-----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, Qjjel2H+JC75Dnbk0wO1RijzJeJKpkmUi3qRA4Ch1wTlMlQdTeCUVkvg6edWzrYP vl+R9YLEP5cBftRWJRP22Q== 0000912057-01-506093.txt : 20010409 0000912057-01-506093.hdr.sgml : 20010409 ACCESSION NUMBER: 0000912057-01-506093 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 21 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SYLVAN LEARNING SYSTEMS INC CENTRAL INDEX KEY: 0000912766 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-EDUCATIONAL SERVICES [8200] IRS NUMBER: 521492296 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22844 FILM NUMBER: 1589318 BUSINESS ADDRESS: STREET 1: 1000 LANCASTER ST CITY: BALTIMORE STATE: MD ZIP: 21202 BUSINESS PHONE: 4108438000 MAIL ADDRESS: STREET 1: 1000 LANCASTER ST CITY: BALTIMORE STATE: MD ZIP: 21202 10-K 1 a2043474z10-k.txt 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934 for the fiscal year ended DECEMBER 31, 2000. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from _________ to _________. Commission File Number 0-22844 SYLVAN LEARNING SYSTEMS, INC. (Exact name of registrant as specified in its charter) MARYLAND 52-1492296 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1001 FLEET STREET, BALTIMORE, MARYLAND 21202 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (410) 843-8000 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered COMMON STOCK, PAR VALUE $.01 NASDAQ PREFERRED STOCK PURCHASE RIGHTS NONE Securities registered pursuant to the Section 12 (g) of the Act: NONE 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 definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting Common Stock held by non-affiliates of the registrant was approximately $691 million as of March 26, 2001. The registrant had 37,739,597 shares of Common Stock outstanding as of March 26, 2001. DOCUMENTS INCORPORATED BY REFERENCE Certain information in Sylvan Learning Systems, Inc.'s definitive Proxy Statement for its 2001 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A no later than April 30, 2001, is incorporated by reference in Part III of this Form 10-K. INDEX
PAGE NO. PART I. Item 1. Business.......................................................................1 Item 2. Properties.................................................................... 9 Item 3. Legal Proceedings.............................................................10 Item 4. Submission of Matters to a Vote of Security Holders...........................10 PART II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.....................................11 Item 6. Selected Consolidated Financial Data..........................................11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..............................14 Item 7A. Quantitative and Qualitative Disclosures About Market Risk...............................................................22 Item 8. Financial Statements and Supplementary Data...................................23 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.....................................23 PART III. Items 10., 11., 12. and 13. are incorporated by reference from Sylvan Learning Systems, Inc.'s definitive Proxy Statement which will be filed with the Securities and Exchange Commission, pursuant to Regulation 14A, not later than April 30, 2001...............................................24 PART IV. Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.....................................................25 SIGNATURES..............................................................................................27
PART I. ITEM 1. BUSINESS Sylvan Learning Systems, Inc. ("the Company" or "Sylvan") is a leading international provider of educational services to families and schools. The Company seeks to maintain its leadership position in the core K-12 educational services market while dramatically expanding its post secondary offerings and establishing a leadership role in the educational technology marketplace. The Company plans to achieve this leadership position through focus on the following business concentrations: - K-12. Providing consumer and institutionally focused education services for students ranging from kindergarten through high school education levels. Services are provided through Sylvan Learning Centers and Sylvan Education Solutions. This business focuses on proven successful grade level advancement of students through direct student-instructor interaction. - POST-SECONDARY. Providing educational services to students beyond the high school education level through a network of fully accredited international universities, center based adult English language instruction and accredited teacher training university courses and degree programs. Services are tailored to address the fast growing international marketplace for advanced education as well as the shortage of teaching professionals in the United States. Services are provided through the four universities that comprise Sylvan International Universities as well as the Wall Street Institute and Canter. - EDUCATION TECHNOLOGY. Focusing on investment in companies employing emerging technology solutions in the education marketplace. Building on brand recognition and an industry-leading position in education services, the Company seeks to create shareholder value by capitalizing on an opportunity to establish a leadership position in the application of Internet and wireless technologies to the marketplace through Sylvan Ventures. The Company provides lifelong educational services through five separate business segments. The Sylvan Learning Centers segment designs and delivers individualized tutorial programs to school age children through franchised and Company-owned Learning Centers. This segment also includes the operations of Schulerhilfe, a major provider of tutoring services in Germany. The Education Solutions segment principally provides educational programs to students of public and non-public school districts through contracts funded by Title 1 and state-based programs. This segment also provides professional development and graduate degree programs to teachers through the Canter Group. The Sylvan English Language Instruction segment consists of the operations of Wall Street Institute, B.V., ("WSI"), a European-based franchiser and operator of learning centers that teach the English language to professionals. Sylvan International Universities segment has acquired controlling interests in four private, for-profit universities since its inception in the second quarter of 1999. Through its universities in Spain, Mexico, Switzerland and Chile, Sylvan International Universities now controls the largest global network of fully accredited universities. The Company's newest segment, Sylvan Ventures, was launched in the first quarter of 2000 to invest in and incubate companies developing emerging technology solutions for the education marketplace. Consistent with the stated goal of focusing management's efforts and the Company's resources on the core business of consumer educational services and in order to fund expansion of technology applications in educational and training services, the Company consumated the sales of three business units in fiscal 1999 and 2000. On December 31, 1999, The PACE Group ("PACE"), the Company's corporate training business was sold in exchange for an equity investment in Frontline Group, Inc., the owner of a corporate training enterprise. On March 3, 2000, Prometric, the computer-based testing business, was sold for approximately $775 million in cash. On October 6, 2000, Aspect Language Schools, Inc. ("Aspect"), an English Language study/travel business, was sold for approximately $19.8 million in cash. Unless specifically noted, all discussion of financial results excludes the results of PACE, Prometric and Aspect except as disclosed as discontinued operations. Sylvan's services are delivered through an international network of Company owned and franchised educational centers as well as universities. In 2000, Company revenues were approximately $316.7 million, composed of $98.9 million from the Sylvan Learning Centers segment, $105.2 million from the Sylvan Education Solutions segment, $49.9 million from the Sylvan English Language Instruction segment, and $62.6 million from the Sylvan International Universities segment. System wide revenues, which include franchised Learning Center revenues of $293.1 million and franchised WSI revenues of $123.5 million, totaled $733.3 million in 2000. Note 17 of the 2000 audited financial statements contain additional disclosures regarding the Company's segments and geographic information. 1 SYLVAN LEARNING CENTERS Sylvan provides high quality educational services with consistent, quantifiable results. It has delivered its core educational service to more than 1.4 million students in grades K-12 over the past 20 years. The Company's Sylvan Learning Centers segment provides supplemental, remedial, and enrichment instruction primarily in reading, writing, mathematics, study skills, and test preparation, featuring an extensive series of standardized diagnostic assessments, individualized instruction, a student motivational system and continued involvement from both parents and the child's regular school teacher. Parents learn about Sylvan from the Company's media advertising, from a referral from another parent, or from school personnel. The Learning Center's Sylvan-trained educators use assessment results to diagnose students' skill gaps and to design an individual learning program for each student. Sylvan Learning Center's curriculum is consistent throughout North America. Instruction is typically given three times per week for one hour per visit at U-shaped tables designed to ensure that teachers work with three to four students at a time. Instructional programs are research based and built upon the philosophy of mastery learning. There are special incentives, such as tokens redeemable for novelties and toys, to motivate the student to achieve the program's objectives, build self-confidence, and to strengthen the student's enthusiasm for learning. A student's progress is monitored and parent conferences are scheduled after every 12 hours of a student's program. Throughout a student's course of study, the Learning Center assesses the student's progress using the same standardized diagnostic assessments. The results are shared with the parents in personal conferences, during which the student's continuation in a Sylvan program is discussed. FRANCHISE OPERATIONS. As of December 31, 2000, there were a total of 765 Learning Centers in 49 states, 8 Canadian provinces, Spain, Hong Kong and Guam operated by its franchisees. As of that date, there were 441 U.S. franchisees operating Sylvan Learning Centers. During 2000, a net of 56 franchised Learning Centers were opened. Additionally, during 2000, the Company acquired 1 franchisee-owned Learning Center. The Company's typical franchise agreement (the "License Agreement") grants a license to operate a Sylvan Learning Center and to use Sylvan's trademarks within a specified territory. The Company currently offers a License Agreement with an initial term of ten years, subject to unlimited additional ten-year extensions at the franchisee's option on the same terms and conditions. The initial license fee and royalty rates vary depending on upon the demographics of the territory. Franchisees must obtain the Company's approval for the location and design of the Learning Center and of all advertising, and must operate the Learning Center in accordance with the Company's methods, standards and specifications. The franchisee is required to purchase from Sylvan certain diagnostic and instructional materials, student record forms, parental information booklets and explanatory and promotional brochures developed by the Company. Sylvan specifies requirements for other items necessary for operation of a Learning Center, such as computers, instructional materials and furniture (franchisees must submit monthly financial data to the Company). The Company actively manages its franchise system. The Company requires franchisees and their employees to attend initial training in Learning Center operations and Sylvan's educational programs. The Company also offers franchisees continuing training each year. The Company employs field operations managers that act as "consultants" to provide assistance to franchisees in technology implementation, business development, marketing, education and operations. These employees also facilitate regular communications between franchisees and the Company. The Company believes there is significant potential for additional franchised Learning Centers both domestically and internationally. A number of territories with only one Learning Center could support one or more additional Learning Centers based upon the number of school-age children in the market area. The Company is actively encouraging existing franchisees in these territories to open additional Learning Centers. In addition, management has identified at least 206 territories in North America, primarily in smaller markets, in which there are no Learning Centers. The Company is actively seeking franchisees for a number of these territories. Forty-one new territories were sold in 2000. The Company has sold franchise rights for the operation of Learning Centers in Hong Kong, the United Kingdom, France and Spain. In pricing international franchise rights, the Company takes into account estimates of the number of centers that could be opened in an area. A master franchisee operates Sylvan Learning Centers in Spain and at December 31, 2000, had 103 centers in operation. 2 COMPANY-OWNED LEARNING CENTERS. As of December 31, 2000, Sylvan owned and operated 82 Learning Centers: 7 in the greater Baltimore, MD area, 10 in the greater Philadelphia, PA area, 9 in the greater Washington, D.C. area, 12 in South Florida, 5 in Alabama, 5 in the greater Minneapolis, MN area, 7 in Dallas, TX, 8 in Houston, TX, 5 in the greater Salt Lake, UT area and 14 in the greater Los Angeles, CA area. The Company recently completed the acquisition of 3 centers in Austin, Texas and 2 centers in Baltimore, MD, in the first quarter of 2001. The Company's operation of Learning Centers enables it to test new educational programs, marketing plans and Learning Center management procedures. Company-owned Learning Centers give the Company a local presence in key markets, which has been helpful in cross-marketing the Company's other educational services in these communities. The Company may consider selected acquisitions of additional Learning Centers now operated by franchisees. SCHULERHILFE. As of December 31, 2000, Schulerhilfe, a major provider of tutoring services in Germany, has approximately 213 company-owned centers and approximately 722 franchise locations in Germany, Italy and Austria. Schulerhilfe is engaged in providing tutoring service to primary and secondary students with an operational business model that is similar to Sylvan Learning Centers. Students typically attend twice per week and are instructed in small groups of four to six students per session. Schulerhilfe advertises using print, radio and television advertisements on local and national levels. IVY WEST. On May 19, 2000, the company acquired Ivy West, an SAT preparation company based in California. Ivy West offers individual home-based instruction for preparation of the SAT I, SAT II, PSAT, and ACT. Ivy West also offers School Partnerships to provide SAT preparation materials and instruction in a group or classroom environment. Sylvan Learning Centers also offer the Ivy Prep program in their centers using the traditional 3 to 1 student - teacher ratio, small group instruction and school partnership programs. 3 SYLVAN EDUCATION SOLUTIONS TEACHER TRAINING AND DEVELOPMENT Through its Canter business unit, SES provides graduate courses and masters degree programs to teachers across America. Working in partnership with 17 degree-granting institutions of higher education, Canter delivered over 30,000 graduate courses in 2000. By the close of 2000, an additional 8,800 teachers were enrolled in its masters degree programs. Canter is the leading provider of teacher training in the United States. Its courses focus on educational topics that are key to teaching success. Topics include such areas as reading at the elementary and secondary level, math, learning styles, instructional strategies, collaborative action research, classroom management and parental involvement. Canter programs incorporate the best in video, online and teacher collaboration - bringing national experts and real classroom application scenes to its students. All Canter courses focus directly on improving teacher practice. A recent study, conducted by Dr. Evelyn Odgen, an Independent Consultant, showed that graduates of Canter's Masters in the Art of Teaching demonstrated significant improvement in their daily classroom practice. In addition to its Canter business unit, SES also addresses school districts' specific teacher training needs through its Alternative Certification, Teacher Test Preparation, and on-site professional development programs. These programs are run under contract with districts and are funded by federal and state Departments of Education programs. DIRECT INSTRUCTION Since 1993, SES has been delivering direct instructional service to children and adults through its contracts with public schools, non-public schools, and adult welfare agencies. SES takes the Sylvan learning model into our country's most economically disadvantaged communities, providing access to the same individualized instruction that their more affluent counterparts receive at their local Sylvan Learning Centers. SES programs are funded by federal Department of Education programs, such as Title I, state programs, such as PA Act 89, and federal Department of Labor initiatives. In 2000, SES served over 100,000 students in its direct instruction programs. 4 SYLVAN ENGLISH LANGUAGE INSTRUCTION Sylvan provides post-secondary English Language Instruction through the Wall Street Institute, a European-based franchiser and operator of language centers where English is taught through a combination of computer-based and live instruction. Typically, the instructional programs are approximately nine months to one year in duration. WSI uses a proprietary teaching system composed of multimedia interactive video on CD-ROM, live, personalized instruction and small group classes. WSI has more than 49 Company-owned and 325 franchised centers in operation throughout Europe, Latin America, the Middle East and Asia. These centers also serve as distribution points for the Company's other product offerings. WSI has 166 centers in Spain (139 franchised and 27 Company-owned) with the remainder in France, Germany, Italy, Portugal, Switzerland, Turkey, Czech Republic, Hong Kong, Saudi Arabia, Panama, Mexico, Chile, Israel, Colombia, Argentina, Brazil, Ecuador, Venezuela and China. WSI's initial international expansion was accomplished by selling Master Licensing rights, with each Master Licensor obtaining franchisees to open centers in its development areas. In 2000, consistent with the change in Sylvan's international expansion strategy of retaining ownership of franchise territories in high potential markets, Sylvan continued to expand WSI's presence globally, through the opening of new Company-owned centers, with a focus on the Middle East, Latin America, Europe and the Pacific Rim regions. Additional expansion of the WSI business model is occurring through the adoption of the programs at universities in the SIU network. WSI students, typically working professionals, learn through center based instruction, which applies modern technology and proven methods of individual instruction. A variety of educational courses are offered from beginning to advanced English language skills as well as courses for specific purposes such as business English. All WSI centers have computer labs and include Internet use for collaborative learning experiences. Per center enrollment averages 400 to 450 students per year. Students typically attend 2-3 hours per week and receive individual instruction in groups of one to six students. Wall Street Institute advertises using print, radio and television advertisements on local and national levels. SYLVAN INTERNATIONAL UNIVERSITIES The Sylvan International Universities ("SIU") segment was formed in 1999 to allow the Company to capitalize on opportunities in the international educational marketplace. Features that make this market attractive for the Company's investment include: severe imbalances of university supply and demand, a rising middle class in many countries, governments that are unable to accommodate all qualified applicants, rapidly changing technology and economic globalization. The Company has leveraged these business opportunities by creating a "Sylvan Signature" university network that is focused on critical competencies such as: career oriented programs, bilingual instruction, technology centered education, and a leveraged network of universities equipped to provide centers of excellence and distance learning. Currently, SIU owns controlling interests in the parent companies of four fully locally accredited higher education institutions: Universidad Europea de Madrid, Les Roches School of Hotel Management, Universidad del Valle de Mexico and Universidad de Las Americas. UNIVERSIDAD EUROPEA DE MADRID CEES ("UEM") SIU acquired a 54% controlling interest in Prouniversidad, S.A. in April 1999. Prouniversidad, S. A. was granted a license to operate Universidad Europea de Madrid CEES, a for-profit private university offering a wide array of university degrees officially recognized in Spain, including doctorate degrees. UEM also provides postgraduate courses and dormitory services to students. UEM owns, for student training purposes, a Dentistry Clinic and a Podiatry Clinic. UEM is located in the outskirts of Madrid, Spain and began operating in academic year 1995/1996. Prior to this time, the University was licensed to CEES (a college within the public Universidad Complutense) and has operated since the early 1990's. The UEM campus is built on a 3 million square foot plot of land. At present, the campus development consists of three academic buildings, two student dormitory buildings, sports facilities, and parking areas. There is enough space available at the campus for future expansion. The University's dormitory buildings located on campus can accommodate 529 students. At December 31, 2000, occupancy at the dormitory buildings was almost 100%. In academic year 2000/2001, which began October 1, 2000, UEM provides 28 degree programs in a variety of concentrations to 6,982 degree students, 50 doctorate students and 154 postgraduate students. UEM has had 27% growth in new student enrollment during the current academic year. 5 Bachelor degrees usually take between four and five years to complete. Associate degrees typically span three years, and doctorate degrees span two years after the completion of a bachelor degree. The postgraduate courses span approximately three months. The tuition fee paid per academic year is approximately $6,300 per student, although the fee may vary depending on the degree and on the number of academic credits taken. Quality at UEM is achieved through special attention to the following critical features: low student to teacher ratio, close tutoring of students, and state-of-the-art laboratories and clinics. UEM is also focusing on state-of-the-art information technology infrastructure and advanced methodologies for the instruction of the English language to students. SWISS HOTEL ASSOCIATION HOTEL MANAGEMENT SCHOOL LES ROCHES ("LES ROCHES") SIU acquired 100% ownership of Les Roches in July 2000. The school, located in Switzerland, was founded in 1979 by the Clivaz family and is considered one of the finest hotel management schools in the world. It is accredited by the Swiss Hotel Association and the New England Association of Schools and Colleges and currently enrolls students from nearly 45 countries. Les Roches is a center of excellence renowned for its strong theoretical and practical approach to preparing skilled managers for the hospitality and hotel management industry. It offers degree programs in 4 undergraduate and graduate concentrations. Les Roches campus consists of a main classroom building and 11 residence halls with capacity for 393 students per semester. Enrollments for the 2000/2001 academic year are approximately 1,100 students from 45 countries. New student enrollment increased 14% in the current academic year. Annual tuition fees for Les Roches programs (including room and board) range between $12,000 to $20,400 depending on the program. The school manages its recruitment and enrollment processes through a network of agents located in more than 35 countries. In addition to its on-campus programs, Les Roches offers an MBA online, with emphasis on the hospitality industry, delivered in association with IMCA of the United Kingdom. UNIVERSIDAD DEL VALLE DE MEXICO ("UVM") SIU acquired an 80% controlling interest in Planeacion de Sistemas - ("PLANSI S.A."), parent company of Universidad del Valle de Mexico, in December 2000, forming a joint venture with the Ortega family who founded the university in 1960. It is an officially accredited university by the Mexican Secretary of Education after having met all its requirements. It is also an active member of the National Federation of Private Universities ("FIMPES"). UVM operates 14 campuses in Mexico and is considered the second largest private university in the country. UVM offers 31 degree programs in a wide array of fields and professional disciplines at the pre-college, undegraduate and graduate levels. Undergraduate programs usually take between four and five years and graduate programs typically span 2 years. Enrollments for the 2000 / 2001 academic year were approximately 32,000 full-time students and 8,000 students in continuing education programs. UVM has increased total enrollment by 7% in the current academic year. Average revenue per full-time student is $3,320. UNIVERSIDAD DE LAS AMERICAS ("UDLA") SIU acquired a 60% equity interest in Desarrollo del Conocimiento S.A. ("DECON"), parent company of Universidad de las Americas in December of 2000, forming a joint venture with the Artillo family who founded the university in Santiago, Chile in 1988. The university was granted full accreditation and autonomy by the Chilean Ministry of Education in December of 1997 after having successfully fullfilled the requirements established under the Chilean law. The university offers undergraduate degree programs in 14 professional fields. Typically, undergraduate programs in Chile take five to six years to complete and students receive a solid theoretical foundation coupled with strong practical orientation. The tuition fee paid per academic year is approximately $3,000. UDLA's courses are conducted in company owned and operated facilities. UDLA is an urban university located in downtown Santiago. During the 2000 academic year, which goes from March to December, enrollment reached 5,500 students. Through its Continuing Education division, UDLA also offers a wide array of programs to serve the needs of working adults. 6 SYLVAN VENTURES The Sylvan Ventures segment was established and commenced operations during the first quarter of 2000 with a goal of investing in and developing companies to bring technology solutions to the education and training marketplace. On June 30, 2000, the affiliates of Apollo Management L.P. and certain members of management joined the Company in the legal formation of Sylvan Ventures, LLC with total committed funds of $400 million. Of the $400 million commitment, the Company has committed $285 million, Apollo has committed to $100 million, and Management investors have committed $15 million. Sylvan Ventures intends to emerge as a market leader in the multi-billion dollar, highly fragmented e-learning market. Sylvan Ventures will invest in select, strategic investments in all phases of the online educational lifecycle including K-12, higher education, and professional development. Through promoting activity between portfolio companies and supplementing the strengths of each early stage enterprise with Sylvan's strong brand recognition, established relationships, management team experience, and substantial capital, Sylvan Ventures will create unique and significant operational synergies within and among the portfolio companies. As of December 31, 2000, Sylvan Ventures has investments in eSylvan, Inc., Mindsurf, Inc., Classwell Learning Group, Inc., Caliber Learning Group, Inc., Chancery Software Limited, iLearning, Inc., OnlineLearning.net, HigherMarkets, Inc., Kawama.com, Inc. and Club Mom Inc. Subsequent to year-end, Sylvan Ventures added to its investment portfolio with a significant investment in Walden University. For the year ended December 31, 2000, Sylvan Ventures reported significant losses resulting from recording its proportionate share of losses generated by its investees. These companies are in the early stages of development and significant losses are expected to be incurred through at least 2001. In accordance with the formation agreement, ownership of Sylvan Ventures is controlled in the following percentages: Company 72%, Apollo 25% and management investors 3%. The Company has significant control of the operations of Sylvan Ventures as a result of being the majority shareholder and through representation on the Investment Committee which reviews and approves individual Venture projects. The Sylvan Ventures' Board is comprised of the same slate of directors as the Company's Board. In the event of a profit triggering event, profits will be shared in the following percentages: Company 57%, Apollo 20%, management investors 3% and management profits interests 20% (when fully allocated). As of December 31, 2000 only 15.2% of the management profits interest has been granted to members of Sylvan and Ventures' management teams. Profits are only allocated after all losses have been recaptured. Apollo has a preferred position in allocation of losses following fiscal year 2000. Losses will be allocated first to the Company and Management investors to the extent of the capital accounts, and then to Apollo. No losses can be allocated to the memberships profit interest. The Company maintains a majority-ownership position in Sylvan Ventures and accounts for Sylvan Ventures as a consolidated subsidiary with a minority interest balance representing the minority owners' net investment. MARKETING The Company and its franchisees market Sylvan's Learning Center services to parents of school-aged children at all grade levels and academic abilities. Far beyond tutoring, Sylvan Learning Centers' supplemental education utilizes a diagnostic and prescriptive approach to address the specific needs of each and every student. A portion of Sylvan's advertising includes commercials on morning news on the national networks as well as various cable delivered programs. Sylvan's advertising positions it as the leader in supplemental education and emphasizes Sylvan's high quality curriculum, personalized attention and positive results: better grades and improved self-esteem. Franchisees form local cooperatives to collectively purchase local television and radio advertising and usually supplement their efforts with local newspaper and direct mail. The Company also has additional marketing support for specific programs, including Reading, Math, Algebra, Study Skills, SAT/ACT College Prep, and Writing. The Company markets its school-based educational services to local school districts and state education departments. This marketing effort has been expanded to seek contracts for both public and non-public schools, where both are administered by the local public school district. The Company markets its Canter division primarily through cooperative programs with participating institutions and direct mail advertising to teachers. 7 WSI markets its English language instruction services through the use of national television and radio advertising programs in Spain as well as through locally placed advertising by its franchisees and company-owned centers in various countries. Sylvan International Universities markets its services in Spain, Switzerland, Mexico, and Chile through media ad campaigns as well as directly to prospective students. As part of this marketing effort, UEM, Les Roches , UVM, and UDLA marketing professionals visit private schools across the countries presenting the universities to prospective students and parents. Guided tours of the universities are also provided for high school students. UEM, Les Roches, UVM, and UDLA also carry out nationwide advertising campaigns on television, radio, written media and the Internet during annual enrollment periods. COMPETITION The Company faces competition in each of its business segments. That competition focuses on price, educational quality and location in the franchise businesses. In the Education Solutions and International University businesses, the competition is primarily based on price and educational quality. The Company is aware of only three direct national corporate competitors in its Sylvan Learning Centers segment: Huntington Learning Centers, Inc., Kumon Educational Institutes and Kaplan Educational Centers. The Company believes these competitors operate fewer centers than Sylvan and that these firms concentrate their services within a smaller geographic area. In most areas served by Sylvan Learning Centers, competition also exists from individual tutors and local learning centers. State and local education agencies also fund tutoring by individuals, which compete with the company's Sylvan Learning Centers segment. Schulerhilfe competition consists of one other provider of tutoring services in Germany as well as individual local tutors. The Company's Educational Solution segment's most significant competitor remains the public school system itself. Given the unique position of public education in the United States, the Company believes that educational reforms implemented directly by school officials will not face the same degree of public resistance that the Company may face. The Company also competes with school reform efforts sponsored by private organizations and universities and with consultants hired by school districts to provide assistance in the identification of problems and implementation of solutions. The Company is aware of several entities that currently provide Title I and state-based programs for students attending parochial and private schools on a contract basis. The English Language Instruction market is highly fragmented with numerous public and private sector operators. These include Berlitz/ELS, E.F. (a Swedish company) and Opening (a Spanish company). Berlitz is the largest of these companies in this market segment, with annual revenues of approximately $330 million. The university market in Spain is dominated by the public universities, which have a 95% share of the overall market. In the Madrid area, where UEM operates, the main competitors are: C.E.U, Alfonso X el Sabio, and Universidad Pontificia de Comillas. C.E.U. is believed to be the largest, with several campuses in the Madrid area and approximately 10,000 students. The main competitors of Les Roches within Switzerland are Lausanne and Glion Hotel Schools. UVM is a leader within the growing segment of private universities in Mexico which now account for 29% of the total university enrollments. UVM's market share among private universities is 7% at a national level and 14.5% in the Mexico City metropolitan area. Its closest competitors include, among others, public universities like UNAM and UAM, and private universities like UNITEC, Universidad Panamericana and ITESM. The Chilean higher education system is composed of a group of traditional publicly funded universities (25) and a growing number of private universities (48). The private universties account for 31% of the total higher education enrollments. UDLA's market share within the private university sector amounts to 5.7%. UDLA competes with main traditional publicly funded universities, Universidad de Chile and Universidad Catolica, and also with the following private universities: Universidad Mayor, Universidad Andres Bello, and Universidad Diego Portales. GOVERNMENT REGULATION FRANCHISE. Various state authorities as well as the Federal Trade Commission (the "FTC") regulate the sales of franchises in the United States. The FTC requires that franchisers make extensive disclosure to prospective franchisees but does not require registration. A number of states require registration and prior approval of the franchise-offering document. In addition, several states have "franchise relationship laws" or "business opportunity laws" that limit the ability of a 8 franchiser to terminate franchise agreements or to withhold consent to the renewal or transfer of these agreements. While the Company's franchising operations have not been materially adversely affected by such existing regulation, the Company cannot predict the effect of any future legislation or regulation. TITLE I. Title I school districts are responsible for implementing Title I in carrying out their educational programs. Title I regulations, as well as provisions of Title I itself, direct Title I school districts to satisfy obligations including involving parents in their children's education, evaluating and reporting on student progress, providing equitable services and other benefits to eligible non-public school students in the district and other programmatic and fiscal requirements. In contracting with school districts to provide Title I services, the Company, has become, and will continue to be, subject to various Title I requirements and may become responsible to the school district for carrying out specific functions required by law. For example, Sylvan has responsibility for soliciting parental involvement, introducing program content adequate to achieve certain educational gains and maintaining the confidentiality of student records. The Company's failure to adhere to Title I requirements or to carry out regulatory responsibilities undertaken by contract may result in contract termination, financial liability, or other sanctions. ACCREDITATION. Private Universities must undergo an extensive trial period being overseen by the competent authorities to guarantee levels of academic quality before being granted full autonomy over curricula. The Company's universities in Spain, Switzerland, Mexico and Chile have all been granted full autonomy. The universities are then subject to periodic reviews by authorities. TRADEMARKS The Company has a federal trademark registration for the words "Sylvan Learning Center" and distinctive logo and various other trademarks and service marks and has applications pending for a number of other distinctive phrases. The Company also has obtained foreign registrations of a number of the same trademarks. The Company's License Agreement grants the franchisee the right to use the Company's trademarks in connection with operation of the franchisee's Learning Center. Additionally, the Company has a federal trademark registration for the words "Wall Street Institute" and distinctive logo (Statue of Liberty), as well as foreign trademark registrations and pending applications for the WSI trademark and logo. EMPLOYEES As of December 31, 2000, the Company had approximately 14,200 employees, 5,300 of whom were classified as full-time and 8,900 of whom were classified as part-time. Most of the Company's part-time employees are university employees, teachers in school-based programs, Company-owned Learning Centers and Schulerhilfe centers. The Company's employees are not represented by a union, and the Company considers its relationship with its employees to be good. EFFECT OF ENVIRONMENTAL LAWS The Company believes it is in compliance with all environmental laws, in all material respects. Future compliance with environmental laws is not expected to have a material effect on the business. ITEM 2. PROPERTIES The Company leases most of its facilities, consisting principally of administrative office space and center site locations. The Company's administrative offices consist of four leased facilities in Baltimore, Maryland. The Company's segments lease various sites, primarily in North America and Europe. The Learning Center segment leases space for 84 sites in the United States, and 177 Schulerhilfe sites in Germany; the English Language Instruction segment leases 50 sites around the world; the Education Solutions segment leases 3 regional offices; and the International Universities segment leases 2 sites used for the Dentistry and Podiatry clinics. The Company also owns academic buildings and dormitories on the UEM, Les Roches and UDLA campuses. 9 ITEM 3. LEGAL PROCEEDINGS The Company is the defendant in a legal proceeding pending in the United States District Court for the Northern District of Iowa, Civil Action No. C96-334MJM, filed on November 18, 1996 by ACT, Inc., an Iowa nonprofit corporation formerly known as American College Testing Program, Inc. ("ACT"). ACT's claim arises out of the Company's acquisition of rights to administer testing services for the National Association of Securities Dealers, Inc. ("NASD"). ACT has asserted that the Company tortuously interfered with ACT's relations, contractual and quasi-contractual, with the NASD, that the Company caused ACT to suffer the loss of its advantageous economic prospects with the NASD and other ACT clients and that the Company has monopolized and attempted to monopolize the computer-based testing services market. ACT has claimed unspecified amounts of compensatory, treble and punitive damages, as well as injunctive relief. If ACT were awarded significant compensatory or punitive damages, it could materially adversely affect the Company's results of operations and financial condition. In February 1998, the Court ruled that ACT may proceed only on three of its five antitrust theories and otherwise narrowed the scope of ACT's antitrust claims. In March 1998, the Court denied the Company's motion to dismiss ACT's state law claims. Formal discovery was completed in 1999. Following discovery, in response to the Company's motion to dismiss, the Court further narrowed the scope of the litigation by dismissing all of ACT's tort claims. Following the Court setting a trial date, the Company filed a motion in limine to strike all of ACT's alleged damages. The Court granted that motion on May 8, 2000. The Company then renewed the motion for summary judgment, and ACT filed a motion for reconsideration or, in the alternative, for an interlocutory appeal, as well as a motion to join Prometric, Inc. as an additional defendant. The Court indefinitely postponed the trial date to consider those motions. On March 21, 2001, the Court reaffirmed its earlier decision striking ACT's alleged damages but granted ACT's motion to certify that ruling for an interlocutory appeal to the United States Court of Appeals for the Eighth Circuit. The Court denied ACT's motion for reconsideration and also denied the Company's renewed motion for summary judgment because the Court would not preclude a trial on ACT's claim for injunctive relief. The Court denied all other motions in limine without prejudice and granted ACT's motion to join Prometric, Inc. as an additional defendant. Prometric, Inc. is the Company's former subsidiary that now conducts the computer-based testing business formerly conducted by the Company. The Company believes that all of ACT's claims are without merit but is unable to predict the outcome of the ACT litigation at this time. The Company is the defendant in an arbitration proceeding pending in Los Angeles, California initiated on or about March 22, 1999 by James Jinsoo Choi and Christine Choi. The Chois' claim arose out of the previous relationship Mr. Choi had as a licensee of Sylvan. Mr. Choi was licensed to operate Sylvan Learning Centers in Korea pursuant to a license agreement. In June 1998, Sylvan terminated the license agreement for non-curable defaults. In their complaint, the Chois allege fraud, negligent misrepresentation, breach of fiduciary duty, and breach of contract. The Chois have claimed unspecified compensatory and punitive damages. The arbitration hearing has been completed and the parties are awaiting the decision of the arbitration panel. The Company believes that all of the Chois' claims are without merit but is unable to predict the outcome of the Choi arbitration at this time. At this time the Company is not a party, either as plaintiff or defendant, in any other material litigation. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to be voted on by security holders during the fourth quarter ended December 31, 2000. 10 PART II. ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded on the NASDAQ National Market. The Company's trading symbol is SLVN. The high and low trade prices for 2000 and 1999 for the Company's Common Stock are set out in the following table. These prices are as reported by NASDAQ, and reflect inter-day price quotations, without retail mark-up, mark down or commission, and may not necessarily represent actual transactions.
2000 HIGH LOW ---- ------ ------ 1st Quarter $16.75 $12.56 2nd Quarter $16.75 $10.63 3rd Quarter $16.13 $10.94 4th Quarter $16.31 $12.63 1999 HIGH LOW ---- ------ ------ 1st Quarter $34.63 $24.94 2nd Quarter $29.25 $19.25 3rd Quarter $28.19 $15.25 4th Quarter $19.13 $10.69
No dividends were declared on the Company's common stock during the years ended December 31, 2000 and 1999, and the Company does not anticipate paying dividends in the foreseeable future. The number of registered shareholders of record as of March 26, 2001 was 383. During the year ended December 31, 2000, the Company issued 45,162 shares of its common stock as part of acquisition transactions that were not registered under the Securities Act of 1933. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data for the years ended December 31, 2000, 1999, 1998, 1997, and 1996 have been derived from Sylvan's consolidated financial statements. The financial data should be read in conjunction with the consolidated financial statements and notes thereto. The Company consummated significant purchase business combinations in each of the five years in the period ended December 31, 2000. These business combinations affect the comparability of the amounts presented. Additionally, the accompanying financial data has been restated to reflect the net assets of the disposed operations of Aspect, Prometric and PACE as net assets and net liabilities of discontinued operations. The following data should be read in conjunction with Notes 3 and 4 to the consolidated financial statements. 11
2000(1)(2) 1999(3)(4) 1998(5)(6) 1997 1996(7) ------------- ------------ ----------- ----------- ----------- STATEMENTS OF OPERATIONS DATA: (IN THOUSANDS, EXPECT PER SHARE AMOUNTS) Revenues $316,651 $277,050 $178,802 $118,101 $104,076 Costs and expenses: Direct costs 270,619 220,607 134,132 96,464 86,384 Sylvan Ventures operating costs 18,183 - - - - General and administrative expense 20,306 26,855 15,530 18,085 8,049 Transaction costs related to pooling-of-interests - - 3,245 - - Restructuring and asset impairment charges - 3,569 - - - ------------- ------------ ----------- ----------- ----------- Total costs and expenses 309,108 251,031 152,907 114,549 94,433 ------------- ------------ ----------- ----------- ----------- Operating income 7,543 26,019 25,895 3,552 9,643 Other non-operating income (loss) 20,039 (12,248) 3,988 32,802 1,563 Interest expense (7,322) (4,041) (319) (213) (799) Sylvan Ventures investment losses (11,441) - - - - Equity in net loss of affiliates: Sylvan Ventures investments (21,222) - - - - Other (981) (2,356) (3,500) (2,006) 361 Minority interest: Sylvan Ventures 9,133 - - - - Other (1,674) (319) - - - ------------- ------------ ----------- ----------- ----------- Income (loss) from continuing operations before income taxes and cumulative effect of change in accounting principle (5,925) 7,055 26,064 34,135 10,768 Tax benefit (expense) 4,308 1,284 (6,624) (9,826) (3,839) ------------- ------------ ----------- ----------- ----------- Income (loss) from continuing operations before cumulative effect of change in accounting principle $ (1,617) $ 8,339 $ 19,440 $ 24,309 $ 6,929 ============= ============ =========== =========== =========== Income (loss) from continuing operations per share, basic $ (0.04) $ 0.16 $0.40 $0.57 $0.19 Income (loss) from continuing operations per share, diluted $ (0.04) $ 0.16 0.38 0.54 0.18 BALANCE SHEET DATA: Cash and cash equivalents $ 116,490 $ 18,995 $ 29,267 $ 6,613 $ 3,811 Available-for-sale securities 202,077 10,890 6,108 82,951 16,474 Net working capital 157,458 284,311 24,584 113,572 29,785 Intangible assets and deferred contract costs (net) 285,155 194,645 116,667 25,602 24,212 Net assets of discontinued operations - 280,287 278,150 134,062 99,169 Total assets 1,016,963 764,625 602,410 369,416 229,625 Long-term debt, including current portion and other long term liabilities 192,769 185,934 62,248 73,493 29,917 Stockholders' equity 553,263 474,093 488,833 340,460 182,768
(1) In 2000, the Company acquired controlling interests in Swiss Hotel Association Hotel Management School Les Roches ("Les Roches"), Universidad del Valle De Mexico ("UVM") and Universidad de las America ("UDLA"). These acquisitions were accounted for as purchases. The purchase price for Les Roches totaled approximately $23,198 including net cash payments of $5,219 and the assumption of $17,979 in debt and net liabilities. Additional variable amounts of consideration are also payable to the seller if specified levels of earnings are achieved in 2001 and 2002. The purchase price for UVM totaled approximately $55,481 including net cash payments of $46,964 and the assumption of $8,517 of net liabilities. The purchase price for UDLA totaled approximately $27,871, including cash payments of $23,988 and the assumption of $3,883 of debt and net liabilities. Additional variable amounts of consideration are also payable to the seller if specified levels of earnings are achieved in 2004, 2005 and 2006. The Company's 2000 results of operations include the results of operations of Les Roches for the period June 30, 2000 through December 31, 2000 UVM for the period November 30, 2000 through December 31, 2000, and UDLA for the period December 12, 2000 through December 31, 2000. 12 Additionally, on May 18, 2000, the Company purchased certain assets and assumed certain liabilities of Ivy West. The purchase price totaled approximately $10,200. The Company's 2000 results of operations include the results of Ivy West for the period May 18, 2000 through December 31, 2000. (2) On March 3, 2000, the Company sold Prometric for approximately $775,000 in cash and recorded an estimated gain on the sale of approximately $288,454, net of income taxes of approximately $136,800. On October 6, 2000, the Company sold Aspect for approximately $19,794 in cash and recorded a gain on the sale of approximately $22,353 including, an income tax benefit of approximately $3,047. (3) On April 1, 1999, the Company acquired a controlling interest in the Universidad Europea de Madrid ("UEM") for cash of $26,000. The acquisition was accounted for as a purchase, and Sylvan's 1999 results of operations include the results of operations of UEM for the period April 1, 1999 through December 31, 1999. Also during 1999, the Company acquired 23 WSI franchise businesses for a total purchase price of $65,800. This acquisition was accounted for using the purchase method of accounting. (4) During the quarter ended December 31, 1999, the Company recognized restructuring costs of $3,569 related to continuing operations. Additionally, the Company recognized significant non-recurring operating charges related to continuing operations during the fourth quarter of 1999, which totaled $9,978. These charges were principally related to asset impairment charges, which resulted from management's focus on simplification of the business model and a return to the core business strengths. Losses recorded on disposal of investments in the fourth quarter of 1999 also resulted in $13,370 of non-recurring charges during the period. The cumulative effect of these significant, unusual charges was to reduce income from continuing operations before income taxes and cumulative effect of change in accounting principle by $26,947 during the fourth quarter of 1999. See Notes 18 and 20 to the audited consolidated financial statements. (5) Includes $3,245 of expenses related to a pooling of interest acquisition such as legal, accounting and advisory fees. (6) On January 1, 1998, the Company acquired Canter for an initial purchase price of $25,000. Additional consideration of $48,819 has been recorded to reflect Canter's achievement of certain EBITDA targets. The acquisition was accounted for as a purchase, and Sylvan's results of operations from January 1, 1998 include the operations of Canter. Effective October 28, 1998, the Company acquired Schulerhilfe, in exchange for an initial purchase price of $19,082 in cash. Additional consideration of $10,424 was recorded subsequent to the initial purchase to reflect achievement of revenue and collection targets in 1999. The results of operations of Schulerhilfe subsequent to October 28, 1998 are included in Sylvan's results of operations. (7) Effective December 1, 1996, Sylvan acquired WSI in exchange for an initial purchase price of $21,071. This transaction was accounted for using the purchase method of accounting, and Sylvan's results of operations from December 1, 1996 include the operations of Wall Street. 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company generates revenues from four business segments: Sylvan Learning Centers, which earns primarily franchise royalties, franchise sales fees and Company-owned Learning Center revenues; Sylvan Education Solutions, which earns revenues from providing supplemental remedial education services to public and non-public schools as well as providing teacher training services; Sylvan English Language Instruction, which earns primarily franchise royalties, franchise sales fees, and company-owned center revenue; and Sylvan International Universities, which earns tuition and dormitory fees paid by the students of UEM, Les Roches, UVM and UDLA. During 2000 the fifth segment, Sylvan Ventures, was launched. Sylvan Ventures had no revenues in 2000 but it incurred costs related to its efforts to develop its investments and recorded its equity share of the losses of investments accounted for using the equity method. The following table sets forth the percentage relationships of operating revenues and direct costs for each segment, as well as certain income statement line items expressed as a percentage of total revenues for the periods indicated for the year ended December 31:
2000 1999 1998 --------- ---------- ---------- Revenues: Sylvan Learning Centers 31% 33% 36% Sylvan Education Solutions 33% 37% 48% Sylvan English Language Instruction 16% 19% 16% Sylvan International Universities 20% 12% 0% --------- ---------- ---------- Total revenues 100% 100% 100% Direct costs: Sylvan Learning Centers 24% 25% 25% Sylvan Education Solutions 28% 29% 40% Sylvan English Language Instruction 15% 15% 9% Sylvan International Universities 18% 11% 0% --------- ---------- ---------- Total direct costs 85% 80% 75% General and administrative expenses 6% 10% 9% Sylvan Ventures operating costs 6% 0% 0% Costs related to pooling of interests and restructuring costs 0% 1% 2% --------- ---------- ---------- Operating income (loss) 2% 9% 14% Other non-operating income (loss) 6% (4%) 2% Interest expense (2%) (1%) 0% Sylvan Ventures investment losses (4%) 0% 0% Equity in loss of affiliates (7%) (1%) (2%) Minority interest 2% 0% 0% ----------- ---------- ---------- Income (loss) from continuing operations before taxes (2%) 3% 15% Tax benefit (expense) 1% 0% (4%) --------- ---------- ----------- Income (loss) from continuing operations (1%) 3% 11% =========== ========== ==========
14 RESULTS OF OPERATIONS The Company has continued to grow during 2000 in response to expanding opportunities in the educational services industry. The Company dramatically increased its activity in the post secondary market with the completion of acquisitions of controlling interests in three universities located in Mexico, Switzerland and Chile. The Sylvan International Universities segment now operates the largest global network of international universities with full local accreditation through its network of four universities. Additional post secondary growth also occurred through increased Canter enrollments and the expansion of the WSI operation. The Company's K-12 businesses also displayed continued strong growth with the expansion of the Learning Centers network and the addition of contracts and services within Education Solutions. The Company also moved to address the increasing importance of technology in learning by focusing efforts on applications of Internet technology to the education and instruction marketplaces through the creation of Sylvan Ventures. In order to fund Sylvan International Universities, Sylvan Ventures and to ensure that management remains focused on core business strengths in the educational and training services industry, the Company opted to sell the PACE corporate training business, the Prometric computer-based testing business and the Aspect English language immersion business in December 1999, March 2000 and October 2000, respectively. The operating results of the discontinued businesses have been reported in the discontinued operations section of the consolidated statement of operations. The following comparison of operating results focuses on the continuing operations of the Company. COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 2000 TO RESULTS FOR THE YEAR ENDED DECEMBER 31, 1999. REVENUES. Total revenues from continuing operations increased by $39.6 million, or 14%, to $316.7 million for the year ended December 31, 2000 ("fiscal 2000") from $277.1 million for the year ended December 31, 1999 ("fiscal 1999"). This revenue increase has been primarily driven by expansion of the International Universities segment through university acquisitions along with revenue growth in Learning Centers and Education Solutions segments. These revenue increases were offset by the impact of the Company's announced strategy of foregoing franchise sales in lieu of retaining ownership of franchise territories in high potential markets. SYLVAN LEARNING CENTERS revenues for 2000 increased by $8.3 million, or 9%, to $98.9 million. Franchise royalties increased by $3.2 million, or 18%, as a result of the net increase of 55 franchised Centers opened in 2000 and a 12% increase in same center revenue. Franchise sales fees decreased by $5.6 million, primarily due to an international area development agreement to develop France sold for $5.0 million in September 1999. Ivy West, an SAT preparation company based in California was acquired in 2000, which resulted in additional revenues of $3.0 million. Product sales and other franchise service revenues increased $2.6 million for fiscal 2000, as compared to fiscal 1999. Revenues from Company-owned Learning Centers increased $5.6 million, or 13%, to $47.7 million during 2000. Same center revenues increased 5%, or $2.1 million, with the remaining revenue increase of $3.5 million generated from three new Company-owned centers opened or acquired from franchise owners in 2000. Fiscal 2000 marked the ninth consecutive year of double-digit same-center sales growth for the combined operations of franchise and Company-owned centers. International revenues, primarily Schulerhilfe, decreased by $0.5 million to $13.9 million primarily due to unfavorable foreign exchange variances for fiscal 2000 compared to fiscal 1999. Revenues for Learning Centers represent 31% of the total continuing revenues of the Company for the year ended fiscal December 31, 2000. SYLVAN EDUCATION SOLUTIONS revenue increased by $3.9 million, or 4%, to $105.2 million in fiscal 2000 compared to fiscal 1999. Sylvan At School revenue increased $2.6 million or 4% over the same period in 1999. Canter teacher-training revenue increased $1.3 million to $36.8 million in fiscal 2000 from $35.5 million in the same period of 1999. Canter revenues grew $4.8 million, in fiscal 2000, through programs designed to meet the strong demand for teacher training. This increase in 2000 revenues is partially offset in the comparison to 1999 revenues by a $3.5 million international license fee recorded in 1999. Operating revenue for Education Solutions represents 33% of total revenues from continuing operations of the Company for the year ended December 31, 2000. SYLVAN ENGLISH LANGUAGE INSTRUCTION revenues for fiscal 2000 decreased $2.9 million, or 5%, to $49.9 million. The primary reason for the revenue decrease is that sales of territory fees decreased by $4.7 million to $2.5 million for fiscal 2000 from $7.2 million for fiscal 1999. This decline in territory fees resulted from the aforementioned change in the Company's expansion strategy to one of retaining ownership of franchise territories in high potential markets. The remaining $1.8 million increase in revenue is attributable to expansion in Brazil and Italy. These increases were offset by lower franchise sales, maturation of the market in Spain and unfavorable foreign exchange differences for fiscal 2000 compared to fiscal 1999. Revenue from Sylvan English Language Instruction represents 16% of total continuing revenues of the Company for fiscal 2000. 15 SYLVAN INTERNATIONAL UNIVERSITIES revenue for fiscal 2000 increased $30.3 million, or 94%, to $62.6 million. UEM revenues increased $13.0 million in 2000 principally because fiscal year 1999 included only nine months of operations. Additionally, the acquisitions of controlling interests of Les Roches on June 30, 2000, UVM on November 30, 2000 and UDLA on December 12, 2000 contributed $6.3 million, $10.1 million and $0.9 million, respectively. Revenue from Sylvan International Universities represents 20% of total continuing revenues of the Company for fiscal 2000. DIRECT COSTS. Total direct costs of continuing operations, excluding Sylvan Ventures, increased 23%, to $270.6 million in fiscal 2000 from $220.6 million in fiscal 1999, as a result of business expansion. Direct costs as a percentage of total revenues increased from 80% in 1999 to 85% in 2000. The increase in direct costs as a percentage of total revenues from continuing operations is primarily due to the expenses related to the international expansion of the International Universities and English Language Instruction segments. SYLVAN LEARNING CENTERS expenses increased $8.1 million to $76.8 million, or 78% of Learning Centers revenue for fiscal 2000, compared to $68.7 million, or 76% of Learning Centers revenue for fiscal 1999. The increase for fiscal 2000 is primarily related to expenses incurred by Company-owned Learning Centers due to the acquisition of franchised Learning Centers and costs associated with higher revenues at existing Company-owned centers. Cost increases also related to franchise services support costs as a result of growth in franchised centers over the prior year, costs related to Sylvan Ivy Prep, and increased costs related to international development. These cost increases were offset by a $3.4 million decrease in non-recurring costs incurred in fiscal 1999 related to the technology driven impairment of certain educational programs, and the refocusing of management efforts on core business objectives during 1999. SYLVAN EDUCATION SOLUTIONS expenses increased by $7.6 million to $89.0 million, or 85% of Sylvan Education Solutions revenue for the year ended December 31, 2000, compared to $81.4 million or 80% of Sylvan Education Solutions revenue for the same period of 1999. The increase in expenses as a percentage of revenue for the year ended December 31, 2000 is primarily due to $3.5 million of high-margin fiscal 1999 revenue related to the sale of a territory license to provide Canter's master's degree program in Mexico. SYLVAN ENGLISH LANGUAGE INSTRUCTION expenses increased by $6.0 million to $47.1 million, or 94% of English Language Instruction revenues for fiscal 2000, compared to $41.1 million, or 78% of the segment's revenues in fiscal 1999. The increase in expenses as a percentage of revenues was primarily a result of the business decision to reduce the amount of high margin territory sales further compounded by cost increases in staffing administrative efforts to internally support the international expansion program. SYLVAN INTERNATIONAL UNIVERSITIES expenses increased by $28.2 million to $57.6 million, or 92% of Sylvan International Universities revenue for fiscal 2000, compared to $29.4 million or 91% of Sylvan International Universities revenue for fiscal 1999. This increase in expenses is primarily due to the full year 2000 impact of UEM, which was acquired in April 1999, as well as acquisition of the controlling interests in Les Roches, UVM, and UDLA during fiscal 2000. Additionally, headquarters personnel costs for Sylvan International Universities were also incurred to support the expansion of the university network during fiscal 2000. OTHER EXPENSES. General and administrative expenses decreased by $6.5 million during 2000, to $20.3 million. This decrease in expense was due to overall cost reductions as a result of discontinued business units, as well as $3.0 million of 1999 non-recurring expenses related to business start-up costs and simplification of the Sylvan business model. Excluding these non-recurring expenses, expenses as a percentage of revenues decreased to 6% in fiscal 2000 from 9% in fiscal 1999. Sylvan Ventures operating costs were $18.2 million for fiscal 2000. eSylvan, a wholly-owned subsidiary of the Company, contributed $13.0 million of expenses related to the development of the Company's Internet based tutoring operations. Ventures management expenses of $5.2 million were incurred related to organizational start-up costs and management expenses related to the research, evaluation and management of the investment portfolio companies. Sylvan Ventures investment losses of $11.4 million related to the sale of the Zapme! investment and various impairment charges related to portfolio investments. Sylvan Ventures equity in net losses of affiliates of $21.2 million relates to Sylvan Ventures' share of operating losses generated by the early stage enterprises in the investment portfolio and the amortization of the initial difference between the carrying amount of equity method investments and the underlying equity in net assets of these investments at the time of the purchase. Sylvan Ventures minority interests' share of investment losses totaled $9.1 million for fiscal 2000. Beginning in 2001, any investment losses incurred by Sylvan Ventures will be allocable principally to the Company. 16 Other non-operating income increased $15.6 million in fiscal 2000 as compared to fiscal 1999. This net increase was primarily attributable to a $20.9 million increase in interest income from investing the proceeds of the March 2000 sale of Prometric, offset by a $3.3 million increase in interest expense related to increased borrowings outstanding during the period, and a $2.0 increase in foreign currency exchange losses. The primary reason for the exchange loss was a loss of $3.1 million that was incurred on the settlement of a forward exchange contract acquired to protect against fluctuations in local currency related to a pending International University acquisition. Fiscal 1999 results from continuing operations included $3.6 million in restructuring costs resulting from strategic changes in the Company's core educational services business. These restructuring charges were primarily the result of employee termination costs, school closings and facility exit costs resulting from management's plan to exit certain activities outside the core business of providing educational instruction. In conjunction with the Company's 1999 formal restructuring plan, management also examined existing corporate investments to determine realizable investment value. Non-operating losses totaling $13.4 million were incurred in 1999 as a result of decreases in investment values resulting from changing market conditions for the educational services industry, including an aggregate loss of $11.4 million related to the sale of the investment in JLC Learning Corporation as disclosed in Note 6 to the audited consolidated financial statements. The reported effective income tax rate for continuing operations exceeds the U.S. federal statutory rates due to the impact of state income taxes, the impact of minority interests, and the inability to utilize tax benefits from certain investment losses of Sylvan Ventures. The Company's effective tax rate for continuing operations prior to Sylvan Ventures was 34% for fiscal 2000. The Company's effective tax rate for continuing operations for fiscal 1999 was significantly impacted by utilized tax credits, foreign tax benefits and state income taxes offset by permanent differences that arose due to the significant amount of restructuring and non-recurring charges in 1999. Because of these factors, comparison of the fiscal 2000 and fiscal 1999 effective tax rates is not meaningful. INCOME (LOSS) FROM CONTINUING OPERATIONS. Income (loss) from continuing operations before cumulative effect of change in accounting principle decreased by $10.0 million, to a loss of $1.6 million for fiscal 2000. The decrease is primarily a result of costs and investment losses totaling $25.2 million related to Sylvan Ventures. Prior to the fiscal 2000 impact of Sylvan Ventures and after the removal of 1999 restructuring and non-recurring items, pre-tax income from continuing operations increased in fiscal 2000 by $1.8 million, to $35.8 million, due primarily to the increase in interest income related to the investment of the proceeds of the sale of discontinued operations, offset by the Company's change in international strategy to retaining ownership of franchise territories in high potential markets. COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1999 TO RESULTS FOR THE YEAR ENDED DECEMBER 31, 1998. REVENUES. Total revenues from continuing operations increased by $98.2 million, or 55%, to $277.1 million for the year ended December 31, 1999 from $178.8 million for the same period in 1998. This increase resulted from higher revenues in all business segments - Sylvan Learning Centers, Sylvan Education Solutions, Sylvan English Language Instruction and the initial operations of Sylvan International Universities. SYLVAN LEARNING CENTERS revenues for 1999 increased by $25.9 million, or 40%, to $90.7 million. Franchise royalties increased by $2.5 million, or 16%, as a result of the net increase of 43 franchised Centers opened in 1999 and a 12% increase in same center revenue. Franchise sales fees increased by $1.6 million, primarily due to the sale of a master franchise agreement for France for $5.0 million in September 1999, the effect of which was partially offset by the sale of a master franchise agreement for the United Kingdom for $3.3 million in 1998. Revenues from Company-owned Learning Centers increased $7.8 million, or 23%, to $42.2 million during 1999. Same center revenues increased 7%, or $2.2 million, with the remaining revenue increase of $5.6 million generated from 29 new Company-owned centers opened or acquired from franchise owners in 1998 and 1999. The full year impact of the October 1998 acquisition of Schulerhilfe, a Germany-based tutoring company, resulted in an additional $12.0 million in revenue for the year ended December 31, 1999. Product sales and other franchise service revenues generated the remaining revenue increase of $2.0 million for 1999, as compared to 1998. Revenues for Learning Centers represent 33% of the total continuing revenues of the Company for the year ended December 31, 1999. 17 SYLVAN EDUCATION SOLUTIONS revenues increased for 1999 by $15.0 million, or 17%, to $101.3 million. The revenue increase for the year ended December 31, 1999 was the result of a $3.9 million increase in revenue from Sylvan at School contracts, a $0.3 million increase in Sylvan at Work contracts, and a $10.8 million increase in revenue from the Canter teacher instruction group. The $3.9 million increase in revenue from public and nonpublic schools for 1999 is the result of $4.5 million in revenue attributable to new contracts obtained after December 31, 1998, offset by a $0.6 million decrease in revenue from existing contracts. The revenue increase at Canter was due to increasing demand for domestic teacher training as well as the sale of a license to apply the Canter teachers distance learning masters degree program in Mexico for a licensing fee of $3.5 million. Revenue for Education Solutions represents 37% of total continuing revenues of the Company for the year ended December 31, 1999. SYLVAN ENGLISH LANGUAGE INSTRUCTION revenues increased for 1999 by $25.1 million, or 90%, to $52.8 million The revenue increase was due to a combination of acquisitions of Centers in high-growth European countries coupled with growth in the core areas of the business. Corporate center revenues increased by $24.0 million in 1999 to $30.8 million, primarily due to the inclusion of operating results of centers acquired in Italy, Germany and Spain. Franchising revenues fees increased to $12.6 million in 1999 from $12.3 million in 1998. The growth of the franchising revenues was reduced by a decrease in franchise royalties of $0.2 million for 1999 and the impact of the acquisition of successful franchised centers by WSI in 1999. Revenues from new area development agreements generated $3.9 million in franchise sales fees in 1999, which was a decrease from the 1998 franchise sales fees of $5.1 million. Fees from area development agreements have declined as a result of management's decision to retain undeveloped territories for Company-operated center expansion. Product sales revenues increased by $0.4 million to $6.3 million in 1999 due to increased demand for the English language instruction product. Revenues for the English Language Instruction segment represent 19% of total revenues of the Company for the year ended December 31, 1999. SYLVAN INTERNATIONAL UNIVERSITIES, began operations in the second quarter of 1999 with the acquisition of a controlling interest (54%) in the Universidad Europea de Madrid (UEM). Sylvan assumed operating control of UEM on April 1, 1999, at which time the results of UEM's operations began to be consolidated with those of the Company. Total revenues for UEM subsequent to April 1, 1999 were $32.3 million, which represent 12% of total revenues of the Company for the year ended December 31, 1999. DIRECT COSTS. Total direct costs of continuing operations increased 64%, to $220.6 million in 1999 from $134.1 million in 1998, as a result of business expansion. Direct costs as a percentage of total revenues increased from 75% in 1998 to 80% in 1999. The increase in direct costs as a percentage of total revenues from continuing operations was a result of non-recurring costs in existing businesses, start-up costs of new business ventures and investments in technology enhancements. SYLVAN LEARNING CENTERS expenses increased $23.3 million to $68.7 million, or 76% of Learning Centers revenue for 1999, compared to $45.4 million, or 70% of Learning Centers revenue for 1998. Approximately $7.3 million of the increase for 1999 related to expenses incurred by Company-owned Learning Centers due to the acquisition of franchised Learning Centers and costs associated with higher revenues at existing Company-owned centers. Expenses as a percentage of revenues in Company-owned centers increased for the period as a result of the acquisition of more franchise centers, which tend to operate at lower margins. Cost increases of $2.5 million in 1999 related to franchise services support costs as a result of growth in franchised centers over the prior year. The impact of the October 1998 acquisition of Schulerhilfe resulted in $10.1 million of increased costs for 1999. Approximately $3.4 million of the segments direct cost increase represented non-recurring costs related to the technology driven impairment of certain educational programs, and the refocusing of management efforts on core business objectives. SYLVAN EDUCATION SOLUTIONS expenses increased by $9.4 million to $81.4 million, or 80% of Education Solutions revenue for 1999, compared to $72.0 million, or 83% of Education Solutions revenues for 1998. The decrease in expenses as a percentage of revenue for 1999 was primarily due to the increased volumes at Canter, which has higher operating margins. Canter operating margins were further enhanced by the sale of a license agreement to provide Canter's masters degree program in Mexico. SYLVAN ENGLISH LANGUAGE INSTRUCTION expenses increased $24.3 million to $41.1million, or 78% of WSI revenues for 1999, compared to $16.8 million, or 60% in 1998. This expense increase was primarily due to business growth and the cost of operating the corporate centers that were acquired in 1999. Approximately $24.1 million of the increase for 1999 related to expenses incurred in corporate centers due to the acquisition of franchised centers and costs associated with higher revenues at existing corporate centers. Expenses as a percentage of revenues in corporate centers increased for the period 18 as a result of the acquisition of more franchise centers, which tend to operate at lower margins. SYLVAN INTERNATIONAL UNIVERSITIES expenses were $29.4 million for the nine-month period ended December 31, 1999. These direct expenses consist primarily of personnel, marketing and advertising, and facility-related costs of UEM. These expenses are a larger percentage of the International Universities revenues for the period from acquisition through December 31, 1999 than the anticipated annual percentage because of the seasonality of the business. Classes are not in session for June, July, August and September. However, certain fixed expenses are incurred year round. OTHER EXPENSES. General and administrative expenses increased by $11.3 million during 1999, to $26.9 million. These expenses as a percentage of revenues increased to 10% in 1999. This increase in expenses as a percentage of revenues is largely due to $3.0 million of non-recurring expenses incurred in 1999 related to business start-up costs, asset impairments, and simplification of the Sylvan business model. Also included were the general and administrative costs necessary to provide support for the PACE and Prometric businesses although their operating results are included in discontinued operations. Results from continuing operations included $3.6 million in restructuring costs resulting from strategic changes in the Company's core educational services business. These restructuring charges were primarily the result of employee termination costs, school closings and facility exit costs resulting from management's plan to exit certain activities outside the core business of providing educational instruction. In conjunction with the Company's formal restructuring plan, management also examined existing corporate investments to determine realizable investment value. Non-operating losses totaling $13.4 million were incurred in 1999 as a result of decreases in investment values resulting from changing market conditions for the educational services industry, including an aggregate loss of $11.4 million related to the sale of the investment in JLC Learning Corporation as disclosed in Note 6 to the audited consolidated financial statements. Other non-operating expenses increased $5.7 million as compared to the same period in 1998. This net increase was primarily attributable to a $2.3 million decrease in other investment income, a $3.7 million increase in interest expense related to increased borrowings outstanding during the period, (which included $1.8 million of UEM interest expense) and a $0.3 million minority interest in income of consolidated subsidiary recorded in 1999, which was associated with UEM, offset by favorable impacts of other non-operating expenses of $0.6 million. The Company's effective tax position on continuing operations has been significantly impacted by utilized tax credits, foreign tax benefits and state income taxes offset by permanent differences that arose due to the significant amount of restructuring and non-recurring charges in 1999. Because of these factors, comparison of the 1999 and 1998 effective tax rates is not meaningful. INCOME FROM CONTINUING OPERATIONS. Income from continuing operations before cumulative effect of change in accounting principle decreased by $11.1 million, to $8.3 million for the year ended December 31, 1999. After removing the effects of restructuring charges of $3.6 million, non-recurring operating expenses of $10.0 million and losses on investments of $13.4 million, pre-tax income from continuing operations for the year ended December 31, 1999 increased over 1998 by $8.0 million, or 30.7%, to $34.1 million. This increase was the result of increased revenues and operating income from the Learning Centers, Education Solutions and International University segments. FUTURE ASSESSMENT OF RECOVERABILITY AND IMPAIRMENT OF GOODWILL In connection with various acquisitions, the Company has recorded goodwill. At December 31, 2000, unamortized goodwill was $277.1 million, which represented 27% of total assets and 51% of stockholders' equity. Goodwill arises when an acquirer pays more for a business than the fair value of the tangible and separately measurable intangible net assets. For financial reporting purposes, goodwill and all other intangible assets are amortized over the estimated period benefited. The Company has determined the life for amortizing goodwill based upon several factors, the most significant of which are the relative size, historical financial viability and growth trends of the acquired companies and the relative lengths of time such companies have been in existence. The Company amortizes goodwill on a straight-line basis over periods of 15 to 25 years based upon the factors associated with the specific acquisition. In connection with the Company's fiscal 2000 acquisition of Les Roches and UDLA, additional goodwill may be recorded for variable amounts of contingent consideration that are payable to the seller if certain criteria are met. The 19 contingent consideration will be recorded as additional goodwill when the contingencies are resolved and the additional consideration is payable. Variable amounts of contingent consideration are payable to the seller's of Les Roches if specified levels of earnings are achieved in 2001 and 2002. Variable amounts of contingent consideration are payable to the sellers of UDLA in 2001, 2006 and 2007 if specified levels of earnings are achieved in 2000, 2004, 2005 and 2006. As of December 31, 2000, the Company has recorded an estimate of the consideration due in 2001 as a liability and additional goodwill of approximately $12,000. Management periodically reviews the Company's carrying value and recoverability of unamortized goodwill. If the facts and circumstances suggest that goodwill may be impaired, the carrying value of such goodwill will be adjusted, which will result in an immediate charge against income during the period of the adjustment and/or the length of the remaining amortization period may be shortened, which will result in an increase in the amount of goodwill amortization during the period of adjustment and each period thereafter until fully amortized. Once adjusted, there can be no assurance that there will not be further adjustments for impairment and recoverability in future periods. Of the various factors considered by management of the Company in determining whether goodwill is impaired, the most significant are (i) losses from operations, (ii) loss of customers, and (iii) industry developments, including the Company's inability to maintain its market share, development of competitive products or services, and imposition of additional regulatory requirements. LIQUIDITY AND CAPITAL RESOURCES During 2000, the Company generated $7.9 million of cash flow from operations, a decrease of $63.0 million from the prior year. The reported net income of $305.2 million included significant non-operating elements such as net gain on sale of discontinued operations of $310.8 million, and non-cash elements such as depreciation and amortization charges of $30.4 million, loss from sale of investments of $11.4 million, equity in loss of affiliates, primarily due to Sylvan Ventures, of $22.2 million and minority interest of $7.5 million. Working capital related decreases in liquidity of $39.6 million during the year resulted primarily from an increase in receivables and a reduction of payables and other current liabilities. Cash generated from investing activities was $305.3 million in 2000, an increase of $464.9 million over the cash used in investing activities of $159.3 million in 1999. During 2000, cash generated consisted primarily of proceeds from the sale of Prometric ($710.3 million) and Aspect ($19.8 million). These amounts were offset by purchases of securities ($191.8 million) and net cash used to purchase Les Roches, UVM and UDLA ($64.2 million), Ivy West ($7.9 million), and other businesses, primarily by WSI ($18.7 million), increases in investments in and advances to affiliates primarily related to investments by Sylvan Ventures ($69.5 million), payments of contingent consideration and other accrued liabilities for prior period acquisitions ($19.3 million) and purchases of property and equipment ($33.8 million). The 2000 investment activity was primarily related to the Company's strategic plan to dispose of Sylvan Prometric and Aspect and to invest the proceeds of those sales into expansion of the International University and Sylvan Ventures segments. At December 31, 2000, the Company had accrued obligations payable in cash of $40.1 million related to contingent consideration for certain acquisitions. The amount due will be paid in 2001. During 2000, the Company used cash in financing activities of $212.0 million, which was primarily funded by the proceeds from the sale of the discontinued operations. The financing activity related primarily to the net repayment of the Company's borrowings under its existing credit agreements ($260.0 million) and the payment to repurchase common shares pursuant to two tender offers ($212.0 million). These amounts were offset by borrowings under bank lines of credit ($133.4 million) prior to the Prometric sale, the issuance of convertible debentures ($100.0 million) and capital contributions from minority investors ($24.9 million). The Company anticipates that cash flow from operations, available cash and existing credit facilities, will be sufficient to meet its operating requirements, including the expected expansion of its existing business, fund International University acquisitions, pay contingent consideration and fund Sylvan Ventures investments and operating costs. In connection with the Company's ownership of Sylvan Ventures, commitments have been made to provide certain investments additional funding totaling $44.3 million. The Company continues to examine opportunities in the educational services industry for potential synergistic acquisitions. EURO CONVERSION On January 1, 1999, certain countries of the European Union established fixed conversion rates between their existing currencies and one common currency, the Euro. The Euro is now traded on currency exchanges and may be used in business transactions. The Company encountered no difficulties related to the initial adoption of the Euro in 1999. Beginning in January 2002, new Euro-denominated currencies will be issued and the existing currencies will be withdrawn from circulation. The Company is currently evaluating the systems and business issues raised by the Euro conversion. 20 These issues include the need to adapt computer and other business systems and equipment and the competitive impact of cross-border transparency. At present, management does not believe the Euro conversion will have a material impact on the Company's financial condition or results of operations. CONTINGENT MATTERS In connection with the Company's acquisition of Canter and based on Canter's earnings in 2000, additional consideration of $13.1 million was paid to the seller in cash in 2001. As of December 31, 2000, the Company has recorded this additional consideration as a liability and goodwill, which will be amortized over the remaining amortization period of 22 years. In connection with the Company's acquisition of Les Roches, various amounts of contingent consideration are payable to the seller if specified levels of earnings are achieved in 2001 and 2002. The Company will record the contingent consideration when the contingencies are resolved and the additional consideration is payable. In connection with the Company's acquisition of UDLA, variable amounts of contingent consideration are also payable to the seller in 2006 and 2007 if specified levels of earnings are achieved in 2004, 2005 and 2006. The Company will record the contingent consideration when the contingencies are resolved and the additional consideration is payable. The Company has entered into agreements with franchisees of the Learning Centers and Wall Street Institute that allow the franchisee to put the centers back to the Company in the future at a predetermined multiple of operating results upon the achievement of specified operating thresholds. When the Company can access the likelihood of a put being exercised and the amount of the related commitment to purchase the center such obligation is disclosed. EFFECTS OF INFLATION Inflation has not had a material effect on Sylvan's revenues and income from continuing operations in the past three years. Inflation is not expected to have a material future effect. SEASONALITY IN RESULTS OF OPERATIONS The Company experiences seasonality in results of operations primarily as a result of changes in the level of student enrollments and the timing of semester cycles particularly in the International Universities segment. Timing of semester breaks at the International Universities results in the most favorable operating performance being recognized in the second and fourth quarters of the year. Other factors that impact the seasonality of operating results include: timing of contracts funded under Title I, timing of franchise license fees and the timing of Sylvan Ventures' development costs. Revenues and profits in any period will not necessarily be indicative of results in subsequent periods. ALL STATEMENTS CONTAINED HEREIN THAT ARE NOT HISTORICAL FACTS, INCLUDING BUT NOT LIMITED TO, STATEMENTS REGARDING THE ANTICIPATED IMPACT OF UNCOLLECTIBLE ACCOUNTS RECEIVABLE ON FUTURE LIQUIDITY, THE COMPANY'S CONTINGENT PAYMENT OBLIGATIONS RELATING TO ACQUISITIONS, FUTURE CAPITAL REQUIREMENTS, POTENTIAL ACQUISITIONS, AND THE COMPANY'S FUTURE DEVELOPMENT PLANS ARE BASED ON CURRENT EXPECTATIONS. THESE STATEMENTS ARE FORWARD LOOKING IN NATURE AND INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES. POLITICAL, ECONOMIC, CURRENCY, TAX, REGULATORY, TECHNOLOGICAL, COMPETITIVE AND OTHER FACTORS DESCRIBED IN THE COMPANY'S REPORTS FILED FROM TIME TO TIME WITH THE COMMISSION. THE COMPANY WISHES TO CAUTION READERS NOT TO PLACE UNDUE RELIANCE ON ANY SUCH FORWARD LOOKING STATEMENTS, WHICH STATEMENTS ARE MADE PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND, AS SUCH, SPEAK ONLY AS OF THE DATE MADE. 21 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the risk of loss to future earnings, to fair values or to future cash flows that may result from the changes in the price of financial instruments. The Company is exposed to financial market risks, including changes in foreign currency exchange rates, interest rates and investment values. The Company occasionally uses derivative financial instruments to protect against adverse currency movements related to significant foreign acquisitions. Exposure to market risks related to operating activities is managed through its regular operating and financing activities. FOREIGN CURRENCY RISK The Company derives approximately 40% of its revenues from continuing operations from customers outside of the United States. This business is transacted through a network of international subsidiaries, generally in the local currency that is considered the functional currency of that foreign subsidiary. Expenses are also incurred in the foreign currencies to match revenues earned and minimize the Company's exchange rate exposure to operating margins. A hypothetical weakening of 10% of the U.S. dollar relative to all other currencies should not materially adversely affect expected 2001 earnings or cash flows. The Company generally views its investment in the majority of its foreign subsidiaries as long-term. The functional currencies of these foreign subsidiaries are principally denominated in Euro-based currencies. The effects of a change in foreign currency exchange rates on the Company's net investment in foreign subsidiaries are reflected in other comprehensive income. A 10% depreciation in functional currencies relative to the U.S. dollar would result in a decrease in consolidated stockholders' equity at December 31, 2000 of approximately $16.1 million. The Company has entered into forward foreign exchange contracts principally to manage the currency fluctuations in significant foreign transactions, thereby limiting the Company's risk that would otherwise result from changes in exchange rates. Gains and losses on forward foreign exchange contracts for purposes of business acquisitions are reflected in the income statement. INTEREST RATE RISK The Company holds its cash and cash equivalents in high quality short term fixed income securities consequently, the fair value of the Company's cash and cash equivalents would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due to the short-term nature of the Company's portfolio. The Company's long-term revolving credit facility bears interest at variable rates, and the fair value of this instrument is not significantly affected by changes in market interest rates. The Company's convertible debentures bear interest at 5%, which presently approximates the market rate and therefore the fair value approximates the recorded value of this liability. A 100 basis point decrease in interest rates would impact net interest income and interest expense by reducing pretax income for the year ended December 31, 2000 by $2.7 million. INVESTMENT RISK The Company's investment portfolio contains high quality debt securities that mature within one year. A hypothetical 10% adverse change in the fair value of the debt securities should not materially adversely effect earnings or cash flows because of the Company's ability to hold the debt securities until maturity. In addition to the debt securities, the Company has an investment portfolio that consists of direct investment positions in education technology companies through Sylvan Ventures as well as short-term investments in available-for-sale debt and equity securities. The Company's investment portfolio is exposed to risks arising from changes in these investment values. The Company's investment portfolio includes a number of holdings of non-publicly traded companies in the educational services industry. The Company values these investments at either cost less impairment (if any) or under the equity method of accounting. Equity method investors are specifically excluded from the scope of this disclosure. Non-public investments where the Company owns less than a 20% stake are subject to fluctuations in market value, but their current illiquidity reduces the exposure to pure market risk while resulting in risk that the Company may not be able to liquidate these investments in a timely manner. The Company is exposed to equity price risks on equity securities included in the portfolio of investments entered into for the promotion of business and strategic objectives. These investments are generally small capitalization stocks in the Internet segment of the educational services industry. The Company typically does not attempt to reduce or eliminate its market exposure on these securities. A 10% adverse change in equity prices would not materially impact the fair value of the Company's marketable securities and comprehensive income. All the potential impacts noted above are based on sensitivity analysis performed on the Company's financial 22 position at December 31, 2000. Actual results may differ materially. ITEM 8. FINANCIAL STATEMENTS The financial statements of the Company are included on pages 32 through 60 of the report as indicated on page 31. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There were no changes in accountants, disagreements, or other events requiring reporting under this Item. 23 PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF SYLVAN LEARNING SYSTEMS, INC. Information required is set forth under the caption "Election of Directors" in the Proxy Statement relating to the 2001 Annual Meeting of Shareholders, which will be filed on or before April 30, 2001. Information required pertaining to compliance with Section 16 (a) of the Securities and Exchange Act of 1934 is set forth under the caption "Election of Directors" in the Proxy Statement relating to the 2001 Annual Meeting of Shareholders, which is incorporated by reference. ITEM 11. EXECUTIVE COMPENSATION Information required is set forth under the caption "Executive Compensation" in the Proxy Statement relating to the 2001 Annual Meeting of Shareholders, which is incorporated by reference. ITEM 12. SECURITY OWNERSHIP AND CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required is set forth under the caption "Security Ownership" in the Proxy Statement relating to the 2001 Annual Meeting of Shareholders, which is incorporated by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required is set forth under the caption "Certain Transactions" in the Proxy Statement relating to the 2001 Annual Meeting of Shareholders, which is incorporated by reference. PART IV. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this report: 1. FINANCIAL STATEMENTS The response to this portion of Item 14 is submitted as a separate section of this Report. 2. FINANCIAL STATEMENT SCHEDULES All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are inapplicable or immaterial and therefore have been omitted. (b) Reports on Form 8-K: Form 8-K dated March 6, 2000 ITEM 2. Acquisition or Disposition of Assets ITEM 7. Financial Statements, Pro Forma Financial Information and Exhibits Form 8-K dated October 9, 2000 ITEM 2. Acquisition or Disposition of Assets ITEM 7. Financial Statements, Pro Forma Financial Information and Exhibits 24 3. EXHIBITS (a) Exhibits:
EXHIBIT NUMBER DESCRIPTION ------ ----------- 11.01 Purchase Agreement for $100,000 Convertible Subordinated Debentures Due 2010, 11.02 Formation Agreement by and among Sylvan Learning Systems, Inc., AP Educate Investments, LLC, R. Christopher Hoehn-Saric and Douglas L. Becker dated June 30, 2000, 11.03 Limited Liability Company Agreement of Sylvan Ventures, LLC by and among Sylvan Learning Systems, Inc., AP Educate Investments, LLC, Sylvan Ventures, Inc., R. Christopher Hoehn-Saric and Douglas Becker dated June 30, 2000, 11.04 Stock Purchase Agreement among Optagon Holdings Limited ("Buyer") and Sylvan Learning Systems, Inc., Sylvan Learning Systems International, Ltd. and Aspect International Language Schools, B.V. (collectively, "Seller") dated October 6, 2000, 11.05 Share Purchase Agreement dated as of June 30, 2000 between Francis Clivaz and Christian Clivaz ("Sellers") and Sylvan Learning Systems, Inc. ("Purchaser") regarding Gesthotel S.A., 11.06 Agreement by and among Sylvan Learning Systems Mexico, S. de R.L. de C.V. ("Purchaser") and Jose Ortega Martinez, et. al. ("Sellers") for the purchase of Universidad del Valle de Mexico, A.C. dated September 25, 2000, 11.07 Purchase Agreement dated December 12, 2000 between Sylvan Chile Limitada ("Purchaser") and Indeco S.A. ("Seller") for the purchase of Universidad de las Americas de Chile.
25 23.01 Consent of Ernst & Young LLP with respect to consolidated financial statements of Sylvan Learning Systems, Inc. 23.02 Consent of Ernst & Young LLP with respect to financial statements of Caliber Learning Network, Inc. 23.03 Consent of Ernst & Young LLP with respect to financial statements of Classwell Learning Group, Inc 23.04 Consent of Arthur Anderson LLP with respect to consolidated financial statements of iLearning, Inc 23.05 Consent of Ernst & Young LLP with respect to consolidated financial statements of Highermarkets, Inc. 23.06 Consent of Ernst & Young LLP with respect to consolidated financial statements of Mindsurf, Inc 23.07 Consent of Pricewaterhouse Coopers, LLP with respect to financial statements of Chancery Software, Inc. 99.1 Chancery Software Limited Audited Financial Statements 99.2 Higher Markets, Inc. Audited Financial Statements 99.3 iLearning, Inc. Audited Financial Statements 99.4 Mindsurf, Inc. Audited Financial Statements 99.5 Classwell Learning Group Inc. Audited Financial Statements 99.6 Caliber Learning Network, Inc. Audited Financial Statements
26 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf of the undersigned, thereunto duly authorized on March 29, 2001. SYLVAN LEARNING SYSTEMS, INC. (Registrant) By: /s/ DOUGLAS L. BECKER ------------------------- Douglas L. Becker Chairman of the Board 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 indicated and on March 29, 2001.
SIGNATURE CAPACITY /s/ DOUGLAS L. BECKER Director, Chairman of the Board and Chief -------------------------------------------- Executive Officer Douglas L. Becker /s/ PETER COHEN President and Chief Operating Officer -------------------------------------------- Peter Cohen /s/ NEAL S. COHEN Executive Vice President and Chief Financial -------------------------------------------- Officer Neal S. Cohen /s/ DONALD BERLANTI Director -------------------------------------------- Donald Berlanti /s/ R. CHRISTOPHER HOEHN-SARIC Director ------------------------------------------- R. Christopher Hoehn-Saric /s/JAMES H. MCGUIRE Director ---------------------------------------------- James H. McGuire /s/LAURENCE M. BERG Director ----------------------------------------------- Laurence M. Berg
27 ITEM 14(a)(1) INDEX TO FINANCIAL STATEMENTS
PAGE THE COMPANY: Report of Independent Auditors......................................................................................29 Consolidated Balance Sheets as of December 31, 2000 and December 31, 1999...........................................30 Consolidated Statements of Operations for the years ended December 31, 2000, 1999, and 1998.........................32 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2000, 1999 and 1998................33 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998 .........................34 Notes to Consolidated Financial Statements..........................................................................35
28 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Sylvan Learning Systems, Inc. We have audited the consolidated balance sheets of Sylvan Learning Systems, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. 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. The 2000 financial statements of iLearning, Inc., (a corporation in which the Company has a 29% interest), have been audited by other auditors whose report has been furnished to us; insofar as our opinion on the 2000 consolidated financial statements relates to data included for iLearning, Inc., it is based solely on their report. In the consolidated financial statements, the Company's investment in iLearning, Inc. is stated at $5,568,000 at December 31, 2000, and the Company's equity in the net loss of iLearning, Inc. is stated at $1,932,000, for the year then ended. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in 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 and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and, for 2000, the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sylvan Learning Systems, Inc. and subsidiaries at December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for start-up costs in 1999. /s/ Ernst & Young LLP Baltimore, Maryland February 22, 2001 29 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLAR AND SHARE AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
DECEMBER 31, DECEMBER 31, 2000 1999 ---------------- ------------------- (Restated - Note 1) ASSETS Current assets: Cash and cash equivalents $116,490 $18,995 Available-for-sale securities 202,077 10,890 Receivables: Accounts receivable 68,468 45,537 Costs and estimated earnings in excess of billings on uncompleted contracts 2,613 3,061 Notes receivable from tuition financing 7,489 4,647 Other notes receivable 13,317 16,783 Other receivables 15,549 1,265 ---------------- ------------------- 107,436 71,293 Allowance for doubtful accounts (5,554) (2,138) ---------------- ------------------- 101,882 69,155 Inventory 5,832 6,098 Deferred income taxes 3,936 6,963 Prepaid expenses and other current assets 20,955 9,073 Net current assets of discontinued operations - 280,287 ---------------- ------------------- Total current assets 451,172 401,461 Notes receivable from tuition financing, less current portion 8,313 5,330 Other notes receivable, less current portion 2,378 1,879 Property and equipment: Land and buildings 94,151 63,319 Furniture, computer equipment and software 94,249 69,770 Leasehold improvements 22,407 10,819 ---------------- ------------------- 210,807 143,908 Accumulated depreciation (38,965) (28,090) ---------------- ------------------- 171,842 115,818 Intangible assets: Goodwill 296,422 200,382 Other 2,611 2,574 ---------------- ------------------- 299,033 202,956 Accumulated amortization (21,078) (11,952) ---------------- ------------------- 277,955 191,004 Investments in and advances to affiliates 57,999 13,317 Other investments 25,935 25,933 Deferred costs, net of accumulated amortization of $1,969 and $984 at December 31, 2000 and 1999, respectively 7,200 3,641 Other assets 14,169 6,242 ---------------- ------------------- Total assets $1,016,963 $764,625 ================ ===================
30 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLAR AND SHARE AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
DECEMBER 31, DECEMBER 31, 2000 1999 --------------- ------------- (Restated - Note 1) LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 20,108 $ 23,456 Accrued expenses 40,452 21,234 Income taxes payable 119,511 9,711 Current portion of long-term debt 20,292 14,315 Due to shareholders of acquired companies 40,195 22,474 Deferred revenue 42,483 23,234 Other current liabilities 10,673 - Net current liabilities of discontinued operations - 2,726 --------------- ------------- Total current liabilities 293,714 117,150 Long-term debt, less current portion 128,575 146,095 Deferred income taxes 4,824 12,152 Other long-term liabilities 3,707 3,050 --------------- ------------- Total liabilities 430,820 278,447 Minority interest 32,880 12,085 Stockholders' equity: Preferred stock, par value $.01 per share--authorized 10,000 shares, no shares issued and outstanding as of December 31, 2000 and 1999 - - Common stock, par value $.01 per share--authorized 90,000 shares, issued and outstanding shares of 37,278 as of December 31, 2000 and 50,904 as of December 31, 1999 373 509 Additional paid-in capital 205,343 414,567 Retained earnings 360,232 60,762 Accumulated other comprehensive loss (12,685) (1,745) --------------- ------------- Total stockholders' equity 553,263 474,093 --------------- ------------- Total liabilities and stockholders' equity $1,016,963 $764,625 =============== =============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 31 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLAR AND SHARE AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 2000 1999 1998 --------------- --------------- ---------------- (Restated - (Restated - Note 1) Note 1) REVENUES $316,651 $277,050 $178,802 COST AND EXPENSES Direct costs 270,619 220,607 134,132 Sylvan Ventures operating costs 18,183 - - General and administrative expense 20,306 26,855 15,530 Transaction costs related to pooling-of-interests - - 3,245 Restructuring charges - 3,569 - --------------- --------------- ---------------- Total expenses 309,108 251,031 152,907 --------------- --------------- ---------------- Operating income 7,543 26,019 25,895 OTHER INCOME (EXPENSE) Investment and other income 20,039 1,122 3,988 Interest expense (7,322) (4,041) (319) Sylvan Ventures investment losses (11,441) - - Other investment losses - (13,370) - Equity in net loss of affiliates: Sylvan Ventures (21,222) - - Other (981) (2,356) (3,500) --------------- --------------- ---------------- (22,203) (2,356) (3,500) Minority interest in consolidated subsidiaries: Sylvan Ventures 9,133 - - Other (1,674) (319) - --------------- --------------- ---------------- 7,459 (319) - --------------- --------------- ---------------- Income (loss) from continuing operations before income taxes and cumulative effect of change in accounting principle (5,925) 7,055 26,064 Income tax benefit (expense) 4,308 1,284 (6,624) --------------- --------------- ---------------- Income (loss) from continuing operations before cumulative effect of change in accounting principle (1,617) 8,339 19,440 Income (loss) from discontinued operations, net of income tax expense of $163, $12,398 and $14,958, respectively (3,968) 4,964 16,269 Gain (loss) on disposal of discontinued operations, net of income tax expense of $133,753 and $1,100, respectively 310,807 (26,968) - --------------- --------------- ---------------- Income (loss) before cumulative effect of change in accounting principle 305,222 (13,665) 35,709 Cumulative effect of change in accounting principle, net of income tax benefit of $682 - (1,323) - --------------- --------------- ---------------- Net income (loss) $305,222 $ (14,988) $35,709 =============== =============== ================ Earnings (loss) per common share, basic: Income (loss) from continuing operations before cumulative effect ofchange in accounting principle $(0.04) $ 0.16 $0.40 Net income (loss) $7.02 $ (0.29) $0.73 Earnings (loss) per common share, diluted: Income (loss) from continuing operations before cumulative effect of change in accounting principle $(0.04) $ 0.16 $0.38 Net income (loss) $7.02 $ (0.28) $0.70
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 32 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (AMOUNTS IN THOUSANDS)
ACCUMULATED ADDITIONAL OTHER TOTAL COMMON PAID-IN RETAINED COMPREHENSIVE STOCKHOLDERS' STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY --------- ----------- ----------- ------------- ------------- Balance at January 1, 1998 $455 $302,022 $ 39,144 $(1,161) $ 340,460 Options and warrants exercised for purchase of 654 shares of common stock, including income tax benefit of $5,176 7 11,531 11,538 Stock options granted to non-employees 539 539 Issuance of 27 shares of common stock in connection with the Employee Stock Purchase Plan 527 527 Issuance of 2,570 shares of common stock in connection with contingent consideration related to the acquisition of Drake 26 39,179 39,205 Issuance of 964 shares of common stock in connection with the acquisition of NAI / Block 10 24,990 25,000 Issuance of 345 shares of common stock in connection with contingent consideration related to the acquisition of PACE 3 11,305 11,308 Issuance of 864 shares of common stock in connection with other acquisitions and investments 9 19,301 999 20,309 Capital contribution by former shareholders of Aspect 1,300 1,300 Comprehensive income: Net income for 1998 35,709 35,709 Foreign currency translation adjustment 2,938 2,938 ------------- Total comprehensive income 38,647 --------- ----------- ------------ ------------- ------------- Balance at December 31, 1998 510 410,694 75,852 1,777 488,833 Options and warrants exercised for purchase of 311 shares of common stock, including income tax benefit of $1,456 3 4,391 4,394 Stock options granted to non-employees 348 348 Repurchase of 1,730 shares of common stock for payment of future contingent consideration resulting from business combinations (17) (36,195) (36,212) Issuance of 41 shares of common stock in connection with the Employee Stock Purchase Plan 961 961 Issuance of 510 shares of common stock in connection with the contingent consideration related to the acquisition of Canter 5 11,162 11,167 Issuance of 720 shares of common stock in connection with contingent consideration related to theacquisition of Drake 7 21,343 21,350 Issuance of 99 shares of common stock in connection with other acquisitions 1 1,863 (102) 1,762 Comprehensive income (loss): Net loss for 1999 (14,988) (14,988) Foreign currency translation adjustment (6,639) (6,639) Unrealized gain on available-for-sale securities 3,117 3,117 ------------- Total comprehensive loss (18,510) --------- ----------- ----------- ----------- ------------- Balance at December 31, 1999 509 414,567 60,762 (1,745) 474,093 Repurchase of 13,823 shares of common stock for cash (139) (211,850) (211,989) Options exercised for purchase of 91 shares of common stock, including income tax benefit of $322 1 801 802 Issuance of 62 shares of common stock in connection with the Employee Stock Purchase Plan 1 785 786 Effect of change in year-end of subsidiary (5,752) (5,752) Other 1 1,040 1,041 Comprehensive income (loss): Net income for 2000 305,222 305,222 Foreign currency translation adjustment (8,140) (8,140) Unrealized loss on available-for-sale securities (793) (793) Reclassification adjustment, net of tax (2,007) (2,007) ----------- Total comprehensive income 294,282 ---------- ----------- ----------- ----------- ----------- Balance at December 31, 2000 $373 $205,343 $360,232 $(12,685) $553,263 ========== =========== =========== =========== ===========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 33 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLAR AND SHARE AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ---------------------------------------------------------- 2000 1999 1998 ---------------- --------------- ------------- OPERATING ACTIVITIES Net income (loss) $305,222 $(14,988) $35,709 Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation 16,700 25,999 15,599 Amortization 13,742 20,788 16,724 (Gain) loss from discontinued operations (310,807) 26,891 - Loss on investments 11,441 13,370 - Other non-cash items 2,063 2,586 672 Minority interest in income of consolidated subsidiaries (7,459) 319 - Cumulative effect of change in accounting principle - 1,323 - Equity in net loss of affiliates 22,203 2,140 3,504 Deferred income taxes (4,639) (317) 1,265 Changes in operating assets and liabilities: Receivables (21,304) (35,109) (22,734) Inventory, prepaid expenses and other current assets 8,185 (4,018) (8,653) Accounts payable, income taxes payable and accrued expenses (21,386) 30,029 8,475 Deferred revenue and other current liabilities (6,033) 1,907 7,565 ---------------- --------------- ------------- Net cash provided by operating activities 7,928 70,920 58,126 ---------------- --------------- ------------- INVESTING ACTIVITIES Purchase of available-for-sale securities (418,828) - (2,502) Proceeds from sale or maturity of available-for-sale securities 227,026 3,082 79,611 Investment in and advances to affiliates and other investments (69,524) (10,510) (16,618) Purchase of property and equipment, net (33,813) (61,211) (58,294) Proceeds from sale of discontinued operations 730,106 Proceeds from sale of investment in JLC Learning Corporation - 15,211 - Purchases of international universities, including direct costs of acquisition, net of cash acquired (64,173) (26,000) - Payment of contingent consideration for prior period acquisitions (19,323) (16,689) (13,532) Cash paid for other businesses, net of cash acquired (26,833) (48,989) (54,512) Expenditures for deferred contract costs (3,711) (10,367) (2,771) Increase in other assets (15,665) (3,854) (5,895) ---------------- --------------- ------------- Net cash provided by (used in) investing activities 305,262 (159,327) (74,513) ---------------- --------------- ------------- FINANCING ACTIVITIES Proceeds from exercise of options and warrants 480 2,938 6,362 Repurchases of common stock (211,989) (36,212) - Proceeds from issuance of common stock 785 961 527 Proceeds from issuance of long-term debt 233,437 207,748 136,435 Payments on long-term debt (259,670) (97,295) (126,092) Cash received from minority interest members in Sylvan Ventures 24,931 - - Decrease in long-term liabilities - (1,268) - ---------------- --------------- ------------- Net cash provided by (used in) financing activities (212,026) 76,872 17,232 ---------------- --------------- ------------- Effect of subsidiary year-end change on cash (2,565) - - and cash equivalents Effects of exchange rate changes on cash (1,104) (2,640) 2,507 ---------------- --------------- ------------- Net increase (decrease) in cash and cash equivalents 97,495 (14,175) 3,352 Cash and cash equivalents at beginning of year 18,995 33,170 29,818 ---------------- --------------- ------------- Cash and cash equivalents at end of year $116,490 $18,995 $33,170 ================ =============== =============
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. 34 Sylvan Learning Systems, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Dollar and share amounts in thousands, except per share data) NOTE 1 - DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION Sylvan Learning Systems, Inc. and subsidiaries ("the Company" or "Sylvan") is an international provider of educational services. The Company conducts operations in five separate business segments- Sylvan Learning Centers, Sylvan Education Solutions, Sylvan English Language Instruction, Sylvan International Universities and Sylvan Ventures. The Sylvan Learning Centers segment designs and delivers individualized tutorial programs to school age children through franchised and Company-owned Learning Centers. The Sylvan Education Solutions segment principally provides educational programs to students of public and non-public school districts through contracts funded by federal Title I and state-based programs, and professional development services to teachers. The Sylvan English Language Instruction segment includes the operations of Wall Street Institute, B.V. ("WSI") a European-based franchiser and operator of learning centers that teach the English language. The Sylvan International Universities segment, which commenced operations in the second quarter of 1999, has controlling interests in four private, for-profit universities. This segment principally earns tuition and dormitory fees paid by university students. The newest segment, Sylvan Ventures, was launched in the first quarter of 2000 to invest in and incubate companies developing emerging technology solutions for the education marketplace. The Company sold the PACE Group ("PACE") corporate training business during fiscal year 1999. The Company sold its computer-based testing division, Sylvan Prometric, in the first quarter 2000 and its English language immersion division, Aspect, in the fourth quarter 2000. The accompanying consolidated balance sheets, statements of operations and related notes have been restated to reflect PACE, Sylvan Prometric and Aspect as discontinued operations for all periods presented. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States that require the Company's management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. Certain amounts previously reported have been reclassified to conform with the 2000 presentation. PRINCIPLES OF CONSOLIDATION The various interests that the Company acquires in its affiliated companies are accounted for under three methods: consolidation, equity method, or cost method. The Company determines the method of accounting for its affiliated companies on a case-by-case basis based upon its ownership percentage in each affiliated company, as well as its degree of influence over each affiliated company. CONSOLIDATION. Affiliated companies in which the Company owns, directly or indirectly, or otherwise controls more than 50% of the outstanding voting interests are accounted for under the consolidation method of accounting. Under this method, an affiliated company's results of operations are reflected within the Company's consolidated statements of operations. Earnings or losses attributable to other stockholders of a consolidated affiliated company are classified as "minority interest in consolidated subsidiaries" in the Company's consolidated statements of operations. Minority interest adjusts the Company's consolidated net results of operations to reflect only its share of the earnings or losses of an affiliated company. Transactions between the Company and its consolidated affiliated companies are eliminated in consolidation. EQUITY METHOD. Affiliated companies, in which the Company owns 50% or less of the outstanding voting interests, but over which the Company exercises significant influence, are accounted for under the equity method of accounting. Significant influence with respect to an affiliated company depends on an evaluation of several factors including, among other things, representation on the associated company's board of directors, ownership percentage and voting rights associated with the Company's holdings in the securities of the affiliated company. Investments accounted for under the equity method are reflected in the consolidated balance sheet as "investments in and advances to affiliates". Under the equity method of accounting, affiliated companies' results of operations are not reflected within the Company's consolidated operating results. However, the Company's share of the earnings or losses of these affiliated companies is classified as "equity in net income 35 NOTE 1 - BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS (CONTINUED) (loss) of affiliates" in the Company's consolidated statements of operations. The Company initially records its share of the earnings or losses of an affiliated company based upon its proportionate ownership of voting common stock. If the affiliated company is incurring losses, and previous losses have reduced the common stock investment account to zero, or if the Company holds no common stock, the Company continues to recognize equity method losses based on the ownership level of the particular affiliated company security or loan/advance held by the Company to which the equity method losses are being applied. The Company continues to report losses up to the investment carrying value, including any additional financial support made or committed to by the Company. The amount by which the Company's carrying value exceeds its share of the underlying net assets of the affiliated companies accounted for under the equity method of accounting, if any, is amortized on a straight-line basis over the estimated useful life of three years. This amortization adjusts the Company's share of the "equity in net loss of affiliates" in the Company's consolidated statements of operations. COST METHOD. Affiliated companies not accounted for under either the consolidation or the equity method of accounting are accounted for under the cost method of accounting. Under this method, the Company's share of earnings or losses of these companies is not included in the Company's consolidated statements of operations. However, a series of operating losses of an affiliated company or other factors may indicate that a decrease in value of the investments has occurred which is other than temporary. These impairment losses are recognized in the consolidated statements of operations and are included in "investment losses." The Company records its ownership interest in equity securities of its affiliated companies accounted for under the cost method at cost, unless the securities have readily determinable fair values based on quoted market prices, in which case these interests are reported at fair value. NOTE 2 - ACCOUNTING POLICIES CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. INVESTMENTS Available-for-sale securities are carried at fair value, with any unrealized gains and losses, net of tax, reported in other comprehensive income (loss). The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are included in investment and other income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment and other income. INVENTORY Inventory, consisting primarily of computer software and educational, instructional, and marketing materials and supplies, is stated at the lower of cost (first-in, first-out) or market value. PROPERTY AND EQUIPMENT Property and equipment is stated at cost. Included in property and equipment are the direct costs of developing or obtaining software for internal use. Depreciation is determined using the straight-line method over the estimated useful lives of the assets, which are as follows: Buildings 29-50 years Furniture, computer equipment and software 2-7 years Leasehold improvements 3-10 years
36 NOTE 2 - ACCOUNTING POLICIES (CONTINUED) INTANGIBLE ASSETS Goodwill consists of the cost in excess of fair value of assets acquired in purchase transactions, and is amortized on a straight-line basis over the estimated future periods to be benefited, which range from 15 to 25 years. At December 31, 2000 and 1999, accumulated amortization of goodwill was $19,370 and $10,480, respectively. DEFERRED COSTS Deferred costs include direct-mail advertising costs for university-based distance learning masters programs. Under these arrangements, the Company incurs certain direct-mail advertising costs to market its programs in advance of the program start date. These costs are capitalized and amortized over the estimated useful life of the programs, which approximate eighteen months. Deferred costs also include the cost of internally developing proprietary products and materials. These costs are capitalized and amortized over the estimated useful life of the products and materials, which approximates five years. IMPAIRMENT OF LONG-LIVED ASSETS Long-lived assets, including intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. If an impairment indicator is present, the Company evaluates whether impairment exists on the basis of undiscounted expected future cash flows from operations for the remaining amortization period. If impairment exists, the asset is reduced by the estimated shortfall of discounted cash flows. REVENUE RECOGNITION Revenue related to single-center and area franchise sales is recognized when all material services or conditions relating to the sales have been substantially performed or satisfied by the Company and collectibility of the fee is reasonably assured. For single-center franchise sales, the criteria for substantial performance include: (1) receipt of an executed franchise license agreement, (2) receipt of full payment of the franchise fee, (3) completion of requisite training by the franchisee or center director, and (4) completion of site selection assistance and site approval. Area franchise sales generally transfer to the licensee the right to develop and operate centers in a specified territory, primarily in a foreign country, and the Company's future obligations are insignificant. Area franchise fees are recognized upon the signing of the license agreement and the determination that (1) all material services or conditions relating to the sale have been satisfied and the fee is non-refundable, (2) a minimum payment of 50% of the fee is required within 90 days of the date of the agreement, and (3) the Company has the ability to estimate the collectibility of any unpaid amounts. Franchise sales fees not meeting the recognition criteria are recorded as deferred revenue if not refundable, or deposits from franchisees if refundable. Fixed price contracts with school districts receiving funds under the federal Title I program and state-based programs are accounted for using the percentage-of-completion method. Income is recognized based on the percentage of contract completion determined by the total expenses incurred to date as a percentage of total estimated expenses at the completion of the contract. Total contract income is estimated as contract revenue less total estimated costs considering the most recent cost information. Revenues from cost-plus-fee contracts are recognized on the basis of costs incurred during the period plus the fee earned. Franchise royalties are reported as revenue as the royalties are earned and become receivable, unless collection is not reasonably assured. Revenues from educational services are recognized in the period the services are provided. Revenue from the sale of educational products is generally recognized when shipped. Tuition and dormitory revenues are recognized over the term that the services are provided. Semester based expenses are recognized over the matching revenue recognition period. 37 NOTE 2 - ACCOUNTING POLICIES (CONTINUED) ADVERTISING The Company expenses advertising costs as incurred, except for direct-mail advertising, which is capitalized and amortized over its expected period of future benefit. Advertising expense for the years ended December 31, 2000, 1999 and 1998 was $25,841, $23,663, and, $9,313 respectively. Capitalized direct-response advertising consists primarily of the costs to produce direct-mail order catalogues and brochures that are used to solicit students of educational programs who have responded directly to the advertising. The capitalized production costs are amortized over the period of the respective programs, ranging from one to three years. At December 31, 2000 and 1999, advertising costs totaling approximately $4,280 and $3,253, respectively, were included in deferred costs. STOCK OPTIONS GRANTED TO EMPLOYEES AND NON-EMPLOYEES The Company records compensation expense for all stock-based compensation plans using the intrinsic-value-based method and provides pro forma disclosures of net income (loss) and net earnings (loss) per common share as if the fair value method had been applied in measuring compensation expense. The Company records compensation expense for all stock options granted to non-employees in an amount equal to their estimated fair value at the earlier of the performance commitment date or the date at which performance is complete, determined using the Black-Scholes option valuation model. The compensation expense is recognized ratably over the vesting period. FOREIGN CURRENCY TRANSLATION The financial statements of foreign subsidiaries with a functional currency other than the U.S. dollar have been translated into U.S. dollars using the current rate method. Assets and liabilities have been translated using the exchange rates at year-end. Income and expense amounts have been translated using the average exchange rates for the year. Translation gains or losses resulting from the changes in exchange rates have been reported as a component of accumulated other comprehensive income (loss) included in stockholder's equity, net of tax. OTHER COMPREHENSIVE INCOME The Company displays the accumulated balance of other comprehensive income or loss in accumulated other comprehensive income in the statement of stockholders' equity. The components were as follows at December 31:
2000 1999 ------------- -------------- Foreign currency translation adjustment $(13,002) $(4,862) Unrealized gain on available for-sale-securities, net of tax 317 3,117 ------------ -------------- Accumulated other comprehensive loss $(12,685) $(1,745) ============= ==============
INCOME TAXES The Company accounts for income taxes using the liability method. Under the liability method, deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e. temporary differences) and are measured at prevailing enacted tax rates that will be in effect when these differences have been settled or realized. 38 NOTE 2 - ACCOUNTING POLICIES (CONTINUED) ACCOUNTING CHANGE On January 1, 1999, the Company adopted the provisions of AICPA Statement of Position No. 98-5, REPORTING THE COSTS OF START-UP ACTIVITIES ("SOP 98-5"), which requires start-up costs capitalized prior to January 1, 1999 to be written-off and any future start-up costs to be expensed as incurred. The Company previously capitalized pre-contract costs directly associated with specific anticipated contracts as well as development costs for new educational programs that were estimated to be recoverable. The cumulative effect of adopting SOP 98-5 in 1999 decreased net income for the year ended December 31, 1999 by $1,323 (net of $682 in income taxes). The amount of the cumulative effect related to the discontinued operations was $567 (net of $291 in income taxes). IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. Statement No. 133 provides standards on accounting and disclosure for derivative instruments, and requires that all derivatives be measured at fair value and reported as either assets or liabilities in the Company's consolidated balance sheet. The Company will be required to adopt the provisions of Statement No. 133 no later than the beginning of fiscal year 2001. The Company has completed its evaluation of adopting Statement No. 133 on its consolidated financial position and results of operations, and has determined that it will not be material. NOTE 3 - DISCONTINUED OPERATIONS ASPECT On October 6, 2000, the Company sold its English Language immersion business, Aspect ("Aspect") for $19,794 in cash. The gain on the disposition recognized in the year ended December 31, 2000 was $22,353, which includes an income tax benefit of $3,047. The Company has estimated the domestic and foreign income taxes resulting from the sale based on the expected allocation of proceeds to subsidiaries that are a party to the transaction and the tax laws of the jurisdictions in which theses subsidiaries operate, assuming that undistributed gains outside the United States will be reinvested outside the United States. Effective January 1, 2000, the Company changed the year-end of Aspect from September 30 to December 31 to produce a consistent reporting period for the consolidated entity. As a result of this change in year-end, Aspect's net results of operations for the three month period ended December 31, 1999 are reflected as an adjustment to retained earnings on the consolidated balance sheet as of January 1, 2000. The impact of this change resulted in a decrease in retained earnings of approximately $5,752. The results of Aspect's operations, which are included in discontinued operations, for the period October 1, 1999 to December 31, 1999 are summarized as follows: Revenues $10,709 Direct costs (16,350) Operating loss (5,641) Other expense (111) -------------- Net loss $ (5,752) ==============
39 NOTE 3 - DISCONTINUED OPERATIONS (CONTINUED) SYLVAN PROMETRIC On March 3, 2000, the Company sold its computer-based testing division, Sylvan Prometric ("Prometric") for approximately $775,000 in cash. The gain on the disposition recognized in the year ended December 31, 2000 was approximately $288,454 net of income taxes of $136,800. The final proceeds from the sale may change based on contractual provisions that provide for certain adjustments to the sale price, including an adjustment for changes in working capital of Prometric between November 30, 1999 and March 3, 2000. The Company and the buyer have not completed the process required to provide for a final settlement of the sale proceeds. However, management believes that any future adjustments will be immaterial to financial position and results of operations. The Company has estimated the domestic and foreign income taxes resulting from the sale based on the expected allocation of proceeds to subsidiaries that are a party to the transaction and the tax laws of the jurisdictions in which these subsidiaries operate, assuming that undistributed gains outside the United States will be reinvested outside the United States. THE PACE GROUP On September 30, 1999, the Company adopted a formal plan to dispose of PACE. The sale transaction closed on December 31, 1999, and the Company received 10 shares of series C preferred stock and 2,503 shares of common stock of Frontline Group, Inc., a private investment holding company. The Company's investment in the stock was recorded at its estimated fair value at December 31, 1999 of $7,000, based on an independent appraisal, and a resulting loss on disposition was recorded of approximately $27,000, including income tax expense of approximately $1,100. SUMMARIZED FINANCIAL INFORMATION OF DISCONTINUED OPERATIONS Summarized operating information of the Company's discontinued operations for the years ended December 31 are as follows :
2000 1999 1998 ----------------- --------------- -------------- Revenues $75,898 $293,877 $261,531 ----------------- --------------- -------------- Income (loss) before income taxes (3,805) 17,362 31,227 Income tax expense 163 12,398 14,958 ------------------ --------------- -------------- Net income (loss) ($3,968) $ 4,964 $ 16,269 ================== =============== ==============
Included in income from discontinued operations for the years ended December 31, 2000, 1999, and 1998 is an allocation of corporate interest expense of $784, $2,411, and $232, respectively, based upon a percentage of the net equity investment in discontinued operations to the net equity of the Company including the discontinued operations. The accompanying consolidated statements of operations have been restated to reflect the results of operations for these entities as discontinued operations. The accompanying consolidated balance sheet at December 31, 1999 reflects the net assets of Sylvan Prometric as net assets of discontinued operations and net liabilities of Aspect as net liabilities of discontinued operations. Net long-lived assets of Prometric and Aspect as of December 31, 1999 have been included in the net current asset and net current liability amounts because the sale transactions closed during the year ended December 31, 2000. The net assets of discontinued operations and net liabilities of discontinued operations include the following for Prometric and Aspect as of December 31, 1999: Accounts and notes receivable, net $50,598 Accounts payable and accrued expenses (41,332) Other, net 1,621 Net long-lived assets 269,400 ------------------ Net current assets of Prometric discontinued operations $280,287 ==================
40 NOTE 3 - DISCONTINUED OPERATIONS (CONTINUED) Cash and marketable securities $ 1,415 Accounts and notes receivable, net 6,312 Accounts payable and accrued expenses (7,226) Other current liabilities, net (10,948) Net long-lived assets 13,070 Long-term debt (5,109) Other non-current liabilities, net (240) ------------------ Net current liabilities of Aspect discontinued operations $ (2,726) ==================
At December 31, 2000, undistributed gains on the sale of non-domestic discontinued operations totaled approximately $238,400. Deferred tax liabilities have not been recognized for these undistributed gains because it is management's intention to reinvest such undisbtributed gains outside of the United States. If all undistributed gains were remitted to the United States, the amount of incremental United States federal income taxes, net of foreign tax credits, would be approximately $83,400. NOTE 4 - ACQUISITIONS UNIVERSIDAD DE LAS AMERICAS Effective December 12, 2000, the Company acquired a 60% controlling interest in Universidad de Las Americas ("UDLA"), a private, for-profit university in Chile. The purchase price totaled approximately $27,871; including an initial net cash payment of $11,988, payments due of $12,000 after finalization of 2000 operating results, the assumption of $3,882 in outstanding debt. The final purchase price may differ from this preliminary amount due to adjustments to acquisition related costs. The acquisition was accounted for using the purchase method of accounting and goodwill of $19,734 was recorded and is being amortized over 25 years. The results of operations of UDLA are included in the accompanying consolidated statements of operations from December 12, 2000 through December 31, 2000. In connection with the Company's acquisition of UDLA, variable amounts of contingent consideration are also payable to the seller in 2006 and 2007 if specified levels of earnings are achieved in 2004, 2005 and 2006. The Company will record the contingent consideration when the contingencies are resolved and the additional consideration is payable. The final payment in 2007 will also include the Company's purchase of an additional 20% ownership interest for an agreed upon multiple of average operating performance of 2005 and 2006. UNIVERSIDAD DE VALLE DE MEXICO Effective November 24, 2000, the Company acquired an 80% controlling interest in Universidad de Valle de Mexico ("UVM"), a private, for-profit university in Mexico. The purchase price totaled approximately $55,481 including estimated net cash payments of $46,964 and the assumption of $8,517 of net liabilities. The final purchase price may differ from this preliminary amount due to adjustments to acquisition related costs. The acquisition was accounted for using the purchase method of accounting and goodwill of $38,595 was recorded and is being amortized over 25 years. The results of operations of UVM are included in the accompanying consolidated statements of operations from November 24, 2000 through December 31, 2000. LES ROCHES Effective July 25, 2000, the Company acquired Les Roches, a private, for-profit university in Switzerland. The purchase price totaled approximately $23,198 including estimated net cash payments of $5,219 and the assumption of $11,117 in outstanding debt and $6,862 of other net liabilities. The transaction was accounted for using the purchase method of accounting. The results of operations of Les Roches are included in the accompanying consolidated statements of operations from July 25, 2000 through December 31, 2000. In connection with the Company's acquisition of Les Roches, variable amounts of contingent consideration are also payable to the seller if specified levels of earnings are achieved in 2001 and 2002. The Company will record the contingent consideration when the contingencies are resolved and the additional consideration is payable. 41 NOTE 4 - ACQUISITIONS (CONTINUED) IVY WEST Effective May 18, 2000, the Company purchased certain assets and assumed certain liabilities of Ivy West, which offers SAT test preparation services. The purchase price totaled approximately $10,200 including estimated net cash payments of $7,900, a promissory note of $1,400, common stock valued at $250, common stock of a subsidiary of the Company valued at approximately $250 and the assumption of $400 of liabilities. The acquisition was accounted for using the purchase method of accounting and goodwill of $9,300 was recorded and is being amortized over 15 years. The results of operations of Ivy West are included in the accompanying consolidated statements of operations from May 18, 2000 through December 31, 2000. UNIVERSIDAD EUROPEA DE MADRID Effective April 1, 1999 the Company acquired a 54% controlling interest in Universidad Europea de Madrid ("UEM"), a private, for-profit university. The purchase price, including acquisition costs, was approximately $26,000 in cash, net of cash received. The acquisition was accounted for using the purchase method of accounting and goodwill of $10,445 was recorded and is being amortized over a period of 25 years. The results of operations of UEM for the periods subsequent to acquisition are included in the accompanying consolidated statement of operations. CANTER & ASSOCIATES, INC. AND CANTER EDUCATIONAL PRODUCTIONS, INC. Effective January 1, 1998, the Company acquired all of the outstanding stock of Canter & Associates, Inc. and Canter Educational Productions, Inc. (collectively, "Canter"), commonly controlled companies engaged in the business of providing materials and training programs for educators, for an initial purchase price of $25,000 in cash. The acquisition was accounted for using the purchase method of accounting and goodwill of $24,559 was recorded and is being amortized over a period of 25 years. The results of operations of Canter for the periods subsequent to acquisition are included in the accompanying consolidated statements of operations. The purchase agreement required the Company to pay Canter's shareholders additional consideration in the event that earnings in 1998, 1999 and 2000 exceeded certain prescribed levels. For the 1998 contingency period, the Company determined that additional consideration of $26,674 was due, and cash of $15,507 and restricted common stock with a value of $11,167 was paid in 1999. In 2000, the Company settled all remaining contingent payments for $22,145 consisting of $9,000 in cash and a commitment to pay the remaining $13,145 in 2001. SCHULERHILFE Effective October 28, 1998, the Company acquired two entities in Germany operating as Schulerhilfe for an initial purchase price of $16,554 in cash and 124 shares of restricted common stock valued at $2,528. The acquisition was accounted for using the purchase method of accounting and goodwill of $19,749 was recorded and is being amortized over a period of 25 years. The results of operations of Schulerhilfe subsequent to acquisition are included in the accompanying consolidated statements of operations. In connection with the Company's acquisition of Schulerhilfe, and based on the amount of 1999 franchise fees collected, additional consideration was payable to the seller in cash. As of December 31, 1999, the Company recorded this consideration as a liability and additional goodwill of $10,424, which is being amortized over the remaining amortization period of 24 years. WALL STREET INSTITUTE FRANCHISES During 1999, the Company acquired 23 WSI franchise businesses for a combined cash purchase price of approximately $65,800 including estimated net cash payments of $35,981 in 1999 and $18,719 in 2000, a promissory note of $2,600 and the assumption of approximately $8,500 of net current liabilities. The acquisitions were accounted for using the purchase method of accounting, and goodwill of $55,700 was recorded and is being amortized over 25 years. In connection with one of the 1999 acquisitions, contingent consideration was payable to the seller if a certain level of earnings was achieved in 2000. As of December 31, 2000, the Company has recorded an estimate of the contingent consideration of $12,000 as a liability and additional goodwill. 42 NOTE 4 - ACQUISITIONS (CONTINUED) UNAUDITED PRO FORMA RESULTS OF OPERATIONS The following combined unaudited pro forma results of operations of the Company give effect to the Les Roches, UVM, UDLA and UEM acquisitions as though they had occurred on January 1, 1999 for the years ended December 31:
2000 1999 ------------- ------------- Revenues $427,526 $389,128 Income from continuing operations before cumulative effect of change in accounting principle 342 9,169 Net income (loss) 367,181 (14,158) Earnings (loss) per common share, diluted: Continuing operations before cumulative effect of change in accounting principle $0.01 $ 0.17 Net income (loss) $7.06 $(0.27)
NOTE 5 - AVAILABLE-FOR-SALE SECURITIES The following is a summary of available-for-sale securities at December 31:
2000 1999 ------------- ------------- Equity securities $ 99 $ 8,281 Debt securities 201,649 - Cash reserve fund and other 329 2,609 ------------- ------------- $202,077 $10,890 ============= =============
At December 31, 2000, equity securities represent common stock investments in a public company with a cost of $250 and a quoted market price of $99. The adjustment to unrealized holding loss of $151 is a component of accumulated other comprehensive income (loss), included in stockholders' equity. The cost of the Company's other investments approximates fair value. Aggregate maturities of debt securities are as follows: $136,631 within 1 year, $40,604 within 2-5 years and $24,414 thereafter. The investments are classified as current as the Company views its available-for-sale securities as available for use in its current operations. NOTE 6 - INVESTMENTS FORMATION OF SYLVAN VENTURES The Sylvan Ventures segment was established during the first quarter of 2000 to invest in and develop companies developing emerging technology solutions for the education and training marketplace ("portfolio companies"). On June 30, 2000, the affiliates of Apollo Management L.P. ("Apollo") and certain members of management ("management investors") joined the Company to form Sylvan Ventures, LLC, with total committed funds of $400,000. Of the $400,000 commitment, the Company has committed $285,000, including investments in portfolio companies valued at $65,000, Apollo has committed $100,000, and management investors have committed $15,000. On June 30, 2000, the Company transferred four investments in portfolio companies to Sylvan Ventures - eSylvan, Inc., Caliber Learning Network, Inc., OnlineLearning.net, and Zapme! corporation. Upon formation, Sylvan Ventures issued common membership interests to Sylvan and the management investors and preferred membership interests to Apollo. Additionally, Sylvan Ventures authorized the granting of plan membership profit interests to members of management that entitles the recipients to receive an aggregate allocation of 20% of any cumulative net profits. As of December 31, 2000, the plan membership profit interests have been granted to management for an aggregate allocation of approximately 15% of the cumulative net profits upon a profits interest event. In 2000, the membership agreement provided for the allocation of net losses to the common and preferred members on a pro rata basis. Beginning January 1, 2001, net losses will be allocated on a pro rata basis only to the common membership interest holders until their capital account balances have been reduced to zero, at which time any losses will be allocated to Apollo until its capital account balance has been reduced to zero. Thereafter, any losses will be allocated to all membership 43 NOTE 6 - INVESTMENTS (CONTINUED) interest holders. Any profits earned after January 1, 2001 will first be allocated to Apollo until it has recovered its 2000 allocated losses and then to the common membership interest holders to recover previously allocated losses. After all previously allocated losses have been recovered through profit allocations, any additional net profits will be allocated on a pro rata basis to all interest holders, including the plan membership profit interest holders. CONSOLIDATED INVESTMENTS eSylvan is a start-up organization designed to distribute the Company's highly successful learning center tutoring product to students at home via a computer. Sylvan Ventures owns 98% of eSylvan. eSylvan has not generated significant revenue through December 31, 2000 and its operating expenses have been included in the 2000 consolidated statement of operations as a component of Sylvan Ventures operating costs. Sylvan Ventures has committed additional funding of $13,333 for eSylvan development and operating costs in 2001. INVESTMENT IN AFFILIATES (EQUITY METHOD INVESTMENTS): The Company's investments in and advances to affiliates consist of investments in and loans to companies in the initial or early stages of development. These companies are frequently illiquid or experiencing cash flow deficits from operations. Further, investments are generally unsecured and subordinated to the claims of other creditors. Accordingly, the Company's investments in and advances to affiliates are subject to a high degree of investment and credit risk. The Company's accounting policies with respect to its investments are described in Note 2. The Company has made estimates of the recoverability of loans and advances to its affiliates, and due to the inherent uncertainty of the operations of these affiliates, it is reasonably possible that these estimates may change in the near term. Investments in and advances to affiliates consist principally of investments in common stock and preferred stock, as follows as of December 31:
VOTING VOTING 2000 INTEREST 1999 INTEREST -------------- ------------- ------------- ------------- Caliber Learning Network, Inc. $15,123 36% $10,775 10% Chancery Software Limited 14,224 42% - - Classwell Learning Group, Inc. 13,045 42% - - iLearning, Inc. 5,568 29% - - HigherMarkets, Inc. 6,694 31% - - Mindsurf, Inc. 1,109 47% - - Other 2,236 - 2,542 - -------------- ------------- Total $57,999 $13,317 ============== =============
Each period in the table below includes summarized financial data of those affiliates in which Sylvan Ventures had an interest at the end of the respective period and includes results of operations data of the affiliate for the entire year.
2000 1999 1998 -------------- ------------- -------------- Current assets $ 44,420 $ 31,765 $ 37,381 Other assets 67,191 21,519 24,778 Current liabilities 37,902 12,570 9,910 Long-term liabilities and other 7,149 10,250 14,635 Redeemable convertible preferred stock 77,643 15,153 - Net sales 36,086 26,033 15,415 Gross profit 23,105 15,885 4,930 Net loss (66,761) (22,242) (28,825)
Caliber is a leading provider of end-to-end eLearning solutions to global corporations and organizations. Sylvan Ventures has a commitment to fund an additional $2,000 for Series B preferred stock in 2001. The Caliber investment includes a secured note payable to the Company for management services in the amount of $7,150 and $3,024 as of December 31, 2000 and 1999, respectively. The Company has also guaranteed certain future non-cancelable lease obligations relating to Caliber totaling $6,315. Chancery Software Limited is a provider of an enterprise student information system for schools that includes tracking of grading, attendance, and other school and student communications. 44 NOTE 6 - INVESTMENTS (CONTINUED) Classwell Learning Group, Inc. is a start-up organization which aims to establish a definitive K-12 learning community organized around a comprehensive set of tools and branded content. iLearning, Inc. provides to businesses and organizations the ability to convert, host, and monetize their existing training business into an ASP environment with little internal expertise. HigherMarkets Inc. is developing an e-procurement solution for universities and other educational institutions. Mindsurf, Inc. is a start-up organization aimed at improving communication between teachers, students, and parents by providing students with computing and communication resources though low cost, wireless handheld devices. Sylvan Ventures has committed additional funding of $28,200 to Mindsurf if specified performance targets are achieved. The Company's allocable share of losses related to the investments in affiliates for the years ended December 31, 2000 and 1999 was $22,203 and $2,356, respectively. At December 31, 2000, the difference between the carrying amount of equity method investments and the amount of underlying equity in net assets of these investments was $25,305. This amount is being amortized for each investment over a three-year period as a component of the Company's allocable share of income or loss. For the year ended December 31, 2000, equity in net loss of affiliates includes $3,793 of amortization. OTHER INVESTMENTS (COST METHOD INVESTMENTS): Other investments consist of non-marketable investments in common and preferred stocks of private companies in which the Company does not exercise significant influence. These investments are carried at cost unless a decline in estimated fair value is determined to be permanent. Other investments consisted of the following at December 31:
2000 1999 -------------- --------------- ClubMom.com. Inc. $7,000 $ - Chauncey Group International, Ltd. 8,000 8,000 Frontline Group, Inc. 7,000 7,000 Other 3,935 10,933 -------------- --------------- Total $25,935 $25,933 ============== ===============
REALIZED INVESTMENT LOSSES During the years ended December 31, 2000 and 1999, the Company incurred realized investment losses of $11,441 and $13,370, respectively. Sylvan Ventures incurred a $3,051 realized loss in 2000 upon the disposal of its $4,912 investment in the common stock of ZapMe! for cash proceeds of $1,861. Sylvan Ventures also recorded realized investment losses of $8,390 in 2000 based on an assessment that two investments were permanently impaired due to significant deterioration in operating results and concerns regarding the ability of these companies to successfully implement their business plan. During 1999, the Company recorded investment losses of $13,370, principally related to the redemption of the Company's $26,600 investment in JLC Learning Corporation ("JLC") for proceeds of $15,200 in cash and purchase credits for JLC products. In 1999, the Company determined that the remaining amount of the purchase credit would not be realized as a result of the inability to use the credit to purchase products consistent with its customers' needs. The Company wrote-off the remaining product credit and the 1999 realized loss on investments include an aggregate loss of $11,400 related to the sale of the JLC investment. 45 NOTE 7 - LONG-TERM DEBT Long-term debt consists of the following at December 31:
2000 1999 ------------- ------------- Long-term revolving credit facility with banks $ - $122,991 Convertible debentures 100,000 - Mortgages, notes payable and lines of credit related to UEM bearing interest at variable rates ranging from 4.75% to 6.34% 27,313 37,170 Note payable related to Les Roches bearing interest at 4.65% 11,143 - Note payable related to UDLA bearing interest at 10.65% 8,781 - Mortgages and notes payable bearing interest at fixed rates ranging from 5.00% to 8.00% 1,630 249 ------------- ------------- 148,867 160,410 Less: current portion of long-term debt 20,292 14,315 ------------- ------------- Total long-term debt $128,575 $146,095 ============= =============
At December 31, 1999, the Company had a revolving credit facility (the "Facility") with a group of five banks, which allowed the Company to borrow up to an aggregate of $150,000 at variable rates. Effective March 2000, the Company entered into an amendment to the Facility agreement reducing the aggregate amount available to $100,000. Outstanding borrowings under the Facility are unconditionally guaranteed by a pledge of the capital stock of the Company's domestic subsidiaries. Debt covenants of the Facility require the Company to maintain certain debt-to-earnings and interest coverage ratios. Other provisions require maintenance of minimum net worth levels and restrict advances, investments, loans, capital expenditures and dividends. At December 31, 2000 the Company was in compliance with the covenants under the Facility. On June 30, 2000, the Company issued $100,000 of ten-year convertible subordinated debentures to Apollo Management Group. The debentures bear interest at a fixed rate of 5.00%, payable semi-annually, and are convertible at any time into the Company's common stock at $15.735 per share. The debentures mature on June 30, 2010. The outstanding borrowings assumed as part of the UEM, Les Roches and UDLA acquisitions are secured by the underlying property and fixed assets of the universities. Aggregate maturities of Company's borrowings are as follows: 2001 - $20,292; 2002 - $5,769; 2003 - $5,644; 2004 - $4,715; 2005 - $1,875 and thereafter $110,572. NOTE 8 - DUE TO SHAREHOLDERS OF ACQUIRED COMPANIES Due to shareholders of acquired companies consists of the following amounts payable in cash at December 31:
2000 1999 ------------- ------------- Amounts payable to former shareholders of Schulerhilfe $ - $10,424 Amounts payable to former shareholders of Canter 13,145 9,000 Amounts payable to former shareholders of Prometric 3,050 3,050 Amounts payable to former shareholders of WSI franchises 12,000 - Amounts payable to former shareholders of UDLA 12,000 - ------------- ------------- $40,195 $22,474 ============= =============
46 NOTE 9 - LEASES The Company conducts significant operations from leased facilities. These facilities include the Company's corporate headquarters and other office locations, warehouse space, and Company-owned learning centers. The terms of substantially all of these leases are five years or less, with the exception of the Company's corporate headquarters facilities, which have lease terms ending in November 2006 and August 2009, and generally contain renewal options. The Company also leases certain equipment under non-cancelable operating leases, the majority of which are for terms of 36 months or less. Future minimum lease payments related to continuing operations at December 31, 2000, by year and in the aggregate, under all non-cancelable operating leases are as follows: Years ending December 31: 2001 $18,749 2002 17,378 2003 15,893 2004 13,929 2005 12,180 Thereafter 20,501 ------------- $98,630 =============
The Company has entered into sublease agreements with the purchaser of Prometric for leased space at three locations, approximating 70,000 square feet, for an annual fee of $2,750, adjusted annually for increases in gross operating rent and related expenses. The subleases extend from March 3, 2000 through lease expiration in December 2007. Rent expense, net of sub-lease income, included in income from continuing operations for all cancelable and non-cancelable leases was approximately $16,708, $13,505, and $8,259 for the years ended December 31, 2000, 1999 and 1998, respectively. NOTE 10 - STOCKHOLDERS' EQUITY On May 5, 2000, upon conclusion of a Company sponsored tender offer, the Company purchased 8,507 shares of common stock at $15.25 per share. The cost of the shares purchased was approximately $130,097, including transaction costs. On September 13, 2000, upon conclusion of a second Company sponsored tender offer, the Company purchased 4,658 shares of common stock at $15.00 per share. The cost of the shares purchased was approximately $71,651, including transaction costs. As of December 31, 2000, the Company has reserved 17,389 shares of common stock for future issuance upon the exercise of all outstanding stock options and the conversion of debentures. NOTE 11 - CONTINGENCIES LOSS CONTINGENCIES On November 18, 1996, ACT, Inc. filed suit against the Company alleging that the Company violated federal antitrust laws and committed various state law torts in connection with the operations of its computer-based testing operations and in obtaining a testing services contract from the NASD. The Company believes the grounds of the lawsuit are without merit and intends to defend the lawsuit vigorously. Management is unable to predict the ultimate outcome of the lawsuit, but believes that the ultimate resolution of the matter will not have a material effect on consolidated financial position. On November 18, 1998, James Jinsoo and Christine Choi filed suit against the Company seeking damages and recission under the Development Agreement they had entered into for Korea in 1995 and which had been terminated by the Company due to their default under the Development Agreement. The dispute will be decided by arbitration pursuant to the terms of the Agreement. The Company believes the grounds of the lawsuit are without merit and intends to defend the lawsuit vigorously. Management is unable to predict the ultimate outcome of the lawsuit, but believes that the ultimate resolution of the matter will not have a material effect on consolidated financial position. 47 NOTE 11 - CONTINGENCIES (CONTINUED) The Company is subject to other legal actions arising in the ordinary course of its business. In management's opinion, the Company has adequate legal defenses and/or insurance coverage with respect to the eventuality of such actions and does not believe any settlement would materially affect the Company's financial position. CONTINGENT PAYMENTS AND BUSINESS COMBINATIONS During 1999, the Company issued 510 shares of restricted common stock as partial payment of contingent consideration due related to the Company's acquisition of Canter. The shares are restricted through December 31, 2001. At December 31, 2001, the Company is obligated to issue additional shares of common stock if the market value of the restricted common stock on that date is less than three-quarters of the market value at the date of issuance ($21.885 per share). In the normal course of business the Company is party to option agreements with franchisees that allow, under specified circumstances, the repurchase of operating franchises at predetermined multiples of operating results. These options may be at the Company's or the franchisee's discretion based upon the individual agreement and specific operating criteria. None of these option agreements would be individually material and operating results of the Company would not be materially impacted for the current period if the options were exercised. NOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of the Company's financial instruments, which consist primarily of cash and cash equivalents, accounts and notes receivable, available-for-sale investments, accounts payable, due to shareholders of acquired companies, and short and long-term debt, approximate their carrying amounts reported in the consolidated balance sheets. It is not practical to estimate the fair value of the Company's investments in affiliates and other investments because of the lack of quoted market prices of the underlying equity securities and the inability to determine fair value without incurring excessive costs. NOTE 13 - EMPLOYEE BENEFIT PLANS STOCK OPTIONS PLANS The Board of Directors may grant options under five stock option plans to selected employees, officers and directors of the Company to purchase shares of the Company's common stock at a price not less than the fair market value of the stock at the date of the grant. The 1998 Stock Incentive Plan ("1998 Plan") is the only plan with significant stock option awards available for grant. The 1998 Plan allows for the grant of up to 3,750 shares of common stock in the form of incentive and non-qualified stock options, stock appreciation rights, stock awards, phantom stock awards, convertible securities and performance awards that expire six or ten years after the date of grant. Options outstanding under all five of the Company's stock option plans have been granted at prices which are equal to or exceed the market value of the stock on the date of grant and vest ratably over periods not exceeding six years. The following table summarizes the stock option activity of the Company for the years ended December 31:
2000 1999 1998 -------------------------- ------------------------- ------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE ------------- ------------ ------------ ------------ ------------ ------------ Outstanding at beginning of year 10,380 $18.13 9,067 $18.24 6,935 $13.74 Granted 679 14.31 1,737 17.07 2,989 26.77 Exercised (91) 5.42 (243) 9.93 (659) 9.92 Forfeited (1,029) 22.27 (181) 24.62 (198) 17.03 ------------- ------------ ------------ ------------ ------------ ------------ Outstanding at end of year 9,939 $17.52 10,380 $18.13 9,067 $18.24 ============= ============ ============ ============ ============ ============ Exercisable at end of year 5,675 $15.88 4,402 $14.17 3,584 $10.80 ============= ============ ============ ============ ============ ============
48 NOTE 13 - EMPLOYEE BENEFIT PLANS (CONTINUED) The following table summarizes information about stock options outstanding at December 31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------------------- ------------------------------------- WEIGHTED AVERAGE RANGE OF EXERCISE NUMBER OF WEIGHTED AVERAGE REMAINING NUMBER OF WEIGHTED AVERAGE PRICES SHARES EXERCISE PRICES CONTRACTUAL LIFE SHARES EXERCISE PRICES ------------------------ ------------- ------------------- ------------------- ---------------- -------------------- $3.48-$6.08 1,087 $4.61 2.8 1,053 $ 4.60 $6.78-$13.11 1,696 11.47 7.0 686 9.61 $13.55-$19.77 3,404 14.93 5.8 2,223 15.14 $21.15-$32.38 3,752 26.34 6.5 1,713 26.30
Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK BASED COMPENSATION ("Statement No. 123"), defines a fair-value-based method of accounting for an employee stock option. However, it allows an entity to continue to measure compensation cost for those instruments using the intrinsic-value-based method of accounting prescribed by APB Opinion No. 25. As permitted by Statement No. 123, the Company elected to retain the intrinsic-value-based method of accounting for stock options. Statement No. 123 requires certain additional disclosures about stock-based compensation arrangements regardless of the method used to account for them. In accordance with Statement No. 123, the Black-Scholes option-pricing model is one technique allowed to determine the fair value of the options. However, the derived fair value estimates cannot be substantiated by comparison to independent markets. For the years ended December 31, 2000, 1999 and 1998, pro forma net income and earnings per share information required by Statement No. 123 has been determined as if the Company had accounted for its stock options using the fair value method. The fair value of these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for 2000, 1999 and 1998: risk-free interest rate of 5.5%, 5.5% and 6% respectively, dividend yield of 0%, volatility factors of the expected market price of the Company's common stock of .460, .443 and .360, respectively, and an expected life of granted options from four to six years depending upon the vesting period. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. The weighted average estimated fair values of stock options granted during fiscal years 2000, 1999, and 1998 were $6.12, $7.37, and $11.26 respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods. The Company's pro forma information for the years ended December 31 is as follows:
2000 1999 1998 ------------- -------------- ------------ Pro forma income (loss) from continuing operations before $ (8,446) $ 4,176 $10,140 cumulative effect of change in accounting principle Pro forma net income (loss) $298,393 $(21,234) $25,446 Pro forma earnings (loss) per share, basic: Income (loss) from continuing operations before cumulative effect of change in accounting principle $ (0.19) $0.08 $0.21 Net income (loss) $ 6.86 $(0.41) $0.52 Pro forma earnings (loss) per share, diluted: Income (loss) from continuing operations before cumulative effect of change in accounting principle $ (0.19) $0.08 $0.20 Net income (loss) $ 6.86 $(0.41) $0.50
49 NOTE 13 - EMPLOYEE BENEFIT PLANS (CONTINUED) DEFINED CONTRIBUTION RETIREMENT PLAN The Company sponsors a defined contribution retirement plan under section 401(k) of the Internal Revenue Code. The provisions of this plan allow for voluntary employee contributions up to 15% of their salary, subject to certain annual limitations. The Company may at its discretion make matching contributions, which are allocated to eligible participants. All employees are eligible after meeting certain service requirements. The Company made discretionary contributions to this plan of $1,218, $461 and $315 during the years ended December 31, 2000, 1999 and 1998, respectively. EMPLOYEE STOCK PURCHASE PLAN During 1998, the Company adopted an employee stock purchase plan that allows eligible employees to purchase shares of common stock at a 15% discount to the lower of the fair market value on the first day or the last day of the annual offering period. Employees may authorize the Company to withhold up to 10% of their compensation during any offering period, subject to certain limitations. During fiscal 2000, 1999, and 1998, shares totaling 62, 41, and 27 were issued under the plan at an average price of $12.61, $23.23, and $19.74, respectively. MANAGEMENT OWNERSHIP INTERESTS Executives of the Company have been granted options to purchase common stock in the Company's subsidiary operating its International University segment. The options represent 12% of the total outstanding shares and are exercisable at an exercise price 10% greater than estimated fair value at the grant date. The options were fully vested at the grant date and expire three years from the date of issuance. In June 2000, executives of the Company were granted membership profits interest in Sylvan Ventures upon formation in the amount of 15% of total outstanding units. These memberships profits interests entitle the holders to a share of profits upon the occurrence of a profit event and shall be converted into common stock of the corporate successor in the event of a qualified initial public offering of Sylvan Ventures. NOTE 14 - INVESTMENT AND OTHER INCOME The Company's investment and other income consists of the following as of December 31:
2000 1999 1998 -------------- --------------- ------------- Interest and other income $22,068 $1,170 $3,470 Gain (loss) on foreign exchange (2,029) (48) 518 -------------- --------------- ------------- $20,039 $1,122 $3,988 ============== =============== =============
Gain (loss) on foreign exchange in 2000 includes a $3,149 loss related to the settlement of a foreign exchange contract in August 2000. The foreign exchange contract was entered into to protect against the impact of fluctuations in the exchange rate between the U.S. dollar and the Mexican Peso on the amount of U.S. dollars required for the UVM acquisition. 50 NOTE 15 - INCOME TAXES Significant components of the provision for income taxes on earnings from continuing operations for the years ended December 31 are as follows:
2000 1999 1998 -------------- ----------- -------------- Current: Federal ($4,018) $ (180) $1,084 Foreign 6,591 2,114 834 State (2,242) (1,801) 860 ------------ ----------- -------------- 331 133 2,778 Deferred: Federal (3,129) (2,087) 1,345 Foreign (202) 176 1,813 State (1,308) 494 688 ------------ ----------- -------------- (4,639) (1,417) 3,846 ------------ ----------- -------------- Total provision (benefit) $(4,308) $(1,284) $6,624 ============ =========== ==============
For the years ended December 31, 2000, 1999 and 1998, foreign income from continuing operations before income taxes was $20,997, $14,028 and $10,693, respectively. Significant components of the Company's deferred tax assets and liabilities arising from continuing operations as of December 31 are as follows:
2000 1999 ----------- ----------- Deferred tax assets: Net operating loss carryforwards $5,658 $ - Deferred revenue 1,729 1,655 Allowance for doubtful accounts 1,355 401 Deferred compensation 591 398 Equity share of losses of affiliates 18,017 4,377 Charitable contributions carryforward - 672 Non deductible reserves 2,191 2,223 Tax credit carryforward 500 31 Capital loss carryforward - 3,475 Other 146 1,067 ----------- ----------- Total deferred tax assets $30,187 $14,299 =========== =========== Deferred tax liabilities: Advertising costs 1,389 (86) Prepaid expenses 871 - Depreciation 6,933 4,381 Amortization of intangible assets 3,093 773 Deferred income 12,840 12,329 Unbilled receivables 1,113 1,377 Other 979 714 ----------- ----------- Total deferred tax liabilities 27,218 19,488 ----------- ----------- Net future income tax benefits (liabilities) 2,969 (5,189) Valuation allowance for net deferred tax assets (3,857) - ----------- ------------ Net deferred tax liability $ (888) $ (5,189) =========== ============
At December 31, 2000, undistributed earnings from continuing operations of non-U.S. subsidiaries totaled $57,100. Deferred tax liabilities have not been recognized for these undistributed earnings because it is management's intention to reinvest such undistributed earnings outside of the U.S. If all undistributed earnings were remitted to the U.S., the amount of incremental U.S. federal income taxes, net of foreign tax credits, would be approximately $16,700. 51 NOTE 15 - INCOME TAXES (CONTINUED) The net operating loss carryforwards at December 31, 2000 are related to subsidiaries of the Company, and are available only to offset future taxable income of those subsidiaries. These net operating loss carryforwards will begin to expire 2005. Investment tax credits are related to a subsidiary of the Company, and are available only to offset future taxes of that subsidiary. The investment tax credit expires in 2001 and is expected to be fully utilized. The reconciliation of the reported income tax expense to the amount that would result by applying the U.S. federal statutory tax rate of 35% to income from continuing operations before income taxes and cumulative effect of change in accounting principle for the years ended December 31 is as follows:
2000 1999 1998 ------------- ------------- ------------ Tax expense at U.S. statutory rate $(2,073) $ 2,186 $9,645 Expense (benefit) attributable to minority interest (3,542) 154 - Permanent differences (155) 927 (477) State income tax expense, net of federal tax effect (949) (1,196) 767 Tax effect of foreign income taxed at lower rate (1,676) (2,950) (2,822) Change in valuation allowance 3,857 - - Utilized tax credits - (433) - Other 230 28 (489) ------------- ------------- ------------ Total tax provision (benefit) $ (4,308) $(1,284) $6,624 ============= ============= ============
NOTE 16 - EARNINGS (LOSS) PER SHARE The following table summarizes the computations of basic and diluted earnings per share for the years ended December 31:
2000 1999 1998 -------------- ------------ -------------- Numerator used in basic and diluted earnings (loss) per common share: Income (loss) from continuing operations, before cumulative effect of change in accounting principle $(1,617) $ 8,339 $19,440 Income (loss) from discontinued operations, net of tax (3,968) 4,964 16,269 Gain (loss) on disposal of discontinued operations, net of tax 310,807 (26,968) - Cumulative effect of change in accounting principle, net of tax - (1,323) - -------------- ------------ -------------- Net income (loss) $305,222 $ (14,988) $35,709 ============== ============ ============== Denominator for basic earnings (loss) per share - weighted-average common shares outstanding 43,501 51,553 48,962 Net effect of dilutive stock options based on treasury stock method - 1,604 2,324 -------------- ------------ -------------- Denominator for diluted earnings (loss) per share - weighted average common shares outstanding and assumed conversions 43,501 53,157 51,286 ============== ============ ============== Earnings (loss) per common share, basic: Income (loss) from continuing operations, before cumulative effect of change in accounting principle $(0.04) $0.16 $0.40 Income (loss) from discontinued operations, net of tax (0.08) 0.10 0.33 Gain (loss) on disposal of discontinued operations, net of tax 7.14 (0.52) - Cumulative effect of change in accounting principle, net of tax - (0.03) - -------------- ------------ -------------- Earnings (loss) per common share, basic $7.02 $(0.29) $0.73 ============== ============ ============== Earnings (loss) per common share, diluted: Income (loss) from continuing operations, before cumulative effect of change in accounting principle $(0.04) $0.16 $0.38 Income (loss) from discontinued operations, net of tax (0.08) 0.09 0.32 Gain (loss) on disposal of discontinued operations, net of tax 7.14 (0.51) - Cumulative effect of change in accounting principle, net of tax - (0.02) - -------------- ------------ -------------- Earnings (loss) per common share, diluted $7.02 $(0.28) $0.70 ============== ============ ==============
52 NOTE 16 - EARNINGS (LOSS) PER SHARE (CONTINUED) Stock options and the convertible outstanding debentures (see Note 7) were not dilutive for the year ended December 31, 2000 as the Company reported a net loss from continuing operations. NOTE 17 - BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION The Company is organized on the basis of educational services provided. The Company's segments are business units that offer distinct services. The segments are managed separately as they have different customer bases and delivery channels. Reportable segments are as follows: SYLVAN LEARNING CENTERS provides personalized instructional services to students of all ages and skill levels, through its network of franchised and Company-owned learning centers. SYLVAN EDUCATION SOLUTIONS provides educational programs to students of public and non-public school districts through contracts funded by Federal Title I and State-based programs, and professional development services to teachers. SYLVAN ENGLISH LANGUAGE INSTRUCTION provides English language instruction through a combination of computer-based and live instruction through its network of franchised and Company-owned learning centers. SYLVAN INTERNATIONAL UNIVERSITIES provides post-secondary instruction and degree programs through its network of fully accredited universities located in Spain, Switzerland, Mexico and Chile. The segment commenced operations in the second quarter of 1999 with the acquisition of a controlling interest in UEM. During 2000, the Company also acquired a controlling interest in Les Roches, UVM and UDLA. SYLVAN VENTURES began operations in the first quarter of 2000. Sylvan Ventures invests in and incubates companies developing emerging technology solutions for the education and training marketplace. The Company evaluates performance and allocates resources based on operating income before corporate general and administrative expenses and income taxes. There are no significant intercompany sales or transfers. Segment profit is net operating profit (loss) for the operating segments. Segment profit for Sylvan Ventures is calculated as the sum of net development costs, net investment income (loss) and equity in net loss of affiliates. The following table sets forth information on the Company's reportable segments for the years ending December 31:
SYLVAN SYLVAN SYLVAN ENGLISH SYLVAN LEARNING EDUCATION LANGUAGE INTERNATIONAL SYLVAN 2000 CENTERS SOLUTIONS INSTRUCTION UNIVERSITIES VENTURES - -------------------------- -------------- --------------- -------------- -------------- -------------- Revenues $98,943 $105,177 $49,949 $62,582 $ - Segment profit (loss) 22,105 16,132 2,818 4,977 (50,846) Segment assets 84,895 120,756 135,857 239,166 82,006 Long-lived assets 5,820 9,890 9,614 127,098 3,728
SYLVAN SYLVAN SYLVAN ENGLISH SYLVAN LEARNING EDUCATION LANGUAGE INTERNATIONAL SYLVAN 1999 CENTERS SOLUTIONS INSTRUCTION UNIVERSITIES VENTURES - -------------------------- -------------- --------------- -------------- -------------- -------------- Revenues $90,664 $101,263 $52,848 $32,275 - Restructuring charges 170 2,537 - 447 - Segment profit 21,768 17,371 11,742 2,408 - Segment assets 71,097 105,273 121,408 69,042 - Long-lived assets 5,041 10,582 7,491 80,862 -
53 NOTE 17 - BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)
SYLVAN SYLVAN SYLVAN ENGLISH SYLVAN LEARNING EDUCATION LANGUAGE INTERNATIONAL SYLVAN 1998 CENTERS SOLUTIONS INSTRUCTION UNIVERSITIES VENTURES - -------------------------- -------------- --------------- -------------- -------------- -------------- Revenues $64,755 $86,293 $27,754 - - Segment profit 19,339 14,339 7,747 - - Segment assets 56,841 96,438 70,198 - - Long-lived assets 3,823 14,656 4,290 - -
The following tables reconcile the reported information on segment profit and assets to income (loss) before income taxes and cumulative effect of change in accounting principle and total assets reported in the statements of operations and balance sheets for the years ended December 31:
2000 1999 1998 ------------- --------------- ------------- Total profit for reportable segments $(4,814) $53,289 $41,425 Corporate general and administrative expense (20,306) (27,270) (15,530) Other income (expense) 19,195 (18,964) 169 ------------- ---------------- ------------- Income (loss) from continuing operations before income taxes and cumulative effect of change in accounting principle ($5,925) $7,055 $26,064 ============= =============== =============
2000 1999 1998 -------------- --------------- ------------- Segment assets $ 662,680 $366,820 $223,477 Unallocated corporate assets 354,283 117,518 100,783 Net assets of discontinued operations - 280,287 278,150 -------------- --------------- ------------- Total assets $1,016,963 $764,625 $602,410 ============== =============== =============
Two of the Company's segments include revenues generated from both Company-owned and franchised centers. The following table sets forth the components of total revenues of these segments at December 31:
SYLVAN SYLVAN LEARNING CENTERS ENGLISH LANGUAGE INSTRUCTION --------------------------------------------- ---------------------------------------------- 2000 1999 1998 2000 1999 1998 ------------ ------------ ------------- ------------- ------------- ------------ Company-owned centers $53,639 $53,011 $36,166 $31,545 $30,848 $6,876 Franchise centers 45,304 37,653 28,589 18,404 22,000 20,878 ------------ ------------ ------------- ------------- ------------- ------------ Total revenues $98,943 $90,664 $64,755 $49,949 $52,848 $27,754 ============ ============ ============= ============= ============= ============
Direct costs for these segments relate primarily to the Company-owned centers. Costs related to the franchised centers are included in the Company's general segment expenses. It is not practical to quantify these costs separately. 54 NOTE 17 - BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED) Revenue and long-lived assets information by geographic area for the years ended December 31 is as follows:
2000 1999 1998 ------------- -------------- -------------- REVENUES United States $188,582 $167,851 $148,668 Spain 71,012 63,346 22,737 Other foreign countries 57,057 45,853 7,397 ------------- -------------- -------------- Consolidated total $316,651 $277,050 $178,802 ============= ============== ============== LONG-LIVED ASSETS United States $34,948 $27,220 $29,379 Spain 81,590 85,965 4,265 Switzerland 23,665 - - Other foreign countries 31,639 2,633 224 ------------- -------------- -------------- Consolidated total $171,842 $115,818 $33,868 ============= ============== ==============
Revenues are attributed to countries based on the location of the customer. Revenues in individual foreign countries other than Spain and long-lived assets in individual foreign countries other than Spain and Switzerland did not exceed 10% of consolidated amounts in any of the years presented. NOTE 18 - RESTRUCTURING During the fourth quarter of 1999, the Company completed an analysis of its operating structure to improve operating efficiency and to enhance shareholder value. As a result of this analysis, management approved a formal restructuring plan in 1999, and the Company recorded a restructuring charge to operations of approximately $5,100. The restructuring plan was comprised of employee termination and facility exit costs resulting primarily from the Company's plan to exit certain activities outside the core business of providing educational instruction. The Company eliminated 58 professional and administrative positions as a result of the plan. Facility exit costs include approximately $3,500 of costs to close schools and school-based facilities. The Company completed the implementation of the plan by the end of fiscal 2000. During the years ended December 31, 2000 and 1999, the Company paid $2,160 and $2,967, respectively related to the restructuring plan. NOTE 19 - SUPPLEMENTAL CASH FLOW INFORMATION Cash flow information for the Company reflects the total cash flows including continuing operations and discontinued operations. Interest payments were approximately $2,981, $5,090 and $900 for the years ended December 31, 2000, 1999 and 1998, respectively. Income tax payments were $25,112, $15,514 and $7,654 for the years ended December 31, 2000, 1999, and 1998, respectively. In connection with the 2000 acquisitions of Ivy West, Les Roches, UVM, and UDLA for combined net cash consideration of $72,072, the Company acquired assets with a fair value of $150,926 and assumed debt and liabilities of $78,854. In connection with the 1999 acquisitions of UEM and WSI franchise businesses, for aggregate net cash consideration of $62,000 paid in 1999 and $18,700 paid in 2000, the Company acquired assets with a fair value of $177,033 and assumed liabilities of $96,333. In connection with the 1998 acquisitions of Canter and Schulerhilfe for combined consideration of $44,082, the Company acquired assets with a fair value of $50,465 and assumed liabilities of $6,383. 55 NOTE 20 - QUARTERLY FINANCIAL DATA (UNAUDITED) The following 2000 financial information reflects all normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of the results of the interim periods. All periods' results have been restated to separately disclose discontinued operations. Summarized operating data is as follows:
QUARTER ENDED 2000 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 - ---- -------- --------- ------------- ----------- Revenues $75,539 $82,229 $59,969 $98,913 ------------- ---------- ---------- ------------ Operating income (loss) 4,929 5,062 (3,790) 1,342 ------------- ---------- ---------- ------------ Income (loss) from continuing operations before Cumulative effect of change in accounting principle 3,410 6,626 (3,337) (8,316) Income (loss) from discontinued operations, net of tax (3,868) (1,957) 1,903 (46) Gain on disposal of discontinued operations, net of tax 288,454 - - 22,353 ------------- ---------- ---------- ------------ Net income (loss) $287,996 $4,669 $ (1,434) $13,991 ============= ========== ========== ============ Earnings (loss) per common share, basic: Income (loss) from continuing operations before Cumulative effect of change in accounting principle $ 0.07 $ 0.14 $(0.08) $(0.22) Income (loss) from discontinued operations (0.08) (0.04) 0.05 - Gain on disposal of discontinued operations 5.68 - - 0.60 ------------- ---------- ---------- ------------ Net income (loss) $ 5.67 $ 0.10 $(0.03) $0.38 ============= ========== =========== ============ Earnings (loss) per common share, diluted: Income (loss) from continuing operations before Cumulative effect of change in accounting principle $ 0.07 $ 0.14 $(0.08) $(0.22) Income (loss) from discontinued operations (0.08) (0.04) 0.05 - Gain on disposal of discontinued operations 5.59 - - 0.60 ------------- ---------- ---------- ------------ Net income (loss) $ 5.58 $ 0.10 $(0.03) $ 0.38 ============= ========== =========== ============ Shares used in computation: Basic 50,802 45,110 41,084 37,274 ============= ========== =========== ============ Diluted 51,570 45,825 41,084 37,274 ============= ========== =========== ============
56 NOTE 20- QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
QUARTER ENDED ---------------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, ----------- ---------- ------------- ------------ 1999 - ---- Revenues $57,217 $76,841 $66,748 $76,244 ----------- ---------- ---------- ----------- Operating income (loss) 5,178 12,431 17,659 (9,249) ----------- ---------- ---------- ----------- Income (loss) from continuing operations before cumulative effect of change in accounting principle 4,405 8,365 12,574 (17,005) Income (loss) from discontinued operations, net of tax 2,402 3,018 3,358 (3,814) Loss on disposal of discontinued operations, net of tax - - (25,082) (1,886) Cumulative effect of change in accounting principle (1,323) - - - ----------- ---------- ---------- ----------- Net income (loss) $5,484 $11,383 $ (9,150) $(22,705) =========== ========== ========== =========== Earnings (loss) per common share, basic: Income (loss) from continuing operations before cumulative effect of change in accounting principle $0.09 $0.16 $0.24 $(0.34) Income (loss) from discontinued operations 0.05 0.06 0.06 (0.07) Loss on disposal of discontinued operations - - (0.48) (0.04) Cumulative effect of change in accounting principle (0.03) - - - ----------- ---------- ---------- ----------- Earnings (loss) per common share, basic $0.11 $0.22 $(0.18) $(0.45) =========== ========== ========== =========== Earnings (loss) per common share, diluted: Income (loss) from continuing operations before cumulative effect of change in accounting principle $0.08 $0.16 $0.24 $(0.34) Income (loss) from discontinued operations 0.04 0.05 0.06 (0.07) Loss on disposal of discontinued operations - - (0.47) (0.04) Cumulative effect of change in accounting principle (0.02) - - - ----------- ---------- ---------- ----------- Net income (loss) $0.10 $0.21 $(0.17) $(0.45) =========== ========== ========== =========== Shares used in computation: Basic 51,666 51,841 51,897 50,907 =========== ========== ========== =========== Diluted 53,945 53,574 53,284 50,907 =========== ========== ========== ===========
During the quarter ended December 31, 1999, the Company recognized restructuring costs of $3,569. Additionally, the Company also recognized significant non-recurring operating charges during the fourth quarter of 1999, which totaled $9,978. These charges principally related to asset impairment charges, which resulted from management's focus on simplification of the business model and a return to the core business strengths. Losses recorded on disposal of investments in the fourth quarter of 1999 also resulted in $13,400 of non-recurring charges during the period. The cumulative effect of these significant, unusual charges was to reduce income from continuing operations by $26,947 during the fourth quarter of 1999. Earnings per share are computed independently for each of the quarters present. Therefore, the sum of the quarterly net earnings per share will not necessarily equal the total for the year. 57 EX-11.01 2 a2043474zex-11_01.txt EX-11.01 Exhibit 11.01 Sylvan Learning Systems, Inc. $100,000,000 5% Convertible Subordinated Debentures due 2010 ---------------------- PURCHASE AGREEMENT --------------------- Dated as of February 23, 2000 TABLE OF CONTENTS
SECTION PAGE 1. PRELIMINARY MATTERS......................................................................................1 1.1 Authorization of Debentures.....................................................................1 1.2 Issue Taxes.....................................................................................1 1.3 Direct Payment..................................................................................1 1.4 Replacement Debentures..........................................................................2 1.5 Indemnification.................................................................................2 2. SALE AND PURCHASE OF DEBENTURES..........................................................................4 3. CLOSING..................................................................................................4 4. CONDITIONS TO CLOSING....................................................................................4 4.1 Representations and Warranties..................................................................4 4.2 Performance; No Default.........................................................................5 4.3 Compliance Certificates.........................................................................5 4.4 Opinions of Counsel.............................................................................5 4.5 Purchase Permitted By Applicable Law, etc.......................................................5 4.6 Other Agreement.................................................................................5 4.7 Market Conditions...............................................................................6 4.8 Proceedings and Documents.......................................................................6 4.9 Consents and Permits............................................................................6 4.10 New Members of the Board of Directors...........................................................6 5. REPRESENTATIONS AND WARRANTIES OF THE COMPANY............................................................6 5.1 Organization; Power and Authority...............................................................6 5.2 Authorization, etc..............................................................................7 5.3 Capitalization..................................................................................7 5.4 Organization and Ownership of Shares of Subsidiaries............................................7 5.5 Filed Documents and Financial Statements........................................................8 5.6 No Current Violation, Default...................................................................8 5.7 Compliance with Laws, Other Instruments, etc....................................................9 5.8 Consents, Approvals, etc........................................................................9 5.9 Litigation; Observance of Statutes and Orders...................................................9 5.10 Environmental..................................................................................10 5.11 Taxes..........................................................................................10 5.12 Title to Property and Assets; Leases...........................................................10 5.13 Licenses, Permits, etc.........................................................................10 5.14 Compliance with ERISA..........................................................................11 5.15 Private Offering by the Company................................................................12 5.16 Use of Proceeds; Margin Regulations............................................................12 5.17 Status under Certain Statutes..................................................................13 5.18 Certain Payments...............................................................................13 5.19 No Brokers or Finders..........................................................................13 5.20 Insurance......................................................................................13 5.21 Accounting.....................................................................................14 5.22 Registration Rights............................................................................14 5.23 [Intentionally Omitted.].......................................................................14 5.24 Securities Ratings.............................................................................14
i 5.25 Similar Securities Not Listed..................................................................14 5.26 Intellectual Property..........................................................................14 5.27 Authorization of Shares Issuable Upon Conversion...............................................15 5.28 Affiliate Transactions.........................................................................15 5.29 Representations and Warranties in the Prometric Agreements.....................................15 5.30 Investment Company Act.........................................................................15 5.31 Antitakeover Matters...........................................................................15 5.32 Formation and Capitalization of Incubator......................................................16 6. REPRESENTATIONS OF THE PURCHASER........................................................................16 6.1 Organization; Power and Authority..............................................................16 6.2 Authorization, etc.............................................................................17 6.3 Purchase for Investment........................................................................17 7. COVENANTS...............................................................................................17 7.1 Transaction Expenses...........................................................................17 7.2 Operation of Business..........................................................................18 7.3 Access to Books and Records....................................................................18 7.4 Agreement to Take Necessary and Desirable Actions..............................................18 7.5 Compliance with Conditions; Best Efforts.......................................................19 7.6 HSR Act Filings................................................................................19 7.7 Prometric Transaction..........................................................................19 7.8 Antitakeover Matters...........................................................................19 8. SURVIVAL OF REPRESENTATIONS AND WARRANTIES; ENTIRE AGREEMENT............................................19 9. AMENDMENT AND WAIVER....................................................................................20 10. NOTICES.................................................................................................20 11. REPRODUCTION OF DOCUMENTS...............................................................................20 12. SUBSTITUTION OF PURCHASER...............................................................................20 13. MISCELLANEOUS...........................................................................................21 13.1 Successors and Assigns.........................................................................21 13.2 Severability...................................................................................21 13.3 Construction...................................................................................21 13.4 Counterparts...................................................................................21 13.5 Governing Law; Submission to Jurisdiction......................................................21 13.6 Confidentiality................................................................................21
ii SCHEDULE A -- DEFINED TERMS SCHEDULE 1.3 -- Purchaser's Bank Accounts SCHEDULE 2 -- Debenture Purchase Commitments SCHEDULE 5.3 -- Capitalization SCHEDULE 5.4 -- Subsidiaries SCHEDULE 5.5(b) -- Unaudited Interim Financial Statements of the Company SCHEDULE 5.5(c) -- 2000 Budget SCHEDULE 5.8 -- Consents SCHEDULE 5.13 -- Restricted Licenses and Permits SCHEDULE 5.14 -- Employee Benefit Plans SCHEDULE 5.22 -- Registration Rights SCHEDULE 5.28 -- Affiliate Transactions EXHIBIT 1 -- Form of Indenture EXHIBIT 4.4(a) -- Form of Opinion of Venable, Baetjer & Howard, LLP EXHIBIT 4.4(b) -- Form of Opinion of Robert Zentz, General Counsel of the Company EXHIBIT 5.8 -- Form of Registration Rights Agreement EXHIBIT 5.28 -- Form of Investors Agreement EXHIBIT 7.4 -- Terms of Incubator Agreement
iii Sylvan Learning Systems, Inc. 100 Lancaster Street Baltimore, Maryland 21202 Fax: 410-843-8065 $100,000,000 5% Convertible Subordinated Debentures due 2010 As of February 23, 2000 The Purchasers named on the signature pages hereto Ladies and Gentlemen: Sylvan Learning Systems, Inc., a Maryland corporation (the "Company"), agrees with each of the purchasers named on the signature pages hereto (each, a "Purchaser") as follows: 1. PRELIMINARY MATTERS. 1.1 AUTHORIZATION OF DEBENTURES. The Company has authorized the issue and sale of $100,000,000 aggregate principal amount of its 5% Convertible Subordinated Debentures due 2010 (the "DEBENTURES"), such term to include any such Debentures issued in substitution therefor pursuant to the terms of the Indenture. The Debentures shall be issued pursuant to an Indenture substantially in the form set out in Exhibit 1. Certain capitalized terms used in this Agreement are defined in Schedule A; references to a "Schedule" or an "Exhibit" are, unless otherwise specified, to a Schedule or an Exhibit attached to this Agreement. 1.2 ISSUE TAXES. The Company agrees to pay all taxes (other than taxes in the nature of income, franchise or gift taxes) and governmental fees in connection with the issuance, sale, delivery or transfer by the Company to the Purchasers of the Debentures and the execution and delivery of this Agreement and the Other Agreements and any modification of any of this Agreement or the Other Agreements and will save each and all of the Purchasers harmless without limitation as to time against any and all liabilities with respect to all such taxes and fees. The obligations of the Company under this Section 1.2 are in addition to any other obligations of the Company contained elsewhere in this Agreement and shall survive the payment or prepayment of the Debentures, at maturity, upon redemption or otherwise and the termination of this Agreement and the Other Agreements. 1.3 DIRECT PAYMENT. Notwithstanding any provision to the contrary in the Indenture or the Debentures, the Company will pay or cause to be paid all amounts payable with respect to any Debenture held by the Purchasers (without any presentment of such Debenture and without any notation of such payment being made thereon) by crediting (before 12:00 Noon, New York time), by Federal funds bank wire transfer in same day funds to such holder's account in any bank in the United States of America as may be designated 1 and specified in writing by such holder at least two Business Days prior thereto. Each Purchaser's initial bank account for this purpose is on SCHEDULE 1.3 hereto. 1.4 REPLACEMENT DEBENTURES. If a mutilated Debenture that is a Transfer Restricted Security (as defined in the Indenture) is surrendered to the Company or if a Purchaser or any other institutional holder (or nominee thereof) of a Debenture that is a Transfer Restricted Security claims and submits an affidavit or other evidence, satisfactory to the Company, to the effect that the Debenture has been lost, destroyed or wrongfully taken, the Company shall issue a replacement Debenture without the need to post any bond, and no further indemnity shall be required as a condition to the execution and delivery of a new Debenture other than the unsecured written agreement of such owner reasonably satisfactory to the Company, to indemnify the Company. With respect to any Debenture that is not a Transfer Restricted Security which is surrendered to the Company or which is claimed by the Purchaser or its holder to be lost, destroyed or wrongfully taken, the Company may require the Purchaser or such holder to post a bond against any loss arising in connection therewith as a condition to the execution and delivery of a new Debenture and to indemnify the Company, in each case, to the extent provided in the Indenture. 1.5 INDEMNIFICATION. (a) In addition to all other sums due hereunder or provided for in this Agreement or any Other Agreement and any and all obligations of the Company to indemnify any Purchaser hereunder or under any Other Agreement, the Company hereby agrees, without limitation as to time, to indemnify each Purchaser, each Affiliate of each Purchaser and each director, officer, employee, counsel, agent or representative of each Purchaser and its Affiliates (collectively, the "INDEMNIFIED PARTIES") against, and hold it and them harmless from, to the fullest extent lawful, all losses, claims, damages, liabilities, costs (including, without limitation, costs of preparation and attorneys' fees and disbursements) and expenses, including expenses of investigation (collectively, "LOSSES"), incurred by it or them and arising out of or in connection with this Agreement or any Other Agreement, or the Transactions, regardless of whether the Transactions are consummated and regardless of whether any Indemnified Party is a formal party to any proceeding; PROVIDED, that the Company shall not be liable to any Indemnified Party for any Losses to the extent that it shall be finally determined by a court of competent jurisdiction (which determination is not subject to appeal or review) that such Losses arose from the gross negligence or willful misconduct of such Indemnified Party, which (i) is independent of any wrongful act by the Company, its Affiliates or any of its representatives and (ii) was not taken by such Indemnified Party in reliance upon any of the representations, warranties, covenants or promises of the Company herein or in the Other Agreements, including (without limitation) the certificates delivered by the Company pursuant hereto or thereto. The Company agrees to reimburse each Indemnified Party promptly for all such Losses as they are incurred by such Indemnified Party (regardless of whether it is or may be ultimately determined that such Indemnified Party is not entitled to indemnification hereunder), subject to repayment in the event that the Indemnified Party is ultimately determined not entitled to indemnification hereunder (as finally determined by a court of competent jurisdiction (which determination is not subject to review or appeal)). The obligations of the Company to each Indemnified Party hereunder shall be separate obligations, and the Company's liability to any such Indemnified Party hereunder shall not be extinguished solely because any other Indemnified Party is not entitled to indemnity hereunder. The obligations of each Indemnifying Party under this Section 1.5 shall survive the payment or prepayment of the Debentures, at maturity, upon acceleration, redemption or otherwise, the 2 redemption or repurchase of any Common Stock, any transfer of the Debentures or Common Stock by any Purchaser and the termination of this Agreement or any of the Other Agreements. (b) In case any action, claim or proceeding shall be brought against any Indemnified Party with respect to which indemnity may be sought hereunder, such Indemnified Party shall promptly notify the Company in writing and the Company shall assume the defense thereof, including the employment of counsel reasonably satisfactory to such Indemnified Party and payment of all fees and expenses incurred in connection with the defense thereof; PROVIDED, that the failure to so notify the Company shall not affect any obligation it may have to any Indemnified Party under this Agreement or otherwise except to the extent that (as finally determined by a court of competent jurisdiction (which determination is not subject to review or appeal)) such failure materially and adversely prejudiced the Company. The Company shall not, without the Indemnified Party's prior written consent, consent to entry of any judgment or settle or compromise any pending or threatened claim, action or proceeding in respect of which indemnification or contribution may be sought hereunder unless the foregoing contains an unconditional release, in form and substance reasonably satisfactory to the Indemnified Parties, of the Indemnified Parties from all liability and obligation arising therefrom. Each Indemnified Party shall have the right to employ separate counsel in such action, claim or proceeding and participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of each Indemnified Party unless: (i) the Company has agreed to pay such expenses; or (ii) the Company has failed to promptly assume the defense and employ counsel reasonably satisfactory to such Indemnified Party; or (iii) the named parties to any such action, claim or proceeding (including any impleaded parties) include any Indemnified Party and the Company or an Affiliate of the Company, and such Indemnified Party shall have been advised by counsel that either (x) there may be one or more legal defenses available to it that are different from or in addition to those available to the Company or such Affiliate or (y) a conflict of interest may exist if such counsel represents such Indemnified Party and the Company or its Affiliate; PROVIDED that, if such Indemnified Party notifies the Company in writing that it elects to employ separate counsel in the circumstances described in clause (ii) or (iii) above, the Company shall not have the right to assume the defense thereof and such counsel shall be at the expense of the Indemnifying Parties. Notwithstanding any other provision hereof the Company shall not (i) in connection with any one such action or proceeding, be responsible hereunder for the fees and expenses of more than one such firm of separate counsel (in addition to any local counsel), which counsel shall be designated by such Indemnified Party, (ii) be liable for any settlement of any such action effected without its written consent (which shall not be unreasonably withheld or delayed), or (iii) be responsible hereunder for attorneys' fees or expenses incurred by the Indemnified Parties in excess of $500,000 in the aggregate other than 50% of such attorneys' fees and expenses in excess of $1,000,000. (c) If the indemnification provided for in this Section 1.5 is unavailable to, or insufficient to hold harmless, any Indemnified Party in respect of any Losses referred to herein, then the Company shall contribute to the amount paid or payable by such Persons as a result of such Losses in such proportion as is appropriate to reflect the relative fault of the Company, its subsidiaries and Affiliates, on the one hand, and such Indemnified Party, on the other hand, in connection with the actions which resulted in such Losses, as well as any other relevant equitable considerations. The amount paid or payable by any such Person as a result of the Losses referred to above shall be deemed to include any legal or other fees or expenses reasonably incurred by such Person in connection with any investigation, lawsuit or legal or administrative action or proceeding. (d) The parties hereto agree that it would not be just and equitable if contribution pursuant to this Section 1.5 were determined by pro rata allocation or by any other method of 3 allocation which does not take account of the equitable considerations referred to in the immediately preceding paragraph. No Person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any Person who is not guilty of such fraudulent misrepresentation. 2. SALE AND PURCHASE OF DEBENTURES. Subject to the terms and conditions of this Agreement, the Company will issue and sell to each Purchaser, and each Purchaser will severally purchase from the Company, at the Closing, Debentures in the respective amounts as set forth in Schedule 2 at a purchase price of 100% of the principal amount thereof. In connection with the Transactions, the Company shall pay to the Persons designated by Apollo Management IV, L.P. ("APOLLO MANAGEMENT") a closing fee equal to 1% of the aggregate principal amount of Debentures purchased by the Purchasers (the "CLOSING FEE"). 3. CLOSING. The sale and purchase of the Debentures shall occur at the offices of Venable, Baetjer and Howard, LLP, 1800 Mercantile Bank and Trust Building, 2 Hopkins Plaza, Baltimore, Maryland 21201, at 9:00 a.m., local time, at a closing (the "CLOSING"), which shall occur as soon as practicable after satisfaction or waiver of each of the conditions to closing set forth herein (but in no event prior to March 20, 2000) or on such other Business Day thereafter as may be agreed upon by the Company and Apollo Management. The date on which the Closing occurs is referred to herein as the "CLOSING DATE." At the Closing (a) the Company will deliver to each Purchaser the Debentures to be purchased by such Purchaser in the form of a single Debenture (or such greater number of Debentures as Apollo Management may request), dated the Closing Date, and registered in such Purchaser's name (or in the name of such Purchaser's nominee), against delivery by such Purchaser to the Company of immediately available funds in the amount of the purchase price therefor by wire transfer to such bank account as the Company shall have notified Apollo Management in writing and (b) the Company shall pay the Closing Fee in immediately available funds by wire transfer to such bank accounts as Apollo Management shall have notified the Company in writing. If at the Closing the Company shall fail to tender such Debentures to such Purchaser or pay the Closing Fee as provided above in this Section 3, or any of the conditions specified in Section 4 shall not have been fulfilled to such Purchaser's reasonable satisfaction, such Purchaser shall, at its election, be relieved of all further obligations under this Agreement, without thereby waiving any rights it may have by reason of such failure or such nonfulfillment. 4. CONDITIONS TO CLOSING. Each Purchaser's obligation to purchase and pay for the Debentures to be sold to such Purchaser at the Closing is subject to the fulfillment or waiver, prior to or at the Closing, of the following conditions: 4.1 REPRESENTATIONS AND WARRANTIES. The representations and warranties of the Company in this Agreement and each of the Other Agreements shall be correct when made and at the time of the Closing except where such representations and warranties expressly relate to an earlier date. 4.2 PERFORMANCE; NO DEFAULT. 4 The Company shall have performed and complied with all agreements and conditions contained in this Agreement and each of the Other Agreements required to be performed or complied with by it prior to or at the Closing. After giving effect to the Transactions (including, without limitation, the issue and sale of the Debentures (and the application of the proceeds thereof as contemplated by Section 5.16)), no Default or Event of Default (as both terms are defined in the Indenture) shall have occurred and be continuing. 4.3 COMPLIANCE CERTIFICATES. (a) OFFICER'S CERTIFICATE. The Company shall have delivered to the Purchasers an Officer's Certificate, dated the Closing Date, in form and substance reasonably satisfactory to Apollo Management, certifying that the conditions specified in Sections 4.1, 4.2, 4.9 and 4.10 have been fulfilled. (b) SECRETARY'S CERTIFICATE. The Company shall have delivered to the Purchasers a certificate of the secretary of the Company, dated the Closing Date, in form and substance reasonably satisfactory to Apollo Management, certifying, among other things, as to the resolutions attached thereto and other corporate proceedings relating to the authorization, execution and delivery of this Agreement and the Other Agreements and the approval of the Transactions. 4.4 OPINIONS OF COUNSEL. (a) The Purchasers shall have received an opinion, dated the Closing Date, from, Venable, Baetjer & Howard, LLP, special counsel for the Company, in the form set forth in Exhibit 4.4(a) (and the Company hereby instructs such counsel to deliver such opinion to the Purchasers). (b) The Purchasers shall have received an opinion, dated the Closing Date, from, Robert Zentz, General Counsel of the Company, in the form set forth in Exhibit 4.4(b) (and the Company hereby instructs such counsel to deliver such opinion to the Purchasers). (c) The Purchasers shall have received the opinions, dated the Closing Date, as to certain tax matters, described in Exhibit 7.4 (and the Company hereby instructs such counsel to deliver such opinion to the Purchasers). 4.5 PURCHASE PERMITTED BY APPLICABLE LAW, ETC. The Purchaser's purchase of Debentures shall (i) not violate any applicable Law and (ii) not subject any Purchaser to any tax, penalty or liability under or pursuant to any applicable Law. 4.6 OTHER AGREEMENTS. Each Other Agreement (other than the Incubator Agreement) shall have been executed and delivered by all parties thereto and shall be in full force and effect, each party to each Other Agreement shall have performed all of its obligations to be performed thereunder on or prior to the Closing Date, and each of Chris Hoehn-Saric and Douglas Becker shall have entered into employment agreements (collectively, the "EMPLOYMENT AGREEMENTS") with the Incubator, each in a form approved by Apollo Management. 4.7 MARKET CONDITIONS. 5 During the seven-calendar-day period ending on the Closing Date, (a) trading in securities generally on the New York Stock Exchange, the American Stock Exchange or the NASDAQ Stock Market shall not have been suspended and minimum prices shall not have been established on either of such exchanges or such market by such exchange or by the SEC, (b) a general banking moratorium shall not have been declared by Federal or New York or California authorities, and (c) no change (or any condition, event or development involving a prospective change) shall have occurred or be threatened that, in the reasonable judgment of the Purchasers, has had or could, individually or in the aggregate, reasonably be expected to have a material adverse effect upon the prices or trading of securities generally traded on financial markets in the United States. 4.8 PROCEEDINGS AND DOCUMENTS. All corporate and other proceedings in connection with the Transactions and all documents and instruments executed or delivered in connection with such Transactions shall be reasonably satisfactory in form and substance to Apollo Management and Apollo Management shall have received all such counterpart originals or certified or other copies of such documents as Apollo Management may reasonably request. 4.9 CONSENTS AND PERMITS. The Company shall have received all consents, permits, approvals and authorizations and sent or made all notices, filings, registrations and qualifications as may be required pursuant to any Law or pursuant to any Applicable Agreement, in connection with the Transactions to be consummated on or prior to the Closing Date. 4.10 NEW MEMBERS OF THE BOARD OF DIRECTORS. Michael Gross and Laurence Berg shall have been appointed as members of the board of directors of the Company. 5. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company represents and warrants to each Purchaser that: 5.1 ORGANIZATION; POWER AND AUTHORITY. The Company is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation, and is duly qualified as a foreign corporation and is in good standing in each jurisdiction in which such qualification is required by law, other than those jurisdictions as to which the failure to be so qualified or in good standing could not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect. The Company has the power and authority to own or hold under lease the properties it purports to own or hold under lease, to transact the business it transacts and proposes to transact, to execute and deliver this Agreement and the Other Agreements and to perform the provisions hereof and thereof. 5.2 AUTHORIZATION, ETC. (a) This Agreement has been duly authorized, executed and delivered by the Company and is enforceable against the Company in accordance with its terms, except as the enforceability 6 thereof may be limited by (i) bankruptcy, insolvency, reorganization, fraudulent conveyance, moratorium or similar laws affecting creditors' rights generally and (ii) general principals of equity and the discretion of the court before which any proceeding therefor may be brought (regardless of whether such enforcement is considered in a proceeding at law or in equity). (b) Each of the Other Agreements has been duly authorized by the Company and, on the Closing Date, will have been validly executed and delivered by the Company. When each Other Agreement has been duly executed and delivered by the Company such Other Agreement will be a valid and binding agreement of the Company, enforceable against the Company in accordance with its terms, except as the enforceability thereof may be limited by (i) bankruptcy, insolvency, reorganization, fraudulent conveyance, moratorium or similar laws affecting creditors' rights generally and (ii) general principals of equity and the discretion of the court before which any proceeding therefor may be brought (regardless of whether such enforcement is considered in a proceeding at law or in equity). On the Closing Date the Indenture will conform in all material respects to the requirements of the Trust Indenture Act of 1939, as amended (the "TIA" or "TRUST INDENTURE ACT"), and the rules and regulations of the SEC applicable to an indenture which is qualified thereunder. 5.3 CAPITALIZATION. (a) As of the date hereof, the authorized capital stock of the Company consists of: (i) 90,000,000 shares of common stock, par value $0.01 per share ("Common Stock"), of which 50,915,574 shares are issued and outstanding and (ii) 10,000,000 shares of preferred stock, par value $0.01 per share ("Preferred Shares"), of which no shares are issued and outstanding. (b) The outstanding shares of Common Stock have been duly authorized and are validly issued and outstanding, fully paid and nonassessable, and subject to no preemptive or similar rights (and were not issued in violation of any preemptive or similar rights). Except as disclosed in the previous paragraph and in Schedule 5.3, there are no other shares of capital stock of the Company authorized and reserved for issuance and the Company does not have any commitment to authorize, issue or sell any of its capital stock or securities convertible into its capital stock. Schedule 5.3 sets forth the number of shares of Common Stock, or other ownership interests, issuable or reserved for issuance upon exercise of subscriptions, rights, warrants, options, calls, convertible securities, commitments of sale or Liens related to or entitling any person to purchase or otherwise to acquire any shares of the capital stock of the Company (and the exercise price thereof). 5.4 ORGANIZATION AND OWNERSHIP OF SHARES OF SUBSIDIARIES. (a) Except as set forth on Schedule 5.4, all of the outstanding shares of capital stock or similar equity interests of each Subsidiary of the Company have been duly authorized, validly issued, are fully paid and nonassessable, and are owned by the Company or another Subsidiary free and clear of any Lien. Schedule 5.4 sets forth the number of shares of capital stock, or other ownership interests, issuable or reserved for issuance upon exercise of subscriptions, rights, warrants, options, calls, convertible securities, commitments of sale or Liens related to or entitling any person to purchase or otherwise to acquire any shares of the capital stock of each Subsidiary (and the exercise price thereof). (b) Each Subsidiary of the Company is a corporation or other legal entity duly organized, validly existing and in good standing under the laws of its jurisdiction of organization, 7 and is duly qualified as a foreign corporation or other legal entity and is in good standing in each jurisdiction in which such qualification is required by law, other than those jurisdictions as to which the failure to be so qualified or in good standing would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect. Each such Subsidiary has the power and authority to own or hold under lease the properties it purports to own or hold under lease and to transact the business it transacts and proposes to transact. 5.5 FILED DOCUMENTS AND FINANCIAL STATEMENTS. (a) The Company has filed all required forms, reports and documents with the SEC since January 1, 1995 (the "SEC DOCUMENTS"), each of which complied in all material respects with all of the requirements of the Securities Act or the Exchange Act, as applicable, and did not contain any untrue statement of a material fact or omit to state any material fact required to be contained therein or necessary in order to make the statements contained therein, in the light of the circumstances under which they were made, not misleading. All financial statements contained in such filings (including in each case the related schedules and notes) fairly present in all material respects the consolidated financial position of the Company and its Subsidiaries as of the respective dates and the consolidated results of their operations and cash flows for the respective periods and have been prepared in accordance with GAAP, consistently applied throughout the periods involved, except as set forth in the notes thereto (subject, in the case of any interim financial statements, to normal year-end adjustments). (b) The Company's unaudited financial statements attached as Schedule 5.5(b), were prepared on the same basis as the financial statements contained in the SEC Documents and fairly present the consolidated financial position of the Company and its Subsidiaries as of the dates referenced therein and the consolidated results of their operations and cash flow for the respective periods, and have been prepared in accordance with GAAP consistently applied throughout the periods involved, except such statements do not contain footnotes or related schedules. Since December 31, 1999, there has been no material adverse change in the business, operations, properties, prospects or condition (financial or otherwise) of the Company or any of its Subsidiaries. Since December 31, 1999, the Company has conducted its business in the usual, regular and ordinary course. (c) The Company's budget for 2000 attached as Schedule 5.5(c) was prepared in good faith based on assumptions and projections believed to have been reasonable at the time made and were prepared in all material respects consistent with past accounting practices. 5.6 NO CURRENT VIOLATION, DEFAULT. Neither the Company nor any of its Subsidiaries is (a) in violation of its respective charter, by-laws, partnership agreement or similar governing documents ("CHARTER"), as the case may be, or (b) in default (and no condition exists that with notice or lapse of time or both would constitute a default) in the performance of any obligation, agreement or condition contained in any Applicable Agreement, except in case of this clause (b) to the extent such violation or default, if any, could not, singly or in the aggregate, reasonably be expected to have a Material Adverse Effect. As of the date of this Agreement, neither the Company nor any of its Subsidiaries is in default (and no condition exists that with notice or lapse of time or both would constitute a default) in the performance of any obligation, agreement or condition contained in the Prometric Agreements except to the extent such violation or default, if any, could not, singly or in the aggregate, reasonably be expected to have a Material Adverse Effect. 8 5.7 COMPLIANCE WITH LAWS, OTHER INSTRUMENTS, ETC. The execution, delivery and performance by the Company of this Agreement and the Other Agreements, and the consummation of the Transactions, will not violate, contravene, trigger any rights of any shareholder of the Company under, result in any breach of, conflict with, constitute a default under, or result in the creation of any Lien in respect of any property of the Company or any Subsidiary under, (a) any Charter, (b) any Applicable Agreement or (c) any Law, except in the case of clause (b), to the extent such violation or default could not, singly or in the aggregate, reasonably be expected to have a Material Adverse Effect. 5.8 CONSENTS, APPROVALS, ETC. No consent, approval or authorization of, or registration, filing or declaration with, any Governmental Authority or any other Person is required in connection with the execution, delivery or performance by the Company of this Agreement or the Other Agreements or the consummation of the Transactions, except (i) a filing pursuant to the HSR Act as may be required in connection with the conversion of the Debentures, (ii) filings with the SEC required by the Registration Rights Agreement, dated as of the Closing Date, to be entered into among the Company and the Purchasers , in the form attached as Exhibit 5.8 hereto (the "REGISTRATION RIGHTS AGREEMENT"), (iii) any filings required to perfect an exemption from registration under the Securities Act and similar state securities laws for the sale of the Debentures and Common Stock issuable on conversion thereof, (iv) any applicable filing to list the Common Stock issuable on conversion of the Debentures on the applicable national securities exchange or Nasdaq market,and (v) the consents listed on Schedule 5.8. The Company is not aware of any consents listed on Schedule 5.8 that will not be obtained in a timely manner. Schedule 5.8 indicates whether each of the consents listed thereon has been obtain on or prior to the date hereof. 5.9 LITIGATION; OBSERVANCE OF STATUTES AND ORDERS. (a) There are no actions, suits or proceedings pending or, to the knowledge of the Company, threatened against or affecting the Company or any Subsidiary or any property of the Company or any Subsidiary before or by any Governmental Authority that, individually or in the aggregate, could reasonably be expected to have a Material Adverse Effect. (b) Neither the Company nor any Subsidiary is in default under any order, judgment, decree or ruling of any Governmental Authority or is in violation of any applicable Law, which default or violation, individually or in the aggregate, could reasonably be expected to have a Material Adverse Effect. 5.10 ENVIRONMENTAL. (a) The Company and its Subsidiaries are in compliance with all Environmental Laws, except where such non-compliance could not, singly or in the aggregate, reasonably be expected to have a Material Adverse Effect. Neither the Company nor any of its Subsidiaries has received any notice that alleges that the Company or its Subsidiaries is not in compliance with any Environmental Laws, and to the best of the Company's knowledge, there are no circumstances that may prevent or interfere with such compliance in the future. 9 (b) There is no Environmental Claim pending or threatened, to the knowledge of the Company, against the Company or any of its Subsidiaries with respect to the operations or business of the Company or its Subsidiaries, or against any Person whose liability for any Environmental Claim the Company or its Subsidiaries has retained or assumed either contractually or by operation of law, and to the best of the Company's knowledge, there are no circumstances that could form the basis of any such Environmental Claim in the future. 5.11 TAXES. (a) All Tax returns required to be filed by the Company and each of its Subsidiaries have been filed and all such returns are true, complete, and correct in all material respects. All Taxes that are due or claimed to be due from the Company and each of its subsidiaries have been paid, other than those (i) currently payable without penalty or interest or (ii) being contested in good faith and by appropriate proceedings and for which, in the case of both clauses (i) and (ii), adequate reserves have been established on the books and records of the Company and its subsidiaries in accordance with GAAP. There are no proposed Tax assessments against the Company or any of its subsidiaries. To the best knowledge and belief of the Company, the accruals and reserves on the books and records of the Company and its Subsidiaries in respect of any Tax liability for any taxable period not finally determined are adequate to meet any assessments of Tax for any such period. (b) The Company is not currently a United States real property holding corporation as defined in Section 897(c)(2) of the Code. The Company will use its best efforts to not become a United States real property holding corporation in the future. 5.12 TITLE TO PROPERTY AND ASSETS; LEASES. Except as set forth in the SEC Documents filed on or after January 1, 1999, each of the Company and each of its Subsidiaries has good and marketable title, free and clear of all Liens to all of its assets except (i) Liens for taxes not yet due and payable and (ii) immaterial Liens that do not interfere with the use of such assets. All leases to which the Company or any of its Subsidiaries is a party are valid and binding and no default has occurred or is continuing thereunder, other than any such defaults that, singly or in the aggregate, could not reasonably be expected to have a Material Adverse Effect. The Company and its Subsidiaries enjoy a peaceful and undisturbed possession under all such leases to which any of them is a party as lessee with such exceptions as do not materially interfere with the use made by the Company or such Subsidiary. 5.13 LICENSES, PERMITS, ETC. The Company and each of its Subsidiaries has such material permits, licenses, franchises, authorizations of governmental or regulatory authorities, patents, copyrights, service marks, trademarks and trade names, or rights thereto ("licenses and permits") including, without limitation, under any applicable Environmental Laws, as are necessary to own, lease and operate its respective properties and to conduct its business. The Company and each of its Subsidiaries has fulfilled and performed in all material respects all of its obligations with respect to such licenses and permits. No event has occurred that allows, or after notice or lapse of time would allow, revocation or termination thereof or results in any other impairment of the rights of the holder of any such license or permit if the revocation, termination or impairment thereof could, singly or in the aggregate, reasonably be expected to have a Material Adverse Effect; and, except as described in Schedule 5.13, such licenses and permits contain no restrictions that are materially burdensome to the Company or any of its Subsidiaries. 10 5.14 COMPLIANCE WITH ERISA. (a) Schedule 5.14 sets forth a true and complete list of each employment, bonus, deferred compensation, incentive compensation, stock purchase, stock option, stock appreciation right or other stock-based incentive, severance, change-in-control, or termination pay, hospitalization or other medical, disability, life or other insurance, supplemental unemployment benefits, profit-sharing, pension, or retirement plan, program, agreement or arrangement and each other employee benefit plan, program, agreement or arrangement, sponsored, maintained or contributed to or required to be contributed to by the Company or any of its Subsidiaries, or by any trade or business, whether or not incorporated (an "ERISA AFFILIATE"), that together with the Company or any of its Subsidiaries would be deemed a "single employer" within the meaning of Section 4001(b)(1) of ERISA, for the benefit of any current or former employee or director of the Company, or any of its Subsidiaries or any ERISA Affiliate (the "PLANS"). (b) The Company has made available to the Purchasers with respect to all Plans, true, complete and correct copies of the following: all plan documents and the most recent summary plan descriptions and any subsequent summaries of material modifications; forms 5500 as filed with the IRS for the most recent plan year; all trust agreements with respect to the Plans; the most recent IRS determination letter for all plans qualified under Code section 401(a); all handbooks, manuals, and similar documents governing material employment policies, practices and procedures and each form S-8 and each prospectus related thereto filed or used in the past three years. (c) There are no proceedings (other than routine claims for benefits) pending or to the knowledge of the Company threatened with respect to any Plan, the assets of any trust thereunder, or the Plan sponsor or the Plan administrator with respect to the design or operation of any Plan. Each Plan which is intended to be "qualified" within the meaning of section 401(a) of the Code has received a favorable determination letter from the Internal Revenue Service with respect to its tax-qualified status and to the knowledge of the Company, nothing has occurred since the date of the most recent applicable determination letter that would adversely affect the tax-qualified status of any such Plan; (d) The consummation of the Transactions will not, either alone or in combination with another event, (i) entitle any employee of the Company or any Subsidiary of the Company to severance pay, unemployment compensation or any other payment, (ii) accelerate the time of payment or vesting, or increase the amount of compensation due to any such employee, or (iii) result in any liability under Title IV of ERISA. (e) Except with respect to any act that would not have a Material Adverse Effect on the Company, any Subsidiary or ERISA Affiliate, the Company has operated and administered each Plan in substantial compliance with all applicable Laws. (f) None of the Company, any of its Subsidiaries, any ERISA Affiliate, any of the ERISA Plans, any trust created thereunder, nor to the Company's knowledge, any trustee or administrator thereof has engaged in a transaction or has taken or failed to take any action in connection with which the Company, any of its Subsidiaries or any ERISA Affiliate could be subject to any material liability for either a civil penalty assessed pursuant to Section 409 or 502(i) of ERISA or a tax imposed pursuant to Section 4975(a) or (b), 4976 or 4980B of the Code. 11 (g) At no time has the Company, any of its Subsidiaries or any ERISA Affiliate ever, maintained, established, sponsored, participated in or contributed to any ERISA Plan that is subject to Title IV of ERISA. (h) At no time has the Company, any of its Subsidiaries or any ERISA Affiliate ever contributed to or been obliged to contribute to any "multiemployer pension plan, " as such term is defined in Section 3(37) of ERISA. (i) No amounts payable under any of the Plans or any other contract, agreement or arrangement with respect to which the Company or any of its Subsidiaries may have any liability could fail to be deductible for federal income tax purposes by virtue of Section 162(m) or Section 280G of the Code. (j) The Company, its Subsidiaries and its ERISA Affiliates do not have any obligations in connection with any medical, death or other welfare benefit for its employees after they retire, except to the extent required under the group health plan continuation requirements of Section 601 of ERISA or under any applicable state law. 5.15 PRIVATE OFFERING BY THE COMPANY. Neither the Company nor anyone acting on its behalf has offered the Debentures or any similar securities for sale to, or solicited any offer to buy any of the same from, or otherwise approached or negotiated in respect thereof with, any person other than the Purchasers, which have been offered the Debentures at a private sale for investment. Neither the Company nor anyone acting on its behalf has taken, or will take, any action that would subject the issuance or sale of the Debentures to the registration requirements of Section 5 of the Securities Act. No securities of the same class as the Debentures have been issued and sold by the Company within the six-month period immediately prior to the date hereof. Prior to the effectiveness of any registration statement filed under the Securities Act, the Indenture is not required to be qualified under the TIA. 5.16 USE OF PROCEEDS; MARGIN REGULATIONS. At all times after the Closing and prior to contribution thereof to the Incubator in accordance with the Incubator Agreement, the Company will set aside and keep available for such contribution an amount equal to the proceeds from the sale of the Debentures (the "CONTRIBUTION AMOUNT"). Pending such contribution, the Contribution Amount and any portion thereof held by the Company will be held solely in the form of: (i) United States dollars, (ii) securities issued or directly and fully guaranteed or insured by the United States of America or any agency or instrumentality thereof (provided that the full faith and credit of the United States of America is pledged in support thereof), (iii) time deposits and certificates of deposit and commercial paper issued by the parent corporation of any domestic commercial bank of recognized standing having capital and surplus in excess of $500,000,000 and (iv) commercial paper issued by others rated at least A-2 or the equivalent thereof by Standard & Poor's Corporation or at least P-2 or the equivalent thereof by Moody's Investors Service, Inc. and in the case of each of (ii), (iii), and (iv) maturing within one year of the Closing Date. 5.17 STATUS UNDER CERTAIN STATUTES. Neither the Company nor any Subsidiary is, nor after giving effect to the Transactions will any of them be, subject to regulation under the Investment Company Act of 1940, as amended, the Public 12 Utility Holding Company Act of 1935, as amended, the Interstate Commerce Act, as amended, or the Federal Power Act, as amended. 5.18 CERTAIN PAYMENTS. Neither the Company nor any Subsidiary, nor any director, officer, agent, employee, or other person associated with or acting on behalf of any of them, has directly or indirectly (a) made any contribution, gift, bribe, rebate, payoff, influence payment, kickback, or other payment to any Person, private or public, regardless of form, whether in money, property, or services (i) to obtain favorable treatment in securing business, (ii) to pay for favorable treatment for business secured, (iii) to obtain special concessions or for special concessions already obtained, for or in respect of the Company or any Subsidiary or any Affiliate of the Company or any Subsidiary, or (iv) in violation of any Law, or (b) established or maintained any fund or asset that has not been recorded in the books and records of the Company. 5.19 NO BROKERS OR FINDERS. No agent, broker, finder, or investment or commercial banker or other Person engaged by or acting on behalf of the Company or any Subsidiary, is or will be entitled to any brokerage or finder's or similar fee or other commission as a result of this Agreement, the Other Agreements or the Transactions, other than Chase Securities, Inc., which will be entitled to receive an amount not to exceed $750,000 in the aggregate in exchange for delivering a fairness opinion to the Company and all other services in connection with such matters. 5.20 INSURANCE. The Company and its Subsidiaries maintain, with reputable insurers, insurance in such amounts, including deductible arrangements, and of such a character as is usually maintained by reasonably prudent managers of companies engaged in the same or similar business. All policies of title, fire, liability, casualty, business interruption, workers' compensation and other forms of insurance including, but not limited to, directors and officers insurance, held by the Company and its Subsidiaries, are in full force and effect in accordance with their terms. Neither the Company nor any of its Subsidiaries is in default under any provisions of any such policy of insurance and no such Person has received notice of cancellation of any such insurance. 5.21 ACCOUNTING. The Company and each of its Subsidiaries maintains a system of internal accounting controls sufficient to provide reasonable assurance that (i) transactions are executed in accordance with management's general or specific authorizations, (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP and to maintain asset accountability, (iii) access to assets is permitted only in accordance with management's general or specific authorization and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. 5.22 REGISTRATION RIGHTS. Except for the Registration Rights Agreement and as set forth on Schedule 5.22, there are no contracts, agreements or understandings between the Company and any Person granting such Person the right to require the Company to file a registration statement under the Act with respect to any securities of 13 the Company or to require the Company to include such securities with the Debentures or the Common Stock issuable upon conversion thereof registered pursuant to the Registration Rights Agreement. 5.23 [INTENTIONALLY OMITTED.] 5.24 SECURITIES RATINGS. No "nationally recognized statistical rating organization" as such term is defined for purposes of Rule 436(g)(2) under the Securities Act (i) has imposed (or has informed the Company that it is considering imposing) any condition (financial or otherwise) on the Company's retaining any rating assigned to the Company or any securities of the Company or (ii) has indicated to the Company that it is considering (a) the downgrading, suspension, or withdrawal of, or any review for a possible change that does not indicate the direction of the possible change in, any rating so assigned or (b) any change in the outlook for any rating of the Company or any securities of the Company. 5.25 SIMILAR SECURITIES NOT LISTED. When the Debentures are issued and delivered pursuant to this Agreement, the Debentures will not be of the same class (within the meaning of Rule 144A under the Securities Act) as any security of the Company that is listed on a national securities exchange registered under Section 6 of the Exchange Act or that is quoted in a United States automated inter-dealer quotation system. 5.26 INTELLECTUAL PROPERTY. The Company and its Subsidiaries own in all material respects the entire and unencumbered right, title and interest in and to, or possess adequate licenses or other rights to use, all intellectual property, including but not limited to, patents, trademarks, service marks, trade names, copyrights, computer software and know-how used in, or necessary to, the business conducted by the Company or any of its Subsidiaries (the "INTELLECTUAL PROPERTY"). All such Intellectual Property is valid and enforceable and the Company and each of its Subsidiaries has performed all acts and has paid all required fees and Taxes to maintain all registrations and applications of such Intellectual Property in full force and effect. None of the Company or any of its Subsidiaries has received any notice of infringement of or conflict with (or knows or has known of such infringement of or conflict with) asserted rights of others with respect to the use of Intellectual Property. To the Company's knowledge, the Company and its Subsidiaries do not in the conduct of their business infringe or conflict with any right of any third party. None of the Company or any of its Subsidiaries is, nor will any of them be as a result of the execution and delivery of this Agreement or the performance of any obligations hereunder, in breach of any Applicable Agreement relating to any Intellectual Property. 5.27 AUTHORIZATION OF SHARES ISSUABLE UPON CONVERSION. The shares of Common Stock issuable upon conversion of the Debentures have been duly authorized and reserved for issuance upon such conversion and, when issued upon such conversion, will be validly issued, fully paid and nonassessable; and the stockholders of the Company or other holders of the Company's securities have no preemptive or similar rights with respect to the Debentures or the Common Stock issuable upon conversion of the Debentures. 5.28 AFFILIATE TRANSACTIONS. 14 Except for transactions described on Schedule 5.28 and transactions contemplated by the Other Agreements, neither the Company nor any of its Subsidiaries is or has been a party to any transaction or series of transactions described in (a) Item 404 of Regulation S-K under the Securities Act; PROVIDED, HOWEVER, that for purposes hereof, references in such Item 404 to the "registrant" shall be deemed to be references to the Company or such Subsidiary, as the case may be, and references to the "beginning of the registrant's last fiscal year" shall be deemed to be references to the beginning of the Company's fiscal year ended December 31, 1996 or (b) Section 4(b)(i) of the Investors Agreement, to be entered into and dated as of the Closing Date, among the Company and the Purchasers, in the form attached as Exhibit 5.28 hereto (the "INVESTORS AGREEMENT"). 5.29 REPRESENTATIONS AND WARRANTIES IN THE PROMETRIC AGREEMENTS. The representations and warranties of the Company to the Prometric Agreements were true in all material respects as of the date thereof and are true in all material respects on the date hereof. 5.30 INVESTMENT COMPANY ACT. Neither the Company nor each of its Subsidiaries is and, after giving effect to consummation of the transactions contemplated hereby and by the Other Agreements, none of them will be, an "investment company" (as such term is defined in the Investment Company Act of 1940, as amended). 5.31 ANTITAKEOVER MATTERS. Prior to the Closing Date, the Company, its shareholders and its Board of Directors shall have each taken all action required in order to (i) exempt the Purchasers, in respect to their purchase and conversion of the Debentures, from "interested stockholder" status as defined by Title 3, Subtitle 6 of the General Corporation Law of Maryland and (ii) exempt the execution, delivery, and performance of this Agreement and the Other Agreements, and the issuance and conversion of the Debentures, from the requirements of, and from triggering any provisions under, the Rights Agreement or any Antitakeover Law. 5.32 FORMATION AND CAPITALIZATION OF INCUBATOR. Immediately following the Closing: (a) The Incubator will be duly organized and validly existing as a limited liability company in good standing under the laws of the State Delaware. The Incubator will be duly qualified to transact business and in good standing in each jurisdiction in which such qualification is required. The Incubator will have full power and authority to (i) own, lease and operate its properties and to conduct its business as proposed to be conducted and (ii) consummate the Transactions and enter into and perform its obligations under each Other Agreement to which it is a party. (b) The issuance and sale of all the then issued and outstanding membership interests in the Incubator will be duly authorized by all necessary action of the Incubator. Each membership interest of the Incubator that is then issued and outstanding will be duly authorized and validly issued, and not issued in violation of, or subject to, any preemptive or similar rights. Except as set forth in the Incubator Agreement, there will be no outstanding (i) securities convertible into or exchangeable for any membership interests or other equity securities of the Incubator, (ii) options, warrants or other rights to purchase or subscribe to any membership interests or other equity 15 securities of the Incubator or (iii) contracts, commitments, agreements, understandings, arrangements, calls or claims of any kind relating to the issuance of any membership interests or other equity securities of the Incubator, any such convertible or exchangeable securities, or any such options, warrants or rights. (c) The Incubator will have duly authorized, executed and delivered each of the Other Agreements to which it is a party, and each of such Other Agreements will be a valid and binding agreement of the Incubator, enforceable against the Incubator in accordance with its terms, except as the enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting enforcement of creditors' rights generally, or by general principles of equity (regardless of whether enforcement is considered in a proceeding in equity or at law). (d) The Company will have contributed the Initial Company Contribution to the Incubator. 6. REPRESENTATIONS OF THE PURCHASER. 6.1 ORGANIZATION; POWER AND AUTHORITY. Each Purchaser represents that (a) it is duly organized, validly existing and in good standing under the laws of its jurisdiction of organization, and is duly qualified and in good standing in each jurisdiction in which such qualification is required by law, other than those jurisdictions as to which the failure to be so qualified or in good standing would not, individually or in the aggregate, reasonably be expected to have a material adverse effect on its ability to perform its obligations under the Agreement and the Other Agreements to which it is or becomes a party, or the validity or enforceability of this Agreement or the Other Agreements to which it is or becomes a party and (b) it has the organizational power and authority to transact the business it transacts and proposes to transact, to execute and deliver this Agreement and the Other Agreements to which it is or becomes a party, and to perform the provisions hereof and thereof. 6.2 AUTHORIZATION, ETC. Each Purchaser represents that this Agreement and the Other Agreements to which it is or becomes a party, has been duly authorized by all necessary organizational action on the part of it, and this Agreement and the Other Agreements to which it is or becomes a party, constitutes, and upon execution and delivery by the Company of such Agreements, will constitute, legal, valid and binding obligations of it enforceable against it in accordance with their terms, except as such enforceability may be limited by (i) applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforcement of creditors' rights generally and (ii) general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). 6.3 PURCHASE FOR INVESTMENT; ACCREDITED INVESTOR STATUS Each Purchaser represents that it is purchasing the Debentures for its own account or for one or more separate accounts maintained by it and not with a view to the distribution thereof, provided that the disposition of its or their property shall at all times be within its or their control. Each Purchaser understands that the Debentures have not been registered under the Securities Act and may be resold only if registered pursuant to the provisions of the Securities Act or if an exemption from registration is available, except under 16 circumstances where neither such registration nor such an exemption is required by law. Each Purchaser represents that it is an Accredited Investor as defined under Regulation D promulgated pursuant to the Securities Act of 1933. 7. COVENANTS. 7.1 TRANSACTION EXPENSES. Whether or not any of the Transactions are consummated, the Company will pay all reasonable and documented out-of-pocket fees and expenses incurred by the Purchasers or Apollo Management (including the reasonable and documented fees and expenses of a special counsel and other representatives engaged by the Purchasers or Apollo Management) up to an aggregate of $1,500,000 in connection with (i) such Transactions, (ii) any amendments, waivers or consents under or in respect of this Agreement or the Other Documents (whether or not such amendment, waiver or consent becomes effective) or (iii) the Purchaser's investment in the Debentures, including, without limitation: (a) the costs and expenses incurred in enforcing or defending (or determining whether or how to enforce or defend) any rights under this Agreement or any of the Other Documents, or in responding to any subpoena or other legal process or informal investigative demand issued in connection with this Agreement or any of the Other Documents, or by reason of being a holder of any Debenture, (b) the costs and expenses, including financial advisors' fees, incurred in connection with the insolvency or bankruptcy of the Company or any Subsidiary or in connection with any work-out or restructuring of the Transactions, and (c) any filing fees payable by the Company or the Purchasers in connection with any filings or submissions required under the HSR Act in connection with the conversion of the Debentures. Prior to paying such expenses, the Company will be given an opportunity to review reasonably detailed invoices related thereto. The obligations of the Company under this Section 7.1 will survive the payment or transfer of any Debenture, the enforcement, amendment or waiver of any provision of this Agreement or any Other Agreement, and the termination of this Agreement or any Other Agreement. All such fees and expenses incurred as of the Closing Date shall be paid at the Closing in immediately available funds by wire transfer to such bank accounts as the Purchasers or Apollo Management shall have notified the Company in writing. 7.2 OPERATION OF BUSINESS. From the date hereof until the Closing Date, except as contemplated by this Agreement and the Other Agreements (including the schedules hereto or thereto), (a) the Company shall, and shall cause each of the Subsidiaries to, (i) operate its business in the normal course and use its reasonable best efforts to preserve its present business organization intact and its present relationships with persons having material business dealings with it; and (ii) continue to maintain, in all material respects, its assets and properties and keep its books in accordance with present practices in a condition suitable for its current use; and (b) the Company shall not, and shall not permit any of the Subsidiaries to, (i) take any action regarding any matter described in Section 4 of the Investors Agreement; or (ii) take any action that would cause any of the representations and warranties made by the Company in this Agreement not to remain true and correct as if made at and as of the Closing Date. 7.3 ACCESS TO BOOKS AND RECORDS. 17 The Company shall afford, and shall cause each of its Subsidiaries to afford, to each of the Purchasers and the Purchasers' accountants, counsel and representatives full access during normal business hours throughout the period prior to the Closing Date to all the Company's and its Subsidiaries' properties, books, contracts, commitments and records (including, but not limited to, tax returns) and, during such period, shall furnish promptly to each of the Purchasers (a) a copy of each report, schedule and other document filed or received by the Company or any of its Subsidiaries pursuant to the requirements of federal or state securities laws, and (b) all other information concerning the Company's and its Subsidiaries' business, properties and personnel as the Purchasers may reasonably request, PROVIDED that no investigation or receipt of information pursuant to this Section 7.3 shall affect any representation or warranty of the Company or the conditions to the obligations of the Purchasers. 7.4 AGREEMENT TO TAKE NECESSARY AND DESIRABLE ACTIONS. (a) The Company shall, and shall cause each of its Subsidiaries to, execute and deliver this Agreement and the Other Agreements to which each is a party and such other documents, certificates, agreements and other writings and to take such other actions as may be necessary, desirable or reasonably requested by the Purchasers in order to consummate or implement expeditiously the Transactions. (b) The Company and the Purchasers party thereto shall in good faith negotiate, and shall execute and deliver on the Closing Date the Incubator Agreement, which agreement shall contain the terms specified on Exhibit 7.4 (which Exhibit reflects the parties agreement as to the terms of the Incubator). The Company shall, and shall cause each of its Subsidiaries to, execute and deliver such documents, certificates, agreements and other writings and to take such other actions as may be necessary, desirable or reasonably requested by the Purchasers in order to contribute the Initial Company Contribution to the Incubator. 7.5 COMPLIANCE WITH CONDITIONS; BEST EFFORTS. The Company shall use its best efforts to cause all of the obligations imposed upon it in this Agreement to be duly complied with and to cause all conditions precedent to the obligations of the Company and the Purchasers to be satisfied. Upon the terms and subject to the conditions of this Agreement, the Company will use its best efforts to take, or cause to be taken, all action, and to do, or cause to be done, all things necessary, proper or advisable consistent with applicable law to consummate and make effective in the most expeditious manner practicable the Transactions. 7.6 HSR ACT FILINGS. The Company and each of its Subsidiaries shall file all reports and documents as may be necessary to comply with the HSR Act. The Company shall cooperate with and assist the other parties hereto and take such action as may be reasonably required and as permitted under law in connection with such filings (including cooperating with additional requests for information, documents and interviews of officers and personnel by either of the antitrust enforcement agencies). 7.7 PROMETRIC TRANSACTION. The Company agrees promptly to inform Apollo Management in writing of (a) any material development in the proceedings and negotiations related to the Prometric Transaction and (b) the receipt of any notices under the Prometric Agreements. 18 7.8 ANTITAKEOVER MATTERS. Prior to the Closing Date, the Company, its shareholders and its Board of Directors shall take all action required to be taken by in order to (i) exempt the Purchasers, in respect to their purchase and conversion of the Debentures, from "interested stockholder" status as defined by Title 3, Subtitle 6 of the General Corporation Law of Maryland and (ii) exempt the execution, delivery, and performance of this Agreement and the Other Agreements, and the issuance and conversion of the Debentures, from the requirements of, and from triggering any provisions under, the Rights Agreement or any Antitakeover Law. 8. SURVIVAL OF REPRESENTATIONS AND WARRANTIES; ENTIRE AGREEMENT. All representations and warranties contained herein shall survive the execution and delivery of this Agreement and the Other Agreements, the purchase or transfer by the Purchasers of any Debenture or portion thereof or interest therein, and the payment or conversion of any Debenture, and may be relied upon by any Person who purchases any of the first $25,000,000 in principal amount of Debentures sold by any Affiliate of Apollo Management on or prior to the 90th day following the Closing Date, regardless of any investigation made at any time by or on behalf of the Purchasers or any other holder of a Debenture. All statements contained in any certificate or other instrument delivered by or on behalf of the Company pursuant to this Agreement or any other Agreement shall be deemed representations and warranties of the Company under this Agreement. 9. AMENDMENT AND WAIVER. This Agreement may be amended, modified or supplemented, and waivers or consents to departures from the provisions hereof may be given, provided that the same are in writing and signed by each of the parties hereto. 10. NOTICES. All notices and communications provided for hereunder shall be in writing and sent (a) by telecopy if the sender on the same day sends a confirming copy of such notice by a recognized overnight delivery service (charges prepaid), or (b) by registered or certified mail with return receipt requested (postage prepaid), or (c) by a recognized overnight delivery service (with charges prepaid). Any such notice must be sent: (i) if to a Purchaser or a Purchaser's nominee, to such address such Purchaser shall have specified to the Company in writing, (ii) if to the Company, to the Company at its address set forth at the beginning hereof to the attention of Chief Financial Officer, or at such other address as the Company shall have specified to the holder of each Debenture in writing. Notices under this Section 10 will be deemed given only when actually received. 11. REPRODUCTION OF DOCUMENTS. 19 This Agreement and all documents relating thereto, including, without limitation, (a) consents, waivers and modifications that may hereafter be executed, (b) documents received by Apollo Management at the Closing (except the Debentures themselves), and (c) financial statements, certificates and other information previously or hereafter furnished to Apollo Management, may be reproduced by Apollo Management or any Purchaser by any photographic, photostatic, microfilm, microcard, miniature photographic or other similar process and Apollo Management or such Purchaser may destroy any original document so reproduced. The Company agrees and stipulates that, to the extent permitted by applicable law, any such reproduction shall be admissible in evidence as the original itself in any judicial or administrative proceeding (whether or not the original is in existence and whether or not such reproduction was made by Apollo Management or such Purchaser in the regular course of business) and any enlargement, facsimile or further reproduction of such reproduction shall likewise be admissible in evidence. This Section 11 shall not prohibit the Company or any other holder of Debentures from contesting any such reproduction to the same extent that it could contest the original, or from introducing evidence to demonstrate the inaccuracy of any such reproduction. 12. SUBSTITUTION OF PURCHASER. Each Purchaser shall have the right to substitute any designee reasonably acceptable to the Company as the purchaser of the Debentures that such Purchaser has agreed to purchase hereunder, by written notice to the Company. Any affiliate of a Purchaser shall be deemed acceptable to the Company. Upon receipt of such notice, wherever the word "Purchaser" is used in this Agreement (other than in this Section 12), such word shall be deemed to refer to such designee in lieu of such Purchaser. 13. MISCELLANEOUS. 13.1 SUCCESSORS AND ASSIGNS. All covenants and other agreements contained in this Agreement by or on behalf of any of the parties hereto bind and inure to the benefit of their respective successors and assigns (including, without limitation, any permitted subsequent holder of a Debenture) whether so expressed or not. 13.2 SEVERABILITY. Any provision of this Agreement that is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall (to the full extent permitted by law) not invalidate or render unenforceable such provision in any other jurisdiction. 13.3 CONSTRUCTION. Each covenant contained herein shall be construed (absent express provision to the contrary) as being independent of each other covenant contained herein, so that compliance with any one covenant shall not (absent such an express contrary provision) be deemed to excuse compliance with any other covenant. Where any provision herein refers to action to be taken by any Person, or which such Person is prohibited from taking, such provision shall be applicable whether such action is taken directly or indirectly by such Person. 13.4 COUNTERPARTS. 20 This Agreement may be executed in any number of counterparts, each of which shall be an original but all of which together shall constitute one instrument. Each counterpart may consist of a number of copies hereof, each signed by less than all, but together signed by all, of the parties hereto. 13.5 GOVERNING LAW; SUBMISSION TO JURISDICTION;. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF MARYLAND, WITHOUT REGARD TO THE CONFLICT OF LAW RULES THEREOF. EACH OF THE PARTIES HERETO HEREBY IRREVOCABLY SUBMITS TO THE JURISDICTION OF ANY MARYLAND STATE COURT SITTING IN THE CITY OF BALTIMORE OR ANY FEDERAL COURT SITTING IN THE CITY OF BALTIMORE IN RESPECT OF ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT AND IRREVOCABLY ACCEPTS FOR ITSELF AND IN RESPECT OF ITS PROPERTY, GENERALLY AND UNCONDITIONALLY, JURISDICTION OF THE AFORESAID COURTS. EACH OF THE PARTIES HERETO IRREVOCABLY WAIVES, TO THE FULLEST EXTENT IT MAY EFFECTIVELY DO SO UNDER APPLICABLE LAW, ANY OBJECTION WHICH IT MAY NOW OR HEREAFTER HAVE TO THE LAYING OF THE VENUE OF ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT AND ANY CLAIM THAT ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM. 13.6 CONFIDENTIALITY. The terms of this Agreement shall remain confidential until all parties to this Agreement agree in writing to the extent and form of disclosure. 21 If you are in agreement with the foregoing, please sign the form of agreement on the accompanying counterpart of this Agreement and return it to the Company, whereupon the foregoing shall become a binding agreement between you and the Company. Very truly yours, SYLVAN LEARNING SYSTEMS, INC. By: ---------------------------------------- Name: -------------------------------------- Title: ------------------------------------- The foregoing is hereby agreed to as of the date first written above. APOLLO INVESTMENT FUND IV, L.P. By: Apollo Advisors IV, L.P., its general partner By: Apollo Capital Management IV, Inc., its general partner By: ---------------------------------------- Name: -------------------------------------- Title: ------------------------------------- APOLLO OVERSEAS PARTNERS IV, L.P. By: Apollo Advisors IV, L.P., its general partner By: Apollo Capital Management IV, Inc., its general partner By: ---------------------------------------- Name: -------------------------------------- Title: ------------------------------------- INVESTOR (GUERNSEY) LTD. By: ---------------------------------------- Name: -------------------------------------- Title: ------------------------------------- and By: ---------------------------------------- Name: -------------------------------------- Title: ------------------------------------- EX-11.02 3 a2043474zex-11_02.txt EX-11.02 Exhibit 11.02 FORMATION AGREEMENT BY AND AMONG SYLVAN LEARNING SYSTEMS, INC., AP EDUCATE INVESTMENTS, LLC, R. CHRISTOPHER HOEHN-SARIC AND DOUGLAS L. BECKER JUNE 30, 2000 FORMATION AGREEMENT THIS FORMATION AGREEMENT is executed on this 30th day of June, 2000 (the "Closing Date"), by and among SYLVAN LEARNING SYSTEMS, INC. a Maryland corporation ("Sylvan"), AP EDUCATE INVESTMENTS, LLC, a Delaware limited liability company ("Apollo"), R. CHRISTOPHER HOEHN-SARIC ("Hoehn-Saric") and DOUGLAS L. BECKER ("Becker"). WHEREAS, the parties hereto have agreed to create Sylvan Ventures, Inc., a Delaware corporation (the "Corporation"), and Sylvan Ventures, LLC, a Delaware limited liability company (the "Incubator"), for the purposes of (a) investing, either directly or indirectly, in Subject Companies (as defined below); (b) promoting the development of such Subject Companies; (c) providing strategic guidance and operational support to such Subject Companies; (d) promoting collaboration among such Subject Companies; and (e) owning and managing the Real Estate Assets (as defined below). WHEREAS, the parties hereto have agreed to contribute cash to the Corporation, and cash and other property to the Incubator. WHEREAS, in connection with the formation of the Corporation, the parties have agreed to set forth certain of their respective rights and obligations with respect to the Corporation, and the conduct of the business of the Corporation, in that certain Stockholders' Agreement of even date herewith (the "Stockholders' Agreement"), a copy of which is attached hereto as EXHIBIT A. WHEREAS, in connection with the formation of the Incubator, the parties have agreed to set forth certain of their respective rights and obligations (and the rights and obligations of the Corporation) with respect to the Incubator, and the conduct of the business of the Incubator, in that certain Limited Liability Company Agreement of even date herewith (the "Operating Agreement"), a copy of which is attached hereto as EXHIBIT B. WHEREAS, (i) each of Apollo and the Corporation has agreed to set forth certain of their respective rights and obligations with respect to the securities of the Corporation acquired by Apollo hereunder in a Registration Rights Agreement of even date herewith (the "Corporate Registration Rights Agreement"), a copy of which is attached hereto as EXHIBIT C, and (ii) each of Apollo and the Incubator has agreed to set forth certain of their respective rights and obligations with respect to the securities of the Incubator acquired by Apollo hereunder in a Registration Rights Agreement of even date herewith (the "Incubator Registration Rights Agreement"), a copy of which is attached hereto as EXHIBIT D. WHEREAS, the parties hereto intend that this Agreement memorialize their respective representations, warranties, covenants and other agreements made to induce each of the parties hereto to form the Corporation and the Incubator and execute and deliver the other Closing Documents, as defined herein. NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements set forth herein, the parties hereto, intending to be legally bound, hereby agree as follows: I. DEFINITIONS SECTION 1.01. DEFINITIONS. The following capitalized terms shall have the meanings specified in this Section 1.01. Other terms are defined in the recitals hereto or in the text of this Agreement, and shall have the meanings respectively ascribed to them. "ACCREDITED INVESTOR" has the meaning set forth in Section 4.06 hereof. "AGREEMENT" means this Formation Agreement, as the same may be amended, supplemented or modified in accordance with the terms hereof. "CAPITAL STOCK" means, with regard to any corporation, partnership, limited liability company or other business entity, any and all shares, interests, participation or other equivalents (however designated), whether voting or non-voting, representing ownership (whether direct, indirect or contingent) of such corporation, partnership or other business entity. "CERTIFICATE OF FORMATION" means that certain Certificate of Formation with respect to the Incubator filed for record with the Secretary of State before the Closing Date, a copy of which is attached hereto as EXHIBIT E. "CERTIFICATE OF INCORPORATION" means that certain Certificate of Incorporation with respect to the Corporation filed for record with the Secretary of State on or before the Closing Date, a copy of which is attached hereto as EXHIBIT F. "CHANCERY ACQUISITION PRICE" has the meaning set forth in Section 3.04(a) hereof. -2- "CHANCERY ADDITIONAL CAPITAL CALL" has the meaning set forth in Section 3.04(a) hereof. "CHANCERY REIMBURSEMENT AMOUNT" has the meaning set forth in Section 3.04(a) hereof. "CLOSING DOCUMENTS" means this Agreement, the Certificate of Incorporation, the Corporate Bylaws, the Stockholders' Agreement, the Certificate of Formation, the Operating Agreement, the Corporate Registration Rights Agreement, the Incubator Registration Rights Agreement, the Employment Agreements, the Membership Profit Interest Plan, the Membership Profit Interest Grant Agreements, the Closing Tax Opinion, and the Post-Closing Tax Opinions. "CLOSING TAX OPINION" has the meaning set forth in Section 3.05(f) hereof. "COMMON STOCK" has the meaning set forth in Section 2.02 hereof. "COMMON UNITS" has the meaning set forth in the Operating Agreement. "CORPORATE BYLAWS" means the Bylaws of the Corporation to be adopted by the Board of Directors of the Corporation at the organizational meeting of the Corporation, a copy of which is attached hereto as EXHIBIT G. "CORPORATE CLOSING" has the meaning set forth in Section 2.05 hereof. "EMPLOYMENT AGREEMENT(S)" means, collectively, (i) that certain Employment Agreement, dated as of the Closing Date, by and among Sylvan, the Incubator and Becker, and (ii) that certain Employment Agreement, dated as of the Closing Date, by and among the Corporation, the Incubator, Sylvan and Hoehn-Saric, copies of each of which are attached hereto as EXHIBITS H AND I, respectively. "INCUBATOR CLOSING" has the meaning set forth in Section 2.05 hereof. "LIEN" means, with respect to any Person, any mortgage, lien, pledge, charge, security interest or other encumbrance, or any interest or title of any vendor, lessor, lender or other secured party to or of such Person under any conditional sale or other title retention agreement or lease with respect to which the lessee is required concurrently to recognize the acquisition of an asset and the incurrence of a liability in accordance with United States generally accepted accounting principles, upon or with -3- respect to any property or asset of such Person (including in the case of Capital Stock, stockholder agreements, voting trust agreements and all similar arrangements). "MEMBERSHIP INTERESTS" has the meaning set forth in the Operating Agreement. "MANAGEMENT INVESTORS" means each of Hoehn-Saric and Becker. "MATERIAL ADVERSE EFFECT" means, with respect to any Person, a material adverse effect on (i) the business, operations, affairs, condition (financial or otherwise), assets, prospects or properties of such Person taken as a whole, or (ii) the ability of such Person to perform its obligations under this Agreement or any of the other Closing Documents to which it is a party, or (iii) the validity or enforceability of this Agreement or any of the other Closing Documents to which such Person is a party. "MEMBERSHIP PROFIT INTEREST GRANT AGREEMENT(S)" means those certain Membership Profit Interest Grant Agreements, dated as of the Closing Date, by and between the Incubator and each of Hoehn-Saric and Becker, copies of which are attached hereto as EXHIBITS J AND K, respectively. "ONLINE NOTES" has the meaning set forth in Section 3.02 hereof. "PERSON" means any individual, corporation, partnership, joint venture, association, limited liability company, joint-stock company, trust, estate or other entity, unincorporated organization or government or other agency or political subdivision thereof. "PLAN ASSETS" has the meaning set forth in Section 5.06 hereof. "POST-CLOSING TAX OPINIONS" has the meaning set forth in Section 3.02(b) hereof. "PREFERRED STOCK" has the meaning set forth in Section 2.02 hereof. "PREFERRED UNITS" has the meaning set forth in the Operating Agreement. "PURCHASE AGREEMENT" has the meaning set forth in Section 7.04 hereof. "REAL ESTATE ASSETS" has the meaning set forth in the Operating Agreement. -4- "SEC" means the Securities and Exchange Commission. "SECRETARY OF STATE" means the Secretary of State of the State of Delaware. "SHARES" has the meaning set forth in Section 2.02 hereof. "SUBJECT COMPANIES" has the meaning set forth in the Operating Agreement. II. FORMATION OF THE CORPORATION SECTION 2.01. FORMATION. Based upon the representations, warranties, covenants and agreements contained herein and in the other Closing Documents, each of Sylvan, Apollo and the Management Investors hereby agrees to form the Corporation on the terms and conditions set forth herein and therein. SECTION 2.02. PURCHASE PRICE FOR SHARES. Contemporaneously with the execution and delivery of this Agreement, (i) Sylvan is paying cash in the aggregate amount of $19,603.46 to the Corporation in consideration for 7,126 shares of common stock of the Corporation, par value $0.01 per share (the "Common Stock"); (ii) Apollo is paying cash in the aggregate amount of $8,910.65 to the Corporation in consideration for 2,499 shares of convertible preferred stock of the Corporation, par value $0.01 per share (the "Preferred Stock"); and (iii) the Management Investors are paying cash in the aggregate amount of $1,336.59 to the Corporation in consideration for 375 shares of Common Stock as follows: Hoehn-Saric: $668.30 for 187.5 shares Becker: $668.29 for 187.5 shares Upon payment in full of such amounts, all such shares of Capital Stock of the Corporation (collectively, the "Shares") shall be validly issued, fully-paid and non-assessable, subject to Article IV of the Stockholders' Agreement. -5- SECTION 2.03. ORGANIZATION. Sylvan hereby represents and warrants that, prior to the Corporate Closing, the Certificate of Incorporation was filed for record with the Secretary of State. Effective immediately after the Corporate Closing, the Board of Directors of the Corporation shall hold the organizational meeting of the Corporation (which may be by unanimous consent of all directors in lieu of a meeting) pursuant to which the Corporation shall, among other things, (i) adopt and approve the Corporate Bylaws, (ii) authorize the issuance of the Shares to Sylvan, Apollo and the Management Investors pursuant to this Agreement, (iii) authorize and approve the Stockholders' Agreement, the Corporate Registration Rights Agreement, and the Employment Agreement with Hoehn-Saric, and (iv) authorize and approve the Operating Agreement, the acquisition by the Corporation of a Membership Interest in the Incubator, and the capital contributions by the Corporation to the Incubator pursuant to Sections 3.02 and 3.04 hereof. SECTION 2.04. COMPANY CAPITAL CALL. (a) In connection with the Chancery Additional Capital Call, the parties hereto acknowledge and agree that the Corporation shall be deemed to have made a "Company Capital Call" (as defined in the Stockholders' Agreement) in the aggregate amount of $51,035.14 representing the Corporation's pro-rata share of the Chancery Reimbursement Amount, pursuant to which each of Sylvan (subject to Section 2.04(b) below), Apollo and the Management Investors shall contribute, contemporaneously with the execution and delivery of this Agreement and in accordance with Section 4.01 of the Stockholders' Agreement, the following amounts to the Corporation: Sylvan: $33,515.62 Apollo: $15,234.37 Hoehn-Saric: $ 1,142.57 Becker: $ 1,142.58 TOTAL: $51,035.14 ==========
(b) The parties hereto acknowledge and agree that, in lieu of Sylvan paying in cash its $33,515.62 share of such Company Capital Call, such amount (on a dollar-for-dollar basis) shall be applied to, credited against, and treated as a payment of, the amount payable by the Corporation pursuant to Section 3.04 hereof in connection with the Chancery Additional Capital Call; provided, however, that in no event shall such payment reduce the amount payable by each of Apollo and the Management Investors pursuant to Section 2.04(a) hereof. SECTION 2.05 CLOSING. Closing with respect to the initial capitalization of the Corporation (the "Corporate Closing") is occurring on the Closing Date -6- contemporaneously with the execution and delivery of this Agreement by the parties hereto, and shall be deemed to occur immediately prior to the closing with respect to the initial capitalization of the Incubator hereunder (the "Incubator Closing"). At the Corporate Closing, (i) each of Sylvan, Apollo and the Management Investors is paying (by cashier's or certified check) the purchase price for its respective Shares in accordance with Section 2.02 hereof and its pro-rata share of the Company Capital Call pursuant to Section 2.04 hereof, (ii) each of Sylvan, Apollo, the Management Investors and the Corporation is executing and delivering the Stockholders' Agreement, and (iii) each of Apollo and the Corporation is executing and delivering the Corporate Registration Rights Agreement. III. FORMATION OF THE INCUBATOR SECTION 3.01. FORMATION. Based upon the representations, warranties, covenants and agreements contained herein and in the other Closing Documents, each of Sylvan, Apollo and the Management Investors hereby agrees to form (and cause the Corporation to form) the Incubator on the terms and conditions set forth herein and in the Operating Agreement. SECTION 3.02. INITIAL CAPITAL CONTRIBUTIONS. (a) Contemporaneously with the execution and delivery of this Agreement: (i) in consideration for 284.34 Common Units of the Incubator, Sylvan is contributing (or, in the case of the Real Estate Assets, will contribute, pursuant to Section 3.02(b) hereof, and, in the case of the Capital Stock of Caliber (as defined below), has previously contributed) to the Incubator (A) cash in the aggregate amount of $6,547,463.00; (B) all of Sylvan's rights, title and interest in and to the Real Estate Assets; and (C) all of Sylvan's rights, title and interest in and to the Capital Stock and any options, warrants or rights to acquire Capital Stock of each of Caliber Learning Network, Inc., a Maryland corporation ("Caliber"), ZapMe! Corporation, a Delaware corporation ("ZapMe"), OnlineLearning.Net, Inc., a Delaware corporation ("Online") and eSylvan, Inc., a Maryland corporation ("eSylvan") (collectively, the "Contributed Entities"), and, in the case of Online, each of the following Bridge Notes payable by Online to Sylvan (collectively, the "Online Notes"): -7- (1) Bridge Note dated April 7, 1999 in the original principal sum of $213,253, as amended by that certain Extension Agreement dated April 30, 1999 by and between Online and Sylvan. (2) Bridge Note dated May 26, 1999 in the original principal sum of $479,819. (3) Bridge Noted dated May 1, 2000 in the original principal sum of $319,880. (ii) Apollo is contributing $2,976,120.00 to the Incubator in consideration for 99.70 Preferred Units; (iii) the Corporation is contributing $29,850.70 to the Incubator in consideration for one (1) Common Unit; and (iv) the Management Investors are contributing an aggregate of $446,567.00 to the Incubator in consideration for an aggregate of 14.96 Common Units, as follows: Hoehn-Saric: $223,283 for 7.48 Common Units Becker: $223,283.50 for 7.48 Common Units
(b) The parties hereto acknowledge and agree that: (i) as soon as practicable after the Incubator Closing, and as part of the initial capitalization of the Incubator, Sylvan shall identify and acquire the Real Estate Assets, and contribute to the Incubator all of Sylvan's rights, title and interest in and to such Real Estate Assets; (ii) as a condition precedent to each of Sylvan's contributions of the Real Estate Assets to the Incubator, Apollo shall receive a tax opinion of Venable, Baetjer and Howard, LLP in substantially the form attached hereto as EXHIBIT L (collectively, the "Post-Closing Tax Opinions"); (iii) the aggregate gross fair market value of the Real Estate Assets, as of the date such Real Estate Assets are contributed to the Incubator, shall not exceed $70,000,000, and such Real Estate Assets shall secure non-recourse liabilities (which shall at all times be non-recourse to the Incubator and each of its "Members," as defined in the Operating Agreement) in an amount not to exceed $65,000,000 relating to such Real Estate Assets; and -8- (iv) the fair market value of the Contributed Entities as of the Closing Date is $65,000,000. (c) The parties intend that the contributions to the Incubator set forth in this Section 3.02 with respect to each of the parties hereto shall be treated as a contribution of property in exchange for an interest in the Incubator within the meaning of Section 721 of the Internal Revenue Code of 1986, as amended (the "Code"), and all such parties shall report such contributions accordingly for purposes of all Federal, state and local taxes. (d) Sylvan shall pay all real property transfer taxes and all other transfer, sales and use taxes directly or indirectly resulting from, or arising out of or in connection with, the contribution by Sylvan of the Real Estate Assets and the Contributed Entities. SECTION 3.03. ORGANIZATION. Sylvan hereby represents and warrants that, prior to the Incubator Closing, the Certificate of Formation was filed for record with the Secretary of State. Effective as of the Incubator Closing, the Board of Managers of the Incubator shall authorize and approve each of the Employment Agreements, the Membership Profit Interest Plan Grant Agreements, and the Incubator Registration Rights Agreement, and shall adopt and approve the Membership Profit Interest Plan. SECTION 3.04. ACQUISITION OF CHANCERY SOFTWARE, LTD. (a) Contemporaneously with the execution and delivery of this Agreement, Sylvan is contributing to the Incubator all of Sylvan's rights, title and interest in and to 2,443,792 Class A Preferred Shares, no par value, and 368,875 Common Shares, no par value, of Chancery Software, Ltd., a British Columbia corporation (collectively, the "Chancery Shares"), which Sylvan previously acquired, on behalf of the Incubator, for an aggregate purchase price of $17,096,769.69, consisting of $16,666,661.44 for the Class A Preferred Shares and $430,108.25 for the Common Shares (the "Chancery Acquisition Price"), all pursuant to that certain Preferred Share Purchase Agreement, dated March 24, 2000, by and among Chancery Software, Ltd., Sylvan and certain other investors. The parties hereto acknowledge and agree that the Incubator shall reimburse Sylvan for the full amount of the Chancery Acquisition Price (the "Chancery Reimbursement Amount"), and in connection therewith, the Incubator shall be deemed to have made an "Additional Capital Call," as defined in the Operating Agreement, in an aggregate amount equal to the Chancery Reimbursement Amount (the "Chancery Additional Capital Call"), pursuant to which each of Sylvan, Apollo, the Management Investors and the Corporation are paying (subject to Section 3.04(b) below) at the Incubator Closing, in accordance with Section 3.1.3 of the Operating Agreement, the following amounts: -9- Sylvan: $ 11,194,218.88 Apollo: $ 5,088,281.30 Corporation: $ 51,035.14 Hoehn-Saric: $ 381,617.19 Becker: $ 381,617.18 TOTAL: $ 17,096,679.69 ================
(b) The parties hereto acknowledge and agree that (i) in lieu of Sylvan paying in cash its $11,194,218.88 share of such Chancery Additional Capital Call, and (ii) in lieu of the Corporation paying $33,515.62 of the Corporation's $51,035.14 share of the Chancery Additional Capital Call (which $33,515.62 represents Sylvan's pro-rata share of the Corporation's share of the Chancery Additional Capital Call pursuant to Section 2.04 hereof), all such amounts (on a dollar-for-dollar basis) shall be applied to, credited against, and treated as a payment of, the Chancery Reimbursement Amount; provided, however, that in no event shall such payment reduce the amount payable by each of Apollo, the Management Investors and, except to the extent set forth in clause (ii) above, the Corporation, pursuant to Section 3.04(a) hereof. (c) The parties intend that the contribution of the Chancery Shares by Sylvan to the Incubator, and the payment of the Chancery Reimbursement Amount by the Incubator to Sylvan, set forth in this Section 3.04, shall be treated as a contribution followed by a reimbursement of a pre-formation expenditure within the meaning of U.S. Treasury Regulation Section 1.707-4(d) promulgated under the Code, and all such parties shall report such contribution and reimbursement accordingly for purposes of all Federal, state and local taxes. (d) The parties hereto agree to cause the Incubator to further reimburse Sylvan for any and all costs, expenses, fees, taxes and other out-of-pocket payments which Sylvan has incurred or may incur in connection with, or as a result of, Sylvan's acquisition and/or holding of the Chancery Shares, and/or the transactions described in this Section 3.04, and all such amounts shall be treated as an addition to, and part of, the Chancery Reimbursement Amount. SECTION 3.05. CLOSING. The Incubator Closing shall occur immediately subsequent to the Corporate Closing. At the Incubator Closing: (a) each of Sylvan, Apollo, the Corporation and the Management Investors are paying, by wire transfer of immediately available funds (or in the case of the Corporation, by cashier's or certified check), their respective cash contributions to the Incubator's capital and their pro-rata share of the Chancery Additional Capital Call in accordance with Sections 2.02 and 2.04 hereof, respectively; -10- (b) Sylvan is contributing (or, in the case of Caliber, has previously contributed) the Contributed Entities and the Online Notes by endorsing and delivering stock certificates, related stock powers, and/or other evidence of transfer with respect to the Capital Stock of the Contributed Entities and the Online Notes , copies of which are attached hereto as EXHIBIT M; (c) Sylvan is contributing the Chancery Shares by endorsing and delivering stock certificates, related stock powers, and/or other evidence of transfer with respect to the Chancery Shares, copies of which are attached hereto as EXHIBIT N; (d) the Incubator is paying Sylvan, by wire transfer of immediately available funds, the Chancery Reimbursement Amount, less the amount of such Chancery Reimbursement Amount deemed to be paid to Sylvan in accordance with Section 3.04(b) hereof; (e) each of Sylvan, Apollo, the Corporation, the Management Investors and the Incubator (as the case may be) are executing each of the Operating Agreement, the Incubator Registration Rights Agreement, the Employment Agreements, and the Membership Profit Interest Plan Grant Agreements; and (f) Venable, Baetjer and Howard, LLP is delivering a tax opinion, a copy of which is attached hereto as EXHIBIT O (the "Closing Tax Opinion"). IV. REPRESENTATIONS AND WARRANTIES OF SYLVAN To induce Apollo to enter into this Agreement and the other Closing Documents to which it is a party, Sylvan hereby represents and warrants to Apollo as follows, as of the date hereof: SECTION 4.01. ORGANIZATION AND CORPORATE POWER. Sylvan is duly organized, validly existing and in good standing under the laws of the State of Maryland, and is duly qualified as a foreign corporation and is in good standing in each jurisdiction in which such qualification is required by law, other than those jurisdictions as to which the failure to be so qualified or in good standing could not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect. Sylvan has the power and authority to (i) own or hold under lease the properties it purports to own or hold under lease, (ii) transact the business it transacts and proposes to transact, (iii) execute and deliver this Agreement and all of the other Closing Documents to which it is a party, and (iv) perform the provisions hereof and thereof. -11- SECTION 4.02. AUTHORIZATION AND VALIDITY. This Agreement and each of the other Closing Documents to which Sylvan is a party has been duly authorized, executed and delivered by Sylvan and is enforceable against Sylvan in accordance with its respective terms, except as the enforceability thereof may be limited by (i) bankruptcy, insolvency, reorganization, fraudulent conveyance, moratorium, or similar laws affecting creditors' rights generally, and (ii) general principles of equity and the discretion of the court before which any proceeding therefor may be brought (regardless of whether such enforcement is considered in a proceeding at law or in equity). SECTION 4.03. CAPITAL STOCK OF THE CONTRIBUTED ENTITIES. (a) Sylvan previously owned 1,227,393 shares of the issued and outstanding Common Stock of Caliber and 5,167,328 shares of the 6% non-voting convertible preferred stock of Caliber, all of which have been contributed by Sylvan to the Incubator, and as of the date hereof are, free and clear of all Liens. (b) Sylvan owns 652,495 shares of the issued and outstanding common stock of ZapMe and warrants to acquire an additional 150,000 shares of common stock of ZapMe, all of which are being contributed by Sylvan to the Incubator hereunder, free and clear of all Liens, except for Item 7 on EXHIBIT P hereof. (c) Sylvan owns 2,000,000 shares of the issued and outstanding Series B Preferred Stock of Online, 600,000 shares of the issued and outstanding Series C Preferred Stock of Online, warrants to acquire an additional 350,000 shares of common stock of Online, and each of the Online Notes, all of which are being contributed by Sylvan to the Incubator hereunder, free and clear of all Liens, except for Items 5, 6 and 8 on EXHIBIT P hereof. (d) Sylvan owns 13,666,666 shares of the issued and outstanding common stock of eSylvan, all of which are being contributed by Sylvan to the Incubator hereunder, free and clear of all Liens. (e) The Shares of Capital Stock mentioned above in Sections 4.03(a), (b), (c), (d) and (e) constitute all the shares of Capital Stock of the Persons mentioned in such Sections that Sylvan owns, directly or indirectly, or has the right to acquire, other than any such rights relating to the Online Notes. SECTION 4.04. CONSENTS. Except as has been delivered or received, no consent, approval or authorization of, or registration or filing with, any Person is required in connection with the execution, delivery or performance by Sylvan of this Agreement and the other Closing Documents to which Sylvan is a party. -12- SECTION 4.05. NO CONFLICTS. The execution, delivery and performance by Sylvan of this Agreement and the other Closing Documents to which Sylvan is a party, and the consummation of the transactions contemplated thereby, do not violate, contravene, result in any breach of, conflict with, constitute a default under, or result in the creation of any Lien in respect of any property of Sylvan under (i) the charter or bylaws of Sylvan, (ii), any bond, debenture, note or any other evidence of indebtedness, or any other agreement, lease, deed of trust, mortgage, indenture or instrument to which Sylvan is a party or by which Sylvan is bound, or (iii) any Federal, state, local or foreign statute, law, regulation, ordinance, rule, judgment, order, decree, permit, concession, grant, franchise, license, agreement or governmental restriction, except in the case of clause (ii), to the extent such violation, breach or default, if any, could not, singly or in the aggregate, reasonably be expected to have a Material Adverse Effect. Notwithstanding the foregoing, after the date of this Agreement, the business conducted by the Incubator may be restricted by certain restrictive covenants set forth in Items 1 and 2 on EXHIBIT P hereof. SECTION 4.06. INVESTMENT/ACCREDITED INVESTOR. Sylvan is acquiring its Shares in the Corporation and its Membership Interests in the Incubator for its own account for investment and not for distribution or resale to others in any transaction which would be in violation of the securities laws of the United States or any other jurisdiction. Sylvan is an "Accredited Investor" as defined in Regulation D under the Securities Act of 1933 (an "Accredited Investor"). V. REPRESENTATIONS AND WARRANTIES OF APOLLO To induce Sylvan to enter into this Agreement and the other Closing Documents to which it is a party, Apollo hereby represents and warrants to Sylvan as follows, as of the date hereof: SECTION 5.01. ORGANIZATION AND POWER. Apollo is duly organized, validly existing and in good standing under the laws of its jurisdiction of organization, and is duly qualified and in good standing in each jurisdiction in which such qualification is required by law, other than those jurisdictions as to which the failure to be so qualified or in good standing could not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect. Apollo has the power and authority to transact the business it transacts and proposes to transact, and to execute and deliver this Agreement and all of the other Closing Documents to which it is a party, and to perform the provisions hereof and thereof. -13- SECTION 5.02. AUTHORIZATION AND VALIDITY. This Agreement and each of the other Closing Documents to which Apollo is a party has been duly authorized, executed and delivered by Apollo and is enforceable against Apollo in accordance with its respective terms, except as the enforceability thereof may be limited by (i) bankruptcy, insolvency, reorganization, fraudulent conveyance, moratorium, or similar laws affecting creditors' rights generally, and (ii) general principles of equity and the discretion of the court before which any proceeding therefor may be brought (regardless of whether such enforcement is considered in a proceeding at law or in equity). SECTION 5.03. CONSENTS. No consent to, approval or authorization of, or registration or filing with, any Person is required in connection with the execution, delivery or performance by Apollo of this Agreement and the other Closing Documents to which Apollo is a party. SECTION 5.04. NO CONFLICTS. The execution, delivery and performance by Apollo of this Agreement and the other Closing Documents to which Apollo is a party, and the consummation of the transactions contemplated thereby, do not violate, contravene, result in any breach of, conflict with, constitute a default under, (i) any charter, bylaws, partnership agreement, operating agreement or similar governing documents of Apollo, (ii) any bond, debenture, note or any other evidence of indebtedness, or any other agreement, lease, deed of trust, mortgage, indenture or instrument to which Apollo is a party or by which it is bound, or (iii) any Federal, state, local or foreign statute, law, regulation, ordinance, rule, judgment, order, decree, permit, concession, grant, franchise, license, agreement or governmental restriction, except in the case of clause (ii), to the extent such violation, breach or default, if any, could not, singly or in the aggregate, reasonably be expected to have a Material Adverse Effect. SECTION 5.05. INVESTMENT; ACCREDITED INVESTOR. Apollo is acquiring its Shares in the Corporation and its Membership Interests in the Incubator for its own account for investment and not for distribution or resale to others in any transaction which would be in violation of the securities laws of the United States or any other jurisdiction. Apollo is an Accredited Investor. SECTION 5.06. PLAN ASSETS. Apollo does not hold any "plan assets," as defined in United States Labor Regulations, 29 CFR Section 2510.3-101 ("Plan Assets"). VI. REPRESENTATIONS AND WARRANTIES OF MANAGEMENT INVESTORS To induce Apollo to enter this Agreement and the other Closing Documents to which it is a party, each of the Management Investors hereby severally represents and warrants to Apollo as follows, as of the date hereof: -14- SECTION 6.01. NO CONFLICTS. The execution, delivery and performance by such Management Investor of this Agreement and the other Closing Documents to which such Management Investor is a party, and the consummation of the transactions contemplated thereby, do not violate, contravene, result in any breach of, conflict with, constitute a default under, (i) any employment agreement, bond, debenture, note or any other evidence of indebtedness, or any other agreement, lease, deed of trust, mortgage, indenture or instrument to which such Management Investor is a party or by which he is bound, or (ii) any Federal, state, local or foreign statute, law, regulation, ordinance, rule, judgment, order, decree, permit, concession, grant, franchise, license, agreement or governmental restriction, except in the case of clause (i), to the extent such violation, breach or default, if any, could not, singly or in the aggregate, reasonably be expected to have a Material Adverse Effect. SECTION 6.02. INVESTMENT/ACCREDITED INVESTOR. Such Management Investor is acquiring its Shares in the Corporation and Membership Interests in the Incubator for its own account for investment and not for distribution or resale to others in any transaction which would be in violation of the securities laws of the United States or any other jurisdiction. Such Management Investor is an Accredited Investor. VII. MISCELLANEOUS SECTION 7.01. ARBITRATION. In the event of any dispute among the parties arising under or relating to this Agreement, the parties shall use their best efforts to resolve such dispute by negotiation, including pursuing available dispute resolution procedures such as mediation. If the parties are unable to resolve such dispute within ten (10) days after a party provides Notification to another party of such party's intent to submit the dispute to arbitration pursuant hereto, such dispute shall be submitted by the parties to arbitration in accordance with the procedures of the American Arbitration Association. Any resulting hearing shall be held in the Baltimore, Maryland area, or at such other location as may be agreed upon by the parties. The resolution of any dispute achieved through such arbitration shall be binding and enforceable by a court of competent jurisdiction. The costs of any arbitration shall be borne equally by the parties. SECTION 7.02. FURTHER ASSURANCES. Each of the parties hereto shall execute all such certificates and other documents and shall do all such filing, recording, publishing and other acts as appropriate to comply with the requirements of law for the formation and operation of the Corporation and the Incubator and to comply with any laws, rules, and regulations relating to the acquisition, operation, or holding of property of the Corporation and the Incubator. -15- SECTION 7.03. NOTIFICATIONS. Any notice, demand, consent, election, offer, approval, request, or other communication (each, a "Notification") required or permitted under this Agreement must be in writing and either delivered personally or sent by certified or registered mail, postage prepaid, return receipt requested. A Notification to any party hereto must be addressed to such party at the last known address on the records of the Incubator. A Notification delivered personally will be deemed given only when acknowledged in writing by the Person to whom it is delivered. A Notification that is sent by certified or registered mail will be deemed given on the date of certification or registry thereof. Any party may designate, by Notification to all of the others, substitute addresses or addressees for notices, and, thereafter, notices are to be directed to those substitute addresses or addressees. SECTION 7.04. ENTIRE AGREEMENT; AMENDMENT; WAIVER. This Agreement, the Operating Agreement, the Corporate Registration Rights Agreement, the Incubator Registration Rights Agreement, and that certain Purchase Agreement dated February 23, 2000, by and among Sylvan, Apollo Investment Fund IV, LP, Guernsey and certain other Persons (other than that certain Term Sheet attached as Exhibit 7.4 to such Purchase Agreement (the "Term Sheet")), as amended (the "Purchase Agreement") constitute the entire agreement between the parties pertaining to the subject matter hereof, and supersede any and all prior agreements, understandings, negotiations, and discussions of the parties, whether oral or written, including without limitation the Term Sheet. No amendment, modification or waiver of this Agreement shall be binding unless executed in writing by all of the parties hereto, or in the case of a waiver, by the party for whom such benefit was intended. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provision of this Agreement, whether or not similar, nor shall such waiver constitute a continuing waiver unless otherwise expressly so provided in writing. SECTION 7.05. APPLICABLE LAW; JURISDICTION. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Delaware without regard to principles of conflict of laws, and the rights, duties, and obligations of the parties shall be as stated in the Delaware General Corporation Law or the Delaware Limited Liability Company Act, as the case may be, except as provided herein. Any suit involving any dispute or matter arising under this Agreement may only be brought in the United States District Court for the State of Delaware or any Delaware court having jurisdiction over the subject matter of the dispute or matter. Each Member consents to the exercise of personal jurisdiction by any such court with respect to any such proceeding. SECTION 7.06. WORD MEANINGS; HEADINGS. In this Agreement, the singular shall include the plural and the masculine gender shall include the feminine and neuter and vice versa unless the context otherwise requires. The headings herein are -16- inserted as a matter of convenience only, and do not define, limit, or describe the scope of this Agreement or the intent of the provisions hereof. SECTION 7.07. BINDING EFFECT. This Agreement shall be binding upon, and shall inure to the benefit of, the parties hereto and their respective successors and permitted assigns. SECTION 7.08 INTERPRETATION. The parties and their respective legal counsel actively participated in the negotiation and drafting of this Agreement, and in the event of any ambiguity or mistake herein, or any dispute among the parties with respect to the provisions hereof, no provision of this Agreement shall be construed unfavorably against any of the parties on the ground that he, it or his or its counsel was the drafter thereof. SECTION 7.09. SEPARABILITY. Each provision of this Agreement shall be considered separable, and if, for any reason, any provision or provisions herein are determined to be invalid and contrary to any existing or future law, such invalidity shall not impair the operation of or affect those portions of this Agreement which are valid. SECTION 7.10. ASSIGNMENT. This Agreement may not be assigned, in whole or in part, by any of the parties hereto without the prior written consent of all of the other parties hereto. The parties agree that any assignment and transfer of (i) any Capital Stock of the Corporation shall be governed by the Stockholders' Agreement, and (ii) any Membership Interests in the Incubator shall be governed by the Operating Agreement. SECTION 7.11. COUNTERPARTS. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same document. -17- IN WITNESS WHEREOF, each of Sylvan, Apollo has caused this Agreement to be executed on its behalf by its respective duly authorized officers or members, and each of the Management Investors has executed this Agreement, or has caused this Agreement to be executed on their behalf by their duly authorized representatives, as of the day and year first above written. WITNESS/ATTEST: SYLVAN LEARNING SYSTEMS, INC. By: - ---------------------------------- ------------------------------------- Name: Title: WITNESS/ATTEST: AP EDUCATE INVESTMENTS, LLC BY: APOLLO MANAGEMENT IV, L.P., ITS MANAGER BY: AIF IV MANAGEMENT, INC., ITS GENERAL PARTNER By: - ----------------------------------- ------------------------------------ Name: Title: WITNESS: MANAGEMENT INVESTORS: -------------------- - ----------------------------------- ------------------------------------ R. Christopher Hoehn-Saric - ----------------------------------- ------------------------------------ Douglas L. Becker -18- FORMATION AGREEMENT LIST OF EXHIBITS Exhibit A Stockholders' Agreement Exhibit B Operating Agreement Exhibit C Corporate Registration Rights Agreement Exhibit D Incubator Registration Rights Agreement Exhibit E Certificate of Formation Exhibit F Certificate of Incorporation Exhibit G Corporate Bylaws Exhibit H Hoehn-Saric Employment Agreement Exhibit I Becker Employment Agreement Exhibit J Hoehn-Saric Membership Profit Interest Grant Agreement Exhibit K Becker Membership Profit Interest Grant Agreement Exhibit L Form of Post-Closing Tax Opinion (USRPHC) Exhibit M Transfer Documents - Contributed Entities and Online Notes Exhibit N Transfer Documents - Chancery Shares Exhibit O Closing Tax Opinion - Allocations Exhibit P Disclosure Schedule
EX-11.03 4 a2043474zex-11_03.txt EX-11.03 Exhibit 11.03 LIMITED LIABILITY COMPANY OF SYLVAN VENTURES, LLC BY AND AMONG SYLVAN LEARNING SYSTEMS, INC., AP EDUCATE INVESTMENTS, LLC, SYLVAN VENTURES, INC., R. CHRISTOPHER HOEHN-SARIC, AND DOUGLAS L. BECKER JUNE 30, 2000 Table of Contents Page ---- Article I Defined Terms 1.1 Defined Terms................................... 1 Article II Organization 2.1 Formation....................................... 17 2.2 Name............................................ 17 2.3 Purpose......................................... 17 2.4 Term............................................ 17 2.5 Registered Office; Principal Place of Business.. 17 2.6 Registered Agent................................ 17 2.7 Members......................................... 17 Article III Capital Contributions; Additional Preferred Units; Membership Profit Interest Plan 3.1 Capital Contributions........................... 18 3.2 Issuance of Additional Units.................... 21 3.3 Membership Profit Interest Plan................. 22 Article IV Allocations and Distributions 4.1 Distributions .................................. 22 4.2 Allocations .................................... 27 4.3 Special Allocations............................. 30 4.4 Other Allocation and Distribution Rules......... 32 Article V Management: Board of Managers, etc. 5.1 Authority of Board; Election of Managers; Removal; Vacancies; Meetings of the Board................ 34 5.2 Meetings of Members............................. 42 5.3 Officers........................................ 43 5.4 Waiver of Notification.......................... 44 5.5 Personal Services............................... 44 5.6 Limitation on Authority of Members.............. 44 5.7 Liability and Indemnification................... 44 Article VI Transfer of Membership Interests 6.1 No Transfer or Voluntary Withdrawal............. 46 6.2 Transfer of Preferred Units..................... 47 6.3 Transfer by Management Members.................. 47 6.4 Transfer of Membership Profit Interests......... 48 6.5 Tag-Along Rights................................ 48 6.6 Registration Rights............................. 49 6.7 Admission of Transferee as Member............... 49 Article VII Miscellaneous Agreements 7.1 Preemptive Rights............................... 50 7.2 Optional Conversion of Preferred Units.......... 52 -i- 7.3 Qualified IPO................................... 57 7.4 Exclusivity..................................... 59 7.5 Real Estate Assets.............................. 60 7.6 Investment Company Act.......................... 61 7.7 Plan Assets..................................... 61 Article VIII Dissolution, Liquidation, and Termination of the Company 8.1 Events of Dissolution........................... 61 8.2 Procedure for Winding Up and Dissolution........ 62 Article IX Books, Records, Accounting 9.1 Books and Records; Accounting Period and Policies...................................... 62 9.2 Bank Accounts................................... 63 9.3 Taxes and Reports............................... 63 Article X General Provisions 10.1 Title to Company Property....................... 64 10.2 Arbitration..................................... 64 10.3 Assurances...................................... 65 10.4 Notifications................................... 65 10.5 Specific Performance............................ 65 10.6 Entire Agreement; Amendment; Waiver............. 65 10.7 Applicable Law; Jurisdiction.................... 66 10.8 Word Meanings; Headings......................... 66 10.9 Binding Effect.................................. 66 10.10 Interpretation.................................. 66 10.11 Separability.................................... 66 10.12 Counterparts.................................... 66 List of Exhibits Exhibit A Members, Initial Capital Contributions, Commitments, Units and Percentages Exhibit B Certificate of Formation and Certificate of Amendment Exhibit C Membership Profit Interest Plan Exhibit D Calculation of Conversion of Membership Profit Interests Upon a Qualified IPO Exhibit E Description of Real Estate Assets Exhibit F Permitted Affiliate Transactions -ii- LIMITED LIABILITY COMPANY AGREEMENT OF SYLVAN VENTURES, LLC THIS LIMITED LIABILITY COMPANY AGREEMENT (this "Agreement") is executed on this 30th day of June, 2000 (the "Effective Date"), by and among SYLVAN LEARNING SYSTEMS, INC., a Maryland corporation ("Sylvan"), AP EDUCATE INVESTMENTS, LLC, a Delaware limited liability company ("Apollo"), SYLVAN VENTURES, INC., a Delaware corporation ("Holding"), R. CHRISTOPHER HOEHN-SARIC ("Hoehn-Saric"), and DOUGLAS L. BECKER ("Becker"), and the other "Members" (as defined below). WHEREAS, the parties hereto have entered into that certain Formation Agreement of even date herewith (the "Formation Agreement") setting forth certain representations, warranties, covenants and agreements in connection with the formation and capitalization of the "Company," as defined herein. WHEREAS, the parties hereto have further agreed to organize and operate the Company in accordance with the terms and conditions set forth in this Agreement. NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements set forth herein, the parties hereto, intending to be legally bound, hereby agree as follows: ARTICLE I Defined Terms 1.1 Defined Terms. The following capitalized terms shall have the meanings specified in this Article I. Other terms are defined in the recitals hereto or in the text of this Agreement, and shall have the meanings respectively ascribed to them. "Act" means the Delaware Limited Liability Company Act (6 Del. C. ss.ss.18-101 et. seq.), as amended from time to time. "Acquiring Persons" has the meaning set forth in Section 7.1.1 hereof. "Additional Capital Call" has the meaning set forth in Section 3.1.3 hereof. "Additional Units" has the meaning set forth in Section 3.2 hereof. "Adjusted Capital Account Balance" means, with respect to each Membership Interest Holder, the balance of the Capital Account of such Membership Interest Holder as of the end of the applicable Fiscal Year of the Company, adjusted for the following: (i) Such Capital Account shall be credited for any amounts which such Membership Interest Holder is obligated or treated as obligated to restore with respect to any deficit balance in its Capital Account pursuant to Regulation Sections 1.704-1(b)(2)(ii)(b)(3) and 1.704-1(b)(2)(ii)(c), respectively. (ii) Such Capital Account shall be credited for any amounts which such Membership Interest Holder is deemed to be obligated to restore with respect to any deficit balance in his or its Capital Account pursuant to the next to last sentences of each of Regulation Section 1.704-2(g)(1) (that is, the Membership Interest Holder's share of Minimum Gain) and Regulation Section 1.704-2(i)(5) (that is, the Membership Interest Holder's share of partner nonrecourse debt minimum gain). (iii) Such Capital Account shall be debited for any adjustment, allocation or distribution described in paragraph (4), (5) or (6) of Regulation Section 1.704-1(b)(2)(ii)(d). "Adjusted Capital Account Deficit" means, with respect to any Membership Interest Holder, the deficit balance, if any, in such Membership Interest Holder's Capital Account as of the end of the relevant taxable year, after giving effect to the following adjustments: (i) The deficit shall be decreased by the amounts, if any, which such Membership Interest Holder is obligated to restore pursuant to Section 3.1.2 hereof, or is deemed obligated to restore pursuant to Regulations Section 1.704-1(b)(2)(ii)(c), 1.704-2(g)(1) and 1.704-2(i)(5); and (ii) The deficit shall be increased by the items described in Regulations Section 1.704-1(b)(2)(ii)(d)(4), (5), and (6). The foregoing definition of Adjusted Capital Account Deficit is intended to comply with Regulations Section 1.704-1(b)(2)(ii)(d) and shall be interpreted consistently therewith. -2- "Affiliate" means either: (i) with respect to any Person other than an individual, any other Person who, directly or indirectly through one or more intermediaries, Controls, or is Controlled by, or is under common Control with, such Person; and (ii) with respect to an individual: (A) any other Person, directly or indirectly through one or more intermediaries, Controlled by such individual; (B) any parent, grandparent, sibling, lineal descendant, or the spouse, of such individual; (C) any trust established for the benefit of such individual or for the benefit of any other individual described in subsection (B) above; or (D) the testamentary estate, executor, executrix, administrator, personal representative, heir, or devisee of such individual. "Affiliate Transaction" has the meaning set forth in Section 5.1.1 hereof. "Agreement" means this Agreement and all Exhibits attached hereto, as originally executed and as amended from time to time, as the context requires. Words such as "herein," "hereinafter," "hereof," "hereto," "hereby" and "hereunder," when used with reference to the Agreement, refer to this Agreement as a whole, unless the context otherwise requires. "Apollo" has the meaning set forth in the preamble hereto. "Apollo Permitted Transferee" means any Affiliate or Related Person of Apollo. "Apollo Person" means Apollo or any member of Apollo. "Becker" has the meaning set forth in the preamble hereto. "Board" means the Board of Managers of the Company elected by the Members in accordance with the provisions of this Agreement. "Business" means the business of the Company of (i) making (directly or through intermediate Persons) Investments in Subject Companies, (ii) promoting the development of Portfolio Companies, including without limitation, management and supervision (depending on the level of investment), (iii) providing -3- strategic guidance and operational support to such Portfolio Companies, (iv) promoting collaboration among such Portfolio Companies, and (v) owning and managing the Real Estate Assets. "Call Due Date" has the meaning set forth in Section 3.1.3 hereof. "Capital Account" means the capital account maintained by the Company for each Membership Interest Holder in accordance with the following provisions: (i) A Membership Interest Holder's Capital Account shall be credited with the Membership Interest Holder's Capital Contributions, the amount of any Company liabilities assumed by the Membership Interest Holder (or which are secured by Company property distributed to the Membership Interest Holder), the Membership Interest Holder's allocable share of Profit, Real Estate Profit, and any share of income or gain specially allocated to such Membership Interest Holder pursuant to the provisions of Section 4.3 (other than Section 4.3.3) hereof; and (ii) A Membership Interest Holder's Capital Account shall be debited with the amount of money and the fair market value of any Company property distributed to the Membership Interest Holder, the amount of any liabilities of the Membership Interest Holder assumed by the Company (or which are secured by property contributed by the Membership Interest Holder to the Company), the Membership Interest Holder's allocable share of Loss, Real Estate Loss, and any share of deductions or losses specially allocated to the Membership Interest Holder pursuant to the provisions of Section 4.3 (other than Section 4.3.3) hereof. If any Membership Interest is transferred pursuant to the terms of this Agreement, the transferee shall succeed to the Capital Account of the transferor to the extent the Capital Account is attributable to the transferred Membership Interest. It is intended that the Capital Accounts of all Membership Interest Holders shall be maintained in compliance with the provisions of Regulations Section 1.704-1(b), and all provisions of this Agreement relating to the maintenance of Capital Accounts shall be interpreted and applied in a manner consistent with such Regulations. "Capital Contribution" means, with respect to any Member at any time, the aggregate amount of cash and the fair market value of other assets (net of liabilities secured by such assets) contributed (or deemed contributed under Regulations Section 1.704-1(b)(2)(iv)(d)) to the Company by such Member at or prior to such time. "Capital Proceeds" means the net amount of cash or other consideration received by the Company from a Capital Transaction other than Real Estate Proceeds, after payment of all expenses associated with the Capital Transaction. -4- "Capital Transaction" means any transaction not in the ordinary course of business which results in the Company's receipt of cash or other consideration (other than Capital Contributions), including, without limitation, proceeds of sales or exchanges or other dispositions of substantially all of the Company's property or substantially all of any Investment, financings, refinancings, condemnations, recoveries of damage awards, and insurance proceeds. "Certificate" has the meaning set forth in Section 2.1 hereof. "Code" means the Internal Revenue Code of 1986, as amended, or any corresponding provision of any succeeding law. "Commitment" means, with respect to each Member, the maximum amount of Capital Contributions which such Member may be obligated to contribute to the Company pursuant to Section 3.1 hereof, less the aggregate amount of such Capital Contributions actually contributed to the Company by such Member. The respective Commitments of each of Sylvan, Apollo, Holding and the Management Members are set forth on Exhibit A attached hereto. "Commitment Ratio" means, with respect to any Member, a fraction, the numerator of which is such Member's Commitment as of the date of such determination, and the denominator of which is the sum of the Commitments of all Members as of the date of such determination. "Common Units" means Units designated as Common Units on Exhibit A hereof. "Company" means the limited liability company formed in accordance with this Agreement and the Act, as said limited liability company may be constituted from time to time. "Company Acceptance Notice" has the meaning set forth in Section 7.4.2 hereof. "Company Subsidiary" means any Person Controlled by the Company or by any other Company Subsidiary. "Consent of the Members" means the vote or written consent of Members owning more than 50% of the Percentages. "Consent of the Preferred" means the vote or written consent of Members owning more than 50% of the outstanding Preferred Units. "Control" means, with respect to any Person, the possession, directly or indirectly, of the power to direct or cause the direction of the management and -5- policies of such Person through the ownership of voting securities, by contract or otherwise. "Conversion Price" has the meaning set forth in Section 7.2.1 hereof. "Convertible Securities" has the meaning set forth in Section 7.2.4 hereof. "Corporate Successor" means the corporate successor of the Company (other than Holding) formed in connection with a Qualified IPO. "Defaulting Member" has the meaning set forth in Section 3.1.3 hereof. "Dilutive Event" has the meaning set forth in Section 7.2.4 hereof. "Effective Date" has the meaning set forth in the preamble hereto. "Escrow Account" means an account maintained with the Escrow Agent, into which the Company shall deposit funds as required pursuant to Section 4.1.6. "Escrow Agent" means a bank or other corporation selected by the Board, that (a) is organized and doing business under the laws of the United States of America or of any state thereof or of the District of Columbia authorized under such laws to exercise corporate trustee power, (b) is subject to supervision or examination by Federal or state or the District of Columbia authority, and (c) has a combined capital and surplus of at least $100,000,000 as set forth in its most recent published annual report of condition. "Exchange Act" has the meaning set forth in the definition of Fair Market Value in this Section 1.1. "Fiscal Year" means each year ended December 31, and the period beginning on January 1 and ending on the date on which the Company is fully and finally liquidated. "Fair Market Value" means, with respect to any security or other asset constituting an Investment held by the Company, the value of such security or other asset determined as set forth below: (a) The value of securities that are not registered under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the value of any other asset that is not a security shall be: -6- (i) the value of such security or asset evidenced by the most recently completed arm's-length transaction between the Company and a Person other than an Affiliate of the Company, the consummation of which shall have occurred within the ninety (90) days immediately preceding the date of determination; (ii) if no such transaction shall have occurred within such ninety (90)-day period, the value of such security or asset most recently determined as of a date within the ninety (90) days immediately preceding the date of determination by an independent financial expert of national standing mutually acceptable to the Board and a majority in interest of the Plan Membership Interest Holders; or (iii) if neither clause (i) nor (ii) is applicable, the value of the security or other asset as determined pursuant to a unanimous vote of the members of the Board taking into account the Valuation Adjustment Factors; provided, however, that if the members of the Board are unable to unanimously agree upon such value within a reasonable time, the Board shall select an independent financial expert of national standing mutually acceptable to the Board and a majority in interest of the Plan Membership Interest Holders who shall determine the value of such security or asset (taking into account the Valuation Adjustment Factors). (b) The value of securities that are registered under the Exchange Act shall be based on the average of the daily market prices for each business day during the period commencing fifteen (15) business days before the date of determination and ending on the date one day prior to such date or, if the security has been registered under the Exchange Act for less than thirty (30) consecutive business days before such date, then the average of the daily market prices for all of the business days before such date for which daily market prices are available. If the market price is not determinable for at least fifteen (15) business days in such period, the value of the security shall be determined as if the security were not registered under the Exchange Act. "Formation Agreement" has the meaning set forth in the preamble hereto. "Fully-Diluted Basis" means and includes (i) the aggregate number of all Common Units outstanding at the time of determination, plus (ii) the aggregate number of all Common Units issuable upon conversion of all Preferred Units outstanding at the time of determination, plus (iii) the aggregate number of all Common Units issuable upon the exercise or conversion of all Options and Convertible Securities. -7- "Gross Asset Value" means, with respect to any asset, the asset's adjusted basis for United States federal income tax purposes, subject to the following exceptions and adjustments: (a) The initial Gross Asset Value of any asset contributed by a Member to the Company will be the gross Fair Market Value of such asset; (b) The Gross Asset Value of all Company assets shall be adjusted to equal their respective gross Fair Market Values immediately preceding the occurrence of any of the following events: (i) a contribution of money or other property (other than a de minimis amount) as consideration for the acquisition of an additional interest in the Company by any new or existing Member if the Board determines that such adjustment is necessary or appropriate to reflect the relative economic interests of the Member in the Company; (ii) the distribution by the Company to a Member of more than a de minimis amount of money or other property as consideration for an interest in the Company if the Board determines that such adjustment is necessary or appropriate to reflect the relative economic interests of the Members in the Company; (iii) the liquidation or dissolution of the Company within the meaning of Regulation Section 1.704-1(b)(2)(ii)(g); and (iv) a grant or forfeiture under the Membership Profit Interest Plan; (c) The Gross Asset Value of any Company asset distributed to any Member will be the gross Fair Market Value of such asset on the date of distribution; (d) The Gross Asset Values of Company assets will be increased (or decreased) to reflect any adjustment to the adjusted basis of such assets pursuant to Code Section 734(b) or Section 743(b), but only to the extent that such adjustments are taken into account in determining Capital Accounts pursuant to Regulations Section 1.704-1(b)(2)(iv)(m); and (e) If the Gross Asset Value of an asset has been determined or adjusted pursuant to subsection (a), (b), or (d) above, such Gross Asset Value will thereafter be adjusted by the book depreciation (calculated in accordance with Regulations Section 1.704-1(b)(2)(iv)(g)) rather than depreciation or amortization or other cost recovery deduction as determined for United States federal income tax purposes, taken into account with respect to such asset for purposes of computing Profit or Loss. "Hoehn-Saric" has the meaning set forth in the preamble hereto. "Holding" has the meaning set forth in the preamble hereto. -8- "Industry Companies" has the meaning set forth in Section 7.4.1 hereof. "Investment Committee" has the meaning set forth in Section 5.1.7 hereof. "Investment Notice" has the meaning set forth in Section 7.4.1 hereof. "Investments" means investments in equity and equity-related securities, notes, debentures, limited partnership interests, limited liability company interests, and other equity or debt instruments, interests or investments of any nature whatsoever, including without limitation, common or preferred stock, assets, and options, warrants and other rights to purchase any such Investments. "Investor Committee Members" has the meaning set forth in Section 5.1.7 hereof. "Investor Managers" has the meaning set forth in Section 5.1.2 hereof. "Involuntary Withdrawal" means, with respect to any Member, the occurrence of any of the events set forth in Section 18-801(b) of the Act. "Management Member(s)" means each of Hoehn-Saric and Becker and any transferees permitted pursuant to Section 6.3 hereof. "Management Employment Documents" has the meaning set forth in Section 3.3 hereof. "Management Transaction" means any contract, agreement, arrangement or transaction between (a) the Company or any Company Subsidiary, on the one hand, and (b) either any director, officer or employee (including without limitation Hoehn-Saric and Becker) of the Company or any Company Subsidiary, or any Affiliate of any such director, officer or employee (other than the Company, any Company Subsidiary, Sylvan and/or any Sylvan Subsidiary), on the other hand. Notwithstanding the foregoing, a Management Transaction shall not include the hiring of any prospective employee by the Company or any Company Subsidiary, and the terms and conditions of such employment provided that such terms and conditions are customary for employees of similar rank and position. "Manager" means each individual who from time to time serves as a member of the Board. Each Manager shall be a "manager" (within the meaning of Section 18-101(10) of the Act) of the Company. -9- "Maximum Number" has the meaning set forth in Section 6.5.2 hereof. "Member(s)" means each of Sylvan, Apollo, Holding, the Management Members, and each Person, if any, who subsequently is admitted as a Member in accordance with this Agreement. "Member Loan Nonrecourse Deductions" means any Company deduction that would be a Nonrecourse Deduction if it was not attributable to a loan made or guaranteed by a Member or a Person related to a Member within the meaning of Regulations Section 1.704-2(i). "Membership Interest" means the ownership interest of a Member in the Company, including without limitation, rights to distributions (liquidating or otherwise), allocations, information, and to consent, approve or vote upon matters which Members are entitled to so consent to, approve, or vote upon hereunder. All Membership Interests shall be represented by Units. "Membership Interest Holder" means any Person who holds a Membership Interest, whether as a Member or as an unadmitted assignee of a Member. "Membership Profit Interest" means the aggregate number of Common Units granted from time to time by the Company as performance incentives to certain officers, employees or consultants of the Company, pursuant to the Membership Profit Interest Plan. "Membership Profit Interest Plan" means the Company's Membership Profit Interest Plan adopted by the Board (and approved by the Members pursuant to Section 3.3 hereof) as of the Effective Date, a copy of which is attached hereto as Exhibit C, as amended from time to time in accordance with the terms thereof. "Minimum Gain" has the meaning set forth in Regulations Section 1.704-2(d). Minimum Gain shall be computed separately for each Member in a manner consistent with the Regulations under Code Section 704(b). "Negative Capital Account" means a Capital Account with a balance less than zero dollars ($0.00). "Net Capital Investment-Common Units" means, with respect to each Membership Interest Holder owning Common Units, the aggregate Capital Contributions by such Membership Interest Holder with respect to its Common Units (excluding the Capital Contribution of the Real Estate Assets by Sylvan), reduced by any distributions to such Membership Interest Holder pursuant to Sections 4.1.2(ii) and (iv) hereof. -10- "Net Capital Investment-Preferred Units" means, with respect to each Membership Interest Holder owning Preferred Units, the aggregate Capital Contributions by such Membership Interest Holder with respect to its Preferred Units, reduced by any distributions to such Membership Interest Holder pursuant to Section 4.1.2(i) hereof. "Net Capital Proceeds" means, with respect to any Capital Proceeds realized by the Company upon disposition of an Investment, the portion of such Capital Proceeds that exceeds the sum of (i) the amount of cash or the Fair Market Value of other securities or property paid by the Company to make such Investment (such Fair Market Value being determined as of the time such Investment was made) and (ii) all expenses associated with such Investment. "Net Cash Flow" means all cash funds derived from the operations of the Company (including interest received on reserves and Investments and dividends and other distributions received in respect of Investments, but excluding management and other fees received from Portfolio Companies and reimbursements of costs and expenses charged by the Company to Portfolio Companies), without reduction for any non-cash charges. Net Cash Flow shall not include Capital Proceeds, Real Estate Proceeds or Capital Contributions. "Nonrecourse Deductions" has the meaning set forth in Regulations Section 1.704-2(b)(1). The amount of Nonrecourse Deductions for a taxable year of the Company equals the net increase, if any, in the amount of Minimum Gain during that taxable year, determined according to the provisions of Regulations Section 1.704-2(c). "Nonrecourse Liability" means any liability defined in Regulation Section 1.704-2(b)(3). "Notice of Acceptance" has the meaning set forth in Section 7.1.2 hereof. "Notification" means a writing containing the information required by this Agreement to be communicated to any Person, as provided in Section 10.4 hereof. "Offer" has the meaning set forth in Section 7.1.1 hereof. "Offered Securities" has the meaning set forth in Section 7.1.1 hereof. "Options" has the meaning set forth in Section 7.2.4 hereof. "Participating Members" has the meaning set forth in Section 6.5.1 hereof. -11- "Percentage" means, with respect to each Membership Interest Holder, a fraction (expressed as a percentage), the numerator of which is the sum of the number of Common Units then held by such Membership Interest Holder and the number of Common Units issuable upon conversion of all Preferred Units then held by such Membership Interest Holder, and the denominator of which is the sum of all Common Units then held by all Membership Interest Holders and the number of Common Units then issuable upon conversion of all Preferred Units then held by all Membership Interest Holders. "Permitted Fund" means an investment fund or investment entity whose general partner (or, in the case of a limited liability company, the general manager) is (i) an Apollo Person, (ii) an Affiliate of an Apollo Person, or (iii) an officer, director, general partner or manager of an Apollo Person or an Affiliate of an Apollo Person. "Person" means any individual, corporation, partnership, joint venture, association, limited liability company, joint-stock company, trust, estate, or other entity, unincorporated organization or government or other agency or political subdivision thereof. "Plan Assets" has the meaning set forth in Section 6.1.2 hereof. "Plan Membership Interest Holder" means any Person granted a Membership Interest under the Membership Profit Interest Plan pursuant to Section 3.3 hereof. "Portfolio Companies" means and includes, at any time, Subject Companies in which the Company has any Investment at such time. "Preferred Units" means Units designated as Preferred Units on Exhibit A hereof. "Pro Forma Return Ratio" means, as of any date of calculation and with respect to any proposed distribution, the ratio of: (a) the sum of (i) all amounts held in the Escrow Account on such date (immediately prior to any deposit on such date) pursuant to the provisions of Section 4.1.6 plus (ii) the Fair Market Value, as of the date of calculation, of all Temporary Investments and all Investments in Portfolio Companies, in each case, that would be held by the Company immediately after making such proposed distribution plus (iii) except to the extent taken into account under clauses (i) and (ii) above, the amount of Net Cash Flow, and the amount of Capital Proceeds from dispositions of Investments in Portfolio Companies, in each case, received by the Company in cash on or prior to such date, less (iv) all Net Cash Flow and Capital -12- Proceeds distributed to Plan Membership Interest Holders pursuant to Article IV including amounts contributed to the Escrow Account, divided by (b) the aggregate amount of Capital Contributions made by all the Members, on or prior to such date (without giving effect to any return of capital), less Capital Contributions attributable to Real Estate Assets. "Profit" and "Loss" means, for each taxable year of the Company (or other period for which Profit or Loss must be computed), and without duplication, the Company's taxable income or loss determined in accordance with Code Section 703(a), with the following adjustments: (i) All items of income, gain, loss, deduction, or credit required to be stated separately pursuant to Code Section 703(a)(1) shall be included in computing taxable income or loss; (ii) Any tax-exempt income of the Company, not otherwise taken into account in computing Profit or Loss, shall be included in computing taxable income or loss; (iii) Any expenditures of the Company described in Code Section 705(a)(2)(B) (or treated as such pursuant to Regulations Section 1.704-1(b)(2)(iv)(i)) and not otherwise taken into account in computing Profit or Loss, shall be subtracted from taxable income or loss; (iv) Gain or loss resulting from any disposition of Company property shall be computed by reference to the Gross Asset Value of the property disposed of, notwithstanding the fact that such Gross Asset Value differs from the adjusted basis of the property for United States federal income tax purposes; (v) If the Gross Asset Value of any Company asset is adjusted pursuant to section (b) or (d) of the definition of Gross Asset Value, the amount of such adjustment will be taken into account as gain or loss from the disposition of such asset for purposes of computing Profit or Loss; (vi) In lieu of the depreciation, amortization, or cost recovery deductions allowable in computing taxable income or loss, there shall be taken into account the depreciation computed based upon the adjusted book value of the asset; and (vii) Notwithstanding any other provision of this definition, any Real Estate Profit, Real Estate Loss and any items which are specially -13- allocated pursuant to Section 4.3 hereof shall not be taken into account in computing Profit or Loss. "Proposed Investment" has the meaning set forth in Section 7.4.1 hereof. "Proposed Transferee" has the meaning set forth in Section 6.5.1 hereof. "Purchase Offer" has the meaning set forth in Section 6.5.1 hereof. "Qualified IPO" means the sale of more than 10% of the common stock of Holding or the Corporate Successor, in accordance with the Qualified IPO Structure, at a pre-money valuation of at least One Billion Dollars ($1,000,000,000) in a bona fide underwritten initial public offering of common stock registered under the Securities Act of 1933, as amended, resulting in a listing of such securities on a national securities exchange or quotation on NASDAQ National Market. "Qualified IPO Structure" has the meaning set forth in Section 7.3.1 hereof. "Real Estate Assets" means all of the right, title and interest in and to those certain direct or indirect fee interests in commercial real property, as more fully described on Exhibit E attached hereto, which Exhibit E shall be updated from time to time upon the contribution by Sylvan of such Real Estate Assets (which contribution must be acceptable to Apollo in its reasonable discretion) pursuant to Section 7.5 hereof and Section 3.02(b) of the Formation Agreement. "Real Estate Investment" means, with respect to Sylvan, the direct or indirect Capital Contribution attributable to the Real Estate Assets, reduced by (i) any funds applied to the Sylvan Commitment pursuant to Section 4.1.3(i) hereof and (ii) any distributions to Sylvan pursuant to Section 4.1.3(ii) hereof. "Real Estate Proceeds" means the net amount of cash received by the Company from a Capital Transaction involving the Real Estates Assets (or any portion thereof) after satisfaction of all liabilities in connection with the Real Estate Assets and payment of all expenses associated with such Capital Transaction. "Real Estate Profit" and "Real Estate Loss" means, for each taxable year of the Company (or other period for which Real Estate Profit and Real Estate Loss must be computed), Profit and Loss (as each term is defined herein, but with respect to clause (vii) of the definition thereof, without regard to the reference to Real Estate Profit and Real Estate Loss) which is attributable solely to the Real Estate Assets, the calculation of which shall include, inter alia, an allocable share of overhead -14- expenses incurred for and on behalf of the Company in connection with the Real Estate Assets. "Registration Agreement" has the meaning set forth in Section 6.6 hereof. "Regulations" means the federal income tax regulations promulgated under the Code, as amended from time to time, and including corresponding provisions of succeeding regulations. "Related Person" means (i) any Apollo Person, (ii) any officer, director, partner or member of, or Person Controlling, an Apollo Person, or (iii) any other Person that is (x) an Affiliate of an Apollo Person, (y) an Affiliate of the general partner(s) (or, in the case of a limited liability company, the general manager(s)) of an Apollo Person, or (z) a Permitted Fund. "Selling Member" has the meaning set forth in Section 6.5.1 hereof. "Secretary of State" means the Secretary of State of the State of Delaware. "Subject Companies" means Persons that, as a significant component of the value of their business, directly or directly (a) provide, deliver or develop goods, services or content on the Internet or any similar computer network, (b) facilitate commercial transactions or educational programming conducted on the Internet or any similar computer network, (c) provide world wide web or similar development services and related software, (d) provide access to the Internet or any similar computer network, (e) provide hardware or software tools for use of the Internet or any similar computer network, (f) employ electronic or computer technology for educational purposes, or (g) are involved in the creation, production or delivery of new media products or content. "Sylvan" has the meaning set forth in the preamble hereto. "Sylvan Board" has the meaning set forth in Section 5.1.2 hereof. "Sylvan Committee Members" has the meaning set forth in Section 5.1.7 hereof. "Sylvan Exclusivity Period" has the meaning set forth in Section 7.4.2 hereof. "Sylvan Managers" has the meaning set forth in Section 5.1.2 hereof. -15- "Sylvan Subsidiaries" means any Person Controlled by Sylvan or by any other Sylvan Subsidiary. "Tag Along Members" has the meaning set forth in Section 6.5.1 hereof. "Tag Along Rights Notice" has the meaning set forth in Section 6.5.1 hereof. "Tax Matters Member" means the Member designated in Section 9.3 hereof as the "tax matters partner" as defined in Section 6231(a)(7) of the Code. "Temporary Investments" means Investments: (i) in direct obligations of the United States of America, or obligations of any instrumentality or agency thereof, payment of principal and interest of which is unconditionally guaranteed by the United States of America, having a final maturity of not more than One (1) year and One (1) day from the date of issue thereof; (ii) in certificates of deposit or repurchase agreements having a final maturity not more than One (1) year and One (1) day from the date of acquisition thereof issued by any bank or trust company organized under the laws of the United States of America or any state thereof having capital and surplus of at least $100,000,000; and (iii) in commercial paper payable on demand or having a final maturity not more than One (1) year and One (1) day from the date of acquisition thereof which has the highest credit rating of either Standard & Poor's Corporation or Moody's Investors Service, Inc. "Transfer" means, when used as a noun, any voluntary sale, conveyance, hypothecation, pledge, assignment, attachment, or other transfer, and, when used as a verb, means, voluntarily to sell, convey, hypothecate, pledge, assign, or otherwise transfer. "Unit" means a share of Membership Interest. Each Unit owned by any Member shall be designated by the Company on Exhibit A hereof as a "Common Unit" or "Preferred Unit," and each such class of Units shall have the respective rights and obligations set forth in this Agreement. "Valuation Adjustment Factors" means, with respect to any securities or other assets, all factors that might reasonably affect the sales price thereof, including without limitation, if and as appropriate, (i) any restrictions on the -16- marketability of such securities or other assets, (ii) the amount of such securities relative to the trading volume of securities of the same class, (iii) the existence or absence of a control premium, if any, associated with such securities, (iv) the lack of a market for such securities, (v) the anticipated effect of immediate sale of such securities or other assets, (vi) the time before sales of such securities or other assets become possible, (vii) the cost and complexity of such sales, and (viii) any other factors that are customarily taken into account in determining the fair market value of securities or other assets. "Voluntary Withdrawal" means a Member's dissociation with the Company by means other than by a Transfer or an Involuntary Withdrawal. ARTICLE II Organization 2.1 Formation. Sylvan, Apollo, Holding and the Management Members hereby organize a limited liability company pursuant to the Act and the provisions of this Agreement and, for that purpose, have authorized Sylvan to cause that certain Certificate of Formation and Certificate of Amendment (collectively, the "Certificate") to be prepared, executed and filed for record with the Secretary of State on or before the Effective Date. A copy of such Certificate is attached hereto as Exhibit B. 2.2 Name. The name of the Company shall be "Sylvan Ventures, LLC". The Company may do business under that name and under any other name or names which the Board shall select. If the Company does business under a name other than that set forth in the Certificate, as amended from time to time, the Company shall file any certificates or documents required by law. 2.3 Purpose. The purposes for which the Company is organized are to (i) conduct the Business and (ii) do any and all things necessary or incidental to the foregoing. 2.4 Term. The term of the Company shall commence as of the date of filing of the Certificate with the Secretary of State, and shall continue perpetually, unless the Company is dissolved and its affairs wound up pursuant to Article VIII hereof. 2.5 Registered Office; Principal Place of Business. The registered office of the Company in the State of Delaware shall be located at 1013 Centre Road in the City of Wilmington, County of New Castle, or at any other place within the State of Delaware which the Board shall select. The principal place of business of the Company shall be at such location as the Board shall select. -17- 2.6 Registered Agent. The name and address of the Company's initial registered agent for service of process in the State of Delaware shall be Corporation Service Company, 1013 Centre Road, Wilmington, Delaware. 2.7 Members. The name, present mailing address, initial Capital Contribution, Commitment, number of Units and Percentage of each Member (as of the Effective Date) are set forth on Exhibit A attached hereto. From time to time, the Board shall cause to be prepared and distributed to all Members a revised Exhibit A reflecting all modifications and additions to Exhibit A, including without limitation, the issuance of Common Units of Membership Profit Interests pursuant to the Membership Profit Interest Plan. ARTICLE III Capital Contributions; Capital Accounts 3.1 Capital Contributions. 3.1.1 The parties hereto acknowledge and agree that, contemporaneously with the execution of this Agreement, each of Sylvan, Apollo, Holding and the Management Members contributed to the Company its respective initial Capital Contribution set forth on Exhibit A attached hereto in accordance with the terms and conditions set forth in the Formation Agreement. 3.1.2 Except as set forth in Section 3.1.3 hereof, no Member shall be required to contribute any additional capital to the Company, and except as set forth in the Act, no Member shall have any personal liability for any obligation of the Company. Except as set forth in Section 4.1.5(b) hereof, no Member shall have any obligation to restore any deficit balance in its Capital Account. Membership Interest Holders shall not be paid interest on their Capital Contributions. Except as otherwise provided in the Act and in this Agreement, no Membership Interest Holder shall have the right to receive the return of any Capital Contribution; provided, however, that if a Membership Interest Holder is entitled to receive a return of a Capital Contribution, the Membership Interest Holder shall not have the right to receive anything but cash in return of such Capital Contribution, and the Company may distribute cash, notes, other property or a combination thereof to the Membership Interest Holder in return of such Capital Contribution; provided further, however, that (i) the Company may only distribute Real Estate Assets to the Membership Interest Holders in the order specified in Section 4.1.3; and (ii) except upon a dissolution of the Company, the Company may not distribute notes or property (other than cash and/or the Real Estate Assets as provided herein). 3.1.3 If, at any time and from time to time prior to a Qualified IPO, the Board determines that it is advisable and in the best interests of the Company to raise additional capital to make an Investment in a Subject Company, the Board shall -18- make one or more calls for additional cash Capital Contributions to the Company (each, an "Additional Capital Call") in an aggregate amount equal to the amount of cash needed for such Investment. In addition, if, at any time and from time to time prior to a Qualified IPO, the Board determines that the amount of cash and Temporary Investments held by the Company is insufficient for the reasonable day-to-day operating expenses relating to the Business (not including amounts that constitute Investments), then the Board shall make one or more Additional Capital Calls for the purpose of obtaining cash to fund such reasonable operating expenses; provided, however, that with respect to Additional Capital Calls described in this sentence, (A) without the prior written consent of Apollo, (i) the aggregate amount of all such Additional Capital Calls made during any one Fiscal Year shall not exceed $10,000,000, and (ii) the Company shall not make any such Additional Capital Call for less than an aggregate of $2,500,000; and (B) the Company shall not make any such Additional Capital Call if, after giving effect thereto, the aggregate amount of the Members' Commitments is not greater than zero. In the event of any Additional Capital Call, each Member shall be obligated to make an additional Capital Contribution equal to the lesser of (a) such Member's Commitment, and (b) the product of (i) the aggregate amount of the Additional Capital Call, multiplied by (ii) such Member's Commitment Ratio. (i) The Board shall make any such Additional Capital Call by providing a Notification to each Member setting forth (A) the purpose for the Additional Capital Call, (B) the aggregate amount of the Additional Capital Call, (C) each Member's respective share of the Additional Capital Call, and (D) the date on which such Additional Capital Call is due (the "Call Due Date"), which Call Due Date shall be no earlier than twenty (20) business days from the date of such Notification. Each Member shall be obligated to pay any such Additional Capital Call on or before the Call Due Date. (ii) If any Member fails to fully pay any Additional Capital Call on or before the Call Due Date (a "Defaulting Member"), such Defaulting Member shall forfeit all of its Membership Interest, a corresponding reduction shall be made to such Defaulting Member's Capital Account, and such Defaulting Member shall no longer be a Member. (iii) If any Membership Interest is forfeited during the Fiscal Year pursuant to this Section 3.1.3, the Company's books shall be closed as of the Call Due Date on which such forfeiture is effective. For the period ending on each such date, Profit, Loss and distributions shall be allocated and distributed pursuant to the provisions of Article IV according to the relative Percentages in effect prior to the date of such adjustment, and Profit, Loss and distributions for the balance of such Fiscal Year shall be allocated and distributed pursuant to the provisions of Article IV according to the relative Percentages as so adjusted. -19- (iv) The parties hereto acknowledge and agree that the provisions of Section 3.1.3(ii) shall be in addition to, and not in lieu of, any and all other remedies that the Company may have in connection with any Additional Capital Call pursuant to this Agreement. (v) For purposes of this Section 3.1.3, at the time of any Additional Capital Call, Sylvan's Commitment shall be determined without reduction for Sylvan's direct or indirect Capital Contribution attributable to the Real Estate Assets; provided, however, that upon the Transfer of the Real Estate Assets (or any interest therein) by the Company pursuant to Section 7.5 hereof, Sylvan shall be deemed to make a Capital Contribution to the extent of the Real Estate Proceeds, if any, received by the Company and retained in accordance with Section 4.1.3(i) hereof. (vi) Notwithstanding anything in the last sentence of the first paragraph of Section 3.1.3 above, in the event one or more Additional Capital Calls are made by the Board hereunder after February 21, 2001: (A) Sylvan agrees to pay (as an additional Capital Contribution) that portion of such Additional Capital Calls otherwise payable by Apollo under this Section 3.1.3 up to an amount (the "Sylvan Advance Commitment") equal to the excess of (x) the "Year 2000 Loss Allocation" as defined in Section 4.2.1(c)(i) hereof, over (y) the aggregate amount of Profit allocated from time to time to Apollo pursuant to Section 4.2.1(c)(ii) hereof (the actual amount paid by Sylvan hereunder is referred to herein as the "Sylvan Advance Contribution"); provided, however, that (i) in no event (except as provided in Section 3.1.3(vii)(C) hereof) shall the Commitment of Apollo be reduced (or be deemed to be reduced) by Sylvan's obligation to pay (and payment of) all or any portion of such Sylvan Advance Commitment and Sylvan Advance Contribution; and (ii) Sylvan's Commitment shall be reduced to the extent of the Sylvan Advance Contribution but such reduction shall not be taken into account in determining Sylvan's relative Commitment Ratio for purposes of calculating the Members' relative funding obligations pursuant to clause "(b)" of the last sentence of the first paragraph of Section 3.1.3 hereof. (B) In the event Sylvan pays all or any portion of the Sylvan Advance Commitment, and the Sylvan Advance Commitment is reduced to zero (whether as a result of such payments or as a result of allocations of Profit to Apollo pursuant to Section 4.2.1(c)(ii) hereof), Apollo agrees to pay (as an additional Capital Contribution) that portion of such Additional Capital Calls otherwise payable by Sylvan under this Section 3.1.3 up to an amount equal to the lesser of (x) the amount of the Sylvan Advance Contribution, and (y) the aggregate amount of Profit allocated to Apollo pursuant to Section 4.2.1(c)(ii) hereof; provided, however, that Apollo's Commitment shall be reduced to the extent Apollo pays any amount pursuant to this Section 3.1.3(vi)(B), and to the same extent, such amount shall be taken into account in determining the relative Commitment Ratios of Apollo and Sylvan (notwithstanding anything in Section 3.1.3(vi)(A)(ii) to the contrary). -20- (vii) In the event the aggregate Capital Contributions (including the Sylvan Advance Contribution) of the Members equal or exceed an amount equal to the excess of Four Hundred Million Dollars ($400,000,000) (such amount to be adjusted upward to reflect the additional Commitments upon issuance of Additional Units in accordance with Section 3.2 hereof) over the Year 2000 Loss Allocation (the "Trigger Level") and, as of the date on which such Trigger Level is reached, Apollo has not been allocated Profit in the full amount of the Year 2000 Loss Allocation pursuant to Section 4.2.1(c)(ii) hereof (such deficiency is referred to herein as the "Allocation Deficiency"), the Company shall deliver a Notification to Apollo stating that the Trigger Level has been reached and Apollo shall have the right (exercisable by delivering a Notification (the "Election Notice") to the Company within fifteen (15) days after the Company gives such Notification to Apollo) to elect to either: (A) make an additional Capital Contribution (within twenty (20) business days after delivering the Election Notice) in an amount equal to the Allocation Deficiency, and receive the gross income allocations described in Section 4.2.1(d) hereof, in which case Section 3.1.3(vi)(B) hereof shall terminate and be of no further force or effect immediately upon Apollo's payment of such additional Capital Contribution; or (B) continue to be bound by the provisions of Section 3.1.3(vi)(B) hereof; or (C) reduce Apollo's Commitment by an amount equal to the Allocation Deficiency, in which case Section 3.1.3(vi)(B) hereof shall terminate and be of no further force or effect immediately upon Apollo's delivery of such Election Notice. In the event Apollo fails to deliver the Election Notice within such fifteen (15) day period, Apollo shall be deemed to have elected option "(B)" above. 3.1.4 The Members hereby acknowledge and agree that, in connection with a Qualified IPO prior to the seventh anniversary of the Effective Date, the Board, if so advised by the managing underwriter of such Qualified IPO, may require all (but not less than all) of the Members to make Capital Contributions in each case in an amount equal to the total amount of any and all distributions of Net Cash Flow or Capital Proceeds that, in accordance with Article IV hereof (collectively, "Distributions"), were received by such Member any time after the Effective Date, but only to the extent that such Distributions exceed the aggregate amount of Profit of the Company allocated to such Member at any time after the Effective Date; provided, however, that (a) the maximum amount of such Capital Contributions required to be made by any Member pursuant to this Section 3.1.4 shall not exceed the sum of such Member's initial Capital Contribution plus such Member's Commitment (determined, for purposes of this Section 3.1.4, by reducing the amount of such Member's previous Capital Contributions by the -21- amount of Distributions previously received by such Member); and (b) that for purposes of this Section 3.1.4, Profit and Loss of the Company shall be determined without regard to the provisions of clause (v) of the definition of "Profit" and "Loss." 3.2 Issuance of Additional Units. The Members hereby acknowledge and agree that Sylvan shall have the right, from time to time, to require the Board to cause the Company to issue Units (including, without limitation, Preferred Units) to one (1) or more purchasers (and to admit such purchasers as Members) on terms no more favorable to the purchasers of such Units than the terms on which Apollo is purchasing its Preferred Units (collectively, the "Additional Units"); provided, however, that (a) any such purchaser of Additional Units shall not have any rights pursuant to this Agreement that are granted herein specifically to Apollo and not generally to all holders of Preferred Units, (b) any and all purchasers of Additional Units shall be reasonably acceptable to Apollo as evidenced by its written consent, which consent shall not be unreasonably withheld, and (c) without the written consent of Apollo (which may be granted or withheld in its absolute discretion), (i) the maximum amount of Capital Contributions payable to the Company for such Additional Units (including, without limitation, any Additional Units acquired by Apollo upon exercise of its preemptive rights in accordance with Section 7.1 hereof) shall be One Hundred Million Dollars ($100,000,000), and (ii) the sale and issuance of Additional Units shall not result in the treatment of the Company as a "publicly-traded partnership" for tax purposes within the meaning of Section 7704 of the Code. 3.3 Membership Profit Interest Plan. The Members hereby (i) consent to and approve the Membership Profit Interest Plan, (ii) acknowledge and agree that grants of Membership Profit Interests available under the Membership Profit Interest Plan shall be made to such grantees (including, without limitation, the Management Members) and in such amounts as the Board (or an authorized committee or other designee thereof) shall determine in accordance with such Membership Profit Interest Plan; provided, however, that each of Hoehn-Saric and Becker shall be granted that number of Common Units of Membership Profit Interests set forth in, and in accordance with, their respective Employment Agreements and Membership Profit Interest Grant Agreements with the Company dated as of the Effective Date (collectively, the "Management Employment Documents"), and (iii) acknowledge and agree that upon the grant of Membership Profit Interests to a grantee under the Membership Profit Interest Plan, and the execution and delivery of a counterpart signature page to this Agreement by such grantee, such grantee shall be admitted as a Member of the Company. -22- ARTICLE IV Allocations and Distributions 4.1 Distributions. 4.1.1 General. After taking into consideration distributions made pursuant to Section 4.1.4 hereof, (i) during the period commencing on the Effective Date and continuing until December 30, 2001, the Board may (but shall not be required to) distribute Net Cash Flow, Capital Proceeds, and Real Estate Proceeds to and among the Membership Interest Holders, at such times as the Board may determine, in accordance with the provisions of this Article IV; provided, however, that any such Capital Proceeds that are not distributed to the Membership Interest Holders, must be used to purchase Investments or Temporary Investments (and may not be used to fund operating expenses of the Company); and (ii) during the period commencing on December 30, 2001 and continuing until the earlier of the consummation of a Qualified IPO or the dissolution and termination of the Company, the Board shall distribute Net Cash Flow to and among the Membership Interest Holders, on a quarterly basis, in accordance with the provisions of this Article IV and the Board shall distribute Capital Proceeds and Real Estate Proceeds to and among the Membership Interest Holders as soon as practicable following receipt thereof by the Company, in accordance with the provisions of this Article IV. 4.1.2 Distribution of Net Cash Flow and Capital Proceeds. Except as otherwise provided in Sections 4.1.1, 4.1.5, 4.1.6 and 4.4.6 hereof, upon any distribution of Net Cash Flow and Capital Proceeds to the Membership Interest Holders, Net Cash Flow and Capital Proceeds shall be distributed in the following order of priority: (i) First, an aggregate amount equal to the aggregate Net Capital Investment-Preferred Units shall be distributed to the Membership Interest Holders owning Preferred Units, pro-rata, in proportion to their respective Net Capital Investment-Preferred Units. (ii) Second, Net Cash Flow and Capital Proceeds shall be distributed (A) fifty percent (50%) to the Plan Membership Interest Holders, pro rata, in proportion to their relative Percentages; and (B) fifty percent (50%) to the Membership Interest Holders owning Common Units, pro-rata, in proportion to their respective Net Capital Investment-Common Units, until either (1) the Plan Membership Interest Holders have received distributions pursuant to this Section 4.1.2(ii) equal to the lesser of (a) twenty percent (20%) of the total amount to be distributed that consists of Net Cash Flow or Capital Proceeds or (b) the aggregate amount of Profit allocated to the Plan Membership Interest Holders pursuant to Section 4.2.l(a)(iv); or (2) the Membership Interest Holders owning Common Units have received distributions -23- pursuant to this Section 4.1.2(ii), in the aggregate, equal to their respective Net Capital Investment-Common Units. (iii) Third, to the extent that the Plan Membership Interest Holders have not received distributions pursuant to Section 4.1.2(ii) equal to the lesser of (A) twenty percent (20%) of the total amount to be distributed that consists of Net Cash Flow or Capital Proceeds or (B) the aggregate amount of Profit allocated to them pursuant to Section 4.2.l(a)(iv), then to the Plan Membership Interest Holders, pro rata, in proportion to their relative Percentages, until they have received distributions of Net Cash Flow and Capital Proceeds pursuant to Sections 4.1.2(ii) and (iii) equal to the lesser of (1) twenty percent (20%) of the total amount to be distributed that consists of Net Cash Flow or Capital Proceeds or (2) the aggregate amount of Profit allocated to them pursuant to Section 4.2.l(a)(iv). (iv) Fourth, to the extent that the Membership Interest Holders owning Common Units have not received distributions pursuant to Section 4.1.2(ii) equal to their respective Net Capital Investment-Common Units, then to the Membership Interest Holders owning Common Units, pro-rata, in proportion to their respective Net Capital Investment-Common Units, until they have received distributions pursuant to Sections 4.1.2(ii) and (iv), in the aggregate, equal to their respective Net Capital Investment-Common Units. (v) Finally, any remaining Net Cash Flow and Capital Proceeds shall be distributed to the Membership Interest Holders (other than the Plan Membership Interest Holders), pro-rata, in proportion to the relative Percentages owned by such Membership Interest Holders. 4.1.3 Distribution of Real Estate Proceeds. Subject to the provisions of Section 4.1.1 hereof and except as otherwise provided in Section 4.1.5 hereof, Real Estate Proceeds shall be distributed or otherwise applied as follows and in the following order of priority: (i) First, an aggregate amount equal to any unfunded Commitment of Sylvan with respect to any Additional Capital Call shall be retained by the Company and applied in full or partial (as the case may be) satisfaction of such Commitment and shall reduce the Capital Contribution required by Sylvan under Section 3.1 hereof. (ii) Second, an aggregate amount equal to the Real Estate Investment shall be distributed (which shall include deemed distributions pursuant to Section 4.1.3(i) hereof) to Sylvan. (iii) Third, any remaining Real Estate Proceeds shall be distributed to the Membership Interest Holders owning Common Units (other than Apollo, its Transferees and other holders of Preferred Units or Common Units issued -24- upon conversion of the Preferred Units), in proportion to the allocations of Real Estate Profit to such Membership Interest Holders pursuant to Section 4.2.2(a)(ii) until such Membership Interest Holders have received Real Estate Proceeds equal to the amount of such allocations. For purposes of this clause "(iii)", allocations of Real Estate Profit to Sylvan pursuant to Section 4.2.2(a)(ii) shall be reduced to the extent Real Estate Proceeds allocated to Sylvan pursuant to Section 4.1.3(i) exceed the Real Estate Investment. (iv) Finally, any remaining Real Estate Proceeds shall be distributed to Sylvan. 4.1.4 Mandatory Tax Distributions. Notwithstanding anything to the contrary contained in this Article IV, no later than ninety (90) days after the end of each Fiscal Year of the Company, the Board shall, subject to the net profit, Net Cash Flow, Net Capital Proceeds and Real Estate Proceeds limitations described in the succeeding sentence hereto, make distributions (i) to the Membership Interest Holders, pro-rata in accordance with their relative Percentages, equal to the sum of (a) forty percent (40%) of all Profit for such Fiscal Year that is treated as long-term capital gain for United States federal income tax purposes, plus (b) forty-two percent (42%) of all Profit for such Fiscal Year that is treated as ordinary income or short-term capital gain for United States federal income tax purposes; and (ii) to the Plan Membership Interest Holders, pro-rata in accordance with their relative Percentages, equal to the sum of (a) twenty-five percent (25%) of all Real Estate Profit allocated to the Plan Membership Interest Holders for such Fiscal Year that is treated as long-term capital gain for United States federal income tax purposes, plus (b) forty-five percent (45%) of all Real Estate Profit allocated to the Plan Membership Interest Holders for such Fiscal Year that is treated as ordinary income or short-term capital gain for United States federal income tax purposes. Mandatory tax distributions described in (i) above shall be made only (A) to the extent Profits exceed Losses previously realized by the Company in the Fiscal Year and all prior Fiscal Years, and (B) to the extent of available Net Cash Flow and Net Capital Proceeds; and mandatory tax distributions described in (ii) above shall be made only (Y) to the extent Real Estate Profits exceed Real Estate Losses previously realized by the Company in the Fiscal Year and all prior Fiscal Years, and (Z) to the extent of Real Estate Proceeds and all other proceeds attributable to the Real Estate Assets. All such distributions pursuant to this Section 4.1.4 shall be treated as an advance with respect to amounts otherwise distributable to the Membership Interest Holders under this 4.1. 4.1.5 Distributions upon Liquidation; Limited Deficit Restoration Obligation. (a) Upon the liquidation of the Company, the assets of the Company (including any net proceeds from the sale of any Company assets) shall be distributed and applied as follows and in the following order of priority: (i) first, to the creditors of the Company for the payment or due provisions for the liabilities of the -25- Company (including loans, if any, to the Company from any Membership Interest Holders), and (ii) second, to the Membership Interest Holders, pro-rata, in accordance with their respective positive Capital Account balances (after the allocation of all items of Profit, Loss, deduction, credit and deduction (or items thereof) under and pursuant to this Article IV). (b) Each Plan Membership Interest Holder shall have an obligation to restore a Negative Capital Account upon the liquidation of his or her interest or upon a liquidation or dissolution of the Company to the extent such Plan Membership Interest Holder has received aggregate distributions in accordance with this Agreement in excess of the sum of (i) such Plan Membership Interest Holder's Capital Contributions, plus (ii) such Plan Membership Interest Holder's net allocation of Profit pursuant to this Article IV. If a Plan Membership Interest Holder is obligated to make a payment to the Company pursuant to this Section 4.1.5(b), such payment must be made by the end of the Company's Fiscal Year (or, if later, within ninety (90) days after the date of the liquidation) and, upon the liquidation or dissolution of the Company, the Company shall distribute such amount in accordance with the provisions of Section 4.1.5(a). 4.1.6 Escrow Account. (a) Notwithstanding the other provisions of this Section 4.1 (other than Section 4.1.4), (i) if, on any date prior to a Qualified IPO, there is to be a distribution (other than a distribution pursuant to Section 4.1.4 hereof) to the Plan Membership Interest Holders, then the Board shall calculate the Pro Forma Return Ratio as if the distribution had occurred and (ii) if the Pro Forma Return Ratio as so computed is less than 1.15, then the Company shall deposit in the Escrow Account all or a portion of the then proposed distribution to the Plan Membership Interest Holders as may be required to the extent necessary so that the Pro Forma Return Ratio, calculated with effect to the holding in the Escrow Account of such distribution or portion thereof, is 1.15. (b) If the Company is required to deposit funds in the Escrow Account pursuant to Section 4.1.6(a) and after giving effect to such deposit the Pro Forma Return Ratio is less than 1.15, then, subject to Section 4.1.6(d) below, the Plan Membership Interest Holders shall immediately deposit in the Escrow Account an amount sufficient so that the Pro Forma Return Ratio, calculated with effect to the holding in the Escrow Account, is 1.15. (c) On the last day of the second and fourth fiscal quarter of each fiscal year of the Company, prior to a Qualified IPO, the Board shall calculate the Pro Forma Return Ratio. If the Pro Forma Return Ratio on such date is less than 1.15, then, subject to Section 4.1.6(d) below, the Plan Membership Interest Holders shall immediately deposit in the Escrow Account an amount sufficient so that the Pro Forma Return Ratio, calculated with effect to the holding in the Escrow Account of such amount, is 1.15. If the Pro Forma Return Ratio on such date is greater than 1.15, then all amounts held in the Escrow -26- Account in excess of the amount required to maintain the Pro Forma Return Ratio at 1.15 shall be paid to the Plan Membership Interest Holders pro-rata, in proportion to the respective Percentages owned by such Plan Membership Interest Holders. (d) If the Plan Membership Interest Holders are required to make any deposit to the Escrow Account pursuant to the provisions of Section 4.1.6(b) or Section 4.1.6(c), then each of the Plan Membership Interest Holders shall be obligated to fund its pro-rata portion of such deposit, in proportion to the respective Percentages owned by each of the Plan Membership Interest Holders. Notwithstanding the foregoing, each of the amounts that each of the Plan Membership Interest Holders shall be obligated to deposit in the Escrow Account shall not exceed the aggregate net amount of cash that such Plan Membership Interest Holder has previously received from the Company pursuant to the provisions of Section 4.1.2 and this Section 4.1.6 (taking into account any amounts deposited by such Plan Membership Interest Holder in the Escrow Account and any payments from the Escrow Account to such Plan Membership Interest Holder). (e) The amounts deposited in the Escrow Account shall be invested in Temporary Investments and the earnings on such account shall remain in such account until distributed in accordance with the provisions hereof. (f) Upon dissolution and liquidation of the Company, subject to the requirements of the Act, any amounts then held in the Escrow Account shall first be used to satisfy the obligations of the Plan Membership Interest Holders pursuant to Section 4.1.5(b), and then shall be distributed to the Plan Membership Interest Holders pro-rata, in proportion to the respective Percentages owned by such Plan Membership Interest Holders. (g) For all purposes of this Agreement (including, without limitation, the determination of the Capital Accounts of the Plan Membership Interest Holders and the determination of allocations pursuant to Section 4.2), any amounts held in the Escrow Account shall be considered to have been distributed to the Plan Membership Interest Holders. (h) Notwithstanding the other provisions of this Section 4.1.6, all amounts held in the Escrow Account shall be distributed to the Plan Membership Interest Holders pro-rata, in proportion to the respective Percentages owned by such Plan Membership Interest Holders, immediately upon the consummation of a Qualified IPO. -27- 4.2 Allocations. 4.2.1 Allocation of Profit and Loss. (a) Subject to the provisions of Sections 4.3 and 4.4.6 hereof and Sections 4.2.1(c) and 4.2.1(d) hereof, Profit for each Fiscal Year (or other period) shall be allocated as follows and in the following order of priority: (i) First, to the Members, to the extent of any allocations of Loss pursuant to Section 4.2.1(b)(iv) (in proportion to the amount of Loss allocated pursuant to Section 4.2.1(b)(iv)), until the aggregate allocations pursuant to this Section 4.2.1(a)(i) equal the aggregate allocations pursuant to Section 4.2.1(b)(iv). (ii) Second, to the Members owning Preferred Units, to the extent of any allocations of Loss pursuant to Section 4.2.1(b)(iii) (in proportion to the amount of Loss allocated pursuant to Section 4.2.1(b)(iii)), until the aggregate allocations pursuant to this Section 4.2.1(a)(ii) equal the aggregate allocations pursuant to Section 4.2.1(b)(iii). (iii) Third, to the Members owning Common Units, to the extent of any allocations of Loss pursuant to Section 4.2.1(b)(ii) (in proportion to the amount of Loss allocated pursuant to Section 4.2.1(b)(ii)), until the aggregate allocations pursuant to this Section 4.2.1(a)(iii) equal the aggregate allocations pursuant to Section 4.2.1(b)(ii). (iv) Thereafter, Profit shall be allocated (A) twenty percent (20%) to the Plan Membership Interest Holders, pro-rata, in proportion to the relative Percentages owned by the Plan Membership Interest Holders, and (B) eighty percent (80%) to the Membership Interest Holders (other than the Plan Membership Interest Holders), pro-rata, in proportion to the relative Percentages owned by such Membership Interest Holders. (b) Subject to the provisions of Section 4.3 hereof and Sections 4.2.1(c) and 4.2.1(d) hereof, Loss for each Fiscal Year (or other period) shall be allocated as follows and in the following order of priority: (i) First, to the Members, to the extent of any allocations of Profit pursuant to Section 4.2.1(a)(iv) (in proportion to the amount of Profit allocated to each such Membership Interest), until the aggregate allocations pursuant to this 4.2.1(b)(i) equals the aggregate allocations pursuant to Section 4.2.1(a)(iv). (ii) Second, Loss shall be allocated to the Members owning Common Units (in proportion to their positive Adjusted Capital Account Balances) until the positive Adjusted Capital -28- Account Balances of each such Membership Interest Holder has been reduced to zero (0). (iii) Third, Loss shall be allocated to the Members owning Preferred Units (in proportion to their positive Adjusted Capital Account Balances) until the positive Adjusted Capital Account Balance of each such Membership Interest Holder has been reduced to zero (0). (iv) Finally, any remaining Loss shall be allocated (A) twenty percent (20%) to the Plan Membership Interest Holders, pro-rata, in proportion to the relative Percentages owned by the Plan Membership Interest Holders, and (B) eighty percent (80%) to the Membership Interest Holders (other than the Plan Membership Interest Holders), pro-rata, in proportion to the relative Percentages owned by such Membership Interest Holders. (c) Notwithstanding any other provision contained in this Section 4.2.1 (other than Section 4.2.1(d)), and subject to Section 4.3, the Members acknowledge and agree as follows: (i) Up to Ten Million Dollars ($10,000,000) of Loss for the Fiscal Year ending December 31, 2000, shall be allocated to Apollo based on its relative Percentage (the actual amount of such Loss allocation is referred to herein as the "Year 2000 Loss Allocation"). Allocations of Loss to Apollo pursuant to this Section 4.2.1(c)(i) shall consist of a pro rata portion of each Company item of expense, deduction and loss that is taken into account in determining Loss for the Fiscal Year. (ii) For the Fiscal Years of the Company following the Fiscal Year ending December 31, 2000, the Members acknowledge and agree that Profit shall first be allocated to Apollo to reverse the allocations of Loss to Apollo made pursuant to Section 4.2.1(c)(i). Allocations of Profit to Apollo pursuant to this Section 4.2.1(c)(ii) shall consist of a pro rata portion of each Company item of income and gain that is taken into account in determining Profit for the Fiscal Year for which the allocation is made. (d) Notwithstanding any other provision contained in this Section 4.2.1, and subject to Section 4.3, the Members further acknowledge and agree that, if Apollo elects pursuant to Section 3.1.3(vii)(A) to (i) make an additional Capital Contribution to the Company in an amount equal to the Allocation Deficiency; and (ii) receive gross income allocations under this Section 4.2.1(d), the Company shall, immediately after Apollo makes the additional Capital Contribution described above, begin making allocations of gross income and gain (other than gross income and gain attributable to the Real Estate Assets) to Apollo until Apollo has received, in the aggregate, gross income and gain allocations pursuant to this Section 4.2.1(d) in an amount equal to (i) the Allocation Deficiency; plus (ii) all items of expense and deduction allocable to Apollo during the period during which Apollo receives gross income -29- allocations pursuant to this Section 4.2.1(d). Allocations of gross income and gain to Apollo pursuant to this Section 4.2.1(d) shall consist of a pro rata portion of each Company item of income and gain (other than income and gain attributable to the Real Estate Assets) for the Fiscal Year for which the allocation is made. 4.2.2 Allocation of Real Estate Profit and Real Estate Loss. (a) Subject to the provisions of Section 4.3 hereof, the distributive shares of each item of Real Estate Profit for any taxable year of the Company (or other period) shall be allocated as follows and in the following order of priority: (i) First, an aggregate amount of Real Estate Profit shall be allocated to the Membership Interest Holders owning Common Units (other than Apollo, its Transferees hereunder and other holders of Preferred Units or Common Units issued upon conversion of the Preferred Units), pro-rata, in proportion to the relative Percentages owned by such Membership Interest Holders, until the cumulative amount of Real Estate Profit allocated to such Membership Interest Holders pursuant to this Section 4.2.2(a)(i) equals the aggregate cumulative amount of Real Estate Loss previously allocated to such Membership Interest Holders pursuant to Section 4.2.2(b)(ii) hereof. (ii) Finally, any remaining Real Estate Profit shall be allocated to the Membership Interest Holders owning Common Units (other than Apollo, its Transferees hereunder and other holders of Preferred Units or Common Units issued upon conversion of the Preferred Units), pro-rata, in proportion to the relative Percentages owned by such Membership Interest Holders. (b) Subject to the provisions of Sections 4.2.2(c) and 4.3 hereof, the distributive shares of each item of Real Estate Loss for any taxable year of the Company (or other period) shall be allocated as follows and in the following order of priority: (i) First, an aggregate amount of Real Estate Loss shall be allocated to the Membership Interest Holders owning Common Units (other than Apollo, its Transferees hereunder and other holders of Preferred Units or Common Units issued upon conversion of the Preferred Units), pro-rata, in proportion to the relative Percentages owned by such Membership Interest Holders, until the cumulative amount of Real Estate Loss allocated to such Membership Interest Holders pursuant to this Section 4.2.2(b)(i) equals the aggregate cumulative amount of Real Estate Profit previously allocated to such Membership Interest Holders pursuant to Section 4.2.2(a)(ii) hereof. (ii) Finally, any remaining Real Estate Loss shall be allocated to the Membership Interest Holders owning Common Units (other -30- than Apollo, its Transferees hereunder and other holders of Preferred Units or Common Units issued upon conversion of the Preferred Units), pro-rata, in proportion to the relative Percentages owned by such Membership Interest Holders. (c) To the extent any Real Estate Loss cannot be allocated to any Membership Interest Holder as a result of Section 4.3.1, such Real Estate Loss shall be reallocated to the Membership Interest Holders owning Common Units (other than Apollo, its Transferees hereunder and other holders of Preferred Units or Common Units issued upon conversion of the Preferred Units) with Adjusted Capital Account Balances that are greater than zero (0). 4.3 Special Allocations. 4.3.1 Qualified Income Offset. No Membership Interest Holder shall be allocated Losses or deductions if the allocation (i) causes a Membership Interest Holder to have an Adjusted Capital Account Deficit or (ii) increases a Membership Interest Holder's Adjusted Capital Account Deficit. If a Membership Interest Holder receives an allocation of Loss or deduction (or item thereof), or any distribution, which (i) causes the Membership Interest Holder to have an Adjusted Capital Account Deficit or (ii) increases a Membership Interest Holder's Adjusted Capital Account Deficit, at the end of any taxable year, then all items of income and gain of the Company (consisting of a pro-rata portion of each item of Company income, including gross income and gain) for that taxable year shall be allocated to that Membership Interest Holder before any other allocation is made of Company items for that taxable year, in the amount and proportion required to eliminate the deficit as quickly as possible. This Section 4.3.1 is intended to comply with, and shall be interpreted consistently with, the "qualified income offset" provisions of the Regulations promulgated under Code Section 704(b). 4.3.2 Minimum Gain Chargeback. Except as set forth in Regulations Section 1.704-2(f), if, during any taxable year, there is a net decrease in Minimum Gain, each Membership Interest Holder, prior to any other allocation pursuant to this Section IV, shall be specially allocated items of gross income and gain for such taxable year (and, if necessary, subsequent taxable years) in an amount equal to that Membership Interest Holder's share of the net decrease of Minimum Gain, computed in accordance with Regulations Section 1.704-2(g). Allocations of gross income and gain pursuant to this Section 4.3.2 shall be made first from gain recognized from the disposition of Company assets subject to Nonrecourse Liabilities to the extent of the Minimum Gain attributable to those assets, and thereafter, from a pro-rata portion of the Company's other items of income and gain for the taxable year. It is the intent of the parties hereto that any allocation pursuant to this Section 4.3.2 shall constitute a "minimum gain chargeback" under Regulations Section 1.704-2(f). 4.3.3 Contributed Property. In accordance with Code Section 704(c) and the Regulations thereunder, as well as Regulations -31- Section 1.704-1(b)(2)(iv)(d)(3), income, gain, loss, and deduction with respect to any property contributed (or deemed contributed) to the Company shall, solely for tax purposes, be allocated among the Membership Interest Holders so as to take account of any variation between the adjusted basis of the property to the Company for United States federal income tax purposes and its fair market value at the date of contribution (or deemed contribution). If the fair market value of any Company asset is adjusted as provided herein, subsequent allocations of income, gain, loss, and deduction with respect to such asset shall take account of any variation between the adjusted basis of such asset for United States federal income tax purposes and its fair market value in the manner required under Code Section 704(c) and the Regulations thereunder. In connection therewith, it is understood and agreed that any tax items under Code Section 704(c) shall be allocated to the Membership Interest Holders in accordance with the "traditional method" of allocation as set forth in Regulation Section 1.704-3(b). 4.3.4 Code Section 754 Adjustment. To the extent an adjustment to the tax basis of any Company asset pursuant to Code Section 734(b) or 743(b) is required, pursuant to Regulations Section 1.704-1(b)(2)(iv)(m), to be taken into account in determining Capital Accounts, the amount of the adjustment to the Capital Accounts shall be treated as an item of gain (if the adjustment increases the basis of the asset) or loss (if the adjustment decreases such basis), and the gain or loss shall be specially allocated to the Membership Interest Holders in a manner consistent with the manner in which their Capital Accounts are required to be adjusted pursuant to those Sections of the Regulations. 4.3.5 Nonrecourse Deductions. Nonrecourse Deductions relating to the Real Estate Assets for a taxable year or other period shall be specially allocated among the Membership Interest Holders owning Common Units (other than Apollo, its Transferees hereunder and other holders of Preferred Units or Common Units issued upon conversion of the Preferred Units) in proportion to their respective Percentages. All other Nonrecourse Deductions for a taxable year or other period shall be specially allocated (A) twenty percent (20%) to the Plan Membership Interest Holders, pro-rata, in proportion to the relative Percentages owned by Plan Membership Interest Holders, and (B) eighty percent (80%) to the Membership Interest Holders (other than the Plan Membership Interest Holders), pro-rata, in proportion to the relative Percentages owned by such Membership Interest Holders. 4.3.6 Member Loan Nonrecourse Deductions. Any Member Loan Nonrecourse Deduction for any taxable year or other period shall be specially allocated to the Member who bears the risk of loss with respect to the loan to which the Member Loan Nonrecourse Deduction is attributable in accordance with Regulations Section 1.704-2(b). 4.3.7 Gross Income Allocations. To the extent that any Membership Interest Holder has an Adjusted Capital Account Deficit at the end of any -32- taxable year, then all items of income and gain of the Company (consisting of a pro-rata portion of each item of Company income, including gross income and gain) for that taxable year shall be allocated to that Membership Interest Holder before any other allocation is made of Company items for that taxable year, in the amount and proportion required to eliminate the deficit as quickly as possible. 4.3.8 Subsequent Allocations. Any special allocations of items of income, gain, loss or deduction pursuant to Sections 4.3.1, 4.3.2, 4.3.4, 4.3.5, 4.3.6 or 4.3.7 hereof (collectively, the "Regulatory Allocations") shall be taken into account in computing subsequent allocations of Profits pursuant to this Article IV, so that the net amount of any items so allocated and the Profits, Losses and all other items allocated to each Membership Interest Holder pursuant to this Article IV shall, to the extent possible, be equal to the net amount that would have been allocated to each such Membership Interest Holder pursuant to the provisions of this Article IV if such special allocations had not been required. This provision shall take into account future Regulatory Allocations that, although not yet made, are likely to offset Regulatory Allocations previously made under this Section 4.3. 4.4 Other Allocation and Distribution Rules. 4.4.1 Authority of Board. The Board is hereby authorized, upon the advice of the Company's tax counsel, to amend this Article IV to comply with the Code and the Regulations promulgated under Code Section 704(b); provided, however, that no such amendment shall materially affect distributions to a Membership Interest Holder without the Membership Interest Holder's prior written consent. 4.4.2 Transfer of Membership Interest. If any Membership Interest is Transferred or forfeited during any accounting period in compliance with the provisions of this Agreement, Profits, Losses, each item thereof and all other items attributable to such Membership Interest for such period shall be divided and allocated between the transferor and the transferee by taking into account their varying Membership Interests during the period in accordance with Code Section 706(d), using any conventions permitted by law and selected by the Board. 4.4.3 Withholding. All amounts required to be withheld pursuant to Section 1446 of the Code or any other provision of United States federal, state, or local tax law shall be treated as amounts actually distributed to the affected Membership Interest Holders pursuant to this Article IV for all purposes under this Agreement or, in the discretion of the Board, to the extent such withholding has not reduced the amounts actually distributed to an affected Membership Interest Holder, as a demand loan to such Member, which demand loan shall bear interest at a rate of 10% per annum for all purposes of this Agreement. 4.4.4 Limitation on Distributions. Notwithstanding anything herein to the contrary, the Company shall not make any distributions to the extent the -33- Board determines that such distributions are prohibited under the Act (including without limitation, Section 18-607 thereof) or other applicable law. 4.4.5 Guaranteed Payment. To the extent any compensation paid to any Member by the Company is determined by the Internal Revenue Service (i) not to be a guaranteed payment under Code Section 707(c), and (ii) not to be paid to the Member other than in the Person's capacity as a Member within the meaning of Code Section 707(a), in each such case the Member shall be specially allocated gross income of the Company in an amount equal to the amount of such compensation, and the Member's Capital Account shall be adjusted to reflect such allocations and the payment of such compensation. 4.4.6 Plan Membership Interest Holder Allocation and Distribution Limitation. The Members hereby acknowledge and agree that the references to twenty percent (20%) in Sections 4.1.2, 4.2.1, 4.3.5 and 7.3.4 (the "Ceiling Percentages") shall apply to the Plan Membership Interest Holders on a particular allocation or distribution date only to the extent that the Plan Membership Interest Holders hold all of the Units issuable under the Membership Profit Interest Plan as of that particular date. To the extent that the Plan Membership Interest Holders do not hold all of the Units issuable under the Membership Profit Interest Plan as of a particular date, the Ceiling Percentages shall be reduced for purposes of applying Sections 4.1.2, 4.2.1, 4.3.5 and 7.3.4 to a percentage determined by multiplying the Ceiling Percentages by a fraction, the numerator of which shall equal the number of outstanding Units granted to the Plan Membership Interest Holders under the Membership Profit Interest Plan on the date in question, and the denominator of which shall equal the maximum amount of Units issuable to the Plan Membership Interest Holders under the Membership Profit Interest Plan as of that date. Further, to the extent that the Ceiling Percentages are reduced for purposes of applying Sections 4.1.2, 4.2.1 and 4.3.5 pursuant to the provisions of this Section 4.4.6, the references to eighty percent (80%) in Sections 4.1.2, 4.2.1 and 4.3.5 (the "Floor Percentages") shall be increased by an amount equal to the amount by which the Ceiling Percentages were reduced. For example, if (i) the Plan Membership Interest Holders collectively hold eighty (80) Units that have been granted under the Membership Profit Interest Plan on December 31, 2000, and (ii) as of December 31, 2000, the Company has the authority to issue a total of one hundred (100) Units to the Plan Membership Interest Holders under the Membership Profit Interest Plan, then (iii) for purposes of applying Sections 4.1.2, 4.2.1, 4.3.5 and 7.3.4 on December 31, 2000, (A) the Ceiling Percentages shall be reduced by four percent (4%) from twenty percent (20%) to sixteen percent (16%) (20% x 80/100 = 16%), and (B) the Floor Percentages shall be increased by four percent (4%) from eighty percent (80%) to eighty-four percent (84%) (80% + 4% = 84%). -34- ARTICLE V Management: Board of Managers, etc. 5.1 Authority of Board; Election of Managers; Removal; Vacancies; Meetings of the Board. 5.1.1 Authority of Board. (i) The Business of the Company shall be managed under the direction and control of the Board, which shall consist of Managers who shall act as fiduciaries of the Company in accordance with, and pursuant to, this Agreement. Decisions of the Board within its scope of authority shall be binding upon the Company and each Member. Managers need not be Members. Subject to the limitations set forth in Sections 5.1.1(ii), (iii), (iv) and (v) hereof, all powers of the Company shall be exercised by or under the authority of the Board, and the Board shall have full, exclusive and complete discretion, power and authority to manage, control, administer and operate the Business, including, without limitation, the power to: (A) make Investments in Subject Companies; provided, however, that all such Investments shall be approved (prior to making such Investment) by the Investment Committee; (B) make Temporary Investments; (C) exercise all rights, powers, privileges and other incidents of ownership with respect to the Company's Investments and Temporary Investments, including without limitation, representation in the management of Portfolio Companies; (D) Transfer any or all of the Company's Investments and Temporary Investments; (E) make Additional Capital Calls, subject to and in accordance with, Section 3.1.3 hereof; (F) employ officers, other management personnel and other personnel, and engage consultants, professionals or other specialists in any field of endeavor, including Persons who are Members, or delegate authority to do so; (G) grant Membership Profit Interests in accordance with the Membership Profit Interest Plan, and grant options or other equity incentives (in the Company or in any Portfolio Company) to Management Members or other officers, employees and consultants of the Company, or delegate authority to do so; -35- (H) determine, settle and pay all expenses, debts and obligations of, and claims against, the Company, and make all accounting and financial determinations and decisions; (I) enter into, make and perform all contracts, agreements and other undertakings (and execute all other certificates, instruments and documents of any kind) which the Board determines to be necessary, advisable or incidental to the conduct of the Business; (J) make any and all expenditures which the Board deems necessary or appropriate in connection with the management of the affairs of the Company and the carrying out of its obligations and responsibilities under this Agreement, including, without limitation, all legal, accounting and other related expenses incurred in connection with the organization, financing and operation of the Company; and (K) engage in any kind of activity necessary or incidental to the accomplishment of the purposes of the Company. (ii) Notwithstanding anything to the contrary in this Agreement, the Company shall not (and the Board shall have no authority to cause the Company to) engage in any Management Transaction without the consent of Apollo; provided, however, that this Section 5.1.1(ii) shall terminate and be of no further force or effect upon the first date on which Apollo and the Permitted Funds cease to own, in the aggregate, at least 50% of the Units which Apollo held as of the Effective Date (subject to adjustment for any change to such Units by reason of conversion, split, recapitalization or other similar transaction). (iii) Notwithstanding anything to the contrary in this Agreement, the Company shall not (and the Board shall have no authority to cause the Company to) issue any Units or Convertible Securities (other than Membership Profit Interests in accordance with the Membership Profit Interest Plan) or engage in any other equity financing, in each case if the aggregate amount of Commitments is not less than Five Hundred Million Dollars ($500,000,000), or make any Additional Capital Calls (except in accordance with Section 3.1.4 hereof) after the Company has received Capital Contributions in the aggregate amount of Five Hundred Million Dollars ($500,000,000), without the consent of Apollo; provided, however, that this Section 5.1.1(iii) shall terminate and be of no further force or effect upon the first date on which neither Apollo nor any Permitted Fund is a Member, or if earlier (1) upon a Qualified IPO with respect to any issuance where the securities issued reflect a valuation of the Company of at least the valuation reflected in the Qualified IPO, or (2) upon the first anniversary of a Qualified IPO with respect to any other issuance. -36- (iv) Notwithstanding anything to the contrary in this Agreement, the Company shall not (and the Board shall have no authority to cause the Company to) engage in any of the following transactions without the consent of Apollo; provided, however, that (x) clauses "(A)" and "(C)" of this Section 5.1.1(iv) shall terminate and be of no further force or effect upon the first date on which neither Apollo nor any Permitted Fund is a Member, or if earlier upon a Qualified IPO, and (y) clause "(B)" of this Section 5.1.1(iv) shall terminate and be of no further force or effect upon the first date on which the number of Investor Managers is reduced to zero (0): (A) issuing any indebtedness or borrowing any amounts whatsoever (other than trade payables owed to suppliers and other trade creditors incurred in the ordinary course of the Company's Business); (B) changing the compensation payable by the Company to Hoehn-Saric or Becker, solely with respect to (i) granting options to Hoehn-Saric or Becker or other equity incentives in the Company or in any Portfolio Company, (ii) increasing the respective interests of Hoehn-Saric and/or Becker in the Membership Profit Interest Plan as set forth in Section 3.3 hereof, and (iii) changing the vesting schedule applicable to any options or other equity incentives; (C) taking any action that would result in (i) the Company incurring any item of "unrelated business taxable income" (within the meaning of Section 512 of the Code) or "debt-financed income" (within the meaning of Section 514 of the Code); (ii) withholding tax obligations with respect to Apollo, or (iii) the treatment of the Company as a "United States Real Property Holding Corporation" (within the meaning of Section 897 of the Code) for Federal income tax purposes (tested as if the Company were a corporation for such purposes); and (D) amending or modifying the Certificate or this Agreement in a manner that adversely affects Apollo or any holder of Preferred Units. (v) Notwithstanding anything to the contrary in this Agreement, the Company shall not (and the Board shall have no authority to cause the Company to) engage in any transaction (other than a Management Transaction approved in accordance with the preceding clause "(ii)", and other than the transactions set forth on Exhibit F hereof) with an Affiliate of the Company (an "Affiliate Transaction") unless: (A) such Affiliate Transaction is fair and reasonable to the Company, and no less favorable to the Company than could have been obtained in an arm's length transaction with a non-Affiliate; and -37- (B) if such Affiliate Transaction involves consideration to either the Company or such Affiliate in excess of One Million Dollars ($1,000,000), such Affiliate Transaction is approved by a majority of the Managers who are disinterested in such Affiliate Transaction; and (C) if such Affiliate Transaction involves consideration to either the Company or such Affiliate in excess of Five Million Dollars ($5,000,000), the Company obtains a written favorable opinion from an independent investment banking or valuation firm of national reputation as to the fairness (from a financial viewpoint) of such Affiliate Transaction to the Company. 5.1.2 Election of Managers. The Managers shall be nominated and elected by the Members as provided herein, and each Manager shall serve as a Manager until the next annual meeting of the Members (or until his earlier resignation or removal) and thereafter until his successor is duly elected and qualified. (i) Each Member agrees to vote or cause to be voted all Units owned by it or over which it has voting control, and shall take all other necessary or desirable actions within its control (whether in its capacity as a Member, Manager, member of a committee of the Board, officer of the Company or otherwise, including without limitation, attendance at meetings in person or by proxy for purposes of obtaining a quorum and execution of written consents in lieu of meeting), and the Board shall cause the Company to take all necessary or desirable actions within its control (including, without limitation, calling special Board or Member meetings), so that: (A) at all times, the authorized number of Managers on the Board shall be established at nine (9) Managers; (B) at all times, seven (7) Managers, and at all times after the effective date of a Qualified IPO, seven (7) directors of the Corporate Successor, designated by Sylvan (collectively, the "Sylvan Managers") shall be elected to the Board (or the board of directors of the Corporate Successor, as the case may be); provided, however, that (i) in no event shall any Person who is not a member of the board of directors of Sylvan (the "Sylvan Board") be designated to serve (or otherwise serve) as a Sylvan Manager; (ii) in no event shall any member of the Sylvan Board designated as such by Apollo or any of its Affiliates be designated to serve (or otherwise serve) as a Sylvan Manager; and (iii) in all events, no more than two (2) of the Sylvan Managers shall be employees of Sylvan, Holding and/or the Company; (C) at all times, subject to Section 5.1.2(ii) hereof, two (2) Managers (or directors of the Corporate Successor following a Qualified IPO) designated by Apollo (collectively, the "Investor Managers") shall be elected to the Board (or the board of directors of the Corporate Successor, as the case may be); provided, however, that in the event (and to the extent) Apollo and/or any of -38- its Affiliates has the right to designate one or more members of the Sylvan Board, such individuals shall be designated as the Investor Managers; and (D) The Members hereby acknowledge and agree that, at any time following a Qualified IPO, the number of members of the board of directors of the Corporate Successor may be increased or decreased from time to time, subject to Sections 5.1.2(i)(B) and 5.1.2(i)(C) hereof. (ii) Notwithstanding anything in Section 5.1.2(i) hereof, if the number of Units (including the Common Units into which the Preferred Units are converted) or, after the effective date of a Qualified IPO, the number of shares of common stock of the Corporate Successor, held by Apollo and Permitted Funds in the aggregate (as adjusted for Unit splits, stock splits and similar transactions, the conversion of Preferred Units into Common Units pursuant to Section 7.2 hereof, and the conversion of Units into shares of stock in connection with the Qualified IPO) is less than the number specified below (as so adjusted), then the number of Investor Managers (or directors, as the case may be) shall be reduced as follows: Number of Units or Shares Investor Managers (or directors) Less than 33.23 (but greater than or equal to 9.97) 1 Less than 9.97 0 Notwithstanding the preceding Section 5.1.2(ii), in the event Apollo Transfers any Units pursuant to clause (i) of Section 6.2 hereof, to a Person that is not an Affiliate of Apollo, the respective "Number of Units or Shares" set forth above shall be reduced proportionately based on Apollo's initial ownership of 99.7 Units as of the Effective Date. (iii) Notwithstanding anything to the contrary in this Section 5.1.2: (A) if, at any time, the number of Units held by Sylvan represents less than 40% of the aggregate number of all outstanding Units determined on a Fully-Diluted Basis (but, for purposes of this Section 5.1.2(iii), without regard to Units issued or issuable pursuant to the Membership Profit Interest Plan), the Managers shall be elected pursuant to cumulative voting by the Members, with each Member having a number of votes equal to the product of the number of Units held by such Member times the total number of Managers to be elected by the Members at a meeting of Members duly called and at which a quorum is present; and (B) in the event the number of Investor Managers is reduced pursuant to Section 5.1.2(ii) hereof, the total number of Managers shall likewise be reduced. -39- 5.1.3 Removal. The Managers may be removed at any time, as follows: (i) Sylvan may remove any or all of the Sylvan Managers from office, with or without cause, and may designate (in the manner set forth in Section 5.1.2 for the election of the Sylvan Managers) a successor or successors to fill any resulting vacancies for the unexpired term and thereafter until a successor or successors are duly elected and qualified; and (ii) Apollo may remove any or all of the Investor Managers from office, with or without cause, and may designate (in the manner set forth in Section 5.1.2 for the election of the Investor Managers) a successor or successors to fill any resulting vacancies for the unexpired term and thereafter until a successor or successors are duly elected and qualified; and (iii) In the event the number of Investor Managers is reduced pursuant to Section 5.1.2(ii) hereof, Apollo shall designate which of the Investor Managers shall be removed. 5.1.4 Vacancies. Vacancies in the Board shall be filled as follows: (i) If the office of a Sylvan Manager becomes vacant for any reason, such vacancy shall be filled by Sylvan (in the manner set forth in Section 5.1.2 for the election of the Sylvan Managers), and any such successor Manager shall serve for the unexpired term and thereafter until a successor is duly elected and qualified; and (ii) If the office of an Investor Manager becomes vacant for any reason (except in accordance with Section 5.1.3(iii)), such vacancy shall be filled by Apollo (in the manner set forth in Section 5.1.2 for the election of the Investor Managers), and any such successor Manager shall serve for the unexpired term and thereafter until a successor is duly elected and qualified. 5.1.5 Meetings. (i) General. (A) The Board may hold meetings, both regular and special, either within or without the State of Delaware. Regular meetings of the Board may be held at such time and at such place as may from time to time be determined by the Board. Special meetings of the Board may be called by the President or by the Chairman of the Board, if there be one, or by any Manager. Notification of meetings, both regular and special, stating the place, date and hour of the meeting shall be given to -40- each Manager by reputable next day courier or facsimile not less than forty-eight (48) hours before the date of the meeting. (B) Any action required or permitted to be taken at any meeting of the Board or of any committee thereof may be taken without a meeting, if all the members of the Board or committee, as the case may be, consent thereto in writing, and the consents are filed with the minutes of proceedings of the Board or committee. (C) Members of the Board, or any committee thereof, may participate in a meeting of the Board or such committee by means of a conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear and speak to each other, and participation in a meeting pursuant to this Section 5.1.5(i)(C) shall constitute presence in person at such meeting. (ii) Quorum; Voting. At all meetings of the Board, a majority of the entire Board shall constitute a quorum for the transaction of business, and the act of a majority of the entire Board shall be the act of the Board. If a quorum shall not be present at any meeting of the Board, the Managers present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. 5.1.6 Committees-In General. The Board may, by resolution passed by a majority of the entire Board, designate one or more committees, each committee to consist of two or more of the Managers; provided however, (i) as long as Sylvan shall be entitled to designate at least one (1) Sylvan Manager (or director, as the case may be), a Sylvan Manager shall serve on each committee of the Board, and (ii) as long as Apollo shall be entitled to designate at least one (1) Investor Manager (or director, as the case may be), an Investor Manager shall serve on each committee of the Board. Any committee, to the extent allowed by law and provided in the resolution establishing such committee, shall have and may exercise all the powers and authority of the Board in the management of the business and affairs of the Company. Each committee shall keep regular minutes and report to the Board when required. 5.1.7 Investment Committee. The Board shall designate an Investment Committee which shall have the exclusive power and authority to approve (by majority vote) all of the Company's proposed Investments in Subject Companies (the "Investment Committee"); provided, however, that upon a Qualified IPO of Holding or the Corporate Successor (as the case may be), all such power and authority of the Investment Committee shall terminate and such authority shall vest directly in the Board of Directors of Holding or the Corporate Successor (as the case may be). -41- (i) The Board shall cause the Company to take all necessary or desirable actions within its control (including, without limitation, calling special Board or Member meetings), so that: (A) the authorized number of Persons serving on the Investment Committee shall be established at six (6); (B) three (3) Persons designated by Sylvan (collectively, the "Sylvan Committee Members") shall be appointed to the Investment Committee, subject to Section 5.1.7(ii) hereof; and (C) three (3) Persons designated by Apollo (collectively, the "Investor Committee Members") shall be appointed to the Investment Committee, subject to Section 5.1.7(ii) hereof; and (ii) Notwithstanding anything in Section 5.1.7(i) hereof, (A) in the event the number of Investor Managers is reduced at any time in accordance with Section 5.1.2(ii) hereof, the number of Investor Committee Members shall likewise be reduced to equal the number of Investor Managers, and (B) in the event the number of Sylvan Managers is reduced at any time in accordance with Section 5.1.2(iii) hereof, the respective number of Sylvan Committee Members shall likewise be reduced to equal the number of Sylvan Managers (but the number of Investor Committee Members shall not be reduced). 5.1.8 Compensation. The Managers may be paid their expenses, if any, for attendance at each meeting of the Board, and the Managers (who are not employees of Sylvan, the Company, Holding, any Company Subsidiary or any other entity Controlled by Holding or Sylvan) may be paid a fixed sum for attendance at each meeting of the Board or a stated salary as Manager. Subject to Apollo's approval rights set forth in Section 5.1.1(iv) hereof, no such payment shall preclude any Manager from serving the Company in any other capacity and receiving compensation therefor. Members (who are not employees of Sylvan, the Company, Holding, any Company Subsidiary or any other entity Controlled by Holding or Sylvan) of special or standing committees may be allowed like compensation for attending committee meetings. 5.1.9 Nominations. The Company shall at all times before and after a Qualified IPO support the nominations to the Board (or the board of directors of the Corporate Successor) of the Persons designated by the Members in accordance with the provisions of Section 5.1.2, and the board of directors of the Corporate Successor, if any (and the Corporate Successor's nominating committee, if any) shall recommend the inclusion of such Persons in the slate of nominees recommended to stockholders for election as directors of the Corporate Successor at each annual meeting of stockholders of the Corporate Successor. -42- 5.2 Meetings of Members. 5.2.1 Place of Meeting. Meetings of the Members for the election of Managers or for any other purpose shall be held at such time and place, either within or without the State of Delaware, as shall be designated from time to time by the Board and stated in the Notification of the meeting or in a duly executed waiver of notice thereof. 5.2.2 Annual Meetings. The annual meeting of Members shall be held on such date and at such time as shall be designated from time to time by the Board and stated in the Notification of the meeting, at which meeting the Members shall elect the Board and transact such other business as may properly be brought before the meeting. Notification of the annual meeting stating the place, date and hour of the meeting shall be given to each Member entitled to vote at such meeting by reputable next day courier or facsimile not less than forty-eight (48) hours before the date of the meeting. 5.2.3 Special Meetings. Special meetings of Members, for any purpose or purposes, may be called by the Chairman of the Board, if there is one, by the Board, or by any Manager. Such request shall state the purpose or purposes of the proposed meeting. Notification of a special meeting stating the place, date and hour of the meeting and the purpose or purposes for which the meeting is called shall be given by reputable next-day courier or facsimile not less than forty-eight (48) hours before the date of the meeting to each Member entitled to vote at such meeting. 5.2.4 Quorum. At all meetings of the Members, the holders of more than 50% of the Percentages held by Members, present in person or represented by proxy, shall constitute a quorum for the transaction of business. If, however, such quorum shall not be present or represented at any meeting of the Members, the Members entitled to vote thereat, present in person or represented by proxy, shall have power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally noticed. If the adjournment is for more than forty-five (45) days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each Member entitled to vote at the meeting. 5.2.5 Voting. Except as otherwise provided in this Agreement, the holders of the Preferred Units and the holders of Common Units shall vote together as a single class on all matters submitted to a vote of the Members. Unless otherwise required by law, the Certificate, or this Agreement, any question brought before any meeting of Members shall be decided by Consent of the Members. Except as otherwise permitted in connection with cumulative voting pursuant to Section 5.1.2(iii) hereof, each Member represented at a meeting of Members shall be entitled to one (1) vote for each -43- Unit held by such Member (determined on a Fully-Diluted Basis) on each motion submitted to a vote at a meeting of the Members; provided, however, that for purposes of any such vote, each Member that holds Preferred Units shall be deemed to hold the number of Common Units into which such Preferred Units are then convertible. Such votes may be cast in person or by proxy, but no proxy shall be voted on or after three (3) years from its date, unless such proxy provides for a longer period. The Board, in its discretion, or the officer of the Company presiding at a meeting of Members, in his discretion, may require that any votes cast at such meeting shall be cast by written ballot. 5.2.6 Consent of Members in Lieu of Meeting. Any action required or permitted to be taken at any annual or special meeting of Members, may be taken without a meeting, without prior Notification and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by Members holding not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all Units entitled to vote thereon were present and voted. Prompt notice of the taking of the action without a meeting by less than unanimous written consent shall be given to those Members who have not consented in writing. 5.3 Officers. 5.3.1 General. The Board, in its discretion, may appoint officers of the Company, which officers may include a President, a Chairman of the Board (who must be a Manager), a Treasurer, a Secretary, and one or more Vice Presidents, Assistant Secretaries, Assistant Treasurers and other officers, each of which shall have the respective power and authority designated by the Board from time to time. Any number of offices may be held by the same Person, unless otherwise prohibited by law. The officers of the Company need not be Members, nor, except in the case of the Chairman of the Board, need such officers be Managers. 5.3.2 Election. The Board, at its first meeting held after each annual meeting of Members, shall elect the officers of the Company who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board, and all officers of the Company shall hold office until their successors are chosen and qualified, or until their earlier resignation or removal. Any officer elected by the Board may be removed at any time by the affirmative vote of a majority of the Board. Any vacancy occurring in any office of the Company shall be filled by the Board. 5.4 Waiver of Notification. Whenever any Notification is required by law or this Article V to be given to any Manager, member of a committee, or Member, a waiver thereof in writing, signed by the Person or Persons entitled to said Notification, whether before or after the time stated therein, shall be deemed equivalent thereto. 5.5 Personal Services. No Member shall be required to perform services for the Company solely by virtue of being a Member. Unless approved by the -44- Board, no Member (or Affiliate thereof) shall be entitled to compensation for any services performed for the Company other than as an employee of the Company. 5.6 Limitation on Authority of Members. 5.6.1.No Member is an agent of the Company solely by virtue of being a Member, and no Member has authority to act for the Company solely by virtue of being a Member. 5.6.2.This Section 5.6 supersedes any authority granted to the Members pursuant to Section 18-402 of the Act. Any Member who takes any action or binds the Company in violation of this section shall be solely responsible for any loss and expense incurred by the Company as a result of the unauthorized action and shall indemnify and hold the Company harmless with respect to such loss or expense. 5.7 Liability and Indemnification. 5.7.1. Right to Indemnification. Subject to the limitations and conditions set forth in this Section 5.7, each Person who was or is made a party (or is threatened to be made a party) to, or is involved in any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative, arbitrative or investigative proceeding (hereinafter a "Proceeding"), or any appeal in such a Proceeding or any inquiry or investigation that could lead to such a Proceeding, by reason of the fact that he or she, or a Person of whom he or she is the legal representative, is or was a Manager or officer of the Company or while a Manager or officer of the Company is or was serving at the request of the Company as a manager, director, officer, partner, venturer, proprietor, trustee, employee, agent, or similar functionary of another Person (each, an "Indemnified Person"), shall be indemnified by the Company, against judgments, penalties (including excise and similar taxes and punitive damages), fines, settlements and reasonable expenses (including, without limitation, attorneys' fees) actually incurred by such Indemnified Person in connection with such Proceeding, and indemnification under this Section 5.7 shall continue as to an Indemnified Person who has ceased to serve in the capacity which initially entitled such Indemnified Person to indemnity hereunder. The rights granted pursuant to this Section 5.7 shall be deemed contract rights, and no amendment, modification, or repeal of this Agreement shall have the effect of limiting or denying any such rights with respect to actions taken or Proceedings arising prior to any such amendment, modification or repeal. The indemnification provided in this Section 5.7 could involve indemnification for negligence or under theories of strict liability but shall not extend to any matter for which the final disposition of the Proceeding determines that the conduct of such Indemnified Person constituted self-dealing or fraud. 5.7.2. Advance Payment. The right to indemnification conferred in this Section 5.7 shall include the right to be paid or reimbursed by the Company the -45- reasonable expenses incurred by an Indemnified Person who was, is or is threatened to be made a named defendant or respondent in a Proceeding in advance of the final disposition of the Proceeding and without any determination as to the Indemnified Person's ultimate entitlement to indemnification; provided, however, that the payment of such expenses incurred by any such Indemnified Person in advance of the final disposition of a Proceeding shall be made only upon delivery to the Company of a written affirmation by such Indemnified Person of his or her good faith belief that he or she has met the standard of conduct necessary for indemnification under this Section 5.7 and a written undertaking, by or on behalf of such Indemnified Person, to repay all amounts so advanced if it shall ultimately be determined that such Indemnified Person is not entitled to be indemnified under this Section 5.7 or otherwise. 5.7.3. Indemnification of Employees and Agents. The Company, by adoption of a resolution of the Board, may (i) indemnify and advance expenses to an employee or agent of the Company to the same extent and subject to the same conditions under which it may indemnify and advance expenses to an Indemnified Person under this Section 5.7; and (ii) indemnify and advance expenses to Persons who are not or were not Managers, officers, employees or agents of the Company but who are or were serving at the request of the Company as a manager, director, officer, partner, venturer, proprietor, trustee, employee, agent or similar functionary of another Person against any liability asserted against him and incurred by him in such a capacity or arising out of his status as such a Person to the same extent which it may indemnify and advance expenses to an Indemnified Person under this Section 5.7. 5.7.4. Appearance as a Witness. Notwithstanding any other provision of this Section 5.7, the Company shall pay or reimburse expenses incurred by a Manager or officer in connection with his appearance as a witness or other participation in a Proceeding at a time when he is not a named defendant or respondent in the Proceeding. 5.7.5. Nonexclusivity of Rights. The right to indemnification and the advancement and payment of expenses conferred in this Section 5.7 shall not be exclusive of any other right which a Manager, officer or other Person indemnified pursuant to Section 5.7.3. may have or hereafter acquire under any law (common or statutory), provision of the Certificate, this Agreement, any other agreement, vote of Members or disinterested Managers or otherwise. 5.7.6. Savings Clause. If this Section 5.7 or any portion hereof shall be invalidated on any ground by any court of competent jurisdiction, then the Company shall nevertheless indemnify and hold harmless each Manager or officer or any other Person indemnified pursuant to this Section 5.7 as to costs, charges and expenses (including reasonable attorneys' fees), judgments, fines and amounts paid in settlement with respect to any action, suit or proceeding, whether civil, criminal, administrative or investigative to the full extent permitted by any applicable portion of this Section 5.7 that shall not have been invalidated and to the fullest extent permitted by applicable law. -46- 5.7.7. Limitation on Liability. No Manager or officer shall be personally liable, as such, for any action taken or omitted from being taken unless: (i) such Manager or officer breached or failed to perform the duties of his office; and (ii) such breach or failure to perform constituted self-dealing or fraud. The foregoing shall not apply to any responsibility or liability under a criminal statute or liability for the payment of taxes under Federal, state, or local law. ARTICLE VI Transfer of Membership Interests 6.1 No Transfer or Voluntary Withdrawal. 6.1.1. General Restriction. Except as set forth in this Article VI, during the period commencing on the Effective Date and ending on the earlier to occur of (i) the third anniversary of the Effective Date, and (ii) the consummation of a Qualified IPO (and, in the case of a Qualified IPO, the termination of the applicable lock-up period required by the managing underwriters of such Qualified IPO, such period not to exceed One Hundred Eighty (180) days), no Member may Transfer to any Person all or any portion of its Membership Interest, directly or indirectly, without both the prior Consent of the Members and the prior Consent of the Preferred. Any Transfer in contravention of this Section 6.1 shall be null and void. The Company shall not be required to recognize any Transfer until the instrument conveying such Membership Interest has been delivered to the Company for recordation on the books of the Company. Unless an assignee becomes a Member in accordance with the provisions of Section 6.7, it shall not be entitled to any of the rights granted to a Member hereunder, other than the right to receive all or part of the share of the Profits, Losses, distributions of cash or property or returns of capital to which his assignor would otherwise be entitled. No Member shall Voluntarily Withdraw or otherwise resign or retire from the Company without the prior Consent of the Members. 6.1.2 .Special Restriction. Notwithstanding any other provision of this Agreement, no Member may Transfer all of any part of its Membership Interests and no attempted or purported Transfer of such Membership Interests shall be effective (i) if, in the opinion of counsel to the Company, such Transfer (A) may not be affected without registration under the Securities Act of 1933, as amended (the "Securities Act"); (B) would result in the violation of any applicable state securities laws; (C) would result in the treatment of the Company as an association taxable as a corporation or as a "publicly-traded partnership" for tax purposes, unless such a Transfer is consented to in writing by all of the Members; (D) would result in the Company becoming subject to the Investment Company Act of 1940, as amended (the "Investment Company Act"); -47- or (E) would cause the Company to be deemed to hold "plan assets," as such term is defined in United States Labor Regulations, 29 CFR Section 2510.3-101 ("Plan Assets"), or result in a nonexempt prohibited transaction pursuant to Section 406 of the Employee Retirement Income Security Act of 1974, as amended, or Code Section 4975; and (ii) unless such Member Transfers a pro-rata portion of such Member's stock of Holdings, if any, contemporaneously with such Transfer of Membership Interests. 6.2 Transfer of Preferred Units. Notwithstanding anything in Section 6.1.1 hereof to the contrary (but subject to Section 6.1.2 hereof), Apollo and the Permitted Funds shall be permitted to Transfer (i) up to 19.94 Preferred Units (subject to adjustments for Unit splits and similar transactions) to Persons (reasonably acceptable to Sylvan) who are not Affiliates of Apollo; and (ii) any number of Units to any Apollo Permitted Transferee (including any non-Affiliates of Apollo in excess of the Units permitted under (i) above), in each case with prior Notification to Sylvan and the Company; provided, however, that (1) in the case of clauses (i) and (ii) hereof, such Transferee is financially able to satisfy any and all Additional Capital Calls with respect to the Commitment related to the Transferred Units (taking into account the financial condition of such Transferee and any guarantor of such Transferee's obligations with respect to such Commitment); and (2) in the case of clause (ii) hereof, any such Transferee who is not either a Permitted Fund or an Affiliate of an Apollo Person shall not have any of the rights granted pursuant to this Agreement specifically to Apollo and not generally to all holders of Preferred Units. 6.3. Transfer by Management Members. Notwithstanding anything in Section 6.1.1 hereof to the contrary (but subject to Section 6.1.2 hereof), each of the Management Members shall be permitted to Transfer any or all Units held by him to one or more of his respective Affiliates (including, without limitation, (i) a limited partnership or limited liability company Controlled by Hoehn-Saric and Becker, and (ii) Sterling Capital, Ltd., an Illinois limited partnership, Sterling Advisors, and Sterling Venture Partners, LP, an Illinois limited partnership); provided, however, that (A) such Transferee is financially able to satisfy any and all Additional Capital Calls with respect to the Commitment related to the Transferred Units (taking into account the financial condition of such Transferee and any guarantor of such Transferee's obligations with respect to such Commitment), and (B) such Transferee shall agree to be subject to the same restrictions on Transfer and other provisions hereof applicable to the Management Members. 6.4. Transfer of Membership Profit Interests. Notwithstanding anything in Section 6.1.1 hereof to the contrary (but subject to Section 6.1.2 hereof), Common Units granted to participants in (and in accordance with) the Membership Profit Interest Plan shall be Transferable only in accordance with the terms and conditions set forth in the applicable Management Employment Documents. -48- 6.5 Tag-Along Rights. 6.5.1. Subject to the provisions of Sections 6.1 and 6.2, if any of any Management Member, Sylvan, Apollo or any Apollo Permitted Transferee (other than a Related Person that is not either a Permitted Fund or an Affiliate of an Apollo Person) (collectively, the "Tag Along Members") negotiates or receives and elects to accept one or more bona fide offers from a third party buyer who is not an Affiliate of such Tag Along Member (the "Proposed Transferee") to purchase or otherwise acquire for value any Units held by such Tag Along Member (excluding with respect to any Management Member, any Membership Interest received pursuant to the Membership Profits Interest Plan) (the "Selling Member") pursuant to a Transfer by such Selling Member, then such Selling Member shall notify in writing the other Tag Along Members (the "Participating Members") and the Company of the terms and conditions of such offer (a "Purchase Offer") and the number and class of Units proposed for Transfer pursuant to the Purchase Offer. Such notice (the "Tag-Along Rights Notice") shall be delivered by the Selling Member, promptly following the date that the Selling Member elects to accept the Purchase Offer, and must include therewith a copy of drafts of all materials, if any, relating to the Purchase Offer. 6.5.2. The Participating Members shall have the right, exercisable upon Notification to the Selling Member within twenty (20) days after the date of receipt of the Tag-Along Rights Notice, to participate in accordance with the terms and conditions set forth below in the Selling Member's Transfer of Units pursuant to the specified terms and conditions of such Purchase Offer. To the extent any of the Participating Members exercise such right of participation, the number of Units that the Selling Member may sell pursuant to such Purchase Offer shall be correspondingly reduced. Each Participating Member may sell all or any part of that number of Units owned by such Participating Member (the "Maximum Number") that is not in excess of the product of (i) the total number of Units proposed for Transfer pursuant to the Purchase Offer multiplied by (ii) a fraction, the numerator of which is the number of Units held by such Participating Member (determined on a Fully-Diluted Basis), and the denominator of which is the total number of Units held by the Selling Member and all the Participating Members that elect to sell Units pursuant to the Purchase Offer (determined on a Fully-Diluted Basis). 6.5.3. The Selling Member and the Participating Members shall sell to the Proposed Transferee all, or, at the option of the Proposed Transferee, any part, of the Units proposed for Transfer pursuant to the Purchase Offer at not less than the price and upon such other terms and conditions, if any, not more favorable to the Proposed Transferee than those set forth in the Tag Along Rights Notice; provided, however, that any purchase of less than all of such Units by the Proposed Transferee shall be made from the Selling Member and the Participating Members pro-rata based upon the relative amount of the Units that each such Member is otherwise entitled to sell pursuant to Section 6.5.2. In the event that the Proposed Transferee refuses to comply with any or part of the provisions set forth in this Section 6.5, the Selling -49- Member shall be prohibited from Transferring any of his or her Units, and any Transfer in violation of this Section 6.5 above shall be considered null and void and without effect. If there is any material adverse change in the terms and conditions of the transaction described in the Tag-Along Rights Notice (including, without limitation, any decrease in the purchase price) after a Participating Member makes the election set forth above, then such Participating Member shall have the right to withdraw from participation in such transaction any or all of its Units prior to the closing. 6.5.4. The exercise or non-exercise of the rights of the Participating Members to participate in one or more Transfers of Units made by a Selling Member shall not adversely affect the rights of the Participating Members to participate in subsequent Transfers by a Selling Member pursuant to this Section 6.5. 6.5.5. This Section 6.5 shall survive the consummation of a Qualified IPO; provided however that the rights set forth in this Section 6.5 shall terminate and be of no further force or effect (i) with respect to Sylvan, on the first date on which Sylvan ceases to own at least 50% of the Units (subject to adjustment for any change to such Units by reason of conversion, split, recapitalization or other similar transaction) which it held as of the Effective Date; and (ii) with respect to Apollo and any Apollo Permitted Transferee who has such rights pursuant to this Section 6.5, on the first date on which Apollo, the Permitted Funds, and/or such Apollo Permitted Transferee cease to own in the aggregate at least 50% of the Units (subject to adjustment for any change to such Units by reason of conversion, split, recapitalization or other similar transaction) which Apollo held as of the Effective Date. 6.5.6. This Section 6.5 shall not apply to Transfers of Units pursuant to Rule 144. 6.6. Registration Rights. The holders of Units shall have the registration rights set forth in that certain Registration Rights Agreement, dated as of the Effective Date, by and between the Company and such holders (the "Registration Agreement"). 6.7 Admission of Transferee as Member. No transferee of any portion of any Membership Interest shall be admitted as a Member unless: 6.7.1 such Membership Interest is transferred in compliance with the applicable provisions of this Agreement; 6.7.2 such transferee shall have executed and delivered to the Company such instruments as the Company or its counsel deems necessary or desirable to effectuate the admission of such transferee as a Member and confirm the agreement of such transferee to be bound by all of the terms and provisions of this Agreement with respect to such Membership Interest. -50- 6.7.3 if requested by a Member or the Company, such transferee shall have delivered to the Company, at the transferee's sole cost and expense, a favorable opinion of legal counsel reasonably acceptable to the Company, to the effect that: (i) such transferee has the legal right, power and capacity to own the Membership Interest proposed to be transferred; and (ii) such Transfer does not violate any provision of Section 6.1.2. hereof. As promptly as practicable after the admission of any Person as a Member, the books and records of the Company shall be changed to reflect such admission. All reasonable costs and expenses incurred by the Company in connection with any Transfer of any Membership Interest (and, if applicable, the admission of any transferee as a Member) shall be paid by the transferee. ARTICLE VII Miscellaneous Agreements 7.1 Preemptive Rights. 7.1.1. If, at any time prior to a Qualified IPO, the Company proposes to issue any Units, Options or Convertible Securities, including, without limitation, Additional Units (collectively, the "Offered Securities"), the Company shall first deliver to Apollo a Notification of such proposed issuance of Offered Securities (the "Offer"), which Offer shall (i) identify and describe the Offered Securities, (ii) describe the price and other terms upon which the Offered Securities are to be issued and the number and amount of the Offered Securities to be issued, all as shall at the time of such Offer, have been fully negotiated, (iii) identify the acquiring Person or Persons (the "Acquiring Persons"), and (iv) include an offer to issue to Apollo a pro-rata portion of the Offered Securities determined by multiplying the number of Offered Securities by a fraction, the numerator of which is the sum of (a) the aggregate number of Common Units then held, in the aggregate, by Apollo and its Permitted Funds on a -51- Fully-Diluted Basis plus (b) the aggregate number of Common Units (on a Fully-Diluted Basis) Transferred by Apollo pursuant to the provisions of Section 6.2(i) hereof, and the denominator of which is the total number of Common Units then outstanding on a Fully-Diluted Basis (the "Pro-Rata Share"). 7.1.2. To accept an Offer, in whole or in part, Apollo must deliver a Notification to the Company prior to the fifteenth (15th) day following receipt of the Offer, setting forth the portion of Apollo's Pro-Rata Share which Apollo elects to purchase (the "Notice of Acceptance"). The Company shall have ninety (90) days from the expiration of such fifteen (15) day period to issue all or any part of such Offered Securities as to which a Notice of Acceptance has not been given by Apollo, but only upon terms and conditions that are not more favorable, in the aggregate, to the Acquiring Persons or less favorable to the Company than those set forth in the Offer. Upon the closing of the issuance of the Offered Securities, Apollo shall acquire from the Company, and the Company shall issue to Apollo, the number of Offered Securities specified in the Notice of Acceptance, upon the terms and conditions specified in the Offer. Any Offered Securities not acquired by Apollo or the Acquiring Persons in accordance with this Section 7.1.2 may not be issued, sold or exchanged until they are again offered to Apollo under the procedures specified in this Section 7.1. 7.1.3. Notwithstanding anything in this Section 7.1 to the contrary, the term "Offered Securities" shall not include: (i) Common Units issued as a distribution to holders of Common Units or upon any split, subdivision, combination or other reclassification of shares of Common Units; (ii) Common Units issued upon conversion of Preferred Units; (iii) Common Units issued pursuant to the Membership Profit Interest Plan; (iv) securities issued in consideration for the acquisition (whether by merger or otherwise) by the Company of all or substantially all of the stock (or other equity interests) or assets of any other Person; (v) Units sold by the Company (or shares of stock sold by the Corporate Successor) in a Qualified IPO; (vi) common stock and Options issued to Plan Membership Interest Holders pursuant to Section 7.3.4; or (vii) Additional Capital Calls. -52- 7.1.4. This Section 7.1. shall terminate and be of no further force or effect upon the purchase by Apollo of Offered Securities that, when added to the amount of Offered Securities previously purchased by Apollo pursuant to the provisions of this Section 7.1, equal or exceed an amount of Offered Securities in respect of which Apollo shall have made (or may be required to make pursuant to the terms hereof or of such securities) Capital Contributions equal to Twenty Five Million Dollars ($25,000,000) or more. 7.2 Optional Conversion of Preferred Units. 7.2.1. In General. At any time and from time to time prior to the consummation of a Qualified IPO, any Member holding Preferred Units may convert all or any of the Preferred Units held by such Member into a number of Common Units (including fractional interests in such Common Units) computed by multiplying the number of Preferred Units proposed to be converted by One Million Dollars ($1,000,000), and dividing the result by the applicable "Conversion Price" (as defined herein) then in effect. The initial conversion rate for Preferred Units surrendered for conversion shall be one (1) Common Unit for each Preferred Unit surrendered for conversion, representing an initial "Conversion Price" of One Million Dollars ($1,000,000) per Common Unit, subject to adjustment as hereinafter provided. The Members acknowledge and agree that the One Million Dollar ($1,000,000) amounts in this Section 7.2.1 represent the quotient of the aggregate Capital Contributions (other than the Real Estate Investment) and Commitments of all Members ($400,000,000), divided by the aggregate number of Units (400) other than Units issuable under the Membership Profit Interest Plan. 7.2.2 Conversion Procedure. (i) Any holder of Preferred Units desiring to convert any portion thereof into Common Units shall provide Notification to the Company of its election to convert the same. Conversion shall be effective upon receipt by the Company of such Notification. In case of any liquidation, dissolution and winding up of the Company, such right shall cease and terminate at the close of business on the business day fixed for payment of the amount distributable to the holders of Preferred Units pursuant to Section 4.1.5. (ii) The Company shall assist and cooperate with any holder of Preferred Units required to make any governmental filings or obtain any governmental approval prior to or in connection with any conversion of Preferred Units hereunder (including, without limitation, making any filings required to be made by the Company). The Company shall take all such actions as may be reasonably necessary to ensure that all such Common Units may be so issued without violation of any applicable law or governmental regulation. -53- 7.2.3 Subdivision or Combination of Common Units. If the Company subdivides (by any Unit split, dividend, distribution, recapitalization or otherwise) the outstanding Common Units into a greater number of Units, the applicable Conversion Price in effect immediately prior to such subdivision shall be proportionately decreased to account for such subdivision, and if the Company combines (by reverse Unit split or otherwise) the outstanding Common Units into a smaller number of Units, the applicable Conversion Price in effect immediately prior to such combination shall be proportionately increased. 7.2.4 Adjustment of Conversion Price Upon Certain Issuances of Units. If the Company shall issue or sell, or is, in accordance with subparagraphs 7.2.4(i) through 7.2.4(vi), deemed to have issued or sold, any Units (including Common Units and all Options and Convertible Securities) for a consideration per Unit less than the applicable Conversion Price for the Preferred Units in effect immediately prior to the time of such issue or sale (a "Dilutive Event"), then, forthwith upon such Dilutive Event, such applicable Conversion Price shall be reduced concurrently with such issue to an amount equal to the quotient of (i) (A) the Conversion Price immediately prior to such Dilutive Event, multiplied by (B) the number of Common Units outstanding immediately prior to such Dilutive Event determined on a Fully-Diluted Basis (including, but not limited to, all Units issued and issuable pursuant to the Membership Profit Interest Plan), plus (C) the aggregate consideration, if any, received or to be received by the Company upon such Dilutive Event, divided by (ii) the sum of the number of Common Units outstanding immediately after such Dilutive Event, determined on a Fully-Diluted Basis (including, but not limited to, all Units issued and issuable pursuant to the Membership Profit Interest Plan). The Conversion Price shall be determined in accordance with the foregoing formula and shall be rounded to the nearest one tenth of one cent ($0.001). Notwithstanding the foregoing, if, as of the effective date of any conversion of Preferred Units under Sections 7.2 or 7.3.2 hereof, the Member converting all or any of its Preferred Units has not made aggregate Capital Contributions equal to the full amount of such Member's Commitment as set forth on Exhibit A hereof, the Conversion Price shall be readjusted to eliminate the effect of any and all prior Dilutive Events with respect to which the aggregate consideration per Unit received by the Company in connection with such Dilutive Effect was equal to or greater than the quotient of the aggregate Capital Contributions of such Member, divided by the aggregate number of Preferred Units held by such Member. For purposes of this Section 7.2.4, the following subparagraphs (i) to (v) shall also be applicable: (i) Issuance of Rights or Options. In case the Company shall in any manner grant (whether directly or by assumption in a merger or otherwise) any warrants or other rights to subscribe for or to purchase, or any options for the purchase of, Common Units or any Units or security convertible into or -54- exchangeable for Common Units (such warrants, rights or options being called "Options" and such convertible or exchangeable Units or securities being called "Convertible Securities"), whether or not such Options or the right to convert or exchange any such Convertible Securities are immediately exercisable, and the price per Unit for which Common Units are issuable upon the exercise of such Options or upon the conversion or exchange of such Convertible Securities (determined by dividing (a) the total amount, if any, received or receivable by the Company as consideration for the granting of such Options, plus the minimum aggregate amount of additional consideration payable to the Company upon the exercise of all such Options, plus, in the case of such Options which relate to Convertible Securities, the minimum aggregate amount of additional consideration, if any, payable upon the issue or sale of such Convertible Securities and upon the conversion or exchange thereof, by (b) the total maximum number of Common Units issuable upon the exercise of all such Options or upon the conversion or exchange of all such Convertible Securities issuable upon the exercise of such Options) shall be less than the applicable Conversion Price for the Preferred Units immediately prior to the time of the granting of such Options or Convertible Securities, then the total maximum number of Common Units issuable upon the exercise of such Options or upon conversion or exchange of the total maximum amount of such Convertible Securities issuable upon the exercise of such Options shall be deemed to have been issued for such price per Unit as of the date of granting of such Options or the issuance of such Convertible Securities and thereafter shall be deemed to be outstanding. Except as otherwise provided in subparagraph (iii), no adjustment of any Conversion Price shall be made upon the actual issue of such Common Units or of such Convertible Securities upon exercise of such Options or upon the actual issue of such Common Units upon conversion or exchange of such Convertible Securities. (ii) Issuance of Convertible Securities. In case the Company shall in any manner issue (whether directly or by assumption in a merger or otherwise) or sell any Convertible Securities, whether or not the rights to exchange or convert any such Convertible Securities are immediately exercisable, and the price per Unit for which Common Units are issuable upon such conversion or exchange (determined by dividing (a) the total amount received or receivable by the Company as consideration for the issue or sale of such Convertible Securities, plus the minimum aggregate amount of additional consideration, if any, payable to the Company upon the conversion or exchange thereof, by (b) the total maximum number of Common Units issuable upon the conversion or exchange of all such Convertible Securities) shall be less than the applicable Conversion Price for the Preferred Units immediately prior to the time of such issue or sale, then the total maximum number of Common Units issuable upon conversion or exchange of all such Convertible Securities shall be deemed to be outstanding, provided that (a) except as otherwise provided in subparagraph (iii), no adjustment of any Conversion Price shall be made upon the actual issue of such Common Units upon conversion or exchange of such Convertible Securities, and (b) if any such issue or sale of such Convertible Securities is made upon exercise of any Options to purchase any such Convertible Securities for which -55- adjustments of any Conversion Price have been or are to be made pursuant to other provisions of this Section 7.2.4., no further adjustment of such Conversion Price shall be made by reason of such issue or sale. (iii) Change in Option Price or Conversion Rate. Upon the happening of any of the following events, namely, if the purchase price provided for in any Option referred to in subparagraph (i), the additional consideration, if any, payable upon the conversion or exchange of any Convertible Securities referred to in subparagraph (i) or (ii), or the rate at which Convertible Securities referred to in subparagraph (i) or (ii) are convertible into or exchangeable for Common Units shall change at any time (including, but not limited to, changes under or by reason of provisions designed to protect against dilution), the applicable Conversion Price for the Preferred Units at the time of such event shall forthwith be readjusted to the Conversion Price which would have been in effect at such time had such Options or Convertible Securities still outstanding included such changed purchased price, additional consideration or conversion rate, as the case may be, at the time initially granted, issued or sold, but in no event will the applicable Conversion Price be readjusted to an amount greater than the applicable Conversion Price which would have been in effect had the Options or Convertible Securities subject to the above described consideration changes never been granted, issued or sold. In addition, on the expiration or exchange of any Option or Convertible Securities prior to the conversion of the Preferred Units, the applicable Conversion Price then in effect hereunder shall forthwith be adjusted to the applicable Conversion Price which would have been in effect had such Options or Convertible Securities never been issued; provided, that any consideration which was actually received by the Company in connection with the issuance or sale of such Options or Convertible Securities shall be included in the readjustment computation even though such Options or Convertible Securities shall have expired or terminated; provided, further, that no such readjustment to the Conversion Price shall affect any Common Units previously issued upon conversion of Preferred Units. (iv) Distribution of Units. In case the Company shall make any distribution upon any Common Units of the Company payable in Common Units, Options or Convertible Securities, any Common Units, Options or Convertible Securities, as the case may be, issued in payment of such distribution shall be deemed to have been issued or sold at a consideration equal to $.01 per Unit. (v) Consideration. In case any Common Units, Options or Convertible Securities shall be issued or sold for cash, the consideration received therefor shall be deemed to be the amount received by the Company therefor, net of accrued interest, but without deduction therefrom of any expenses incurred or any underwriting commissions or concessions paid or allowed by the Company in connection therewith. In case any Common Units, Options or Convertible Securities shall be issued or sold for a consideration other than cash, the amount of the consideration other than cash received by the Company shall be deemed -56- to be the fair value of such consideration as determined in good faith by the Board, without deduction of any amounts paid or receivable for accrued interest and any expenses incurred or any underwriting commissions or concessions paid or allowed by the Company in connection therewith. In case any Options shall be issued in connection with the issue and sale of other securities of the Company, together comprising one integral transaction in which no specific consideration is allocated to such Options by the parties thereto, the consideration shall be allocated between the Options and such other securities as determined in good faith by the Board. (vi) Adjustment. In case any event shall occur as to which the provisions of this Section 7.2.4 are not strictly applicable but the failure to make any adjustment would not fairly protect the conversion rights of the holders of the Preferred Units in accordance with the essential intent and principles of such provisions, then, in each such case, the Company shall make a good faith adjustment to the Conversion Price in accordance with the intent of this Section 7.2.4 and, upon the written request of the holders of a majority of the Preferred Units, shall appoint a firm of independent certified public accountants of recognized national standing (which may be the regular auditors of the Company), which shall give their opinion upon the adjustment, if any, on a basis consistent with the essential intent and principles established in this Section 7.2.4, necessary to preserve, without dilution, the conversion rights associated with the Preferred Units. Upon receipt of such opinion, the Company shall promptly mail a copy thereof to the holders of each Preferred Unit and shall make the adjustments described therein. 7.2.5.Notification. Immediately upon any adjustment of the applicable Conversion Price, the Company shall give Notification thereof to all Members holding Preferred Units, setting forth in reasonable detail, and certifying, the calculation of such adjustment. 7.2.6.Certain Issues of Common Units Excepted. The Company shall not be required to make any adjustment of the applicable Conversion Price in the case of the issuance of: (i) Units issued or issuable upon conversion of Preferred Units; (ii) Units issued or issuable as a distribution on Preferred Units; (iii) Units issued or issuable pursuant to the Membership Profit Interest Pool; (iv) Units, the issuance of which is approved by the Investor Managers; -57- (v) common stock and options issued to Plan Membership Interest Holders pursuant to Section 7.3.4; or (vi) Units issued or issuable by reason of a dividend, split, or other distribution on Units excluded from adjustment of the applicable Conversion Price pursuant to the preceding clauses (i), (ii), (iii), (iv) and (v). 7.3 Qualified IPO. 7.3.1.Authority. If the Board determines that it is advisable and in the best interests of the Company to consummate a Qualified IPO, Sylvan and Apollo shall negotiate in good faith to determine (A) whether such Qualified IPO is to be effected by Holding, the Company or otherwise, taking into account all reasonable tax, financial, accounting, marketing and other considerations (the "Qualified IPO Structure"), (B) any and all events of dissolution of the Company and Holding, and (C) in the event of a Qualified IPO of Holding, (i) the applicable conversion ratio for Units converted or convertible into shares of common stock of Holding, (ii) the timing of any such conversion, and (iii) whether any such conversion is mandatory or elective; provided, that, upon determination of the Qualified IPO Structure, the Board shall have the power and authority to take any and all actions necessary or desirable to consummate such Qualified IPO including without limitation, incorporating the business of the Company to form the Corporate Successor or merge the Company with and into Holding (depending on the nature of the Qualified IPO Structure), and each Member hereby agrees to cooperate with the Company in connection with such Qualified IPO (including, without limitation, such incorporation or merger) and to execute and deliver any and all certificates, instruments and documents necessary or desirable to effectuate such Qualified IPO, it being acknowledged and agreed by the Members that, whether the Qualified IPO is effected by Holding, the Company or otherwise, the Members shall take any and all actions necessary or desirable to cause all rights and obligations of the Members under this Agreement which by their terms survive a Qualified IPO, to so survive. 7.3.2.Mandatory Conversion of Preferred Units. Immediately prior to the consummation of a Qualified IPO of Holding (or, in the event of a Qualified IPO of the Corporate Successor, immediately prior to the conversion of the Company into such Corporate Successor), each Preferred Unit shall automatically be converted into Common Units at the then effective applicable Conversion Price. 7.3.3.Optional Conversion of Common Units. From and after the date immediately prior to the consummation of a Qualified IPO of Holding, any Member holding Common Units may convert all or any of such Units into shares of common stock of Holding at the conversion ratio determined in accordance with Section 7.3.1 hereof. -58- 7.3.4.Conversion of Membership Profit Interests. Upon the consummation of a Qualified IPO and approval by the Board, the Membership Profit Interests shall be converted into common stock of the Corporate Successor (or Holding, as the case may be) based upon the pre-money valuation (calculated based on the actual Qualified IPO price per share but without regard to receipt of proceeds from the Qualified IPO) of the Corporate Successor (or Holding, as the case may be) in accordance with the positive Capital Account balances of the Plan Membership Interest Holders; provided, however, that such common stock (and the options to be issued pursuant to the next sentence hereof) shall be subject (i) to the same vesting and forfeiture provisions applicable to the Membership Profit Interests prior to such conversion; and (ii) at the request of the Sylvan Board, to reasonable restrictions on transfer. In addition, the Corporate Successor (or Holding, as the case may be) will grant to the Plan Membership Interest Holders, as compensation for services, ten (10) year options to purchase a number of shares of common stock in the Corporate Successor (or Holdings, as the case may be) so that the sum of (i) the common stock issued pursuant to the preceding sentence and (ii) the common stock issuable upon the exercise of the options granted pursuant to this sentence equals, in the aggregate, twenty percent (20%) (subject to Section 4.6.4 hereof) of the outstanding shares of the Corporate Successor (or Holding, as the case may be) on a fully diluted basis immediately prior to the Qualified IPO. The options issued pursuant to this Section 7.3.4 shall be issued at an exercise price per share equal to the price per share issued in the Qualified IPO. Calculations made pursuant to this Section 7.3.4 shall be made in accordance with the methodology employed in the following examples: Example 1: If (i) an aggregate of $200 million in Capital Contributions are made to the Company (with the remaining Commitments being cancelled in accordance with Section 7.3.6 hereof), (ii) the number of issued and outstanding shares of stock of the Corporate Successor determined on a Fully-Diluted Basis (but without regard to the conversion of the Membership Profit Interests) is 100,000,000, and (iii) the pre-money valuation of the Company at the time of the Qualified IPO (calculated based on the actual Qualified IPO price per share but without regard to receipt of proceeds from the Qualified IPO) is One Billion Dollars ($1,000,000,000), then, in such case, the Membership Profit Interests shall be converted, in the aggregate, into 19,047,619 shares of common stock with a pre-money valuation of $160 million (i.e., 20% of the excess of $1 billion over $200 million). In addition, as compensation for services, options to purchase 5,952,381 shares of common stock at an exercise price per share equal to the Qualified IPO price shall be granted to the Plan Membership Interest Holders. Such calculation is set forth on Exhibit D hereto. Example 2: Assuming the same facts as in Example 1 above, except in accordance with Section 3.1.4 hereof as a result of advice of the managing underwriter with respect to the Qualified IPO, that $100,000,000 of the remaining Commitments be paid as Capital Contributions in connection with the Qualified IPO, then, in such case, the Membership Profit Interests shall be converted, in the -59- aggregate, into 16,279,070 shares of common stock with a pre-money valuation of $140 million (i.e., 20% of the excess of $1 billion over $300 million). In addition, as compensation for services, options to purchase 8,720,930 shares of common stock at an exercise price per share equal to the Qualified IPO price shall be granted to the Plan Membership Interest Holders. Such calculation is set forth on Exhibit D hereto. 7.3.5.Special Right to Cause a Qualified IPO. If neither the Company nor Holding has consummated a Qualified IPO on or before the third anniversary of the Effective Date, Apollo shall have the right to provide Notification to the Company and Sylvan, and pursuant thereto require Sylvan and the Company to pursue a Qualified IPO with an underwriter selected by Apollo and reasonably acceptable to Sylvan (such acceptance not to be withheld unreasonably); provided, however, that the determination of the Qualified IPO Structure shall be made as set forth in Section 7.3.1 hereof. 7.3.6.Cancellation of All Commitments. Upon the consummation of a Qualified IPO, all remaining Commitments automatically shall be cancelled; provided, however, that nothing herein shall be deemed to terminate or otherwise limit the Members' respective obligations under Sections 3.1.3 and 3.1.4 hereof incurred prior to such Qualified IPO; provided, further, that notwithstanding anything in Sections 3.1.3 or 7.3.6 hereof to the contrary, immediately prior to a Qualified IPO, Apollo shall have the right (exercisable by delivering a Notification to the Company) to elect to either: (A) make an additional Capital Contribution (immediately prior to the Qualified IPO) in an amount equal to the excess, if any, of (i) the amount of the Sylvan Advance Contribution over (ii) the aggregate amounts previously paid by Apollo pursuant to Section 3.1.3(vi)(B) hereof, and receive allocations of Profit from the Fiscal Year including or ending on the date of the Qualified IPO equal to the amount of the additional Capital Contribution it makes pursuant to this Section 7.3.6; or (B) cancel Apollo's remaining Commitment in accordance with this Section 7.3.6. In the event Apollo fails to deliver such Notification on or before the date that is thirty (30) days prior to the consummation of a Qualified IPO, Apollo shall be deemed to have elected option "(B)" above. 7.4 Exclusivity. 7.4.1.Sylvan hereby acknowledges and agrees that, as long as Sylvan owns 40% or more of the outstanding Units (determined on a Fully-Diluted Basis), (i) Sylvan shall not finance any incubator (other than the Company), the primary purpose of which is to provide funding to Industry Companies (as defined herein), and (ii) Sylvan shall (and shall cause the Sylvan Subsidiaries to) provide a Notification to the Company (the "Investment Notice") prior to Sylvan or such Sylvan Subsidiaries making any Investment in any Person that, as the primary component of such Person's business, provides, delivers or develops goods, services or content relating to education or testing through the use of the Internet or similar network or by electronic or computer technology (collectively, "Industry Companies"). Such -60- Investment Notice shall set forth the material terms and conditions of such Investment (a "Proposed Investment") to the extent then known by Sylvan. 7.4.2.The Company shall have thirty (30) days from the date of the Investment Notice to provide Notification to Sylvan of the Company's decision to make the Proposed Investment (the "Company Acceptance Notice"). In the event the Company fails to provide the Company Acceptance Notice to Sylvan within such thirty (30) day period, or in the event the Company at any time provides Notification to Sylvan of the Company's decision not to make the Proposed Investment, or in the event the Company fails to make such Proposed Investment or any other Investment in such Industry Company within ninety (90) days from the date of the Company Acceptance Notice, Sylvan and the Sylvan Subsidiaries shall have the exclusive right for a period of ninety (90) days (the "Sylvan Exclusivity Period") to make the Proposed Investment on terms and conditions no more favorable to Sylvan (and the Sylvan Subsidiaries) than those set forth in the Investment Notice. If Sylvan does not consummate the Proposed Investment during the Sylvan Exclusivity Period, then Sylvan shall not make the Proposed Investment without again complying with all the provisions of this Section 7.4. 7.4.3.This Section 7.4 shall not apply to (i) any Proposed Investment with a purchase price of Twenty-Five Million Dollars ($25,000,000) or more as a result of which Sylvan and/or the Sylvan Subsidiaries would control 70% or more of the voting or economic rights related to the Industry Company in which the Proposed Investment would be made; or (ii) any supplement to the delivery, support or use of a then-existing product or service of Sylvan and/or its Sylvan Subsidiaries to take advantage of technology (including the Internet or similar network or electronic or computer technology) without fundamentally altering the nature of such product or service. 7.5. Real Estate Assets. 7.5.1.The Members hereby acknowledge and agree that, as soon as practicable after the Effective Date and as part of the initial capitalization of the Company, Sylvan shall identify and acquire the Real Estate Assets and contribute to the Company all of Sylvan's rights, title and interest in and to such Real Estate Assets in accordance with Section 3.02(b) of the Formation Agreement. 7.5.2.Without the prior written consent of Sylvan, the Company shall not Transfer the Real Estate Assets (or any interest therein) for so long as the Real Estate Assets serve a business purpose for the Company (including, without limitation, collateralizing the preferential return on the Preferred Units pursuant to Section 4.1.2 hereof; provided, however, that, upon Notification by Apollo to the Company (for so long as Apollo is a Member), the Company shall distribute or otherwise Transfer the Real Estate Assets (in a manner reasonably determined by Sylvan, and at Sylvan's option, to Sylvan or any Member other than Apollo) -61- immediately prior to a Qualified IPO or, if earlier, at such time as Apollo reasonably determines to be in the best interests of the Company. 7.5.3.Sylvan hereby agrees to indemnify, defend and hold harmless the Company, Apollo, the direct and indirect owners of Apollo and Holding from and against any and all losses (other than losses allocated hereunder to Holding), damages, costs, expenses, claims, suits, actions and proceedings, directly or indirectly related to or arising out of the Real Estate Assets, or the ownership by the Company thereof, including, without limitation, (i) taxes (other than taxes on income allocated hereunder to Holding from the Real Estate Assets), interest and penalties imposed or assessed against such Persons resulting from the Company's ownership or disposition of the Real Estate Assets, and (ii) claims under any Federal, state, local or foreign laws relating to protection of the environment related to or arising from the ownership or disposition of the Real Estate Assets. 7.6 Investment Company Act. The Company shall use its best efforts to ensure that the Company and its Investments are structured to avoid the Company and Sylvan becoming an "investment company" within the meaning of the Investment Company Act; provided, however, that this Section 7.6 is not intended (and shall not be construed) to limit in any manner the authority of the Board and the Investment Committee to exercise their respective power and authority and to carry out their respective duties in accordance with Article V hereof. If changing laws, regulations and interpretations make it necessary or advisable to register the Company under the Investment Company Act, the Board shall have the power to take such action as it may reasonably deem advisable (provided that such action is not adverse to the interests of any Member) in light of changing regulatory conditions in order to permit the Company to continue in existence and to carry on its activities as provided for herein, including, without limitation, registering the Company under the Investment Company Act and taking any and all action necessary to secure such registration, and amending this Agreement as provided in Section 10.6 hereof. 7.7 Plan Assets. Apollo hereby covenants and agrees that, as long as Apollo is a Member of the Company, Apollo shall not hold Plan Assets. ARTICLE VIII Dissolution, Liquidation, and Termination of the Company 8.1 Events of Dissolution. The Company shall be dissolved upon the happening of any of the following events prior to a Qualified IPO: 8.1.1.upon the Consent of the Members and Consent of the Preferred; -62- 8.1.2.upon the entering of a decree of judicial dissolution under ss.18-802 of the Act; 8.1.3.upon the sale of all or substantially all of the assets of the Company; or 8.1.4.upon each anniversary of the Effective Date occurring on or after the tenth anniversary of the Effective Date, unless the Members vote to not dissolve the Company at such time, pursuant to a Consent of the Members and a Consent of the Preferred. An Involuntary Withdrawal of a Member shall not cause the termination or dissolution of the Company, and the business of the Company shall continue. Upon any such occurrence, subject to Section 6.7 hereof, the trustee, receiver, executor, administrator, committee, guardian or conservator of such Member shall have all the rights of such Member for the purpose of settling or managing its estate or property, subject to satisfying conditions precedent to the admission of any assignee as a substitute Member. The Transfer by such trustee, receiver, executor, administrator, committee, guardian or conservator of any Membership Interest shall be subject to all of the restrictions hereunder to which such Transfer would have been subject if such Transfer had been made by such Member. 8.2 Procedure for Winding Up and Dissolution. If the Company is dissolved, the Board shall have full authority and shall proceed without any unnecessary delay to wind up the affairs of the Company. Upon winding up of the Company, each Member shall be furnished with a statement prepared by the Company's independent accountants setting forth the assets and liabilities of the Company as of the date of dissolution, and the assets of the Company shall be distributed in accordance with Section 4.1.5 hereof. If the Company is dissolved, the Board shall promptly execute, deliver and file any and all certificates, statements or documents with the Secretary of State as may be required under the Act. ARTICLE IX Operations 9.1 Books and Records; Accounting Period and Policies. 9.1.1.The Board shall keep or cause to be kept complete and accurate books and records of the Company and supporting documentation of the transactions with respect to the conduct of the Company's Business. The records shall include, but not be limited to, (i) true and full information regarding the state of the Business and financial condition of the Company, (ii) a copy of the Certificate and this -63- Agreement, and all amendments to the Certificate and/or this Agreement, (iii) a current list of the name and last known business, residence, or mailing address of each Member; and (iv) copies of the Company's federal, state, and local income tax or information returns and reports. 9.1.2.The Company's books and records shall be maintained in accordance with United States generally accepted accounting principles and shall be available at the Company's principal office for examination by any Member or a Member's duly authorized representative at any and all reasonable times during normal business hours. Each Member shall reimburse the Company for all costs and expenses incurred by the Company in connection with the Member's inspection and copying of the Company's books and records. 9.1.3.Unless otherwise determined by the Board, the Company's fiscal year and taxable year shall be the calendar year, subject to the requirements and limitations of the Code. 9.2 Bank Accounts. All funds of the Company shall be deposited in a bank account or accounts maintained in the Company's name. The Board shall determine the institution or institutions at which the accounts will be opened and maintained, the types of accounts, and the Persons who will have authority with respect to the accounts and the funds therein. 9.3 Taxes and Reports. 9.3.1.The Company shall duly and timely file with appropriate United States federal, state and other governmental agencies all tax returns and other reports required to be filed by it. At least twenty (20) days prior to the filing of such tax returns with such governmental agencies, the Company shall deliver to the Board draft tax returns. The Company shall timely pay in full and/or make adequate provisions for the payment of all taxes, interest, penalties, assessments or deficiencies shown to be due on tax returns or by any taxing authorities. Within seventy-five (75) days after the end of each taxable year of the Company, the Board shall cause to be sent to each Person who was a Member at any time during the accounting year then ended: (i) an annual compilation report, prepared by the Company's independent accountants in accordance with standards issued by the American Institute of Certified Public Accountants; and (ii) a report summarizing the fees and other remuneration paid by the Company to any Member in respect of the taxable year. In addition, within seventy-five (75) days after the end of each taxable year of the Company, the Board shall cause to be sent to each Person who was a Membership Interest Holder at any time during the taxable year then ended, the tax information concerning the Company which is necessary for preparing the Membership Interest Holder's income tax returns for that year. At the request of any Member, and at the Member's expense, the Board shall cause an audit of the Company's books and records to be prepared by the Company's independent accountants for the period requested by the Member. -64- 9.3.2.Sylvan shall be the Company's Tax Matters Member so long as it is a Member. Subject to the direction of the Board, the Tax Matters Member shall have all powers and responsibilities of the "tax matters partner" provided in Code Section 6221, et seq. The Tax Matters Member shall keep all Members informed of all notices from government taxing authorities which may come to the attention of the Tax Matters Member. The Company shall pay and be responsible for all reasonable third-party costs and expenses incurred by the Tax Matters Member in performing those duties. A Member shall be responsible for any costs incurred by the Member with respect to any tax audit or tax-related administrative or judicial proceeding against any Member, even though it relates to the Company. 9.3.3.Until such time as the Company determines to convert to a corporation pursuant to Section 7.3 hereof, the Tax Matters Member and the Company shall take any and all actions required to classify the Company as a partnership for United States federal income tax purposes (and shall take no action inconsistent with the Company's intent to be classified as a partnership for United States federal income tax purposes). By executing this Agreement, each of the Members hereby consents to actions taken by the Company and the Tax Matters Member consistent with this Section 9.3. 9.3.4.The Board shall have the authority to cause the Tax Matters Member to make all Company elections permitted under the Code, including, without limitation, elections of methods of depreciation and elections under Code Section 754. ARTICLE X General Provisions 10.1 Title to Company Property. All property owned by the Company shall be owned by the Company as an entity and, insofar as permitted by applicable law, no Member shall have any ownership interest in any Company property in its individual name or right, and each Member's Membership Interest shall be personal property for all purposes. 10.2 Arbitration. Subject to Section 10.5 hereof, in the event of any dispute between the Members arising under or relating to this Agreement, the Members shall use their best efforts to resolve such dispute by negotiation, including pursuing available dispute resolution procedures such as mediation. If the Members are unable to resolve such dispute within ten (10) days after either Member provides Notification to the other of such Member's intent to submit the dispute to arbitration pursuant hereto, such dispute shall be submitted by the Members to arbitration in accordance with the procedures of the American Arbitration Association. Any resulting hearing shall be held in the Baltimore, Maryland area, or at such other location as may be agreed upon by the -65- Members. The resolution of any dispute achieved through such arbitration shall be binding and enforceable by a court of competent jurisdiction. The costs of any arbitration shall be borne equally by the parties. 10.3 Assurances. Each Member shall execute all such certificates and other documents and shall do all such filing, recording, publishing and other acts as the Board deems appropriate to comply with the requirements of law for the formation and operation of the Company and to comply with any laws, rules, and regulations relating to the acquisition, operation, or holding of property of the Company. 10.4 Notifications. Any notice, demand, consent, election, offer, approval, request, or other communication (each, a "Notification") required or permitted under this Agreement must be in writing and either delivered personally or sent by certified or registered mail, postage prepaid, return receipt requested. A Notification must be addressed to a Membership Interest Holder at the Membership Interest Holder's last known address on the records of the Company. A Notification to the Company must be addressed to the Company's principal office (Attention: Chief Executive Officer). A Notification delivered personally will be deemed given only when acknowledged in writing by the Person to whom it is delivered. A Notification that is sent by certified or registered mail will be deemed given on the date of certification or registry thereof. Any party may designate, by Notification to all of the others, substitute addresses or addressees for notices, and, thereafter, notices are to be directed to those substitute addresses or addressees. 10.5 Specific Performance. The parties recognize that irreparable injury will result from a breach of any provision of this Agreement and that money damages will be inadequate to fully remedy such injury. Accordingly, in the event of a breach or threatened breach of one or more of the provisions of this Agreement, any party who may be injured shall be entitled to seek (in addition to any other remedies which may be available to that party) one or more preliminary or permanent orders (i) restraining and enjoining any act which would constitute a breach or (ii) compelling the performance of any obligation which, if not performed, would constitute a breach. 10.6 Entire Agreement; Amendment; Waiver. This Agreement, the Formation Agreement, the Registration Agreement, the Management Employment Documents and that certain Purchase Agreement dated February 23, 2000, by and among Sylvan, Apollo Investment Fund IV, LP and certain other Persons (other than that certain Term Sheet attached as Exhibit 7.4 to such Purchase Agreement (the "Term Sheet")), as amended, constitute the entire agreement between the parties pertaining to the subject matter hereof, and supersede any and all prior agreements, understandings, negotiations, and discussions of the parties, whether oral or written, including without limitation the Term Sheet. Except as set forth in Section 4.4.1 hereof, no amendment, modification or waiver of this Agreement shall be binding unless approved in writing by Consent of the Members (subject to Section 5.1.1(iv)(D) hereof), or in the case of a waiver, by the party for whom such benefit was intended. No waiver of any of the provisions of this -66- Agreement shall be deemed or shall constitute a waiver of any other provision of this Agreement, whether or not similar, nor shall such waiver constitute a continuing waiver unless otherwise expressly so provided in writing. 10.7 Applicable Law; Jurisdiction. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Delaware without regard to principles of conflict of laws, and the rights, duties, and obligations of the Members shall be as stated in the Act except as provided herein. Any suit involving any dispute or matter arising under this Agreement may only be brought in the United States District Court for the State of Delaware or any Delaware court having jurisdiction over the subject matter of the dispute or matter. Each Member consents to the exercise of personal jurisdiction by any such court with respect to any such proceeding. 10.8 Word Meanings; Headings. In this Agreement, the singular shall include the plural and the masculine gender shall include the feminine and neuter and vice versa unless the context otherwise requires. The headings herein are inserted as a matter of convenience only, and do not define, limit, or describe the scope of this Agreement or the intent of the provisions hereof. 10.9 Binding Effect. This Agreement shall be binding upon, and shall inure to the benefit of, the parties hereto and their respective successors and permitted assigns. 10.10 Interpretation. The parties and their respective legal counsel actively participated in the negotiation and drafting of this Agreement, and in the event of any ambiguity or mistake herein, or any dispute among the parties with respect to the provisions hereof, no provision of this Agreement shall be construed unfavorably against any of the parties on the ground that he, it, or his or its counsel was the drafter thereof. 10.11 Separability. Each provision of this Agreement shall be considered separable, and if, for any reason, any provision or provisions herein are determined to be invalid and contrary to any existing or future law, such invalidity shall not impair the operation of or affect those portions of this Agreement which are valid. 10.12 Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, and all of which together shall constitute one and the same document. [THIS SPACE INTENTIONALLY LEFT BLANK] -67- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date set forth above. WITNESS/ATTEST: MEMBERS: SYLVAN LEARNING SYSTEMS, INC. - ------------------------------ By: /s/ ------------------------------------ Name: Title: AP EDUCATE INVESTMENTS, LLC By: APOLLO MANAGEMENT IV, L.P., its manager By: AIF IV MANAGEMENT, INC., its General Partner - ------------------------------ By: /s/ ------------------------------------ Name: Title: SYLVAN VENTURES, INC. - ------------------------------ By: /s/ ------------------------------------ Name: Title: BBHT EDUCATE INVESTMENT, LLC - ------------------------------- By: /s/ ------------------------------------ Name: Title: BBHT EDUCATE INVESTMENT II, LLC - -------------------------------- By: /s/ ------------------------------------ Name: Title: -68- INCUBATOR INVESTMENT, LLC - -------------------------------- By: /s/ ------------------------------------ Name: Title: - -------------------------------- /s/B. Lee McGee ------------------------------------------- Name: B. Lee McGee - -------------------------------- /s/Timothy Daniels ------------------------------------------- Name: - -------------------------------- /s/Bruce Davis ------------------------------------------- Name: Bruce Davis - -------------------------------- /s/Brett Forman ------------------------------------------- Name: Brett Forman - -------------------------------- /s/Earle Pratt ------------------------------------------- Name: Earle Pratt - -------------------------------- /s/David C. Benoit ------------------------------------------- Name: David C. Benoit - -------------------------------- /s/Mark Sneff ------------------------------------------- Name: Mark Sneff -69- SYLVAN VENTURES, LLC AMENDED AND RESTATED OPERATING AGREEMENT LIST OF EXHIBITS Exhibit A List of Members, Initial Capital Contributions, Commitments, Units and Percentages Exhibit B Certificate of Organization and Certificate of Amendment Exhibit C Membership Profit Interest Plan Exhibit D Calculation of Conversion of Membership Profit Interests upon Qualified IPO Exhibit E Description of Real Estate Assets Exhibit F Permitted Affiliate Transactions -70- EX-11.04 5 a2043474zex-11_04.txt EX-11.04 Exhibit 11.04 STOCK PURCHASE AGREEMENT THIS STOCK PURCHASE AGREEMENT (this "AGREEMENT"), dated as of September 7, 2000, is by and among Optagon Holdings Limited, a corporation duly organized and existing under the laws of England and Wales (the "BUYER"), on the one hand, and on the other hand, each of Sylvan Learning Systems, Inc., a corporation duly organized and existing under the laws of Maryland ("SYLVAN"), Sylvan Learning Systems International, Ltd., a corporation duly organized and existing under the laws of Delaware ("SLI"), (Sylvan and SLI being the sole stockholders of Pacific Language Associates, Inc., a corporation duly organized and existing under the laws of the State of Oregon ("PACIFIC"), and ASPECT International Language Schools, B.V., a limited liability company organized under Netherlands Law ("ASPECT")), and ASPECT. For purposes of this Agreement, each of Sylvan, SLI and, after the Restructuring, ASPECT may sometimes be referred to individually as a "SELLER" and collectively as the "SELLERS", and each of ASPECT, Pacific and, after the Restructuring, ASPECT II may sometimes be referred to individually as a "COMPANY" and collectively as the "COMPANIES." RECITALS WHEREAS, Sylvan is the record and beneficial owner of 100% of the Shares of Pacific Common Stock, constituting all of issued and outstanding shares of capital stock of Pacific on the date hereof; WHEREAS, SLI is the record and beneficial owner of 100% of the Shares of ASPECT Common Stock, constituting all of issued and outstanding shares of capital stock of ASPECT on the date hereof; WHEREAS, after the Restructuring ASPECT shall be the record and beneficial owner of 100% of the Shares of ASPECT II Common Stock, constituting all of issued and outstanding shares of capital stock of ASPECT II on the Closing Date; WHEREAS, the Companies are in the language school business and affiliated activities; and WHEREAS, the Sellers desire to sell to Buyer, and Buyer desires to purchase from the Sellers, the Shares of ASPECT II Common Stock, the Shares of Pacific Common Stock and the Advance, in exchange for the Purchase Price upon the terms and subject to the conditions hereinafter set forth. NOW, THEREFORE, in consideration of the premises and mutual covenants hereinafter contained, the parties hereto agree as follows: ARTICLE I DEFINITIONS SECTION 1.01. DEFINITIONS. As used in this Agreement, the following terms shall have the indicated meanings, which meanings shall be applicable, except to the extent otherwise indicated in a definition of a particular term, both to the singular and plural forms of such terms. Any agreement referred to below shall mean such agreement as amended, supplemented and modified from time to time to the extent permitted by the applicable provisions thereof and by this Agreement. The term "including" as used in this Agreement shall mean including without limitation. "ADVANCE" has the meaning specified in Section 2.01(b) of this Agreement. "AEI" shall mean ASPECT Education, Inc., a corporation duly organized and existing under the laws of the State of California. "AFFILIATE" as to a specified Person, means a Person that directly, or indirectly through one or more intermediaries, controls, or is controlled by or is under common control with, the Person specified. "ASPECT II" has the meaning specified in Section 2.03 of this Agreement. "ASPECT COMMON STOCK" shall mean the Common Stock, with a nominal value of NLG 1,000.00 per share, of ASPECT. "ASPECT II COMMON STOCK" shall mean the Ordinary Shares, with a nominal value of NLG 10.00 per share, of ASPECT II. "ASPECT EMPLOYEE BENEFIT PLANS" shall mean Employee Benefit Plans and any other material employee benefit arrangements, maintained by ASPECT, ASPECT II or any of its Subsidiaries or to which ASPECT or any of its Subsidiaries has contributed or is or was obligated to make payments, with respect to any employees or former employees of ASPECT or any of its Subsidiaries, or under which any employee, former employee or director of ASPECT or any of its Subsidiaries or any beneficiary thereof is covered, is eligible for coverage or has benefit rights. "ASPECT EMPLOYEE PENSION PLANS" shall mean ASPECT Employee Benefit Plans which constitute "employee pension benefit plans" as defined in Section 3(2) of ERISA. "ASPECT FINANCIAL STATEMENTS" shall mean (i) the consolidated balance sheet of ASPECT and its Subsidiaries as of the Balance Sheet Date and the related consolidated -2- statements of income and cash flows of ASPECT and its Subsidiaries for the fiscal period then ended; (ii) the consolidated balance sheets of ASPECT and its Subsidiaries as of September 30, 1999 and 1998 and the related consolidated statements of income and cash flows of ASPECT and its Subsidiaries for the periods then ended; and (iii) the consolidated balance sheets of ASPECT and its Subsidiaries as of December 31, 1999 and March 31, 2000 and the related consolidated statements of income and cash flows of ASPECT and its Subsidiaries for the period then ended. "ASPECT WELFARE PLANS" shall mean ASPECT Employee Benefit Plans which constitute "employee welfare benefit plans" within the meaning of Section 3(1) of ERISA. "BALANCE SHEET DATE" shall mean June 30, 2000. "BANKRUPTCY AND EQUITY EXCEPTIONS" shall mean all applicable bankruptcy, insolvency, reorganization, moratorium and similar laws affecting creditors' rights and remedies generally, and, as to enforceability, general principles of equity (regardless of whether enforcement is sought in a proceeding at law or in equity). "BEST EFFORTS" shall mean reasonable good faith efforts but shall in no event require the commencement of litigation against any third party or the payment of any fees to any third party. "BUSINESS CONDITION" has the meaning specified in Section 4.01 of this Agreement. "BUSINESS DAY" shall mean any weekday on which commercial banks in New York, New York and London, England are open. Any action, notice or right which is to be exercised or lapses on or by a given date which is not a Business Day may be taken, given or exercised, and shall not lapse, until the end of the next Business Day. "BUYER" has the meaning specified in the first paragraph of this Agreement. "BUYER CHARTER DOCUMENTS" shall mean the Buyer's Articles of Incorporation and By-Laws or other comparable charter documents (each as amended). "CLAIM" has the meaning specified in Section 9.05 of this Agreement. "CLAIM NOTICE" has the meaning specified in Section 9.05 of this Agreement. "CLOSING" has the meaning specified in Section 3.01 of this Agreement. "CLOSING DATE" has the meaning specified in Section 3.01 of this Agreement. -3- "CODE" shall mean the United States Internal Revenue Code of 1986, as amended. "COMPANY" or "COMPANIES" has the meaning specified in the first paragraph of this Agreement. "COMPANY CHARTER DOCUMENTS" has the meaning specified in Section 4.01 of this Agreement. "DAMAGES" has the meaning specified in Section 9.01 of this Agreement. "EMPLOYEE BENEFIT PLAN" shall have the meaning ascribed to such term by Section 3(3) of ERISA. "ENCUMBRANCES" shall mean any encumbrance, lien, security interest, mortgage, pledge, hypothecation, easement or conditional sale or other title retention agreement. "ENVIRONMENTAL LAWS" shall mean any applicable country, federal, state, or local law, ordinance, regulation, order or permit pertaining to the environment, natural resources or public health or safety or to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals or industrial, toxic or hazardous substances or wastes into the environment (including, without limitation, ambient air, soil, surface water, ground water, wetlands, land or subsurface strata), or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, chemicals or industrial, toxic or hazardous substances or wastes as presently in effect. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended and the rules and regulations thereunder. "FOUNDATION FINANCIAL STATEMENTS" means (i) the audited balance sheets of Aspect Foundation as of September 30, 1999 and 1998, and the related audited consolidated statements of operations, fund equity and cash flows for each of the fiscal years then ended, together with a true and correct copy of the report on such audited information by Smith Lange & Phillips LLP, and all letters from such accountants with respect to the results of such audits; and the unaudited balance sheets of Aspect Foundation and its consolidated subsidiaries as of March 31 and June 30, 2000 and 1999, and the related unaudited consolidated statements of operations, fund equity and cash flows for the portion of the fiscal year then ended. "GAAP" shall mean U.S. generally accepted accounting principles applied on a consistent basis. -4- "GOVERNMENTAL AUTHORITY" shall mean any governmental, regulatory or administrative body, agency or authority, any court of judicial authority or any arbitrator, whether foreign, federal, state or local. "HART-SCOTT-RODINO ACT" shall mean the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended and the rules and regulations thereunder. "INDEBTEDNESS" shall mean any and all of the following: (i) any obligations that arise from borrowed money or the deferred purchase price of property or services, (ii) any obligations evidenced by notes, bonds, debentures or similar instruments, (iii) any obligations for the deferred purchase price of goods or services (other than trade payables or accruals incurred in the ordinary course of business), (iv) any obligations under capital leases and (v) any obligations in the nature of guarantees of the obligations described in clauses (i) through (iv) above of any other Person. "INDEMNIFIED PARTY" has the meaning specified in Section 9.05(a) of this Agreement. "INDEMNIFYING PARTY" has the meaning specified in Section 9.05(a) of this Agreement. "KNOWLEDGE" shall mean, with respect to a particular fact, only the actual knowledge of the individual to which the term is applicable. When such term is used in connection with the Knowledge of Sellers, the Companies or their respective Subsidiaries, such Knowledge shall mean the Knowledge of one or more of the following: B. Lee McGee, Robert Zentz, Tom Ericsson, Ingmar Berg, Miranda Mountney, Stuart Finnigan, Norman Bloomberg or Ward Lee. When such term is used in connection with any other corporate entity, such Knowledge shall mean the Knowledge of any executive officer of such entity. "MATERIAL CONTRACTS" has the meaning specified in Section 4.11(a) of this Agreement. "MATERIAL ADVERSE EFFECT" shall mean, with respect to the Companies or with respect to any other Person, a material adverse effect on the Companies' or such other Person's business, condition (financial or other), properties, business, or results of operations taken as a whole (excluding any effect on each Company or such other Person caused by economic, tax or other matters of general applicability or matters generally affecting the industry in which the Companies or such other Person conducts its business). "MATERIAL LEASE" or "MATERIAL LEASES" has the meaning specified in Section 4.08 of this Agreement. -5- "MULTIEMPLOYER PLAN" shall have the meaning ascribed to such term by Section 3(37) of ERISA. "OPERATIVE AGREEMENTS" means the Transitional Services Agreement and any other support or other agreements mutually agreed upon by the parties to be entered into in connection with the transactions contemplated hereby. "PACIFIC COMMON STOCK" shall mean the Common Stock, $0.01 par value per share, of Pacific. "PACIFIC EMPLOYEE BENEFIT PLANS" shall mean Employee Benefit Plans and any other material employee benefit arrangements, maintained by Pacific or any of its Subsidiaries or to which Pacific or any of its Subsidiaries has contributed or is or was obligated to make payments, with respect to any employees or former employees of Pacific or any of its Subsidiaries, or under which any employee, former employee or director of Pacific or any of its Subsidiaries or any beneficiary thereof is covered, is eligible for coverage or has benefit rights. "PACIFIC EMPLOYEE PENSION PLANS" shall mean Pacific Employee Benefit Plans which constitute "employee pension benefit plans" as defined in Section 3(2) of ERISA. "PACIFIC FINANCIAL STATEMENTS" shall mean (i) the balance sheet of Pacific as of the Balance Sheet Date and the related statements of income and cash flows of Pacific for the fiscal period then ended, (ii) the balance sheet of Pacific as of September 30, 1999 and the related statement of income and cash flows of Pacific for the period then ended, and (iii) the balance sheets of Pacific as of December 31, 1999 and March 31, 2000 and the related statements of income and cash flows of Pacific for the fiscal quarters then ended. "PACIFIC WELFARE PLANS" shall mean Pacific Employee Benefit Plans which constitute "employee welfare benefit plans" within the meaning of Section 3(1) of ERISA. "PERMITTED ENCUMBRANCE" shall mean, (a) Encumbrances imposed by any Governmental Authority for Taxes, assessments or charges not yet due and payable or which are being contested in good faith and by appropriate proceedings if reserves with respect thereto are maintained on the books of the Companies in accordance with GAAP; (b) purchase money security interests or liens incurred in connection with equipment acquisitions; (c) carriers', warehousemen's, mechanics', materialmen's, employees', repairmen's or other like Encumbrances arising in the ordinary course of business which are not overdue for a period of more than 60 days or which are being contested in good faith and by appropriate proceedings, if reserves with respect thereto are maintained on the books of the Companies in accordance with GAAP; (d) pledges or deposits in connection with worker's compensation, unemployment insurance and other social security legislation; (e) deposits to secure the performance of any or all of the following: bids, trade contracts (other than for borrowed money), leases, statutory -6- obligations, surety and appeal bonds, performance bonds and other obligations of a like nature incurred in the ordinary course of business; and (f) easements, rights-of-way, restrictions and other similar encumbrances on real property incurred in the ordinary course of business and encroachments (whether or not in the ordinary course of business) which, in the aggregate, are not substantial in amount, and which do not in any case materially detract from the value of the property subject thereto or materially interfere with the ordinary conduct of the business thereon as currently conducted by each Company. "PERSON" shall mean any natural person, corporation, company, partnership, limited liability company, business trust, proprietorship, other business organization, trust, union, association or Governmental Authority. "PURCHASE PRICE" has the meaning specified in Section 2.02 of this Agreement. "REPRESENTATIVE" shall mean any officer, director, principal, attorney, partner, advisor, accountant, employee, consultant, trustee or other representative. "RESTRUCTURING" has the meaning specified in Section 2.03 of this Agreement. "SCHEDULES" shall mean those schedules referred to in this Agreement delivered concurrently with the execution of this Agreement, all of which schedules are incorporated in and made a part hereof by reference. "SECURITIES ACT" shall mean the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. "SELLER" or "SELLERS" has the meaning specified in the first paragraph of this Agreement. "SELLER CHARTER DOCUMENTS" shall mean the Sellers' Articles of Incorporation and By-Laws or other comparable charter documents (each as amended). "SHARE" or "SHARES" has the meaning specified in Section 2.01 of this Agreement. "SUBSIDIARY" means, with respect to any Person, any other Person in which such Person, directly or indirectly through Subsidiaries or otherwise, beneficially owns more than fifty percent (50%) of either the equity interests in, or the voting control of, such other Person. "SUBSIDIARY CHARTER DOCUMENTS" shall mean the articles of incorporation and by-laws (or other comparable charter documents) or each Subsidiary of each Company. -7- "TAX" or "TAXES" means all taxes, charges, fees, imposts, levies or other assessments, including, without limitation, all net income, franchise, profits, gross receipts, capital, sales, use, ad valorem, value added, transfer, transfer gains, inventory, capital stock, license, withholding, payroll, employment, social security, unemployment, excise, severance, stamp, occupation, real or personal property, and estimated taxes, water, rent and sewer service charges, customs duties, fees, assessments and charges of any kind whatsoever, together with any interest and any penalties, fines, additions to tax or additional amounts thereon, imposed by any taxing authority (federal, state, local or foreign) and shall include any transferee liability in respect of Taxes. "TAX RETURN" means all returns, declarations, reports, estimates, information returns and statements required to be filed in respect of any Taxes. "THIRD PERSON" has the meaning specified in Section 9.05(c) of this Agreement. "TRANSFER TAXES" means all sales, use, goods and services, transfer, capital duty (including any clawbacks of Dutch capital duty), recording, ad valorem and similar Taxes and fees incurred as a result of the transactions contemplated by this Agreement. "TRANSITIONAL SERVICES AGREEMENT" shall mean a transitional services agreement to be entered into on the Closing Date by Sellers and Buyer in the form attached hereto as EXHIBIT A. ARTICLE II CONSIDERATION SECTION 2.01. SALE OF SHARES; SALE OF ADVANCE. (a) On the terms and subject to the conditions set forth in this Agreement, and on the Closing Date: (i) Buyer hereby agrees to purchase all of the Shares of Pacific Common Stock from Sylvan, and Sylvan hereby agrees to sell, assign and transfer to Buyer such Shares of Pacific Common Stock, for the Pacific Common Stock Purchase Price; (ii) Buyer hereby agrees to purchase all of the Shares of ASPECT II Common Stock from ASPECT, and ASPECT hereby agrees to sell, assign and transfer to Buyer such Shares of ASPECT II Common Stock, for the ASPECT II Common Stock Purchase Price; and -8- (iii) Buyer hereby agrees to purchase the entire Advance from Sylvan, and Sylvan hereby agrees to sell, assign and transfer to Buyer such Advance, for the Advance Purchase Price. (b) As used herein, "SHARES" shall mean 4,376 Shares of ASPECT II Common Stock and 150 shares of Pacific Common Stock, and the "ADVANCE" shall mean (i) the aggregate advances made by Sylvan in respect of the operating expenses of the Companies and their Subsidiaries as of the Closing Date, and (ii) any and all claims of any kind whatsoever relating thereto, all of which are to be sold by the Sellers and purchased by the Buyer pursuant to this Section 2.01. For information purposes, the aggregate amount of the Advance on the Balance Sheet Date as reflected on the balance sheet included in the ASPECT Financial Statements was $14,498,409. SECTION 2.02. PURCHASE PRICE. (a) The purchase price for the Shares of Pacific Common Stock is equal to $500,000 (the "PACIFIC PURCHASE PRICE"); the purchase price for the Shares of ASPECT II Common Stock is equal to $13,500,000 (the "ASPECT II PURCHASE PRICE"); and the purchase price for the Advance is equal to $8,000,000 (the "ADVANCE PURCHASE PRICE"). The aggregate purchase price for the Shares of Pacific Common Stock, the Shares of ASPECT II Common Stock and the Advance (the "PURCHASE PRICE") is equal to $22,000,000 in cash (without interest); such amount, to be paid at the Closing by wire transfer in same day funds to the account designated by Sellers in Section 3.02(d). (b) For the avoidance of doubt, in connection with the purchase of the Shares hereunder, and except as set forth in Section 7.10, all of the liabilities and obligations of the Companies and the Subsidiaries, including, without limitation, all of the Indebtedness, will remain outstanding following the Closing and Buyer will assume all such liabilities and obligations, including, without limitation, the Indebtedness. SECTION 2.03. PRE-CLOSING RESTRUCTURING. SLI currently owns all of the authorized capital stock of ASPECT, consisting of 668 ordinary shares of ASPECT Common Stock with a nominal value of NLG 1,000.00 per share. On or prior to closing Sylvan will cause all of the following to be completed: (1) ASPECT will purchase all of the issued and outstanding shares of Proxima, BV, a private limited liability company organized under Netherlands law; (2) the name of Proxima, BV shall be changed to "ASPECT International Language Schools II, B.V." (both Proxima, BV and ASPECT International Language Schools II, B.V., "ASPECT II"); (3) ASPECT will contribute all of its assets and liabilities to ASPECT II, which assets consist principally of the stock of certain Subsidiaries that are set forth in SCHEDULE 4.03 as being owned, fully or partially, by ASPECT; (4) ASPECT shall change its name to a name that does not include "Aspect" or any derivative thereof and is not confusingly similar to "ASPECT International -9- Language Schools" or any other Subsidiary of the Companies; and (5) appropriate registrations shall then be made in the Netherlands and the countries where these certain Subsidiaries are incorporated to effect the transactions contemplated by this Section 2.03 (all of the steps to the above-described restructuring transaction shall be collectively referred to herein as the "RESTRUCTURING"). -10- ARTICLE III CLOSING SECTION 3.01. CLOSING. Except as hereinafter provided, execution of this Agreement and the closing of the transactions contemplated by this Agreement (the "CLOSING") shall take place contemporaneously at the offices of Piper Marbury Rudnick & Wolfe LLP, 111 South Calvert Street, Suite 1950, Baltimore, Maryland 21202 at 10:00 A.M. on (a) the fifth Business Day after the day on which the last of all of the consents, approvals, actions, filings, notices or waiting periods specifically set forth herein as being required for the Closing has been obtained, made or given or has expired, as applicable, including, without limitation, the consents and filings described in or related to the consents filings described in Schedules 4.14, 5.04, and 6.04, or (b) such other date as Buyer and Sellers mutually agree upon in writing. The time and date of the Closing are herein referred to as the "CLOSING DATE." SECTION 3.02. CLOSING DELIVERIES; CONDITIONS. Each party hereby agrees that, at or prior to the Closing, it will take the following actions set forth below as being required to be taken by it, and the obligations of each party hereunder are conditioned upon the other party taking such required actions at or prior to Closing: (a) The Sellers will deliver the certificates, and other items described in this Section 3.02 for delivery at Closing and such other evidence of the performance of all of the covenants and the satisfaction of all conditions required of the Sellers by this Agreement as Buyer shall reasonably require. (b) Buyer will deliver the certificates, and other items described in this Section 3.02 for delivery at Closing and such other evidence of the performance of all the covenants and the satisfaction of all conditions required of Buyer by this Agreement as the Sellers shall reasonably require. (c) In respect to Pacific, Sylvan will assign and transfer to Buyer all of Sylvan's right, title and interest in and to the Shares of Pacific Common Stock by delivering to Buyer the original stock certificates representing the Shares of Pacific Common Stock duly endorsed in blank or accompanied by stock powers duly executed in blank with requisite stock transfer tax stamps, if any, attached. In respect to ASPECT II, ASPECT shall assign and transfer to Buyer all of ASPECT's right, title and interest in and to the Shares of ASPECT II Common Stock by delivering to Buyer at Closing or reasonably promptly thereafter the Shares -11- of ASPECT II Common Stock to be transferred to Buyer by Notarial Deed and otherwise as required by the laws of the Netherlands. Sylvan will assign and transfer to Buyer all of Sylvan's right, title and interest in and to the Advance by delivering to Buyer a written assignment of interest, duly executed with requisite transfer tax stamps, if any, attached. (d) Buyer will deliver the Purchase Price via wire transfer to the account of Sellers, such account to be designated by Sellers two (2) days before Closing. (e) Buyer will provide Sellers at Closing a good standing certificate (or other comparable document) of Buyer dated no earlier than 10 calendar days prior to the Closing Date, certifying that Buyer is in good standing in the jurisdiction of its incorporation. (f) Sellers will provide to Buyer good standing certificates (or other comparable documents), certifying that such Companies are in good standing in the jurisdiction of their incorporation, as follows: (i) at Closing for each Seller, ASPECT, ASPECT II, Pacific, AEI and Anglo World and (ii) within 30 days of Closing for all other Subsidiaries of ASPECT, except for any Subsidiary identified as "dormant" on SCHEDULE 4.01, dated no later than 30 calendar days after the Closing Date; provided, however, that Sellers shall use best commercial efforts to provide such good standing certificates at Closing. (g) Sellers will provide resignations of each of the directors of the Companies and their respective Subsidiaries unless otherwise requested in writing. (h) Sellers will provide if required by the terms of any Material Lease, a landlord consent in form and substance reasonably satisfactory to the Buyer and its counsel with respect to each such Material Lease. If the consent to such assignments shall not be obtained and if Buyer elects to waive this condition to Closing, Sellers shall cooperate with Buyer in any reasonable arrangement designed to provide for Buyer the benefits intended to be assigned to Buyer under the Material Leases, including enforcement at Sellers' cost and for the account of Buyer of any and all rights of Seller against the other parties thereto arising out of the breach or cancellation thereof by such other party or otherwise. If and to the extent that such arrangements cannot be made, Buyer shall have no obligation with respect to any such Material Lease. (i) All material consents of and material filings required to be obtained or made by Buyer, Sellers or the Companies with any Governmental Authority or agency or any third party consent as required by Section 3.01 and all material consents and material approvals of third parties (including, without limitation, those set forth in SCHEDULE 4.14) shall have been obtained or made and shall be in full force and effect. (j) All required antitrust or similar filings to be made with any Governmental Authority (including Hard-Scott-Rodino) shall have been completed and all applicable time limitations shall have expired without a request for further information by the -12- relevant federal authorities or in the event of such a request for further information, the expiration of all applicable time limitations without the objection of such federal authorities. (k) Buyer will provide Sellers a certificate of a duly authorized officer of Buyer, dated the Closing Date, attaching its charter documents and setting forth the resolutions of the Board of Directors of Buyer authorizing the execution and delivery of this Agreement and the consummation of the transactions contemplated hereby, and certifying that such resolutions were duly adopted and have not been rescinded or amended as of the Closing Date. (l) Sellers will provide to Buyer a certificate of a duly authorized officer of Sellers, dated the Closing Date, attaching their charter documents and setting forth the resolutions of the Board of Directors of Sellers authorizing the execution and delivery of this Agreement and the consummation of the transactions contemplated hereby, and certifying that such resolutions were duly adopted and have not been rescinded or amended as of the Closing Date. (m) Provided Sylvan has taken all action reasonably necessary on its part to effect the Restructuring, the Restructuring shall have been in the opinion of Donahoe & Partners LLP satisfactorily completed. (n) The obligation of Buyer hereunder to purchase the Shares is also subject to the fulfillment, at or before the Closing, of each of the following additional conditions (all or any of which may be waived in whole or in part by Buyer in its sole discretion): (i) Representations and Warranties. Each of the representations and warranties made by Sellers in this Agreement (other than those made as of a specified date earlier than the Closing Date) shall be true and correct in all material respects on and as of the Closing Date as though such representation or warranty was made on and as of the Closing Date, and any representation or warranty made as of a specified date earlier than the Closing Date shall have been true and correct in all material respects on and as of such earlier date. (ii) Performance. Sellers shall have performed and complied with, in all material respects, each agreement, covenant and obligation required by this Agreement to be so performed or complied with by Sellers at or before the Closing. (iii) Officers' Certificates. Seller shall have delivered to Buyer a certificate, dated the Closing Date and executed in the name and on behalf of each Seller by its Chairman of the Board, President or any Executive or Senior Vice President to the effect that the conditions in clauses (i) and (ii) above have been satisfied. -13- (iv) Orders and Laws. There shall not be in effect on the Closing Date any order or law restraining, enjoining or otherwise prohibiting or making illegal the consummation of any of the transactions contemplated by this Agreement or any of the Operative Agreements, and there shall not be pending on the Closing Date any action or proceeding in, before or by any Governmental Authority which could reasonably be expected to result in the issuance of any such order or the enactment, promulgation or deemed applicability to Buyer, the Companies, any Subsidiary of either Company or the transactions contemplated by this Agreement or any of the Operative Agreements of any such law. (v) Opinion of Counsel. Buyer shall have received the opinion of counsel to the Sellers and the Companies, dated the Closing Date, in respect to each Seller (including ASPECT) and each Company (including ASPECT II) in form and substance reasonably appropriate for a transaction of this type and otherwise reasonably acceptable to Buyer. (vi) Title Insurance. Buyer shall have received a policy of title insurance on forms of and issued by one or more title companies reasonably satisfactory to Buyer insuring the title by either Company or its Subsidiaries, as applicable, to all real property owned by either Company or its Subsidiaries, subject only to such exceptions as are reasonably satisfactory to Buyer and the Permitted Encumbrances. (vii) Transitional Services Agreement. At Closing, Sellers and Buyer shall enter into the Transitional Services Agreement. (viii) Aspect Foundation Inc. Such trustees and officers of Aspect Foundation, Inc. as are designated by Buyer to Sellers shall have tendered, effective at the Closing, their resignations as such trustees and officers, and individuals designated by Buyer shall be appointed to replace such trustees and officers. (ix) Execution of Certain Agreements. Sylvan shall have executed and delivered to AEI lease assignments, in form and substance reasonably acceptable to Buyer, reassigning all of Sellers' right title and interest in the leases relating to (i) Suite 500, 530 Bush Street, San Francisco, CA, (ii) 6th floor, 126 Newbury Street, Boston, MA and (iii) 1111 Torrey Pines Road, La Jolla, CA, which were assigned to Sylvan, free and clear of all Encumbrances and such assignments shall be in full force and effect. If the consent to such assignments shall not be obtained, Sellers shall cooperate with Buyer in any reasonable arrangement designed to provide for Buyer the benefits intended to be assigned to Buyer under the leases, including enforcement at the cost and for the account of Buyer of any and all rights of Seller against the other parties thereto arising out of the breach or cancellation thereof by such other party or otherwise. If and to the extent that such arrangements cannot be made, Buyer shall -14- have no obligation with respect to any such lease. Aspect Foundation and Aspect Language Schools, Ltd. (Switzerland) shall have renewed and extended through December 31, 2000, the International Promotional Agreement previously in effect that expired in December 1998. (x) Tax Election. Seller shall have executed and filed with the United States Internal Revenue Service a check-the-box election (Form 8832) with respect to ASPECT II, with an effective date no later than one day prior to the Closing Date, and Buyer shall have received a copy of such filing. (o) The obligation of the Sellers hereunder to sell the Shares is also subject to the fulfillment, at or before closing, of each of the following additional conditions (all or any of which may be waived in whole or in part by the Sellers in their sole discretion): (i) Representations and Warranties. Each of the representations and warranties made by Buyer in this Agreement (other than those made as of a specified date earlier than the Closing Date) shall be true and correct in all material respects on and as of the Closing Date as though such representation or warranty was made on and as of the Closing Date, and any representation or warranty made as of a specified date earlier than the Closing Date shall have been true and correct in all material respects on and as of such earlier date. (ii) Performance. Buyer shall have performed and complied with, in all material respects, each agreement, covenant and obligation required by this Agreement to be so performed or complied with by Buyer at or before the Closing. (iii) Officers' Certificates. Buyer shall have delivered to Sellers a certificate, dated the Closing Date and executed in the name and on behalf of the Buyer by a director, its Chief Executive Officer, President or any Executive or Senior Vice President to the effect that the conditions in clauses (i) and (ii) above have been satisfied. (iv) Orders and Laws. There shall not be in effect on the Closing Date any order or law restraining, enjoining or otherwise prohibiting or making illegal the consummation of any of the transactions contemplated by this Agreement or any of the Operative Agreements, and there shall not be pending on the Closing Date any action or proceeding in, before or by any Governmental Authority which could reasonably be expected to result in the issuance of any such order or the enactment, promulgation or deemed applicability to Sellers or the transactions contemplated by this Agreement or any of the Operative Agreements of any such law. (v) Opinion of Counsel. Sellers shall have received the opinion of counsel to the Buyer, dated the Closing Date, in form and substance reasonably -15- appropriate for a transaction of this type and otherwise reasonably acceptable to Sellers. (vi) Sylvan Guaranties. Sylvan shall have been released from the guaranties and similar arrangements existing for the benefit of or otherwise in respect to any Company and disclosed in SCHEDULE 4.30. (p) Transitional Services Agreement. At Closing, Sellers and Buyer shall enter into the Transitional Services Agreement. ARTICLE IV REPRESENTATIONS AND WARRANTIES AS TO THE COMPANIES Sylvan in respect to Pacific, SLI and each of their respective Subsidiaries and SLI in respect to ASPECT, ASPECT II and each of their respective Subsidiaries hereby represent and warrant to Buyer that, except as otherwise set forth in the Schedules referred to in this ARTICLE IV or in ARTICLE V, the following representations and warranties are true and correct as of the date hereof (it being understood that the inclusion of any item on a Schedule hereto shall not be deemed an acknowledgment that such item is material, and any disclosure set forth on any schedule is deemed to be set forth on all other schedules, to the extent applicable and reasonably apparent): SECTION 4.01. ORGANIZATION AND GOOD STANDING. ASPECT is a limited liability company duly organized and validly existing under the laws of the Netherlands. ASPECT II is a limited liability company duly organized and validly existing under the laws of the Netherlands. Pacific is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Oregon. The Companies have full corporate power and authority to conduct their business as and to the extent now conducted and to own, use and lease their assets and properties, and are duly qualified, admitted and in good standing in all jurisdictions in which the conduct of their business or activities or their ownership of assets requires qualification under applicable law, except for those jurisdictions in which the adverse effects of all such failures by either Company and its Subsidiaries to be qualified, licensed or admitted and in good standing can in the aggregate be eliminated without material cost or expense by either Company becoming qualified, licensed or admitted and in good standing. SCHEDULE 4.01 lists all entities in which a Company owns, directly or indirectly, an equity interest. Copies of each Company's Articles of Incorporation and By-Laws or equivalent organizational documents (each as amended) (the "Company Charter Documents") have been previously delivered or made available to the Buyer. -16- SECTION 4.02. CAPITALIZATION. The entire authorized capital stock of ASPECT consists of 1,000 shares of Common Stock, with a nominal value of NLG 1,000.00 per share, of which there are 668 shares of ASPECT Common Stock issued and outstanding. The entire authorized capital stock of ASPECT II shall consist of 200,000 shares of Common Stock, with a nominal value of NLG 10.00 per share, of which there will be 4,376 shares of ASPECT II Common Stock issued and outstanding. The entire authorized capital stock of Pacific consists of 1,000 shares of which there are 150 shares of Pacific Common Stock, $0.01 par value, issued and outstanding. The Shares are duly authorized, validly issued, outstanding, fully paid and nonassessable. The delivery of a certificate or certificates at the Closing representing the Shares in the manner provided in Section 3.02 will transfer to Buyer good and valid title to the Shares, free and clear of all Encumbrances. All of the Shares of ASPECT Common Stock are owned beneficially and of record by SLI and all of the Shares of ASPECT II Common Stock shall be owned beneficially and of record by ASPECT. All of the Shares of Pacific Common Stock are owned beneficially and of record by Sylvan. Except as disclosed on SCHEDULE 4.02, there are no outstanding options, rights (preemptive or otherwise), warrants, calls, convertible securities or commitments or any other arrangements (collectively, "OPTIONS") to which the Companies are a party requiring or restricting issuance, sale or transfer of any of their respective Shares, or evidencing the right to subscribe for any of their respective Shares or for any authorized but unissued shares of capital stock of the Companies, or giving any Person any rights with respect to the Shares or with respect to any authorized but unissued shares of capital stock of the Companies. Except as contemplated by this Agreement or disclosed on SCHEDULE 4.02, there are no voting agreements, voting trusts, other agreements (including cumulative voting rights), commitments or understandings to which either the Companies or any of the Sellers is a party with respect to any Shares or to any authorized but unissued shares of capital stock of the Companies. SECTION 4.03. SUBSIDIARIES. SCHEDULE 4.03 lists the name of each Subsidiary of each Company. Each Subsidiary of each Company is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation identified in SCHEDULE 4.03, and has full corporate power and authority to conduct its business as and to the extent now conducted and to own, use and lease its assets and properties. Each Subsidiary of each Company is duly qualified, licensed or admitted to do business and is in good standing in those jurisdictions in which the ownership, use or leasing of such Subsidiary's assets and properties, or the conduct or nature of its business, makes such qualification, licensing or admission necessary, except for those jurisdictions in which the adverse effects of all such failures by either Company and its Subsidiaries to be qualified, licensed or admitted and in good standing can in the aggregate be eliminated without material cost or expense by either Company or its Subsidiaries, as the case may be, becoming qualified, licensed or admitted and in good standing. Schedule 4.03 lists for each such Subsidiary the record owners of such Subsidiaries' outstanding capital stock. -17- Except as disclosed in SCHEDULE 4.03, all of the outstanding shares of capital stock of each Subsidiary of each Company have been duly authorized and validly issued, are fully paid and nonassessable, and are owned, beneficially and of record, by either Company or Subsidiaries wholly owned by either Company free and clear of all Encumbrances. Except as disclosed in SCHEDULE 4.03, there are no outstanding Options with respect to any Subsidiary. Each Seller has prior to the execution of this Agreement delivered to Buyer true and complete copies of the Subsidiary Charter Documents. Except for the equity interests in the Subsidiaries owned by the Companies, the Companies do not presently own, of record or beneficially, or control, directly or indirectly, any capital stock, securities convertible into capital stock or any other equity interest in any corporation, association or business entity, nor are the Companies, directly or indirectly, a participant in any joint venture, partnership or other non-corporate entity. SECTION 4.04. FINANCIAL STATEMENTS. The Sellers have delivered to Buyer copies of the ASPECT and Pacific Financial Statements and the Foundation Financial Statements. The ASPECT and Pacific Financial Statements were prepared from the books and records of the respective Companies. The ASPECT and Pacific Financial Statements have been prepared in accordance with GAAP applied on a consistent basis throughout the periods covered thereby, subject to normal year-end adjustments (which were not and are not expected to be material) and the omission of footnote disclosure, present fairly in all material respects the consolidated financial position, results of operations and cash flows of the Companies at the dates and for the periods indicated. Each Company and the Subsidiaries have maintained their respective books and records in a manner sufficient to permit the preparation of financial statements in accordance with GAAP. SECTION 4.05. NO UNDISCLOSED LIABILITIES. As of the Balance Sheet Date and except as set forth in the ASPECT or Pacific Financial Statements, as the case may be, neither the Companies nor any of their Subsidiaries had (individually or in the aggregate) any material outstanding indebtedness (including Indebtedness) or liabilities (whether accrued, absolute, contingent or otherwise, and whether due or to become due) of the type required to be disclosed under GAAP. Neither the Companies nor any of their Subsidiaries has incurred (individually or in the aggregate) any material outstanding indebtedness (including Indebtedness) or liability other than those disclosed in a schedule hereto or in any document referred to in a schedule or those incurred in the ordinary course of business, consistent with past practice since the Balance Sheet Date. SECTION 4.06. NO MATERIAL ADVERSE CHANGE. Since the Balance Sheet Date, there has been no change, event or development which could reasonably be expected to result in a Material Adverse Effect on the business, assets, -18- results of operations or financial condition (collectively, the "BUSINESS CONDITION") of the Companies and their Subsidiaries taken as a whole. Except as disclosed in SCHEDULE 4.06, there has not occurred between the Balance Sheet Date and the date hereof: (i) any declaration, setting aside or payment of any dividend or other distribution in respect of the capital stock of either Company or any Subsidiary not wholly owned by either Company, or any direct or indirect redemption, purchase or other acquisition by either Company or any Subsidiary of either Company of any such capital stock of or any Option with respect to either Company or any Subsidiary not wholly owned by either Company; (ii) any authorization, issuance, sale or other disposition by either Company or any Subsidiary of either Company of any shares of capital stock of or Option with respect to either Company or any such Subsidiary, or any modification or amendment of any right of any holder of any outstanding shares of capital stock of or Option with respect to either Company or any such Subsidiary; (iii) (x) any material increase in the salary, wages or other compensation of any officer, employee or consultant of either Company or any Subsidiary of either Company, except following normal review procedures or as reasonably deemed necessary, in each case, in amounts in the ordinary course of business consistent with past practice; (y) any establishment or modification of (A) targets, goals, pools or similar provisions in respect of any fiscal year under any Aspect Employee Benefit Plan or any Pacific Employee Benefit Plan (collectively, the "Benefit Plans"), employment-related contract or other employee compensation arrangement or (B) salary ranges, increase guidelines or similar provisions in respect of any Benefit Plan, employment-related contract or other employee compensation arrangement; or (z) any adoption, entering into or becoming bound by any Benefit Plan, employment-related contract or collective bargaining agreement, or amendment, modification or termination (partial or complete) of any Benefit Plan, employment-related contract or collective bargaining agreement, except to the extent required by applicable law; (iv) except as provided in Section 7.10, (x) incurrences by either Company or any Subsidiary of either Company of Indebtedness in an aggregate principal amount exceeding $100,000 (net of any amounts discharged during such period), or (y) any voluntary purchase, cancellation, prepayment or complete or partial discharge in advance of a scheduled payment date with respect to, or waiver of any right of either Company or any such Subsidiary under, any Indebtedness of or owing to either Company or any such Subsidiary; (v) any physical damage, destruction or other casualty loss (whether or not covered by insurance) affecting any of the real property, personal property or equipment of either Company or any Subsidiary of either Company in an aggregate amount exceeding $200,000; -19- (vi) any change in (x) any pricing, investment, accounting, financial reporting, inventory, credit, allowance or tax practice or policy of either Company or any Subsidiary of either Company, or (y) any method of calculating any bad debt, contingency or other reserve of either Company or any such Subsidiary for accounting, financial reporting or tax purposes, or any change in the fiscal year of either Company or any such Subsidiary; (vii) any write-off or write-down of or any determination to write off or write down any of the assets and properties of either Company or any Subsidiary of either Company in an aggregate amount exceeding $200,000; (viii) any acquisition or disposition of, or incurrence of an Encumbrance (other than a Permitted Encumbrance) on, any assets and properties of either Company or any Subsidiary of either Company, other than in the ordinary course of business consistent with past practice; (ix) any (x) amendment of the certificate or articles of incorporation or by-laws (or other comparable corporate charter documents) of either Company or any Subsidiary of either Company, (y) recapitalization, reorganization, liquidation or dissolution of either Company or any such Subsidiary or (z) merger or other business combination involving either Company or any such Subsidiary and any other Person; (x) any entering into, amendment, modification, termination (partial or complete) or granting of a waiver under or giving any consent with respect to (i) any Material Contract that is required (or had it been in effect on the date hereof would have been required) to be disclosed or (ii) any material license held by either Company or any Subsidiary of either Company; (xi) capital expenditures or commitments for additions to property, plant or equipment of either Company and the Subsidiaries of each constituting capital assets in an aggregate amount exceeding $200,000; (xii) any transaction, payment or other distribution by either Company or any Subsidiary of either Company with, to or on behalf of any Seller, any officer, director or affiliate (other than either Company or any such Subsidiary) of Seller other than as provided in Section 7.10 or pursuant to any contract in effect on the Balance Sheet Date and disclosed in SCHEDULE 4.06; (xiii) any commencement or termination by either Company or any Subsidiary of either Company of any activities not involving the provision of English language education or reasonably related thereto; (xiv) any entering into of a Contract to do or engage in any of the foregoing after the date hereof; or -20- (xv) any other transaction involving or development affecting either Company or any Subsidiary of either Company outside the ordinary course of business consistent with past practice. SECTION 4.07. TAXES. Except as set forth on SCHEDULE 4.07: (a) The Companies and their Subsidiaries do not have any material liability for any Taxes imposed by law in respect of any taxable period ending on or before the Closing Date (a "PRE-CLOSING PERIOD"), other than amounts properly reserved or reflected in the ASPECT Financial Statements or Pacific Financial Statements arising in the ordinary course of business after the Balance Sheet Date. (b) The Companies and their Subsidiaries have filed or will timely file all Tax Returns required to have been filed prior to the Closing Date (subject to any timely extensions permitted by law) by them with the appropriate taxing authority with respect to Taxes for any Pre-Closing Period, and all Taxes due with respect to such periods have been paid or will be paid prior to the Closing Date. (c) No deficiency for any amount of Tax has been asserted or assessed by a taxing authority against the Companies or their Subsidiaries, which is still pending, and neither the Companies nor any of their Subsidiaries have filed any waiver of the statute of limitations applicable to the assessment or collection of any Tax imposed in respect of a tax period which is still open. (d) All Taxes that the Companies and their Subsidiaries are required by law to withhold or collect have been duly withheld or collected, and have been timely paid over to the appropriate tax authorities. (e) The Companies and their Subsidiaries are not a party to any tax indemnity agreement, tax sharing agreement or other agreement under which the Company could become liable to another Person as a result of the imposition upon of a Tax upon such Person, or the assessment or collection of such a Tax. (f) There are no Encumbrances, other than Permitted Encumbrances, on any of the assets of either Company or any of its Subsidiaries that arose in connection with any failure (or alleged failure) to pay any Tax. SECTION 4.08. REAL PROPERTY; LEASES OF REAL PROPERTY. -21- (a) SCHEDULE 4.08 sets forth all of the real property owned by each Company and any of their respective Subsidiaries (the "Owned Real Property"). Immediately prior to the Closing, the Owned Real Property shall be free and clear of all Encumbrances except (A) Encumbrances set forth on SCHEDULE 4.08, (B) Encumbrances for taxes, special assessments or governmental charges or levies if the same shall not at the time be delinquent or thereafter can be paid without penalty, or are being contested in good faith by appropriate proceedings, (C) Encumbrances to secure Indebtedness as disclosed on SCHEDULE 4.11, (D) mechanic's, materialmen's and other similar Liens that have arisen in the ordinary course of business in respect of obligations which are not delinquent or material in amount, and (D) Encumbrances and other matters affecting title which do not in the aggregate materially and adversely affect the Seller's use or disposition of the Owned Real Properties in the Business as it is presently being conducted. SCHEDULE 4.08 hereto contains a complete and correct list of all leases, subleases, license agreements or other rights of possession or occupancy of real property to which either Company or any of their respective Subsidiaries is a party (as tenant, occupier or possessor) pursuant to which the net annual rent payable by the Company (or any of their respective Subsidiaries) currently exceeds $50,000 (each such lease or agreement, a "MATERIAL LEASE" and collectively the "MATERIAL LEASES"). Except as set forth on SCHEDULE 4.08, all of the Material Leases are legal, valid and binding upon Sellers and, assuming that such Material Leases are legal, valid and binding upon the respective lessor thereunder, are in full force and effect. The current net annual rent payable by the Company (or any of their respective Subsidiaries) in respect to all leases that are not included as Material Leases does not exceed $50,000 in the aggregate. Except as disclosed in Schedule 4.08, no additional real property is reasonably necessary to carry on the business of the Companies and their Subsidiaries as currently conducted. (b) Except as disclosed on SCHEDULE 4.08, Sellers have received no written notice from any Governmental Authority that the Owned Real Property, or the use thereof, contravenes or violates any building, zoning, administrative, occupational safety and health or other applicable law in any material respect. (c) Neither Company nor any of its Subsidiaries has received notice of any, default (or any condition or event which, after notice or lapse of time or both, would constitute a default) under any Material Leases. Neither Company nor any of its Subsidiaries owes any brokerage commissions with respect to any such leased space. (d) Except as disclosed on SCHEDULE 4.08, no tenant or other party is in possession of any of the Owned Real Property, or has any right to purchase, or holds any right of first refusal to purchase, such properties. (e) To the Knowledge of Sellers, there are no condemnation or appropriation proceedings pending or threatened against any Owned Real Property. To the Knowledge of Sellers, the Companies and their Subsidiaries hold all material planning, zoning, -22- fire and health and safety certificates, permissions or consents necessary to operate the business in the manner currently conducted. (f) The Sellers have made available in the data room prior to the execution of this Agreement true and complete copies of (i) all deeds, mortgages, deeds of trust, certificates of occupancy, title insurance policies, title reports, surveys and similar documents, and all amendments thereof, with respect to the Owned Real Property, and (ii) all Material Leases (including any amendments and renewal letters) and, to the extent reasonably available, all other related documents. SECTION 4.09. PERMITS; COMPLIANCE WITH LAWS. (a) SCHEDULE 4.09 contains a true and complete list of all material licenses, permits, certificates of authority or accreditation, authorizations, approvals, registrations, franchises and similar consents granted or issued by any Governmental Authority or other Person (collectively, "Licenses") used in the business or operations of each Company and its Subsidiaries (and all pending applications for any such Licenses). Each of the Companies and their respective Subsidiaries has all licenses material to ownership, operation or occupancy of their respective properties and assets and the carrying out of their businesses. Each Company and its Subsidiaries are (i) duly licensed in each jurisdiction where the Company or any Subsidiary currently provides language instruction, and (ii) accredited by an accrediting body that is recognized by, and satisfactory to both the regulatory agency or institution in the jurisdiction where the language instruction is provided and the agency or institution that regulates or administers the distribution of visas in the country where the language instruction is provided, in each case, that such licensing or accreditation is required. The Sellers have made available in the data room prior to the execution of this Agreement true and complete copies of Licenses. (b) Except as set forth on SCHEDULE 4.09, the conduct of the business of each of the Companies and their respective Subsidiaries materially complies and has since the date it was acquired by Sellers with all applicable country, federal, state and local laws and regulations including Environmental Laws. SECTION 4.10. INSURANCE. SCHEDULE 4.10 sets forth a complete and correct list in all material respects of all policies of insurance of any kind or nature covering the Companies and their respective Subsidiaries, and such policies are in full force and effect. Complete and correct copies of each such policy have been furnished or made available to Buyer. Except as set forth on SCHEDULE 4.10, no written notice of cancellation or rate adjustment has been received by the Companies or any of their respective Subsidiaries with respect to any insurance policies, and no such policies are subject to any retroactive rate or audit adjustments or coinsurance arrangements. Each such policy is valid and binding and in full force and effect, and no -23- premiums due thereunder have not been paid. To the Sellers' Knowledge, the insurance policies listed in SCHEDULE 4.10 are in amounts and have coverages that are reasonable and customary for Persons engaged in such businesses and operations and having such assets and properties. Neither Company, no Subsidiary of either Company nor the Person to whom such policy has been issued has received notice that any insurer under any policy referred to in this Section is denying liability with respect to a claim thereunder or defending under a reservation of rights clause. SECTION 4.11. MATERIAL CONTRACTS. (a) Except as listed on SCHEDULE 4.11 or any other schedule hereto, the Companies and their respective Subsidiaries are not a party to any of the following (each, a "MATERIAL CONTRACT" and, collectively, the "MATERIAL CONTRACTS"): (i) material contract not made in the ordinary course of business that obligates the Companies or one of their Subsidiaries to make payments in excess of $50,000 per year; (ii) contract for the employment of any officer or employee; (iii) contract for the future purchase of materials, supplies, services, merchandise or equipment not capable of being fully performed or not terminable within a period of one (1) year from the date hereof or in excess of normal operating requirements; (iv) agreement for the sale or lease of any of its assets other than in the ordinary course of business; (v) contract or commitment for capital expenditures in excess of $50,000; (vi) mortgage, pledge, conditional sales contract, security agreement, factoring agreement, or other similar agreement with respect to any of its real or personal property; (vii) lease of machinery or equipment involving annual payments in excess of $50,000; (viii) agreement with a labor union or labor association; (ix) loan agreement, promissory note issued by it, guarantee, subordination or similar type of agreement; (x) stock option, retirement, severance, pension, bonus, profit sharing, group insurance, medical or other fringe benefit plan or program providing employee benefits; (xi) consulting agreement involving annual payments in excess of $50,000, (xii) contracts with any Person containing any provision or covenant prohibiting or limiting the ability of either Company or any of its Subsidiaries to engage in any business activity or compete with any Person; (xiii) partnership, joint venture, shareholders' or other similar contracts with any Person; (xiv) contracts with representatives and sales agencies; (xv) contracts between or among either Company or any of its Subsidiaries, on the one hand, and either Seller, any officer, director or other Affiliate of Seller, on the other hand; (xvi) contracts that (A) limit or contain restrictions on the ability of either Company or any of its Subsidiaries to declare or pay dividends on, to make any other distribution in respect of or to issue or purchase, redeem or otherwise acquire its capital stock, to incur Indebtedness, to incur or suffer to exist any Encumbrance, to purchase or sell any assets and properties, to change the lines of business in which it participates or engages or to engage in any business combination or other similar transaction or (B) require either Company or any of its Subsidiaries to maintain specified financial ratios or levels of net worth or other indicia of financial condition; or (xvii) contracts relating to Indebtedness of either Company or its Subsidiaries in excess of $50,000 or to preferred stock issued by either Company or its Subsidiaries; -24- (b) Each contract required to be disclosed in SCHEDULE 4.11 is in full force and effect and constitutes a legal, valid and binding agreement, enforceable in accordance with its terms, of each party thereto. Except as set forth on SCHEDULE 4.11, the Companies have not received any written notice that a Company is in default under or has failed to perform all obligations required to be performed under each Material Contract and neither the Companies nor, to the Knowledge of the Sellers, any other party to any Material Contract, is (with or without the lapse of time or the giving of notice or both) in breach or default in any material respect thereunder. The Companies have not been notified that any party to any Material Contract intends to cancel, terminate, not renew or exercise an option under any Material Contract. SECTION 4.12. TITLE TO PROPERTIES; ABSENCE OF ENCUMBRANCES. (a) Except for properties disposed of in the ordinary course of business consistent with past practice, the Companies or one of their respective Subsidiaries owns or has good and marketable title to, or holds by valid and existing lease or license, each piece of personal property currently used by them in, and reasonably necessary to carry on their businesses as presently conducted, free and clear of any and all Encumbrances except (i) as set forth in the ASPECT or Pacific Financial Statements, as the case may be or (ii) for Permitted Encumbrances. (b) The Companies own no investment assets. SECTION 4.13. COMPENSATION; EMPLOYMENT AGREEMENTS. SCHEDULE 4.13 sets forth a list, which is complete and accurate in all material respects, showing all officers and directors of the Companies and their respective Subsidiaries. SCHEDULE 4.13 also sets forth a listing of all employment agreements with such officers and directors and the rate of compensation of each of such Persons as of the Balance Sheet Date. SECTION 4.14. LITIGATION; CONSENTS. Except as disclosed on SCHEDULE 4.14, there is no action, suit, proceeding or formal governmental inquiry or investigation pending or, to the Knowledge of the Sellers, threatened against the Companies (or any Subsidiary) which seeks to restrain or prohibit or otherwise challenges the consummation, legality or validity of the transactions contemplated hereby, or could reasonably be expected to result in any injunction or other equitable relief against either Company or any Subsidiary of either Company that would interfere in any material respect with its business or operations. Except as disclosed on SCHEDULE 4.14 hereto, there is no action, suit, proceeding, formal governmental inquiry or investigation pending or, to the Knowledge of the Sellers, threatened against the Sellers, either Company (or any Subsidiary) involving a potential future payment by such Company (or any Subsidiary) of $30,000, or -25- more, or otherwise material to such Company (or any Subsidiary). Except for compliance with the provisions of the Hart-Scott-Rodino Act and as set forth on SCHEDULE 4.14, no consent, approval or authorization of any Governmental Authority on the part of Sellers, the Companies (or any Subsidiary) is required in connection with the execution and delivery of this Agreement or the consummation of any of the transactions contemplated hereby. SECTION 4.15. COLLECTIVE BARGAINING AGREEMENTS AND LABOR. (a) Except as set forth on SCHEDULE 4.15, to the Sellers' Knowledge, none of the Companies or any of their respective Subsidiaries is a party to any labor or collective bargaining agreement and there are no labor or collective bargaining agreements which pertain to employees of any of the Companies or their Subsidiaries. (b) Except as set forth on SCHEDULE 4.15, to the Knowledge of Sellers, there are no material pending complaints, charges or claims against any of the Companies or their respective Subsidiaries filed with any public or governmental authority, arbitrator or court based upon the employment or termination of employment by such Company or Subsidiary of any individual. SECTION 4.16. EMPLOYEE BENEFIT PLANS; ERISA. (a) SCHEDULE 4.16(a) sets forth a list that is complete and accurate in all material respects, of ASPECT Employee Benefit Plans and Pacific Employee Benefit Plans. SCHEDULE 4.16(a) identifies all ASPECT Employee Benefit Plans and Pacific Employee Benefit Plans that are (i) ASPECT Employee Pension Plans or Pacific Employee Benefit Plans (as the case may be), (ii) plans intended to qualify under Section 401 of the Code, and (iii) ASPECT Welfare Plans or Pacific Welfare Plans (as the case may be), which provide for continuing benefits or coverage for any participant or any beneficiary of a participant after such participant's termination of employment except coverage or benefits required by Part 6 of Title I of ERISA or Section 4980B of the Code if paid 100% by the participant or beneficiary. (b) Except as set forth on SCHEDULE 4.16(b): (i) true, correct and complete copies of the following documents, with respect to ASPECT Employee Benefit Plans and Pacific Employee Benefit Plans, have been made available or delivered to Buyer: (A) all plan documents, including trust agreements, insurance policies and service agreements and amendments thereto, (B) the most recent Forms 5500 and any financial statements attached thereto and those for the prior three years, (C) the last Internal Revenue Service determination letter, (D) summary plan descriptions, (E) the most recent actuarial report and those for the prior three years to the extent in Sellers' possession, and (F) written descriptions of all non-written agreements relating to any such plan; -26- (ii) there are no material pending claims or lawsuits which have been asserted or instituted by or against any of ASPECT Employee Benefit Plans or Pacific Employee Benefit Plans, against the assets of any of the trusts under such plans or by or against the plan sponsor, plan administrator, or any fiduciary of the ASPECT Employee Benefit Plans or Pacific Employee Benefit Plans (other than routine benefit claims) and the Sellers have no Knowledge of any facts which could form the basis for any such claim or lawsuit; (iii) with respect to each Benefit Plan (A) the Companies are in material compliance with the terms of such plan and all applicable laws, rules and regulations governing such plan, including without limitation ERISA and the Code; (B) each such plan intended to be "qualified" within the meaning of Section 401(a) of the Code has received from the Internal Revenue Service a determination letter that the plan is so qualified with respect to all applicable provisions of the Code for which the applicable remedial amendment period has expired and no circumstances exist that could reasonably be expected to result in the revocation of any such determination; and (C) all required contributions which are due have been made and a proper accrual has been made for all contributions due in the current fiscal year; (iv) with respect to each Employee Pension Plan, neither the Sellers nor the Companies have received any written notice that: (A) the Companies or their Subsidiaries have failed to meet the minimum funding standards or to make all contributions required under Section 302 of ERISA and Section 412 of the Code; (B) any accumulated funding deficiency, whether or not waived, exists or any event has occurred or circumstance exists that may result in an accumulated funding deficiency as of the last day of the current plan year for such plan; (C) the Companies or their Subsidiaries have not paid all premiums due to the Pension Benefit Guaranty Corporation under Section 4007 of ERISA; (D) any event has occurred or circumstance exists that could subject the Companies to any liability arising under or based upon any provision of Title IV of ERISA (whether to a governmental agency, a Multiemployer Plan or to any other Person or entity) which could reasonably be expected to have a Material Adverse Effect on the Companies; (E) any transaction or arrangement has occurred that is prohibited under Section 406 of ERISA or is a "prohibited transaction" under Section 4975 of the Code, except exempt transactions or arrangements; and (F) any notice of intent to terminate has been issued nor has any amendment or Board of Directors resolutions been adopted to treat any ASPECT Employee Pension Plan or Pacific Employee Pension Plan as terminated; (v) neither the Sellers nor the Companies have received any written notice that they have incurred any liability under Title IV of ERISA as a result of any withdrawal from a Multiemployer Plan; nor will the transactions contemplated under this Agreement give rise to any such withdrawal liability. Neither the Sellers nor the Companies have received notice from any Multiemployer Plan that the plan is in reorganization or is insolvent, that -27- increased contributions may be required to avoid a reduction in plan benefits or the imposition of any excise tax, or that such plan intends to terminate or has terminated; (vi) none of ASPECT's Employee Benefit Plans or Pacific's Employee Benefit Plans contains any provisions which would prohibit the transactions contemplated by this Agreement or which would give rise to any severance, termination, plant closing or other payments or liabilities as a result of the transactions contemplated by this Agreement; (vii) except with respect to plans maintained pursuant to collective bargaining agreements, each of the ASPECT's Employee Benefit Plans and Pacific's Employee Benefit Plans (including without limitation each such Plan covering retirees of the Companies or any of their Subsidiaries) may be terminated or amended by its sponsoring employer, in any manner and at any time, without the consent of and without any liability to its participants for benefits that may be accrued and expenses that may be incurred after the date of such termination or amendment, assuming the amendment or termination is accomplished in accordance with all applicable laws; and (viii) there has been no announcement or legally binding commitment by the Companies or any of their Subsidiaries to create an additional Benefit Plan or to amend a Employee Benefit Plan except for amendments required by applicable law which do not materially increase the costs of such Employee Benefit Plans. SECTION 4.17. INTELLECTUAL PROPERTY; PERMITS AND INTANGIBLES. The Companies or one of their Subsidiaries owns, or has a valid license to use, all of the patents, trademarks, trade names, service marks, registered copyrights or applications ("Intellectual Property"), which are currently used by them in, or are necessary to enable them to carry on, their businesses as presently conducted. SCHEDULE 4.17 sets forth a complete and correct list of each material patent, trademark, trade name, service mark and registered copyright owned or used by the Companies or one of their Subsidiaries and any registrations and pending applications therefor, and each license or other agreement relating thereto. Except as disclosed in SCHEDULE 4.17, (i) the Companies and their Subsidiaries have the exclusive right to use the Intellectual Property disclosed in SCHEDULE 4.17, (ii) all registrations with and applications to Governmental Authorities in respect of such Intellectual Property are valid and in full force and effect and all taxes and maintenance fees due as of the date hereof have been paid, (iii) except for standard restrictions on the direct or indirect transfer of any contract or interest therein (none of which apply to the transactions contemplated by this Agreement), there are no restrictions on the direct or indirect transfer of any contract, or any interest therein, held by the Companies and their Subsidiaries in respect of such Intellectual Property, (iv) Sellers have made available to Buyer prior to the execution of this Agreement documentation with respect to any invention, process, design, computer program or other know-how or trade secret included in such Intellectual Property, which documentation is accurate in all material respects and reasonably sufficient in detail and content to identify and -28- explain such invention, process, design, computer program or other know-how or trade secret and to facilitate its full and proper use without reliance on the special knowledge or memory of any Person, (v) the Companies and their Subsidiaries have taken reasonable security measures to protect the secrecy, confidentiality and value of their trade secrets, and (vi) to the Knowledge of Sellers, no such Intellectual Property is being infringed by any other Person. Neither the Sellers, the Companies nor any of their Subsidiaries have received notice that they are infringing any Intellectual Property of any other Person, no claim is pending or, to the Knowledge of Sellers, has been made to such effect that has not been resolved and, to the Knowledge of Sellers, neither Company nor any of its Subsidiaries is infringing any Intellectual Property of any other Person. SECTION 4.18. NO BROKERS. Except for Wit SoundView Corporation, whose fees, commissions and expenses are the sole responsibility of Sellers, all negotiations relative to this Agreement and the transactions contemplated hereby have been carried out by Sellers directly with Buyer without the intervention of any Person in such manner as to give rise to any valid claim by any Person against Buyer, the Companies or any of their Subsidiaries for a finder's fee, brokerage commission or similar payment. SECTION 4.19. BANK ACCOUNTS, ETC. SCHEDULE 4.19 sets forth a true and complete list of all bank accounts, safe deposit boxes and lock boxes of each of the Companies and their respective Subsidiaries including, with respect to each such account and lock box, identification of all authorized signatories. SECTION 4.20. BOOKS AND RECORDS. The minute books and other similar records of each Company and its Subsidiaries as made available to Buyer prior to the execution of this Agreement substantially contain a true and complete record, in all material respects, of all action taken at all meetings and by all written consents in lieu of meetings of the stockholders, the boards of directors and committees of the boards of directors of each Company and its Subsidiaries. The stock transfer ledgers and other similar records of each Company and its Subsidiaries as made available to Buyer prior to the execution of this Agreement accurately reflect in all material respects all record transfers prior to the execution of this Agreement in the capital stock of each Company and its Subsidiaries. Except as set forth in SCHEDULE 4.20, neither Company nor any of its Subsidiaries has any of its books and records recorded, stored, maintained, operated or otherwise wholly or partly dependent upon or held by any means (including any electronic, mechanical or photographic process, whether computerized or not) which (including all means of access thereto and therefrom) are not under the exclusive ownership and direct control of either Company or its Subsidiaries. -29- SECTION 4.21. AFFILIATE TRANSACTIONS. Except as disclosed in SCHEDULE 4.21 and except for inter-company borrowing and/or payments in the ordinary course of business consistent with past practice as reflected by the Inter Company Balance account on the balance sheets included in the ASPECT and Pacific Financial Statements, (i) there are no intercompany liabilities between either Company or any of its Subsidiaries, on the one hand, and either Seller or any officer, director or other Affiliate of either Seller, on the other, (ii) neither Seller nor any such officer, director or Affiliate provides or causes to be provided any assets, services or facilities to either Company or its Subsidiaries, (iii) neither Company nor any of its Subsidiaries provides or causes to be provided any assets, services or facilities to either Seller or any such officer, director or Affiliate and (iv) neither Company nor any of its Subsidiaries beneficially owns, directly or indirectly, any investment assets issued by either Seller or any such officer, director or Affiliate. Except as disclosed in SCHEDULE 4.21, each of the liabilities and transactions listed in SCHEDULE 4.21 was incurred or engaged in, as the case may be, on an arm's-length basis. Except as disclosed in SCHEDULE 4.21, since the Balance Sheet Date, all settlements of intercompany liabilities between each Company and its Subsidiaries, on the one hand, and either Seller or any such officer, director or Affiliate, on the other, have been made, and all allocations of intercompany expenses have been applied, in the ordinary course of business consistent with past practice and in a manner consistent with Sections 2.01(a)(iii) and 7.10. SECTION 4.22. NO POWERS OF ATTORNEY. Except as set forth in SCHEDULE 4.22, neither Company nor any of its Subsidiaries has any powers of attorney or comparable delegations of authority outstanding. SECTION 4.23. DISCLOSURE. No representation or warranty contained in this Agreement, and no statement contained in the any Schedule or in any certificate, list or other writing furnished to Buyer pursuant to any provision of this Agreement, contains any untrue statement of a material fact or omits to state a material fact necessary in order to make the statements herein or therein, in the light of the circumstances under which they were made, not misleading. SECTION 4.24. FOREIGN CORRUPT PRACTICES ACT. To the Knowledge of Sellers, neither Company nor any of its Subsidiaries, nor any director, officer or employee has engaged or is engaged in any course of conduct, or is a party to any agreement or involved in any transaction, which has or would give rise to a violation of the Foreign Corrupt Practices Act of 1977 or any other United States statute or regulation governing the conduct of business abroad by corporations having U.S. operations and their subsidiaries. -30- SECTION 4.25. ASPECT FOUNDATION, INC. To the Knowledge of Sellers, Aspect Foundation, Inc. ("ASPECT FOUNDATION") is: (i) duly qualified as a tax-exempt organization under Section 501(c)(3) of the Code, (ii) is in compliance in all material respects with the applicable rules of the IRS related to such tax-exempt organizations, (iii) is in compliance with U.S. Information Agency rules governing foreign exchanges programs and legally capable to issue J-1 visas to prospective exchange students, and (iv) listed by the Commission on Standards for International Educational Travel. To the Knowledge of Sellers, the commission structure currently in place between either Company or any of its Subsidiaries and Aspect Foundation and each other non-profit organization with which either Company or any of its Subsidiaries has entered into agreements, can be maintained in all material respects All of the trustees of Aspect Foundation are listed on SCHEDULE 4.25. SECTION 4.26. SIGNIFICANT AGENTS. SCHEDULE 4.26 sets forth a true, complete and accurate list of the top 20 agents in the U.S., U.K., Australia and Canada based on weeks produced during the period from October 1, 1999 through June 30, 2000 and the number of weeks during such period and the corresponding period in 1999. Except as disclosed in SCHEDULE 4.26, no such agent has ceased or materially reduced its sales or provision of services to either Company or any of their Subsidiaries since June 30, 2000, or to the Knowledge of Sellers, has threatened to cease or materially reduce such sales or provision of services after the date hereof. To the Knowledge of Sellers, no such agent is threatened with bankruptcy or insolvency. SECTION 4.27. ACCOUNTS RECEIVABLE. Except as set forth in SCHEDULE 4.27, the accounts and notes receivable of the Companies and their Subsidiaries reflected as of the Balance Sheet Date included in the Aspect Financial Statements and the Pacific Financial Statements, and all accounts and notes receivable arising subsequent to the Balance Sheet Date, (i) arose from bona fide sales transactions in the ordinary course of business and are payable on ordinary trade terms, (ii) are legal, valid and binding obligations of the respective debtors enforceable in accordance with their terms, (iii) are not subject to any valid set-off or counterclaim, (iv) are collectible in the ordinary course of business consistent with past practice in the aggregate recorded amounts thereof, net of any applicable reserve reflected in the balance sheet included in the Financial Statements, and (v) are not the subject of any actions or proceedings brought by or on behalf of either Company or any Subsidiary. SECTION 4.28. DEFERRED REVENUE. SCHEDULE 4.28 sets forth a complete and accurate list by school of the amounts that represent deferred revenue for each of the Companies and their Subsidiaries as reflected on the -31- balance sheet as of the Balance Sheet Date included in the ASPECT and Pacific Financial Statements. All deferred revenue subsequent to the Balance Sheet Date arose in the ordinary course of business consistent with past practices and was recognized only after the relevant student weeks were performed, and all deferred revenue recorded subsequent to the Balance Sheet Date arose in the ordinary course of business consistent with past practices and represents student weeks for students that have not cancelled their reservations. SECTION 4.29. PREPAID EXPENSES. The prepaid expenses of the Companies and their Subsidiaries reflected on the balance sheet as of the Balance Sheet Date included in the ASPECT and Pacific Financial Statements, and all prepaid expenses made subsequent to the Balance Sheet Date, were paid with respect to bona fide expenses relating solely to the business and operations of the Companies and their Subsidiaries and were paid on an arms' length basis in the ordinary course of business consistent with past practices. SECTION 4.30. GUARANTEES. Except as set forth in SCHEDULE 4.30, none of the liabilities of the Companies and their Subsidiaries incurred in connection with the conduct of their business is guaranteed by or subject to a similar contingent obligation of any other Person, nor has either Company or any of its Subsidiaries guaranteed or become subject to a similar contingent obligation in respect of the liabilities of any customer, supplier or other Person to whom the Companies and their Subsidiaries sell goods or provide services in the conduct of their business or with whom the Companies and their Subsidiaries otherwise has significant business relationships. ARTICLE V REPRESENTATIONS AND WARRANTIES OF THE SELLERS Each Seller hereby represents and warrants to Buyer that, except as otherwise set forth in the schedules referred to in this ARTICLE V OR ARTICLE IV, the following representations and warranties are true and correct (it being understood that the inclusion of any item on a schedule hereto shall not be deemed an acknowledgment that such item is material, and any disclosure set forth on any schedule is deemed to be set forth on all other schedules, to the extent applicable and reasonably apparent): SECTION 5.01. ORGANIZATION AND GOOD STANDING. Sylvan is a corporation, validly existing and in good standing under the laws of the State of Maryland. SLI is a corporation, validly existing and in good standing under the laws of the State of Delaware. ASPECT II is a corporation, validly existing and in good standing under the laws of the Netherlands. -32- SECTION 5.02. TITLE; AGREEMENTS. SLI and Sylvan own and hold of record and beneficially the Shares of ASPECT Common Stock and Pacific Common Stock, respectively, free and clear of any and all Encumbrances or other restrictions on transfer. After the Restructuring, ASPECT owns and holds of record and beneficially the Shares of ASPECT II Common Stock, free and clear of any and all Encumbrances or other restrictions on transfer. Except as set forth on SCHEDULE 5.02 hereto, no Seller is a party to any voting trust, proxy or other agreement or understanding with respect to any capital stock of the Companies or any of their Subsidiaries. Sylvan owns the Advance free and clear of any and all Encumbrances or other restrictions on transfer. SECTION 5.03. EXECUTION AND EFFECT OF AGREEMENT. Each Seller has the full right, power and authority (corporate or otherwise) to execute and deliver this Agreement and the Operative Agreements to which it is a party, to perform its obligations hereunder and thereunder, and to consummate the transactions contemplated hereby and thereby. The execution and delivery of this Agreement and the Operative Agreements to which it is a party by each Seller and the consummation by each Seller of the transactions contemplated hereby and thereby have been duly authorized by all necessary action (corporate or otherwise) and no other proceeding on the part of such Seller is necessary to authorize the execution, delivery and performance of this Agreement and the Operative Agreements to which it is a party and the transactions contemplated hereby and thereby. This Agreement and the Operative Agreements to which it is a party have been duly executed and delivered by each Seller and constitute the legal, valid and binding obligations of such Seller, enforceable against such Seller in accordance with their respective terms, subject to the Bankruptcy and Equity Exceptions. SECTION 5.04. LITIGATION; CONSENTS. Except for compliance with the provisions of the Hart-Scott-Rodino Act and as set forth on SCHEDULE 5.04 hereto, there is no action, suit, proceeding or formal governmental inquiry or investigation pending, or, to the Knowledge of either Seller, threatened against any Seller that seeks to restrain or prohibit or otherwise challenges the consummation, legality or validity of the transactions contemplated hereby or could reasonably be expected to result in any injunction or other equitable relief against either Company or any Subsidiary of either Company that would interfere in any material respect with its business or operations. Except for compliance with the Hart-Scott-Rodino Act and as set forth in SCHEDULE 5.04, no consent, approval or authorization of any Governmental Authority on the part of either Seller is required in connection with the execution and delivery of this Agreement or the consummation of any of the transactions contemplated hereby. -33- SECTION 5.05. RESTRICTIONS. Except for compliance with the provisions of the Hart-Scott-Rodino Act and as set forth on SCHEDULE 5.05 hereto, neither the execution or delivery of this Agreement by either Seller nor the consummation by either Seller of the transactions contemplated hereby will (i) violate in any material respect any statute, regulation, rule, injunction, judgment, order, decree, ruling, charge or restriction of any Governmental Authority applicable to any Seller or any of its assets or properties, or violate in any respect the provisions of the Seller Charter Documents, (ii) except as disclosed in SCHEDULE 5.05, (A) conflict with or result in a violation or breach of, (B) constitute (with or without notice or lapse of time or both) a default under, (C) require Buyer to obtain any consent, approval or action of, make any filing with or give any notice to any Person as a result or under the terms of, (D) result in or give to any Person any right of termination, cancellation, acceleration or modification in or with respect to, or (E) result in or give to any Person any additional rights or entitlement to increased, additional, accelerated or guaranteed payments under, any contract or license to which Seller is a party or by which any of its respective assets and properties is bound, or (iii) constitute a default thereunder, or result in the creation of any Encumbrance upon Seller, the Companies or any of their Subsidiaries or any of their respective assets. ARTICLE VI REPRESENTATIONS AND WARRANTIES OF BUYER Buyer hereby represents and warrants to the Sellers that, except as otherwise set forth in the schedules referred to in this ARTICLE VI, the following representations and warranties are true and correct as of the date hereof (it being understood that inclusion of any item on a schedule hereto shall not be deemed an acknowledgement that such item is material): SECTION 6.01. ORGANIZATION AND GOOD STANDING. Buyer is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation. Buyer has full corporate power and authority to own, use and lease its assets and its properties and carry on its business as it is now being conducted. Buyer is duly qualified to do business as a foreign corporation and is in good standing under the laws of each jurisdiction in which the conduct of its business or the ownership of its assets requires such qualification under applicable law and where a failure to be so qualified or in good standing would not be material to the Buyer. SECTION 6.02. EXECUTION AND EFFECT OF AGREEMENT. Buyer has the full right, power and authority (corporate or otherwise) to execute and deliver this Agreement and the Operative Agreements to which it is a party, to perform its obligations hereunder and thereunder, and to consummate the transactions contemplated -34- hereby and thereby. The execution and delivery of this Agreement and the Operative Agreements to which it is a party by Buyer and the consummation by Buyer of the transactions contemplated hereby and thereby have been duly authorized by all necessary action (corporate or otherwise) on the part of Buyer, and no other proceeding on the part of Buyer is necessary to authorize the execution, delivery and performance of this Agreement and the Operative Agreements to which it is a party, and the transactions contemplated hereby and thereby. This Agreement and the Operative Agreements to which it is a party have been duly executed and delivered by Buyer and constitute the legal, valid and binding obligation of Buyer, enforceable against it in accordance with its terms, subject to the Bankruptcy and Equity Exceptions. SECTION 6.03. RESTRICTIONS. Except for compliance with the provisions of the Hart-Scott-Rodino Act and as set forth in SCHEDULE 6.03 hereto, neither the execution or delivery of this Agreement by Buyer nor the consummation of the transactions contemplated hereby, will (i) violate any statute, regulation, rule, injunction, judgment, order, decree, ruling, charge or restriction of any Governmental Authority, or court to which Buyer or any of its subsidiaries is a party or to which any of them is bound or subject, or violate in any respect the provisions of the Buyer Charter Documents, or (ii) except as disclosed in SCHEDULE 6.03, (A) conflict with or result in a violation or breach of, (B) constitute (with or without notice or lapse of time or both) a default under, (C) require Buyer or any subsidiary of Buyer to obtain any consent, approval or action of, make any filing with or give any notice to any Person as a result or under the terms of, (D) result in or give to any Person any right of termination, cancellation, acceleration or modification in or with respect to, or (E) result in or give to any Person any additional rights or entitlement to increased, additional, accelerated or guaranteed payments under, any contract or license to which Buyer or any subsidiary of Buyer is a party or by which any of their respective assets and properties is bound, or (iii) constitute a default thereunder, or result in the creation of any Encumbrance upon any Buyer, any subsidiary of Buyer or any of their respective assets. SECTION 6.04. LITIGATION; CONSENTS. There is no action, suit, proceeding or formal governmental inquiry or investigation pending, or to the Buyer's Knowledge threatened, against Buyer that seeks to restrain or prohibit or otherwise challenges the consummation, legality or validity of the transactions contemplated hereby or could reasonably be expected to result in any injunction or other equitable relief against Buyer. Except for compliance with the Hart-Scott-Rodino Act and as set forth in SCHEDULE 6.04, no consent, approval or authorization of any Governmental Authority on the part of Buyer is required in connection with the execution and delivery of this Agreement or the consummation of any of the transactions contemplated hereby. -35- SECTION 6.05. INVESTMENT. Buyer is acquiring the Shares for its own investment and not with a view to sale or distribution thereof, except in accordance with applicable law and the terms and conditions of this Agreement. Buyer has no present intention of selling, granting any participation in, or otherwise distributing the Shares except in accordance with applicable law and the terms and conditions of this Agreement. Buyer does not have any contract, undertaking, agreement or arrangement with any Person to sell, transfer or grant participation in the Shares to such Person or any third Person. SECTION 6.06. FINANCIAL ABILITY. Buyer has sufficient cash, available lines of credit or other sources of immediately available funds to enable it to make payment of the Purchase Price and consummate the transactions contemplated hereby. Warburg Pincus has provided Sylvan with a letter, reasonably satisfactory to Sylvan, stating that Warburg Pincus has entered into an agreement to provide financing to Buyer and as a result Buyer shall have sources of immediately available funds to enable it to make payment of the Purchase Price and consummate the transactions contemplated hereby at Closing. SECTION 6.07. NO BROKERS. Except for Equity Ventures, whose fees, commissions and expense are the sole responsibility of Buyer, all negotiations relative to this Agreement and the transactions contemplated hereby have been carried out by Buyer directly with the Sellers without intervention of any Person in such manner as to give rise to any valid claim by any Person against the Sellers for a finder's fee, brokerage commission or similar payment. ARTICLE VII COVENANTS OF THE SELLERS AND BUYER SECTION 7.01. MAINTENANCE OF RECORDS. (a) Following the Closing, each party will afford the other party, its counsel and its accountants, during normal business hours, reasonable access to the books, records and other data relating to the business or condition of the Companies in its possession with respect to periods on and prior to the Closing Date and the right to make copies and extracts therefrom, with respect to (i) the preparation of financial statements or tax returns, (ii) the determination or enforcement of rights and obligations under this Agreement, (iii) compliance with the requirements of any Governmental Authority, (iv) the determination or enforcement of the rights and obligations of any party to this Agreement or any of the Operative Agreements or -36- (v) in connection with any actual or threatened action or proceeding. Further, each party agrees for a period extending six (6) years after the Closing Date not to destroy or otherwise dispose of any such books, records and other data unless such party shall first offer in writing to surrender such books, records and other data to the other party and such other party shall not agree in writing to take possession thereof during the ten (10) day period after such offer is made. (b) If, in order properly to prepare its tax returns, other documents or reports required to be filed with Governmental Authorities or its financial statements or to fulfill its obligations hereunder, it is necessary that a party be furnished with additional information, documents or records relating to the business or condition of the Company not referred to in paragraph (a) above, and such information, documents or records are in the possession or control of the other party, such other party shall use its best efforts to furnish or make available such information, documents or records (or copies thereof) at the recipient's request, cost and expense. Any information obtained by Sellers in accordance with this paragraph shall be held confidential by Seller in accordance with the terms of the Confidentiality Agreement. SECTION 7.02. FURTHER ASSURANCES. The parties hereto agree to execute and deliver, or cause to be executed and delivered, such further instruments or documents or take such other action as may be reasonably necessary to carry out the transactions contemplated hereby. Without limiting the generality of the foregoing, at any time or from time to time after the Closing, Sellers shall execute and deliver to Buyer such other documents and instruments, provide such materials and information and take such other actions as Buyer may reasonably request to more effectively vest title to the Shares in Buyer, and otherwise to cause each Seller to fulfill its obligations under this Agreement and the Operative Agreements to which it is a party. SECTION 7.03. WEBSITE. Prior to the Closing Date, the Companies shall have assigned and transferred to Sylvan the domain name EnglishOne.com, the related Website and other related intellectual property rights associated with this domain name and Website, including and not limited to the technology related to the Website development and any other technology necessary to support or otherwise related to the domain name and Website. As a result of these transactions, the above referenced assets are excluded from the transactions contemplated by this Agreement. Notwithstanding the above, and during the six (6) months following Closing, if any inquiries are received on the EnglishOne Website in respect to student travel business of either Company or any of their Subsidiaries, Sylvan shall refer such inquiry exclusively to Buyer. SECTION 7.04 REGULATORY AND OTHER APPROVALS. -37- Each party will, and will cause its Subsidiaries to, as promptly as practicable (a) take all commercially reasonable steps necessary or desirable to obtain all consents, approvals or actions of, make all filings with and give all notices to Governmental Authorities or any other Person required of it or its Subsidiaries to consummate the transactions contemplated hereby and by the Operative Agreements, (b) provide such other information and communications to such Governmental Authorities or other Persons as such Governmental Authorities or other Persons may reasonably request in connection therewith and (c) cooperate with each other in connection with the performance of its obligations hereunder. Each party will provide prompt notification to the other Party when any such consent, approval, action, filing or notice referred to in clause (a) above is obtained, taken, made or given, as applicable, and will advise the other Party of any communications (and, unless precluded by law, provide copies of any such communications that are in writing) with any Governmental Authority or other Person regarding any of the transactions contemplated by this Agreement or any of the Operative Agreements. SECTION 7.05 NO SOLICITATIONS. Neither Seller will take, nor will it permit the Companies, their Subsidiaries or any Affiliate of the Sellers (or authorize or permit any investment banker, financial advisor, attorney, accountant or other Person retained by or acting for or on behalf of Seller, the Company, the Subsidiaries or any such Affiliate) to take, directly or indirectly, any action to solicit, encourage, receive, negotiate, assist or otherwise facilitate (including by furnishing confidential information with respect to the Companies or any of their Subsidiaries or permitting access to their assets and properties and books and records) any offer or inquiry from any Person concerning a merger or other business combination to which either Company or any of its Subsidiaries is a party or the direct or indirect acquisition of any equity interest in, or a substantial portion of the assets of, either Company or any of its Subsidiaries (an "Acquisition Proposal"). If either Seller, either Company, any Subsidiary of either Company or any such Affiliate (or any such Person acting for or on their behalf) receives from any Person any offer, inquiry or informational request referred to above, Sellers will promptly advise such Person, by written notice, of the terms of this Section and will promptly deliver a copy of such notice to Buyer. This Section 7.05 specifically does not survive the termination of this Agreement. SECTION 7.06 CONDUCT OF BUSINESS. Except as set forth on SCHEDULE 7.06, Sellers will cause each Company and their respective Subsidiaries to conduct business only in the ordinary course consistent with past practice. Without limiting the generality of the foregoing, Sellers will: (a) cause the Companies and their Subsidiaries to use commercially reasonable efforts to (i) preserve intact the present business organization and reputation of the Companies and their Subsidiaries, (ii) keep available (subject to dismissals and retirements in the ordinary -38- course of business consistent with past practice) the services of the present officers, employees and consultants of the Companies and their Subsidiaries, provided, however, that Buyer acknowledges and agrees that the Sellers shall not be required to enter into any retention agreements with such Persons, (iii) maintain the assets and properties of the Companies and their Subsidiaries in good working order and condition, ordinary wear and tear excepted, (iv) maintain the good will of customers, suppliers, lenders and other Persons to whom either Company or any of its Subsidiaries sells goods or provides services or with whom either Company or any of its Subsidiaries otherwise has significant business relationships and (v) continue all current sales, marketing and promotional activities relating to the business and operations of each Company and its Subsidiaries; (b) except to the extent required by applicable law, (i) cause the books and records to be maintained in the usual, regular and ordinary manner, (ii) not permit any change in (A) any pricing, investment, accounting, financial reporting, inventory, credit, allowance or tax practice or policy of either Company or any of its Subsidiaries, or (B) any method of calculating any bad debt, contingency or other reserve of either Company or any of its Subsidiaries for accounting, financial reporting or tax purposes and (iii) not permit any change in the fiscal year of either Company or any of its Subsidiaries; and (c) cause each Company and its Subsidiaries to comply, in all material respects, with all laws and orders applicable to its business and operations, and promptly following receipt thereof to give Buyer copies of any notice received from any Governmental Authority or other Person alleging any violation of any such law or order. SECTION 7.07 FINANCIAL STATEMENTS AND REPORTS. Sellers will deliver to Buyer true and complete copies of all regularly prepared financial statements, reports and analyses as may be prepared or received by Sellers, the Companies or any Subsidiary of either Company relating to the business or operations of the Companies or any of their Subsidiaries. SECTION 7.08 EMPLOYEE MATTERS. After the date hereof and except as may be required by law, Sellers will refrain, and will cause the Companies and their Subsidiaries to refrain, from directly or indirectly: (a) making any representation or promise, oral or written, to any officer, employee or consultant of the Companies or any of their Subsidiaries concerning any Benefit Plan, except for statements as to the rights or accrued benefits of any officer, employee or consultant under the terms of any Benefit Plan; -39- (b) making any increase in the salary, wages or other compensation of any officer, employee or consultant of the Companies or any of their Subsidiaries whose annual salary is, or after giving effect to such change, would be $50,000 or more; (c) adopting, entering into or becoming bound by any Benefit Plan, employment-related contract or collective bargaining agreement, or amending, modifying or terminating (partially or completely) any Benefit Plan, employment-related contract or collective bargaining agreement, except to the extent required by applicable law and, in the event compliance with legal requirements presents options, only to the extent that the least costly option is chosen; or (d) establishing or modifying any (i) targets, goals, pools or similar provisions in respect of any fiscal year under any Benefit Plan, employment-related contract or other employee compensation arrangement or (ii) salary ranges, increase guidelines or similar provisions in respect of any Benefit Plan, employment-related contract or other employee compensation arrangement. SECTION 7.09 CERTAIN RESTRICTIONS. Except as provided for in SCHEDULE 7.09, Sellers will cause each Company and its Subsidiaries to refrain from: (a) amending the Company Charter Documents and the Subsidiary Charter Documents; (b) authorizing, issuing, selling or otherwise disposing of any shares of capital stock of or any Option with respect to either Company or any of its Subsidiaries, or modifying or amending any right of any holder of outstanding shares of capital stock of or Option with respect to either Company or any of its Subsidiaries; (c) declaring, setting aside or paying any dividend or other distribution in respect of its capital stock, or directly or indirectly redeeming, purchasing or otherwise acquiring any of capital stock of either Company or any Subsidiary not wholly owned by either Company or any Option with respect thereto; (d) acquiring or disposing of, or incurring any Encumbrance (other than a Permitted Encumbrance) on, any assets and properties, other than in the ordinary course of business consistent with past practice; (e) (i) entering into, amending, modifying, terminating (partially or completely), granting any waiver under or giving any consent with respect to (A) any Material Contract that would, if in existence on the date of this Agreement, be required to be disclosed in SCHEDULE 4.11 or (B) any material License or (ii) granting any irrevocable powers of attorney; -40- (f) violating, breaching or defaulting under in any material respect, or taking or failing to take any action that (with or without notice or lapse of time or both) would constitute a material violation or breach of, or default under, any term or provision of any License held or used by either Company or any of its Subsidiaries or any Contract to which either Company or any of its Subsidiaries is a party or by which any of their respective assets and properties is bound; (g) except as set forth in Section 7.10, (i) incurring Indebtedness in an aggregate principal amount exceeding $50,000 (net of any amounts of Indebtedness discharged during such period), or (ii) voluntarily purchasing, canceling, prepaying or otherwise providing for a complete or partial discharge in advance of a scheduled payment date with respect to, or waiving any right of either Company or any of its Subsidiaries under, any Indebtedness of or owing to either Company or any of its Subsidiaries; (h) engaging with any Person in any merger or other business combination; (i) making capital expenditures or commitments for additions to property, plant or equipment constituting capital assets in an aggregate amount exceeding $200,000; (j) making any change in the lines of business in which they participate or are engaged; (k) writing off or writing down any of their assets and properties outside the ordinary course of business consistent with past practice; (l) entering into any transaction with, or making any payment to or on behalf of any Seller, any officer, director or affiliate (other than either Company or one of its Subsidiaries) of Seller other than pursuant to any contract or other arrangement in effect on the Balance Sheet Date; or (m) entering into any contract to do or engage in any of the foregoing. SECTION 7.10 AFFILIATE TRANSACTIONS. Prior to the Closing, neither Company nor any of its Subsidiaries will enter into any contract or amend or modify any existing contract, and will not engage in any transaction outside the ordinary course of business consistent with past practice or not on an arm's-length basis, with Sellers or any such officer, director or Affiliate. For the period beginning at the close of business on the Balance Sheet Date and ending on the Closing Date, Sylvan will continue to fund those operating expenses of the Companies and their Subsidiaries that Sylvan has been funding in the ordinary course of business consistent with past practice in nature and amount, including without limitation, all employee payroll, lease rental payments, telephone -41- and telecopy expenses, and other operating expenses, all of which shall constitute a part of the Advance. SECTION 7.11. BOOKS AND RECORDS. On the Closing Date, Sellers will deliver or make available to Buyer at the offices of the Companies and their Subsidiaries all of their books and records, and if at any time after the Closing Sellers discover in their possession or under their control any other books and records of the Companies and their Subsidiaries, they will forthwith deliver such books and records to Buyer. SECTION 7.12 NONCOMPETITION. (a) Sellers will, for a period of two (2) years after the Closing Date, refrain from, either alone or in conjunction with any other Person, or directly or indirectly, through its present or future Affiliates, by referral, or otherwise: (i) employing, engaging or seeking to employ or engage any Person who within the prior twelve (12) months had been an officer or employee of either Company or one of its Subsidiaries, unless such officer or employee (A) resigns voluntarily (without any solicitation from Sellers or any of its Affiliates), (B) is listed on SCHEDULE 7.12, or (C) is terminated by the Companies or their Subsidiaries after the Closing Date; (ii) causing or attempting to cause (A) any agent, client, customer or supplier of either Company or any of its Subsidiaries to terminate or materially reduce its business with the Companies and their Subsidiaries or (B) any officer, employee, agent or consultant of the Companies or any of their Subsidiaries to resign or sever a relationship with the Companies or their Subsidiaries; (iii) disclosing (unless compelled by judicial or administrative process) or using any confidential or secret information relating to the Companies or any of their Subsidiaries or any of their respective clients, customers or suppliers; or (iv) participating or engaging in (other than through the ownership of five percent (5%) or less of any class of securities registered under the Securities Exchange Act of 1934, as amended) the business of the Companies as conducted on the date hereof, which for purposes of this Section 7.12(a)(iv) shall mean the student travel business having as a component English language instruction in any jurisdiction in which the Companies or their Subsidiaries participate or engage in such line of business on the Closing Date. -42- (b) The parties hereto recognize that the laws and public policies of the various states of the United States may differ as to the validity and enforceability of covenants similar to those set forth in this Section. It is the intention of the parties that the provisions of this Section be enforced to the fullest extent permissible under the laws and policies of each jurisdiction in which enforcement may be sought, and that the unenforceability (or the modification to conform to such laws or policies) of any provisions of this Section shall not render unenforceable, or impair, the remainder of the provisions of this Section. Accordingly, if any provision of this Section shall be determined to be invalid or unenforceable, such invalidity or unenforceability shall be deemed to apply only with respect to the operation of such provision in the particular jurisdiction in which such determination is made and not with respect to any other provision or jurisdiction. SECTION 7.13 NOTICE AND CURE. Each party will notify the others in writing of, and contemporaneously will provide true and complete copies of any and all information or documents relating to, and will use all commercially reasonable efforts to cure before the Closing, any event, transaction or circumstance, as soon as practicable after it becomes known to such party, occurring after the date of this Agreement that causes or will cause any covenant or agreement of such party under this Agreement to be breached or that renders or will render untrue any representation or warranty of such party contained in this Agreement as if the same were made on or as of the date of such event, transaction or circumstance. No notice given pursuant to this Section shall have any effect on the representations, warranties, covenants or agreements contained in this Agreement for purposes of determining satisfaction of any condition contained herein or shall in any way limit such party's right to seek indemnity hereunder. SECTION 7.14 FULFILLMENT OF CONDITIONS. Each party will execute and deliver at the Closing each Operative Agreement that it is required hereby to execute and deliver as a condition to the Closing, will take all commercially reasonable steps necessary or desirable and proceed diligently and in good faith to satisfy each condition to its Closing obligations contained in this Agreement and will not knowingly, directly or indirectly, take or fail to take any action that could reasonably be expected to result in the nonfulfillment of any such condition. SECTION 7.15 INVESTIGATION BY BUYER. Sellers will, and will cause the Companies and their Subsidiaries to, (a) provide Buyer and Warburg Pincus, who is providing financing to Buyer to finance the Purchase Price and their respective officers, directors, employees, agents, counsel, accountants, financial advisors, consultants and other Representatives with full access, upon reasonable prior notice and during normal business hours, to all officers, employees, agents and accountants of the Companies and their Subsidiaries and their assets and properties and books and records, and -43- (b) furnish Buyer and such other Persons with all such information and data (including without limitation copies of contracts, Benefit Plans and other books and records) concerning the business and operations of the Companies and their Subsidiaries as Buyer or any of such other Persons reasonably may request in connection with such investigation. ARTICLE VIII SURVIVAL OF REPRESENTATIONS AND WARRANTIES SECTION 8.01. SURVIVAL OF REPRESENTATIONS AND WARRANTIES. Notwithstanding any right of Buyer (whether or not exercised) to investigate the affairs of the Companies and their respective Subsidiaries or any right of any party (whether or not exercised) to investigate the accuracy of the representations and warranties of the other party contained in this Agreement, Sellers and Buyer have the right to rely upon the representations, warranties, covenants and agreements of the other contained in this Agreement. The parties hereto agree that the representations and warranties and the covenants and agreements contained in this Agreement or in any certificate, document or instrument delivered in connection herewith, shall survive the execution and delivery of this Agreement, and the Closing hereunder, regardless of any investigation made by the parties hereto; PROVIDED, HOWEVER, that any claims or actions with respect thereto shall terminate unless within eighteen (18) months from the Closing Date written notice of such claims is given to the Sellers, in the case of claims made pursuant to Section 9.01 hereof, or to Buyer, in the case of claims made pursuant to Section 9.02 hereof, or such actions are commenced within such eighteen (18) month period; PROVIDED FURTHER, that any claims or actions by Buyer in respect to (a) the representations and warranties dealing with Taxes set forth in Sections 4.07 and 4.16 (insofar as they relate to ERISA, the Code or other comparable foreign provisions) shall survive until sixty (60) days after the expiration of the applicable statute of limitations with respect to the Tax or ERISA matters in question (giving effect to any waiver, mitigation or extension thereof); (b) (i) the representations and warranties contained in Sections 4.02 and 4.03 that relate only to stock ownership and the representations and warranties contained in Sections 4.18 and 6.07 and (ii) the covenants and agreements contained in Sections 7.02, 14.01 and 14.03 shall survive indefinitely; and (c) each other covenant or agreement contained in this Agreement to be performed in whole or in part after the Closing shall survive until sixty (60) days following the last date on which such covenant or agreement would reasonably be performed and PROVIDED FURTHER, that nothing in this ARTICLE VIII shall (a) limit the indemnification obligations of the parties under ARTICLES IX AND X with respect to claims timely made or actions timely commenced in accordance with the provisions of ARTICLES VIII, IX AND X or (b) limit Buyer's or Sellers' obligations pursuant to ARTICLE XIII of this Agreement. -44- ARTICLE IX INDEMNIFICATION SECTION 9.01. BY THE SELLERS. Each Seller agrees to indemnify and hold Buyer and its Affiliates and Representatives harmless from and against any and all losses, claims, demands, liabilities, obligations, damages, deficiencies, assessments, judgments, payments, penalties, costs and expenses (including without limitation reasonable attorneys' fees, any amounts paid in investigation, defense or settlement of any of the foregoing and interest) (herein, "DAMAGES") incurred by the Buyer, or any of their respective Affiliates or Representatives, in connection with, arising out of, resulting from or incident to, (a) any breach of the representations and warranties, (i) in the case of SLI, made by it, and (ii) in the case of Sylvan, made by it and/or SLI, in each case as set forth in ARTICLES IV AND V hereof or on the schedules or certificates delivered in connection herewith, or (b) any breach of any covenant or agreement (i) in the case of SLI, made by it, and (ii) in the case of Sylvan, made by it and/or SLI, in each case as set forth in this Agreement. For purposes of this Section 9.01, and in respect to the determination of Damages only, the amount of Damages shall be determined in all cases as if the terms "material" or "materially" were not included in the representations, warranties, covenants and agreements of either Seller contained in this Agreement. SECTION 9.02. BY BUYER. Buyer agrees to indemnify and hold each of the Sellers (whether in their capacity as an individual, entity, trust, director, officer or otherwise) and their Affiliates and Representatives harmless from and against any and all Damages incurred by the Sellers or any of their respective Affiliates or Representatives in connection with, arising out of, resulting from or incident to, (a) any breach of the representations and warranties of the Buyer set forth in ARTICLE VI hereof or on the schedules or certificates delivered in connection herewith, or (b) any breach of any covenant or agreement made by Buyer in this Agreement. SECTION 9.03. EXCLUSIVE REMEDY. Except as set forth in ARTICLE XIII, the rights of indemnification provided to Buyer and the Sellers in this ARTICLE IX AND ARTICLE X are intended to be the sole remedies of such parties -45- for any claim by either Buyer against the Sellers or by the Sellers against Buyer, and the parties intend, to the maximum possible extent, to preclude any other claims, on whatever cause of action predicated. SECTION 9.04. LIMITATIONS ON INDEMNIFICATION. (a) In addition to any other limitations described herein, the Persons or entities indemnified pursuant to ARTICLE IX shall not assert any claim for indemnification hereunder until such time as, and solely to the extent that, the aggregate of all claims which such Persons may have shall exceed $500,000 in which event such indemnification shall be effective, dollar for dollar, with respect to all Damages; PROVIDED, HOWEVER, that the aggregate amount of such Damages thereafter shall in no case exceed the Purchase Price; PROVIDED FURTHER, HOWEVER, that this Section shall not apply to claims of or relating to fraud or willful misrepresentation or willful misconduct by any party or to any breach of Sections 4.02, 4.03 or 5.02 that relate only to stock ownership and Sections 4.18 or 6.07 or a breach of the covenants and agreements set forth in Sections 7.06, 7.09, 7.10 and 14.03. (b) If the Buyer is the indemnified party, the amount of any indemnification under this Agreement shall be reduced by any insurance proceeds paid to the Companies or the Buyer, as the case may be, as a result of such Damages. The indemnified party shall be obligated to submit to its insurance carrier all coverable claims and pursue such claims against its insurance carrier in good faith. In addition, if the Buyer is the indemnified party, the Buyer shall be obligated to use its Best Efforts to cause the Companies to submit to its insurance carrier all coverable claims and pursue such claims against its insurance carrier in good faith. SECTION 9.05. DEFENSE OF CLAIMS; THIRD PERSON CLAIMS. (a) If a claim for Damages (a "CLAIM") is to be made by a party entitled to indemnification hereunder (an "Indemnified Party") against the indemnifying party (the "Indemnifying Party"), the party claiming such indemnification shall, give prompt written notice (a "CLAIM NOTICE") to the Indemnifying Party as soon as practicable after the Indemnified Party becomes aware of any fact, condition or event which may give rise to Damages for which indemnification may be sought under this ARTICLE IX. Such Claim Notice shall specify the nature and amount of the Claim asserted, if actually known to the party entitled to indemnification hereunder. The failure of any Indemnified Party to give prompt written notice hereunder shall not affect rights to indemnification hereunder, except to the extent that the Indemnifying Party demonstrates actual damage caused by such failure. After such notice, if the Indemnifying Party shall acknowledge in writing to the Indemnified Party that the Indemnifying Party shall be obligated under the terms of its indemnity hereunder or fails to notify the Indemnified Party within 30 days of its receipt of a Claim Notice hereunder (the "Dispute Period") whether the Indemnifying Party disputes the Claim described in such Claim Notice, the Damages arising from the Claim specified in such Claim Notice will be -46- conclusively deemed a liability of the Indemnifying Party under this ARTICLE IX and the Indemnifying Party shall pay the amount of such Damages to the Indemnified Party on demand following the final determination thereof. If the Indemnifying Party has timely disputed its liability with respect to such Claim, the Indemnifying Party and the Indemnified Party will proceed in good faith to negotiate a resolution of such dispute, and if not resolved through negotiations within the period ending thirty (30) days following receipt by an Indemnified Party of a written notice from an Indemnifying Party stating that it disputes all or any portion of a Claim set forth in a Claim Notice (the "Resolution Period"), such dispute shall be resolved by litigation in a court of competent jurisdiction. (b) In the event that any action, suit, proceeding or investigation relating hereto or to the transactions contemplated by this Agreement is commenced, the parties hereto agree to reasonably cooperate to defend against and respond thereto and make available to each other such personnel, witnesses, books, records, documents or other information within its control that are reasonably necessary or appropriate for such defense. (c) Promptly after the Indemnified Party has received notice of or has Knowledge of any Claim by a Person not a party to this Agreement ("THIRD PERSON"), or of the commencement of any action or proceeding by a Third Person, the Indemnified Party shall give the Indemnifying Party prompt written notice of such claim or the commencement of such action or proceeding. Such notice shall state the nature and the basis of such claim and a reasonable estimate of the amount thereof. If the Indemnified Party fails to provide the notice with reasonable promptness after the Indemnified Party receives notice of a claim by a Third Person, the Indemnifying Party will not be obligated to indemnify the Indemnified Party with respect to such Third Person claim to the extent that the Indemnifying Party's ability to defend has been irreparably prejudiced by such failure of the Indemnified Party. The Indemnifying Party will notify the Indemnified Party as soon as practicable within the Dispute Period whether the Indemnifying Party disputes its liability to the Indemnified Party under this ARTICLE IX. The Indemnifying Party shall have the right to defend and settle, at its own expense and by its own counsel reasonably acceptable to the Indemnified Person, any such matter so long as the Indemnifying Party pursues the same in good faith and diligently, PROVIDED THAT the Indemnifying Party shall not settle any proceeding without the written consent of the Indemnified Party, such consent not to be unreasonably withheld or delayed. If the Indemnifying Party undertakes to defend or settle, it shall promptly notify the Indemnified Party of its intention to do so, and the Indemnified Party shall reasonably cooperate, at the Indemnifying Party's expense, with the Indemnifying Party and its counsel in the defense thereof and in any settlement thereof. If the Indemnifying Party desires to accept a final and complete settlement of any such Third Person claim and the Indemnified Party refuses to consent to such settlement, then the Indemnifying Party's liability under this Section with respect to such Third Person claim shall be limited to the amount so offered in settlement to said Third Person plus all indemnifiable costs and expenses incurred to date, the Indemnifying Party shall be relieved of its duty to defend and shall tender the Third Person claim back to the Indemnified Party, who shall thereafter, at its own expense, be responsible for the defense and -47- negotiation of such Third Person claim. If the Indemnifying Party does not undertake within the Dispute Period to defend such matter to which the Indemnified Party is entitled to indemnification hereunder, or fails diligently to pursue such defense, the Indemnified Party may undertake such defense through counsel of its choice, at the cost and expense of the Indemnifying Party, and the Indemnified Party may settle such matter, and the Indemnifying Party shall reimburse the Indemnified Party for the amount paid in such settlement and any other liabilities or expenses incurred by the Indemnified Party in connection therewith, PROVIDED, HOWEVER, that under no circumstances shall the Indemnified Party settle any Third Person claim without the written consent of the Indemnifying Party, which consent shall not be unreasonably withheld or delayed. The Indemnified Party may retain separate counsel to represent it in, but not control, any defense or settlement of any Third Person claim controlled by the Indemnifying Party pursuant to this paragraph, and the Indemnified Party will bear its own costs and expenses with respect to such separate counsel, except that the Indemnifying Party will pay the costs and expenses of such separate counsel if (x) in the Indemnified Party's good faith judgment, it is advisable, based on advice of counsel, for the Indemnified Party to be represented by separate counsel because a conflict or potential conflict exists between the Indemnifying Party and the Indemnified Party which makes representation of both parties inappropriate under applicable standards of professional conduct or (y) the named parties to such Third Person claim include both the Indemnifying Party and the Indemnified Party and the Indemnified Party determines in good faith, based on advice of counsel, that defenses are available to it that are unavailable to the Indemnifying Party. Notwithstanding the foregoing, the Indemnified Party may retain or take over the control of the defense or settlement of any Third Person claim the defense of which the Indemnifying Party has elected to control if the Indemnified Party irrevocably waives its right to indemnity under this ARTICLE IX with respect to such Third Person claim. ARTICLE X TAX MATTERS AND POST-CLOSING TAXES SECTION 10.01. PAYMENT OF TAXES. Sellers shall timely pay, and Sellers shall indemnify and hold Buyer harmless for, all Transfer Taxes. (a) Sellers shall prepare and file, or cause to be prepared and filed, all Tax Returns of or which include the Companies and their Subsidiaries (including any amendments thereto) with respect to a Pre-Closing Period. Notwithstanding anything to the contrary in this Agreement, except to the extent attributable to actions of the Buyer and its Affiliates, Sellers shall pay and shall indemnify and hold Buyer harmless from and against any and all Taxes with respect to the Companies and their Subsidiaries for a Pre-Closing Period, including, without limitation, (A) any Taxes imposed on either Company or any of its Subsidiaries pursuant to Treasury Regulations Section 1.1502-6 (or any similar provision of state, local or -48- foreign law) as a result of being a member of any consolidated tax group prior to the Closing Date, (B) any Tax which is determined by income or earned surplus attributable to a Pre-Closing Period, and (C) any Taxes imposed on the direct or indirect stockholders of Buyer attributable to actions taken by the Companies or their Subsidiaries prior to the Closing. Buyer shall prepare and file, or cause to be prepared and filed, all Tax Returns of or which include the Companies and their Subsidiaries, and shall pay and shall indemnify and hold Sellers harmless from and against all Taxes attributable to the actions of Buyer and its Affiliates, as well as all Taxes with respect to the Tax Returns for all taxable periods other than a Pre-Closing Period, except to the extent provided in the preceding sentence and in the second sentence of Section 10.01(b). (b) For purposes of Section 10.01(a) and this Section 10.01(b), if, for foreign, federal, state or local tax purposes, the taxable period of either Company or its Subsidiaries that includes the Closing Date does not terminate on the Closing Date (a "Straddle Period"), the parties hereto will, to the extent permitted by applicable law, elect with the relevant Governmental Authority to treat a portion of any such Straddle Period as a short taxable period ending as of the Closing Date and such short taxable period shall be treated as a Pre-Closing Period for purposes of this Agreement. In any case where applicable law does not permit such an election to be made, then, for purposes of this Agreement, Taxes with respect to the Companies and their Subsidiaries for the Straddle Period shall be allocated to the Pre-Closing Period using an interim closing-of-the-books method that complies with Treasury Regulations Section 1.1502-76(b)(2)(i) (assuming that such taxable period ended on the Closing Date) and treating such period as a Pre-Closing Period for purposes of this Agreement, except that (A) exemptions, allowances or deductions that are calculated on an annual basis (such as the deduction for depreciation) shall be apportioned on a per diem basis, and (B) real property taxes shall be allocated in accordance with Section 164(d) of the Code. In the case of any Straddle Period described in the preceding sentence, Buyer shall provide Sellers and their authorized representatives with copies of the completed Tax Return for such period and a statement certifying the amount of Taxes shown on such Tax Return that are chargeable to Sellers (the "Tax Statement") at least 30 days prior to the due date for the filing of such Tax Return (including any extension thereof), and Sellers and their authorized representatives shall have the right to review such Tax Return and Tax Statement prior to the filing of such Tax Return. Buyer will consider in good faith any issues arising as a result of the review of such Tax Return and Tax Statement by Sellers or their authorized representatives. Not later than five days before the due date (including any extensions thereof) for payment of Taxes with respect to such Tax Return, Sellers shall pay to Buyer an amount equal to the Taxes shown on the Tax Statement as being chargeable to Sellers pursuant to this Section 10.01(b). For avoidance of doubt, the Tax Statement shall not include, and Buyer shall indemnify and hold Sellers harmless from and against, all Taxes attributable to the actions of Buyer and its Affiliates. -49- SECTION 10.02. POST-CLOSING AUDITS AND OTHER PROCEEDINGS. In the case of an audit, examination or other proceeding ("Proceeding") with respect to Taxes for which Sellers may be liable pursuant to this Agreement, Buyer shall promptly inform Sellers, and Buyer shall execute or cause to be executed powers of attorney or other documents necessary to enable Sellers to take such actions desired by Sellers consistent with the terms of this Agreement with respect to such Proceeding to the extent such Proceeding may affect the amount of Taxes for which Sellers are liable pursuant to this Agreement. Sellers shall have the right to control any such Proceedings. All costs and expenses incurred in connection with any such Proceeding shall be borne by Sellers, and Buyer and the Companies shall be reimbursed by Sellers for any and all reasonable out of pocket expenses, including the costs and expenses of legal counsel and accountants, incurred by them in connection with such Proceeding. Sellers will not settle any Proceeding without first presenting to Buyer Sellers' written promise to pay the costs of settling such Proceeding and then obtaining Buyer's prior written consent. In the event that Buyer's consent is withheld, Buyer will assume the control, costs and expenses of the Proceeding. If such Proceeding is ultimately resolved by payment of an amount in excess of the amount in the original settlement proposal, Buyer will pay the amount of such excess to Sellers. If such Proceeding is ultimately resolved by payment of an amount less than the amount of the original settlement proposal (or a refund or credit in an amount greater than the original settlement proposal), Sellers will reimburse Buyer for its costs and expenses to the extent of such differences. SECTION 10.03. TAX MATTERS. (a) The Shares are being transferred to Buyer free and clear of any and all Encumbrances of any nature for Taxes, except Liens for Taxes not yet due, and Sellers shall indemnify Buyer against any such Liens for Taxes in accordance with the provisions of ARTICLE IX. (b) On or before thirty (30) days prior to the income tax return filing deadline of Sellers for the period that takes into account the transactions contemplated herein, as extended, Buyer will propose and negotiate in good faith with Sellers to determine a mutually agreeable allocation of the Aspect II Purchase Price. Each party agrees (i) that any such allocation shall be consistent with the requirements of applicable law, (ii) to file all forms and Tax Returns consistent with such allocation and (iii) not to take any position on any Tax Return before any Governmental Entity that is in any manner inconsistent with the terms of any such allocation without the consent of the other parties. SECTION 10.04. TERMINATION OF PRIOR TAX SHARING AND TAX SETTLEMENT AGREEMENTS. Any tax sharing agreement to which either Company or its Subsidiaries is a party shall terminate as of the Closing Date and will have no further effect for any taxable year. Any tax settlement agreements, arrangements, policies or guidelines, formal or informal, express or -50- implied that may exist between either Company and Sellers or any affiliate of Sellers (a "Settlement Agreement"), shall terminate as of the Closing Date and any obligations to make payments under any Settlement Agreement shall be canceled as of the Closing Date. ARTICLE XI INTENTIONALLY OMITTED ARTICLE XII TERMINATION SECTION 12.01. TERMINATION. This Agreement may be terminated, and the transactions contemplated hereby may be abandoned: (a) at any time before the Closing, by mutual written agreement of Sellers and Buyer; (b) at any time before the Closing, by Sellers or Buyer, in the event (i) of a material breach hereof by the non-terminating party if such non-terminating party fails to cure such breach within ten (10) Business Days following notification thereof by the terminating party or (ii) upon notification of the non-terminating party by the terminating party that the satisfaction of any condition to the terminating party's obligations under this Agreement becomes impossible or impracticable with the use of commercially reasonable efforts if the failure of such condition to be satisfied is not caused by a breach hereof by the terminating party; or (c) at any time after October 22, 2000 by Sellers or Buyer upon notification of the non-terminating party by the terminating party if the Closing shall not have occurred on or before such date and such failure to consummate is not caused by a breach of this Agreement by the terminating party. SECTION 12.02. EFFECT OF TERMINATION. If this Agreement is validly terminated pursuant to Section 12.01, this Agreement will forthwith become null and void, and there will be no liability or obligation on the part of Sellers or Buyer (or any of their respective officers, directors, employees, agents or other Representatives or Affiliates), except as provided in the next succeeding sentence and except that the provisions with respect to expenses in Section 14.03 and confidentiality in Section 14.01 will continue to apply following any such termination. Notwithstanding any other -51- provision in this Agreement to the contrary, upon termination of this Agreement pursuant to Section 12.01(b) or (c), Sellers will remain liable to Buyer for any willful breach of this Agreement by Seller existing at the time of such termination, and Buyer will remain liable to Sellers for any willful breach of this Agreement by Buyer existing at the time of such termination, and Sellers or Buyer may seek such remedies, including damages and fees of attorneys, against the other with respect to any such breach as are provided in this Agreement or as are otherwise available at law or in equity. ARTICLE XIII SPECIFIC PERFORMANCE SECTION 13.01. SPECIFIC PERFORMANCE. The parties hereto acknowledge that irreparable damage would result if this Agreement is not specifically enforced. Therefore, the rights and obligations of the parties under the Agreement, including, without limitation, their respective rights and obligations to sell and purchase the Shares, shall be enforceable by a decree of specific performance issued by any court of competent jurisdiction, and appropriate injunctive relief may be applied for and granted in connection therewith. Such remedies shall, however, be cumulative and not exclusive and shall be in addition to any other remedies which any party may have under this Agreement or otherwise. ARTICLE XIV GENERAL PROVISIONS SECTION 14.01. CONFIDENTIALITY; PRESS RELEASES. (a) The parties agree that this Agreement and the Operative Agreements are confidential and shall not be disclosed unless disclosure is legally compelled as being required by law or recognized regulatory authority or unless written approval is obtained from the other party. In addition, the obligations of the parties under the Confidentiality Agreement dated June 7, 2000 between Sylvan and an Affiliate of Buyer (the "Confidentiality Agreement") shall survive the Closing Date in accordance with its terms; PROVIDED that following the Closing the restrictions will not apply to Buyer's use of documents and information concerning the Companies and their Subsidiaries furnished by Sellers hereunder or under the Confidentiality Agreement. (b) At all times at or before the Closing, neither the Buyer, nor any of the Sellers or their Subsidiaries shall make any press release or public announcement or generally to the employees, customers, suppliers or other Persons to whom either Company or any of its Subsidiaries sells goods or provides services or with whom either Company or any of its -52- Subsidiaries otherwise has significant business relationships in connection with this Agreement or the transactions contemplated hereby without prior written consent of the other parties or, if required by law, without prior consultation with the other parties. In addition, the parties shall agree on the content, form and timing of any such press release or public announcement. Sellers and Buyer will also obtain the other party's prior approval of any press release to be issued immediately following the Closing announcing the consummation of the transactions contemplated by this Agreement (or, if required by law, with prior consultation with the other parties). In no event will any press release or public announcement by Sellers contain any negative or derogatory comments about either Company or its businesses. SECTION 14.02. NO RELIANCE ON OTHER INFORMATION. Except for the representations and warranties contained in this Agreement, none of the parties hereto nor any Representative or Affiliate or other Person acting for any of them makes any other representation or warranty, express or implied. SECTION 14.03. EXPENSES. Whether or not the transactions contemplated hereby are consummated, (a) each party shall pay all of its legal, accounting, and other out-of-pocket expenses incident to the negotiation, execution and closing of this Agreement, the Operative Agreements and transactions contemplated hereby and (b) the Sellers shall pay the respective legal, accounting and other out-of-pocket expenses of the Companies and their respective Subsidiaries incident to the negotiation, execution and closing of this Agreement, the Operative Agreements and transactions contemplated hereby. As the acquiring party the Buyer shall pay the filings fees associated with the Hart-Scott-Rodino filings. SECTION 14.04. NOTICES. Any notices or other communications required or permitted hereunder, shall be sufficiently given if in writing and personally delivered or sent by pre-paid first class mail, overnight courier, telex or facsimile, addressed as follows or to such other address as the parties shall have given notice of pursuant hereto: In the case of Buyer: Optagon Holdings Limited 46 Crawford Street London, W1Hoover's 1HA Attention: David Jones Telecopy: 011-44-207-723-9396 -53- With a copy to: Sadis & Goldberg, LLC 463 Seventh Avenue, 16th Floor New York, New York 10018 Attention: Crayton L. Bell Telecopy: (212) 947-3796 In the case of the Sellers: Sylvan Learning Systems, Inc. 1000 Lancaster Street Baltimore, Maryland 21201 Attention: B. Lee McGee Robert Zentz, Esq. Telecopy: (410) 843-8060 With a copy to: Piper Marbury Rudnick & Wolfe LLP 6225 Smith Avenue Baltimore, Maryland 21209-3600 Attention: Herbert D. Frerichs, Jr., Esquire Telecopy: (410) 580-3001 All such notices an communications shall be deemed to have been duly given: when personally delivered; upon receipt, if deposited in the mail, as aforesaid; upon receipt, if by overnight courier; when answered back, if telexed; and when receipt is acknowledged, if transmitted by facsimile. Any party from time to time may change its address, facsimile number or other information for the purpose of notices to that party by giving notice specifying such change to the other party hereto. SECTION 14.05. ENTIRE AGREEMENT. This Agreement together with all exhibits and schedules hereto and the Operative Agreements and the Confidentiality Agreement represent the entire understanding and agreement among the parties hereto with respect to the subject matter hereof and supersede all prior understandings and agreements, whether written or oral, and can be amended, supplemented or changed, and any provision hereof can be waived, only by written instrument making specific reference to this Agreement signed by the party against whom enforcement of any such amendment, supplement, modification or waiver is sought. Notwithstanding the foregoing, following the Closing the Confidentiality Agreement will not apply to Buyer's use of any documents or -54- information solely concerning the Companies or their respective Subsidiaries. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provision hereof (whether or not similar), nor shall such waiver constitute a continuing waiver unless otherwise expressly provided. SECTION 14.06. SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and assigns; provided, however, that this Agreement and all rights and obligations hereunder may not be assigned or transferred without the prior written consent of the other parties hereto except as follows: (a) assignments and transfers that occur by operation of law; (b) to the extent necessary and upon the completion of the Restructuring by Sylvan, SLI may assign any or all of its rights, interests and obligations hereunder to ASPECT (which at the time will own all the issued and outstanding shares of ASPECT II, a newly formed entity that has succeeded to all the assets and liabilities of ASPECT); and (c) that Buyer may assign any or all of its rights, interests and obligations hereunder to (i) a wholly-owned Subsidiary, provided that any such Subsidiary agrees in writing to be bound by all of the terms, conditions and provisions contained herein and such Subsidiary has the financial wherewithal to close the transactions contemplated hereby, (ii) any post-Closing purchaser of all of the issued and outstanding stock of either Company or a substantial part of its assets or (iii) any financial institution providing purchase money or other financing to Buyer or either Company (including its Subsidiaries) from time to time as collateral security for such financing. Notwithstanding any permitted assignment of this Agreement by Buyer or Sellers, (i) Sellers shall remain liable to Buyer for all obligations and liabilities to be performed by or on behalf of Sellers hereunder with respect to Buyers and all assignees of Sellers shall be jointly liable with Sellers as to all obligations of Sellers hereunder and (ii) Buyer shall remain liable to Sellers for all obligations and liabilities to be performed by or on behalf of Buyer hereunder with respect to Sellers and all assignees of Buyer shall be jointly liable with Buyer as to all obligations of Buyer hereunder. Notwithstanding the foregoing, the parties hereto agree to cooperate with each other to optimize the tax efficiency of the transactions contemplated hereby provided that such optimization satisfies the mutual objectives of Sellers and Buyer. SECTION 14.07. CHOICE OF LAW. (a) This Agreement shall be construed, interpreted and the rights of the parties determined in accordance with the laws of the State of New York, U.S.A. (without reference to the choice of law provisions of New York law). (b) Each of the parties hereto irrevocably consents to the service of any process, pleading, notices or other papers by the mailing of copies thereof by registered, certified or -55- first class mail, postage prepaid, to such party at such party's address set forth herein, or by any other method provided or permitted under New York law. (c) Each party irrevocably and unconditionally agrees and consents that any suit, action or other legal proceeding arising out of or related to this Agreement shall be brought and heard in the Federal District Court located in New York City, State of New York, U.S.A. and each party irrevocably consents to personal jurisdiction in said tribunal. SECTION 14.08. SEVERABILITY. In case any provision of this Agreement shall be invalid, illegal or unenforceable, it shall, to the extent possible, be modified in such manner as to be valid, legal and enforceable but so as to most nearly retain the intent of the parties, and if such modification is not possible, such provision shall be severed from this Agreement, and in either case the validity, legality and enforceability of the remaining provisions of this Agreement shall not in any way be affected or impaired thereby. SECTION 14.09. TITLES. The titles, captions or headings of the Articles and Sections herein are inserted for convenience of reference only and are not intended to be a part of or to affect the meaning or interpretation of this Agreement. SECTION 14.10. COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which taken together shall constitute one and the same instrument. SECTION 14.11. NO THIRD-PARTY BENEFICIARIES. No Person (other than parties to this Agreement or their respective successors or permitted assigns) shall have or be construed to have any legal or equity right, remedy or claim under or in respect of or by virtue of this Agreement or any provision herein contained; and PROVIDED, HOWEVER, that the provisions of ARTICLE IX and ARTICLE X above concerning indemnification are intended for the benefit of the individuals specified therein. SECTION 14.12. CONSTRUCTION. The parties have participated jointly in the negotiation and drafting of this Agreement. In the event an ambiguity or question of intent or interpretation arises, this Agreement shall be construed as if drafted jointly by the parties and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of authorship of any provision of this Agreement. -56- IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the date first above written. OPTAGON HOLDINGS LIMITED By -------------------------------------------- Name: David Jones Title: Director SYLVAN LEARNING SYSTEMS, INC. By ------------------------------------------- Name: B. Lee McGee Title: Executive Vice President, Chief Financial Officer SYLVAN LEARNING SYSTEMS INTERNATIONAL, LTD. By ------------------------------------------- Name: B. Lee McGee Title: Vice President ASPECT INTERNATIONAL LANGUAGE SCHOOLS, B.V. By ------------------------------------------- Name: B. Lee McGee Title: Director -57- EX-11.05 6 a2043474zex-11_05.txt EX-11.05 SHARE PURCHASE AGREEMENT (the "AGREEMENT") dated as of June 30, 2000 between FRANCIS CLIVAZ Rue du Rhone 11 1204 Geneve (hereinafter the "SELLER 1") CHRISTIAN CLIVAZ Rue du Rhone 11 1204 Geneve (hereinafter the "SELLER 2", and together with the Seller 1 the "SELLERS") and SYLVAN LEARNING SYSTEMS, INC. 1000 Lancaster Street Baltimore, Maryland 21202 U.S.A. (hereinafter the "PURCHASER") regarding GESTHOTEL SA (hereinafter the "COMPANY") Share Purchase Agreement - 2 - ================================================================================ TABLE OF CONTENTS ARTICLE I - PURCHASE AND SALE OF SHARES.......................................8 I.1 PURCHASE AND SALE.................................................8 I.2 PURCHASE PRICE PAYMENT............................................8 (a) Dividend..........................................................8 (b) Cash Payment at Closing...........................................9 (c) Earn-out Payments.................................................9 I.3 EARN-OUT PAYMENT 2000.............................................9 I.4 EARN-OUT PAYMENT 2001............................................10 I.5 EARN-OUT PAYMENT 2002............................................11 ARTICLE II - CLOSING.........................................................12 II.1 PLACE AND DATE...................................................12 II.2 EFFECTIVE DATE...................................................12 II.3 CLOSING DOCUMENTS................................................12 (a) Documents to be Delivered by the Sellers.........................12 (b) Documents to be Delivered by the Purchaser.......................13 ARTICLE III - REPRESENTATIONS AND WARRANTIES.................................13 III.1 REPRESENTATIONS AND WARRANTIES OF PURCHASER......................13 (a) Organization of the Purchaser....................................13 (b) Authority........................................................13 (c) Authorization....................................................13 (d) Financial Statements.............................................14 (e) SEC Filings......................................................14 (f) Litigation.......................................................14 (g) No Intent to Resell..............................................14 (h) Brokers..........................................................14 III.2 REPRESENTATIONS AND WARRANTIES OF THE SELLERS....................14 (a) Ownership of Sale Shares.........................................14 (b) Organization of Company..........................................15 (c) Authority; No Conflict...........................................15 (d) Capitalization...................................................15 Share Purchase Agreement - 3 - ================================================================================ (e) Share Capital Paid-up............................................15 (f) No Rights of Third Party Over Equity Interests...................16 (g) Financial Statements.............................................16 (h) No Undisclosed Liabilities.......................................16 (i) Accounts Receivable..............................................16 (j) Capital Improvements.............................................16 (k) Absence of Change................................................17 (l) Insolvency.......................................................18 (m) Taxes............................................................18 (n) Environment......................................................19 (o) Leases; Real Property............................................20 (p) Condition of Assets; Sufficiency.................................20 (q) Intellectual Property Rights.....................................21 (r) Contracts........................................................21 (s) Litigation.......................................................22 (t) Compliance with Laws.............................................22 (u) Insurance........................................................22 (v) Employees........................................................23 (w) Professional and Social Welfare..................................23 (x) No Collective Bargaining.........................................23 ARTICLE IV - COVENANTS.......................................................24 IV.1 COVENANT NOT TO COMPETE AND NOT TO SOLICIT.......................24 IV.2 CONDUCT OF THE BUSINESS..........................................25 IV.3 ELECTION OF BOARD MEMBERS........................................25 IV.4 BEST EFFORTS.....................................................25 ARTICLE V - CONDITIONS TO CLOSING............................................25 V.1 CONDITIONS TO OBLIGATIONS OF THE PURCHASER AND THE SELLERS.......25 V.2 CONDITIONS TO OBLIGATIONS OF THE PURCHASER.......................26 V.3 CONDITIONS TO OBLIGATIONS OF THE SELLERS.........................26 ARTICLE VI - INDEMNIFICATION.................................................27 VI.1 INDEMNIFICATION BY THE SELLERS...................................27 VI.2 SECURITY.........................................................27 Share Purchase Agreement - 4 - ================================================================================ VI.3 INDEMNIFICATION BY THE PURCHASER.................................27 VI.4 DEDUCTIONS FROM PAYMENTS.........................................27 VI.5 LIMITATION IN TIME...............................................28 VI.6 LIMITATIONS ON AMOUNT............................................28 (a) Deductible.......................................................28 (b) Ceiling..........................................................28 (c) Effect of Provisions.............................................28 VI.7 THIRD PARTY CLAIMS...............................................29 VI.8 ADJUSTMENT OF INDEMNITY PAYMENT..................................29 VI.9 EFFECT OF KNOWLEDGE ON REPRESENTATIONS AND WARRANTIES............30 VI.10 REMEDIES.........................................................30 ARTICLE VII - MISCELLANEOUS..................................................30 VII.1 NOTICES..........................................................30 VII.2 ENTIRE AGREEMENT.................................................31 VII.3 SEVERABILITY OF PROVISIONS.......................................31 VII.4 BINDING EFFECT; BENEFIT..........................................32 VII.5 ASSIGNABILITY....................................................32 VII.6 CHANGE OF CONTROL................................................32 VII.7 AMENDMENT AND MODIFICATION; WAIVER...............................32 VII.8 ANNOUNCEMENTS....................................................33 (a) Employees........................................................33 (b) Press Releases and Public Announcements..........................33 VII.9 CONFIDENTIALITY..................................................33 VII.10 ADVISER'S FEES; EXPENSES.........................................33 VII.11 APPLICABLE LAW...................................................33 VII.12 ARBITRATION......................................................34 LIST OF ANNEXES..............................................................36 LIST OF SCHEDULES............................................................37
Share Purchase Agreement - 5 - ================================================================================ WHEREAS the Company is a company incorporated in Switzerland, having its registered office at Pre Fleuri, Rue Ancienne Poste B, 3975 Randogne, VS, Switzerland; WHEREAS the Company has a fully paid-up share capital of CHF 1'500'000.-, divided into 1500 registered shares with a par value of CHF 1'000.- (Swiss francs one thousand) each; WHEREAS the Sellers are the owners of the entire outstanding share capital of the Company; WHEREAS the Sellers desire to sell and the Purchaser desires to purchase 100% of the outstanding share capital on the terms and conditions set out in this Agreement; NOW THEREFORE, the parties hereto agree as follows: DEFINITIONS "ACCOUNTS" shall mean the audited financial statements (consisting of the income statement, the balance sheet and notes to the financial statements) and the annual report of the Company for the business years 1997, 1998, and 1999. "ACCOUNTS RECEIVABLE" shall mean any and all accounts receivable, trade receivables, notes receivable and other receivables arising in connection with the Business. "AFFILIATE" shall mean, with respect to any person, any other person directly or indirectly controlling, controlled by, or under common control with such other person. "BEST KNOWLEDGE" shall mean that level and extent of knowledge which, reasonably is, or should be, held after having made reasonable inquiries. "BUSINESS" shall mean the business carried on by the Company as of the date hereof, in particular the management of the Swiss Hotel Association Hotel Management School Les Roches. "BUSINESS DAY" shall mean any day other than Saturday or Sunday on which banks are open for business in Baltimore, Maryland; New York, and Geneva, Switzerland. "CASH PAYMENT AT CLOSING" shall be the sum of CHF 35,000,000.- less (i) the amount of any negative Working Capital pursuant to the June 30 2000 Balance Sheet, and (ii) the amount of the Long Term Debt outstanding pursuant to the June 30, Balance Sheet, payable in cash by the Purchaser at Closing. "CLOSING" shall have the meaning set forth in Article II.1. "CLOSING DATE" shall have the meaning set forth in Article II.1. Share Purchase Agreement - 6 - ================================================================================ "CORPORATE DOCUMENTS" shall mean the share certificates representing the Sale Shares and the share register of the Company, and up-to-date, complete and legally compliant copies of the Articles of association of the Company. "EARN-OUT PAYMENT 2000" shall have the meaning described in Article I.3(a). "EARN-OUT PAYMENT 2001" shall have the meaning described in Article I.4(a). "EARN-OUT PAYMENT 2002" shall have the meaning described in Article I.5(a). "ENVIRONMENTAL LAW" shall mean any and all applicable laws or regulations regarding the protection of the environment (land, air, water or any combination thereof) and of nature or human health and safety. "EXECUTIVE EMPLOYMENT AGREEMENT" shall mean the employment agreement between the Company and Francis Clivaz attached hereto as ANNEX 1. "FINANCIAL REPORTS" shall mean the unaudited management accounts as of June 30, 2000 including the income statement and balance sheet prepared by the management of the Company for internal purposes only. "GUARANTEE PROPERTIES" shall mean the following plots and buildings (i) Pre-Fleuri A (no 576), (ii) Praz d'Anchettes (PPE n(degree) 51461 to 51482 of no(degree) 477), and (iii) Rocailles B and C (nos 2853, 2873, 2875 and 5803), all located in Randogne. "GUARANTEE PROPERTIES MORTGAGE CERTIFICATE" shall mean the duly executed certificate evidencing the first priority mortgage in the amount of CHF 6,900,000.- on the Guarantee Properties in favor of the Sellers to secure the Earn-out Payment 2002. "INDEPENDENT AUDITOR" shall mean Arthur Andersen SA, Geneva branch or another mutually acceptable internationally recognized auditing firm. "INTELLECTUAL PROPERTY RIGHTS" shall mean all patents and patent applications, all trademarks and trademark applications, all copyrights; all registrations and applications and renewals for any of the foregoing; all trade names, trade secrets, confidential information, ideas, formulae, compositions, know-how, technical and computer data, documentation and software, financial, business and marketing plans, customer and supplier lists and related information, marketing and promotional materials and all other information and intellectual property rights and all tangible embodiments thereof. "JUNE 30, 2000 BALANCE SHEET" shall mean the pro forma balance sheet of the Company prepared on a basis consistent with the last audited balance sheets of the Company but including the Real Estate and the assets and liabilities resulting from the transactions contemplated herein as if they were made and effective as of June 30, 2000 and including a summary computation of the Working Capital (showing the points at issue between the parties) and Long Term Debt under the same assumptions, all as set forth in ANNEX 2. "KEY PERSONS" shall mean the Sellers and Messrs. Pierre Martinet, Bernard Detienne, Jean-Claude Bailly, Marcel Clivaz, and Reynald Actis. "LONG TERM DEBT" shall mean the amount of long term debt owed by the Company as set forth in the June 30, 2000 Balance Sheet. Share Purchase Agreement - 7 - ================================================================================ "MARKETING AGREEMENT" shall mean the agreement between the Company and Clivaz Marketing and Public Relation Services SA attached hereto as ANNEX 3. "MATERIAL ADVERSE EFFECT" shall mean, with respect to any person or entity, a material adverse effect on the financial condition, business or results of operations of such person or entity, taken as a whole. "OBJECTION NOTICE" shall have the meaning set forth in Article I.3.(c) of this Agreement. "PRE FLEURI B AND C LEASE" shall mean the lease between the Seller 1, Marie-Helene Clivaz and the Company attached hereto as ANNEX 4. "PRE FLEURI B AND C MORTGAGE CERTIFICATE" shall mean the duly executed certificate evidencing the first priority mortgage in the amount of CHF 1,000,000.- on Pre Fleuri B and C in favor of the Purchaser. "PRE FLEURI B AND C PURCHASE AGREEMENT" shall mean the real estate purchase agreement between the Seller 1 and the Company to be entered into substantially pursuant to the terms of the Pre-Fleuri B and C Option Agreement promptly after the Earn-out Payment 2002 has been determined, in accordance with Article I.5 hereof, to be in excess of CHF 4,500,000. "PRE FLEURI B AND C OPTION AGREEMENT" shall mean the agreement between the Seller 1 and the Company attached hereto as ANNEX 5. "PURCHASE PRICE" shall mean the aggregate of the following: (i) Cash Payment at Closing; PLUS PLUS (ii) the Earn-out Payments 2000, 2001 and 2002, if any such earn-out payments are due. "REAL ESTATE" shall mean the following plots and buildings (i) Batiments Les Roches (Land Reg. no. 2880), (ii) St. Francois (no 1366), (iii) Pre-Fleuri A (no 576), (iv) Praz d'Anchettes (PPE n(degree) 51461 to 51482 of no(degree) 477), and (v) Rocailles B and C (nos 2853, 2873, 2875 and 5803), all located in Randogne. "REAL ESTATE PURCHASE AGREEMENTS" shall mean the agreements between the Company and the owners of the Real Estate attached hereto as ANNEXES 6 TO 9. "RECURRING EBIT" shall mean the Company's operating income before interest, taxes and all other non operating costs as determined in accordance with US generally accepted accounting principles, applied in a manner consistent with the past practice of the Company, to the extent such practice is consistent with US generally accepted accounting principles which shall in any case prevail. It shall include all divisions and subsidiaries which represent a succession to and a continuation of the Business, as the Business may be expanded at les Roches an in Spain, except that any loss, charge, payment or expense shall be excluded from such computation to the extent it is (i) extraordinary or non-recurring, (ii) not related to the Business or is incurred in relation with the expansion of the business operations by way of acquisitions or opening and staffing new schools or offices, (iii) a payment, charge or expense for allocation of home office, executive, general and administrative expense or similar payment to the Purchaser and its affiliates, (iv) an interest expense or charge relating to funds furnished to the Company in replacement of funds withdrawn from the company (by way of dividends, loans or otherwise) by the Purchaser or any of its affiliates, and (v) depreciation or amortization of the real estate in excess of 2% of the value of the real estate of the Company as of the date of its acquisition by the Company. Share Purchase Agreement - 8 - ================================================================================ "SALE SHARES" shall mean the entire outstanding share capital of the Company, currently consisting of 1'500 registered shares with a par value of CHF 1'000.- (Swiss francs one thousand) each. "SOCIAL SECURITY CONTRIBUTIONS" shall mean the mandatory contributions to the old-age pension insurance scheme (AHV), pension fund scheme (BVG), invalidity insurance (IV), loss of salary insurance (EO) and unemployment insurance (ALV), or any equivalent or similar contributions and any other social security contributions (including accident and health insurance contributions as the case may be) applicable in the jurisdictions in which the Company does business, together with any interest or any penalty imposed by any social security authority with respect thereto. "TAXES" shall mean any and all Swiss taxes, together with any penalties, additions to tax or additional amounts imposed by any taxing authority with respect thereto. "WORKING CAPITAL" shall mean an amount equal to the sum of all current assets after deduction of all current liabilities, determined in accordance with US generally accepted accounting principles and, to the extent compatible with these principles, in a manner consistent with the past practice of the Company. ARTICLE I - PURCHASE AND SALE OF SHARES I.1 PURCHASE AND SALE In accordance with the terms of this Agreement, the Sellers shall sell to the Purchaser and the Purchaser shall purchase from the Sellers good and valid title to the Sale Shares free and clear from encumbrances, mortgages, charges, liens, security interests and other rights of any third party, for the consideration set out in Article I.2 below: I.2 PURCHASE PRICE PAYMENT (a) DIVIDEND Promptly after execution of this Agreement, the parties shall appoint PriceWaterhouseCoopers (PwC), Geneva branch, or another mutually acceptable internationally recognized accounting firm, to determine the Working Capital of the Company as of June 30, 2000. PwC shall determine the Working Capital based on the actual computations of the parties (which are reflected in the June 30, 2000 Balance Sheet) and the submissions of the parties' accountants, Mr. Cosimo Picci in Geneva and Fiduciaire Actis in Sion. The determination of PwC shall be final and binding upon the parties hereto. Upon detemination of the Working Capital, the Sellers shall be entitled to cause the Company and the Purchaser shall vote to approve (if such vote or approval is necessary) and pay out to the Sellers a dividend for the business year 1999 equal to the amount of the positive Working Capital as such Working Capital is determined by PWC, provided, however, that the dividend shall be no less than CHF Share Purchase Agreement - 9 - ================================================================================ 874,000 (the Purchaser's computation) nor more than CHF 1,138,000 (the Sellers' computation). The dividend shall be granted in accordance with the legal requirements of Swiss law. The party whose computation of the Working Capital is the further away from PwC's computation shall bear the fees of PwC in relation herewith. (b) CASH PAYMENT AT CLOSING At Closing, the Purchaser and the Sellers shall jointly instruct the escrow agent to pay by wire transfer of immediately available funds to a bank account as previously specified by the Sellers to the Purchaser, the Cash Payment plus interests accrued thereon in the hands of the escrow agent less the escrow agents' fees in relation therewith, if any. (c) EARN-OUT PAYMENTS Subsequent to Closing, the Purchaser shall pay to the Sellers or in accordance with their instructions the Earn-out Payments 2000, 2001, and 2002, all in accordance with the terms of this Article I. I.3 EARN-OUT PAYMENT 2000 (a) No later than February 28, 2001, the Purchaser shall cause to be prepared and delivered to the Sellers the audited financial statements for fiscal year 2000 and its calculation of the Recurring EBIT and the Earn-out Payment 2000. The Earn-out Payment 2000 shall be the positive amount by which the Recurring EBIT of the Company for fiscal year 2000 exceeds CHF 5,100,000.-, such amount not to exceed in any circumstances CHF 700,000.-. The Purchaser shall grant the Sellers access to the auditors and to the relevant information to the extent such right of access is exercised in a orderly manner until the final resolution of any dispute pursuant to this Article I.3. (b) If the Sellers do not object to the calculation of the Earn-out Payment 2000 in the manner described in Article 1.6(c), then the Purchaser shall pay to the Sellers the Earn-out Payment 2000 to an account previously specified by the Sellers. If the Sellers have objected to the calculation of the Earn-out Payment 2000 in the manner described in Article 1.6(c), then the Earn-out Payment 2000 shall be made within seven business days after the final resolution of such objection in accordance with Section 1.6(c). (c) If the Sellers object to the calculation of the Earn-out Payment 2000, then, within 30 Business Days after delivery of the audited financial statements for fiscal year 2000 and the calculation of Recurring EBIT for the fiscal year 2000 and the Earn-out Payment 2000 to the Sellers, the Sellers shall so advise the Purchaser by delivery to the Purchaser of a written notice (the "OBJECTION NOTICE"). The Objection Notice Share Purchase Agreement - 10 - ================================================================================ shall specify the reasons for objection and set forth the Sellers' calculation of the Earn-out Payment 2000. (d) If the parties hereto agree on a resolution of the dispute set out in the Objection Notice, they shall put such resolution in writing and thereafter be bound by it. (e) If the parties hereto are unable to settle any dispute notified in the Objection Notice within 20 Business Days after delivery of the Objection Notice, then, at the instigation of either party hereto, the final determination of the dispute may be submitted to the Independent Auditor. (f) The determination of the Earn-out Payment 2000 by the Independent Auditor shall be made within 30 Business Days (or such longer time as the parties hereto shall agree in writing) after the date the dispute was submitted to the Independent Auditor and the determination of the Independent Auditor shall be final and binding on the parties hereto. The Independent Auditor shall act as an expert arbitrator (schiedsgutachter). The Independent Auditor shall give the parties hereto the right to be heard and shall set forth the reasons for its decisions in writing. The costs and expenses of the Independent Auditor shall be borne equally by the Sellers and the Purchaser. (g) Any Earn-out Payment 2000 payable under this Article 1.6 shall be paid together with interest thereon calculated monthly from February 28, 2001 on to the date of payment, at the thirty day Swiss franc rate of the London Interbank Offered Rate ("LIBOR") on February 28, 2001 for deposits of the size of the Earn-out Payment 2000. I.4 EARN-OUT PAYMENT 2001 (a) No later than February 28, 2002, the Purchaser shall cause to be prepared and delivered to the Sellers the audited financial statements for fiscal year 2001 and its calculation of the Recurring EBIT and the Earn-out Payment 2001. The Earn-out Payment 2001 shall be the positive amount by which the Recurring EBIT of the Company for fiscal year 2001 exceeds CHF 5,100,000.-, such amount not to exceed CHF 700,000.-, minus the Earn-out Payment 2000. (b) Article 1.3(b) to 1.3(g) and the right of access to the auditors in Article I.3(a) shall apply MUTATIS MUTANDIS to the calculation and payment of the Earn-out Payment 2001. Share Purchase Agreement - 11 - ================================================================================ I.5 EARN-OUT PAYMENT 2002 (a) Not later than February 28, 2003, the Purchaser shall cause to be prepared and delivered to the Sellers the audited financial statements for fiscal year 2002 and its calculation of the Recurring EBIT and the Earn-out Payment 2002. Subject to paragraph (b) of this Article 1.5, the Earn-out Payment 2002 shall be (i) CHF 9,350,000.- if the Recurring EBIT for the fiscal year 2002 is higher than CHF 7,045,000.-; (ii) CHF 6,510,000.- if the Recurring EBIT for the fiscal year 2002 is higher than CHF 6,205,000.- but lower than or equal to CHF 7,045,000.-; (iii) CHF 4,500,000.- if the Recurring EBIT for the fiscal year 2002 is lower than or equal to 6,205,000.- but higher than or equal to CHF 6,100,000.-. No Earn-out Payment 2002 is due if the Recurring EBIT for the fiscal year 2002 is lower than CHF 6,100,000.-. (b) If the Company terminates the Executive Employment Agreement with respect to the Seller 1 before March 31, 2003 without reasons which constitute grounds for immediate dismissal under Swiss law, then the 2002 Earn-out Payment shall be CHF 9,350,000.- and shall be payable to the Sellers upon such dismissal. Any damages or severance payments due under the Executive Employment Agreement (except salary and benefits until the date of termination) shall, however, be deducted from this amount. If the Executive Employment Agreement is terminated before March 31, 2003 and an employment agreement is promptly executed between the Company and the Seller 2 substantially on the same terms as the Executive Employment Agreement, the first sentence of this paragraph (b) shall not apply. If however the Company terminates this new employment agreement with the Seller 2 before March 31, 2003 without reasons which constitute grounds for immediate dismissal under Swiss law, then the minimum 2002 Earn-out Payment shall be CHF 6,510,000.- (this minimum 2002 Earn-out Payment being payable to the Seller 2 immediately upon such dismissal and the balance of the 2002 Earnt-out Payment, if any, being due upon determination of the Recurring EBIT). (c) As security for the payment of the Earn-out Payment 2002, the Purchaser shall grant the Sellers a first priority mortgage in the amount of CHF 6,900,000.- on the Guarantee Properties. (d) Any Earn-out Payment 2002 due shall be reduced by the purchase price as defined in the Pre Fleuri B and C Purchase Agreement, i.e. CHF 4,500,000.-. (e) In all other respects, article 1.3(b) to 1.3(g) and the right of access to the auditors in Article I.3(a) shall apply MUTATIS MUTANDIS to the calculation and payment of the Earn-out Payment 2002. Share Purchase Agreement - 12 - ================================================================================ ARTICLE II - CLOSING II.1 PLACE AND DATE The closing of the transactions contemplated herein ("CLOSING") shall take place at the offices of Lenz & Staehelin in Geneva, as soon as possible, but in no event later than 10 Business Days after satisfaction or waiver of the conditions set forth in Article V hereof, or at such other place, date and time agreed on by the parties hereto, the date on which Closing occurs being the "CLOSING DATE". II.2 EFFECTIVE DATE Except at otherwise stated herein or in an agreement contemplated herein, the transactions contemplated in this Agreement shall be effective as of July 1, 2000 or such other date and time as the parties may mutually agree on in writing. II.3 CLOSING DOCUMENTS (a) DOCUMENTS TO BE DELIVERED BY THE SELLERS Upon Closing, the Sellers shall deliver to the Purchaser: (i) the certificates representing the Sale Shares duly endorsed in blank; (ii) a resolution of the Company's board of directors consenting to the transfer of the Sale Shares to the Purchaser and authorizing the Purchaser's registration, immediately after Closing, in the Company's share register; (iii) the Company's share register evidencing the registration of the Purchaser as the owner of the Sale Shares; (iv) to the extent required by the Purchaser, letters of resignation as directors of the Company by Messrs Reynald Actis and Bernard Detienne, each containing a statement of the resigning director that he has been fully compensated for his services rendered to the Company and that he has no claim of whatever nature against the Company as the case may be; (v) the Pension Fund Certificate pursuant to Article III.2(x); (vi) the duly executed Marketing Agreement; (vii) the duly executed Executive Employment Agreement; (viii) the duly executed Pre Fleuri B and C Lease; (ix) the duly executed Real Estate Purchase Agreements; Share Purchase Agreement - 13 - ================================================================================ (x) the duly executed Pre Fleuri B and C Mortgage Certificate; (xi) the duly executed Pre Fleuri B and C Option Agreement. (b) DOCUMENTS TO BE DELIVERED BY THE PURCHASER Upon Closing, the Purchaser shall deliver to the Sellers: (i) evidence of payment of the Cash Payment at Closing to the account previously specified by the Sellers and (ii) the Guarantee Properties Mortgage Certificate. ARTICLE III - REPRESENTATIONS AND WARRANTIES Each party hereto hereby makes the representations and warranties contained in this Article III to the other party hereto, each of which is true and correct as of the date hereof. The parties hereto do not make any representations nor give any warranties other than the representations and warranties contained in this Article III. III.1 REPRESENTATIONS AND WARRANTIES OF PURCHASER The Purchaser hereby represents and warrants to the Sellers as follows: (a) ORGANIZATION OF THE PURCHASER The Purchaser is duly organized and validly existing under the laws of Maryland. (b) AUTHORITY This Agreement has been duly authorized and validly executed and delivered by the Purchaser and is valid and enforceable against the Purchaser in accordance with its terms; the Purchaser has full power and authority to enter into this Agreement and to carry out the transactions contemplated by this Agreement. The execution and delivery of this Agreement by the Purchaser does not violate the Purchaser's articles of association or internal regulations, any agreement to which it is a signatory or any governmental law, regulation, order or judgement to which it is subject. (c) AUTHORIZATION The Purchaser is not required to give notice or obtain any governmental or other authorization (except internal authorizations) to execute or consummate this Share Purchase Agreement - 14 - ================================================================================ Agreement. (d) FINANCIAL STATEMENTS The Purchaser has delivered to the Sellers its audited balance sheet for the last three business years. (e) SEC FILINGS The Purchaser's SEC filings are up to date. (f) LITIGATION There is no claim, action, suit, arbitration, inquiry, proceeding or investigation by or before any Swiss or foreign governmental commission, court, tribunal or arbitral body by or against the Purchaser or any of its assets or properties pending, or, to the Best Knowledge of the Purchaser, threatened to be brought, which would preclude or materially adversly affect the transactions contemplated in this Agreement. (g) NO INTENT TO RESELL The Purchaser does not intend to resell the Sale Shares except to an entity of the group of companies to which the Purchaser belongs. (h) BROKERS The Purchaser has not entered into any agreement with a broker which materially affects or will materially affect the Sellers. III.2 REPRESENTATIONS AND WARRANTIES OF THE SELLERS The Sellers hereby make the following representations and warranties to the Purchaser: (a) OWNERSHIP OF SALE SHARES The Sellers have, and at Closing the Purchaser shall receive, good and valid title to the Sale Shares, including those shares held in a fiduciary capacity by any director of the Company. The Sale Shares are free and clear of all encumbrances, mortgages, charges, liens, security interests or any other rights of any third party. Share Purchase Agreement - 15 - ================================================================================ (b) ORGANIZATION OF COMPANY The Company is duly organized and validly existing under the laws of Switzerland, has the corporate power to own and operate its assets and to carry on the Business as now being conducted. The Articles of association and the internal regulations of the Company, which are attached hereto as SCHEDULE III.2.(b) are true, correct, in compliance with applicable law and up-to-date. (c) AUTHORITY; NO CONFLICT Neither the execution and delivery of this Agreement or of any other agreements contemplated herein nor the consummation or performance of any of the other agreements contemplated by this Agreement will directly or indirectly (1) violate, conflict with, or give any governmental body or other person a right to challenge, in full or in part, any of the transactions contemplated under this Agreement under any applicable law or regulation or any order or judicial or administrative decision to which the Sellers or the Company is subject; (2) violate, conflict with the terms of, or give any governmental body a right to revoke, suspend, or modify any governmental authorization permit or recognition held by the Company, except to the extent such violation, conflict or right has no Material Adverse Effect on the Company ; (3) violate, conflict with, or give any person the right to terminate, declare a default or exercise any other remedy under, any agreement to which the Company is a party, except to the extent such violation, conflict, right or other remedy has no Material Adverse Effect on the Company; (4) result in the creation or imposition of any lien or other charge on any asset of the Company except to the extent such lien or charge is contemplated herein; (5) require any governmental authorization, with the exception of authorizations required under the Swiss federal statute on the acquisition of real estate by foreign persons. (d) CAPITALIZATION The Company has the following capital structure: a fully paid-up share capital of CHF 1'500'000.-, divided into 1'500 registered shares numbered 1 to 1'500 with a par value of CHF 1'000.- each. There are no other share certificates of the Company circulating. (e) SHARE CAPITAL PAID-UP All the issued and outstanding shares of the Company are duly and validly authorized, issued and fully paid-up. Share Purchase Agreement - 16 - ================================================================================ (f) NO RIGHTS OF THIRD PARTY OVER EQUITY INTERESTS Except as set forth on SCHEDULE III.2(f), there is no option, warrant, conversion privilege, pledge, right of pre-emption, right to acquire, right of first refusal or similar or analogous right over or affecting any of the Sale Shares or shares of the Company, nor is there any commitment to give or create any of the foregoing, and no person has claimed to be entitled to any of the foregoing. The option agreement ("PROMESSE DE VENTE ET D'ACHAT") dated January 9, 1997 between the Seller 1 and Mr. Marcel Clivaz pursuant to which the Seller 1 has granted to Mr. Marcel Clivaz the right to purchase the Sale Shares is terminated as of the Closing according to ANNEX 10 and no rights will be exercised thereunder. (g) FINANCIAL STATEMENTS The Sellers have delivered to the Purchaser the Accounts as well as the Financial Reports and the budget for the fiscal year 2000, all as set forth in SCHEDULE III.2.(g). The Accounts have been prepared in accordance with the provisions of Swiss law and generally accepted accounting principles in Switzerland, applied consistently throughout the last 3 financial years. The Accounts are correct and complete and give a true and fair view of the financial condition and the results of operations of the Company. The Financial Reports have been prepared with due care and in good faith for the purposes of management support in accordance with the accounting principles of the Company consistently applied. (h) NO UNDISCLOSED LIABILITIES The Accounts contain all material actual, conditional and contingent liabilities and all material accruals and reserves that, according to the provisions of Swiss law and generally accepted accounting principles in Switzerland should be contained therein. As of the date hereof, there exist no material liabilities of the Company other than those set out in the Accounts, with the exception of liabilities which have been incurred in the ordinary course of business since January 1, 2000. (i) ACCOUNTS RECEIVABLE SCHEDULE III.2(i) sets forth a true, accurate and complete aging schedule of all Accounts Receivable exceeding CHF 10,000.- of the Company outstanding at May 31, 2000. All outstanding Accounts Receivable of the Company have arisen out of bona fide transactions in the ordinary course of business. (j) CAPITAL IMPROVEMENTS SCHEDULE III.2(j) describes all capital improvements or purchases or other capital expenditures (as determined in accordance with the provisions of Swiss law and Share Purchase Agreement - 17 - ================================================================================ generally accepted accounting principles in Switzerland) as of May 31, 2000 exceeding CHF 10,000.- which the Company has committed to or contracted for and which have not been completed prior to the date hereof and the costs and expenses (including professional fees and charges) reasonably estimated as being required to complete such transactions. (k) ABSENCE OF CHANGE Except as set forth on SCHEDULE III.2.(k), since December 31, 1999, there has not been any of the following events, with the exception of events which would, by itself or taken together with other events falling under the following list, not have a Material Adverse Effect on the Company: (i) change in the financial condition, assets, liabilities, personnel or operations of the Company or in its relations with suppliers, customers, lessors or others, other than changes in the ordinary course of business, with the exception of changes in relation with thetransactions contemplated by this Agreement, including, without limitation, the Real Estate Purchase Agreements; (ii) changes which have had or could have a Material Adverse Effect on the Business or the Company, with the exception of changes in relation with thetransactions contemplated by this Agreement, including, without limitation, the Real Estate Purchase Agreements; (iii) damage, destruction, loss, or other action which may give rise to any liability or obligation of the Company (whether or not covered by insurance) adversely affecting its assets, except in relation with the transactions contemplated by this Agreement, including, without limitation, the Real Estate Purchase Agreements; (iv) (x) indebtedness for borrowed money incurred by the Company becoming, or becoming capable of being declared, repayable earlier than the due date for payment or (y) forgiveness or cancellation of indebtedness owed to the Company or waiver of any claims or rights by the Company with regard to such indebtedness, except in relation with the transactions contemplated by this Agreement, including, without limitation, the Real Estate Purchase Agreements; (v) increase in the compensation or benefits paid or payable by the Company to any of its officers or employees or agreement to do the same, except for scheduled increases in the ordinary course of business consistent with past practice ; (vi) dividend, distribution or other disposition or any transfer, lease, license of assets of the Company to the Sellers; (vii) encumbrances placed on or created or extended over any of the assets of the Company, except in relation with the transactions contemplated by this Agreement, including, without limitation, the Real Estate Purchase Agreements; Share Purchase Agreement - 18 - ================================================================================ (viii) amendment or termination of any lease, contract, license or other agreement of the type described in Article III.2.(r) to which the Company is a party, other than in the ordinary course of business, except in relation with the transactions contemplated in this Agreement, including, without limitation, the Real Estate Purchase Agreements; (ix) change in the collection, payment or credit practices of the Company or in the accounting practices, procedures or methods of the Company; (x) agreement, arrangement or transaction, other than in the ordinary course of business consistent with past practice and of an entirely arm's length nature, between the Company and (i) one or both of the Sellers, (ii) any officer or employee of the Company or, (iii) any other person or entity affiliated with or related to one or both of the Sellers or an officer or employee of such entity, with the exception of the transactions contemplated by this Agreement including, without limitation, the Real Estate Purchase Agreements; or (xi) notice given by any officer, supplier, customer or contractual counterpart of the Company that they intend to terminate or by which they terminate a current contractual relationship with the Company. (l) INSOLVENCY (i) No order has been notified and no resolution has been passed for the winding up of the Company or for a provisional liquidator to be appointed in respect of the Company and no petition has been presented and no meeting has been convened for the purpose of winding up the Company. (ii) No receiver (which expression shall include an administrative receiver) has been appointed in respect of the Company or all or any of its assets. (iii) The Company is not insolvent, unable to pay its debts and has not stopped paying its debts as they fall due. (iv) No unsatisfied judgement is outstanding against the Company. (v) To the Best Knowledge of the Sellers and the Key Persons, there are no reasons that any of the events described under III.2.(l)(i) to (iv) above shall occur. (m) TAXES (i) Filing of Returns The Company has filed when due, materially accurate returns for Taxes (except in cases where inaccuracies are covered by sufficient tax provisions) and has otherwise complied in all respects with requirements relating to the filing of Tax returns and the supply of all information required to be supplied to any tax authority. Share Purchase Agreement - 19 - ================================================================================ (ii) Payment of Taxes The Company has complied with all and any requirements relating to the payment of Taxes, of whatever nature, including interest and penalties, if any. (iii) Tax Provisions The Company has paid and, if not paid, established adequate provisions in the Accounts for the year 1999 for all Taxes of whatever nature that may be assessed or computed on the results, operations or transactions of the Company for all periods prior to the date hereof, regardless of the financial period during which such Taxes may become due and payable. For the Company, the amount of the provision for deferred Taxes in the December 1999 balance sheet is adequate and fully in accordance with Swiss law and generally accepted accounting principles in Switzerland and practices commonly adopted by companies carrying on businesses similar to those carried on by the Company. (iv) No Dispute Except as set forth in SCHEDULE III.2(m)(iv), the Company is to the Best Knowledge of the Key Persons, not subject to formal proceedings or investigations related to Taxes (except for requests for additional information) by the respective authorities and no such proceedings are threatened against the Company. (v) No Withholding Tax on Dividends The Company has not distributed or caused to be distributed, any hidden or constructive dividend, nor distributed or granted any other benefit to the Sellers or any other person which could lead to the imposition of any withholding taxes on such hidden or constructive dividend. (vi) No Adverse Tax Consequences Except as set forth in SCHEDULE III.2(m)(vi) the acquisition of the Sale Shares by the Purchaser will not give rise to any adverse tax consequences for the Company. (n) ENVIRONMENT To the Best Knowledge of the Key Persons, (i) the Company conducts and has always conducted its activities in conformity with Environmental Law; (ii) until and including the date hereof, the Company has complied with and not violated any Environmental Law at the time when such law was applicable; (iii) no action has been undertaken or, threatened to be undertaken by Swiss or Share Purchase Agreement - 20 - ================================================================================ foreign authorities with respect to Environmental Law which could have a Material Adverse Effect on the Company or its activities; and (iv) no facts, events or conditions in existence on or prior to the date hereof and relating to the past or present facilities, properties or operations of the Company will give rise to any investigatory, remedial or corrective obligations pursuant to Environmental Law, or give rise to any other liabilities for onsite or offsite releases of hazardous materials, substances or wastes, personal injury, contamination of soil, water, air or groundwater, property damage or damage to natural resources, pursuant to Environmental Law. (o) LEASES; REAL PROPERTY SCHEDULE III.2(o) sets forth a complete and correct list of all real property or premises leased in whole or in part (including "droits reels" like right of land use ("droits de superficie") and similar rights) by the Company. The leases to which the Company is a party allow unencumbered use of the leased property in accordance with the terms and conditions of such leases. None of the leases is terminable by any third party, or would be breached, in both cases, as a result of the transactions contemplated by this Agreement, except if such termination or breach would have no Material Adverse Effect on the Company, Each lease of premises utilized by the Company is legal, valid and binding, as between the Company and the other party or parties thereto, and the Company is tenant in good standing thereunder, free of any default or breach and quietly enjoys the premises provided for therein. Each rental and other payment due from the Company thereunder has been duly paid; to the Best Knowledge of the Key Persons, each act required to be performed by the Company which if not performed would constitute a breach thereof has been duly performed; and to the Best Knowledge of the Key Persons, no act forbidden to be performed by the Company has been performed thereunder. All buildings occupied by the Company have been constantly maintained in accordance with past practice of the Company and in accordance with any applicable lease. None of such premises or properties has been condemned or otherwise taken by public authority and no such condemnation or taking is threatened or contemplated. The Company has all required material legal or governmental approvals for each of the properties, leased, used or occupied by it. All rights to real property, including "droits reels" and the like and options and preemption rights to real estate and to any other "droits reels" are legal, valid, registered in the land register (to the extent possible under applicable law) and binding between the respective parties. (p) CONDITION OF ASSETS; SUFFICIENCY The equipment and other tangible assets (other than inventory) owned by the Company are owned free of third party rights and are in good repair and operating condition, normal wear and tear excepted; have been maintained regularly in Share Purchase Agreement - 21 - ================================================================================ accordance with past practice of the Company and in accordance with any applicable manufacturer's guidelines; and may be used for their intended purpose in the normal course of the Business. In the Financial Reports, the assets and the inventory included among the assets of the Company are valued in accordance with applicable accounting principles consistently applied. (q) INTELLECTUAL PROPERTY RIGHTS (i) Except as set forth in SCHEDULE III.2(q), the Company owns and possesses all right, title and interest in and to, or has a written, enforceable license to use, all of the Intellectual Property Rights currently used in the operation of the Business free and clear of all liens, security interests, restrictions and encumbrances with the exception of the software jointly developed with College du Leman, as to which the Company and College du Leman are jointly entitled. (ii) No claim by any third party contesting the validity, enforceability, use or ownership of any Intellectual Property Rights owned or used by the Company has been made, is currently outstanding or, to the Best Knowledge of the Key Persons, is threatened, and there are, to the Best Knowledge of the Key Persons, no grounds for such claim. (iii) Except as set forth in SCHEDULE III.2(q), the Company has not infringed, misappropriated or otherwise acted in conflict with any Intellectual Property Rights of any third party, nor is any Key Persons aware, to their Best Knowledge, of any infringement, misappropriation or conflict which will occur as a result of the continued operation of the Business as conducted. (r) CONTRACTS SCHEDULE III.2.(r) hereto sets forth a complete and correct list, of all (written or oral) contracts (except employment contracts), agreements, commitments, instruments or other consensual obligations to which the Company is a party or by which the Company, or any of the assets of the Company are bound or liable excluding customary inventory purchase orders in the ordinary course of business (these agreements collectively referred to as the "SIGNIFICANT AGREEMENTS"): (i) which each involve a yearly aggregate consideration of CHF 100'000.- or more; (ii) which guarantee the performance, liabilities or obligations of any other person (whether legal or natural); (iii) which restrict the ability of the Company, taken as a whole, to conduct any business activities; (iv) which are not in the ordinary course of the business; Share Purchase Agreement - 22 - ================================================================================ (v) which are concluded with or for the benefit of any Affiliate or relative of one or both of the Sellers. Each Significant Agreement disclosed in Schedule III.2(r) is a valid and binding agreement of the Company and is in full force and effect. The Company is not in material breach of any of the Significant Agreements, nor, to the Best Knowledge of the Key Persons, is any third party in material breach of the Significant Agreements or has repudiated any provision of the Significant Agreements and no event has occurred which with notice, lapse of time or both would constitute a material breach or default or permit termination, modification or acceleration of any such Significant Agreement. (s) LITIGATION Except as disclosed in SCHEDULE III.2(s), there is no claim, action, suit, arbitration, inquiry, proceeding or investigation by or before any Swiss or foreign governmental commission, court, tribunal or arbitral body by or against the Company or any of its assets or properties pending, or, to the Best Knowledge of the Key Persons, threatened to be brought against one or both of the Sellers or any of the Company's officers or staff relating to the Business, by or before any Swiss or foreign governmental commission, court, tribunal or arbitral body nor, to the Best Knowledge of the Key Persons, do any circumstances exist, which are likely to give rise to any such claim, action suit, arbitration, inquiry, proceedings or investigation. There are no claims of whatever nature against the Company by any former directors, officers, or employees of the Company. (t) COMPLIANCE WITH LAWS To the Best Knowledge of the Key Persons, the Business has been conducted in material compliance with all laws and regulations of Swiss local and federal authorities applicable to the Company. To the actual knowledge without investigation of the Key Persons, the Business has been conducted in compliance with all laws and regulations of foreign governmental authorities applicable to the Company and they have received no notice to the effect that the Business has not been conducted in such a manner. The Company possesses, and is in compliance with, all licenses, permits, approvals and other governmental authorizations necessary to the conduct of the Business, which licenses, permits and approvals are set forth on SCHEDULE III.2.(t), and there is no reason or circumstance which indicates that such licenses, permits, approvals and authorizations are likely to be revoked or confer a right of revocation. (u) INSURANCE SCHEDULE III.2.(u) contains a true and accurate list of all risk-based insurance contracts that the Company has entered into and lists the premiums payable under these contracts and any increases of these premiums in the last three years. The Company has not received any notice or other communication from any insurance company within 3 years prior to the date hereof canceling or amending such policies and, tro the Best Knowledge of the Key Persons, no such cancellation or amendment is threatened. Share Purchase Agreement - 23 - ================================================================================ All premiums pertaining to the insurance policies have been paid as they fell due, or are duly provided for in the Accounts. (v) EMPLOYEES SCHEDULE III.2.(v)(i) contains a list of all employees of the Company as of May 31, 2000. This list contains details about salary, (including benefits in kind), age, seniority, length of service, notice periods for termination, right to severance pay and to bonus. Except for employment contracts listed in SCHEDULE III.2.(v)(ii), each contract of employment to which the Company is a party and which is for an annual consideration of CHF 75,000.- or more can be terminated by the Company without damages or compensation (other than that payable by law) by giving at any time not more than six months' notice. (w) PROFESSIONAL AND SOCIAL WELFARE Any and all returns and reports related to Social Security Contributions that are required to be filed with respect to the Company prior to the date hereof have been filed timely and correctly in all material respects. The Company has paid in full any and all Social Security Contributions as and when due. No social security authority is now asserting any deficiency or claim for additional Social Security Contributions (or interest thereon or penalties in connection therewith) and any and all Social Security Contributions which (although not due) have accrued on the basis of the salaries to be paid until the date hereof, have been fully provisioned. Except as set forth in SCHEDULE III.2(w)(i), to the Best Knowledge of the Key Persons, there are no facts or circumstances existing or having arisen prior to the date hereof which have or may lead to a re-assessment by any social security authority of Social Security Contributions to be made by the Company relating to any period prior to the date hereof. The details of the employee pension fund of the Company are described in SCHEDULE III.2.(w)(ii) (hereinafter the "PENSION FUND"). The Company is meeting all its obligations under the Pension Fund and specifically has paid (or provisioned) all contributions required prior to the date hereof as stipulated by the regulations of the Pension Fund. Performance of these obligations is acknowledged in the pension fund certificate (hereinafter the "PENSION FUND CERTIFICATE") attached hereto as SCHEDULE III.2.(w)(iii). The Company is not required to contribute to any pension fund other than the Pension Fund. (x) NO COLLECTIVE BARGAINING There is no collective bargaining or other union agreement or arrangement (whether binding or not) to which the Company is a party or by which it is bound or which is Share Purchase Agreement - 24 - ================================================================================ currently being negotiated and no dispute between the Company and any trade union or other organization formed for a similar purpose is existing, pending or threatened. ARTICLE IV - COVENANTS IV.1 COVENANT NOT TO COMPETE AND NOT TO SOLICIT For the purpose of assuring to the Purchaser the full benefit of the business and goodwill of the Company, each of the Sellers undertakes by way of further consideration for the obligations of the Purchaser under this Agreement as a separate and independent agreement that: (a) he will at no time after Closing disclose to any person, or himself use for any purpose, except to the extent required for the proper performance of this Agreement and the transactions contemplated herein, any information concerning the business, accounts or finances of the Company or any of its clients' or customers' transactions or affairs of which he has knowledge and that he will use his best endeavors to prevent the publication or disclosure of such information; (b) for 3 years after the termination of the Executive Employment Agreement, either on his own account or for any other person directly or indirectly solicit, interfere with or endeavor to entice away from the Company or any member of the Purchaser's group of companies as then constituted, any person who to his knowledge is, or has during the immediately preceding 3 years been, a client, customer or employee of, or in the habit of dealing with the Company or any member of the Purchaser's Group of Companies as then constituted; (c) for the periods set out in (b) above he will not, alone, or jointly with, or as manager, agent for, or employee of any person, or as a shareholder of more than a 5% interest directly or indirectly carry on or be engaged, concerned or interested in (i) the Business; or (ii) any business competitive with the Business as then carried on by the Company or by any member of the Purchaser's group of companies as then constituted. The Sellers' activities of conducting the business of the College du Leman substantially as currently conducted shall not constitute a violation of this Article IV.1.In case of a violation of the duties under this Article IV.1(b) and (c), the Sellers shall, be entitled to demand by written notice that the activities contrary to the duties under Article IV.1(b) and (c) be terminated immediately and any damages occurred be cured. If such activities are not terminated immediately upon receipt of such notice, the Sellers shall jointly and severally, pay to the Purchaser liquidated damages in the amount of CHF 500,000.- for each violation. In addition to the payment of liquidated damages, the Purchasers and the Company shall have the right to request further damages incurred by the Purchaser, any member of the Purchaser's group of companies as then constituted or the Company, and the right to request the immediate termination of any activity which is contrary to the duties under this Article IV.1. The Sellers shall notify the Purchaser of any intended activities that could reasonably be viewed as a violation of the duties under Article IV.1(b) and (c) hereof. Share Purchase Agreement - 25 - ================================================================================ IV.2 CONDUCT OF THE BUSINESS From the date hereof until the Closing Date, the Sellers shall procure that the Business is conducted in the ordinary course consistent with past practice and they shall use their best efforts to preserve intact the Business, the relationships of the Company with third persons, and to keep available the services of the present employees. Without limiting the foregoing, except as contemplated herein, the Sellers shall not, and shall cause the Company not to, (i) take or agree to take any action that would make any representation or warranty of the Sellers hereunder inaccurate in any respect at, or as of any time prior to, the Closing Time or (ii) omit or agree to omit to take any action necessary to prevent any such representation or warranty from bein inaccurate in any respect at any such time. IV.3 ELECTION OF BOARD MEMBERS At signing of this Agreement, the Sellers shall vote the Sale Shares to elect such new members of the Company's board of directors, as the Purchaser shall have designated reasonably in advance. Until Closing, the Sellers shall vote the Sale Shares with regard to the election of board members only as directed by the Purchaser. IV.4 BEST EFFORTS The parties hereto covenant to use their best efforts to take all action and do all things necessary to consummate the transactions contemplated herein, in particular to cooperate to obtain any required authorization (or - if appropriate - the ruling that no such authorization is required) for the real estate and share transfers contemplated herein. In addition, the Purchaser agrees to use its best efforts to cause the Company to purchase Pre Fleuri B and C according to the terms and conditions of the Pre Fleuri B and C Purchase Agreement, if an Earn-out Payment 2002 has been determined to be in excess of CHF 4,500,000 pursuant to Article I.5 hereof. ARTICLE V - CONDITIONS TO CLOSING V.1 CONDITIONS TO OBLIGATIONS OF THE PURCHASER AND THE SELLERS The obligations of the Purchaser and the Sellers to consummate the Closing are subject to the satisfaction or waiver of the following conditions: (a) All actions by or in respect of or filings with any governmental body, agency, official or authority required to permit the consummation of the Closing shall have been taken, made and obtained; (b) a final decision by the competent authorities declaring the non-applicability to, or the authorization of, the transactions contemplated in the Real Estate Purchase Agreements under the federal law on the acquisition of real estate by foreigners shall have been obtained by September 30, 2000. Share Purchase Agreement - 26 - ================================================================================ V.2 CONDITIONS TO OBLIGATIONS OF THE PURCHASER The obligations of the Purchaser to consummate the Closing are subject to the satisfaction or waiver of the following further conditions: (a) The Sellers shall have performed in all material respects all of their obligations hereunder required to be performed by it on or prior to the Closing. (b) The representations and warranties of the Sellers contained in this Agreement shall be true at and as of the Closing Date. (c) The Purchaser shall have obtained a confirmation from the competent authority in a form and content satisfactory to the Purchaser to the effect that the transactions contemplated in this Agreement do not constitute grounds for a withdrawal or modification of the recognition dated November 6, 1985 nor to propose or initiate any other action of a supervisory nature regarding the Swiss Hotel Association Hotel Management School Les Roches. (d) The Real Estate Purchase Agreements and the Pre Fleuri B and C Option Agreement shall have been duly executed and filed with the Land Register. (e) A final decision by the competent authorities declaring the non-applicability to, or the authorization of, the transactions contemplated in the Pre Fleuri B and C Option Agreement under the federal law on the acquisition of real estate by foreigners shall have been obtained by September 30, 2000. (f) After the execution of this Agreement, there shall have been no development or developments that has (or have), in the aggregate, a Material Adverse Effect on the Company or that would, in the aggregate reasonably be expected to have a Material Adverse Effect on the Company. (g) The constitution of the Company's board of directors shall not have changed since the signing of this Agreement other than with the written consent of the Purchaser. V.3 CONDITIONS TO OBLIGATIONS OF THE SELLERS The obligation of the Sellers to consummate the Closing is subject to the following further conditions: (a) The Purchaser shall have performed in all material respects all of its obligations hereunder required to be performed by it at or prior to the Closing. (b) The representations and warranties of the Purchaser contained in this Agreement shall be true at and as of the Closing Date. Share Purchase Agreement - 27 - ================================================================================ ARTICLE VI - INDEMNIFICATION VI.1 INDEMNIFICATION BY THE SELLERS The Sellers shall indemnify and hold harmless the Purchaser from and against any and all losses, damages, liabilities, obligations, claims, judgements, costs and expenses including reasonable attorney's fees incurred by the Purchaser in connection, directly or indirectly, with (x) a breach of or inaccuracy in the representations and warranties contained in Article III.2 or (y) a breach of or inaccuracy in any of the other agreements and covenants contained in this Agreement. The Sellers' obligation to indemnify shall be joint and several in the amount of 10% of any claim for indemnification; for the exceeding amount, only the Seller 1 shall be liable. Articles 201 and 210 of the Swiss Code of Obligations shall not be applicable to any claim arising out of or in connection with this Agreement. An obligation to indemnify hereunder shall be satisfied first by a reduction of the Purchase Price, provided that such reduction (set-off) may not exceed CHF 1,000,000, and second by payment by the Sellers of the excess amount, if any. For the avoidance of doubt, it is agreed that the Seller 1 shall not delay or withhold the execution, delivery, and recording of the Pre Fleuri B and C Purchase Agreement because of indemnification claimed by the Purchaser. VI.2 SECURITY As security for any claims made by the Purchaser under Article VI.1, the Sellers shall grant the Purchaser a first priority mortgage on Pre Fleuri B and C. VI.3 INDEMNIFICATION BY THE PURCHASER The Purchaser shall indemnify and hold harmless the Sellers from and against any losses, damages, liabilities, obligations, claims, judgements, costs and expenses including reasonable attorneys' fees incurred by the Sellers by reason of or resulting from a breach of or inaccuracy in the representations and warranties contained in Article III.1. VI.4 DEDUCTIONS FROM PAYMENTS (a) All sums payable under this Article VI shall be paid free and clear of all deductions or withholdings whatsoever, save only as may be required by law. (b) If any deductions or withholdings are required by law to be made from any of the sums payable under this Article VI, the paying party shall be obliged to pay the receiving party such sum as will, after the deduction or withholding has been made, Share Purchase Agreement - 28 - ================================================================================ leave the receiving party with the same amount as it would have been entitled to receive in the absence of any such requirement to make a deduction or withholding. (c) If any Taxes shall be payable by the receiving party on any sum payable under this Article VI, the paying party shall be obliged to pay to the receiving party such sum as will, after the payment of such Taxes has been made by the receiving party, leave the receiving party with the same amount as it would have been entitled to receive in the absence of any such requirement to pay Taxes. All Tax benefits of the receiving party related to the claim which is indemnified shall be deducted according to the same principles. (d) All sums payable under this Article VI shall be appropriately adjusted for any sums received from insurances or other third parties for the underlying claims. The parties hereto covenant to pursue such claims in good faith. In addition, the amount of any indemnification payment shall be reduced if the indemnitee failed to use reasonable efforts to mitigate its damages in good faith. VI.5 LIMITATION IN TIME A party to this Agreement may request indemnification as provided in Article VI.1 or claim for breach of a warranty contained in Article III: (i) during a period ending on December 31, 2001 (ii) in case of a breach of the Sellers' representations and warranties in Article III.2.(m) and (x) until the expiration of the applicable statutory limitation period in the relevant statute of limitations (or comparable statute) in each relevant jurisdiction, plus 60 days. Both cases of (i) and (ii) shall hereinafter be referred to as the "INDEMNIFICATION PERIOD"). Upon expiry of the relevant Indemnification Period, the right to request indemnification shall lapse. VI.6 LIMITATIONS ON AMOUNT (a) DEDUCTIBLE The Sellers and the Purchaser shall have no liability with respect to the matters described in Article VI.1 and VI.3 hereof until the party to be indemnified has suffered damages in excess of CHF 500,000.- in the aggregate, at which point the liable party shall indemnify the other party only against such damages in excess of such amount. (b) CEILING The maximum liability of the Sellers and the Purchaser with respect to the matters described in Article VI.1 and VI.3 hereof shall be CHF 3,000,000. (c) EFFECT OF PROVISIONS The Sellers' liability shall be reduced by any provisions created in the Closing Balance Sheet Share Purchase Agreement - 29 - ================================================================================ to cover the kind of risk, loss, or damage that would otherwise give rise to a claim for indemnification. VI.7 THIRD PARTY CLAIMS Promptly after a party entitled to indemnification under this Article VI (an "INDEMNIFIED PARTY") shall have received notice (an "INDEMNIFICATION NOTICE") of the commencement of any action by a third party in respect of which the Indemnified Party will or may seek indemnification under this Article VI or shall have discovered other facts that the Indemnified Party believes give rise to a right to indemnity under this Agreement, the Indemnified Party shall notify the party providing the indemnification hereunder (the "INDEMNIFYING PARTY") thereof in writing but no failure to so notify the Indemnifying Party shall relieve the Indemnifying Party from any liability that it has to the Indemnified Party except if and to the extent that the Indemnifying Party shall have been materially prejudiced thereby. In making any claim under this Article VI.6, the Indemnified Party will specify with reasonable particularity the item or items giving rise to the claim and the basis of the claim. The Indemnified Party shall be entitled to defend lawsuits or actions (including, without limitation, all administrative appeals, proceedings, hearing and conferences with any tax authority and all aspects of any litigation relating to taxes) and to employ and engage attorneys of its own choice to adequately handle and defend the same. The reasonable fees of such attorneys shall be borne by the Indemnifying Party. The Indemnifying Party shall have the right to employ its own, separate counsel who may give non-binding advice to the Indemnified Party and shall have the right to be consulted by the Indemnified Party in the defense of such lawsuit or action, but the fees and expenses of such counsel shall be at the expense of the Indemnifying Party. The Indemnifying Party shall co-operate in all reasonable respects with the Indemnified Party and its attorneys in the investigation, trial and defense of such lawsuit or action and any appeal arising therefrom. The Indemnified Party shall, in conducting any relevant lawsuit or action, take into account the reasonable interests of the Indemnifying Party. The Indemnified Party shall not make any admission of liability, agreement or compromise with any person, body or authority in relation thereto without the prior written consent of the Indemnifying Party which shall not be unreasonably withheld or delayed. VI.8 ADJUSTMENT OF INDEMNITY PAYMENT If any amount is paid by an Indemnifying Party pursuant to this Article VI in respect of any item, then to the extent that the Indemnified Party later recovers in respect of such item an amount which, when added to the indemnification payment previously received in respect thereof pursuant to this Article VI, exceeds the amount which the Indemnified Party was entitled to receive in respect of such item in accordance with the terms hereof, the Indemnified Party will pay to the Indemnifying Party promptly the amount of such excess. Share Purchase Agreement - 30 - ================================================================================ VI.9 EFFECT OF KNOWLEDGE ON REPRESENTATIONS AND WARRANTIES Unless, and then only to the extent, expressly contained in this Agreement and the Annexes and Schedules hereto, no knowledge on the part of the Purchaser's external lawyers and accountants shall limit the Sellers' obligations with respect to, or liabilities for breach of, representations, warranties, disclosures or other obligations hereunder. VI.10 REMEDIES After the Closing, the remedies provided for in this Agreement shall be the only available remedies under this Agreement. Neither party hereto shall be entitled to satisfy its claims under this Article VI by set-off in excess of CHF 1,000,000. The remedies available under applicable law with respect to the various side agreements contemplated by this Agreement shall not be affected by this Article VI.10. ARTICLE VII - MISCELLANEOUS VII.1 NOTICES All notices, requests, demands, waivers and other communications (together "NOTICES"), required or permitted to be given under this Agreement shall be in writing and shall be deemed to have been duly given if sent by registered mail or by telefax with a confirmation by registered mail, as follows: (a) if to the Sellers, to: Francis and Christian Clivaz 11 Rue du Rhone 1204 Geneva Fax No: +41 22 317 80 99 with a copy to: Roy F. Ryan Jones, Day, Reavis & Pogue 20 Rue de Candolle 1205 Geneva Fax No: + 41 22 320 12 32 (b) if to the Purchaser, to: Share Purchase Agreement - 31 - ================================================================================ Sylvan Learning Systems, Inc. Att.: Robert W. Zentz General Counsel 1000 Lancaster Street Baltimore, Maryland 21202 U.S.A. Fax No. 001 410 843 8060 with a copy to: Shelby R. du Pasquier Lenz & Staehelin 25 Grand-Rue 1211 Geneva 11 Fax No: +41 22 318 71 00 or to such other substitute person or address as any party hereto shall from time to time specify by notice in writing to the other party hereto. Notices and communications made by fax shall be deemed to be received on the date of dispatch provided that an answer-back confirmation is available, irrespective of the date of receipt of the confirmation by registered mail. Notices given by registered mail only are deemed to be received upon delivery to the addressee. VII.2 ENTIRE AGREEMENT This Agreement (including the Annexes and Schedules which are part of this Agreement, and documents and agreements to be delivered in accordance with this Agreement) constitutes the entire agreement between the Parties hereto and supersedes all prior agreements and undertakings, oral or written, between the Parties hereto with respect to the subject matter hereof. VII.3 SEVERABILITY OF PROVISIONS If any term or provision of this Agreement or the application thereof to any person or circumstance shall, to any extent, be invalid or unenforceable, the remainder of this Agreement and the application of such term or provision to persons or circumstances other than those as to which it is held invalid or unenforceable, shall not be affected thereby, and each term and provision of this Agreement shall be valid and be enforceable to the fullest extent permitted by law. Share Purchase Agreement - 32 - ================================================================================ VII.4 BINDING EFFECT; BENEFIT With the exception of Article IV.2, this Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective successors and assigns. Nothing in this Agreement, express or implied, is intended to confer on any person other than the parties hereto or their respective successors and assigns, any rights, remedies, obligations or liabilities under or by reason of this Agreement. VII.5 ASSIGNABILITY This Agreement shall not be assigned by any party hereto without the prior written consent of the other party hereto. The Purchaser may, however, assign without the Sellers' prior consent all or part of its rights and duties under this Agreement to any entity of the group to which it belongs or owns controlling interests in, provided that the Purchaser will remain liable for the duties and obligations under this Agreement until any Earn-out Payments 2000, 2001, and 2002 due are paid. In this case, the Purchaser's liability for the duties and obligations arising under this Agreement shall be secondary to the assignee's. However, the Purchaser shall not raise any defenses or objections that were not available to the assignee and the Purchaser shall accept a final and binding court or arbitral decision against the assignee or an unconditional admission of liability by the assignee. VII.6 CHANGE OF CONTROL The maximum Earn-out Payments 2000, 2001, and 2002 shall be immediately payable to the Sellers if there is a Change of Control with regard to the Company. For purposes of this Agreement, a Change of Control shall be deemed to have occured when a party other than a member of the Purchaser's group of companies acquires direct or indirect control over the Company or if all of the Company's assets or a substantial part thereof are transferred to an entity other than a member of the Purchaser's group of companies. For the avoidance of doubt, it is agreed that a possible going public or spin-off of the Purchaser's International University Business business shall not be deemed a Change of Control. VII.7 AMENDMENT AND MODIFICATION; WAIVER This Agreement may be amended or modified by a written instrument duly executed by the Purchaser and the Sellers at any time with respect to any of the terms contained herein. No waiver by any party hereto of any provision hereof shall be effective unless explicitly set forth in writing and executed by the party hereto so waiving. Except as provided in the preceding sentence, no action taken pursuant to this Agreement, including, without limitation, any investigation by or on behalf of any party hereto, shall be deemed to constitute a waiver by the party hereto taking such action of compliance with any representations, warranties, covenants, or agreements contained herein, and in any documents delivered or to be delivered pursuant to this Agreement and in connection with the Closing hereunder. The waiver by any party hereto of a breach of any provision of this Agreement shall not operate or be construed Share Purchase Agreement - 33 - ================================================================================ as a waiver of any other or subsequent breach or a waiver of any other provision of this Agreement. VII.8 ANNOUNCEMENTS (a) EMPLOYEES The transactions contemplated by this Agreement shall be announced to the employees of the Company prior to or simultaneous with any press release or public announcement in a form to be agreed upon by the parties hereto and in accordance with applicable laws. (b) PRESS RELEASES AND PUBLIC ANNOUNCEMENTS No announcement concerning this sale and purchase or this Agreement shall be made before, on or after Closing by any party to this Agreement except as required by law or any competent stock exchange or regulatory authority (provided that in any such case a party hereto required to make such an announcement has, where reasonably practicable, first consulted the other party hereto and taken into account the reasonable comments, objections and requirements of the other party hereto) or with the written approval of the other party hereto (such approval not to be unreasonably withheld or delayed). VII.9 CONFIDENTIALITY The parties hereto agree to keep the terms of this Agreement and any information acquired during the course of the negotiations having led to this Agreement strictly confidential. VII.10 ADVISER'S FEES; EXPENSES Except as otherwise specifically provided in this Agreement, each of the parties hereto shall bear its own fees and costs incident to this Agreement and the transactions contemplated hereby, including those of its financial, technical, legal and other advisers. VII.11 APPLICABLE LAW This Agreement and the legal relations between the parties hereto shall be governed by and construed in accordance with the laws of Switzerland. Share Purchase Agreement - 34 - ================================================================================ VII.12 ARBITRATION (a) All disputes arising out of or in connection with this Agreement which cannot be settled by mutual agreement between the parties shall be finally settled under the Rules of Arbitration of the Geneva Chamber of Commerce, to the exclusion of the ordinary courts, by a three-person arbitral tribunal (the "ARBITRAL TRIBUNAL"). (b) The Arbitral Tribunal shall have its seat in Geneva and the arbitration proceedings, including arguments and briefs, shall be conducted in English and French, both languages being equally valid. A translation of documents in French into English and documents in English into French shall not be required. (c) The parties hereby waive the filing of the award with the competent judicial authority. The award shall be delivered to the parties by the Arbitral Tribunal. Share Purchase Agreement - 35 - ================================================================================ IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. - ---------------------- ------------------------- Francis Clivaz Christian Clivaz Sylvan Learning Systems, Inc. - ----------------------- ------------------------- Name : Name : Title : Title : Share Purchase Agreement - 36 - ================================================================================ LIST OF ANNEXES ANNEX N(DEGREE) DESCRIPTION 1 Executive Employment Agreement 2 June 30 Balance Sheet 3 Marketing Agreement 4 Pre Fleuri B and C Lease 5 Pre Fleuri B and C Option Agreement 6 Real Estate Purchase Agreement (Marcel Clivaz/Les Roches and StFrancois) 7 Real Estate Purchase Agreement (Beatrice, Dominique and Marie Christine Clivaz/Les Rocailles) 8 Real Estate Purchase Agreement (Dominique Clivaz/ Praz d'Anchettes) 9 Real Estate Purchase Agreement (Marie-Helene, Jean-Philippe and Pierre-Andre Clivaz/ Pre Fleuri A) 10 Termination of Marcel Option on Sale Shares Share Purchase Agreement - 37 - ================================================================================ LIST OF SCHEDULES SCHEDULE N(Degree) DESCRIPTION III.2.(b) Articles of Incorporation and internal regulations of the Company III.2.(f) Rights over Equity Interests III.2.(g) Financial Statements III.2.(i) Accounts Receivable III.2.(j) Capital Improvements III.2.(k) Absence of Change III.2.(m)(iv) Tax Disputes III.2.(m)(vi) Adverse Tax Consequences III.2.(o) Lease; Real Property III.2.(q) Intellectual Property III.2.(r) Contracts III.2.(s) Litigation III.2.(t) Licenses, Permits, Approvals III.2(u) Insurance III.2.(v)(i) List of Employees III.2.(v)(ii) Termination of Employment Agreements III.2.(w)(i) Social Security III.2.(w)(ii) Pension Fund III.2.(w)(iii) Pension Fund Certificate EX-11.06 7 a2043474zex-11_06.txt EX-11.06 Exhibit 11.06 CONTRIBUTION AGREEMENT THIS CONTRIBUTION AGREEMENT (the "Agreement") is entered into as of this 22 day of November, 2000, among Sylvan Learning Systems Mexico, S. de R.L. de C.V., hereinafter referred to as "Sylvan", a company organized under the laws of Mexico, and Jose Ortega Martinez, Jorge E. Ortega Martinez, Rosalba Ortega Martinez, Maria Teresa Ortega Martinez, Maria de los Angeles Ortega Martinez and Maria Teresa Martinez Nunez, hereinafter each individual denominated as a "Family Member" and collectively denominated as the "Family Members" or the "Ortega Family". BACKGROUND: Sylvan is a Mexican subsidiary of Sylvan International, B.V., which in turn is a wholly owned subsidiary of Sylvan Learning Systems, Inc., and part of a corporate group engaged in the educational business in several countries around the world. Sylvan is a corporation validly existing and in good standing under the laws of Mexico, and desires to subscribe and pay 80% of the common shares representative of the corporate capital of Plansi. (as defined hereinbelow). The Family Members are Mexicans, with full capacity to enter into this Agreement, and 100% owners, either directly or indirectly, of the associate rights of Universidad del Valle de Mexico, A.C. ("UVM") and Grupo Educativo Potosino, A.C. ("GEP"). These two associations are duly incorporated and validly existing under the laws of Mexico and are engaged in the rendering of educational services in Mexico. The Family Members are also 100% owners, either directly or indirectly, of the corporate parts of Estrategia Educativa y Cultural de Tabasco, S.C. ("EET"), a Mexican civil company engaged in the rendering of educational services in Mexico. The associate rights of UVM and GEP as well as the corporate parts of EET, shall hereinafter be collectively and indistinctly referred as the "Interests". Each of UVM, GEP and EET shall hereinafter be referred indistinctly as an "Entity," and collectively as the "Entities". Sylvan and the Ortega Family shall incorporate a Mexican corporation, Sociedad Anonima de Capital Variable, with the corporate name of Planeacion de Sistemas, S.A. de C.V. ("Plansi"). Sylvan and the Ortega Family want to enter into this Agreement in order to set forth the terms and conditions for incorporating Plansi, carry out their respective contribution and subscribe and pay the common shares representative of the corporate capital of Plansi, as well as to set forth their mutual rights and obligations as future partners. Each Family Member in the aggregate, desires to subscribe and pay up to 20% of the common shares representative of the corporate capital of Plansi and, under the terms and conditions set forth in the corporate Bylaws of Plansi and in that certain Administration Trust Agreement executed on the date hereof, 100% of the preferred shares with limited voting rights representative of the corporate capital of Plansi. In addition to the foregoing, Sylvan and each Family Member have agreed on the execution of the following documents: (i) Trust Agreement; (ii) Plansi's Bylaws; (iii) Transitory Clauses for the Bylaws of Plansi; (iv) Lease Agreements; (v) Employment Agreement for Mr. Jose Ortega Martinez and (vi) other documents related with the foregoing. NOW, THERFORE, the parties hereto agree as follows: ARTICLE I Incorporation of Plansi 1.1 Bylaws (Estatutos Sociales). Sylvan and the Ortega Family have agreed on the Bylaws that shall govern Plansi. A complete copy of those Bylaws, including the transitory clauses is attached hereto as Exhibit 1.1. Both parties agree that the shareholders' rights and obligations, voting rights, management, surveillance, as well as any other provision related to the operation and governance of Plansi, is reflected in the attached Bylaws. Any situation not foreseen in the Bylaws shall be resolved in accordance with the Mexican General Law of Business Organizations. 1.2 Permits and Authorizations. Sylvan and the Ortega Family have obtained the respective permit from the Ministry of Foreign Affairs in order to use the name Planeacion de Sistemas, S.A. de C.V., and such permit is in full force and effect. Pursuant to the educational activities in which the Entities are engaged, the parties have obtained the respective authorization from the National Commission of Foreign Investments by means of which the corporate capital of Plansi, as direct holding company of the Entities, may be subscribed and paid in more than 49% by Sylvan. The Notary Public that will formalize the incorporation of Plansi has received the original of both documents and set forth the required references in the charter of incorporation. 1.3 Incorporation Date. Sylvan and the Ortega Family hereby acknowledge and agree that Plansi shall be incorporated at 9:00 a.m. on November 24, 2000, at the Mexico City offices of White & Case, S.C. (hereinafter referred to as the "Incorporation Date"). ARTICLE II Contribution 2.1 The Ortega Family. The Ortega Family hereby agrees to contribute to Plansi, on the Incorporation Date, in exchange for 1,375,000 shares, equivalent to 20% of the common shares representative of the corporate capital of Plansi, 100% of the Interests in the Entities, free of all liens and encumbrances. Additionally, in exchange for such contribution and subject to the terms and conditions of the Bylaws of Plansi, as well as to that certain Administration Trust Agreement executed as of the date hereof, the Ortega Family shall receive 20,625,000 preferred shares, equivalent to 100% of the preferred shares with limited voting rights, representative of the corporate capital of Plansi. 2.2 Sylvan. Sylvan hereby agrees to contribute to Plansi, on the Incorporation Date, in exchange for 5,500,000 shares, equivalent to 80% of the common shares representative of the corporate capital of Plansi, $42,400,000 U.S dollars (Forty two million, four hundred thousand dollars of the United States of America), in immediately available funds, by check to be deposited with the Board of Directors of Plansi at the time of incorporation. 2.3 Financial Information. The Ortega Family and Sylvan hereby acknowledge that the amount of the contribution agreed by each party was calculated based on the financial information prepared as of October 31, 2000, attached hereto as Exhibit 2.3 (the "Financial Information"). 2.4 Corporate Documents. The parties have agreed on the amount of their contribution, on the subscription of their respective shares as well on all other documents required to implement the steps described in the Transitory Clauses of the Bylaws of Plansi. Therefore, on the Incorporation Date the parties will receive their stock certificates and the Secretary of Plansi shall proceed to prepare and register the entries required by law in the corporate books of Plansi. ARTICLE III Representations and Warranties 3.1 Representations of the Ortega Family Each of the Family Members jointly and severally hereby represents and warrants to Sylvan, that: a) Individual Authority. Each Family Member is an individual residing in, and a citizen of, Mexico with full power and capacity under the laws of Mexico to enter into this Agreement and all of the documents to be entered into by him/her in connection herewith and to consummate the transactions contemplated hereby and thereby. b) No Breach of Agreements. The execution, delivery and performance of this Agreement and each of the other documents to be entered into by each Family Member in connection herewith, and the consummation of the transactions contemplated hereby and thereby (i) do not, in the case of each Family Member materially conflict ("materially" or "material" means, with respect to any person, any adverse effect in the business, operations, assets, condition (financial or otherwise), prospects, operating results or liabilities of such person or any casualty loss or damage to the assets of such person, whether or not covered by insurance that would impede the continuation of the business and/or cause significant casualty loss or damage to any assets) with any agreement, contract or judgment entered by him/her/it and does not materially conflict with the Articles of Incorporation or other constitutive documents of the corporation or civil corporations; and (ii) do not, materially violate any law, rule, regulations, writ, judgment, injunction, decree, determination or award applicable to him/her/it. c) Government Consents. Except for those authorizations, approvals, permits, actions, notices and filings mentioned in Section 1.2 above, no authorization or approval or other action by, and no notice to or filing with, any governmental authority, regulatory body or agency is required for its due execution, delivery, recordation, filing or performance of this Agreement or any of the other documents to be entered into by each Family Member in connection herewith, or for the consummation of the transactions contemplated hereby and thereby. d) No Breach of Contract. The execution, delivery and performance of this Agreement and each of the other documents to be entered into by each Family Member in connection herewith, and the consummation of the transactions contemplated hereby and thereby (i) do not materially conflict with or result in a default under, or permit the acceleration of, any agreement, instrument or obligation to which each Family Member is a party and (ii) do not require any consent or notice under any agreement, instrument or obligation to which each Family Member is a party. e) Enforceability. This Agreement has been duly executed and delivered by each Family Member and this Agreement constitutes his/her legal, valid and binding obligation enforceable against him/her in accordance with the terms of this Agreement. Upon the execution and delivery of each of the other documents to be entered into by each Family Member in connection herewith, such documents shall constitute his/her legal, valid and binding obligations enforceable against each Family Member in accordance with the terms of such documents. f) Organization. Each of the Entities is a Mexican civil association/ corporation, duly incorporated, validly existing and in good standing under the laws of Mexico and has all necessary corporate power and authority to operate its business as now being conducted. Neither of the Entities is a party or subject to any agreement or commitment materially restricting the conduct of its business in any location. As of October 31, 2000 none of the Entities has entered into any agreement or assumed any liability or obligation other than in the ordinary course of business as historically conducted. g) Real Estate. None of the Entities owns real estate, however, they have entered into all the necessary lease agreements that allow the Entities to continue using the installations in order to operate their business as now being conducted during the next ten years. Exhibit 3.1 (g) attached hereto lists all the lease agreements entered into by each of the Entities required to continue with the operation of the business as historically conducted. h) Patents and Patent Rights. To each Family Member's best knowledge (following internal due diligence by those Family Members competent to perform such due diligence), the Entities do not own or use any patent and have not filed any patent applications. The present use of any invention, process, model, design or formula by the Entities do not conflict with, infringe on or violate any patent or other rights of any other person. i) Trademarks, Patents, Tradenames, Service Marks and Copyrights. Exhibit 3.1 (i) attached hereto lists: (i) all trademarks, tradenames and service marks owned or used by each of the Entities; (ii) all registrations owned and registration applications filed by each of the Entities for trademarks and service marks, and the jurisdiction that has issued each such registration or in which each such application has been filed (including registration and application numbers); and (iii) all registrations owned and registration applications filed by each of the Entities for copyrights owned or used by each of the Entities and each jurisdiction that has issued each such registration or in which each such application has been filed (including registration and application numbers). Exhibit 3.1 (i) also includes a list of each license or other agreement to which each of the Entities is a party whether as licensor, licensee or otherwise, with respect to any tradenames, trademarks, service marks and copyrights. To each Family Member's best knowledge all of the registered trademarks, service marks and copyrights listed on Exhibit 3.1 (i) attached hereto are valid and subsisting, and no such registered trademarks, service marks or copyrights have been, in whole or in part, abandoned, dedicated, disclaimed or allowed to lapse for nonpayment of fees or taxes or for any other reason. To each Family Member's best knowledge, each of the Entities has the right and authority to use all tradenames, trademarks, service marks and copyrights reasonably necessary to conduct its business as historically conducted. To each Family Member's best knowledge, each of the Entities has not infringed and is not now infringing on any tradename, trademark, service mark or copyright belonging to any other person. j) Permits; Authorizations. Except as established on Exhibit 3.1(j) attached hereto and to each family Member's best knowledge, the Entities have all the licenses, permits, certifications or approvals required to conduct its business as historically conducted by the Entities (the "Permits and Authorizations"). To each Family Member's best knowledge the Permits and Authorizations are in full force and effect, all fees and charges payable with respect thereto have been paid, and neither of the Entities has received any notice of any revocation, limitation or violation thereof. k) Contracts. Exhibit 3.1 (k) attached hereto lists each contract currently in full force and effect, entered into by each of the Entities involving an aggregate value in excess of US $100,000. To each Family Member's best knowledge all the contracts executed as of this date by each of the Entities have been entered into in the ordinary course of business on terms consistent with past practices. l) Investments. To each Family Member's best knowledge neither of the Entities owns any capital stock of, any equity Interests in, or any other ownership or investment interest in, any corporation, partnership, joint venture or other business entity, except for those mentioned in Exhibit 3.1 (l). m) Capitalization. The Interests of each Family Member in the Entities existing as of the date hereof, are as set forth in Exhibit 3.1 (m), attached hereto. All of the issued and outstanding Interests of the Entities are duly authorized, validly issued and fully paid and are owned beneficially and of record as set forth on such Exhibit 3.1 (m) attached hereto. All such Interests are free and clear of all liens and other adverse claims. None of the Entities has issued any Interests in violation of any applicable law. There are no existing options or other rights of any character relating to authorized but unissued Interests of any of the Entities. Other than the bylaws of each of the Entities, there are no other documents or agreements governing the transfer or voting of the Interests. n) Compliance with Laws. To Each Family Member's best knowledge each of the Entities is materially in compliance with all applicable Mexican federal, state and local laws, and all the services provided by the Entities, and all marketing material and promotion arrangements used or employed by the Entities, materially conform to all requirements of all applicable Mexican federal, state and local laws. o) Employee Relations. To each Family Member's best knowledge none of the Entities is delinquent in the payment to any of their employees or consultants or to any regulatory authorities of any wages, salaries, commissions, bonuses, health benefits, housing benefits, social security, retirement benefits or other direct compensation or benefits for any services performed by them to the date hereof or amounts required to be reimbursed to such employees. Exhibit 3.1 (o) attached hereto contains a list of all employees and consultants employed in connection with the operations of the Entities who, individually, have received or are scheduled to receive compensation from any of the Entities for the current fiscal year in excess of US $50,000. p) Environmental Compliance. To each Family Member's best knowledge, the Entities' operations are and have been in compliance in all material respects with all applicable Environmental Laws. To each Family Member's best knowledge, none of the Entities has received any written notice, mandate, order or request under any Environmental Law concerning the Entities' facilities that relates to any hazardous substance. To each Family Member's best knowledge there is no proceeding pending against any of the Entities by any Mexican federal, state or local court, tribunal, administrative agency, department, commission, board or other authority or instrumentality with respect to the presence or release of any hazardous substance from or on the Entities' facilities. To each Family Member's best knowledge there has not been released from or on the Entities' facilities any hazardous substance in a quantity or concentration that would require remedial action under any applicable Environmental Law. To each Family Member's best knowledge all storage tanks (whether above or below ground) on or at any of the Entities' facilities installed or used by any of the Entities, are in sound condition free of corrosion or leaks that could permit any release of any hazardous substance. Except in the companies ordinary course of the business, none of their facilities has been used for processing, storing or otherwise utilizing any hazardous substances and none of the Entities has received notice that any hazardous substance is present on or at any of their facilities. To each Family Member's best knowledge all hazardous substances resulting from the Entities' operations have been disposed of in accordance with applicable Environmental Laws and none of the Entities has received notice from any person, including any Mexican federal or state environmental agency, of its possible involvement with any disposal site under investigation by any such person. To each Family Member's best knowledge each of the Entities is in compliance in all material respects with all applicable Mexican federal, state and local filing and notification requirements respecting hazardous substances. To each Family Member's best knowledge there are no wells located on the Entities facilities that are contaminated or are constructed or maintained in such a manner that their continued use or existence endangers ground water quality or are a safety or health hazard, or are inoperable or not in use, or must be sealed under the provisions of applicable law. q) Tax Matters. To each Family Member's best knowledge each of the Entities has, with respect to all years for which the applicable statute of limitations for assessment, reassessment or collection has not yet expired, paid or caused to be paid, all taxes required to be paid by them. There is no material tax deficiency or claim of additional taxes or interest thereon or penalties in connection therewith, asserted or, to each Family Member's knowledge, threatened to be asserted against any of the Entities or any of their businesses by any taxing authority. To each Family Member's best knowledge each of the Entities has, in accordance with applicable law, timely filed all tax reports or returns required to be filed by it through the date hereof. Each such tax report and return materially reflects the amount of tax liability of such Entity for such period and other required information, and all amounts shown as payable thereon have been paid. To each Family Member's best knowledge no audit of any tax return of any of the Entities is in progress and, to each Family Member's knowledge, no such audit is contemplated or pending. No extension of time with respect to any date on which a tax return was or is to be filed by any Entity is in force, and no waiver or agreement is in force for the extension of time or for the assessment or payment of any tax. To each Family Member's best knowledge there are no security interest in any of the assets owned by the Entities that arose in connection with any failure to pay taxes. r) Litigation. Except as set forth on Exhibit 3.1 (r) attached hereto, the Entities are not a party to, and there is no claim, action, suit, proceeding, arbitration or any investigation or inquiry, before any Mexican federal, state, municipal, foreign or other court or governmental or administrative body or agency, or any private arbitration tribunal now pending or, to the knowledge of the Ortega Family, threatened against or relating to the Entities or that relates to the transactions contemplated by this Agreement. s) Undisclosed Liabilities. To each Family Member's knowledge (following internal due diligence by those Family Members competent to perform such due diligence), each of the Entities, on an individual basis, are not subject to any material obligation, liability, debt or commitment, contingent or otherwise, other than: (i) liabilities reflected on the Financial Information; (ii) liabilities not required to be disclosed on the Financial Information but otherwise disclosed herein; (ii) liabilities incurred since the date of the Financial Information in the ordinary course of business; and (iv) liabilities arising hereunder. t) Transactions with Related Parties. Exhibit 3.1 (t) attached hereto, lists all contracts, agreements or transactions currently in force and effect carried out by each of the Entities with any Related Party. For purposes of this Section, the term Related Party includes (i) any corporation, limited liability company, partnership, joint venture, trust, other entity and/or other person controlled, directly or indirectly, by the Entities and/or by any of the Family Members whether through the ownership of capital stock or other equity interests, by contract or otherwise; and (ii) each director, officer, employee and consultant of the Entities. u) Investment Banks; Brokers. The Ortega Family has not employed any investment bank in connection with the transactions contemplated by this Agreement. It has not employed any broker or finder, other than Mr. Javier Arrechea, or incurred any liability for any brokerage fees, commissions or finders fees in connection with the transactions contemplated by this Agreement, other than those payable to Mr. Javier Arrechea. v) No Material Omission. No representation by the Ortega Family on their own right or on behalf of the Entities, contained herein or any writing to be delivered hereunder to Sylvan or to Plansi contains any untrue statement of material fact or omits material facts required to make the statements herein or therein contained not misleading. Every representation and warranty is materially true and correct, and valid as of the Incorporation Date. w) Financial Statements. Attached hereto as Exhibit 3.1 (w) are audited financial statements of each of the Entities, as of December 31, 1999, and unaudited financial statements as of October 31, 2000 of each of the entities (collectively "the Financial Statements"). The Financial Statements are true and correct in all material respects, fairly present the financial position and results of operations of each of the Entities, as of the dates and for the periods indicated, and were prepared in conformity with Mexican GAAP applied on a consistent basis. x) Labor Matters. Exhibit 3.1 (x-a) contains a list of all employees of the Entities as of October 31, 2000. This list contains details about salary, (including benefits in kind), age, seniority, length of service, notice periods for termination, right to severance pay and to bonus. To each Family Member's best knowledge (following internal due diligence by those Family Members competent to perform such due diligence) and except for employment contracts listed in Exhibit 3.1(x-b), each contract of employment to which the Entities are party and which is for an annual consideration of $50,000 or more can be terminated by the Entities without damages or compensation (other than that payable by laws) by giving at any time not more than six months' notice. To each Family Member's best knowledge (following internal due diligence by those Family Members competent to perform such due diligence) and except as set forth in Exhibit 3.1 (x-c), there are no collective bargaining or other union agreements or arrangements (whether binding or not) to which the Entities are party of by which there are bound or which are currently being negotiated and no dispute between the Entities and any trade union or other organization formed for a similar purpose are existing, pending or threatened. y) Professional and Social Welfare. To each Family Member's best knowledge (following internal due diligence by those Family Members competent to perform such due diligence), any an all returns and reports related to Social Security contributions that are required to be filed with respect to the Entities prior to the date hereof have been filed timely and correctly in all material respects. To each Family Member's best knowledge (following internal due diligence by those Family Members competent to perform such due diligence), the Entities have paid in full any and all Social Security contributions as and when due. No social security authority is currently asserting any deficiency or claim for additional Social Security contributions (or interest thereon or penalties in connection therewith) and any and all Social Security contributions which (although not due) have accrued on the basis of the salaries to be paid until the date hereof, have been fully provisioned. Except as set forth in Exhibit 3.1 (y-a) to the best knowledge of each of the Family Member's, there are no facts or circumstances existing or having arisen prior to the date hereof which have or may lead to a re-assessment by any Social Security authority of Social Security contributions to be made by the Entities relating to any period prior to the date hereof. The details of the employee pension fund of each of the Entities are described in Exhibit 3.1 (y-b)(hereinafter the "Pension Fund"). The Entities are meeting all their obligations under the Pension Fund and specifically have paid (or provisioned) all contributions required prior to the date hereof as stipulated by the regulations of the Pension Fund. Performance of these obligations is acknowledged in the pension fund certificate (hereinafter the "Pension Fund Certificate") attached hereto as Exhibit 3.1 (y-c). The Entities are not required to contribute to any pension fund other than the Pension Fund. z) Bank Accounts. Exhibit 3.1 (z) attached hereto, lists each bank account opened in favor of each one of the Entities, including the authorized signatories. The amounts described in each bank account are true and correct and the respective sums shall be kept until the Incorporation Date. aa) Powers of Attorney. The Ortega Family acknowledges and accepts that at the Incorporation Date each one of the Entities will hold associates/partners meetings in which diverse powers of attorney may be revoked, amended and/or granted. bb) Insurance. To each Family Member's best knowledge (following internal due diligence by those Family Members competent to perform such due diligence), all the equipment, vehicles, and any other assets owned by each one of the Entities, are duly insured by a Mexican authorized insurance company, and the respective insurance policies are in full force and effect, and will continue valid until December 31, 2000. Exhibit 3.1 (bb) contains a list of the insurance agreements obtained by each one of the Entities and currently in force. The Ortega Family acknowledges and agrees that there are no current material claims against any of the Entities. To each Family Member's best knowledge (following internal due diligence by those Family Members competent to perform such due diligence), all premiums pertaining to the insurance policies have been paid as they fell due, or are duly provided for in the Financial Statements. cc) Working Capital. The parties hereby acknowledge and accept that the Ortega Family will have the right to withdraw $40,000,000.00 Mex. Cy. (Forty Million pesos Mexican Currency) of working capital over a period of time enough in order to not affect in any way the cash flow of the Entities. dd) Validity of the Representations. The Ortega Family hereby acknowledges and accepts that each of the representations and warranties, except specifically determined otherwise, is in full force and effect as of the date hereof. 3.2 Representations regarding Sylvan. Sylvan hereby represents and warrants to the Ortega Family, that: a) Authority. It is a Sociedad de Responsabilidad Limitada, duly incorporated and validly existing under the laws of Mexico and has all necessary corporate power and authority to enter into this Agreement and each of the other documents to be entered into by it in connection herewith and to consummate the transactions contemplated hereby and thereby. Its execution, delivery and performance hereof and each of the other documents to be entered into by it in connection herewith and its consummation of the transactions contemplated hereby and thereby have been duly and validly authorized by all necessary corporate action. b) No Breach of Law. Its execution, delivery and performance of this Agreement and each of the other documents to be entered into by it in connection herewith, and its consummation of the transactions contemplated hereby and thereby (i) do not conflict with its Articles of Incorporation or other constitutive documents; (ii) do not, violate any law, rule, regulations, writ, judgment, injunction, decree, determination or award applicable to it. c) Government Consents. Except for those authorizations, approvals, permits, actions, notices and filings mentioned in Section 1.2 above, which have been satisfied, there are no other authorizations, approvals or other actions by, and no notice to or filing with, any governmental authority, regulatory body or agency required for the due execution, delivery, filing or performance of this Agreement or any of the other documents to be entered into by it in connection herewith, or for the consummation of the transactions contemplated hereby and thereby. d) No Breach of Contract. Its execution, delivery and performance of this Agreement and each of the other documents to be entered into by it in connection herewith, and the consummation of the transactions contemplated hereby and thereby (i) do not conflict with or result in a default under, or permit the acceleration of, any agreement, instrument or obligation to which it is a party or by which it or any of its properties may be affected or be bound; and (ii) do not require any consent or notice under any agreement, instrument or obligation to which it is a party of by which it or any of its properties may be affected or be bound. e) Enforceability. This Agreement has been duly executed and delivered by it, and (assuming due authorization, execution and delivery by the Ortega Family) this Agreement constitutes its legal, valid and binding obligation enforceable against it in accordance with the terms of this Agreement. Upon its execution and delivery of each of the other documents to be entered into by it in connection herewith (assuming due authorization, execution and delivery by the other parties signatories thereto), such documents shall constitute its legal, valid and binding obligations enforceable against it in accordance with the terms of such documents. ARTICLE IV Conditions to the Ortega Family Obligations Each and every obligation of the Ortega Family under this Agreement shall be subject to the fulfillment, prior to or at the Incorporation Date, of each of the following conditions. If any of the following conditions to the Incorporation Date shall not have been satisfied, the Ortega Family may elect to terminate this Agreement, or to waive such condition and to consummate the transactions contemplated hereby despite such failure. 4.1. Opinion of Counsel. Martinez, Rodriguez y Asociados, S.C., counsel to Sylvan, shall have delivered to the Ortega Family an opinion dated the Incorporation Date in the form of Exhibit 4.1, attached hereto. 4.2 Approvals and Consents. Sylvan shall have obtained and have provided to the Ortega Family such authorizations as are required by law in order to consummate the transactions contemplated hereby. ARTICLE V Conditions to Sylvan Obligations Each and every obligation of Sylvan under this Agreement shall be subject to the fulfillment, prior to or at the Incorporation Date, of each of the following conditions. If any of the following conditions to the Incorporation Date shall not have been satisfied, Sylvan may elect to terminate this Agreement or to waive such condition and to consummate the transactions contemplated hereby despite such failure. 5.1. Opinion of Counsel. White & Case, S.C., special Mexican counsel to the Ortega Family, shall have delivered to Sylvan an opinion dated the Incorporation Date in the form of Exhibit 5.1 attached hereto. 5.2. Approvals and Consents. The Ortega Family shall have obtained and have provided to Sylvan such authorizations as are required by law or under agreements with third parties in order to consummate the transactions contemplated hereby and to continue the business of the Entities. ARTICLE VI Conduct Subsequent to the Incorporation Date 6.1. Further Assurances. From and after the Incorporation Date, upon the reasonable request of Sylvan or the Ortega Family, the Ortega Family or Sylvan shall execute, acknowledge and deliver to Sylvan or to the Ortega Family, such further instruments and take such other actions as Sylvan or the Ortega Family may reasonably request, in order to carry out the intent and purposes of this Agreement and/or more effectively reflect the consummation of the transactions contemplated hereby. ARTICLE VII Non Compete; Confidentiality 7.1 Non Compete. Each of the Family Members hereby acknowledge and agree that none of the Family Members shall compete in Mexico, directly or through another person or entity, for a four (4) year period in the university education segment. This four (4) year period shall be counted as from the Incorporation Date. For purposes of this clause, the following shall not be deemed to mean competition: (i) Holding individually up to 2% or jointly amongst the six Family Members up to 12% of the voting equity of a company involved in the university education segment; (ii) Holding a teaching position at a company involved in the university education segment, (iii) Participating in a non-for-profit organization with the purpose of promoting (not providing) university level education, or (iv) existing businesses in which the Ortega Family is currently participating (e.g. Nuevo Continente Schools, Profesionistas y Docentes Asociados, S.A. de C.V., Red Tercer Milenio, S.C., Red Univercom, S.C., Procesos Educativos y de Consultoria, S.C., Centro de Formacion Continua, Formacion Completa, S.C. [Campus Lago de Guadalupe], Sociedad Mexicana de Normalizacion y Certificacion, S.C., Centro Mexicano de Tecnologia para la Competividad, S.C., and Centro Universitario ETAC, A.C.), but in no event to directly or indirectly compete with the university education segment business of the Entities. 7.2. Confidentiality. Each of the Family members and Sylvan, hereby agrees and acknowledges that in connection with the negotiation, preparation and execution of this Agreement and the agreements and/or documents related thereto, it has had, and derived from their relation with Plansi they will continue to have, access to Confidential Information. Each of the Family Members (and/or the corporations or civil corporations) and Sylvan, hereby accept not to divulge, disclose or communicate, or permit to be divulged, disclosed or communicated, to any third party in any manner, directly or indirectly, any Confidential Information, and it shall disclose or permit to be disclosed the Confidential Information only to those of its representatives who have a need to know such Confidential Information solely in connection with the conduct of Plansi and/or the Entities business in the ordinary course, and shall take measures to ensure that such representatives agree to be bound by the provisions hereof, and it shall take all other necessary or appropriate actions to preserve the confidentiality of the Confidential Information. For purposes hereof, "Confidential Information" shall mean all financial and other technical data and information, business and commercial information, and know-how of Plansi, the Entities, each of the Family Members and Sylvan, relating in any manner to their business, written or unwritten that has been, prior to the date hereof, or may be, following the date hereof delivered or furnished to any party. In addition, "Confidential Information" includes any analysis, market study or compilation in respect of any of the foregoing. The restrictions contained herein shall not apply to Confidential Information that: (i) at the time of disclosure is generally available to the public (than as a result of a disclosure directly or indirectly by the party otherwise subject to the provisions of this Article, or any of its representatives in violation of this Agreement); (ii) is obtained by a party otherwise subject to the provisions of this Article, or any of its respective representatives on a nonconfidential basis from a source that is not bound by a confidentiality agreement with, or other obligation of confidentiality to, Plansi, the Entities or Sylvan; (iii) has been independently acquired or developed by a party otherwise subject to the provisions of this Article or any of its representatives without use of or reference to the Confidential Information (iv) is required to be disclosed by law; or (v) was within the receiving party's possession prior to its being furnished to the receiving party by or on behalf of the disclosing party pursuant hereto, provided that the source of such information was not known by the receiving party to be bound by a confidentiality agreement with or other contractual, legal or fiduciary obligation of confidentiality to the disclosing party or any other party with respect to such information. The Ortega Family hereby acknowledges and agrees that all the information received by Sylvan, including the Confidential Information, may be used by Sylvan in order to comply with the applicable laws and regulations of the different jurisdictions where Sylvan Learning Systems, Inc., has or may have business. Sylvan may have the possibility at all times of sharing the information, including the Confidential Information, with all its related companies around the world, including the parent companies. ARTICLE VIII Indemnification 8.1. Indemnification by the Ortega Family. The Ortega Family, jointly and severally, shall indemnify and hold Sylvan and/or their respective shareholders, directors, officers, employees, agents, successors and/or assigns harmless from and against any and all losses, liabilities, damages, claims, costs, expenses and/or assessments (including reasonable and duly documented attorneys and other professional fees and costs as well as fines, penalties and/or interest) (collectively, "Losses") suffered or incurred by any of them which result from or arise out of: (a) An inaccurate or untrue statement or omission of a material fact made by the Ortega Family on their own right or on behalf of the Entities, herein or in any agreement, instrument or certificate delivered pursuant hereto; (b) The failure by the Ortega Family to comply with or perform any covenant or agreement of the Ortega Family set forth herein or in any agreement, instrument or certificate delivered pursuant hereto; (c) The parties agree that the Ortega Family will not have any obligation to indemnify Sylvan or any of its shareholders, directors, officers, employees, agents, successors and/or assigns until any individual loss exceeds US$100,000, in which case the Ortega Family will indemnify for the full amount of said loss. Likewise, the parties agree that the obligation to indemnify for losses is limited (individually and in the aggregate) to US$42,400,000. 8.2. Indemnification by Sylvan. Sylvan shall indemnify and hold the Family Members and/or their successors, agents and/or assigns, harmless from and against any and all Losses suffered or incurred by any of them which result from or arise out of: (a) The inaccurate or breach of any representation or warranty made by Sylvan herein or in any agreement, instrument or certificate delivered pursuant hereto; or (b) The failure by Sylvan to comply with or perform any covenant or agreement of Sylvan set forth herein or in any agreement, instrument or certificate delivered pursuant hereto. 8.3. Notice of Claims. Promptly after any person entitled to indemnification hereunder (an "Indemnitee") (i) receives notice of any claim or the commencement of any proceeding against it, or (ii) has knowledge of any claim or proceeding against it or of any Loss for which it intends to seek indemnification hereunder, such person shall, if a claim for reimbursement with respect thereto is to be made against any party hereto obligated to provide indemnification (the "Indemnifying Party") hereunder, promptly give the Indemnifying Party written notice of such claim or Loss or the commencement of such proceeding; provided, however, that failure to give such notification shall not affect indemnification hereunder, except to the extent that the Indemnifying Party is unable to defend any such claim or is required to pay a greater amount or accrue additional expenses with respect to any claim or Loss as a result of such failure to provide prompt notice. 8.4. Defense of Third Party Claims. The Indemnifying Party shall have the right to compromise or defend, at its own expense and by its counsel, any third party claim made against the Indemnitee; provided, however, that no compromise of any claim shall be made without the consent of the Indemnitee unless such compromise results in the full and unconditional release of all claims against the Indemnitee by the person asserting such claim. The Indemnifying Party shall notify the Indemnitee whether it elects to assume the defense of any third party claim within ten (10) days after the Indemnifying Party receives notice thereof from the Indemnitee as provided in Section 8.3. The Indemnitee shall cooperate with the Indemnifying Party or its counsel in the defense against any such third party claim and in any compromise thereof. Such cooperation shall include, but not be limited to, furnishing the Indemnifying Party with any books, records or information reasonably requested by the Indemnifying Party. Except as provided below, after the Indemnifying Party has notified the Indemnitee of its intention to undertake to compromise or defend any such third party claim, the Indemnifying Party shall not be liable for any additional legal expense incurred by the Indemnitee. However, the Indemnitee shall have the right to retain its own counsel and participate in the defense of such claim at the expense of the Indemnitee, in which case the Indemnifying Party shall cooperate in providing information to and consulting with the Indemnitee about the claim. If the Indemnifying Party does not assume the defense of such claim, the Indemnitee may defend against or settle such claim in such manner and on such terms as it deems appropriate, and shall be indemnified by the Indemnifying Party for the amount of any judgment or settlement and for all losses or expenses, including attorneys' and other professional fees and costs, incurred by the Indemnitee in connection with the defense or settlement of such claim. Any issue can only be settled with the consent of the Indemnitee, in the understanding that if no consent can be reached, the parties will have to resolve the dispute by arbitration according to point 9.2 of this agreement. 8.5. Payment. If any Indemnitee shall incur any Loss for which it is entitled to indemnification hereunder, the Indemnifying Party shall make the indemnification payment required under this Article VIII within ten (10) days after receipt by the Indemnifying Party of written notice from the Indemnitee stating the amount of the Loss and of the indemnification payment requested. ARTICLE IX Miscellaneous 9.1 Expenses. The Ortega Family shall be responsible for any taxes which become due as a result of the transfer of the Interests to Plansi. Each party shall pay its own expenses and costs relating to the negotiation, execution and performance of this Agreement and the agreements, documents and instruments derived here from. 9.2. Governing Law; Arbitration. This Agreement shall be governed by, and construed and interpreted in accordance with the laws of the United Mexican States, and shall be subject to arbitration in Mexico or such other place as the Ortega Family and Sylvan shall mutually agree and shall be held in accordance with the rules of the International Chamber of Commerce. Any controversy or claim arising out of or relating to this Agreement, or the breach thereof or relationship created thereby, that is not settled through negotiation shall be resolved exclusively by arbitration under the auspices of and in accordance with the Rules of Conciliation and Arbitration of the International Chamber of Commerce then in effect. The arbitration shall be conducted in English language. The arbitration shall be heard before three arbitrators, one to be chosen by Sylvan, one to be chosen by the Ortega Family, and the third to be chosen by those two arbitrators. The arbitration shall be final and binding on the parties, and shall not be subject to any appeal. Judgment on the award of the arbitrators may be entered by any court having jurisdiction to do so. The losing party, so declared by the arbitrators, shall pay all out-of-pocket expenses incurred by the prevailing party in connection with any such dispute. Notwithstanding any other provision of this agreement, any party shall be entitled to seek injunctive or other provisional relief from any court of competent jurisdiction pending the final decision or award of the arbitrators. 9.3. Notices. Any notice or request with respect to this Agreement shall be in writing in English language and shall be delivered personally, by registered mail, by express courier or by any electronic media with acknowledge receipt, at the following addresses: To the Ortega Family: Segunda Cerrada de Galeana No. 15 Colonia San Angel 01000 Mexico, D.F. Attention: Mr. Jose Ortega Fax: 55 50 41 51 With copy to: White & Case, S.C. Av. Paseo de las Palmas 405, 5th Floor, Col. Lomas de Chapultepec 11000 Mexico, D.F. Attention: Mr. Alexis Rovzar Fax (52) 5540 96 99 To Sylvan 1000 Lancaster Street, Baltimore, Maryland 21202 U.S.A. Attention: Mr. Robert W. Zentz Fax: (410) 843 8060 With copy to: Martinez, Rodriguez y Asociados, S.C. Insurgentes Sur No. 800, 10th Floor, Col. Del Valle 03100 Mexico, D.F. Attention: Mr. Eduardo Martinez Fax (52) 5523 52 43 9.4. Certain Definitions. Unless the context clearly otherwise requires, as used herein, the term "Agreement" means this Agreement and the Exhibits hereto. The words "herein," "hereof" and "hereunder" and other words of similar import refer to this Agreement as a whole and not to any particular Article, Section, Paragraph or other subdivision. The use of the neuter pronoun "it" shall also refer as appropriate to the masculine and/or feminine gender. The use of the singular herein shall, where appropriate, be deemed to include the plural and vice versa. As used herein, the word "person" refers to any individual, corporation, partnership, trust, governmental body or authority or other organization or entity. As used herein, the term "including" means "including, without limitation." As used herein, "dollars" and "$" refer to United States Dollars. For purposes of this agreement, "to the knowledge of any person" shall mean any matter within the actual knowledge of such person and/or any matter that should have been known by such person in connection with the performance of his duties as an employee, officer and/or director, and/or any matter that should have been known by such person as a result of a reasonable inquiry. 9.5. Headings. The headings to Articles and Sections of this Agreement are for reference only and shall not be used in construing the provisions hereof or otherwise affect the meaning hereof. 9.6. Entire Agreement. This Agreement embodies the entire agreement and understanding between Sylvan and the Ortega Family and supersedes all prior agreements and understandings related to the subject matter hereof. There are no representations, warranties, covenants, promises or agreements on the part of any party to any other party hereto which are not explicitly set forth herein. 9.7. Modifications, Waivers. Any modification or amendment of or with respect to any provisions of this Agreement or any agreement, instrument or document delivered pursuant hereto shall not be effective unless it shall be in writing and signed by Sylvan and the Family Members and shall designate specifically the terms and provisions so modified. Any waiver of or with respect to any provisions of this Agreement or any agreement, instrument or document delivered pursuant hereto shall not be effective unless it shall be in writing and signed by Sylvan, in the case of a waiver by Sylvan, and by the Ortega Family, in the case of a waiver by the Ortega Family. 9.8. Benefit; Assignment. This Agreement shall be binding upon and inure to the benefit of Sylvan and the Ortega Family and their respective successors and permitted assigns. Sylvan and the Ortega Family may assign their rights or delegate their obligations hereunder following the terms and conditions of the Bylaws of Plansi. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. SYLVAN LEARNING SYSTEMS MEXICO, S. DE R.L. DE C.V. /s/ EDUARDO MARTINEZ RODRIGUEZ - --------------------------------------- By: Eduardo Martinez Rodriguez Its: Attorney in fact ORTEGA FAMILY /s/ JOSE ORTEGA MARTINEZ /s/ JORGE E. ORTEGA MARTINEZ - --------------------------------- --------------------------------------- JOSE ORTEGA MARTINEZ JORGE E. ORTEGA MARTINEZ /s/ ROSALBA ORTEGA MARTINEZ /s/ MARIA TERESA ORTEGA MARTINEZ - --------------------------- --------------------------------------- ROSALBA ORTEGA MARTINEZ MARIA TERESA ORTEGA MARTINEZ /s/ MARIA DE LOS ANGELES ORTEGA MARTINEZ - --------------------------------------------- MARIA DE LOS ANGELES ORTEGA MARTINEZ /s/ MARIA TERESA MARTINEZ NUNEZ - ------------------------------------ MARIA TERESA MARTINEZ NUNEZ LIST OF EXHIBITS 1.1 Plansi Bylaws 2.3 Financial Information 3.1(g) Lease Agreements 3.1(i) Trademarks, Tradenames, Service Marks and Copyrights. 3.1(j) Permits, Authorizations 3.1(k) Contracts 3.1(l) Investments in other Entities. 3.1(m) Capitalization 3.1(o) Employee Relations 3.1(r) Litigation 3.1(t) Transactions with Related Parties 3.1(w) Financial Statements 3.1(x-a) List of Employees 3.1(x-b) Employment Contracts 3.1(x-c) Collective Bargaining Agreements 3.1(y-a) Re-assessments 3.1(y-b) Employee Pension Fund 3.1(y-c) Pension Fund Certificate 3.1(z) Bank Accounts 3.1(bb) Insurance Agreements 4.1 Martinez, Rodriguez y Asociados, S.C., Opinion 5.1 White & Case, S.C., Opinion. EX-11.07 8 a2043474zex-11_07.txt EX-11.07 EXHIBIT 11.07 SHARE PURCHASE AGREEMENT In Santiago, Chile, as of December 12, 2000, by and between, (a) SYLVAN CHILE LIMITADA ("SYLVAN"), a limited liability company incorporated according to the laws of the Republic of Chile, represented by Mr. Alfonso Alan Diaz Ortiz, both domiciled for this purpose in Santiago, Chile, Isidora Goyenechea 2939, Piso 11, county of Las Condes, hereinafter "the BUYER"; and (b) INDECO S.A. ("INDECO"), a corporation (sociedad anonima) incorporated according to the laws of the Republic of Chile, represented by Mr. Lorenzo Francisco Antillo Matas, both domiciled for this purpose in Santiago Chile, Avenida Manuel Montt No. 948, county of Providencia, hereinafter "the SELLER"; the following share purchase agreement ("the CONTRACT") has been agreed. ARTICLE I. RECITALS SECCION 1.01. The Seller owns, directly or indirectly, the following companies, hereinafter referred to as "the Companies", which are currently related among them in the manner specified in Exhibit 1.01 hereto: 1 (a) DESARROLLO DEL CONOCIMIENTO S.A. ("DECON"), a corporation incorporated according to the laws of the Republic of Chile, registered under page 17.150 No. 13.817 of the Commerce Registry of Santiago, corresponding to the year 2000. DECON currently has a paid in capital of Ch$62,000,000,000, divided into 6,200,000 nominal shares. As of to date, the Seller is the owner of 6,199,999 shares of DECON according to Titles No. 6, 7 and 8. The remaining 1 share of DECON is currently owned by Mr. Jorge Guerrero Velasquez, according to Title No. 4 . The latter will be transferred to the Seller no later than December 31, 2000. DECON has no debt, liability or contingency of any kind. As of to date, the only assets of DECON are rights equivalent to 99.999982% of "Instituto Nacional de Computacion y Administracion de Empresas Indae Limitada", 684,999,999 shares of "Pvscam S.A.", 10,000 shares of Campvs Mater and social rights equivalent to 7% of each one of the following companies: Delfos, Matgar, Seyca and Mayjo. (b) INSTITUTO NACIONAL DE COMPUTACION Y ADMINISTRACION DE EMPRESAS INDAE LIMITADA ("INDAE"), a limited liability company incorporated according to the laws of the Republic of Chile, registered under page 24.202 No. 13.338 of the Commerce Registry of Santiago, corresponding to the year 1981. INDAE currently has a paid in capital of Ch$50,000,000, and its only partners are DECON with 2 99.999982% of its corporate rights and Messrs. Dionisio Matas Usabiaga, Lorenzo Francisco Antillo Matas, Lorenzo Antillo Escobar, Carlos Leonardo Joui Petersen, Sergio Francisco Aguilera Helena, Isabel Margarita Antillo Matas, Ana Maria Antillo Matas, Carlos Alberto Garate Antillo y Jorge Christian Guerrero Velasquez with 0.000002% of its corporate rights each one of the, which shall be transferred to PVSCAM within six months from the date hereof, pursuant to the Promise of Assignment of Company's Rights Agreement entered into as of this date. (c) PVSCAM S.A. ("PVSCAM"), a corporation incorporated according to the laws of the Republic of Chile, registered under page 23,065No. 18,335 of the Commerce Registry of Santiago, corresponding to the year 2000. PVSCAM currently has a paid in capital of Ch$685,000,000, divided into 685,000,000 nominal shares. As of to date, PVSCAM's only shareholders are DECON which is the owner of 684,999,999 shares of PVSCAM, according to Title No. 29, and Jorge Guerrero Velasquez which is the owner of 1 share of PVSCAM, according to Title No. 28. (d) CAMPVS MATER S.A. ("CAMPVS MATER"), a corporation incorporated according to the laws of the Republic of Chile, registered under page 4.564 No. 2.247 of the Commerce Registry of Santiago, corresponding to the year 1992. Campvs Mater currently has a paid in capital of Ch$388,853,000, divided into 1,131,340 nominal shares. As of to date, Campvs Mater's only shareholders are PVSCAM which is the owner of 3 1,121,340 shares of Campvs Mater, according to Title No. 11, and DECON which is the owner of 10,000 shares of Campvs Mater, according to Titles No. 12, 13, 14, 15 16, 17 and 18. (e) SOCIEDAD PROCESADORA DE ALIMENTOS Y BANQUETERIA LIMITADA ("BAPROAL"), a limited liability company incorporated according to the laws of the Republic of Chile, registered under page 7.897 No. 3.863 of the Commerce Registry of Santiago, corresponding to the year 1997. BAPROAL currently has statutory capital of Ch$3,000,000, and its only partners are PVSCAM with 99% of its corporate rights and Campvs Mater with 1% of its corporate rights. (f) INMOBILIARIA E INVERSIONES SAN GENARO S.A. ("SAN GENARO"), a corporation incorporated according to the laws of the Republic of Chile, registered under page 16.398 No. 13.456 of the Commerce Registry of Santiago, corresponding to the year 1994. San Genaro currently has a paid in capital of Ch250,808,143 divided into 2,416 nominal shares. As of to date, San Genaro's only shareholders are Campvs Mater, which is the owner of 2,110 shares of San Genaro, according to Title No. 6, and PVSCAM which is the owner of 306 shares of San Genaro, according to Title No. 8. (g) SOCIEDAD EDUCACIONAL CAMPVS S.A. ("SECSA"), a corporation incorporated according to the laws of the Republic of Chile, registered under page 33.319 No. 16.738 of the Commerce Registry of Santiago, 4 corresponding to the year 1998. SECSA currently has a paid for statutory capital of Ch$15,000,000, divided into 10,000 nominal shares. As of to date, SECSA's only shareholders are PVSCAM, which is the owner of 9,000 shares of SECSA, according to Title No. 16, and Campvs Mater which is the owner of 1,000 shares of SECSA, according to Title No. 8. (h) SOCIEDAD DE COMPUTACION E INFORMATICA LIMITADA ("DATVM "), a limited liability company incorporated according to the laws of the Republic of Chile, registered under page 2.868 No. 1.459 of the Commerce Registry of Santiago, corresponding to the year 1985. DATVM currently has a statutory capital of Ch$164,000,000, and its only partners are Campvs Mater with 72.62% of its corporate rights and PVSCAM with 27.38% of its corporate rights. (i) INVERSIONES MATGAR LIMITADA ("MATGAR"), a limited liability company incorporated according to the laws of the Republic of Chile, registered under page 268 No. 140 of the Commerce Registry of Santiago, corresponding to the year 1985. Its only partners are PVSCAM with 93% of its corporate rights and DECON with 7% of its corporate rights. (j) INVERSIONES SEYCA LIMITADA ("SEYCA"), a limited liability company incorporated according to the laws of the Republic of Chile, registered under page 342 No. 176 of the Commerce Registry of Santiago, corresponding to the year 1985. Its only partners are 5 PVSCAM with 93% of its corporate rights and DECON with 7% of its corporate rights. (k) INVERSIONES DELFOS LIMITADA ("DELFOS"), a limited liability company incorporated according to the laws of the Republic of Chile, registered under page 267 No. 139 of the Commerce Registry of Santiago, corresponding to the year 1985. Its only partners are PVSCAM with 93% of its corporate rights and DECON with 7% of its corporate rights. (l) INVERSIONES MATGAR LIMITADA ("MATGAR"), a limited liability company incorporated according to the laws of the Republic of Chile, registered under page 9.551 No. 7.897 of the Commerce Registry of Santiago, corresponding to the year 1993. Its only partners are PVSCAM with 93% of its corporate rights and DECON with 7% of its corporate rights. SECTION 1.02 By means of a private document entered into on May 4th, 2000 ("the Option Agreement"), amended by means of a private document date July 31st, 2000, by means of a private document dated September 28th, 2000, by means of a private document dated October 31st, 2000, and bye means of a private document dated November 15, 2000, and by means of a private document dated November 21, 2000, Sylvan Learning Systems, Inc., parent company of Sylvan and Mr. Lorenzo Antillo Matas, acting on his own and on behalf of the individuals and corporations identified in 6 the above referred to document, executed an Option Agreement under which Sylvan Learning Systems, Inc. was granted, in case of exercising the option provided under said agreement, the right to (i) acquire an amount equal to 80% of the shares of DECON, and (ii) acquire the right to designate 80% of the Board of Directors of Universidad de las Americas, hereinafter "the University", under the terms and conditions established in the Option Agreement and its amendments, which is attached as Exhibit 1.02. By means of a private document dated November 29, 2000, and pursuant to paragraph S of the Option Agreement, Sylvan Learning Systems, Inc assigned and transferred to its subsidiary Sylvan, all its rights and obligations under the Option Agreement On November 30, 2000, Sylvan expressed to INDECO its intention to exercise the option granted in the Option Agreement. SECTION 1.03 Universidad de las Americas de Chile is a Chilean, private post-secondary education institution, fully autonomous, which is incorporated as a non-for-profit private corporation and is subject to the Constitutional Law of Education of Chile. The following persons are the only Founding Members, Active Members and Members of the Board of Directors of the University: Lorenzo Antillo Escobar, Dionisio Matas Usabiaga, Lorenzo Francisco Antillo Matas, Carlos Leonardo Joui Petersen, Sergio Francisco Aguilera 7 Helena, Isabel Margarita Antillo Matas y Carlos Alberto Garate Antillo. Likewise, Messrs. Ana Maria Antillo Matas and Jorge Christian Guerrero Velasquez are only Active Members of the University. Accordingly, the decision making, management and operation regarding the University, reside exclusively in the aforementioned individuals. The current by-laws of the University, as well as the amendment agreed as of this date, are included as Exhibit 1.03 hereto. SECTION 1.04 The University has entered into several agreements with the Companies, all of which are specified in Exhibit 1.04 hereof. ARTICLE II. PURCHASE AND SALE OF SHARES SECTION 2.01 By means of this document, the Seller sells to the Buyer, and the Buyer buys for itself, 4,960,000 shares of DECON, hereinafter "the Sold Shares". The Sold Shares represent 80% of the issued , outstanding and paid in shares of DECON. SECTION 2.02 The Sold Shares are transferred or will be transferred, according to what is stated in Article IV, with all their economic and corporate rights, free of all debt, obligation, encumbrance, Lien, guarantee, resolutory condition, forbiddance of any type or kind that limits or constrains in any manner their ownership, 8 possession, holding, transferability, right of vote or right of use. ARTICLE III. PURCHASE PRICE AND PAYMENT SECTION 3.01 The total purchase price of the Sold Shares will be determined based on the result of the following calculation and will be paid according to the following procedure: (a) DOWNPAYMENT. 398,302.12 Unidades de Fomento ("UF"), that corresponds to sixty percent (60%) of six (6) times one hundred and thirty percent (130%) of the audited recurrent Consolidated EBIT for the period commencing on January 1, 2000 and ending on June 30, 2000 (the "Downpayment"), amount that is paid in this act to the entire satisfaction of the Seller. (b) FIRST INSTALLMENT. The equivalent amount in UF, that corresponds to sixty percent (60%) of six (6) times of the audited recurrent Consolidated EBIT for the fiscal year ending on December 31, 2000, less the Downpayment. This payment shall be made no later than March 31, 2001 or 45 days after Sylvan receives DECON's financial statements corresponding to the year 2000, duly audited by DECON's external auditors, which ever may be later. This amount will be decreased by (i) any negative consolidated net working capital (consolidated current assets less consolidated current liabilities) of DECON and its Consolidated Subsidiaries and of the University as of this date, and (ii) eighteen percent (18%) of the Deductible Debt. 9 Should the amount determined according to the last paragraph be negative, said amount shall be deducted from the Second Installment set forth in paragraph (c) below, and it shall accrue interest at the "current interest rate for adjustable obligations" (INTERESES CORREIENTES PARA OPERACIONES REAJUSTABLES), as defined in Chilean Law 18,010, between the due date of the First Installment and the due date of the Second Installment. The Seller has the right to prepay this amount at any time, in which case interest shall accrue until the date of effective payment of said amount. (c) SECOND INSTALLMENT. The equivalent amount in UF, that corresponds to sixty percent (60%) of six (6) times the average of the audited recurring Consolidated EBIT for the fiscal years ended on December 31, 2004 and December 31, 2005, less the recurring audited Consolidated EBIT for the fiscal year ended on December 31, 2000. This amount shall be paid no later than March 31, 2006 or 45 days after Sylvan receives DECON's financial statements corresponding to the year 2005, duly audited by DECON's external auditors, whichever date may be later. This amount shall be adjusted downward for forty-two percent (42%) of the Deductible Debt. (d) THIRD INSTALLMENT. The equivalent amount in UF, that corresponds to twenty percent (20%) of four (4) times of the average of the audited recurring Consolidated EBIT for the fiscal years ended on 10 December 31, 2005 and December 31, 2006. This amount shall be paid no later than March 31, 2007 or 45 days after Sylvan receives DECON's financial statements corresponding to the year 2006, duly audited by DECON's external auditors, whichever date may be later. This amount will be decrease by twenty percent (20%) of the Deductible Debt. SECTION 3.02. The First Installment, the Second Installment, and the Third Installment shall be calculated in UFs, according to the value of the UF on the date of closing of the financial statements (this is, December 31 of the respective year) considered as the base for the calculation of the Consolidated EBIT under the respective installment. The payment of each installment shall be made in Chile, or in the location agreed to by the parties, in pesos, according to the value of the UF as of the payment date. However, upon Seller's request, payment may be made in Dollars, in which the exchange rate agreed upon by the parties shall be used. Absent an agreement among the parties as to the applicable exchange rate, the installments shall be paid in pesos. SECTION 3.03. The parties agree that the amount of 9,100 Unidades de Fomento, out of the Downpayment, has been invested in a time deposit with automatic renewal as a guarantee for the complete and timely fulfillment of the indemnification obligation set forth in Section 8.01 hereof and, especially, to compensate Buyer for any damage arising from the contingencies detailed in 11 Exhibit 6.16 hereof (hereinafter the "Guarantee Deposit"). The parties agree that the Guarantee Deposit shall be delivered as of this date by the Seller to the Notary Public Mr. Raul Undurraga Laso, to whom the Sellers shall irrevocable instruct to pay to the Buyer, with the deposited funds and interest, the necessary amount in order to comply with any obligation to pay the Buyer the amounts owed by the Seller in accordance with Section 8.01 of the Contract, with prior agreement of the parties or pursuant to a resolution by the arbitrator established in Article XV below. The Guarantee Deposit, or the remains of it, shall be returned to the Seller (i) if the parties jointly instruct the Notary Public to do so, or (ii) on March 31, 2006. SECTION 3.04 The parties agree that the Buyer shall be authorized to deduct from any of the installments of the balance of the purchase price, any amount that the Buyer or the Companies may have been judicially obligated to pay as a consequence of a breach of any of the Representations and Warranties stated in Article VI. Especially, it may deduct the ones arising from the exceptions provided in Exhibit 6.16 hereof. 12 SECTION 3.05. Should the Buyer fail to pay in due time the total amount of one or more of the installments referred to above, such installments will accrue interest at a rate equivalent to the maximum rate permitted by Chilean law for adjustable credit obligations (INTERES MAXIMO CONVENCIONAL PARA OPERACIONES DE CREDITO REAJUSTABLES). ARTICLE IV. DELIVERY AND TRANSFER OF SHARES SECTION 4.01 Through this act, the Seller delivers to the Buyer, Title Number 6 for 3,720,000 shares of DECON, equivalent to sixty percent (60%) of the subscribed and paid -in shares of the corporation, sold under the terms of this contract, and a pro-forma transfer document of said shares. SECTION 4.02 Present to this act, Mr. Sergio Aguilera Helena, in its capacity as General Manager of DECON, who acknowledges the transfer of 3,720,000 shares of DECON, that corresponds to sixty percent (60%) of the subscribed and paid-in shares of the corporation, and proceeds to register the transfer of shares in favor of Sylvan in DECON's Shareholder Registry, proceeding also to issue new Title Number 9 for 3,720,000 shares, in favor of Sylvan, which is delivered to the Buyer's representative. SECTION 4.03 The Seller is obliged to transfer to the 13 Buyer the remaining 1,240,000 Sold Shares, that represent twenty percent (20%) of the subscribed and paid-in shares of DECON, simultaneously with the payment of the Third Installment referred to in Section 3.01 (d) above. Until the transfer of said shares (that represents 20% of the subscribed and paid -in shares of the company) from the Seller to the Buyer is executed, and the registration of such shares in the Shares Registry in DECON is done, the exercise of the corporate rights that correspond to such shares, such as the collection of dividends, attendance and voting in Sshareholders Meetings and others, will be located exclusively in the Seller. ARTICLE V. GUARANTEES SECTION 5.01 In order to guarantee the total, full, and timely compliance with the obligation undertaken by Buyer to pay the balance of the purchase price of the Sold Shares, Sylvan, through a public deed of even date, furnishes commercial pledge pursuant to Article 813 and subsequent of the Chilean Commercial Code, regarding the 3,720,000 shares of DECON which have been transferred to Buyer by Seller, in favor of Seller, which expressly accepts such pledge. Likewise, Sylvan commits through said document not to dispose of, lien or encumber the pledged shares without prior written approval of the seller. 14 The parties agree that the pledge shall be extended to guarantee all the extensions, renewals and amendments that may suffer the guaranteed obligations. Likewise, the parties agree that the pledge shall not extend to the dividends that DECON may distribute during the term of the pledge. The parties agree that, in case the capital of the Company is increased in the future and should Sylvan subscribe additional shares in such capital increase, thus maintaining its ratio of shares in such capital, it shall include in this pledge such additional shares as may be necessary so that the pledge covers always an amount of shares equal to 60% of the outstanding shares of the Company. The parties agree that Sylvan shall be always allowed to replace this guarantee with other guarantee acceptable to the Seller, with the prior written consent of the Seller. SECTION 5.02 Likewise, in order to guarantee the total, full, and timely compliance with the obligation undertaken by Seller to transfer the shares indicated in Section 4.03 herein, INDECO, through a public deed of even date, furnishes commercial pledge pursuant to Article 813 and subsequent of the Chilean Commercial Code, regarding the 1,240,000 shares of DECON, in 15 favor of Buyer, which expressly accepts such pledge. Likewise, INDECO commits through said document not to dispose of, lien or encumber the pledge shares without the prior written approval of the Buyer. The parties agree that the pledge shall be extended to guarantee all the extensions, renewals and amendments that may suffer the guaranteed obligations. Likewise, the parties agree that the pledge shall not extend to the dividends that DECON may declare and pay during the term of the pledge. ARTICLE VI. SELLERS' REPRESENTATIONS AND WARRANTIES The Seller represents and warrants to the Buyer, as of the date of this Contract that: SECTION 6.01 The Seller is the actual owner of the Sold Shares. The Seller may freely dispose of the Sold Shares. The statements made in Sections 1.01 (a) through (h), both inclusive, are true and correct. SECTION 6.02 The Sold Shares are owned free of all Liens and have full voting rights, with no restriction or 16 limitation. SECTION 6.03 There are no pending subscription rights in favor of any of the shareholders or partners of the Companies, or in favor of third parties, nor an option or right of any kind that gives the Seller or its Subsidiaries, or to third parties, the right to purchase, subscribe or acquire, any title, share or right in the Companies or to capitalize credits against the Companies. SECTION 6.04 The execution of this Contract was approved and the required powers of attorney were granted by the Board of Directors of the Seller on November, 30, 2000. The individuals who appear on behalf of the Seller, have all the necessary powers and authority to execute and perform the obligations arising under this Contract. The execution and performance of this Contract has been approved and authorized by all the individuals, committees and corporate bodies of the Seller and of the respective Companies that must know and approve said execution and performance. SECTION 6.05 The execution and performance of this Contract: (i) does not contravene any provision contained in the by-laws, statutes or other analogous provisions of the Seller or the respective Companies, nor any shareholder agreement or other contracts and covenants with respect to the Seller, of the respective Companies or the Sold Shares; (ii) does not grant the right to terminate or resolve any material contract in 17 which the Companies are parties; does not mean, directly or indirectly, the non-compliance with any material contract in which the Companies are parties; and, does not signify the loss of a benefit for the respective Companies or for those who will become shareholders of the Companies; (iii) does not require the authorization or consent of any individual or entity, under any kind of material contract, including any material credit, concession, licensing and franchise contracts; and (iv) does not contravene any legal provision, Chilean or of any other competent jurisdiction. SECTION 6.06 The information contained in Section 1.01 is true and complete. SECTION 6.07 The Financial Statements, as of their respective dates (December 31, 1999 and June 30, 2000): (i) were prepared, in all material aspects, according to generally accepted accounting principles of the Untied States of America (US GAAP), principles that were applied consistently during the periods relevant to the Financial Statements, (ii) reflect appropriately, in all material aspects, the financial and equity situation of the Companies and the University during the periods relevant to the Financial Statements, as well as the results of operations, change in equity and cash flow of the Companies and the University during the periods relevant to the Financial Statements; and (iii) fulfill, in all material aspects, all the requirements of form and substance demanded by the applicable provisions. 18 SECTION 6.08 As of the date of the respective Financial Statements, the Companies and the University do not have any material obligations, indebtedness, liabilities or contingencies, that a ccording to the applicable accounting rules and principles, must have been reflected in the Financial Statements or their notes, different from those that are reflected in the Financial Statements. For these purposes, it is understood that an obligation, Indebtedness, liability or contingency is material, only if it has an adverse financial impact, individually or collectively, above US$100,000. Between June 30, 2000 and the date of this Contract, each of the Companies and the University have conducted their business and/or operations according to the normal and ordinary course of said business, consistent with past practices. Except for obligations incurred in the normal and ordinary course of business and that do not require a cost or disbursement, considered individually, above US$100,000, none of the Companies or the University have any contingencies or obligations that are not reflected in the respective general balance sheet, but that should be reflected in the financial statements of the referred to Companies and the University according to applicable accounting rules and principles, if said financial statements were prepared as of the date of this Contract. Except for obligations incurred in the normal and ordinary course of business and that do not require a cost or disbursement, considered individually, above US$100,000, none of the Companies or the University 19 has any contingencies or obligations that are not reflected in the respective general balance sheet. SECTION 6.09 The Seller is a corporation duly organized and existing under the laws of the Republic of Chile. The Seller possesses sufficient capacity, power and authorization to execute this Contract, to perform the contracted obligations, and to execute the acts and obligations provided in this Contract, including, without limitation, the capacity to own and the faculty to sell and transfer the Sold Shares. SECTION 6.10 Each of the Companies and the University: (i) exists and is duly organized and validly existing, according to the laws of the country in which it was incorporated; and (ii) possesses all the permits, authorizations and certifications from the competent authorities, necessary to develop the activities and businesses that are currently undertaken by them, in the places under the conditions in which they currently operate. SECTION 6.11 Exhibit 1.01 hereof contains a list of all Subsidiaries and affiliates of the each of the Companies. SECTION 6.12 As of June 30, 2000, the Companies considered as a whole and the University, have not suffered a Material Adverse Change. The parties 20 expressly declare that the Future Legal Structure of the Sellers, according to meaning stated in the Option Agreement, does not constitute a Material Adverse Change. SECTION 6.13 Since June 30, 2000, none of the Companies (i) has agreed to distribute, declare or pay dividend of any kind, except for dividends corresponding to profits from fiscal year 1999; (ii) has made other kind of distributions of cash or assets to their shareholders, except for the withdrawals of profits corresponding to fiscal year 1999 or (iii) has sold, restituted, ceded, granted a buy option, encumbered, transferred or promised to transfer, any title, asset that is used in the normal course of business (the "Transfers"), except for those Transfers made during the normal and ordinary course of operations, consistent with past practices, and the transfer of assets among the Companies made during the execution of the Future Legal Structure of the Sellers, according to meaning of such concept stated in the Option Agreement. SECTION 6.14 Each of the Companies and the University is the current owner of all goods and assets that are reflected in their balance sheet and inventories as of June 30, 2000 (except those that have been transferred in the normal and ordinary course of business of the respective Companies and the University, consistent with past practices). All goods and assets are (i) free of all encumbrances, Liens, forbiddances or limitations that restrict their ownership 21 or use, with exception to those encumbrances, Liens, forbiddances or limitations indicated in Exhibit 6.14 hereof; and (iii) in a good state of conservation. Except the exceptions indicated in Exhibit 6.14 hereof, each of the Companies and the University are in possession of their respective goods and assets and may dispose of them freely. SECTION 6.15 Exhibit 6.15 hereof, indicates all the lease and rental agreements to which the Companies and the University are parties or that affect some of their goods and assets that require an annual payment above US$100,000. Neither the Companies nor the University are in breach neither of the above mentioned lease and rental agreements nor of any other material agreement to which they are parties. Neither are the counterparts of the above mentioned lease and rental agreements in breach of said agreements. All the rent payments and lease installments, as well as the costs associated with said contracts, have been duly paid and are current. The latter does not include rental or lease agreements entered into exclusively among the Companies and which, therefore, do not involve third parties. SECTION 6.16 Except for the exceptions contained in Exhibit 6.16 hereof, as of the date of this Contract, there are no suits, claims, petitions, or any other type of legal action, administrative proceedings or labor disputes, or extra-judicial claims pending, in process or that may be 22 assumed will be initiated, for any motive, against one or more of the Companies or the University. SECTION 6.17 Each of the Companies and the University has presented timely and in good faith all the declarations and reports required by the laws, rules and regulations of autonomous entities and instructions and circulars of administrative entities, related to taxes, customs, foreign exchange, and social security in general. SECTION 6.18 Each of the Companies and the University has presented all tax returns, and sworn affidavits and requests and has submitted all presentations required by tax legislation and all other applicable regulations. All the referred to tax returns, presentations and affidavits have been timely submitted in compliance with the requirements set forth in the law. SECTION 6.19 Each of the Companies and the University has paid fully and opportunely all tax, fees, interests, rights, contributions and municipal patents of any kind and has withheld fully and opportunely all those taxes which it is obligated to withhold. 23 SECTION 6.20 Each of the Companies and the University has fulfilled fully and opportunely all other obligations and charges imposed by the respective and applicable legislation and tax regulations. SECTION 6.21 Each of the Companies and the University has retained and paid fully and opportunely all social security payments required by the laws, rules and other applicable social security regulations. SECTION 6.22 The Seller has delivered to the Buyer an original and complete copy of the employment contracts of the general manager and of the employees indicated in Exhibit 6.22 hereof, which correspond to the employees with the highest salaries for each of the Companies and the University, which states the terms and conditions of employment of each employee, and specially the hiring date, vacation rights, work days, salary, wage, commission, gratifications, guaranteed severance payments and other additional benefits. The Seller has delivered to the Buyer a original and complete sample of the model or standard individual employment contract utilized by each of the Companies and the University, a summary of the general terms of the contracts or general policies of terms and conditions of employment, a list of all the employees that have ceased to be employed, for any reason, during a period of six months prior to the celebration of this Contract and a list of all existing disputes between each of the Companies and the University and their current and former employees. All the salaries, wages, 24 commissions, remuneration, gratifications, compensations, severance payments, and social security payments of the employees of the Companies and the University are current in payment and, as of June 30, 2000, they have not incurred any amounts for any of these concepts, excepts for the normal and ordinary course of business of the respective Company, consistent with past practices. SECTION 6.23 There are no collective employment agreements to which any ofthe Companies and/or the University are parties. None of the Companies or the University are currently in the process or about to initiate the process of collective negotiation with its workers, nor have any knowledge of activities on process by the workers' organization that have as their objective the formation of a union or the initiation of collective negotiation. SECTION 6.24 None of the Companies or the University is subject to a material labor complaint, action or dispute, for which they have received written notice. SECTION 6.25 Except for their respective employment contracts, there are no contracts, pledges, and agreements of any nature, regarding the hiring, remuneration, termination, rendering of service, 25 advisory, reimbursement of expenses, insurance plans, use of assets, benefits, or others of similar nature, that require a total payment of US$100,000 or more, celebrated by any of the Companies or the University and their respective directors, managers, agents, executives, commissioners and representatives, or affiliated to these individuals. SECTION 6.26 Exhibit 6.26 hereof contains an original and complete copy of all the consulting, advisory, professional services contracts and others of similar nature, to which each of the Companies and the University are parties, either as a lender or receiver of the services, except the contracts and agreements that are celebrated under market conditions, within the normal and ordinary course of business of the respective Company and the University, consistent with past practices. All the referred to agreements are valid, legal and there are no breaches of them. SECTION 6.27 Exhibit 6.27 hereof details all the promise to purchase agreements, options, and general promise for purchase, sale, rent, lease, acquisition and transfer of any assets to which each of the Companies and the University are parties to, except for those contracts and agreements celebrated under market conditions and within the normal and ordinary course of business of the respective Company and the University, consistent with past practices. All the referred to agreements are valid, legal and there are no breaches of them. 26 SECTION 6.28 Exhibit 1.04 hereof identifies all contracts and agreements celebrated between the Companies and the University that are currently in effect and in force. SECTION 6.29 The goods included as assets in the Financial Statements of each of the Companies and the University are currently in a sufficient state of conservation for the purposes for which they are required, except for the deterioration related to their normal wear and tear; they are being depreciated according to estimations of useful life and residual value consistent with generally accepted accounting principles; and are not obsolete. SECTION 6.30 Each of the Companies and the University have fulfilled in the past and presently comply with all legal, regulatory, municipal and administrative regulations for environmental protection. None of the Companies or the University has received notification regarding a suit, complaint or legal proceeding of any kind that has been initiated or is about to be initiated against them for an infraction of the environmental protection laws or for endangering the environment or riskin the health of one or more individuals. Each of the Companies and the University have applied for and received all the permits and authorizations required for the construction, installation, and operation of its facilities. 27 SECTION 6.31 Exhibit 6.31 of this Contract identifies all the registered commercial trademarks, names, patents, computer / software programs, databases, industrial designs and other intellectual property of which the Companies are proprietors or have the right to use, identifying the nature of each respective right and the registry number, which ever is the case. The trademarks and names indicated do not have any material restrictions that make said trademarks and names inadequate for the current activities of the Companies and the University. Each of the Companies and the University have sufficient rights to use all the other names, patents, computer/software programs, databases, industrial designs and intellectual and industrial property in general currently utilized in the activities proper to their operations. The execution of this Contract does not affect said rights. In the development of their operations, none of the Companies and the University has infringed or is currently infringing, in a material manner, licensing contracts or laws regarding intellectual or industrial property. SECTION 6.32 Neither the Companies nor the University have hired, paid, pledged, or offered fees, remuneration, or comp ensation of any kind, to brokers, banks (commercial or investment), consultants, advisors, lawyers, accountants, auditors or other professionals for services related to the negotiation and/or celebration of this Contract or the Option Agreement, and has not permitted their intervention 28 such that would origin a charge to any of the Companies or the University for said concept. Neither have the Companies or the University paid or offered to pay any compensation to its dependents, managers, executives or directors for services related to the celebration of this Contract or the Option Agreement, in addition to their normal and ordinary compensation previously agreed to with said dependents, managers, executives and directors. SECTION 6.33 Neither the Companies nor the University are currently in non-compliance or in default or simple delay to comply with a material obligation, whatever its origin, nor of a resolution by a court or administrative authority. Each of the Companies and the University have complied and is currently complying with all its contracts, covenants or agreements of any type, and has no knowledge that their counterparts in those contracts, covenants, and agreements are not fulfilling them in time and form. There is no reason to think that each of the Companies and the University may not exercise the rights that corresponds to each of them under said contracts, covenants, and agreements. SECTION 6.34 Each of the Companies and the University develop their activities and business fulfilling, in all material aspects, with all laws, rules, instructions, circulars, ordinances, and other applicable 29 provisions. SECTION 6.35 Exhibit 6.35 hereof contains a list of all insurance policies of each of the Companies and the University, which cover the risks that affect all those assets of the Companies and the University which are essential to the development of their businesses; said policies are valid an currently in effect. Neither the Companies nor the University have received a written communication or notice of any kind indicating the cancellation or termination of any of the insurance policies. SECTION 6.36 Exhibit 6.36 hereof contains an accurate and complete list of all current checking or similar accounts held at banks or other financial institutions, local or foreign, be it in pesos, Dollars, or any other currency, of the Companies and the University, indicating all the individuals authorized to manage, sign or act in any other form with respect to any of the stipulated accounts. SECTION 6.37 Exhibit 6.37 hereof contains an exact and complete list of each and every power of attorney and authorizations granted by each of the Companies and the University, along with an original and complete copy of each power of attorney and authorization. SECTION 6.38 DECON is a "holding" or investment company that as of today: (i) does not perform any activity other than holding the shares and rights 30 described in Section 1.01, and (ii) it does not have dependent employees and is not party to any agreement, except for the employment contracts entered into with the Strategic Executives, as defined in the Shareholders Agreement of DECON entered into as of this date by and between INDECO and Sylvan. SECTION 6.39 Between the date of the Option Agreement and this Contract, the Seller has complied in good faith all obligations established in Section M of the Option Agreement. The parties make express notice that the fact that the Buyer, directly and/or through its advisors, has conducted an audit and a tax, legal, financial and accounting due diligence, and has had access to and revised legal, accounting, financial, labor and tax information, as well as other information of the Companies and the University, does not assure that it has knowledge or must have known that one or more of the representations and warranties referred to in Article VI, totally or partially, are false, inexact or incomplete; the Seller is responsible for the veracity and accuracy of the representations and warranties in the terms established in this Contract. ARTICLE VII. BUYER'S REPRESENTATIONS AND WARRANTIES SECTION 7.01 The Buyer is a limited liability company duly organized and existing under the laws of 31 the Republic of Chile. The Buyer is a subsidiary of Sylvan Learning Systems, Inc., a corporation duly incorporated under the laws of the State of Maryland, United States of America. SECTION 7.02 The execution of this Contract was known and approved by Sylvan Learning Systems, Inc.'s Board of Directors and by Sylvan's Board. The individuals who execute this Contract on behalf of the Buyer have all the required powers and authorizations to execute this Contract and to execute and perform all other agreements contemplated in this Contract. SECTION 7.03 The execution of this Contract does not: (i) contravene or infringe any provision in the bylaws or other analogous provisions of Sylvan Learning Systems, Inc. or of the Buyer; (ii) does not mean, directly or indirectly, the breach of any agreement in which Sylvan Learning Systems, Inc. or the Buyer is party to; and (iii) does not contravene any legal, regulatory or administrative provision, nor any judicial or administrative resolution of any kind. SECTION 7.04 The Buyer represents that it will have sufficient resources to pay the price stated in Article III and that it will pay the three installments in due time and course. SECTION 7.05 The Buyer represents that its parent company Sylvan Learning Systems, Inc. has 32 acknowledged and approved the terms of this Contract. SECTION 7.06 The Buyer represents that (i) Sylvan has as its only partners Sylvan International BV, formerly known as Aspect International Language Schools BV, owner of 99.99% of its corporate rights, and Sylvan I, BV, owner of 0.01% of its corporate rights, and (ii) that Sylvan Learning Systems, Inc. is the sole shareholder of Sylvan International BV, formerly known as Aspect International Language Schools, BV. ARTICLE VIII. NON-COMPLIANCE AND INDEMNIFICATION SECTION 8.01. In the event that as of today or after the execution of this Contract, one or more of the representations and warranties given in Article VI of this Contract turn out to be false or materially inaccurate, according to the terms agreed in this Contract, said falsity or inaccuracy will be considered to be a breach by the Seller ("Infraction of Warranties"), and will give the Buyer the right to demand indemnification for damages from the Seller. In any case, the Seller shall indemnify the Buyer for all damages derived from the Infraction of Warranties. The infraction, falsity or inaccuracy of one or more of the representations and warranties given in Article VI of this Contract will not give the Buyer the right to seek termination of this contract or to seek nullity or rescission, except if there is gross negligence or fraud. 33 SECTION 8.02 In the event that as of today or after the execution of this Contract, one or more of the representations and warranties given in Article VII of this Contract turn out to be false or materially inaccurate, according to the terms agreed in this Contract, said falsity or inaccuracy will be considered to be a breach by the Buyer ("Infraction of Warranties"), and will give the Seller the right to demand indemnification for damages from the Buyer. In any case, the Buyer shall indemnify the Seller for all damages derived from the Infraction of Warranties. The infraction, falsity or inaccuracy of one or more of the representations and warranties given in Article VII of this Contract will not give the Seller the right to seek termination of this contract or to seek nullity or rescission, except if there is gross negligence or fraud ARTICLE IX. LIMITATIONo.F LIABILITY SECTION 9.01. The Buyer cannot claim damages against the Seller for infraction of warranties, unless the Buyer has presented such claim in writing to the Seller, specifying (in reasonable detail) the subject matter to which the claim is referring, the nature of the infraction of the warranties and the amount of damages claimed (detailing the calculation made by the Buyer with respect to the loss suffered by the Buyer or any of the 34 companies). The Buyer can claim damages against the Seller for infraction of warranties at any time until the date of the fifth anniversary of this Contract. SECTION 9.02. When the Buyer becomes aware of facts constituting an Infraction of Warranties or becomes aware of the existence of a suit, claim, action or summons against the Buyer or one of the Companies relating to subject matter that can serve as a basis for claiming damages against the Seller for an Infraction of Warranties, the Buyer and the respective Company or the University, whichever is applicable, shall: (a) Notify the Seller in writing, within 20 business days, of the fact that the Seller can be responsible for an Infraction of Warranties, it being understood, in any case, that failure to give such notification to the Seller will not liberate the Seller from its obligation to indemnify the Buyer. (b) Cooperate with the Seller, carry out all actions, deliver all information and grant access to the Seller (and entities under its control) to all personnel, spaces, property, documents and records that are relevant and that the Seller reasonably requests in writing, with the objective of avoiding, disposing, opposing, mitigating, compromising, agreeing, defending or appealing any of 35 said claims; subject, however, in all the mentioned cases, to the condition that those acts, information and access, or their possible effects, shall not be prejudicial to the Buyer or the respective Company or the University. (c) In the event that a claim, administrative complaint or other legal action (the "Legal Action") in relation to any subject matter covered by the warranties is formally initiated against the Buyer or one or more of the Companies or the University (the "Relevant Company"), the Buyer shall give immediate notice to the Seller of the existence of said Legal Action and shall deliver a copy of all the written documentation received in relation to the same. The Seller shall assume the defense of the Legal Action and notify the Buyer in writing that Seller has taken up such defense within 30 days of the receipt of notice from the Buyer of the existence of the Legal Action. If the Seller assumes the defense of a Legal Action, the Seller shall be the only one responsible for the costs of said defense and for the results of the Legal Action, reimbursing the Buyer for all sums that Buyer must pay in relation to the Legal Action and as a result of same. If the Seller does not say anything within the term referred to above and if the Seller in its communication does not assume full responsibility for the defense of the Legal Action expressly, then the Buyer or the Relevant Company may freely decide in which form to defend the Legal Action, being able to present the objections, allegations and defenses that the Buyer or the Relevant Company deems appropriate. If the Buyer or the Relevant Company assume the defense of the Legal Action and 36 the result of same is adverse to the Buyer or to the Relevant Company, the Seller cannot claim as a complete defense or as limitation of its own liability, the fact that the Buyer or the Relevant Company did not properly defend the Legal Action. (d) If the Seller assumes, at its own cost, exclusive responsibility for the defense of a Legal Action, the Buyer shall (i) permit the Seller to assume the complete defense in said Action; (ii) carry out, in representation of the Buyer and of the Relevant Company, all those acts that the Seller in good faith believes appropriate, and grant (or the Relevant Company shall grant) the Seller assistance reasonably required to avoid, dispute, oppose, defend or appeal any of said claims, and (iii) instruct lawyers and other professional advisors that the Seller shall act on behalf of the Buyer and /or the Relevant Company, whatever the case may be; subject, however, in all the enumerated cases to the following: (1) that the Seller shall keep the Buyer informed of the progress of the defense and the projected actions; (2) that the defense and the acts projected by the Seller and the effects of such defense and actions are not prejudicial to the Buyer or to the Relevant Company, allowing the Buyer or the Relevant Company to decide in what manner the defense or projected action will be prejudicial to them; and (3) that the lawyers and other professionals designated by the Seller are approved by the Buyer (approval that cannot be unreasonably withheld). 37 (e) Not admit responsibility nor settle with a third party for anything that gave rise to the Legal Action, without the previous written consent of the Seller (consent which cannot be unreasonably withheld), except in the case that the Legal Action has been acknowledged; and (f) Execute all reasonable actions to mitigate any loss suffered by the Buyer and/ or the Relevant Company for whom a claim against the Seller may be formulated for infraction of warranties SECTION 9.03 The Seller shall have in every moment the right to settle a Legal Action, subject, however, that the settlement or their possible effects do not cause any damages to the Buyer or any Relevant Company, understanding that the cost and expenses of such settlement will be borne exclusively by the Seller. ARTICLE X. OTHER DOCUMENTS SECTION 10.01. The parties acknowledge that, together with the execution of this Contract, and in connection with this transaction, the following documents are being executed: (a) Shareholders Agreement of DECON. 38 (b) Amendment of the University's By-laws. (c) Non-competition Agreement between Sylvan and Messrs. Lorenzo Antillo Escobar, Dionisio Matas Usabiaga, Lorenzo Francisco Antillo Matas, Carlos Leonardo Joui Petersen, Isabel Margarita Antillo Matas, Sergio Francisco Aguilera Helena y Carlos Alberto Garate Antillo. (d) Employment contracts between DECON and the Strategic Executives. ARTICLE XI. EXPENSES SECTION 11.01. Each party shall pay the expenses it has incurred as a result of the execution of this Contract. SECTION 11.02. The Buyer will not be responsible for the expenses or costs incurred by the Seller, its Subsidiaries, the Companies or the University in relation with the execution of this Contract. The Seller shall bear the cost of the Companies for services provided by lawyers, auditors, consultants and others in relation to the execution of this Contract. ARTICLE XII. TAXES SECTION 12.01. All the possible taxes deriving from the present Contract shall be at the cost of the party that should bear them, according to the law. In particular, 39 the Seller will be responsible for all possible income taxes and capital gains that result from the sale or transfer of Sold Shares, in whatever jurisdiction. ARTICLE XIII. MISCELLANEOUS SECTION 13.01. The Seller and the Buyer will mutually agree on the form and contents of any public announcement being made in connection with this Contract Neither party shall make any public announcement without the consent of the other. However, the latter does not prohibit any notice that has to be given pursuant to the law, regulation or stock exchange regulations in which the shares of any of the parties or related companies are traded. SECTION 13.02. All the exhibits referred to in any section of this Contract (the "Exhibits") are understood to be part of this Contract, for all legal purposes. SECTION 13.03. This Contract may only be amended by mutual written agreement between the Buyer and the Seller. ARTICLE XIV. APPLICABLE LAW This Contract is subject to the laws of Chile. ARTICLE XV. ARBITRATION 40 SECTION 15.01 All disagreements, conflicts, questions or difficulties that arise between the parties related to the validity, nullity, interpretation, extension, application, compliance or non-compliance with this Agreement or to any other matter directly or indirectly related with this Contract, and with respect to which other subject matter that the parties may establish in this regard, shall be attempted to be resolved by mutual agreement. Should the parties not reach a mutual agreement, the subject in question will be submitted to an arbitrator, in accordance with the Regulations of the Arbitration Center of the Santiago Chamber of Commerce A.G. (REGLAMENTO DEL CENTRO DE ARBITRAJES DE LA CAMARA DE COMERCIO DE SANTIAGO A.G.) which appear in the public record dated December 10, 1992, granted in the Santiago Notary's Office of Mr. Sergio Rodriguez Garces, and which the parties acknowledge and accept. The arbitrator may act as often as may be necessary, without formal trial, making a definitive decision that cannot be challenged, and the parties expressly agree to seek no other remedy, except for reinstatement, clarification or interpretation, rectification or amendment of the complaint. The arbitrator shall be fluent in English and it shall be appointed by mutual agreement of the parties and, absent that agreement, by the Arbitration Center of the Santiago Chamber of Commerce, from the members of the arbitration body of said institution, for which purpose the parties grant an irrevocable power of attorney. 41 ARTICLE XVI. ASSIGNMENT OF RIGHTS The rights, benefits and obligations arising from this Contract shall not be assigned or transferred without the previous written consent of the other party. However, the Seller is authorized to assign to a third party the right to receive the balance of the purchase price of the Sold Shares. ARTICLE XVII. NOTICES SECTION 17.01. All communications, notices, requests, or requirements foreseen in this Contract shall be made in writing and become effective only if they have been delivered personally or via facsimile (with confirmation), courier service (with confirmation of delivery) to: In the case of the SELLER: Attention: Lorenzo Francisco Antillo Matas Address: Manuel Montt 948, Providencia, Santiago Fax: (562) 225-8520 With copy to: Jorge Christian Guerrero Velasquez Address: Moneda 920, Oficina 702, Santiago Fax: (562) 672-4462 In the case of the BUYER: Attention: Robert W. Zentz Address: 1000 Lancaster St., Baltimore, MD 21202 Fax: 1 (410) 843-8055 42 With copy to: Barros & Errazuriz Abogados Attention: Pablo Guerrero Valenzuela Address: Isidora Goyenecha 2939, Piso 11 Santiago Fax: (562) 362-0387 ARTICLE XVIII. DEFINITIONS SECTION 18.01 For purposes of this Contract, the terms defined below will have the meanings given for each of them: (a) "LEGAL ACTION" shall have the meaning given in Section 9.05(c). (b) "SOLD STOCKS" shall have the meaning given in Section 2.01. (c) "EXHIBITS" shall have the meaning given in Section 13.02. (d) "BAPROAL" shall have the meaning given in Section 1.01(e). (e) "MATERIAL ADVERSE CHANGE" refers to any instance in whichever entity experiences an adverse change in business assets, obligations, financial condition, cash flow or other operations with a financial impact greater than US$100,000. 43 (f) "CAMPVS MATER" shall have the meaning given in Section 1.01(d). (g) "CH$" or "PESOS" refers to the currency of the Republic of Chile. (h) "RELEVANT COMPANY" shall have the meaning given in Section 9.02(c). (i) "COMPANY" shall have the meaning given in Section 1.01. (j) "BUYER" shall have the meaning given in the introduction to this Contract. (k) "CONTRACT" shall have the meaning given in the introduction to this contract. (l) "OPTION AGREEMENT" shall have the meaning given in Section 1.02. (m) "DATVM " shall have the meaning given in Section 1.01(h). (n) "DECON" shall have the meaning given in Section 1.01(a). (o) "DEDUCTIBLE DEBT" refers to the long term debt of Decon, its Consolidated Subsidaries and the University, existing as of May 31, 2000, amounting to 69,263.84 UFs, minus the amortizations from said date and until the date hereof. 44 (p) "DOLLAR", "DOLLARS", "$" or " US$" means the currency of the United States of America. (q) "CONSOLIDATED EBIT" means the audited recurring earnings before interest and income taxes of DECON and its Consolidated Subsidiaries, determined in pesos in accordance with US GAAP, including the surplus arising from the University, as further explained. The Consolidated EBIT will be adjusted for non-recurring income and expense items, which shall be defined by the parties on the dates the calculation of the Consolidated EBIT is made for the effect of the payment of the purchase price stated in Section 3.01, or by the arbitrator appointed pursuant to Section 15.01 hereof, absent an agreement among the parties. The surplus arising from the University shall be aggregated to Consolidated EBIT, being therefore part of it, to the extent that such surplus is distributable or transferable to DECON or its Consolidated Subsidiaries in the short term. The methodology for calculating Consolidated EBIT is given in Exhibit 18.01(q) hereof. (r) "INDEBTEDNESS" with respect to either of the Companies or the University, shall mean all its respective liabilities that are (i) the product of credit operations, (ii) represented by promissory notes, bonds, debentures or similar nstruments, (iii) property ori services balances (different from accounts payable and services rendered during the ordinary course of business of the respective entity), (iv) existing through leasing contracts and (v) guarantees granted to secure 45 any of the obligations referred to in (i) to (v) of this definition, including those in favor of third parties. (s) "FINANCIAL STATEMENTS" shall mean the following financial reports, which are included as Exhibit 18.01(s): (i) Combined Financial Statements of Universidad de las Americas and Related Companies, as of December 31, 1999, audited by Ernst & Young. (ii) Combined Financial Statements of Universidad de las Americas and Related Companies, as of June 30, 2000, audited by Ernst & Young. (t) "SUBSIDIARY" of a company or entity means another company or entity of which the former owns or controls at least 50% of rights or voting stock of the latter5. (u) "CONSOLIDATED SUBSIDIARY" means any Subsidiary the accounts of which should be consolidated with those of DECON in the consolidated financial statements of DECON, in accordance with US GAAP. (v) "LIENS" means any pledge, mortgage, security, usufruct, lien, limitation, prohibition, cancellation action, bailment, right of use or enjoyment, right or encumbrance of any kind. 46 (w) "INDAE" shall have the meaning given in Section 1.01(b). (x) "INFRACTION OF WARRANTIES" shall have the meaning given in Section 8.01. (y) "DOWNPAYMENT" shall have the meaning given in Section 3.01(a) (z) "LOSS" means each and every damage, loss, fine, interest, deficiency, punishment, cost and expense (including without limitation interest, legal costs, reasonable attorney's fees, accountant and other expert fees, and all other reasonable litigation or arbitration expenses, including costs for suits, claims, noncompliance, draft, notification or survey. (aa) "PVSCAM" shall have the meaning given in Section 1.01(c). (bb) "SAN GENARO" shall have the meaning given in Section 1.01(f). (cc) "SECSA" shall have the meaning given in Section 1.01(g). (dd) "SYLVAN" shall have the meaning given in the introduction to this Contract. (ee) "UNIDAD DE FOMENTO" or "UF" refers to the value of this unit as determined by the Central Bank of Chile in 47 accordance with Article 35 No. 9 of Law 18.840, the Law Governing the Central Bank of Chile, and with Chapter II.B.three of the Compendium of Financial Norms of the Central Bank of Chile. (ff) "UNIVERSITY" shall have the meaning given in Section 1.02. (gg) "UDLA" shall have the meaning given in the introduction to this Contract. (hh) "US GAAP" means the generally accepted accounting principles of the United States of America. (ii) "SELLER" shall have the meaning given in the introduction to this Contract. ARTICLE XX. LANGUAGE This Agreement is signed in English and Spanish; in case of discrepancies between the English and Spanish version, the English version will prevail. ARTICLE XXI. COUNTERPARTS This Contract is executed in four counterparts of even wording and date, and each party shall retain two of them. 48 - -------------------------------------- -------------------------------------- SYLVAN CHILE LIMITADA INDECO S.A. -------------------------------------- GERENTE GENERAL DESARROLLO DEL CONOCIMIENTO S.A. 49 EX-23.01 9 a2043474zex-23_01.txt EXHIBIT 23.01 EXHIBIT 23.01 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the following Registration Statements of our report dated February 22, 2001, with respect to the consolidated financial statements of Sylvan Learning Systems, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 2000. REGISTRATION STATEMENTS ON FORM S-3:
REGISTRATION NUMBER DATE FILED 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 333-48997 March 31, 1998 333-50993 April 24, 1998 333-61083 August 25, 1998 333-65197 October 1, 1998 333-67727 December 4, 1998 333-78961 May 20, 1999
REGISTRATION STATEMENTS ON FORM S-8:
NAME REGISTRATION NUMBER DATE FILED 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997 1998 Stock Incentive Plan 333-62011 August 21, 1998 1993 Employee Stock Option Plan and Employee Stock Purchase Plan 33-77390 September 14, 1998
/s/ Ernst & Young LLP Baltimore, Maryland March 28, 2001 EX-23.02 10 a2043474zex-23_02.txt EXHIBIT 23.02 EXHIBIT 23.02 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the following Registration Statements of Sylvan Learning Systems, Inc. of our report dated February 14, 2001, except for Note 16, as to which the date is March 26, 2001, with respect to the consolidated financial statements of Caliber Learning Network, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 2000. REGISTRATION STATEMENTS ON FORM S-3:
REGISTRATION NUMBER DATE FILED 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 333-48997 March 31, 1998 333-50993 April 24, 1998 333-61083 August 25, 1998 333-65197 October 1, 1998 333-67727 December 4, 1998 333-78961 May 20, 1999
REGISTRATION STATEMENTS ON FORM S-8:
NAME REGISTRATION NUMBER DATE FILED 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997 1998 Stock Incentive Plan 333-62011 August 21, 1998 1993 Employee Stock Option Plan and Employee Stock Purchase Plan 33-77390 September 14, 1998
/s/ Ernst & Young LLP Baltimore, Maryland March 27, 2001 EX-23.03 11 a2043474zex-23_03.txt EXHIBIT 23.03 EXHIBIT 23.03 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the following Registration Statements of Sylvan Learning Systems, Inc. of our report dated March 16, 2001, with respect to the financial statements of Classwell Learning Group Inc. included in the Annual Report (Form 10-K) of Sylvan Learning Systems, Inc. for the year ended December 31, 2000. REGISTRATION STATEMENTS ON FORM S-3:
REGISTRATION NUMBER DATE FILED 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 333-48997 March 31, 1998 333-50993 April 24, 1998 333-61083 August 25, 1998 333-65197 October 1, 1998 333-67727 December 4, 1998 333-78961 May 20, 1999
REGISTRATION STATEMENTS ON FORM S-8:
NAME REGISTRATION NUMBER DATE FILED 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997 1998 Stock Incentive Plan 333-62011 August 21, 1998 1993 Employee Stock Option Plan and Employee Stock Purchase Plan 33-77390 September 14, 1998
/s/ Ernst & Young LLP Boston, Massachusetts March 28, 2001 EX-23.04 12 a2043474zex-23_04.txt EXHIBIT 23.04 EXHIBIT 23.04 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference in this Form 10-K of our report dated March 27, 2001, with respect to the consolidated financial statements of iLearning, Inc. included in the following registration statements: REGISTRATION STATEMENTS ON FORM S-3:
REGISTRATION NUMBER DATE FILED 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 333-48997 March 31, 1998 333-50993 April 24, 1998 333-61083 August 25, 1998 333-65197 October 1, 1998 333-67727 December 4, 1998 333-78961 May 20, 1999
REGISTRATION STATEMENTS ON FORM S-8:
NAME REGISTRATION NUMBER DATE FILED 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997 1998 Stock Incentive Plan 333-62011 August 21, 1998 1993 Employee Stock Option Plan and Employee Stock Purchase Plan 33-77390 September 14, 1998
/S/ ARTHUR ANDERSEN LLP Baltimore, Maryland, March 27, 2001 EX-23.05 13 a2043474zex-23_05.txt EXHIBIT 23.05 EXHIBIT 23.05 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the following Registration Statements of Sylvan Learning Systems, Inc. of our report dated March 5, 2001, with respect to the financial statements of Higher Markets, Inc. included in the Annual Report (Form 10-K) of Sylvan Learning Systems, Inc. for the year ended December 31, 2000. REGISTRATION STATEMENTS ON FORM S-3:
REGISTRATION NUMBER DATE FILED 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 333-48997 March 31, 1998 333-50993 April 24, 1998 333-61083 August 25, 1998 333-65197 October 1, 1998 333-67727 December 4, 1998 333-78961 May 20, 1999
REGISTRATION STATEMENTS ON FORM S-8:
NAME REGISTRATION NUMBER DATE FILED 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997 1998 Stock Incentive Plan 333-62011 August 21, 1998 1993 Employee Stock Option Plan and Employee Stock Purchase Plan 33-77390 September 14, 1998
/s/ Ernst & Young LLP San Francisco, California March 27, 2001 EX-23.06 14 a2043474zex-23_06.txt EXHIBIT 23.06 EXHIBIT 23.06 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the following Registration Statements of Sylvan Learning Systems, Inc. of our report dated February 22, 2001, with respect to the consolidated financial statements of MindSurf, Inc. included in the Annual Report (Form 10-K) of Sylvan Learning Systems, Inc. for the year ended December 31, 2000. REGISTRATION STATEMENTS ON FORM S-3:
REGISTRATION NUMBER DATE FILED 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 333-48997 March 31, 1998 333-50993 April 24, 1998 333-61083 August 25, 1998 333-65197 October 1, 1998 333-67727 December 4, 1998 333-78961 May 20, 1999
REGISTRATION STATEMENTS ON FORM S-8:
NAME REGISTRATION NUMBER DATE FILED 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997 1998 Stock Incentive Plan 333-62011 August 21, 1998 1993 Employee Stock Option Plan and Employee Stock Purchase Plan 33-77390 September 14, 1998
/s/ Ernst & Young LLP Baltimore, Maryland March 27, 2001 EX-23.07 15 a2043474zex-23_07.txt EX-23.07 Exhibit 23.07 Consent of Independent Auditors We consent to the incorporation by reference in the following Registration Statements of our report dated November 10, 2000 (except for not 12 which is as of December 15, 2000), with respect to the consolidated financial statements of Chancery Software Ltd. included in the Annual Report (Form 10-K) of Sylvan Learning Systems, Inc. for the year ended December 31, 2000. Registration Statements on Form S-3:
REGISTRATION NUMBER DATE FILED - ------------------- ---------- 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 26, 1996 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 333-48997 March 31, 1998 333-50993 April 24, 1998 333-61093 August 25, 1998 333-62197 October 1, 1998 333-67727 December 4, 1998 333-78961 May 20, 1999
Registration Statements on Form S-8:
Name Registration Number Date Filed - ---- ------------------- ---------- 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77386 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997 1998 Stock Option Plan 333-62011 August 21, 1998 1993 Employee Stock Option Plan and Employee Stock Purchase Plan 33-77390 September 14, 1998
"PricewaterhouseCoopers LLP" Chartered Accountants Vancouver, Canada March 29, 2001 EX-99.1 16 a2043474zex-99_1.txt EXHIBIT 99.1 Exhibit 99.1 [PricewaterhouseCoopers Logo] Chancery Software Ltd. Consolidated Financial Statements September 30, 2000 and 1999 (tabular amounts expressed in thousands of U.S. dollars) [PricewaterhouseCoopers Logo] - -------------------------------------------------------------------------------- PricewaterhouseCoopers LLP Chartered Accountants 1111 West Hastings Street Vancouver British Columbia Canada V6E 3R2 Telephone +1 (604) 806 7000 Facsimile +1 (604) 806 7806 Auditors' Report To the Directors and Shareholders of Chancery Software Ltd. We have audited the consolidated balance sheets of Chancery Software Ltd. as at September 30, 2000 and 1999 and the consolidated statements of operations, changes in shareholders' equity and cash flows for the years ended September 30, 2000 and 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 auditing standards generally accepted in the United States. Those standards require that we plan and perform an audit to obtain reasonable assurance 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. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at September 30, 2000 and 1999 and the results of its operations and its cash flows for the years ended September 30, 2000 and 1999 in accordance with generally accepted accounting principles in the United States. PricewaterhouseCoopers LLP Chartered Accountants Vancouver, Canada November 10, 2000 (except for note 12 which is as of December 15, 2000) PricewaterhouseCoopers refers to the Canadian firm of PricewaterhouseCoopers LLP and other members of the worldwide PricewaterhouseCoopers organization Chancery Software Ltd. Consolidated Balance Sheets As at September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) 2000 1999 $ $ Assets Current assets Cash and cash equivalents 6,311 2,580 Short-term investments 7,399 -- Accounts receivable (note 4) 2,956 3,046 Prepaid expenses and deposits 511 307 Work-in-process 169 -- Inventory 132 112 ---------------------- 17,478 6,045 Long-term accounts receivable 100 -- Investment - at cost -- 6 Property and equipment - net (note 4) 1,804 672 Intangible assets 1,308 244 Goodwill 1,991 -- ---------------------- 22,681 6,967 ---------------------- The accompanying notes are an integral part of these consolidated financial statements. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Consolidated Balance Sheets...continued As at September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars)
2000 1999 $ $ Liabilities Current liabilities Accounts payable and accrued liabilities (notes 4 and 6) 2,160 2,521 Income taxes payable 42 -- Note payable (note 5) 500 -- ---------------- 2,702 2,521 Unearned revenue 5,736 3,925 ---------------- Total current liabilities 8,438 6,446 Deferred income taxes 268 -- ---------------- 8,706 6,446 ------------------ Redeemable Convertible Preferred Stock (note 7) Authorized 100,000,000 Class A voting redeemable convertible preferred shares, no par value, 4% cumulative dividend Issued and outstanding 4,667,419 (1999 - nil) Class A voting redeemable convertible preferred shares (including accretion of cumulative dividend of $629,997 and net of issuance costs of 326,000) 32,204 -- ------------------ Shareholders' Equity Capital stock (note 8) Authorized 100,000,000 voting common shares, no par value Issued and outstanding 7,208,348 (1999 - 18,095,715) voting common shares (net of issuance costs of $86,600) 4,399 9,360 Other capital accounts (72) 494 Accumulated other comprehensive income 1,558 1,098 Deficit (24,114) (10,431) ------------------ (18,229) 521 ------------------ 22,681 6,967 ------------------
Approved by the Board of Directors _________________________ Director ______________________________ Director The accompanying notes are an integral part of these consolidated financial statements. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Consolidated Statements of Operations For the years ended September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars except per share amounts) 2000 1999 $ $ Revenue 14,029 11,453 Costs 3,786 2,652 --------------------- Gross profit 10,243 8,801 --------------------- Expenses Sales and marketing 5,946 3,799 Research and development 5,170 1,949 General and administration 3,616 2,387 Depreciation 489 235 Amortization of intangible assets 330 37 Amortization of goodwill 398 -- --------------------- 15,949 8,407 --------------------- (5,706) 394 Gain on sale of investment 945 -- Interest income 421 26 Foreign exchange gain (loss) 656 (217) --------------------- (Loss) earnings before income taxes (3,684) 203 Provision for income taxes 167 -- --------------------- Net (loss) earnings for the year (3,851) 203 --------------------- The accompanying notes are an integral part of these consolidated financial statements. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Consolidated Statements of Changes in Shareholders' Equity For the years ended September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars)
Other capital accounts ----------------------------------- Accumu- lated other Total Common Stock Additional Deferred compre- stock- --------------------- paid-in compen- hensive holders' Shares Amount capital sation income Deficit equity $ $ $ $ $ $ Balance - September 30, 1998 1,557,185 1,910 109 -- 905 (10,634) (7,710) Issuance of shares for cash 111,050 42 -- -- -- -- 42 Issuance on conversion of Class A Preferred Stock 2,820,930 1,280 140 -- -- -- 1,420 Issuance on conversion of Class B Preferred Stock 2,782,135 1,263 (26) -- -- -- 1,237 Issuance on conversion of Class C Preferred Stock 1,224,555 556 7 -- -- -- 563 Issuance on conversion of Class D Preferred Stock 14,480 7 -- -- -- -- 7 Issuance on conversion of Class A debentures 3,467,880 1,574 -- -- -- -- 1,574 Issuance on conversion of Class B debentures 6,117,500 2,776 -- -- -- -- 2,776 Share issuance costs -- (48) -- -- -- -- (48) Employee option grants -- -- 462 (462) -- -- -- Amortization of deferred compensation expense -- -- -- 264 -- -- 264 Comprehensive income (loss) Accumulated other comprehensive income - foreign currency translation -- -- -- -- 193 -- Net earnings for the year -- -- -- -- -- 203 Total comprehensive income -- -- -- -- -- -- 396 -------------------------------------------------------------------------------------------- Balance - September 30, 1999 18,095,715 9,360 692 (198) 1,098 (10,431) 521 Issuance of shares for cash 1,002,028 329 -- -- -- -- 329 Issuance on acquisition of Misty City Software Inc. 467,835 546 -- -- -- -- 546 Redemption (12,537,230) (5,836) (715) -- -- (8,067) (14,618) Class A Preferred Stock cumulative dividend -- -- -- -- -- (630) (630) Adjustment of Class A Preferred Stock to redemption value -- -- -- -- -- (1,135) (1,135) Employee option grants -- -- 23 (23) -- -- -- Amortization of deferred compensation expense -- -- -- 149 -- -- 149 Comprehensive income (loss) Accumulated other comprehensive income - foreign currency translation -- -- -- -- 460 -- Loss for the year -- -- -- -- -- (3,851) Total comprehensive income -- -- -- -- -- -- (3,391) -------------------------------------------------------------------------------------------- Balance - September 30, 2000 7,028,348 4,399 -- (72) 1,558 (24,114) (18,229) --------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Consolidated Statements of Cash Flows For the years ended September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars)
2000 1999 $ $ Cash flows used in operating activities Net (loss) earnings for the year (3,851) 203 Adjustments to reconcile loss for the year to net cash used in operating activities Non-cash revenue (506) -- Depreciation 489 284 Amortization of intangible assets 330 -- Amortization of goodwill 398 -- Gain on sale of investment (945) -- Stock-based compensation 149 264 Foreign exchange gain (656) -- Deferred income taxes 125 -- Changes in operating working capital items Accounts receivable 177 (1,317) Prepaid expenses and deposits (202) (126) Work-in-process (169) -- Inventory (16) 8 Long-term accounts receivable (100) -- Accounts payable and accrued liabilities (437) 944 Income taxes payable 42 -- Unearned revenue 1,041 1,055 ----------------- (4,131) 1,315 ----------------- Cash flows used in investing activities Proceeds on sale of investment 951 -- Purchase of Misty City Software (1,225) -- Cash acquired on acquisition of Misty City Software Inc. 102 -- Purchase of property and equipment (1,582) (749) Purchase of intangible assets (236) -- Purchase of short-term investments (7,399) -- ----------------- (9,389) (749) ----------------- Cash flows used in financing activities Redemption of common shares (14,618) -- Issuance of Common Stock for cash 329 42 Issuance of redeemable convertible Preferred Stock for cash 31,574 -- Repayment of note payable (500) -- Share issuance costs -- (48) Convertible debentures -- (66) ----------------- 16,785 (72) ----------------- Foreign exchange effect on cash 466 193 ----------------- Increase in cash and cash equivalents 3,731 687 Cash and cash equivalents - Beginning of year 2,580 1,893 ----------------- Cash and cash equivalents - End of year 6,311 2,580 -----------------
The accompanying notes are an integral part of these consolidated financial statements. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) 1 The Company Chancery Software Ltd. ("the Company") is incorporated under the laws of British Columbia, Canada. The Company develops, markets, and sells Student Information Systems ("SIS") software primarily to schools and school districts in the K-12 market. The Company also operates its web portal, K12Planet.com, which serves as an online community incorporating the information generated by its SIS software at the school level with educational and informational content for teachers, students, parents, and other stakeholders in the educational system. 2 Summary of significant accounting policies Use of estimates The preparation of consolidated 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principles of consolidation and basis of presentation The financial statements as at September 30, 2000 and for the year then ended are consolidated and include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated on consolidation. Foreign currency translation and transactions The Company has adopted the U.S. dollar as its reporting currency. The functional currency of the Company's operations located outside the U.S. is the Canadian currency. The consolidated financial statements are translated to U.S. dollars using the period-end exchange rate for assets and liabilities and weighted-average exchange rates for the period for revenues and expenses. Translation gains and losses are deferred and accumulated as a component of other comprehensive income in shareholders' equity. Net gains and losses resulting from foreign exchange transactions are included in the consolidated income statement. Cash and cash equivalents Cash and cash equivalents consists of cash on deposit and highly liquid short-term interest bearing securities with maturity at the date of acquisition of three months or less. Short-term investments Short-term investments consist of highly liquid short-term interest bearing securities with maturities at the date of acquisition greater than three months. Interest earned is recognized immediately in the statement of operations. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) Fair value of financial instruments The Company's financial instruments, consisting of cash and cash equivalents, accounts receivable, and accounts payable and accrued liabilities are carried at cost, which approximates their fair value due to the short-term maturity of these instruments. Inventory Inventory consists of finished product and raw materials for the Company's products. Inventory is valued at the lower of cost, determined on the first-in first-out basis, and net realizable value. Property and equipment Property and equipment are stated at historical cost. Depreciation and amortization are computed using the straight line method over the estimated useful lives of the assets, generally five years or less. Intangible assets Goodwill and other intangible assets resulting from the acquisition of Misty City Software Inc. ("Misty City") were estimated by management to be primarily associated with the intellectual property of Misty City's core product and to the acquired customer list. As a result of the rapid technological changes occurring in the software industry, goodwill and other intangible assets are amortized on a straight-line basis over 36 months, being the estimated periods of benefit. See note 5 - Acquisition. Acquired computer software, including third party installation charges, is recorded at cost and is amortized on a straight-line basis over 36 months. Intangible assets - Web site development costs The Company accounts for web site development costs in accordance with Emerging Issues Task Force Abstract ("EITF") No. 00-02, "Accounting for Web Site Development Costs". EITF 00-02 requires the capitalization of certain web site development costs incurred in the production and building of a web site for quarters beginning after June 30, 2000. Costs related to planning and web site maintenance are expensed as incurred. Amounts capitalized are capitalized in accordance with AICPA Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". Prior to June 30, 2000, the Company expensed all web site development costs as part of research and development expenses. Web site development costs are amortized on a straight-line basis over three years, being the estimated period of benefit. Impairment of long-lived assets The Company evaluates the recoverability of long-lived assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of". SFAS No. 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) Revenue recognition Revenues are recognized in accordance with AICPA SOP 97-2, "Software Revenue Recognition". The Company generally sells product with multiple elements, including software, post-contract customer support, implementation consulting, and training. For these transactions, the Company recognizes revenue for delivered elements upon delivery, when the Company's fee is fixed and determinable, collection is probable and persuasive evidence of an arrangement exists. The fair value of the undelivered elements, based on vendor-specific objective evidence, is deferred and recognized as revenue upon the ultimate delivery of such elements. The Company also sells post-contract customer support and consulting services. For post-contract customer support, the Company recognizes revenue ratably over the period, when the Company's fee is fixed and determinable and collection is probable. For consulting services, the Company recognizes revenue as services are performed, when the Company's fee is fixed and determinable and collection is probable. Revenue from a contract to develop state specific reporting templates has been accounted for on the completed contract basis. Direct costs of the contract are included in work-in-process at the lower of cost and net realizable value. Provision would be made for all anticipated losses as soon as they became evident. Research and development Research and development costs include expenses incurred by the Company to develop, enhance, and manage the Company's suite of software products, as well as to enhance, manage, monitor, and operate the Company's various web sites. Research and development costs are expensed as incurred. Stock-based compensation The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and complies with the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". Under APB No. 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of the Company's stock and the exercise price. The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and EITF 96-18. Income taxes Income taxes are accounted for using an asset and liability approach, which requires the recognition of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Company's financial statements or tax returns. The measurement of the current and deferred tax liabilities and assets are based on the provisions of enacted tax law; the effects of future changes in tax laws or rates are not anticipated. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance where, based on available evidence, the probability of realization of the deferred tax asset does not meet a more likely than not criteria. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) Investment tax credits Prior to the completion of a financing in March 2000, the Company was a Canadian Controlled Private Corporation ("CCPC"). A CCPC is entitled to an investment tax credit at a rate of 35% of the first $2 million (20% on amounts in excess of $2 million) of eligible current research and development expenditures. Investment tax credits on current expenditures earned at the 35% rate are fully refundable in cash to the Company upon filing a claim and having it approved by taxation authorities. Current investment tax credits earned on capital expenditures at a rate of 35% and on excess current expenditures at a rate of 20% are refundable in cash at a rate of 40% of the amount of the credit. The non-refundable investment tax credit component can be applied against future income taxes payable. Non-CCPC corporations are entitled to investment tax credits at a rate of 20%, with no refundable cash components available, on both current and capital expenditures. On March 30, 2000, the Company lost its CCPC status as a result of the issuance of redeemable convertible Preferred Stock. Accordingly, the Company is not entitled to the refundable component of investment tax credits for the year ending September 30, 2000. The refundable and non-refundable portion of investment tax credits are accounted for as a reduction of the related expenditure for items of a current expense nature and a reduction of the related assets for items of a long-term nature, when the Company has reasonable assurance that the credit will be realized. Comprehensive income The Company accounts for comprehensive income in accordance with SFAS No. 130, "Reporting Comprehensive Income". Comprehensive income, as defined, includes all changes in equity (net assets) during a period from non-owner sources. The Company's comprehensive income consists of foreign currency translation adjustments and net income. Recent accounting pronouncements In December 1999 and during calendar 2000, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements", and subsequent amendments and interpretations. The Company believes that its current revenue recognition and reporting policies are consistent with the Staff's views set out in those bulletins. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) 3 Supplemental cash flow information
2000 1999 $ $ Cash paid for income taxes -- -- Cash paid for interest (35) -- Non-cash investing and financing activities Issuance of promissory note on purchase of Misty City 1,000 -- Issuance of Common Stock on purchase of Misty City 546 -- Redemption of term preferred shares by issuance of Common Stock -- 3,227 Redemption of subordinated debentures by issuance of Common Stock -- 4,350 Additional paid-in capital -- 121
4 Balance Sheet components
2000 1999 $ $ Accounts receivable Trade accounts receivable 2,738 2,827 Tax credit receivable -- 205 Other 292 94 Less: Allowance for doubtful accounts (74) (80) --------------- 2,956 3,046 --------------- Property and equipment Computer equipment 2,636 1,678 Furniture and fixtures 1,024 513 Leasehold improvements 341 134 Capital lease equipment 445 453 --------------- 4,446 2,778 Less: Accumulated depreciation 2,642 2,106 --------------- 1,804 672 --------------- Intangible assets Computer software acquired 667 430 Website development 160 -- Acquired technology 842 -- Acquired customer list 123 -- Human capital 30 -- --------------- 1,822 430 Less: Accumulated amortization (514) (185) --------------- 1,308 245 ---------------
[PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) 2000 1999 $ $ Accounts payable and accrued liabilities Trade 884 663 Accrued sales and marketing 180 252 Accrued compensation and related benefits 683 999 Other accrued liabilities 413 607 --------------- 2,160 2,521 --------------- 5 Acquisition of Misty City Software Inc. On April 6, 2000, the Company acquired 100% of the Common Stock of Misty City Software Inc. ("Misty City"), which develops, markets, and sells software aimed at the educational industry. The agreement stated a purchase price of $3,000,000 consisting of 467,835 shares of the Company stock, a note payable for $1,000,000 and cash of $1,200,000. Under APB 16 the shares have been valued at the announcement date which resulted in the Common Stock being recorded at $546,000. The acquisition has been accounted for using the purchase method of accounting and accordingly, the purchase price of $2,771,000, including related expenses of approximately $25,000, consisting primarily of legal and other professional service fees, has been allocated to the tangible and intangible assets acquired and liabilities assumed on the basis of their respective fair values on the acquisition date. The purchase price was allocated to net tangible liabilities assumed ($471,000) and intangible assets, including completed technology ($842,000), customer list ($123,000), human capital ($31,000), and goodwill ($2,246,000). The intangible assets are being amortized over their estimated useful lives of 36 months. As at September 30, 2000, $500,000 of the note payable was outstanding with the remaining instalments of $250,000 due on December 31, 2000 and March 31, 2000 with interest at 6% per annum. 6 Income taxes Income before income taxes Income before income taxes was generated by both domestic and U.S. operations during 2000 and 1999. The components of income before equity income, income taxes and minority interest are as follows: 2000 1999 $ $ Canadian (3,996) (519) U.S. 312 722 ---------------- (3,684) 203 ---------------- [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) Current income taxes The provision for current income taxes consists of the following: 2000 1999 $ $ Current Canadian 17 -- U.S. federal 25 -- ------------------- 42 -- Deferred U.S. federal 125 -- ------------------- 167 -- ------------------- The provision for income taxes differs from the amount computed by applying the statutory income tax rate to net income before taxes as follows: 2000 1999 % % Canadian statutory rate (45.62) 45.62 Loss carry forward not recognized 21.44 -- Deferred tax assets not recognized 31.10 112.31 Foreign tax at other than Canadian statutory rate (1.98) (40.01) Non-deductible expenses 7.62 66.32 Prior year's loss carry forward not previously recognized (4.61) (184.24) Non-taxable income (3.88) -- Large corporations tax 0.46 -- ---------------- 4.53 -- ---------------- [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) Deferred income taxes Significant components of the Company's deferred tax assets and liabilities are as follows: 2000 1999 $ $ Deferred tax asset Property and equipment and intangible assets 479 129 Other 199 (43) Tax losses carryforward 1,259 1,985 Scientific research and experimental development expenditures carried forward 792 675 ------------------ 2,729 2,746 Valuation allowance (2,997) (2,746) ------------------ Net deferred tax liability (268) -- ------------------ Management believes that, based on a number of factors, it is more likely than not that the deferred tax assets will not be utilized. Accordingly, a valuation allowance for the full amount of the deferred tax assets has been recorded. The Company has non-capital losses of approximately $2,759,000, and scientific research and experimental development ("SR&ED") expenditures of approximately $1,737,000, which are available for carryforward against taxable income earned in Canada in future years. The SR&ED expenditures carry forward indefinitely, and non-capital losses expire as follows: $ 2001 160 2002 858 2003 175 2007 1,566 ----- 2,759 ----- [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) 7 Mandatorily Redeemable Convertible Preferred Stock On March 15, 2000, the Company cancelled its previously authorized Class A, B, C, and D Preferred Stock. None of this stock was issued and outstanding at the date of cancellation. On March 15, 2000, the Company authorized 100,000,000 shares of Class A Voting Mandatorily Redeemable Convertible Preferred Stock. Class A Mandatorily Redeemable Convertible Preferred Stock On March 30, 2000, the Company issued 4,667,419 shares of its Class A Mandatorily Redeemable Convertible Preferred Stock ("Class A Preferred Stock") for $31,900,000. The Class A Preferred Stock entitles holders to a 4% cumulative stock and/or cash dividend accruing from the date of issuance. Holders of the Class A Preferred Stock are entitled to the number of votes equal to the number of Common Shares into which the Class A Preferred Stock could be converted at the time of the vote, and vote on an equal basis with holders of the Company's Common Stock, together as a single class. The Class A Preferred Stock ranks senior to all classes of capital stock upon liquidation, dissolution, and wind-up, and ranks junior in right of payment of all indebtedness of the Company and its subsidiaries. The Class A Preferred Stock has a mandatory redemption on the earlier of March 31, 2005, liquidation, dissolution, or wind-up of the Company, change in control of the Company, a sale of substantially all the assets of the Company, bankruptcy of the Company, or any material breach of the terms and conditions surrounding the Class A Preferred Stock. The Class A Preferred Stock is redeemable at a liquidation value of the greater of (a) $6.82 per share plus all accrued but unpaid cumulative dividends thereon, or (b) the fair market value of the Preferred Stock, on an after conversion basis, based upon the number of shares of Common Stock the Class A Preferred Stock is convertible into and the market price, as determined by a published market (if one exists), of the Common Stock. At the option of the Company, any accrued but unpaid cumulative dividends may be settled by issuance of additional Class A Preferred Stock, the number of shares to be determined by dividing the accrued but unpaid cumulative dividends by $6.82. Upon a qualified underwritten initial public offering, each share of the Class A Preferred Stock will be converted into Common Stock of the Company at a ratio of five for one. A qualified underwritten initial public offering is one in which net proceeds to the Company are at least $40 million, occurs prior to March 31, 2005, and occurs at a price not less than four times the initial issue price of the Class A Preferred Stock, which was $6.82. If the underwritten initial public offering occurs prior to March 31, 2001, the price need only be two times the initial issue price, and if prior to September 30, 2001, the price need only be three times the initial issue price, in order to be qualified. The Class A Preferred Stock may be converted by the holders into Common Stock at any time, at a ratio of five for one. At the option of the Company, any accrued but unpaid cumulative dividends may be settled by issuance of additional Class A Preferred Stock, the number of shares to be determined by dividing the accrued but unpaid cumulative dividends by $6.82. In addition, the holders of the Class A Preferred Stock have anti- dilution protection. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) 8 Capital Stock Share capital transactions On October 30, 1998, the shareholders and debentureholders accepted an offer from the principal investors of the Company to convert all previously authorized class A, B, C and D preferred shares and its series A and B debentures into Common Stock. Pursuant to this offer, each security held was converted as follows: all debentures and shareholder loans outstanding at the time of the restructuring were assigned one share of Common Stock for every $3.50 of debt outstanding; the Class A and B preferred shares were discounted at 0.888 to reflect the present value at the redemption date times the original purchase price of the preferred shares and issued one share of Common Stock for every $3.50 of the discounted original purchase price; each Class C preferred share was exchanged for 33.82 shares of Common Stock and each Class D preferred share was exchanged for 0.4 shares of Common Stock. On March 30, 2000, 12,537,230 shares of Common Stock were redeemed for $14,618,000. The redemption has been recorded as a reduction in Common Stock of $5,836,000, a reduction in additional paid in capital of $715,000 and a charge to deficit of 8,067,000. On April 6, 2000, in connection with the acquisition of Misty City, the Company issued 467,835 shares of Common Stock. The issuance was recorded at $546,000, being the estimated fair value of the shares of Common Stock at the date of acquisition. On June 29, 2000, the Board of Directors approved a five-for-one share split of the Company's Common Stock. All share amounts have been presented on a post stock split basis. 9 Stock based compensation Stock option plan In December 1998, the Company's Board of Directors adopted the Stock Option Plan (the "Plan") and reserved 10,000,000 shares of Common Stock for issuance thereunder. The Plan provides for the granting of stock options to Eligible Persons (defined as directors, officers, employees, or consultants of the Company or any of its subsidiaries). No person shall be eligible to receive more than 5% of the total number of outstanding number of Common Shares at the date of the grant. Terms and conditions of options granted under the Plan are determined solely by the Compensation Committee (the "Committee") of the Board of Directors, however, generally are granted for periods not exceeding eight years at prices equal to the fair value of the shares on the date of grant as determined by the Committee. Exercise prices for the Company's stock options are fixed in Canadian dollars. Options under the plan are not immediately exercisable and generally vest over a period of 36 months. The vesting schedule for each grant is determined by the Committee. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) The following table summarizes activity under the Company's stock option plan for the years ended September 30, 2000 and 1999: 2000 1999 -------------- --------------------------- Weighted Weighted average average Shares exercise price Shares exercise price Cdn. $ Cdn. $ Stock options Outstanding - beginning of year 4,670,905 0.56 333,590 0.20 Granted 3,175,705 2.34 4,477,760 0.58 Exercised (234,700) 0.41 (19,375) 0.53 Cancelled (158,425) 0.62 (121,070) 0.50 Expired -- -- -- -- --------- --------- Outstanding - end of year 7,453,485 1.32 4,670,905 0.56 --------- --------- Exercisable - September 30 3,159,825 -- 1,351,404 -- --------- --------- Weighted average fair value of options granted during the year 0.08 1.22 The following table summarizes information about fixed stock options outstanding at September 30, 2000: Options outstanding at September 30, 2000 -------------------------------------------------------------------- Exercise Number Remaining Number price outstanding contractual life exercisable Cdn. $ (years) 0.20 223,915 3.7 211,215 0.53 3,531,625 6.1 2,214,024 1.00 861,925 7.1 261,916 2.50 2,836,020 7.5 472,670 --------- --------- 1.32 7,453,485 3,159,825 --------- --------- [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) Fair value disclosures The Company calculated the minimum fair value of each option grant on the date of grant using the Black-Scholes option pricing model as prescribed by SFAS No. 123 using the following assumptions: 2000 1999 % % Risk-free interest rate 6.3 4.8 Expected lives (in years) 3.0 3.0 Dividend yield 0.0 0.0 Expected volatility 0.0 0.0 The fair value of each option grant was determined using the minimum value method. The effect of compensation cost on net income and (loss) earnings per share for the years ended September 30, 2000 and 1999 is as follows: 2000 1999 $ $ Net (loss) earnings As reported (3,703) 203 Pro forma (3,779) (67) Unearned stock-based compensation In connection with certain stock option grants during the years ended September 30, 2000 and 1999, the Company recognized unearned compensation totalling $23,000 and $462,000, respectively, which is being amortized over the three year vesting periods of the related options. Amortization expense recognized during the years ended September 30, 2000 and 1999 totalled approximately $149,000 and $264,000, respectively. 10 Concentration of credit risk Financial instruments that potentially subject the Company to a significant concentration of credit risk consist mainly of cash and cash equivalents and accounts receivable. The Company limits its exposure to credit loss by placing its cash and cash equivalents with high credit, quality financial institutions. Concentration of credit risk with respect to accounts receivable is considered to be limited due to the credit quality of the customers comprising the Company's customer base. The Company's customer base consists primarily of government-funded organizations including schools, school districts, and state and provincial governments. The Company performs ongoing credit evaluations of the financial condition of those customers not represented by this customer base, in order to determine the need for an allowance for doubtful accounts. The Company maintains an allowance for doubtful accounts receivable based upon the expected collectibility of accounts receivable. The Company has not experienced significant credit losses to date, and during the years ended September 30, 2000 and 1999, no customers accounted for more than 10% of net revenues or net accounts receivable. [PricewaterhouseCoopers Logo] Chancery Software Ltd. Notes to Consolidated Financial Statements September 30, 2000 and 1999 - -------------------------------------------------------------------------------- (tabular amounts expressed in thousands of U.S. dollars) 11 Commitments The Company leases certain facilities and equipment used in its operations under operating leases. Future minimum lease payments under these lease agreements at September 30, 2000 are as follows: $ 2001 742 2002 728 2003 266 2004 20 2005 -- 12 Subsequent event On December 15, 2000, the Company signed a memorandum of understanding ("MOU") to merge with a company in the K-12 market whose products and services are complimentary to Chancery's own products and services. The MOU is not binding unless and until a final definitive agreement has been executed, except for the requirement of the Company to pay a break up fee of $1,500,000 in the event certain dates are not met as a direct result of the Company's failure to use commercially reasonable efforts to negotiate terms or conclude the transaction. 13 Unaudited subsequent event On February 2, 2001, the company terminated the arrangement to merge with the target company pursuant to the MOU (note 12). The target company subsequently filed a lawsuit to recover the break-up fee of $1,500,000. The company believes the lawsuit is without merit and intends to vigorously defend the lawsuit. [PricewaterhouseCoopers Logo] EX-99.2 17 a2043474zex-99_2.txt EXHIBIT 99.2 FINANCIAL STATEMENTS HigherMarkets, Inc. (a development stage company) for the period from February 15, 2000 (inception) through December 31, 2000 with Report of Independent Auditors HigherMarkets, Inc. (a development stage company) Financial Statements Period from February 15, 2000 (inception) through December 31, 2000 Contents Report of Independent Auditors.................................................1 Financial Statements Balance Sheet..................................................................2 Statement of Operations........................................................3 Statement of Redeemable Convertible Preferred Stock and Stockholders' Deficit..4 Statement of Cash Flows........................................................6 Notes to Financial Statements..................................................7 Report of Independent Auditors The Board of Directors and Stockholders HigherMarkets, Inc. We have audited the accompanying balance sheet of HigherMarkets, Inc. (a development stage company) as of December 31, 2000 and the related statements of operations, redeemable convertible preferred stock and stockholders' deficit, and cash flows for the period from February 15, 2000 (inception) through December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of HigherMarkets, Inc. at December 31, 2000, and the results of its operations and its cash flows for the period from February 15, 2000 (inception) through December 31, 2000, in conformity with generally accepted accounting principles in the United States. The accompanying financial statements have been prepared assuming that HigherMarkets will continue as a going concern. As more fully described in Note 1, the Company has incurred operating losses since inception and forecasts indicate that the Company may not have sufficient cash to fund its development activities through 2001. These conditions raise substantial doubt about the Company's ability to continue as a going concern. (Management's plans in regard to these matters are also described in Note 1.) The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. /s/ Ernst & Young LLP San Francisco, California March 5, 2001 3 HigherMarkets, Inc. (a development stage company) Balance Sheet December 31, 2000 Assets Current assets: Cash $ 7,686,139 Restricted cash 507,422 Short-term investments 39,074 Prepaid expenses and other current assets 122,029 ------------ Total current assets 8,354,664 Certificate of deposit 469,942 Other assets 24,406 Property and equipment, net 2,956,408 ------------ Total assets $ 11,805,420 ============ Liabilities and stockholders' deficit Current liabilities: Accounts payable $ 1,323,250 Accrued expenses 40,492 Accrued dividend on redeemable convertible Series B preferred stock 276,760 Due to related party 160,409 Capital lease obligations, current portion 93,862 ------------ Total current liabilities 1,894,773 Capital lease obligations 41,094 Redeemable convertible Series B preferred stock, $0.001 par value, liquidation preference $3.72: Authorized shares - 11,440,323 Issued and outstanding shares - 11,159,678 13,906,033 Stockholders' deficit: Series A preferred stock, $0.001 par value, liquidation preference $0.39: Authorized shares - 3,589,746 Issued and outstanding shares - 3,589,746 3,590 Common stock, $0.001 par value: Authorized shares - 26,000,000 Issued and outstanding shares - 7,324,500 7,325 Additional paid-in capital 1,506,137 Deferred compensation (6,650) Deficit accumulated during the development stage (5,546,882) ------------ Total stockholders' deficit (4,036,480) ------------ Total liabilities and stockholders' deficit $ 11,805,420 ============ See accompanying notes. 4 HigherMarkets, Inc. (a development stage company) Statement of Operations Period from February 15, 2000 (inception) through December 31, 2000 Operating expenses: Product development $ 2,134,929 General and administrative 2,153,249 Marketing 702,436 Depreciation and amortization 94,551 ----------- Total operating expenses 5,085,165 Other income and (expense): Interest income 112,448 Interest expense (297,405) ----------- Net other (184,957) ----------- Net loss $(5,270,122) =========== See accompanying notes. 5 HigherMarkets, Inc. (a development stage company) Statement of Redeemable Convertible Preferred Stock and Stockholders' Deficit Period from February 15, 2000 (inception) through December 31, 2000
Stockholders' Deficit ----------------------------------------------------- Redeemable Convertible Convertible Preferred Stock Series B Preferred Stock Series A Common Stock ---------------------------------------------------------------------------------- Shares Amount Shares Amount Shares Amount ---------------------------------------------------------------------------------- Issuance of common stock to founders and investor for cash, net of issuance costs of $4,020 -- $ -- -- $ -- 6,174,500 $ 6,175 Issuance of Series A preferred stock, net of issuance costs of $25,464 -- -- 3,589,746 3,590 -- -- Issuance of common stock to employee for cash -- -- -- -- 1,150,000 1,150 Repurchase of common stock from founder for cash, net of compensation expense -- -- -- -- (375,000) (375) Issuance of common stock to employee for cash -- -- -- -- 375,000 375 Issuance of warrants to purchase Series B redeemable convertible preferred stock in conjunction with issuance of convertible notes payable -- 291,000 -- -- -- -- Issuance of Series B redeemable convertible preferred stock for cash and conversion of convertible note payable and related accrued interest, net of issuance costs of $222,968 11,159,678 13,615,033 -- -- -- -- Stockholders' Deficit -------------------------------------------------------- Deficit Accumulated Additional During Total Paid-In Deferred Development Stockholders' Capital Compensation Stage Deficit ----------- ----------- ----------- ----------- Issuance of common stock to founders and investor for cash, net of issuance costs of $4,020 $ (4,020) $ -- $ -- $ 2,155 Issuance of Series A preferred stock, net of issuance costs of $25,464 1,370,947 -- -- 1,374,537 Issuance of common stock to employee for cash 90,850 -- -- 92,000 Repurchase of common stock from founder for cash, net of compensation expense (32,915) -- -- (33,290) Issuance of common stock to employee for cash 74,625 -- -- 75,000 Issuance of warrants to purchase Series B redeemable convertible preferred stock in conjunction with issuance of convertible notes payable -- -- -- -- Issuance of Series B redeemable convertible preferred stock for cash and conversion of convertible note payable and related accrued interest, net of issuance costs of $222,968 -- -- -- --
6 HigherMarkets, Inc. (a development stage company) Statement of Redeemable Convertible Preferred Stock and Stockholders' Deficit (continued) Period from February 15, 2000 (inception) through December 31, 2000
Stockholders' Deficit -------------------------------------------------------- Redeemable Convertible Convertible Preferred Stock Series B Preferred Stock Series A Common Stock ------------------------------------------------------------------------------------ Shares Amount Shares Amount Shares Amount ------------------------------------------------------------------------------------ Issuance of common stock warrants in connection with office lease - $ - - $ - - $ - Dividend accrual in conjunction with Series B redeemable convertible preferred stock - - - - - - Net loss - - - - - - ------------------------------------------------------------------------------------ Balance at December 31, 2000 11,159,678 $ 13,906,033 3,589,746 $ 3,590 7,324,500 $ 7,325 ==================================================================================== Stockholders' Deficit ------------------------------------------------------------ Deficit Accumulated Additional During Total Paid-In Deferred Development Stockholders' Capital Compensation Stage Deficit ------------------------------------------------------------ Issuance of common stock warrants in connection with office lease $ 6,650 $ (6,650) $ - $ - Dividend accrual in conjunction with Series B redeemable convertible preferred stock - - (276,760) (276,760) Net loss - - (5,270,122) (5,270,122) ------------------------------------------------------------ Balance at December 31, 2000 $ 1,506,137 $ (6,650) $ (5,546,882) $ (4,036,480) ============================================================
See accompanying notes. 7 HigherMarkets, Inc. (a development stage company) Statement of Cash Flows Period from February 15, 2000 (inception) through December 31, 2000 Operating activities Net loss $ (5,270,122) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 94,551 Interest expense in connection with Series B Stock warrants 291,000 Interest expense on convertible notes payable 1,727 Compensation expense related to repurchase of shares from founder 41,710 Changes in operating assets and liabilities: Restricted cash (507,422) Prepaid expenses and other assets (122,029) Other assets (24,406) Accounts payable 1,323,250 Accrued expenses 40,492 Due to related party 160,409 ------------ Net cash used in operating activities (3,970,840) Investing activities Purchases of property and equipment (2,855,923) Purchases of short-term investments and certificate of deposit (509,016) ------------ Net cash used in investing activities (3,364,939) Financing activities Net proceeds from issuance of convertible Series A preferred stock 1,374,537 Net proceeds from issuance of redeemable convertible Series B preferred stock 12,803,306 Principal payments on capital lease obligations (60,080) Net proceeds from issuance of common stock 169,155 Repurchase of common stock from founder (75,000) Proceeds from issuance of convertible notes payable 810,000 ------------ Net cash provided by financing activities 15,021,918 ------------ Net increase in cash 7,686,139 Cash at beginning of period -- ------------ Cash at end of period $ 7,686,139 ============ Supplemental disclosure of non-cash transactions Property, plant and equipment acquired under capital lease obligations $ 195,036 ============ Deferred compensation related to stock option grants and common stock issuances and issuance of common stock warrants $ 6,650 ============ Accrual of dividend on redeemable convertible Series B preferred stock $ 276,760 ============ Conversion of convertible notes payable and related accrued interest to $ 811,727 redeemable convertible Series B preferred stock ============
See accompanying notes. 8 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements December 31, 2000 1. Company HigherMarkets, Inc. (the "Company") was incorporated in the state of Delaware on February 15, 2000. The Company is a development stage application service provider that is developing an e-procurement solution for universities and other educational institutions. The Company's activities since inception have consisted primarily of raising capital, recruiting key personnel, and the initial design and development of the e-procurement software. Accordingly, the Company is considered to be in the development stage. The Company has generated operating losses since inception and forecasts that it may not have sufficient cash to fund its development activities through 2001. This situation raises substantial doubt about the Company's ability to continue as a going concern. Management is actively pursuing the sale of its e-procurement solution to several customers and is also pursuing additional sources of financing. However, there can be no assurances that the Company will be able to generate cash flow from operations or additional financing in sufficient amounts to meet its development and operating needs, or that such financing would be available on terms acceptable to the Company. 2. Summary of Significant Accounting Policies Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities in the financial statements and accompanying notes. Actual results could differ materially from those estimates. Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents. The Company's cash equivalents consist mainly of money market funds and certificates of deposit. 9 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) Certificate of Deposit The certificate of deposit is restricted and secures a letter of credit related to the Company's lease agreement (see Note 5). The carrying amount approximates fair value. Concentration of Credit Risk The Company is subject to concentrations of credit risk from its cash investments. The Company's credit risk is managed through monitoring the stability of the financial institutions utilized and diversification of its financial resources. Property and Equipment Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over estimated useful lives of the respective assets, ranging from two to five years. The Company capitalizes certain internal use software costs in accordance with Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Capitalized internal use software costs with an expected useful life in excess of one year are amortized on a straight-line basis over their estimated useful lives ranging from 18 months to three years. Income Taxes The Company utilizes the liability method of accounting, under which deferred tax assets and liabilities are determined based on differences between financial reporting and tax reporting bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. 10 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 2. Summary of Significant Accounting Policies (continued) Stock Based Compensation The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock issued to Employees (APB 25), and related interpretations, in accounting for its employee stock options rather than the alternative fair value accounting allowed by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS 123"). APB No. 25 provides that the compensation expense relative to the Company's employee stock options is measured based on the intrinsic value of the stock option. SFAS 123 requires companies that continue to follow APB 25 to provide a pro forma disclosure of the impact of applying the fair value of SFAS 123 (see Note 7). 3. Property and Equipment Property and equipment consists of the following at December 31, 2000: Computers and equipment $ 317,518 Furniture and fixtures 17,744 Capitalized software 2,440,195 Leasehold improvements 275,502 ---------- 3,050,959 Less: accumulated depreciation and amortization 94,551 ---------- $2,956,408 ========== The Company leases certain furniture, office and computer equipment under noncancelable lease agreements that are accounted for as capital leases. Such cost for furniture, office and computer equipment under capital lease arrangements, included in property and equipment, aggregated approximately $195,036 as at December 31, 2000. Related accumulated amortization was approximately $26,913 at December 31, 2000. Amortization expense related to the capitalized software was $54,158. 11 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 4. Income Taxes The Company has deferred tax assets of approximately $2,094,000 at December 31, 2000. The deferred tax assets relate primarily to start-up costs and software development costs and have been fully offset by a valuation allowance. 5. Commitments and Contingencies Capital and Operating Leases The Company leases its office space under an operating lease with fixed rental payments through January 2006. Under the lease arrangement, the Company is required to maintain a letter of credit secured by a certificate of deposit totaling $469,942. Rent expense totaled $116,891 for the period from February 15, 2000 (inception) to December 31, 2000. Future minimum commitments under noncancelable capital leases and operating leases with initial terms of one year or more are as follows: Capital Operating Leases Leases ------------------------ 2001 $ 102,020 $ 841,000 2002 42,756 860,000 2003 -- 805,000 2004 -- 676,000 2005 and thereafter -- 697,000 ------------------------ Total minimum lease payments 144,776 $3,879,000 ========== Less interest 9,820 ---------- Present value of minimum lease payments 134,956 Less current portion 93,862 ---------- Capital lease obligations, less current portion $ 41,094 ========== 12 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 5. Commitments and Contingencies (continued) The Company has executed a three year contract with an internet service provider to host its website and e-procurement software. The contract contains a cancellation penalty equal to the net present value of $4,000 per month for the remaining term, discounted at 5%. The contract term ends in July 2003. The Company is obligated to pay a minimum royalty of 1% of annual revenue in connection with software it has licensed from a third party. No royalty liability has been incurred for 2000. Bank Line of Credit In December 2000, the Company secured a $500,000 bank line of credit expiring in one year with interest at the bank's prime rate, 9.5% at December 31, 2000. The line of credit is secured by a certificate of deposit held with the financial institution, which has been classified as restricted cash. No borrowings have been made under this agreement. 13 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 6. Convertible Notes and Redeemable Convertible Series B Preferred Stock Convertible Notes Payable In September 2000, the Company issued convertible notes payable for total cash proceeds of $810,000. The notes were convertible into shares of Series B redeemable preferred stock at approximately $1.24 per share. The notes had an original maturity date of March 2001 and were subject to interest at 6% per annum. The notes and $1,727 in accrued but unpaid interest were converted into shares of Series B redeemable convertible preferred stock in September 2000. In conjunction with this debt issuance, the company issued to the holders of the notes warrants to purchase 162,000 shares of the Company's Series B redeemable convertible preferred stock at an exercise price of $1.24 per share. The warrants have a contractual life of ten years. At the date of grant, the value ascribed to the warrants was approximately $0.96, based on a Black-Scholes valuation model (using volatility of 1.0, risk free interest rate of 6%, dividend yield of 0% and expected life of ten years). The amount was recorded as a discount to convertible notes payable. The fair value of the warrants and the resulting beneficial conversion associated with the notes, determined in accordance with EITF 00-27 Application of EITF Issue No. 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios," to Certain Convertible Instruments totaled $291,000 and were recorded as interest expense. None of the warrants were exercised as of December 31, 2000. In September 2000, the Company issued 11,159,678 shares of Series B redeemable preferred stock ("Series B") at $1.24 per share in exchange for cash proceeds of $13,026,274 and the conversion of notes payable and related accrued interest expense of $811,127, net of issuance costs of $222,968. Each share of the Series B redeemable convertible preferred stock is, at the option of the holder, convertible into shares of common stock, subject to certain antidilution adjustments, in accordance with the conversion formula provided in the Company's Articles of Incorporation (currently a 1:1 ratio). Outstanding Series B shares automatically convert into common stock: a) at the election of at least a majority of the outstanding shares or b) upon the closing of an initial public offering of the Company's common stock in which gross proceeds exceed $25,000,000 and a minimum per share price equal to or in excess of $4.96 per share, subject to certain antidilution adjustments. 14 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 15 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 6. Convertible Notes and Redeemable Convertible Series B Preferred Stock (continued) Holders of Series B are entitled to receive a cumulative dividend of $0.0992 per share per annum. A dividend of $276,760 has been accrued at December 31, 2000, but is not subject to payment until declared by the Board of Directors. Series B stockholders are entitled to the number of votes equal to the number of shares of common stock into which their shares could be converted. In addition, Series B stockholders have the right to elect two directors voting together as a single class. At any time after September 29, 2005, upon the written consent of a majority of the holders of the outstanding shares of Series B, the Company must redeem all issued, outstanding, and unconverted shares. The redemption price for each share of Series B is an amount equal to the greater of the original issue price for Series B or the fair value of such shares. The difference between the original purchase price of the Series B shares and its fair value will be accreted via a charge to accumulated deficit over the period extending to September 29, 2005. There was no charge to accumulated deficit for the period from February 15, 2000 (inception) to December 31, 2000. Upon liquidation, the Series B preferred stockholders would receive a return equal to $3.72 per share and any accrued but unpaid dividends. In the event of a liquidation not sufficient to satisfy the intended liquidation provisions, Series B preferred stockholders will generally have preference over Series A preferred stockholders. 16 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 7. Stockholders' Deficit Series A Convertible Preferred Stock In March, May and July 2000, the Company issued a total of 3,589,746 shares of Series A Convertible Preferred Stock for cash proceeds of $1,374,537, net of issuance costs of $25,464. Each share of the Series A convertible preferred stock is, at the option of the holder, convertible into shares of common stock, subject to certain antidilution adjustments, in accordance with the conversion formula provided in the Company's Articles of Incorporation (currently a 1:1 ratio). Outstanding Series A preferred shares automatically convert into common stock: a) at the election of at least a majority of the outstanding Series A shares or b) upon the closing of an initial public offering of the Company's common stock in which gross proceeds exceed $10,000,000 and a minimum per share price equal to or in excess of $1.17 per share, subject to certain antidilution adjustments. Each share of convertible preferred stock is entitled to the number of votes equal to the number of shares of common stock into which such shares could be converted. In addition, Series A stockholders have the right to elect one director, voting together as a single class. Upon liquidation, Series A preferred stockholders will receive $0.39 per share plus any declared but unpaid dividends. In the event of a liquidation not sufficient to satisfy the intended liquidation provisions, Series B preferred stockholders will be given preference over the Series A preferred stockholders. Common Stock Under certain conditions, the Company has the option to repurchase all or a portion of the unvested shares of common stock issued to the Company's founders and certain employees of the Company at the original purchase price per share. At December 31, 2000, 3,870,225 shares were unvested and will continue to vest at various rates through October 2004. 17 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 7. Stockholders' Deficit (continued) 2000 Stock Plan In July 2000, the Board approved the adoption of the 2000 Stock Plan (the "Plan"), which authorizes the issuance of 2,800,000 shares of common stock under the plan. Under the terms of the Plan, the Board of Directors may grant incentive stock options ("ISOs") to employees and nonstatutory stock options ("NSOs") to employees, officers, directors, and consultants. Generally, the Company grants stock options at a price not less than 85% of the fair market value of the common stock on the date of the grant, as determined by the Company's Board of Directors. Options generally vest over a four-year period at a rate of 25% one year from the grant date and 1/48 monthly thereafter and expire a maximum of ten years from the date of grant. The stock options are exercisable immediately upon vesting. A summary of activity under the Plan is as follows: Outstanding Options ------------------------------ Shares Weighted- Available for Number of Average Exercise Grant Shares Price Per Share ---------------------------------------------- Initial authorized shares 2,800,000 -- $ -- Granted (1,521,500) 1,521,500 0.11 Canceled 75,000 (75,000) 0.08 ---------------------------------------------- Outstanding at December 31, 2000 1,353,500 1,446,500 $0.11 ============================================== The weighted average fair value of options granted to employees under the Plan in 2000 was $0.10 per share. The weighted average remaining contractual life of options outstanding under the Plan at December 31, 2000 is 9.51 years. 18 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 7. Stockholders' Deficit (continued) 2000 Stock Plan (continued) The following table summarizes information about stock options outstanding and exercisable at December 31, 2000: Outstanding Options Weighted- Weighted- Average Average Remaining Number of Number of Exercise Price Contractual Options Shares Per Share Life (Years) Exercisable Exercise Price $0.08 1,104,500 $0.08 9.43 80,000 $0.20 342,000 $0.20 9.78 -- --------- 1,446,500 ========= Pro Forma Disclosures of the Effect of Stock-Based Compensation The Company has elected to follow APB 25 and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FAS 123 requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, when the exercise price of the Company's employee stock options equals or exceeds the market price of the underlying common stock on the grant date, no compensation expense is recorded. For the period ended December 31, 2000, pro forma net loss and pro forma net loss per share were as follows: Net loss $5,270,122 Incremental pro forma compensation expense under FAS 123 15,641 ---------- Net loss - pro forma $5,285,763 ========== 19 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 7. Stockholders' Deficit (continued) Pro Forma Disclosures of the Effect of Stock-Based Compensation (continued) The fair value of each option grant is estimated at the date of grant using a Black-Scholes option pricing model, assuming no expected dividends and with the following weighted-average assumptions for the period ended December 31, 2000: Volatility 1.0 Risk-free interest rate 6% Expected life of the option 10 years Expected dividend yield 0% The pro forma impact of options on the net loss for the period ended December 31, 2000 is not representative of the effects on net income (loss) for future years, as future years will include the effects of additional years of stock option grants. Common Stock Warrants and Options The Company has granted 35,000 warrants to certain lessors. Such warrants were fully vested and exercisable at the issuance date and expire in December 2010. The fair value of these warrants is charged to expense over the period of the related lease term or the period in which services are received. In addition, the company has granted 10,000 options to a service provider that vested during the year. The fair value of these warrants and options is included in general and administrative expense. The value of the warrants and options was estimated using the Black-Scholes option pricing model based on a weighted average, risk-free interest rate of approximately 6%, an exercise period equal to the life of the warrant and option, volatility of 1.0 and, no dividend yield. 20 HigherMarkets, Inc. (a development stage company) Notes to Financial Statements (continued) 7. Stockholders' Deficit (continued) Common Stock Reserved for Future Issuance The following shares of common stock were reserved at December 31, 2000: Stock option plan 2,800,000 Conversion of common stock warrants 35,000 Conversion of Series A preferred stock 3,589,746 Conversion of Series B redeemable preferred stock 11,159,678 Exercise and conversion of Series B redeemable preferred stock warrants 162,000 ---------- 17,746,424 ---------- 8. Related Party Transactions The Company reimbursed a Series B Redeemable convertible stockholder for $160,409 of legal expenses incurred in connection with the purchase of Series B redeemable convertible shares. 21 EX-99.3 18 a2043474zex-99_3.txt EXHIBIT 99.3 iLearning, Inc. Consolidated financial statements As of December 31, 2000 Together with report of independent public accountants Report of independent public accountants To the Board of Directors of iLearning, Inc.: We have audited the accompanying consolidated balance sheet of iLearning, Inc. and subsidiary (the Company) as of December 31, 2000, and the related consolidated statements of operations, redeemable securities and stockholders' deficit, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of iLearning, Inc. and subsidiary as of December 31, 2000, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Arthur Andersen LLP Baltimore, Maryland March 27, 2001 iLearning, Inc. Table of contents Consolidated balance sheet As of December 31, 2000......................................................1 Consolidated statement of operations For the year ended December 31, 2000.........................................2 Consolidated statement of redeemable securities and stockholders' deficit For the year ended December 31, 2000.........................................3 Consolidated statement of cash flows For the year ended December 31, 2000.........................................4 Notes to consolidated financial statements December 31, 2000............................................................5 iLearning, Inc. Consolidated balance sheet As of December 31, 2000 Assets Current assets: Cash and cash equivalents $ 780,857 Accounts receivable 100,139 Inventory 103,491 Prepaid expenses 186,681 ------------ Total current assets 1,171,168 ------------ Property and equipment, net 172,462 Software development costs, net 443,675 Acquired intangibles, net 890,092 Other assets, net 236,828 ------------ Total assets $ 2,914,225 ============ Liabilities and stockholders' deficit Current liabilities: Accounts payable $ 2,029,671 Accrued expenses 268,947 Deferred revenue 568,400 Current portion of note payable 285,000 ------------ Total current liabilities 3,152,018 Note payable, net of current portion 570,000 ------------ Total liabilities 3,722,018 ------------ Commitments and contingencies Redeemable convertible preferred stock: Series A convertible preferred stock, convertible into one share of common stock, liquidation preference of $5.56 per share plus accrued dividends, $.01 par value, 10,000,000 shares authorized, 4,003,388 issued and outstanding 12,306,870 Stockholders' deficit: Class A common stock, $.01 par value, 25,000,000 shares authorized, 5,404,000 shares issued and outstanding 54,040 Additional paid-in capital 661,569 Accumulated deficit (13,830,272) ------------ Total stockholders' deficit (13,114,663) ------------ Total liabilities and stockholders' deficit $ 2,914,225 ============ The accompanying notes are an integral part of this consolidated statement. 1 iLearning, Inc. Consolidated statement of operations For the year ended December 31, 2000 Revenues $ 1,152,224 Costs of revenues 2,260,140 ----------- Gross margin (1,107,916) ----------- Operating expenses: Product development 794,980 Sales and marketing 3,169,595 General and administrative 4,289,282 ----------- Total operating expenses 8,253,857 ----------- Loss from operations (9,361,773) Interest income, net 34,994 ----------- Net loss $(9,326,779) =========== The accompanying notes are an integral part of this consolidated statement. 2 iLearning, Inc. Consolidated statement of redeemable securities and stockholders' deficit For the year ended December 31, 2000
Stockholders' deficit ------------------------------------------------------------ Redeemable Convertible Preferred Stock Common stock ------------------------ Members' ------------------------ Subscription Shares Amount Capital Shares Amount receivable --------- ------------ ------------ --------- ------------ ------------ Balance, December 31, 1999a -- $ -- $ 1,887,500 -- $ -- $ (210,000) Issuance of common stock in iLearning, Inc. -- -- (1,887,500) 5,402,000 54,020 210,000 Issuance of Redeemable Convertible Preferred Stock 4,003,388 11,129,419 -- -- -- -- Issuance of common stock for services -- -- -- 2,000 20 -- Accretion of Redeemable Convertible Preferred Stock -- 1,177,451 -- -- -- -- Net loss -- -- -- -- -- -- --------- ------------ ------------ --------- ------------ ------------ Balance, December 31, 2000a 4,003,388 $ 12,306,870 $ -- 5,404,000 $ 54,040 $ -- ========= ============ ============ ========= ============ ============ Stockholders' deficit --------------------------------------------- Additional Total paid-in Accumulated stockholders' capital deficit equity (deficit) ------------ ------------ ---------------- Balance, December 31, 1999a $ -- $ (4,503,493) $ (2,825,993) Issuance of common stock in iLearning, Inc. 1,833,480 -- 210,000 Issuance of Redeemable Convertible Preferred Stock -- -- -- Issuance of common stock for services 5,540 -- 5,560 Accretion of Redeemable Convertible Preferred Stock (1,177,451) -- (1,177,451) Net loss -- (9,326,779) (9,326,779) ------------ ------------ ------------ Balance, December 31, 2000a $ 661,569 $(13,830,272) $(13,114,663) ============ ============ ============
3 iLearning, Inc. Consolidated statement of cash flows For the year ended December 31, 2000 Cash flows from operating activities: Net loss $ (9,326,779) Adjustments to reconcile net loss to net cash used in operating activities- Depreciation and amortization 271,924 Noncash general and administrative expense 5,560 Changes in assets and liabilities: Accounts receivable (15,521) Prepaid expenses (86,681) Inventory (103,491) Other assets (225,427) Accounts payable (1,199,788) Accrued liabilities 185,029 Deferred revenue 568,400 ------------ Net cash flows used in operating activities (9,926,774) ------------ Cash flows from investing activities: Purchase of property and equipment (146,145) Software development costs (543,302) ------------ Net cash flows used in investing activities (689,447) ------------ Cash flows from financing activities: Repayments on notes payable (285,000) Proceeds from issuance of preferred stock 11,129,419 Proceeds from collection of subscription receivable 210,000 ------------ Net cash flows provided by financing activities 11,054,419 ------------ Net increase in cash and cash equivalents 438,198 Cash and cash equivalents, beginning of year 342,659 ------------ Cash and cash equivalents, end of year $ 780,857 ============ The accompanying notes are an integral part of this consolidated statement. 4 iLearning, Inc. Notes to consolidated financial statements December 31, 2000 1. Organization and nature of business iLearning, Inc.(iLearning or the Company, formerly Leaplt.com, Inc.) was incorporated in the State of Delaware on April 14, 2000. A Subscription Agreement between LeapIt.com, LLC and LeapIt.com Inc., was entered into on April 20, 2000 whereby LeapIt.com, LLC subscribed to purchase common shares of LeapIt.com, Inc., in consideration for the transfer, conveyance and delivery of all the assets and liabilities of LeapIt.com, LLC to the Company as of its March 31, 2000 balance sheet. The transaction was intended to qualify as a tax-free exchange under Section 351 of the Internal Revenue Code of 1986, as amended. As both entities had previously been under common control, this transaction has been accounted for similar to a pooling of interests transaction, with presentation of the transaction as if it occurred at the beginning of the period with all assets and liabilities recorded at their carryover basis. ILearning, Inc. provides innovative training and educational solutions for businesses and organizations. From content to delivery, iLearning's products are customized to meet each organization's educational needs. iLearning's firewall friendly, proprietary technology uniquely positions the company to deliver relevant content at near full motion frame rate, with as little as a 28.8K dial-up connection. iLearning provides 1) the backend technology, implementation and support, 2) an instructional content development and delivery service, and 3) the front-end administrative tools for client management of site content and member databases. iLearning, Inc. was originally founded as LeapIt.com, Inc. with an initial focus on the development and implementation of a consumer web-based information technology career training and management platform. The LeapIt.com consumer web site was launched in May 2000. Membership was over 70,000 by August and over 100,000 by the end of 2000. In order to build a membership base, all training on the LeapIt.com web site was free to members in 2000 with a subscription fee service to be introduced in 2001. It is this web site that serves as a working portal that demonstrates the iPlatform technology and product line which iLearning brings to its business and organization client base. iLearning signed its first iPlatform client in November 2000. As of January 1, 2000, LeapIt.com, LLC entered into a Stock Purchase Agreement to acquire all of the issued and outstanding shares of capital stock of LANWrights, Inc., a Texas corporation. The purchase price for the shares was $1,140,000 payable 25 percent at closing and 25 percent on each of January 1, 2001, 2002 and 2003, with the final payment subject to offset for an EBITDA adjustment. The acquisition was accounted for under the purchase method of accounting, whereby the purchase price was allocated to net assets and acquired intangibles for $93,000 and $1,047,000, respectively. The LANWrights, Inc. acquisition was included and made a part of the Assignment and Assumption Agreement associated with the Subscription Agreement between LeapIt.com, LLC and the Company. LANWrights, Inc. provides network-oriented writing, training, and consulting and supplies accurate, timely information on cutting-edge technologies and certification. LANWrights is known for developing technical materials for companies such as Microsoft, Novell, GTE, Symantec and SUN Microsystems. Substantially all of 5 iLearning's revenues in 2000 were derived from services performed by its LANWrights subsidiary. Since inception, the Company has incurred an accumulated deficit of approximately $13.8 million. During 2000, the Company experienced operating losses and negative cash flows from operations due to software development and sales and marketing expenses associated with developing, branding and launching its technology. In 2000, the Company raised approximately $13 million in funding, consisting of: $7.5 million in venture funding and $5.5 million in private equity financing. The Company intends on raising additional capital during fiscal 2001. Management remains committed to taking all appropriate and necessary actions to effect timely cost reductions and cash preservation in the event management's revenue and cash flow expectations are not substantially met during fiscal 2001. Management believes that, based on its plans, including raising new capital, the Company will have sufficient cash to support operations during fiscal 2001. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. However, iLearning cannot assure that it will be able to obtain the financing necessary to continue to support its business. 2. Summary of accounting policies: Principles of consolidation The consolidated financial statements include the accounts of iLearning, Inc. and its subsidiary. All material intercompany accounts and transactions have been eliminated in consolidation. Use of estimates The preparation of financial statements, in conformity with accounting principles generally accepted in the United States, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Cash and cash equivalents Cash and cash equivalents consist of cash on hand and highly liquid investments with an original maturity of three months or less when purchased. Concentration of credit risk Financial instruments which potentially expose the Company to a concentration of credit risk consist primarily of trade accounts receivable. The Company did not record an allowance for doubtful accounts in 2000 as an allowance was not considered necessary. Trade accounts receivable at year-end were current. Inventory Inventory consists of courseware books and other peripherals sold as supplemental materials for the Company's online courses. Inventory is valued at the cost of acquisition and relieved against cost of revenue for sales, obsolete products and shortages discovered in physical inventory procedures. 6 Prepaid Assets Prepaid assets consisted of the following as of December 31, 2000: Prepaid content license fees $179,375 Other prepaid assets 7,306 -------- Total prepaid assets $186,681 ======== Property and equipment Property and equipment are recorded at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets, generally three to seven years for furniture and equipment, and over the shorter of the estimated useful life of leasehold improvements or the related lease term for such improvements. Upon the disposition of assets, the costs and related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the consolidated statement of operations. Expenditures for repairs and maintenance are expensed as incurred. Software development costs The Company follows the guidelines established by Statement of Financial Accounting Standards (SFAS) No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." The Company's policy is to expense the costs incurred prior to the establishment of technological feasibility as product development costs. The establishment of technological feasibility and the ongoing assessment of recoverability of software development costs requires considerable judgment by management with respect to certain external factors, including anticipated future gross revenue, estimated economic life and changes in technologies. Based on the Company's product development process, technological feasibility is established upon completion of a working model and related testing. Development costs incurred beyond the point of technological feasibility are capitalized. Capitalized software development costs currently are all related to the Company's proprietary iPlatform technology and were incurred after the Company developed a working model in 2000 and until the iPlatform technology was first launched in May 2000. Amortization begins when the product/functionality is available for general release and is computed using the straight-line method over the estimated economic life of three years. Development costs incurred to establish technological feasibility are reflected as product development costs on the accompanying statement of operations, net of any capitalized development costs and amounted to approximately $735,000 for the year ended December 31, 2000. Other assets Other assets consist principally of content licenses that provide the Company with the right to resell the content through its website. 7 Long-lived assets The Company assesses potential impairments to its long-lived assets when there is evidence that events or changes in circumstances have made recovery of the asset's carrying value unlikely. An impairment loss would be recognized when the sum of the expected future undiscounted net cash flows is less than the carrying amount of the asset. The Company has identified no such impairment losses. Deferred revenue Deferred revenues are related to the sale of software licenses and deposits for services to be performed. Software license revenues were deferred in accordance with Statement of Position 97-2, "Software Revenue Recognition". The Company expects to recognize the license fee revenue on a straight-line basis over the term of our licensing agreements. The Company expects to recognize retainer revenues in 2001. Fair value of financial instruments The Company's financial instruments consist primarily of cash and cash equivalents, accounts receivable, prepaid expenses, accounts payable, accrued expenses and notes payable. In management's opinion, the carrying amount of these financial instruments approximated their fair values at December 31, 2000. Revenue recognition Revenue sources for 2000 consist of product (supplemental courseware books and peripherals) sales, royalty income and services income. Product sales revenue is derived completely from online sales. Revenues for product sales are recorded on a monthly basis as products are shipped. Royalty revenue is recognized at the time royalty checks are received from the third party agent due to uncertainties over the completion of the earnings process until that time. Revenue from consulting services is recognized when the work is completed or on a time and materials basis over the course of the engagement. Customers The Company's customers consist primarily of national and international associations, training/staffing businesses, educational enterprises and corporate users. Cost of revenues Cost of revenues include software enhancement costs, consulting direct costs, content conversion fees, content acquisition and license fees, hosting and product delivery, fulfillment and maintenance. Advertising costs Advertising costs for producing and communicating advertising are expensed when incurred. Total advertising expense for the year ended December 31, 2000, including initial branding and development of collateral, was $2,652,908. 8 Accounting for income taxes The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109), which requires that deferred tax assets and liabilities be recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The recognition of net deferred assets is reduced, if necessary, by a valuation allowance for the amount of any tax benefits that, based on available evidence, are not expected to be realized. Deferred tax assets and liabilities are measured using expected tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date. 3. Software development costs Activity related to software development costs consisted of the following during the year ended December 31, 2000: Balance, January 1, 2000 $ -- Costs capitalized 543,302 Amortization during the year (99,627) --------- Balance, December 31, 2000 $ 443,675 ========= 4. Property and equipment Property and equipment consisted of the following as of December 31, 2000: Equipment $ 142,580 Furniture and fixtures 71,012 Leasehold improvements 18,020 --------- 231,612 Less- accumulated depreciation and amortization (59,150) --------- Property and equipment, net $ 172,462 ========= Depreciation and amortization expense related to property and equipment was $51,643 in 2000. 5. Accrued liabilities Accrued liabilities consisted of the following as of December 31, 2000: Accrued bonus and payroll $204,166 Deferred salaries payable 62,394 Other accrued liabilities 2,387 -------- Total accrued liabilities $268,947 ======== 9 6. Redeemable convertible preferred stock: In April 2000, the Company raised $11.1 million through the sale of 4,003,388 shares of its Series A Redeemable Convertible Preferred Stock (the Series A Stock). The Series A Stock is redeemable at the option of the holder for $5.56 per share plus all accumulated and unpaid dividends at any time after April 20, 2005, and before April 20, 2006, if the Company receives a notice from at least 50 percent of the outstanding shares of the Series A Stock. Additionally, holders of the Series A Stock are entitled to receive dividends at a rate of $0.139 per share when and if declared by the Board of Directors of the Company. The carrying amount of the securities is being accreted to the redemption value of $5.56 per share plus accrued dividends using the effective interest method. The accretion period is from the date of issuance of the Series A Stock to the earliest date at which these securities become redeemable at the option of the holder. Each share of Series A Stock is convertible, at anytime by the holder, into one share of common stock. The Series A stockholders are also entitled to liquidation preference to $2.78 per share. The Series A stockholders have one vote for each share of Series A Stock owned. 7. Stock-based compensation: The Company has a stock option plan (the Plan) authorizing the grant of options to employees, consultants and nonemployee directors. Under the Plan, the Company may grant options to purchase up to 2,200,000 shares of common stock. Stock options expire ten years form the date granted and vest over periods ranging from six months to four years. During the year ended December 31, 2000, the Company granted options to purchase 435,500 shares in accordance with the Plan. Shares available for future grants amounted to 1,764,500 as of December 31, 2000. The Plan also allows for the granting of nonqualified options, restricted stock and restricted stock units. The Company applies APB Option No. 25 and related interpretations in accounting for the Plan. During the year ended December 31, 2000, the Company granted options with an exercise price equivalent or above the fair market value of the stock at the date of grant. Had compensation expense for the Company's stock-based compensation plan been determined based on the fair value of the options at the grant dates for awards under the Plan consistent with the method of Statement of Financial Accounting Standards No. 123, "Stock-Based Compensation" (SFAS No. 123), the Company's pro forma net loss would have been changed to the pro forma amounts indicated below: Net loss: As reported $(9,326,779) Pro forma (9,338,057) 10 A summary of qualified option transactions during the year ended December 31, 2000, is as follows: Weighted average exercise Options price ------- -------- Outstanding, December 31, 1999 -- $ -- 2000 activity: Granted 435,500 2.42 Forfeited 31,500 2.78 ------- ------- Outstanding, December 31, 2000 404,000 $ 2.39 ======= ======= At December 31, 2000, there were 61,300 qualified options that were exercisable. The weighted average fair value of qualified options granted to employees during the year ended December 31, 2000, was $0.19 per share. The qualified options granted during the year ended December 31, 2000, were granted at an exercise price ranging from $2.00 to $2.78 per share and had a weighted average remaining contractual life of 9.36 years. The Company has computed, for pro forma disclosure purposes, the value of all options granted during the year ended December 31, 2000, using the Black-Scholes option pricing model as prescribed by SFAS No. 123 and the following weighted average assumptions: Risk-free interest rate 6.0% Expected life 5 years Volatility 0.01% Dividend rate 0% 8. Income taxes: At December 31, 2000, the Company had approximately $8.2 million of tax net operating loss carryforwards (NOLs) which expire in the year 2020. SFAS No. 109 requires that the tax benefit of such NOLs be recorded as an asset to the extent that management assesses the utilization of such NOLs to be "more likely than not". Realization of the future tax benefits is dependent on the Company's ability to generate taxable income within the carryforward period and also is limited under certain circumstances, if the Company has a change in control, as defined. Future levels of operating income are dependent upon general economic conditions, including interest rates and general levels of economic activity, competitive pressure on sales and margins and other factors beyond the Company's control. Therefore, no assurance can be given that sufficient taxable income will be generated for full utilization of the NOLs. Based on the Company's history of earnings, future earnings of the Company may not be sufficient to utilize these NOLs prior to their expiration. Accordingly, the Company has recorded a deferred tax asset and a valuation allowance of $3,531,327 relating to the net deferred tax assets of the Company. The Company will continue to evaluate the likelihood of future profits and the necessity of future adjustments to the deferred tax asset valuation allowance. 11 The difference between the recorded income tax benefit and the "expected" tax benefit, based on the statutory federal income tax rate, is as follows as of December 31, 2000: Tax benefit at federal statutory rates $ 3,171,105 State income taxes, net of federal income tax effect 419,705 Other, net (59,483) Valuation allowance (3,531,327) ----------- Benefit for income taxes $ -- =========== Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred taxes consist of the following: Deferred tax assets Deferred revenue $ 192,500 Amortization of software development costs 59,712 Net operating loss 3,147,655 Accrued liabilities 92,470 Amortization of organization costs 38,990 ----------- Total deferred tax assets 3,531,327 Valuation allowance (3,531,327) ----------- Net deferred tax asset $ -- =========== 9. Employee benefit plan The Company has a 401(k) Profit Sharing Plan (the 401(k) Plan) available to all employees meeting certain eligibility criteria which permits participants to contribute up to certain limits as established by the Internal Revenue Service. The 401(k) Plan provides for discretionary matching contributions by the Company in an amount to be determined on an annual basis. In 2000, the Company did not match employee contributions. 10. Related parties In 1999, iLearning entered into a Course Conversion and Hosting Agreement (the Agreement) with an entity in which one of iLearning's investors owns a voting interest, pursuant to which the vendor would provide certain courseware conversion and hosting services to iLearning. Pursuant to the terms of the Agreement, iLearning retains all intellectual property rights of the converted courses. Expenses incurred by iLearning for services performed by the vendor under the Agreement were $1,750,000 in 2000. In November 2000, iLearning entered into a one-year renewable Training Product Sales Representative Agreement with an entity in which one of iLearning's investors owns a minority interest, pursuant to which the entity will market and sell iLearning courses in consideration for revenue sharing proceeds. Revenues will be recognized on a monthly basis, based on actual courses sold. 12 In November 2000, iLearning entered into a Master Web Site Development and Hosting Services Agreement with an entity controlled by one of iLearning's investors, pursuant to which iLearning has agreed to develop and operate the customer's web site portal. The terms of the agreement are similar to those of other Master Web Site Development and Hosting Services Agreements entered into with other third parties. Revenues will be recognized over the five-year term of the agreement. There was no revenue recognized in 2000 related to this agreement. 11. Commitments and contingencies: Operating leases The Company leases office space and certain office equipment under noncancelable operating leases expiring through 2004. Future minimum annual rental commitments under the lease agreements for the years ending December 31 are as follows: 2001 $58,615 2002 3,173 2003 3,334 2004 2,002 ------- Total minimum lease payments $67,124 ======= Rent expense for the year ended December 31, 2000, was $119,931. Litigation The Company, from time to time, is involved in routine legal matters incidental to its normal operations. In management's opinion, the resolution of such matters will not have a material adverse effect on the Company's consolidated financial condition, results of operations or liquidity. 12. Subsequent events: In January 2001, the Company entered into a three-year initial term Reseller Agreement with a related party to the Company. The agreement provides for initial non-refundable fees to the Company of $1,100,000 and on-going revenue sharing income. In March 2001, iLearning entered into a Master Services Agreement with a major national association to provide software and website development (its iPlatform product), hosting and consulting services. The agreement has an initial term of six years, and the Company anticipates substantial revenues resulting from the agreement. In March 2001, the Company raised $2.0 million through the sale of 719,424 shares of its Series A Redeemable Convertible Preferred Stock to a third party. This instrument has terms consistent with the Series A Stock issued in 2000. 13 EX-99.4 19 a2043474zex-99_4.txt EXHIBIT 99.4 MINDSURF, INC. Audited Consolidated Financial Statements For the Period October 25, 2000 (inception) through December 31, 2000 with Report of Independent Auditors MindSurf, Inc. (a Development Stage Enterprise) Audited Consolidated Financial Statements For the period October 25, 2000 (date of inception) through December 31, 2000 Contents Report of Independent Auditors.................................................2 Audited Consolidated Financial Statements Consolidated Balance Sheet ....................................................3 Consolidated Statement of Operations ..........................................5 Consolidated Statement of Stockholders' Equity ................................6 Consolidated Statement of Cash Flows...........................................7 Notes to Consolidated Financial Statements.....................................8 Report of Independent Auditors The Board of Directors and Stockholders MindSurf, Inc. We have audited the accompanying consolidated balance sheet of MindSurf, Inc., a development stage company, as of December 31, 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for the period October 25, 2000 (date of inception) through December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MindSurf, Inc. at December 31, 2000, and the results of its operations and its cash flows for the period October 25, 2000 (date of inception) through December 31, 2000, in conformity with accounting principles generally accepted in the United States. /s/Ernst & Young LLP Baltimore, Maryland February 22, 2001 2 MindSurf, Inc. (a Development Stage Company) Consolidated Balance Sheet December 31, 2000 Assets Current assets: Cash $ 1,925,545 Restricted cash 160,215 Prepaid expenses 71,054 Other current assets 107,674 ------------ Total current assets 2,264,488 Property and equipment: Furniture and equipment 1,488,310 Software 970,020 Leasehold improvements 22,955 ------------ 2,481,285 Accumulated depreciation (139,182) ------------ 2,342,103 Intangible assets: Goodwill 20,481,386 Assembled workforce 4,868,500 ------------ 25,349,886 Accumulated amortization (1,170,113) ------------ 24,179,773 Security deposits 513,156 ------------ Total assets $ 29,299,520 ============ 3 MindSurf, Inc. (a Development Stage Company) Consolidated Balance Sheet (continued) December 31, 2000 Liabilities and stockholders' equity Current liabilities: Accounts payable and accrued expenses $ 2,875,027 Accrued compensation 258,706 Due to related parties 1,333,266 Current portion of capital lease obligations 99,398 Dividends payable 43,397 ------------ Total current liabilities 4,609,794 Capital lease obligations, less current portion 183,619 Commitments and contingent obligations -- Stockholders' equity: Series Y Preferred Stock, par value $.01 per share -23,391,812 shares authorized, issued and outstanding; aggregate liquidation value of $ 16,000,000 233,918 Series B Convertible Preferred Stock, par value $.01 per share - 8,040,936 shares authorized, issued and outstanding; aggregate liquidation value of $5,579,562 80,409 Series A Convertible Preferred Stock, par value $.01 per share -28,500,000 shares authorized, 17,543,860 shares issued and outstanding; aggregate liquidation value of $10,144,658 175,439 Series X Preferred Stock, par value $.01 per share -28,500,000 shares authorized, no shares issued and outstanding -- Common stock , par value $.01 per share - 40,000,000 shares authorized, no shares issued and outstanding -- Additional paid-in capital 31,946,136 Unearned compensation (291,891) Deficit accumulated during the development stage (7,637,904) ------------ Total stockholders' equity 24,506,107 ------------ Total liabilities and stockholders' equity $ 29,299,520 ============
See accompanying notes. 4 MindSurf, Inc. (a Development Stage Company) Consolidated Statement of Operations For the period October 25, 2000 (date of inception) through December 31, 2000 Revenues $ -- Costs and expenses Sales and marketing 1,330,731 General and administrative 2,673,018 Research and development 2,314,094 Services and other charges from related parties 1,333,266 ----------- Total operating costs and expenses 7,651,109 ----------- Loss from operations (7,651,109) Interest income 13,205 ----------- Net loss accumulated during the development stage $(7,637,904) =========== See accompanying notes. 5 MindSurf, Inc. (a Development Stage Company) Consolidated Statement of Stockholders' Equity For the period October 25, 2000 (date of inception) through December 31, 2000
Series B Series A Series Y Convertible Convertible Series X Preferred Preferred Stock Preferred Preferred Common Stock Stock Stock Stock ------------------------------------------------------------------------ Issuance of 14,298,246 shares of Series A Convertible Preferred Stock at inception for cash of $8,150,000, net of direct costs of issuance of $140,001 (see Note 8) $ -- $ -- $ 142,983 $ -- $ -- Issuance of 8,040,936 shares of Series B Convertible Preferred Stock on October 25, 2000 valued at $5,500,000 in connection with acquisition of HiFusion (see Note 2) -- 80,409 -- -- -- Issuance of 23,391,812 shares of Series Y Preferred Stock on October 25, 2000 valued at $16,000,000 in connection with acquisition of HiFusion (see Note 2) 233,918 -- -- -- -- Conversion of liabilities assumed in acquisition of HiFusion to 3,245,614 shares of Series A Convertible Preferred Stock at face value of $1,850,000 (see Note 8) -- -- 32,456 -- -- Value of options to purchase common stock to be issued in connection with acquisition of HiFusion (see Note 2) -- -- -- -- -- Amortization of unearned compensation -- -- -- -- -- Accrued dividends on Series Y Preferred Stock -- -- -- -- -- Net loss for the period October 25, 2000 (date of inception) through December 31, 2000 -- -- -- -- -- ------------------------------------------------------------------------ Balance at December 31, 2000 $ 233,918 $ 80,409 $ 175,439 $ -- $ -- ======================================================================== Deficit Accumulated Additional During Paid-In Unearned Development Capital Compensation Stage Total --------------------------------------------------------------- Issuance of 14,298,246 shares of Series A Convertible Preferred Stock at inception for cash of $8,150,000, net of direct costs of issuance of $140,001 (see Note 8) $ 7,867,016 $ -- $ -- $ 8,009,999 Issuance of 8,040,936 shares of Series B Convertible Preferred Stock on October 25, 2000 valued at $5,500,000 in connection with acquisition of HiFusion (see Note 2) 5,419,591 -- -- 5,500,000 Issuance of 23,391,812 shares of Series Y Preferred Stock on October 25, 2000 valued at $16,000,000 in connection with acquisition of HiFusion (see Note 2) 15,766,082 -- -- 16,000,000 Conversion of liabilities assumed in acquisition of HiFusion to 3,245,614 shares of Series A Convertible Preferred Stock at face value of $1,850,000 (see Note 8) 1,817,544 -- -- 1,850,000 Value of options to purchase common stock to be issued in connection with acquisition of HiFusion (see Note 2) 1,119,300 (310,421) -- 808,879 Amortization of unearned compensation -- 18,530 -- 18,530 Accrued dividends on Series Y Preferred Stock (43,397) -- -- (43,397) Net loss for the period October 25, 2000 (date of inception) through December 31, 2000 -- -- (7,637,904) (7,637,904) --------------------------------------------------------------- Balance at December 31, 2000 $ 31,946,136 $ (291,891) $ (7,637,904) $ 24,506,107 ===============================================================
6 MindSurf, Inc. (a Development Stage Company) Consolidated Statement of Cash Flows For the period October 25, 2000 (date of inception) through December 31, 2000 Operating activities Net loss accumulated during the development stage $ (7,637,904) Adjustments to reconcile net loss accumulated during the development stage to net cash used in operating activities: Depreciation 138,182 Amortization of intangible assets 1,170,113 Amortization of unearned compensation 18,530 Changes in operating assets and liabilities: Prepaid expenses 30,151 Other current assets (107,424) Accounts payable and accrued expenses (896,000) Accrued compensation 47,008 Due to related parties 1,333,266 ------------ Net cash used in operating activities (5,904,078) Investing activities Purchase of property and equipment (146,090) ------------ Net cash used in investing activities (146,090) Financing activities Issuance of Series A Convertible Preferred Stock for cash 8,009,999 Payments of capital lease obligations (34,286) ------------ Net cash provided by financing activities 7,975,713 ------------ Net change in cash and cash at end of period $ 1,925,545 ============ Non-Cash Investing and Financing Activities Issuance of Series B Convertible Preferred Stock in connection with acquisition of HiFusion, Inc. $ 5,500,000 Issuance of Series Y Preferred Stock in connection with acquisition of HiFusion, Inc. 16,000,000 Conversion of notes payable assumed in acquisition of HiFusion to shares of Series A Convertible Preferred Stock 1,850,000
See accompanying notes. 7 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements December 31, 2000 1. Organization and Summary of Significant Accounting Policies Organization MindSurf, Inc., (the "Company") was incorporated on October 25, 2000 under the laws of the state of Delaware for the purpose of providing an affordable mobile wireless computing infrastructure that seamlessly links students, teachers and parents, improving communication in the school community and enriching the K-12 learning experience. The Company was established as a strategic partnership between Sylvan Learning Systems, Inc. ("Sylvan"), Aether Systems, Inc. ("Aether") and Critical Path, Inc. ("Critical Path"). Since inception, the Company's activities have consisted primarily of organizational and research and development activities for its planned principal operations. Accordingly, no revenue has been earned, and the Company is considered a development stage company at December 31, 2000. Principles of Consolidation The consolidated financial statements include the accounts of Mindsurf, Inc. and its wholly owned subsidiary, HiFusion, Inc. ("HiFusion"). All material intercompany accounts and transactions have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Restricted Cash and Letter of Credit Restricted cash consists of cash pledged as collateral on an outstanding letter of credit expiring on November 30, 2001 that is required under the Company's operating lease for office space. At December 31, 2000, restricted cash consists of a certificate deposit bearing interest at 5.10% and maturing on November 19, 2002. Any amounts drawn under the letter of credit will bear interest at the prime rate. 8 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 1. Organization and Summary of Significant Accounting Policies (continued) Property and Equipment Property and equipment is stated at cost and depreciated using the straight-line method over estimated useful lives of three years. Assets held under capital leases are stated at the lesser of the present value of future minimum lease payments using the Company's incremental borrowing rate at the inception of the lease or the fair value of the property at the inception of the lease. The assets recorded under capital leases are generally amortized over the lesser of the lease term or the estimated useful life of the assets in a manner consistent with the Company's depreciation policy for owned assets. Amortization of assets under capital leases is included in depreciation expense. Intangible Assets Intangible assets consist of goodwill and assembled workforce recorded in connection with the acquisition of HiFusion on October 25, 2000. The Company amortizes its goodwill and assembled workforce using the straight-line method over estimated useful lives of four years. Impairment of Long-Lived Assets Long-lived assets, including intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. If an impairment indicator is present, the Company evaluates whether an impairment exists on the basis of undiscounted expected future cash flows from operations for the remaining amortization period. If an impairment exists, the asset is reduced by the estimated shortfall of discounted cash flows from the asset's carrying value. Security Deposits Security deposits consist of amounts deposited with lessors to secure the Company's obligations under certain capital lease obligations. These amounts will be refunded to the Company upon the satisfaction of all payments under the related leases that expire through 2003. 9 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 1. Organization and Summary of Significant Accounting Policies (continued) Research and Development and Software Development Costs Costs for the development of new software products are expensed as research and development costs as incurred until technological feasibility is established, at which time any additional development costs are capitalized until the product is available for general release to customers. The Company defines technological feasibility as the completion of a working model of the software product that has been tested to be consistent with the product design specifications. As of December 31, 2000, the Company has not established technological feasibility for its software under development and therefore all costs have been expensed as research and development costs. Income Taxes The Company uses the liability method in accounting for income taxes. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Advertising The Company expenses advertising costs as incurred. Advertising expense totaled approximately $142,000 for the period October 25, 2000 (date of inception) through December 31, 2000. Effect of Pending Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, which is required to be adopted in years beginning after June 15, 2000. Because of the Company's minimal use of derivatives, the adoption of the new Statement will not have a significant effect on earnings or the financial position of the Company. 10 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 2. Acquisition of HiFusion On October 25, 2000, the Company acquired all of the outstanding common stock of HiFusion, Inc. ("HiFusion"), an Internet education portal developer and service provider for teachers, parents and students. The purchase price consisted of 8,040,936 shares of Series B Convertible Preferred Stock valued at $5,500,000 and 23,391,812 shares of Series Y Preferred Stock valued at $16,000,000. The securities issued in the acquisition were valued in good faith by the Company based on contemporaneous cash transactions in its equity securities and other pertinent factors. In addition, the Company agreed to exchange all of the outstanding vested and unvested options to purchase an aggregate of 2,899,250 shares of common stock of HiFusion for options to purchase the same number of shares of common stock of the Company at an exercise price of $0.57 per share. The fair value of the options to be granted to the former HiFusion option holders was estimated by the Company to be $1,119,300, determined using the Black-Scholes option-pricing model. This amount has been included in the total purchase price, reduced by the portion related to unearned employee compensation of $310,421. The acquisition was accounted for using the purchase method of accounting, and the results of operations of HiFusion are included in the accompanying consolidated statement of operations commencing October 25, 2000. The total purchase price is summarized as follows: Series B Convertible Preferred Stock $ 5,500,000 Series Y Preferred Stock 16,000,000 Options to purchase common stock 1,119,300 Less: unearned compensation (310,421) ------------ $ 22,308,879 ============ The total purchase price was allocated as follows: Current assets $ 699,655 Property and equipment 2,335,195 Notes payable (1,850,000) Other liabilities assumed (4,225,857) Goodwill 20,481,386 Assembled workforce 4,868,500 ------------ $ 22,308,879 ============ 11 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 3. Services Agreements with Related Parties Upon formation, the Company entered into service agreements with each of three principal stockholders, as described below. Under the master services agreement with Sylvan, Sylvan will provide certain marketing, product development, sales, financial, and other management or administrative services upon request. Under the agreement Sylvan will also provide certain start up resources such as interim facilities, recruitment, financial accounting, and temporary labor to help accelerate the Company's business plan. Under the agreement, the Company is required to pay a quarterly fee that is based on Sylvan's good faith estimate of the cost of such services. This agreement has a five-year term, is renewable for one additional year, and can be terminated by either party with 60 days notice. Sylvan charged the Company $736,918 under this master services agreement for the period October 25, 2000 (date of inception) through December 31, 2000, principally related to research and development activities, which is included in services and other charges from related parties in the accompanying consolidated statement of operations and due to related parties in the accompanying consolidated balance sheet. Under the master services agreement with Aether, Aether will provide wireless systems integration technology, network implementation, and product support services. Aether will charge an hourly rate for its personnel used during the internal development and preparation of the network. The hourly rate will be established and agreed upon in advance and will be invoiced on a monthly basis. Any direct materials will be charged at Aether's cost. This agreement has a five-year term, is renewable for one additional year, and can be terminated by either party with 60 days notice. Aether charged the Company $580,959 under this master services agreement for the period October 25, 2000 (date of inception) through December 31, 2000, which is included in services and other charges from related parties in the accompanying consolidated statement of operations and due to related parties in the accompanying consolidated balance sheet. 12 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 3. Services Agreements with Related Parties (continued) Under the master services agreement with Critical Path, Critical Path will provide professional services to develop Internet-based messaging services to be integrated into the Company's product offerings, and related customer support services. The cost of these services will be determined based on terms that are commercially favorable and will be invoiced on a monthly basis. This agreement has a five-year term, is renewable for one additional year and is can be terminated by either party with 60 days notice. Critical Path charged the Company $15,389 under this master services agreement for the period October 25, 2000 (date of inception) through December 31, 2000, which is included in services and other charges from related parties in the accompanying consolidated statement of operations and due to related parties in the accompanying consolidated balance sheet. 4. Income Taxes The significant components of the Company's deferred tax assets and liabilities as of December 31, 2000 are as follows: Deferred tax assets: Net operating loss carryforward $ 9,468,087 Contribution carryforward 614 Vacation pay accrual 76,045 ----------- Total deferred tax assets 9,544,746 Deferred tax liabilities: Depreciation 73,003 ----------- Net deferred tax assets 9,471,743 Valuation allowance for deferred tax assets (9,471,743) ----------- Net deferred tax assets $ -- =========== The Company has reported losses since inception. The losses have not resulted in reported tax benefits because of increases in the valuation allowance for deferred tax assets that result primarily from the inability to determine the realizability of the net operating loss carryforwards. The Company paid no income taxes during the period October 25, 2000 (date of inception) through December 31, 2000. 13 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 4. Income Taxes (continued) At December 31, 2000, the Company had net operating loss carryforwards of approximately $24,516,000 which expire in 2020. Included in this amount is approximately $18,172,000 of net operating loss carryforwards acquired from HiFusion for which a full valuation allowance was applied on the date of the acquisition. These net operating loss carryforwards begin to expire in 2019 and are available only to offset future taxable income of HiFusion. Upon the realization of the HiFusion net operating loss carryforwards, the benefit realized from the elimination of the valuation allowance will be recorded as a reduction of goodwill. A reconciliation of the reported income tax expense to the amount that would result by applying the U.S. federal statutory rate to the loss for the period October 25, 2000 (date of inception) through December 31, 2000 is as follows: Tax benefit at U.S. statutory rate of 34% $(2,596,887) Effect of permanent differences 436,578 State income taxes, net of federal benefit (293,548) Effect of change in valuation allowance for deferred tax assets 2,453,857 ----------- Total $ -- =========== 5. Capital Lease Obligations The Company has entered into capital lease agreements to acquire certain equipment. Property and equipment in the accompanying balance sheet includes this equipment, which has a cost of $350,979 and accumulated amortization of $46,773. Amortization of the leased property is included in depreciation expense. Future minimum payments under capital lease obligations consist of the following at December 31, 2000: 2001 $ 122,058 2002 121,575 2003 77,508 --------- Total minimum lease payments 321,141 Amounts representing interest (38,124) --------- Present value of net minimum lease payments (including current portion of $99,398) $ 283,017 ========= 14 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 6. Series Y Preferred Stock As of December 31, 2000, the Company has authorized the issuance of up to 88,432,748 shares of preferred stock, par value $0.01 per share, of which 23,391,812 has been designated Series Y Preferred Stock ("Series Y"). On October 25, 2000, in connection with the acquisition of HiFusion (see Note 2), the Company issued 23,391,812 shares of Series Y that were valued at $16,000,000. Dividends The holders of the Series Y are entitled to receive cumulative dividends at the annual rate of $0.0103 per share out of assets of the Company legally available for distribution, payable annually on each October 1. In the event of non-payment, the dividends will accrue at the annual rate of $0.0239 per share until paid. After the third anniversary of the issuance date, the holders of the Series Y are entitled to receive cumulative dividends at the annual rate of $0.041 per share out of assets of the Company legally available for distribution, payable annually on each October 1. In the event of non-payment, the dividends will accrue at the annual rate of $0.0547 per share until paid. The dividend rights of the Series Y holders are superior to all other classes of securities. As of December 31, 2000, the Company has accrued dividends payable to the Series Y holders of $43,397. The Series Y was recorded at estimated fair value on the date of issuance, assuming a constant dividend yield of 6% per annum. The excess of the redemption value over the fair value of $1,918,610 is being accreted by periodic charges to additional paid-in capital during the period from the date of issuance through the commencement of the perpetual dividend payments using the interest method. Liquidation Each share of Series Y has a preference on liquidation equal to $0.684 per share plus all accrued and unpaid dividends. The liquidation preference of the Series Y is senior to the holders of all other securities. Voting Rights The holders of the Series Y are not entitled to vote. 15 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 6. Series Y Preferred Stock (continued) Redemption At any time beginning immediately prior to the closing of an underwritten public offering with at least $35 million of gross proceeds to the Company or the change of control of the Company (a "redemption event"), the Company may redeem all of part of the issued and outstanding shares of Series Y at a price equal to $0.684 per share plus all accrued and unpaid dividends. If the Company does not redeem all of the issued and outstanding shares of Series Y within 30 days of a redemption event, the holders of the Series Y will be entitled to cash dividends at an annual rate of $0.137 per share. 7. Series B Convertible Preferred Stock The Company has authorized the issuance of up to 8,040,936 shares of Series B Convertible Preferred Stock ("Series B"), par value $0.01 per share. On October 25, 2000, in connection with the acquisition of HiFusion (see Note 2), the Company issued 8,040,936 shares of Series B that was valued at $5,500,000. Conversion Rights The Series B is convertible into common stock, at the option of the holder, beginning 18 months after the date of issuance. In addition, the Series B will convert automatically into shares of common stock upon the closing of an underwritten public offering with at least $35 million of gross proceeds to the Company, upon the change of control of the Company, or upon the affirmative vote of two-thirds of the Series B holders. Each share of Series B is initially convertible into one share of common stock. This conversion ratio is subject to adjustment upon the occurrence of certain specified dilutive events. 16 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 7. Series B Convertible Preferred Stock (continued) Dividends The holders of the Series B are entitled to receive cumulative dividends at the annual rate of $0.0547 per share commencing on the date of issuance and continuing until the third anniversary of issuance, when and if declared by the Board of Directors, and regardless of whether there are actual profits or other funds available for dividend payment. These dividend rights of the Series B holders are superior to those of the common stockholders and equal to the rights of the holders of the Series A Convertible Preferred Stock ("Series A"). After the third anniversary of the issuance date, the holders of the Series B are entitled to receive cumulative dividends at the annual rate of $0.041 per share out of assets of the Company legally available for distribution, payable annually on each October 1. In the event of non-payment, the dividends will accrue at the annual rate of $0.0547 per share until paid. These dividend rights of the Series B holders are superior to both the common and Series A stockholders. Dividends in arrears on the Series B were $79,562 at December 31, 2000. Liquidation Each share of Series B has a preference on liquidation equal to $0.684 per share plus all accrued and unpaid dividends. The liquidation preference of the Series B is senior to the holders of the Series A but subordinate to the holders of the Series Y. Voting Rights The holders of the Series B are not entitled to vote. 8. Series A Convertible Preferred Stock The Company has authorized the issuance of up to 28,500,000 shares of Series A, par value $0.01 per share. On October 25, 2000, the Company entered into a stock purchase agreement with Sylvan, Aether, and Critical Path under which it has agreed to sell an aggregate of 122,807,017 shares of Series A for gross proceeds of $70,000,000. In connection with the execution of this agreement, the Company issued 17,543,860 shares of Series A in exchange for cash of $8,150,000 and the termination of certain notes payable to Aether (assumed in the acquisition of HiFusion) with an aggregate face value of $1,850,000. The Company can call the remaining $60,000,000 at any time after certain funding targets set forth in the stock purchase agreement are met (see Note 14). 17 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 8. Series A Convertible Preferred Stock (continued) Conversion Rights The Series A is convertible into common stock at the option of the holder at any time. In addition, the Series A will convert automatically into shares of common stock upon the closing of an underwritten public offering with at least $35 million of gross proceeds to the Company, upon the change of control of the Company, or upon the affirmative vote of two-thirds of the Series A holders. Each share of Series A is initially convertible into one share of common stock. This conversion ratio is subject to adjustment upon the occurrence of certain specified dilutive events. Dividends The holders of Series A are entitled to receive cumulative dividends at the annual rate of $0.0456 per share when and if declared by the Board of Directors, and regardless of whether there are actual profits or other funds available for dividend payment. The dividend rights of the Series A holders are superior to those of the common stockholders. Dividends in arrears on the Series A were $144,658 at December 31, 2000. Liquidation Each share of Series A has a preference on liquidation equal to $0.57 per share plus all accrued and unpaid dividends. The liquidation preference of the Series A is subordinate to the holders of the Series B and the Series Y. Voting Rights Each share of Series A has substantially the same voting rights as the number of shares of common stock into which it can be converted. In addition, certain corporate actions require the consent of two-thirds of the outstanding shares of Series A and the holders of the Series A in the aggregate are entitled to appoint all seven members of the Board of Directors. 18 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 9. Series X Preferred Stock The Company has authorized the issuance of up to 28,500,000 shares of Series X Preferred Stock ("Series X"), par value $0.01 per share. As of December 31, 2000, the Company has not issued any Series X. The Series X is not convertible into common stock, does not accrue dividends and the holders are not entitled to vote. Each share of Series X has a preference on liquidation equal to $0.57 per share. The liquidation preference of the Series X is subordinate to the holders of the Series A, Series B and Series Y. 10. Stock Options On October 25, 2000, the Company adopted the Mindsurf Inc. 2000 Equity Incentive Plan. The plan allows for the grant of options to purchase common stock to employees, officers, directors and consultants of the Company in the form of incentive and non-qualified stock options. The aggregate number of shares of common stock that may be issued under the plan may not exceed 15% of the total number of shares of common stock issued and outstanding, assuming the conversion of all convertible securities. As of December 31, 2000, options to purchase 4,514,964 shares of common stock may be granted under the plan. No awards have been granted as of December 31, 2000; however, the Company has agreed to grant options to purchase 2,899,250 shares common stock to the former option holders of HiFusion at an exercise price of $0.57 per share as required under the purchase agreement (see Note 2). 11. Shares Reserved for Future Issuance As of December 31, 2000, the Company has reserved shares of common stock for issuance as follows: Conversion of Series A 17,543,860 Conversion of Series B 8,040,936 Exercise of stock options available for granting under 2000 Equity Incentive Plan 4,514,964 ---------- 30,099,760 ========== 19 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 12. Operating Leases The Company leases office space and certain computer equipment under non-cancelable operating leases. Future minimum lease payments under non-cancelable operating leases consisted of the following at December 31, 2000: 2001 $1,160,460 2002 383,261 2003 320,964 ---------- $1,864,685 ========== Rent expense under all operating leases for the period October 25, 2000 (date of inception) through December 31, 2000 was $542,217. 13. Employee Benefit Plan Effective October 25, 2000, the Company adopted the defined contribution retirement plan previously established by HiFusion, Inc. The plan covers substantially all employees of the Company. Participants may contribute from 1% to 15% of their annual compensation to the plan. In addition, the Company may make discretionary matching and profit-sharing contributions to the plan. As of December 31, 2000, no discretionary contributions have been made to the plan. 20 MindSurf, Inc. (a Development Stage Company) Notes to Consolidated Financial Statements (continued) 14. Liquidity and Capital Resources For the period October 25, 2000 (date of inception) through December 31, 2000, the Company incurred a net loss of $7.6 million and used $5.9 million of cash in its operations. A working capital deficit of $2.3 million exists at December 31, 2000. To provide needed capital, the Company's agreement with Sylvan, Aether, and Critical Path provides for the sale of an aggregate of 122,807,017 shares of Series A for gross proceeds of $70 million. As of December 31, 2000, the Company has issued 17,543,860 shares of Series A for total consideration of $10 million. The Company can call the remaining $60 million at any time after certain funding targets set forth in the stock purchase agreement are met. These funding targets are summarized as follows: 1. Successful installation and initiation of prototype testing in one class in the selected target school allows the Company to call $10 million. 2. Successful installation and initiation of demonstration system testing more than one class in the selected target school allows the Company to call an additional $20 million. 3. The sale of the first 100 units allows the Company to call the final $30 million. In November 2000, the Company met the first funding target and in January 2001 called $10 million from the investors. On February 16, 2001, $9.4 million was received from Sylvan and Aether in addition to $2.3 million of additional voluntary funding. As a result of not participating in this capital call, the 1,052,632 shares of Series A held by Critical Path have been converted into Series X. In addition, in February 2001, the Company met the second funding target, but has not yet called the $20 million available under that target. Management believes that the amounts received to date and the amounts currently callable provide sufficient capital in the near term to meet the Company's obligations in the normal course of business. 21 EX-99.5 20 a2043474zex-99_5.txt EXHIBIT 99.5 Exhibit 99.5 AUDITED FINANCIAL STATEMENTS Classwell Learning Group Inc. (A Development-Stage Company) Period from July 27, 2000 (date of inception) through December 31, 2000 Classwell Learning Group Inc. (A Development-Stage Company) Audited Financial Statements Period from July 27, 2000 (date of inception) through December 31, 2000 CONTENTS Report of Independent Auditors.........................................................................1 Audited Financial Statements Balance Sheet..........................................................................................2 Statement of Operations................................................................................3 Statement of Redeemable Convertible Common Stock and Stockholders' Deficit.............................4 Statement of Cash Flows................................................................................5 Notes to Financial Statements..........................................................................6
Report of Independent Auditors To the Board of Directors and Stockholders of Classwell Learning Group Inc. We have audited the accompanying balance sheet of Classwell Learning Group Inc. (a development-stage company) (the "Company") as of December 31, 2000, and the related statements of operations, redeemable convertible common stock and stockholders' deficit, and cash flows for the period from July 27, 2000 (date of inception) through December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Classwell Learning Group Inc. (a development-stage company) at December 31, 2000, and the results of its operations and its cash flows for the period from July 27, 2000 (date of inception) through December 31, 2000 in conformity with accounting principles generally accepted in the United States. The accompanying financial statements have been prepared assuming that Classwell Learning Group Inc. will continue as a going concern. As more fully discussed in Note 1, the Company has incurred operating losses since inception, and has not achieved and does not expect to achieve sufficient revenues to support future operations without additional financing. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regards to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. /s/ Ernst & Young LLP Boston, Massachusetts March 16, 2001 1 Classwell Learning Group Inc. (A Development-Stage Company) Balance Sheet December 31, 2000 ASSETS Current assets: Cash and cash equivalents $ 2,319,937 Prepaid expenses and other current assets 174,678 ------------------- Total current assets 2,494,615 Property and equipment, net 1,513,889 Capitalized software costs 1,503,637 Electronic publishing and ancillary agreements, net 3,697,169 Goodwill, net 4,766,996 Prepaid royalties to shareholder 2,000,000 Investment 550,000 ------------------- Total assets $ 16,526,306 =================== LIABILITIES, REDEEMABLE CONVERTIBLE COMMON STOCK AND STOCKHOLDERS' DEFICIT Current liabilities: Royalties payable to stockholder $ 2,000,000 Accounts payable and accrued expenses 1,185,560 Accounts payable to stockholder 424,946 ------------------- Total current liabilities 3,610,506 Commitments Redeemable convertible common stock: Class A common stock, $0.001 par value; 11,000,000 shares authorized, 8,438,868 shares issued and outstanding (stated at liquidation and redemption value) 39,650,534 Class D common stock, $0.001 par value; 7,800,000 shares authorized, no shares issued and outstanding - Common stock subscription receivables (Note 1 and 9) (20,404,417) Stockholders' deficit: Class B common stock, $0.001 par value; and 15,000,000 shares authorized, 159,253 share issued and outstanding 159 Class C common stock, $0.001 par value; and 2,018,744 shares authorized, issued and outstanding 2,019 Additional paid-in capital 2,182,400 Accumulated deficit (6,990,292) Deferred compensation (1,524,603) ------------------- Total stockholders' deficit (6,330,317) ------------------- Total liabilities, redeemable convertible common stock and stockholders' deficit $ 16,526,306 ===================
SEE ACCOMPANYING NOTES. 2 Classwell Learning Group Inc. (A Development-Stage Company) Statement of Operations For the period from July 27, 2000 (date of inception) through December 31, 2000 Operating expenses: Research and development $ 3,639,899 Selling and marketing 1,756,394 General and administrative 1,504,973 ------------------- Loss from operations (6,901,266) Interest income 118,989 ------------------- Loss before benefit from income taxes (6,782,277) Income tax benefit 1,595,197 ------------------- Net loss $(5,187,080) ===================
SEE ACCOMPANYING NOTES. 3 Classwell Learning Group Inc. (A Development-Stage Company) Statement of Cash Flows For the period from July 27, 2000 (date of inception) through December 31, 2000 OPERATING ACTIVITIES Net loss $ (5,187,080) Adjustments to reconcile net loss to net cash used in operating activities: Benefit from deferred tax liability (1,595,197) Depreciation and amortization expense 728,216 Amortization of acquired prepaid license and market research 521,059 Stock-based compensation 286,897 Changes in operating assets and liabilities: Prepaid expenses and other current assets (124,678) Accounts payable and accrued expenses 1,185,560 Accounts payable to stockholder 424,946 --------------------- Net cash used in operating activities (3,760,277) INVESTING ACTIVITIES Purchases of property and equipment (1,206,914) Capitalized software costs (1,321,477) --------------------- Net cash used in investing activities (2,528,391) FINANCING ACTIVITIES Proceeds from sale of Class A and Class D common stock 8,606,586 Proceeds from sale of Class C common stock 2,019 --------------------- Net cash provided by financing activities 8,608,605 --------------------- Net increase in cash and cash equivalents 2,319,937 Cash and cash equivalents at July 27, 2000 (date of inception) - --------------------- Cash and cash equivalents at December 31, 2000 $ 2,319,937 ===================== SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Issuance of Class A, Class B and Class D common stock in conjunction with the acquisition of certain noncash assets $ 9,207,378 ===================== Issuance of common stock subscription receivables in conjunction with issuance of Class A and Class D common stock $20,404,417 ===================== Conversion of Class D common stock into Class A common stock $34,953,847 ===================== Accretion of Class A common stock to redemption value $ 1,803,212 ===================== Accrual of prepaid royalties to stockholder $ 2,000,000 =====================
SEE ACCOMPANYING NOTES. 4 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements December 31, 2000 1. ORGANIZATION AND NATURE OF OPERATIONS NATURE OF OPERATIONS Classwell Learning Group Inc. (the "Company") was incorporated in the state of Delaware on July 27, 2000 to provide online supplemental education services to meet the educational needs of teachers, students, parents and administrators by providing new teaching and learning resources. The Company's principal market is the United States. The Company operates in a single segment: online education services for pre-kindergarten through secondary education levels. DEVELOPMENT STAGE REPORTING The Company is considered to be in the development stage as no significant revenues have been derived from operations. Accordingly, the financial statements are presented in accordance with Statement of Financial Accounting Standards ("SFAS") No. 7, ACCOUNTING AND REPORTING BY DEVELOPMENT STAGE ENTERPRISES. The Company's ability to progress beyond the development stage is subject to risks common to technology-based companies including, but not limited to, the development of new technology, the ability to obtain adequate financing to fund future operations, the successful development and marketing of commercial products, expansion of markets and distribution channels, competition from substitute products and larger companies, and dependence on key personnel. GOING CONCERN The Company has incurred significant operating losses since inception, and has not achieved and does not expect to achieve sufficient revenues to support future operations without additional financing. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The financial statements have been prepared assuming that the Company will continue as a going concern and, accordingly, do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. Management believes that the continued development of its products is the key element to the Company's ability to secure adequate financing until the Company is operating profitably. Management believes expected financing and current operations will be sufficient to allow the Company to continue as a going concern at least through 2001. Should revenues not materialize to planned levels, or additional equity financing be unavailable to the Company, management will restrict certain of the Company's planned activities and operations, as necessary, to sustain operations and conserve cash resources. 5 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 1. ORGANIZATION AND NATURE OF OPERATIONS (CONTINUED) INITIAL CAPITALIZATION On September 6, 2000, the Company entered into a stock purchase agreement with Houghton Mifflin Company ("HMCo"), Sylvan Ventures, LLC (a subsidiary of Sylvan Learning Systems, Inc.), Inception Capital, LLC and Event411.com, Inc. (collectively the "Investors") whereby the Company issued shares of its Class A, Class B, Class C and Class D common stock (collectively the "Common Stock") in exchange for cash and stock subscription receivables from the Investors as well as contributed assets from HMCo and Event411.com, Inc. The following is a summary of the Common Stock exchanged in the transaction: Issuance of 645,162 shares of Class A common stock $ 3,000,003 Issuance of 159,253 shares of Class B common stock 371,059 Issuance of 2,018,744 shares of Class C common stock 2,019 Issuance of 7,793,706 shares of Class D common stock 36,240,733 Issuance costs (1,393,414) -------------------- $ 38,220,400 ====================
The following is a summary of the assets that the Company received in exchange for the issuance of the Common Stock: Cash proceeds ($10,002,019, net of issuance costs of $1,393,414) $ 8,608,605 Stock subscription receivables 20,404,417 Prepaid license fees and market research 571,059 Property and equipment 612,766 Investment in Event411.com, Inc. 550,000 Electronic publishing and ancillary agreements 3,961,253 Goodwill 5,107,497 Deferred tax liabilities for electronic publishing and ancillary agreements (1,595,197) -------------------- $ 38,220,400 ====================
The allocation of purchase price to intangible assets reflects preliminary estimates. 6 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 1. ORGANIZATION AND NATURE OF OPERATIONS (CONTINUED) The stock subscription receivables are noninterest bearing promissory note agreements payable in three quarterly installments on December 1, 2000, March 1, 2001 and June 1, 2001. However, the Company can request payment of unpaid principal owed under these agreements in which payment will be due 10 days after such request. The Company has been receiving payment upon its request. Subsequent to December 31, 2000, Inception Capital, LLC informed the Company that it would not fund all of its stock subscription receivable. Accordingly, the agreement is in the process of being renegotiated (see Note 9). The electronic publishing and ancillary agreements are comprised of value assigned to a trademark license arrangement and an electronic publishing agreement entered into between the Company and HMCo. These agreements are described in greater detail in Note 8. In accordance with the terms of the stock purchase agreement, the Company reimbursed HMCo for operating costs incurred on behalf of the Company from July 1, 2000 through September 6, 2000 while the Company completed formation and initiated operations. Accordingly, the Company has reimbursed HMCo approximately $858,000, consisting of approximately $813,000 in operating expenses and approximately $45,000 in property and equipment purchases. The operating expenses have been charged to operations as the stock purchase agreement had valued the initial capitalization transaction on or about July 1, 2000, although the transaction was not completed until September 6, 2000. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying financial statements reflect the application of certain significant accounting policies as described in this note and elsewhere in the accompanying financial statements and notes. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and footnotes thereto. Actual results could differ from those estimates. CASH EQUIVALENTS The Company invests its excess cash primarily in money market mutual funds. Accordingly, these investments are subject to minimal credit and market risk. For financial reporting purposes, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. 7 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Major replacements and improvements are capitalized while general repairs and maintenance are charged to expense as incurred. Depreciation is computed using the straight-line method based upon the estimated useful lives of the assets. INVESTMENT The Company accounts for its investment under the cost method. The Company obtained 18,333 shares of Class A preferred stock in Event 411.com valued at $550,000 as part of the consideration received from the stock purchase agreement dated September 6, 2000, as described in Note 1. CAPITALIZED SOFTWARE COSTS Capitalized software costs consist of costs incurred in the development of the Company's internet-based technology. Such costs consist of salaries, consulting fees, and software licenses for the design, deployment and enhancement of the Company's technology . The Company capitalizes such costs under Statement of Position ("SOP") 98-1, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE, and Financial Accounting Standards Board Emerging Issues Task Force ("EITF") Issue No. 00-2, ACCOUNTING FOR WEBSITE DEVELOPMENT COSTS. Under SOP 98-1 and EITF 00-2, costs of internal use software are expensed during the preliminary project and post-implementation stages. Costs are capitalized during the application development stage. Capitalization ends when the project is substantially complete and the software is ready for its intended use. The Company capitalized approximately $1,504,000 since inception. No amortization expense was recognized during this period. Capitalized software development costs will be amortized over three years from the point that the software is ready for its intended use. 8 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) GOODWILL AND OTHER INTANGIBLE ASSETS Amortization of goodwill and other intangible assets is provided using the straight-line method over their estimated useful lives, five years. Other intangible assets consist of electronic publishing and ancillary agreements, and are being amortized over their estimated useful lives of five years. The Company reviews the carrying value of goodwill and other intangible assets for impairment whenever events in circumstances indicate that the carrying value may not be recoverable. At December 31, 2000, accumulated amortization for goodwill and other intangible assets was $340,501 and $264,084, respectively. INCOME TAXES The Company provides for income taxes under SFAS No. 109, ACCOUNTING FOR INCOME TAXES. Under SFAS No. 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. STOCK-BASED COMPENSATION The Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"), and related interpretations. Accordingly, compensation expense is recorded for stock options awarded to employees and directors to the extent that the option exercise prices are less than the common stock's fair market value on the date of grant, where the number of shares and exercise price are fixed. The difference between the fair value of the Company's common stock and the exercise price of the stock option, if any, is recorded as deferred compensation and is amortized to compensation expense over the vesting period of the underlying stock option. The Company follows the disclosure requirements of SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. All stock-based awards to nonemployees are accounted for at their fair value in accordance with SFAS No. 123 and related interpretations. RESEARCH AND DEVELOPMENT EXPENSES Research and development costs are charged to expense as incurred. These costs totaled approximately $3,640,000 in 2000. 9 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying value of the Company's financial instruments, which include cash equivalents, accounts payable, and accrued expenses approximate their fair values at December 31, 2000. The estimated fair values of the Company's notes receivable approximate their carrying value based upon current rates offered to the Company for similar type arrangements (see Note 1 and 9). RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Company, to date, has not engaged in derivative and hedging activities, and therefore the adoption of SFAS No. 133 and related amendments in fiscal year 2001 is not expected to have a material impact on its financial reporting. In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44 ("FIN 44"), ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION AN INTERPRETATION OF APB 25. FIN 44 clarifies guidance for certain issues that arose in the application of APB 25. Areas of focus within FIN 44 include repricings, modifications to extend the opinion term, change of grantee status, modifications to accelerate vesting and options exchanged in a purchase business combination. FIN 44 is generally effective prospectively to new awards, modifications to outstanding awards, and changes in employee status on or after July 1, 2000. 3. PROPERTY AND EQUIPMENT At December 31, 2000, property and equipment consisted of the following:
ESTIMATED USEFUL LIFE (IN YEARS) --------------- Computer equipment 3 $ 1,509,508 Furniture and fixtures 5 128,012 ------------------- 1,637,520 Less accumulated depreciation 123,631 ------------------- Property and equipment, net $ 1,513,889 ===================
10 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 4. COMMON STOCK The Company has four classes of common stock: Class A, Class B, Class C and Class D. Class B and Class C common stock are considered junior stock to Class A common stock. The Company has reserved 8,438,868 shares and 1,700,000 shares of Class B common stock for the conversion of Class A common stock and issuance under the Company's 2000 Stock Compensation Plan, respectively. The Company's common stock have the following significant characteristics: LIQUIDATION, DISSOLUTION AND WINDING-UP In the event of any voluntary or involuntary liquidation, dissolution or winding-up of the Company, the holders of Class A common stock are entitled to be paid out of the assets available for distribution, the purchase price ($4.65) of the respective shares, plus unpaid dividends (declared or undeclared). All remaining assets after the initial distribution to Class A common stockholders shall be distributed on a pro rata basis among the holders of Class A, Class B and Class C common stock based upon the number shares held by each, assuming conversion of Class A common stock into Class B common stock. If the assets of the Company are insufficient to pay the full preferential amounts to the holders of Class A common stock, the assets will be distributed ratably among the holders of Class A common stock in proportion to their aggregate liquidation preference amounts. The holders of Class D common stock have no special rights in liquidation, dissolution or winding-up. At December 31, 2000, the liquidation value of Class A common stock equals its redemption value. DIVIDENDS The holders of Class A common stock are entitled to receive, when and if declared by the Board of Directors, quarterly dividends at the per annum rate of 5.0% of $4.65 per share. Dividends accrue, whether or not declared or paid, and are cumulative for liquidation purposes. Cumulative unpaid and undeclared dividends included in the value of Class A common stock at December 31, 2000 are approximately $410,000. The holders of Class B and Class C common stock are entitled to receive dividends, when and if declared by the Board of Directors. The holders of Class D common stock have no dividend rights. 11 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 4. COMMON STOCK (CONTINUED) REGISTRATION RIGHTS At any time more than six months after a qualified public offering, as defined, by the Company, a majority of the holders of Class A and Class B common stock (the Registrable Securities) may request the Company to register the shares, provided that the anticipated aggregate offering price of the registration is at least $5,000,000. The holders of Class C and Class D common stock have no registration rights. REDEMPTION At any time after August 1, 2005, upon the written request of a majority of Class A common stockholders, excluding Houghton Mifflin Company, the Company is required to redeem all of the Class A common stock outstanding. The redemption price for the Class A common stock is equal to the greater of the fair market value of Class A common stock or the original purchase price ($4.65) plus any accrued or unpaid dividends. The Company is required to immediately redeem Class C common stock, at par value, upon the issuance of Class B common stock for the conversion of other securities into Class B common stock, the issuance of Class B common stock upon the exercise of options or the vesting of restricted shares of Class B common stock. At December 31, 2000, the Class A common stock has been accreted to its redemption value. RIGHT OF FIRST REFUSAL At December 31, 2000, all holders of the Company's common stock have the right of first refusal to purchase any new securities offered by the Company. The right of first refusal terminates immediately prior to the closing of a qualified initial public offering, as defined, of the Company's common stock. CONVERSION Each share of Class A common stock is initially convertible at the option of the holder into one share of Class B common stock. The conversion ratio is subject to adjustment upon the occurrence of certain dilutive events, such as, but not limited to, stock splits, dividends, issuances of other securities, and change in conversion price. Upon the consummation of a qualified public offering with gross proceeds to the Company of not less than $25,000,000, all shares of Class A common stock are subject to mandatory conversion. All shares of Class D common stock are automatically converted, on a one-for-one basis, into Class A common stock upon the earlier of the expiration or 12 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 4. COMMON STOCK (CONTINUED) termination of the waiting period prescribed by the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. All shares of Class D common stock were converted into Class A common stock on October 19, 2000 upon the termination of the waiting period. Class B and Class C common stock have no conversion rights. VOTING RIGHTS The holders of Class A common stock are entitled to the number of votes equal to the number of Class B common stock shares into which they are convertible. The holders of Class A and Class C common stock vote with the holders of Class B common stock as a single class. The holders of Class D common stock do not have any voting rights. The holders of Class A common stock are also entitled to nominate directors. Furthermore, the Company is required to obtain the approval of a majority of the holders of Class A common stock for the sale of substantially all of the Company's assets or declare, or pay, dividends on junior stock and at least 85% of the holders of Class A common stock to amend or restate the Company's certificate of incorporation or change the number of seats of the Company's Board of Directors. 5. STOCK COMPENSATION PLAN In February 2001, the Company's Board of Directors approved the 2000 Stock Compensation Plan (the "Plan") for which 1,700,000 shares of Class B common stock have been reserved. Under the terms of the Plan, the Company may grant incentive stock options to employees of the Company and nonqualified stock options, awards of restricted stock, and direct stock purchase opportunities to directors, officers, employees and consultants of the Company. The exercise price, vesting provisions and duration of incentive stock options and nonqualified stock options shall be determined for each grant by the Board of Directors. The maximum term of the options is ten years. Incentive stock options may not be granted at less than the fair market value of the Company's common stock at the date of grant and for a term not to exceed ten years. For holders of 10% or more of the Company's outstanding common stock, options may not be granted at less than 110% of the fair market value of the common stock at the date of grant and the option term may not exceed five years. Nonqualified options may be granted at an exercise price less than, equal to or greater than the fair market value on the date of grant, as determined by the Board of Directors. 13 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 5. STOCK COMPENSATION PLAN (CONTINUED) Incentive stock options generally vest over a four-year period. The Company's stock option activity from July 27, 2000 (date of inception) through December 31, 2000 is summarized as follows:
WEIGHTED- AVERAGE EXERCISE OPTIONS PRICE ----------------------------------- Granted (exercise price below fair value) 800,000 $ 0.10 Granted (exercise price equal to fair value) 321,500 2.33 Canceled (20,000) 2.33 ------------------ Outstanding at end of year 1,101,500 0.71 =================================== Exercisable at end of year 50,000 $ 0.10 ===================================
The fair value of the options granted during the period from July 27, 2000 (date of inception) through December 31, 2000 is estimated to be $2.26 for options granted with exercise prices below the Class B common stock fair value and $0.63 for options granted with exercise prices equal to the Class B common stock fair value. The following table summarizes information about stock options outstanding and exercisable at December 31, 2000:
WEIGHTED- AVERAGE REMAINING OPTIONS CONTRACTUAL OPTIONS EXERCISE PRICE OUTSTANDING LIFE (IN YEARS) EXERCISABLE - ---------------------------------------------------------------------------------------------------- $ 0.10 800,000 9.7 50,000 2.33 301,500 9.8 - --------------------- --------------------- 1,101,500 50,000 ===================== =====================
14 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 5. STOCK COMPENSATION PLAN (CONTINUED) SFAS No. 123 encourages but does not require companies to record compensation cost for stock-based employee compensation at fair value. The Company has chosen to account for stock-based compensation granted to employees using the intrinsic value method prescribed in APB 25 and related interpretations. Accordingly, deferred compensation cost for restricted stock awards and stock options granted to employees is measured as the excess, if any, of the fair value of the Company's stock at the date of the grant over the amount that must be paid to acquire the stock. For the period from July 27, 2000 (date of inception) through December 31, 2000, the Company recorded $1,784,000 in deferred compensation for options to purchase common stock granted at exercise prices determined to be below the fair value of the common stock on the date of grant. The Company recognized compensation expense of $278,187 during this period related to these arrangements. Furthermore, during the same period, the Company recorded deferred compensation and compensation expense of $27,500 and $8,710, respectively, for options granted to nonemployees. Option valuation models have been developed to estimate the fair value of traded options, which have no vesting restrictions and are fully transferable. Such models require the input of highly subjective assumptions. Because the Company's employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The fair value of each option grant is estimated on the date of grant using the minimum value method. The following assumptions were made for grants in 2000: Dividend yield 0% Expected lives of options (in years) 5 Risk-free interest rate 5.33%-6.08%
Had the Company accounted for stock options to employees under the fair value method prescribed under SFAS No. 123, pro forma net losses would have been as follows (the effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts): Net loss (as reported) $(5,187,080) Incremental stock compensation expense (9,039) --------------------- Pro forma net loss $(5,196,119) =====================
15 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 6. INCOME TAXES A reconciliation of the Company's income tax provision to the statutory federal and state provision is as follows: Statutory federal income tax provision $ (2,306,000) State income taxes, net of federal tax benefit (425,000) Change in deferred tax asset valuation allowance 989,000 Amortization of goodwill 116,000 Other items 31,000 ------------------- Net income tax expense / (benefit) $ (1,595,000) ===================
Significant components of the Company's deferred tax liabilities and assets at December 31, 2000 consist of the following: Deferred tax liabilities: Electronic publishing and ancillary agreements $ 1,489,000 Capitalized software costs 606,000 ------------------- Total deferred tax liabilities 2,095,000 Deferred tax assets: Net operating loss carryforwards 1,899,000 Startup costs 1,166,000 Property and equipment 19,000 ------------------- Total deferred tax assets 3,084,000 Valuation allowance for deferred tax assets (989,000) ------------------- Net deferred tax assets 2,095,000 ------------------- Net deferred tax liabilities / (assets) $ - ===================
The Company has net operating loss carryforwards for both federal and state of approximately $4,716,000 available at December 31, 2000 to offset future taxable income. The above net operating loss carryforwards expire at various times through fiscal year 2020. Net operating loss carryforwards are subject to review and possible adjustment by the Internal Revenue Service. Under the provisions of the Internal Revenue Code, certain substantial changes in the Company's ownership may limit the amount of net operating loss carryforwards which could be utilized annually to offset future taxable income. Subsequent significant ownership changes could further effect the limitation in future years. 16 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 6. INCOME TAXES (CONTINUED) The Company has incurred losses since inception and has provided a full valuation allowance on its deferred tax assets at December 31, 2000 since realization of these future benefits is uncertain. No income taxes were paid in the period from July 27, 2000 (date of inception) through December 31, 2000. 7. EMPLOYEE BENEFIT PLAN In 2000, the Company established the Classwell 401(k) Plan (the "Plan") for its employees, which is designed to be qualified under Section 401(k) of the Internal Revenue Code. Eligible employees are permitted to contribute to the Plan within statutory and plan limits. The Company has not contributed to the Plan during 2000. 8. RELATED PARTY TRANSACTIONS In accordance with the stock purchase agreement dated September 6, 2000, the Company entered into the following arrangements with Houghton Mifflin Company ("HMCo"), a shareholder: REIMBURSEMENT OF OPERATING EXPENSES The Company reimbursed HMCo for operating costs incurred on behalf of the Company from July 1, 2000 through September 6, 2000 while the Company completed formation and initiated operations. Accordingly, the Company has reimbursed HMCo approximately $858,000, consisting of approximately $813,000 in operating expenses and approximately $45,000 in property and equipment purchases. The operating expenses have been charged to operations as the stock purchase agreement had valued the initial capitalization transaction on or about July 1, 2000, although the transaction was not completed until September 6, 2000. ADMINISTRATIVE AND SERVICES AGREEMENT The Company entered into an agreement with HMCo that provides administrative support services including payroll processing, use of a general ledger system, use of an accounts payable and check processing system, and access to consulting and or other support services. The monthly cost for these administrative support services is $1,000 plus time and materials costs for consulting or other support. The agreements is scheduled to terminate on May 31, 2001. During 2000, the Company charged administrative support expenses to operations of approximately $12,000 related to this agreement. 17 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 8. RELATED PARTY TRANSACTIONS (CONTINUED) USE AND OCCUPANCY AGREEMENT The Company has an agreement with HMCo that grants the Company a license to occupy certain leased space and use certain furniture and equipment for a monthly cost of approximately $49,000. The agreement was scheduled to terminate on May 31, 2001. The Company has made arrangements to extend the license of the leased space and equipment with minimum lease payments totaling approximately $592,000 for 2001. During 2000, the Company charged rent expense to operations of approximately $222,000. The Company also paid approximately $33,000 to HMCo for utilization of property and equipment under this agreement. TRADEMARK LICENSE ARRANGEMENT The Trademark License Agreement ("TLA") allows the Company to use HMCo licensed trademarks, including HMCo's trade name and as defined, for approximately ten years through December 31, 2010 on a royalty free, nonexclusive basis. Through August 1, 2003, HMCo cannot grant the use of its licensed trademarks to any of the Company's competitors. Furthermore, for a two-year period, the TLA requires that HMCo will not establish a new business until after December 31, 2002 that is substantially equivalent in scope and nature to the Company. ELECTRONIC PUBLISHING AGREEMENT The Electronic Publishing Agreement ("EPA") provides the Company with electronic revision and electronic distribution rights of HMCo copyrighted materials, as defined. The EPA includes provisions for a royalty payment equal to 5% of net revenues earned until December 31, 2003, 4% in 2004, 3% in 2005 and 1% thereafter until December 31, 2010. The EPA includes terms for a minimum royalty payment of $8 million payable in cash and/or stock. A maximum of $4 million can be paid with voting stock, at the Company's option. The fair value of the stock is valued at $4.65 for the purposes of this agreement. Minimum royalty payments are scheduled as follows:
OBLIGATION DATE PAYMENT DUE DATE -------------------------- ------------------------- $2.0 million payable in cash September 6, 2000 October 31, 2001 $2.0 million payable in cash October 31, 2001 October 31, 2001 $1.3 million payable in cash or stock October 31, 2001 October 31, 2001 $1.35 million payable in cash or stock October 31, 2002 October 31, 2002 $1.35 million payable in cash or stock October 31, 2003 October 31, 2003
18 Classwell Learning Group Inc. (A Development-Stage Company) Notes to Financial Statements (continued) 8. RELATED PARTY TRANSACTIONS (CONTINUED) Each minimum royalty payment shall be used to offset percentage royalties due HMCo by crediting such minimum payments against royalties owed HMCo during the term of the ten-year agreement. As of December 31, 2000, the Company has recorded $2.0 million of prepaid royalties and $2.0 million in accrued royalties to recognize the minimum royalty obligation due as of October 31, 2001. HMCo may, in its sole discretion, extend the payment due dates, but not the obligation dates, for any, or all, of the royalty payments due as of October 31, 2001 to the earlier to occur of (a) January 30, 2002, or (b) to the date of closing of a next round of equity financing by the Company. 9. SUBSEQUENT EVENTS INCEPTION CAPITAL, LLC STOCK SUBSCRIPTION RECEIVABLE In conjunction with the Company's stock purchase transaction on September 6, 2000, the Company issued a stock subscription receivable to Inception Capital, LLC. The stock subscription receivable is a noninterest bearing promissory note agreement payable in three quarterly installments of $2,220,492, $1,973,770 and $839,942 on December 1, 2000, March 1, 2001 and June 1, 2001, respectively. However, the Company can request payment of unpaid principal owed under the agreement in which payment will be due 10 days after such request. Subsequent to December 31, 2000, Inception Capital, LLC informed the Company that it would not fund the total amount of its stock subscription receivable. Accordingly, the Company and Inception Capital, LLC are currently renegotiating this agreement. EDTOPIA.COM ASSET PURCHASE AND SALE AGREEMENT On February 2, 2001, the Company entered into an Asset Purchase and Sale Agreement with Edtopia.com (d/b/a GlobaLearn) ("Edtopia") whereby the Company, for a purchase price of $206,500, agreed to purchase certain intellectual property and miscellaneous property and equipment from Edtopia. The payment of $206,500 is comprised of $81,500 paid at the closing and issuance of a noninterest bearing note for $125,000 due February 2, 2002. 19 Classwell Learning Group Inc. (A Development-Stage Company) Statement of Redeemable Convertible Common Stock and Stockholders' Deficit For the period from July 27, 2000 (date of inception) through December 31, 2000
Class A Common Stock Class D Common Stock Common Stock ---------------------------- -------------------------- Subscription Shares Amount Shares Amount Receivable ------------ ------------- ----------- ------------- -------------- Issuance of Class A, Class B, Class C and Class D common stock for cash, subscription receivable, fixed assets and intangible assets, net of issuance costs of $1,393,414, on September 6, 2000 645,162 $ 2,893,475 7,793,706 $ 34,953,847 $(20,404,417) Conversion of Class D common stock into Class A common stock on October 19, 2000 ................. 7,793,706 34,953,847 (7,793,706) (34,953,847) Deferred compensation related to stock options grants to employees and nonemployees ............. Amortization of deferred compensation .............. Accretion of Class A common stock to redemption value ................................. 1,803,212 Net loss ........................................... ------------ ------------- ----------- ------------- -------------- Balance at December 31, 2000 ....................... 8,438,868 $39,650,534 -- $ - $(20,404,417) ============ ============= =========== ============= ==============
Class B Common Stock Class C Common Stock Additional ----------------------- ------------------------ Paid-in Accumulated Shares Par Value Shares Par Value Capital Deficit ---------- ------------ ----------- ----------- ---------- ------------- Issuance of Class A, Class B, Class C and Class D common stock for cash, subscription receivable, fixed assets and intangible assets, net of issuance costs of $1,393,414, on September 6, 2000 159,253 $ 159 2,018,744 $ 2,019 $ 370,900 Conversion of Class D common stock into Class A common stock on October 19, 2000 ................. Deferred compensation related to stock options grants to employees and nonemployees ............. 1,811,500 Amortization of deferred compensation .............. Accretion of Class A common stock to redemption value ................................. $ (1,803,212) Net loss ........................................... (5,187,080) ---------- ------------ ----------- ----------- ---------- ------------- Balance at December 31, 2000 ....................... 159,253 $ 159 2,018,744 $ 2,019 $2,182,400 $ (6,990,292) ========== ============ =========== =========== ========== =============
Total Deferred Stockholders' Compensation Deficit ------------ ------------- Issuance of Class A, Class B, Class C and Class D common stock for cash, subscription receivable, fixed assets and intangible assets, net of issuance costs of $1,393,414, on September 6, 2000 $ 373,078 Conversion of Class D common stock into Class A common stock on October 19, 2000 ................. Deferred compensation related to stock options grants to employees and nonemployees ............. $(1,811,500) -- Amortization of deferred compensation .............. 286,897 286,897 Accretion of Class A common stock to redemption value ................................. (1,803,212) Net loss ........................................... (5,187,080) ------------ ------------- Balance at December 31, 2000 ....................... $(1,524,603) $(6,330,317) ============ =============
See accompanying notes. EX-99.6 21 a2043474zex-99_6.txt EXHIBIT 99.6 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Caliber Learning Network, Inc. We have audited the accompanying balance sheets of Caliber Learning Network, Inc. as of December 31, 1999 and 2000, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Caliber Learning Network, Inc. at December 31, 1999 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 15 to the financial statements, the Company has a deficiency of working capital of $662,672 at December 31, 2000 and has incurred operating losses since inception. This condition raises substantial doubt about the Company's ability to continue as a going concern. Management's plans to address this matter are also described in Note 15. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. /s/ Ernst & Young LLP Baltimore, Maryland February 14, 2001 except for Note 16, as to which the date is March 26, 2001 F-1 CALIBER LEARNING NETWORK, INC. BALANCE SHEETS
DECEMBER 31, --------------------------- 1999 2000 ------------ ------------ ASSETS Current assets: Cash and cash equivalents................................. $ 25,923,169 $ 7,578,511 Accounts receivable, net of allowance of $3,727,944 in 1999 and $294,949 in 2000............................... 3,727,637 4,139,010 Receivable from related party............................. 2,000,000 750,000 Prepaid expenses and other current assets................. 114,524 189,152 ------------ ------------ Total current assets........................................ 31,765,330 12,656,673 Property and equipment: Furniture and fixtures.................................... 3,059,913 3,386,818 Computer equipment and software........................... 18,823,316 21,833,837 Leasehold improvements.................................... 10,628,772 10,644,187 ------------ ------------ 32,512,001 35,864,842 Accumulated depreciation and amortization................. (11,384,337) (19,032,924) ------------ ------------ 21,127,664 16,831,918 Other assets................................................ 391,183 385,855 ------------ ------------ Total assets................................................ $ 53,284,177 $ 29,874,446 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses..................... $ 4,443,697 $ 2,865,559 Payable to Sylvan......................................... 2,961,809 4,716 Current portion of note payable to Sylvan................. -- 2,936,000 Accrued dividends payable................................. 73,720 1,471,278 Current portion of deferred tenant allowances............. 375,846 358,842 Current portion of capital lease obligations due to related party........................................... 4,715,227 5,682,950 ------------ ------------ Total current liabilities................................... 12,570,299 13,319,345 Note payable to Sylvan, less current portion................ -- 4,214,000 Deferred tenant allowances, less current portion............ 1,190,757 839,389 Capital lease obligations due to related party, less current portion................................................... 9,059,318 5,247,502 Commitments and contingencies............................... -- -- 7.5% Series A Redeemable Convertible Preferred Stock, $.01 par value; authorized shares of 225,000; issued and oustanding shares of 150,000 in 1999...................... 15,152,807 -- Stockholders' equity: 7.5% Series B Redeemable Convertible Preferred Stock, $.01 par value; authorized shares--500,000; issued and oustanding shares of 110,000 in 2000; liquidation preference of $100 per share aggregating $11,000,000.... -- 1,100 7.5% Series A-2 Redeemable Convertible Preferred Stock, $.01 par value; authorized shares--225,000; issued and oustanding shares 150,000 in 2000; liquidation preference of $100 per share plus accrued interest aggregating $16,337,558................................. -- 1,500 6% Non-Voting Convertible Preferred Stock, $.01 par value; authorized shares of 5,167,328; issued and outstanding shares of 5,167,328 in 1999 and 2000.................... 51,674 51,674 Common stock, $.01 par value; authorized shares- 50,000,000; issued and oustanding shares of 12,443,797 in 1999 and 12,595,282 in 2000.......................... 124,438 125,953 Additional paid-in capital................................ 81,606,725 106,547,799 Accumulated deficit....................................... (66,471,841) (100,473,816) ------------ ------------ Total stockholders' equity.................................. 15,310,996 6,254,210 ------------ ------------ Total liabilities and stockholders' equity.................. $ 53,284,177 $ 29,874,446 ============ ============
The accompanying notes are an integral part of these financial statements. F-2 CALIBER LEARNING NETWORK, INC. STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ------------------------------------------ 1998 1999 2000 ------------ ------------ ------------ Revenues: Service fee revenue............................... $ 13,348,828 $ 20,055,383 $ 18,337,993 Service fee revenue from related party............ -- 2,000,000 1,750,000 Management fee from Sylvan........................ 2,066,250 3,977,366 816,578 ------------ ------------ ------------ 15,415,078 26,032,749 20,904,571 Cost and expenses: Operating expenses................................ 24,256,603 27,626,288 25,663,122 Management fees to Sylvan......................... 2,000,000 2,000,000 1,845,024 Other selling, general and administrative expenses........................................ 18,157,203 18,556,641 27,632,150 ------------ ------------ ------------ 44,413,806 48,182,929 55,140,296 Other income (expense): Other income...................................... -- -- 600,000 Interest income................................... 1,571,078 1,348,787 665,712 Interest expense.................................. (1,396,864) (1,440,628) (1,031,962) ------------ ------------ ------------ 174,214 (91,841) 233,750 ------------ ------------ ------------ Net loss............................................ (28,824,514) (22,242,021) (34,001,975) Dividends accrued on preferred stock................ (314,409) (266,507) (1,244,751) ------------ ------------ ------------ Net loss attributable to common stockholders........ $(29,138,923) $(22,508,528) $(35,246,726) ============ ============ ============ Basic and diluted loss per common share attributable to common stockholders............................ $ (2.61) $ (1.82) $ (2.82) ============ ============ ============
The accompanying notes are an integral part of these financial statements. F-3 CALIBER LEARNING NETWORK, INC. STATEMENTS OF STOCKHOLDERS' EQUITY
SERIES A-2 SERIES A-1 SERIES B NON- REDEEMABLE REDEEMABLE REDEEMABLE VOTING CONVERTIBLE CONVERTIBLE CONVERTIBLE CONVERTIBLE CLASS A CLASS B PREFERRED PREFERRED PREFERRED PREFERRED COMMON COMMON COMMON STOCK STOCK STOCK STOCK STOCK STOCK STOCK ----------- ----------- ----------- ----------- -------- -------- -------- Balance at January 1, 1998......... $ -- $ -- $ -- $ -- $38,300 $51,674 $ -- Issuance of 18,750 shares of Class A common stock................... -- -- -- -- 188 -- -- Conversion of 3,848,736 shares of Class A common stock into 3,848,736 shares of common stock............................ -- -- -- -- (38,488) -- 38,488 Conversion of 5,167,328 shares of Class B common stock into 5,167,328 shares of 6% Non-Voting Convertible Preferred Stock...... -- -- -- 51,674 -- (51,674) -- Conversion of 2,442,513 shares of Series B Redeemable Convertible Preferred Stock into 2,442,513 shares of common stock........... -- -- -- -- -- -- 24,425 Conversion of 1,227,393 shares of Series B Redeemable Junior Convertible Preferred Stock into 1,227,393 shares of common stock............................ -- -- -- -- -- -- 12,274 Payment of stock subscription...... -- -- -- -- -- -- -- Issuance of 4,775,000 shares of common stock..................... -- -- -- -- -- -- 47,750 Proceeds from exercise of stock options.......................... -- -- -- -- -- -- 60 Loss for the year ended December 31, 1998......................... -- -- -- -- -- -- -- Dividends on 6% Non-Voting Convertible Preferred Stock and 8% Series A Convertible Preferred Stock............................ -- -- -- -- -- -- -- ----------- ----------- ----------- ------- ------- ------- -------- Balance at December 31, 1998....... -- -- -- 51,674 -- -- 122,997 Proceeds from exercise of stock options.......................... -- -- -- -- -- -- 45 Proceeds from sale of 139,624 shares under the employee stock purchase program................. -- -- -- -- -- -- 1,396 Loss for the year ended December 31, 1999......................... -- -- -- -- -- -- -- Dividends on 6% Non-Voting Convertible Preferred Stock and 7.5% Series A Redeemable Convertible Preferred Stock...... -- -- -- -- -- -- -- ----------- ----------- ----------- ------- ------- ------- -------- Balance at December 31, 1999....... -- -- -- 51,674 -- -- 124,438 Proceeds from exercise of stock options.......................... -- -- -- -- -- -- 271 Exchange of 150,000 shares of Series A Redeemable Convertible Preferred Stock for 150,000 shares of Series A-1 Redeemable Convertible Preferred Stock............................ -- 1,500 -- -- -- -- -- Exchange of 150,000 shares of Series A-1 Redeemable Convertible Preferred Stock for 150,000 shares of Series A-2 Redeemable Convertible Preferred Stock...... 1,500 (1,500) -- -- -- -- -- Issuance of 110,000 shares of Series B Redeemable Convertible Preferred Stock.................. -- -- 1,100 -- -- -- -- Proceeds from sale of 124,413 shares under the employee stock purchase program................. -- -- -- -- -- -- 1,244 Loss for the year ended December 31, 2000......................... -- -- -- -- -- -- -- Dividends on 6% Non-Voting Convertible Preferred Stock, and 7.5% Series A-1 Redeemable Convertible Preferred Stock...... -- -- -- -- -- -- -- ----------- ----------- ----------- ------- ------- ------- -------- Balance at December 31, 2000....... $ 1,500 $ -- $ 1,100 $51,674 $ -- $ -- $125,953 =========== =========== =========== ======= ======= ======= ======== ADDITIONAL TOTAL PAID-IN SUBSCRIPTION ACCUMULATED STOCKHOLDERS' CAPITAL RECEIVABLE DEFICIT EQUITY ------------ ------------ ------------- ------------- Balance at January 1, 1998......... $ 9,179,334 $(5,364,358) $ (15,405,306) $(11,500,356) Issuance of 18,750 shares of Class A common stock................... 149,812 -- -- 150,000 Conversion of 3,848,736 shares of Class A common stock into 3,848,736 shares of common stock............................ -- -- -- -- Conversion of 5,167,328 shares of Class B common stock into 5,167,328 shares of 6% Non-Voting Convertible Preferred Stock...... -- -- -- -- Conversion of 2,442,513 shares of Series B Redeemable Convertible Preferred Stock into 2,442,513 shares of common stock........... 9,975,575 -- -- 10,000,000 Conversion of 1,227,393 shares of Series B Redeemable Junior Convertible Preferred Stock into 1,227,393 shares of common stock............................ 1,287,726 -- -- 1,300,000 Payment of stock subscription...... -- 5,364,358 -- 5,364,358 Issuance of 4,775,000 shares of common stock..................... 61,384,472 -- -- 61,432,222 Proceeds from exercise of stock options.......................... 7,448 -- -- 7,508 Loss for the year ended December 31, 1998......................... -- -- (28,824,514) (28,824,514) Dividends on 6% Non-Voting Convertible Preferred Stock and 8% Series A Convertible Preferred Stock............................ (314,409) -- -- (314,409) ------------ ------------ ------------- ------------ Balance at December 31, 1998....... 81,669,958 -- (44,229,820) 37,614,809 Proceeds from exercise of stock options.......................... 47,495 -- -- 47,540 Proceeds from sale of 139,624 shares under the employee stock purchase program................. 155,779 -- -- 157,175 Loss for the year ended December 31, 1999......................... -- -- (22,242,021) (22,242,021) Dividends on 6% Non-Voting Convertible Preferred Stock and 7.5% Series A Redeemable Convertible Preferred Stock...... (266,507) -- -- (266,507) ------------ ------------ ------------- ------------ Balance at December 31, 1999....... 81,606,725 -- (66,471,841) 15,310,996 Proceeds from exercise of stock options.......................... 31,932 -- -- 32,203 Exchange of 150,000 shares of Series A Redeemable Convertible Preferred Stock for 150,000 shares of Series A-1 Redeemable Convertible Preferred Stock............................ 14,998,500 -- -- 15,000,000 Exchange of 150,000 shares of Series A-1 Redeemable Convertible Preferred Stock for 150,000 shares of Series A-2 Redeemable Convertible Preferred Stock...... -- -- -- -- Issuance of 110,000 shares of Series B Redeemable Convertible Preferred Stock.................. 10,975,600 -- -- 10,976,700 Proceeds from sale of 124,413 shares under the employee stock purchase program................. 179,793 -- -- 181,037 Loss for the year ended December 31, 2000......................... -- -- (34,001,975) (34,001,975) Dividends on 6% Non-Voting Convertible Preferred Stock, and 7.5% Series A-1 Redeemable Convertible Preferred Stock...... (1,244,751) -- -- (1,244,751) ------------ ------------ ------------- ------------ Balance at December 31, 2000....... $106,547,799 $ -- $(100,473,816) $ 6,254,210 ============ ============ ============= ============
The accompanying notes are an integral part of these finanical statements. F-4 CALIBER LEARNING NETWORK, INC. STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------------------ 1998 1999 2000 ------------ ------------ ------------ OPERATING ACTIVITIES Net loss............................................ $(28,824,514) $(22,242,021) $(34,001,975) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization..................... 4,207,032 6,788,822 7,648,587 Negative amortization of capital lease obligations charged to interest expense..................... 968,216 -- -- Amortization of deferred tenant allowances recorded as a reduction of rent expense......... (176,109) (389,325) (368,372) Changes in operating assets and liabilities: Accounts receivable, net........................ (4,939,055) 1,228,818 (411,373) Receivable from related party................... -- (2,000,000) 1,250,000 Prepaid expenses and other current assets....... (177,640) 122,304 (74,628) Accounts payable and accrued expenses........... 2,464,579 (86,318) (1,578,138) Payable to related party........................ 1,345,776 1,616,033 4,192,907 Management fee payable to Sylvan................ (2,880,500) -- -- Interest payable to Sylvan...................... (301,784) -- -- ------------ ------------ ------------ Net cash used in operating activities............... (28,313,999) (14,961,687) (23,342,992) INVESTING ACTIVITIES Purchases of property and equipment................. (6,866,873) (2,804,930) (2,756,359) Proceeds from sale-leaseback of property and equipment......................................... 540,690 -- 1,341,050 Purchases of available-for-sale securities.......... (8,254,174) -- -- Proceeds from sale of available-for-sale securities........................................ -- 8,254,174 -- Proceeds from deferred tenant allowances............ 2,070,022 54,586 -- Change in other assets.............................. (102,852) (8,450) 5,328 ------------ ------------ ------------ Net cash (used in) provided by investing activities........................................ (12,613,187) 5,495,380 (1,409,981) FINANCING ACTIVITIES Issuance of common stock in initial public offering, net of offering costs of $738,278................. 61,432,222 -- -- Repayments of loan from Sylvan...................... (3,000,000) -- -- Issuance of Class A common stock.................... 150,000 -- -- Issuance of Series A Redeemable Convertible Preferred Stock, net of offering costs of $53,700........................................... -- 14,946,300 -- Issuance of Series B Redeemable Convertible Preferred Stock, net of offering costs of $23,300........................................... -- -- 10,976,700 Proceeds from exercise of stock options............. 7,508 47,540 32,203 Proceeds from purchase of shares under the employee stock purchase program............................ -- 157,175 181,037 Payment of subscription receivable.................. 5,364,358 -- -- Payment of accrued dividends on preferred stock..... (1,210,689) (85,000) -- Payment of capital lease obligations................ (1,787,852) (3,555,340) (4,781,625) ------------ ------------ ------------ Net cash provided by financing activities........... 60,955,547 11,510,675 6,408,315 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents....................................... 20,028,361 2,044,368 (18,344,658) Cash and cash equivalents, beginning of year........ 3,850,440 23,878,801 25,923,169 ------------ ------------ ------------ Cash and cash equivalents, end of year.............. $ 23,878,801 $ 25,923,169 $ 7,578,511 ============ ============ ============
The accompanying notes are an integral part of these financial statements. F-5 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS The Company was founded in 1996 by Sylvan Learning Systems, Inc. ("Sylvan") and MCI WorldCom, Inc. ("MCI") to provide learning services to corporations and universities using the Internet, telecommunications and multimedia technology within a network of specially equipped classroom facilities. Currently, the Company is a leading provider of e-learning infrastructure and services to major corporations in support of their strategic initiatives. The Company has developed a proprietary technology platform that connects large numbers of enterprise constituents, including employees, suppliers, customers and business partners to enable the delivery of targeted, timely information. The Company's focus is on the enterprise learning needs of Global 2000 corporations located in the United States and internationally. RECLASSIFICATION Certain amounts in the accompanying 1999 financial statements have been reclassified to conform to the presentation used in 2000. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. PROPERTY AND EQUIPMENT Property and equipment is stated at cost. Depreciation is computed for owned assets using the straight-line method over the estimated useful lives of the assets. Assets capitalized under capital leases are amortized using the straight-line method over the lesser of the lease terms or the estimated useful lives of the assets. DEFERRED TENANT ALLOWANCES Payments made by landlords to the Company as incentives under operating leases are recorded as liabilities and recognized as reductions in rental expense ratably over the terms of the leases. REVENUE RECOGNITION Revenue is generated primarily from learning services provided to corporations, graduate level learning courses, hourly classroom rental and related services. Revenue from learning courses and training events is recognized over the contract period as the events are delivered. Services unrelated to learning courses or training events are recognized in the period the services are provided. The Company also generates revenue from hourly classroom rental, which is recognized when the service is provided. F-6 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Management fees under an agreement with Sylvan to manage certain computer-based certification centers were calculated based on a fixed amount per month, plus an additional fee per test delivered above a specified number of test examinations. These fees were recognized as revenue upon delivery of the examination. In March 2000, the Company assigned its rights and responsibilities under this agreement to an independent third party. ADVERTISING Costs of advertising are expensed as incurred. Advertising expense totaled $4,071,549, $2,012,240 and $1,826,140 in 1998, 1999 and 2000, respectively. STOCK OPTIONS GRANTED TO EMPLOYEES The Company records compensation expense for all stock-based compensation plans using the intrinsic value method prescribed by APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Financial Accounting Standards Board Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("Statement No. 123") encourages companies to recognize expense for stock-based awards based on their estimated value on the date of grant. Statement No. 123 requires the disclosure of pro forma income and earnings per share data in the notes to the financial statements if the fair value method is not elected. The Company has supplementally disclosed in these financial statements the required pro forma information as if the fair value method had been elected. IMPACT OF ADOPTION OF RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This statement, which is required to be adopted in January 2001, provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. Management does not anticipate that the adoption of the new Statement will have an effect on the financial position or results of operations of the Company. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS. The Company has adopted the provision of SAB No. 101 in its financial statements for the fiscal year ending December 31, 2000. The adoption of this pronouncement did not have any impact on the Company's financial position or results of operations. F-7 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 2. LOSS PER SHARE The following table sets forth the computation of basic and diluted loss per share:
YEAR ENDED DECEMBER 31, ------------------------------------------ 1998 1999 2000 ------------ ------------ ------------ Numerator: Net loss.......................................... $(28,824,514) $(22,242,021) $(34,001,975) Preferred stock dividends......................... (314,409) (266,507) (1,244,751) ------------ ------------ ------------ Net loss attributable to common stockholders...... $(29,138,923) $(22,508,528) $(35,246,726) ============ ============ ============ Denominator: Weighted average number of shares of common stock outstanding during the period................... 11,127,121 12,338,195 12,497,433 Shares of common stock issued for a nominal value........................................... 50,643 -- -- ------------ ------------ ------------ Denominator for loss per share...................... 11,177,764 12,338,195 12,497,433 ============ ============ ============ Basic and diluted loss per share.................... $ (2.61) $ (1.82) $ (2.82) ============ ============ ============
Basic loss per share is based upon the average number of shares of common stock outstanding during each period. As required by the Securities and Exchange Commission in Staff Accounting Bulletin No. 98, all securities issued by the Company for a nominal value have been included in the computations as if they were outstanding for all periods prior to the Company's initial public offering of common stock in May 1998. Diluted loss per common share is equal to basic loss per common share because if potentially dilutive securities were included in the computation the result would be anti-dilutive. These potentially dilutive securities consist of convertible preferred stocks, warrants and stock options. 3. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
YEAR ENDED DECEMBER 31, ----------------------------------- 1998 1999 2000 ----------- --------- --------- Non-cash investing and financing activities: Equipment acquired under capital lease.................. $13,400,271 $ 716,178 $ 596,482 Dividends accrued on 7.5% Series A, 7.5% Series A-1 Redeemable Convertible Preferred Stock and 6% Non-Voting Convertible Preferred Stock............. 314,409 266,507 1,244,751 Interest paid........................................... 1,788,176 1,440,628 1,031,962
4. TRANSACTIONS WITH SYLVAN AND ITS AFFILIATES Effective May 1, 1997, the Company entered into an agreement with Sylvan to manage the operations of certain certification centers located throughout the United States which administer computer-based tests for major corporations, professional associations and government agencies. Revenues under this agreement are classified in the accompanying statements of operations as management fee from Sylvan. F-8 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 4. TRANSACTIONS WITH SYLVAN AND ITS AFFILIATES (CONTINUED) The Company's obligations under this agreement terminated in March 2000 after Caliber assigned the agreement to an independent third party. During all periods presented, the Company purchased under a Management and Facility Use Agreement with Sylvan specified management, accounting and administrative services. In addition, this agreement provides for the use by the Company of certain office space under lease to Sylvan. Annual management fees in 1998, 1999 and 2000 were $2,000,000, $2,000,000 and $1,845,024, respectively. The Company utilizes a centralized disbursement function managed by Sylvan. During 1998, 1999 and 2000, Sylvan paid certain amounts on behalf of the Company related to payroll and other expenses. Amounts payable to Sylvan related to these transactions were $1,345,776, $2,961,809 and $7,154,716 at December 31, 1998, 1999 and 2000, respectively. In February 2001, the Company signed a $7,150,000 promissory note with Sylvan due March 31, 2004 as consideration for this amount payable to Sylvan. The accompanying balance sheet at December 31, 2000 has been reclassified to present the obligation to Sylvan in accordance with its contractual payment terms. The note bears interest at 15% per annum and is payable in installments consisting of (i) $1,000,000 upon signing the note, (ii) $736,000 on March 31, 2001, (iii) three quarterly payments of $400,000 commencing June 30, 2001, (iv) eight quarterly payments of $500,000 in 2002 and 2003, and (v) a final payment of $214,000 on March 31, 2004. The interest rate of 15% per annum consists of a cash component equal to 8% per annum payable quarterly and a component which accrues and is payable at maturity equal to 7% of principal. The promissory note is secured by a lien on all of the Company's assets. In connection with the issuance of a note to Sylvan in February 2001, the Company granted Sylvan warrants to purchase 240,000 shares of common stock at an exercise price of $3.50 per share. One half of the warrants vested upon the signing of the note, and the remaining half vest on December 31, 2001. During the third quarter of 1999, the Company entered into a Course Conversion and Hosting Agreement with LeapIT.com, LLC, an affiliate of Sylvan. For the years ended December 31, 1999 and 2000, service fee revenue from related party in the accompanying statements of operations includes $2,000,000 and $1,750,000, respectively, of revenues from LeapIT.com, LLC. In addition, $2,000,000 and $750,000 is included as a receivable from related party in the accompanying balance sheets at December 31, 1999 and 2000, respectively, related to this agreement. The Company provided consulting and other services under this agreement, which was concluded in 2000. 5. CAPITAL LEASES MCI WorldCom, a stockholder of the Company, provided an aggregate of $20.0 million in lease financing guaranties for the purchase of furniture and equipment. F-9 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 5. CAPITAL LEASES (CONTINUED) Property and equipment includes the following amounts for leases that have been capitalized at December 31, 2000: Furniture and fixtures...................................... $ 632,265 Computer equipment and software............................. 16,029,332 Leasehold improvements...................................... 3,338,403 ----------- 20,000,000 Less: accumulated amortization.............................. (11,308,419) ----------- $ 8,691,581 ===========
Amortization of leased assets is included in depreciation and amortization expense. Future minimum payments under capital lease obligations consist of the following at December 31, 2000: 2001........................................................ $ 6,490,340 2002........................................................ 3,820,404 2003........................................................ 1,717,184 2004........................................................ 171,908 ----------- Total minimum lease payments................................ 12,199,836 Amounts representing interest............................... (1,269,384) ----------- Present value of net minimum lease payments (including current portion of $5,682,950)............................ $10,930,452 ===========
6. INITIAL PUBLIC OFFERING AND RECAPITALIZATION In May 1998, the Company completed an initial public offering of its Common Stock. The net proceeds to the Company from the sale of the 4,500,000 shares of Common Stock offered therein were approximately $58.1 million. Also during May 1998, the underwriters of the initial public offering exercised their over-allotment option in full. The net proceeds to the Company from this sale of an additional 275,000 shares of its Common Stock was approximately $3.6 million. The initial public offering of Common Stock met the criteria for the automatic conversion of the outstanding 8% Series A Redeemable Convertible Preferred Stock and Series B Redeemable Junior Convertible Preferred Stock into Common Stock and the repayment of all accrued and unpaid dividends on the 8% Series A Redeemable Convertible Preferred Stock. Additionally, the Company completed a recapitalization effective upon closing of the initial public offering referred to above. The Company's charter was amended to authorize a single class of Common Stock, $0.01 par value, for which all shares of Class A Common Stock were exchanged on a share-for-share basis, and a series of 6% Non-Voting Convertible Preferred Stock, for which all shares of Class B Common Stock were exchanged on a share-for-share basis. F-10 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 7. PREFERRED STOCK The Company has three series of Preferred Stock outstanding at December 31, 2000, 6% Non-Voting Convertible Preferred Stock, 7.5% Series A-2 Redeemable Convertible Preferred Stock and 7.5% Series B Redeemable Convertible Preferred Stock. Each share of the 6% Non-Voting Convertible Preferred Stock issued in connection with the 1998 recapitalization described in Note 6 is convertible into one share of common stock at the option of the holder at any time after May 2000. Dividends of $60,000 per year are cumulative and were first payable in May 1999. In October 1999, the Company issued 150,000 shares of 7.5% Series A Redeemable Convertible Preferred Stock ("Series A") for a total aggregate purchase price of $15.0 million. In September 2000, all of the holders of the Company's outstanding Series A Redeemable Convertible Preferred Stock exchanged their shares for a like number of shares of a new series of preferred stock designated as Series A-1 Redeemable Convertible Preferred Stock ("Series A-1"). On December 29, 2000, all of the holders of the Company's outstanding Series A-1 Redeemable Convertible Preferred Stock exchanged their shares for a like number of shares of a new series of preferred stock designated as Series A-2 Redeemable Convertible Preferred Stock ("Series A-2") due to a change in conversion rights. On December 29, 2000, the Company also issued 110,000 shares of 7.5% Series B Redeemable Convertible Preferred Stock ("Series B") for a total aggregate purchase price of $11.0 million. The Series A-2 and Series B were issued with the following terms: REDEMPTION RIGHTS The Series A-2 and Series B are redeemable in whole on October 31, 2005 and June 30, 2005, respectively. Both series are redeemable in cash or common stock at the option of the Company and have a redemption amount of $100 per share plus all accrued and unpaid dividends. CONVERSION RIGHTS The Series A-2 and Series B are convertible into Common Stock at the option of the holder at any time. The Series A-2 and Series B are convertible at a converison price of $3.50 per share. Both series will be adjusted to provide for certain subsequent issuances of Common Stock which would result in dilution. DIVIDENDS The holders of both series are entitled to receive quarterly cumulative dividends at a rate of 7.5% per annum. The first dividend payment dates on the Series A-2 and Series B are December 31, 2000 and March 31, 2001, respectively. Accrued dividends may be payable at the election of the Company in cash or additional shares. LIQUIDATION Both series have a preference on liquidation equal to $100 per share plus all accrued and unpaid dividends. The Series B has preference in liquidation over Series A-2. VOTING RIGHTS Both Series have substantially the same voting rights as the number of shares of Common Stock into which they can be converted. F-11 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 8. WARRANT AND SHARES RESERVED FOR FUTURE ISSUANCE The Company at December 31, 2000 has reserved 3,514,068 shares of common stock for future issuance upon the exercise of stock options eligible for granting or previously granted under the 1997 and 1998 Plans and under other grants made to certain executives, 4,681,303 shares of common stock issuable upon the conversion of the 7.5% Series A-2 Redeemable Convertible Preferred Stock, 8,571,429 shares of common stock issuable upon the conversion of the 7.5% Series B Redeemable Convertible Preferred Stock assuming the issuance of $30.0 Million in 7.5% Series B Redeemable Convertible Preferred Stock at an initial conversion price of $3.50, 5,167,328 shares of common stock issuable upon the conversion of the 6% Non-Voting Convertible Preferred Stock and 400,000 shares issuable under the Employee Stock Purchase Plan. In addition, a warrant to purchase 1,193,573 shares of common stock for $3.169 per share was outstanding at December 31, 2000. This warrant expires on November 22, 2006. 9. STOCK COMPENSATION PLAN Effective April 30, 1997, the Company adopted the Caliber Learning Network, Inc. 1997 Stock Option Plan (the "1997 Plan") which is administered by the Board of Directors. The 1997 Plan provides for the granting of either qualified or non-qualified options to purchase an aggregate of up to 1,227,400 shares of Common Stock to eligible employees, officers, and consultants of the Company. Effective February 17, 1998, the Company terminated the 1997 Plan except in respect to awards outstanding as of that date. Effective February 17, 1998, the Company adopted the Caliber Learning Network, Inc. 1998 Stock Incentive Plan (the "1998 Plan") which is administered by the Board of Directors. The 1998 Plan provides for the granting of either qualified or non-qualified options to purchase an aggregate of up to 1,416,603 shares of Common Stock to eligible employees, officers, directors and consultants of the Company. During 2000, the Company granted options to purchase 1,200,000 shares of Common Stock to certain executives of the Company. These grants were not made pursuant to the 1997 Plan or the 1998 Plan, but were specifically approved by the Board of Directors. A summary of the Company's stock option activity, and related information for the years ended December 31, 1998, 1999 and 2000 is as follows:
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------------------ 1998 1999 2000 ---------------------------- ---------------------------- ---------------------------- NUMBER OF WEIGHTED-AVERAGE NUMBER OF WEIGHTED-AVERAGE NUMBER OF WEIGHTED-AVERAGE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE --------- ---------------- --------- ---------------- --------- ---------------- Outstanding, beginning of year............... 1,070,047 $1.07 1,176,399 $2.21 1,043,744 $2.81 Granted................. 206,165 7.62 118,500 5.20 2,184,000 3.01 Excercised.............. (6,994) 1.07 (45,276) 1.05 (28,298) 1.18 Forfeited............... (92,819) 1.05 (205,879) 1.42 (294,209) 2.59 --------- ----- --------- ----- --------- ----- Outstanding, end of year.................. 1,176,399 $2.21 1,043,744 $2.81 2,905,237 $3.00 ========= ===== ========= ===== ========= ===== Excercisable at end of year............... 195,420 339,514 457,294 ========= ========= =========
F-12 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 9. STOCK COMPENSATION PLAN (CONTINUED) During 2000, the Company granted options to purchase common stock when the quoted market price of common stock was equal to or less than the exercise price of the granted options. The following table summarizes the weighted-average fair values and exercise prices of granted stock options during 2000:
WEIGHTED AVERAGE WEIGHTED AVERAGE EXERCISE PRICE FAIR VALUE ---------------- ---------------- Market price equal to exercise price on grant date........................................ $2.94 $2.81 Market price less than exercise price on grant date........................................ 3.00 1.47
Options granted in 1998 and 1999 had a fair value at the date of grant of $2.74 and $3.56, respectively. Exercise prices for options outstanding as of December 31, 2000 ranged from $1.02 to $14.31 as follows:
WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE EXCERCISE PRICES REMAINING CONTRACTUAL EXERCISE PRICES RANGE OF EXERCISE OPTIONS OF OPTIONS LIFE OF OPTIONS OPTIONS OF OPTIONS PRICES OUTSTANDING OUTSTANDING OUTSTANDING EXCERCISABLE EXCERCISABLE - ----------------- ----------- ---------------- --------------------- ------------ ---------------- $1.02-$2.44.......... 746,737 $ 1.11 6.83 412,394 $ 1.08 $3.00-$3.88.......... 1,932,000 $ 3.00 9.79 2,000 $ 3.00 $4.12-$5.38.......... 158,000 $ 4.67 9.00 15,500 $ 5.23 $8.00-$14.31......... 68,500 $13.42 7.49 27,400 $12.93
To determine the pro forma data required by Statement No. 123, the Company used option pricing models to measure the fair value of options at the date of grant. For all option grants prior to May 5, 1998 (the initial public offering date), the Company used the minimum value method to calculate pro forma compensation expense. For all grants after May 5, 1998, the Company used the Black-Scholes option pricing model. The minimum value method calculates the fair value of options as the excess of the estimated fair value of the underlying stock at the date of grant over the present value of both the exercise price and the expected dividend payment, each discounted at the risk-free rate, over the expected life of the option. In determining the estimated fair value of granted stock options under the minimum value method, the risk-free interest rate was assumed to be 5.5%, the dividend yield was estimated to be 0% and the expected life of granted options varied from one to five years depending upon the vesting period. Options valued using the Black-Scholes option pricing model assumed the following: risk-free interest rate of 5.5% in 1998, 1999 and 2000, dividend yields of 0% in 1998, 1999 and 2000, volatility factors of the expected market price of the Company's common stock of 1.04 in 1998, .792 in 1999 and 1.186 in 2000 and an expected life of the granted options of one to five years, depending on the vesting period. The Black-Scholes option pricing model and other models were developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. F-13 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 9. STOCK COMPENSATION PLAN (CONTINUED) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma net loss attributable to common stockholders was $29.3 million, $22.7 million and $36.0 million for the years ended December 31, 1998, 1999 and 2000, respectively. Pro forma basic and diluted loss per share attributable to common stockholders was $(2.62), $(1.84) and $(2.88) for the years ended December 31, 1998, 1999 and 2000, respectively. 10. INCOME TAXES At December 31, 2000, the Company had net operating loss carryforwards for income tax purposes of approximately $93.9 million, which will begin to expire in 2011. Income tax regulations contain provisions which may limit the net operating loss carryforwards available to be used in any given year if certain events occur, including changes in ownership interest. Significant components of the Company's deferred tax assets and liabilities are as follows:
DECEMBER 31 --------------------------------------- 1998 1999 2000 ----------- ----------- ----------- Net operating loss carryforwards...................... $14,719,056 $22,606,186 $36,262,432 Start-up costs capitalized for tax purposes........... 182,850 129,330 -- Allowance for doubtful accounts....................... 1,033,471 1,439,732 104,043 Deferred revenue...................................... 93,396 123,629 160,727 Book over tax depreciation............................ 869,386 1,096,037 2,030,958 Other................................................. 114,118 162,143 73,051 ----------- ----------- ----------- Total deferred tax assets........................... 17,012,277 25,557,057 38,631,211 ----------- ----------- ----------- Total deferred tax liabilities...................... 34,339 21,402 -- ----------- ----------- ----------- Net future income tax benefit......................... 16,977,938 25,535,655 38,631,211 Valuation allowance for deferred tax assets........... (16,977,938) (25,535,655) (38,631,211) ----------- ----------- ----------- Net deferred tax assets............................... $ -- $ -- $ -- =========== =========== ===========
The reconciliation of the reported income tax benefit to the amount that would result by applying the U.S. federal statutory tax rate to the reported net loss is as follows:
DECEMBER 31 ---------------------------------------- 1998 1999 2000 ----------- ----------- ------------ Tax benefit at U.S. federal statutory rate............ $(9,800,335) $(7,562,287) $(11,560,672) Effect of permanent differences....................... 11,910 32,151 36,007 State income taxes.................................... (1,331,693) (1,027,581) (1,570,891) Increase in valuation allowance....................... 11,120,118 8,557,717 13,095,556 ----------- ----------- ------------ Total............................................... $ -- $ -- $ -- =========== =========== ============
11. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of accounts receivable. The Company maintains an allowance for losses on receivables F-14 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 11. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK (CONTINUED) based on the collectibility of all amounts owed. The Company generally does not require collateral for trade receivables. At December 31, 2000, 36% of accounts receivable was due from two customers. 12. OPERATING LEASES The Company conducts all of its operations from leased facilities under operating leases that have terms of up to ten years and generally contain renewal options and rental escalation clauses. The rental payments under certain leases are based on minimum fixed rentals plus a percentage of revenues earned at the location. Future minimum payments under noncancelable operating leases with initial terms of one year or more consisted of the following at December 31, 2000: 2001........................................................ $3,113,049 2002........................................................ 2,996,842 2003........................................................ 2,066,184 2004........................................................ 1,420,965 2005........................................................ 386,747 Thereafter.................................................. -- ---------- Total....................................................... $9,983,787 ==========
The Company incurred rent expense of $5,194,910, $5,148,566 and $4,330,739 in 1998, 1999 and 2000, respectively. 13. DEFINED CONTRIBUTION RETIREMENT PLAN Employees of the Company are eligible to participate in a defined contribution retirement plan sponsored by Sylvan. The provisions of the plan allow for voluntary employee contributions, subject to certain annual limitations, and discretionary contributions by the employer, which are allocated to eligible participants based upon compensation. All employees are eligible after meeting certain age and service requirements. The Company made contributions of $30,337, $85,852 and $102,888 for the years ended December 31, 1998, 1999 and 2000, respectively. 14. BUSINESS SEGMENT INFORMATION DESCRIPTION OF SEGMENTS The Company provides high-quality continuing education and training services. Prior to the first quarter of 2000, the Company operated in three distinct operating segments--Academic, Corporate and Other Products and Services. During the first quarter of 2000, the Company changed the manner in which it manages its operations and reports the activities of those operations. The Company is now organized into two distinct operating segments--Corporate and Other Products and Services. A description of each segment is provided below. F-15 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 14. BUSINESS SEGMENT INFORMATION (CONTINUED) CORPORATE SEGMENT The Company markets its network to Global 2000 corporations, as a solution to their corporate communications, professional development and training needs. The Company makes its network available to corporations to provide nationwide distribution of corporate communications, professional development and training programs. In addition, the Company has partnered with universities having national reputations in various fields of expertise to market content to corporations. OTHER PRODUCTS AND SERVICES SEGMENT The Company's Other Products and Services Segment principally consist of training services and test administration services, as well as a developing portfolio of solutions designed to maximize the revenue generating capabilities of its network and achieve the fullest possible utilization of the network infrastructure and Company personnel. MEASUREMENT OF SEGMENT PROFIT OR LOSS AND SEGMENT ASSETS The Company evaluates the performance of its operating segments and allocates resources based on an internally defined measure of operating income. Operating income is defined as revenue less certain direct costs that are directly attributable to the activities of the operating segment. These direct costs include labor, production and delivery costs to develop and facilitate various programs. Costs associated with the facilities used for test administration services are included in the direct costs of the Other Products and Services segment. Unallocated expenses, consisting principally of Caliber center operating expenses and depreciation and amortization expense are not directly attributable to the operating segments and are not allocated. The Company does not allocate assets to its reportable segments as assets are not specifically attributable to any particular segment. Accordingly, asset information by reportable segment is not presented. The accounting policies used by the reportable segments are the same as those used by the Company as described in Note 1 of the financial statements. There are no significant intersegment sales or transfers. FACTORS MANAGEMENT USES TO IDENTIFY THE COMPANY'S REPORTABLE SEGMENTS The Company's reportable segments are business lines that offer distinct products and services. The segments are managed separately as they have different customer bases. F-16 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 14. BUSINESS SEGMENT INFORMATION (CONTINUED) The following table sets forth information on the Company's reportable segments:
YEAR ENDED DECEMBER 31, 1998 ------------------------------------------ OTHER PRODUCTS CORPORATE AND SERVICES TOTAL ----------- -------------- ----------- Revenues.............................. $11,518,107 $ 3,896,971 $15,415,078 Direct costs.......................... 5,178,406 5,306,519 10,484,925 ----------- ----------- ----------- Segment operating income (loss)....... $ 6,339,701 $(1,409,548) $ 4,930,153 =========== =========== ===========
YEAR ENDED DECEMBER 31, 1999 ------------------------------------------ OTHER PRODUCTS CORPORATE AND SERVICES TOTAL ----------- -------------- ----------- Revenues.............................. $17,199,385 $8,833,364 $26,032,749 Direct costs.......................... 4,941,712 5,205,890 10,147,602 ----------- ---------- ----------- Segment operating income.............. $12,257,673 $3,627,474 $15,885,147 =========== ========== ===========
YEAR ENDED DECEMBER 31, 2000 ------------------------------------------ OTHER PRODUCTS CORPORATE AND SERVICES TOTAL ----------- -------------- ----------- Revenues.............................. $15,609,142 $5,295,429 $20,904,571 Direct costs.......................... 5,589,046 1,345,730 6,934,776 ----------- ---------- ----------- Segment operating income.............. $10,020,096 $3,949,699 $13,969,795 =========== ========== ===========
The following table reconciles the reported information on segment direct costs to total operating expenses as reported in the statement of operations for the year ended December 31, 1998, 1999 and 2000:
1998 1999 2000 ----------- ----------- ----------- Segment direct costs.................. $10,484,925 $10,147,602 $ 6,934,776 Fixed costs Depreciation and amortization....... 4,207,032 6,788,822 7,648,587 Unallocated center operating expenses.......................... 9,564,646 10,689,864 11,079,759 ----------- ----------- ----------- Operating expenses.................... $24,256,603 $27,626,288 $25,663,122 =========== =========== ===========
F-17 CALIBER LEARNING NETWORK, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 14. BUSINESS SEGMENT INFORMATION (CONTINUED) The following table reconciles the reported information on segment operating income to net loss as reported in the statements of operations for the year ended December 31, 1998, 1999 and 2000:
1998 1999 2000 ------------ ------------ ------------ Segment operating income............ $ 4,930,153 $ 15,885,147 $ 13,969,795 Unallocated operating expenses: Sales and marketing............... (8,621,042) (9,745,788) (14,687,173) Depreciation and amortization..... (4,207,032) (6,788,822) (7,648,587) Center operating expenses......... (9,564,646) (10,689,864) (11,079,759) General and administrative expenses.......................... (9,536,161) (8,810,853) (12,944,977) Management fee payable to Sylvan.... (2,000,000) (2,000,000) (1,845,024) Other income (expense).............. 174,214 (91,841) 233,750 ------------ ------------ ------------ Net loss............................ $(28,824,514) $(22,242,021) $(34,001,975) ============ ============ ============
Substantially all of the revenues and assets of the Company's reportable segments are located in the United States. The Company had one customer in the Corporate Segment that represented 29% of revenues for the year ended December 31, 2000. 15. GOING CONCERN The Company's financial statements have been prepared on a going concern basis, which contemplates the realization of assets and settlement of liabilities in the normal course of business. As of December 31, 2000, the Company had cash and cash equivalents of $7,578,511 and a working capital deficiency of $662,672. The Company believes that its cash will be sufficient to meet its obligations in the ordinary course of business into May 2001. The Company is currently seeking additional long-term financing to provide for its anticipated cash needs until cash flows from operations are sufficient to sustain the growth of the business. Management believes that sufficient capital can be obtained to support planned operations through December 31, 2001. However, there can be no assurance that the Company will be able to obtain this financing on acceptable terms. 16. SUBSEQUENT EVENTS In March 2001, the Company issued 40,000 shares of 7.5% Series B Redeemable Convertible Preferred Stock for a total aggregate purchase price of $4.0 million. The terms are the same as described in Note 7 for the Series B Redeemable Convertible Preferred Stock issued in December 2000. In March 2001, the Company acquired all of the outstanding stock of Fulcrum Information Services, Inc. ("Fulcrum"), an established provider of high-level content and services for corporations and professional services firms for an initial cash purchase price of $1.0 million. The acquisition was accounted for using the purchase method of accounting. In addition, variable amounts of contingent consideration also are payable to Fulcrum's selling shareholders if specified levels of earnings are achieved in 2001 and 2002, payable in common stock. The Company will record the contingent consideration as goodwill when the contingencies are resolved and the additional consideration is payable. F-18 -----END PRIVACY-ENHANCED MESSAGE-----