- (1) The term "Available Graduates" refers to all graduates except those who are pursuing further education, deceased, in active military service, have medical conditions that prevent such graduates from working or are international students no longer residing in the United States. (2) If the graduates of NCPT and NYRS (since its acquisition in August 1996) were included in this table, then the number of graduates and placement rates for 1996, 1997 and 1998 would have been 4,167, 4,749 and 4,719, and 86.4%, 87.3%, and 90.9%, respectively. In addition, the data for 1999 exclude graduates of programs in teach-out status. Had these 230 graduates been included, the total number of graduates available for employment would have been 4,949 with a placement rate of 90.9%. (3) The information presented reflects employment in fields related to graduates' programs of study within six months after graduation. For calendar year 1998, the approximate average starting salaries of graduates of degree and diploma programs at The Art Institutes were as follows: The School of Culinary Arts--$23,300; The School of Design--$24,500; The School of Fashion--$21,900; and The School of Media Arts--$22,800. Each Art Institute offers career-planning services to all graduating students through its employment assistance department. Specific career advice is provided during the last two quarters of a student's education. Interviewing techniques and resume-writing skills are developed, and students receive portfolio counseling where appropriate. The Art Institutes maintain contact with approximately 40,000 employers nationwide. Employment assistance advisors educate employers about the programs at The Art Institutes and the caliber of their graduates and also participate in professional organizations, trade shows and community events to keep apprised of industry trends and maintain relationships with key employers. Employers of Art Institute graduates include numerous small and medium-sized companies, as well as better-known larger companies. The following companies are representative of the larger companies that employ Art Institute graduates: Bell Atlantic Corporation, The Boeing Company, Eddie Bauer, Inc., Ethan Allen Interiors Inc., Flight Safety International, The Home Depot, Inc., Humongous Entertainment, Inc., J. C. Penney Company, Inc., Kinko's Corporation, Marriott International, Inc., The May Department Stores Company, Microsoft Corporation, The Neiman Marcus Group, Inc., Nintendo of America, Nordstrom, Inc., The Ritz-Carlton, Sears Roebuck and Co., Sierra On-Line, Inc., Take2 Interactive Software, Inc., Tele-Communications, Inc., Time Warner Inc., Turner Broadcasting System, Inc., and The Walt Disney Company. ACCREDITATION Accreditation is a process through which an institution submits itself to qualitative review by an organization of peer institutions. Accrediting agencies primarily examine the academic quality of the instructional programs of an institution, and a grant of accreditation is generally viewed as certification that an institution's programs meet generally accepted academic standards. Accrediting agencies also review the administrative and financial operations of the institutions they accredit to ensure that each institution has the resources to perform its educational mission. 5 6 Pursuant to provisions of the Higher Education Act of 1965 ("HEA"), the U.S. Department of Education relies on accrediting agencies to determine whether institutions' educational programs qualify them to participate in federal financial aid programs under Title IV of the HEA ("Title IV Programs"). The HEA specifies certain standards that all recognized accrediting agencies must adopt in connection with their review of postsecondary institutions. All of EDMC's schools are accredited by one or more accrediting agencies recognized by the U.S. Department of Education. Five of the Company's schools are either accredited, or are candidates for accreditation, by one of the six regional accrediting agencies that accredit virtually all of the public and private non-profit colleges and universities in the United States. The following table shows the location of each of EDMC's schools, the name under which it operates, the year of its establishment, the date EDMC opened or acquired it, the number of students enrolled as of the beginning of the second (fall) quarter of fiscal 1999, and the accrediting agencies (for schools accredited by more than one recognized accrediting agency, the primary accrediting agency is listed first).
FISCAL YEAR CALENDAR EDMC YEAR ACQUIRED/ SCHOOL LOCATION ESTABLISHED OPENED ENROLLMENT ACCREDITING AGENCY ------ --------------------- ------------ ------------ ---------- ----------------------------- The Art Institute of Atlanta.................... Atlanta, GA 1949 1971 1,699 Commission on Colleges of the Southern Association of Colleges and Schools ("SACS") The Art Institute of Dallas..................... Dallas, TX 1964 1985 1,334 SACS The Art Institute of Fort Lauderdale................. Fort Lauderdale, FL 1968 1974 2,645 Accrediting Commission of Career Schools and Colleges of Technology ("ACCSCT") The Art Institute of Houston.................... Houston, TX 1974 1979 1,690 ACCSCT, SACS (Candidate) The Art Institute of Los Angeles.................... Los Angeles, CA 1997 1998 407 ACCSCT, as an additional location of The Art Institute of Pittsburgh The Art Institute of Philadelphia............... Philadelphia, PA 1971 1980 2,361 ACCSCT The Art Institute of Phoenix.................... Phoenix, AZ 1995 1996 834 ACCSCT, as an additional location of The Colorado Institute of Art The Art Institute of Pittsburgh................. Pittsburgh, PA 1921 1970 2,585 ACCSCT The Art Institute of Seattle.................... Seattle, WA 1946 1982 2,700 ACCSCT Commission on Colleges of the Northwest Association of Schools and Colleges ("NWASC") (Candidate) The Art Institutes International at Portland................... Portland, OR 1963 1998 205 NWASC The Art Institutes International at San Francisco.................. San Francisco, CA 1939 1998 77 ACCSCT The Art Institutes International Minnesota.... Minneapolis, MN 1964 1997 531 Accrediting Council for Independent Colleges and Schools ("ACICS") The Colorado Institute of Art........................ Denver, CO 1952 1976 1,748 ACCSCT The Illinois Institute of Art at Chicago................. Chicago, IL 1916 1996 804 ACCSCT The Illinois Institute of Art at Schaumburg.............. Schaumburg, IL 1983 1996 507 ACCSCT, as an additional location of The Illinois Institute of Art at Chicago
6 7
FISCAL YEAR CALENDAR EDMC YEAR ACQUIRED/ SCHOOL LOCATION ESTABLISHED OPENED ENROLLMENT ACCREDITING AGENCY ------ --------------------- ------------ ------------ ---------- ----------------------------- NCPT: The National Center for Paralegal Training......... Atlanta, GA 1973 1973 385 ACICS The New York Restaurant School..................... New York, NY 1980 1997 1,006 ACCSCT, New York State Board of Regents
Accrediting agencies monitor each institution's performance in specific areas. In the event that the information provided by a school to an accrediting agency indicates that such school's performance in one or more areas falls below certain parameters, the accrediting agency may require that school to supply it with supplemental reports on the accrediting agency's specific areas of concern until that school meets the accrediting agency's performance guideline or standard. A school that is subject to this heightened monitoring must seek the prior approval of its accrediting agency in order to open or commence teaching at new locations. The accrediting agencies do not consider requesting that a school provide supplemental reports to be a negative action. ACCSCT has notified three of the Company's schools that, due to concerns regarding student completion rates for certain programs at each of those schools, such schools were required to provide certain supplemental reports to the agency. ACCSCT's standards define a program's completion rate as the percentage of the students who started that program during a twelve-month period and who have either graduated from that program within a period of time equal to 150% of that program's length or withdrawn from that program during the same period in order to accept full-time employment in the occupation or job category for which the program was offered. Because that calculation can only be performed after a student's scheduled completion date, it does not provide a timely basis for a school to take action to affect student outcomes. For that reason, for internal purposes, the Company uses the net annual persistence rate as a method to track the retention rate of students. At the time that the Company purchased the assets of Bassist College in Portland, Oregon, the school was on probation status with NWASC due to concerns that NWASC had with the financial stability of the school's previous owner. NWASC approved the change of ownership of that school to the Company while continuing its probation status. NWASC removed the school (now named The Art Institutes International at Portland) from probation status at its spring 1999 meeting. STUDENT FINANCIAL ASSISTANCE Many students at EDMC's schools must rely, at least in part, on financial assistance to pay the cost of their education. The largest source of such support is the federal programs of student financial assistance under Title IV of the HEA. Additional sources of funds include other federal grant programs, state grant and loan programs, private loan programs and institutional grants and scholarships. To provide students access to financial assistance resources available through Title IV Programs, a school must be (i) authorized to offer its programs of instruction by the relevant agency of the state in which it is located, (ii) accredited by an agency recognized by the U.S. Department of Education, and (iii) certified as an eligible institution by the U.S. Department of Education. In addition, the school must ensure that Title IV Program funds are properly accounted for and disbursed in the correct amounts to eligible students. All Art Institutes and NYRS participate in Title IV Programs. NATURE OF FEDERAL SUPPORT FOR POSTSECONDARY EDUCATION While the states support public colleges and universities primarily through direct state subsidies, the federal government provides a substantial part of its support for postsecondary education in the form of grants and loans to students who can use this support at any institution that has been certified as eligible by the U.S. Department of Education. Students at EDMC's schools receive loans, grants and work-study funding to fund their education under several Title IV Programs, of which the two largest are the Federal Family Education Loan ("FFEL") program and the Federal Pell Grant ("Pell") program. The Company's schools also participate in the Federal Supplemental Educational Opportunity Grant ("FSEOG") program, the Federal Perkins Loan ("Perkins") program, and the Federal Work-Study ("FWS") program. 7 8 FFEL. The FFEL program consists of two types of loans, Stafford loans, which are made available to students regardless of financial need, and PLUS loans, which are made available to parents of students classified as dependents. Under the Stafford loan program, a student may borrow up to $2,625 for the first academic year, $3,500 for the second academic year and, in certain educational programs, $5,500 for each of the third and fourth academic years. Students who are classified as independent can obtain an additional $4,000 for each of the first and second academic years and, depending upon the educational program, an additional $5,000 for each of the third and fourth academic years. Amounts received by students in the Company's schools under the Stafford loan program in fiscal 1999 equaled approximately 37% of the Company's net revenues. PLUS loans may be obtained by the parents of a dependent student in an amount not to exceed the difference between the total cost of that student's education (including allowable expenses) and other aid to which that student is entitled. Amounts received by parents of students in the Company's schools under the PLUS loan program in fiscal 1999 equaled approximately 15% of the Company's net revenues. Under the Federal Direct Student Loan Program ("FDSL"), students may obtain loans directly from the U.S. Department of Education rather than commercial lenders. The conditions on FDSL loans are generally the same as on loans made under the FFEL program. All of the Company's schools currently eligible to participate in Title IV Programs are also approved by the U.S. Department of Education to participate in the FDSL program, but all have deferred participation since their respective students' loan needs continue to be satisfied under the FFEL program. Pell. Pell grants are the primary component of the Title IV Programs under which the U.S. Department of Education makes grants to students who demonstrate financial need. Every eligible student is entitled to receive a Pell grant; there is no institutional allocation or limit. During fiscal 1999, Pell grants ranged from $400 to $3,000 per year; beginning on July 1, 1999, the limit was increased to $3,125 per year. Amounts received by students enrolled in the Company's schools in fiscal 1999 under the Pell program equaled approximately 7% of the Company's net revenues. FSEOG. FSEOG awards are designed to supplement Pell grants for the neediest students. FSEOG grants generally range in amount from $100 to $4,000 per year; however, the availability of FSEOG awards is limited by the amount of those funds allocated to an institution under a formula that takes into account the size of the institution, its costs and the income levels of its students. At most of the Company's schools, FSEOG awards generally do not exceed $1,200 per eligible student per year. The Company is required to make a 25% matching contribution for all FSEOG program funds disbursed. Resources for this institutional contribution may include institutional grants and scholarships and, in certain states, portions of state grants and scholarships. In fiscal 1999, the Company's required 25% institutional match was approximately $840,000. Amounts received by students in the Company's schools under the FSEOG program in fiscal 1999 equaled approximately 1% of the Company's net revenues. Perkins. Eligible undergraduate students may borrow up to $4,000 under the Perkins program during each academic year, with an aggregate maximum of $15,000, at a 5% interest rate and with repayment delayed until nine months after a student ceases enrollment as at least a half-time student. Perkins loans are made available to those students who demonstrate the greatest financial need. Perkins loans are made from a revolving account, with 75% of new funding contributed by the U.S. Department of Education, and the remainder by the applicable school. Subsequent federal capital contributions, which must be matched by school funds, may be received if an institution meets certain requirements. Each school collects payments on Perkins loans from its former students and relends those funds to currently enrolled students. Collection and disbursement of Perkins loans is the responsibility of each participating institution. During fiscal 1999, the Company collected approximately $2.5 million from its former students. In fiscal 1999, the Company's required matching contribution was approximately $190,000. The Perkins loans disbursed to students in the Company's schools in fiscal 1999 were less than 1% of the Company's net revenues. Ten of the Company's schools participate in the Perkins program. Federal Work-Study. Under the FWS program, federal funds are made available to pay up to 75% of the cost of part-time employment of eligible students, based on their financial need, to perform work for the institution or for off-campus public or non-profit organizations. At least 5% of an institution's FWS allocation 8 9 must be used to fund student employment in community service positions. In fiscal 1999, FWS funds accounted for less than 0.5% of the Company's net revenues. OTHER FINANCIAL ASSISTANCE SOURCES Students at several of the Company's schools participate in state grant programs. In fiscal 1999, approximately 3% of the Company's net revenues was derived from state grant programs. In addition, certain students at some of the Company's schools receive financial aid provided by the United States Department of Veterans Affairs, the United States Department of the Interior (Bureau of Indian Affairs) and the Rehabilitative Services Administration of the U.S. Department of Education (vocational rehabilitation funding). In fiscal 1999, financial assistance from such federal and state programs equaled less than 2% of the Company's net revenues. The Art Institutes also provide institutional scholarships to qualified students. In fiscal 1999, institutional scholarships had a value equal to approximately 3% of the Company's net revenues. The Company has also arranged alternative supplemental loan programs that allow students to repay a portion of their loans after graduation and allow students with lower than average credit ratings to obtain loans. The primary objective of these loan programs is to lower the monthly payments required of students. Such loans are without recourse to the Company or its schools. AVAILABILITY OF LENDERS During fiscal 1999, five lending institutions provided over 81% of all federally guaranteed loans to students attending the Company's schools. While the Company believes that other lenders would be willing to make federally guaranteed student loans to its students if loans were no longer available from its current lenders, there can be no assurances in this regard. In addition, the HEA requires the establishment of lenders of last resort in every state to make certain loans to students at any school that cannot otherwise identify lenders willing to make federally guaranteed loans to its students. One student loan guaranty agency (USA Group Guarantee Services, formerly United Student Aid Funds) currently guarantees approximately 87% of all federally guaranteed student loans made to students enrolled at the Company's schools. The Company believes that other guaranty agencies would be willing to guarantee loans to the Company's students if that agency ceased guaranteeing those loans or reduced the volume of those loans it guaranteed. FEDERAL OVERSIGHT OF TITLE IV PROGRAMS Each institution that participates in Title IV Programs must annually submit to the U.S. Department of Education an audit by an independent accounting firm of that school's compliance with Title IV Program requirements, as well as audited financial statements. The U.S. Department of Education also conducts compliance reviews, which include on-site evaluations, of several hundred institutions each year, and directs student loan guaranty agencies to conduct additional reviews relating to student loan programs. In addition, the Office of the Inspector General of the U.S. Department of Education conducts audits and investigations in certain circumstances. Under the HEA, accrediting agencies and state licensing agencies also have responsibilities for overseeing institutions' compliance with certain Title IV Program requirements. As a result, each participating institution is subject to frequent and detailed oversight and must comply with a complex framework of laws and regulations or risk being required to repay funds or becoming ineligible to participate in Title IV Programs. Cohort Default Rates. The U.S. Department of Education may impose sanctions on institutions whose former students default at an "excessive" rate on the repayment of federally guaranteed student loans. A school's cohort default rate under the FFEL program is calculated on an annual basis as the rate at which student borrowers scheduled to begin repayment on their loans in one federal fiscal year default on those loans by the end of the next federal fiscal year. Any institution whose FFEL cohort default rate equals or exceeds 25% for three consecutive years will no longer be eligible to participate in that program or the FDSL program for the remainder of the federal fiscal year in which the U.S. Department of Education determines that such institution has lost its eligibility and for the two subsequent federal fiscal years. In addition, an institution whose FFEL cohort default rate for any federal fiscal year exceeds 40% may have its eligibility to participate in all Title IV Programs limited, 9 10 suspended or terminated. Since the calculation of FFEL cohort default rates involves the collection of data from many non-governmental agencies (i.e., lenders and non-federal guarantors), as well as the U.S. Department of Education, the HEA provides a formal process for the review and appeal of the accuracy of FFEL cohort default rates before the U.S. Department of Education takes any action against an institution based on its FFEL cohort default rates. As part of that process, the U.S. Department of Education provides each institution with its FFEL cohort default rate on a preliminary basis for review. Preliminary cohort default rates are subject to revision by the U.S. Department of Education based on information that schools and guaranty agencies identify and submit to the U.S. Department of Education for review in order to correct any errors in the data previously provided. None of the Company's schools has had an FFEL cohort default rate of 25% or greater for the last three consecutive federal fiscal years. For federal fiscal year 1996, the most recent year for which such rates have been published, the average FFEL cohort default rate for borrowers at all proprietary institutions was 18.2%. For that year, the combined preliminary FFEL cohort default rate for all borrowers at the Company's schools was 16.6%. For federal fiscal year 1997, the combined preliminary FFEL cohort default rate for all borrowers at the Company's schools was 14.7% and its individual schools' preliminary rates ranged from 4.4% to 22.6%, although only two such schools had preliminary rates that exceeded 20%. EDMC has submitted information to the U.S. Department of Education with respect to the preliminary FFEL cohort default rates for federal fiscal year 1997 for most of its schools and believes that the published FFEL cohort default rates for such year for one or more of its schools will be greater or less than such schools' preliminary rates. If an institution's FFEL cohort default rate equals or exceeds 25% in any of the three most recent federal fiscal years, or if its cohort default rate for loans under the Perkins program exceeds 15% for the most recent federal award year (i.e., July 1 through June 30), that institution may be placed on provisional certification status for up to four years. Provisional certification does not limit an institution's access to Title IV Program funds, but does subject that institution to closer review by the U.S. Department of Education and possible summary adverse action if that institution commits a material violation of Title IV Program requirements. To EDMC's knowledge, the U.S. Department of Education reviews an institution's compliance with the cohort default rate thresholds described in this paragraph only when that school is otherwise subject to a U.S. Department of Education certification review. As a result of such a certification review in 1997, The Art Institute of Houston was placed on provisional certification status because of its FFEL cohort default rates for federal fiscal years 1993 and 1994. Five of the Company's schools had Perkins cohort default rates in excess of 15% for students who were to begin repayment during the federal award year ending June 30, 1998, the most recent year for which such rates have been calculated. For each of those schools, funds from the Perkins program equaled less than 4% of the school's net revenues in fiscal 1999. To date, none of those schools has been placed on provisional certification status for this reason. If an institution is placed on such status for this reason and the institution reduces its Perkins cohort default rate to below 15% in a subsequent year, the institution can ask the U.S. Department of Education to remove the provisional status. Each of the Company's schools has adopted a student loan default management plan. Those plans provide for extensive loan counseling, methods to increase student persistence and completion rates and graduate employment rates, strategies to increase graduate salaries and, for most schools, the use of external agencies to assist the school with loan counseling and loan servicing if a student ceases to attend that school. Those activities are in addition to the loan servicing and collection activities of FFEL lenders and guaranty agencies. Regulatory Oversight. The U.S. Department of Education is required to conduct periodic reviews of the eligibility and certification of every institution participating in Title IV Programs. A denial of recertification precludes a school from continuing to participate in Title IV Programs. The Art Institutes International Minnesota, The Illinois Institute of Art at Chicago and The Illinois Institute of Art at Schaumburg applied for recertification by the U.S. Department of Education during fiscal 1999, and each has received recertification. During fiscal 2000, eight of the Company's schools are scheduled to apply for recertification. NYRS, The Art Institutes International at San Francisco and The Art Institutes International at Portland are provisionally certified by the U.S. Department of Education due to their recent acquisition by the Company. None 10 11 of the Company's other schools that are participating in Title IV Programs are on provisional certification status except The Art Institute of Houston which in the course of the normal recertification process was provisionally recertified in 1997 because of its 1993 and 1994 FFEL cohort default rates. The HEA requires each accrediting agency recognized by the U.S. Department of Education to undergo comprehensive periodic review by the U.S. Department of Education to ascertain whether such accrediting agency is adhering to required standards. Each accrediting agency that accredits any of the Company's schools has been reviewed by the U.S. Department of Education within the past four years and re-approved for continued recognition by the U.S. Department of Education. Financial Responsibility Standards. All institutions participating in Title IV Programs must satisfy a series of specific standards of financial responsibility. Institutions are evaluated for compliance with those requirements as part of the U.S. Department of Education's quadrennial recertification process and also annually as each institution submits its audited financial statements to the U.S. Department of Education. For the year ended June 30, 1999, the Company believes that, on an individual institution basis, each of its schools then participating in Title IV Programs satisfied the financial responsibility standards. The Illinois Institute of Art at Schaumburg, The Art Institute of Phoenix and The Art Institute of Los Angeles are combined with their main campuses, The Illinois Institute of Art at Chicago, The Colorado Institute of Art, and The Art Institute of Pittsburgh, respectively, for that purpose. Restrictions on Operating Additional Schools. The HEA generally requires that certain institutions, including proprietary schools, be in full operation for two years before applying to participate in Title IV Programs. However, under the HEA and applicable regulations, an institution that is certified to participate in Title IV Programs may establish an additional location and apply to participate in Title IV Programs at that location without reference to the two-year requirement, if such additional location satisfies all other applicable requirements. In addition, a school that undergoes a change of ownership resulting in a change in control (as defined under the HEA) must be reviewed and recertified for participation in Title IV Programs under its new ownership. Previously, if a school was awaiting recertification, the U.S. Department of Education would suspend Title IV Program funding to that school's students. Recently, a mechanism was developed that allows most of a school's change of ownership application to be reviewed prior to the change of ownership. If the application is considered to be substantially complete, the U.S. Department of Education may generate a temporary Provisional Program Participation Agreement allowing the school's students to continue to receive federal funding, subject to certain conditions. After the change of ownership and the remainder of the application is submitted, if the school is recertified, it is recertified on a provisional basis. During the time a school is provisionally certified, it may be subject to summary adverse action for a material violation of Title IV Program requirements and may not establish additional locations without prior approval from the U.S. Department of Education. However, provisional certification does not otherwise limit an institution's access to Title IV Program funds. The Company's expansion plans are based, in part, on its ability to add additional locations and acquire schools that can be recertified. Certain of the state authorizing agencies and accrediting agencies with jurisdiction over the Company's schools also have requirements that may, in certain instances, limit the ability of the Company to open a new school, acquire an existing school or establish an additional location of an existing school. The Company does not believe that those standards will have a material adverse effect on the Company or its expansion plans. The "90/10 Rule." Under a provision of the HEA commonly referred to as the "90/10 Rule" (formerly known as the "85/15 Rule"), a proprietary institution such as each of EDMC's schools will cease to be eligible to participate in Title IV Programs if, on a cash accounting basis, more than 90% of its revenues for the prior fiscal year was derived from Title IV Programs. Any school that violates the 90/10 Rule immediately becomes ineligible to participate in Title IV Programs and is unable to apply to regain its eligibility until the following fiscal year. For fiscal 1999, the range for the Company's schools was from approximately 52% to approximately 72%. Restrictions on Payment of Bonuses, Commissions or Other Incentives. The HEA prohibits an institution from providing any commission, bonus or other incentive payment based directly or indirectly on success in securing enrollments or financial aid to any person or entity engaged in any student recruitment, admission or 11 12 financial aid awarding activity. EDMC believes that its current compensation plans are in compliance with HEA standards. STATE AUTHORIZATION Each of EDMC's schools is authorized to offer education programs and grant degrees or diplomas by the state in which such school is located. The level of regulatory oversight varies substantially from state to state. In some states, the schools are subject to licensure by the state education agency and also by a separate higher education agency. State laws establish standards for instruction, qualifications of faculty, location and nature of facilities, financial policies and responsibility and other operational matters. State laws and regulations may limit the ability of the Company to obtain authorization to operate in certain states or to award degrees or diplomas or offer new degree programs. Certain states prescribe standards of financial responsibility that are different from those prescribed by the U.S. Department of Education. The Company believes that each of the Company's schools is in substantial compliance with state authorizing and licensure laws. EMPLOYEES As of June 30, 1999, EDMC employed 1,998 full-time and 782 part-time staff and faculty. COMPETITION The postsecondary education market is highly competitive. The Art Institutes compete with traditional public and private two-year and four-year colleges and universities and other proprietary schools. Certain public and private colleges and universities may offer programs similar to those of The Art Institutes. Public institutions often receive government subsidies, government and foundation grants, tax-deductible contributions and other financial resources generally not available to proprietary schools. Accordingly, public institutions may have facilities and equipment, which are superior to those of the private sector, and can offer lower tuition prices. However, tuition at private non-profit institutions is, on average, higher than The Art Institutes' tuition. SEASONALITY IN RESULTS OF OPERATIONS EDMC has experienced seasonality in its results of operations primarily due to the pattern of student enrollments. Historically, EDMC's lowest quarterly revenues and income have been in the first quarter (July to September) of its fiscal year due to fewer students being enrolled during the summer months and the expenses incurred in preparation for the peak in enrollment in the fall quarter (October to December). EDMC expects that this seasonal trend will continue. ITEM 2--PROPERTIES As of June 30, 1999, EDMC's schools were located in major metropolitan areas in 12 states. Typically, the schools occupy an entire building or several floors or portions of floors in a building. The Company and its subsidiaries currently lease the majority of their facilities. In fiscal 1999, the Company acquired the 71,627 square foot main facility of The Art Institute of Seattle, a 99,400 square foot building in Denver to be occupied by The Colorado Institute of Art, a 51,545 square foot dormitory facility in Fort Lauderdale and a 177,600 square foot building in Pittsburgh, which will house The Art Institute of Pittsburgh after renovations currently anticipated to be completed in June 2000. 12 13 \The following table sets forth certain information as of June 30, 1999 with respect to the principal properties leased by the Company and its subsidiaries:
LOCATION (CITY/STATE) SQUARE FEET --------------------- ----------- Phoenix, AZ................... 58,635 Los Angeles, CA............... 45,835 San Francisco, CA............. 53,095 Denver, CO.................... 59,755 Ft. Lauderdale, FL(1)......... 118,590 Atlanta, GA(2)................ 106,197 Atlanta, GA................... 119,375 Chicago, IL................... 54,553 Schaumburg, IL................ 39,970
LOCATION (CITY/STATE) SQUARE FEET --------------------- ----------- Minneapolis, MN............... 67,750 New York, NY.................. 64,697 Portland, OR.................. 27,115 Philadelphia, PA(3)........... 116,375 Pittsburgh, PA(2)............. 36,930 Pittsburgh, PA(2)............. 128,200 Dallas, TX.................... 96,190 Houston, TX................... 83,600 Seattle, WA................... 149,755
- --------- (1) One of the properties occupied by The Art Institute of Fort Lauderdale is owned by a limited partnership that includes among its limited partners one current member of EDMC's management who is also a director. (2) These leases expire in fiscal 2000 (Atlanta) and fiscal 2001 (Pittsburgh). (3) One of the properties occupied by The Art Institute of Philadelphia is owned indirectly by a limited partnership that includes among its limited partners one current member of EDMC's management who is also a director and another current director of EDMC. ITEM 3--LEGAL PROCEEDINGS The Company and its wholly-owned subsidiaries The Art Institutes International, Inc. and The Art Institute of Houston, Inc. are defendants in a suit filed in the District Court of Harris County, Texas on June 30, 1999. The lawsuit was brought by 145 former and current students of The Art Institute of Houston who allege being misled about the benefits or quality of educational services provided to them. The complaint was subsequently amended to add claims by an additional 90 plaintiffs. The complaint does not specify the amount of damages being sought. The Company is also a defendant in other legal proceedings in the ordinary course of business. While there can be no assurance as to the ultimate outcome of any litigation involving the Company, in the opinion of management, based upon its investigation of these claims and discussion with legal counsel, the ultimate outcome of such legal proceedings, individually and in the aggregate, will not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 13 14 PART II ITEM 5-- MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS The Common Stock is traded on the Nasdaq National Market System under the symbol "EDMC." As of September 20, 1999, there were 29,318,522 shares of Common Stock outstanding held by approximately 480 holders of record. The prices set forth below reflect the high and low sales prices, adjusted for a two-for-one stock split effected in the form of a stock dividend in December 1998, for the Company's Common Stock, as reported in the consolidated transaction reporting system of the Nasdaq National Market System.
1998 1999 ---------------- ---------------- THREE MONTHS ENDED HIGH LOW HIGH LOW ------------------ ---- --- ---- --- September 30.................... $14.50 $12.13 $20.13 $14.50 December 31..................... 16.00 12.25 24.00 15.63 March 31........................ 17.63 13.63 31.75 21.75 June 30......................... 19.06 15.83 30.75 14.56
EDMC has not declared or paid any cash dividends on its capital stock during the past two years. EDMC currently intends to retain future earnings, if any, to fund the development and growth of its business and does not anticipate paying any cash dividends in the foreseeable future. 14 15 ITEM 6--SELECTED FINANCIAL DATA The following summary consolidated financial and other data should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto filed in response to Item 8 and the information included in response to Item 7 below. Certain of the summary consolidated financial data presented below are derived from the Company's consolidated financial statements audited by Arthur Andersen LLP, independent public accountants, whose report covering the financial statements as of June 30, 1998 and 1999 and for each of the three years in the period ended June 30, 1999 also is filed in response to Item 8 below. The summary consolidated income statement data for the years ended June 30, 1995 and 1996 and the summary consolidated balance sheet data as of June 30, 1995, 1996 and 1997 are derived from audited financial statements not included herein.
YEAR ENDED JUNE 30, ------------------------------------------------------ 1995(7)(8) 1996(8) 1997(8) 1998 1999 ---------- ------- ------- ---- ---- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) INCOME STATEMENT DATA: Net revenues.............................. $131,227 $147,863 $182,849 $221,732 $260,805 ESOP expense(1)........................... 7,086 1,366 -- -- -- Income before extraordinary item(2)....... 1,513 6,846 9,985 14,322 18,752 Net income................................ 1,513 5,920 9,985 14,322 18,752 Dividends on Series A Preferred Stock(3)................................ 2,249 2,249 83 -- -- Other Series A Preferred Stock transactions(3)......................... -- -- 403 -- -- PER SHARE DATA(3): Basic: Income (loss) before extraordinary item................................. $ (.05) $ .33 $ .40 $ .50 $ .64 Net income (loss)....................... $ (.05) $ .27 $ .40 $ .50 $ .64 Weighted average number of shares outstanding, in thousands(4)......... 13,780 13,826 23,878 28,908 29,314 Diluted: Income (loss) before extraordinary item................................. $ (.05) $ .19 $ .36 $ .48 $ .61 Net income (loss)....................... $ (.05) $ .15 $ .36 $ .48 $ .61 Weighted average number of shares outstanding, in thousands(4)......... 13,780 23,748 27,342 29,852 30,615 OTHER DATA: Capital expenditures(5)................... $ 11,640 $ 14,981 $ 18,487 $ 17,951 $ 54,933 Enrollments at beginning of fall quarter(6).............................. 12,749 13,407 15,838 18,763 21,518
AS OF JUNE 30, ------------------------------------------------------ 1995 1996 1997 1998 1999 ---- ---- ---- ---- ---- (IN THOUSANDS) BALANCE SHEET DATA: Total cash and cash equivalents........... $ 39,623 $ 27,399 $ 33,227 $ 47,310 $ 32,871 Receivables, net.......................... 7,414 8,172 10,547 11,678 15,333 Current assets............................ 49,662 39,858 48,886 65,623 55,709 Total assets.............................. 102,303 101,412 126,292 148,783 178,746 Current liabilities....................... 34,718 27,264 36,178 38,097 45,188 Long-term debt (including current portion)................................ 69,810 65,919 34,031 38,382 37,231 Shareholders' investment.................. 1,855 9,656 57,756 73,325 96,805
- --------- (1) Expenses incurred in connection with the Education Management Corporation Employee Stock Ownership Plan and Trust (the "ESOP") equal the sum of the payments on the senior term loan obtained for the ESOP's acquisition of securities from EDMC (the "ESOP Term Loan"), plus repurchases of shares from participants in the ESOP, less the dividends paid on the shares of Series A 10.19% Convertible Preferred Stock, $.0001 par value (the "Series A Preferred Stock"), previously held by the ESOP. In fiscal 1995, the Company made 15 16 a voluntary prepayment of $2.1 million on the ESOP Term Loan. In fiscal 1996, the ESOP Term Loan was repaid in full. Therefore, subsequent thereto there has not been, nor will there be in the future ESOP expense resulting from the repayment of such loan or, so long as the Common Stock is publicly traded, from repurchases of shares. (2) In fiscal 1996, the $25.0 million aggregate principal amount of the Company's 13.25% Senior Subordinated Notes due 1999 (the "Subordinated Notes") was prepaid in full. The resulting $1.5 million prepayment penalty is classified as an extraordinary item, net of the related income tax benefit. (3) Dividends on the outstanding shares of Series A Preferred Stock, dividends accrued but not paid on outstanding shares of Series A Preferred Stock and a redemption premium paid upon redemption of 75,000 shares of Series A Preferred Stock have been deducted from net income (loss) in calculating net income (loss) per share of Common Stock. (4) The weighted average shares outstanding used to calculate basic income (loss) per share does not include potentially dilutive securities (such as stock options, warrants and convertible preferred stock). Diluted income (loss) per share includes, where dilutive, the equivalent shares of Common Stock calculated under the Treasury stock method for the assumed exercise of options and warrants and conversion of shares of Series A Preferred Stock. (5) Capital expenditures for fiscal 1999 reflect approximately $5.1 million included in accounts payable at year-end. (6) Excludes students enrolled in programs at those colleges and universities with which the Company has consulting arrangements. (7) Results for fiscal 1995 include a $1.1 million nonrecurring credit for the refund of state and local business and occupation taxes. (8) Charges of $1.1 million, $0.5 million and $0.4 million are reflected in 1995, 1996 and 1997, respectively, to account for non-cash compensation expense related to the performance-based vesting of nonqualified stock options. 16 17 ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the Company's results of operations and financial condition should be read in conjunction with the information filed in response to Item 6 above and Item 8 below. Unless otherwise specified, any reference to a "year" is to a fiscal year ended June 30. BACKGROUND EDMC is one of the largest providers of proprietary postsecondary education in the United States, based on student enrollments and revenues. Through its operating units, primarily The Art Institutes, the Company offers bachelor's and associate's degree programs and non-degree programs in the areas of design, media arts, culinary arts, fashion and paralegal studies. The Company has provided career-oriented education programs for over 35 years, and its schools have graduated more than 100,000 students. As of June 30, 1999, the Company operated 18 schools in 15 major metropolitan areas throughout the United States. Net revenues, income before interest and taxes and net income increased in each of the last two years. Net revenues are presented after deducting refunds, scholarships and other adjustments. Net revenues increased 42.6% to $260.8 million in 1999 from $182.8 million in 1997. Income before interest and taxes increased 68.4% to $31.7 million in 1999 from $18.8 million in 1997. Net income increased by 87.8% to $18.8 million in 1999 from $10.0 million in 1997. Average quarterly student enrollments at the Company's schools were 19,325 in 1999 compared to 14,490 in 1997. The increase in average enrollments relates to, among other factors, new education programs and additional school locations, along with expanded bachelor's degree and evening degree program offerings. The Company's revenues consist of tuition and fees, student housing fees and student supply store and restaurant sales. In 1999, the Company derived 88.0% of its net revenues from net tuition and fees paid by, or on behalf of, its students. Tuition revenue generally varies, based on the average tuition charge per credit hour and the average student population. Student supply store and housing revenue is largely a function of the average student population. The average student population is influenced by the number of continuing students attending school at the beginning of a fiscal period and by the number of new students entering school during such period. New students enter The Art Institutes at the beginning of each academic quarter, which typically commence in January, April, July and October. The Company believes that the size of its student population is influenced by the number of graduating high school students, the attractiveness of its program offerings, the effectiveness of its marketing efforts, changes in technology, the persistence of its students, the length of its education programs and general economic conditions. The introduction of additional program offerings at existing schools and the establishment of new schools (through acquisition or start-up) are important factors influencing the Company's average student population. Tuition increases have been implemented in varying amounts in each of the past several years. Historically, the Company has been able to pass along cost increases through increases in tuition. The Company believes that it can continue to increase tuition as educational costs at other postsecondary institutions, both public and private, continue to rise. The Company's schools implemented tuition rate increases averaging approximately 6% during 1999. Tuition rates have generally been consistent across the Company's schools and programs. However, as the Company enters more markets in different geographic regions, tuition rates across Company schools might not remain consistent. The majority of students at The Art Institutes rely on funds received under various government sponsored student financial aid programs, especially Title IV Programs, to pay a substantial portion of their tuition and other education-related expenses. For the year ended June 30, 1999, approximately 66% of the Company's net revenues was indirectly derived from Title IV Programs. Educational services expense consists primarily of costs related to the development, delivery and administration of the Company's education programs. Major cost components are faculty compensation, administrative salaries, costs of educational materials, facility and school occupancy costs, information systems costs, bad debt expense and depreciation and amortization of property and equipment. During 1999, the Company's faculty 17 18 comprised approximately 46% full-time and approximately 54% part-time employees. In 1998, these same percentages were 45% and 55%, respectively. General and administrative expense consists of marketing and student admissions expenses and certain central staff departmental costs such as executive management, finance and accounting, legal and corporate development and other departments that do not provide direct services to the Company's students. The Company has centralized many of these services to gain consistency in management reporting, efficiency in administrative effort and control of costs. Amortization of intangibles relates to the values assigned to identifiable intangible assets and goodwill. These intangible assets arose principally from the application of purchase accounting to the establishment and financing of the ESOP and the related leveraged transaction in October 1989 and the acquisitions of the schools discussed below. See Note 2 of Notes to Consolidated Financial Statements. In August 1996, the Company purchased certain assets of NYRS for approximately $9.5 million. The Company acquired current assets net of specified current liabilities, property and equipment and certain other intangible assets. In January 1997, the Company acquired the assets of Lowthian College in Minneapolis, Minnesota for $0.4 million, which included the assumption of certain liabilities. The school was renamed The Art Institutes International Minnesota. In March 1997, the Company established The Art Institute of Los Angeles, at which classes began in October 1997. In December 1997, the Company purchased certain assets of the Louise Salinger School in San Francisco, California for $0.6 million in cash. The Company also entered into a consulting agreement with its former president in exchange for an option to purchase 20,000 shares of Common Stock. The school was renamed The Art Institutes International at San Francisco. In February 1998, the Company acquired certain assets related to the operations of Bassist College in Portland, Oregon, for approximately $0.9 million in cash. The purchase agreement provides for additional consideration based upon a specified percentage of gross revenues over the next five years. The school was renamed The Art Institutes International at Portland. In October 1998, the Company acquired the assets of Socrates Distance Learning Technologies Group for approximately $0.5 million in cash. This acquisition was made to further the development of the Company's distance learning capabilities. The Company employs the previous owners under two-year employment and non-compete arrangements. Start-up schools and smaller acquisitions are expected to incur operating losses during the first two to three years following their opening or purchase. The combined operating losses of the Company's newer schools were approximately $6.0 million in 1999. 18 19 RESULTS OF OPERATIONS The following table sets forth for the periods indicated the percentage relationships of certain income statement items to net revenues.
YEAR ENDED JUNE 30, --------------------------- 1997 1998 1999 ---- ---- ---- Net revenues.................................... 100.0% 100.0% 100.0% Costs and expenses: Educational services............................ 66.1 66.4 65.5 General and administrative...................... 22.4 21.7 21.9 Amortization of intangibles..................... 1.1 0.7 0.5 ----- ----- ----- 89.7 88.9 87.8 ----- ----- ----- Income before interest and taxes................ 10.3 11.1 12.2 Interest expense (income), net.................. 0.9 -- -- ----- ----- ----- Income before income taxes...................... 9.4 11.1 12.2 Provision for income taxes...................... 4.0 4.7 5.0 ----- ----- ----- Net income...................................... 5.5% 6.5% 7.2% ===== ===== =====
YEAR ENDED JUNE 30, 1999 COMPARED WITH YEAR ENDED JUNE 30, 1998 NET REVENUES Net revenues increased by 17.6% to $260.8 million in 1999 from $221.7 million in 1998. The revenue increase was primarily due to an increase in average quarterly student enrollments ($23.2 million) and tuition increases of approximately 6% ($12.5 million). The average academic year (three academic quarters) tuition rate for a student attending classes at an Art Institute on a recommended full schedule increased to $11,262 in 1999 from $10,350 in 1998. Net housing revenues increased by 13.4% to $14.7 million in 1999 from $12.9 million in 1998 and revenues from the sale of educational materials in 1999 increased by 17.3% to $12.3 million. Both increased primarily as a result of higher average student enrollments. Refunds increased from $7.1 million in 1998 to $8.0 million in 1999. As a percentage of gross revenue, refunds decreased slightly from 1998. EDUCATIONAL SERVICES Educational services expense increased by $23.4 million, or 15.9%, to $170.7 million in 1999 from $147.3 million in 1998. The increase was primarily due to additional costs required to service higher student enrollments, accompanied by normal cost increases for wages and other services at the schools owned by EDMC prior to 1998 ($15.8 million) and schools added in 1998 and 1999 ($6.0 million). Higher costs associated with establishing and supporting new schools and developing new education programs contributed to the increase. As a percentage of net revenues, educational services expense decreased from 66.4% in 1998 to 65.5% in 1999, reflecting leverage on fixed costs. GENERAL AND ADMINISTRATIVE General and administrative expense increased by 18.9% to $57.2 million in 1999 from $48.1 million in 1998 due to the incremental marketing and student admissions expenses incurred to generate higher student enrollments at the schools owned by EDMC prior to 1998 ($4.8 million), and additional marketing and student admissions expenses at the schools added in 1998 and 1999 ($2.9 million). General and administrative expense increased slightly as a percentage of net revenues in 1999 compared to 1998 as a result of increased advertising expenditures designed to promote awareness of and generate inquiries about the newer locations and new program offerings. 19 20 AMORTIZATION OF INTANGIBLES Amortization of intangibles decreased by $.4 million, or 25.3%, to $1.2 million in 1999 from $1.6 million in 1998, as a result of certain intangible assets becoming fully amortized. INTEREST EXPENSE (INCOME), NET The Company had net interest income of $113,000 in 1999 as compared to $3,000 in 1998. The average outstanding debt balance decreased from $5.6 million in 1998 to $4.6 million in 1999. Accordingly, less interest cost on borrowings has been offset against interest earned on investments. PROVISION FOR INCOME TAXES The Company's effective tax rate decreased to 41.1% in 1999 from 42.0% in 1998. This reduction reflects a more favorable distribution of taxable income among the states in which the Company operates and a decrease in non-deductible expenses as a percentage of taxable income. The effective rates differed from the combined federal and state statutory rates due to expenses that are nondeductible for tax purposes. NET INCOME Net income increased by $4.4 million or 30.9% to $18.8 million in 1999 from $14.3 million in 1998. The increase resulted from improved operations at the Company's schools owned prior to 1998, reduced amortization of intangibles and a lower effective income tax rate. YEAR ENDED JUNE 30, 1998 COMPARED WITH YEAR ENDED JUNE 30, 1997 NET REVENUE Net revenues increased by 21.3% to $ 221.7 million in 1998 from $182.8 million in 1997. The revenue increase was primarily due to an increase in average quarterly student enrollments ($25.5 million) and an approximate 5% tuition increase ($7.4 million) at schools owned by EDMC prior to 1998, and the addition of three schools ($2.0 million). The average academic year (three academic quarters) tuition rate for a student attending classes at an Art Institute on a recommended full schedule increased to $10,350 in 1998 from $9,860 in 1997. The Art Institute of Los Angeles was established in March 1997 and commenced classes in October 1997. The Company acquired the Louise Salinger School in December 1997 (renamed The Art Institutes International at San Francisco) and Bassist College in February 1998 (renamed The Art Institutes International at Portland). Net housing revenues increased by 24.3% to $12.9 million in 1998 from $10.4 million in 1997 and revenues from the sale of educational materials in 1998 increased by 20.3% to $10.4 million. Both increased primarily as a result of higher average student enrollments. Refunds for 1998 increased from $6.0 million in 1997 to $7.1 million in 1998. As a percentage of gross revenue, refunds decreased slightly from 1997. EDUCATIONAL SERVICES Educational services expense increased by $26.4 million, or 21.8%, to $147.3 million in 1998 from $120.9 million in 1997. The increase was primarily due to additional costs required to service higher student enrollments, accompanied by normal cost increases for wages and other services at the schools owned by EDMC prior to 1997 ($16.8 million) and schools added in 1997 and 1998 ($7.6 million). Higher costs associated with establishing and supporting new schools and developing new education programs contributed to the increase. GENERAL AND ADMINISTRATIVE General and administrative expense increased by 17.2% to $48.1 million in 1998 from $41.0 million in 1997 due to the incremental marketing and student admissions expenses incurred to generate higher student enrollments at the schools owned by EDMC prior to 1997 ($4.5 million), and additional marketing and student admissions expenses at the schools added in 1997 and 1998 ($3.0 million). General and administrative expense decreased slightly as a percentage of net revenues in 1998 compared to 1997 as a result of a reduction of expenses incurred by the Company's central staff organization. 20 21 AMORTIZATION OF INTANGIBLES Amortization of intangibles decreased by $0.5 million, or 22.4%, to $1.6 million in 1998 from $2.1 million in 1997, as a result of certain intangible assets becoming fully amortized. INTEREST EXPENSE (INCOME), NET The Company had net interest income of $3,000 in 1998 as compared to interest expense of $1.6 million in 1997. The lower interest expense was primarily attributable to a decrease in the average outstanding debt balance from $22.4 million in 1997 to $5.6 million in 1998. PROVISION FOR INCOME TAXES The Company's effective tax rate was 42.0% in 1998 and 1997, and differed from the combined federal and state statutory rates due to expenses that are nondeductible for tax purposes. NET INCOME Net income increased by $4.3 million or 43.4% to $14.3 million in 1998 from $10.0 million in 1997. The increase resulted from improved operations at the Company's schools owned prior to 1997 and reduced net interest expense, partially offset by a higher provision for income taxes. SEASONALITY AND OTHER FACTORS AFFECTING QUARTERLY RESULTS The Company's quarterly revenues and income fluctuate primarily as a result of the pattern of student enrollments. The Company experiences a seasonal increase in new enrollments in the fall (fiscal year second quarter), which is traditionally when the largest number of new high school graduates begin postsecondary education. Some students choose not to attend classes during summer months, although the Company's schools encourage year-round attendance. As a result, total student enrollments at the Company's schools are highest in the fall quarter and lowest in the summer months (fiscal year first quarter). The Company's costs and expenses, however, do not fluctuate as significantly as revenues on a quarterly basis. The Company anticipates that the seasonal pattern in revenues and earnings will continue in the future. QUARTERLY FINANCIAL RESULTS (UNAUDITED) The following table sets forth the Company's quarterly results for 1998 and 1999.
1998 ----------------------------------------------- SEPT. 30 DEC. 31 MAR. 31 JUNE 30 (SUMMER) (FALL) (WINTER) (SPRING) -------- ------- -------- -------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Net revenues..................................... $43,176 $63,068 $59,807 $55,681 Income before interest and taxes................. $ 228 $13,174 $ 8,004 $ 3,285 Income before income taxes....................... $ 181 $13,120 $ 8,019 $ 3,374 Net income....................................... $ 105 $ 7,610 $ 4,651 $ 1,956 Net income per share --Basic........................................ $ .00 $ .26 $ .16 $ .07 --Diluted...................................... $ .00 $ .26 $ .16 $ .06
1999 ----------------------------------------------- SEPT. 30 DEC. 31 MAR. 31 JUNE 30 (SUMMER) (FALL) (WINTER) (SPRING) -------- ------- -------- -------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Net revenues..................................... $50,079 $74,986 $70,575 $65,165 Income before interest and taxes................. $ 698 $16,646 $10,249 $ 4,105 Income before income taxes....................... $ 732 $16,543 $10,365 $ 4,171 Net income....................................... $ 425 $ 9,749 $ 6,105 $ 2,473 Net income per share --Basic........................................ $ .01 $ .33 $ .21 $ .08 --Diluted...................................... $ .01 $ .32 $ .20 $ .08
21 22 LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY The Company's cash flow from operations has been the primary source of financing for capital expenditures and growth. Cash flow from operations was $28.2 million, $28.6 million and $35.7 million for 1997, 1998 and 1999, respectively. For the year ended June 30, 1999, cash flow from operations and cash flow from investing activities are reflected net of approximately $5.1 million of capital expenditures included in accounts payable as of June 30, 1999. As a result of the significant increase in capital expenditures, the Company had net working capital of $10.5 million as of June 30, 1999, down from $27.5 million as of June 30, 1998. As of June 30, 1999, gross trade accounts receivable increased by $3.5 million, or 21.6%, to $19.5 million from the prior year as a result of the increased net revenues. The allowance for doubtful accounts increased by $1.0 million, or 12.6%, to $9.4 million in 1999 from $8.3 million in 1998. DEBT SERVICE The Company's Amended and Restated Credit Agreement, dated March 16, 1995, as amended (the "Revolving Credit Agreement"), currently allows for maximum borrowings of $60 million, reduced annually by $5 million, through its expiration on October 13, 2000. Borrowings under the Revolving Credit Agreement bear interest at one of three rates set forth in the Revolving Credit Agreement at the election of the Company. Certain outstanding letters of credit reduce the facility. As of June 30, 1999, the Company had approximately $22.5 million of additional borrowing capacity available under the Revolving Credit Agreement. The Revolving Credit Agreement contains customary covenants that, among other matters, require the Company to maintain specified levels of consolidated net worth and meet specified interest, leverage and fixed charge ratio requirements, and restrict repurchases of Common Stock and the incurrence of certain additional indebtedness. As of June 30, 1999, the Company was in compliance with all covenants under the Revolving Credit Agreement. Borrowings under the Revolving Credit Agreement are used by the Company primarily to fund its occasional working capital needs, arising from the seasonal pattern of cash receipts throughout the year. The level of accounts receivable reaches a peak immediately after the billing of tuition and fees at the beginning of each academic quarter. Collection of these receivables is heaviest at the start of each academic quarter. FUTURE FINANCING AND CASH FLOWS The Company believes that cash flow from operations, supplemented from time to time by borrowings under the Revolving Credit Agreement, will provide adequate funds for ongoing operations, planned expansion to new locations, planned capital expenditures and debt service during the term of the Revolving Credit Agreement. CAPITAL EXPENDITURES Capital expenditures made during the three years ended June 30, 1999 reflect the implementation of the Company's initiatives emphasizing the addition of new schools and programs and investment in classroom technology. During 1999, the Company purchased buildings in Denver, Ft. Lauderdale, Pittsburgh and Seattle. The buildings in Ft. Lauderdale and Seattle were previously leased. The real estate purchases in Denver and Pittsburgh will become, after completion of renovations, the new facilities of The Colorado Institute of Art and The Art Institute of Pittsburgh. The aggregate purchase price and costs of subsequent improvements made during the fiscal year related to the buildings acquired was approximately $29.1 million. The Company's capital expenditures were $18.5 million, $18.0 million and $54.9 million for 1997, 1998 and 1999, respectively. Exclusive of the real estate purchases and related improvements, the Company expects that total capital spending for 2000 will increase as a percentage of net revenues, as compared to 1999. The anticipated expenditures relate principally to the introduction and expansion of culinary programs, further investment in schools acquired or started during the previous four years and anticipated to be added in 2000, continued improvements to the facilities currently under construction, additional or replacement school and housing facilities and classroom technology. 22 23 The Company leases the majority of its facilities. Future commitments on existing leases will be paid from cash provided by operating activities. REGULATION The Company indirectly derived approximately 66% of its net revenues from Title IV Programs in 1999. U.S. Department of Education regulations prescribe the timing of disbursements of funds under Title IV Programs. Students must apply for a new loan for each academic year. Lenders in multiple disbursements each academic year generally provide loan funds. For first-time students in their first academic quarter, the initial loan disbursement is generally received at least 30 days after the commencement of that academic quarter. Otherwise, the first loan disbursement is received, at the earliest, 10 days before the commencement of the student's academic quarter. U.S. Department of Education regulations require Title IV Program funds received by the Company's schools in excess of the tuition and fees owed by the relevant students at that time to be, with these students' permission, maintained and classified as restricted until they are billed for the portion of their education program related to those funds. Funds transferred through electronic funds transfer programs are held in a separate cash account and released when certain conditions are satisfied. These restrictions have not significantly affected the Company's ability to fund daily operations. Effective July 1997, postsecondary education institutions became subject to changes in the delivery of FFEL program proceeds. Prior to July 1997, certain schools delivered FFEL proceeds for an academic year (typically three quarters) to students in two equal disbursements. The change resulted in FFEL proceeds being delivered equally in each of the academic quarters. Some of the Company's schools began to deliver loan proceeds in this manner prior to the change in regulation becoming effective. Education institutions participating in Title IV Programs must satisfy a series of specific standards of financial responsibility. Under regulations that took effect in July 1998, the U.S. Department of Education has adopted standards (replacing the former "acid test," tangible net worth test and two-year operating loss test) to determine an institution's financial responsibility to participate in Title IV Programs. The regulations establish three ratios: (i) the equity ratio, measuring an institution's capital resources, ability to borrow and financial viability; (ii) the primary reserve ratio, measuring an institution's ability to support current operations from expendable resources; and (iii) the net income ratio, measuring an institution's profitability. Each ratio is calculated separately, based on the figures in the institution's most recent annual audited financial statements, and then weighted and combined to arrive at a single composite score. Such composite score must be at least 1.5 for the institution to be deemed financially responsible without conditions or additional oversight. Regulations promulgated under the HEA also require all proprietary education institutions to comply with the "90/10 Rule," (previously referred to as the "85/15 Rule"), which prohibits participating schools from deriving 90% or more of total revenue from Title IV Programs in any year. If an institution fails to meet any of these requirements, it may be deemed to be not financially responsible by the U.S. Department of Education, or otherwise ineligible to participate in Title IV Programs. The Company believes that all of its participating schools met these requirements as of June 30, 1999. EFFECT OF INFLATION The Company does not believe its operations have been materially affected by inflation. IMPACT OF NEW ACCOUNTING STANDARDS In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," was issued. The statement establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. Additionally, SFAS No. 133 requires that changes in a derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. This statement has been amended by SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral 23 24 of the effective date of SFAS No. 133." SFAS No. 137 will be effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company does not anticipate that these standards will have a significant impact on its financial statements. YEAR 2000 ISSUES THE PROBLEM The Year 2000 problem arises from the fact that many existing information technology ("IT") hardware and software systems and non-information technology ("non-IT") products containing embedded microchip processors were originally programmed to represent any date with six digits (e.g., 12/31/99), as opposed to eight digits (e.g., 12/31/1999). Accordingly, problems may arise for many such products and systems when attempting to process information containing dates that fall after December 31, 1999. As a result, many such products and systems could experience miscalculations, malfunctions or disruptions. This problem is commonly referred to as the "Year 2000" problem, and the acronym "Y2K" is commonly substituted for the phrase "Year 2000." At this time, the Company believes that all of the significant internal IT and non-IT systems with potential Y2K problems have been repaired, replaced or upgraded in order to avoid any major business interruption from Y2K issues. THE COMPANY'S STATE OF READINESS FOR ITS YEAR 2000 ISSUES As a result of the Company's software upgrades and computer system purchases over the past few years, a substantial number of EDMC's computer systems should not have a Y2K problem (i.e., are "Y2K-compliant") or have been warranted to be Y2K-compliant by third-party vendors. The Company created a task force (the "Y2K Task Force") which has members from the Company's significant operating areas. The Y2K Task Force implemented a program, the goal of which was to assess the potential exposure of each such area to the Y2K problem, the first phase of EDMC's overall Y2K program, and, as the second phase thereof, designed a coordinated plan to determine whether any such potential exposure would result in a problem that would require some remediation. As each such area's Y2K problems have been identified, the third phase has been to formulate proposals to determine the best course of action to address each such problem, implement the solution and develop contingency plans to the extent possible and necessary. The final phase of the overall Y2K program is both independent and coordinated testing to ensure Y2K compliance in each operating area. The Y2K Task Force has the responsibility for addressing any Y2K problems in either IT or non-IT systems. The Company has completed the assessment/inventory phase for its IT systems, including its accounting, human resources, admissions, education, student financial services and student services systems. The Y2K Task Force reports that testing of EDMC's most critical IT systems is substantially completed. The Y2K Task Force has also substantially finished its identification of non-IT systems that may have Y2K problems, and has sent inquiries to the entities that own or control any of those non-IT systems, including elevators, electricity, telephones, security systems and HVAC systems, that could have a material impact on the Company's operations, such as the owners of the buildings and other facilities that house or service the Company's schools and administrative offices. The Y2K Task Force has also identified those third parties, such as governmental and other regulatory agencies, guaranty agencies, software and hardware suppliers, telephone companies, significant vendors and external file exchange system providers, whose Y2K compliance or lack thereof may pose problems for the Company. Pursuant to the Y2K Task Force's plan, inquiries have been sent to those third parties. All entities have responded with Y2K compliance plans that appear to be adequate. However, the Company can not independently verify each agency. THE COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES To date, the Company has incurred approximately $150,000 of costs directly associated with its efforts to address its Y2K issues. This amount does not include an allocation of salaries of EDMC personnel participating in this effort. Nor does it include recent hardware, software, or systems purchases which are, or have been, warranted to be Y2K-compliant. Based upon its current understanding of the Company's Y2K issues, the Y2K Task Force anticipates additional direct costs ranging from $250,000 to $350,000, will be incurred to address 24 25 these issues. This represents a reduction from previous estimates ranging to $750,000. Of the remaining cost to be incurred, approximately $150,000 will be used, if necessary, to replace technology hardware and software at Company schools; $100,000 is budgeted for contingency plan implementation, if necessary. The Company plans to charge its direct Y2K expenses to its information systems budget. All Y2K-related expenditures are expensed as incurred. RISKS RELATED TO THE COMPANY'S YEAR 2000 ISSUES The Company has identified several possible worst-case scenarios that could arise because of Y2K issues; however, at this time, the Company does not have sufficient information to make an assessment of the likelihood of any of these worst-case scenarios. It should be noted that the Company's schools will not be in session on December 31, 1999 or January 1, 2000, with classes resuming in mid-January 2000. The Company has shifted resources to the resolution of Y2K issues. This has resulted in the deferral of some existing or contemplated projects, particularly computer-system oriented projects. Although the Company is unable at this time to quantify its internal, indirect costs resulting from such changes, with its resultant deferral of projects, management believes that the cost of remediating the Company's internal Y2K problems will not have a material adverse impact upon its business, results of operations, liquidity or financial condition. Because the Company is in a regulated industry and relies, indirectly, on only a few sources for a substantial portion of its revenues, EDMC's business is very dependent upon those entities' efforts to address their own Y2K issues. The Y2K Task Force has identified those third parties whose failure to resolve their own Y2K issues could have a material impact upon the Company's operations, and is taking steps it currently believes appropriate to analyze both such parties' Y2K status and the Company's options in the event that any such party is not Y2K-compliant in sufficient time prior to December 31, 1999. Should any such third parties experience Y2K-related disruptions, it could have a material adverse impact on the Company's business, results of operations, liquidity or financial condition. For example, as with all postsecondary education-oriented businesses whose students receive governmental financial aid, the Company's operations and liquidity depend upon the student funding provided by Title IV Programs for its students. The U.S. Department of Education's computer systems handle processing of applications for this funding. The U.S. Department of Education has stated that its systems are Y2K-compliant. The Company has successfully completed file exchange tests with the U.S. Department of Education. Any problems with the U.S. Department of Education's systems could result in an interruption in the funding for students nationwide, including the Company's students. Any prolonged interruption could have a material adverse impact upon the education industry and, accordingly, upon the Company's business, results of operations, liquidity and financial condition. Similarly, the Company's schools are licensed by one or more agencies in the states in which they are based and accredited by one or more accrediting bodies that are recognized by the U.S. Department of Education. The Company continues to assess the Y2K-readiness of these agencies and bodies. In the event that any of these entities are unable, due to Y2K problems, to renew a school's license or accreditation, an interruption in such school's operations could occur. Depending upon the school involved, a prolonged interruption could have a material adverse impact upon the Company's business, results of operations, liquidity and financial condition. Five guaranty agencies provide the vast majority of the guarantees for the loans issued to the Company's students under Title IV Programs. The Company has completed file exchange tests successfully with the agency that accounts for approximately 85% of those guarantees. The Company is investigating all these agencies to determine whether they will be Y2K-compliant or whether contingency plans need to be made with respect thereto. As with the U.S. Department of Education, the Company is unable to assess independently the readiness of any of these agencies at the present time, although all such agencies have reported that they are Y2K-compliant. The majority of the Title IV Program loans to the Company's students are funded through six banks, five of which work with the Company's primary guaranty agency. The five lenders that work with that agency use an affiliate of that agency to disburse and service their loans, and the Company has successfully completed file exchange tests with the affiliated agency. The Company is exploring as a contingency plan the availability of other lenders that have stated that they expect to be Y2K-compliant. 25 26 The Company has also reviewed the Y2K compliance efforts of its transfer agent and of the NASDAQ National Market System and does not anticipate any serious disruptions in service from these providers. The Y2K Task Force has made inquiries of the major financial institutions and utilities that provide services to the Company and continues to assess the potential effects of those entities' failures to become Y2K-compliant within the time remaining. If, notwithstanding any such entity's representations that it will be Y2K-compliant in time, it is not compliant, the Company's business, results of operations, liquidity and financial condition could be adversely affected. CONTINGENCY PLANS The Y2K Task Force's responsibilities include developing contingency plans for each of EDMC's significant operating areas. These contingency plans would be utilized in the event that, despite the Company's best efforts, or due to the Company's lack of control over certain third parties, a system is not Y2K-compliant and EDMC's business is adversely affected. Each operating area is preparing a contingency plan to operate for up to three consecutive days without standard computer support. In addition, the Company maintains a "hot site" contract with Hewlett-Packard that allows it to run its day-to-day central computer operations from a remote location in Washington State. The "hot site" is a contingency against a regional Y2K failure that would cause business interruptions at the Company's corporate offices in Pittsburgh, Pennsylvania. The Y2K Task Force expects to have substantially all of its contingency plans in place by December 1, 1999. RISK FACTORS In addition to the important factors described elsewhere in this Annual Report on Form 10-K, the following factors, among others, could affect the Company's business, results of operations, financial condition and prospects in fiscal 2000 and later years: (i) the perceptions of the U.S. Congress, the U.S. Department of Education and the public concerning proprietary postsecondary education institutions to the extent those perceptions could result in changes in the HEA in connection with its reauthorization; (ii) EDMC's ability to comply with federal and state regulations and accreditation standards, including any changes therein or changes in the interpretation thereof; (iii) the Company's capability to foresee changes in the skills required of its graduates and to design new courses and programs to develop those skills; (iv) the ability of the Company to gauge successfully which markets are underserved in the skills that the Company's schools teach; (v) the Company's ability to gauge appropriate acquisition and start-up opportunities and to manage and integrate them successfully; (vi) the Company's ability to defend litigation successfully; and (vii) competitive pressures from other educational institutions. ITEM 7A-- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS The fair values and carrying amounts of the Company's financial instruments, primarily accounts receivable and debt, are approximately equivalent. The debt instruments bear interest at floating rates based upon market rates or at fixed rates that approximate market rates. All other financial instruments are classified as current and will be utilized within the next operating cycle. 26 27 ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES: We have audited the accompanying consolidated balance sheets of Education Management Corporation (a Pennsylvania corporation) and Subsidiaries as of June 30, 1998 and 1999, and the related consolidated statements of income, shareholders' investment and cash flows for each of the three years in the period ended June 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Education Management Corporation and Subsidiaries as of June 30, 1998 and 1999, and their results of operations and their cash flows for each of the three years in the period ended June 30, 1999 in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP Pittsburgh, Pennsylvania, July 28, 1999 27 28 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
AS OF JUNE 30, -------------------- 1998 1999 ---- ---- ASSETS CURRENT ASSETS: Cash and cash equivalents, including restricted balances of $777 and $725....................................... $ 47,310 $ 32,871 Receivables: Trade, net of allowances of $8,318 and $9,367.......... 7,689 10,100 Notes, advances and other.............................. 3,989 5,233 Inventories............................................... 1,933 2,038 Deferred income taxes..................................... 2,361 2,476 Other current assets...................................... 2,341 2,991 -------- -------- Total current assets................................. 65,623 55,709 -------- -------- PROPERTY AND EQUIPMENT, NET................................. 57,420 96,081 DEFERRED INCOME TAXES AND OTHER LONG-TERM ASSETS............ 6,287 7,614 GOODWILL, NET OF AMORTIZATION OF $3,873 AND $4,484.......... 19,453 19,342 -------- -------- TOTAL ASSETS......................................... $148,783 $178,746 ======== ======== LIABILITIES AND SHAREHOLDERS' INVESTMENT CURRENT LIABILITIES: Current portion of long-term debt......................... $ 2,615 $ 731 Accounts payable.......................................... 6,982 12,110 Accrued liabilities....................................... 10,162 11,438 Advance payments.......................................... 18,338 20,909 -------- -------- Total current liabilities............................ 38,097 45,188 -------- -------- LONG-TERM DEBT, LESS CURRENT PORTION........................ 35,767 36,500 DEFERRED INCOME TAXES AND OTHER LONG-TERM LIABILITIES....... 1,594 253 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' INVESTMENT: Common Stock, par value $.01 per share; 60,000,000 shares authorized; 28,998,892 and 29,546,833 shares issued.... 290 295 Additional paid-in capital................................ 88,880 93,736 Treasury stock, 78,802 and 85,646 shares at cost.......... (354) (495) Stock subscriptions receivable............................ (8) -- Retained earnings (accumulated deficit)................... (15,483) 3,269 -------- -------- TOTAL SHAREHOLDERS' INVESTMENT....................... 73,325 96,805 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' INVESTMENT....... $148,783 $178,746 ======== ========
The accompanying notes to consolidated financial statements are an integral part of these statements. 28 29 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE YEARS ENDED JUNE 30, -------------------------------- 1997 1998 1999 ---- ---- ---- NET REVENUES............................................... $182,849 $221,732 $260,805 COSTS AND EXPENSES: Educational services..................................... 120,918 147,336 170,742 General and administrative............................... 41,036 48,094 57,162 Amortization of intangibles.............................. 2,076 1,611 1,203 -------- -------- -------- 164,030 197,041 229,107 -------- -------- -------- INCOME BEFORE INTEREST AND TAXES........................... 18,819 24,691 31,698 Interest expense (income), net........................... 1,603 (3) (113) -------- -------- -------- INCOME BEFORE INCOME TAXES................................. 17,216 24,694 31,811 Provision for income taxes............................... 7,231 10,372 13,059 -------- -------- -------- NET INCOME................................................. $ 9,985 $ 14,322 $ 18,752 ======== ======== ======== INCOME AVAILABLE TO COMMON SHAREHOLDERS: Dividends paid on Series A Preferred Stock................. $ (83) $ -- $ -- Redemption premium paid on Series A Preferred Stock........ (107) -- -- Dividends accrued on Series A Preferred Stock, but not paid..................................................... (296) -- -- -------- -------- -------- Net income available to common shareholders -- basic....... $ 9,499 $ 14,322 $ 18,752 Net income available to common shareholders -- diluted..... $ 9,878 $ 14,322 $ 18,752 INCOME PER SHARE: Basic................................................. $ .40 $ .50 $ .64 Diluted............................................... $ .36 $ .48 $ .61 WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (IN 000'S): Basic................................................. 23,878 28,908 29,314 Diluted............................................... 27,342 29,852 30,615
The accompanying notes to consolidated financial statements are an integral part of these statements. 29 30 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
FOR THE YEARS ENDED JUNE 30, -------------------------------- 1997 1998 1999 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................................ $ 9,985 $ 14,322 $ 18,752 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FLOWS FROM OPERATING ACTIVITIES: Depreciation and amortization........................ 12,343 14,316 16,766 Vesting of compensatory stock options................ 375 -- -- Deferred credit for income taxes..................... (1,613) (1,184) (1,992) Changes in current assets and liabilities: Receivables....................................... (158) (1,084) (3,655) Inventories....................................... (73) (577) (105) Other current assets.............................. 443 (87) (650) Accounts payable.................................. 1,993 1 57 Accrued liabilities............................... 2,269 473 3,940 Advance payments.................................. 2,715 2,413 2,571 -------- -------- -------- Total adjustments............................... 18,294 14,271 16,932 -------- -------- -------- Net cash flows from operating activities.......... 28,279 28,593 35,684 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of subsidiaries, net of cash acquired......... (9,753) (1,488) (500) Expenditures for property and equipment................... (18,487) (17,951) (49,862) Other items, net.......................................... 119 (233) (674) -------- -------- -------- Net cash flows from investing activities.......... (28,121) (19,672) (51,036) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: New borrowings............................................ -- 8,000 1,500 Principal payments on debt................................ (31,988) (3,689) (2,651) Net proceeds from issuance of Common Stock................ 45,143 737 2,197 Redemption of Series A Preferred Stock.................... (7,607) -- -- Other capital stock transactions, net..................... 122 114 (133) -------- -------- -------- Net cash flows from financing activities.......... 5,670 5,162 913 -------- -------- -------- NET CHANGE IN CASH AND CASH EQUIVALENTS..................... 5,828 14,083 (14,439) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 27,399 33,227 47,310 -------- -------- -------- CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 33,227 $ 47,310 $ 32,871 ======== ======== ========
The accompanying notes to consolidated financial statements are an integral part of these statements. 30 31 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' INVESTMENT (DOLLARS IN THOUSANDS)
SERIES A CLASS A CLASS B PREFERRED COMMON COMMON COMMON STOCK STOCK AT STOCK STOCK STOCK ADDITIONAL SUB- PAID-IN AT PAR AT PAR WARRANTS AT PAR PAID-IN TREASURY SCRIPTIONS VALUE VALUE VALUE OUTSTANDING VALUE CAPITAL STOCK RECEIVABLE --------- ------- ------- ----------- ------ ---------- -------- ---------- Balance, June 30, 1996....... $ 22,075 $-- $ 1 $ 7,683 $ -- $19,742 $ (99) $(442) Net income................. -- -- -- -- -- -- -- -- Dividends on Series A Preferred Stock.......... -- -- -- -- -- -- -- -- Dividends accrued on Series A Preferred Stock, but not paid................. -- -- -- -- -- 296 -- -- Series A Preferred Stock redemption............... (7,606) -- -- -- -- -- -- -- Series A Preferred Stock Stock redemption premium.................. 107 -- -- -- -- -- -- -- Conversion of Series A Preferred Stock.......... (14,576) -- -- -- -- 14,576 -- -- Purchase of Class B Common Stock............... -- -- (1) -- -- (2) (255) -- Payments on stock subscriptions receivable............... -- -- -- -- -- -- -- 320 Exercise of warrants....... -- -- -- (7,683) -- 7,683 -- -- Exercise of stock options.................. -- -- -- -- -- 419 -- -- Issuance of Common Stock in connection with IPO and employee stock purchase plan..................... -- -- -- -- 289 44,659 -- -- Vesting of compensatory stock options............ -- -- -- -- -- 375 -- -- -------- --- --- ------- ---- ------- ----- ----- Balance, June 30, 1997....... -- -- -- -- 289 87,748 (354) (122) Net income................. -- -- -- -- -- -- -- -- Payments on stock subscriptions receivable............... -- -- -- -- -- -- -- 114 Exercise of stock options.................. -- -- -- -- 1 611 -- -- Stock options issued in connection with acquisition of subsidiary............... -- -- -- -- -- 77 -- -- Issuance of Common Stock in connection with employee stock purchase plan...... -- -- -- -- -- 444 -- -- -------- --- --- ------- ---- ------- ----- ----- Balance, June 30, 1998....... -- -- -- -- 290 88,880 (354) (8) Net income................. -- -- -- -- -- -- -- -- Purchase of Common Stock... -- -- -- -- -- -- (141) -- Payments on stock subscriptions receivable............... -- -- -- -- -- -- -- 8 Exercise of stock options.................. -- -- -- -- 5 4,278 -- -- Issuance of Common Stock in connection with employee stock purchase plan...... -- -- -- -- -- 578 -- -- -------- --- --- ------- ---- ------- ----- ----- Balance, June 30, 1999....... $ -- $-- $-- $ -- $295 $93,736 $(495) $ -- ======== === === ======= ==== ======= ===== ===== RETAINED EARNINGS (ACCUMU- TOTAL LATED SHAREHOLDERS' DEFICIT) INVESTMENT -------- ------------- Balance, June 30, 1996....... $(39,304) $ 9,656 Net income................. 9,985 9,985 Dividends on Series A Preferred Stock.......... (83) (83) Dividends accrued on Series A Preferred Stock, but not paid................. (296) -- Series A Preferred Stock redemption............... -- (7,606) Series A Preferred Stock Stock redemption premium.................. (107) -- Conversion of Series A Preferred Stock.......... -- -- Purchase of Class B Common Stock............... -- (258) Payments on stock subscriptions receivable............... -- 320 Exercise of warrants....... -- -- Exercise of stock options.................. -- 419 Issuance of Common Stock in connection with IPO and employee stock purchase plan..................... -- 44,948 Vesting of compensatory stock options............ -- 375 -------- ------- Balance, June 30, 1997....... (29,805) 57,756 Net income................. 14,322 14,322 Payments on stock subscriptions receivable............... -- 114 Exercise of stock options.................. -- 612 Stock options issued in connection with acquisition of subsidiary............... -- 77 Issuance of Common Stock in connection with employee stock purchase plan...... -- 444 -------- ------- Balance, June 30, 1998....... (15,483) 73,325 Net income................. 18,752 18,752 Purchase of Common Stock... -- (141) Payments on stock subscriptions receivable............... -- 8 Exercise of stock options.................. -- 4,283 Issuance of Common Stock in connection with employee stock purchase plan...... -- 578 -------- ------- Balance, June 30, 1999....... $ 3,269 $96,805 ======== =======
The accompanying notes to consolidated financial statements are an integral part of these statements. 31 32 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. OWNERSHIP AND OPERATIONS: Education Management Corporation ("EDMC" or the "Company") is among the largest providers of proprietary postsecondary education in the United States, based on student enrollments and revenues. Through its operating units, primarily the Art Institutes ("The Art Institutes"), the Company offers bachelor's and associate's degree programs and non-degree programs in the areas of design, media arts, culinary arts, fashion and paralegal studies. The Company has provided career oriented education programs for over 35 years. As of June 30, 1999, EDMC operated 18 schools in 15 major metropolitan areas throughout the United States. The Company's main operating unit, The Art Institutes, offer programs designed to provide the knowledge and skills necessary for entry-level employment in various fields, including computer animation, culinary arts, graphic design, multimedia, video production, interior design, industrial design, photography, and fashion. Those programs typically are completed in 18 to 48 months and culminate in a bachelor's or associate's degree. As of June 30, 1999, eight Art Institutes offered bachelor's degree programs. As of June 30, 1999, the Company offered a culinary arts curriculum at 10 Art Institutes and The New York Restaurant School ("NYRS"), a culinary arts and restaurant management school located in New York City. NYRS offers an associate's degree program and certificate programs. The Company offers paralegal and legal nurse consulting training and financial planning certificate programs for college graduates and working adults at The National Center for Paralegal Training ("NCPT") in Atlanta, and through relationships with five colleges and universities. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: BASIS OF CONSOLIDATION AND PRESENTATION The consolidated financial statements include the accounts of Education Management Corporation and its subsidiaries. All significant intercompany transactions and balances have been eliminated. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. GOVERNMENT REGULATIONS The Art Institutes and NYRS ("the participating schools") participate in various federal student financial assistance programs ("Title IV Programs") under Title IV of the Higher Education Act of 1965, as amended (the "HEA"). Approximately 66% of the Company's net revenues in 1999 was indirectly derived from funds distributed under these programs to students at the participating schools. The participating schools are required to comply with certain federal regulations established by the U.S. Department of Education. Among other things, they are required to classify as restricted certain Title IV Program funds in excess of charges currently applicable to students' accounts. Such funds are reported as restricted cash in the accompanying consolidated balance sheets. The participating schools are required to administer Title IV Program funds in accordance with the HEA and U.S. Department of Education regulations and must use due diligence in approving and disbursing funds and servicing loans. In the event a participating school does not comply with federal requirements or if student loan default rates are at a level considered excessive by the federal government, that school could lose its eligibility to participate in Title IV Programs or could be required to repay funds determined to have been improperly 32 33 disbursed. Management believes that the participating schools are in substantial compliance with the federal requirements and that student loan default rates are not at a level considered to be excessive. EDMC makes contributions to Federal Perkins Loan Programs (the "Funds") at certain Art Institutes. Current contributions to the Funds are made 75% by the federal government and 25% by EDMC. The Company carries its investments in the Funds at cost, net of an allowance for estimated future loan losses. CASH AND CASH EQUIVALENTS The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. These investments are stated at cost which, based upon the scheduled maturities, approximates market value. U.S. Department of Education regulations require Title IV Program funds received by the Company's schools in excess of the tuition and fees owed by the relevant students at that time to be, with these students' permission, maintained and classified as restricted until the students are billed for the portion of their education program related to those funds. Funds transferred through electronic funds transfer programs are held in a separate cash account and released when certain conditions are satisfied. These restrictions have not significantly affected the Company's ability to fund daily operations. ACQUISITIONS Effective August 1, 1996, the Company purchased certain assets of NYRS for $9.5 million in cash. The assets acquired consisted principally of current assets net of specified current liabilities, property and equipment and certain intangible assets. On January 30, 1997, the Company acquired the assets of Lowthian College, located in Minneapolis, Minnesota, for $200,000 in cash and approximately $200,000 of assumed liabilities. The Company acquired principally accounts receivable, equipment, and certain intangible assets. The school was renamed The Art Institutes International Minnesota. On December 19, 1997, the Company purchased certain assets of the Louise Salinger School in San Francisco, California, for $600,000 in cash,. The Company also entered into a consulting agreement with the former president in exchange for an option to purchase 20,000 shares of the Company's Common Stock at an exercise price of $12.97 (the closing price as of the acquisition date). The assets acquired were principally accounts receivable and equipment. The school was renamed The Art Institutes International at San Francisco. On February 7, 1998, the Company acquired certain assets related to the operations of Bassist College in Portland, Oregon for approximately $900,000 in cash. The purchase agreement provides for certain adjustments based upon the resolution of certain liabilities and additional consideration based upon a specified percentage of gross revenues over the next five years. The assets acquired were principally accounts receivable and equipment. The school was renamed The Art Institutes International at Portland. On October 1, 1998, the Company acquired the assets of Socrates Distance Learning Technologies Group for approximately $500,000 in cash. This acquisition was made to further the development of the Company's distance learning capabilities. The Company employs the previous owners under two-year employment and non-compete arrangements. These acquisitions were accounted for using the purchase method of accounting, with the excess of the purchase price over the fair value of the assets acquired being assigned to identifiable intangible assets and goodwill. The results of the acquired entities have been included in the Company's results from the respective dates of acquisition. The pro forma effects, individually and collectively, of the acquisitions in the Company's consolidated financial statements would not materially impact the reported results. LEASE ARRANGEMENTS The Company conducts a major part of its operations from leased facilities. In addition, the Company leases a portion of its furniture and equipment. In those cases in which the lease term approximates the useful life of the 33 34 leased asset or the lease meets certain other prerequisites, the leasing arrangement is classified as a capitalized lease. The remaining lease arrangements are treated as operating leases. PROPERTY AND EQUIPMENT Property and equipment are stated at cost, net of accumulated depreciation. Expenditures for additions and major improvements are capitalized, while those for maintenance, repairs and minor renewals are expensed as incurred. The Company uses the straight-line method of depreciation for financial reporting, while using different methods for tax purposes. Depreciation is based upon estimated useful lives, ranging from 5 to 30 years. Leasehold improvements are amortized over the term of the lease, or over their estimated useful lives, whichever is shorter. FINANCIAL INSTRUMENTS The fair values and carrying amounts of the Company's financial instruments, primarily accounts receivable and debt, are approximately equivalent. The debt instruments bear interest at floating rates based upon market rates or at fixed rates that approximate market rates. All other financial instruments are classified as current and will be utilized within the next operating cycle. REVENUE RECOGNITION AND RECEIVABLES The Company's net revenues consist of tuition and fees, student housing charges and supply store and restaurant sales. In fiscal 1999, the Company derived 88.0% of its net revenues from tuition and fees paid by, or on behalf of, its students. Net revenues, as presented, are reduced for student refunds and scholarships. The Company recognizes tuition and housing revenues on a monthly pro rata basis over the term of instruction, typically an academic quarter. Fees are generally recognized as revenue at the start of the academic period to which they apply. Student supply store and restaurant sales are recognized as they occur. Refunds are calculated in accordance with federal, state and accrediting agency standards. Advance payments represent that portion of payments received but not earned and are reflected as a current liability in the accompanying consolidated balance sheets. The trade receivable balances are comprised of individually insignificant amounts due primarily from students throughout the United States. COSTS AND EXPENSES Educational services expense consists primarily of costs related to the development, delivery and administration of the Company's education programs. Major cost components are faculty compensation, administrative salaries, costs of educational materials, facility leases and school occupancy costs, information systems costs and bad debt expense, along with depreciation and amortization of property and equipment. General and administrative expense consists of marketing and student admissions expenses and certain central staff departmental costs such as executive management, finance and accounting, legal, corporate development and other departments that do not provide direct services to the Company's students. Amortization of intangibles relates principally to the values assigned to identifiable intangibles and goodwill, which arose principally from the application of purchase accounting to the establishment and financing of the Education Management Corporation Employee Stock Ownership Plan and Trust (the "ESOP") and the related leveraged transaction in October 1989. In addition, this balance includes the amortization of intangible assets and goodwill that resulted from the acquisitions discussed above. These intangible assets are amortized over periods ranging from 2 to 40 years. NEW ACCOUNTING STANDARDS During fiscal 1999, the Company adopted the Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosure about Segments of an Enterprise 34 35 and Related Information." The adoption of these statements did not have a significant impact on the financial statements and disclosures, as the Company's comprehensive income is equal to its net income and it has no reportable segments. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
YEAR ENDED JUNE 30, ---------------------------- 1997 1998 1999 ------ ------- ------- (IN THOUSANDS) Cash paid during the period for: Interest (net of amount capitalized)......... $2,264 $ 771 $ 313 Income taxes................................. 8,279 13,373 13,846 Noncash investing and financing activities: Expenditures for property and equipment included in accounts payable.............. -- -- 5,071 Tax deduction for options exercised.......... -- 291 2,664
RECLASSIFICATIONS Certain prior year balances have been reclassified to conform to the current year presentation. 3. SHAREHOLDERS' INVESTMENT: On December 2, 1998, the Company's Board of Directors authorized a two-for-one stock split effected in the form of a stock dividend. The distribution was made on December 29, 1998 to shareholders of record as of the close of business on December 8, 1998. Shareholders received one share of Common Stock for each outstanding share of Common Stock owned. Except as noted herein, all applicable data, including earnings per share, related to the Company's Common Stock have been restated to reflect this stock split. In November 1996, the Company completed the initial public offering ("IPO") of 10,147,200 shares of its Common Stock, $.01 par value (the "Common Stock"), including 3,402,782 shares sold by certain shareholders, at a price to the public of $7.50 per share. Since that date, the authorized capital stock of the Company has consisted of the Common Stock and Preferred Stock, $.01 par value (the "Preferred Stock"). From 1989 until immediately prior to the consummation of the IPO, the Company's outstanding capital stock consisted of Class A Common Stock, $.0001 par value ("Class A Stock"), Class B Common Stock, $.0001 par value ("Class B Stock"), and Series A 10.19% Convertible Preferred Stock, $.0001 par value (the "Series A Preferred Stock"). All the outstanding shares of Series A Preferred Stock were owned by the ESOP. In addition, warrants to purchase shares of Class B Stock were outstanding. Immediately prior to the consummation of the IPO, the following occurred: (i) the warrants to purchase 5,956,079 shares of Class B Stock were exercised ($.0001 exercise price per share), (ii) the ESOP converted all the outstanding shares of Series A Preferred Stock into 2,249,954 shares of Class A Stock, (iii) the Company's Articles of Incorporation were amended and restated to authorize the Common Stock and Preferred Stock and (iv) all outstanding shares of Class A Stock and Class B Stock (including the shares resulting from the exercise of the warrants and the conversion of the Series A Preferred Stock) were reclassified into shares of Common Stock on a one-for-two basis (also referred to as a one-for-two reverse stock split). For the purpose of presenting comparable financial information for 1997 in this report, the per share amounts, the number of shares of Class A Stock and Class B Stock, the conversion ratio for the Series A Preferred Stock and the exercise price for the warrants have been restated to reflect the one-for-two reverse stock split and the two-for-one stock split, except in this Note 3. In the IPO, the Company received total net proceeds, after deduction of expenses and underwriting discounts payable by the Company, of approximately $45 million. On the date the IPO closed, $38.5 million of those proceeds were used to repay the outstanding indebtedness under the Company's amended and restated credit 35 36 facility dated March 16, 1995 (the "Revolving Credit Agreement"). The remaining proceeds were used for general corporate purposes. Pursuant to a Preferred Share Purchase Rights Plan (the "Rights Plan") approved by the Company's Board of Directors, which became effective upon the consummation of the IPO, one Preferred Share Purchase Right (a "Right") is associated with each outstanding share of Common Stock. Each Right entitles its holder to buy one two-hundredth of a share of Series A Junior Participating Preferred Stock, $.01 par value, at an exercise price of $50, subject to adjustment (the "Purchase Price"). The Rights Plan is not subject to shareholder approval. The Rights will become exercisable under certain circumstances following a public announcement by a person or group of persons (an "Acquiring Person") that they acquired or commenced a tender offer for 17.5% or more of the outstanding shares of Common Stock. If an Acquiring Person acquires 17.5% or more of the Common Stock, each Right will entitle its holder, except the Acquiring Person, to acquire upon exercise a number of shares of Common Stock having a market value of two times the Purchase Price. In the event that the Company is acquired in a merger or other business combination transaction or 50% or more of its consolidated assets or earning power are sold after a person or group of persons becomes an Acquiring Person, each Right will entitle its holder to purchase, at the Purchase Price, that number of shares of the acquiring company having a market value of two times the Purchase Price. The Rights will expire on the tenth anniversary of the closing of the IPO and are subject to redemption by the Company at $.01 per Right, subject to adjustment. On November 10, 1997, certain principal shareholders of the Company sold 6,141,984 shares of Common Stock in a public offering. The Company did not receive any proceeds from this offering and was reimbursed by the selling shareholders for all out-of-pocket expenses related to this offering. The unaudited pro forma income statement data in the following table gives effect to the IPO as if it had occurred on July 1, 1996. Proceeds from the IPO were utilized pro forma to retire outstanding indebtedness under the Revolving Credit Agreement and for general corporate purposes. The adjustment to interest expense represents the effect of the reduction of debt as if it had been repaid on July 1, 1996. Pro forma taxes are applied at an effective tax rate of 42% of taxable income. This unaudited pro forma income statement data is not necessarily indicative of what the Company's results of operations actually would have been had the above transactions in fact occurred on July 1, 1996.
YEAR ENDED JUNE 30, 1997 ----------------------------------------- ACTUAL ADJUSTMENTS PRO FORMA --------- ------------- ----------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Income before interest and taxes........... $18,819 $ -- $18,819 Interest expense, net...................... 1,603 (931) 672 ------- ------ ------- Income before income taxes................. 17,216 931 18,147 Income taxes............................... 7,231 391 7,622 ------- ------ ------- Net income................................. $ 9,985 $ 540 $10,525 ======= ====== ======= Net income available to common shareholders............................. $ 9,499 $ 540 $10,039 Earnings per share: --Basic $ 0.40 $ (.05) $ 0.35 --Diluted $ 0.36 $ (.01) $ 0.35 Weighted average number of shares outstanding: --Basic.................................. 23,878 4,904 28,782 --Diluted................................ 27,342 2,146 29,488
4. EARNINGS PER SHARE: Basic EPS is computed using the weighted average number of shares actually outstanding during the period, while diluted EPS is calculated to reflect the potential dilution related to stock options, warrants and the assumed conversion of Series A Preferred Stock. 36 37 RECONCILIATION OF DILUTED SHARES
YEAR ENDED JUNE 30, -------------------------- 1997 1998 1999 ------ ------ ------ (IN THOUSANDS) Basic shares..................................... 23,878 28,908 29,314 Dilution for stock options....................... 648 944 1,301 Dilution for warrants and Series A Preferred Stock.......................................... 2,816 -- -- ------ ------ ------ Diluted shares................................... 27,342 29,852 30,615 ====== ====== ======
The net income available to common shareholders in 1997 has been reduced by the Series A Preferred Stock dividends in the computation of basic EPS. The premium paid upon the redemption of 75,000 shares of Series A Preferred Stock has been deducted from net income in calculating both basic and diluted EPS for 1997. 5. PROPERTY AND EQUIPMENT: Property and equipment consisted of the following as of June 30:
1998 1999 -------- -------- (IN THOUSANDS) Assets (asset lives in years) Land................................................ $ 300 $ 2,800 Buildings and improvements (30)..................... 1,841 16,075 Equipment and furniture (5 to 10)................... 73,469 89,528 Leasehold interests and improvements (4 to 20)...... 42,201 50,399 Construction in progress............................ -- 12,550 -------- -------- Total............................................ 117,811 171,352 Less accumulated depreciation....................... 60,391 75,271 -------- -------- $ 57,420 $ 96,081 ======== ========
6. LONG-TERM DEBT: The Company and its subsidiaries were indebted under the following obligations as of June 30:
1998 1999 ------- ------- (IN THOUSANDS) Revolving Credit Agreement.............................. $35,000 $36,500 Capitalized lease and equipment installment note obligations........................................... 3,382 731 ------- ------- 38,382 37,231 Less current portion.................................... 2,615 731 ------- ------- $35,767 $36,500 ======= =======
The Revolving Credit Agreement, as amended, currently allows for maximum borrowings of $60 million, reduced annually by $5 million through its expiration on October 13, 2000. The Revolving Credit Agreement requires, among other matters, that the Company maintain a specified level of consolidated net worth and meet specified interest, leverage and fixed charge ratio requirements, and restricts repurchases of Common Stock and the incurrence of additional indebtedness, as defined. As of June 30, 1999, the Company was in compliance with all covenants. Borrowings under this agreement are secured by the stock of the Company's subsidiaries and all of the Company's assets and accrue interest at either prime, Eurodollar or cost of funds (as defined) rates, at the option of the Company. As of June 30, 1999, the interest rate under the Revolving Credit Agreement was 7.75%. 37 38 Relevant information regarding borrowings under the Revolving Credit Agreement is reflected below:
YEAR ENDED JUNE 30, ----------------------------- 1997 1998 1999 ------- ------- ------- (IN THOUSANDS) Outstanding borrowings, end of period......... $27,000 $35,000 $36,500 Approximate average outstanding balance throughout the period....................... 13,602 530 2,550 Approximate maximum outstanding balance during the period.................................. 55,000 35,000 37,000 Weighted average interest rate for the period...................................... 7.20% 8.50% 7.48%
Capitalized leases and installment notes for equipment and furniture expire in fiscal 2000. The total future minimum payments under these obligations are approximately $772,000, with approximately $41,000 representing interest. Depreciation expense on assets originally financed through capitalized leases and installment notes was approximately $3,705,000, $3,441,000 and $2,907,000 for the years ended June 30, 1997, 1998 and 1999, respectively. 7. COMMITMENTS AND CONTINGENCIES: The Company and its subsidiaries lease certain classroom, dormitory and office space under operating leases, which expire on various dates through August 2019. Rent expense under these leases was approximately $20,226,000, $24,904,000 and $28,250,000, respectively for 1997, 1998 and 1999. The approximate minimum future commitments under non-cancelable, long-term operating leases as of June 30, 1999 are reflected below:
FISCAL YEARS (IN THOUSANDS) - ------------ -------------- 2000.................................................. $ 20,039 2001.................................................. 15,676 2002.................................................. 13,020 2003.................................................. 12,971 2004.................................................. 13,089 Thereafter............................................ 105,250 -------- $180,045 ========
The Company has a management incentive compensation plan that provides for the awarding of cash bonuses to management personnel using formalized guidelines based upon the operating results of each subsidiary and the Company. The Company and its wholly-owned subsidiaries, The Art Institutes International, Inc. ("AII") and The Art Institute of Houston, Inc. are defendants in a suit brought by 145 former and current students who allege being misled about the benefits or quality of educational services provided to them at The Art Institute of Houston. The complaint was subsequently amended to add claims by an additional 90 plaintiffs. The complaint does not specify the amount of damages being sought. The Company is also a defendant in certain other legal proceedings arising out of the conduct of its businesses. In the opinion of management, based upon its investigation of these claims and discussion with legal counsel, the ultimate outcome of such legal proceedings, individually and in the aggregate, will not have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company. 8. RELATED PARTY TRANSACTIONS: The Art Institute of Philadelphia, Inc., a wholly-owned subsidiary of AII, leases one of the buildings it occupies from a partnership in which the subsidiary serves as a 1% general partner and an executive officer/director and a director of EDMC are minority limited partners. The Art Institute of Fort Lauderdale, Inc., another wholly-owned subsidiary of AII, leases part of its facility from a partnership in which an executive officer/director of EDMC is a minority limited partner. Total rental payments under these arrangements were 38 39 $1,894,000 for each of the years ended June 30, 1997 and 1998, and $1,901,000 for the year ended June 30, 1999. 9. EMPLOYEE BENEFIT PLANS: The Company sponsors a retirement plan, which covers substantially all employees. This plan provides for matching Company contributions of 100% of employee 401(k) contributions up to 3% of compensation and 50% of contributions between 4% and 6% of compensation. Other contributions to the plan are at the discretion of the Board of Directors. The expense relating to these plans was approximately $526,000, $1,198,000 and $2,198,000 for the years ended June 30, 1997, 1998 and 1999, respectively. The Company established an ESOP in 1989, which enables eligible employees to acquire stock ownership in the Company. Allocations of forfeited shares and cash are made to the accounts of eligible participating employees based upon each participant's compensation level relative to the total compensation of all eligible employees. Eligible employees vest their ESOP accounts based on a seven-year schedule, which includes credit for past service. Distribution of shares from the ESOP is made following the retirement, disability or death of an employee. For employees who terminate for any other reason, their vested balance will be offered for distribution in accordance with the terms of the ESOP. 10. DEFERRED INCOME TAXES AND OTHER LONG-TERM ASSETS: Deferred income taxes and other long-term assets consist of the following as of June 30:
1998 1999 ------ ------ (IN THOUSANDS) Investment in Federal Perkins Loan Program, net of allowance for estimated future loan losses of $1,032 and $1,155.................................................. $2,408 $2,617 Cash value of life insurance, net of loans of $781 each year; face value of $6,065.............................. 2,045 2,324 Deferred income taxes..................................... -- 548 Other, net of amortization of $201 and $349............... 1,834 2,125 ------ ------ $6,287 $7,614 ====== ======
11. ACCRUED LIABILITIES: Accrued liabilities consist of the following as of June 30:
1998 1999 ------- ------- (IN THOUSANDS) Payroll taxes and payroll related....................... $ 6,297 $ 6,924 Income and other taxes.................................. 431 545 Other................................................... 3,434 3,969 ------- ------- $10,162 $11,438 ======= =======
39 40 12. INCOME TAXES: The provision for income taxes includes current and deferred taxes as reflected below:
YEAR ENDED JUNE 30, ---------------------------- 1997 1998 1999 ------ ------- ------- (IN THOUSANDS) Current taxes: Federal...................................... $7,594 $ 9,780 $11,824 State........................................ 1,250 1,776 3,227 ------ ------- ------- Total current taxes....................... 8,844 11,556 15,051 ------ ------- ------- Deferred taxes................................. (1,613) (1,184) (1,992) ------ ------- ------- Total provision........................... $7,231 $10,372 $13,059 ====== ======= =======
The provision for income taxes reflected in the accompanying consolidated statements of income vary from the amounts that would have been provided by applying the federal statutory income tax rate to earnings before income taxes as shown below:
YEAR ENDED JUNE 30, -------------------- 1997 1998 1999 ---- ---- ---- Federal statutory income tax rate........................... 35.0% 35.0% 35.0% State and local income taxes, net of federal income tax benefit................................................... 5.1 4.7 4.6 Amortization of goodwill and other intangibles.............. .9 .6 .5 Non-deductible expenses..................................... .8 1.0 .7 Other, net.................................................. .2 .7 .3 ---- ---- ---- Effective income tax rate.............................. 42.0% 42.0% 41.1% ==== ==== ====
Net deferred income tax assets (liabilities) consist of the following as of June 30:
1997 1998 1999 ------ ------ ------ (IN THOUSANDS) Deferred income tax--current................................ $1,509 $2,361 $2,476 Deferred income tax--long term.............................. (1,661) (1,329) 548 ------ ------ ------ Net deferred income tax asset (liability)................. $ (152) $1,032 $3,024 ====== ====== ====== Consisting of: Allowance for doubtful accounts........................ $2,959 $3,494 $3,850 Assigned asset values in excess of tax basis........... (2,006) (1,753) (1,585) Depreciation........................................... (697) (314) 1,508 Financial reserves and other........................... (408) (395) (749) ------ ------ ------ Net deferred income tax asset (liability)................. $ (152) $1,032 $3,024 ====== ====== ======
13. STOCK BASED COMPENSATION: The Company adopted a Stock Incentive Plan in October 1996 (the "1996 Plan") for directors, executive management and key personnel. The 1996 Plan provides for the issuance of stock-based incentive awards with respect to a maximum of 2,500,000 shares of Common Stock. During 1997, 1998 and 1999, options covering a total of 1,219,000, 40,000 and 1,372,523 shares, respectively, were granted under the 1996 Plan. Options issued under this plan provide for time-based vesting over four years. The Company also has two non-qualified management stock option plans under which options to purchase a maximum of 1,119,284 shares of Common Stock were granted to management employees, prior to 1996. Substantially all outstanding options under these non-qualified plans are fully vested. Under the terms of the three plans, the Board of Directors granted options to purchase shares at prices varying from $1.27 to $19.38 per share, 40 41 representing the fair market value at the time of the grant. Compensation expense related to vesting of certain options of $375,000 was recognized for the year ended June 30, 1997. In 1997, the Company adopted an employee stock purchase plan. The plan allows eligible employees of the Company to purchase up to an aggregate of 1,500,000 shares of Common Stock at quarterly intervals through periodic payroll deduction. The number of shares of Common Stock issued under this plan was 15,672 in 1997, 36,508 in 1998 and 37,620 in 1999. The Company accounts for these plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Had compensation expense for the stock option and stock purchase plans been determined consistent with SFAS No. 123, "Accounting for Stock Based Compensation," the Company's net income and earnings per share would have been reduced to the following pro forma amounts:
1997 1998 1999 ---- ---- ---- Net income (in 000's):................... As reported $9,985 $14,322 $18,752 Pro forma $9,553 $13,591 $16,850 Basic EPS:............................... As reported $ .40 $ .50 $ .64 Pro forma $ .38 $ .47 $ .57 Diluted EPS:............................. As reported $ .36 $ .48 $ .61 Pro forma $ .35 $ .46 $ .55
SUMMARY OF STOCK OPTIONS
1997 1998 1999 --------------------- --------------------- --------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE --------- ----- --------- ----- --------- ----- Outstanding at beginning of year...................... 1,226,290 $ 2.49 2,192,716 $ 5.00 2,110,240 $ 5.21 Granted..................... 1,262,000 7.54 60,000 13.14 1,372,523 15.54 Exercised................... 105,200 3.33 115,476 5.09 544,610 4.42 Forfeited................... 190,374 6.61 27,000 7.50 65,500 13.29 ---------- ------ ---------- ------ ---------- ------ Outstanding, end of year.... 2,192,716 $ 5.00 2,110,240 $ 5.21 2,872,653 $10.11 ========== ====== ========== ====== ========== ====== Exercisable, end of year.... 1,042,716 1,267,164 1,031,753 ========== ========== ========== Weighted average fair value of options granted (000's)*.................. $ 3,852 $ 240 $ 10,919 ========== ========== ==========
- --------- * The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for grants:
1997 1998 1999 ----- ----- ----- Risk free interest rate................. 6.14% 6.12% 4.97% Expected dividend yield................. 0 0 0 Expected life of options (years)........ 6 6 6 Expected volatility rate................ 34.3% 33.7% 46.0%
14. SUBSEQUENT EVENTS: Subsequent to June 30, 1999, the following transactions occurred: ACQUISITIONS: Effective August 17, 1999, the Company acquired American Business and Fashion Institute in Charlotte, North Carolina. Additionally, effective August 26, 1999, the Company acquired Massachusetts Communications 41 42 College in Boston Massachusetts. These transactions are subject to obtaining certain regulatory approvals. The Company acquired the outstanding stock of both of these entities and these transactions will be accounted for using the purchase method of accounting. STOCK REPURCHASE PROGRAM: On August 3, 1999, the Board of Directors authorized the Company to repurchase up to $10 million of its currently outstanding Common Stock. The quantity and timing of such purchases will be determined by management based upon market conditions and other factors, including the effect such repurchases could have on potential business combinations accounted for using the pooling of interests method of accounting. ITEM 9-- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 42 43 PART III ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY The information required by this Item will be contained in the Proxy Statement under the captions "Nominees as Directors for Terms Expiring at the 2002 Annual Meeting of Shareholders," "Directors Continuing in Office," "Executive Officers of the Company," and "Section 16(a) Beneficial Ownership Reporting Compliance," and is incorporated herein by reference. ITEM 11--EXECUTIVE COMPENSATION The information required by this Item will be contained in the Proxy Statement under the captions "Compensation of Executive Officers and Directors," "Compensation Committee Interlocks and Insider Participants" and "Employment Agreements," and is incorporated herein by reference. ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item will be contained in the Proxy Statement under the caption "Security Ownership," and is incorporated herein by reference. ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item will be contained in the Proxy Statement under the caption "Certain Transactions," and is incorporated herein by reference. PART IV ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The exhibits listed on the Exhibit Index on pages E-1 and E-2 of this Form 10-K are filed herewith or are incorporated herein by reference. (1) Financial Statements: The following financial statements of the Company and its subsidiaries are included in Part II, Item 8, on pages 27 through 42 of this Form 10-K. Report of Independent Public Accountants Consolidated Balance Sheets for years ended June 30, 1998 and 1999 Consolidated Statements of Income for years ended June 30, 1997, 1998 and 1999 Consolidated Statements of Cash Flows for years ended June 30, 1997, 1998 and 1999 Consolidated Statements of Shareholders' Investment for years ended June 30, 1997, 1998 and 1999 Notes to Consolidated Financial Statements (2) Supplemental Financial Statement Schedules Valuation and Qualifying Accounts, on page S-1 of this Form 10-K is filed herewith. (b) No reports on Form 8-K were filed during the three months ended June 30, 1999. 43 44 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. EDUCATION MANAGEMENT CORPORATION By: /s/ ROBERT B. KNUTSON ------------------------------------ Robert B. Knutson Chairman and Chief Executive Officer Date: September 28, 1999 PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE --------- ----- ---- /s/ ROBERT B. KNUTSON Chairman and Chief September 28, 1999 - --------------------------------------------- Executive Officer; Director Robert B. Knutson /s/ ROBERT T. GIOELLA President and Chief September 28, 1999 - --------------------------------------------- Operating Officer; Director Robert T. Gioella /s/ JOHN R. MCKERNAN, JR. Vice Chairman; Director September 28, 1999 - --------------------------------------------- John R. McKernan, Jr. /s/ ROBERT T. MCDOWELL Executive Vice President and September 28, 1999 - --------------------------------------------- Chief Financial Officer Robert T. McDowell /s/ MIRYAM L. KNUTSON Director September 28, 1999 - --------------------------------------------- Miryam L. Knutson /s/ JAMES J. BURKE, JR. Director September 28, 1999 - --------------------------------------------- James J. Burke, Jr. /s/ ALBERT GREENSTONE Director September 28, 1999 - --------------------------------------------- Albert Greenstone /s/ ROBERT H. ATWELL Director September 28, 1999 - --------------------------------------------- Robert H. Atwell /s/ WILLIAM M. CAMPBELL, III Director September 28, 1999 - --------------------------------------------- William M. Campbell, III /s/ JAMES S. PASMAN, JR. Director September 28, 1999 - --------------------------------------------- James S. Pasman, Jr. /s/ DANIEL M. FITZPATRICK Vice President and Controller September 28, 1999 - --------------------------------------------- Daniel M. Fitzpatrick
44 45 EXHIBIT INDEX
EXHIBIT NUMBER EXHIBIT METHOD OF FILING - ------- ------- ---------------- 3.01 Amended and Restated Articles of Incorporation Incorporated herein by reference to Exhibit 3.01 to the Annual Report on Form 10-K for the year ended June 30, 1997 (the "1997 Form 10-K") 3.02 Articles of Amendment filed on February 4, 1997 Incorporated herein by reference to Exhibit 3.02 to the 1997 Form 10-K 3.03 Restated By-laws Incorporated herein by reference to Exhibit 3.03 to the 1997 Form 10-K 4.01 Specimen Common Stock Certificate Incorporated herein by reference to Exhibit 4.01 to Amendment No. 3 filed on October 28, 1996 to the Registration Statement on Form S-1 (File No. 333-10385) filed on August 19, 1996 (the "Form S-1") 4.02 Rights Agreement, dated as of October 1, 1996, between Education Incorporated herein by Management Corporation and Mellon Bank, N.A. reference to Exhibit 4.02 to the 1997 Form 10-K 4.03 Amended and Restated Credit Agreement, dated March 16, 1995, Incorporated herein by among Education Management Corporation, certain banks and PNC reference to Exhibit 4.16 Bank, National Association to Amendment No. 1 to the Form S-1, filed on October 1, 1996 ("Amendment No. 1") 4.04 First Amendment to Amended and Restated Credit Agreement, dated Incorporated herein by October 13, 1995, among Education Management Corporation, certain reference to Exhibit 4.17 banks and PNC Bank, National Association to the Form S-1 4.05 Second Amendment to Amended and Restated Credit Agreement, dated Incorporated herein by July 31, 1996, among Education Management Corporation, certain reference to Exhibit 4.18 banks and PNC Bank, National Association to Amendment No. 1 4.06 Third Amendment to Amended and Restated Credit Agreement, dated Incorporated herein by March 14, 1997, among Education Management Corporation, certain reference to Exhibit 10.23 banks and PNC Bank, National Association to the 1997 Form 10-K 4.07 Fourth Amendment to Amended and Restated Credit Agreement, dated Incorporated herein by June 30, 1998, among Education Management Corporation, certain reference to Exhibit 10.25 banks and PNC Bank, National Association to the Annual Report on Form 10-K for the year ended June 30, 1998 (the "1998 Form 10-K") 4.08 Fifth Amendment to Amended and Restated Credit Agreement, dated Filed herewith July 30, 1999, among Education Management Corporation, certain banks and PNC Bank, National Association
E-1 46
EXHIBIT NUMBER EXHIBIT METHOD OF FILING - ------- ------- ---------------- 10.01 Education Management Corporation Retirement Plan Filed herewith 10.02 Education Management Corporation Management Incentive Stock Incorporated herein by Option Plan, effective November 11, 1993 reference to Exhibit 10.05 to the Form S-1* 10.03 EMC Holdings, Inc. Management Incentive Stock Option Plan, Incorporated herein by effective July 1, 1990 reference to Exhibit 10.06 to Amendment No. 1* 10.04 Form of Management Incentive Stock Option Agreement, dated Incorporated herein by various dates, between EMC Holdings, Inc. and various management reference to Exhibit 10.07 employees to Amendment No. 1* 10.05 Form of Amendment to Management Incentive Stock Option Agreement, Incorporated herein by dated January 19, 1995, among Education Management Corporation reference to Exhibit 10.08 and various management employees* to Amendment No. 1* 10.06 Education Management Corporation Deferred Compensation Plan Filed herewith * 10.07 1996 Employee Stock Purchase Plan Incorporated herein by reference to Exhibit 10.12 to Amendment No. 1 10.08 Education Management Corporation 1996 Stock Incentive Plan Incorporated herein by reference to Exhibit 10.13 to Amendment No. 1* 10.09 Third Amended and Restated Employment Agreement, dated as of Filed herewith* September 8, 1999 between Robert B. Knutson and Education Management Corporation 10.10 Form of Employment Agreement, dated as of June 4 and September 8, Filed herewith* 1999 between certain executives and Education Management Corporation 10.11 Form of EMC-Art Institutes International, Inc. Director's and/or Incorporated herein by Officer's Indemnification Agreement reference to Exhibit 10.17 to the Form S-1 10.12 Senior Management Team Incentive Compensation Plan Filed herewith* 10.13 Common Stock Registration Rights Agreement, dated as of August Incorporated herein by 15, 1996, among Education Management Corporation and Marine reference to Exhibit 10.19 Midland Bank, Northwestern Mutual Life Insurance Company, to the 1997 Form 10-K National Union Fire Insurance Company of Pittsburgh, PA, Merrill Lynch Employees LBO Partnership No. I, L.P., Merrill Lynch IBK Positions, Inc., Merrill Lynch KECALP L.P., 1986, Merrill Lynch Offshore LBO Partnership No. IV, Merrill Lynch Capital Corporation, Merrill Lynch Capital Appreciation Partnership IV, L.P., Robert B. Knutson and certain other individuals 21.01 Material subsidiaries of Education Management Corporation Filed herewith 23.01 Consent of Arthur Andersen LLP Filed herewith 27.01 Financial Data Schedule Filed herewith
- --------- * Management contract or compensatory plan or arrangement E-2 47 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Education Management Corporation and Subsidiaries included in this registration statement, and have issued our report thereon dated July 28, 1999. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in Item 14(a)(2) of this Form 10-K is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ Arthur Andersen LLP Pittsburgh, Pennsylvania July 28, 1999 48 SCHEDULE EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS)
BALANCE AT ADDITIONS BALANCE AT BEGINNING CHARGED TO END OF OF PERIOD EXPENSES DEDUCTIONS OTHER(A) PERIOD ---------- ---------- ---------- -------- ---------- ALLOWANCE ACCOUNTS FOR: Year ended June 30, 1997 Uncollectible accounts receivable......... $2,938 $3,911 $ -- $544 $7,393 Estimated future loan losses.............. 575 27 -- -- 602 Year ended June 30, 1998 Uncollectible accounts receivable......... 7,393 5,443 4,518 -- 8,318 Estimated future loan losses.............. 602 430 -- -- 1,032 Year ended June 30, 1999 Uncollectible accounts receivable........... 8,318 5,660 4,611 -- 9,367 Estimated future loan losses.............. 1,032 123 -- -- 1,155
- --------- (a) Uncollectible accounts receivable acquired in connection with acquisitions of subsidiaries. S-1 EX-4.8 2 AMENDED AND RESTATED CREDIT AGREEMENT 1 EXHIBIT 4.08 FIFTH AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT Dated as of July 30, 1999 By and Among EDUCATION MANAGEMENT CORPORATION, as the Borrower THE BANKS PARTY THERETO, as the Banks PNC BANK, NATIONAL ASSOCIATION, as the Issuing Bank and as the Agent 2 FIFTH AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT THIS FIFTH AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT is made as of the 30th day of July, 1999 (the "FIFTH AMENDMENT"), to that certain Amended and Restated Credit Agreement dated as of March 16, 1995, as previously amended by the First Amendment to Amended and Restated Credit Agreement dated as of October 13, 1995, the Second Amendment to Amended and Restated Credit Agreement dated as of July 31, 1996, the Third Amendment to Amended and Restated Credit Agreement dated as of March 14, 1997, and the Fourth Amendment to Amended and Restated Credit Agreement dated as of June 30, 1998 (the Amended and Restated Credit Agreement as previously amended, together with all exhibits and schedules thereto, the "ORIGINAL AGREEMENT") (the Original Agreement as amended by the Fifth Amendment, together with all extensions, substitutions, replacements, restatements and other amendments or modifications thereof or thereto, the "CREDIT AGREEMENT") by and among EDUCATION MANAGEMENT CORPORATION, a corporation organized and existing under the laws of the Commonwealth of Pennsylvania (the "BORROWER"), the FINANCIAL INSTITUTIONS listed on the signature pages to this Fifth Amendment (individually a "BANK" and collectively the "BANKS"), PNC BANK, NATIONAL ASSOCIATION as the issuer of letters of credit under the Credit Agreement (in such capacity the "ISSUING BANK") and PNC BANK, NATIONAL ASSOCIATION, a national banking association as the agent for the Banks (in such capacity the "AGENT"). WITNESSETH: WHEREAS, the Borrower and the Banks, the Issuing Bank and the Agent desire to amend the Original Agreement as set forth herein. NOW, THEREFORE, in consideration of the terms and conditions contained herein, and other good and valuable consideration, the parties hereto, intending to be legally bound, hereby agree as follows: ARTICLE I AMENDMENTS TO ORIGINAL AGREEMENT FIRST: Section 1.1 of the Original Agreement is hereby amended in the following particulars: The following definitions are added to Section 1.1: (a) "Common Stock Repurchase Program" means the Borrower's announced program to repurchase, up to $10,000,000 of the Borrower's common stock in one or more series of purchases at the current market price at the time of each such purchase. (b) "Fifth Amendment" means the Fifth Amendment to the Amended and Restated Credit Agreement dated as of July 30, 1999. SECOND: Section 5.1 of the Original Agreement is amended and restated in its entirety to read as follows: 3 5.1 Use of Proceeds. Proceeds of the Term Loans hereunder will be used to purchase the 1989 Term Loans from the 1989 Banks. Proceeds of the Revolving Credit Loans shall be used by the Borrower (a) to refinance the revolving credit loans, if any, outstanding under the 1989 Credit Agreement, (b) for general working capital purposes of the Borrower and its Active Subsidiaries, including but not limited to capital expenditures, the acquisition and development of additional schools, draws to meet DOE regulatory requirements and Permitted Acquisitions, (c) to refinance the existing Senior Subordinated Notes; provided, however, such proceeds must be used to repay existing Senior Subordinated Notes in full not later than October 13, 1995 or the Borrower shall lose the ability to use proceeds of the Revolving Credit Loans for this purpose, (d) for financing of loans to the ESOP, (e) provided the provisions of Section 7.3 have been satisfied, to acquire and hold as treasury shares up to approximately 98,000 shares of the Borrower's Series A 10.19% convertible preferred stock; provided, however, proceeds used for such purchase may not exceed $10,000,000 and must be disbursed in a single Disbursement; and provided, further this Preferred Stock Repurchase Draw may only be repaid with Net Offering Proceeds or by the issuance of Additional Term Loan Notes, and (f) to finance the Common Stock Repurchase Program; provided, however, proceeds of the Revolving Credit Loans used for such purchases must not exceed $10,000,000 in the aggregate. THIRD: Section 6.12b of the Original Agreement is hereby amended and restated in its entirety to read as follows: 6.12b Redemption Restrictions. The Borrower shall not, nor shall it permit any Subsidiary to, purchase the Borrower's capital stock while the Credit Facility is outstanding, except for (i) the redemption of any such capital stock held by the ESOP in connection with the termination of service of employees of the Borrower or its Subsidiaries, (ii) the Common Stock Repurchase Program, and (iii) the redemption of any such capital stock by the Borrower from Management Shareholders as more fully set forth below. (A) Upon the death, incapacity, retirement or termination of a Management Stockholder (other than Knutson, except as provided below), the Borrower may purchase such Management Stockholder's capital stock upon the terms and conditions set forth in the applicable Management Repurchase Agreement; provided that after giving effect to such purchase no Event of Default has occurred and is continuing; and provided, further, that the aggregate Net Purchase Price of all such purchases does not exceed in any Fiscal Year beginning on and after July 1, 1994, the sum of: (1) the applicable amount from among the following amounts: (a) $500,000, (b) the difference between (i) $1,000,000 in the earlier to occur of (A) any Fiscal Year ended after July 1, 1996 or (B) any Fiscal Year during which the Borrower's Consolidated Net Worth is greater than or equal to $50,000,000, plus (2) the proceeds paid to the Borrower during such Fiscal Year pursuant to life insurance policies on its employees, plus (3) the Net Proceeds paid to the Borrower during such Fiscal Year upon the resale or reissuance of the treasury stock related to repurchased capital stock. -2- 4 (B) Upon the death, incapacity, retirement or termination of Knutson, the Borrower may purchase his capital stock upon the terms and conditions set forth in the RBK Exchange and Repurchase Agreement, provided that after giving effect to such purchase no Event of Default has occurred or is continuing, and if such purchase is pursuant to the Initial Put and the Secondary Put (as such terms are defined in the RBK Exchange and Repurchase Agreement) (1) such purchases do not exceed the amounts set forth in Section 10(b) of the RBK Exchange and Repurchase Agreement, and (2) any purchases of capital stock owned by any Permitted Owner for cash may not exceed the proceeds available for such purposes under Key Man Life Insurance; provided, however, to the extent that such Key Man Life Insurance is unavailable or insufficient, the Borrower may purchase capital stock owned by any Permitted Owner subject to the limitations set forth in item (A) of this Subsection 6.12b. The foregoing notwithstanding, any amount permitted to be expended, pursuant to items (A) and (B) immediately above, to redeem the capital stock of the Borrower in the immediate Fiscal Year, but not so expended, may be expended in the next succeeding Fiscal Year. ARTICLE II CONDITIONS PRECEDENT This Fifth Amendment shall become operative as of the date hereof when each of the following conditions precedent are satisfied in the judgment of the Agent or have been waived in writing by the Agent: (a) Fifth Amendment. Receipt by the Agent on behalf of the Banks and the Issuing Bank of duly executed counterparts of this Fifth Amendment from the Borrower and the Required Banks and the Issuing Bank. (b) Closing Certificate. Receipt by the Agent on behalf of the Banks of a certificate signed by an Authorized Officer of the Borrower dated as of even date herewith certifying (i) that the representations and warranties set forth in the Original Agreement are true and correct in all material respects on and as of the date of this Fifth Amendment as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date (in which case, such representations and warranties shall have been true and correct on and as of such earlier date), and (ii) that no Default or Event of Default has occurred. (c) Pro Forma Projections. Receipt by the Agent of pro forma financial calculations establishing that had the Borrower borrowed the entire $10,000,000 for the Common Stock Repurchase Program on or before June 30, 1999, it would have been in compliance with each of the Fiscal Covenants set forth in Sections 6.1, 6.2, 6.3 and 6.4 as of June 30, 1999. (d) Fee. Receipt by the Agent for the pro rata benefit of the Banks of a fee in the amount of $30,000. (e) Form U-1. Receipt by the Agent of executed and completed forms U-1. -3- 5 (f) Proceedings Satisfactory. Receipt by the Agent on behalf of the Banks of evidence that all proceedings taken in connection with this Fifth Amendment and the consummation of the transactions contemplated hereby and all documents and papers relating hereto have been completed or duly executed, and receipt by the Agent on behalf of the Banks of such documents and papers, all in form and substance reasonably satisfactory to the Agent and Agent's special counsel, as the Agent or its special counsel may reasonably request in connection therewith. ARTICLE III MISCELLANEOUS FIRST: Except as expressly amended by this Fifth Amendment, the Original Agreement and each and every representation, warranty, covenant, term and condition contained therein is specifically ratified and confirmed. SECOND: Except for proper nouns and as otherwise defined or amended herein, capitalized terms used herein which are not defined herein, but which are defined in the Original Agreement, shall have the meaning given them in the Original Agreement. THIRD: This Fifth Amendment has been duly authorized, executed and delivered by the Borrower. FOURTH: This Fifth Amendment shall be binding upon and inure to the benefit of the Borrower, the Banks, the Issuing Bank, the Agent and their respective successors and assigns. FIFTH: Nothing in this Fifth Amendment shall be deemed or construed to be a waiver, release or limitation upon the Agent's or any Bank's exercise of any of their respective rights and remedies under the Original Agreement or the other Loan Documents, whether arising as a consequence of any Events of Default which may now exist, hereafter arise or otherwise, and all such rights and remedies are hereby expressly reserved. SIXTH: This Fifth Amendment may be executed in as many different counterparts as shall be convenient and by the different parties hereto on separate counterparts, each of which when executed by the Borrower, a Bank, the Issuing Bank and the Agent shall be regarded as an original. All such counterparts shall constitute but one and the same instrument. SEVENTH: This Fifth Amendment shall be a contract made under and governed by the laws of the Commonwealth of Pennsylvania without regard to the principles thereof regarding conflict of laws. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] -4- 6 Executed as of the day and year first above written. EDUCATION MANAGEMENT CORPORATION By: /s/ Robert T. McDowell Name:Robert T. McDowell Title:Senior Vice President and CFO PNC BANK, NATIONAL ASSOCIATION, in its capacity as the Agent, a Bank and the Issuing Bank By: /s/ Christine A. Filippi Name:Christine A. Filippi Title:Vice President KEYBANK NATIONAL ASSOCIATION By: /s/ Lawrence A. Mack Name:Lawrence A. Mack Title:Senior Vice President NATIONAL CITY BANK OF PENNSYLVANIA By: /s/ Vincent J. Delio, Jr. Name:Vincent J. Delio, Jr. Title:Vice President -5- EX-10.1 3 EDUCATION MANAGEMENT CORPORATION RETIREMENT PLAN 1 EXHIBIT 10.01 THE EDUCATION MANAGEMENT CORPORATION RETIREMENT PLAN 2 TABLE OF CONTENTS QUICK-REFERENCE INFORMATION Sponsor .................................................................................................1 Other Participating Employers............................................................................1 Plan Administrator.......................................................................................1 Trustee .................................................................................................1 Appeals Authority........................................................................................1 Classification of Employees Eligible to Get Into The Plan................................................2 Minimum Length of Service to Get Into The Plan...........................................................2 Length of Service Required For Benefits (Vesting Schedule)...............................................2 Plan Year Ends Every.....................................................................................2 Plan Number..............................................................................................2 WELCOME TO THE PLAN! Introduction.............................................................................................3 Individual Accounts......................................................................................3 Contributions............................................................................................3 Payments ................................................................................................3 Plan and Summary Plan Description........................................................................4 Ordinary Names...........................................................................................4 Effective Date...........................................................................................4 HOW YOU GET INTO THE PLAN Introduction.............................................................................................5 The Eligibility Requirements.............................................................................5 Actually Getting In......................................................................................5 If Things Change.........................................................................................5 TRADING OFF YOUR PAY FOR CONTRIBUTIONS TO THE PLAN Introduction.............................................................................................6 How Much You Can Trade Off...............................................................................6 How to Do it.............................................................................................6 MATCHING CONTRIBUTIONS Introduction.............................................................................................7 Rate of Match............................................................................................7 Reports .................................................................................................7
3 PROFIT SHARING CONTRIBUTIONS AND FORFEITURES Introduction.............................................................................................8 Profit Sharing Contributions.............................................................................8 Who Shares in Profit Sharing Contributions...............................................................8 How Much You Get.........................................................................................8 Reports .................................................................................................8 ESOP CONTRIBUTIONS AND FORFEITURES Introduction.............................................................................................9 ESOP Contributions and Forfeitures.......................................................................9 Who Has an Employer Stock Account........................................................................9 Who Shares in Employer Contributions and Forfeitures.....................................................9 How Much You Get........................................................................................10 Reports ................................................................................................10 INCOMING ROLLOVERS Introduction............................................................................................10 Direct Rollover.........................................................................................10 Indirect Rollover.......................................................................................10 Rules Applicable to Both Types of Rollover..............................................................10 Approval of Plan Administrator..........................................................................11 Separate Accounting.....................................................................................11 WHAT HAPPENS TO THE MONEY WHILE IT'S IN THE PLAN Introduction............................................................................................11 "Exclusive Benefit".....................................................................................11 Investment..............................................................................................11 Recordkeeping...........................................................................................11 Return of Contributions.................................................................................11 MAKING YOUR OWN INVESTMENT DECISIONS Introduction............................................................................................12 The Choices.............................................................................................12 Getting Information.....................................................................................12 Implementing Your Choices...............................................................................12 Your Responsibility.....................................................................................13 WHEN YOU RETIRE OR TERMINATE EMPLOYMENT Introduction............................................................................................13 Normal Retirement after Age 65..........................................................................13 Early Retirement after Age 55...........................................................................13 Disability..............................................................................................13
4 Other Termination of Employment.........................................................................14 Forfeitures.............................................................................................14 Some Special Rules about Termination of Employment......................................................15 WHEN PAYMENT IS ACTUALLY MADE Introduction............................................................................................15 Normal or Early Retirement or Disability................................................................15 Other Termination of Employment.........................................................................15 Your Choices about Timing...............................................................................16 Latest Possible Date to Take the Money (Or Stock).......................................................16 HOW PAYMENT IS MADE Introduction............................................................................................17 All Accounts Other than Employer Stock Account..........................................................17 Employer Stock Account..................................................................................17 Having the Money Transferred Directly to Another Plan...................................................17 "Put" Option............................................................................................18 HOW TO CLAIM YOUR MONEY OR STOCK Introduction............................................................................................19 First-Level Decision....................................................................................19 Appeal .................................................................................................19 Discretionary Authority.................................................................................19 PAYMENT BEFORE TERMINATION OF EMPLOYMENT Introduction............................................................................................20 Withdrawal of After-Tax Contributions...................................................................20 Age 59 1/2 .............................................................................................20 Age 70 1/2 .............................................................................................20 Hardship ...............................................................................................20 BORROWING MONEY FROM YOUR ACCOUNTS Introduction............................................................................................21 Eligibility.............................................................................................21 Number .................................................................................................22 Amount .................................................................................................22 Promissory Note.........................................................................................22 Term ...................................................................................................22 Interest ...............................................................................................22 Source and Application of Funds.........................................................................22 Repayment...............................................................................................22 Security ...............................................................................................23 Pre-Payment.............................................................................................23 Default ................................................................................................23 How to Apply............................................................................................23
5 IN CASE OF DEATH Introduction............................................................................................24 If You're Married and You Were a Participant in the Plan Before May 1, 1992.............................24 If You're Married and Became a Participant in the Plan on or after May 1, 1992..........................25 If You're Not Married...................................................................................25 Naming Your Beneficiary and Getting Spousal Consent.....................................................25 Claiming Your Accounts..................................................................................26 CHILD SUPPORT, ALIMONY AND PROPERTY DIVISION IN DIVORCE Introduction............................................................................................26 What a Domestic Relations Order Is......................................................................26 What Happens When a Domestic Relations Order Comes In...................................................27 HOW THE LENGTH OF YOUR SERVICE IS CALCULATED Introduction............................................................................................27 12-Month Periods........................................................................................27 Years of Service........................................................................................28 Full-Time Employees.....................................................................................28 Part-Time Faculty.......................................................................................28 Other Part-Time Employees...............................................................................28 Back Pay ...............................................................................................28 Breaks in Service.......................................................................................28 How Breaks in Service Cancel Years of Service...........................................................29 Service with Related Employers..........................................................................29 WHEN YOU RETURN FROM MILITARY SERVICE Introduction............................................................................................30 Break in Service........................................................................................30 401(k) Contributions....................................................................................30 Matching Contributions..................................................................................30 Profit Sharing Contributions and ESOP Contributions.....................................................30 Your "Pay"..............................................................................................31 Percentage of Entitlement to Employer Accounts..........................................................31 Limits and Testing......................................................................................31 WHAT THE PLAN ADMINISTRATOR DOES Introduction............................................................................................31 Reporting and Disclosure................................................................................31 Bonding ................................................................................................32 Numerical Testing.......................................................................................32 Prohibited Transactions.................................................................................32 Expenses ...............................................................................................32 Limitation..............................................................................................32
6 WHAT THE EMPLOYER DOES Introduction............................................................................................33 Establishment...........................................................................................33 Contributions...........................................................................................33 Employment Records......................................................................................33 Insurance and Indemnification...........................................................................33 Changing the Plan.......................................................................................33 Ending the Plan.........................................................................................34 MAXIMUM AMOUNT OF 401(k) CONTRIBUTIONS Introduction............................................................................................34 $10,000 Limit...........................................................................................34 If the $10,000 Limit Is Exceeded........................................................................34 Utilization Test........................................................................................35 Who the Restricted Employees Are........................................................................35 Performing the Utilization Test.........................................................................35 If the Utilization Test Reveals a Problem...............................................................36 Returning Excess Contributions..........................................................................37 Combining Plans.........................................................................................37 MAXIMUM AMOUNT OF MATCHING CONTRIBUTIONS Introduction............................................................................................38 Matching Contributions by Themselves....................................................................38 Matching Contributions in Combination...................................................................38 If this Test of Matching Contributions Reveals a Problem................................................38 MAXIMUM AMOUNT OF TOTAL CONTRIBUTIONS Introduction............................................................................................39 25% of Pay Limit........................................................................................39 If There's More than One Defined Contribution Plan......................................................39 If There's Also a Defined Benefit Plan..................................................................40 Related Employers.......................................................................................40 IMPROVEMENTS WHEN THE PLAN IS TOP-HEAVY Introduction............................................................................................40 Who Is in the Concentration Group.......................................................................41 Performing the Concentration Test.......................................................................41 Changes If the Plan Is Top-Heavy........................................................................42 ALTERNATIVE FORM OF PAYMENT FOR GRANDFATHERED MEMBERS Introduction............................................................................................43 Single Employees........................................................................................43 Married Employees.......................................................................................44 Beneficiary Is Fixed on Your Annuity Starting Date......................................................44 Legal Limitation on Age of Your Beneficiary.............................................................45 Notice from the Plan Administrator......................................................................45
7 SPECIAL ESOP PROVISIONS Introduction............................................................................................45 The Nature of an ESOP...................................................................................45 Investment..............................................................................................46 "Employer Securities"...................................................................................46 Voting .................................................................................................47 Diversification.........................................................................................48 "Nonterminable" Protections and Rights..................................................................49 Non-Allocation under Code Section 409(n)................................................................49 MISCELLANEOUS What "Pay" or "Compensation" Means......................................................................50 Leased Employees........................................................................................50 Family and Medical Leave................................................................................50 Changes in Vesting Schedule.............................................................................51 Non-Alienation..........................................................................................51 Payments to Minors......................................................................................51 Unclaimed Benefits......................................................................................51 Plan Assets Sole Source of Benefits.....................................................................51 No Right to Employment..................................................................................51 Profit Sharing and Stock Bonus Plan.....................................................................51 Merger of Plan..........................................................................................52 Protection of Benefits, Rights, and Features from Previous Edition of Plan..............................52 Governing Law...........................................................................................52 No PBGC Coverage........................................................................................52 Statement of ERISA Rights...............................................................................52 SPECIAL ARRANGEMENTS FOR NEW PARTICIPATING EMPLOYERS Introduction............................................................................................53 Illinois Institute of Art...............................................................................53 New York Restaurant School..............................................................................53 Art Institutes International Portland, Inc..............................................................54
8 QUICK-REFERENCE INFORMATION SPONSOR Education Management Corporation 300 Sixth Avenue, Suite 800 Pittsburgh, PA 15222 Employer identification number assigned by the IRS: 25-1119571 OTHER PARTICIPATING EMPLOYERS The other participating employers are listed on Appendix A, which appears at the end of the plan PLAN ADMINISTRATOR Retirement Committee c/o Education Management Corporation 300 Sixth Avenue, Suite 800 Pittsburgh, PA 15222 Telephone (412) 562-0900 TRUSTEE Fidelity Management Trust Company 82 Devonshire Street Boston, MA 02109 (Prior to the merger of the ESOP into the Retirement Plan, the trustee of the assets of the ESOP was: Marine Midland Bank One Marine Midland Center, 17th Floor P. O. Box 4567 Buffalo, NY 14240) APPEALS AUTHORITY Retirement Committee c/o Education Management Corporation 300 Sixth Avenue, Suite 800 Pittsburgh, PA 15222 -1- 9 CLASSIFICATION OF EMPLOYEES ELIGIBLE TO GET INTO THE PLAN All employees of the employer who are classified by the employer as salaried, clerical or hourly employees, except for (a) individuals matriculated in an employer with an enrollment agreement (i.e., students) and (b) members of a collective bargaining unit unless the collective bargaining agreement provides for participation in this plan. Independent contractors are not employees of the employer, nor are workers whose services are leased from a leasing organization (such as "temps"), and they are therefore not eligible for the plan. MINIMUM LENGTH OF SERVICE TO GET INTO THE PLAN One year of service. (This doesn't necessarily mean 12 months. You may be credited with a "year of service" after just 900 hours of service. This is explained in the plan under the heading "How the Length of Your Service Is Calculated.") LENGTH OF SERVICE REQUIRED FOR BENEFITS (VESTING SCHEDULE) less than 3 years of service..................................................0% 3 years of service...........................................................20% 4 years of service...........................................................40% 5 years of service...........................................................60% 6 years of service...........................................................80% 7 years of service or more..................................................100% PLAN YEAR ENDS EVERY December 31 PLAN NUMBER 001 -2- 10 WELCOME TO THE PLAN! INTRODUCTION. This is the Retirement Plan sponsored by Education Management Corporation, which we will call "the sponsor." It is maintained by the sponsor and the other participating employers identified above in the section called "Quick-Reference Information" under the heading "Other Participating Employers." Please note: The sponsor used to maintain two separate plans the Retirement Plan and the Employee Stock Ownership Plan. To simplify administration and make it easier for you to understand your retirement benefits, they have now been consolidated into a single plan, and this is it. INDIVIDUAL ACCOUNTS. Simply put, the plan consists of a series of individual accounts set up for the employees who are in the plan. Actually, an employee may have a number of different accounts: - a 401(k) account (if you choose to trade off pay for contributions to the plan), - a match account (again, if you choose to trade off pay for contributions to the plan), - a profit sharing account, - an employer stock account (if you are eligible to participate in the ESOP portion of the plan), and - a rollover account (if you roll money into this plan from another plan). Employees who were in this plan (that is, the Retirement Plan) before May 1, 1992 and who made after-tax employee contributions also have an after-tax contribution account for those after-tax employee contributions. CONTRIBUTIONS. Money goes into your 401(k) account if you choose to trade off pay for a contribution to the plan. If you do, the employer matches your 401(k) contributions (as described later in the plan); the matching contributions go into your match account. The employer is permitted (but not required) to make additional contributions beyond your 401(k) contributions and any matching contributions. Your share of any additional contributions goes into your profit sharing account. And if you are eligible to participate in the ESOP portion of the plan, your employer stock account participates in any forfeitures from the employer stock accounts of other participants who leave before becoming fully vested. PAYMENTS. While the money is in the plan, it is invested in accordance with your investment instructions (except for any employer stock account, of course, which is invested in employer stock). Then, after you leave the company, you are entitled to all of the money in your 401(k) account (and any rollover account or after-tax employee contribution account, if you have one). Depending on the length of your service, you may be entitled to part or all of the money in your match account and your profit sharing account and the stock in your employer stock account. -3- 11 Please note: Federal law may require withholding or other taxes on the money that you are paid from this plan. The plan administrator will naturally comply with any such law. But for the sake of simplicity, we will say here in the plan that you will receive "all the money." Just keep in mind that "all the money" is before any required withholding or other taxes. PLAN AND SUMMARY PLAN DESCRIPTION. The plan document that's what this is sets out the rules for how and when you get into the plan, how and when money goes into your accounts, what happens to the money while it's in the plan, and how and when you can get the money out. This plan is written in simple, easy-to-understand language. Therefore, it serves as both the plan document and the "summary plan description" required by federal law. ORDINARY NAMES. Throughout the plan, we will refer to things by their ordinary names. We will call this plan simply "the plan." We will call the sponsor which is identified in the section called "Quick-Reference Information" simply "the sponsor." When we say "employer," we mean the sponsor or one of the other participating employers whichever one employs you. When we say "you," we mean you the employee (or former employee) who participates in the plan. When we say "Code," we mean the federal Internal Revenue Code of 1986, as in effect from time to time. There is one exception to this rule. From time to time, we will refer to your "pay" or "compensation." Unfortunately, those terms have highly technical meanings, which can change for different purposes under the plan. The various technical definitions are set forth at the end of the plan under the heading "Miscellaneous." EFFECTIVE DATE. This consolidated plan takes effect on April 7, 1999. As of that date, the Education Management Corporation Employee Stock Ownership Plan is hereby merged into the Education Management Corporation Retirement Plan, with the Retirement Plan as the surviving plan. This document constitutes the merger document and represents an amendment of the Employee Stock Ownership Plan, too, to effectuate the merger. This restatement of the Education Management Corporation Retirement Plan including the merger of the Employee Stock Ownership Plan is conditional upon approval by the Internal Revenue Service. Sometimes, the IRS asks for minor, technical changes in order to give their approval, but if any such changes are made, we will let you know. -4- 12 HOW YOU GET INTO THE PLAN INTRODUCTION. Before you can get any benefit from the plan, you have to get into the plan. This part of the plan document explains how you get in. THE ELIGIBILITY REQUIREMENTS. There are three requirements in order to be eligible to get into the plan: - First, you have to be an employee of the employer. Remember, when we say "the employer," we mean the sponsor or one of the other participating employers whichever one employs you. - Second, you must be working in the classification of employees identified at the beginning of the plan in the section called "Quick-Reference Information" under the heading "Classification Of Employees Eligible To Get Into The Plan." - Third, you must have worked for the employer for the period shown at the beginning of the plan in the section called "Quick-Reference Information" under the heading "Minimum Length Of Service To Get Into The Plan." (To figure out whether you meet this requirement, see "How The Length Of Your Service Is Calculated," later in the plan.) Any special arrangements that might be made for employees of new participating employers are described at the end of the plan in the section called "Special Arrangements for New Participating Employers." ACTUALLY GETTING IN. As soon as you meet all of the eligibility requirements at the same time, you are enrolled in the plan on the next January 1 or July 1. Enrollment is automatic; you don't have to fill out any forms just to get into the plan. But you do have to complete the appropriate form and file it with the plan administrator if you want to: - trade off pay for contributions to the plan, as explained in the following section called "Trading Off Your Pay for Contributions to the Plan," or - direct the investment of your accounts into any investment option other than the default investment option, as explained later in the section called "Making Your Own Investment Decisions," or - name a beneficiary for any benefits that may be payable after your death, as explained in the section called "In Case of Death." IF THINGS CHANGE. If at any time you cease to be an employee of the employer or you cease to be employed in the classification of employees who are eligible to get into the plan, then your participation in the plan ceases immediately and automatically. (If you later return to employment with the employer in the classification of eligible employees, you will participate in the plan again immediately. It may be necessary to sign a new authorization form, as described in the next section.) Of course, after you leave the plan, you may still be entitled to receive the money in your account. (We will discuss this later in the section called "When You Retire or Terminate Employment.") And you remain entitled to direct the investment of the money in your account until it is paid or forfeited. -5- 13 TRADING OFF YOUR PAY FOR CONTRIBUTIONS TO THE PLAN INTRODUCTION. You may have heard about plans called "401(k)" plans. That's what this is. It offers you the opportunity to trade off your pay for contributions to the plan. It is particularly attractive because, under the current federal income tax law, you don't pay current federal income tax on the amount of pay that you trade off for a contribution to the plan. Please note: While free from federal income tax, these amounts are still subject to Social Security tax (FICA) and state and local income tax in Pennsylvania and a few other states. HOW MUCH YOU CAN TRADE OFF. You can trade off any percentage of your pay, expressed in whole numbers, up to 10% of your pay. HOW TO DO IT. If you would like to trade off some of your pay in return for a contribution to the plan, you complete a form authorizing the employer to reduce your pay by a certain percentage and, instead of paying it to you in cash, to put that amount into your 401(k) account in the plan. There are several simple rules for making contributions by this method (these rules were created by the IRS): - You must sign an agreement with the employer to do this. (The plan administrator will provide you with the forms at the appropriate time or on request.) - The agreement only applies to pay that you earn after the agreement is signed. (In other words, you can't make this type of contribution retroactively). - You can terminate the agreement at any time by filing a new form with the plan administrator showing zero as the rate of contribution, but the agreement still applies to all pay that was earned while the agreement was in effect. (In other words, you can't terminate the agreement retroactively.) - You can change your agreement at any time, but the change will take effect at the beginning of the following month. Whenever a contribution is made by this method, you will see it on your pay stub. From this point forward in the plan, we will call these your "401(k) contributions." -6- 14 MATCHING CONTRIBUTIONS INTRODUCTION. In order to encourage employees to make 401(k) contributions (in other words, to encourage savings for retirement), the employer agrees to make an additional contribution to the plan on your behalf if you make 401(k) contributions. This is called a matching contribution and it is an additional contribution on top of your pay. RATE OF MATCH. The employer agrees to make an additional contribution to the plan of $1 for every dollar of 401(k) contributions that you choose to make up to 3% of your pay plus $.50 for every dollar of 401(k) contributions from 4% to 6% of your pay. Here is a table showing the match that would apply to various levels of 401(k) contributions: 401(k) Contributions Match -------------------- ----- 1% 1% 2% 2% 3% 3% 4% 3.5% 5% 4% 6% - 10% 4.5% Matching contributions are made each pay period. (Please note: a mid-month advance for an employee who is paid monthly does not count as a pay period, so no 401(k) contributions will be taken from mid-month advances. The full 401(k) contribution will be taken from the paycheck that is cut at the end of the pay period.) With one exception, the matching contribution is calculated separately for each pay period, based on your 401(k) contributions for that pay period alone, not on a cumulative basis during the plan year. For example, if your rate of 401(k) contributions is less than 6% for a particular pay period (so you're not getting the maximum available matching contribution), you can't make it up by boosting your rate to more than 6% in some future pay period. And if your 401(k) contributions reach the dollar limit described later in the plan in the section called "Maximum Amount of 401(k) Contributions" (and therefore stop) before the end of the year, your matching contributions will stop at the same time. As an exception, however, effective January 1, 1999, if you have maintained a rate of 401(k) contributions of 6% or more throughout the plan year but your matching contributions stop because you reach the dollar limit on 401(k) contributions before the end of the year, the employer will make a "catch-up" matching contribution, as soon as administratively possible at the end of the plan year, in whatever additional amount is necessary to provide you with the maximum available matching contribution for the plan year. REPORTS. The employer's matching contribution is added to your match account. When the employer contributes in this manner, you will see it on your quarterly statement. -7- 15 PROFIT SHARING CONTRIBUTIONS AND FORFEITURES INTRODUCTION. In addition to 401(k) contributions that you choose to make, and the matching contributions that go with them, the employer can make profit sharing contributions whenever it chooses to do so. Also, if participants in the plan leave before becoming entitled to all of the money in their profit sharing accounts, the unvested portion is forfeited and re-distributed among the remaining participants in the same manner as a profit sharing contribution. PROFIT SHARING CONTRIBUTIONS. The employer is under no obligation to contribute to the plan in this manner. If the employer contributes in this manner, its contribution is on top of your pay. That is, the employer makes the contribution out of its own money; you don't have to trade off any pay to get it. We will call these "profit sharing contributions." WHO SHARES IN PROFIT SHARING CONTRIBUTIONS. If the employer makes a profit sharing contribution (or there are forfeitures from profit sharing accounts), the amount is allocated as of the last day of the plan year (currently, December 31) among the individual accounts of all the participants in the plan who meet both of these requirements: - you completed a year of service during that plan year (see "How the Length of Your Service Is Calculated," later in the plan, for what constitutes a "year of service") and - you were employed by the employer on the last day of the plan year, currently December 31 (or you retired during the year, became disabled during the year or died during the year). Keep in mind that only employees who have joined the plan are entitled to share in profit sharing contributions. If you do not enter the plan until January 1, you do not share in the profit sharing contributions for the preceding year, because you were not a participant in the plan on the preceding December 31. HOW MUCH YOU GET. Profit sharing contributions (and forfeitures from profit sharing accounts) are divided in proportion to each employee's pay from the employer during that year so everybody gets an amount equal to the same percentage of pay added to his or her account. REPORTS. A profit sharing contribution by the employer (or your share of any forfeitures from profit sharing accounts) is added to your profit sharing account. When the employer contributes in this manner, you will see it on your quarterly statement. -8- 16 ESOP CONTRIBUTIONS AND FORFEITURES INTRODUCTION. The ESOP loan has been paid off, so no more ESOP contributions by the employer are contemplated (as explained near the end of the plan in the section called "Special ESOP Provisions"). But there are forfeitures from time to time, and they are allocated in the same manner as ESOP contributions, so it is useful to describe the system. ESOP CONTRIBUTIONS AND FORFEITURES. The employer is under no obligation to make ESOP contributions to the plan but may do so at its discretion. However, if employees in the plan leave before becoming entitled to all of the stock in their employer stock accounts, the unvested portion is forfeited and re-distributed among the employer stock accounts of employees remaining in the plan in the same manner as an ESOP contribution by the employer (we'll call these "ESOP forfeitures" to distinguish them from forfeitures of matching contributions or profit sharing contributions). WHO HAS AN EMPLOYER STOCK ACCOUNT. Not everyone in the plan has an employer stock account. There are two categories of employees who have employer stock accounts: - Everyone who had an account in the Education Management Corporation Employee Stock Ownership Plan before it was merged into this plan, effective April 7, 1999, still has an employer stock account. It is the same account that he or she had under the ESOP; now it is maintained under this plan instead. - Everyone who receives an allocation of ESOP contributions or forfeitures in accordance with the following subsection also has an employer stock account, in which those ESOP contributions or forfeitures are held. WHO SHARES IN EMPLOYER CONTRIBUTIONS AND FORFEITURES. For each plan year, ESOP forfeitures (and ESOP contributions, if any) are allocated as of the last day of the plan year (currently, December 31) among the employer stock accounts of employees in the plan who meet both of these requirements: - You were employed on the last day of the plan year by an employer that participates in the ESOP feature of the plan (or you retired from such an employer during the year, became disabled from such an employer during the year, or died during the year while employed by such an employer). Please note: Not all employers who participate in the 401(k) feature of the plan participate in the ESOP feature. To find out if your employer participates in the ESOP feature, look at the list of participating employers on Appendix A at the end of this plan: employers that do not participate in the ESOP are denoted with an asterisk. - You completed a year of service during that plan year (see "How the Length of Your Service Is Calculated," later in the plan, for what constitutes a "year of service"). Keep in mind that only employees who have joined the plan are entitled to share in ESOP forfeitures. If you do not enter the plan until January 1, you do not share in the ESOP forfeitures for the preceding year, because you were not a participant in the plan on the preceding December 31. HOW MUCH YOU GET. ESOP forfeitures (and ESOP contributions, if any) are divided in proportion to each eligible employee's pay from the employer during that year so everybody gets an amount equal to the same percentage of pay added to his or her employer stock account. (If you are still technically employed by the sponsor or another employer that participates in the ESOP, so that you are entitled to share in ESOP contributions or forfeitures, but some of your pay comes from another employer that does not participate in the ESOP feature, your pay from both employers will be taken into account for this purpose.) REPORTS. Your share of ESOP forfeitures (and ESOP contributions, if any) is added to your employer stock account as of the last day of the plan year. You will see the amount on your quarterly statement. -9- 17 INCOMING ROLLOVERS INTRODUCTION. There is one other way that money can come into the plan for you. That is when money is transferred from another plan. It is called a "rollover," and this section will explain how it works. DIRECT ROLLOVER. If you are entitled to get money from a pension, profit sharing or stock bonus plan, and it constitutes an "eligible rollover distribution" under the Code, that plan must offer you the opportunity to have the money transferred directly to another plan (instead of paid to you in cash) if you can find a plan that will take it. This plan will take a direct transfer of that type, if all of the other rules of this section are met. (This is what the law calls a "direct rollover.") INDIRECT ROLLOVER. Instead of choosing a direct rollover from that other plan to this plan, you may choose to take the money in cash from that other plan. If you do, and you get what the law calls an "eligible rollover distribution," you can still make a rollover to this plan if: - you deliver a check to the plan administrator not later than the 60th day after you received the money from the other plan, or - put the money in a "conduit" individual retirement account within 60 days after you received the money from the other plan, never make any other contributions to that conduit IRA, and then transfer all of that money to this plan; and - all of the other rules of this section are met. The rules of the Code for indirect rollovers are very strict and can be very tricky. This plan does not attempt to explain those rules. You should consult the tax advisor of your choice. RULES APPLICABLE TO BOTH TYPES OF ROLLOVER. This plan will not accept any rollover that does not comply with the requirements of the Code. Foremost among them is the requirement that the rollover come from a pension, profit sharing or stock bonus plan that is qualified under section 401(a) of the Code. In addition, this plan is set up to be generally exempt from the joint and survivor annuity rules of the Code. This plan will not accept any transfer of assets from another plan if the effect would be to make this a "transferee plan" subject to those rules. APPROVAL OF PLAN ADMINISTRATOR. If you would like to make a rollover to this plan, get in touch with your local director of human resources, who can give you the forms. The plan administrator has complete authority to deny any requested rollover if the person requesting the rollover is unable or unwilling to satisfy the plan administrator that the rollover complies with these rules and will not jeopardize the intended status and operation of the plan. -10- 18 SEPARATE ACCOUNTING. If the plan accepts a rollover on your behalf, that rollover will be put into a separate account for you separate from your 401(k) account, your match account, your profit sharing account and your employer stock account (if any). WHAT HAPPENS TO THE MONEY WHILE IT'S IN THE PLAN INTRODUCTION. As required by law, the individual accounts of the employees in the plan are held in trust by the trustee identified at the beginning of the plan in the section called "Quick-Reference Information" under the heading "Trustee." A trust is a pool of assets held by an individual or company (such as a bank) who is called the "trustee." All contributions to the plan are paid in cash to the trustee. "EXCLUSIVE BENEFIT". The trustee holds the assets of the plan for the exclusive benefit of the employees in the plan that is, exclusively for the purposes of providing benefits to participants and beneficiaries of the plan and defraying the reasonable expenses of administering the plan. INVESTMENT. Assets held by the trustee are invested by the trustee in accordance with the terms of the plan. Except for employer stock accounts, the plan gives you free choice among a number of different investment funds (as described in the following section of the plan). Employer stock accounts are invested in employer stock, as described in more detail near the end of the plan in the section called "Special ESOP Provisions." RECORDKEEPING. Though the money is all pooled together for investment purposes, you still have one or more individual accounts. The plan administrator is responsible for keeping track of your individual accounts. The investments are valued daily. But the government requires us to say here that the plan administrator will figure out the total value of the investments of the plan at the end of every year. If the value has gone up since the last valuation, then all of the accounts will be increased in the same proportion. If the value has gone down since the last valuation, then all of the accounts will be decreased in the same proportion. The plan administrator will give you periodic reports of the value of your account. RETURN OF CONTRIBUTIONS. Except for a few unusual circumstances, once the employer puts money into the plan, the money can never come back to the employer. Here are the exceptions: - If the employer made the contribution by mistake of fact, then it can be returned within 1 year after the contribution was made. - All contributions by the employer are made on the condition that they are deductible by the employer for federal income tax purposes. If any part of a contribution is disallowed, that part of the contribution can be returned to the employer within 1 year after disallowance of the deduction. -11- 19 - If this plan fails to qualify initially for favorable tax treatment under the Code, then all contributions can be returned to the employer, as long as an application for determination on the plan was filed with the Internal Revenue Service by the due date of the employer's return for the taxable year in which the plan was adopted. MAKING YOUR OWN INVESTMENT DECISIONS INTRODUCTION. This plan allows you to have considerable control over how your money is invested. This section of the plan will explain how you do it. Keep in mind that this section applies to all of your accounts except your employer stock account, which is invested in employer stock (but can be diversified after age 55 and 10 years of participation in the plan), as described in more detail near the end of the plan in the section called "Special ESOP Provisions." THE CHOICES. The plan offers a number of choices. They are listed on Appendix B, which is a separate sheet that forms a part of this plan and which also includes a brief description of each alternative (taken from information published by Fidelity). The choices may change from time to time. When they do, you will be given a new Appendix B showing all of the choices that are in effect after the change is made. GETTING INFORMATION. The plan administrator cannot tell you which investment choice is best for you; that is your decision alone, and the plan administrator is not licensed as an investment advisor. But the plan administrator will provide you with more specific information about the choices, including exactly what each fund is invested in, who runs each fund, and how each fund has performed in the past. We hope this information will be helpful to you in making your choices. IMPLEMENTING YOUR CHOICES. When you first join the plan, you will be asked to make your investment choices on a form available from the plan administrator. Fill it out and return it to the plan administrator. After joining the plan, you can change your investment choices whenever you like during normal business hours. Just call the trustee (Fidelity) on the toll-free number shown in the materials that you receive from the trustee. A representative will guide you through making the change. If for any reason there is no current investment direction on file for you with the trustee, the plan hereby requires that your accounts (other than your employer stock account, if any) be invested in the Managed Income Portfolio, and neither the plan administrator nor the trustee nor any other fiduciary of the plan shall have any authority or discretion to direct otherwise. The same applies to any portion of your investment direction that becomes out of date, such as if you have chosen a particular fund and that fund is no longer offered (unless a substitute fund is automatically provided). -12- 20 YOUR RESPONSIBILITY. In return for complete freedom to choose how your accounts are invested among the available investment funds, you take complete responsibility for your choices. No one else is responsible for helping you or keeping you from making bad decisions. In fact, no one monitors your decisions at all. This plan is designed to take advantage of section 404(c) of the Employee Retirement Income Security Act of 1974, as amended, which means that the plan administrator and the trustee and all other fiduciaries of the plan are relieved of any and all responsibility for the investment decisions that you make. WHEN YOU RETIRE OR TERMINATE EMPLOYMENT INTRODUCTION. This is a retirement plan. The purpose is for both you and the employer to save for your retirement. This section will explain when you can get your money (or stock, in the case of an employer stock account). NORMAL RETIREMENT AFTER AGE 65. If your employment with the employer terminates any time on or after your 65th birthday, you are entitled to all the money in your 401(k) account, match account, and profit sharing account, as well as all of the money in your after-tax contribution account and rollover account, if you have them. In addition, you are entitled to all of the stock and cash in your employer stock account (and cash equal to any fractional share of stock). EARLY RETIREMENT AFTER AGE 55. If your employment with the employer terminates any time before age 65 but after age 55 and you have completed at least 7 years of service, you are entitled to all the money in your 401(k) account, match account, and profit sharing account, as well as all of the money in your after-tax contribution account and rollover account, if you have them. In addition, you are entitled to all of the stock and cash in your employer stock account (and cash equal to any fractional share of stock). (To figure out your length of service, see the section entitled "How Your Length Of Service Is Calculated.") DISABILITY. If you become permanently and totally disabled, then you are entitled to all the money in your 401(k) account, match account, and profit sharing account, as well as all of the money in your after-tax contribution account and rollover account, if you have them. In addition, you are entitled to all of the stock and cash in your employer stock account (and cash equal to any fractional share of stock). For this purpose, "totally and permanently disabled" means that, in the opinion of a physician selected by the plan administrator, you are unable to engage in any substantially gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long, continued and indefinite duration. OTHER TERMINATION OF EMPLOYMENT. If your employment with the employer terminates before normal or early retirement or disability (as just described), you are entitled to receive all the money in your 401(k) account, as well as all of the money in your after-tax contribution account and rollover account, if you have them. In addition, you are entitled to receive part or all of the money in your match account, your profit sharing -13- 21 account, and your employer stock account (if you have them) if you completed at least 3 years of service before your employment terminated. Whether you get all or just a portion of your match account, profit sharing account, and employer stock account depends on your length of service. At the beginning of the plan, in the section called "Quick-Reference Information," under the heading "Length Of Service Required For Benefits," there is a table showing what percentage of these accounts you get. (To figure out your length of service, see the section entitled "How Your Length Of Service Is Calculated.") FORFEITURES. Aside from normal and early retirement and disability, if your employment terminates before you have completed at least 3 years of service, you are not entitled to any of the money in your match account or profit sharing account or any of the stock or cash in your employer stock account. As soon as you suffer a break in service year (as described below under the heading "How the Length of Your Service Is Calculated"), those accounts are forfeited. If you have completed at least 3 years of service but not 7 years of service, you are entitled to some but not all of the money (or stock) in those accounts. If you take the portion to which you are entitled, the balance is forfeited as soon as your suffer a break in service year. If you choose to leave the money in the plan, the balance is forfeited when you have five consecutive break in service years (or when you take the money, if you take it before then). With respect to your employer stock account, forfeitures are taken first from any cash in your account; they are taken from stock allocated to your account only as a last resort. If you are later re-employed, the amount of the forfeiture (with no adjustment for subsequent gains, losses, or expenses) will be restored to your accounts if, and only if, you re-pay the full amount that you previously received from the plan. Re-payment must be made within 5 years after you are first re-employed and before you suffer 5 break in service years in a row (as described below under the heading "How The Length Of Your Service Is Calculated"). The money or stock to restore each of your accounts (match, profit sharing or employer stock) will come from forfeitures from accounts of the same type occurring during the same year when restoration is required. If those forfeitures are inadequate, the employer will contribute the balance in cash. Any balance of forfeitures from any one type of account (match, profit sharing or employer stock) during a plan year in excess of what is necessary to restore accounts of the same type during that year will be used as follows: - forfeitures from match accounts will be applied toward the employer's obligation to make matching contributions and allocated as if they were matching contributions, thus reducing the amount of cash contribution necessary from the employer to make the required matches, - forfeitures from profit sharing accounts will be allocated as if they were discretionary employer contributions, and - forfeitures from employer stock accounts will be allocated as if they were ESOP contributions. SOME SPECIAL RULES ABOUT TERMINATION OF EMPLOYMENT. When we say your "employment with the employer terminates," we mean that you are no longer employed by any employer that participates in the plan nor by any other member of the controlled group of trades or businesses (as described later in the plan under the heading "How The Length Of Your Service Is Determined"). In addition, we mean that you have a "separation from service" that permits you to receive your 401(k) contributions under the rules of section 401(k) of the Code and the regulations under that section. -14- 22 WHEN PAYMENT IS ACTUALLY MADE INTRODUCTION. The preceding section described what you are entitled to when you retire or your employment terminates for some other reason. This section will go on to describe when payment is actually made, which depends on a number of factors. NORMAL OR EARLY RETIREMENT OR DISABILITY. If you take normal or early retirement or suffer disability (as described in the preceding section), payment is made as soon as administratively possible after your termination of employment. OTHER TERMINATION OF EMPLOYMENT. If your employment terminates for any reason other than normal or early retirement or disability, the time of payment is different for different types of accounts. 401(k) Account, After-Tax Account, Rollover Account --------------------------------------------------- Payment of the money in your 401(k) account, after-tax account, and rollover account (if you have them) is made as soon as administratively possible after your termination of employment. Match Account, Profit Sharing Account ------------------------------------- Payment of your match account and profit sharing account (if you have them) will not be made until you have a "break in service." Breaks in service are described later in the plan under the heading "How the Length Of Your Service Is Calculated." Employer Stock Account ---------------------- Payment of your employer stock account will be made: - in 1999, if your employment with the employer ended during 1996 or 1997, - in 2000, if your employment with the employer ended during 1998, or - if your employment with the employer ends after 1998, as soon as administratively feasible after you suffer a break in service year (as described below under the heading "How the Length of Your Service Is Calculated"). Payment of your employer stock account will be made during the calendar quarter that corresponds to the calendar quarter in which your employment terminated. For example, if your employment terminated in the second quarter of 1997, payment of your employer stock account will be made in the second quarter of 1999. YOUR CHOICES ABOUT TIMING. If your entitlement is $5,000 or less, you do not have any choices about timing. You must take the money (or stock) when you are first entitled to payment. (For distributions before March 22, 1999, there was an additional rule that your entitlement was never more than $5,000 on the occasion of any previous distribution.) If your entitlement is $5,000 or less, the plan administrator will notify you and, if you don't initiate a withdrawal by calling the trustee, will direct the trustee to pay you your entitlement. -15- 23 But if your entitlement is more than $5,000, payment will not be made unless and until you apply for it. This gives you some ability to postpone payment. When you want to take the money (or stock), start the process by calling the trustee (Fidelity) at (800) 835-5092. The trustee will prepare the paperwork and send it to you. Then you check it, sign it if it's correct, and forward it to the plan administrator. The plan administrator will need a little time to process your application. If your application is approved, the plan administrator will direct the trustee to pay the money (or stock). The law says that, after your employment terminates, you must receive the money (or stock) no later than 60 days after the close of the plan year in which your employment terminated (or you attain age 65, if later) unless you choose not to take it. If you don't apply for the money by that date, we will interpret your silence as your choice not to take the money yet. LATEST POSSIBLE DATE TO TAKE THE MONEY (OR STOCK). While you have some ability to postpone payment of your benefit, you can't postpone it forever. Once your employment has terminated and you have reached age 70, you must at least begin to take the money by April 1 of the following year (that is, April 1 of the year following the year in which your employment with the employer terminates or you attain age 70, whichever comes later). Then you must take more by the end of that plan year and every following plan year on a schedule that does not extend beyond your life expectancy (or the joint life expectancies of you and your designated beneficiary). Life expectancy is determined by tables issued by the Internal Revenue Service and will be re-determined every year. (Of course, you may take all the money to which you are entitled at any time after age 70; you need not string it out.) Please note: There is a stricter rule for 5% owners. Any employee who is a 5% owner upon attainment of age 70 must begin to take the money by April 1 of the following year even if he or she remains employed. The plan administrator will pay you whatever is necessary to comply with this provision of the law (section 401(a)(9) of the Code, including the "minimum incidental death benefit" rules) even if you don't apply for payment. Payments that are required to be made under this section can not be transferred to another plan in a direct rollover. HOW PAYMENT IS MADE INTRODUCTION. When your employment has terminated and the time comes for payment, the next question is, In what form is the payment made? This section will answer that question. ALL ACCOUNTS OTHER THAN EMPLOYER STOCK ACCOUNT. The normal form of payment for all accounts other than your employer stock account(if you have one) is payment in a single sum by check made payable to you. -16- 24 Alternatively, if you were a member of this plan (that is, the Retirement Plan) before May 1, 1992, you may choose to receive your benefit in the form of an annuity contract purchased from an insurance company, rather than in a lump sum payment. Because the rules are rather complicated and nobody has ever actually chosen to receive an annuity contract, we have relegated this alternative to its own section of the plan, near the end, entitled "Alternative Form of Payment for Grandfathered Members." EMPLOYER STOCK ACCOUNT. Now that the stock of Education Management Corporation is publicly traded, the form of payment of your employer stock account is always the same form in which your account is invested. That is, any stock in your account is paid in stock, either by having the stock issued in your name and sending the actual stock certificate to you or your account at some institution or, if the trustee can do it, by making a wire transfer to a brokerage account that you designate. Any cash is paid in the form of cash, except that you have the right to demand payment of the cash portion of your account in stock. Any remaining partial share of stock is paid in cash, of course. You may take payment of your employer stock account in a single payment. Or, if you prefer, you may take your account in annual installments over two, three, four or five years. If you take it in installments, each annual payment is equal to the amount in your account, divided by the number of remaining payments. For example, if you chose to take your employer stock account in annual installments over five years, when the first payment was to be made, there would be 5 remaining payments, so you would get 1/5 of the amount in your account at that time. The next year, there would be 4 remaining payments, so you would get 1/4 of the amount in your account at that time. Eventually, in the fifth year, there would be only 1 remaining payment, so you would get 1/1 (that is, all) of the amount in your account at that time. After receiving stock from the trustee, it's yours to keep or sell on the open market, as you see fit. (The stock is publicly traded.) HAVING THE MONEY TRANSFERRED DIRECTLY TO ANOTHER PLAN. Rather than taking the money (or stock) and paying taxes on it when the time comes for payment, you may be able to make a "direct rollover" to another plan. Direct rollovers can be made to plans of these types: - a pension, profit sharing or stock bonus plan that is qualified under section 401(a) of the Code, or - an individual retirement account or individual retirement annuity (IRA), or - an annuity plan described in section 403(a) of the Code. This might happen, for example, if you get another job and the plan of your new employer will accept the transfer. Naturally, this plan will not make the transfer if the other plan will not accept it. All payments from this plan are eligible for direct rollover except the following: - any payment to the extent that it is required because you have reached age 70, - effective for payments after 1999, any hardship distribution of 401(k) contributions, and - any payment under an annuity contract that has been purchased for and given to you as described near the end of the plan in the section called "Alternative Form of Payment for Grandfathered Members." If the money that you are about to receive is eligible for direct rollover to another plan, the plan -17- 25 administrator will notify you and give you at least 30 days to decide whether you would like to have a direct rollover to another plan. On the other hand, you don't have to wait 30 days; you may take the money or do the direct rollover as soon as 7 days after receiving notification from the plan administrator, as long as you sign the appropriate form waiving your right to consider your decision for 30 days. "PUT" OPTION. In the unusual event that the stock of Education Management Corporation that you receive is subject to a restriction under any federal or state securities law, any regulation thereunder, or an agreement affecting the security, that would make the security not as freely tradable as a security not subject to restriction, you are entitled to make Education Management Corporation buy the stock back from you for cash. This is officially known as a "put option" and it also applies to any beneficiary of yours. Here are the rules: - You can exercise the put option at any time within 60 days after you get the stock or during a corresponding window period of 60 days during the following plan year. (The time will be extended by any period during which Education Management Corporation is prohibited by law from buying the stock back from you.) - You exercise your put option by notifying Education Management Corporation in writing. - Education Management Corporation will buy the stock back from you at fair market value, as determined by the ESOP Committee. Or, with the consent of Education Management Corporation, the trustee may buy the stock back from you at fair market value. - If the stock was distributed to you within a single taxable year and represented your complete entitlement under the plan, payment for your stock will be made in substantially equal installments (at least annually) over a period of not more than 5 years, as chosen by the purchaser, with the first payment within 30 days after you exercise the put option. The unpaid installments will bear a reasonable rate of interest and will be adequately secured by the purchaser. - On the other hand, if the stock is coming to you in installments, payment for your stock will be made within 30 days after you exercise the put option with respect to each installment. HOW TO CLAIM YOUR MONEY OR STOCK INTRODUCTION. To claim your entitlement under the plan, start by calling the trustee (Fidelity). The trustee will talk with you about the options that are available and, when you decide what you would like to do, provide you with the application forms. Complete and return them to Human Resources at EDMC in Pittsburgh. FIRST-LEVEL DECISION. Applications are reviewed and approved on the 15th of the month and again on the last day of the month. After your application is approved: -18- 26 - For all accounts other than your employer stock account, you can expect to receive payment from the trustee within 7 to 10 days. - For your employer stock account, it takes the trustee about 4 to 6 weeks to issue a paper stock certificate. If you would prefer a wire transfer to a brokerage account of your choosing, ask the trustee whether wire transfers are available. If so, the trustee will provide you with the necessary information. Wire transfers (if available) can be made in 7 to 10 days. If your claim is denied, the plan administrator will respond to you in writing, point out the specific reasons and plan provisions on which the denial is based, describe any additional information needed to complete the claim, and describe the appeal procedure. APPEAL. If your claim is denied and you disagree and want to pursue the matter, you must file an appeal in accordance with the following procedure. You cannot take any other steps unless and until you have exhausted the appeal procedure. For example, if your claim is denied and you do not use the appeal procedure, the denial of your claim is conclusive and cannot be challenged, even in court. To file an appeal, write to the appeals authority identified at the beginning of the plan in the section called "Quick-Reference Information" stating the reasons why you disagree with the denial of your claim. You must do this within 60 days after the claim was denied. In the appeal process, you have the right to review pertinent documents. You have the right to be represented by anyone else, including a lawyer if you wish. And you have the right to present evidence and arguments in support of your position. The appeals authority will issue a written decision within 60 days. The appeals authority may, in its sole discretion, decide to hold a hearing, in which case it will issue its decision within 120 days. The decision will explain the reasoning of the appeals authority and refer to the specific provisions of this plan on which the decision is based. DISCRETIONARY AUTHORITY. The plan administrator and appeals authority shall have and shall exercise complete discretionary authority to construe, interpret and apply all of the terms of the plan, including all matters relating to eligibility for benefits, amount, time or form of benefits, and any disputed or allegedly doubtful terms. In exercising such discretion, the plan administrator and appeals authority shall give controlling weight to the intent of the sponsor of the plan. All decisions of the appeals authority in the exercise of its authority under the plan (or of the plan administrator absent an appeal) shall be final and binding on the plan, the plan sponsor and all participants and beneficiaries. PAYMENT BEFORE TERMINATION OF EMPLOYMENT INTRODUCTION. Normally, your accounts will be paid after you retire (or your employment terminates for some other reason). But there are a few circumstances in which you can take money out of certain accounts even before your employment has terminated. This part of the plan explains those times. -19- 27 WITHDRAWAL OF AFTER-TAX CONTRIBUTIONS. If you were a member of this plan (that is, the Retirement Plan) before May 1, 1992 and you made after-tax contributions, you may withdraw all or any portion of those contributions at any time upon request, except that if the value of your after-tax contribution account has declined below the amount of contributions that you made, you may only withdraw the lesser amount, of course. AGE 59. When you reach age 59, you may withdraw all or any portion of your 401(k) account upon request, except that withdrawal may not be made more often than once during each plan year, and the minimum withdrawal is $500. AGE 70. After you reach age 70, you may take all the money in all your accounts at any time upon request, even if you are still employed by the employer. HARDSHIP. If you suffer immediate and heavy financial need (whether or not you are still employed by the employer), you may be able to get some or all of your 401(k) contributions out of the plan. There are general eligibility rules, but there is also a "safe harbor." The "safe harbor" means that you qualify automatically for a hardship withdrawal under particular, narrow circumstances. We will describe the safe harbor eligibility rules first. Safe harbor. Under the safe harbor eligibility rules, the following four types of financial need automatically qualify for a hardship withdrawal: - medical expenses that would be deductible under section 213 of the Code, - purchase of a principal residence for the employee, - payment of college or graduate school tuition (for the next school term only) for the employee, spouse, children or other dependents, or - the need to prevent eviction of the employee or foreclosure on his or her personal residence. If you have one of those financial needs, you can get a hardship withdrawal (no more than the amount of the financial need, of course), provided that: - you have obtained all distributions and loans available under all plans of the employer; - all qualified plans of the employer provide that your 401(k) contributions and employee contributions (if applicable under the plan) will be suspended for at least 12 months following the distribution (this plan so provides if you choose to use this safe harbor); and - all qualified plans of the employer provide that the 401(k) contributions made during the year of the distribution will count against the $10,000 limit on 401(k) contributions (described later in this plan) for the calendar year following the calendar year of the distribution (this plan so provides if you choose to use this safe harbor). General eligibility rules. If you do not have one of the four "safe harbor" financial needs, or if you choose not to use the safe harbor, you may still qualify for a hardship withdrawal. The plan administrator will determine whether your financial need is immediate and heavy within the meaning of the plan, taking into account whether the need was predictable and within your control. The amount of hardship distribution that you can receive from the plan under the general eligibility rules is only that which is necessary to respond to the need after all other resources reasonably available to you have been exhausted. All other resources available to you will be considered to have been exhausted only if you truthfully affirm that the need cannot be met by insurance reimbursement, reasonable liquidation of your assets -20- 28 or assets of your husband or wife or minor children that are reasonably available to you, cessation of 401(k) contributions or employee contributions under any plan of the employer, borrowing from commercial sources or other distributions or non-taxable loans from any employer. Source of hardship distribution. A hardship distribution can be made from the contributions that were made by trading off pay. This really means just the contributions, not any earnings on those amounts, except that, if you were a member of the plan before January 1, 1989 and you made 401(k) contributions, then the earnings on those contributions up through December 31, 1988 can be taken into account. Application. If you suffer immediate and heavy financial need and want a hardship distribution from the plan, you need to do two things. First, get a form from your local director of human resources, fill it out and return it to the plan administrator. Then call the trustee (Fidelity) to set up your hardship withdrawal pending approval from the plan administrator. BORROWING MONEY FROM YOUR ACCOUNTS INTRODUCTION. This is a retirement plan, and we do not encourage people to take loans from their accounts. Nevertheless, active employees (not retirees or other former employees) may borrow from their 401(k) account (and after-tax account and rollover account, if any), and this section of the plan will describe how much you can get and how to do it. ELIGIBILITY. Loans are available only to members of the plan who are receiving a paycheck from the employer. For example, loans are available to active employees, employees on paid leave of absence and former employees who are receiving severance pay. But loans are not available to other former employees (such as retirees) or to employees on unpaid leave of absence. In addition, under the law, loans are not available to anyone who is treated as an owner-employee under section 408(d) of ERISA or to the members of their families. NUMBER. You may have one home loan (as described below) and one personal loan (as described below) but you may not have more than one of each kind (that is, you may not have more than two loans). AMOUNT. The minimum loan is $1,000. The maximum loan is one-half of the sum of your 401(k) account and, if you have them, your rollover account and after-tax contribution account. The amount is judged at the time of your application for the loan. As an exception, you may never have loans outstanding of more than $50,000 from all plans of the employer and any other members of the same controlled group of trades or businesses. And the limit of $50,000 is reduced by the amount by which you have paid off any loans within the previous twelve months. EXAMPLE: In January, you took out a loan of $30,000. By December, you have paid it down to $25,000. Though the present balance is $25,000 and you might think that you could get another $25,000 loan, the amount that you paid off during the past year $5,000 counts against the $50,000 limit, so you can't get a loan of more than $20,000 now. -21- 29 PROMISSORY NOTE. Loans from the plan must be evidenced by a legally enforceable promissory note. TERM. You may choose the term of the loan, except that the term for a personal loan may not be more than five years and the term for a home loan may not be longer than twenty years. A "home loan" is a loan that is used to acquire a dwelling unit that, within a reasonable time after the loan is made, will be used as your principal residence. (Home improvement loans, loans to buy a second home, and loans to buy homes for other members of the family do not qualify as loans used to acquire a dwelling unit that will be used as your principal residence.) All other loans are "personal loans." INTEREST. Loans bear interest at the same rate charged by the employer's principal bank on loans of the same type. Specifically, loans used to acquire a dwelling unit that will be used as your principal residence bear the same interest rate as mortgage loans. All other loans bear the same rate of interest as secured personal loans. The rate is the rate quoted by the bank on the first business day of the month in which you request the loan. SOURCE AND APPLICATION OF FUNDS. The money to make a loan is obtained by liquidating investments in your 401(k) account. (If you have a rollover account or after-tax contribution account in addition to your 401(k) account, the money is taken from all of them proportionately.) The promissory note is then considered an asset of that account or accounts. When made, repayments (both principal and interest) are credited proportionately to the account or accounts from which the money was originally taken to make the loan. REPAYMENT. Repayment must be made on a schedule set out in (or attached to) the promissory note, requiring payment of principal and interest in regular, substantially equal installments over the term of the loan. Repayment must be made by payroll deduction from each paycheck (not counting mid-month advances for employees who are paid monthly). As an exception, the duty to pay according to the payment schedule will be suspended (but not for more than one year) while you are on a leave of absence without pay. When you return from the leave, the installment payments will resume in the original amount and the term of the loan will be extended by the same number of payments which were suspended. If such an extension would extend the term of the loan beyond five years (in the case of a personal loan) or twenty years (in the case of a home loan), however, a new installment payment schedule will be established instead, under which the new installment payments are sufficient to pay off the remaining balance of the loan by the end of the maximum five- or twenty-year period. As another exception, the duty to pay according to the payment schedule will be suspended if, and for as long as, you are performing military service within the meaning of the federal Uniformed Services Employment and Reemployment Rights Act of 1994. When you cease to perform such service, the installment payments will resume in the original amount and the term of the loan will be extended by the same number of payments which were suspended. SECURITY. As a condition of receiving a loan, you must post collateral by pledging as security for the loan fifty percent of your vested accrued benefit under the plan at the time when the loan is made. PRE-PAYMENT. You may pay the outstanding balance of a loan at any time without penalty for pre-payment. DEFAULT. If you fail to make the full amount of any required installment payment by payroll deduction, the loan will be considered in default, and the entire outstanding balance due and payable immediately, on the last day of the calendar quarter following the calendar quarter in which the installment -22- 30 payment was due. This may occur, for example, when your employment with the employer terminates or if you declare bankruptcy. If your loan goes into default and you do not pay the outstanding balance, the outstanding balance will be considered a "deemed distribution" for tax purposes to the extent provided in regulations of the Internal Revenue Service. When you become entitled to a distribution from the plan, the plan administrator will foreclose on your vested accrued benefit that was pledged as security for the loan in order to satisfy the unpaid balance of the loan, effectively offsetting the unpaid balance of the loan against the amount otherwise payable from the plan. In addition, all loans will be due and payable immediately upon distribution of assets in the event of termination of the plan. HOW TO APPLY. To get the ball rolling, call the trustee at (800) 835-5092. You will need to know the identification number that the trustee has assigned to this plan for its internal purposes, which is 90094. The trustee will check on the amount available in your account and talk to you about how much you would like, what the monthly payments would be, and what the length of the loan would be. When you are happy with the terms of the loan, the trustee will generate the loan application and send it to you. All you have to do is sign where indicated and send it on to Human Resources at EDMC in Pittsburgh. Loans are reviewed and approved on the 15th of each month and again on the last day of each month. If your loan is approved, you should expect to get a check from the trustee in 7 to 10 days. The payroll department will automatically start to withhold the loan payments from your paycheck. IN CASE OF DEATH INTRODUCTION. If you die before your entitlement has been paid (such as while you are still employed by the employer), the plan will pay out all of the money (and stock) in all your accounts under the plan, regardless of how long you have worked for the employer. Whom it is paid to, and how, depends on a number of factors. This section will explain. Please note: If you are married at the time of your death, your choice of beneficiary cannot be honored for certain portions of your accounts unless your husband or wife consented before you died, in accordance with the rules explained in this section. This is called "spousal consent" and it is explained in this section under the heading "Naming your beneficiary and getting spousal consent." -23- 31 IF YOU'RE MARRIED AND YOU WERE A PARTICIPANT IN THE PLAN BEFORE MAY 1, 1992. If you were married at the time of your death and you were a participant in this plan (that is, the Retirement Plan) before May 1, 1992, then your accounts are divided up and paid out as follows:
PORTION SUBJECT TO SPOUSAL CONSENT PORTION NOT SUBJECT TO SPOUSAL CONSENT ---------------------------------- -------------------------------------- This portion consists of: This portion consists of: - half of your 401(k) account, - the other half of your 401(k) account, - half of your match account, - the other half of your match account, WHAT - half of your profit sharing account, - the other half of your profit sharing - half of your after-tax account (if any), and account, - all of your employer stock account (if any). - the other half of your after-tax account (if any), and - all of your rollover account (if any). - ---------------------------------------------------------------------------------------------------------------------- This portion is paid to your surviving husband or This portion is paid to the beneficiary that you wife, unless, before your death, you named some last designated on the records of the plan WHO other beneficiary with the written consent of the administrator before you died. Your surviving husband or wife who survives you (as described husband or wife does not have to consent to your below). choice of beneficiary for this portion of your accounts. - ---------------------------------------------------------------------------------------------------------------------- It is paid in a single sum, if the recipient so It is paid in a single sum to the designated chooses. (If the recipient is your surviving beneficiary. (If your designated beneficiary is husband or wife, he or she may make a direct your surviving husband or wife, he or she may rollover into an IRA.) make a direct rollover into an IRA.) HOW If the recipient does not make a choice, this portion of your accounts (except for your employer stock account, which is always paid in a single sum) will be applied to the purchase of an annuity contract from an insurance company, in which the insurance company promises to make monthly payments to the recipient for as long as he or she lives.
IF YOU'RE MARRIED AND BECAME A PARTICIPANT IN THE PLAN ON OR AFTER MAY 1, 1992. If you were married at the time of your death but you became a participant in this plan (the Retirement Plan) on or after May 1, 1992, then the money (or stock) will be paid to your surviving husband or wife in a single payment, unless, before your death, you named some other beneficiary with the written consent of the husband or wife who survives you (as described below). If the recipient is your surviving husband or wife, he or she may make a direct rollover into an IRA. -24- 32 IF YOU'RE NOT MARRIED. If you are not married at the time of your death, then the money will be paid to whomever you named as your beneficiary before your death. (If you and your husband or wife die simultaneously, so that you do not have a "surviving spouse," you will be treated as if you were unmarried at the time of your death, and this paragraph will apply.) NAMING YOUR BENEFICIARY AND GETTING SPOUSAL CONSENT. You can name your beneficiary at any time before your death by completing a form from the plan administrator and returning it to the plan administrator. Your beneficiary is whomever you last named on the records of the plan administrator. Please note: Only you can change your beneficiary, and you can only do it by filing a new beneficiary designation with the plan administrator. Death or divorce does not automatically change your beneficiary. Because there is some disagreement among the federal courts on how to apply this provision, however, you should always make a new beneficiary designation after a divorce, even if you want to keep the same person as your beneficiary. If you have named a beneficiary in place of your surviving husband or wife, your choice of beneficiary will not be honored for any portion of your accounts that is subject to spousal consent unless your surviving husband or wife has consented in writing (or can't be located). The plan administrator has a form for this purpose, which must be completed, signed by your husband or wife, witnessed by a notary public, and filed with the plan administrator before you die. If you complete and file the form with the plan administrator and then want to change your mind (that is, you would like to go back to having your husband or wife as your beneficiary), you can withdraw the form just by filing a new beneficiary form with the plan administrator any time before you die. If money should be paid to a beneficiary, but you have not named a beneficiary or your beneficiary does not survive you, the money will be divided among the people in the first of the following classes that contains a survivor: (a) your surviving husband or wife, (b) your children, (c) your parents, (d) your brothers and sisters, or (e) your estate. CLAIMING YOUR ACCOUNTS. To claim the money, your husband, wife or other beneficiary should contact the plan administrator, get an application form, and follow the same procedure as you would have done to claim the money. While we expect payment to happen as soon as administratively possible after your death, we must recite here, in accordance with IRS rules, that all of your accounts must be completely paid out not later than five years after your death. CHILD SUPPORT, ALIMONY AND PROPERTY DIVISION IN DIVORCE INTRODUCTION. The plan will honor certain court orders made in the context of family law, child support, alimony and division of property in divorce. This means that part of your account may have to be paid to someone else; you may not get all that you are expecting. This section of the plan will explain when and how that can happen. -25- 33 WHAT A DOMESTIC RELATIONS ORDER IS. It is a judgment, decree or order of a court (including approval of a property settlement) made pursuant to state domestic relations law (including a community property law) that provides child support, alimony payments, or marital property rights to your spouse, former spouse, child or other dependent. The plan will not honor a domestic relations order unless it specifies: - that it applies to this plan, - your name and last known mailing address, as well as the name and last known mailing address of anyone else who is supposed to get payments, - the amount or percentage of your benefits that are supposed to be paid to someone else, or the manner in which the amount or percentage is to be determined, and - the number of payments or the period to which the order applies. Also, the plan will not honor a domestic relations order if it attempts to require the plan to: - provide increased benefits, - provide any type or form of benefit, or any option, that is not already provided for here in the plan document (except to the extent specifically permitted by the Code), or - pay to anyone any benefits that are already required to be paid to someone else under a previous domestic relations order. WHAT HAPPENS WHEN A DOMESTIC RELATIONS ORDER COMES IN. When a domestic relations order comes to the plan administrator, the plan administrator will first notify you and everyone else who is supposed to get part of your benefit under the order that the order has come in. The plan administrator will also tell you about the following procedure for deciding whether to honor the order. Next, the plan administrator will separately account for the benefits that, under the order, would be paid to someone other than you and hold onto them while deciding whether to honor the order. Next, the plan administrator will decide whether the plan should honor the order, applying the rules that are described in this section of the plan. When the decision is made, the plan administrator will notify you and everyone else who is supposed to get part of your benefit. If the plan administrator decides that the plan will honor the order, the plan administrator will proceed to make the payments required by the order (or schedule them for future payment, if they are not due yet). If the plan administrator decides that the plan cannot honor the order, the plan administrator will make payment as if there had been no order. In the unlikely event that the plan administrator cannot decide whether the plan should honor the order within 18 months after the first payment should have been made under the order, the plan administrator will make payments as if there had been no order until the decision is made, and then make future payments (but no past payments) in accordance with the decision. -26- 34 HOW THE LENGTH OF YOUR SERVICE IS CALCULATED INTRODUCTION. The length of your service with the employer can matter for two reasons under the plan: for getting into the plan and for deciding what portion of your account you are entitled to if you leave before retirement or disability. This part of the plan will explain how to calculate the length of your service. Two notes before we start. First, this section of the plan describes the rules currently in effect. Other rules may have been in effect for earlier periods, such as before ERISA took effect and before the Retirement Equity Act took effect. Those earlier rules continue to apply to service that was rendered before those laws took effect. Second, any special arrangements that might be made for employees of new participating employers are described at the end of the plan in the section called "Special Arrangements for New Participating Employers." 12-MONTH PERIODS. The plan looks at how many hours of service you have in certain 12-month periods. Getting into the plan. For the purpose of joining the plan, the first 12-month period runs from your date of hire to the first anniversary of your date of hire. After that, the 12-month period is the plan year, beginning with the plan year in which the first anniversary of your date of hire occurs. Portion of your account. For the purpose of determining what portion of your account you are entitled to if you leave before retirement or disability, the 12-month periods are plan years. At the beginning of the plan, in the section called "Quick-Reference Information," it shows what the plan year is. YEARS OF SERVICE. Your length of service is measured in full years. You get credit for a year of service if you complete 900 hours of service during that 12-month period. You get credit for the year whenever you have accumulated 900 hours of service, regardless of what happens during the rest of the year. (This is entirely independent of whether you are working in the classification of employees covered by the plan.) However, years of service can be cancelled by breaks in service, as explained below. FULL-TIME EMPLOYEES. Full-time employees are credited with 45 hours of service for each week in which they receive credit for one hour of service for performing services for the employer. A full-time employee for this purpose is any employee who works the regularly scheduled full work week as established by normal office hours for the location where the employee is employed. PART-TIME FACULTY. Part-time faculty are credited with 1.88 hours of service for each one hour of actual classroom time in recognition of the required preparation for classroom time. For this purpose, any faculty member who is assigned to teach less than a full work week will be considered part-time faculty. OTHER PART-TIME EMPLOYEES. Part-time employees other than faculty receive credit for each clock hour for which the employee is paid (or entitled to payment) by the employer. It doesn't matter how much you are paid for that hour; an overtime hour is still one hour. Working hours. Hours of service naturally include hours when you are actually working as an employee. -27- 35 Non-working hours. They also include hours when you are still an employee but not working due to vacation, holiday, illness, layoff, jury duty, military service, and leave of absence, if you are paid (or entitled to payment) for those hours by the employer. The number of hours credited for a time when you were not working is the number of regularly scheduled working hours in the period for which you are paid. For example, if a day consists of 8 regularly scheduled working hours and you are paid for a day of vacation, you get credit for 8 hours of service. As an exception, no more than 501 hours of service will be credited for any one, continuous period during which you were not working (or, in the case of back pay, would not have been working). As another exception, payments made solely to comply with workers' compensation, unemployment compensation, or disability insurance laws, and payments that reimburse you for medical expenses, do not result in credit for hours of service. BACK PAY. If for some reason you don't work for some period but are later granted back pay for that time, hours of service include hours for which you are granted back pay. Credit for hours of service is allocated to the period when the work was (or would have been) performed. BREAKS IN SERVICE. If you complete fewer than 100 hours of service during one of these 12-month periods, that is a "break in service." The one exception is if you are absent due to pregnancy, birth (or placement for adoption), or caring for a child immediately after birth (or placement). If you don't have more than 100 hours of service in the year when absence begins but the hours that would normally have been credited for the absence during that year would bring your total over 100, then that 12-month period will not count as a break in service. (If you have more than 100 hours in the year when the absence begins, but you don't have more than 100 hours in the following year, this rule applies to the second year instead. That is to say, if you remain absent during the following year and the hours that would normally have been credited for the absence during the following year would bring your total over 100, then the following year will not count as a break in service.) HOW BREAKS IN SERVICE CANCEL YEARS OF SERVICE. A break in service cancels your credit for all prior years of service temporarily until you return to work and complete another year of service. A break in service cancels your credit for all prior years of service permanently if: - when the first break in service occurred, you had no entitlement to any portion of any account derived from employer contributions (within the meaning of section 410(a)(5)(D)(iii) of the Code); and - you have at least 5 break in service years in a row; and - the number of break in service years is at least equal to your prior years of service. EXAMPLE: You accumulate 3 years of service. Then you have 1 break in service. Then you return to work. When you return, you have credit for no years of service (the break in service has temporarily cancelled all prior service credit). But suppose that, after returning to work, you complete another full year of service. Then you regain credit for the first 3 years, and you have credit for a total of 4 years of service. EXAMPLE: You accumulate 2 years of service. Then you have 5 consecutive breaks in service. Then you return to work. You have credit for no years of service, but even if you work another full year of service, you will still not regain any of your prior years of service. They were -28- 36 permanently cancelled because you had 5 consecutive breaks in service, which was equal to or greater than your prior service credit. SERVICE WITH RELATED EMPLOYERS. Service with someone other than the employer still counts for the purpose of calculating the length of your service with the employer under this section of the plan if it was performed at a time when the employer maintained this plan and it was performed for: - a corporation which, at that time, was under common control with the employer under section 414(b) of the Code, or - a trade or business which, at that time, was under common control with the employer under section 414(c) of the Code, or - an entity which, at that time, was a member of an affiliated service group with the employer under section 414(m) of the Code, or - an entity which, at that time, was required to be aggregated with the employer under section 414(o) of the Code (including the regulations under that section). Please note: service with related employers does not count for any other purpose under the plan. Specifically, you are not entitled to get into the plan or to get a share of the employer contributions if you are working for anyone other than the employer. WHEN YOU RETURN FROM MILITARY SERVICE INTRODUCTION. There are a few special rules to accommodate employees who enter military service and then return to employment with the employer, and they are listed in this section. These rules apply only to employees who are entitled to re-employment under the federal Uniformed Services Employment and Reemployment Rights Act of 1994 (which is called "USERRA"), as it may be amended from time to time, which contains detailed rules about what "military service" is, how long an employee can be absent, when the employee must return, and other conditions such as an honorable discharge. If you do not meet the requirements of USERRA, this section of the plan does not apply to you. Please note: It is your responsibility to let the plan administrator know if you are returning from military service, so that this section of the plan can be appropriately applied. BREAK IN SERVICE. If you are entitled to re-employment and are in fact re-employed in accordance with USERRA, you will not be considered to have incurred a break in service (as described in the preceding section of the plan) by reason of that military service. 401(k) CONTRIBUTIONS. You obviously were not in a position to make 401(k) contributions to the plan during your military service. But if you are entitled to re-employment and are in fact re-employed in accordance with USERRA, you are entitled to "make up" those contributions. Here's how: - Besides the amount of contributions that you could ordinarily get by trading off your pay for -29- 37 contributions to the plan, you may trade off additional pay (that is, pay for work performed after you are re-employed) for additional contributions to the plan. - The maximum amount of additional contributions that you can get by trading off your pay is the maximum amount that you could have gotten if you had not been absent in military service. - You can make these additional 401(k) contributions any time beginning on your re-employment and ending after a period equal to three times your period of military service (or five years, whichever comes first). For example, if your military service lasted 10 months, you can make these additional 401(k) contributions over a period of 30 months, beginning with your date of re-employment. MATCHING CONTRIBUTIONS. If you choose to make the additional 401(k) contributions referred to in the preceding paragraph, your employer contribution account will be credited with the corresponding matching contributions that it would have received if you had not been absent in military service. (Your account will not be credited with investment earnings on those amounts that you might have earned if you had not been absent in military service.) PROFIT SHARING CONTRIBUTIONS AND ESOP CONTRIBUTIONS. If you are entitled to re-employment and are in fact re-employed in accordance with USERRA, your profit sharing account will be credited with the employer profit sharing contributions (and your employer stock account will be credited with the ESOP contributions) that you would have received if you had not been absent in military service. This means contributions only; your account will not be credited with investment earnings on those amounts or forfeitures that you might have received if you had not been absent in military service. YOUR "PAY". For the purpose of this section of the plan, you will be treated as though you received pay at the same rate that you would have received if you had not been absent in military service (including raises, for example, that you would have received if you had not been absent). If the amount of pay cannot be determined with reasonable certainty, you will be treated as though you continued to receive pay during your absence at the same rate as your average rate of pay from the employer during the 12 months before you entered military service. PERCENTAGE OF ENTITLEMENT TO EMPLOYER ACCOUNTS. If you are entitled to re-employment and are in fact re-employed in accordance with USERRA, you will be given credit for that period of military service when the plan administrator calculates the percentage of your employer contribution accounts to which you are entitled on the table under the heading "Length Of Service Required For Benefits" in the section called "Quick-Reference Information." LIMITS AND TESTING. Contributions made under this section of the plan because of USERRA: - will not be taken into account at all for the purpose of the utilization test described in the section entitled "Maximum Amount of 401(k) Contributions" or the section entitled "Maximum Amount of Matching Contributions"; - will not cause the plan to fail to meet the requirements in the section entitled "Improvements When the Plan is Top-Heavy"; - will be subject to the limits in the year when they would have been paid if you had not entered military service (rather than the year in which they are actually paid under this section) for the purpose of the $10,000 limit described in the section entitled "Maximum Amount of 401(k) Contributions" and the section entitled "Maximum Amount of Total Contributions" and will be ignored when applying those limits to the other contributions actually paid for those years. -30- 38 WHAT THE PLAN ADMINISTRATOR DOES INTRODUCTION. The plan administrator has all rights, duties and powers necessary or appropriate for the administration of the plan. Many of those functions are described elsewhere in the plan. This section will mention some others. Please note: The description in this section of certain responsibilities imposed by law is solely for convenient reference by the plan administrator and is not intended to alter or increase those duties or transform them into contractual duties. REPORTING AND DISCLOSURE. The plan administrator will provide a copy of this plan to each new member of the plan no later than 90 days after joining the plan. The plan administrator will prepare and file the annual return/report (Form 5500) for the plan each year, if required. For that purpose, the plan administrator will retain an independent qualified public accountant (within the meaning of ERISA) to perform such services as ERISA requires. After filing the annual return/report, the plan administrator will distribute to all participants and to all beneficiaries receiving benefits the "summary annual report" if required by ERISA. The plan administrator will furnish to any participant or beneficiary, within 30 days of a written request, any and all information required by ERISA to be provided, including copies of the plan and any associated trust agreements and insurance contracts. The participant must pay the plan the actual cost of copying (unless that is more than the maximum permitted by ERISA, in which case the plan administrator will charge the maximum permitted by ERISA). BONDING. The plan administrator will assure that all "plan officials" who are required by ERISA to be covered by a fidelity bond are so covered. NUMERICAL TESTING. It is the responsibility of the plan administrator to monitor compliance with the following sections of the plan regarding (1) the maximum amount of 401(k) contributions, (2) the maximum amount of matching contributions, (3) the maximum amount of total contributions, and (4) top-heavy. It is the plan administrator's responsibility to take whatever action is required by those sections. PROHIBITED TRANSACTIONS. ERISA prohibits a variety of transactions, most involving "parties in interest." The plan administrator will not cause the plan to engage in any transaction that is prohibited by ERISA. EXPENSES. The expenses of administering the plan will be paid out of the plan assets. They may include, for example, fidelity bond premiums, trustee and investment management fees, and professional fees. If the plan administrator is a full-time employee of the employer, then the plan administrator will not -31- 39 receive any compensation from the plan for serving as plan administrator but will be reimbursed for expenses. LIMITATION. The plan administrator does not have any authority or responsibility to perform any of the functions that are described in the following section as employer functions. Specifically: - The plan administrator must accept as a fact the employment information furnished by the employer. The plan administrator has no authority or responsibility with regard to the employment relationship, and any disputes over the employment history are strictly between the employer and the employee. To the extent possible, the plan administrator will, of course, give effect under the plan to any new or corrected employment information furnished by the employer. - The plan administrator has no authority or responsibility for collecting employer contributions. WHAT THE EMPLOYER DOES INTRODUCTION. The sponsor and the participating employers have functions entirely different from the administration functions that are performed by the plan administrator. This section will identify those functions. ESTABLISHMENT. The sponsor was responsible for establishing the plan in the first place. That included establishing all the terms of the plan as set forth in this document. CONTRIBUTIONS. The employer contributes to the plan as described above in the sections entitled "Trading Off Your Pay For Contributions To The Plan," "Matching Contributions," "Profit Sharing Contributions and Forfeitures," and "ESOP Contributions and Forfeitures." In addition, the employer may, but does not have to, pay any expenses of the plan, so that they are not charged against the plan assets. EMPLOYMENT RECORDS. Since the plan administrator does not employ the employees who are members of the plan and does not keep employment records, it is the responsibility of the employer to provide to the plan administrator whatever information the plan administrator needs to apply the rules of the plan. INSURANCE AND INDEMNIFICATION. The employer will provide fiduciary liability insurance to, or otherwise indemnify, every employee of the employer who serves the plan in a fiduciary capacity against any and all claims, loss, damages, expense, and liability arising from any act or failure to act in that capacity unless there is a final court decision that the person was guilty of gross negligence or willful misconduct. -32- 40 CHANGING THE PLAN. The sponsor has the right to change the plan in any way and at any time and does not have to give any reason for doing so. These changes can be retroactive. For example, the plan names the plan administrator, the trustee, any investment manager or insurance company, and the appeals authority (they're all shown at the beginning of the plan in the section called "Quick-Reference Information"). The sponsor has the right to amend the plan to replace any of those individuals or firms at any time and without giving any reason. Exceptions. The Code says that no amendment can be adopted that would make it possible for the assets of the plan to be used for, or diverted to, purposes other than the exclusive benefit of participants and beneficiaries, and the plan adopts that language but only to the extent (and with the same meaning) required by the Code. The plan also adopts, but only to the extent and with the same meaning required by the Code, the Code prohibition on amendments which have the effect of reducing the "accrued benefit" of any member of the plan (including the provision of the Code which imposes the same prohibition on amendments eliminating or reducing an early retirement benefit or a retirement-type subsidy or eliminating an optional form of payment). Changes made by the sponsor may be made by resolution of the board of directors of the sponsor adopted in accordance with the by-laws of the sponsor. Alternatively, changes that do not materially increase the liability of the sponsor or any participating employer under the plan may be made by the Retirement Committee of the sponsor, as long as any such amendment is reflected in a writing that is formally designated as an amendment to this plan, is adopted by the unanimous consent of the members of the Retirement Committee, and is broadly applicable to participants under the plan (rather than targeted at any individual or small group of participants). For this purpose, the decision to admit a new participating employer will be considered as not materially increasing the liability of the sponsor or any participating employer under the plan. ENDING THE PLAN. The plan has no set expiration date; when it was established, it was not intended to be temporary. Nevertheless, the sponsor has the right to end the plan (in whole or in part) at any time and without giving a reason for doing so. The procedure for the sponsor to end the plan is the same as for changing the plan, as described in the preceding paragraph. In addition, any participating employer may withdraw from participation in the plan at any time and without giving a reason for doing so. If there is a "termination" or "partial termination" of the plan within the meaning of Treasury Regulation 1.411(d)-2 (sorry, but it's too difficult to try to describe what that is, particularly because it is not the same as ending the plan) or a complete discontinuance of contributions, everyone who is affected by the termination or partial termination or complete discontinuance of contributions and who is still a member of the plan at that time will automatically be advanced to 100% on the table at the beginning of the plan in the section called "Quick-Reference Information" under the heading "Length Of Service Required For Benefits," regardless of their length of service. For this purpose, those whose employment previously terminated at a time when their percentage was zero will be considered to have been "cashed out" at zero and will no longer be considered participants. MAXIMUM AMOUNT OF 401(k) CONTRIBUTIONS INTRODUCTION. The Code puts a couple of different limits on the amount that you can cause the employer to contribute to the plan by trading off your pay. This part of the plan describes them. -33- 41 $10,000 LIMIT. Contributions that you cause the employer to make by trading off your pay cannot be more than $10,000 in any one calendar year. And we are not talking just about this plan. This limit applies to any and all plans of any and all employers, including 401(k) plans, simplified employee pension plans, and 403(b) tax-sheltered annuities. The $10,000 figure changes from time to time according to the cost-of-living. The plan administrator can tell you what the exact figure is for this year. In the paragraphs that follow, however, we'll keep saying "$10,000" just because it's easier that way. IF THE $10,000 LIMIT IS EXCEEDED. There are two ways in which the $10,000 limit might be exceeded. First, although this plan prohibits 401(k) contributions of more than $10,000, a mistake might be made. In that case, as soon as the mistake is discovered, the plan administrator will simply return any and all 401(k) contributions that were more than $10,000 for a given plan year, adjusted for any income or loss experienced while the excess was in the plan. Second, although 401(k) contributions to this plan are not more than $10,000, you might have worked for some other employer during part of the year and the total of 401(k) contributions made to this plan and the plan of that other employer might be more than $10,000. In that case, you may withdraw all or part of the excess from this plan (not more than the 401(k) contributions that were actually made to this plan, of course), as long as you give the plan administrator written notice which is received by the plan administrator no later than March 15 of the calendar year following the year in which the excess 401(k) contributions were made. Then the plan administrator will return the amount that you have designated, adjusted for any income or loss experienced while the excess was in the plan. UTILIZATION TEST. How much employees at the top of the organization can trade off pay for contributions depends on how much all the other employees trade off their pay for contributions. You only have to worry about this if you are at the top of the organization. We will call these people "restricted employees." WHO THE RESTRICTED EMPLOYEES ARE. The restricted employees are determined each year. They are anybody who owned 5% or more of the employer during that year or the preceding year. They are also anybody who had compensation from the employer during the preceding year of more than $80,000. (The dollar figure changes slightly from year to year according to the cost-of-living. The plan administrator can tell you what the exact figure is for this year.) Special rules for former employees. Former employees are considered restricted employees if they were restricted any time after age 55 or they were restricted when they left the employer. Special rule for non-resident aliens. Non-resident aliens who have no U.S.-source income are not taken into account at all when applying this part of the plan. PERFORMING THE UTILIZATION TEST. First, the plan administrator will identify all the restricted employees who are eligible to choose 401(k) contributions to the plan for the plan year being tested (whether or not they have chosen to trade off pay for contributions). The plan administrator will figure, separately for each such employee, what percent of pay he or she has traded off for contributions. For employees who have chosen not to trade off pay for contributions, this percentage will be zero. The plan administrator will then average all of those percentages. Second, the plan administrator will focus on the year before the year being tested, identifying those individuals who were not restricted employees but were eligible to choose 401(k) contributions to the plan for that plan year (whether or not they chose to trade off pay for contributions). The plan administrator will figure, -34- 42 separately for each such employee, what percent of pay he or she traded off for contributions during the preceding year. Once again, for employees who chose not to trade off pay for contributions, this percentage will be zero (except to the extent that the employer chooses to make "qualified nonelective contributions" as described below). The plan administrator will then average all of those percentages. (As an exception for 1997 only, instead of using the year before the year being tested, the administrator may use the year being tested.) Please note: In calculating these averages, the plan administrator may take advantage of any special rules provided in the law or in published guidance from the IRS. For example, the plan administrator may exclude from the calculation entirely individuals who are not restricted employees and who have neither attained age 21 nor completed one year of service with the employer. Alternatively, the plan administrator may consider all individuals who have neither attained age 21 nor completed one year of service with the employer, whether they are restricted employees or not, as a separate plan for this purpose, as long as the coverage rules of section 410(b) of the Code would be met by both this plan and the separate plan. In calculating these percentages, the plan administrator will take into account only pay that, but for the choice to trade it off for contributions to the plan, would have been received by the employee in the appropriate plan year or is attributable to services performed in that plan year and would have been received by the employee within 2 months after the end of the plan year. In addition, 401(k) contributions will be taken into account for a plan year only if not contingent on participation or performance of services after the end of the plan year and actually paid to the trustee not later than 12 months after the end of the plan year. If the average for the employees who are not restricted was less than 2% in the preceding year, the average for the restricted employees in the year being tested cannot be more than twice that percentage. If the average for the employees who are not restricted was between 2% and 8% in the preceding year, the average for the restricted employees in the year being tested cannot be more than 2 percentage points higher. If the average for the employees who are not restricted was more than 8% in the preceding year, the average for the restricted employees in the year being tested cannot be more than 1.25 times that percentage. IF THE UTILIZATION TEST REVEALS A PROBLEM. If the average for the restricted employees is higher than it should be, the plan administrator will correct the problem by paying the contributions back to the restricted employees, as follows. Step 1 -- Calculating the total amount to be returned. The plan administrator will take the restricted employee with the highest percentage of 401(k) contributions and figure out how much of that employee's 401(k) contributions would have to be returned to that employee so that his or her percentage would be reduced enough to solve the problem for the whole group, but not more than would make the percentage of that employee's 401(k) contributions equal the percentage for the restricted employee with the second-highest percentage. If the problem has not been solved for the group as a whole, then the plan administrator will figure out how much of the 401(k) contributions of both of those people (the restricted employee with the highest percentage and the employee with the second-highest percentage) would have to be returned so that their percentage would be reduced enough to solve the problem for the whole group, but not more than would make the percentage for those two employees equal the percentage for the restricted employee with the third-highest percentage. If the problem has not been solved for the group as a whole, the plan administrator will keep doing this until the problem is solved. Then the administrator will complete step one by totalling the dollar amount of the contributions that would have to be returned to solve the problem. That is the total amount that will have to be returned. Step 2 -- Calculating how much is returned to each restricted employee. Now the administrator will take the restricted employee with the highest dollar amount of 401(k) contributions and return that employee's 401(k) contributions to him or her until (a) the total amount that has to be returned (as determined in step one) has been -35- 43 returned or (b) the dollar amount of that employee's 401(k) contributions has been reduced to the dollar amount of the restricted employee with the second-highest dollar amount of 401(k) contributions. If the total amount that has to be returned has not yet been returned, then the plan administrator will return the 401(k) contributions of those two employees (the restricted employee with the highest dollar amount and the employee with the second-highest dollar amount) to those two employees until (a) the total amount that has to be returned (as determined in step one) has been returned or (b) the dollar amount of those two employees' 401(k) contributions has been reduced to the dollar amount of the restricted employee with the third-highest dollar amount of 401(k) contributions. If the total amount that has to be returned (as determined in step one) has not yet been returned, the plan administrator will keep doing this until the total amount that has to be returned has been returned. It is understood that, after returning 401(k) contributions by this method, if the utilization test were to be run again, it might still not be passed, but the IRS has stated in Notice 97-2 that this is the method to be used and when this method has been followed, the utilization test is considered to have been satisfied. RETURNING EXCESS CONTRIBUTIONS. The concept of returning any excess contributions (due to either the $10,000 limit or the limitation on restricted employees) is simply to reverse the contributions as if they had never been made. If the contributions had never been made, of course, the employee would have received those amounts as pay and would have had to pay federal income tax on them. So you have to pay income tax on them when you get them back. When you get the excess contributions back depends on why you are getting them back: - If you are getting them back because of the $10,000 limit, you will get them back (including the allocable income or loss) by April 15 of the following year. The returned contributions are included in your taxable income for the previous year (the year when they were contributed), while the income on them is included in your taxable income for the year when you actually receive it. - If you are getting them back because of the utilization test, you will get them back (including allocable income or loss) by the end of the following plan year. The returned contributions and any allocable income are included in your taxable income for the year in which you actually receive them. (The only exception is the unlikely event that you get them back before March 15 of the following year, in which case they are included in your taxable income for the previous year.) The allocable income or loss is that portion of the total income or loss for the year for your 401(k) account which bears the same proportion to the total as the excess 401(k) contributions for the year bear to the account balance of your 401(k) account at the end of the year (minus the income (or plus the loss) on that account for the year). The amount of excess contributions returned to you because of the annual dollar limit will be reduced by any excess contributions previously returned to you because of the limitation on restricted employees for the plan year beginning with or within your taxable year. And the amount of excess contributions returned to you because of the limitation on restricted employees will be reduced by any excess contributions previously returned to you because of the annual dollar limit for your taxable year ending with or within the plan year. COMBINING PLANS. If two or more plans are aggregated for purposes of section 401(a)(4) of the Code or section 410(b) of the Code (other than section 410(b)(2)(A)(ii)), then all 401(k) contributions made under both plans will be treated as made under a single plan, for the purpose of this section of the plan. (Of course, the aggregated plans must comply with sections 401(a)(4) and 410(b) as though they were a single plan.) In addition, if a restricted employee is eligible to trade off contributions under two or more plans of the employer, those cash-or-deferred arrangements will be treated as a single arrangement, unless the applicable rules would prohibit permissive aggregation of those arrangements. -36- 44 MAXIMUM AMOUNT OF MATCHING CONTRIBUTIONS INTRODUCTION. Besides limiting the amount of 401(k) contributions that can be made on behalf of restricted employees, the Code also limits the amount of matching contributions that can be made for restricted employees both by themselves and when considered in combination with the 401(k) contributions. This part of the plan describes these additional limitations. MATCHING CONTRIBUTIONS BY THEMSELVES. The plan administrator will test the matching contributions by themselves by running the same test as described in the preceding section ("Maximum Amount of 401(k) Contributions"), taking into account all the same employees but using matching contributions rather than their 401(k) contributions. MATCHING CONTRIBUTIONS IN COMBINATION. If the utilization test for 401(k) contributions (described in the preceding section of the plan) and the utilization test for matching contributions (described in the preceding paragraph of this section) both show that the average for the restricted employees is more than 1.25 times the average for all other employees (after any corrective distributions), then the plan administrator must run this additional test. Step 1. The plan administrator will add the average percentage for the restricted employees under the trade-off test (already calculated under the preceding section of the plan) and the average percentage for the restricted employees under the matching test (already calculated under the preceding paragraph of this section). Step 2. The plan administrator will look at the average percentage for all other employees under the trade-off test (already calculated under the preceding section of the plan) and the average percentage for all other employees under the matching test (already calculated under the preceding paragraph of this section) and identify which is larger. Step 3. The plan administrator will take the larger number in Step 2 and multiply by 1.25, then take the smaller number and either add 2 percentage points or double it (whichever produces the lower number), and then add those two numbers together. Step 4. The plan administrator will take the smaller number in Step 2 and multiply by 1.25, then take the larger number and either add 2 percentage points or double it (whichever produces the lower number), and then add those two numbers together. -37- 45 Step 5. The plan administrator will see if the number in Step 1 is larger than both the number in Step 3 and the number in Step 4. If it is larger than both of them, the test is failed. If it is smaller than either of them, the test is passed. IF THIS TEST OF MATCHING CONTRIBUTIONS REVEALS A PROBLEM. If the matching contributions fail the tests in this section (either by themselves or in combination with the 401(k) contributions), then the plan administrator will return the excess matching contributions in the same manner as under the preceding section of the plan (which specifies how excess 401(k) contributions are returned). Alternatively, the employer may, but is not required to, solve the problem in whole or in part by making additional "qualified nonelective contributions" to the 401(k) accounts of employees who are not restricted, as described in the preceding section of the plan. MAXIMUM AMOUNT OF TOTAL CONTRIBUTIONS INTRODUCTION. Federal law sets a limit on how much money can go into your accounts in this plan in any one year. This section describes the limit. You don't have to worry about this, though; the plan administrator will pay attention to this section and make sure that the limit is not exceeded. 25% OF PAY LIMIT. The total of employer contributions, employee contributions (if applicable), and forfeitures allocated to your accounts for any one plan year cannot be more than 25% of your compensation from the employer (or $30,000, whichever is less). (As the $30,000 figure rises in accordance with the cost of living, the new figure will automatically be applied here.) As an exception, forfeitures of stock that was acquired with the proceeds of an exempt loan will not count against the limit if no more than one-third of the employer contributions to this plan for a year which are deductible under section 404(a)(9) of the Code are allocated to highly compensated employees all within the meaning of section 415(c)(6) of the Code. If this limitation would be exceeded as a result of the allocation of forfeitures, a reasonable error in estimating your annual compensation, a reasonable error in determining the amount of 401(k) contributions that may be made on your behalf within this limitation, or any other facts and circumstances that the Commissioner of Internal Revenue finds justifies relief under this paragraph, the excess amounts otherwise allocable to your account for that plan year will be used to reduce employer contributions for the next plan year (and succeeding plan years, as necessary) for you, as long as you are covered by the plan at the end of that plan year. However, if you are not covered by the plan at the end of that plan year, the excess amounts will be held unallocated in a suspense account for that plan year and allocated and reallocated in the next plan year to all of the remaining participants in the plan in accordance with the rules set forth in subparagraph Treas. Reg. 1.415-6(b)(6)(i). Furthermore, the excess amounts will be used to reduce employer contributions for the next plan year (and succeeding plan years, as necessary) for all of the remaining participants in the plan. And, though it may never apply, the IRS requires us to say that the $30,000 limit is reduced by employer contributions allocated to any individual medical account which is part of a pension or annuity plan and contributions on behalf of a member of the concentration group, as described below under the heading "Improvements When the Plan Is Top-Heavy," to a separate account for post-retirement medical benefits pursuant to Code section 419A(d) prior to the employee's separation from service. -38- 46 IF THERE'S MORE THAN ONE DEFINED CONTRIBUTION PLAN. All "defined contribution" plans of the employer (that's what this is) are considered to be one plan, so that, if the employer runs any other defined contribution plans, the limit applies to the total contributions under all of those plans. These may be plans qualified under section 401(a) of the Code, annuity plans under section 403(a), annuity contracts under section 403(b), or simplified employee pension plans under section 408(k). But the limitation of this section of the plan will be applied first to the other plan or plans, reducing the annual additions under those plans to elimination before any reduction is applied under this plan. "Employee contributions" does not include rollover contributions from another plan and does not include employee contributions to a simplified employee pension plan that are excludable from gross income under section 408(k)(6) of the Code. IF THERE'S ALSO A DEFINED BENEFIT PLAN. There are some complicated mathematics if you are a participant in this plan and also a participant in any "defined benefit" plan that the employer has ever maintained (a pension plan that promises you a fixed pension calculated by a formula). In essence, the plan administrator must figure out how much of the maximum permissible benefit you are getting from the defined benefit plan and how much of the maximum permissible contributions you have gotten in this plan and then compare to be sure that they don't exceed the combined limit. Defined benefit fraction. The plan administrator will divide your projected annual benefit under the defined benefit plan as of the end of the year by either (i) 1.25 times the dollar limit in effect for that year under section 415(b)(1)(A) of the Code or (ii) 1.4 times your average compensation for your high 3 years under section 415(b)(1)(B), whichever is less. That will be your "defined benefit fraction." Defined contribution fraction. The plan administrator will divide the total annual additions (for this year and all prior years) to all of your accounts under this and all other defined contribution plans of the employer as of the close of the year by the sum, for all prior years of service with the employer, of either (i) 1.25 times the dollar limit in effect for that year under section 415(c)(1)(A) of the Code (without regard to section 415(c)(6) or (ii) 1.4 times 25% of your compensation for that year under section 415(c)(1)(B), whichever is less (figured separately for each prior year). That will be your "defined contribution fraction." The rule. The defined benefit fraction and the defined contribution fraction, when added together, cannot exceed 1. If there is a problem, then your benefit in the defined benefit plan will be reduced just enough to eliminate the problem. No change will be made in your accounts under this plan. RELATED EMPLOYERS. For the purpose of this section of the plan, all related employers are considered to be a single employer to the extent required by Code sections 414(b), (c), (m), and (o) and 415(h). -39- 47 IMPROVEMENTS WHEN THE PLAN IS TOP-HEAVY INTRODUCTION. The plan administrator has to monitor the plan year by year to see if the benefits of the plan are concentrated in a group of employees that we will call the "concentration group." If so, the plan is said to be "top-heavy" and several improvements are automatically made in the plan for that year. This section of the plan describes what the plan administrator does to figure out if the plan is top-heavy and what improvements are made if it is. Please note: This plan has never been top-heavy and is unlikely ever to become top-heavy. But the IRS makes us put these provisions in the document just in case. WHO IS IN THE CONCENTRATION GROUP. The plan administrator will first figure out who is in the concentration group for a given plan year. This is what the plan administrator will do: Officers. List each officer on the last day of each of the five preceding plan years and how much he or she made each year. Delete from the list anyone who did not make more than the defined benefit dollar limit in section 415 of the Code for that year. Find the highest number of employees of the employer at any time during the five preceding plan years, excluding employees who have not completed 6 months of service, employees who normally work less than 17 hours per week, employees who normally work during not more than 6 months during any year, employees who have not attained age 21, and employees included in a collective bargaining unit. And then delete from the list of officers as follows: - If the number of employees is less than 30, delete all but the 3 officers having the greatest aggregate compensation during those five years. - If the number of employees is more than 30 but less than 500, take 10 percent of that number, round to the next highest whole number, and then delete all but the resulting number of officers having the greatest aggregate compensation during those five years. - If the number of employees is more than 500, delete all but the 50 officers having the greatest aggregate compensation during those five years. Everybody left on the list is in the concentration group. 5% Owners. List all employees who owned more than 5% of the value of the stock or voting power of the stock of the employer on the last day of the preceding plan year. All those people are in the concentration group. 1% Owners. Separately for each of the five preceding years, list all employees who owned more than 1% (but not more than 5%) of the value of the stock or voting power of the stock of the employer on the last day of each year. Delete anyone who did not make more than $150,000 that year. (That figure is adjusted for the cost of living every year.) Everybody left on the list is in the concentration group. % Owners. Separately for each of the five preceding years, list all employees who owned more than % of the value of the stock or voting power of the stock of the employer at any time during those five plan years. Delete the entry for any year if the employee did not make more than the defined contribution dollar limit in 415 that year. Select the 10 entries having the highest ownerships. (In case of a tie in ownership, the one with the higher compensation wins.) Those ten people are in the concentration group. PERFORMING THE CONCENTRATION TEST. To test for top-heaviness, the plan administrator will identify all pension, profit sharing and stock bonus plans of the employer in which any member of the concentration group participated in any of the preceding five years. (This includes -40- 48 plans that have previously been terminated if they were maintained at any time during those five years.) In addition, if any of those plans relies on the existence of some other plan in order to meet the coverage or nondiscrimination rules, then that other plan will also be thrown into the test. All of them will be tested together as if they were one plan. Defined benefit plans. For each defined benefit plan, the plan administrator will calculate the present value of each participant's accrued benefit as of the valuation date coincident with or last preceding the end of the last plan year, as if the participant terminated on the valuation date, using the same actuarial assumptions for all plans. This will include the value of nonproportional subsidies and accrued benefits attributable to nondeductible employee contributions (whether voluntary or mandatory). If there is no uniform accrual method under all such defined benefit plans, the plan administrator will determine the accrued benefit by applying the slowest accrual rate permitted under the "fractional rule" of Code section 411(b)(1)(C). Defined contribution plans. For each defined contribution plan (including this one), the plan administrator will calculate the account balance of each participant, as of the valuation date coincident with or last preceding the end of the last plan year. This will include contributions due by the last day of the last plan year. Add-backs. For both defined benefit and defined contribution plans, the plan administrator will add back in the value of all distributions made in those five years, except to the extent already taken into account. Exclusions. The plan administrator will exclude from the total all accrued benefits and account balances of persons who were members of the concentration group for prior years but are not members of the concentration group for the year being tested. The plan administrator will also exclude from the total all rollovers except those which (1) were not made at the initiative of the employee or (2) came from a plan of an employer required to be aggregated with this employer under section 414 of the Code. Concentration percentage. The plan administrator will divide the total accrued benefits and account balances of the members of the concentration group by the total accrued benefits and account balances of everyone in the plans. If the result is more than 60%, all the plans are top-heavy. If the result is 60% or less, none of the plans are top-heavy. Exception. If the percentage is more than 60%, but would not be more than 60% if another plan were added to the group of plans that are being tested (and that plan is one which could be added without taking the group out of compliance with the coverage and nondiscrimination rules), then none of the plans are top-heavy. CHANGES IF THE PLAN IS TOP-HEAVY. There are three changes that apply for a particular plan year if the plan is top-heavy for that year. Benefits in the event of termination of employment before retirement. If the plan is top-heavy for a particular year, then the schedule at the beginning of the plan in the section called "Quick-Reference Information" under the heading "Length Of Service Required For Benefits" may be changed for everyone who has at least one hour of service after the plan became top-heavy. - If that schedule provides for 100% after 5 years of service, it is changed to 100% after 3 years of service. - If it provides for gradually increasing percentages from 3 to 7 years of service, it is changed to provide the same progression but from 2 to 6 years of service. - If it already provides a schedule which is better than 100% after 3 years or graded from 2 to 6 years, then there is no change in the schedule. If, in a future year, the plan is no longer top-heavy, the schedule in "Quick-Reference Information" is -41- 49 reinstated, except that the reinstatement of the original schedule is treated as an amendment to the plan subject to the two limitations described below in the "Miscellaneous" section under the heading "Changes in the Vesting Schedule." Minimum contribution. For a year when the plan is top-heavy, each member of the plan who is not a member of the concentration group will receive an employer contribution on top of his pay of at least 3%, with three exceptions: - The percentage is not required to be greater than the highest percentage received for that year by anyone who is a member of the concentration group. In figuring that percentage, contributions made by trading off pay are counted as contributions, as are matching contributions. - If the employer also maintains a defined benefit plan that is top-heavy and that plan provides that the concentration requirements will be met by providing the minimum required accrual in that defined benefit plan, then there is no minimum contribution required in this plan. - If the employer also maintains a defined benefit plan that is top-heavy and that plan does not provide that the concentration requirements will be met by providing the minimum required accrual in that defined benefit plan, then the minimum contribution in this plan is 5%. The minimum contribution requirement applies to everyone in the plan who has not separated from service by the end of the plan year, including those who have not completed 1000 hours of service during the year and those who have not chosen to trade off pay for contributions. The minimum contribution requirement cannot be met by counting contributions made by trading off pay or matching contributions. Maximum amount of total contributions. Under the heading "Maximum Amount of Total Contributions," there are rules that apply when the employer maintains both this plan and a defined benefit plan. If the plan is top-heavy for a particular year, the factor of 1.25 is replaced with the factor of 1.0. (A corresponding change is made in the transition factor in section 415(e)(6)(B)(i).) There is one exception. If the concentration percentage is not more than 90%, the factor of 1.25 can still be used if each person in the plan who is not a member of the concentration group gets a minimum contribution of at least 4% (rather than 3%) or, if the employer also maintains a defined benefit plan, the defined benefit plan provides a minimum accrual of 3% per year of service (to a maximum of 30%). ALTERNATIVE FORM OF PAYMENT FOR GRANDFATHERED MEMBERS INTRODUCTION. For accounts other than employer stock accounts, the normal form of payment is a single payment of cash (sometimes called a "lump sum"). But if you were a member of this plan (that is, the Retirement Plan) before May 1, 1992, there is an alternative available. This section of the plan lays out that alternative form of payment. Remember, when we say "you" in this section of the plan, we are referring only to employees who were members of this plan (the Retirement Plan) before May 1, 1992. -42- 50 SINGLE EMPLOYEES. If you are not married on your "annuity starting date" (that's the first day of the first period for which benefits are payable, in the form of an annuity or otherwise), you may choose to have the plan purchase an annuity and give it to you. An annuity is an insurance contract, in which the insurance company promises to make monthly payments to you for as long as you live. If you would prefer, the plan can purchase an annuity that provides for payments after your death to a beneficiary (that you choose before the annuity is purchased), with the beneficiary receiving monthly payments for as long as your beneficiary lives after your death equal to at least 50%, but not more than 100%, of the amount that you were receiving before your death. Exactly what the monthly payments will be under any particular annuity depends on how much of your account balance is used to purchase the annuity and what type of annuity is purchased. In any event, the different annuities will all have the same actuarial present value, namely, the amount that is paid for them. If you would like to consider this alternative, please tell the plan administrator what options you would like to consider and who your beneficiary will be, so that the plan administrator can calculate how much your (and your beneficiary's) monthly pension would be in that form of payment. MARRIED EMPLOYEES. If you are married on your annuity starting date, you can take your entitlement in any of the annuity forms that we just described for employees who are single. However, if you choose any annuity other than an annuity with your husband or wife as the beneficiary receiving at least 50% of the amount that you were receiving before your death, you can get the optional form only if your husband or wife consents in writing in accordance with these rules: - You must fill out a form supplied by the plan administrator that explains the consequences of not taking an annuity that contains protection for your husband or wife. - Your husband or wife must sign the form too, and his or her signature must be witnessed by a notary public. - If you are choosing a form of payment with survivor payments to a beneficiary other than your husband or wife, the form must specify that other beneficiary and will apply only with respect to that beneficiary unless the form also states that you may change the beneficiary without getting any further written consent from your husband or wife. - And you must file the completed, notarized form with the plan administrator. You can complete and file the form any time during the 90 days immediately preceding your annuity starting date. (As required by law, forms completed or filed earlier than 90 days before your annuity starting date are invalid.) If you complete and file the form with the plan administrator and then want to change your mind (that is, you would like to go back to having an annuity for the life of both you and your husband or wife), you can withdraw the form just by telling the plan administrator any time before your annuity starting date. BENEFICIARY IS FIXED ON YOUR ANNUITY STARTING DATE. It is very important to note that, if your annuity involves a beneficiary (whether your husband or wife or some other person) that person is fixed on your annuity starting date and cannot be changed. For example, if you choose an annuity with payments after your death to your husband or wife, the "husband or wife" that will get payments after your death is the person that you are married to on your annuity starting date. If you get divorced later, that person will still be entitled to the pension after your death. And if you get re-married, your new husband or wife will not be entitled to any pension from this plan after your death. Therefore, if you are considering retirement and want an annuity but you are having marital difficulties, you might want to resolve the marital difficulties before your annuity starting date. Please note too: The plan will honor domestic relations orders in some circumstances. (See "Divorce, Etc.") For example, before your pension starts, a domestic relations order may require the plan to treat your former -43- 51 spouse as if he or she were your current spouse, in which case your pension will cover you and your former spouse; your current spouse will get nothing. After your pension has started, of course, no changes can be made under any circumstances. LEGAL LIMITATION ON AGE OF YOUR BENEFICIARY. If your beneficiary is not your husband or wife, the government has a rule that the present value of the payments that are expected to be made to you during your life must be more than 50% of the present value of the payments that are expected to be made to you and your beneficiary, which is a fancy way of saying that you cannot name a beneficiary who is too much younger than you are. The plan administrator will tell you if this rule creates a problem with your choice. NOTICE FROM THE PLAN ADMINISTRATOR. Be sure to let the plan administrator know when you are planning to retire. The plan administrator will provide you with a complete description of the annuities in which your pension can be paid, the requirements for choosing them, and all the necessary paperwork. The plan administrator must provide you with this information no earlier than 90 days before your "annuity starting date" and no later than 30 days before your "annuity starting date." Depending on when you tell the plan administrator about your plans and when the plan administrator can get this information out to you, your "annuity staring date" may have to be adjusted to fit these requirements. There are two possible exceptions: - You may choose to start your annuity less than 30 days after receiving the information from the plan administrator, as long as you are notified of your right to consider the information for 30 days and you sign a written form waiving that right, in which case your annuity can start as soon as 7 days after you received the information. - Your "annuity starting date" can actually be before you are provided with this information as long as you are notified of your right to consider the information for 30 days and payments do not actually begin until at least 7 days after you receive the information. (In this case, payment will be made retroactively to your annuity starting date.) SPECIAL ESOP PROVISIONS INTRODUCTION. Since the Education Management Corporation Employee Stock Ownership Plan has been merged into this plan (the Education Management Corporation Retirement Plan), there are a number of special provisions from the Employee Stock Ownership Plan that need to be preserved in this plan. This section contains them. THE NATURE OF AN ESOP. This type of ESOP borrows money from a bank and uses it to buy stock of the sponsor Education Management Corporation. The stock is held as collateral for the loan. Then, from year to year, the employer makes cash contributions to the plan that are used to pay down the loan. As the loan is paid down each year, a corresponding amount of stock no longer needs to be held as collateral for the loan. The stock that is released is allocated among the employer stock accounts of the employees who are in the plan. -44- 52 Over time, the idea is that the loan will be completely paid off, which means that all of the stock will be released and allocated to the accounts of the employees in the plan. As a matter of fact, in this plan, that has already happened: the loan has been paid off and the stock has all been allocated to the employer stock accounts of the employees in the plan. INVESTMENT. Investments of employer stock accounts are made at the direction of the plan administrator. Since this is in part an ESOP, however, the assets of the employer stock accounts must be invested primarily in stock of Education Management Corporation. (If any future ESOP contributions are made or dividends are paid, the trustee must use them to buy more stock of Education Management Corporation to the extent that stock is available on terms that the plan administrator considers prudent.) Technically, this includes any "qualifying employer security" within the meaning of section 407(d)(5) of ERISA that also meets the requirements of section 409(l) of the Code. This includes common stock issued by Education Management Corporation that is readily tradable on an established securities market, as well as noncallable preferred stock (as long as it is convertible at any time into readily tradable common stock and the conversion price was reasonable when the noncallable preferred stock was acquired by this plan). The full definition is set out later in this section, but we will call this simply "stock" or "employer stock." Purchases of stock must be made at a price which, in the judgment of the plan administrator, does not exceed the fair market value of the stock. Sales of stock may be made to any person, except that if the buyer is a "disqualified person" under section 4975(e)(2) of the Code, the sales price may not be less than the fair market value of the stock and no commission can be charged on the sale. All sales will comply with section 408(e) of ERISA. There may also be a small amount of cash in employer stock accounts. It may be invested in bank accounts, certificates of deposit, securities, short-term funds maintained by the trustee, or any other kind of investment in accordance with the trust agreement, or it may simply be held in cash. "EMPLOYER SECURITIES". We said earlier that the stock must constitute "employer securities" under Code section 409(l). Here is the text of Code section 409(l) so there is no doubt about what we mean: "(1) IN GENERAL.--The term 'employer securities' means common stock issued by the employer (or by a corporation which is a member of the same controlled group) which is readily tradable on an established securities market. "(2) SPECIAL RULE WHERE THERE IS NO READILY TRADABLE COMMON STOCK.--If there is no common stock which meets the requirements of paragraph (1), the term 'employer securities' means common stock issued by the employer (or by a corporation which is a member of the same controlled group) having a combination of voting power and dividend rights equal to or in excess of-- "(A) that class of common stock of the employer (or of any other such corporation) having the greatest voting power, and "(B) that class of common stock of the employer (or of any other such corporation) having the greatest dividend rights. "(3) PREFERRED STOCK MAY BE ISSUED IN CERTAIN CASES.--Noncallable preferred stock shall be treated as employer securities if such stock is convertible at any time into stock which meets the requirements of paragraph (1) or (2) (whichever is applicable) and if such conversion is at a conversion price which (as of the date of the acquisition by the tax credit employee stock ownership plan) is reasonable. For purposes of the preceding sentence, under regulations prescribed by the Secretary, preferred stock shall be treated as noncallable if after the call there will be a reasonable opportunity for a conversion which meets the requirements of the preceding sentence. -45- 53 "(4) APPLICATION TO CONTROLLED GROUP OF CORPORATIONS.-- "(A) IN GENERAL.--For purposes of this subsection, the term 'controlled group of corporations' has the meaning given to such term by section 1563(a) (determined without regard to subsections (a)(4) and (e)(3)(C) of section 1563). "(B) WHERE COMMON PARENT OWNS AT LEAST 50 PERCENT OF FIRST TIER SUBSIDIARY.--For purposes of subparagraph (A), if the common parent owns directly stock possessing at least 50 percent of the voting power of all classes of stock and at least 50 percent of each class of nonvoting stock in a first tier subsidiary, such subsidiary (and all other corporations below it in the chain which would meet the 80 percent test of section 1563(a) if the first tier subsidiary were the common parent) shall be treated as includible corporations. "(C) WHERE COMMON PARENT OWNS 100 PERCENT OF FIRST TIER SUBSIDIARY.--For purposes of subparagraph (A), if the common parent owns directly stock possessing all of the voting power of all classes of stock and all of the nonvoting stock, in a first tier subsidiary, and if the first tier subsidiary owns directly stock possessing at least 50 percent of the voting power of all classes of stock, and at least 50 percent of each class of nonvoting stock, in a second tier subsidiary of the common parent, such second tier subsidiary (and all other corporations below it in the chain which would meet the 80 percent test of section 1563(a) if the second tier subsidiary were the common parent) shall be treated as includible corporations. "(5) NONVOTING COMMON STOCK MAY BE ACQUIRED IN CERTAIN CASES.--Nonvoting common stock of an employer described in the second sentence of section 401(a)(22) shall be treated as employer securities if an employer has a class of nonvoting common stock outstanding and the specific shares that the plan acquires have been issued and outstanding for at least 24 months." VOTING. In a number of instances, you may be entitled to direct how the stock in your employer stock account is voted when votes of the shareholders of Education Management Corporation are taken. Here they are: - If any class of stock in the plan is required to be registered under section 12 of the Securities Exchange Act of 1934, as amended, then you are entitled to instruct the plan administrator how to vote the stock in your employer stock account to the extent required under section 409(e) of the Code. - As to any stock acquired by the ESOP with the proceeds of a loan with respect to which the lenders exclude from federal taxable income a portion of the interest pursuant to section 133 of the Code, you are entitled to instruct the plan administrator how to vote the stock in your employer stock account, to the extent required under section 133(b)(7)(A) of the Code. - In any event, you are entitled to direct the plan administrator how to vote the stock in your employer stock account with respect to any vote of shareholders on any corporate merger, consolidation, recapitalization, reclassification, liquidation, dissolution, sale of substantially all assets, or a similar transaction, to the extent required by Sections 401(a)(22) and 409(e) of the Code and regulations thereunder. If you do not instruct the plan administrator how to vote the stock in your employer stock account (or if there is any stock that is not allocated to the accounts of the members of the plan), the plan administrator is entitled to instruct the trustee how to vote the stock, assuming that the instructions of the plan administrator are consistent with ERISA. DIVERSIFICATION. If you have reached age 55 and you have participated in the ESOP for at least ten years, you may choose to have some of the stock in your employer stock account sold and the proceeds transferred to your profit sharing account here in the plan, where it will be invested in accordance with the investment instructions then in effect for your profit sharing account. This is called "diversification." -46- 54 In measuring your period of participation in the ESOP, your participation in the ESOP while it was a separate plan before April 7, 1999 will obviously count; participation in this consolidated plan on and after April 7, 1999 will also count. And since the ESOP was only established effective January 1, 1989, ten years of participation in the ESOP obviously can't happen until the end of 1998. Your "window of opportunity." The opportunity to diversify your employer stock account begins as soon as you have attained age 55 and completed 10 years of participation in the plan (or upon the adoption of this edition of the plan, if later). For example, once this edition of the plan is adopted, if you have already completed 10 years of participation in the plan, it begins on your 55th birthday. On the other hand, if you reach age 55 before you have completed 10 years of participation in the plan, it begins after you have completed 10 years of participation. The opportunity continues for the rest of that plan year (the plan year in which you attained age 55 and completed 10 years of participation) and then for the next six full plan years. EXAMPLE: Your participation in the ESOP began effective January 1, 1989. You remain a participant through December 31, 1998, so that, as of January 1, 1999, you have completed 10 years of participation in the plan. This edition of the plan is adopted on April 7, 1999. Then you attain age 55 on September 12, 1999. You may diversify the investment of your employer stock account beginning on September 12, 1999. The opportunity continues for the rest of the 1999 and then for the next six full plan years, the years 2000, 2001, 2002, 2003, 2004 and 2005. What portion of your account can be diversified. There's a formula to determine what portion of your account can be diversified. It is: - 25% (or, in the case of the last year in which you can diversify, 50%) of the number of shares of stock that have ever been allocated to your account as of the most recent December 31 minus - the number of shares that you have previously asked to have diversified under this section. EXAMPLE: You may diversify the investment of your employer stock account beginning on September 12, 1999. As of December 31, 1998, the total number of shares of stock ever allocated to your account was 100 shares. That means you may diversify up to 25 shares of stock beginning on September 12, 1999. EXAMPLE CONTINUED: Suppose you choose to diversify 10 shares of stock in January of the year 2000. You still have the opportunity to diversify through the year 2005. Suppose that no additional shares are allocated to your account. Since the total number of shares ever allocated to your account is 100 and you have previously chosen to diversify 10 shares, you may diversify up to 15 more shares at any time through the year 2005. EXAMPLE CONTINUED: Suppose you diversify another 15 shares during the year 2001. You have now diversified 25 shares, so you are at the limit of 25%. But in the year 2005, the limit rises to 50%, so during the year 2005, you may diversify up to another 25 shares (for a total of 50 shares out of 100). How. Call the trustee (Fidelity) whenever you are eligible to diversify. The trustee will verify your eligibility against the information provided by the plan administrator, calculate the number of shares that are available to be diversified, and take your direction to diversify part or all of those shares. What happens. After receiving your call, the trustee (Fidelity) will take out of your employer stock account the number of shares that you have chosen to diversify. It will then sell them as soon as administratively -47- 55 possible on the open market. The money that it receives from selling those shares will be deposited in your profit sharing account here in the plan, where it will automatically be invested in accordance with the investment instructions then in effect for your profit sharing account. "NONTERMINABLE" PROTECTIONS AND RIGHTS. With one exception, stock will never be subject to a put, call or other option or a buy-sell or similar arrangement while held by and when distributed from this plan. The exception is that stock may be subject to a put option to the extent provided earlier in the plan in the section called "How Payment Is Made" under the heading "'Put' Option." This prohibition remains effective despite the fact that the ESOP loan has been repaid and regardless of whether the plan remains an ESOP in the future. And the provision of the plan regarding put options also remains effective despite the fact that the ESOP loan has been repaid and regardless of whether the plan remains an ESOP in the future. NON-ALLOCATION UNDER CODE SECTION 409(N). While there is no stock acquired in a transaction for which the seller has elected favorable tax treatment under section 1042 of the Code that remains unallocated at the present time, this section expresses a rule that was applied when the stock was allocated, for historical purposes only. No employer securities, or other assets attributable to or in lieu of such employer securities, acquired in such a transaction may be allocated directly or indirectly, to the Accounts of: - such seller; - any individual who is related to the seller (within the meaning of Section 267(b) of the Code), or - any other individual who owns (directly or by attribution, after the application of section 318(a) of the Code applied without regard to the employee trust exception in section 318(a)(2)(B)(i) of the Code) more than 25% of (A) any class of outstanding stock of the employer or any affiliate, or (B) the total value of any class of outstanding stock of the employer or of any affiliate. The restriction on allocations to persons described in the first or second bullet points shall apply only during a nonallocation period which shall begin on the date of the section 1042 sale and end on the later of (A) the tenth (10th) anniversary of the date of the section 1042 sale, or (B) the date of the allocation attributable to the last payment of principal and/or interest on the exempt loan incurred with respect to the section 1042 sale. The restriction on allocation to persons described in the second bullet point shall not apply to participants who are lineal descendants of the seller, except that the aggregate amount allocated to the benefit of all such lineal descendants during the nonallocation period shall not exceed 5% of the employer securities (or other amounts attributable to or in lieu thereof) held by the trust attributable to a section 1042 sale of employer securities to the trust by any person who is related (within the meaning of section 267(c)(4) to such lineal descendants. An individual shall be restricted under the third bullet point if he or she is described by that clause at any time during the one-year period ending on the date of the section 1042 sale or as of the date employer securities are allocated to participants. -48- 56 MISCELLANEOUS WHAT "PAY" OR "COMPENSATION" MEANS. With the three exceptions noted below in this section, when we refer to your "pay" or "compensation" we mean your taxable wages for the purpose of federal income tax as shown in the box labelled "Wages, Tips, Other Compensation" on your W-2, plus any amounts excluded solely because of the nature or location of the services provided. The period used to determine your pay or compensation for a plan year is the plan year. Adding back salary reduction amounts. "Pay" or "compensation" also includes salary reduction amounts under a cafeteria plan (Code section 125), a 401(k) plan (Code section Code section 402(e)(3)), a tax-sheltered annuity (Code section 403(b)), a simplified employee pension plan (Code section 402(h)) or an eligible deferred compensation plan of a tax-exempt organization (Code section 457). Excluding extraordinary items. For all purposes except the limit described under the heading "Maximum Amount of Total Contributions" and the rules described under the heading "Improvements When the Plan Is Top-Heavy," "pay" or "compensation" does not include: - reimbursements or other expense allowances, - fringe benefits(cash and non-cash), - moving expenses, - deferred compensation, or - welfare benefits. $160,000 limit on compensation. As required by section 401(a)(17) of the Code, compensation in excess of $160,000 (adjusted for the cost of living) is not taken into account for any purpose under this plan. LEASED EMPLOYEES. If the employer previously leased your services from a leasing organization but later you become employed by the employer itself, your length of service includes your service as a leased employee if it was performed at a time when the employer maintained this plan. (When we say "employer," we include related employers, as described above under the heading "How The Length of Your Service Is Calculated".) For this purpose, service as a leased employee is service performed under primary direction or control by the employer, pursuant to an agreement between a leasing organization and the employer, regardless of how long you performed that service. FAMILY AND MEDICAL LEAVE. Any leave to which you are entitled under the federal Family and Medical Leave Act of 1993 will not result in the loss of any "employment benefit" provided by this plan that had accrued prior to the leave and that would not have been lost if you had remained actively at work during the leave. CHANGES IN VESTING SCHEDULE. If the schedule shown at the beginning of the plan in the section called "Quick-Reference Information" under the heading "Length of Service Required for Benefits" is ever changed, there are two limitations. First, the change will never reduce the percentage that applies to your account based on employer contributions that were made on top of your pay through the end of the last year before the change was adopted (or became effective, if later). Second, if you have 3 or more years of service when the change is adopted (or becomes effective, if later), you may nevertheless choose to stay under the schedule that was in effect before the change was made. NON-ALIENATION. Except for domestic relations orders described in the section entitled "Child Support, Alimony and Division of Property in Divorce," your right to benefits under the plan cannot be assigned or alienated. This means you cannot sell your interest in the plan or pledge it as security for a loan. No creditor of yours can take away your interest in the plan. This provision of the plan is intended to comply with, -49- 57 and apply just as broadly and as stringently as, section 206(d) of ERISA and section 401(a)(13) of the Code. PAYMENTS TO MINORS. If the proper recipient of money from the plan is a minor, or if the plan administrator believes the recipient to be legally incompetent to receive it, the plan administrator may direct that the payment be made instead to anyone who has authority over the affairs of the recipient, such as a parent, guardian, or other relative. Payment made in this manner will entirely satisfy the obligation of the plan to pay the money, and the plan administrator will have no responsibility to see what happens to the money after it is paid. UNCLAIMED BENEFITS. People are expected to claim their money from the plan when their employment terminates. It is your responsibility to make the claim; the plan administrator does not have any responsibility to track you down. If you still haven't claimed your money by the time when it must be paid, the plan administrator will make a reasonable effort to locate you (such as inquiring of the employer, sending a letter to your last known address, and inquiring of the Social Security Administration). If the plan administrator still can't find you, the plan administrator will set up an interest-bearing account with a financial institution in your name in order to get your money out of the plan. If no financial institution will set up an account in your name without your participation, the plan administrator will have to assume that you are dead and pay the money in accordance with the death provisions of the plan. PLAN ASSETS SOLE SOURCE OF BENEFITS. The plan assets (held in the trust fund or by an insurance company) are the only source of benefits under the plan. The employer and plan administrator are not responsible to pay benefits from their own money, nor do they guarantee the sufficiency of the trust fund or insurance contracts in any way. NO RIGHT TO EMPLOYMENT. Many of the requirements of the plan depend on your employment status, particularly how long you have worked for the employer. But your employment status is purely a matter between you and your employer; the plan does not change anything. The fact that your rights under the plan might be different if your employment history were different does not give you any different employment rights than if the plan had never existed. PROFIT SHARING AND STOCK BONUS PLAN. This plan is intended to qualify under section 401(a) of the Code as a profit sharing plan with a qualified cash-or-deferred arrangement and, to the extent of the employer stock accounts, as a stock bonus plan. MERGER OF PLAN. The Code requires that the plan contain the following provision (which is also a requirement of ERISA). However, the interpretation and application of this provision are quite different from what it appears to say, and we intend that it be interpreted and applied no more strictly than required by the regulations under the Code: The plan may not merge or consolidate with, or engage in a transfer of assets or liabilities with, any other plan unless the benefit that each participant in this plan would receive if both plans terminated immediately after the transaction is no less than the benefit that the participant would have received if this plan had terminated immediately before the transaction. PROTECTION OF BENEFITS, RIGHTS, AND FEATURES FROM PREVIOUS EDITION OF PLAN. Since this document constitutes an amendment and restatement of the plan, it must preserve, to the minimum extent required by section 411(d)(6) of the Code and Treasury Regulation 1.411(d)-4, all benefits, rights and features required by that Code section and regulation to be protected against reduction. While we believe that this document preserves all such benefits, rights and features, as a failsafe we recite here that the terms of all such benefits, rights, and features, to the extent entitled -50- 58 to protection under this restatement of the plan, are hereby incorporated by reference from the prior plan document. GOVERNING LAW. The plan is subject to ERISA and therefore governed exclusively by federal law except where ERISA provides otherwise. If state law ever applies to the interpretation or application of the plan, it shall be the law of the state where the employer has its principal place of business. NO PBGC COVERAGE. This plan is not covered by the plan termination insurance system established under Title IV of ERISA and administered by the Pension Benefit Guaranty Corporation. As a defined contribution, individual account plan, it is not eligible for coverage under the law. STATEMENT OF ERISA RIGHTS. Regulations of the federal government require that the following "Statement of ERISA Rights" appear in this document, and we are reproducing it here with quotation marks. Not all of the statement is necessarily accurate or applies to this plan. Neither the employer nor the plan administrator takes any responsibility for the accuracy or completeness of this statement, which is made to you by the federal government, not by anyone connected with the plan: "As a participant in this plan, you are entitled to certain rights and protections under the Employee Retirement Income Security Act of 1974 (ERISA). ERISA provides that all plan participants shall be entitled to: "Examine, without charge, at the plan administrator's office and at other specified locations, such as worksites and union halls, all plan documents, including collective bargaining agreements and copies of all documents filed by the plan with the U.S. Department of Labor, such as detailed annual reports and plan descriptions. "Obtain copies of all plan documents and other plan information upon written request to the plan administrator. The administrator may make a reasonable charge for the copies. "Receive a summary of the plan's annual financial report. The plan administrator is required by law to furnish each participant with a copy of this summary annual report. "Obtain a statement telling you whether you have a right to receive a pension at normal retirement age (age 65) and if so, what your benefits would be at normal retirement age if you stopped working under the plan now. If you do not have a right to a pension, the statement will tell you how many more years you have to work to get a right to a pension. This statement must be requested in writing and is not required to be given more than once a year. The plan must provide the statement free of charge. "In addition to creating rights for plan participants, ERISA imposes duties upon the people who are responsible for the operation of the employee benefit plan. The people who operate your plan, called 'fiduciaries' of the plan, have a duty to do so prudently and in the interest of you and other plan participants and beneficiaries. No one, including your employer or any other person, may fire you or otherwise discriminate against you in any way to prevent you from obtaining a pension benefit or exercising your rights under ERISA. If your claim for a pension benefit is denied in whole or in part you must receive a written explanation of the reason for the denial. You have the right to have the plan review and reconsider your claim. Under ERISA, there are steps you can take to enforce the above rights. For instance, if you request materials from the plan and do not receive them within 30 days, you may file suit in a federal court. In such a case, the court may require the plan administrator to provide the materials and pay you up to $100 a day until you receive the materials, unless the materials were not sent because of reasons beyond the control of the administrator. If you have a claim for benefits which is denied or ignored, in whole or in part [and you have exhausted the plan's claim and appeal procedure], you may file suit in a state or federal court. If it should happen that plan fiduciaries misuse the plan's money, or if you are discriminated against for asserting your rights, you may seek assistance from the U.S. Department of Labor, or you may file suit in a federal court. The court will decide who should pay court costs and legal fees. If you are successful the court may order the person you have sued to pay these costs and fees. If you lose, the court may order you to pay these costs and fees, for example, if it finds your claim is frivolous. If you have any questions about this -51- 59 statement or about your rights under ERISA, you should contact the nearest Area Office of the U.S. Labor-Management Services Administration, Department of Labor." Service of legal process may be made on the plan administrator or any trustee. SPECIAL ARRANGEMENTS FOR NEW PARTICIPATING EMPLOYERS INTRODUCTION. When a new school joins the EDMC family, it is sometimes appropriate to make special arrangements for the employees of that school, in order to bring them into this plan in a way that harmonizes with the plan that they were in before. If a special arrangement is made, this section describes it. ILLINOIS INSTITUTE OF ART. In determining the length of your service for getting into this plan (that is, the Retirement Plan) effective January 1, 1996 and for deciding what portion of your account you are entitled to if you leave before age 65, hours of service in the employ of Ray College of Design from January 1, 1995 to November 8, 1995 are taken into account as hours of service under the plan to the same extent as if Ray College of Design had been a participating employer during that period. NEW YORK RESTAURANT SCHOOL. In determining the length of your service for getting into this plan (that is, the Retirement Plan) effective January 1, 1997 and for deciding what portion of your account you are entitled to if you leave before age 65, hours of service in the employ of New York Restaurant School, Inc. from January 1, 1996 to August 2, 1996 are taken into account as hours of service under the plan to the same extent as if New York Restaurant School, Inc. had been a participating employer during that period. In addition, any individual who was an employee of New York Restaurant School, Inc. immediately prior to August 2, 1996 and was eligible to participate in the New York Restaurant School, Inc. 401(k) Profit Sharing Plan and becomes an employee eligible to participate in this plan by reason of New York Restaurant School's becoming a participating employer on or about August 2, 1996 is eligible to participate in this plan effective September 1, 1996 notwithstanding the semi-annual entry dates otherwise provided in the section entitled "How You Get Into the Plan." ART INSTITUTES INTERNATIONAL PORTLAND, INC. In determining the length of your service for getting into this plan (that is, the Retirement Plan) effective April 1, 1998 and for deciding what portion of your account you are entitled to if you leave before age 65, hours of service in the employ of Bassist College from January 1, 1997 to February 26, 1998 are taken into account as hours of service under the plan to the same extent as if Bassist College had been a participating employer during that period. -52- 60 APPENDIX A TO THE EDUCATION MANAGEMENT CORPORATION RETIREMENT PLAN Participating Employers As of April 7, 1999 ------------------------------------------- (* denotes employer that does not participate in ESOP feature)
Art Institute of Atlanta Art Institute of Philadelphia 3376 Peachtree Road, NE 622 Chestnut Street Atlanta, GA 30326 Philadelphia, PA 19103 Art Institute of Dallas Art Institute of Phoenix* 8080 Park Lane, Suite 100 2233 West Dunlap Avenue Dallas, TX 75231 Phoenix, AZ 85021 Art Institute of Ft. Lauderdale Art Institute of Seattle 1799 SE 17th Street 2323 Elliott Avenue Ft. Lauderdale, FL 33316 Seattle, WA 98121 Art Institute of Houston Colorado Institute of Art 1900 Yorktown 200 East 9th Avenue Houston, TX 77056 Denver, CO 80203 Art Institutes International at San Francisco* EDMC OnLine* 101 Jessie Street 6737 West Union Hills Drive San Francisco, CA 94105 Glendale, AZ 85308 (effective December 19, 1997) Illinois Institute of Art at Chicago* Art Institutes International Portland, Inc.* 350 North Orleans, Suite 136-L 2000 Southwest Fifth Avenue Chicago, IL 60654 Portland, OR 97201 (effective April 1, 1998) Illinois Institute of Art at Schaumburg* 1000 Plaza Drive, Suite 1000 Art Institute of Los Angeles* Schaumburg, IL 60173 Santa Monica Business Park, Building T 2950 31st Street, Suite 150 National Center for Paralegal Training Santa Monica, CA 90405 3414 Peachtree Road, N.E., Suite 528 (effective January 13, 1997) Atlanta, GA 30326 Art Institutes International Minnesota, Inc.* National Center for Professional Development 15 South 9th Street University Division LaSalle Building 3414 Peachtree Road, N.E., Suite 528 Minneapolis, MN 55402 Atlanta, GA 30326 (effective January 28, 1997) Mind Leap, Inc.* Art Institute of Pittsburgh 230 West Monroe Street, Suite 2450 526 Penn Avenue Chicago, IL 60606 Pittsburgh, PA 15222 New York Restaurant School* 75 Varick Street, 16th Floor New York, NY 10013
61 APPENDIX B TO THE EDUCATION MANAGEMENT CORPORATION RETIREMENT PLAN Investment Options Effective July 1, 1998 ----------------------------------------- MANAGED INCOME PORTFOLIO (FIDELITY). This is a commingled pool of the Fidelity Group Trust for Employee Benefit Plans. Its objective is to preserve principal while earning interest income. It invests in investment contracts offered by major insurance companies and other approved financial institutions and in certain types of fixed income securities. A small portion of the fund is invested in a money market fund to provide daily liquidity. FIDELITY INTERMEDIATE BOND FUND. This is a mutual fund that invests in all types of U. S. and foreign bonds, including corporate or U. S. government issues. Normally, it selects bonds considered medium to high quality ("investment grade") while maintaining an average maturity of 3 to 10 years. These bond prices will go up and down more than those of short-term bonds. FIDELITY ASSET MANAGER. This is a mutual fund that invests in all three basic types of investments: stocks, bonds and short-term instruments of U. S. and foreign issuers. The managers may gradually shift assets from one type to another based on the current outlook of the various markets. But over the long term, the fund will generally aim for 50% stocks, 40% bonds, and 10% in short-term/money market instruments. FIDELITY ASSET MANAGER: INCOME. This is a mutual fund that invests in all three basic types of investments: stocks, bonds and short-term instruments of U. S. and foreign issuers. Its approach focuses on bonds and short-term investments for current income. The managers may gradually shift assets from one type to another based on the current outlook of the various markets. But over the long term, the fund will generally aim for 20% stocks, 50% bonds, and only 30% in short-term/money market instruments. FIDELITY ASSET MANAGER: GROWTH. This is a mutual fund that invests in all three basic types of investments: stocks, bonds and short-term instruments of U. S. and foreign issuers. Its more aggressive approach focuses on stocks for high potential return. The managers may gradually shift assets from one type to another based on the current outlook of the various markets. But over the long term, the fund will generally aim for 70% stocks, 25% bonds, and only 5% short-term/money market instruments. This is Fidelity's most flexible and aggressive asset allocation fund. SPARTAN U. S. EQUITY INDEX FUND. This fund, managed by Bankers Trust, seeks to provide investment results that correspond to the total return of common stocks publicly traded in the United States. In seeking this objective, the fund attempts to duplicate the composition and total return of the S&P 500. The fund uses an "indexing" approach and allocates its assets similarly to those of the index. The fund's composition may not always be identical to that of the S&P 500. FIDELITY MAGELLAN FUND. This is a growth mutual fund that seeks long-term capital appreciation by investing in the stocks of both well-known and lesser known companies with potentially above-average growth potential and a correspondingly higher level of risk. Securities may be of foreign, domestic, and multinational companies. MAS VALUE PORTFOLIO. This fund, managed by Miller, Anderson & Sherrerd, LLP, invests mostly in common stocks of large undervalued companies. It looks for undervalued companies with potential for growth in stock price. Investments are spread out across different kinds of companies and industries. Share price and return will vary. FIDELITY GROWTH COMPANY FUND. This is a mutual fund that seeks long-term capital appreciation by investing primarily in common stocks and securities convertible into 62 common stocks. It may invest in companies of any size with above-average growth potential, though growth is most often sought in smaller, less well known companies in emerging areas of the economy. The stocks of small companies often involve more risk than those of larger companies. NEUBERGER & BERMAN GENESIS TRUST. This fund invests primarily in common stocks of small-cap companies (those with market capitalizations of $1.5 billion or less at the time of investment). Market capitalization refers to the total market value of a company's outstanding stock. The fund looks for growth potential by investing in strong companies with solid performance histories and a proven management team. The fund diversifies among many companies and industries. FIDELITY WORLDWIDE FUND. This is a mutual fund that seeks growth of capital by investing in securities issued anywhere in the world. Under normal conditions, it will invest in at least three different countries, one of which will be the U. S. The fund will invest in established companies as well as newer or smaller capitalization companies. Foreign investments may pose greater risks and potential rewards than U. S. investments. The risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. EX-10.6 4 DEFERRED COMPENSATION PLAN 1 EXHIBIT 10.06 THE EDUCATION MANAGEMENT CORPORATION DEFERRED COMPENSATION PLAN 2 TABLE OF CONTENTS Welcome to the Plan!....................................................Page 1 Participation................................................................1 Salary Deferrals.............................................................2 Company Credits..............................................................3 Investment Credits...........................................................4 Lack of Funding..............................................................5 Payment of Benefits..........................................................6 Hardship Withdrawals.........................................................8 Administration, Claims and Appeals...........................................9 Miscellaneous...............................................................10 3 WELCOME TO THE PLAN! INTRODUCTION. This is the plan document for the Education Management Corporation Deferred Compensation Plan. This is an unfunded, non-qualified deferred compensation arrangement. The purpose is to allow additional retirement savings for a select group of management or highly compensated employees in view of the restrictions on the contributions that can be made, or benefits that can be accrued, for these employees under tax-qualified retirement plans of the employer. ORDINARY NAMES. In this document, we will call things by their ordinary names. Education Management Corporation will be called "the company." This plan will simply be called "the plan." When we say "you," we mean employees who are eligible to participate in the plan and choose to do so. When we say "the Code," we mean the Internal Revenue Code of 1986, as amended. EFFECTIVE DATE. This document amends and restates the plan effective January 1, 1998. PARTICIPATION COMMITTEE DISCRETION. The Retirement Committee has complete discretion to select employees for participation in this plan. CURRENT CRITERIA. At present, the Retirement Committee has exercised its discretion to make eligible each employee of the company who is: - an elected officer of the company or - chief executive of an operating unit. LEGAL LIMITATION. Despite the discretion of the Retirement Committee and the current criteria just described, no employee will be selected for participation or continued as a participant in this plan if, due to the employee's participation, the plan would fail to qualify as primarily for the purpose of providing deferred compensation to a select group of management or highly compensated employees, within the meaning of sections 201, 301 and 401 of the Employee Retirement Income Security Act of 1974, as amended. PARTICIPATION AGREEMENT. Participation is not automatic if and when you satisfy the current criteria. Instead, employees who satisfy the current criteria will be notified of their eligibility and offered the opportunity to participate. If you wish to participate, you must complete and file with the administrator of the plan a written participation agreement. If you choose to make salary deferrals, the participation agreement will reflect your choice. But in any event, the participation agreement will (i) confirm your participation, (ii) indicate your choice with regard to investment credits on any company credits that may be made, (iii) indicate your choice as to the form of payment - -------------------------------------------------------------------------------- Deferred Compensation Plan Page 1 4 and (iv) designate your beneficiary. ANNUAL DETERMINATION. Eligibility to participate is determined annually. The fact that you were eligible to participate (and did participate) in one year does not automatically entitle you to participate in any future year. Your participation agreement, however, is "evergreen." It remains in effect and governs your choices under the plan during those years when you do participate in the plan, unless and until you change it by completing and filing a new one. SALARY DEFERRALS INTRODUCTION. You may choose to defer a certain percentage of your salary and/or bonus into the plan. If you do, that amount will not be paid to you currently in cash but will be credited to a bookkeeping account in your name under the plan. AMOUNT. There are two possible elements of your choice to defer. Ordinary deferral of salary. First, you may defer a fixed, whole percentage of your salary and/or bonus. The amount of deferral must be at least 1% of your compensation or $1,000, whichever is less. The amount may not be more than 7% of your compensation. Supplemental deferral based on amounts returned under Retirement Plan. Second, entirely separate from the percentage described in the preceding paragraph, you may defer an additional amount of salary equal to all or a portion of any elective contributions (plus interest) that are returned to you from the Education Management Corporation Retirement Plan (we'll just call it the "Retirement Plan") by reason of the non-discrimination requirements of law. That is to say, in a given calendar year, elective contributions made under the Retirement Plan in the preceding year may be returned to you (with interest) because of the non-discrimination requirements of law. If you have elected supplemental deferral under this paragraph, while the elective contributions (and interest) will still be returned to you in cash from the Retirement Plan, an offsetting additional deferral will be taken from your current salary under this plan. The net economic effect will be that the amount remains deferred, but under this plan instead of under the Retirement Plan. You may elect to defer any whole percentage of any such return of elective contributions, from zero to 100%. WRITTEN ELECTION. In order to defer compensation into the plan, you must complete and file with the administrator of the plan a written election. The written election will specify the percentage and whether it applies to salary or bonus or both. The election will also specify whether you wish to defer an additional amount equal to all or any portion of any elective contributions (and interest) that may be returned to you in the particular calendar year. TIMING. In order to defer for a particular calendar year, you must complete and file the written election with the administrator of the plan no later than December 15 of the preceding calendar year. With respect to the additional deferral equal to all or a portion of the elective contributions that may be returned under the Retirement Plan, the timing may require more explanation. An election made by December 15 - -------------------------------------------------------------------------------- Page 2 The Education Management Corporation 5 of Year 1 applies to compensation earned in Year 2. In the case of supplemental deferrals equal to contributions that are returned under the Retirement Plan, the supplemental deferral occurs in Year 2 based on elective contributions that are returned in Year 2 and the deferral is made from compensation earned and otherwise payable in Year 2. This is so even though the contributions returned from the Retirement Plan in Year 2 were made to the Retirement Plan in Year 1. An election of supplemental deferral under this plan must therefore be made before it is known whether elective contributions will be returned from the Retirement Plan at all. The election will therefore be contingent applicable only if and when elective contributions are in fact returned under the Retirement Plan. COMPANY CREDITS INTRODUCTION. Whether or not you choose to defer salary and/or bonus, you may receive company credits under the plan in the following circumstances. MATCHING CONTRIBUTIONS. If you made elective contributions under the Retirement Plan that generated the maximum matching contribution under the Retirement Plan (or your matching contributions did not reach the maximum because your elective contributions reached the dollar limit before the end of the year), you may be entitled to a company credit under this section. If so, you are entitled to a credit under this section if the amount of matching contributions that you received under the Retirement Plan was limited: - by section 410(a)(17) of the Code (which limits compensation taken into account under the Retirement Plan to a stated amount, which was $160,000 in 1998, for example) or - by section 402(g) of the Code (which limits elective contributions under the Retirement Plan to a stated amount, which was $10,000 in 1998, for example). If so, the company will credit you under this plan with an amount equal to the additional matching contribution that you would have received under the Retirement Plan if you had not been so limited. EXAMPLE 1: It is 1998. Your compensation is $200,000. You make elective contributions under the Retirement Plan of 6% of compensation. Since compensation for that purpose is limited by law to $160,000, your elective contributions amount to $9,600. You receive a matching contribution under the Retirement Plan equal to 4% of $160,000, or $7,200. Under this section of this plan, you receive a company credit equal to 4% of $40,000, or $1,800. EXAMPLE 2: Same facts as Example 1, except that you make elective contributions under the Retirement Plan of 4% of compensation. You receive no credit under this section of this plan, because you did not make elective contributions under the Retirement Plan that generated the maximum matching contribution under the Retirement Plan, nor did your matching contributions reach the maximum because your elective contributions reached the dollar limit. EXAMPLE 3: It is 1998. Your compensation is $240,000. You make elective contributions under the Retirement Plan of 6.25% of compensation. Your elective contributions amount - -------------------------------------------------------------------------------- Deferred Compensation Plan Page 3 6 exactly to the limit of $10,000 (6.25% of $160,000). You receive a matching contribution under the Retirement Plan equal to 4 % of $160,000 or $7,200. Under this section of this plan, you receive a company credit equal to 4 % of $80,000, or $3,600. EXAMPLE 4: Same facts as Example 3, except that you make elective contributions under the Retirement Plan of 10% of compensation. As a result, your elective contributions under the Retirement Plan hit the limit of $10,000 after just five months and are shut off. And, as a result, your matching contributions total just $4,500. Under this section of this plan, you receive a company credit equal to $2,700 (the difference between the maximum match under the Retirement Plan and the match you actually received) plus 4 % of $80,000, for a total credit under this section of the plan of $6,300. DISCRETIONARY CONTRIBUTIONS AND FORFEITURES. Your share of company discretionary contributions and forfeitures under the Retirement Plan may be limited by either or both of two legal limits the limit on compensation that may be taken into account under the Retirement Plan (in 1998, $160,000) and the limit under section 415 of the Code on total allocations of contributions and forfeitures under the Retirement Plan and the Education Management Corporation Employee Stock Ownership Plan (which we will call "the ESOP"). If so, the company will credit you under this plan with the discretionary contributions and/or forfeitures that you would have received under the Retirement Plan (if the Retirement Plan had not been subject to those two legal limits) but did not receive under the Retirement Plan. ESOP CONTRIBUTIONS. Your share of company contributions and forfeitures under the ESOP may likewise be limited by the legal limit on compensation taken into account and the limit under section 415 of the Code. If so, the company will credit you under this plan with the contributions and/or forfeitures that you would have received under the ESOP (if the ESOP had not been subject to those two legal limits) but did not receive under the ESOP. These credits are in cash, of course, not stock. INVESTMENT CREDITS INTRODUCTION. The amount that you are entitled to receive under the plan is a function of the salary deferrals that you make, the company credits that you receive under the plan, and investment credits. This section will explain the system of investment credits. HYPOTHETICAL INVESTMENTS. Investment credits are calculated as if the amounts standing to your credit under the plan were invested in one or more of a variety of mutual or collective funds (listed below). While we call them investment "credits," you realize of course that they may be either positive or negative, depending on the performance of the funds that are used as measuring devices. In addition, we want to emphasize that, for legal reasons, the amounts standing to your credit under the plan are nothing more than bookkeeping entries that measure the extent of the company's contractual obligation to pay you under the terms of the plan. That includes the investment credits. You do not have any right to, or interest in, any assets that the company may set aside for this purpose or investment gains on them. YOUR CHOICE. You do, however, have a choice as to the mutual or collective funds that will be used as the measuring stick for the investment credits that will be added to your account. When you first become eligible to participate, you will be asked to choose from among the funds offered under the Retirement Plan. Those choices - -------------------------------------------------------------------------------- Page 4 The Education Management Corporation 7 are shown on Appendix A to the Retirement Plan, which is incorporated here by reference as it may be in effect from time to time. As an exception, the Managed Income Portfolio (Fidelity) is not available under this plan. If for any reason there is no current choice on file for you, the plan hereby requires that the measuring stick be the Fidelity Intermediate Bond Fund, and neither the plan administrator nor any other fiduciary of the plan shall have any authority or discretion to direct otherwise. The same applies to any portion of your choice that becomes out of date, such as if you have chosen a particular fund and that fund is no longer offered (unless a substitute fund is automatically provided). The choice that you make for the amounts currently standing to your credit under the plan need not be the same as the choice you make for future credits. But choices among the funds are not permitted in increments smaller than 10% of the amount to which they apply. STATEMENTS. The administrator of the plan will provide regular statements showing the amounts standing to your credit under the plan. The statements will separately account for salary deferrals, different types of company credits, and investment credits. LACK OF FUNDING INTRODUCTION. We say "credits" in this document deliberately, because this plan involves nothing more than a contractual promise by the company to pay deferred compensation when (and in the amounts) determined under the terms of the plan. Legally, the plan is unfunded and unsecured, as this section will explain. UNFUNDED, UNSECURED PROMISE TO PAY. This plan is unfunded and has no assets. The promise of benefits under the plan is no more than a contractual obligation of the company to be satisfied from its general assets. Participation in the plan gives you nothing more than the company's contractual promise to pay deferred compensation when due in accordance with the terms of this plan. SALARY DEFERRAL. Just to make the point clear once again, if you choose to defer salary under the plan, the amount that you choose to defer is not an "employee contribution" and is not an asset of yours or of the plan. It reflects nothing more than a re-structuring of your compensation arrangement, whereby current compensation is somewhat less and deferred compensation is somewhat more. RESERVES. The company is not required to segregate, maintain or invest any portion of its assets by reason of its contractual commitment to pay deferred compensation under this plan. If the company nevertheless chooses to establish and invest a reserve (as a matter of prudent management of its contractual liability), such reserve remains an asset of the company in which no participating employee has any right, title or interest. Employees entitled to deferred compensation under this plan have the status of general unsecured creditors of the company. RABBI TRUST. Though not required to do so, the company may establish (and has in fact established) a so-called rabbi trust (so named because it was invented by a synagogue and first approved by the IRS for a rabbi). Here is how the rabbi trust works: - The rabbi trust is held by a financial institution as trustee under a detailed, written trust agreement. - -------------------------------------------------------------------------------- Deferred Compensation Plan Page 5 8 - The company contributes cash to the rabbi trust at whatever times and in whatever amounts it chooses. - The assets of the trust are considered to be assets of the company. For example, the investment earnings of the trust are taxable income to the company under the "grantor trust" rules. As noted in the previous section of this plan, no participant or beneficiary of the plan has any right, title or interest in the assets of the rabbi trust. - But under the terms of the rabbi trust, the assets may be used only for the purpose of paying benefits under this plan, barring bankruptcy of the company (or similar events), in which event the assets of the rabbi trust are available not just to participants and beneficiaries of this plan but to all other creditors of the company as well. - To the extent that payments are made to participants and beneficiaries by the trustee from the rabbi trust, those payments are considered payments by the company under the plan and satisfy the company's obligation under the plan. PAYMENT OF BENEFITS INTRODUCTION. This section of the plan explains when you are entitled to payment under the plan, how much, and in what form. NORMAL RETIREMENT. If your employment with the company terminates on or after your 65th birthday, you are entitled to receive payment equal to the total amount standing to your credit under the plan, including salary deferral credits, company credits, and investment credits. EARLY RETIREMENT. If your employment with the company terminates on or after your 55th birthday and you have completed at least 7 years of service with the company (with the meaning of the Retirement Plan), you are entitled to receive payment equal to the total amount standing to your credit under the plan, including salary deferral credits, company credits, and investment credits. DISABILITY. If you become totally and permanently disabled while still employed by the company, you are entitled to receive payment equal to the total amount standing to your credit under the plan, including salary deferral credits, company credits, and investment credits. For this purpose, total and permanent disability means that you are unable to engage in any substantial gainful activity by reason of any physical or mental impairment which is expected to result in death or be of a long, continued and indefinite duration, as certified by a written opinion of a physician selected by the administrator of the plan. DEATH. If you die while still employed by the company, your beneficiary is entitled to receive payment equal to the total amount standing to your credit under the plan, including salary deferral credits, company credits, and investment credits. OTHER TERMINATION OF EMPLOYMENT. If your employment with the company terminates under any circumstances other than those previously listed in this section, you are entitled to receive all of your salary deferral credits and investment credits on them. - -------------------------------------------------------------------------------- Page 6 The Education Management Corporation 9 You are also entitled to receive some or all of the company credits and investment credits on them if you have completed at least 3 years of service (within the meaning of the Retirement Plan). The percentage that you are entitled to receive is determined by the following table: Years of Service Percentage ---------------- ---------- 3 20% 4 40% 5 60% 6 80% 7 or more 100%. FORM OF PAYMENT. The available forms of payment are: - a single payment of cash or - annual installment payments over a period that you choose, as long as it is at least 2 years and not more than 10 years. If you choose installment payments, the unpaid balance of your entitlement will remain in the plan and will remain subject to investment credits. The amount of each annual payment will be the balance then standing to your credit under the plan multiplied by a fraction which is 1 divided by the number of remaining payments. Payment will be made in the form indicated on your original participation agreement. As an exception, you may change the form of payment by indicating a different choice on a subsequent participation agreement, but the new choice will apply only to amounts credited to you under the plan after the new participation agreement is filed with the administrator of the plan. WHEN PAYMENT IS MADE. Ordinarily, payment is made (or, in the case of installments, begun) as soon as administratively feasible after the event triggering payment. On your participation agreement, however, you may choose for payment (or, in the case of installments, the start of payments) to be delayed for a fixed period or until a fixed date. If you die before payment is made in full, the balance of your entitlement will be paid to your beneficiary as soon as administratively feasible. YOUR BENEFICIARY. Your beneficiary is the individual or entity designated on the last participation agreement that was completed and filed with the administrator of the plan before your death. Please note that separation or divorce does not automatically change your designation of beneficiary. It is your responsibility to keep your designation current based on your current circumstances. If no designated beneficiary survives you, your estate will be considered your beneficiary. This might occur if you fail to name a beneficiary or if all of your designated beneficiaries die before you do. If your beneficiary is a minor or legally incompetent, the administrator may, in its discretion, make payment to a legal or natural guardian, other relative, court-appointed representative, or any other adult with whom the minor or incompetent resides. Any payment made in good faith by the administrator will fully discharge the obligation of the plan with regard to that payment, and the administrator will have no duty or responsibility to see to the proper application of any such payment. FORFEITURES. If your employment terminates as described above under the heading "Other termination - -------------------------------------------------------------------------------- Deferred Compensation Plan Page 7 10 of employment" and you are not entitled to 100% of your company credits (and investment credits on them), the balance will be retained on the books of the plan until you have a "Break in Service" within the meaning of the Retirement Plan but will then be permanently forfeited. That is to say, if you return to employment before incurring a "Break in Service," the forfeiture amount will remain in your account and you may be able to earn additional entitlement to that amount with additional years of service. But if you return after incurring a "Break in Service," the forfeiture amount will have been removed from your account and you will never be able to earn any additional entitlement to that amount. HARDSHIP DISTRIBUTIONS INTRODUCTION. Besides the events described in the preceding section of the plan all of which involve termination of employment with the company there is one circumstance in which you may be able to withdraw from the plan while still employed. ADMINISTRATOR'S DISCRETION. The administrator of the plan has discretion to grant an in-service withdrawal in the circumstance where you establish hardship. But hardship withdrawal is limited to your salary deferral credits. That means no company credits and no investment credits on either salary deferral credits or company credits. HARDSHIP. For this purpose, hardship means severe financial hardship to you resulting from: - a sudden and unexpected illness or accident of you or a dependent (within the meaning of section 152(a) of the Code), - loss of your property due to casualty, or - other similar extraordinary and unforeseeable circumstances arising as a result of events beyond your control. The need to send a child to college and the desire to purchase a home do not qualify for a hardship withdrawal. AMOUNT AVAILABLE. The amount available is not more than is reasonably necessary to satisfy the need after exhaustion of other sources such as: - reimbursement or compensation by insurance or otherwise, - liquidation of other assets (except to the extent that such liquidation would itself create a hardship), and - cessation of salary deferrals under this plan. - -------------------------------------------------------------------------------- Page 8 The Education Management Corporation 11 ADMINISTRATION, CLAIMS AND APPEALS INTRODUCTION. The administrator of the plan is the Retirement Committee appointed by the board of directors of the company. The administrator has all rights, duties and powers necessary or appropriate for the administration of the plan. CLAIMS. To claim your money under the plan, file a written claim with the administrator (c/o Education Management Corporation, 300 Sixth Avenue, Pittsburgh, PA 15222). The plan administrator will respond in writing within 90 days and, if the claim is denied, point out the specific reasons and plan provisions on which the denial is based, describe any additional information needed to complete the claim, and describe the appeal procedure. APPEAL. If your claim is denied and you disagree and want to pursue the matter, you must file an appeal in accordance with the following procedure. You cannot take any other steps unless and until you have exhausted the appeal procedure. For example, if your claim is denied and you do not use the appeal procedure, the denial of your claim is conclusive and cannot be challenged, even in court. To file an appeal, write to the administrator stating the reasons why you disagree with the denial of your claim. You must do this within 60 days after the claim was denied. In the appeal process, you have the right to review pertinent documents. You have the right to be represented by anyone else, including a lawyer if you wish. And you have the right to present evidence and arguments in support of your position. The administrator will ordinarily issue a written decision within 60 days. The administrator may extend the time to 120 days as long as it notifies you of the extension within the original 60 days. The administrator may, in its sole discretion, hold a hearing. The decision will explain the reasoning of the administrator and refer to the specific provisions of this plan on which the decision is based. DISCRETIONARY AUTHORITY. The administrator shall have and shall exercise complete discretionary authority to construe, interpret and apply all of the terms of the plan, including all matters relating to eligibility for benefits, amount, time or form of benefits, and any disputed or allegedly doubtful terms. In exercising such discretion, the administrator shall give controlling weight to the intent of the company in establishing the plan. All decisions of the administrator in the exercise of its appellate authority under the plan (or in the exercise of its claims authority, absent an appeal) shall be final and binding on the plan, the company and all participants and beneficiaries. MISCELLANEOUS INTEGRATION. This plan document represents the totality of the company's commitment to provide deferred compensation under this plan. There are no other writings, nor are there any oral representations or understandings, that reflect, add to, subtract from, or alter the terms of this document. AMENDMENT AND TERMINATION. Although the plan was not established with the intention that it be temporary or expire on a certain date, the company reserves the right, in its sole discretion, to amend or terminate the plan at any time, for any reason (or no reason), without notice, retroactively or prospectively. As the only exception to the foregoing authority to amend or terminate, the company may not amend or - -------------------------------------------------------------------------------- Deferred Compensation Plan Page 9 12 terminate the plan in such a way as to reduce the balance that stands to the credit of any participant as of the date of adoption of any such amendment or termination, including salary deferral credits, company credits, and investment credits earned up to that time. EXPENSES. The expenses of the plan will be borne by the company. NON-ALIENATION. As required by the Internal Revenue Service, your right to benefits under this plan is not subject in any manner to anticipation, sale, transfer, assignment, pledge, encumbrance, attachment, garnishment or any other type of alienation, whether initiated by you or by creditors of you or your beneficiary. Any attempt at alienation will simply be void. LIMITATION OF LIABILITY. No director, officer, or other employee of the company shall be personally liable for any action taken or omitted in connection with this plan and its administration unless attributable to his own fraud or willful misconduct. The company hereby agrees to provide insurance to, or otherwise indemnify, every director, officer, and other employee of the company who serves the plan in an administrative or fiduciary capacity against any and all claims, loss, damages, expense, and liability arising from any act or failure to act in that capacity unless there is a final court decision that the person was guilty of gross negligence or willful misconduct. APPLICABLE LAW. This plan will be construed according to the law of the Commonwealth of Pennsylvania to the extent not pre-empted by ERISA. - -------------------------------------------------------------------------------- Page 10 The Education Management Corporation EX-10.9 5 FORM OF EMPLOYMENT AGREEMENT 1 EXHIBIT 10.09 THIRD AMENDED AND RESTATED EMPLOYMENT AGREEMENT WITH ROBERT B. KNUTSON SEPTEMBER 8, 1999 The parties to this Third Amended and Restated Employment Agreement (this "Agreement") are Education Management Corporation, a Pennsylvania corporation (the "Company"), and Robert B. Knutson (the "Executive"). The Company and the Executive currently are parties to the Second Amended and Restated Employment Agreement of Robert B. Knutson dated August 14, 1996 (the "Existing Employment Agreement"). The Executive is presently the Chairman and Chief Executive Officer of the Company and the parties wish to provide for the continued employment of the Executive in such positions. Accordingly, the parties, intending to be legally bound, agree that the Existing Employment Agreement is amended and restated in its entirety as follows: 1. Position and Duties. During the term of the Executive's employment under this Agreement, the Company shall employ the Executive and the Executive shall serve the Company as its Chairman and Chief Executive Officer. He shall report to and otherwise shall be subject to the direction and control of the Board of Directors of the Company. The Executive's duties, titles and responsibilities shall not be changed materially at any time without his consent (which consent shall not be unreasonably withheld). The Executive shall use his best efforts to promote the Company's interests and he shall perform his duties and responsibilities faithfully, diligently and to the best of his ability, consistent with sound business practices. The Executive shall devote his full working time to the business and affairs of the Company, but may engage in such activities that do not, in the reasonable opinion of the Board of Directors of the Company, violate Section 8 or materially interfere with the performance of his obligations to the Company under this Agreement. The Executive shall perform his duties under this Agreement at the Company's principal executive offices in Pittsburgh, Pennsylvania. 2 2. Term of Employment. The term of the Executive's employment by the Company or any direct or indirect subsidiary of the Company under this Agreement shall be for a period of three (3) years commencing on the date of this Agreement (the "Effective Date"), subject to earlier termination under Section 5 or Section 6 or extension of such term as described in the next sentence. The Executive's employment under this Agreement shall renew automatically for successive one-year periods, unless at least one hundred eighty (180) days prior to the third or any subsequent anniversary of the Effective Date (each such anniversary referred to herein as an "Expiration Date") either party shall have given notice to the other party that the term of employment shall terminate on that anniversary date. The term during which the Executive is employed pursuant to this Agreement shall be referred to herein as the "Employment Term." 3. Compensation. 3.1. Base Salary. During the Employment Term, the Executive shall be entitled to receive a base salary ("Base Salary") at the annual rate of not less than $375,000 for services rendered to the Company or any of its direct or indirect subsidiaries and payable in substantially equal biweekly installments. The Executive's Base Salary under this Section 3.1 shall be increased on each July 1 during the Employment Term, beginning on July 1, 2000, by the percentage increase, if any, in the United States Bureau of Labor Statistics Consumer Price Index for Urban Wage Earners and Clerical Workers - all items, for the Pittsburgh Metropolitan Area during the immediately preceding twelve (12) months. The Executive's Base Salary shall be subject to further increases, if any, as may be approved at any time by the Board of Directors of the Company in its discretion, on the recommendation of the Compensation Committee of the Board of Directors. 3.2. Incentive Compensation. During the Employment Term, the Executive also shall be entitled to receive incentive compensation (a "Bonus") in such amounts and at such times as the Board of Directors of the Company (or a duly authorized Compensation Committee of the Board, if applicable) may determine in its discretion to award to him under any incentive compensation or other bonus plan or plans for senior executives of the Company as may be established by the Company from time to time (collectively, the "Executive Bonus Plan"). The -2- 3 amount of any Bonus payable to the Executive under the Executive Bonus Plan shall be paid to the Executive in accordance with the terms of the Executive Bonus Plan. In accordance with the provisions of the Executive Bonus Plan and generally subject to the discretion of the Board of Directors, the Executive shall have an annual target bonus opportunity (a "Bonus Opportunity"). For the Company's fiscal year ending June 30, 2000, the Executive's Bonus Opportunity shall be not less than $400,000, but the actual bonus amount earned and payable shall be contingent on the Executive meeting or exceeding performance standards and goals to be established by the Board of Directors of the Company (or the Compensation Committee, if applicable). For fiscal years beginning after June 30, 2000, the Executive's Bonus Opportunity shall be determined by the Board of Directors of the Company (or a duly authorized Compensation Committee of the Board, if applicable) in its discretion. 4. Expenses and Other Benefits. 4.1. Reimbursement of Expenses. During the Employment Term, the Executive shall be entitled to receive prompt reimbursement for all reasonable expenses incurred by him (in accordance with the policies and practices presently followed by the Company or as may be established by the Board of Directors of the Company for its senior executive officers) in performing services under this Agreement, provided that the Executive properly accounts for such expenses in accordance with the Company's policies. 4.2. Employee Benefits. During the Employment Term, the Executive shall be entitled to participate in and to receive benefits as a senior executive under all of the Company's employee benefit plans, programs and arrangements, as they may be duly amended, approved or adopted by the Board of Directors of the Company as of the Effective Date and from time to time thereafter, including any retirement plan, profit sharing plan, savings plan, life insurance plan, health insurance plan, stock-based compensation or incentive plan, accident or disability insurance plan and any vacation policy. 4.3. Vesting of Stock Options. Any stock options granted to the Executive during the term of the Existing Employment Agreement, to the extent those options have not previously vested or terminated, shall be fully vested and exercisable no later than June 30, 2000. -3- 4 5. Termination of Employment. 5.1. Death. The Executive's employment under this Agreement shall terminate upon his death. 5.2. Termination by the Company. (a) With or Without Cause. Subject to the provisions of Section 5.2(b), the Company may terminate the Executive's employment under this Agreement with or without Cause (as defined below). For purposes of this Agreement, the Company shall have "Cause" to terminate the Executive's employment under this Agreement if (i) the Executive willfully, or as a result of gross negligence on his part, fails substantially to perform and to discharge his duties and responsibilities under this Agreement for any reason other than the Executive's Disability (as defined in Section 6) or (ii) the Executive engages in an action or course of conduct which is unlawful or materially in violation of his obligations to the Company under this Agreement and which is demonstrably and substantially injurious to the Company, or (iii) the Executive deliberately and intentionally violates the provisions of Sections 8.1, 8.2, 8.3 or 8.4. For purposes of this Agreement, a "termination by the Company without Cause" shall include the termination of the Executive's employment on the Expiration Date solely as a result of the Company's electing under Section 2 not to extend the term of the Agreement. (b) Right to Cure. The Executive shall not be deemed to have been terminated for Cause unless and until the occurrence of the following two events: (i) The Executive is given a notice from the Board of Directors of the Company that identifies with reasonable specificity the grounds for the proposed termination of the Executive's employment and notifies the Executive that he shall have an opportunity to address the Board of Directors with respect to the alleged grounds for termination at a meeting of the Board called and held for the purpose of determining whether the Executive engaged in conduct described in Section 5.2. The notice shall, except as is otherwise provided in the last sentence of this Subsection (i), provide the Executive with thirty (30) days from the day such notice is given to cure the alleged grounds of termination contained in this Agreement. The Board of Directors shall determine, reasonably and in good faith, whether the Executive has -4- 5 effectively cured the alleged grounds of termination. If the grounds for termination are limited to acts or conduct described in Subsections (ii) or (iii) of Section 5.2(a), and in the reasonable good faith opinion of the Board of Directors those grounds may not reasonably be cured by the Executive, then the notice required by this Section 5.2(b)(i) need not provide for any cure period; and (ii) The Executive is given a copy of certified resolutions, duly adopted by the affirmative vote of not less than a majority of the entire membership of the Board of Directors (excluding the Executive, if applicable) at a meeting of the Board of Directors called and held for the purpose of finding that, in the reasonable good faith opinion of a majority of the Board of Directors, the Executive was guilty of conduct set forth in Section 5.2, which specify in detail the grounds for termination and indicate that the grounds for termination have not been cured within the time limits, if any, specified in the notice referred to in Section 5.2(b)(i). 5.3. Termination by the Executive. The Executive may terminate his employment under this Agreement with or without Good Reason (as defined below). If such termination is with Good Reason, the Executive shall give the Company notice, which shall identify with reasonable specificity the grounds for the Executive's resignation and provide the Company with thirty (30) days from the day such notice is given to cure the alleged grounds for resignation contained in the notice. In the event that the Executive fails to give such notice and the Executive's employment under this Agreement in fact terminates at the initiation of the Executive, such termination shall be deemed a termination by the Executive without Good Reason. For purposes of this Agreement, "Good Reason" shall mean any of the following to which the Executive shall not consent in writing: (i) a reduction in the Executive's Base Salary, (ii) a reduction in the amount of the Executive's annual Bonus Opportunity of more than 20% of the Applicable Base Period Bonus Opportunity (as defined below), including a material change in the individual performance goals applicable to the Executive's annual Bonus Opportunity that (A) as of the date of such change, makes achievement of those goals highly unlikely even if the Executive performs his obligations under this Agreement, and (B) would result in a reduction in the annual Bonus Opportunity of more than such 20% amount, (iii) a relocation of the -5- 6 Executive's primary place of employment from his current place of employment as described in Section 1, (iv) any change or diminution in offices, titles, status or reporting requirements in the Executive's specific executive officer position, other than an insubstantial and inadvertent act that is remedied by the Company promptly after receipt of notice given by the Executive, or (v) on or after a Change in Control (as defined in Section 7.3(d)), in addition to those events stated above, a material reduction in the Executive's actual annual Bonus. For purposes of this Agreement, "Applicable Base Period Bonus Opportunity" means (A) with respect to the annual Bonus Opportunity for any fiscal year ending on or prior to June 30, 2002, the annual Bonus Opportunity in effect for fiscal year 2000, and (B) with respect to the annual Bonus Opportunity for any fiscal year ending after June 30, 2002, the average annual Bonus Opportunity in effect for the three preceding fiscal years. 5.4. Date of Termination. "Date of Termination" shall mean the earlier of (a) the "Expiration Date" (as defined in Section 2) and (b) if the Executive's employment is terminated (i) by his death, the date of his death, or (ii) pursuant to the provisions of Section 5.2 or Section 5.3, as the case may be, the date on which the Executive's employment with the Company actually terminates. 6. Disability. The Executive shall be determined to be "Disabled" (and the provisions of this Section 6 shall be applicable) if the Executive is unable to perform his duties under this Agreement on essentially a full-time basis for six (6) consecutive months by reason of a physical or mental condition (a "Disability") and, within thirty (30) days after the Company gives notice to the Executive that it intends to replace him due to his Disability, the Executive shall not have returned to the performance of his duties on essentially a full-time basis. Upon a determination that the Executive is Disabled, the Company may replace the Executive without breaching this Agreement; provided, however, that this Agreement shall not terminate until the Expiration Date next following the date that the Executive is determined to be Disabled. Prior to such Expiration Date, the Executive shall continue to be entitled to the compensation and benefits provided in Sections 3 and 4; provided, however, that the Company shall be entitled to offset against the amounts payable by the Company to the Executive under this Agreement the amount of benefits -6- 7 received by the Executive from third parties under long-term disability plans carried by the Company (if any) and that in no event shall the total annual obligation of the Company under this Agreement to make Base Salary payments to the Executive during a period of his Disability be greater than an amount equal to two-thirds (2/3) of the Executive's Base Salary, beginning in the year in which the Executive is replaced in accordance with this Section 6, and continuing until the earlier of the year in which the Expiration Date occurs or the year in which the Executive dies. 7. Compensation Upon Termination. 7.1. Death. If the Executive's employment under this Agreement is terminated by reason of his death, the Company shall continue to pay the Executive's Base Salary at the rate in effect at the time of his death to such person or persons as the Executive shall have designated for that purpose in a notice filed with the Company, or, if no such person shall have been so designated, to his estate, for a period of six (6) months after the Executive's date of death. The Company also shall pay to such person(s) or estate, (a) the amount of the Executive's Accrued Obligations (as defined below), and (b) an amount equal to one-twelfth (1/12) of the Executive's average annual Bonus paid or payable under Section 3.2 with respect to the most recent three (3) full fiscal years or, if greater, the most recent twelve (12)-month period (in each case, determined by annualizing the bonus paid or payable with respect to any partial fiscal year) (the "Average Bonus"), that amount being payable in each of the six (6) months following the Date of Termination. Any amounts payable under this Section 7.1 shall be exclusive of and in addition to any payments which the Executive's widow, beneficiaries or estate may be entitled to receive pursuant to any pension plan, profit sharing plan, employee benefit plan, or life insurance policy maintained by the Company. For purposes of this Agreement, the Executive's "Accrued Obligations" means, as of the Date of Termination, any accrued but unpaid Base Salary, accrued Bonus (including (1) any accrued but unpaid Bonus (if any) with respect to the fiscal year prior to the year in which the Date of Termination occurs, and (2) the amount of the Executive's Average Bonus multiplied by a fraction, the numerator of which is the number of days from the first day of the fiscal year of the Company in which such termination occurs through and -7- 8 including the Date of Termination and the denominator of which is 365 (the "Pro Rata Bonus")) and any accrued but unpaid cash entitlements. 7.2. By the Company for Cause or the Executive Without Good Reason. If the Executive's employment is terminated by the Company for Cause, or if the Executive terminates his employment other than for Good Reason, the Company shall pay to the Executive the amount of any Accrued Obligations within 30 days of the Date of Termination and the Company thereafter shall have no further obligation to the Executive under this Agreement, other than for payment of any amounts accrued and vested under any employee benefit plans or programs of the Company. 7.3. By the Executive for Good Reason or the Company other than for Cause. (a) Termination Prior to a Change in Control. (i) Severance Benefits. Subject to the provisions of Section 7.3(a)(ii) and Section 7.3(c), if, prior to (and not in anticipation of) or more than two (2) years after a Change in Control (as defined in Section 7.3(d)), the Company terminates the Executive's employment without Cause, or the Executive terminates his employment for Good Reason, then the Executive shall be entitled to the following benefits (the "Severance Benefits"): (A) the amount of his Accrued Obligations, that amount being payable in a single lump sum cash payment within thirty (30) days of the Date of Termination; (B) a cash amount equal to the sum of (1) one-twelfth (1/12) of the Executive's Base Salary at the highest rate in effect at any time during the twelve (12)-month period prior to the Date of Termination, and (2) one-twelfth (1/12) of the Executive's Average Bonus, that total amount being payable in each of the twelve (12) months following the month in which the Date of Termination occurs; (C) all welfare benefits, including (to the extent applicable) medical, dental, vision, life and disability benefits pursuant to plans maintained by the Company under which the Executive and/or the Executive's family is eligible to receive benefits and/or coverage, shall be continued for the twelve (12)-month period following the Date of Termination, with such benefits provided to the Executive at no less than the same coverage level -8- 9 as in effect as of the Date of Termination and the Executive shall pay any portion of such cost as was required to be borne by key executives of the Company generally on the Date of Termination; provided, however, that, notwithstanding the foregoing, the benefits described in this Section 7.3(a)(i)(C) may be discontinued prior to the end of the period provided in this Subsection (C) to the extent, but only to the extent, that the Executive receives substantially similar benefits from a subsequent employer; (D) key executive outplacement services in accordance with Company policies for senior executives as in effect on the Date of Termination (or, at the request of the Executive, a lump sum payment in lieu thereof, in an amount determined by the Company to be equal to the estimated cost of those services); and (E) notwithstanding any provisions of any applicable stock option plan and agreement(s) to the contrary, any nonvested stock options held by the Executive as of the Date of Termination shall become vested and immediately exercisable by the Executive as of the Date of Termination. (ii) Conditions to Receipt of Severance Benefits under Section 7.3(a). As a condition to receiving any Severance Benefits (other than any Accrued Obligations) to which the Executive may otherwise be entitled under this Section 7.3(a) only, the Executive shall execute a release (the "Release"), in a form and substance reasonably satisfactory to the Company, of any claims, whether arising under Federal, state or local statute, common law or otherwise, against the Company and its direct or indirect subsidiaries which arise or may have arisen on or before the date of the Release, other than any claims under this Agreement or any rights to indemnification from the Company and its direct or indirect subsidiaries pursuant to any provisions of the Company's (or any of its subsidiaries') articles of incorporation or by-laws or any directors and officers liability insurance policies maintained by the Company. If the Executive fails or otherwise refuses to execute a Release within a reasonable time after the Company's request to do so, the Executive will not be entitled to any Severance Benefits or any other benefits provided under this Agreement and the Company shall have no further obligations with respect to the payment of the Severance Benefits. In addition, if, following a termination of -9- 10 employment that gives the Executive a right to the payment of Severance Benefits under Section 7.3(a), the Executive engages in any activities that would have violated any of the covenants in Section 8.3 (had those covenants been applicable), the Executive shall have no further right or claim to any Severance Benefits (other than any Accrued Obligations) to which the Executive may otherwise be entitled under this Section 7.3(a) from and after the date on which the Executive engages in such activities and the Company shall have no further obligations with respect to the payment of the Severance Benefits. (b) Termination In Anticipation of or After a Change in Control. (i) Change in Control Severance Benefits. Subject to the provisions of Section 7.3(c), if, in anticipation of (as defined below) or within a two (2) year period following the occurrence of a Change in Control, the Company terminates the Executive's employment without Cause, or the Executive terminates his employment for Good Reason, then the Executive shall be entitled to the following benefits (the "Change in Control Severance Benefits"): (A) the sum of his Accrued Obligations, that amount being payable in a single lump sum cash payment within thirty (30) days of the Date of Termination; (B) a cash amount equal to twenty-four (24) times the sum of (1) one-twelfth (1/12) of the Executive's Base Salary at the highest rate in effect at any time during the twelve (12)-month period prior to the Date of Termination, and (2) one-twelfth (1/12) of the Executive's Average Bonus, that total amount being payable in a single lump sum cash payment within thirty (30) days of the Date of Termination; (C) all welfare benefits, including (to the extent applicable) medical, dental, vision, life and disability benefits pursuant to plans maintained by the Company under which the Executive and/or the Executive's family is eligible to receive benefits and/or coverage, shall be continued for the twenty-four (24) month period following the Date of Termination, with such benefits provided to the Executive at no less than the same coverage level as in effect as of the Date of Termination and the Executive shall pay any portion of such cost as was required to be borne by key executives of the Company generally on the Date of -10- 11 Termination; provided, however, that, notwithstanding the foregoing, the benefits described in this Section 7.3(b)(i)(C) may be discontinued prior to the end of the period provided in this Subsection (C) to the extent, but only to the extent, that the Executive receives substantially similar benefits from a subsequent employer; (D) key executive outplacement services in accordance with Company policies for senior executives as in effect on the Date of Termination (or, at the request of the Executive, a lump sum payment in lieu thereof, in an amount determined by the Company to be equal to the estimated cost of those services); (E) notwithstanding any provisions of any applicable stock option plan and agreement(s) to the contrary, all unexercised stock options held by the Executive as of the Date of Termination shall become fully vested and shall be immediately exercisable by the Executive; and (F) notwithstanding any provisions of the Supplemental Executive Retirement Plan ("SERP") in which the Executive is a participant to the contrary, the Executive shall be deemed fully vested and entitled to an immediate lump sum distribution of his benefit under the SERP, calculated as if the Executive had been employed during the twenty-four (24) month period following the Date of Termination and had received compensation as provided under Section 3 for that period. (ii) Definition of In Anticipation Of. For purposes of this Section 7.3, the termination of the Executive's employment shall be deemed to have been "in anticipation of" a Change in Control if such termination (A) was at the request of an unrelated third party who has taken steps reasonably calculated to effect a Change in Control, or (B) otherwise arose in connection with a Change in Control. (c) Superseding Termination. If, subsequent to the giving by either party of a notice of termination under this Agreement and prior to the actual Date of Termination pursuant to such notice, the Executive's employment is properly terminated pursuant to any other provision of this Agreement, the Executive shall be entitled only to those benefits, if any, arising out of such subsequent and superseding termination. -11- 12 (d) Definition of Change in Control. For purposes of this Agreement, a "Change in Control" shall mean, and shall be deemed to have occurred upon the occurrence of, any one of the following events: (i) The acquisition in one or more transactions by any individual, entity (including any employee benefit plan or any trust for an employee benefit plan) or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of shares or other securities (as defined in Section 3(a)(10) of the Exchange Act) representing 50% or more of either (1) the shares of common stock of the Company (the "Company Common Stock") or (2) the combined voting power of the securities of the Company entitled to vote generally in the election of directors (the "Company Voting Securities"), in each case calculated on a fully-diluted basis in accordance with generally accepted accounting principles after giving effect to the acquisition; provided, however, that none of the following acquisitions shall constitute a Change in Control as defined in this clause (i): (A) any acquisition by any shareholder or group consisting solely of shareholders of the Company immediately prior to the date of this Agreement or (B) any acquisition by the Company so long as such acquisition does not result in any Person (other than any shareholder or shareholders of the Company immediately prior to the date of this Agreement), beneficially owning shares or securities representing 50% or more of either the Company Common Stock or Company Voting Securities; or (ii) Any election has occurred of persons to the Board that causes two-thirds of the Board to consist of persons other than (A) persons who were members of the Board on the date of this Agreement and (B) persons who were nominated for elections as members of the Board at a time when two-thirds of the Board consisted of persons who were members of the Board on the date of this Agreement; provided, however, that any person nominated for election by a Board at least two-thirds of whom constituted persons described in clauses (A) and/or (B) or by persons who were themselves nominated by such Board shall, for -12- 13 this purpose, be deemed to have been nominated by a Board composed of persons described in clause (A); (iii) The shareholder rights plan of the Company is triggered and the Board fails to redeem the rights within the time provided for in the rights agreement; (iv) Approval by the shareholders of the Company of a reorganization, merger, consolidation or similar transaction (a "Reorganization Transaction"), in each case, unless, immediately following such Reorganization Transaction, more than 50% of, respectively, the outstanding shares of common stock (or similar equity security) of the corporation or other entity resulting from or surviving such Reorganization Transaction and the combined voting power of the securities of such corporation or other entity entitled to vote generally in the election of directors, in each case calculated on a fully-diluted basis in accordance with generally accepted accounting principles after giving effect to such Reorganization Transaction, is then beneficially owned, directly or indirectly, by the shareholders of the Company immediately prior to such approval; or (v) Approval by the shareholders of the Company of (A) a complete liquidation or dissolution of the Company or (B) the sale or other disposition of all or substantially all of the assets of the Company, other than to a corporation or other entity, with respect to which immediately following such sale or other disposition more than 50% of, respectively, the shares of common stock (or similar equity security) of such corporation or other entity and the combined voting power of the securities of such corporation or other entity entitled to vote generally in the election of directors, in each case calculated on a fully-diluted basis in accordance with generally accepted accounting principles after giving effect to such sale or other disposition, is then beneficially owned, directly or indirectly, by the shareholders of the Company immediately prior to such approval. 7.4. No Mitigation. The Executive shall not be required to mitigate the amount of any payment or benefit provided for in this Section 7 by seeking other employment or otherwise, and, except as otherwise expressly provided in Sections 7.3(a)(i)(C) and 7.3(b)(i)(C), the amounts of compensation or benefits payable or otherwise due to the Executive under this Section 7 or other -13- 14 provisions of this Agreement shall not be reduced by compensation or benefits received by the Executive from any other employment he shall choose to undertake following termination of his employment under this Agreement; provided, however, that the Executive's entitlement to Severance Benefits or Change in Control Severance Benefits, as the case may be, shall be subject to his compliance with the covenants set forth in Section 8. 7.5. Certain Additional Payments by the Company. (a) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any economic benefit, payment or distribution by the Company to or for the benefit of the Employee, whether paid, payable, distributed or distributable pursuant to the terms of this Agreement or otherwise (a "Payment"), would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"), or any interest or penalties with respect to such excise tax (such excise tax and any applicable interest and penalties, collectively referred to in this Agreement as the "Excise Tax"), then the Executive shall be entitled to receive an additional payment (a "Gross-Up-Payment") in an amount such that after payment by the Executive of all applicable taxes (including any interest or penalties imposed with respect to such taxes), the Executive retains an amount equal to the amount he would have retained had no Excise Tax been imposed upon the Payment. (b) Subject to the provisions of Section 7.5(c), all determinations required to be made under this Section 7.5, including whether a Gross-Up Payment is required and the amount of such Gross-Up Payment, shall be made by the Company's regular outside independent public accounting firm (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the Date of Termination, if applicable, or such earlier time as is requested by the Company. The initial Gross-Up Payment, if any, as determined pursuant to this Section 7.5, shall be paid to the Executive within 5 business days of the receipt of the Accounting Firm's determination. If the Accounting Firm determines that no Excise Tax is payable by the Executive, it shall furnish the Executive with an opinion that he has substantial authority not to report any Excise Tax on his federal income tax return. Any determination by the Accounting Firm shall be binding upon the -14- 15 Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm, it is possible that Gross-Up Payments that have not been made by the Company should have been made ("Underpayment"), consistent with the calculations required to be made under this Section 7.5(b). In the event that the Company exhausts its remedies pursuant to Section 7.5(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. (c) The Executive shall notify the Company of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment under the terms of this Section 7.5. This notice shall be given as soon as practicable but no later than ten business days after the later of either (i) the date the Executive has actual knowledge of the claim, or (ii) ten days after the Internal Revenue Service issues to the Executive either a written report proposing imposition of the Excise Tax or a statutory notice of deficiency with respect to the Excise Tax, and shall apprise the Company of the nature of the claim and the date on which the claim is requested to be paid. The Executive shall not pay the claim prior to the expiration of the thirty-day period following the date on which he gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to the claim is due). If the Company notifies the Executive prior to the expiration of the above period that it desires to contest the claim, the Executive shall: (A) give the Company any information reasonably requested by the Company relating to the claim, (B) take such action in connection with contesting the claim as the Company shall reasonably request in writing from time to time, including accepting legal representation with respect to the claim by an attorney reasonably selected by the Company, (C) cooperate with the Company in good faith in order to effectively contest the claim, (D) permit the Company to participate in any proceedings relating to the claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income -15- 16 tax, including interest and penalties with respect thereto, imposed as a result of such representation and payment of costs and expenses. Without limitation of the foregoing provisions of this Section 7.5(c), the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of the claim and may, at its sole option, either direct the Executive to request or accede to a request for an extension of the statute of limitations with respect only to the tax claimed, or pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay the claim and sue for a refund, the Company shall advance the amount of the required payment to the Executive, on an interest-free basis and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax, including interest or penalties with respect thereto, imposed with respect to any advance or with respect to any imputed income in relation to any advance; and further provided that any extension of the statute of limitations requested or acceded to by the Executive at the Company's request and relating to payment of taxes for the taxable year of the Executive with respect to which the contested amount is claimed to be due is limited solely to the contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable under the Agreement and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (d) If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 7.5(c), the Executive becomes entitled to receive any refund with respect to the claim, the Executive shall (subject to the Company's complying with the requirements of Section 7.5(c)) promptly pay to the Company the amount of that refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 7.5(c), a -16- 17 determination is made that the Executive shall not be entitled to any refund with respect to the claim and the Company does not notify the Executive of its intent to contest such denial of refund prior to the expiration of thirty days after the determination, then the advance shall be forgiven and shall not be required to be repaid and the amount of the advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. (e) In the event that any state or municipality or subdivision thereof shall subject any Payment to any special tax which shall be in addition to the generally applicable income tax imposed by the state, municipality, or subdivision with respect to receipt of the Payment, the foregoing provisions of this Section 7.5 shall apply, mutatis mutandis, with respect to such special tax. 7.6. Severance Benefits Not Includable for Employee Benefits Purposes. Subject to all applicable federal and state laws and regulations, income recognized by the Executive pursuant to the provisions of this Section 7 (other than income accrued but unpaid as of the Date of Termination) shall not be included in the determination of benefits under any employee benefit plan (as that term is defined in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended) or any other benefit plans, policies or programs applicable to the Executive that are maintained by the Company or any of its direct or indirect subsidiaries and the Company shall be under no obligation to continue to offer or provide such benefits to the Executive after the Date of Termination other than as provided under this Section 7 or to the extent to which any benefit under a pertinent plan has accrued as of the Date of Termination. 7.7. Exclusive Benefits. The Severance Benefits payable under Section 7.3(a) and the Change in Control Severance Benefits payable under Section 7.3(b), if either benefits become applicable under the terms of this Agreement, shall be mutually exclusive and shall be in lieu of any other severance or similar benefits that would otherwise be payable under any other agreement, plan, program or policy of the Company. 8. Restrictive Covenants. 8.1. Confidentiality. The Executive recognizes that the services to be performed by him under this Agreement are special, unique and extraordinary in that, by reason of his -17- 18 employment with the Company, he may acquire confidential information and trade secrets concerning the operation of the Company or an Affiliate (as defined below), the use or disclosure of which could cause the Company or an Affiliate substantial loss and damages which could not be readily calculated and for which no remedy at law would be adequate. For purposes of this Section 8, the term "Affiliate" means any direct or indirect subsidiary of the Company, including any individual, partnership, firm, corporation or other business organization or entity that controls, is controlled by, or is under common control with, the Company. Accordingly, during the Employment Term and at all times thereafter, the Executive covenants and agrees with the Company that he shall not at any time, except in the performance of his obligations to the Company under this Agreement or with the prior written consent of the Board of Directors of the Company, directly or indirectly, disclose any secret or confidential information that he may learn or has learned by reason of his association with the Company, or any predecessors to their business, or use any such information to the detriment of the Company. The term "confidential information" includes information not previously disclosed to the public or to the trade by the Company's management or otherwise known by the public or the trade with respect to the Company's products, facilities and methods, research and development, trade secrets and other intellectual property, systems, patents and patent applications, procedures, manuals, confidential reports, product price lists, customer lists, financial information (including the revenues, costs or profits associated with any of the Company's products), business plans, prospects or opportunities; provided, however, that the term "confidential information" shall not include, and the Executive shall have no obligation under this Agreement with respect to, any information that (a) becomes generally available to the public other than as a result of a disclosure by the Executive or his agent or other representative or (b) becomes available to the Executive on a non-confidential basis from a source other than the Company or any Affiliate. The Executive shall have no obligation under this Agreement to keep confidential any of the confidential information to the extent that a disclosure of it is required by law or is consented to by the Company; provided, however, that if and when such a disclosure is required by law, the Executive promptly -18- 19 shall provide the Company with notice of such requirement, so that the Company may seek an appropriate protective order. 8.2. Exclusive Property. The Executive confirms that all confidential information is the exclusive property of the Company. All business records, papers and documents kept or made by the Executive relating to the business of the Company or its direct or indirect subsidiaries shall be and remain the property of the Company or the applicable subsidiary during the Employment Term and at all times thereafter. Upon the termination of his employment with the Company or upon the request of the Company at any time, the Executive shall promptly deliver to the Company, and shall retain no copies of, any written materials, records and documents made by the Executive or coming into his possession concerning the business or affairs of the Company or its direct or indirect subsidiaries; provided, however, that the Executive shall be permitted to retain copies of any documents or materials of a personal nature or otherwise related to the Executive's rights under this Agreement. 8.3. Non Competition. During the Employment Term and, except as provided in the last sentence of this Section 8.3, for a period of one (1) year after the Date of Termination, the Executive shall not, unless he receives the prior written consent of the Company, directly or indirectly, own an interest in, manage, operate, join, control, lend money or render financial or other assistance to, participate in or be connected with, as an officer, employee, partner, stockholder, consultant or otherwise, or engage in any activity or capacity (collectively, the "Competitive Activities") with respect to any individual, partnership, limited liability company, firm, corporation or other business organization or entity (each, a "Person"), that is engaged directly or indirectly in the ownership or operation of proprietary post-secondary schools or that is in competition with any of the business activities of the Company or its direct or indirect subsidiaries either (i) anywhere in the United States or (ii) in any other country in which the Company or its direct or indirect subsidiaries conduct, or actively intend to conduct, business as of the Date of Termination; provided, however, that the foregoing (a) shall not apply with respect to any line-of-business in which the Company or its direct or indirect subsidiaries was not engaged on or before the Expiration Date or the Date of Termination, as the case may be, and (b) -19- 20 shall not prohibit the Executive from owning, or otherwise having an interest in, less than one percent (1%) of any publicly-owned entity or three percent (3%) of any private equity fund or similar investment fund that invests in education companies, provided the Executive has no active role with respect to any investment by such fund in any Person referred to in this Section 8.3. The Executive shall not be subject to the covenants contained in this Section 8.3 and such covenants shall not be enforceable against the Executive from and after the date that the Executive's employment is terminated (i) by the Company without Cause, (ii) by the Executive for Good Reason or (iii) in anticipation of or within two (2) years after a Change in Control. 8.4. Non-Solicitation. During the Term of the Executive's Employment and for a period of one (1) year after the Date of Termination, the Executive shall not, whether for his own account or for the account of any other Person (other than the Company or its direct or indirect subsidiaries), intentionally solicit, endeavor to entice away from the Company or its direct or indirect subsidiaries, or otherwise interfere with the relationship of the Company or its direct or indirect subsidiaries with, any person who is employed by the Company or its direct or indirect subsidiaries (including, but not limited to, any independent sales representatives or organizations). 8.5. Injunctive Relief. Subject to the exceptions contained in Section 8.3, the Executive acknowledges that a breach of any of the covenants contained in this Section 8 may result in material, irreparable injury to the Company for which there is no adequate remedy at law, that it shall not be possible to measure damages for such injuries precisely and that, in the event of such a breach or threat of breach, the Company shall be entitled to obtain a temporary restraining order and/or a preliminary or permanent injunction restraining the Executive from engaging in activities prohibited by this Section 8 or such other relief as may be required to specifically enforce any of the covenants in this Section 8. The Executive agrees and consents that injunctive relief may be sought in any state or federal court of record in the Commonwealth of Pennsylvania, or in the state and county in which a violation may occur or in any other court having jurisdiction, at the election of the Company; to the extent that the Company seeks a temporary restraining order (but not a preliminary or permanent injunction), the Executive agrees -20- 21 that a temporary restraining order may be obtained ex parte. The Executive agrees and submits to personal jurisdiction before each and every court designated above for that purpose. 8.6. Blue-Pencilling. The parties consider the covenants and restrictions contained in this Section 8 to be reasonable. However, if and when any such covenant or restriction is found to be void or unenforceable and would have been valid had some part of it been deleted or had its scope of application been modified, such covenant or restriction shall be deemed to have been applied with such modification as would be necessary and consistent with the intent of the parties to have made it valid, enforceable and effective. 9. Miscellaneous. 9.1. Assignment; Successors; Binding Agreement. This Agreement may not be assigned by either party, whether by operation of law or otherwise, without the prior written consent of the other party, except that any right, title or interest of the Company arising out of this Agreement may be assigned to any corporation or entity controlling, controlled by, or under common control with the Company, or succeeding to the business and substantially all of the assets of the Company or any affiliates for which the Executive performs substantial services; provided, however, that no such assignment shall relieve the Company of its obligations hereunder without the express written consent of the Executive. Subject to the foregoing, this Agreement shall be binding upon and shall inure to the benefit of the parties and their respective heirs, legatees, devisees, personal representatives, successors and assigns. 9.2. Modification and Waiver. No provision of this Agreement may be modified, waived, or discharged unless such waiver, modification or discharge is duly approved by the Board of Directors of the Company and is agreed to in writing by the Executive and such officer(s) as may be specifically authorized by the Board of Directors of the Company to effect it. No waiver by any party of any breach by any other party of, or of compliance with, any term or condition of this Agreement to be performed by any other party, at any time, shall constitute a waiver of similar or dissimilar terms or conditions at that time or at any prior or subsequent time. 9.3. Entire Agreement. No agreement or representation, oral or otherwise, express or implied, with respect to the subject matter of this Agreement, has been made by either party -21- 22 which is not set forth expressly in this Agreement. Further, this Agreement shall amend and supersede any and all previously existing employment or consulting agreements between the Executive and the Company or any of its direct or indirect subsidiaries or affiliates. 9.4. Governing Law. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the Commonwealth of Pennsylvania other than the conflict of laws provision thereof. 9.5. Arbitration. In the event of any dispute, controversy or claim between the Company and the Executive arising out of or relating to the interpretation, application or enforcement of any provision of this Agreement (other than with respect to provisions under Section 8 of this Agreement), either the Company or the Executive may, by written notice to the other, require such dispute or difference to be submitted to arbitration. The arbitrator or arbitrators shall be selected by agreement of the parties or, if they do not agree on an arbitrator or arbitrators within 30 days after one party has notified the other of his or its desire to have the question settled by arbitration, then the arbitrator or arbitrators shall be selected by the American Arbitration Association (the "AAA") in Pittsburgh, Pennsylvania. The determination reached in such arbitration shall be final and binding on all parties without any right of appeal or further dispute. Execution of the determination by such arbitrator may be sought in any court of competent jurisdiction. The arbitrators shall not be bound by judicial formalities and may abstain from following the strict rules of evidence and shall interpret this Agreement as an honorable engagement and not merely as a legal obligation. Unless otherwise agreed by the parties, any such arbitration shall take place in Pittsburgh, Pennsylvania, and shall be conducted in accordance with the Commercial Arbitration Rules of the AAA. 9.6. Consent to Jurisdiction and Service of Process. In the event of any dispute, controversy or claim between the Company and the Executive arising out of or relating to the interpretation, application or enforcement of the provisions of Section 8 or Section 9.5, the Company and the Executive agree and consent to the personal jurisdiction of the Court of Common Pleas for Allegheny County, Pennsylvania and/or the United States District Court for the Western District of Pennsylvania for resolution of the dispute, controversy or claim, and that -22- 23 those courts, and only those courts, shall have exclusive jurisdiction to determine any dispute, controversy or claim related to, arising under or in connection with Section 8 of this Agreement. The Company and the Executive also agree that those courts are convenient forums for the parties to any such dispute, controversy or claim and for any potential witnesses and that process issued out of any such court or in accordance with the rules of practice of that court may be served by mail or other forms of substituted service to the Company at the address of its principal executive offices and to the Executive at his or her last known address as reflected in the Company's records. 9.7. Withholding of Taxes. The Company shall withhold from any amounts payable under the Agreement all Federal, state, local or other taxes as legally shall be required to be withheld. 9.8. Notice. For the purposes of this Agreement, notices and all other communications to either party provided for in this Agreement shall be furnished in writing and shall be deemed to have been duly given when delivered or when mailed if such mailing is by United States certified or registered mail, return receipt requested, postage prepaid, addressed to such party (notices to the Company being addressed to the Secretary of the Company) at the Company's principal executive office, or at other address as either party shall have designated by giving written notice of such change to the other party at anytime hereafter. 9.9. Severability. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 9.10. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together shall constitute one and the same instrument. 9.11. Headings. The headings used in this Agreement are for convenience only, do not constitute a part of the Agreement, and shall not be deemed to limit, characterize, or affect in any way the provisions of the Agreement, and all provisions of the Agreement shall be construed as if no headings had been used in the Agreement. -23- 24 9.12. Construction. As used in this Agreement, unless the context otherwise requires: (a) the terms defined herein shall have the meanings set forth herein for all purposes; (b) references to "Section" are to a section hereof; (c) all "Schedules" referred to herein are incorporated herein by reference and made a part hereof; (d) "include," "includes" and "including" are deemed to be followed by "without limitation" whether or not they are in fact followed by such words or words of like import; (e) "writing," "written" and comparable terms refer to printing, typing, lithography and other means of reproducing words in a visible form; (f) "hereof," "herein," "hereunder" and comparable terms refer to the entirety of this Agreement and not to any particular section or other subdivision hereof or attachment hereto; (g) references to any gender include references to all genders; and (h) references to any agreement or other instrument or statute or regulation are referred to as amended or supplemented from time to time (and, in the case of a statute or regulation, to any successor provision). IN WITNESS WHEREOF, the parties have duly executed this Agreement on the date and year first above written. EDUCATION MANAGEMENT CORPORATION By: /s/ James J. Burke, Jr. ------------------------- James J. Burke, Jr. Chairman of the Compensation Committee EXECUTIVE /s/ Robert B. Knutson ----------------------- Robert B. Knutson -24- EX-10.10 6 FORM OF EMPLOYMENT AGREEMENT 1 EXHIBIT 10.10 EMPLOYMENT AGREEMENT WITH [NAME](1) September 8, 1999(2) The parties to this Employment Agreement (this "Agreement") are Education Management Corporation, a Pennsylvania corporation (the "Company"), and [Name] (the "Executive"). The Executive is presently the [title] (3) of the Company and the parties wish to provide for the continued employment of the Executive as an executive officer of the Company. Accordingly, the parties, intending to be legally bound, agree as follows: 1. Position and Duties. During the term of the Executive's employment under this Agreement, the Company shall employ the Executive and the Executive shall serve the Company as an executive officer. As of the date of this Agreement, the Executive is the [title shown in note 3] of the Company. He shall report to the Chief Executive Officer of the Company and otherwise shall be subject to the direction and control of the Board of Directors of the Company. The Executive shall use his best efforts to promote the Company's interests and he shall perform his duties and responsibilities faithfully, diligently and to the best of his ability, consistent with sound business practices. The Executive shall devote his full working time to the business and affairs of the Company, but may engage in such activities that do not, in the reasonable opinion of the Board of Directors of the Company, violate Section 8 or materially interfere with the performance of his obligations to the Company under this Agreement. - -------- (1) As executed by each of Messrs. Robert P. Gioella, Robert T. McDowell, John R. McKernan, Jr. and David J. Pauldine in identical form except as otherwise indicated in these notes. (2) The date of Mr. McKernan's agreement is June 4, 1999. (3) Mr. Gioella: President and Chief Operating Officer; Mr. McDowell: Executive Vice President and Chief Financial Officer; Mr. McKernan: Vice Chairman; Mr. Pauldine: Executive Vice President. 2 The Executive shall perform his duties under this Agreement at the Company's principal executive offices in Pittsburgh, Pennsylvania.(4) 2. Term of Employment. The term of the Executive's employment by the Company or any direct or indirect subsidiary of the Company under this Agreement shall be for a period of three (3) years commencing on the date of this Agreement (the "Effective Date"), subject to earlier termination under Section 5 or Section 6 or extension of such term as described in the next sentence. The Executive's employment under this Agreement shall renew automatically for successive one-year periods, unless at least one hundred eighty (180) days prior to the third or any subsequent anniversary of the Effective Date (each such anniversary referred to herein as an "Expiration Date") either party shall have given notice to the other party that the term of employment shall terminate on that anniversary date. The term during which the Executive is employed pursuant to this Agreement shall be referred to herein as the "Employment Term." 3. Compensation. 3.1. Base Salary. During the Employment Term, the Executive shall be entitled to receive a base salary ("Base Salary") at the annual rate of not less than $_______(5) for services rendered to the Company or any of its direct or indirect subsidiaries and payable in substantially equal biweekly installments. The Executive's Base Salary under this Section 3.1 shall be increased on each July 1 during the Employment Term, beginning on July 1, 2000, by the percentage increase, if any, in the United States Bureau of Labor Statistics Consumer Price Index for Urban Wage Earners and Clerical Workers - all items, for the Pittsburgh Metropolitan Area during the immediately preceding twelve (12) months. The Executive's Base Salary shall be subject to further increases, if any, as may be approved at any time by the Board of Directors of the Company in its discretion, on the recommendation of the Compensation Committee of the Board of Directors. - -------- (4) Mr. McKernan's agreement states that he will perform his duties primarily in Washington, D.C. and Portland, Maine, with the likelihood of substantial business travel, including regular travel to and from the Company's principal executive offices in Pittsburgh, Pennsylvania. (5) Mr. Gioella: $250,000; Mr. McDowell: $200,000; Mr. McKernan: $200,000; Mr. Pauldine: $200,000. -2- 3 3.2. Incentive Compensation. During the Employment Term, the Executive also shall be entitled to receive incentive compensation (a "Bonus") in such amounts and at such times as the Board of Directors of the Company (or a duly authorized Compensation Committee of the Board, if applicable) may determine in its discretion to award to him under any incentive compensation or other bonus plan or plans for senior executives of the Company as may be established by the Company from time to time (collectively, the "Executive Bonus Plan"). The amount of any Bonus payable to the Executive under the Executive Bonus Plan shall be paid to the Executive in accordance with the terms of the Executive Bonus Plan. In accordance with the provisions of the Executive Bonus Plan and generally subject to the discretion of the Board of Directors, the Executive shall have an annual target bonus opportunity (a "Bonus Opportunity"). For the Company's fiscal year ending June 30, 2000, the Executive's Bonus Opportunity shall be not less than $_______,(6) but the actual bonus amount earned and payable shall be contingent on the Executive meeting or exceeding performance standards and goals to be established by the Board of Directors of the Company (or the Compensation Committee, if applicable). For fiscal years beginning after June 30, 2000, the Executive's Bonus Opportunity shall be determined by the Board of Directors of the Company (or a duly authorized Compensation Committee of the Board, if applicable) in its discretion. 4. Expenses and Other Benefits. 4.1. Reimbursement of Expenses. During the Employment Term, the Executive shall be entitled to receive prompt reimbursement for all reasonable expenses incurred by him (in accordance with the policies and practices presently followed by the Company or as may be established by the Board of Directors of the Company for its senior executive officers) in performing services under this Agreement, provided that the Executive properly accounts for such expenses in accordance with the Company's policies. 4.2. Employee Benefits. During the Employment Term, the Executive shall be entitled to participate in and to receive benefits as a senior executive under all of the Company's - -------- (6) Mr. Gioella: $200,000; Mr. McDowell: $140,000; Mr. McKernan: $150,000; Mr. Pauldine: $140,000. -3- 4 employee benefit plans, programs and arrangements, as they may be duly amended, approved or adopted by the Board of Directors of the Company as of the Effective Date and from time to time thereafter, including any retirement plan, profit sharing plan, savings plan, life insurance plan, health insurance plan, stock-based compensation or incentive plan, accident or disability insurance plan and any vacation policy. 5. Termination of Employment. 5.1. Death. The Executive's employment under this Agreement shall terminate upon his death. 5.2. Termination by the Company. (a) With or Without Cause. Subject to the provisions of Section 5.2(b), the Company may terminate the Executive's employment under this Agreement with or without Cause (as defined below). For purposes of this Agreement, the Company shall have "Cause" to terminate the Executive's employment under this Agreement if (i) the Executive willfully, or as a result of gross negligence on his part, fails substantially to perform and to discharge his duties and responsibilities under this Agreement for any reason other than the Executive's Disability (as defined in Section 6) or (ii) the Executive engages in an action or course of conduct which is unlawful or materially in violation of his obligations to the Company under this Agreement and which is demonstrably and substantially injurious to the Company, or (iii) the Executive deliberately and intentionally violates the provisions of Sections 8.1, 8.2, 8.3 or 8.4. For purposes of this Agreement, a "termination by the Company without Cause" shall include the termination of the Executive's employment on the Expiration Date solely as a result of the Company's electing under Section 2 not to extend the term of the Agreement. (b) Right to Cure. The Executive shall not be deemed to have been terminated for Cause unless and until the occurrence of the following two events: (i) The Executive is given a notice from the Board of Directors of the Company that identifies with reasonable specificity the grounds for the proposed termination of the Executive's employment and notifies the Executive that he shall have an opportunity to address the Board of Directors with respect to the alleged grounds for termination at a meeting of -4- 5 the Board called and held for the purpose of determining whether the Executive engaged in conduct described in Section 5.2. The notice shall, except as is otherwise provided in the last sentence of this Subsection (i), provide the Executive with thirty (30) days from the day such notice is given to cure the alleged grounds of termination contained in this Agreement. The Board of Directors shall determine, reasonably and in good faith, whether the Executive has effectively cured the alleged grounds of termination. If the grounds for termination are limited to acts or conduct described in Subsections (ii) or (iii) of Section 5.2(a), and in the reasonable good faith opinion of the Board of Directors those grounds may not reasonably be cured by the Executive, then the notice required by this Section 5.2(b)(i) need not provide for any cure period; and (ii) The Executive is given a copy of certified resolutions, duly adopted by the affirmative vote of not less than a majority of the entire membership of the Board of Directors (excluding the Executive, if applicable) at a meeting of the Board of Directors called and held for the purpose of finding that, in the reasonable good faith opinion of a majority of the Board of Directors, the Executive was guilty of conduct set forth in Section 5.2, which specify in detail the grounds for termination and indicate that the grounds for termination have not been cured within the time limits, if any, specified in the notice referred to in Section 5.2(b)(i). 5.3. Termination by the Executive. The Executive may terminate his employment under this Agreement with or without Good Reason (as defined below). If such termination is with Good Reason, the Executive shall give the Company notice, which shall identify with reasonable specificity the grounds for the Executive's resignation and provide the Company with thirty (30) days from the day such notice is given to cure the alleged grounds for resignation contained in the notice. In the event that the Executive fails to give such notice and the Executive's employment under this Agreement in fact terminates at the initiation of the Executive, such termination shall be deemed a termination by the Executive without Good Reason. For purposes of this Agreement, "Good Reason" shall mean any of the following to which the Executive shall not consent in writing: (i) a reduction in the Executive's Base Salary, (ii) a reduction in the amount of the Executive's annual Bonus Opportunity of more than 20% of -5- 6 the Applicable Base Period Bonus Opportunity (as defined below), including a material change in the individual performance goals applicable to the Executive's annual Bonus Opportunity that (A) as of the date of such change, makes achievement of those goals highly unlikely even if the Executive performs his obligations under this Agreement, and (B) would result in a reduction in the annual Bonus Opportunity of more than such 20% amount, (iii) a relocation of the Executive's primary place of employment to a location more than fifty (50) miles from his place of employment as described in Section 1, (iv) the reassignment of the Executive to a position that is not an executive officer level position or the assignment of duties that are not consistent with such a position, or (v) on or after a Change in Control (as defined in Section 7.3(d)), in addition to those events stated above, a material reduction in the Executive's actual annual Bonus or any diminution in offices, titles, status or reporting requirements in the Executive's specific executive officer position from those in effect as of one hundred eighty (180) days prior to the Change in Control, other than an insubstantial and inadvertent act that is remedied by the Company promptly after receipt of notice given by the Executive. For purposes of this Agreement, "Applicable Base Period Bonus Opportunity" means (A) with respect to the annual Bonus Opportunity for any fiscal year ending on or prior to June 30, 2002, the annual Bonus Opportunity in effect for fiscal year 2000, and (B) with respect to the annual Bonus Opportunity for any fiscal year ending after June 30, 2002, the average annual Bonus Opportunity in effect for the three preceding fiscal years. 5.4. Date of Termination. "Date of Termination" shall mean the earlier of (a) the "Expiration Date" (as defined in Section 2) and (b) if the Executive's employment is terminated (i) by his death, the date of his death, or (ii) pursuant to the provisions of Section 5.2 or Section 5.3, as the case may be, the date on which the Executive's employment with the Company actually terminates. 6. Disability. The Executive shall be determined to be "Disabled" (and the provisions of this Section 6 shall be applicable) if the Executive is unable to perform his duties under this Agreement on essentially a full-time basis for six (6) consecutive months by reason of a physical or mental condition (a "Disability") and, within thirty (30) days after the Company gives notice -6- 7 to the Executive that it intends to replace him due to his Disability, the Executive shall not have returned to the performance of his duties on essentially a full-time basis. Upon a determination that the Executive is Disabled, the Company may replace the Executive without breaching this Agreement; provided, however, that this Agreement shall not terminate until the Expiration Date next following the date that the Executive is determined to be Disabled. Prior to such Expiration Date, the Executive shall continue to be entitled to the compensation and benefits provided in Sections 3 and 4; provided, however, that the Company shall be entitled to offset against the amounts payable by the Company to the Executive under this Agreement the amount of benefits received by the Executive from third parties under long-term disability plans carried by the Company (if any) and that in no event shall the total annual obligation of the Company under this Agreement to make Base Salary payments to the Executive during a period of his Disability be greater than an amount equal to two-thirds (2/3) of the Executive's Base Salary, beginning in the year in which the Executive is replaced in accordance with this Section 6, and continuing until the earlier of the year in which the Expiration Date occurs or the year in which the Executive dies. 7. Compensation Upon Termination. 7.1. Death. If the Executive's employment under this Agreement is terminated by reason of his death, the Company shall continue to pay the Executive's Base Salary at the rate in effect at the time of his death to such person or persons as the Executive shall have designated for that purpose in a notice filed with the Company, or, if no such person shall have been so designated, to his estate, for a period of six (6) months after the Executive's date of death. The Company also shall pay to such person(s) or estate, (a) the amount of the Executive's Accrued Obligations (as defined below), and (b) an amount equal to one-twelfth (1/12) of the Executive's average annual Bonus paid or payable under Section 3.2 with respect to the most recent three (3) full fiscal years or, if greater, the most recent twelve (12)-month period (in each case, determined by annualizing the bonus paid or payable with respect to any partial fiscal year) (the "Average Bonus"), that amount being payable in each of the six (6) months following the Date of Termination. Any amounts payable under this Section 7.1 shall be exclusive of and in addition -7- 8 to any payments which the Executive's widow, beneficiaries or estate may be entitled to receive pursuant to any pension plan, profit sharing plan, employee benefit plan, or life insurance policy maintained by the Company. For purposes of this Agreement, the Executive's "Accrued Obligations" means, as of the Date of Termination, any accrued but unpaid Base Salary, accrued Bonus (including (1) any accrued but unpaid Bonus (if any) with respect to the fiscal year prior to the year in which the Date of Termination occurs, and (2) the amount of the Executive's Average Bonus multiplied by a fraction, the numerator of which is the number of days from the first day of the fiscal year of the Company in which such termination occurs through and including the Date of Termination and the denominator of which is 365 (the "Pro Rata Bonus")) and any accrued but unpaid cash entitlements. 7.2. By the Company for Cause or the Executive Without Good Reason. If the Executive's employment is terminated by the Company for Cause, or if the Executive terminates his employment other than for Good Reason, the Company shall pay to the Executive the amount of any Accrued Obligations within 30 days of the Date of Termination and the Company thereafter shall have no further obligation to the Executive under this Agreement, other than for payment of any amounts accrued and vested under any employee benefit plans or programs of the Company. 7.3. By the Executive for Good Reason or the Company other than for Cause. (a) Termination Prior to a Change in Control. (i) Severance Benefits. Subject to the provisions of Section 7.3(a)(ii) and Section 7.3(c), if, prior to (and not in anticipation of) or more than two (2) years after a Change in Control (as defined in Section 7.3(d)), the Company terminates the Executive's employment without Cause, or the Executive terminates his employment for Good Reason, then the Executive shall be entitled to the following benefits (the "Severance Benefits"): (A) the amount of his Accrued Obligations, that amount being payable in a single lump sum cash payment within thirty (30) days of the Date of Termination; (B) a cash amount equal to the sum of (1) one-twelfth (1/12) of the Executive's Base Salary at the highest rate in effect at any time during the twelve (12)-month -8- 9 period prior to the Date of Termination, and (2) one-twelfth (1/12) of the Executive's Average Bonus, that total amount being payable in each of the twelve (12) months following the month in which the Date of Termination occurs; (C) all welfare benefits, including (to the extent applicable) medical, dental, vision, life and disability benefits pursuant to plans maintained by the Company under which the Executive and/or the Executive's family is eligible to receive benefits and/or coverage, shall be continued for the twelve (12)-month period following the Date of Termination, with such benefits provided to the Executive at no less than the same coverage level as in effect as of the Date of Termination and the Executive shall pay any portion of such cost as was required to be borne by key executives of the Company generally on the Date of Termination; provided, however, that, notwithstanding the foregoing, the benefits described in this Section 7.3(a)(i)(C) may be discontinued prior to the end of the period provided in this Subsection (C) to the extent, but only to the extent, that the Executive receives substantially similar benefits from a subsequent employer; (D) key executive outplacement services in accordance with Company policies for senior executives as in effect on the Date of Termination (or, at the request of the Executive, a lump sum payment in lieu thereof, in an amount determined by the Company to be equal to the estimated cost of those services); and (E) notwithstanding any provisions of any applicable stock option plan and agreement(s) to the contrary, and, to the extent necessary, any such plan and agreement(s) are hereby amended such that, any stock options granted by the Company to the Executive prior to September 10, 1998 and held by the Executive as of the Date of Termination, to the extent those options were not forfeited under the terms of the applicable plan and agreement(s) prior to the Date of Termination, that are or would have otherwise vested pursuant to the vesting schedule applicable to such options on or before the next applicable vesting date following the Date of Termination shall become fully vested as of the Date of Termination, and shall be exercisable pursuant to the provisions of the applicable plan and agreement(s); and -9- 10 (F) notwithstanding any provisions of any applicable stock option plan and agreement(s) to the contrary, and, to the extent necessary, any such plan and agreement(s) are hereby amended such that, any stock options granted by the Company to the Executive on September 10, 1998 and held by the Executive as of the Date of Termination, to the extent those options were not forfeited under the terms of the applicable plan and agreement(s) prior to the Date of Termination, shall continue to vest (to the extent those options are not vested as of the Date of Termination) pursuant to the vesting schedule applicable to such options during the twelve (12)-month period following the Date of Termination and such options, whether vested or unvested, shall terminate upon the first anniversary of the Date of Termination or the last day of the option term under the applicable option agreement, whichever is earlier (further, any option agreement entered into between the Company and the Executive after the Effective Date shall contain provisions no less favorable to the Executive than those contained in this Section 7.3(a)(i)(F)). (ii) Conditions to Receipt of Severance Benefits under Section 7.3(a). As a condition to receiving any Severance Benefits (other than any Accrued Obligations) to which the Executive may otherwise be entitled under this Section 7.3(a) only, the Executive shall execute a release (the "Release"), in a form and substance reasonably satisfactory to the Company, of any claims, whether arising under Federal, state or local statute, common law or otherwise, against the Company and its direct or indirect subsidiaries which arise or may have arisen on or before the date of the Release, other than any claims under this Agreement or any rights to indemnification from the Company and its direct or indirect subsidiaries pursuant to any provisions of the Company's (or any of its subsidiaries') articles of incorporation or by-laws or any directors and officers liability insurance policies maintained by the Company. If the Executive fails or otherwise refuses to execute a Release within a reasonable time after the Company's request to do so, the Executive will not be entitled to any Severance Benefits or any other benefits provided under this Agreement and the Company shall have no further obligations with respect to the payment of the Severance Benefits. In addition, if, following a termination of employment that gives the Executive a right to the payment of Severance Benefits under Section -10- 11 7.3(a), the Executive engages in any activities that would have violated any of the covenants in Section 8.3 (had those covenants been applicable), the Executive shall have no further right or claim to any Severance Benefits (other than any Accrued Obligations) to which the Executive may otherwise be entitled under this Section 7.3(a) from and after the date on which the Executive engages in such activities and the Company shall have no further obligations with respect to the payment of the Severance Benefits. (b) Termination In Anticipation of or After a Change in Control. (i) Change in Control Severance Benefits. Subject to the provisions of Section 7.3(c), if, in anticipation of (as defined below) or within a two (2) year period following the occurrence of a Change in Control, the Company terminates the Executive's employment without Cause, or the Executive terminates his employment for Good Reason, then the Executive shall be entitled to the following benefits (the "Change in Control Severance Benefits"): (A) the sum of his Accrued Obligations, that amount being payable in a single lump sum cash payment within thirty (30) days of the Date of Termination; (B) a cash amount equal to twenty-four (24) times the sum of (1) one-twelfth (1/12) of the Executive's Base Salary at the highest rate in effect at any time during the twelve (12)-month period prior to the Date of Termination, and (2) one-twelfth (1/12) of the Executive's Average Bonus, that total amount being payable in a single lump sum cash payment within thirty (30) days of the Date of Termination; (C) all welfare benefits, including (to the extent applicable) medical, dental, vision, life and disability benefits pursuant to plans maintained by the Company under which the Executive and/or the Executive's family is eligible to receive benefits and/or coverage, shall be continued for the twenty-four (24) month period following the Date of Termination, with such benefits provided to the Executive at no less than the same coverage level as in effect as of the Date of Termination and the Executive shall pay any portion of such cost as was required to be borne by key executives of the Company generally on the Date of Termination; provided, however, that, notwithstanding the foregoing, the benefits described in -11- 12 this Section 7.3(b)(i)(C) may be discontinued prior to the end of the period provided in this Subsection (C) to the extent, but only to the extent, that the Executive receives substantially similar benefits from a subsequent employer; (D) key executive outplacement services in accordance with Company policies for senior executives as in effect on the Date of Termination (or, at the request of the Executive, a lump sum payment in lieu thereof, in an amount determined by the Company to be equal to the estimated cost of those services); (E) notwithstanding any provisions of any applicable stock option plan and agreement(s) to the contrary, all unexercised stock options held by the Executive as of the Date of Termination shall become fully vested and shall be immediately exercisable by the Executive; and (F) notwithstanding any provisions of the Supplemental Executive Retirement Plan ("SERP") in which the Executive is a participant to the contrary, the Executive shall be deemed fully vested and entitled to an immediate lump sum distribution of his benefit under the SERP, calculated as if the Executive had been employed during the twenty-four (24) month period following the Date of Termination and had received compensation as provided under Section 3 for that period. (ii) Definition of In Anticipation Of. For purposes of this Section 7.3, the termination of the Executive's employment shall be deemed to have been "in anticipation of" a Change in Control if such termination (A) was at the request of an unrelated third party who has taken steps reasonably calculated to effect a Change in Control, or (B) otherwise arose in connection with a Change in Control. (c) Superseding Termination. If, subsequent to the giving by either party of a notice of termination under this Agreement and prior to the actual Date of Termination pursuant to such notice, the Executive's employment is properly terminated pursuant to any other provision of this Agreement, the Executive shall be entitled only to those benefits, if any, arising out of such subsequent and superseding termination. -12- 13 (d) Definition of Change in Control. For purposes of this Agreement, a "Change in Control" shall mean, and shall be deemed to have occurred upon the occurrence of, any one of the following events: (i) The acquisition in one or more transactions by any individual, entity (including any employee benefit plan or any trust for an employee benefit plan) or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of shares or other securities (as defined in Section 3(a)(10) of the Exchange Act) representing 50% or more of either (1) the shares of common stock of the Company (the "Company Common Stock") or (2) the combined voting power of the securities of the Company entitled to vote generally in the election of directors (the "Company Voting Securities"), in each case calculated on a fully-diluted basis in accordance with generally accepted accounting principles after giving effect to the acquisition; provided, however, that none of the following acquisitions shall constitute a Change in Control as defined in this clause (i): (A) any acquisition by any shareholder or group consisting solely of shareholders of the Company immediately prior to the date of this Agreement or (B) any acquisition by the Company so long as such acquisition does not result in any Person (other than any shareholder or shareholders of the Company immediately prior to the date of this Agreement), beneficially owning shares or securities representing 50% or more of either the Company Common Stock or Company Voting Securities; or (ii) Any election has occurred of persons to the Board that causes two-thirds of the Board to consist of persons other than (A) persons who were members of the Board on the date of this Agreement and (B) persons who were nominated for elections as members of the Board at a time when two-thirds of the Board consisted of persons who were members of the Board on the date of this Agreement; provided, however, that any person nominated for election by a Board at least two-thirds of whom constituted persons described in clauses (A) and/or (B) or by persons who were themselves nominated by such Board shall, for -13- 14 this purpose, be deemed to have been nominated by a Board composed of persons described in clause (A); (iii) The shareholder rights plan of the Company is triggered and the Board fails to redeem the rights within the time provided for in the rights agreement; (iv) Approval by the shareholders of the Company of a reorganization, merger, consolidation or similar transaction (a "Reorganization Transaction"), in each case, unless, immediately following such Reorganization Transaction, more than 50% of, respectively, the outstanding shares of common stock (or similar equity security) of the corporation or other entity resulting from or surviving such Reorganization Transaction and the combined voting power of the securities of such corporation or other entity entitled to vote generally in the election of directors, in each case calculated on a fully-diluted basis in accordance with generally accepted accounting principles after giving effect to such Reorganization Transaction, is then beneficially owned, directly or indirectly, by the shareholders of the Company immediately prior to such approval; or (v) Approval by the shareholders of the Company of (A) a complete liquidation or dissolution of the Company or (B) the sale or other disposition of all or substantially all of the assets of the Company, other than to a corporation or other entity, with respect to which immediately following such sale or other disposition more than 50% of, respectively, the shares of common stock (or similar equity security) of such corporation or other entity and the combined voting power of the securities of such corporation or other entity entitled to vote generally in the election of directors, in each case calculated on a fully-diluted basis in accordance with generally accepted accounting principles after giving effect to such sale or other disposition, is then beneficially owned, directly or indirectly, by the shareholders of the Company immediately prior to such approval. 7.4. No Mitigation. The Executive shall not be required to mitigate the amount of any payment or benefit provided for in this Section 7 by seeking other employment or otherwise, and, except as otherwise expressly provided in Sections 7.3(a)(i)(C) and 7.3(b)(i)(C), the amounts of compensation or benefits payable or otherwise due to the Executive under this Section 7 or other -14- 15 provisions of this Agreement shall not be reduced by compensation or benefits received by the Executive from any other employment he shall choose to undertake following termination of his employment under this Agreement; provided, however, that the Executive's entitlement to Severance Benefits or Change in Control Severance Benefits, as the case may be, shall be subject to his compliance with the covenants set forth in Section 8. 7.5. Certain Additional Payments by the Company. (a) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any economic benefit, payment or distribution by the Company to or for the benefit of the Employee, whether paid, payable, distributed or distributable pursuant to the terms of this Agreement or otherwise (a "Payment"), would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code"), or any interest or penalties with respect to such excise tax (such excise tax and any applicable interest and penalties, collectively referred to in this Agreement as the "Excise Tax"), then the Executive shall be entitled to receive an additional payment (a "Gross-Up-Payment") in an amount such that after payment by the Executive of all applicable taxes (including any interest or penalties imposed with respect to such taxes), the Executive retains an amount equal to the amount he would have retained had no Excise Tax been imposed upon the Payment. (b) Subject to the provisions of Section 7.5(c), all determinations required to be made under this Section 7.5, including whether a Gross-Up Payment is required and the amount of such Gross-Up Payment, shall be made by the Company's regular outside independent public accounting firm (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the Date of Termination, if applicable, or such earlier time as is requested by the Company. The initial Gross-Up Payment, if any, as determined pursuant to this Section 7.5, shall be paid to the Executive within 5 business days of the receipt of the Accounting Firm's determination. If the Accounting Firm determines that no Excise Tax is payable by the Executive, it shall furnish the Executive with an opinion that he has substantial authority not to report any Excise Tax on his federal income tax return. Any determination by the Accounting Firm shall be binding upon the -15- 16 Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm, it is possible that Gross-Up Payments that have not been made by the Company should have been made ("Underpayment"), consistent with the calculations required to be made under this Section 7.5(b). In the event that the Company exhausts its remedies pursuant to Section 7.5(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. (c) The Executive shall notify the Company of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment under the terms of this Section 7.5. This notice shall be given as soon as practicable but no later than ten business days after the later of either (i) the date the Executive has actual knowledge of the claim, or (ii) ten days after the Internal Revenue Service issues to the Executive either a written report proposing imposition of the Excise Tax or a statutory notice of deficiency with respect to the Excise Tax, and shall apprise the Company of the nature of the claim and the date on which the claim is requested to be paid. The Executive shall not pay the claim prior to the expiration of the thirty-day period following the date on which he gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to the claim is due). If the Company notifies the Executive prior to the expiration of the above period that it desires to contest the claim, the Executive shall: (A) give the Company any information reasonably requested by the Company relating to the claim, (B) take such action in connection with contesting the claim as the Company shall reasonably request in writing from time to time, including accepting legal representation with respect to the claim by an attorney reasonably selected by the Company, (C) cooperate with the Company in good faith in order to effectively contest the claim, (D) permit the Company to participate in any proceedings relating to the claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income -16- 17 tax, including interest and penalties with respect thereto, imposed as a result of such representation and payment of costs and expenses. Without limitation of the foregoing provisions of this Section 7.5(c), the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of the claim and may, at its sole option, either direct the Executive to request or accede to a request for an extension of the statute of limitations with respect only to the tax claimed, or pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay the claim and sue for a refund, the Company shall advance the amount of the required payment to the Executive, on an interest-free basis and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax, including interest or penalties with respect thereto, imposed with respect to any advance or with respect to any imputed income in relation to any advance; and further provided that any extension of the statute of limitations requested or acceded to by the Executive at the Company's request and relating to payment of taxes for the taxable year of the Executive with respect to which the contested amount is claimed to be due is limited solely to the contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable under the Agreement and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (d) If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 7.5(c), the Executive becomes entitled to receive any refund with respect to the claim, the Executive shall (subject to the Company's complying with the requirements of Section 7.5(c)) promptly pay to the Company the amount of that refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 7.5(c), a -17- 18 determination is made that the Executive shall not be entitled to any refund with respect to the claim and the Company does not notify the Executive of its intent to contest such denial of refund prior to the expiration of thirty days after the determination, then the advance shall be forgiven and shall not be required to be repaid and the amount of the advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. (e) In the event that any state or municipality or subdivision thereof shall subject any Payment to any special tax which shall be in addition to the generally applicable income tax imposed by the state, municipality, or subdivision with respect to receipt of the Payment, the foregoing provisions of this Section 7.5 shall apply, mutatis mutandis, with respect to such special tax. 7.6. Severance Benefits Not Includable for Employee Benefits Purposes. Subject to all applicable federal and state laws and regulations, income recognized by the Executive pursuant to the provisions of this Section 7 (other than income accrued but unpaid as of the Date of Termination) shall not be included in the determination of benefits under any employee benefit plan (as that term is defined in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended) or any other benefit plans, policies or programs applicable to the Executive that are maintained by the Company or any of its direct or indirect subsidiaries and the Company shall be under no obligation to continue to offer or provide such benefits to the Executive after the Date of Termination other than as provided under this Section 7 or to the extent to which any benefit under a pertinent plan has accrued as of the Date of Termination. 7.7. Exclusive Benefits. The Severance Benefits payable under Section 7.3(a) and the Change in Control Severance Benefits payable under Section 7.3(b), if either benefits become applicable under the terms of this Agreement, shall be mutually exclusive and shall be in lieu of any other severance or similar benefits that would otherwise be payable under any other agreement, plan, program or policy of the Company. 8. Restrictive Covenants. 8.1. Confidentiality. The Executive recognizes that the services to be performed by him under this Agreement are special, unique and extraordinary in that, by reason of his -18- 19 employment with the Company, he may acquire confidential information and trade secrets concerning the operation of the Company or an Affiliate (as defined below), the use or disclosure of which could cause the Company or an Affiliate substantial loss and damages which could not be readily calculated and for which no remedy at law would be adequate. For purposes of this Section 8, the term "Affiliate" means any direct or indirect subsidiary of the Company, including any individual, partnership, firm, corporation or other business organization or entity that controls, is controlled by, or is under common control with, the Company. Accordingly, during the Employment Term and at all times thereafter, the Executive covenants and agrees with the Company that he shall not at any time, except in the performance of his obligations to the Company under this Agreement or with the prior written consent of the Board of Directors of the Company, directly or indirectly, disclose any secret or confidential information that he may learn or has learned by reason of his association with the Company, or any predecessors to their business, or use any such information to the detriment of the Company. The term "confidential information" includes information not previously disclosed to the public or to the trade by the Company's management or otherwise known by the public or the trade with respect to the Company's products, facilities and methods, research and development, trade secrets and other intellectual property, systems, patents and patent applications, procedures, manuals, confidential reports, product price lists, customer lists, financial information (including the revenues, costs or profits associated with any of the Company's products), business plans, prospects or opportunities; provided, however, that the term "confidential information" shall not include, and the Executive shall have no obligation under this Agreement with respect to, any information that (a) becomes generally available to the public other than as a result of a disclosure by the Executive or his agent or other representative or (b) becomes available to the Executive on a non-confidential basis from a source other than the Company or any Affiliate. The Executive shall have no obligation under this Agreement to keep confidential any of the confidential information to the extent that a disclosure of it is required by law or is consented to by the Company; provided, however, that if and when such a disclosure is required by law, the Executive promptly -19- 20 shall provide the Company with notice of such requirement, so that the Company may seek an appropriate protective order. 8.2. Exclusive Property. The Executive confirms that all confidential information is the exclusive property of the Company. All business records, papers and documents kept or made by the Executive relating to the business of the Company or its direct or indirect subsidiaries shall be and remain the property of the Company or the applicable subsidiary during the Employment Term and at all times thereafter. Upon the termination of his employment with the Company or upon the request of the Company at any time, the Executive shall promptly deliver to the Company, and shall retain no copies of, any written materials, records and documents made by the Executive or coming into his possession concerning the business or affairs of the Company or its direct or indirect subsidiaries; provided, however, that the Executive shall be permitted to retain copies of any documents or materials of a personal nature or otherwise related to the Executive's rights under this Agreement. 8.3. Non Competition. During the Employment Term and, except as provided in the last sentence of this Section 8.3, for a period of one (1) year after the Date of Termination, the Executive shall not, unless he receives the prior written consent of the Company, directly or indirectly, own an interest in, manage, operate, join, control, lend money or render financial or other assistance to, participate in or be connected with, as an officer, employee, partner, stockholder, consultant or otherwise, or engage in any activity or capacity (collectively, the "Competitive Activities") with respect to any individual, partnership, limited liability company, firm, corporation or other business organization or entity (each, a "Person"), that is engaged directly or indirectly in the ownership or operation of proprietary post-secondary schools or that is in competition with any of the business activities of the Company or its direct or indirect subsidiaries either (i) anywhere in the United States or (ii) in any other country in which the Company or its direct or indirect subsidiaries conduct, or actively intend to conduct, business as of the Date of Termination; provided, however, that the foregoing (a) shall not apply with respect to any line-of-business in which the Company or its direct or indirect subsidiaries was not engaged on or before the Expiration Date or the Date of Termination, as the case may be, and (b) -20- 21 shall not prohibit the Executive from owning, or otherwise having an interest in, less than one percent (1%) of any publicly-owned entity or three percent (3%) of any private equity fund or similar investment fund that invests in education companies, provided the Executive has no active role with respect to any investment by such fund in any Person referred to in this Section 8.3. The Executive shall not be subject to the covenants contained in this Section 8.3 and such covenants shall not be enforceable against the Executive from and after the date that the Executive's employment is terminated (i) by the Company without Cause, (ii) by the Executive for Good Reason or (iii) in anticipation of or within two (2) years after a Change in Control. 8.4. Non-Solicitation. During the Term of the Executive's Employment and for a period of one (1) year after the Date of Termination, the Executive shall not, whether for his own account or for the account of any other Person (other than the Company or its direct or indirect subsidiaries), intentionally solicit, endeavor to entice away from the Company or its direct or indirect subsidiaries, or otherwise interfere with the relationship of the Company or its direct or indirect subsidiaries with, any person who is employed by the Company or its direct or indirect subsidiaries (including, but not limited to, any independent sales representatives or organizations). 8.5. Injunctive Relief. Subject to the exceptions contained in Section 8.3, the Executive acknowledges that a breach of any of the covenants contained in this Section 8 may result in material, irreparable injury to the Company for which there is no adequate remedy at law, that it shall not be possible to measure damages for such injuries precisely and that, in the event of such a breach or threat of breach, the Company shall be entitled to obtain a temporary restraining order and/or a preliminary or permanent injunction restraining the Executive from engaging in activities prohibited by this Section 8 or such other relief as may be required to specifically enforce any of the covenants in this Section 8. The Executive agrees and consents that injunctive relief may be sought in any state or federal court of record in the Commonwealth of Pennsylvania, or in the state and county in which a violation may occur or in any other court having jurisdiction, at the election of the Company; to the extent that the Company seeks a temporary restraining order (but not a preliminary or permanent injunction), the Executive agrees -21- 22 that a temporary restraining order may be obtained ex parte. The Executive agrees and submits to personal jurisdiction before each and every court designated above for that purpose. 8.6. Blue-Pencilling. The parties consider the covenants and restrictions contained in this Section 8 to be reasonable. However, if and when any such covenant or restriction is found to be void or unenforceable and would have been valid had some part of it been deleted or had its scope of application been modified, such covenant or restriction shall be deemed to have been applied with such modification as would be necessary and consistent with the intent of the parties to have made it valid, enforceable and effective. 9. Miscellaneous. 9.1. Assignment; Successors; Binding Agreement. This Agreement may not be assigned by either party, whether by operation of law or otherwise, without the prior written consent of the other party, except that any right, title or interest of the Company arising out of this Agreement may be assigned to any corporation or entity controlling, controlled by, or under common control with the Company, or succeeding to the business and substantially all of the assets of the Company or any affiliates for which the Executive performs substantial services; provided, however, that no such assignment shall relieve the Company of its obligations hereunder without the express written consent of the Executive. Subject to the foregoing, this Agreement shall be binding upon and shall inure to the benefit of the parties and their respective heirs, legatees, devisees, personal representatives, successors and assigns. 9.2. Modification and Waiver. No provision of this Agreement may be modified, waived, or discharged unless such waiver, modification or discharge is duly approved by the Board of Directors of the Company and is agreed to in writing by the Executive and such officer(s) as may be specifically authorized by the Board of Directors of the Company to effect it. No waiver by any party of any breach by any other party of, or of compliance with, any term or condition of this Agreement to be performed by any other party, at any time, shall constitute a waiver of similar or dissimilar terms or conditions at that time or at any prior or subsequent time. 9.3. Entire Agreement. No agreement or representation, oral or otherwise, express or implied, with respect to the subject matter of this Agreement, has been made by either party -22- 23 which is not set forth expressly in this Agreement. Further, this Agreement shall amend and supersede any and all previously existing employment or consulting agreements between the Executive and the Company or any of its direct or indirect subsidiaries or affiliates. 9.4. Governing Law. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the Commonwealth of Pennsylvania other than the conflict of laws provision thereof. 9.5. Arbitration. In the event of any dispute, controversy or claim between the Company and the Executive arising out of or relating to the interpretation, application or enforcement of any provision of this Agreement (other than with respect to provisions under Section 8 of this Agreement), either the Company or the Executive may, by written notice to the other, require such dispute or difference to be submitted to arbitration. The arbitrator or arbitrators shall be selected by agreement of the parties or, if they do not agree on an arbitrator or arbitrators within 30 days after one party has notified the other of his or its desire to have the question settled by arbitration, then the arbitrator or arbitrators shall be selected by the American Arbitration Association (the "AAA") in Pittsburgh, Pennsylvania. The determination reached in such arbitration shall be final and binding on all parties without any right of appeal or further dispute. Execution of the determination by such arbitrator may be sought in any court of competent jurisdiction. The arbitrators shall not be bound by judicial formalities and may abstain from following the strict rules of evidence and shall interpret this Agreement as an honorable engagement and not merely as a legal obligation. Unless otherwise agreed by the parties, any such arbitration shall take place in Pittsburgh, Pennsylvania, and shall be conducted in accordance with the Commercial Arbitration Rules of the AAA. 9.6. Consent to Jurisdiction and Service of Process. In the event of any dispute, controversy or claim between the Company and the Executive arising out of or relating to the interpretation, application or enforcement of the provisions of Section 8 or Section 9.5, the Company and the Executive agree and consent to the personal jurisdiction of the Court of Common Pleas for Allegheny County, Pennsylvania and/or the United States District Court for the Western District of Pennsylvania for resolution of the dispute, controversy or claim, and that -23- 24 those courts, and only those courts, shall have exclusive jurisdiction to determine any dispute, controversy or claim related to, arising under or in connection with Section 8 of this Agreement. The Company and the Executive also agree that those courts are convenient forums for the parties to any such dispute, controversy or claim and for any potential witnesses and that process issued out of any such court or in accordance with the rules of practice of that court may be served by mail or other forms of substituted service to the Company at the address of its principal executive offices and to the Executive at his or her last known address as reflected in the Company's records. 9.7. Resignation from Board. Upon a termination of the Executive's employment under this Agreement for any reason, the Executive shall, if requested by the Company's Board of Directors, promptly resign as a member of the Board of Directors of the Company or its direct or indirect subsidiaries. 9.8. Withholding of Taxes. The Company shall withhold from any amounts payable under the Agreement all Federal, state, local or other taxes as legally shall be required to be withheld. 9.9. Notice. For the purposes of this Agreement, notices and all other communications to either party provided for in this Agreement shall be furnished in writing and shall be deemed to have been duly given when delivered or when mailed if such mailing is by United States certified or registered mail, return receipt requested, postage prepaid, addressed to such party (notices to the Company being addressed to the Secretary of the Company) at the Company's principal executive office, or at other address as either party shall have designated by giving written notice of such change to the other party at anytime hereafter. 9.10. Severability. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 9.11. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together shall constitute one and the same instrument. -24- 25 9.12. Headings. The headings used in this Agreement are for convenience only, do not constitute a part of the Agreement, and shall not be deemed to limit, characterize, or affect in any way the provisions of the Agreement, and all provisions of the Agreement shall be construed as if no headings had been used in the Agreement. 9.13. Construction. As used in this Agreement, unless the context otherwise requires: (a) the terms defined herein shall have the meanings set forth herein for all purposes; (b) references to "Section" are to a section hereof; (c) all "Schedules" referred to herein are incorporated herein by reference and made a part hereof; (d) "include," "includes" and "including" are deemed to be followed by "without limitation" whether or not they are in fact followed by such words or words of like import; (e) "writing," "written" and comparable terms refer to printing, typing, lithography and other means of reproducing words in a visible form; (f) "hereof," "herein," "hereunder" and comparable terms refer to the entirety of this Agreement and not to any particular section or other subdivision hereof or attachment hereto; (g) references to any gender include references to all genders; and (h) references to any agreement or other instrument or statute or regulation are referred to as amended or supplemented from time to time (and, in the case of a statute or regulation, to any successor provision). IN WITNESS WHEREOF, the parties have duly executed this Agreement on the date and year first above written. EDUCATION MANAGEMENT CORPORATION By: /s/ Robert B. Knutson ---------------------------------- Robert B. Knutson Chairman & Chief Executive Officer EXECUTIVE /s/ [Name of Executive] ---------------------------------- [Name of Executive] -25- EX-10.12 7 SENIOR MANAGEMENT TEAM INCENTIVE COMPENSATION PLAN 1 EXHIBIT 10.12 EDUCATION MANAGEMENT CORPORATION SENIOR MANAGEMENT TEAM INCENTIVE COMPENSATION PLAN JULY, 1999 2 HIGHLIGHTS OF THE MANAGEMENT INCENTIVE COMPENSATION PLAN - - The plan is designed to reward participants for achievement of desired results. - - The plan will help retain key management by tying results achieved by managers to the incentive compensation received. - - The plan will be predictable, fair, timely, objective and measurable. - - The plan retains some flexibility to adjust formula bonus amounts to reflect current performance, history, past practice, economic factors and other anomalies. - - It is designed to be as simple as possible and to provide for relative administrative ease. -2- 3 OVERVIEW A plan that provides incentive payments to senior management team participants based on: - - Reward for performance in key result areas: Earnings, Revenues, Key Personal Objectives - - The achievement of at least 97% of a trigger objective composed of our planned placement rate and average starting salary for our graduates. - - Target bonus amounts expressed as a specific dollar amount depending on the position held. - - Bonuses earned based on performance against two financial targets and up to three key personal objectives. - - Weighting of the targets will be assigned to each participant using one of three weight distributions depending on the position held. - - Minimum performance in a category is 75% of target. Performance above or below target will be increased or reduced by 4 percentage points per each 1% difference between plan and actual performance. - - The maximum is 150% of target performance in each category. -3- 4 TRIGGER - - The proposed trigger(s) will be the planned placement rate and the average starting salary of our graduates. School positions will be measured by their school's planned rates. Positions at the Central Staff or those operating units without such measurements will be compared to system-wide targets. - - The minimum performance will be 97% of the consolidated results for the operating unit or the company as a whole, compared to the planned targets. - - If the minimum trigger performance is not met, then bonuses will be determined only by performance against Key Personal Objectives (Discussed below). In other words, bonus potential will be dramatically limited if our trigger measures are not met. - - Focusing on the results of our placement efforts in this important way will help ensure that graduate outcomes are realized. TARGET BONUS AMOUNTS The target bonus will be expressed as a specific dollar amount. At the beginning of the plan year each participant will be informed as to what the target bonus amount will be for the year. COMPONENTS 1. EARNINGS - EARNINGS PER SHARE measure will apply to: - Corporate Officers - Central Staff Officers - OPERATING INCOME (Before MICP Expense) measurements will apply to: - Group Vice Presidents - Operating Unit Executives 2. REVENUE: Applies to All positions 3. KEY PERSONAL OBJECTIVES (KPO): Up to three weighted objectives. -4- 5 - - KPOs will be approved by the EDMC Executive Committee. - - KPOs for school Executive Committee positions will be approved by the Operating Unit President and by the respective Central Staff Department Heads. KPOs for School Presidents will be approved by the School's Board of Trustees where they exist. WEIGHTING OF COMPONENTS All positions will have the measured components weighted according to one of the following distributions: - -------------------------------------------------------------------------------- EARNINGS REVENUES KPO POSITIONS - -------------------------------------------------------------------------------- A 60% 20% 20% EDMC Corporate Officers (EPS for Earnings) - -------------------------------------------------------------------------------- B 40% 40% 20% Group Vice Presidents and School Presidents - -------------------------------------------------------------------------------- B 30% 20% 50% Central Staff Officers (EPS for Earnings) and Operating Unit Executive Committee Members. - -------------------------------------------------------------------------------- BONUS CALCULATION - - Performance against financial targets (Earnings/EPS and Revenues) will be calculated by the Finance Department. - - Performance against KPOs will be determined by the participant's direct and indirect supervisors, with concurrence by the EDMC Executive Committee. - - Minimum performance in a category is 75% of target. Performance below target will be reduced by 4 percentage points per each 1% miss. Performance above target will be increased by 4 percentage points per each 1% over target. KPOs that do not lend themselves to such a measurement should be assessed more subjectively. In such a case the KPO could be considered achieved (at 100%) or not achieved (at 0%). - - A MANAGEMENT DISCRETION FACTOR may be applied to any calculated bonus amount that may increase or decrease the calculated amount by up to 20%. This factor will be applied only to adjust a bonus to provide for fairness, equity, recent performance changes or environmental factors outside the -5- 6 participant's control. This factor may be applied only by the EDMC Executive Committee, or in the case of a school president at Schools where there is a Board of Trustees, by the Board of Trustees. - - The maximum payment is 150% of the target in each category and in the total. -6- 7 EXAMPLES: Dean of Education Jones has a base salary of $60,000 with a target bonus of $15,000. In Example 1 below, Dean Jones' bonus would be calculated as 110% of his target bonus. Since performance ABOVE plan is increased by 4 percentage points for each 1% above plan, his performance for both Earnings and Revenues would be increased. His bonus would be calculated as $16,500. ($15,000 target x 110%) Example 1 - ---------------------------------------------------------------------------- School's Targets Actual % Attainment Weight Weighted % - ---------------------------------------------------------------------------- EARNINGS 1,000,000 1,050,000 105% 30% 36%(1) - ---------------------------------------------------------------------------- REVENUES 10,000,000 10,500,000 105% 20% 24%(2) - ---------------------------------------------------------------------------- KPO 100% 50% 50% - ---------------------------------------------------------------------------- - ---------------------------------------------------------------------------- Total 100% 110% - ---------------------------------------------------------------------------- If, however, Dean Jones had identical results in the financial arena but only managed to complete 85% of his KPOs, his calculated bonus would be quite different. (See Example 2 below) Since performance BELOW plan is reduced by 4 percentage points for each 1% miss, his calculated attainment for the KPO area would be significantly lower. In this example, his bonus would be $12,000. ($15,000 target x .80) Example 2 - ---------------------------------------------------------------------------- School's Targets Actual % Attainment Weight Weighted % - ---------------------------------------------------------------------------- EARNINGS 1,000,000 1,050,000 105% 30% 36% - ---------------------------------------------------------------------------- REVENUES 10,000,000 10,500,000 105% 20% 24% - ---------------------------------------------------------------------------- KPO 85% 50% 20%(3) - ---------------------------------------------------------------------------- - ---------------------------------------------------------------------------- Total 100% 80% - ---------------------------------------------------------------------------- 1 ( (+ 5% x 4) + 100%) x 30% = 36% 2 ( (+ 5% x 4) + 100%) x 20% = 24% 3 ( 100% - (15% x 4) ) x 50% = 20% -7- 8 PAYMENT OF BONUSES - ------------------ Bonuses earned under the plan will be paid to eligible employees in cash promptly after the bonus amounts have been determined. All bonus payments are subject to applicable tax withholdings. To be eligible to receive a payment under this plan, a participant must be actively employed on the date the payment is made. The EDMC Executive Committee may grant a payment under this plan to a former or inactive employee for compelling reasons in its sole discretion. MISCELLANEOUS PROVISIONS - ------------------------ CHANGING OR ENDING THE PLAN It is the intention of the Company that the plan has no expiration date, nor is it intended to be temporary. However, the Company has the right to change the plan in any way and at any time and is not required to give a reason for, or notice of the changes. Any special arrangement made by the Company for an individual will constitute an amendment to this plan applicable only to that individual. The Company has the right to end the plan (in whole or in part) at any time. GOVERNING LAW This plan is governed by the internal laws of The Commonwealth of Pennsylvania. PARTICIPATION IN THE PLAN Participation in the plan does not constitute a guarantee of employment, nor is continued participation in the plan guaranteed. Participants will be notified of their right to participate in the plan on an annual basis. NO ASSIGNMENT No person having a benefit under the plan may assign or transfer that benefit. -8- EX-21.1 8 MATERIAL SUBSIDIARIES 1 EXHIBIT 21.01 MATERIAL SUBSIDIARIES
NAME OF SUBSIDIARY JURISDICTION OF INCORPORATION - ------------------ ----------------------------- The Art Institutes International, Inc. Pennsylvania The Art Institute of Atlanta, Inc. Georgia The Art Institute of Dallas, Inc. Texas The Art Institute of Fort Lauderdale, Inc. Florida The Art Institute of Houston, Inc. Texas The Illinois Institute of Art, Inc. Illinois The Illinois Institute of Art at Schaumburg, Inc. Illinois The Art Institute of Los Angeles, Inc. California The Art Institute of Los Angeles--Orange County, Inc. California The Art Institutes International Minnesota, Inc. Minnesota The New York Restaurant School, Inc. New York The Art Institute of Philadelphia, Inc. Pennsylvania The Art Institute of Phoenix, Inc. Arizona The Art Institutes International at Portland, Inc. Oregon The Art Institutes International at San Francisco, Inc. California The Art Institute of Seattle, Inc. Washington The Colorado Institute of Art, Inc. Colorado The National Center for Professional Development, Inc. Georgia NCPT, Inc. Georgia American Business and Fashion Institute, Inc. North Carolina Massachusetts Communications College Massachusetts
EX-23.1 9 CONSENT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 23.01 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference of our report dated July 28, 1999 included in this Form 10-K into the Company's previously filed Registration Statements on Form S-8, File Nos. 333-20057 and 333-20073. It should be noted that we have not audited any financial statements of the Company subsequent to June 30, 1999 or performed any audit procedures subsequent to the date of our report. Pittsburgh, Pennsylvania September 27, 19999 EX-27.1 10 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF INCOME AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR JUN-30-1999 JUL-01-1998 JUN-30-1999 32,871 0 19,467 (9,367) 2,038 55,709 171,352 (75,271) 178,746 45,188 36,500 0 0 295 96,510 178,746 260,805 260,805 170,742 229,107 0 5,660 (113) 31,811 13,059 18,752 0 0 0 18,752 .64 .61 On December 2, 1998, the Company's Board of Directors authorized a 2-for-1 stock split effected in the form of a stock dividend. The distribution was made on December 29, 1998 to shareholders of record as of the close of business on December 8, 1998. Financial Data Schedules reported prior to the stock split have not been restated to reflect this stock split.
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