10-K/A 1 edmc0630201410-ka.htm 10-K/A EDMC 06.30.2014 10-K/A
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A

Amendment No. 1

ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2014
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 No: 001-34466
_________________________________
EDUCATION MANAGEMENT CORPORATION
(Exact name of registrant as specified in its charter)
_________________________________
Pennsylvania
 
25-1119571
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
210 Sixth Avenue, Pittsburgh, PA, 33rd Floor
 
15222
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (412) 562-0900
_________________________________
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $0.01 per share
 
The NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act:
None
_________________________________

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  ý
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  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) 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.    ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
¨
Accelerated filer
ý
 
 
 
 
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes  ¨    No  ý
The aggregate market value of the voting common stock held by non-affiliates of the registrant as of December 31, 2013, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $200.7 million. As of October 16, 2014, there were 126,059,632 shares of the registrant’s common stock outstanding.

 



Explanatory Note

This Amendment No. 1 to our Annual Report on Form 10-K for the fiscal year ended June 30, 2014 (originally filed with the Securities and Exchange Commission on October 16, 2014) is being filed in order to amend Item 8 to correct errors in the table of Supplemental Quarterly Financial Information included therein. Specifically, the diluted loss per share for the quarters ended June 30, 2014, June 30, 2012 and March 31, 2012 were corrected. The complete text of Item 8, as amended, is included in this amendment.  With the exception of the foregoing, no other changes are being made to our Report on Form 10-K for the fiscal year ended June 30, 2014.

2


PART II
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


3


Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of
Education Management Corporation and Subsidiaries

We have audited the accompanying consolidated balance sheets of Education Management Corporation and Subsidiaries as of June 30, 2014 and 2013, and the related consolidated statements of operations, comprehensive loss, cash flows, and shareholders' equity for each of the three years in the period ended June 30, 2014. Our audits also included the financial statement schedule listed in the Index. 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 the standards of the Public Company Accounting Oversight Board (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 consolidated financial position Education Management Corporation and Subsidiaries at June 30, 2014 and 2013, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 2014, in conformity with U.S. generally accepted accounting principles. 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.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Education Management Corporation and Subsidiaries’ internal control over financial reporting as of June 30, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated October 16, 2014 expressed an adverse opinion thereon.

/s/ Ernst & Young LLP
 
Pittsburgh, Pennsylvania
October 16, 2014


4


Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of 
Education Management Corporation and Subsidiaries

We have audited Education Management Corporation and Subsidiaries internal control over financial reporting as of June 30, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) (the COSO criteria). Education Management Corporation and Subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment. Management has identified a material weakness in internal control over financial reporting related to the selection and application of generally accepted accounting principles (GAAP) related to revenue recognition. Members of the Company’s management team with the appropriate level of accounting knowledge, experience and training commensurate with the financial reporting requirements did not analyze certain accounting issues at the level of detail required to ensure proper application of GAAP in certain circumstances. Specifically, the process for analyzing the collectibility criterion for revenue recognition was not designed to assess collectibility, on a student-by-student basis, throughout the period revenue was recognized by the Company's institutions. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Education Management Corporation and Subsidiaries as of June 30, 2014 and 2013, and related consolidated statements of operations, comprehensive loss, cash flows and shareholders’ equity for each of the three years in the period ended June 30, 2014 of Education Management Corporation and Subsidiaries. This material weakness was considered in determining the nature, timing and extent of audit tests applied in our audit of the 2014 financial statements, and this report does not affect our report dated October 16, 2014 , which expressed an unqualified opinion on those financial statements.
In our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Education Management Corporation and Subsidiaries has not maintained effective internal control over financial reporting as of June 30, 2014, based on the COSO criteria.  
/s/ Ernst & Young LLP
 
 
Pittsburgh, Pennsylvania
October 16, 2014

5


EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
 
 
June 30, 2014
 
June 30, 2013
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
270,567

 
$
130,695

Restricted cash
271,681

 
271,340

Total cash, cash equivalents and restricted cash
542,248

 
402,035

Student receivables, net of allowances of $143,335 and $174,760 (Note 6)
210,182

 
206,406

Notes, advances and other receivables
57,908

 
32,547

Deferred income taxes (Note 11)
24,502

 
76,927

Prepaid income taxes
5,283

 
20,854

Other current assets
35,843

 
32,850

Total current assets
875,966

 
771,619

Property and equipment, net (Note 4)
429,457

 
525,625

Goodwill (Note 5)
343,406

 
777,153

Intangible assets, net (Note 5)
169,823

 
300,435

Other long-term assets
58,384

 
48,524

Total assets
$
1,877,036

 
$
2,423,356

Liabilities and shareholders’ (deficit) equity
 
 
 
Current liabilities:
 
 
 
Revolving credit facility (Note 8)
$
219,890

 
$
75,000

Current portion of long-term debt (Note 8)
11,875

 
12,076

Accounts payable
38,553

 
32,559

Accrued liabilities (Note 7)
167,282

 
157,417

Unearned tuition
115,869

 
113,371

Advance payments
81,856

 
95,675

Total current liabilities
635,325

 
486,098

Long-term debt, less current portion (Note 8)
1,271,586

 
1,273,164

Deferred income taxes (Note 11)
58,577

 
72,622

Deferred rent
185,795

 
201,202

Other long-term liabilities
10,626

 
34,414

Shareholders’ (deficit) equity:
 
 
 
Common stock, at par
1,452

 
1,435

Additional paid-in capital
1,815,860

 
1,794,846

Treasury stock, at cost
(331,877
)
 
(328,605
)
Accumulated deficit
(1,762,096
)
 
(1,098,179
)
Accumulated other comprehensive loss
(8,212
)
 
(13,641
)
Total shareholders’ (deficit) equity
(284,873
)
 
355,856

Total liabilities and shareholders’ (deficit) equity
$
1,877,036

 
$
2,423,356




The accompanying notes are an integral part of these consolidated financial statements.

6


EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
 
 
For the Fiscal Year Ended June 30,
 
2014
 
2013
 
2012
Net revenues
$
2,272,736

 
$
2,498,599

 
$
2,760,967

Costs and expenses:
 
 
 
 
 
Educational services
1,373,699

 
1,447,097

 
1,502,356

General and administrative
667,567

 
689,143

 
762,863

Depreciation and amortization
152,501

 
164,712

 
158,663

Long-lived asset impairments (Notes 4 and 5)
568,216

 
300,104

 
1,662,288

Total costs and expenses
2,761,983

 
2,601,056

 
4,086,170

Loss before interest, loss on debt refinancing and income taxes
(489,247
)
 
(102,457
)
 
(1,325,203
)
Interest expense, net
128,033

 
124,663

 
110,330

Loss on debt refinancing (Note 8)

 
5,232

 
9,474

Loss before income taxes
(617,280
)
 
(232,352
)
 
(1,445,007
)
Income tax expense (benefit) (Note 11)
46,637

 
12,038

 
(11,437
)
Net loss
$
(663,917
)
 
$
(244,390
)
 
$
(1,433,570
)
Loss per share: (Note 3)
 
 
 
 
 
Basic
$
(5.29
)
 
$
(1.96
)
 
$
(11.32
)
Diluted
$
(5.29
)
 
$
(1.96
)
 
$
(11.32
)
Weighted average number of shares outstanding: (Note 3)
 
 
 
 
 
Basic
125,504

 
124,560

 
126,659

Diluted
125,504

 
124,560

 
126,659

















The accompanying notes are an integral part of these consolidated financial statements.

7


EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)


 
For the Fiscal Year Ended June 30,
 
2014
 
2013
 
2012
Net loss
$
(663,917
)
 
$
(244,390
)
 
$
(1,433,570
)
Other comprehensive income (loss):
 
 
 
 
 
Net change in interest rate swaps:
 
 
 
 
 
Periodic revaluation of interest rate swaps, net of tax benefit of $1,252, $1,545 and $8,049
(1,799
)
 
(2,619
)
 
(13,646
)
Reclassification adjustment for interest recognized in consolidated statements of operations, net of tax expense of $4,658, $4,448 and $4,988
7,898

 
7,542

 
8,457

Net change in unrecognized loss on interest rate swaps, net of tax
6,099

 
4,923

 
(5,189
)
Foreign currency translation loss
(670
)
 
(527
)
 
(658
)
Other comprehensive income (loss)
5,429

 
4,396

 
(5,847
)
Comprehensive loss
$
(658,488
)
 
$
(239,994
)
 
$
(1,439,417
)























The accompanying notes are an integral part of these consolidated financial statements.

8


EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) 
 
For the Fiscal Year Ended June 30,
 
2014
 
2013
 
2012
Cash flows from operating activities:
 
 
 
 
 
Net loss
$
(663,917
)
 
$
(244,390
)
 
$
(1,433,570
)
Adjustments to reconcile net loss to net cash flows from operating activities:
 
 
 
 
 
Depreciation and amortization of property and equipment
146,158

 
157,871

 
151,023

Amortization of intangible assets
6,343

 
6,841

 
7,640

Bad debt expense
141,946

 
171,850

 
163,926

Long-lived asset impairments
568,216

 
300,104

 
1,662,288

Amortization of debt issuance costs
14,160

 
8,460

 
1,071

Loss on debt refinancing

 
5,232

 
9,474

Share-based compensation
16,419

 
17,112

 
13,290

Non-cash adjustments related to deferred rent
(18,654
)
 
(17,477
)
 
(12,956
)
Amortization of deferred gains on sale-leaseback transactions
(2,252
)
 
(1,575
)
 

Deferred income taxes
36,274

 
(18,840
)
 
(130,194
)
Changes in assets and liabilities:
 
 
 
 
 
Restricted cash
(341
)
 
(3,460
)
 
(220,367
)
Receivables
(174,163
)
 
(195,336
)
 
(220,319
)
Reimbursements for tenant improvements
2,457

 
10,054

 
15,307

Inventory
(469
)
 
2,505

 
1,203

Other assets
7,338

 
15,151

 
(3,856
)
Accounts payable
4,404

 
(19,596
)
 
(1,637
)
Accrued liabilities, including income taxes
(1,998
)
 
6,092

 
20,454

Unearned tuition
2,497

 
(2,906
)
 
(23,873
)
Advance payments
(13,772
)
 
(6,385
)
 
(9,754
)
Total adjustments
734,563

 
435,697

 
1,422,720

Net cash flows provided by (used in) operating activities
70,646

 
191,307

 
(10,850
)
Cash flows from investing activities:
 
 
 
 
 
Expenditures for long-lived assets
(73,760
)
 
(83,241
)
 
(93,546
)
Proceeds from sale of fixed assets
9,565

 
65,065

 

Reimbursements for tenant improvements
(2,457
)
 
(10,054
)
 
(15,307
)
Other

 
2,418

 

Net cash flows used in investing activities
(66,652
)
 
(25,812
)
 
(108,853
)
Cash flows from financing activities:
 
 
 
 
 
Borrowings under revolving credit facility
219,890

 
75,000

 
111,300

Payments under revolving credit facility
(75,000
)
 
(111,300
)
 
(79,000
)
Repayment of senior notes

 
(171,953
)
 

Principal payments on long-term debt
(12,051
)
 
(12,155
)
 
(11,025
)
Debt issuance costs and other

 
(5,232
)
 
(11,928
)
Issuance of common stock as a result of stock-option exercises
2,968

 
3

 
2,355

Gross excess tax benefit from share-based compensation
3,417

 

 
263

Minimum tax withholding requirements for restricted stock units
(3,272
)
 

 

Common stock repurchased for treasury

 

 
(104,073
)
Net cash flows provided by (used in) financing activities
135,952

 
(225,637
)
 
(92,108
)
Effect of exchange rate changes on cash and cash equivalents
(74
)
 
(171
)
 
(405
)
Net change in cash and cash equivalents
139,872

 
(60,313
)
 
(212,216
)
Cash and cash equivalents, beginning of period
130,695

 
191,008

 
403,224

Cash and cash equivalents, end of period
$
270,567

 
$
130,695

 
$
191,008

Cash paid (received) during the period for:
 
 
 
 
 
Interest (including swap settlement)
$
116,639

 
$
111,396

 
$
116,014

Income taxes, net of refunds
$
(1,464
)
 
$
46,699

 
$
114,629

 
As of June 30,
Noncash investing activities:
2014
 
2013
 
2012
Capital expenditures in current liabilities
$
13,780

 
$
9,022

 
$
13,201



 The accompanying notes are an integral part of these consolidated financial statements.

9


EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
 
 
Common
Stock at
Par Value (2)
 
Additional
Paid-in
Capital
 
Treasury
Stock, at cost (2)
 
(Accumulated Deficit) Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Total
 
(In thousands)
 
 
June 30, 2011
$
1,431

 
$
1,761,848

 
$
(226,926
)
 
$
579,781

 
$
(12,190
)
 
$
2,103,944

Net loss

 

 

 
(1,433,570
)
 

 
(1,433,570
)
Share-based compensation

 
13,290

 

 

 

 
13,290

Exercise of stock-options including net excess tax benefit
3

 
2,594

 

 

 

 
2,597

Common stock repurchased for treasury

 

 
(101,679
)
 

 

 
(101,679
)
Other comprehensive loss

 

 

 

 
(5,847
)

(5,847
)
June 30, 2012
1,434

 
1,777,732

 
(328,605
)
 
(853,789
)
 
(18,037
)
 
578,735

Net loss

 

 

 
(244,390
)
 

 
(244,390
)
Share-based compensation
1

 
17,111

 

 

 

 
17,112

Exercise of stock-options

 
3

 

 

 

 
3

Other comprehensive loss

 

 

 

 
4,396

 
4,396

June 30, 2013
1,435

 
1,794,846

 
(328,605
)
 
(1,098,179
)
 
(13,641
)
(1) 
355,856

Net loss

 

 

 
(663,917
)
 

 
(663,917
)
Share-based compensation

 
16,419

 

 

 

 
16,419

Exercise of stock-options
17

 
2,951

 

 

 

 
2,968

Net excess tax benefit from share based compensation

 
1,644

 

 

 

 
1,644

Minimum tax withholding requirements for restricted stock units


 

 
(3,272
)
 

 

 
(3,272
)
Other comprehensive income

 

 

 

 
5,429

 
5,429

June 30, 2014
$
1,452

 
$
1,815,860

 
$
(331,877
)
 
$
(1,762,096
)
 
$
(8,212
)
(1) 
$
(284,873
)
(1)
The balance in accumulated other comprehensive loss at June 30, 2014 and 2013 was comprised of $6.6 million and $12.7 million of cumulative unrealized losses on interest rate swaps, net of tax, respectively and $1.6 million and $0.9 million of cumulative foreign currency translation losses, respectively.
(2)
There were 600,000,000 authorized shares of $0.01 par value common stock at June 30, 2014 and 2013. Common stock outstanding and treasury stock balances and activity were as follows for the periods indicated:
 
Treasury Shares
 
Net Shares Outstanding
June 30, 2011
13,333,972

 
129,811,749

Repurchased for treasury
5,568,168

 
(5,568,168
)
Issued for stock-based compensation plans

 
234,226

June 30, 2012
18,902,140

 
124,477,807

Issued for stock-based compensation plans

 
123,717

June 30, 2013
18,902,140

 
124,601,524

Issued for stock-based compensation plans

 
1,716,419

Minimum tax withholding requirements for restricted stock units

274,644

 
(274,644
)
June 30, 2014
19,176,784

 
126,043,299





The accompanying notes are an integral part of these consolidated financial statements.

10



1.
DESCRIPTION OF BUSINESS AND CHANGE IN OWNERSHIP

Description of Business
Education Management Corporation ("EDMC" and collectively with its subsidiaries, the “Company”) is among the largest providers of post-secondary education in North America, with approximately 125,560 enrolled students as of October 2013. The Company offers campus-based education through four different education systems and through online platforms at three of the four education systems, or through a combination of both. These four education systems comprise the Company's reportable segments, which are The Art Institutes, Argosy University, Brown Mackie Colleges and South University. Refer to Note 17, "Segment Reporting" for additional information.
The Company is committed to offering quality academic programs and strives to improve the learning experience for its students to help them achieve their educational goals across the spectrum of in-demand careers. The Company's innovative academic programs are designed with an emphasis on employment-focused content and technology that advances education, and are taught primarily by faculty members who, in addition to having appropriate academic credentials, offer practical and relevant professional experience in their respective fields.
Ownership
On June 1, 2006, the Company was acquired by a consortium of private equity investment funds led by Providence Equity Partners, Goldman Sachs Capital Partners and Leeds Equity Partners (collectively, the “Sponsors”). The acquisition was accomplished through the merger of EM Acquisition Corporation into EDMC, with EDMC surviving the merger (the "Transaction") and was financed by equity invested by the Sponsors and other investors, cash on hand and secured and unsecured borrowings. Refer to Note 8, "Short-Term and Long-Term Debt" for more information.
In October 2009, EDMC completed an initial public offering of 23.0 million shares of its common stock, $0.01 par value per share ("Common Stock"), at a per share price of $18.00 (the "Initial Public Offering"). The Sponsors did not sell any of their shares in connection with the Initial Public Offering.
In June 2010, the Company’s Board of Directors approved a stock repurchase program under which it could purchase its common stock in the open market, in privately negotiated transactions, through accelerated repurchase programs or in structured share repurchase programs. From the inception of the stock repurchase program through its expiration on December 31, 2012, the Company repurchased 18.9 million shares of its common stock for a total cost of $328.6 million.
Government Regulations
Each of the Company’s schools located in the United States is recognized by accreditation agencies and by the U.S. Department of Education, enabling students to access federal student loans, grants and other forms of public and private financial aid. Participating institutions are required to administer Title IV program funds in accordance with the Higher Education Act of 1965, as amended (“HEA”), and U.S. Department of Education regulations and must use diligence in approving and disbursing funds and servicing loans. In the event a participating institution does not comply with federal requirements or if student loan default rates are at a level that exceeds certain thresholds set by statute and regulation, that institution could lose its eligibility to participate in Title IV programs or could be required to repay funds determined to have been improperly disbursed. Most of the students who attend the Company’s institutions participate in federal and state financial aid and assistance programs. The percentage of net revenues derived from Title IV programs ranged from approximately 55% to 81%, with a weighted average of approximately 76% in fiscal 2014 compared to a range of 56% to 82%, with a weighted average of approximately 76% in fiscal 2013.
Revisions and Reclassifications
The goodwill impairment charges from fiscal 2013 and 2012 have been adjusted as further described in Note 5, "Goodwill and Intangible Assets" under "Correction of Immaterial Errors." In addition, certain amounts in prior periods have been reclassified to conform to the fiscal 2014 presentation, with no effect on previously reported net income or shareholders' equity.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation (Including Debt Restructuring)
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company transactions and balances have been eliminated. Unless otherwise specified, any reference to a “year” is to a fiscal year ended June 30.

11


The Company has experienced deteriorating results from operations over the last several fiscal years, which coupled with the use of cash, created uncertainty as to the Company's ability to continue as a going concern. The Company has entered into the following agreements and taken the following actions to mitigate these risks: 

an amendment agreement dated September 5, 2014 (the "Amendment Agreement"), with the holders of in excess of 98% of the term loan facilities and 100% of the revolving credit facility (collectively, the "Consenting Lenders") pursuant to which, among other things, (i) the maturity on the revolving credit facility was extended from June 1, 2015 to July 2, 2015, (ii) the Consenting Lenders under the revolving credit facility agreed to accept payment of interest in kind rather than cash through June 30, 2015, (iii) the Consenting Lenders holding term loans agreed that no amortization payments will be payable through June 30, 2015 and to accept the payment of interest in kind rather than cash through June 30, 2015, (iv) EDMC became a guarantor and granted a lien on substantially all of its assets to secure the obligations under the agreement, (v) compliance with the financial covenants was waived through June 30, 2015, and (vi) the security agreement governing the credit facility was amended such that the collateral proceeds “waterfall” set forth therein now provides that obligations owing to any lenders that are not Consenting Lenders shall be paid only after satisfaction in full of obligations owing to Consenting Lenders and swap counterparties who have executed the RSA (as defined below);

a supplemental indenture dated September 5, 2014 (the "Supplemental Indenture"), pursuant to which the Indenture governing the cash pay/PIK notes due 2018 (the "Cash Pay/PIK Notes") was amended (i) to require the Company to offer all holders of the Cash Pay/PIK Notes the opportunity to receive the same consideration in the Debt Restructuring (as defined below) as holders of the Interim Notes (as defined below), (ii) to provide for (a) the release of EDMC’s guarantee and (b) the termination of certain covenants and certain events of default, in each case upon the completion of the exchange of Cash Pay/PIK Notes and Interim Notes contemplated by the Debt Restructuring and (iii) to provide that if Education Management LLC is no longer subject to the reporting requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, it will not be required to file reports with the Securities and Exchange Commission but instead will be required to distribute annual, quarterly and current reports to the trustee under the Indenture and hold a conference call within 20 business days of furnishing required annual and quarterly reports;

an exchange agreement dated September 5, 2014 (the "Exchange Agreement"), pursuant to which the holders of 86% of the outstanding Cash Pay/PIK Notes exchanged their Cash Pay/PIK Notes for a like principal amount of new Senior PIK Toggle Notes due 2018 (the "Interim Notes" and together with the Cash Pay/PIK Notes, the "Notes"), whose terms are substantially similar to those of the Cash Pay/PIK Notes, except that their interest is payable entirely in kind for the two interest periods ending September 30, 2014 and March 30, 2015;

a new indenture dated September 5, 2014 (the "New Indenture"), pursuant to which the Interim Notes were issued; and

a Restructuring Support Agreement dated September 4, 2014 (the "RSA"), pursuant to which the Consenting Lenders, holders of in excess of 65% of the outstanding Notes (the "Consenting Noteholders"), certain of the Company's swap counter-parties and holders of in excess of 72% of the Company's outstanding common stock (the "Consenting Shareholders") agreed to support a comprehensive debt restructuring ("Debt Restructuring") as described below.

Pursuant to the Debt Restructuring:

$150 million of revolving loans under the existing revolving credit facility will be repaid in cash at par, with such amount available for re-borrowing under a new revolving credit facility;

the remaining portion of the Company's $1.5 billion of outstanding indebtedness, including the Interim Notes, will be exchanged for two first lien senior secured term loans due July 2, 2020 in the aggregate principal amount of $400 million, mandatorily convertible preferred stock, optionally convertible preferred stock and warrants for common stock; and

the Company’s current shareholders will retain their outstanding common stock, which in aggregate will equal 4% of the Company’s outstanding common stock after giving effect to the conversion of all of the preferred stock described above and subject to further dilution by a management incentive plan (the "MIP") and warrants (including those described in the next sentence) to be awarded pursuant to the Debt Restructuring. In addition, current shareholders will receive warrants for 5% of the Company’s common stock (subject to dilution by the MIP).

12


In addition to these actions, management has developed a plan to reduce cash outflows in fiscal 2015 in order to maintain sufficient liquidity to allow the Company to meet its obligations as they become due. While no assurance can be given that management’s plan will be fully implemented in fiscal 2015, based on the agreements executed and management’s projected cash flows for fiscal 2015, management believes that cash flow from operations and available cash on hand, supplemented from time to time with borrowings under the revolving credit facility, will provide adequate funds for ongoing operations, required debt service and other obligations as they become due during the next twelve months.
The accompanying consolidated financial statements have been prepared on the assumption that the Company will continue to operate as a going concern and do not include any adjustments that might result from the Company not being able to continue as a going concern.  Accordingly, assets and liabilities are recorded on the basis that the Company will be able to realize its assets and discharge its liabilities in the normal course of business. 
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management bases these estimates on assumptions that it believes to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
Cash and Cash Equivalents and Restricted Cash
The Company considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents. These investments are stated at cost, which approximates fair value.
The Company’s institutions hold funds from the United States government under various student aid grant and loan programs in separate bank accounts, and serve as trustee for the U.S. Department of Education or respective lender or student borrower, as applicable. The Company does not record funds held in these bank accounts as cash or restricted cash until the authorization and disbursement process has occurred. Once the authorization and disbursement process to the student has been completed, the funds are transferred to unrestricted accounts and become available for use in current operations, except as noted in footnote two to the table below. This transfer generally occurs for the period of the academic term for which such funds were authorized, with no term being more than 16 weeks in length.
Restricted cash consisted of the following at June 30 (in thousands):
 
 
2014
 
2013
Cash secured letters of credit (1)
$
210,000

 
$
210,000

Title IV funds received in excess of charges applied (2)
50,406

 
56,595

Surety bonds (3)
7,275

 

Escrowed in connection with student lending program (4)
2,500

 
2,500

Endowments (5)
1,500

 
1,500

Escrowed in connection with operating lease

 
745

Restricted cash
$
271,681

 
$
271,340


(1) Includes liens on certain of the Company's cash deposits, which equal 105% of the aggregate $200.0 million of outstanding letters of credit under the Company's cash secured letter of credit facilities further explained in Note 8, "Short-Term and Long-Term Debt." Such cash is not available for any purpose other than to reimburse drawings under the letters of credit or to pay related fees and obligations.  
(2) U.S. Department of Education regulations require Title IV program funds received by the Company’s educational institutions in excess of the charges applied to the relevant students at that time to be, with these students’ permission, maintained and classified as restricted. In addition, some states have similar requirements. Such funds are recorded as restricted cash due to legal restrictions on the use of the funds and as advance payments on the Company’s consolidated balance sheets. The balances also include $35.1 million and $39.3 million at June 30, 2014 and 2013, respectively, related to Title IV amounts that the Company has already received for courses that fully-online students attending Argosy University and South University have not begun. Since these students take classes under a non-term academic structure, the cash is classified as restricted because the Company does not intend to use the funds for operating purposes until a student successfully demonstrates academic progress with respect to each course the student attends in the student’s program of study.
(3) Relates to amounts required to be maintained on deposit in connection with surety bonds primarily provided to state regulatory agencies as described in Note 14, "Commitments and Contingencies."
(4) Relates to an account required to be maintained in connection with the Company's student lending program further described in Note 6, "Student Receivables."
(5) Relates to endowments required by state law at certain of the Company's schools.

13


Revenue Recognition
The Company’s net revenues consist primarily of tuition and fees, student housing fees, bookstore sales, restaurant sales in connection with culinary programs, workshop fees and sales of related study materials. Net revenues are reduced for student refunds and scholarships. The Company derived approximately 93% of its net revenues from tuition and fees in each of the fiscal years ended June 30, 2014, 2013 and 2012.
The Company bills tuition and housing revenues at the beginning of an academic term and recognizes the revenue on a pro rata basis over the term of instruction or occupancy. Some of the Company’s academic terms have starting and ending dates that differ from the Company’s fiscal quarters. Therefore, at the end of each fiscal quarter, the Company has tuition from academic terms with respect to which the associated revenue has not yet been earned. Such amounts are recorded as unearned tuition, which is a current liability in the accompanying consolidated balance sheets. Advance payments are generally refundable and relate to payments received for future academic periods and are also recorded as a current liability in the accompanying consolidated balance sheets.
If a student withdraws from one of the Company’s schools, the extent of his or her obligation for tuition and fees depends on when that student withdraws during an academic term. The Company reduces the student's obligation depending upon its refund policies, which vary by state and institution and take into account the refund requirements of the U.S. Department of Education, most state education authorities that regulate the Company’s schools, the accrediting commissions that accredit the Company’s schools and the Company’s institutional policies (collectively, “Refund Policies”). In the vast majority of situations, if a student withdrew from school after attending classes for at least 60.0% of a term of instruction, he or she would not be eligible for any reduction in tuition under the Company's Refund Policies. Accordingly, the student would have to pay the Company the balance of tuition and fees that has not been received already either in the form of financial aid or payments from the student. However, if a student withdraws from school prior to attending classes for at least 60.0% of a term of instruction, the Company may reduce the amount of a student's obligation for tuition and fees based on a tiered approach under which, in general, the greater the portion of the academic term that has elapsed at the time the student withdraws, the greater the student’s obligation is to the school for the tuition and fees related to that academic term.
Based on the application of its refund policies, the Company may be entitled to incremental revenue on the day the student withdraws from one of its schools. Prior to fiscal 2014, the Company recorded this incremental revenue, related student receivable and an estimate of the amount it did not expect to collect as bad debt expense during the fiscal quarter a student withdrew. Effective in fiscal 2014, the Company reassesses collectability when a student withdraws from the institution (i.e., is no longer enrolled) and records incremental revenue after a student's withdrawal from school based on cash received. This correction in policy had the effect of reducing net revenues and student receivables by $36.7 million and bad debt expense and the corresponding allowance for doubtful accounts by $33.2 million, which resulted in an increase to the loss before taxes of $3.5 million in the fiscal year ended June 30, 2014. Prior year amounts were not corrected because the effects were not material.
Student Receivables
The Company records student receivables at cost less an estimated allowance for doubtful accounts, which is determined on a quarterly basis based on the likelihood of collection considering students' enrollment status and historical payment experience. Historical collection experience is analyzed by disaggregating the student receivable balances based on predominant risk characteristics, such as whether the student is currently in-school, recently withdrew from school, or has not made a payment for a longer period of time. This level of disaggregation of student receivables results in individual pools of receivables which management believes appropriately differentiates credit risk in the portfolio and provides a reasonable basis to compute the estimate of loss. When certain criteria are met, which is generally when receivables age past the due date by more than four months, and internal collection measures have been taken without success, the accounts of former students are placed with a collection agency. Student accounts that have been placed with a collection agency are almost fully reserved and are written off after collection attempts have been unsuccessful.
During fiscal 2013, the Company reduced the number of days since last payment after which accounts placed with a collection agency are written off. This change did not impact the statement of operations or net student receivables as the applicable accounts were already fully reserved. Refer to Note 6, "Student Receivables," for more information.
Inventories
Inventories consist mainly of textbooks and supplies held for sale to students enrolled in the Company’s educational programs and are presented in other current assets in the accompanying consolidated balance sheets. Cost is determined using the average cost method and inventories are valued at the lower of cost or market.

14


Leases
The Company leases certain classroom, dormitory and office space, as well as equipment and automobiles under operating leases. Before entering into a new lease, an analysis is performed to determine whether a lease should be classified as capital or operating.
Certain of the Company’s lease agreements include tenant improvement allowances. Once the lease agreement is signed, these tenant improvement allowances are recorded as other current assets with the offset to deferred rent liabilities on the consolidated balance sheets. Concurrent with the expenditures for lease improvements, the Company records increases to leasehold improvement assets in property and equipment. Other current assets are reduced once the landlord reimburses the Company. The deferred rent liabilities related to tenant improvements are amortized over the term of the lease as a reduction to rent expense upon possession of the lease space.
Many of the Company’s lease agreements contain escalation clauses under which, if fixed and determinable, rent expense is recognized on a straight-line basis over the lives of the leases, which generally range from five to 15 years with one or more renewal options. For leases with renewal options, the Company records rent expense over the original lease term, exclusive of the renewal period. When a renewal occurs, the Company records rent expense over the new lease term.
Property and Equipment and Finite-Lived Intangible Assets
Property and equipment is recorded at its cost less accumulated depreciation. Depreciation policies for such assets are as follows:
Buildings are depreciated over an estimated useful life of 30 years using the straight-line method;
Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, exclusive of any renewal periods, or their estimated useful lives; and
The remainder of the Company’s property and equipment is depreciated over estimated useful lives ranging from three to 10 years using the straight-line method, depending on the asset.
Finite-lived intangible assets primarily relate to curriculum developed for fully-online courses which are amortized over a two-year useful life.
The Company records impairment losses on property and equipment and finite-lived intangible assets when events and circumstances indicate that the undiscounted cash flows estimated to be generated by those assets or asset groups are less than their carrying amounts. Events and circumstances that could trigger an impairment review include changes in the regulatory environment, deteriorating economic conditions or poor operating performance at individual campus locations. Any resulting impairment loss would be measured as the difference between the fair value of the assets or asset groups and their carrying value with the loss recorded as an operating expense in the consolidated statement of operations in the period incurred. Refer to Note 4, "Property and Equipment," for more information.
Goodwill and Indefinite-Lived Intangible Assets
In connection with the Transaction, property, equipment, intangible assets other than goodwill and other assets and liabilities were recorded at fair value. The excess of the amount paid to acquire the Company at the time of the Transaction over the fair values of these net assets represented the intrinsic value of the Company beyond its tangible and identifiable intangible net assets and was assigned to goodwill.
The Company formally evaluates the carrying amount of goodwill for each of its reporting units on April 1 of each fiscal year. In addition, the Company performs an evaluation on an interim basis if it determines that recent events or prevailing conditions indicate a potential impairment of goodwill. A significant amount of judgment is involved in determining whether an indicator of impairment has occurred between annual impairment tests. These indicators include, but are not limited to, overall financial performance such as adverse changes in recent forecasts of operating results, industry and market considerations, a sustained decrease in the price of a share of EDMC Common Stock, updated business plans and regulatory and legal developments.
Goodwill is impaired when the carrying amount of a reporting unit’s goodwill exceeds its implied fair value, as determined under a two-step approach. In the first step, the Company determines the fair value of each reporting unit and compares that fair value to each reporting unit’s carrying value. The Company estimates the fair value of its reporting units using a combination of the discounted cash flow method (income approach) and the guideline public company method (market approach), which takes into account the invested capital and associated earnings multiples of publicly-traded peer companies. If the results of the first step indicate the carrying amount of a reporting unit is higher than its fair value, a second step must be performed, which requires the Company to determine the implied fair value of goodwill in the same manner as if it had acquired the reporting unit in an arm’s length transaction as of the testing date. This second step is performed by deducting the

15


estimated fair value of all tangible and identifiable intangible net assets of the reporting unit from the estimated fair value of the reporting unit. If the recorded amount of goodwill exceeds this implied fair value, an impairment charge is recorded for the difference as an operating expense in the period incurred.
Indefinite-lived intangible assets, consisting of the licensing, accreditation and Title IV program participation assets for all reporting units and The Art Institute trade name, are also evaluated annually on April 1 for impairment and on an interim basis if events or changes in circumstances between annual tests indicate that the asset might be impaired. Trade names are valued by the relief from royalty method (income approach), which focuses on the level of royalty payments that the user of an intangible asset would have to pay a third party for the use of the asset if it were not owned by the user. The Company uses a combination of the cost and income approaches to establish the asset value of licenses, accreditation and Title IV program participation assets. On the impairment testing date, if the fair value of the intangible asset is less than its carrying value, an impairment loss is recognized for an amount equal to the difference. The intangible asset is then carried at its new fair value.
Income Taxes
The Company accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities result from (i) temporary differences in the recognition of income and expense for financial and income tax reporting requirements, and (ii) differences between the recorded value of assets acquired in business combinations accounted for as purchases for financial reporting purposes and their corresponding tax bases. Deferred income tax assets are reduced by a valuation allowance if it is more-likely-than-not that some portion of the deferred income tax asset will not be realized.
The Company recognizes the tax benefit from an uncertain tax position only if it is at least more-likely-than-not that the tax position will be sustained upon examination by the taxing authorities based on the technical merits of the position. The amount of the tax benefit that is recognized is measured as the largest amount of benefit that is more-likely-than-not to be realized upon effective settlement. The Company classifies interest and penalties accrued in connection with unrecognized tax benefits as income tax expense in its consolidated statement of operations.
Refer to Note 11, "Income Taxes," for more information.
Derivative Financial Instruments
Education Management LLC ("EM LLC"), an indirect wholly-owned subsidiary of the Company, utilizes interest rate swap agreements, which are contractual agreements to exchange payments based on underlying interest rates, to manage a portion of its floating rate term debt. The swaps are accounted for as an asset or a liability in the consolidated balance sheets at fair value. The Company uses “Level Two” inputs to value its interest rate swaps, which are defined in Note 10, "Fair Value of Financial Instruments." The application of these Level Two inputs is based on LIBOR forward curves and an assessment of non-performance risk based upon published market data. If interest rate swap agreements are deemed highly effective for accounting purposes and are designated as cash flow hedges, the changes in their fair values are recorded in other comprehensive income (loss), net of tax. If they are not deemed highly effective, the changes in their fair values are recorded in interest expense in the consolidated statements of operations. The Company does not use derivative financial instruments for trading or speculative purposes. Refer to Note 9, "Derivative Instruments," for more information.
Foreign Currency Translation
The financial position and results of operations of the Company’s foreign subsidiary are initially measured at its functional currency, which is the Canadian dollar. Accordingly, the assets and liabilities of the foreign subsidiary are translated to U.S. dollars using the exchange rates in effect at the balance sheet date. Revenues and expenses are translated into U.S. dollars using average monthly exchange rates. Translation adjustments resulting from this process are recorded as a separate component of equity designated as accumulated other comprehensive income (loss) in the consolidated balance sheets. Translation gains and losses were not material in fiscal 2014, 2013 or 2012.
Share-Based Compensation
The Black-Scholes-Merton option pricing model is used to determine the fair value of all of the Company’s stock-options at the grant date. The Company recognizes compensation costs on time-based options and restricted stock units on a straight-line basis over the requisite service period, which is generally the vesting term, net of expected forfeitures. See Note 12, “Share-Based Compensation,” for more information.
Contingencies
The Company accrues for contingent obligations when it is probable that a liability has been incurred and the amount is reasonably estimable. As facts concerning contingencies evolve and become known, management reassesses the likelihood of probable loss and makes appropriate adjustments to its financial statements.

16


Costs and Expenses
Educational services expense consists primarily of costs related to the development, delivery and administration of the Company’s education programs. Major cost components are faculty compensation, administrative salaries, facility occupancy costs, bad debt expense, costs of educational materials and information systems costs. These costs are expensed as services are provided to the Company or as incurred.
General and administrative expense consists of marketing and student admissions expenses and certain central staff costs such as executive management, finance and accounting, legal and consulting services, corporate development and other departments that do not provide direct services to the Company’s students. These costs are expensed as services are provided to the Company or as incurred.
Marketing costs are expensed in the fiscal year incurred and are classified as general and administrative expense in the accompanying consolidated statements of operations. The Company’s marketing expense was $255.9 million, $255.0 million and $296.9 million during the fiscal years ended June 30, 2014, 2013 and 2012, respectively.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, “Revenue from Contracts with Customers." The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is not permitted. The Company is currently evaluating the impact that the standard will have on its financial condition, results of operations, and disclosures.
In April 2014, the FASB issued amendments to guidance for reporting discontinued operations and disposals of components of an entity. The amended guidance requires that a disposal representing a strategic shift that has (or will have) a major effect on an entity’s financial results or a business activity classified as held for sale should be reported as discontinued operations. The amendments also expand the disclosure requirements for discontinued operations and add new disclosures for individually significant dispositions that do not qualify as discontinued operations. The amendments are effective prospectively for fiscal years, and interim reporting periods within those years, beginning after December 15, 2014 (early adoption is permitted only for disposals that have not been previously reported). The implementation of the amended guidance is not expected to have a material impact on the Company's consolidated financial statements.
In July 2013, the FASB clarified the presentation of an unrecognized tax benefit when a net operating loss or tax credit carryforward exists.  The clarification requires that an unrecognized tax benefit be presented as a reduction of a deferred tax asset for a net operating loss or tax credit carryforward when settlement of the unrecognized tax benefit using those carryforwards is available pursuant to existing tax law.  The Company's adoption of the FASB clarification had no impact on its consolidated financial statements.
3.
EARNINGS PER SHARE
Basic earnings per share (“EPS”) is computed using the weighted average number of shares outstanding during the period. The Company uses the treasury stock method to compute diluted EPS, which assumes that restricted stock units were converted into common stock and that outstanding stock options that are in-the-money were exercised and the resulting proceeds (which includes unrecognized compensation expense and excess tax benefits) were used to acquire shares of common stock at its average market price during the reporting period.
Basic and diluted EPS were calculated as follows (in thousands, except per share amounts):
 
For the Fiscal Year Ended June 30,
 
2014
 
2013
 
2012
Net loss
$
(663,917
)
 
$
(244,390
)
 
$
(1,433,570
)
Weighted average number of shares outstanding:
 
 
 
 
 
Basic
125,504

 
124,560

 
126,659

Effect of stock-based awards

 

 

Diluted
125,504

 
124,560

 
126,659

Loss per share:
 
 
 
 
 
Basic
$
(5.29
)
 
$
(1.96
)
 
$
(11.32
)
Diluted
$
(5.29
)
 
$
(1.96
)
 
$
(11.32
)
All outstanding time-based stock options and restricted stock units were excluded from the computation of diluted EPS for the fiscal years ended June 30, 2014, 2013 and 2012 because the Company recorded a net loss, which made all awards anti-dilutive.
4.
PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at June 30 (in thousands):
Asset Class
2014
 
2013
Leasehold improvements
$
577,537

 
$
570,286

Technology
329,361

 
324,403

Furniture and equipment
162,872

 
163,595

Software
120,242

 
98,537

Library books
44,604

 
44,248

Construction in progress
16,683

 
19,601

Buildings and improvements
5,798

 
25,566

Land
3,605

 
5,495

Total
1,260,702

 
1,251,731

Less accumulated depreciation
(831,245
)
 
(726,106
)
Property and equipment, net
$
429,457

 
$
525,625

Depreciation and amortization expense related to property and equipment was $146.2 million, $157.9 million and $151.0 million, respectively, for the fiscal years ended June 30, 2014, 2013 and 2012. Included in these amounts is amortization expense on software of $18.3 million, $20.2 million and $14.7 million, respectively. Amortization expense on software assets for the year ended June 30, 2013 included $4.6 million in accelerated amortization resulting from the write off of a software asset that no longer had a useful life.
Sale-Leaseback Transactions
The Company completed six sale-leaseback transactions with unrelated third parties for net proceeds of $9.6 million and $65.1 million in fiscal 2014 and 2013, respectively, which are classified as an investing activity in the consolidated statement of cash flows. The transactions resulted in net losses of $3.5 million and $3.9 million recorded in educational services expense upon closing the transactions. In connection with the prior year sale-leaseback transactions, gains of $17.8 million were deferred, of which $14.3 million remains at June 30, 2014. The deferred gains are classified within deferred rent on the consolidated balance sheet and are being recognized over the initial terms of the new leases as a reduction to educational services expense. At the time of closing for all transactions, the Company entered into agreements to lease all of these properties back from the purchasers over initial lease terms ranging from three to 15 years. The Company classified these leases as operating and considers them normal leasebacks with no other continuing involvement. Refer to Note 18, "Subsequent Events," for a description of an additional sale-leaseback transaction that occurred in August 2014.
Lease Abandonment and Restructuring
During fiscal 2014, management determined it would not begin admitting students for one of its start-up Art
Institute locations as was previously anticipated. As a result, the Company recorded a $6.3 million lease abandonment charge in educational services expense during the fiscal year ended June 30, 2014 which was comprised of existing construction-in-progress assets (which resulted in a reduction to property and equipment) and accelerated rent expense based on the remaining minimum obligations under the existing lease, net of expected sublease income. In addition, in connection with restructuring plans across the organization intended to improve operational efficiencies and align costs with student enrollment levels as further described in Note 7, "Accrued Liabilities," the Company recorded lease restructuring charges during fiscal 2014, 2013 and 2012 of $5.8 million, $2.0 million and $2.5 million, respectively, which primarily comprised of existing leasehold improvement assets (which resulted in a reduction to property and equipment) and accelerated rent expense.
Impairments
During fiscal 2014 and 2013, the Company recorded charges of $6.1 million and $1.2 million in long-lived asset impairments in the consolidated statements of operations as estimated future cash flows at three of the Company's Brown Mackie College locations and one of the Company's Argosy University locations, respectively, were insufficient to support the carrying values of their property and equipment, which primarily consisted of leasehold improvement assets. These charges were calculated using an income valuation approach.

5.
GOODWILL AND INTANGIBLE ASSETS

In connection with the Transaction on June 1, 2006, the Company recorded approximately $2.6 billion of goodwill, which was allocated to its four reporting units: The Art Institutes, Argosy University, Brown Mackie Colleges and South University. The goodwill balance attributed to the Brown Mackie Colleges reporting unit was fully written off in connection with an impairment charge incurred during fiscal 2012. Including the effects of the immaterial errors that were corrected during the

17


following periods, which are described below, a roll forward of the Company's consolidated goodwill balance from June 30, 2011 to June 30, 2014 is as follows (in thousands):
 
 
The Art Institutes
 
Argosy University
 
Brown Mackie Colleges
 
South University
 
Total
Balance Sheet as of June 30, 2011:
 
 
 
 
 
 
 
 
 
 
Gross
 
$
1,984,688

 
$
219,350

 
$
254,561

 
$
123,400

 
$
2,581,999

Accumulated impairments
 

 

 

 

 

Goodwill
 
1,984,688

 
219,350

 
254,561

 
123,400

 
2,581,999

 
 
 
 
 
 
 
 
 
 
 
Statement of Operations for the Fiscal Year Ended June 30, 2012:
 
 
 
 
 
 
 
 
 
 
Impairment charge
 
(1,063,088
)
 
(139,361
)
 
(254,561
)
 
(76,962
)
 
(1,533,972
)
 
 
 
 
 
 
 
 
 
 
 
Balance Sheet as of June 30, 2012:
 
 
 
 
 
 
 
 
 
 
Gross
 
1,984,688

 
219,350

 
254,561

 
123,400

 
2,581,999

Accumulated impairments
 
(1,063,088
)
 
(139,361
)
 
(254,561
)
 
(76,962
)
 
(1,533,972
)
Goodwill
 
921,600

 
79,989

 

 
46,438

 
1,048,027

 
 
 
 
 
 
 
 
 
 
 
Statement of Operations for the Fiscal Year Ended June 30, 2013:
 
 
 
 
 
 
 
 
 
 
Impairment charge
 
(270,874
)
 

 

 

 
(270,874
)
 
 
 
 
 
 
 
 
 
 
 
Balance Sheet as of June 30, 2013:
 
 
 
 
 
 
 
 
 
 
Gross
 
1,984,688

 
219,350

 
254,561

 
123,400

 
2,581,999

Accumulated impairments
 
(1,333,962
)
 
(139,361
)
 
(254,561
)
 
(76,962
)
 
(1,804,846
)
Goodwill
 
650,726

 
79,989

 

 
46,438

 
777,153

 
 
 
 
 
 
 
 
 
 
 
Statement of Operations for the Fiscal Year Ended June 30, 2014:
 
 
 
 
 
 
 
 
 
 
Impairment charge
 
(433,747
)
 

 

 

 
(433,747
)
 
 
 
 
 
 
 
 
 
 
 
Balance Sheet as of June 30, 2014:
 
 
 
 
 
 
 
 
 
 
Gross
 
1,984,688

 
219,350

 
254,561

 
123,400

 
2,581,999

Accumulated impairments
 
(1,767,709
)
 
(139,361
)
 
(254,561
)
 
(76,962
)
 
(2,238,593
)
Goodwill
 
$
216,979

 
$
79,989

 
$

 
$
46,438

 
$
343,406

Correction of Immaterial Errors
During the quarter ended March 31, 2014, the Company identified errors in prior periods in the calculation of deferred taxes that is required in connection with the hypothetical purchase price allocation performed in the step two portion of the goodwill impairment test. The errors in calculating the deferred taxes affected the magnitude of the goodwill impairment charges previously recorded during the fiscal years ended June 30, 2013 and 2012, and as a result, the goodwill impairment charges in the fiscal years ended June 30, 2013 and 2012 were decreased by $23.6 million and $84.5 million, respectively, and decreased previously reported net losses by $23.6 million (net of tax) and $82.2 million (net of tax). In connection with these revisions, the Company's consolidated goodwill balance increased by $108.1 million at June 30, 2013. The impact of these errors was not material to any prior period; however, the aggregate pre-tax amount of the prior period errors of $108.1 million would have been material to the Company's consolidated statements of operations for the fiscal year ended June 30, 2014. Consequently, the Company has corrected the errors by revising the impacted prior period balances on the accompanying consolidated financial statements and related notes. These revisions do not impact EBITDA excluding certain expenses as presented in Note 17, "Segment Reporting" nor do they affect the Company’s past compliance with debt covenants.

The following table summarizes the previously reported and corrected amounts of the impacted balances presented in the accompanying consolidated financial statements (in thousands except per share data).

18


 
As Previously Reported
 
Adjustments
 
As Adjusted
Statement of Operations and Comprehensive Loss for the Fiscal Year Ended June 30, 2012
 
 
 
 
 
Long-lived asset impairments
$
1,746,765

 
$
(84,477
)
 
$
1,662,288

Loss before interest, loss on debt refinancing and income taxes
(1,409,680
)
 
84,477

 
(1,325,203
)
Loss before taxes
(1,529,484
)
 
84,477

 
(1,445,007
)
Income tax benefit
(13,743
)
 
2,306

 
(11,437
)
Net loss
(1,515,741
)
 
82,171

 
(1,433,570
)
Basic & diluted loss per share
(11.97
)
 
0.65

 
(11.32
)
Comprehensive loss
(1,521,588
)
 
82,171

 
(1,439,417
)
 
 
 
 
 
 
Statement of Shareholders' Equity for the Fiscal Year Ended June 30, 2012
 
 
 
 
 
Accumulated deficit at June 30, 2012
(935,960
)
 
82,171

 
(853,789
)
Total shareholders' equity at June 30, 2012
496,564

 
82,171

 
578,735

 
 
 
 
 
 
Balance Sheet as of June 30, 2013
 
 
 
 
 
Goodwill
669,090

 
108,063

 
777,153

Total assets
2,315,293

 
108,063

 
2,423,356

Deferred income taxes liability
70,316

 
2,306

 
72,622

Accumulated deficit
(1,203,936
)
 
105,757

 
(1,098,179
)
Total shareholders' equity
250,099

 
105,757

 
355,856

Total liabilities and shareholders' equity
2,315,293

 
108,063

 
2,423,356

 
 
 
 
 
 
Statement of Operations and Comprehensive Loss for the Fiscal Year Ended June 30, 2013
 
 
 
 
 
Long-lived asset impairments
323,690

 
(23,586
)
 
300,104

Loss before interest, loss on debt refinancing and income taxes
(126,043
)
 
23,586

 
(102,457
)
Loss before taxes
(255,938
)
 
23,586

 
(232,352
)
Net loss
(267,976
)
 
23,586

 
(244,390
)
Basic & diluted loss per share
(2.15
)
 
0.19

 
(1.96
)
Comprehensive loss
(263,580
)
 
23,586

 
(239,994
)
 
 
 
 
 
 
Statement of Shareholders' Equity for the Fiscal Year Ended June 30, 2013
 
 
 
 
 
Accumulated deficit at June 30, 2013
(1,203,936
)
 
105,757

 
(1,098,179
)
Total shareholders' equity at June 30, 2013
250,099

 
105,757

 
355,856

Goodwill Impairment Charges
As previously disclosed, during the second quarter of fiscal 2014, the Company observed declining application trends for future academic terms, particularly at The Art Institutes reporting unit, and performed a sensitivity analysis of its fair value using the most recently completed long range forecast and available earnings multiples of the Company's peer group. This sensitivity analysis resulted in management concluding that none of its reporting units experienced a triggering event that would have required a step one interim goodwill impairment analysis at December 31, 2013. Additionally, The Art Institutes had positive year-over-year growth in new student enrollment during the second fiscal quarter.
During the quarter ended March 31, 2014, new students decreased approximately 16% at The Art Institutes compared to the prior year quarter. Due primarily to lower than anticipated application production for future periods at The Art Institutes together with a significant deterioration in the Company's market capitalization and credit rating downgrades during the third

19


fiscal quarter resulted in management no longer believing that it was more-likely-than-not that the fair values of each of its reporting units exceeded their carrying values at March 31, 2014. As a result, management revised its long-term projections and performed a step one interim goodwill impairment test for each of its reporting units.
The results indicated that the Argosy University and South University reporting units had fair values in excess of their carrying values. However, the test indicated that the fair value of The Art Institutes fell below its carrying value as of March 31, 2014. Therefore, a step two test was required to be performed for The Art Institutes reporting unit, which yielded a goodwill impairment charge of $433.7 million in the quarter ended March 31, 2014. None of this charge was deductible for income tax purposes.
The step one interim impairment tests performed as of March 31, 2014 used cash flow projections and market data as of that date. The Company does not believe that cash flow projections or the earnings multiples of its publicly-traded peer companies changed materially between March 31, 2014 and the Company's annual assessment date, which is April 1, 2014. In addition, management considered the change in the Company's stock price between these dates and concluded that based on all the available evidence, the impairment test performed as of March 31, 2014 was appropriate to use as the Company's annual April 1, 2014 test.  
During the quarter ended June 30, 2014, management made several decisions that materially affected the short-term projections at The Art Institutes and revised consolidated projections accordingly. In addition, the Company continued to experience significant deterioration in the market capitalization of its stock and declines in the fair values of its publicly-traded debt. These facts and circumstances, among others, resulted in the Company performing a step one interim goodwill impairment test for each of its reporting units at June 30, 2014, the results of which indicated that all reporting units had fair values in excess of their carrying values at June 30, 2014 by more than 25%.
At March 31 and June 30, 2014, the Company estimated the fair value of its reporting units in step one using a combination of the traditional discounted cash flow method (income approach) and the guideline public company method (market approach), which takes into account the relative price and associated earnings multiples of publicly-traded peer companies. Accordingly, these step one interim impairment tests used cash flow projections and market data as of March 31, 2014 and June 30, 2014.
The valuation of the Company's reporting units under the traditional discounted cash flow method requires the use of internal business plans that are based on judgments and estimates, which account for expected future economic conditions, demand and pricing for the Company's educational services, costs, inflation and discount rates, and other factors. The use of judgments and estimates involves inherent uncertainties. The Company's measurement of the fair values of its reporting units is dependent on the accuracy of the assumptions used and how the Company's estimates compare to future operating performance. The key assumptions used are, but not limited to, the following:
Future cash flow assumptions — The Company's projections are based on organic growth and are derived from historical experience and assumptions regarding future growth and profitability trends. These projections also take into account the current economic climate and the extent to which the regulatory environment is expected to impact future growth opportunities. The Company's analysis incorporated an assumed period of cash flows of ten years with a terminal value determined using the Gordon Growth Model.
Discount rate — The discount rate is based on each reporting unit’s estimated weighted average cost of capital ("WACC"). The three components of WACC are the cost of equity, cost of debt and capital structure, each of which requires judgment by management to estimate. The Company develops its cost of equity estimate using the Capital Asset Pricing Model based on perceived risks and predictability of each reporting unit’s future cash flows. The cost of debt component represents a market participant’s estimated cost of borrowing, which the Company estimates using the average return on corporate bonds as of the valuation date, adjusted for taxes. At March 31, 2014, the WACC used to estimate the fair value of The Art Institutes reporting unit was 15.0%, and the Argosy University and South University reporting units were valued using a WACC of 17.5%. At June 30, 2014, the WACC used to estimate the fair value of The Art Institutes reporting unit was 15.5%, and the Argosy University and South University reporting units were valued using a WACC of 18.0%. The increase in the WACC for all three reporting units from March 31, 2013 to June 30, 2014 was the result of an increase in the industry-specific beta component of the WACC.
Intangible Assets
Intangible assets other than goodwill consisted of the following amounts (in thousands): 

20


 
2014
 
2013
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Gross
Carrying
Amount
 
Accumulated
Amortization
Tradename-Art Institute
$
73,200

 
$

 
$
190,000

 
$

Licensing, accreditation and Title IV program participation
87,862

 

 
95,862

 

Curriculum and programs
21,420

 
(14,379
)
 
43,575

 
(32,596
)
Student contracts, applications and relationships
10,510

 
(9,492
)
 
39,511

 
(37,381
)
Favorable leases and other
6,057

 
(5,355
)
 
19,424

 
(17,960
)
Total intangible assets
$
199,049

 
$
(29,226
)
 
$
388,372

 
$
(87,937
)
During the fiscal year ended June 30, 2014, the Company disposed of approximately $69 million of intangible assets that no longer had a useful life. Because these assets were fully amortized, this write-off had no impact to the consolidated statement of operations.
Trade names are often considered to have useful lives similar to that of the overall business, which generally means such assets are assigned an indefinite life for accounting purposes. State licenses and accreditations of the Company’s schools as well as their eligibility for Title IV program participation are periodically renewed in cycles ranging from every year to up to every ten years depending upon government and accreditation regulations. Because the Company considers these renewal processes to be a routine aspect of the overall business, these assets are assigned indefinite lives. A roll forward of the Company's consolidated indefinite-lived intangible assets balances from June 30, 2011 to June 30, 2014 is as follows (in thousands):

21


 
 
Tradename-Art Institute

 
Licensing, accreditation and Title IV program participation

Balance Sheet at June 30, 2011:
 
 
 
 
Gross
 
$
330,000

 
$
112,179

Accumulated impairments
 

 

Net balance
 
330,000

 
112,179

 
 
 
 
 
Statement of Operations for the Fiscal Year Ended June 30, 2012:
 
 
 
 
Impairment charge
 
(112,000
)
 
(16,317
)
 
 
 
 
 
Balance Sheet at June 30, 2012:
 
 
 
 
Gross
 
330,000

 
112,179

Accumulated impairments
 
(112,000
)
 
(16,317
)
Net balance
 
218,000

 
95,862

 
 
 
 
 
Statement of Operations for the Fiscal Year Ended June 30, 2013:
 
 
 
 
Impairment charge
 
(28,000
)
 

 
 
 
 
 
Balance Sheet at June 30, 2013:
 
 
 
 
Gross
 
330,000

 
112,179

Accumulated impairments
 
(140,000
)
 
(16,317
)
Net balance
 
190,000

 
95,862

 
 
 
 
 
Statement of Operations for the Fiscal Year Ended June 30, 2014:
 
 
 
 
Impairment charge
 
(116,800
)
 
(8,000
)
 
 
 
 
 
Balance Sheet at June 30, 2014:
 
 
 
 
Gross
 
330,000

 
112,179

Accumulated impairments
 
(256,800
)
 
(24,317
)
Net balance
 
$
73,200

 
$
87,862

Intangible Asset Impairments
In connection with the goodwill analyses performed as of March 31, 2014 and June 30, 2014 described above, the Company also performed impairment analyses with respect to indefinite-lived intangible assets at these dates. The fair value of The Art Institutes trade name was determined under the relief from royalty method (income approach), which is the same method the Company used to value this asset at the Transaction date. The relief from royalty method focuses on the level of royalty payments that the user of an intangible asset would have to pay a third party for the use of the asset if it were not owned by the user.
The Company recorded two impairments of The Art Institutes trade name totaling $116.8 million during the fiscal year ended June 30, 2014, utilizing the following key assumptions:
a 15.5% discount rate and 1.5% royalty rate at March 31, 2014; and
a 16.0% discount rate and a 1.0% royalty rate at June 30, 2014.
In the fiscal 2013 analysis, the Company used a royalty rate of 2.0%. The royalty rate decreased throughout the year due primarily to reductions in long term revenue forecasts at The Art Institutes compared to the prior year long range projections. The increase in the discount rate was consistent with the increase in the WACC used in the goodwill impairment analysis for The Art Institutes.
The Company also revalued the licensing, accreditation and Title IV program participation assets for all reporting units at March 31, 2014 and June 30, 2014 using the same approaches used to value these assets as of the date of the Transaction,

22


which resulted in an $8.0 million impairment at The Art Institutes. A $16.3 million impairment of these assets was recorded during fiscal 2012, which consisted of $15.0 million at The Art Institutes and $1.3 million at Argosy University. These assets were valued by a combination of the cost and income approaches. The cost approach is used for the licensing and accreditation portions of this asset. Numerous factors are considered in order to estimate the Title IV portion of the asset, including the estimated amount of time it would take for an institution to qualify for Title IV funds as a new operation, the number of students currently receiving federal financial aid, the amount schools would have to lend students during the estimated time it would take to qualify for Title IV funds and the present value of projected cash flows.
During the fiscal year ended June 30, 2014, the Company recorded a $3.6 million charge in long-lived asset impairments in the consolidated statement of operations relating to definite-lived curriculum intangible assets at Argosy University as the estimated future cash flows could not support the carrying value of the asset. The charge was calculated using an income valuation approach.
Amortization of Intangible Assets
Amortization of intangible assets was $6.3 million, $6.8 million and $7.6 million during the fiscal years ended June 30, 2014, 2013 and 2012, respectively. Total estimated amortization of the Company’s intangible assets for each of the years ending June 30, 2015 through 2019 was as follows at June 30, 2014 (in thousands):
Fiscal years
Amortization
Expense
2015
$
5,434

2016
2,936

2017
340

2018
51

 
6.
STUDENT RECEIVABLES
The Company offers three types of financial arrangements to its students to assist with the obligation associated with tuition and fees, which helps students fund the difference between total tuition and fees and the amount covered by various sources of financial aid, including amounts awarded under Title IV programs, private loans and cash payments: due and payable amounts; a tuition payment plan; and lines of credit. Due and payable amounts are short-term extensions of credit for typically small balances which are repayable upon demand by the Company. Tuition payment plans are short-term credit extensions for 12 months or less. Lines of credit are extensions of credit which include a monthly minimum payment amount and permit students to repay amounts borrowed over a period of up to 42 months after graduation. During fiscal 2013, the Company extended the repayment period for financing made available to students from a maximum of 36 months beyond graduation to a maximum of 42 months beyond graduation. The majority of applicable line of credit accounts incur interest charges that accrue each month on unpaid balances except for those accounts that have been placed into collections. Student receivables include $29.3 million (net of $32.2 million allowance) and $24.3 million (net of $27.9 million allowance) recorded in other long-term assets on the accompanying balance sheets related to lines of credit to students for amounts due beyond one year.
The Company monitors its student receivables based on enrollment status. Receivables from former students who are in collections are reserved for at a very high rate. Receivables from former students that are out-of-school are reserved for at a higher rate than the receivables from students that are in-school. The gross current and non-current student receivables, which excludes loans awarded under the student lending program further described below, by student status were as follows at June 30 (in thousands):        
 
2014
 
2013
In-school
$
236,144

 
$
194,062

Out-of-school (1)
63,624

 
128,375

Collections
115,293

 
110,955

Gross student receivables
$
415,061

 
$
433,392

A roll forward of the Company's total allowance for doubtful accounts and loan loss reserves from June 30, 2011 to June 30, 2014 is as follows (in thousands):

23


Balance June 30, 2011
$
199,357

Bad debt expense
163,926

Amounts written off
(113,001
)
Balance June 30, 2012
250,282

Bad debt expense
171,850

Amounts written off  (2)
(213,884
)
Balance June 30, 2013
208,248

Bad debt expense (1)
141,946

Amounts written off
(156,354
)
Balance June 30, 2014
$
193,840

(1) Refer to Note 2, "Summary of Significant Accounting Policies," for details with respect to a correction in the Company's policy regarding the recognition of incremental revenue recorded when students withdraw.
(2) As explained in Note 2, "Summary of Significant Accounting Policies," the Company reduced the number of days after which accounts in collections are written off during fiscal 2013.
The amounts set forth above are recorded within student receivables, net and other long-term assets on the consolidated balance sheets. Recoveries of amounts previously written off were not significant in any period presented.
The Company commenced a new student lending program in fiscal 2013 under which it purchases loans awarded and disbursed to its students from a private lender. The loans purchased under this program are included in other long-term assets, net of an allowance, at an amount of $8.7 million and $0.4 million at June 30, 2014 and 2013, respectively, on the accompanying consolidated balance sheets.
7.
ACCRUED LIABILITIES

Accrued liabilities consisted of the following at June 30 (in thousands):
 
2014
 
2013
Payroll and related taxes
$
35,918

 
$
39,330

Advertising
25,597

 
33,010

Benefits
15,345

 
16,235

Interest
7,900

 
10,416

Capital expenditures
7,387

 
4,113

Other
75,135

 
54,313

Total accrued liabilities
$
167,282

 
$
157,417

Over the past several fiscal years, the Company has completed restructuring plans across the organization intended to improve operational efficiencies and align costs with student enrollment levels. During the fiscal years ended June 30, the Company recorded the following restructuring expenses in educational services expense and general and administrative expense (in thousands):
 
2014
 
2013
 
2012
Employee severance and other
$
21,141

 
$
11,877

 
$
11,633

Leases
5,811

 
2,043

 
2,500

Total restructuring expense
$
26,952

 
$
13,920

 
$
14,133


At June 30, 2014, the remaining liability for all restructuring plans was $13.7 million, consisting of employee severance of $5.8 million recorded in accrued liabilities in which the significant majority will be paid through June 30, 2015 and net rent charges of $7.9 million recorded in deferred rent that will be paid through the remaining lease terms through 2022.
As further described in Note 14, "Commitments and Contingencies," the Company is involved in multiple legal matters. The increase in other accrued liabilities since June 30, 2013 primarily relates to amounts that have been recorded for such matters, the majority of which is offset by receivables from the Company's insurers that have been recorded in other current assets in the accompanying consolidated balance sheet.

24


8.
SHORT-TERM AND LONG-TERM DEBT

Debt Restructuring
Refer to Note 2, "Summary of Significant Accounting Policies," under "Basis of Presentation" for a description of the debt restructuring in September 2014.
U.S. Department of Education Letters of Credit:
The Company had outstanding letters of credit of $307.6 million at June 30, 2014, the largest of which is issued to the U.S. Department of Education, which requires that the Company maintain a letter of credit due to its failure to satisfy certain regulatory financial ratios after giving effect to the Transaction. In January 2014, the U.S. Department of Education decreased the amount of the required letter of credit from $348.6 million to $302.2 million, which equals 15% of the total Title IV aid received by students attending the Company’s institutions during the fiscal year ended June 30, 2013.
During fiscal 2012, the Company entered into two cash secured letter of credit facilities pursuant to which the lenders agreed to issue letters of credit at any time to the U.S. Department of Education in an aggregate face amount of up to $200.0 million. The Company's obligations with respect to such letters of credit are secured by liens in favor of the lenders on certain of the Company's cash deposits, which must total at least 105% of the aggregate face amount of any outstanding letters of credit. The cash secured letter of credit facilities were amended in April 2014 to extend their maturities from July 8, 2014 to June 1, 2015 or earlier if the existing revolving credit facility is terminated. Any future reduction in the usage of the cash secured letter of credit facilities will reduce the amount of cash that is classified as restricted cash on the consolidated balance sheet.
As of June 30, 2014, in order to fund its current letter of credit obligation to the U.S. Department of Education, the Company used all $200.0 million of capacity under the cash secured letter of credit facilities, in connection with which the Company classifies $210.0 million as restricted cash to satisfy the 105% collateralization requirement described above and utilized $102.2 million letter of credit capacity under its revolving credit facility. Any future reduction in the usage of the cash secured letter of credit facilities will reduce the amount of cash that is classified as restricted cash on the consolidated balance sheet.
Short-Term Debt:
At June 30, 2014 and 2013, the Company had $219.9 million and $75.0 million, respectively, of borrowings outstanding under the $328.3 million revolving credit facility, which currently expires in July 2015 after giving effect to the pre-restructuring amendments to existing debt further described in Note 2, "Significant Accounting Policies." These borrowings existed in order to satisfy year-end regulatory financial ratios as well as aid in the ongoing negotiations with the Company's lenders. Outstanding balances under the revolving credit facility are classified as short-term debt on the consolidated balance sheets. After adjusting for outstanding letters of credit under the revolving credit facility, which decrease its availability for borrowings, the Company had $0.8 million additional capacity under the revolving credit facility at June 30, 2014 available for borrowings or issuance of letters of credit.
The interest rate on amounts outstanding at June 30, 2014 and 2013 under the revolving credit facility was 4.25%, which equals LIBOR plus a margin of 4.00%. The applicable margin for borrowings under the revolving credit facility can change dependent on certain leverage ratios and credit ratings. EM LLC is obligated to pay a per annum commitment fee on undrawn amounts under the revolving credit facility, which is currently 0.375% and varies based on certain leverage ratios. The Company must also pay customary letter of credit fees for outstanding letters of credit under the revolving credit facility, which is secured by certain of the Company's assets and is subject to the Company's satisfaction of certain covenants and financial ratios described below.
Long-Term Debt:
The Company’s long-term debt consisted of the following at June 30 (in thousands): 

25


 
2014
 
2013
Senior secured term loan facility, due in June 2016 ("Tranche C-2 Loan")
$
728,369

 
$
736,454

Senior secured term loan facility, due in March 2018, net of discount of $2,288 and $2,898 ("Tranche C-3 Loan")
339,183

 
342,364

Senior cash pay/PIK notes due 2018, net of discount of $22,335 and $27,712 ("Cash Pay/PIK Notes")
215,909

 
206,242

Other

 
180

Total long-term debt
1,283,461

 
1,285,240

Less current portion
(11,875
)
 
(12,076
)
Total long-term debt, less current portion
$
1,271,586

 
$
1,273,164

At June 30, 2014, future annual principal payments on long-term debt and the revolving credit facility were as follows for the fiscal years ending June 30 (in thousands): 
Fiscal year:
 
Amount
2015
 
$
231,765

2016
 
724,072

2017
 
3,753

2018
 
330,140

2019
 
255,944

Total
 
$
1,545,674

These amounts are presented gross of the $2.3 million discount on the senior secured term loan facility due in March 2018 and the $22.3 million discount on the Cash Pay/PIK Notes and include $17.7 million of unamortized PIK interest that is capitalized to the principal balance of the Cash Pay/PIK Notes through its maturity in July 2018. The amendment to the senior credit facility and the terms of the new Indenture were effective upon execution on September 5, 2014 and therefore, eliminate a significant portion of principal payments for fiscal 2015 and beyond. Refer to Note 2, "Significant Accounting Policies," under "Basis of Presentation" for more information.
Senior Secured Credit Facilities:
The Tranche C-3 Loan bears interest at a rate equal to the greater of three-month LIBOR or 1.25%, plus a margin of 7.0%, or 8.25% at June 30, 2014 and 2013. The Tranche C-2 Loan bears interest at a rate equal to three-month LIBOR plus a margin of 4.00%, or 4.25% and 4.31% at June 30, 2014 and June 30, 2013, respectively. 
On March 30, 2012, EM LLC completed a refinancing of the $348.6 million portion of the $1.1 billion term loan under its senior secured credit facility that was due to expire in June 2013 by replacing it with $350.0 million of new term debt under the same credit agreement and recorded a loss on debt refinancing of $9.5 million.
Senior Cash Pay/PIK Notes
On March 5, 2013, EM LLC and Education Management Finance Corp. (a wholly-owned subsidiary of EM LLC) completed a private exchange offer (the "Exchange Offer") in which they offered to exchange their 8.75% senior notes due June 1, 2014 ("Old Notes") for (i) new Senior Cash Pay/PIK Notes due July 1, 2018 ("Cash Pay/PIK Notes") and (ii) cash. In connection with the Exchange Offer, a simultaneous private exchange on the same terms and an extinguishment at par of the Old Notes not tendered in the Exchange Offer, the Company issued $203.0 million of Cash Pay/PIK Notes and paid down $172.0 million of Old Notes with cash on hand. Included in the $365.3 million of Old Notes tendered for exchange was $4.0 million owned by an affiliate of one of the Sponsors. The Company incurred $5.2 million of fees to third parties in connection with this transaction that were reported as a loss on debt refinancing in the consolidated statement of operations in the fiscal year ended June 30, 2013. Included in these third party fees was $2.9 million paid to affiliates of one of the Sponsors.
Cash interest on the Cash Pay/PIK Notes accrues at the rate of 15% per annum and is payable semi-annually on March 30 and September 30, commencing on September 30, 2013. For any interest period after March 30, 2014 up to and including July 1, 2018, interest in addition to the cash interest payable will be paid by increasing the principal amount of the outstanding PIK Notes (“PIK Interest”). Additionally, the Cash Pay/PIK Notes are required to be paid at a premium of 13% at their contractual maturity, which is recorded as an original issuance discount. Including PIK interest and the original issuance discount, the annual effective interest rate on the Cash Pay/PIK Notes is 19.8%.

26


9.
DERIVATIVE INSTRUMENTS
In April 2011, the Company entered into three new interest rate swap agreements for an aggregate notional amount of $950.0 million, each of which became effective on July 1, 2011. One swap agreement, which expired on June 1, 2013, was for a notional amount of $325.0 million and effectively fixed future interest payments at a maximum rate of 9.44%. The other two swap agreements, one of which was entered into with an affiliate of one of the Sponsors, are for notional amounts of $312.5 million each and effectively fix future interest payments at a rate of 6.26% through June 1, 2015. The fair values of the interest rate swap liabilities were $11.2 million and $20.2 million at June 30, 2014 and 2013, and recorded in accrued liabilities and other long-term liabilities, respectively.
Historically, both interest rate swaps were highly effective for accounting purposes and have qualified for cash flow hedge accounting treatment. Accordingly, changes in their fair values have been recorded in other comprehensive income or loss. On September 4, 2014, in connection with the Debt Restructuring described in Note 2, "Summary of Significant Accounting Policies," under "Basis of Presentation," EM LLC entered into agreements to terminate its interest rate swaps at termination values payable to the counter-parties in the form of a combination of term loans and preferred stock. As a result, approximately $7 million will be reclassified from other comprehensive loss to the statement of operations, net of tax, during the first quarter of fiscal 2015.
10.
FAIR VALUE OF FINANCIAL INSTRUMENTS 
The Company determines the fair value of assets and liabilities based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. The fair values are based on assumptions that market participants would use when pricing an asset or liability, including assumptions about risk and the risks inherent in valuation techniques and the inputs to valuations. The fair value hierarchy is based on whether the inputs to valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's own assumptions of what market participants would use. The fair value hierarchy includes three levels of inputs that may be used to measure fair value as described below.
Level One - Quoted prices for identical instruments in active markets.
Level Two - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations for which all significant inputs are observable market data.
Level Three - Unobservable inputs significant to the fair value measurement supported by little or no market activity.
In some cases, the inputs used to measure fair value may meet the definition of more than one level of fair value hierarchy. The lowest level input that is significant to the fair value measurement in its totality determines the applicable level in the fair value hierarchy.
The following table presents the carrying amounts and fair values of the interest rate swap liabilities, which are measured at fair value on a recurring basis based on the framework described in Note 9, "Derivative Instruments," and the fair values of the Company's debt, which is recorded at carrying value (in thousands):
 
June 30, 2014
 
June 30, 2013
 
Carrying Value
Level 1
Level 2
Level 3
 
Carrying Value
Level 1
Level 2
Level 3
Recurring:
 
 
 
 
 
 
 
 
 
Interest rate swap liability
$
11,223

$

$
11,223

$

 
$
20,232

$

$
20,232

$

Disclosure only:
 
 
 
 
 
 
 
 
 
Variable rate debt
1,067,552


824,715


 
1,078,818


962,134


Fixed rate debt
215,909



232,102

 
206,422



206,422

The fair values of the Company’s variable rate debt at the dates presented above were based on each instrument’s trading value in markets that are not active. The Company's fixed rate debt is comprised of the Company's Cash Pay/PIK Notes, on which there is currently no observable trading; therefore, the fair value of the Cash Pay/PIK Notes at June 30, 2014 was estimated using a premium of 107.5, which is the current call price. Cash and cash equivalents, restricted cash, student accounts receivable, notes receivable, the revolving credit facility, accounts payable and accrued expenses have fair values that approximate their carrying values.

27


As described in Note 4, "Property and Equipment" and Note 5, "Goodwill and Intangible Assets," the Company recorded asset impairments during fiscal 2014 and fiscal 2013. This resulted in the following assets being measured at fair value on a non-recurring basis using Level Three inputs:
goodwill at The Art Institutes reporting unit at March 31, 2014 and March 31, 2013;
the trade name for The Art Institutes reporting unit at June 30, 2014, March 31, 2014 and March 31, 2013;
the licensing, accreditation and Title IV program participation assets at The Art Institutes reporting units at June 30, 2014;
certain long-lived assets at the Brown Mackie Colleges and Argosy University reporting units.
11.
INCOME TAXES
The composition of (loss) income before taxes from domestic and foreign locations was as follows for the fiscal years ended June 30 (in thousands): 
 
2014
 
2013
 
2012
Domestic
$
(619,243
)
 
$
(233,153
)
 
$
(1,446,575
)
Foreign
1,963

 
801

 
1,568

Loss before taxes
$
(617,280
)
 
$
(232,352
)
 
$
(1,445,007
)
The components of income tax expense (benefit) reflected in the accompanying consolidated statements of operations were as follows for the fiscal years ended June 30 (in thousands): 
 
2014
 
2013
 
2012
Current taxes:
 
 
 
 
 
Federal
$
7,472

 
$
32,441

 
$
104,730

State and local
2,891

 
(1,563
)
 
14,027

Total current tax expense
10,363

 
30,878

 
118,757

Deferred tax expense (benefit)
36,274

 
(18,840
)
 
(130,194
)
Income tax expense (benefit)
$
46,637

 
$
12,038

 
$
(11,437
)
Income tax expense (benefit) reflected in the accompanying consolidated statements of operations varies from the amounts that would have been provided by applying the United States federal statutory income tax rate to earnings before income taxes as shown below for the fiscal years ended June 30 (in thousands): 
 
2014
 
2013
 
2012
U.S. federal statutory income tax
$
(216,048
)
 
$
(81,323
)
 
$
(505,752
)
State and local income taxes, net of federal benefit
(10,708
)
 
(196
)
 
(6,741
)
Increase in valuation allowance
127,738

 
151

 
3,069

State tax settlements, net of federal benefit

 
(3,808
)
 

Permanent items
1,880

 
2,913

 
1,477

Nondeductible goodwill
151,812

 
94,805

 
497,991

Uncertain tax positions
(2,956
)
 
(490
)
 
(602
)
Other items, net
(5,081
)
 
(14
)
 
(879
)
Income tax expense (benefit)
$
46,637

 
$
12,038

 
$
(11,437
)
The effective tax rates in the current and prior fiscal years were significantly impacted by goodwill impairment charges, the majority of which were not deductible for income tax purposes.
Net deferred income tax assets and liabilities consisted of the following at June 30 (in thousands): 

28


 
2014
 
2013
Current deferred tax assets:
 
 
 
Allowance for doubtful accounts
$
71,689

 
$
71,769

Accrued wages
3,481

 
6,872

Interest rate swap
4,887

 

Other
9,069

 
3,434

Gross current deferred tax assets
89,126

 
82,075

Less valuation allowance
(64,624
)
 
(5,148
)
Total current deferred tax assets
$
24,502

 
$
76,927

Noncurrent deferred tax assets:
 
 
 
Interest rate swap
$

 
$
8,819

Deferred liabilities
30,045

 
35,683

Foreign and state net operating losses
12,834

 
7,990

Property and equipment
7,847

 

Share-based compensation
25,493

 
24,023

Other
35,910

 
26,981

Gross noncurrent deferred tax assets
112,129

 
103,496

Less valuation allowance
(87,639
)
 
(19,677
)
Total noncurrent deferred tax assets
24,490

 
83,819

Noncurrent deferred tax liabilities:
 
 
 
Intangible assets
82,569

 
130,491

Property and equipment

 
25,657

Other
498

 
293

Total noncurrent deferred tax liabilities
83,067

 
156,441

Total net noncurrent deferred tax liabilities
$
58,577

 
$
72,622


As discussed in Note 5, "Goodwill and Intangible Assets," the Company incurred long-lived asset impairment charges of $568.2 million, of which $433.7 million related to goodwill that was not deductible, and $300.1 million, of which $270.9 million related to goodwill that was not deductible, in fiscal 2014 and 2013, respectively. These impairment charges were a significant factor contributing to the Company being in a cumulative pre-tax loss position for the past three years. However, even if the goodwill impairment charges are excluded, the Company is still nonetheless in a cumulative pre-tax loss position for the past three years. Management considered the cumulative loss for book purposes as well as sources of taxable income and concluded that it was not more-likely-than-not that the Company’s deferred tax assets would be fully realized. As such, the Company recorded a broader valuation allowance against both its federal and state deferred tax assets as of June 30, 2014. In contrast, as of June 30, 2013, the Company had recorded a valuation allowance only against certain state deferred tax assets.
At June 30, 2014, the Company had state net operating loss carryforwards of approximately $250.0 million available to offset future taxable income and a related deferred tax asset of $12.8 million. The carry forwards expire at varying dates beginning in fiscal 2025 through fiscal 2034. The Company has determined that it is currently more-likely-than-not that the deferred tax assets associated with $245.2 million of its state net operating loss carryforwards will not be realized and has established a valuation allowance equal to the gross deferred tax asset balance of $12.6 million related to these net operating loss carryforwards. In addition, certain of the Company’s state net operating losses may be subject to annual limitations due to these states’ adoption of the ownership change limitations imposed by Internal Revenue Code Section 382 or similar state provisions, which could result in the expiration of the state net operating loss carryforwards before they can be utilized.
The recognition and measurement of tax benefits associated with uncertain income tax positions requires the use of judgment and estimates by management, which are inherently subjective. Changes in judgment about uncertain tax positions taken in previous periods may result from new information concerning an uncertain tax position, completion of an audit or the expiration of statutes of limitation. These changes may create volatility in the Company’s effective tax rate in future periods.
A reconciliation of the beginning and ending balance of unrecognized tax benefits, excluding interest expense and the indirect benefits of state taxes, for the fiscal years ended June 30 is as follows (in thousands): 

29


 
2014
 
2013
 
2012
Unrecognized tax benefits, beginning of year
$
3,962

 
$
4,523

 
$
5,438

(Decrease) in prior year unrecognized tax benefits

 

 
(93
)
Increase in current year unrecognized tax benefits

 
127

 
58

(Decrease) in unrecognized tax benefits due to the expiration of statutes of limitation
(2,926
)
 
(688
)
 
(880
)
Unrecognized tax benefits, end of year
$
1,036

 
$
3,962

 
$
4,523

All of the Company’s $1.0 million in unrecognized tax benefits, excluding interest expense and the indirect benefit of state taxes, would affect the annual effective tax rate if recognized. It is reasonably possible that the total amount of unrecognized tax benefits will decrease by $0.8 million within the next twelve months due to the expiration of certain statutes of limitation. The resulting benefit, if recognized, would affect the tax rate as a discrete item in the quarter ending March 31, 2015. Interest expense and penalties accrued in connection with unrecognized tax benefits were not significant in fiscal 2014, 2013 and 2012.
The statutes of limitation for the Company’s U.S. income tax returns are closed for years through fiscal 2010. The Company's U.S. income tax return for fiscal 2011 was examined by the Internal Revenue Service. The Internal Revenue Service closed the examination without making any adjustments to the return. The statutes of limitation for the Company’s state and local income tax returns for prior periods vary by jurisdiction. However, the statutes of limitation with respect to the major jurisdictions in which the Company files state and local tax returns are generally closed for years through fiscal 2009.
During the current fiscal year, the state of Pennsylvania enacted legislation which, among other things, changed how revenues from the sale of services are sourced for Pennsylvania income tax purposes effective for tax years beginning after December 31, 2013, which for the Company is fiscal 2015. The Company recorded the impact of this law change, which management estimated will result in a deferred tax benefit of approximately $3.2 million, as a discrete item in the first quarter of fiscal 2014. In addition, the state of New York enacted legislation during the current fiscal year which, among other things, changed the state’s corporate income tax rate, the tax filing methodology, and how revenues from the sales are services are sourced for New York income tax purposes. The Company recorded the impact of this law change, which management estimated will result in a deferred tax benefit of approximately $3.3 million, as a discrete item in the third quarter of fiscal 2014.
12.
SHARE-BASED COMPENSATION
Overview
The Company awards share-based compensation under the Education Management Corporation 2012 Omnibus Long-Term Incentive Plan (the “2012 Omnibus Plan”), which replaced the Education Management Corporation Omnibus Long-Term Incentive Plan (the "2009 Omnibus Plan") that became effective upon the completion of the Initial Public Offering. The 2009 Omnibus Plan and the 2006 Stock Option Plan, which it replaced, are now frozen. The 2012 Omnibus Plan may be used to issue stock options, stock appreciation rights, restricted stock, restricted stock units and other forms of long-term incentive compensation.
The Company amended the 2012 Omnibus Plan in November 2013 to increase the number of shares of Common Stock authorized for issuance by 4.0 million and to allow the Company the ability to grant future cash and stock-based awards that generally have a performance period of one year. As of June 30, 2014, approximately 7.7 million shares of Common Stock remain reserved for issuance under the 2012 Omnibus Plan.
The Company recognized $16.4 million, $17.1 million and $13.3 million of share-based compensation expense related to outstanding time-based stock options, restricted stock and other awards during fiscal 2014, 2013 and 2012, respectively. Compensation expense for fiscal 2014 and 2013 includes additional expense recognized upon the termination of former employees who are were no longer required to provide services to obtain certain awards in accordance with the terms of their employment agreements.
During the fiscal year ended June 30, 2014, the Company issued 1.7 million shares of Common Stock related to share-based compensation activity that resulted in gross excess tax benefits of $3.4 million and stock-option exercise proceeds of $3.0 million. The Company received approximately $2.4 million from option holders in fiscal 2012 from the exercise of stock options, on which the excess tax benefit was $0.3 million. Share-based compensation activity was not significant in fiscal 2013. Gross excess tax benefits and stock-option exercise proceeds are classified as cash inflows from financing activities in the accompanying consolidated statement of cash flows.
In connection with the vesting of restricted stock units that occurred in the fiscal year ended June 30, 2014, the Company paid $3.3 million in minimum tax withholdings on behalf of its employees, which is classified as a cash outflow from financing

30


activities. In exchange, the Company retained 0.3 million shares, which was equal to the value of the required tax withholding payments on the vesting dates.
Time-based Stock Options
The Company utilizes the Black-Scholes-Merton method to estimate the fair value of time-based options. The expected term of the Company's options is determined using a simplified method based on the average of the weighted vesting terms and the contractual term of the options. Expected volatility is determined using the historical volatility of a six-company peer group, all of which have publicly traded stock. The risk-free interest rate assumption is determined using the yield on a zero-coupon U.S. Treasury strip by extrapolating to a forward-yield curve. The Company has not historically declared dividends and does not intend to do so in the foreseeable future; therefore, a dividend yield of zero is used. Finally, the forfeiture rate at the date of grant (as depicted in the table below) is generally determined using a historical rate based on actual experience; however, management reviews actual forfeitures on a periodic basis and updates actual and estimated future compensation expense accordingly. Below is a summary of the weighted-average assumptions used for time-based options granted during the years ended June 30, which excludes the replacement options granted in fiscal 2013 in connection with the Options Exchange that is explained separately below:
 
2014
 
2013
 
2012
Weighted average fair value of options
$
7.66

 
$
2.76

 
$
9.29

Expected dividend yield
%
 
%
 
%
Expected volatility
64.0
%
 
78.6
%
 
45.0
%
Risk-free interest rate
1.9
%
 
1.2
%
 
1.5
%
Expected forfeiture rate at the date of grant
12.9
%
 
%
 
7.3
%
Expected term
6.25 years

 
7.5 years

 
6.25 years

Vesting periods
4 years

 
4 years

 
4 years

A roll forward of time-based option activity during fiscal 2014 is presented below.
 
Options (in thousands)
 
Weighted
Average
Exercise Price
 
Weighted
Average
Remaining
Contractual
Life
 
Aggregate
Intrinsic
Value (in
thousands)
Outstanding at June 30, 2013
10,989

 
$
4.06

 
7.5 years
 
$
17,120

Granted
1,534

 
$
12.74

 
 
 
 
Forfeited
(911
)
 
$
5.54

 
 
 
 
Exercised
(753
)
 
$
3.58

 
 
 
 
Expired