LAUR

Business Context and Reporting Period

This Form 10-K covers Sylvan Learning Systems, Inc. (filing as Sylvan Learning Systems, Inc., though the business is transitioning to focus exclusively on higher education) for the fiscal year ended December 31, 2003. The Company has fundamentally restructured its operations, selling its K-12 segments and non-strategic Sylvan Ventures investments on June 30, 2003, to focus exclusively on post-secondary education. The business is now organized into two segments: Campus Based (international universities in Latin America and Europe) and Online Higher Education (distance learning in the U.S.). The Company intends to change its corporate name and NASDAQ symbol by June 2004.

Key Financial Metrics

Segment Performance (2003):

• Campus Based: Revenues of $376.1 million; Segment Profit of $64.1 million.
• Online Higher Education: Revenues of $95.8 million; Segment Profit of $13.3 million.

Profitability: Operating margin improved significantly to approximately 7.1% in 2003 compared to 4.3% in 2002, driven by the sale of lower-margin K-12 operations and growth in higher education segments.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 41% to $472.8 million. This was driven by a 44% increase in Campus Based revenue (due to enrollment growth, tuition increases, and the acquisition of UNAB in Chile) and a 29% increase in Online Higher Education revenue.
• Discontinued Operations: The Company sold its K-12 segment (Principal K-12 Disposal Group) in June 2003, recording a pre-tax gain of $71.8 million. This transaction significantly impacted the 2003 Net Income, which turned from a loss of $95.9 million in 2002 to a profit of $46.1 million in 2003.
• Non-Cash Compensation: A significant non-cash stock compensation expense of $23.1 million was recorded in 2003, primarily due to the modification of employee stock options following the restructuring. This compares to only $1.0 million in 2002.
• Debt Reduction: Long-term debt decreased by approximately $78.4 million, largely due to the conversion of $95 million in convertible debentures into common stock and the repayment of debt assumed in acquisitions.

Guidance, Outlook, and Risks

Outlook: Management expects to continue increasing tuition as market conditions warrant and plans to expand student enrollment through new programs and campus locations. The Company anticipates that cash flow from operations will be sufficient to meet operating requirements and fund future acquisitions.

Key Risks and Contingencies:

• Foreign Currency: Approximately 80% of revenues are generated outside the U.S. A 10% adverse change in exchange rates could decrease operating income by $8.3 million.
• Regulatory Compliance: Online Higher Education units (Walden and NTU) rely on Title IV federal financial aid eligibility. Changes in regulations or loss of eligibility could materially impact enrollment.
• Contingent Consideration: The Company has significant contingent payment obligations related to acquisitions (e.g., UDLA, UNAB). Assuming EBIT remains at 2003 levels, the Company estimates potential future obligations of approximately $48 million for UDLA sellers alone.
• WSI Disposal: The Company committed to a plan to sell its Wall Street Institute (WSI) business, which is classified as a discontinued operation. A loss of $20.8 million was recorded in 2003 related to the write-down of WSI assets.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the sustainability of earnings by excluding the one-time $71.8 million gain from the K-12 sale and the $23.1 million non-cash stock compensation charge.
• Contingent Liabilities: Review the specific EBIT targets and formulas for contingent payments to UDLA and UNAB sellers, as these represent significant future cash outflows.
• Foreign Exchange Exposure: Assess the sensitivity of the Campus Based segment's margins to fluctuations in the Mexican Peso, Chilean Peso, and Euro.
• WSI Sale Status: Monitor the progress of the Wall Street Institute (WSI) sale, as the final tax benefit and proceeds remain uncertain.
• Debt Covenants: Confirm compliance with the new $30 million unsecured credit facility and the terms of various mortgage notes and government loans.