| EDUCATE INC Item 1A Risk Factors |
| Risks Relating to Our Learning Center Segment Our inability to adequately manage our growth could have an adverse effect on our operations |
| We have increased the number of our company-owned Sylvan Learning Center territories from 82 as of January 1, 2000 to 171 as of December 31, 2005 |
| We intend to continue increasing the number of company-owned territories by opening new territories and acquiring franchisee-owned territories |
| We may not be able to integrate territories acquired from franchisees into our other operations without substantial costs, delays or other operational or financial problems |
| In particular, in 2005 we experienced higher than expected integration costs and lesser than expected revenues for many of our acquired territories |
| In addition, as our business grows, more resources will be required to support our operations, including hiring teachers, directors of education, center directors and area managers, particularly if this growth occurs outside of the 37 markets in which we now operate company-owned territories |
| Our inability to manage our anticipated growth may adversely affect the quality and consistency of our programs, our ability to integrate new personnel and our ability to capitalize on new business opportunities |
| In response to our same territory revenue growth in 2005, we implemented a new strategy to restore growth, but we cannot assure you that our new strategy will be effective |
| In 2005, our same territory revenues grew modestly compared to the prior year in our Learning Center business |
| While segment revenues grew by 34prca over 2004 due primarily to acquisitions, same territory revenues increased by 3prca |
| Inquiries declined from the prior year, and we did not achieve expected levels of revenue growth, especially at our company-owned centers |
| In response to these conditions we developed a three-point strategy to restore growth |
| We intend to: (1) implement management changes, designed to add strength while eliminating unneeded layers in the key company-owned center portion of the team, (2) implement new inquiry and enrollment conversion tools, and (3) develop premium and value-based programs |
| However, we cannot assure you that these changes will have the intended effect or that they will result in increased revenues or profits |
| Actions of teachers, instructors and other personnel could lead to liability claims and damage to our reputation, which could cause us to incur substantial costs and strain our relationships with franchisees |
| We could become liable for the actions of teachers and other personnel at our company-owned learning territories or other areas in which we provide services, including schools and students’ homes |
| In the event of accidents or injuries or other harm to students, we could face claims alleging that we were negligent, provided inadequate supervision or were otherwise liable for the injuries |
| A liability claim against us or any of our employees could adversely affect our reputation with our customers, which could adversely affect our 7 ______________________________________________________________________ [34]Table of Contents enrollment and revenue |
| Even if unsuccessful, such a claim could create unfavorable publicity, cause us to incur substantial expenses and divert the time and attention of management |
| Unfavorable publicity resulting from a liability claim against us or any of our employees may also adversely affect our franchisees’ businesses, which could strain our relationships with franchisees |
| Actions taken by our franchisees may harm our business |
| Our business is dependent upon our franchisees and the manner in which they operate their franchised territories under our licensed brand |
| If a franchisee were to engage in unauthorized or unlawful conduct, the general public may associate this conduct with our brand, and negative publicity associated with this conduct could affect the reputation and success of all of our centers |
| Our business may also be adversely affected if our franchisees do not operate their territories and provide tutoring services in a manner consistent with our standards and requirements or do not hire and train qualified teachers |
| Our license agreements with our franchisees do not require them to conduct background checks on prospective employees |
| In addition, a liability claim against a franchised center or any center personnel may result in unfavorable publicity for all of our learning centers, whether or not the claim is successful |
| Our ability to grow may be hindered and our business may suffer if our franchisees do not adopt and effectively implement improved programs and business practices we develop |
| We are dependent on the willingness of our franchisees to adopt and effectively implement improved programs and business practices we develop in order to increase franchised center-based revenues and resulting royalties paid to us |
| However, franchisees often are not required to adopt these practices and they may adopt and implement our programs and business practices more slowly than we anticipate, or not at all |
| Any of these delays or failures could result in lower franchised center-based revenues and royalties paid to us, thus limiting our growth |
| Our failure to maintain good relationships with our franchisees could significantly reduce our revenue and income |
| Our relationships with our franchisees may deteriorate in the future |
| Any deterioration in our relationship with our franchisees could significantly reduce our revenue and require management to direct their time and effort to rebuild strained relationships with franchisees |
| If management’s attention is focused on repairing relationships with franchisees instead of developing new programs and processes to increase revenue and income, our business and prospects may be adversely affected |
| If we fail to sell licenses for new franchise territories, our financial performance and growth prospects may be adversely affected |
| The growth of our business is dependent upon increasing the number of our franchised centers by selling licenses for new territories |
| Damage to our reputation and competition from other franchised supplemental education service providers may adversely affect our ability to sell licenses for additional franchise territories |
| If this were to occur, continued expansion would require the opening of a larger number of company-owned centers than we currently have planned which would require significantly more time and capital expenditures by us and could hinder or prevent our expansion |
| The sale of licenses for new franchise territories could harm our relationship with existing franchisees |
| Some or our franchisees presently benefit from being located adjacent to unlicensed territories |
| If we sell licenses for those unlicensed territories, the existing franchisees may have an adverse reaction, potentially straining our relationship with them |
| New programs, services, and products may not be accepted and purchased by institutional customers and consumers |
| As part of our growth strategy, we intend to implement, offer, and sell new programs, services, and products |
| There can be no guarantee that the new programs, services, and products will be successful or that our institutional customers and consumers will accept and purchase them |
| A source of growth of our business will be in the creation, manufacture, and sale of educational products that are fun, easy to use, and effective |
| We may experience manufacturing problems, distribution problems, and inventory management problems |
| In addition, there are risks due to the seasonal nature of the product business and we may experience problems as we sell the products internationally |
| 8 ______________________________________________________________________ [35]Table of Contents We intend to open additional learning centers in targeted geographic areas, creating the risk that we may over-saturate a particular market |
| As part of our growth strategy, we intend to open additional company-owned learning centers in areas that we believe have a low center density, as measured by centers per child |
| There can be no guarantee that any incremental revenue we realize from this strategy will exceed the increase in our operating costs resulting from opening and operating additional centers |
| If the incremental revenue generated by new centers is less than the added costs of opening and operating additional centers, our operating income will decrease |
| We rely on the accuracy of the unaudited financial information we receive from our franchisees, over which we do not have direct supervision or control and which we do not routinely audit |
| Under their license agreements with us, our franchisees are required to report financial and other data to us, including their learning center revenues and results of operations |
| We rely on franchisee data to make important business decisions |
| However, we do not routinely audit the information that our franchisees report to us, and we do not have direct supervision over the reporting of our franchisees |
| Therefore, we are unable to ensure that the data reported by our franchisees is accurate |
| If the data reported by our franchisees is not accurate, it may cause determinations made by us in reliance on the reported data to be inaccurate and may result in less informed business decisions by management |
| Franchise regulations could limit our ability to terminate or replace unproductive franchises, which could result in lower franchise royalties |
| Applicable laws may delay or prevent us from terminating an unproductive franchise or withholding our consent to renew or transfer a franchise, which could result in lower franchise royalties |
| As a franchisor, we are subject to federal, state and international laws regulating the offer and sale of franchises |
| These laws also frequently apply substantive standards to the relationship between franchisor and franchisee and limit the ability of a franchisor to terminate or refuse to renew a franchise |
| Compliance with federal, state and international franchise laws can be costly and time consuming, and we cannot be certain that we will not encounter delays, expenses or other difficulties in this area |
| Further, the nature and effect of any future legislation or regulation of our franchise operations cannot be predicted |
| The provision of NCLB services under the Ace it! |
| or Sylvan brands by our franchisees may harm our reputation and negatively affect our financial condition |
| Many of our franchisees began providing NCLB services commencing in the 2004-2005 school year under the Ace it! |
| If our franchisees are unsuccessful in providing NCLB services, or are disqualified as providers of these services, the reputation and success of our Sylvan Learning Center business could be adversely affected if consumers associate the provision of such services by our franchisees with the services provided through our Sylvan business |
| Economic, political and other risks associated with our European and Canadian centers could adversely affect our business |
| Our European and Canadian centers are subject to a number of risks inherent to operating in foreign countries |
| For example, risks affecting our European and Canadian centers include: • fluctuations in foreign currency exchange rates; • differences or unexpected changes in regulatory requirements; • foreign governments’ restrictive trade policies; • the imposition of, or increase in, duties, taxes, government royalties or non-tariff trade barriers; • exchange controls; • challenges of operating in international markets with different cultural bases and consumer preferences; and • increased dependence on local country managers |
| We cannot predict the nature or likelihood of any such events |
| However, if such an event should occur, it could adversely affect our business, financial condition and results of operations |
| 9 ______________________________________________________________________ [36]Table of Contents Risks Relating to Our Catapult Learning Segment Our Catapult Learning segment conducts business largely with local education authorities, the composition of which change from time to time |
| As a result of these changes, our relationship can be adversely affected, leading to reductions in business and harm to our reputation |
| A substantial portion of our revenue, 33prca and 26prca in 2004 and 2005, respectively, is generated by our Catapult Learning segment |
| This segment provides services to government agencies, primarily to school districts, and therefore is exposed to the risks associated with government contracting |
| Many of our contracts with school districts are school-year contracts subject to annual renewal at the option of the school district, and in many instances the school district can terminate or modify the contracts at their convenience |
| Any negative publicity, whether or not the reason for such publicity is within our control, could cause a school district to terminate or fail to renew a contract |
| Changes in the composition of local school boards or changes in school district administration may adversely affect a school district’s willingness to contract with us |
| In addition, any termination or non-renewal of a contract with a school district could have an adverse effect on our results of operations, and a termination or non-renewal caused by our failure to improve the poor academic performance of students enrolled in our programs could adversely affect our ability to secure contracts with other school districts |
| Changes in Federal and state laws reducing or eliminating funding for third-party suppliers of supplemental education services could adversely affect our business |
| Our Catapult Learning segment relies almost exclusively on government-funded programs |
| The federal government and state governments may, at any time, reduce, or lower the rate of growth of, funding under the Elementary and Secondary Education Act (ESEA), the Individuals with Disabilities Education Act (IDEA) or similar programs |
| The US Congress may modify or repeal the ESEA (currently reauthorized as the No Child Left Behind Act) or modify the IDEA, thus reducing the amount of federal money available to fund our programs |
| The Federal and state governments may eliminate or specifically limit the amount of funds spent on third-party supplemental education services |
| Any such reduction, limitation or elimination of funding could adversely affect our Catapult Learning revenue |
| If we fail to comply with applicable state and federal regulations, we may face government sanctions |
| As a result of providing services funded by government programs, we are subject to state and federal regulations |
| Compliance with state and federal regulations can be costly and time consuming, and we cannot be sure that we will not encounter delays, expenses or other difficulties |
| Further, our failure to comply with these regulations could result in financial penalties or restrictions on our operations |
| Additional Risks Relating to Our Business and Industry Our operating results may vary significantly from quarter to quarter as a result of seasonal and other variations to which our business is subject |
| This may result in volatility or adversely affect our stock price |
| We experience seasonality in results of operations primarily as a result of changes in the level of student enrollments during the course of the school year and the duration of the school year |
| Also, we recognize franchise royalty revenue based upon our cash receipts from franchisees, in accordance with the terms of our franchise agreements |
| Because many customers prepay for programs at the time of enrollment, the timing of our franchise royalty revenues tends to correspond to student enrollment dates |
| In our company-owned center and other businesses, however, we recognize revenue as we deliver services |
| We typically generate the largest portion of our Learning Center and Catapult Learning revenue in the second quarter, and we experience lower revenues from franchise royalties in the fourth quarter as a result of prepayments by customers to our franchisees in other quarters |
| As our institutional and learning center revenue grows at varying rates, these seasonal fluctuations may become more evident |
| As a result, we believe that quarter-to-quarter comparisons of our results of operations may not be a fair indicator and should not be relied upon as a measure of future performance |
| Our historical results of operations may not be indicative of future performance, which is difficult to forecast |
| We expect our results to vary from quarter to quarter |
| We expect results of operations to fluctuate in response to factors in addition to seasonal fluctuations |
| These factors include the timing of receipt of payment from our customers, including those under government contracts funded under Title I and other legislation, changes in the percentage of customers prepaying in our franchised centers and the timing of revenue recognition of franchise license fees |
| Changes in the pattern of customer prepayments in our franchised centers would cause fluctuations of operating results because these changes impact our franchise royalty revenues |
| In the Catapult Learning segment, there are often significant delays in payment by the school districts |
| We have a limited operating history as an independent company, which may make our business difficult to evaluate |
| We commenced operations as an independent company in 2003 |
| As a result, we have only a limited operating history as an independent company upon which you can evaluate our business and prospects |
| We will encounter risks, uncertainties and difficulties frequently experienced by other similarly situated companies, such as maintaining adequate internal controls and procedures and managing the expansion of our operations |
| If we do not successfully manage these risks, our business, financial condition and results of operations will be adversely affected |
| 10 ______________________________________________________________________ [37]Table of Contents We expect that new products and programs we develop will expose us to risks that may be difficult to identify until such products or programs are implemented |
| We are currently developing, and in the future will continue to develop, new products and programs, the risks of which will be difficult to ascertain until these future programs are implemented |
| For example, we recently introduced new programs and procedures through which our Sylvan Learning Center franchisees may choose to offer NCLB services, under the name Ace it! |
| In addition, in February 2005, we acquired the Hooked on Phonics brand of educational programs |
| These new products and programs differ significantly from the services our Sylvan Learning Center franchisees currently provide in their learning centers |
| Any negative events or results that may arise as we develop new products or programs may adversely affect our reputation, business, financial condition and results of operations |
| New products and programs we develop may compete with our current programs |
| We are presently developing, and will likely in the future develop, products and programs that compete with our existing programs |
| For example, as discussed above, our Sylvan Learning Center franchisees began offering NCLB services under the name Ace it! |
| Our Hooked on Phonics brand, to some extent, also competed with our existing programs |
| Our success depends on our ability to recruit and retain necessary personnel |
| Our success also depends, in large part, upon our ability to attract and retain highly qualified personnel |
| For example, our Progressus Therapy business must recruit qualified occupational therapists, physical therapists and speech language pathologists to administer the specialized services we provide |
| A shortage of qualified therapists and pathologists currently exists, which may inhibit us from satisfying demand and could limit our growth |
| In addition, as a result of higher elementary school enrollment and the retirement of veteran teachers, a shortage of teachers may develop over the next decade |
| We may have difficulty locating and hiring qualified teachers and retaining such personnel once hired |
| We depend on key personnel, including R Christopher Hoehn-Saric, Peter Cohen, Christopher Paucek and Kevin Shaffer, to effectively operate our business |
| If any of our key personnel left our company and we failed to effectively manage a transition to new personnel, or if we fail to attract and retain qualified and experienced personnel on acceptable terms, our business, financial condition and results of operations could adversely be affected |
| Our substantial indebtedness could adversely affect our financial condition and impact our business and growth prospects |
| As of December 31, 2005, our total indebtedness was approximately dlra162dtta8 million |
| Our substantial indebtedness could have important consequences to you |
| For example, it could: • require the use of all or a large portion of our cash to pay principal and interest on our operating company’s secured credit facility, which could reduce the availability of cash to fund working capital, capital expenditures and other business activities; • increase our vulnerability to general adverse economic and industry conditions; • limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; • restrict us from making strategic acquisitions or exploiting business opportunities; • place us at a competitive disadvantage compared to our competitors that have less debt; and • limit our ability to borrow additional funds, dispose of assets or pay cash dividends, if we choose to pay dividends in the future |
| Furthermore, all of our indebtedness under our operating company’s secured credit facility bears interest at variable rates |
| If these rates were to increase significantly, our interest expense would increase, our ability to borrow additional funds may be reduced and the risks related to our substantial indebtedness would intensify |
| The terms of our secured credit facility restrict us from engaging in many activities and require us to satisfy various financial tests |
| We expect that any credit facilities that we obtain in the future will contain similar restrictions and requirements |
| Our secured credit facility contains covenants that restrict, among other things, our ability to incur additional debt, pay cash dividends, create liens, change our fundamental organization or lines of business, make investments and engage in transactions with affiliates and that contains events of default that are triggered, among other things, if there is a change of control of us or our subsidiaries and for certain changes in the composition of our Board of Directors, all of which may adversely affect our ability to grow and to pursue new 11 ______________________________________________________________________ [38]Table of Contents business opportunities |
| The secured credit facility also requires us to maintain specific financial ratios |
| Events beyond our control could affect our ability to meet those financial ratios, and we cannot assure you that we will meet them |
| A breach of any of the covenants contained in our secured credit facility could allow the lenders to declare all amounts outstanding under the secured credit facility to be immediately due and payable |
| We have pledged substantially all of our assets to the lenders as collateral under our secured credit facility |
| The lenders could proceed against the collateral granted to them if we are unable to meet our debt service obligations |
| If the amounts outstanding under our secured credit facility are accelerated, we may be forced to restructure or refinance our obligations, obtain equity financing or sell assets, which we may be unable to accomplish in a timely manner, on terms satisfactory to us or at all |
| If we are unable to restructure or refinance our obligations, we may default under our obligations |
| In order to replace our existing secured credit facility or raise additional capital, we may seek to obtain one or more credit facilities in the future |
| We expect that any credit facilities we enter into in the future will contain restrictions and requirements similar to those described above |
| Natural or manmade disasters could interrupt our business |
| Natural disasters, fire, power shortages, terrorist attacks and other hostile acts, labor disputes, public health issues, and other events beyond our control could interrupt our business operations |
| We cannot predict the occurrences or consequences of these events, which could decrease demand for our products and services, or make it difficult or impossible for us to deliver products and services to our customers |
| These events have adversely affected our operating results and financial condition in the past, and may adversely affect us in the future |
| For example, during 2005 Hurricane Katrina adversely affected the delivery of services in the Learning Center segment and the Catapult Learning segment in the Gulf Coast region, thus adversely affecting our operating results |