-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BIqs+ZGHQEixw97pT9nOe5AelxJVBHL/MvLkJj1+74oeiS9lD4TZeGEgV7g2hkqs yVuAfbQK26gSLnz9GQeiWQ== 0000950128-97-000980.txt : 19970930 0000950128-97-000980.hdr.sgml : 19970930 ACCESSION NUMBER: 0000950128-97-000980 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970929 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: EDUCATION MANAGEMENT CORPORATION CENTRAL INDEX KEY: 0000880059 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-EDUCATIONAL SERVICES [8200] IRS NUMBER: 251119571 FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-21363 FILM NUMBER: 97687860 BUSINESS ADDRESS: STREET 1: 300 SIXTH AVENUE CITY: PITTSBURGH STATE: PA ZIP: 15222 BUSINESS PHONE: 4125620900 MAIL ADDRESS: STREET 1: 300 SIXTH AVE CITY: PITTSBURGH STATE: PA ZIP: 15222 10-K405 1 EDUCATIONAL MANAGEMENT CORP. 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED: JUNE 30, 1997 COMMISSION FILE NUMBER: 000-21363 ------------------------ EDUCATION MANAGEMENT CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) PENNSYLVANIA 25-1119571 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 300 SIXTH AVENUE, PITTSBURGH, PA 15222 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (412) 562-0900 SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $.01 PAR VALUE (TITLE OF CLASS) PREFERRED SHARE PURCHASE RIGHTS (TITLE OF CLASS) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in the definitive proxy statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X The aggregate market value of the voting stock held by non-affiliates of the registrant as of September 22, 1997 was approximately $202,300,000. The number of shares of Common Stock outstanding on September 22, 1997 was 14,434,737 shares. Documents incorporated by reference: Notice of 1997 Annual Meeting and Proxy Statement (Part III of Form 10-K). ================================================================================ 2 PART I ITEM 1--BUSINESS The following discussion contains forward-looking statements relating to future plans, expectations, events or performances that involve risks and uncertainties. The Company's actual results of operations could differ materially from those anticipated in these forward-looking statements as a result of certain factors. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report. GENERAL Education Management Corporation ("EDMC" or the "Company") is among the largest providers of proprietary postsecondary education in the United States based on student enrollments and revenues. Through its operating units, the Art Institutes ("The Art Institutes"), The New York Restaurant School ("NYRS"), The National Center for Paralegal Training ("NCPT") and The National Center for Professional Development ("NCPD"), the Company offers associate's and bachelor's degree programs and non-degree programs in the areas of design, media arts, culinary arts, fashion and professional development. The Company has provided career-oriented education programs for 35 years, and its schools have graduated over 100,000 students. In the fall quarter of fiscal 1997, beginning October 1, 1996, EDMC's schools had approximately 15,800 students enrolled, representing all 50 states and over 80 countries. The Company's main operating unit, The Art Institutes, consists of 13 schools in 12 cities throughout the United States and accounted for approximately 92.7% of the Company's net revenues in fiscal 1997. Art Institute programs are designed to provide the knowledge and skills necessary for entry-level employment in various fields, including graphic design, multimedia, computer animation, video production, culinary arts, interior design, industrial design, photography, fashion marketing and fashion design. Those programs typically are completed in 18 to 27 months and culminate in an associate's degree. Five Art Institutes currently offer bachelor's degree programs, and EDMC expects to continue to introduce bachelor's degree programs at schools in states in which applicable regulations permit proprietary postsecondary institutions to offer such programs. In January 1997, the Company acquired the assets of Lowthian College in Minneapolis, Minnesota and renamed the school The Art Institute of Minnesota. In March 1997, the Company's newest school, The Art Institute of Los Angeles, obtained its license to operate in the state of California. The Art Institute of Los Angeles expects to begin offering classes in October 1997. The Company offers a culinary arts curriculum at six Art Institutes and expects to begin offering that curriculum at The Art Institute of Philadelphia in October 1997. In addition, in August 1996, the Company acquired NYRS, a well-known culinary arts and restaurant management school located in New York City. NYRS offers an associate's degree program and certificate programs. NYRS accounted for approximately 5.4% of the Company's net revenues in fiscal 1997. The Company offers paralegal training at NCPT in Atlanta, a leading source of paralegals in the southeastern United States. NCPT offers certificate programs that generally are completed in four to nine months. NCPD maintains consulting relationships with seven colleges and universities to assist in the development, marketing and delivery of paralegal, legal nurse consultant and financial planner test preparation programs for recent college graduates and working adults. In fiscal 1997, the Company derived approximately 1.8% of its net revenues from NCPT and NCPD combined. EDMC's primary objective is to provide career-focused education that maximizes employment opportunities for its students after graduation. EDMC's graduates are employed by a broad range of employers nationwide. Approximately 86% of the calendar year 1996 graduates of all programs at EDMC's schools who were available for employment obtained positions in fields related to their programs of study within six months of graduation. The Company believes that demand for postsecondary education will generally increase due to (i) an increase of 20% in the number of new high school graduates from approximately 2.5 million in 1994 to 3.0 million in 2005 (as projected by the National Center for Education Statistics), (ii) the growing interest of 2 3 working adults in enhancing their marketable skills, (iii) the income premium attributable to higher education degrees, and (iv) employers' continuing demand for entry-level workers with appropriate technical skills. EDMC has capitalized on these favorable trends in the postsecondary education market through continued implementation of the following strategic initiatives: - Enhancing Growth at the Company's Schools: The Company has continued to expand its evening programs and to augment its efforts to recruit high school students. The total number of students attending The Art Institutes (including schools opened or acquired during fiscal 1996) rose approximately 20.3% from the fall quarter of fiscal 1993 to the fall quarter of fiscal 1997. Excluding those new schools, the increase was approximately 13.4% over the same period. In fiscal 1997, The Art Institutes experienced a 28.7% increase over the prior year in the number of applications from high school seniors for education programs starting in fiscal 1997 or fiscal 1998. - Opening or Acquiring Schools: The Company believes that significant opportunities exist for growth through the establishment of new schools and acquisitions. In fiscal 1996, the Company acquired or opened three schools: The Art Institute of Phoenix, The Illinois Institute of Art at Chicago and The Illinois Institute of Art at Schaumburg. Since the beginning of fiscal 1997, the Company has acquired or opened three additional schools: NYRS, The Art Institute of Minnesota and The Art Institute of Los Angeles. The Company also has committed significant resources to an integrated, customized information network that the Company believes enhances its ability to integrate newly established or acquired schools into the Company's operations. - Expanding Education Programs: EDMC seeks to optimize its portfolio of programs to meet the needs of both its students and the employment market. Since the beginning of fiscal 1994, the Company has increased the number of Art Institutes at which it offers culinary arts programs from three to six (in addition to acquiring NYRS) and expects to start a culinary arts program at The Art Institute of Philadelphia in October 1997. The Company has also added education program offerings in high growth fields such as computer animation, multimedia and video production, and expects to start classes in fiscal 1998 in interactive multimedia programming and web site administration. - Improving Student Outcomes: The Company continues to seek to increase the number of students who finish their programs of study, the number of graduates who find employment in fields related to their programs of study and the starting salaries of those graduates. At The Art Institutes, the average quarterly net persistence rate, a measure of the number of students that are enrolled during an academic quarter and advance to the next academic quarter, improved from 88.4% in fiscal 1994 to 90.2% for the first three quarters of fiscal 1997. From calendar year 1993 to calendar year 1996, the placement rate for all graduates available for employment, who completed any program at an Art Institute, improved from 83.1% to 86.8% and average starting salaries rose 29.5% from approximately $15,600 to approximately $20,200. The Company believes the experience of its management team and the substantial equity ownership of its employees are significant factors contributing to its success. EDMC's senior management has an average of nine years with EDMC and 18 years of experience in the education industry. Approximately two-thirds of the employees of EDMC, including a substantial majority of the management team, has an ownership interest in the Company through direct holdings, participation in the Company's Employee Stock Ownership Plan and Trust (the "ESOP") or both. COMPANY HISTORY The Company was organized as a Pennsylvania corporation in 1962. In 1971, Robert B. Knutson (currently the Chairman and Chief Executive Officer) became President of the Company. At that time, EDMC consisted primarily of The Art Institute of Pittsburgh, which was acquired in 1970. Between 1971 and fiscal 1997, the Company opened two schools and acquired 11 others. A third new school, The Art Institute of Los Angeles, is expected to begin classes in October 1997. Since 1971, the Company's net revenues have increased from approximately $1.9 million to approximately $182.8 million in fiscal 1997. 3 4 In November 1996, the Company and certain shareholders sold shares of the Company's common stock, $.01 par value (the "Common Stock"), to the public in an initial public offering (the "Offering"). INDUSTRY OVERVIEW According to the National Center for Education Statistics, education is the second largest sector of the U.S. economy, accounting for approximately 8% of gross domestic product in 1996, or over $600 billion. EDMC's schools are part of the postsecondary education market, which accounts for approximately one-third of the total sector, or $208 billion. Of the approximately 6,000 postsecondary schools that are eligible to participate in federal financial aid programs ("Title IV Programs") under Title IV of the Higher Education Act of 1965, as amended (the "HEA"), approximately 500 are proprietary degree-granting institutions such as EDMC's schools. The United States Department of Education (the "U.S. Department of Education") estimates that by the year 2001 the number of students enrolled in higher education institutions will increase by more than 1.5 million to over 16 million students. The Company believes that a significant portion of the growth in the postsecondary education market will result from an increase in the number of new high school graduates. According to the U.S. Department of Education, the number of new high school graduates is expected to increase by approximately 20%, from 2.5 million graduates in 1994 to 3.0 million graduates in 2005. Significant growth is also expected to result from increased enrollment of working adults. The U.S. Department of Education estimates that, over the next several years, initial enrollments in postsecondary education institutions by working adults will increase more rapidly than initial enrollments of recent high school graduates. The postsecondary education industry is also expected to benefit from the public's increased recognition of the value of a postsecondary education. According to The National Center for Education Statistics, the percentage of recent high school graduates who continued their education after graduation increased from approximately 53% in 1983 to approximately 63% in 1993. The Company believes that the income premium associated with a postsecondary education has been a significant factor contributing to this trend. The Census Bureau has reported that, in 1995, a full-time male worker with an associate's degree earned an average of 37% more per year than a comparable worker with only a high school diploma, and a full-time male worker with a bachelor's degree earned an average of approximately 72% more per year than a comparable worker with only a high school diploma. In addition, employment in technical occupations is expected to increase over the next several years as the demand for technically skilled labor increases. The Company believes that private degree-granting institutions, such as The Art Institutes and NYRS, will have an advantage over their principal competitors, the public two-year and four-year institutions, in capitalizing on the trends in the postsecondary education market. Private degree-granting institutions have the ability to work closely with employers to develop education programs. Well-capitalized companies, such as EDMC, should benefit from their ability to absorb the increasing costs of regulatory compliance and capital expenditure requirements through their economies of scale and national marketing presence. BUSINESS STRATEGY EDMC intends to capitalize on the trends in the postsecondary education market, creating an opportunity for increased revenues and profitability, by (i) enhancing growth at its current schools, (ii) opening or acquiring schools in attractive markets, (iii) expanding program offerings, and (iv) improving student outcomes. ENHANCING GROWTH AT THE COMPANY'S SCHOOLS EDMC believes that it will continue to benefit from trends relating to the growing number of potential students, particularly new high school graduates and working adults. EDMC augmented its efforts to recruit high school students by enlarging its high school admissions staff by 35% from fiscal 1995 to fiscal 1997 and by increasing the number of high schools visited to approximately 8,500 in fiscal 1997 (an increase of approximately 22% over fiscal 1995) and the number of high schools at which presentations were made to approximately 7,300 in fiscal 1997 (an increase of approximately 21% over fiscal 1995). The Company believes that, due in part to these efforts, applications from high school seniors in fiscal 1997 (for education programs starting in fiscal 1997 4 5 or fiscal 1998) were 28.7% greater than in fiscal 1996. The Company also believes it can penetrate the growing working adult market by introducing and augmenting evening programs. The first introduction of such programs was at The Art Institute of Dallas in fiscal 1993. Now, substantially all of The Art Institutes offer evening programs. The total number of students participating in such programs at The Art Institutes increased 40% to approximately 2,100 students in the spring quarter of fiscal 1997 from approximately 1,500 students in the spring quarter of fiscal 1996. In addition, the Company actively seeks international students for The Art Institutes. The Company employs both admissions personnel with international experience and independent recruiters abroad. To accommodate the special needs of international students, staff members are assigned to act as international student advisors. Average international student enrollments in fiscal 1997 were approximately 27% greater than in fiscal 1996, and international students currently constitute approximately 6% of the total enrollments at The Art Institutes. TARGETING EXPANSION OPPORTUNITIES IN A FRAGMENTED MARKET To further its national presence and to take advantage of the highly fragmented postsecondary education industry, EDMC plans to establish new schools and to acquire existing schools in favorable locations. The Company analyzes a new market for enrollment potential, positive long-term demographic trends, the concentration of likely employers, the level of competition, facility costs, the availability of faculty and management talent, and the regulatory approval process. Establishing New Schools. New schools, such as The Art Institute of Phoenix which opened in fiscal 1996 and The Art Institute of Los Angeles which is expected to begin offering classes in October 1997, will be established primarily as Art Institutes, allowing the Company to use its accumulated knowledge and experience in Art Institute operations. In recent years, the Company has developed a financial and operational model to analyze prospective start-up investments, which takes into account, among other things, enrollment projections, pre-opening expenditures, the marketing expenses necessary to build interest in a school and a risk/return profile. Acquiring Existing Schools. The Company also believes that significant opportunities exist for growth through acquisitions. In particular, many smaller institutions have limited resources to manage the increasingly complex regulatory environment or to fund the high costs of developing the new programs required to meet the changing demands of the employment market. The Company's acquisition focus will be on schools that (i) can be integrated efficiently into its existing operations, (ii) will benefit from EDMC's expertise and scale in marketing and administration, and (iii) possess a strong, established reputation. In November 1995, the Company acquired the assets of the Ray College of Design (renamed The Illinois Institute of Art at Chicago and The Illinois Institute of Art at Schaumburg). Combined enrollment at The Illinois Institutes of Art has increased from 346 as of January 1, 1996 to 604 as of October 1, 1996. In August 1996, the Company acquired the assets of NYRS, a well-known culinary arts and restaurant management school located in New York City. In January 1997, the Company acquired the assets of Lowthian College in Minneapolis, Minnesota (renamed The Art Institute of Minnesota). EXPANDING EDUCATION PROGRAMS EDMC currently offers education programs in a variety of fields and continually seeks to optimize its portfolio of programs to meet the needs of both its students and the employment market. The Company believes that developing programs that balance the opportunities in the job market and the interests of students will increase enrollment and expand the Company's revenue base. Within three years of its development and introduction, the Company's computer animation curriculum had a fiscal fall 1997 enrollment of approximately 3,500 students and generated tuition revenues during fiscal 1997 of approximately $35 million. In addition to the acquisition of NYRS, the Company has introduced culinary arts programs at six Art Institutes, and expects to begin offering a seventh program at The Art Institute of Philadelphia in October 1997. The Company also offers bachelor's degree programs in several fields of study which are designed to appeal to students seeking enhanced career preparation and credentials. Bachelor's degree programs benefit the Company by providing a longer revenue stream than two-year associate's degree programs. The Company will seek to introduce additional bachelor's degree programs at schools in states in which applicable regulations 5 6 permit proprietary postsecondary institutions, such as The Art Institutes, to offer such programs. In fiscal 1997, the Company introduced and augmented its bachelor's degree programs in the areas of computer animation, graphic design, interior design and industrial design, and expects to introduce a bachelor's degree program in interactive multimedia programming in 1998. The average number of students enrolled in bachelor's degree programs at The Art Institutes in fiscal 1997 increased 143% from fiscal 1996 to approximately 600. See "The Business of Education--Programs of Study." The Company has begun to test the feasibility of a new type of program that is intended to serve the needs of working professionals in the art, design and digital publishing fields. In this type of program, the initial instruction will occur at one of The Art Institutes and subsequent work will be done off-site through the use of the World Wide Web. IMPROVING STUDENT OUTCOMES EDMC intends to continue to improve student persistence and graduate starting salaries in order to enhance the reputation of its schools and their education programs and increase student enrollments. Measures implemented by the Company include higher admissions standards, academic placement testing, remediation courses, improved faculty training and increased administrative resources dedicated to placement assistance. The Art Institutes' average net quarterly persistence rate, which measures the number of students that are enrolled during an academic quarter and advance to the next academic quarter, increased from 89.0% in fiscal 1995 to 89.6% in fiscal 1996 to 90.2% for the first three quarters of fiscal 1997. From calendar year 1993 to calendar year 1996, The Art Institutes' placement rate for all graduates available for employment, who completed programs, improved from 83.1% to 86.8% and average starting salaries rose 29.5% from approximately $15,600 to approximately $20,200. THE BUSINESS OF EDUCATION EDMC's primary mission is to maximize student success by providing students with the education necessary to meet employers' current and anticipated needs. To achieve this objective, the Company focuses on (i) marketing to a broad universe of potential students, (ii) admitting students who possess the relevant interests and capabilities, (iii) providing students with courses taught by industry professionals, and (iv) assisting students in job placement upon graduation. STUDENT RECRUITMENT AND MARKETING EDMC seeks to attract students with both the motivation and ability to complete the programs offered by its schools. To generate interest, the Company engages in a broad range of activities to inform potential students and their parents about its schools and programs of study. The general reputation of The Art Institutes and referrals from current students, alumni and employers are the largest sources of new students. The Company also employs marketing tools such as television and print media advertising, the World Wide Web, high school visits and recruitment events, and utilizes its internal advertising agency to create publications, television and radio commercials, videos and other promotional materials for the Company's schools. The Company estimates that in fiscal 1997 referrals accounted for 39% of new student enrollments at The Art Institutes, broadcast advertising accounted for 22%, high school recruitment programs accounted for 21%, print media accounted for 12%, international marketing accounted for 3% and the remaining 3% was classified as miscellaneous. The goal of the Company's recruitment efforts is to increase awareness of the Company's schools among potential applicants in a cost-effective manner. The Company carefully monitors the effectiveness of its marketing efforts. In fiscal 1997, The Art Institutes' marketing efforts generated inquiries from approximately 175,200 qualified prospective students. The Art Institutes' inquiry-to-application conversion ratio increased from 6.5% in fiscal 1992 to 10.4% in fiscal 1997, and the applicant-to-new student ratio increased from 55.8% in fiscal 1992 to 66.8% in fiscal 1997. To capitalize on the growing number of new high school graduates, the Company employs approximately 54 high school representatives and utilizes a variety of strategies. These high school representatives made 6 7 presentations at high schools, during which student artwork, videos and a multimedia demonstration are shown to students and educators to promote The Art Institutes. Each Art Institute also conducts college preview seminars at which prospective students can meet with a representative, view artwork and videos, and receive enrollment information. Summer teenager and teacher workshops are held to inform students and educators of the education programs offered by The Art Institutes. The Company's marketing efforts to reach young adults and working adults who may be attracted to evening programs are conducted through local newspaper advertising, direct mail campaigns and broadcast advertising. NYRS relies on local television and referrals as its primary marketing tools and has begun to use high school representatives and presentations at high schools in the New York metropolitan area to increase its applicant pool. NCPT uses direct mail, print media and advertisements in related national trade periodicals to generate interest. Referrals, especially from employers, are an important source of new students for NCPT. In addition, NCPT conducts an extensive recruitment program at colleges, featuring college visits, participation in college career fairs, posters and advertising in college newspapers. STUDENT ADMISSION AND RETENTION Each applicant for admission to an Art Institute is required to have a high school diploma or a recognized equivalent and submit a written essay. Prospective students are interviewed to assess their qualifications, their interest in the programs offered by the applicable Art Institute and their commitment to their education. In addition, the curricula, student services, education cost, available financial resources and student housing are reviewed during interviews, and tours of the facilities are conducted for prospective students. At each Art Institute, student admissions is overseen by a committee, comprised principally of members of the faculty, that reviews each application and makes admissions decisions. Art Institute students are of varying ages and backgrounds. For fiscal 1997, approximately 29% of the entering students matriculated directly from high school, approximately 28% were between the ages of 19 and 21, approximately 31% were 22 to 29 years of age and approximately 12% were 30 years old or older. The Company recognizes that the ability to retain students until graduation is an important indicator of the success of its schools and that early academic intervention is crucial to improve student persistence and completion rates. As with other postsecondary institutions, students at the Company's schools may fail to complete their programs for a variety of personal, financial or academic reasons. To reduce the risk of student withdrawals, each Art Institute devotes staff resources to advise students regarding academic and financial matters, part-time employment and housing. Remedial courses are mandated for students with low academic skill levels and tutoring is encouraged for students experiencing academic difficulties. The average student-to-faculty ratio at the Company's schools was approximately 18:1 during fiscal 1997. At The Art Institutes, the average net quarterly persistence rate, which measures the number of students that are enrolled during an academic quarter and advance to the next academic quarter, improved from 88.4% in fiscal 1994 to 90.2% for the first three quarters of fiscal 1997. The Company believes that it has been able to improve its average net quarterly persistence rate, in part, due to its investment in academic programs, student academic testing and placement, remediation programs and faculty training initiatives, the increased availability of supplemental student financing and orientation and socialization programs designed to provide transition assistance to incoming students. The Company's schools bill students for their tuition and other institutional charges by the term of instruction, typically an academic quarter. Each school's refund policies must meet the requirements of the U.S. Department of Education and such school's state and accrediting agencies. Generally, if a student ceases attendance during the first 60% of his or her first term, the applicable school will refund institutional charges based on the number of weeks remaining in that term. After a student has attended 60% of that term, the school will retain 100% of the institutional charges. After a student's first term, the school refunds institutional charges based on the number of weeks attended in the quarter in which the student withdraws. Generally, after six weeks of a term, the school will retain 100% of the institutional charges for that academic quarter. 7 8 PROGRAMS OF STUDY EDMC's degree programs are designed to provide career-oriented education to students. The Company believes that the educational needs of students are served through curricula and a teaching/learning model that support the development of problem-solving, interpersonal and team skills, as well as technical and professional skills. The Art Institutes attempt to serve students through education provided by industry-experienced faculty, a low student-to-faculty ratio and an interactive learning methodology. Classes at The Art Institutes are scheduled throughout the year with quarterly start dates for the convenience of students. Classes at NYRS begin monthly and classes at NCPT begin three times annually. The development of new education programs at any postsecondary institution demands a substantial commitment of human resources and capital. Most new programs at The Art Institutes are currently approved on a system-wide basis and are made available to each of The Art Institutes for implementation as determined by that school's administration and its Board of Trustees, where applicable. Faculty, employment assistance specialists, curricula advisory boards, industry experts, industry literature and employers are the most common sources for new program offerings. Approximately 550 employers are represented on local curricula advisory boards for The Art Institutes. Generally, proposed education programs are referred to a series of system-wide administrative bodies that decide whether to proceed with development of those programs. As part of such process, an independent contractor, or internal analyst where appropriate, may be retained to develop and compile data for the purpose of identifying both potential student interest in a program and the skills required of a graduate upon program completion. Such research is then used to produce a curriculum model for final review. The goals of the curriculum development process are to provide new program opportunities and to revise existing curricula to be consistent with changing industry needs. The Art Institutes offer the following degree programs, among others. Not all programs are offered at each Art Institute. THE SCHOOL OF DESIGN Associate's Degree Programs Computer Animation Graphic Design Interior Design Industrial Design Technology Bachelor's Degree Programs Computer Animation Graphic Design Interior Design Industrial Design THE SCHOOL OF CULINARY ARTS Associate's Degree Programs Culinary Arts Travel and Tourism THE SCHOOL OF MEDIA ARTS Associate's Degree Programs Multimedia Photography Video Production Web Site Administration* Bachelor's Degree Programs Interactive Multimedia Programming* THE SCHOOL OF FASHION Associate's Degree Programs Fashion Design Fashion Marketing Bachelor's Degree Programs Fashion Design Fashion Marketing and Management - --------- * Starting in fiscal 1998. Approximately 3.8% of The Art Institutes' average quarterly student enrollments in fiscal 1997 were in specialized diploma programs. Academic credits from all of the specialized diploma programs are fully transferable into associate's and bachelor's degree programs at The Art Institutes. Diploma programs are designed for working adults who seek to supplement their education or are interested in enhancing their marketable skills. The Company expects to continue to add additional bachelor's degree programs at schools in states in which applicable regulations permit proprietary postsecondary institutions to offer such programs. In Pennsylvania, the 8 9 legislature has recently directed the State Board of Education to authorize proprietary postsecondary institutions, such as the Company's schools in Philadelphia and Pittsburgh, to offer bachelor's degree programs. For several other Art Institutes, the Company has determined not to offer such programs at this time because of possible interference with the current regional accreditation process for those schools. See "Accreditation." GRADUATE EMPLOYMENT The Company believes that employment of its graduates in occupations related to their fields of study is critical to the ability of its schools to continue to recruit students successfully. Based on information received from graduating students and employers, the Company believes that students graduating from The Art Institutes during the five calendar years ended December 31, 1996 obtained employment in fields related to their programs of study as follows:
PERCENT OF AVAILABLE GRADUATES WHO OBTAINED NUMBER OF EMPLOYMENT RELATED GRADUATING CLASSES AVAILABLE TO PROGRAM OF STUDY (CALENDAR YEAR) GRADUATES(1) (2) -------------------------------------------------- ------------ ---------------------- 1996......................................... 3,676 86.8% 1995......................................... 3,734 87.4 1994......................................... 3,495 86.4 1993......................................... 3,580 83.1 1992......................................... 3,440 81.7
- --------- (1) The term "Available Graduates" refers to all graduates except those pursuing further education, that are deceased, that are in active military service, with medical conditions that prevent such graduates from working, or who are international students no longer residing in the United States. (2) For calendar years 1996, 1995 and 1994, the information presented reflects employment in fields related to graduates' programs of study within six months after graduation. Prior to calendar year 1994, the Company tracked graduate employment data based on employment rates within nine months after graduation. For calendar year 1996, the approximate average starting salaries of graduates of degree and diploma programs at The Art Institutes were as follows: The School of Culinary Arts--$20,900; The School of Design--$21,800; The School of Fashion--$18,200; and The School of Media Arts--$18,000. Each Art Institute offers career-planning services to all graduating students through its employment assistance department. Specific career advice is provided during the last two quarters of a student's education. Interviewing techniques and resume-writing skills are developed, and students receive portfolio counseling where appropriate. The Art Institutes maintain contact with approximately 38,000 employers nationwide. Employment assistance advisors educate employers about the programs at The Art Institutes and the caliber of their graduates. Employment assistance advisors participate in professional organizations, trade shows and community events to keep apprised of industry trends and maintain relationships with key employers. The Company believes that the ability of employment assistance advisors to generate job leads and match employers' needs with graduates' skills and the active role of graduates in their own job searches are major reasons for the percentage of Art Institute graduates employed in their fields throughout the country. Employers of Art Institute graduates include numerous small and medium-sized companies (such as radio and television stations), as well as better-known larger companies. The following companies are representative of the larger companies that employ Art Institute graduates: Bell Atlantic Corporation, Blockbuster Entertainment Group, The Boeing Company, Eddie Bauer, Inc., Ethan Allen Interiors Inc., Humongous Entertainment, Inc., J. C. Penney Company, Inc., Marriott International, Inc., The May Department Stores Company, Microsoft Corporation, The Neiman Marcus Group, Inc., Nordstrom, Inc., Sierra On-Line, Inc., Take2 Interactive Software, Inc., Tele-Communications, Inc., Time Warner Inc., Turner Broadcasting System, Inc. and The Walt Disney Company. 9 10 SCHOOLS The following table shows the location of each of EDMC's schools, the name under which it operates, the date of its establishment, the date EDMC opened or acquired it, and the number of students enrolled as of the beginning of the second quarter of fiscal 1997.
FISCAL CALENDAR YEAR EDMC YEAR ACQUIRED SCHOOL LOCATION ESTABLISHED /OPENED ENROLLMENT(1) - ----------------------------------- -------------------- ----------- --------- ------------- The Art Institute of Atlanta....... Atlanta, GA 1949 1971 1,455 The Art Institute of Dallas........ Dallas, TX 1964 1985 1,238 The Art Institute of Fort Lauderdale....................... Fort Lauderdale, FL 1968 1974 2,073 The Art Institute of Houston....... Houston, TX 1974 1979 1,111 The Art Institute of Los Angeles... Los Angeles, CA 1997 1998 n/a The Art Institute of Minnesota..... Minneapolis, MN 1964 1997 n/a The Art Institute of Philadelphia..................... Philadelphia, PA 1971 1980 1,840 The Art Institute of Phoenix....... Phoenix, AZ 1995 1996 241 The Art Institute of Pittsburgh.... Pittsburgh, PA 1921 1970 2,431 The Art Institute of Seattle....... Seattle, WA 1946 1982 2,255 The Colorado Institute of Art...... Denver, CO 1952 1976 1,489 The Illinois Institute of Art at Chicago.......................... Chicago, IL 1916 1996 367 The Illinois Institute of Art at Schaumburg....................... Schaumburg, IL 1983 1996 237 National Center for Paralegal Training......................... Atlanta, GA 1973 1973 307 New York Restaurant School......... New York, NY 1980 1997 794
- --------- (1) Enrollments are as of October 1, 1996 (i.e., the start of the second quarter of fiscal 1997), prior to the acquisition of The Art Institute of Minnesota and prior to the start-up of The Art Institute of Los Angeles. GOVERNANCE OF THE ART INSTITUTES EDMC believes that the governance structure for The Art Institutes differs from governance structures at other proprietary school systems and possesses several advantages. EDMC's three-tier structure has the advantage of permitting each of EDMC's schools to be recognized by regulatory authorities and accrediting agencies on an individual basis, thereby enabling the school to be accredited in its geographic region. The Art Institutes International, Inc. ("AII") is the parent corporation for all of The Art Institutes other than The Art Institute of Pittsburgh, which is a division of AII. The Board of Directors of AII approves the annual and long-range operating plans of The Art Institutes, including their annual budgets. The AII Board of Directors also appoints the members of the AII System Coordinating Board, the primary focus of which is AII system-wide education policy and quality. The AII System Coordinating Board coordinates education research, academic programming, development and planning. It also communicates with external governmental and corporate entities on behalf of AII, approves new education programs, reviews existing programs and assists The Art Institutes in developing policies and procedures. At most of The Art Institutes, Boards of Trustees are vested with the authority to manage the schools' business and affairs. Thus, each such Art Institute puts its own imprint on the academic programs it offers, consistent with applicable state laws, regulations and licensure requirements and accreditation standards, while maintaining compatibility among The Art Institutes. Each Board of Trustees is empowered to select the president and adopt institutional policies and procedures to achieve the mission of its Art Institute. In addition, in calendar 1994, AII organized an International Advisory Board (the "IAB"). The IAB is comprised of renowned artists, designers, chefs and entertainment professionals who provide advice and support to AII. Members of the IAB also review curricula as requested and provide other services as agreed upon by the IAB members. 10 11 TECHNOLOGY EDMC is committed to providing its students access to the technology necessary for developing the skills required by their education programs. To help fulfill this commitment, at June 30, 1997, The Art Institutes had approximately 2,075 desktop and workstation computers with applicable software in classroom laboratories, largely operating on a seven-day per week basis. Each Art Institute monitors the utilization of these classroom laboratories to ensure that students have sufficient and appropriate equipment and software. Animation students use powerful desktop and workstation computer technologies to create, animate, color and render two-dimensional and three-dimensional projects. Multimedia students integrate digital audio, screen-layout and motion content into their productions. Design students make significant use of technologies for computer-aided design and layout, photo composition and digital prepress applications. Video production students use computer technologies for programming schedules, digital non-linear editing and special effects. Photography students utilize computers to translate traditional silver-based images into digital forms, where composition, perspective, sharpness and color can be manipulated. Interior and industrial design students learn to use computer-aided drafting and visualization technology and equipment. The Art Institutes have implemented a process to systematize the specification and acquisition of equipment, computer hardware and software based upon present and proposed curricula. Through its director of technology and a technology committee comprised of key faculty and technology staff, each Art Institute researches and monitors changing market and technological requirements. These efforts, conducted in each school's market area and coordinated on a national basis, are used to develop a system-wide, unified strategy for the purchase and implementation of classroom technology. MANAGEMENT AND EMPLOYEES EDMC is led by a senior management team possessing an average of more than 18 years of experience in the education industry and nine years with the Company. A substantial majority of the management team has an ownership interest in the Company through direct holdings, participation in the ESOP or both. As of June 30, 1997, EDMC had 1,554 full-time and 640 part-time staff and faculty. The staff and faculty are experienced in assessing the needs of the employment markets and designing and updating education programs to prepare students for employment opportunities. Many faculty members are or have been successful professionals in their respective fields. ADMINISTRATIVE SUPPORT SYSTEMS During the last four years, EDMC has centralized many of its administrative functions to permit the staff at its schools to devote more of their efforts to attracting new students and promoting student success. Centralized administrative functions include: accounting, marketing, finance, real estate, student financial aid, curricula research and development, purchasing, human resource management, legal, regulatory and legislative affairs, information systems and technology support services. The Company believes that this centralization has contributed to operating efficiencies and has positioned the Company to control general and administrative costs more effectively during its planned expansion. The Company has invested approximately $10.0 million and devoted substantial resources to set-up an integrated, customized information network designed to assist Company personnel in maximizing internal efficiency. The Company believes that this system has improved its ability to recruit new students, administer student financial aid, prepare and track student academic schedules, monitor part-time and full-time employment opportunities for its students and graduates, perform general and student accounting and manage human resources. The Company believes that its investment in technology also facilitates the integration of acquisitions and newly established schools into the Company's operations. NATIONAL CENTER FOR PARALEGAL TRAINING NCPT is one of the leading sources of paralegals in the southeastern United States. NCPT offers certificate programs to recent college graduates, employer-sponsored students and adults interested in changing careers. Programs offered by NCPT include paralegal studies, legal nurse consultant and legal administrative assistant. 11 12 NCPT paralegal and legal administrative assistant graduates are employed in law firms and corporations. Legal nurse consultants typically are employed on a project basis and are trained to be independent contractors. NATIONAL CENTER FOR PROFESSIONAL DEVELOPMENT NCPD maintains consulting relationships with seven colleges and universities. NCPD offers a wide range of services to its college and university clients, including assistance with curricula development, the formulation and execution of marketing strategies for the program offerings, training for admissions staff, program directors and faculty, preparation of annual program budgets, establishment of instructor evaluation guidelines and development of strategies for employment assistance and consultation on other academic issues as requested by a client institution. Certificate programs, developed by NCPD and offered by its client institutions, are paralegal studies, legal nurse consultant training and financial planner test preparation. In the fall of fiscal 1997, NCPD client institutions had approximately 950 students enrolled in these programs. COMPETITION The postsecondary education market is highly competitive. The Art Institutes compete with traditional public and private two-year and four-year colleges and universities and other proprietary schools. Certain public and private colleges and universities may offer programs similar to those of The Art Institutes. Public institutions are often able to charge lower tuition than The Art Institutes due in part to government subsidies, government and foundation grants, tax-deductible contributions and other financial sources not available to proprietary schools. However, tuition at private non-profit institutions is, on average, higher than The Art Institutes' tuition. EDMC believes its students are well served by its student-centered education environment, career-oriented curricula developed with employer input, the effectiveness of its employment assistance activities and its national reputation and market presence. The Company believes that its students also should benefit from its investments in technology, including modern facilities with well-equipped classrooms, programs that permit attendance year-round thereby facilitating early graduation, and the Company's commitment to selecting faculty with appropriate academic credentials and relevant employment experience. Another competitive strength of EDMC's schools is the ability to address evolving regulatory and accreditation requirements. SEASONALITY IN RESULTS OF OPERATIONS EDMC has experienced seasonality in its results of operations primarily due to the pattern of student enrollments. Historically, EDMC's lowest quarterly revenues and income have been in the first quarter (July to September) of its fiscal year due to fewer students being enrolled during the summer months and the expenses incurred in preparation for the peak in enrollment in the fall quarter (October to December). EDMC expects that this seasonal trend will continue. ACCREDITATION Accreditation is a process through which an institution submits itself to qualitative review by an organization of peer institutions. Accrediting agencies primarily examine the academic quality of the instructional programs of an institution, and a grant of accreditation is generally viewed as certification that an institution's programs meet generally accepted academic standards. Accrediting agencies also review the administrative and financial operations of the institutions they accredit to ensure that each institution has the resources to perform its educational mission. Pursuant to provisions of the HEA, the U.S. Department of Education relies on accrediting agencies to determine whether institutions' educational programs qualify them to participate in Title IV Programs. The HEA specifies certain standards that all recognized accrediting agencies must adopt in connection with their review of postsecondary institutions. Accrediting agencies that meet U.S. Department of Education standards are recognized as reliable evaluators of educational quality. All of EDMC's schools, other than The Art Institute of Los Angeles, are accredited by one or more accrediting agencies recognized by the U.S. Department of Education. Four of the Company's schools are either accredited, or are candidates for accreditation, by one of the six 12 13 regional accrediting agencies that accredit virtually all of the public and private non-profit colleges and universities in the United States. The accrediting agencies for each of the Company's schools are set forth in the following table (for schools accredited by more than one recognized accrediting agency, the primary accrediting agency is listed first):
SCHOOL ACCREDITING AGENCY - -------------------------------------------- -------------------------------------------- The Art Institute of Atlanta................ Commission on Colleges of the Southern Association of Colleges and Schools ("COC of SACS") The Art Institute of Dallas................. Accrediting Commission of Career Schools and Colleges of Technology ("ACCSCT") COC of SACS (Candidate) The Art Institute of Fort Lauderdale........ ACCSCT The Art Institute of Houston................ ACCSCT COC of SACS (Candidate) The Art Institute of Los Angeles............ * The Art Institute of Minnesota.............. Accrediting Council for Independent Colleges and Schools ("ACICS") The Art Institute of Philadelphia........... ACCSCT The Art Institute of Phoenix................ ACCSCT The Art Institute of Pittsburgh............. ACCSCT The Art Institute of Seattle................ ACCSCT Commission on Colleges of the Northwest Association of Schools and Colleges (Candidate) The Colorado Institute of Art............... ACCSCT The Illinois Institute of Art at Chicago.... ACCSCT The Illinois Institute of Art at ACCSCT Schaumburg................................ National Center for Paralegal Training...... ACICS (NCPT, Inc.) New York Restaurant School.................. ACCSCT New York State Board of Regents
- --------- * The Company cannot submit an application for The Art Institute of Los Angeles to be accredited until students begin classes there. The Company intends to file such an application with ACCSCT in October 1997. The HEA requires each recognized accrediting agency to submit to a periodic review of its procedures and practices by the U.S. Department of Education as a condition of its continued recognition. Each of the accrediting agencies listed above has been reviewed within the past 26 months and has had its recognition extended. An accrediting agency may place an institution on "reporting" status in order to monitor one or more specified areas of a school's performance. An institution placed on reporting status is required to report periodically to its accrediting agency on that school's performance in the specified areas. While on reporting status, an institution may not open and commence teaching at new locations without first receiving a waiver from its accrediting agency. Two of the Company's schools, The Art Institute of Dallas and The Art Institute of Houston, each of which accounted for approximately 7.3% of the Company's net revenues in fiscal 1997, were placed on reporting status by their accrediting agency in January 1993 and February 1993, respectively, based on that accrediting agency's concern about those schools' reported student completion rates for certain programs. The Art Institute of Philadelphia, which accounted for approximately 11.7% of the Company's net revenues in fiscal 1997, was placed on reporting status in August 1995 by the same accrediting agency based on that accrediting agency's concern about that school's overall student completion rate. The accrediting agency's standards define a program's completion rate as the percentage of the students who started that program during a twelve-month period and who have either graduated from that program within a period of time equal to 150% of that program's length or withdrawn from that program during the same period in order to accept full-time employment in the occupation or job category for which the program was offered. Because that calculation can 13 14 only be performed after a student's scheduled completion date, it does not provide a timely basis for a school to affect student outcomes. For that reason, the Company uses the net quarterly persistence rate as a method to track the retention rate of students. Such rate is equal to the number of students in a program at the beginning of an academic quarter, including any formerly withdrawn students who restarted the program during the prior academic quarter, divided by the number of students enrolled in that program at the beginning of that prior academic quarter. Each of the three schools that were placed on reporting status has filed completion and placement reports as required by the accrediting agency, using the accrediting agency's definition of student completion rate. The Art Institute of Dallas has been notified that it is no longer on reporting status. Although the accrediting agency has acknowledged that there has been some improvement with respect to the completion rates of some programs at the other two schools, and although for The Art Institute of Houston the total number of students enrolled in the programs being monitored is only a small portion of that school's total enrollment, the accrediting agency has continued the two institutions on reporting status based on its concern about some of the reported completion rates. EDMC's expansion plans do not depend on either of those schools opening additional locations. STUDENT FINANCIAL ASSISTANCE As is the case at most postsecondary institutions, many students enrolled at one of EDMC's schools must rely, at least in part, on financial assistance to pay the cost of their education. The largest source of such support is the federal programs of student financial assistance under Title IV of the HEA. Additional sources of funds include other federal grant programs, state grant and loan programs, private loan programs and institutional grants and scholarships. To provide students access to financial assistance resources available through Title IV Programs, a school must be (i) authorized to offer its programs of instruction by the relevant agency of the state in which it is located, (ii) accredited by an accrediting agency recognized by the U.S. Department of Education, and (iii) certified as an eligible institution by the U.S. Department of Education. In addition, that school must ensure that Title IV Program funds are properly accounted for and disbursed in the correct amounts to eligible students. Under the HEA and its implementing regulations, each of the Company's schools that participates in Title IV Programs must comply with certain standards on an institutional basis. For purposes of these standards, the regulations define an institution as a main campus and its additional locations (formerly called branch campuses), if any. Under this definition, each of the Company's schools is a separate institution, except for The Art Institute of Phoenix, which is an additional location of The Colorado Institute of Art, The Illinois Institute of Art at Schaumburg, which is an additional location of The Illinois Institute of Art at Chicago, and The Art Institute of Los Angeles, which will be an additional location of The Art Institute of Pittsburgh. When The Art Institute of Los Angeles receives its accreditation from ACCSCT, The Art Institute of Pittsburgh will file an application with the U.S. Department of Education for The Art Institute of Los Angeles to participate in Title IV Programs as its additional location. All other Art Institutes and NYRS participate in Title IV Programs. NCPT has not applied to participate in Title IV Programs. NATURE OF FEDERAL SUPPORT FOR POSTSECONDARY EDUCATION While the states support public colleges and universities primarily through direct state subsidies, the federal government provides a substantial part of its support for postsecondary education in the form of grants and loans to students who can use this support at any institution that has been certified as eligible by the U.S. Department of Education. Title IV Programs have provided aid to students for more than 30 years and, since the mid-1960s, the scope and size of such programs have steadily increased. Since 1972, Congress has expanded the scope of the HEA to provide for the needs of the changing national student population by, among other things, providing that students at proprietary schools are eligible for assistance under Title IV Programs, establishing a program for loans to parents of eligible students, opening Title IV Programs to part-time students, increasing maximum loan limits and eliminating the requirement that students demonstrate financial need to obtain federally guaranteed student loans. Most recently, the Federal Direct Student Loan ("FDSL") program was enacted, enabling students to obtain loans from the federal government rather than from commercial lenders. In recent years, federal funds 14 15 appropriated for Title IV Programs have increased from $8.6 billion for the federal fiscal year ending September 30, 1994 to $10.5 billion for the federal fiscal year ending September 30, 1996. The volume of federally guaranteed student loans (and, more recently, loans issued under the FDSL program) has increased from $17.9 billion in the federal fiscal year ending September 30, 1993 to $29.1 billion in the federal fiscal year ending September 30, 1996. Students at EDMC's schools receive grants and loans to fund their education under several Title IV Programs, of which the two largest are the Federal Pell Grant ("Pell") program and the Federal Family Education Loan ("FFEL") program. The Company's schools also participate in the Federal Supplemental Educational Opportunity Grant ("FSEOG") program, the Federal Perkins Loan ("Perkins") program and the Federal Work-Study ("FWS") program. Most of the Company's schools also have been selected by the U.S. Department of Education to participate in the FDSL program. Pell. Pell grants are the primary component of the Title IV Programs under which the U.S. Department of Education makes grants to students who demonstrate financial need. Every eligible student is entitled to receive a Pell grant; there is no institutional allocation or limit. During fiscal 1997, Pell grants ranged from $400 to $2,470 per year; beginning on July 1, 1997, the limit was increased to $2,700 per year. Amounts received by students enrolled in the Company's schools in fiscal 1997 under the Pell program equaled approximately 6% of the Company's net revenues. FSEOG. FSEOG awards are designed to supplement Pell grants for the neediest students. FSEOG grants generally range in amount from $100 to $4,000 per year; however, the availability of FSEOG awards is limited by the amount of those funds allocated to an institution under a formula that takes into account the size of the institution, its costs and the income levels of its students. At most of the Company's schools, FSEOG awards generally do not exceed $1,200 per eligible student per year. The Company is required to make a 25% matching contribution for all FSEOG program funds disbursed. Resources for this institutional contribution may include institutional grants and scholarships and, in certain states, portions of state grants and scholarships. In fiscal 1997, the Company's required 25% institutional match was approximately $695,000. Amounts received by students in the Company's schools under the FSEOG program in fiscal 1997 equaled approximately 1% of the Company's net revenues. FFEL. The FFEL program consists of two types of loans, Stafford loans, which are made available to students regardless of financial need, and PLUS loans, which are made available to parents of students classified as dependents. Under the Stafford loan program, a student may borrow up to $2,625 for the first academic year, $3,500 for the second academic year and, in some educational programs, $5,500 for each of the third and fourth academic years. Students with significant financial need qualify for interest subsidies while in school and during grace periods. Students who are classified as independent can increase their borrowing limits and receive additional unsubsidized Stafford loans. Such students can obtain an additional $4,000 for each of the first and second academic years and, depending upon the educational program, an additional $5,000 for each of the third and fourth academic years. The obligation to begin repaying Stafford loans does not commence until six months after a student ceases enrollment as at least a half-time student. Amounts received by students in the Company's schools under the Stafford program in fiscal 1997 equaled approximately 41% of the Company's net revenues. PLUS loans may be obtained by the parents of a dependent student in an amount not to exceed the difference between the total cost of that student's education (including allowable expenses) and other aid to which that student is entitled. Amounts received by parents of students in the Company's schools under the PLUS loan program in fiscal 1997 equaled approximately 14% of the Company's net revenues. Perkins. Eligible undergraduate students may borrow up to $3,000 under the Perkins program during each academic year, with an aggregate maximum of $15,000, at a 5% interest rate and with repayment delayed until nine months after the termination of studies. Perkins loans are made available to those students who demonstrate the greatest financial need. Perkins loans are made from a revolving account, 75% of which is capitalized by the U.S. Department of Education. Subsequent federal capital contributions in the same proportion may be received if an institution meets certain requirements. Each school collects payments on Perkins loans from its former students and reloans those funds to currently enrolled students. Collection and disbursement of Perkins loans is the responsibility of each participating institution. During fiscal 1997, the Company collected approximately 15 16 $1,990,000 from its former students. In fiscal 1997, the Company's required matching contribution was approximately $159,000. The Perkins loans disbursed to students in the Company's schools in fiscal 1997 equaled approximately 2% of the Company's net revenues. Federal Work-Study. Under the FWS program, federal funds are made available to pay up to 75% of the cost of part-time employment of eligible students, based on their financial need, to perform work for the institution or for off-campus public or non-profit organizations. At least 5% of an institution's FWS allocation must be used to fund student employment in community service positions. In fiscal 1997, FWS funds accounted for less than 1% of the Company's net revenues. FDSL. Under the FDSL program, students may obtain loans directly from the U.S. Department of Education rather than commercial lenders. The conditions on FDSL loans are generally the same as on loans made under the FFEL program. Ten of the Company's 13 schools currently eligible to participate in Title IV Programs have been selected by the U.S. Department of Education to participate in the FDSL program, but all have deferred participation since their respective students' loan needs continue to be satisfied under the FFEL program. OTHER FINANCIAL ASSISTANCE SOURCES Students at several of the Company's schools participate in state grant programs. In fiscal 1997, approximately 3% of the Company's net revenues was derived from state grant programs. In addition, certain students at some of the Company's schools receive financial aid provided by the United States Department of Veterans Affairs, the United States Department of the Interior (Bureau of Indian Affairs) and the Rehabilitative Services Administration of the U.S. Department of Education (vocational rehabilitation funding). In fiscal 1997, financial assistance from such federal programs equaled less than 2% of the Company's net revenues. The Art Institutes also provide institutional scholarships to qualified students. In fiscal 1997, institutional scholarships had a value equal to approximately 2% of the Company's net revenues. In September 1995, the Company negotiated access to a supplemental loan program with a commercial bank that allows students to repay loans over ten years after graduation and allows students with lower than average credit ratings to obtain loans. To the Company's knowledge, The Art Institutes are the only institutions primarily offering associate's degree programs that are eligible to participate in that loan program. The primary objective of such loan program is to lower the monthly payments required of students. Such loans are without recourse to the Company or its schools. AVAILABILITY OF LENDERS During the last year, five lending institutions (Bank One, Indianapolis, National Association; First Union Bank; National City Bank, Indiana; Central Bank; and Mellon PSFS (NJ) National Association) provided over 80% of all federally guaranteed loans to students attending the Company's schools. While the Company believes that other lenders would be willing to make federally guaranteed student loans to its students if loans were no longer available from its current lenders, there can be no assurances in this regard. In addition, the HEA requires the establishment of lenders of last resort in every state to make loans to students at any school that cannot otherwise identify lenders willing to make federally guaranteed loans to its students. One student loan guaranty agency (United Student Aid Funds) currently guarantees over 90% of all federally guaranteed student loans made to students enrolled at the Company's schools. The Company believes that other guaranty agencies would be willing to guarantee loans to the Company's students if that agency ceased guaranteeing those loans or reduced the volume of those loans guaranteed. FEDERAL OVERSIGHT OF TITLE IV PROGRAMS The substantial amount of federal funds disbursed through Title IV Programs, coupled with the large numbers of students and institutions participating in them, have led to instances of fraud, waste and abuse. As a result, the United States Congress (the "U.S. Congress") has required the U.S. Department of Education to increase its level of regulatory oversight of schools to ensure that public funds are properly used. Each institution must annually submit to the U.S. Department of Education an audit by an independent accounting firm of that school's compliance with Title IV Program requirements, as well as audited financial statements. The U.S. Department of Education also conducts compliance reviews, which include on-site evaluations, of several 16 17 hundred institutions each year, and directs student loan guaranty agencies to conduct additional reviews relating to student loan programs. In addition, the Office of the Inspector General of the U.S. Department of Education conducts audits and investigations in certain circumstances. Under the HEA, accrediting agencies and state licensing agencies also have responsibilities for overseeing institutions' compliance with Title IV Program requirements. As a result, each participating institution, including each Art Institute and NYRS, is subject to frequent and detailed oversight and must comply with a complex framework of laws and regulations or risk being required to repay funds or becoming ineligible to participate in Title IV Programs. Largely as a result of this increased oversight, more than 800 institutions have either ceased to be eligible for, or have voluntarily relinquished their, participation in some or all Title IV Programs since October 1, 1992. This has reduced competition among institutions with respect to certain markets and education programs. Due to the specialized nature of their education programs, the reduction in the number of participating institutions has had no substantial effect on The Art Institutes. Cohort Default Rates. A significant component of the Congressional initiative aimed at reducing fraud, waste and abuse was the imposition of limitations on participation in Title IV Programs by institutions whose former students defaulted on the repayment of federally guaranteed student loans at an "excessive" rate. Since the U.S. Department of Education began to impose sanctions on institutions with cohort default rates above certain levels, more than 600 institutions have lost their eligibility to participate in some or all Title IV Programs for this reason. However, many institutions, including all of The Art Institutes, have responded by implementing aggressive student loan default management programs aimed at reducing the likelihood of students failing to repay their loans in a timely manner. A school's cohort default rate under the FFEL program is calculated on an annual basis as the rate at which student borrowers scheduled to begin repayment on their loans in one federal fiscal year default on those loans by the end of the next federal fiscal year. Any institution whose FFEL cohort default rate equals or exceeds 25% for three consecutive years will no longer be eligible to participate in that program or the FDSL program for the remainder of the federal fiscal year in which the U.S. Department of Education determines that such institution has lost its eligibility and for the two subsequent federal fiscal years. In addition, an institution whose FFEL cohort default rate for any federal fiscal year exceeds 40% may have its eligibility to participate in all Title IV Programs limited, suspended or terminated. Since the calculation of FFEL cohort default rates involves the collection of data from many non-governmental agencies (i.e., lenders and private guarantors), as well as the U.S. Department of Education, the HEA provides a formal process for the review and appeal of the accuracy of FFEL cohort default rates before the U.S. Department of Education takes any action against an institution based on its FFEL cohort default rates. None of the Company's schools has had a FFEL cohort default rate of 25% or greater for three consecutive federal fiscal years. The Art Institute of Houston, which accounted for approximately 7% of the Company's net revenues in fiscal 1997, had published FFEL cohort default rates of 25.4% and 30.2% for federal fiscal years 1993 and 1994 (the latest years for which rates have been published), respectively, but has received a preliminary FFEL cohort default rate of 20.3% for federal fiscal year 1995. The remainder of the Company's schools had published 1994 FFEL cohort default rates and preliminary 1995 rates below 25%. For federal fiscal year 1994, the combined FFEL cohort default rate for all borrowers at the Company's schools was 18.2% and the individual schools' rates ranged from 9.2% to 30.2%. The average FFEL cohort default rate for all proprietary institutions for federal fiscal year 1994 was 21.1%. For federal fiscal year 1995, the combined preliminary FFEL cohort default rate for all borrowers at the Company's schools was 17.7% and the individual schools' rates ranged from 6.8% to 23.4%. (Preliminary cohort default rates are subject to revision by the U.S. Department of Education based on information that schools and guaranty agencies identify and submit to the U.S. Department of Education for review, in order to correct any errors in the data previously provided to the U.S. Department of Education. Any such adjustment will be made by the U.S. Department of Education at the time that final rates are officially published.) The Company understands that the U.S. Department of Education anticipates issuing official 1995 FFEL cohort default rates in November 1997. If an institution's FFEL cohort default rate equals or exceeds 25% in any of the three most recent federal fiscal years, or if its cohort default rate for loans under the Perkins program exceeds 15% for any federal award 17 18 year (i.e., July 1 through June 30), that institution may be placed on provisional certification status for up to four years. Provisional certification does not limit an institution's access to Title IV Program funds; however, an institution with provisional status is under closer review by the U.S. Department of Education and may be subject to summary adverse action if it commits violations of Title IV Program requirements. To EDMC's knowledge, the U.S. Department of Education reviews an institution's compliance with the cohort default rate thresholds described in this paragraph only when that school is otherwise subject to a U.S. Department of Education certification review. Five of the Company's schools have Perkins cohort default rates in excess of 15% for students who were scheduled to begin repayment in the 1995/1996 federal award year, the most recent year for which such rates have been calculated. Those schools and their Perkins cohort default rates for that year are: The Art Institute of Atlanta (21.3%); The Art Institute of Fort Lauderdale (21.8%); The Art Institute of Houston (49.1%); The Art Institute of Philadelphia (20.4%) and The Art Institute of Seattle (23.3%). Those schools accounted for approximately 9%, 13%, 7%, 12% and 14%, respectively, of the Company's net revenues in fiscal 1997. For each such school, funds from the Perkins program equaled less than 2% of the school's net revenues in fiscal 1997, other than The Art Institute of Houston where such funds equaled approximately 3% of net revenues in fiscal 1997. Thus, those schools could be placed on provisional certification status, which would subject them to closer review by the U.S. Department of Education. To date, none of those schools has been placed on such status for this reason. If one of those schools were placed on provisional certification status for this reason and that school reduced its Perkins cohort default rate below 15% in a subsequent year, that school could ask the U.S. Department of Education to remove the provisional status. One of those schools, The Art Institute of Houston, has been placed on provisional certification status because of its FFEL cohort default rates. Each of the Company's schools has adopted a student loan default management plan. Those plans provide for extensive loan counseling, methods to increase student persistence and completion rates and graduate employment rates, strategies to increase graduates' salaries and, for most schools, the use of external agencies to assist the school with loan counseling and loan servicing if a student ceases attending that school. Those activities are in addition to the loan servicing and collection activities of FFEL lenders and guaranty agencies. Increased Regulatory Scrutiny. The 1992 reauthorization of the HEA contained a three-part initiative, referred to as the Program Integrity Triad, intended to increase regulatory scrutiny of postsecondary education institutions. Part one of that initiative required each state to establish a State Postsecondary Review Entity ("SPRE") to review certain institutions within that state to determine their eligibility to continue participating in Title IV Programs. SPRE review would be mandatory for an institution that met specified statutory criteria, such as high cohort default rates, lack of financial responsibility, certain changes in ownership or a pattern of student complaints, and would be conducted using standards developed by the applicable SPRE based on guidelines in the HEA. The U.S. Congress has declined to provide funding for SPREs and the U.S. Department of Education has repealed its regulations concerning SPREs. As a result, no SPREs are currently functioning. Part two of the Program Integrity Triad expanded the role of accrediting agencies in the oversight of institutions participating in Title IV Programs. As a result, the accrediting agencies of which the Company's schools are members have increased the depth and intensity of reviews and have expanded examinations in such areas as financial responsibility and timeliness of student refunds. The Program Integrity Triad provisions also require each accrediting agency recognized by the U.S. Department of Education to undergo comprehensive periodic reviews by the U.S. Department of Education to ascertain whether such accrediting agency is adhering to required standards. Each accrediting agency that accredits any of the Company's schools has been reviewed by the U.S. Department of Education under the Program Integrity Triad provisions and reapproved for continued recognition by the U.S. Department of Education. Part three of the Program Integrity Triad tightened the standards to be applied by the U.S. Department of Education in evaluating the financial responsibility and administrative capability of institutions participating in Title IV Programs, and mandated that the U.S. Department of Education periodically review the eligibility and certification to participate in Title IV Programs of every such eligible institution. By law, all institutions are required to undergo such a recertification review by the U.S. Department of Education by 1997 and every four years thereafter. Under these standards, each of the Company's schools would be evaluated by the U.S. Department of Education more frequently than in the past. Two of the Company's schools currently have 18 19 recertification applications pending with the U.S. Department of Education. A denial of recertification would preclude a school from continuing to participate in Title IV Programs. Financial Responsibility Standards. All institutions participating in Title IV Programs must satisfy a series of specific standards of financial responsibility. Institutions are evaluated for compliance with those requirements as part of the U.S. Department of Education's quadrennial recertification process and also annually as each institution submits its audited financial statements to the U.S. Department of Education. One standard requires each institution to demonstrate an acid test ratio (defined as the ratio of cash, cash equivalents and current accounts receivable to current liabilities) of at least 1:1 at the end of each fiscal year. Another standard requires that each institution have a positive tangible net worth at the end of each fiscal year. A third standard prohibits any institution from having a cumulative net operating loss during its two most recent fiscal years that results in a decline of more than 10% of that institution's tangible net worth as measured at the beginning of that two-year period. An institution that is determined by the U.S. Department of Education not to meet the standards of financial responsibility on the basis of failing to meet one or more of the specified numeric indicators is nonetheless entitled to participate in Title IV Programs if it can demonstrate to the U.S. Department of Education that it is financially responsible on an alternative basis. An institution may do so by demonstrating, with the support of a statement from a certified public accountant, proof of prior compliance with the numeric standards and other information specified in the regulations, that its continued operation is not jeopardized by its financial condition. Alternatively, an institution may post surety either in an amount equal to one-half of the total Title IV Program funds received by students enrolled at such institution during the prior year or in an amount equal to 10% of such prior year's funds and agree to receive Title IV Program funds under an arrangement other than the U.S. Department of Education's standard advance funding arrangement. The U.S. Department of Education has interpreted this surety condition to require the posting of an irrevocable letter of credit in favor of the U.S. Department of Education. Historically, the U.S. Department of Education has evaluated the financial condition of the Company's schools on an institution-by-institution basis, although recently the U.S. Department of Education has requested, and the Company has provided, financial information concerning The Art Institutes on a consolidated basis at the level of their parent company, AII. Each of The Art Institutes individually (other than The Art Institute of Minnesota, The Illinois Institute of Art at Chicago and The Illinois Institute of Art at Schaumburg) and on a consolidated basis at the level of AII (which is the parent of all The Art Institutes other than The Art Institute of Pittsburgh, which is a division of AII) has met the financial responsibility standards described above as applied by the U.S. Department of Education for the relevant periods. At the times of their acquisitions, The Art Institute of Minnesota, The Illinois Institute of Art at Chicago and The Illinois Institute of Art at Schaumburg satisfied those standards by relying on the consolidated financial statements of AII in their applications to the U.S. Department of Education. In 1996, the U.S. Department of Education issued proposed regulations that, if adopted as issued, would significantly revise the present financial responsibility requirements, primarily by replacing the three separate numeric standards described above with a composite score based on three new calculations. The U.S. Department of Education has extended the period for comment on the proposed regulations on three occasions, due to concerns expressed by institutions about the proposed standards. The U.S. Department of Education has not yet issued the regulations in final form, but has stated its intention to do so by December 1997 and to make the new regulations effective as of July 1, 1998. Restrictions on Operating Additional Schools. The HEA generally requires that certain institutions, including proprietary schools, be in full operation for two years before applying to participate in Title IV Programs. However, under the HEA and applicable regulations, an institution that is certified to participate in Title IV Programs may establish an additional location and apply to participate in Title IV Programs at that location without reference to the two-year requirement, if such additional location satisfies all other applicable requirements. In addition, a school which undergoes a change of ownership resulting in a change in control (as defined under the HEA) must be reviewed and recertified for participation in Title IV Programs under its new ownership. Pending recertification, the U.S. Department of Education suspends Title IV Program funding to that school's students. If a school is recertified, it will be on a provisional basis. During the time a school is provisionally certified, it may be subject to summary adverse action for violations of Title IV Program 19 20 requirements, but provisional certification does not otherwise limit an institution's access to Title IV Program funds. The Company's expansion plans are based, in part, on its ability to add additional locations and acquire schools that can be recertified. The Art Institute of Minnesota, The Illinois Institute of Art at Chicago, The Illinois Institute of Art at Schaumburg and NYRS are provisionally certified by the U.S. Department of Education due to their recent acquisition by the Company. When it receives its accreditation from ACCSCT, a fifth school, The Art Institute of Los Angeles, will file an application with the U.S. Department of Education to participate in Title IV Programs. As it is an additional location of The Art Institute of Pittsburgh, the Company believes that it will be approved and will not be provisionally certified. None of the Company's other schools that are participating in Title IV Programs are on provisional certification status, except The Art Institute of Houston which in the course of the normal recertification process was provisionally recertified in 1997 because of its FFEL cohort default rates. Certain of the state authorizing agencies and accrediting agencies with jurisdiction over the Company's schools also have requirements that may, in certain instances, limit the ability of the Company to open a new school, acquire an existing school or establish an additional location of an existing school. The Company does not believe that those standards will have a material adverse effect on the Company or its expansion plans. The "85/15 Rule." Under a provision of the HEA commonly referred to as the "85/15 Rule," a proprietary institution, such as each of EDMC's schools, would cease being eligible to participate in Title IV Programs if, on a cash accounting basis, more than 85% of its revenues for the prior fiscal year was derived from Title IV Programs. Any school that violates the 85/15 Rule immediately becomes ineligible to participate in Title IV Programs and is unable to apply to regain its eligibility until the following fiscal year. The Company has calculated that, since this requirement took effect in fiscal 1995, none of the Company's schools has derived more than 79% of its revenues from Title IV Programs for any fiscal year, and that for fiscal 1997 the range for the Company's schools was from approximately 50% to approximately 70%. For fiscal 1996, the Company's independent public accountants examined management's assertion that the Company's schools complied with these requirements and opined that such assertion was fairly stated in all material respects. The Company's independent public accountants have not yet issued their reports with respect to these assertions for fiscal 1997. They have, however, informed the Company that their work is substantially complete and that they expect to again opine that management's assertion was fairly stated in all material respects. The Company regularly monitors compliance with this requirement in order to minimize the risk that any of its schools would derive more than 85% of its revenues from Title IV Programs for any fiscal year. If a school appears likely to approach the 85% threshold, the Company would evaluate the appropriateness of making changes in student funding and financing to ensure compliance. Restrictions on Payment of Bonuses, Commissions or Other Incentives. The HEA prohibits an institution from providing any commission, bonus or other incentive payment based directly or indirectly on success in securing enrollments or financial aid to any person or entity engaged in any student recruitment, admission or financial aid awarding activity. EDMC believes that its current compensation plans are in compliance with HEA standards, although the regulations of the U.S. Department of Education do not establish clear criteria for compliance. Legislative Action. The HEA was most recently reauthorized by the U.S. Congress in 1992, at which time funding for Title IV Programs was authorized through September 30, 1997, with an automatic one-year extension if the HEA was not reauthorized by that date. The U.S. Congress has commenced the reauthorization process, which is expected to be completed during 1998. Numerous changes to the HEA have been proposed by the U.S. Department of Education and other parties. At this time it is not possible to predict whether current funding levels will be maintained for any or all Title IV Programs or how current requirements for institutional participation and student eligibility may be changed. In addition, in July 1997, the U.S. Congress passed the Taxpayer Relief Act of 1997, which the President signed into law in August 1997. The new law contains a number of provisions relating to students attending postsecondary education institutions, including various tax credits, tax deductions and provisions liberalizing the use of individual retirement accounts to meet educational expenses. The provisions of this new law will be phased 20 21 in beginning in 1998 and are intended by the U.S. Congress to assist students and their families in paying for their postsecondary education programs. STATE AUTHORIZATION Each of EDMC's schools is authorized to offer education programs and grant degrees or diplomas by the state in which such school is located. The level of regulatory oversight varies substantially from state to state. In some states, the schools are subject to licensure by the state education agency and also by a separate higher education agency. State laws establish standards for instruction, qualifications of faculty, location and nature of facilities, financial policies and responsibility and other operational matters. State laws and regulations may limit the ability of the Company to obtain authorization to operate in certain states or to award degrees or diplomas or offer new degree programs. Certain states prescribe standards of financial responsibility that are different from those prescribed by the U.S. Department of Education. The Company believes that each of the Company's schools is in substantial compliance with state authorizing and licensure laws. ITEM 2--PROPERTIES EDMC's schools are located in major metropolitan areas in eleven states. Typically, the schools occupy an entire building or several floors or portions of floors in a building. The Company and its subsidiaries lease all of their facilities, except in Denver where one building with 44,495 square feet is owned by the Company. Such leases currently have remaining terms ranging from less than one year to 17 years and typically include options for renewal. Most school leases are guaranteed by EDMC. In fiscal 1997, the Company and its subsidiaries paid approximately $12.2 million in rent for educational and administrative facilities. New leases entered into for schools typically are for ten years to 15 years, with two to four five-year renewal options. Currently, the Company expects to spend $40 to $50 per square foot, in addition to any allowance provided by the landlord, to make improvements necessary for the facility to meet the Company's operating standards. For new or rapidly growing schools, a lease typically provides for expansion rights within a building in order to accommodate increases in student enrollment. The majority of schools lease facilities for student parking and housing. These arrangements generally are intended to assist only a limited number of a school's students, are designed to be flexible, are for terms of one to five years and usually do not involve an EDMC guarantee. Annual rent for school-sponsored housing arrangements ranges from approximately $80,000 to $1.2 million per school, depending on the number of housing units and local market conditions. The following table sets forth certain information as of June 30, 1997 with respect to the principal properties leased by the Company and its subsidiaries:
LOCATION (CITY/STATE) SQUARE FEET - ----------------------------- ----------- Phoenix, AZ.................. 53,500 Los Angeles, CA.............. 37,755 Denver, CO................... 59,755 Ft. Lauderdale, FL(1)........ 118,500 Atlanta, GA.................. 88,250 Atlanta, GA.................. 14,570 Chicago, IL.................. 29,470 Schaumburg, IL............... 17,935 LOCATION (CITY/STATE) SQUARE FEET - ----------------------------- ----------- Minneapolis, MN.............. 22,320 New York, NY................. 30,500 Philadelphia, PA(2).......... 113,900 Pittsburgh, PA............... 26,115 Pittsburgh, PA(3)............ 126,500 Dallas, TX(4)................ 75,250 Houston, TX.................. 79,345 Seattle, WA.................. 114,750
21 22 - --------- (1) One of the properties occupied by The Art Institute of Fort Lauderdale is owned by a limited partnership that includes among its limited partners one current member of EDMC's management who is also a director. (2) One of the properties occupied by The Art Institute of Philadelphia is owned indirectly by a limited partnership that includes among its limited partners one current member of EDMC's management who is also a director and another current director of EDMC. (3) This lease expires in the year 2000 with no renewal option. (4) This lease expires in the year 1999 with no renewal option. ITEM 3--LEGAL PROCEEDINGS EDMC is subject to litigation in the ordinary course of its business. Certain proceedings have been brought under the Texas Deceptive Trade Practices Act and similar statutes in other jurisdictions. Typically, under those laws, an individual can seek treble damages and attorneys' fees or, in the alternative, actual and punitive damages, plus interest and court costs. While there can be no assurance as to the ultimate outcome of any litigation involving the Company, the Company does not believe that any pending legal proceeding is likely to result in a judgment or settlement that would have a material adverse effect on the Company's financial condition, results of operations or liquidity. ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5-- MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock is traded on the Nasdaq National Market System under the symbol "EDMC." As of September 22, 1997, there were 14,434,737 shares of Common Stock outstanding held by approximately 525 holders of record. The prices set forth below reflect the high and low sales prices for the Common Stock for the periods indicated, as reported in the consolidated transaction reporting system of the Nasdaq National Market System.
1997 ----------------- THREE MONTHS ENDED HIGH LOW -------------------------------------------------- ------ ------ September 30...................................... N/A N/A December 31....................................... $21.00 $15.50 March 31.......................................... 23.25 18.00 June 30........................................... 26.75 21.50
EDMC has not declared or paid any cash dividends on its capital stock during the last ten years other than on the shares of its Series A 10.19% Convertible Preferred Stock, $.0001 par value (the "Series A Preferred Stock"), none of which is currently outstanding. EDMC currently intends to retain future earnings, if any, to fund the development and growth of its business and does not anticipate paying any cash dividends in the foreseeable future. The payment of dividends by EDMC is, and will continue to be, subject to certain restrictions under the terms of the Amended and Restated Credit Agreement, dated March 16, 1995, as amended (the "Revolving Credit Agreement"). During fiscal 1997, the Company sold 1,500 shares of Common Stock to N.G. Temnick on August 9, 1996 for $3.50 per share ($5,250 in the aggregate) pursuant to the exercise of stock options in a transaction which was intended to be exempt from the registration requirements of the Securities Act of 1933, as amended, by virtue of Section 4(2) thereof. 22 23 ITEM 6--SELECTED FINANCIAL DATA The following summary consolidated financial and other data should be read in conjunction with the Company's Consolidated Financial Statements and Notes Thereto filed in response to Item 8 and the information included in response to Item 7 below. Certain of the summary consolidated financial data presented below are derived from the Company's consolidated financial statements audited by Arthur Andersen LLP, independent public accountants, whose report covering the financial statements as of June 30, 1996 and 1997 and for each of the three years in the period ended June 30, 1997 also is filed in response to Item 8 below. The summary consolidated income statement data for the years ended June 30, 1993 and 1994 are derived from audited financial statements not included herein.
YEAR ENDED JUNE 30, ---------------------------------------------------------- 1993 1994(7) 1995(8)(9) 1996(9) 1997 -------- -------- ---------- -------- -------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) INCOME STATEMENT DATA: Net revenues............................. $117,234 $122,549 $131,227 $147,863 $182,849 Amortization of intangibles(1)........... 10,025 6,599 1,937 1,060 2,076 ESOP expense(2).......................... 4,791 4,759 7,086 1,366 -- Income (loss) from continuing operations before extraordinary item(3)........... (1,174) (1,702) 1,513 6,846 9,985 Net income (loss)........................ (1,174) (1,702) 1,513 5,920 9,985 Dividends on Series A Preferred Stock.... 2,249 2,249 2,249 2,249 83 Other Series A Preferred Stock transactions........................... -- -- -- -- 403 PER SHARE DATA(4): Primary: Income (loss) from continuing operations before extrordinary item............... (.49) (.57) (.11) .45 .72 Net income (loss)........................ (.49) (.57) (.11) .36 .72 Weighted average number of shares of Common Stock outstanding, in thousands(5)........................... 6,959 6,926 6,890 10,170 13,235 Fully Diluted: Income (loss) from continuing operations before extraordinary item.............. (.49) (.57) (.11) .39 .72 Net income (loss)........................ (.49) (.57) (.11) .31 .72 Weighted average number of shares of Common Stock outstanding, in thousands(5)........................... 6,959 6,926 6,890 11,874 13,687 OTHER DATA: Capital expenditures..................... 8,448 6,289 11,640 14,981 18,098 Enrollments at beginning of fall quarter during period(6)....................... 12,708 12,592 12,749 13,407 15,838
AS OF JUNE 30, -------------------------------------------------------- 1993 1994 1995 1996 1997 -------- -------- -------- -------- -------- (IN THOUSANDS) BALANCE SHEET DATA: Total cash and cash equivalents........... $ 24,164 $ 20,487 $ 39,623 $ 27,399 $ 33,227 Current assets............................ 31,729 30,705 49,662 39,858 48,886 Total assets.............................. 85,091 78,527 102,303 101,412 126,292 Current liabilities....................... 30,343 30,129 34,718 27,264 36,178 Long-term debt (including current portions)............................... 68,923 63,112 69,810 65,919 34,031 Shareholders' investment (deficit)(10).... (10,790) (7,724) 1,855 9,656 57,756
- --------- (1) Includes the amortization of goodwill and intangibles resulting from the application of purchase accounting to the establishment and financing of the ESOP and the related leveraged transaction in 1989. See Note 3 of 23 24 Notes to Consolidated Financial Statements on page 43. The majority of the intangible assets related to student enrollments and applications, accreditation and contracts with colleges and universities and were written off over two to five year periods. The excess of the investment in EDMC and other acquisitions (including NYRS) over the fair market value of the net assets acquired has been assigned to goodwill and is being amortized over 40 years. (2) ESOP expense equals the sum of the payments on the senior term loan obtained for the ESOP's acquisition of securities from EDMC (the "ESOP Term Loan"), plus repurchases of shares from participants in the ESOP, less the dividends paid on the shares of Series A Preferred Stock previously held by the ESOP. In fiscal 1995, the Company made a voluntary prepayment of $2.1 million on the ESOP Term Loan. In fiscal 1996, the ESOP Term Loan was repaid in full. Therefore, there will be no future ESOP expense resulting from the repayment of such loan or, as the Offering has been consummated, from repurchases of shares. (3) In fiscal 1996, the $25.0 million aggregate principal amount of the Company's 13.25% Senior Subordinated Notes due 1999 (the "Subordinated Notes") was prepaid in full. The resulting $1.5 million prepayment penalty is classified as an extraordinary item net of the related tax benefit. (4) Dividends on the outstanding shares of Series A Preferred Stock, dividends accrued but not paid on outstanding shares of Series A Preferred Stock and a redemption premium paid upon redemption of 75,000 shares of Series A Preferred Stock have been deducted from net income (loss) in calculating net income (loss) per share of Common Stock. (5) The weighted average number of shares of Common Stock used to calculate income (loss) per share includes, where dilutive, equivalent shares of Common Stock calculated under the treasury stock method and resulting from the conversion of outstanding shares of Series A Preferred Stock. (6) Excludes students enrolled in programs at colleges and universities having consulting agreements with NCPD. (7) A special charge of $3.0 million was recorded in fiscal 1994 for unusual items, including the early write-off of equipment, program termination expenses, severance compensation, expenses related to the settlement of a lease and various legal expenses. Such special charge was included in educational services and general and administrative expenses. (8) Results for fiscal 1995 include a $1.1 million nonrecurring credit for the refund of state and local business and occupation taxes. (9) Charges of $1.1 million, $0.5 million and $0.4 million are reflected in 1995, 1996 and 1997, respectively, to account for non-cash compensation expense related to the performance-based vesting of nonstatutory stock options. (10) Prior to the closing date of an initial public offering of its securities, holders of the Company's equity securities had the right, under certain circumstances, to require the Company to repurchase such securities. In addition, the Company had the right to redeem shares of the Series A Preferred Stock and its Class B Common Stock, $.0001 par value, under certain circumstances. These rights expired upon consummation of the Offering. 24 25 ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BACKGROUND EDMC is among the largest providers of proprietary postsecondary education in the United States based on student enrollments and revenues. Through its operating units, The Art Institutes, NYRS, NCPT and NCPD, the Company offers associate's and bachelor's degree programs and non-degree programs in the areas of design, media arts, culinary arts, fashion and professional development. The Company has provided career-oriented education programs for 35 years, and its schools have graduated over 100,000 students. The Company's main operating unit, The Art Institutes, consists of 13 schools in 12 major metropolitan areas throughout the United States and accounted for 92.7% of the Company's net revenues in 1997. Unless otherwise specified, any reference to a year is to a fiscal year ended June 30. Net revenues, income before interest and taxes and net income increased in each of the last two years. Net revenues are presented after deducting refunds, scholarships and other adjustments. Net revenues increased 39.3% to $182.8 million in 1997 from $131.2 million in 1995. Income before interest and taxes increased 189.2% to $18.8 million in 1997 from $6.5 million in 1995. Net income increased by 560.0% to $10.0 million in 1997 from $1.5 million in 1995. Average quarterly student enrollments at the Company's schools were 14,490 in 1997 compared to 11,349 in 1995. The increase in average enrollments was due to new education programs, additional school locations, and expanded evening program offerings. The Company's revenues consist of tuition and fees, student housing fees and student supply store and restaurant sales. In 1997, the Company derived 87.8% of its net revenues from tuition and fees paid by, or on behalf of, its students. Tuition revenue generally varies based on the average tuition charge per credit hour and the average student population. Student supply store, housing and restaurant revenue is largely a function of the average student population. The average student population is influenced by the number of continuing students attending school at the beginning of a fiscal period and by the number of new students entering school during such period. New students enter The Art Institutes at the beginning of each academic quarter, which typically commence in January, April, July and October. The Company believes that the size of its student population is influenced by the number of graduating high school students, the attractiveness of its program offerings, the effectiveness of its marketing efforts, the strength of employment markets, the persistence of its students, the length of its education programs and general economic conditions. The introduction of additional program offerings at existing schools and the establishment of new schools (through acquisition or start-up) are important influences on the Company's average student population. Tuition increases have been implemented in varying amounts in each of the past several years. Historically, the Company has been able to pass along cost increases through increases in tuition. Tuition rates have generally been consistent across the Company's schools and programs. However, as the Company enters more markets in different geographic regions, tuition rates across Company schools might not remain consistent. The Company believes that it can continue to increase tuition as educational costs at other postsecondary institutions, both public and private, continue to rise. The Company's schools implemented tuition rate increases averaging approximately 5.5% for the fall quarter of 1997. The majority of students at The Art Institutes and NYRS rely on funds received under various government sponsored student financial aid programs, especially Title IV Programs, to pay a substantial portion of their tuition and other education-related expenses. For the year ended June 30, 1997, approximately 63% of the Company's net revenues was indirectly derived from Title IV Programs. Educational services expense consists primarily of costs related to the delivery and administration of the Company's education programs. Major cost components are faculty compensation, administrative salaries, costs of educational materials, facility leases and school occupancy costs, management information system costs, bad debt expense and depreciation and amortization of property and equipment. During 1997, The Art Institutes' faculty was comprised of approximately 44% full-time and approximately 56% part-time employees. In 1996 these same percentages were 45% and 55%, respectively. 25 26 General and administrative expense consists of marketing and student admissions expenses and departmental costs such as executive management, finance and accounting, legal, corporate development and other departments that do not provide direct services to the Company's students. The Company has centralized many of these services to gain consistency in management reporting, efficiency in administrative effort and control of costs. All marketing and student admissions costs are expensed in the year incurred. Amortization of intangibles relates to the values assigned to student enrollment agreements and applications, accreditation, contracts with colleges and universities and goodwill which arose principally from the application of purchase accounting to the establishment and financing of the ESOP and the related leveraged transaction in October 1989 and the acquisitions of NYRS and Lowthian College (renamed the Art Institute of Minnesota). See Note 3 of Notes to Consolidated Financial Statements. ESOP expense equals the sum of the payments on the ESOP Term Loan plus repurchases of shares from participants in the ESOP, less the dividends paid on the Series A Preferred Stock that was held by the ESOP. As of June 30, 1996, the entire ESOP Term Loan was repaid. As a result, there was no ESOP expense in 1997 nor will there be future ESOP expense resulting from the repayment of such loan. Coincident with the Offering, the ESOP converted its shares of Series A Preferred Stock into shares of Common Stock and therefore, dividends are no longer payable on the Series A Preferred Stock. In November 1995, the Company purchased the assets of the two schools of the Ray College of Design for $1.1 million in cash and the assumption of specified liabilities. The Company acquired accounts receivable, property and equipment and certain other assets. The schools, which regained eligibility as of March 1996 to participate in Title IV Programs, were renamed The Illinois Institute of Art at Chicago and The Illinois Institute of Art at Schaumburg. In 1996, the Company established The Art Institute of Phoenix at which classes commenced in January 1996. The Art Institute of Phoenix initiated the accreditation process in January 1996, submitted its application to the U.S. Department of Education in June 1996, and became eligible to participate in Title IV Programs in August 1996. During 1996, the Company deferred approximately $0.4 million of certain pre-opening non-marketing and admissions costs associated with The Art Institute of Phoenix start-up. All of the costs deferred in 1996 were expensed in 1997. In August 1996, the Company purchased certain assets of NYRS for $9.5 million. The Company acquired current assets net of specified current liabilities, property and equipment, student enrollment agreements, curriculum, trade names and certain other assets. The school regained its eligibility as of November 1996 to participate in Title IV Programs. In January 1997, the Company acquired the assets of Lowthian College in Minneapolis, Minnesota for $0.4 million, which included the assumption of certain liabilities. The school, which regained eligibility as of April 1997 to participate in Title IV Programs, has been renamed The Art Institute of Minnesota. In March 1997, the Company established a wholly owned subsidiary, The Art Institute of Los Angeles, which obtained its license to operate in the State of California. In connection with this start-up, marketing and student recruiting activities commenced in April 1997. The school expects to begin classes in October 1997. In 1997, the Company changed its policy and did not defer pre-opening costs for The Art Institute of Los Angeles. The $0.4 million of pre-opening costs incurred in 1997 were expensed. Start-up schools and smaller acquisitions are expected to incur operating losses during the first several quarters following their opening or purchase. As expected, the combined operating losses of the Company's newer schools in Arizona, Illinois, Minnesota and California totaled approximately $3.4 million in 1997. 26 27 RESULTS OF OPERATIONS The following table sets forth for the periods indicated the percentage relationships of certain income statement items to net revenues.
YEAR ENDED JUNE 30, ----------------------------- 1995 1996 1997 ----- ----- ----- Net revenues.................................... 100.0% 100.0% 100.0% Costs and expenses: Educational services.......................... 66.2 66.8 66.1 General and administrative.................... 22.0 21.9 22.4 Amortization of intangibles................... 1.5 0.7 1.1 ESOP expense.................................. 5.4 0.9 -- ----- ----- ----- 95.0 90.4 89.6 Income before interest and taxes................ 5.0 9.6 10.3 Interest expense, net........................... 3.4 2.3 0.9 Income before income taxes...................... 1.6 7.3 9.5 Provision for income taxes...................... 0.4 2.7 4.0 Income before extraordinary item................ 1.2 4.6 5.5 Extraordinary item.............................. -- 0.6 -- Net income...................................... 1.2% 4.0% 5.5%
YEAR ENDED JUNE 30, 1997 COMPARED WITH YEAR ENDED JUNE 30, 1996 NET REVENUES Net revenues increased by 23.7% to $182.8 million in 1997 from $147.9 million in 1996. The revenue increase was primarily due to a 13.1% increase in average quarterly student enrollments ($15.4 million) and an average 5.5% tuition price increase ($5.8 million) at The Art Institutes owned by EDMC prior to 1997 and the addition of two schools ($10.2 million). The average academic year (three academic quarters) tuition rate for a student attending classes at an Art Institute on a recommended full schedule increased to $9,860 in 1997 from $9,345 in 1996. In August 1996, the Company acquired NYRS and in January 1997, the Company acquired Lowthian College in Minneapolis, Minnesota and renamed it The Art Institute of Minnesota. Net housing revenues increased by 12.5% to $10.4 million in 1997 from $9.2 million in 1996 and revenues from the sale of educational materials in 1997 increased by 33.4% to $8.7 million. Both are primarily the result of increased student enrollments. Refunds for 1997 increased $1.3 million from $4.7 million in 1996 to $6.0 million in 1997. As a percentage of gross revenue, refunds remained consistent between years. EDUCATIONAL SERVICES Educational services expense increased by $22.1 million, or 22.3%, to $120.9 million in 1997 from $98.8 million in 1996. The increase was primarily due to incremental education expenses needed to service higher student enrollments accompanied by normal cost increases for wages and other services at the schools owned by EDMC prior to 1996 ($8.8 million) and schools added in 1996 and 1997 ($10.1 million). Other factors that have contributed to the increase are expanded capital spending for culinary arts programs and classroom technology, and initiatives to improve student persistence rates and graduate starting salaries. On an overall basis, as a percentage of net revenue, educational services expense in 1997 decreased by 0.7% from 1996. The reduction is primarily the result of improved efficiencies at The Art Institutes due to economies of scale. 27 28 GENERAL AND ADMINISTRATIVE General and administrative expense increased by $8.7 million, or 26.9%, to $41.0 million in 1997 from $32.3 million in 1996 due in large measure to the incremental increase in marketing and student admissions expenses that resulted in higher student enrollments at the schools owned by EDMC prior to 1996 ($2.2 million), and additional marketing and student admissions expenses at the schools added since 1996 ($3.4 million). During 1997, additional expenses were incurred by the Company's central staff organization that supports school operations because of the increased number of Company-owned schools and the growth in student enrollments. General and administrative expense increased as a percentage of net revenues in 1997 compared to 1996 as a result of the factors described above. AMORTIZATION OF INTANGIBLES Amortization of intangibles increased by $1.0 million, or 90.9%, to $2.1 million in 1997 from $1.1 million in 1996. The higher expense in 1997 was primarily the result of the amortization of goodwill and other intangible assets associated with the acquisition of NYRS. ESOP EXPENSE ESOP expense was zero in 1997, down from $1.4 million in 1996, due to the repayment in 1996 of the final $3.6 million of the ESOP Term Loan. As a result the Company incurred no ESOP expense in 1997 related to the repayment of such loan. INTEREST EXPENSE Net interest expense decreased by $1.8 million, or 52.9%, to $1.6 million in 1997 from $3.4 million in 1996. The factors that contributed to lower interest expense are: (i) a decrease in the average debt balances outstanding from $38.0 million in 1996 to $22.4 million in 1997, and (ii) lower average interest rates on debt instruments. The lower average debt balance is the result of the Company repaying outstanding indebtedness ($38.5 million) under the Revolving Credit Agreement with proceeds from the Offering; the ESOP Term Loan being repaid as of June 30, 1996; and scheduled payments on capitalized leases. In October 1995 the Company retired the entire $25 million issue of its Subordinated Notes with borrowings under the Revolving Credit Agreement which were at a lower rate of interest. Borrowings under the Revolving Credit Agreement were at a weighted average interest rate of 7.3% and 7.2% during 1996 and 1997, respectively. PROVISION FOR INCOME TAX The Company's effective tax rate increased from 37.1% in 1996 to 42.0% in 1997. The effective rate in fiscal 1996 was lower than the combined federal and state statutory rate due to the tax deductible dividends on the Series A Preferred Stock paid to the ESOP and used for ESOP Term Loan repayment. In 1996, tax deductible dividends of $1.6 million offset approximately 14.7% of the Company's income before taxes, substantially reducing the Company's effective tax rate. INCOME BEFORE EXTRAORDINARY ITEM Income before extraordinary item increased by $3.2 million to $10.0 million in 1997 from $6.8 million in 1996. The higher income resulted from improved operations at the Company's schools owned prior to 1996, the addition of NYRS, lower ESOP expense and reduced net interest expense charges, partially offset by increased expense associated with the amortization of intangible assets and a higher provision for income taxes. EXTRAORDINARY ITEM In 1996, the Company prepaid the entire $25 million issue of the Subordinated Notes, resulting in a $0.9 million (net of tax) prepayment penalty. 28 29 YEAR ENDED JUNE 30, 1996 COMPARED WITH YEAR ENDED JUNE 30, 1995 NET REVENUES Net revenues increased by 12.7% to $147.9 million in 1996 from $131.2 million in 1995 due primarily to a 5.7% increase in average quarterly student enrollments ($6.3 million), an average 6.0% tuition price increase at The Art Institutes owned by EDMC prior to 1996 ($7.4 million), and the addition of new schools ($2.0 million). The average academic year (three academic quarters) tuition rate for a student attending classes at an Art Institute on a recommended full schedule increased to $9,345 in 1996 from $8,820 in 1995. In November 1995, the two schools of the Ray College of Design were acquired and renamed The Illinois Institute of Art at Chicago and The Illinois Institute of Art at Schaumburg. A new school, The Art Institute of Phoenix, commenced classes in January 1996. Net housing revenues increased by 7.7% to $9.2 million in 1996 from $8.6 million in 1995, primarily resulting from price increases. Revenues from the sale of educational materials in 1996 increased by 6.5% to $6.5 million. Refunds in 1996 increased $0.6 million from $4.1 million in 1995 to $4.7 million. EDUCATIONAL SERVICES Educational services expense increased by $12.0 million, or 13.8%, to $98.8 million in 1996 from $86.9 million in 1995. The increase was due to $6.8 million of incremental education expenses related to higher student enrollments at the schools owned by EDMC prior to 1996, $3.5 million of education expenses at the three new schools and $1.7 million of additional depreciation expense resulting from expanded capital spending for culinary arts programs and classroom technology. Contributing to the increases at the schools owned by the Company prior to 1996 were investments in initiatives to improve student persistence rates and to increase graduates' starting salaries. These initiatives included additional student remediation, instructor development and expanded employment assistance services. The Art Institutes implemented a system wide remediation program to help students overcome deficiencies in academic preparedness so they successfully complete their education. In addition, a $1.1 million refund of state and local business and occupation taxes reduced educational services expense in 1995. As a result of an administrative appeal, The Art Institute of Seattle was exempted from the State of Washington and the City of Seattle business and occupation taxes. Requests for refunds were filed for prior years to the extent permitted by the statute of limitations. The taxes to which the refunds applied had been originally recorded as educational services expense in the years paid. GENERAL AND ADMINISTRATIVE General and administrative expense increased by $3.5 million, or 12.1%, to $32.3 million in 1996 from $28.8 million in 1995 due principally to the incremental increase in marketing and student admissions expenses that resulted in higher student enrollments at the schools owned by EDMC prior to 1996 and the addition of marketing and student admissions expenses for three schools added in 1996. AMORTIZATION OF INTANGIBLES Amortization of intangibles decreased by $0.9 million, or 45.3%, to $1.1 million in 1996 from $1.9 million in 1995. The reduction in amortization expense occurred because certain intangible assets resulting from the 1989 leveraged ESOP transaction became fully amortized during 1995. ESOP EXPENSE ESOP expense decreased by $5.7 million, or 80.7%, to $1.4 million in 1996 from $7.1 million in 1995 due to the repayment in 1996 of $3.6 million of ESOP debt, as compared to the repayment in 1995 of $9.1 million of ESOP debt. Repayments in 1996 and 1995 included voluntary prepayments of $0.4 million and $2.1 million, respectively, on the ESOP Term Loan. As of June 30, 1996, the entire ESOP Term Loan had been repaid. As a 29 30 result, 1996 was the last year in which the Company incurred ESOP expense resulting from the repayment of such loan. INTEREST EXPENSE Net interest expense decreased by $1.1 million, or 25.0%, to $3.4 million in 1996 from $4.5 million in 1995. The decrease was attributable to (i) a reduction in the average debt balance outstanding to approximately $38.0 million in 1996 from $45.0 million in 1995 as a result of principal payments on the ESOP Term Loan and capitalized leases, and (ii) the retirement in 1996 of the Subordinated Notes through borrowings under the Revolving Credit Agreement. Borrowings under the Revolving Credit Agreement were at a weighted average interest rate of 7.3% during 1996. PROVISION FOR INCOME TAX The Company's effective tax rate increased from 24.5% in 1995 to 37.1% in 1996, which is lower than the Company's blended state and federal statutory rate of 40.0%. The variance from the statutory rate in 1996 was due to the tax deductibility of $1.6 million of dividends on the Series A Preferred Stock paid to the ESOP and used for ESOP Term Loan repayment. The favorable effect of those dividends was partly offset by $0.4 million of non-deductible goodwill amortization and other items. In 1995, tax deductible dividends were $1.6 million which offset approximately 80% of the Company's income before taxes, substantially reducing the Company's effective tax rate. Non-deductible goodwill amortization in 1995 was $0.4 million. The effective tax rate increased in 1996 because the dollar amount of non-deductible goodwill amortization and deductible ESOP dividends remained largely unchanged from 1995, whereas 1996 earnings before taxes were $8.9 million higher than in 1995. INCOME BEFORE EXTRAORDINARY ITEM Income before extraordinary item increased by $5.3 million to $6.8 million in 1996 from $1.5 million in 1995. Higher income before extraordinary item resulted from improved operations at The Art Institutes, coupled with diminished amortization of intangibles, lower ESOP expense and reduced net interest charges, partially offset by a higher provision for income taxes. EXTRAORDINARY ITEM In October 1995, the Company prepaid in full the $25 million issue of the Subordinated Notes resulting in a $0.9 million (net of tax) prepayment penalty. SEASONALITY AND OTHER FACTORS AFFECTING QUARTERLY RESULTS The Company's quarterly revenues and income fluctuate primarily as a result of the pattern of student enrollments. The Company experiences a seasonal increase in new enrollments in the fall (fiscal year second quarter), which is traditionally when the largest number of new high school graduates begin postsecondary education. Some students choose not to attend classes during summer months, although The Art Institutes and NYRS encourage year-round attendance. As a result, total student enrollments at the Company's schools are highest in the fall quarter and lowest in the summer months (fiscal year first quarter). The Company's costs and expenses, however, do not fluctuate as significantly as revenues on a quarterly basis. Historically, EDMC has experienced net losses in its fiscal first quarter ending September 30 due to lower revenues combined with expenses incurred in preparation for the peak enrollments in the fall quarter. The Company anticipates that the seasonal pattern in revenues and earnings will continue in the future. 30 31 The following table sets forth the Company's quarterly results for 1996 and 1997. QUARTERLY FINANCIAL RESULTS
1996 --------------------------------------------- SEPT. 30 DEC. 31 MAR. 31 JUNE 30 (SUMMER) (FALL) (WINTER) (SPRING) -------- ------- -------- ------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Net revenues..................................... $28,333 $42,635 $39,637 $37,258 Income (loss) before interest and taxes.......... $ (565) $ 8,654 $ 5,118 $ 1,045 Income (loss) before income taxes................ $(1,481) $ 7,761 $ 4,239 $ 362 Net income (loss)................................ $ (931) $ 3,955 $ 2,668 $ 228 Net income (loss) per common share --Primary...................................... $ (.22) $ .33 $ .21 $ (.05) --Fully diluted................................ $ (.22) $ .29 $ .18 $ (.05)
1997 --------------------------------------------- SEPT. 30 DEC. 31 MAR. 31 JUNE 30 (SUMMER) (FALL) (WINTER) (SPRING) -------- ------- -------- ------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) Net revenues..................................... $33,410 $52,015 $50,696 $46,728 Income (loss) before interest and taxes.......... $ (143) $10,447 $ 6,401 $ 2,114 Income (loss) before income taxes................ $(1,095) $ 9,848 $ 6,305 $ 2,158 Net income (loss)................................ $ (635) $ 5,709 $ 3,655 $ 1,256 Net income (loss) per common share --Primary...................................... $ (.15) $ .43 $ .25 $ .08 --Fully diluted................................ $ (.15) $ .42 $ .25 $ .08
LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY The Company has generated positive cash flow from operations over the last three years. Cash flow from operations was $22.2 million, $16.3 million and $28.5 million for the years 1995, 1996 and 1997, respectively. During 1995, the Company began to receive student loan receipts via electronic funds transfers ("EFT") from lenders. The introduction of EFT resulted in a one-time increase in cash flows from operations in 1995. The Company had $12.7 million of working capital as of June 30, 1997 as compared to $12.6 million of working capital as of June 30, 1996. At June 30, 1997, gross trade accounts receivable increased by $7.5 million to $16.1 million or 87.2% from $8.6 million. Approximately 60% of the increase is attributable to new schools, including NYRS. Another factor contributing to the increase is the timing of the write off of accounts receivable against the bad debt reserve in 1997 compared to 1996. Because of the completion of the Company's integrated, customized information network in 1996, the Company tracks accounts receivable for longer periods prior to write-off. The allowance for doubtful accounts increased by $4.5 million, or 155%, to $7.4 million in 1997 from $2.9 million in 1996. This increase was the result of the timing of accounts being written off against the reserve in 1997 as compared to 1996, in combination with the increased gross accounts receivable balance. The allowance for doubtful accounts as of June 30, 1996 increased by $1.4 million, or 93.0%, to $2.9 million from $1.5 million as of June 30, 1995. DEBT SERVICE Effective October 13, 1995, the Company and its lenders amended the Revolving Credit Agreement in order to increase the amount of the facility thereunder to $70.0 million and to extend its term to October 13, 2000. Borrowings under the Revolving Credit Agreement bear interest at one of three rates set forth in the Revolving Credit Agreement at the election of the Company. The Revolving Credit Agreement contains customary covenants that, among other things, require the Company to maintain specified levels of consolidated net worth and meet specified interest and leverage ratio requirements, restrict capital expenditures by the Company, restrict 31 32 the payment of dividends on the Common Stock and restrict the incurrence of certain additional indebtedness. As of June 30, 1997, the Company was in compliance with all covenants under the Revolving Credit Agreement. The facility is reduced by outstanding letters of credit. As of June 30, 1997, the Company had $42.5 million of additional borrowing capacity available under the Revolving Credit Agreement. Borrowings under the Revolving Credit Agreement are used by the Company primarily to fund its working capital needs. The pattern of cash receipts is seasonal throughout the year. The level of accounts receivable reaches a peak immediately after the billing of tuition and fees at the beginning of each academic quarter. Collection of these receivables is heaviest at the start of each academic quarter. Borrowings under the Revolving Credit Agreement were used to prepay all of the Subordinated Notes on October 13, 1995 in order to reduce interest expense. The Company incurred a $1.5 million ($0.9 million after the related income tax benefit) prepayment penalty as a result. In June 1995, the Company made a voluntary prepayment of $2.1 million on the ESOP Term Loan. In June 1996, the Company made another voluntary prepayment of $0.4 million on the ESOP Term Loan, at which time it was completely repaid. Following the completion of the Offering on November 5, 1996, $38.5 million of the net proceeds received by the Company was used to repay indebtedness under the Revolving Credit Agreement. FUTURE FINANCING AND CASH FLOWS The Company believes that cash flow from operations, supplemented from time to time by borrowings under the Revolving Credit Agreement, will provide adequate funds for ongoing operations, planned expansion to new locations, planned capital expenditures and debt service during the term of the Revolving Credit Agreement. CAPITAL EXPENDITURES Capital expenditures in 1996 and 1997 have, in substantial part, resulted from the implementation of the Company's initiatives emphasizing the addition of new schools and programs (particularly culinary programs) and investment in classroom technology. The Company's capital expenditures were $11.6 million, $15.0 million and $18.1 million for 1995, 1996 and 1997, respectively. The Company anticipates increased capital spending for 1998, principally related to the introduction and expansion of culinary programs, further investment in schools acquired during 1996 and 1997 and additional classroom technology. As a percentage of net revenues capital expenditures are expected to decline in 1998 compared to 1997. The Company does not have any material commitments for capital expenditures in 1998 or beyond. The Company leases nearly all of its facilities. Future commitments on existing leases will be paid from cash provided by operating activities. REGULATION The Company indirectly derived approximately 63% of its net revenues from Title IV Programs in 1997. U.S. Department of Education regulations prescribe the timing of disbursements of funds under Title IV Programs. Students must apply for a new loan for each academic year. Loan funds are generally provided by lenders in multiple disbursements each academic year. The first disbursement is generally received either at least 30 days after, in the case of students commencing a program of study, or, at the earliest, ten days before, the commencement of the first academic quarter of a student's academic year. U.S. Department of Education regulations require Title IV Program funds received by the Company's schools in excess of the tuition and fees owed by the relevant students at that time to be, with these students' permission, maintained and classified as restricted until they are billed for the portion of their education program related to those funds. In addition, all funds transferred to the Company through EFT programs are held in a separate cash account until certain conditions are satisfied. These restrictions have not significantly affected the Company's ability to fund daily operations. 32 33 Effective July 1997, postsecondary education institutions are subject to changes in the delivery of FFEL program proceeds. Prior to July 1997, certain Company-owned schools delivered FFEL loan proceeds for an academic year (typically three quarters) to students in two equal disbursements. The change will result in FFEL loan proceeds being delivered equally in each of the academic quarters. The Company anticipates that this change will result in a reduction in interest income of approximately $150,000 in 1998. Some of the Company's schools began to deliver loan proceeds in this manner prior to the change in regulation becoming effective. Regulations promulgated under the HEA require all higher education institutions to meet an acid test ratio of at least 1:1 and maintain tangible net worth, calculated at the end of each fiscal year, comply with the 85% rule and insure that any operating losses do not result in a reduction of tangible net worth by 10% or more. The acid test ratio is defined as the ratio of cash (including funds classified as restricted), cash equivalents and current accounts receivable to total current liabilities. Tangible net worth is equal to shareholders equity less intangible assets. The 85% rule prohibits participating schools from deriving 85% or more of total revenue from Title IV Programs. If an institution fails to meet these requirements, it may be deemed to be not financially responsible by the U.S. Department of Education, which could result in a loss of its eligibility to participate in Title IV Programs. These requirements apply to the separate audited financial statements of The Art Institutes and NYRS and historically have not been applied to the Company's consolidated financial statements. All of the participating schools met these requirements as of June 30, 1997. EFFECT OF INFLATION The Company does not believe its operations have been materially affected by inflation. IMPACT OF NEW ACCOUNTING STANDARDS In February 1997, the Financial Accounting Standards Board issued Financial Accounting Standard #128 ("FAS #128"). FAS #128 changes the methodology of calculating earnings per share ("EPS") and renames the two calculations, Basic (currently primary) and Diluted (currently fully diluted) Earnings per Share. The calculations differ by eliminating any common stock equivalents (such as stock options, warrants and convertible preferred stock) from Basic Earnings per Share and changes certain calculations when computing Diluted Earnings per Share. FAS #128 is effective for reporting periods ending after December 15, 1997; early adoption is prohibited and when adopted all prior periods must be restated. However, if FAS #128 were in effect, the new EPS calculations would be as follows:
YEAR ENDED JUNE 30, ----------------------------- 1995 1996 1997 ----- ------- ------- BASIC: Income (loss) before extraordinary item................. $(.11) $ .66 $ .80 Net income (loss)....................................... $(.11) $ .53 $ .80 DILUTED: Income (loss) before extraordinary item................. $(.11) $ .39 $ .72 Net income (loss)....................................... $(.11) $ .31 $ .72 WEIGHTED AVERAGE SHARES OUTSTANDING (IN 000'S):......... Basic................................................... 6,890 6,913 11,939 Diluted................................................. 6,890 11,874 13,671
YEAR 2000 ISSUES The Company is evaluating the year 2000 issues and the impact upon information systems and computer technologies. Certain applications and system software critical to processing financial and operational information is Year 2000 compliant. However, the Company expects to incur some costs in testing and implementing updates to such software. The Company is also evaluating the impact of Year 2000 on other computer technologies and software. All costs to evaluate and make modifications will be expensed as incurred and are not expected to have a significant impact on the Company's ongoing results of operations. 33 34 ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS Not applicable. ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES: We have audited the accompanying consolidated balance sheets of Education Management Corporation (a Pennsylvania corporation) and Subsidiaries as of June 30, 1996 and 1997, and the related consolidated statements of income, shareholders' investment and cash flows for each of the three years in the period ended June 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Education Management Corporation and Subsidiaries as of June 30, 1996 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1997 in conformity with generally accepted accounting principles. Arthur Andersen LLP Pittsburgh, Pennsylvania, August 4, 1997 34 35 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
AS OF JUNE 30, ---------------------- 1996 1997 -------- -------- ASSETS CURRENT ASSETS: Cash and cash equivalents.............................................. $ 26,162 $ 32,646 Restricted cash........................................................ 1,237 581 -------- -------- Total cash and cash equivalents................................... 27,399 33,227 Receivables: Trade, net of allowances of $2,938 and $7,393, respectively.......... 5,680 8,706 Notes, advances and other............................................ 2,492 1,841 Inventories............................................................ 1,271 1,356 Deferred income taxes.................................................. 381 1,509 Other current assets................................................... 2,635 2,247 -------- -------- Total current assets.............................................. 39,858 48,886 -------- -------- PROPERTY AND EQUIPMENT, NET.............................................. 41,174 52,571 OTHER ASSETS............................................................. 5,837 6,381 GOODWILL, NET OF AMORTIZATION OF $2,713 AND $3,236, RESPECTIVELY......... 14,543 18,454 -------- -------- TOTAL ASSETS...................................................... $101,412 $126,292 ========= ========= LIABILITIES AND SHAREHOLDERS' INVESTMENT CURRENT LIABILITIES: Current portion of long-term debt...................................... $ 3,890 $ 3,637 Accounts payable....................................................... 4,776 6,931 Accrued liabilities.................................................... 7,355 9,778 Advance payments....................................................... 11,243 15,832 -------- -------- Total current liabilities......................................... 27,264 36,178 -------- -------- LONG-TERM DEBT, LESS CURRENT PORTION..................................... 62,029 30,394 DEFERRED INCOME TAXES AND OTHER LONG-TERM LIABILITIES.................... 2,463 1,964 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' INVESTMENT: Capital stock: Series A 10.19% Convertible Preferred Stock, at paid-in value........ 22,075 -- Common Stock, Class A, par value $.0001 per share.................... -- -- Common Stock, Class B, par value $.0001 per share.................... 1 -- Common Stock, par value $.01 per share, 14,417,874 issued and outstanding........................................................ -- 144 Warrants outstanding................................................... 7,683 -- Additional paid-in capital............................................. 19,742 87,893 Treasury stock, 39,401 shares at cost.................................. (99) (354) Stock subscriptions receivable......................................... (442) (122) Accumulated deficit.................................................... (39,304) (29,805) -------- -------- TOTAL SHAREHOLDERS' INVESTMENT.................................... 9,656 57,756 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' INVESTMENT.................... $101,412 $126,292 ========= =========
The accompanying notes to consolidated financial statements are an integral part of these statements. 35 36 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEARS ENDED JUNE 30, ------------------------------------ 1995 1996 1997 -------- -------- -------- NET REVENUES.................................................. $131,227 $147,863 $182,849 COSTS AND EXPENSES: Educational services........................................ 86,865 98,841 120,918 General and administrative.................................. 28,841 32,344 41,036 Amortization of intangibles................................. 1,937 1,060 2,076 ESOP expense................................................ 7,086 1,366 -- -------- -------- -------- 124,729 133,611 164,030 -------- -------- -------- INCOME BEFORE INTEREST AND TAXES.............................. 6,498 14,252 18,819 Interest expense, net....................................... 4,495 3,371 1,603 -------- -------- -------- INCOME BEFORE INCOME TAXES.................................... 2,003 10,881 17,216 Provision for income taxes.................................. 490 4,035 7,231 -------- -------- -------- INCOME BEFORE EXTRAORDINARY ITEM.............................. 1,513 6,846 9,985 Extraordinary loss on early extinguishment of debt.......... -- 926 -- -------- -------- -------- NET INCOME.................................................... $ 1,513 $ 5,920 $ 9,985 ========= ========= ========= INCOME AVAILABLE TO COMMON SHAREHOLDERS: Dividends paid on Series A Preferred Stock.................... $ (2,249) $ (2,249) $ (83) Redemption premium paid on Series A Preferred Stock........... -- -- (107) Dividends accrued on Series A Preferred Stock, but not payable..................................................... -- -- (296) -------- -------- -------- Income (loss) before extraordinary item available to common shareholders................................................ $ (736) $ 4,597 $ 9,499 Net income (loss) available to common shareholders............ $ (736) $ 3,671 $ 9,499 Net income (loss) available to common shareholders assuming full dilution............................................... $ (736) $ 3,671 $ 9,878 INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE: PRIMARY: Income (loss) before extraordinary item................... $ (.11) $ .45 $ .72 Extraordinary loss on early extinguishment of debt........ -- (.09) -- -------- -------- -------- Net income (loss)...................................... $ (.11) $ .36 $ .72 ========= ========= ========= FULLY DILUTED: Income (loss) before extraordinary item................... $ (.11) $ .39 $ .72 Extraordinary loss on early extinguishment of debt........ -- (.08) -- -------- -------- -------- Net income (loss)...................................... $ (.11) $ .31 $ .72 ========= ========= ========= WEIGHTED AVERAGE NUMBER OF COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING (IN 000'S): Primary................................................... 6,890 10,170 13,235 Fully diluted............................................. 6,890 11,874 13,687 ========= ========= =========
The accompanying notes to consolidated financial statements are an integral part of these statements. 36 37 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
FOR THE YEARS ENDED JUNE 30, ---------------------------------- 1995 1996 1997 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................................ $ 1,513 $ 5,920 $ 9,985 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FLOWS FROM OPERATING ACTIVITIES: Depreciation and amortization........................ 7,505 8,530 12,343 ESOP expense......................................... 7,086 1,366 -- Tax effect of dividends on unallocated shares held by ESOP........................................... 58 -- -- Vesting of compensatory stock options................ 1,146 464 375 Deferred provision (credit) for income taxes......... (210) 137 (1,613) Changes in current assets and liabilities: Restricted cash................................... (2,406) 6,266 656 Receivables....................................... (223) (758) (158) Inventories....................................... 1 (279) (73) Other current assets.............................. 182 (1,183) 443 Accounts payable.................................. 3,236 (1,213) 1,604 Accrued liabilities............................... 382 (1,015) 2,269 Advance payments.................................. 3,951 (1,921) 2,715 -------- -------- -------- Total adjustments............................... 20,708 10,394 18,561 -------- -------- -------- Net cash flows from operating activities........ 22,221 16,314 28,546 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of subsidiaries............................... -- (400) (9,753) Expenditures for property and equipment................... (10,481) (15,749) (18,098) Other items, net.......................................... (1,492) (2,282) 119 -------- -------- -------- Net cash flows from investing activities............. (11,973) (18,431) (27,732) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuance of common stock................ -- -- 45,143 Principal payments on debt................................ (12,438) (32,525) (31,988) Dividends paid to ESOP.................................... (2,249) (2,249) (83) Payments received from ESOP, net.......................... 2,032 2,220 -- New borrowings............................................ 19,145 28,634 -- Redemption of Series A Preferred Stock and other, net..... (8) 79 (7,402) -------- -------- -------- Net cash flows from financing activities........ 6,482 (3,841) 5,670 -------- -------- -------- NET CHANGE IN CASH AND CASH EQUIVALENTS..................... 16,730 (5,958) 6,484 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 15,390 32,120 26,162 -------- -------- -------- CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 32,120 $ 26,162 $ 32,646 ======= ======= =======
The accompanying notes to consolidated financial statements are an integral part of these statements. 37 38 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' INVESTMENT (DOLLARS IN THOUSANDS)
SERIES A PREFERRED CLASS A CLASS B DEFERRED STOCK COMMON COMMON COMMON COMPEN- STOCK STATED AT STOCK STOCK STOCK ADDITIONAL SATION SUB- PAID-IN AT PAR AT PAR AT PAR WARRANTS PAID-IN RELATED TREASURY SCRIPTIONS VALUE VALUE VALUE VALUE OUTSTANDING CAPITAL TO ESOP STOCK RECEIVABLE --------- ------ ------- ------- ----------- ---------- -------- -------- ---------- Balance, June 30, 1994..... $ 22,075 $ -- $ -- $ 1 $ 7,683 $ 17,972 $(12,706) $ (227) $ (225) Net income............... -- -- -- -- -- -- -- -- -- Dividends on Series A Preferred Stock........ -- -- -- -- -- -- -- -- -- Purchase of Class B Common Stock........... -- -- -- -- -- -- -- (21) -- Payment on stock subscriptions receivable for purchase of stock............... -- -- -- -- -- -- -- -- 13 Payments received on ESOP debt................... -- -- -- -- -- -- 9,119 -- -- Tax effect of dividends on unallocated shares held by ESOP................ -- -- -- -- -- -- -- -- -- Vesting of compensatory stock options.......... -- -- -- -- -- 1,146 -- -- -- Balance, June 30, 1995..... 22,075 -- -- 1 7,683 19,118 (3,587) (248) (212) --------- ------ ------- ------- ----------- ---------- -------- -------- ----- Net income............... -- -- -- -- -- -- -- -- -- Dividends on Series A Preferred Stock........ -- -- -- -- -- -- -- -- -- Sale of Class B Common Stock.................. -- -- -- -- -- 160 -- 149 (239) Payments on stock subscriptions receivable for purchase of stock............... -- -- -- -- -- -- -- -- 9 Payments received on ESOP debt................... -- -- -- -- -- -- 3,587 -- -- Vesting of compensatory stock options.......... -- -- -- -- -- 464 -- -- -- --------- ------ ------- ------- ----------- ---------- -------- -------- ----- Balance, June 30, 1996..... 22,075 -- -- 1 7,683 19,742 -- (99) (442) Net income............... -- -- -- -- -- -- -- -- -- Dividends on Series A Preferred Stock........ -- -- -- -- -- -- -- -- -- Dividends accrued on Series A Preferred Stock, but not payable................ -- -- -- -- -- 296 -- -- -- Series A Preferred Stock redemption............. (7,606) -- -- -- -- -- -- -- -- Series A Preferred Stock redemption premium..... 107 -- -- -- -- -- -- -- -- Conversion of Series A Preferred Stock........ (14,576) -- -- -- -- 14,576 -- -- -- Purchase of Class B Common Stock........... -- -- -- -- -- (2) -- (255) -- Payment on stock subscriptions receivable for purchase of stock............... -- -- -- -- -- -- -- -- 320 Exercise of warrants..... -- -- -- -- (7,683) 7,683 -- -- -- Exercise of stock options................ -- -- -- -- -- 419 -- -- -- Issuance of common stock in connection with IPO and employee stock purchase plan.......... -- 144 -- (1) -- 44,804 -- -- -- Vesting of compensatory stock options.......... -- -- -- -- -- 375 -- -- -- --------- ------ ------- ------- ----------- ---------- -------- -------- ----- Balance, June 30, 1997..... $ -- $144 $ -- $ -- $ -- $ 87,893 $ -- $ (354) $ (122) ======== ======= ====== ====== ========== ======== ======= ======= ======== ACCUMU- TOTAL LATED SHAREHOLDERS' DEFICIT INVESTMENT -------- ------------ Balance, June 30, 1994..... $(42,297) $ (7,724) Net income............... 1,513 1,513 Dividends on Series A Preferred Stock........ (2,249) (2,249) Purchase of Class B Common Stock........... -- (21) Payment on stock subscriptions receivable for purchase of stock............... -- 13 Payments received on ESOP debt................... -- 9,119 Tax effect of dividends on unallocated shares held by ESOP................ 58 58 Vesting of compensatory stock options.......... -- 1,146 Balance, June 30, 1995..... (42,975) 1,855 -------- ------------ Net income............... 5,920 5,920 Dividends on Series A Preferred Stock........ (2,249) (2,249) Sale of Class B Common Stock.................. -- 70 Payments on stock subscriptions receivable for purchase of stock............... -- 9 Payments received on ESOP debt................... -- 3,587 Vesting of compensatory stock options.......... -- 464 -------- ------------ Balance, June 30, 1996..... (39,304) 9,656 Net income............... 9,985 9,985 Dividends on Series A Preferred Stock........ (83) (83) Dividends accrued on Series A Preferred Stock, but not payable................ (296) -- Series A Preferred Stock redemption............. -- (7,606) Series A Preferred Stock redemption premium..... (107) -- Conversion of Series A Preferred Stock........ -- -- Purchase of Class B Common Stock........... -- (257) Payment on stock subscriptions receivable for purchase of stock............... -- 320 Exercise of warrants..... -- -- Exercise of stock options................ -- 419 Issuance of common stock in connection with IPO and employee stock purchase plan.......... -- 44,947 Vesting of compensatory stock options.......... -- 375 -------- ------------ Balance, June 30, 1997..... $(29,805) $ 57,756 ======== ===========
The accompanying notes to consolidated financial statements are an integral part of these statements. 38 39 EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. OWNERSHIP AND OPERATIONS: Education Management Corporation ("EDMC" or the "Company") is among the largest providers of proprietary postsecondary education in the United States based on student enrollments and revenues. Through its operating units, the Art Institutes ("The Art Institutes"), The New York Restaurant School ("NYRS"), The National Center for Paralegal Training ("NCPT"), and The National Center for Professional Development ("NCPD"), the Company offers associate's and bachelor's degree programs and non-degree programs in the areas of design, media arts, culinary arts, fashion and professional development. The Company has provided career-oriented education programs for 35 years. The Company's main operating unit, The Art Institutes, consists of 13 schools in 12 major metropolitan areas throughout the United States. Art Institute programs are designed to provide the knowledge and skills necessary for entry-level employment in various fields, including graphic design, multimedia, computer animation, video production, culinary arts, interior design, industrial design, photography, fashion marketing and fashion design. Those programs typically are completed in 18 to 27 months and culminate in an associate's degree. In addition, as of June 30, 1997, five Art Institutes offered bachelor's degree programs. As of June 30, 1997, the Company offers a culinary arts curriculum at six Art Institutes and NYRS, a culinary arts and restaurant management school located in New York City. The Company expects to open its seventh culinary arts program at an Art Institute in October 1997. NYRS offers an associate's degree program and certificate programs. The Company offers paralegal training at NCPT in Atlanta. NCPT's certificate programs generally are completed in four to nine months. NCPD maintains consulting relationships with colleges and universities to assist in the development, marketing and delivery of paralegal, legal nurse consultant and financial planner test preparation programs for recent college graduates and working adults. 2. INITIAL PUBLIC OFFERING AND SHAREHOLDER INVESTMENT: On November 5, 1996, the Company completed the initial public offering (the "Offering") of 5,073,600 shares of its Common Stock, $.01 par value (the "Common Stock"), including 1,701,391 shares sold by certain shareholders, at a price to the public of $15 per share. Since that date, the authorized capital stock of the Company has consisted of the Common Stock and Preferred Stock, $.01 par value (the "Preferred Stock"). From 1989 until immediately prior to the consummation of the Offering, the Company's outstanding capital stock consisted of Class A Common Stock, $.0001 par value ("Class A Stock"), Class B Common Stock, $.0001 par value ("Class B Stock"), and Series A 10.19% Convertible Preferred Stock, $.0001 par value (the "Series A Preferred Stock"). All the outstanding shares of Series A Preferred Stock were owned by the Education Management Corporation Employee Stock Ownership Plan and Trust (the "ESOP"). In addition, warrants to purchase shares of Class B Stock were outstanding. Immediately prior to the consummation of the Offering, the following occurred: (i) the warrants to purchase 5,956,079 shares of Class B Stock were exercised ($.0001 exercise price per share), (ii) the ESOP converted all the outstanding shares of Series A Preferred Stock into 2,249,954 shares of Class A Stock, (iii) the Company's Articles of Incorporation were amended and restated to authorize the Common Stock and Preferred Stock, and (iv) all outstanding shares of Class A Stock and Class B Stock (including the shares resulting from the exercise of the warrants and the conversion of the Series A Preferred Stock) were reclassified into shares of Common Stock on a one-for-two basis (also referred to as a one-for-two reverse stock split). For the purpose of presenting comparable financial information in this report for 1995, 1996 and 1997, the per share amounts, the number of shares of Class A Stock and Class B Stock, the conversion ratio for the Series A Preferred Stock and the exercise price for the warrants have been restated to reflect the one-for-two reverse stock split, except in this Note 2. 39 40 Prior to the closing of the Offering, holders of the Company's equity securities had the right, under certain circumstances, to require the Company to repurchase such securities. In addition, the Company had the right to redeem shares of Series A Preferred Stock and Class B Stock under certain circumstances. Coincident with the Offering, these rights expired and accordingly, the term "redeemable" that appeared as the caption in previous balance sheets has been removed. In the Offering, the Company received total net proceeds, after deduction of expenses and underwriting discounts payable by the Company, of approximately $45 million. On the date the Offering closed, $38.5 million of those proceeds were used to repay the outstanding indebtedness under the Company's amended and restated credit facility dated March 16, 1995 (the "Revolving Credit Agreement"). The remaining proceeds were used for general corporate purposes. At June 30, 1996 and 1997, the Company's authorized and outstanding preferred and common stock is presented below:
AUTHORIZED OUTSTANDING ---------- ----------- JUNE 30, 1996 Series A Preferred Stock........................... 1,000,000 220,750 Class A Stock.................................... 25,000,000 1,842,802 Class B Stock.................................... 17,000,000 5,103,717 JUNE 30, 1997 Preferred Stock.................................... 10,000,000 -- Common Stock....................................... 60,000,000 14,417,874
Pursuant to a Preferred Share Purchase Rights Plan (the "Rights Plan") approved by the Company's Board of Directors, which became effective upon the consummation of the Offering, one Preferred Share Purchase Right (a "Right") is associated with each outstanding share of Common Stock. Each Right entitles its holder to buy one one-hundredth of a share of Series A Junior Participating Preferred Stock, $.01 par value, at an exercise price of $50, subject to adjustment (the "Purchase Price"). The Rights Plan is not subject to shareholder approval. The Rights will become exercisable under certain circumstances following a public announcement by a person or group of persons (an "Acquiring Person") that they acquired or commenced a tender offer for 17.5% or more of the outstanding shares of Common Stock. If an Acquiring Person acquires 17.5% or more of the Common Stock, each Right will entitle its holder, except the Acquiring Person, to acquire upon exercise a number of shares of Common Stock having a market value of two times the Purchase Price. In the event that the Company is acquired in a merger or other business combination transaction or 50% or more of its consolidated assets or earning power are sold after a person or group of persons becomes an Acquiring Person, each Right will entitle its holder to purchase, at the Purchase Price, that number of shares of the acquiring company having a market value of two times the Purchase Price. The Rights will expire on the tenth anniversary of the closing of the Offering and are subject to redemption by the Company at $.01 per Right, subject to adjustment. Common Stock held in the treasury has from time to time been sold to key management under stock subscription agreements providing for annual payments based on incentive compensation received during the year and interest at the applicable federal rate. In any event, all principal must be repaid by the maturity of the agreements. The remaining maturity of all outstanding agreements is seven years. The unaudited pro forma income statement data in the following table gives effect to the Offering as if it had occurred on July 1, 1996. Proceeds from the Offering were utilized pro forma to retire outstanding indebtedness under the Revolving Credit Agreement and for general corporate purposes. The adjustment to interest expense represents the effect of the reduction of debt as if it had occurred on July 1, 1996. Pro forma taxes are applied at an effective tax rate of 42% of taxable income. This unaudited pro forma income statement data is not necessarily 40 41 indicative of what the Company's results of operations actually would have been had the above transactions in fact occurred on July 1, 1996.
YEAR ENDED JUNE 30, 1997 ------------------------------------- ACTUAL ADJUSTMENTS PRO FORMA ------- ----------- --------- (IN THOUSANDS, EXCEPT PER SHARE INFORMATION) Income before interest and taxes........ $18,819 $ -- $18,819 Interest expense, net................... 1,603 (931) 672 ------- ----------- --------- Income before income taxes.............. $17,216 $ 931 $18,147 Income taxes............................ 7,231 391 7,622 ------- ----------- --------- Net income.............................. $ 9,985 $ 540 $10,525 Net income available to common shareholders.......................... 10,039 ------- ----------- --------- Earnings per share --Primary............................. $ 0.70 --Fully diluted....................... $ 0.70 Weighted average number of common shares --Primary............................. 14,341 --Fully diluted....................... 14,793
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: BASIS OF CONSOLIDATION AND PRESENTATION The consolidated financial statements include the accounts of EDMC and its subsidiaries. All significant intercompany transactions and balances have been eliminated. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. CASH AND CASH EQUIVALENTS The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. These investments are stated at cost which, based upon the scheduled maturities, approximates market value. ACQUISITIONS Effective August 1, 1996, the Company acquired certain assets of NYRS for $9.5 million in cash. The Company acquired principally current assets net of specified current liabilities, property and equipment, student enrollment agreements, curriculum and trade names. The excess of the purchase price over the fair value of the assets acquired has been assigned to goodwill. This transaction was accounted for as a purchase. On January 30, 1997, the company acquired the assets of Lowthian College, located in Minneapolis, Minnesota for $200,000 in cash and approximately $200,000 of assumed liabilities. The Company acquired principally accounts receivable, equipment, and student enrollment agreements. The excess of the purchase price over the fair value of the assets acquired has been assigned to goodwill. The school was renamed The Art Institute of Minnesota. This transaction was accounted for as a purchase. GOVERNMENT REGULATIONS The Art Institutes and NYRS ("the participating schools"), participate in various federal student financial assistance programs ("Title IV Programs") under Title IV of the Higher Education Act of 1965, as amended (the 41 42 "HEA"). Approximately 63% of the Company's net revenues in 1997 was indirectly derived from funds distributed under these programs to students at the participating schools. The participating schools are required to comply with certain federal regulations established by the U.S. Department of Education. Among other things, they are required to classify as restricted certain Title IV Program loan proceeds in excess of charges currently applicable to students' accounts. Such funds are reported as restricted cash in the accompanying consolidated balance sheets. The participating schools are required to administer Title IV Program funds in accordance with the HEA and U.S. Department of Education regulations and must use due diligence in approving and disbursing funds and servicing loans. In the event a participating school does not comply with federal requirements or if student loan default rates are at a level considered excessive by the federal government, that school could lose its eligibility to participate in Title IV Programs or could be required to repay funds determined to have been improperly disbursed. Management believes that the participating schools are in substantial compliance with the federal requirements and that student loan default rates are not at a level considered to be excessive. EDMC makes contributions to Federal Perkins Loan Programs (the "Funds") at certain Art Institutes. Current contributions to the Funds are made 75% by the federal government and 25% by EDMC. EDMC carries its investments in the Funds at cost, net of an allowance for estimated future loan losses. LEASE ARRANGEMENTS The Company conducts a major part of its operations from leased facilities. In addition, the Company leases a portion of its furniture and equipment. In those cases in which the lease term approximates the useful life of the leased asset or the lease meets certain other prerequisites, the leasing arrangement is classified as a capitalized lease. The remaining lease arrangements are treated as operating leases. PROPERTY AND EQUIPMENT Property and equipment are stated at cost, net of accumulated depreciation. Expenditures for additions and betterments are capitalized, while those for maintenance, repairs and minor renewals are expensed as incurred. The Company uses the straight-line method of depreciation for financial reporting, while using different methods for tax purposes. Depreciation is based upon estimated useful lives. Leasehold improvements are amortized over the term of the leases, or over their estimated useful lives, whichever is shorter. SCHOOL START-UP EXPENSE In fiscal 1997 all costs associated with starting up a new school location were expensed as incurred. Principal components of start-up costs include compensation, legal, rent, relocation, marketing and admissions expenses. This represents a change in policy from fiscal 1996 when the Company had capitalized and amortized over one year, non-marketing and admissions expenses associated with the start-up of The Art Institute of Phoenix. This change did not have a material effect on the results of operations or the financial position of the Company. GOODWILL The excess of the investment in EDMC and other acquisitions over the fair market values assigned to the net assets acquired has been classified as goodwill and is being amortized over a period of 40 years. FINANCIAL INSTRUMENTS The fair values and carrying amounts of the Company's financial instruments, primarily accounts receivable and debt, are approximately equivalent. The debt instruments bear interest at floating rates which are based upon market rates or fixed rates which approximate market rates. All other financial instruments are classified as current and will be utilized within the next operating cycle. 42 43 EMPLOYEE STOCK OWNERSHIP PLAN The Company provides the ESOP for certain of its employees. In connection with establishing the ESOP, the borrowings under a senior term loan financing ("ESOP Term Loan") were loaned to the ESOP on the same terms. As this loan was repaid, shares were released from pledge and allocated to ESOP participants' accounts. ESOP expense primarily represents the difference between the cost of shares released to ESOP participants' accounts and the dividends used by the ESOP for principal and interest repayment on this loan. The dividends paid to the ESOP on the Series A Preferred Stock were used by the ESOP trustee to pay the Company for principal and interest due on the ESOP's loan from the Company. As of June 30, 1996, the ESOP Term Loan had been entirely repaid, as was the loan due from the ESOP to the Company. REVENUE RECOGNITION AND RECEIVABLES The Company's net revenues consist of tuition and fees, student housing charges and supply store and restaurant sales. In fiscal 1997, the Company derived 87.8% of its net revenues from tuition and fees paid by, or on behalf of, its students. Net revenues, as presented, are reduced for student refunds and scholarships. The Company recognizes tuition and housing revenues on a monthly pro rata basis over the term of instruction, typically an academic quarter. Fees are generally recognized as revenue at the start of the academic period to which they apply. Student supply store and restaurant sales are recognized as they occur. Refunds are calculated in accordance with federal, state and accrediting agency standards. Advance payments represent that portion of payments received but not earned and are reflected as a current liability in the accompanying consolidated balance sheets. The trade receivable balances are comprised of individually insignificant amounts due primarily from students throughout the United States. COSTS AND EXPENSES Educational services expense consists primarily of costs related to the delivery and administration of the Company's education programs. Major cost components are faculty compensation, administrative salaries, costs of educational materials, facility leases and school occupancy costs, computer systems costs, bad debt expense and depreciation and amortization of property and equipment. General and administrative expense consists of the expenses of marketing and student admissions, executive management, finance and accounting, legal, corporate development and other departments that do not provide direct services to the Company's students. All marketing and student admissions costs are expensed in the fiscal year incurred. Amortization of intangibles relates principally to the values assigned to student enrollment agreements and applications, accreditation, contracts with colleges and universities and goodwill, which arose principally from the application of purchase accounting to the establishment and financing of the ESOP and the related leveraged transaction in October 1989. This transaction was accounted for in accordance with FASB Emerging Issues Task Force Issue No. 88-16. In addition, it includes the amortization of values assigned to student enrollment agreements, curriculum and goodwill that resulted from the acquisition of NYRS in August 1996 and Lowthian College in January 1997. 43 44 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
YEAR ENDED JUNE 30, ---------------------------- 1995 1996 1997 ------ ------ ------ (IN THOUSANDS) Cash paid during the period for: Interest....................................... $5,130 $3,558 $2,264 Income taxes................................... 979 2,854 8,279 Noncash investing and financing activities: Expenditures for property and equipment in accounts payable............................ 931 163 552
RECLASSIFICATIONS Certain prior year balances have been reclassified to conform to the current year presentation. 4. EARNINGS PER SHARE: Earnings per share ("EPS") of common stock have been computed using the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares include stock warrants and options for both the primary and fully diluted computations calculated using the treasury stock method. For all periods presented, the weighted average number of common and common equivalent shares outstanding include options issued within one year of the Offering. The Series A Preferred Stock is assumed to be converted for fully diluted EPS. In 1995, the weighted average common and common equivalent shares does not include the assumed exercise of the stock options and warrants or the conversion of the Series A Preferred Stock as the effect would have been anti-dilutive. The net income available to common shareholders in 1995 and 1996 has been reduced by the dividends paid on Series A Preferred Stock in the computation of both primary and fully diluted EPS. In the event that the Series A Preferred Stock was converted into Class A Stock, the Company would no longer have paid dividends; however, ESOP expense in the accompanying consolidated statements of income would have increased proportionately. In February 1997, the Financial Accounting Standards Board issued Financial Accounting Standard #128 ("FAS #128"), addressing EPS. FAS #128 changes the methodology for calculating EPS and renames the two calculations, Basic (currently primary) and Diluted (currently fully diluted) Earnings per Share. The calculations differ by eliminating any common stock equivalents (such as stock options, warrants and convertible preferred stock) from Basic EPS and changes certain calculations when computing Diluted EPS. FAS #128 is effective for reporting periods ending after December 15, 1997; early adoption is prohibited, and when adopted in fiscal 1998 all prior periods must be restated. However, if FAS #128 were in effect, the new EPS calculations would be as follows:
YEAR ENDED JUNE 30, --------------------------- 1995 1996 1997 ----- ------ ------ BASIC: Income (loss) before extraordinary item........... $(.11) $ .66 $ .80 Net income (loss)................................. $(.11) $ .53 $ .80 DILUTED: Income (loss) before extraordinary item........... $(.11) $ .39 $ .72 Net income (loss)................................. $(.11) $ .31 $ .72 WEIGHTED AVERAGE SHARES OUTSTANDING (IN 000'S): Basic............................................. 6,890 6,913 11,939 Diluted........................................... 6,890 11,874 13,671 ----- ------ ------
44 45 5. PROPERTY AND EQUIPMENT: Property and equipment consist of the following as of June 30:
1996 1997 ------- ------- (IN THOUSANDS) Assets (asset lives) Land.................................................. $ 300 $ 300 Buildings and improvements (20 years)................. 1,841 1,841 Equipment and furniture (5 to 10 years)............... 47,615 61,204 Leasehold interests and improvements (4 to 20 years)............................................. 27,936 36,475 ------- ------- Total.............................................. 77,692 99,820 Less accumulated depreciation......................... 36,518 47,249 ------- ------- $41,174 $52,571 ======= =======
6. LONG-TERM DEBT: The Company and its subsidiaries were indebted under the following obligations as of June 30:
1996 1997 ------- ------- (IN THOUSANDS) Revolving Credit Agreement, secured by the stock of the Company's subsidiaries and all of the Company's assets (see below)........................................... $55,000 $27,000 Capitalized lease and equipment installment note obligations (see below)............................... 10,919 7,031 ------- ------- 65,919 34,031 Less current portion.................................... 3,890 3,637 ------- ------- $62,029 $30,394 ======= =======
The Revolving Credit Agreement, as amended, allows for maximum borrowings of $70,000,000, reduced annually by $5,000,000 beginning on October 13, 1997, through its expiration on October 13, 2000. The Revolving Credit Agreement requires, among other things, that the Company maintain a specified level of consolidated net worth and meet interest and leverage ratio requirements, and restricts capital expenditures, declaration or payment of dividends on or repurchases of Common Stock and the incurrence of additional indebtedness, as defined. As of June 30, 1997, the Company was in compliance with all covenants. The Revolving Credit Agreement interest rate is variable; interest can be charged at prime, Eurodollar or cost of funds (as defined) rates, at the option of the Company. As of June 30, 1997, the average interest rate under the Revolving Credit Agreement was 8.25%. The borrowings outstanding under the Revolving Credit Agreement as of June 30, 1997 were repaid by July 3, 1997. The Company had entered into interest rate swap agreements in order to provide interest rate protection on $15,000,000 of borrowings as required under the Revolving Credit Agreement. Under the swap agreements, the Company paid a fixed rate of interest and received a variable rate of interest based upon the three-month London Interbank Offered Rate. The net effect of the swaps was that the Company paid a fixed rate on $15,000,000 of revolving credit debt. On May 29, 1997, the Company terminated its swap agreements, which were scheduled to expire in November 1998. This termination resulted in the Company receiving approximately $95,000, the estimated fair value of the swaps at that date. This nonleveraged interest rate swap acquired to manage interest rate risk represents the only derivative financial instrument used by the Company. 45 46 Relevant information regarding borrowings under the Revolving Credit Agreement is reflected below:
YEAR ENDED JUNE 30, --------------------------------- 1995 1996 1997 ------- ------- ------- (IN THOUSANDS) Outstanding borrowings, end of period............... $30,000 $55,000 $27,000 Approximate average outstanding balance throughout the period........................................ 415 16,847 13,602 Approximate maximum outstanding balance during the period............................................ 40,000 55,000 55,000 Weighted average interest rate for the period....... 8.46% 7.33% 7.20%
The ESOP Term Loan was prepaid in its entirety on June 30, 1996 by paying $412,000 that was scheduled for payment in September, 1996. The $25,000,000 principal amount of the Company's 13.25% Subordinated Notes was prepaid in full in October 1995. The resulting prepayment penalty of $1,472,000 was classified as an extraordinary item, loss on early extinguishment of debt, in the accompanying consolidated statements of income, net of tax of $546,000. Capitalized leases and installment notes for equipment and furniture expire at various dates through June 2000. The following is a schedule of approximate future minimum payments under capitalized leases, together with the present value of the net minimum payments as of June 30, 1997:
FISCAL YEARS (IN THOUSANDS) ------------------------------------------------------- -------------- 1998................................................... $4,092 1999................................................... 2,820 2000................................................... 772 ------- Total minimum payments................................. 7,684 ------- Less amount representing interest...................... 653 Present value of net minimum payments.................. $7,031 ==========
Depreciation expense on assets financed through capitalized leases and installment notes was approximately $3,913,000, $3,182,000 and $3,705,000 for the years ended June 30, 1995, 1996 and 1997, respectively. 7. COMMITMENTS AND CONTINGENCIES: The Company and its subsidiaries lease certain classroom, dormitory and office space under operating leases which expire on various dates through the year 2014. The approximate minimum future commitments under noncancelable long-term operating leases as of June 30, 1997 are reflected below:
FISCAL YEARS (IN THOUSANDS) ------------------------------------------------------- -------------- 1998................................................... $ 16,899 1999................................................... 14,904 2000................................................... 11,682 2001................................................... 8,713 2002................................................... 6,799 Thereafter............................................. 44,308 -------------- $103,305 ==========
The Company has a management incentive compensation plan which provides for the awarding of cash bonuses to school management personnel using formalized guidelines based upon the operating results of each subsidiary and the Company. The Company is a defendant in certain legal proceedings arising out of the conduct of its businesses. In the opinion of management, based upon its investigation of these claims and discussion with legal counsel, the 46 47 ultimate outcome of such legal proceedings, individually and in the aggregate, will not have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company. 8. RELATED PARTY TRANSACTIONS: The Art Institute of Philadelphia, Inc., a wholly owned subsidiary of The Art Institutes International, Inc. ("AII"), which is a wholly owned subsidiary of EDMC, leases one of the buildings it occupies from a partnership in which the subsidiary serves as a 1% general partner and an executive officer/director and a director of EDMC are minority limited partners. The Art Institute of Fort Lauderdale, Inc., another wholly owned subsidiary of AII, leases part of its facility from a partnership in which an executive officer/director of EDMC is a minority limited partner. Total rental payments under these arrangements were $1,894,000 for each of the three years ended June 30, 1997. 9. EMPLOYEE BENEFIT PLANS: The Company has a defined contribution retirement plan which covers substantially all employees. Contributions to the plan are at the discretion of the Board of Directors. There are no unfunded past service costs related to the plan. Under the 401(k) retirement plan, the Company will match 50% of employee contributions up to 3% of compensation. The expense relating to these plans was approximately $504,000, $515,000 and $526,000 for the years ended June 30, 1995, 1996 and 1997, respectively. The Company has established an ESOP which enables eligible employees to acquire stock ownership in the Company. The Company has made annual contributions, in addition to dividends paid on the Series A Preferred Stock held by the ESOP, sufficient to service the interest and principal obligations on the ESOP's debt to the Company. Since the Company functioned as the lender to the ESOP, the contribution for the interest component of debt service is immediately returned to the Company. Such interest income and expense have been netted in the accompanying consolidated statements of income. As of June 30, 1996, the ESOP Term Loan was entirely repaid, as was the loan between the ESOP and the Company. Shares and cash forfeiture allocations are made to the accounts of eligible participating employees based upon each participant's compensation level relative to the total compensation of all eligible employees. Eligible employees vest their ESOP accounts based on a seven-year schedule which includes credit for past service. Distribution of shares from the ESOP are made following the retirement, disability or death of an employee. For employees who terminate for any other reason, their vested balance will be offered for distribution in accordance with the terms of ESOP. 10. OTHER ASSETS: Other assets consist of the following as of June 30:
1996 1997 ------ ------ (IN THOUSANDS) Investment in Federal Perkins Loan Program, net of allowance for estimated future loan losses of $575 and $602, respectively...................................... $2,343 $2,398 Cash value of life insurance, net of loans of $781 each year; face value of $5,321 and $6,362, respectively..... 1,542 1,785 Other..................................................... 1,952 2,198 ------ ------ $5,837 $6,381 ====== ======
47 48 11. ACCRUED LIABILITIES: Accrued liabilities consist of the following as of June 30:
1996 1997 ------ ------ (IN THOUSANDS) Payroll taxes and payroll related......................... $2,787 $4,599 Income and other taxes.................................... 1,223 1,003 Other..................................................... 3,345 4,176 ------ ------ $7,355 $9,778 ====== ======
12. INCOME TAXES: The provision for income taxes includes current and deferred taxes as reflected below:
YEAR ENDED JUNE 30, ---------------------------- 1995 1996 1997 ----- ------ ------- (IN THOUSANDS) Current taxes: Federal................................................ $ 577 $3,215 $ 7,594 State.................................................. 123 683 1,250 ----- ------ ------- Total current taxes................................. 700 3,898 8,844 ----- ------ ------- Deferred taxes........................................... (210) 137 (1,613) ----- ------ ------- Total provision..................................... $ 490 $4,035 $ 7,231 ===== ====== ======
The provisions for income taxes reflected in the accompanying consolidated statements of income vary from the amounts that would have been provided by applying the federal statutory income tax rate to earnings before income taxes as shown below:
YEAR ENDED JUNE 30, --------------------------- 1995 1996 1997 ----- ---- ---- Federal statutory income tax rate......................... 34.0% 34.0% 35.0% State and local income taxes, net of federal income tax benefit................................................. 6.0 6.0 5.1 Amortization of goodwill and other intangibles............ 8.1 1.5 .9 Deductible portion of dividends on Series A Preferred Stock................................................... (32.1) (6.0) -- Non-deductible expenses................................... 4.9 1.1 .8 All other, net............................................ 3.6 .5 .2 ----- ---- ---- Income tax provision................................. 24.5% 37.1% 42.0% ==== ==== ====
Net deferred income tax assets (liabilities) are composed of the following as of June 30:
1995 1996 1997 ------- ------- ------- (IN THOUSANDS) Deferred income tax-current............................ $ 181 $ 381 $ 1,509 Deferred income tax-long term.......................... (1,809) (2,146) (1,661) ------- ------- ------- Net deferred income tax liability...................... $(1,628) $(1,765) $ (152) ====== ====== ====== Consisting of: Financial reserves and other......................... $ 717 $ 921 $ (408) Reserve for doubtful accounts........................ 612 1,175 2,959 Assigned asset values in excess of tax basis......... (2,369) (2,126) (2,006) Depreciation......................................... (588) (1,735) (697) ------- ------- ------- Total net deferred income tax liability........... $(1,628) $(1,765) $ (152) ====== ====== ======
48 49 13. STOCK BASED COMPENSATION: In October 1996, the Company adopted the 1996 Stock Incentive Plan (the "1996 Plan") for directors, executive management and key personnel. The 1996 Plan provides for the issuance of stock-based incentive awards with respect to a maximum of 1,250,000 shares. During fiscal 1997, options covering a total of 609,500 shares were granted under the 1996 Plan. Options issued under this plan provide for time-based vesting over four years. The Company has two non-qualified management stock option plans under which options to purchase a maximum of 359,642 and 200,000 shares of Common Stock have been granted to management employees. In August 1996 all outstanding options under these non-qualified plans were vested. The option covering 21,500 shares granted during fiscal 1997 under one of these plans provides for time-based vesting over four years. Under the terms of these plans, the Board of Directors granted options to purchase shares at prices varying from $2.54 to $15.00 per share, representing the fair market value at the time of the grant. Compensation expense related to vesting of certain options of $1,146,000, $464,000 and $375,000 was recognized for the years ended June 30, 1995, 1996 and 1997, respectively. In addition to the above stock option plans, an agreement was entered into with an executive during fiscal 1996 granting options for the purchase of 75,000 shares of Class B Stock at $11.00 per share. The agreement provided for time-based vesting over four years. This executive discontinued employment during fiscal 1997 and forfeited options which had been granted with respect to 42,187 shares. The Company accounts for these plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". In fiscal 1997 the Company adopted an employee stock purchase plan. The plan allows eligible employees of the Company to purchase up to an aggregate of 750,000 shares of common stock at quarterly intervals through periodic payroll deduction. In 1997, 7,836 shares of Common Stock were issued under this plan. In addition, eligible employees were permitted to purchase 173,208 shares of Common Stock in the Offering. Had compensation expense for these plans been determined consistent with FASB Statement No. 123, (Accounting for Stock Based Compensation) the Company's net income and earnings per share would have been reduced to the following pro forma amounts:
1996 1997 ------ ------ (IN THOUSANDS) Net income (in 000's):.................... As reported $5,920 $9,985 Pro forma $5,721 $7,730 Primary EPS:.............................. As reported $ 0.36 $ 0.72 Pro forma $ 0.34 $ 0.55 Fully diluted EPS:........................ As reported $ 0.31 $ 0.72 Pro forma $ 0.29 $ 0.55
A summary of stock option activity follows: 49 50 SUMMARY OF STOCK OPTIONS
1995 1996 1997 --------------------- --------------------- --------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE --------- -------- --------- -------- --------- -------- Outstanding at beginning of year............................ 495,293 $ 3.88 538,145 $ 4.15 613,145 $ 4.97 Granted........................... 42,852 7.20 75,000 11.00 631,000 15.07 Exercised......................... -- -- 52,600 6.66 Forfeited......................... -- -- 95,187 13.23 --------- -------- --------- -------- --------- -------- Outstanding at end of year........ 538,145 $ 4.15 613,145 $ 4.98 1,096,358 $10.00 ======= ======= ======= ======= ======== ======= Exercisable at end of year........ 401,022 473,593 521,358 ======= ======= ======== Weighted average fair value of options granted (000's)*........ $ 309 $ 342 $ 3,852 ======= ======= ========
- --------- * The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted averages assumptions for grants in 1996 and 1997. Risk free interest rate.................................... 6.124% Expected dividend yield.................................... 0 Expected life of options................................... 6 years Expected volatility rate................................... 33.7%
14. UNUSUAL ITEM: The Company received a refund of state and local business and occupation taxes in 1995. In the years paid, these taxes had been recorded as educational services expenses. This credit of $1,107,000 is recorded as an offset to educational services expenses in the accompanying consolidated statements of income. 15. STOCK PRICES AND DIVIDENDS: The Company's Common Stock is traded on the Nasdaq National Market System under the symbol "EDMC." The prices set forth below reflect the high and low sales prices for the Common Stock for the periods indicated, as reported in the consolidated transaction reporting system of the Nasdaq National Market System.
1997 ----------------- THREE MONTHS ENDED HIGH LOW ---------------------------------------------------------- ------ ------ September 30.............................................. N/A N/A December 31............................................... $21.00 $15.50 March 31.................................................. 23.25 18.00 June 30................................................... 26.75 21.50
The Company has not declared or paid any cash dividends on its capital stock during the last three years other than on the shares of its Series A Preferred Stock. The payment of dividends by the Company is, and will continue to be, subject to certain restrictions under the terms of its Revolving Credit Agreement. ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 50 51 PART III ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders under the captions "Nominees as Directors for Terms Expiring at the 2000 Annual Meeting of Shareholders," "Directors Continuing in Office," "Executive Officers of the Company," and "Section 16(a) Beneficial Ownership Reporting Compliance," and is incorporated herein by reference. ITEM 11--EXECUTIVE COMPENSATION The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders under the captions "Compensation of Executive Officers and Directors," "Compensation Committee Interlocks and Insider Participants," "Employment Agreement," "Compensation Committee Report on Executive Compensation," and "Performance Graph," and is incorporated herein by reference. ITEM 12-- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders under the caption "Security Ownership," and is incorporated herein by reference. ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders under the caption "Certain Transactions," and is incorporated herein by reference. PART IV ITEM 14-- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K No reports on Form 8-K were filed for the three months ended June 30, 1997. 51 52 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. EDUCATION MANAGEMENT CORPORATION By: /s/ ROBERT B. KNUTSON ------------------------------------ Robert B. Knutson Chairman and Chief Executive Officer Date: September 11, 1997 PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE - ------------------------------------- ------------------------------ ------------------- /s/ ROBERT B. KNUTSON Chairman and September 11, 1997 - ------------------------------------- Chief Executive Officer Robert B. Knutson and Director /s/ MIRYAM L. DRUCKER Vice Chairman and Director September 11, 1997 - ------------------------------------- Miryam L. Drucker /s/ ROBERT T. MCDOWELL Senior Vice President, September 11, 1997 - ------------------------------------- Chief Financial Officer Robert T. McDowell and Treasurer /s/ JAMES J. BURKE, JR. Director September 11, 1997 - ------------------------------------- James J. Burke, Jr. /s/ ALBERT GREENSTONE Director September 11, 1997 - ------------------------------------- Albert Greenstone /s/ ROBERT H. ATWELL Director September 11, 1997 - ------------------------------------- Robert H. Atwell /s/ WILLIAM M. CAMPBELL, III Director September 29, 1997 - ------------------------------------- William M. Campbell, III /s/ JAMES S. PASMAN, JR. Director September 11, 1997 - ------------------------------------- James S. Pasman, Jr.
52 53 EXHIBIT INDEX
EXHIBIT NUMBER EXHIBIT SEQUENTIAL PAGE NUMBER - ------ ----------------------------------------------------- --------------------------- 3.01 Amended and Restated Articles of Incorporation 3.02 Articles of Amendment filed on February 4, 1997 3.03 Restated By-laws 4.01 Specimen Common Stock Certificate Incorporated herein by reference to Exhibit 4.01 to Amendment No. 3 filed on October 28, 1996 to the Registration Statement on Form S-1 (File No. 333-10385) filed on August 19, 1996 (the "Form S-1") 4.02 Rights Agreement, dated as of October 1, 1996, between Education Management Corporation and Mellon Bank, N.A. 10.01 Education Management Corporation Employee Stock Incorporated herein by Ownership Plan reference to Exhibit 10.01 to the Form S-1 10.02 First Amendment to Education Management Corporation Incorporated herein by Employee Stock Ownership Plan reference to Exhibit 10.02 to Amendment No. 1 filed on October 1, 1996 ("Amendment No. 1") to the Form S-1 10.03 Second Amendment to Amended and Restated Education Incorporated herein by Management Corporation Employee Stock Ownership Plan reference to Exhibit 10.03 to the Form S-1 10.04 Third Amendment to Amended and Restated Education Incorporated herein by Management Corporation Employee Stock Ownership Plan reference to Exhibit 10.04 to Amendment No. 1 10.05 Education Management Corporation Management Incentive Incorporated herein by Stock Option Plan, effective November 11, 1993 reference to Exhibit 10.05 to the Form S-1 10.06 EMC Holdings, Inc. Management Incentive Stock Option Incorporated herein by Plan, effective July 1, 1990 reference to Exhibit 10.06 to Amendment No. 1 10.07 Form of Management Incentive Stock Option Agreement, Incorporated herein by dated various dates, between EMC Holdings, Inc. and reference to Exhibit 10.07 various management employees to Amendment No. 1 10.08 Form of Amendment to Management Incentive Stock Incorporated herein by Option Agreement, dated January 19, 1995, among reference to Exhibit 10.08 Education Management Corporation and various to Amendment No. 1 management employees 10.09 Education Management Corporation Retirement Plan Incorporated herein by reference to Exhibit 10.09 to Amendment No. 1 10.10 Education Management Corporation Deferred Incorporated herein by Compensation Plan reference to Exhibit 10.11 to the Form S-1
54
EXHIBIT NUMBER EXHIBIT SEQUENTIAL PAGE NUMBER - ------ ----------------------------------------------------- --------------------------- 10.11 1996 Employee Stock Purchase Plan Incorporated herein by reference to Exhibit 10.12 to Amendment No. 1 10.12 Education Management Corporation 1996 Stock Incentive Incorporated herein by Plan reference to Exhibit 10.13 to Amendment No. 1 10.13 Second Amended and Restated Employment Agreement of Incorporated herein by Robert B. Knutson, dated August 15, 1996, between reference to Exhibit 10.15 Robert B. Knutson and Education Management to the Form S-1 Corporation 10.14 Employment Agreement, dated June 1, 1996, between Incorporated herein by Albert Greenstone and Education Management reference to Exhibit 10.16 Corporation to the Form S-1 10.15 Form of EMC-Art Institutes International, Inc. Incorporated herein by Director's and/or Officer's Indemnification Agreement reference to Exhibit 10.17 to the Form S-1 10.16 Agreement and Lease, dated September 1, 1978, between Incorporated herein by Stabile & Associates and Education Management reference to Exhibit 10.18 Corporation to Amendment No. 1 10.17 Amendment to Agreement and Lease, dated March 1, Incorporated herein by 1980, between Stabile & Associates and Education reference to Exhibit 10.19 Management Corporation to Amendment No. 1 10.18 Renewal Option Letter Agreement dated November 21, Incorporated herein by 1984, between Stabile & Associates and Education reference to Exhibit 10.20 Management Corporation to Amendment No. 1 10.19 Common Stock Registration Rights Agreement, dated as of August 15, 1996, among Education Management Corporation and Marine Midland Bank, Northwestern Mutual Life Insurance Company, National Union Fire Insurance Company of Pittsburgh, PA, Merrill Lynch Employees LBO Partnership No. I, L.P., Merrill Lynch IBK Positions, Inc., Merrill Lynch KECALP L.P. 1986, Merrill Lynch Offshore LBO Partnership No. IV, Merrill Lynch Capital Corporation, Merrill Lynch Capital Appreciation Partnership IV, L.P., Robert B. Knutson and certain other individuals 10.20 Amended and Restated Credit Agreement, dated March Incorporated herein by 16, 1995, among Education Management Corporation, reference to Exhibit 4.16 certain banks and PNC Bank, National Association to Amendment No. 1 10.21 First Amendment to Amended and Restated Credit Incorporated herein by Agreement, dated October 13, 1995, among Education reference to Exhibit 4.17 Management Corporation, certain banks and PNC Bank, to the Form S-1 National Association 10.22 Second Amendment to Amended and Restated Credit Incorporated herein by Agreement, dated July 31, 1996, among Education reference to Exhibit 4.18 Management Corporation, certain banks and PNC Bank, to Amendment No. 1 National Association
55
EXHIBIT NUMBER EXHIBIT SEQUENTIAL PAGE NUMBER - ------ ----------------------------------------------------- --------------------------- 10.23 Third Amendment to Amended and Restated Credit Agreement, dated March 14, 1997, among Education Management Corporation, certain banks and PNC Bank, National Association 10.24 Nonqualified Stock Option Agreement, dated May 2, Incorporated herein by 1996, between Education Management Corporation and reference to Exhibit 4.22 William M. Webster, IV to the Form S-1 10.25 Letter Agreement, dated August 9, 1996, between Incorporated herein by Education Management Corporation Employee Stock reference to Exhibit 4.23 Ownership Trust and Education Management Corporation to Amendment No. 1 10.26 Form of Common Stock Subscription and Repurchase Incorporated herein by Agreement, dated various dates, between Education reference to Exhibit 4.11 Management Corporation and various stock purchasers to Amendment No. 1 10.27 Form of Amendment No. 1 to Common Stock Subscription Incorporated herein by and Repurchase Agreement, dated January 1, 1996, reference to Exhibit 4.12 between Education Management Corporation and certain to Amendment No. 1 management stockholders 10.28 Form of Common Stock Subscription and Repurchase Incorporated herein by Agreement, dated various dates, between Education reference to Exhibit 4.13 Management Corporation and certain management to Amendment No. 1 stockholders (this looks like the same as 4.04, but it was repeated in the S-1) 10.29 Amendment No. 1 to Common Stock Subscription and Incorporated herein by Repurchase Agreement, dated January 19, 1995, between reference to Exhibit 4.14 Education Management Corporation and certain to Amendment No. 1 management stockholders 10.30 Amendment No. 2 to Common Stock Subscription and Incorporated herein by Repurchase Agreement, dated January 1, 1996, between reference to Exhibit 4.15 Education Management Corporation and certain to Amendment No. 1 management stockholders 11.01 Statement re: Calculation of Earnings Per Share 21.01 List of subsidiaries of Education Management Corporation 23.01 Consent of Arthur Andersen LLP 27.01 Financial Data Schedule
EX-3.01A 2 EDUCATIONAL MANAGEMENT CORP. 1 EXHIBIT 3.01 Microfilm Number _________ Filed with the Department of State on _________ Entity Number ____________ _____________________________________ Secretary of the Commonwealth ARTICLES OF AMENDMENT - DOMESTIC BUSINESS CORPORATION DSCB:15-1915 (Rev 90) In compliance with the requirements of 15 Pa.C.S. Section 1915 (relating to articles of amendment), the undersigned business corporation, desiring to amend its Articles, hereby states that: 1. The name of the corporation is: Education Management Corporation 2. The address of this corporation's current (a) registered office in this Commonwealth or (b) commercial registered office provider and the county of venue is (the Department is hereby authorized to correct the following address to conform to the records of the Department): (a) 300 Sixth Ave., Pittsburgh, PA 15222, Allegheny ---------------------------------------------------- Number and Street City State Zip County (b)___________________________________________________________________ Name of Commercial Registered Office Provider For a corporation represented by a commercial registered office provider, the county in (b) shall be deemed the county in which the corporation is located for venue and official publication purposes. 3. The statute by or under which it was incorporated is: Pennsylvania Business Corporation Law of 1988. 4. The date of its incorporation is: May 16, 1962. 5. (Check, and if appropriate complete, one of the following): _X_ The amendment shall be effective upon filing these Articles of Amendment in the Department of State. ___ The amendment shall be effective on: -1- 2 6. (Check one of the following): _X_ The amendment was adopted by the shareholders pursuant to 15 Pa.C.S. Section 1914(a) and (b). ___ The amendment was adopted by the board of directors pursuant to 15 Pa.C.S. Section 1914(c). 7. (Check and if appropriate complete, one of the following): ___ The amendment adopted by the corporation, set forth in full, is as follows: _X_ The amendment adopted by the corporation as set forth in full in Exhibit A, attached hereto and made a part hereof. 8. (Check if the amendment restates the articles) _X_ The restated articles of incorporation supersede the original articles and all amendments thereto. IN TESTIMONY WHEREOF, the undersigned corporation has caused these articles of amendment to be signed by a duly authorized officer thereof this 29th day of October, 1996. EDUCATION MANAGEMENT CORPORATION (Name of Corporation) /s/ William M. Webster, IV ---------------------------- (Signature) By: William M. Webster, IV Title: Executive Vice President -2- 3 AMENDED AND RESTATED ARTICLES OF INCORPORATION OF EDUCATION MANAGEMENT CORPORATION FIRST: The name of the Corporation is: EDUCATION MANAGEMENT CORPORATION. SECOND: The location and post office address of the registered office of the Corporation in this Commonwealth is 300 Sixth Avenue, Pittsburgh, PA 15222, Allegheny County. THIRD: The Corporation is incorporated under the Business Corporation Law of 1988. FOURTH: The term for which the Corporation is to exist is perpetual. FIFTH: A. Authorized Shares The aggregate number of shares which the Corporation shall have authority to issue is Seventy Million (70,000,000) shares, as follows: 1. Sixty Million (60,000,000) shares of Common Stock, with a par value of one cent ($.01) per share. Except for and subject to those rights as may be expressly granted to the holders of Preferred Stock pursuant to the authority vested by these Articles of Incorporation in the Board of Directors of the Corporation, or except as may be provided by the laws of the Commonwealth of Pennsylvania, the holders of Common Stock shall have exclusively all rights of shareholders. 2. Ten Million (10,000,000) shares of Preferred Stock, with a par value of one cent ($.01) per share. B. Authority is hereby expressly vested in the Board of Directors of the Corporation at any time and from time to time by resolution to divide into and issue the Preferred Stock in one or more classes or series, or both, and to determine for any such class or series its designation and the number of shares of the class or series and the voting rights, preferences, limitations and special rights, if any, of the shares of the class or series. -3- 4 SIXTH: The directors of the Corporation shall be divided into three classes: Class I, Class II and Class III. Each class shall consist, as nearly as may be possible, of one-third of the whole number of the Board of Directors. The initial Class I, II and III directors shall be those elected and designated to serve as such directors at the meeting of shareholders to held approve the Articles of Amendment dated as of October 24, 1996 (the "Shareholders Meeting"), such Class I directors shall hold office for a term to expire at the first annual meeting of the shareholders after the Shareholders Meeting; such Class II directors shall hold office for a term to expire at the second annual meeting of the shareholders after the Shareholders Meeting; and such Class III directors shall hold office for a term to expire at the third annual meeting of the shareholders after the Shareholders Meeting, and in the case of each class, until their respective successors are duly elected and qualified. At each annual election the directors elected to succeed those whose terms expire shall be identified as being of the same class as the directors they succeed and shall be elected to hold office for a term to expire at the third annual meeting of the shareholders after their election, and until their respective successors are duly elected and qualified. If the number of directors is changed, any increase or decrease in directors shall be apportioned among the classes so as to maintain all classes as equal in number as possible, and any additional director elected to any class shall hold office for a term which shall coincide with the terms of the other directors in such class and until his successor is duly elected and qualified. Subject to the rights of holders of any series of Preferred Stock then outstanding, in the case of any increase in the number of directors of the Corporation the additional director or directors shall be elected by the Board of Directors. No decrease in the number of directors of the Corporation shall shorten the term of any incumbent director. The entire Board of Directors, or any class of the Board of Directors, or any individual director may be removed from office by vote of the shareholders entitled to vote thereon only for cause. In case the Board of Directors or a class of the Board of Directors or any one or more directors are so removed, new directors may be elected at the same meeting. The repeal of a provision of these Articles or the Bylaws of the Corporation prohibiting, or the addition of a provision to these Articles or the Bylaws of the Corporation permitting, the removal by the shareholders of the Board of Directors, a class of the Board of Directors or a director without assigning any cause shall not apply to any incumbent director during the balance of the term for which he was elected. SEVENTH: The shareholders of the Corporation shall not have the right to cumulate their votes for the election of directors of the Corporation. EIGHTH: Subchapters E, F, G and H of Chapter 25 of the Business Corporation Law of 1988 shall not be applicable to the Corporation. -4- 5 NINTH: The Board of Directors is authorized to adopt, amend or repeal any term or provision of the Bylaws of the Corporation by a vote of a majority of its members, subject always to the power of the shareholders to adopt, amend or repeal the Bylaws of the Corporation by the affirmative vote of the holders of at least two-thirds of the outstanding shares of Common Stock of the Corporation. TENTH: In addition to the requirements of (i) law, and (ii) the other provisions of these Articles of Incorporation, as amended, the affirmative vote of the holders of at least two-thirds of the outstanding shares of Common Stock of the Corporation entitled to vote shall be required to delete, amend or supplement any term or provision of this Article Ten, Articles Four, Six, Seven, Eight or Nine, or Subparagraph B of Article Five hereof. ELEVENTH: Immediately effective upon the filing of the Articles of Amendment dated as of October 29, 1996 in the Department of State of the Commonwealth of Pennsylvania (the "Effective Time"), each share of Class A Common Stock, par value $.0001 per share, and of Class B Common Stock, par value $.0001 per share, outstanding immediately prior to the Effective Time, and each share of Class B Common Stock which immediately prior to the Effective Time is held by the Corporation as treasury stock, automatically and without any action on the part of the holder thereof shall be reclassified as and converted into one-half of a share of Common Stock, par value $.01 per share, subject to the treatment of fractional share interests as described below. Each holder of a certificate or certificates that immediately prior to the Effective Time represented outstanding shares of Class A and Class B Common Stock (the "Old Certificates") will be entitled to receive, upon surrender of such Old Certificates to the Corporation for cancellation, a certificate or certificates (the "New Certificate", whether one or more) representing the number of whole shares of the Common Stock into which and for which the shares of the Class A and Class B Common Stock formerly represented by such Old Certificates so surrendered are reclassified under the terms hereof. From and after the Effective Time, Old Certificates shall represent only the right to receive New Certificates (and, where applicable, cash in lieu of fractional shares, as provided below) pursuant to the provisions hereof. No certificates or scrip representing fractional share interests in Common Stock will be issued, and no such fractional share interest will entitle the holder thereof to vote, or to any rights of a shareholder of the Corporation. In lieu of any such fractional shares of Common Stock, each shareholder with a fractional share will be entitled to receive, upon surrender of Old Certificates to the Corporation for cancellation, an amount in cash equal to the fair market value thereof as determined in good faith by the Board of Directors to be the fair value of one share of Common Stock as of the Effective Time multiplied by such fraction. If more than one Old Certificate shall be surrendered at one time for the account of the same shareholder, the number of full shares of Common Stock for which New Certificates shall be issued shall be computed on the basis of the aggregate number of shares represented by the Old -5- 6 Certificates so surrendered. In the event that the Corporation determines that a holder of Old Certificates has not tendered all his certificates for exchange, the Corporation shall carry forward any fractional share until all certificates of that holder have been presented for exchange such that payment for fractional shares to any one person shall not exceed the value of four-fifths of one share of Common Stock. The Old Certificates surrendered for exchange shall be properly endorsed and otherwise in proper form for transfer, and the person or persons requesting such exchange shall affix any requisite stock transfer tax stamps to the Old Certificates surrendered, or provide funds for their purchase, or establish to the satisfaction of the Corporation that such taxes are not payable. From and after the Effective Time the amount of capital represented by the shares of the Common Stock into which and for which the shares of the Old Common Stock are reclassified under the terms hereof shall be an amount equal to the product of the number of issued and outstanding shares of Common Stock and the One Cent ($.01) par value of each such share. -6- EX-3.01B 3 EDUCATIONAL MANAGEMENT CORP. 1 EXHIBIT 3.02 Microfilm Number _________ Filed with the Department of State on __________ Entity Number ____________ ________________________________________________ Secretary of the Commonwealth ARTICLES OF AMENDMENT - DOMESTIC BUSINESS CORPORATION DSCB:15-1915 (Rev 90) In compliance with the requirements of 15 Pa.C.S. Section 1915 (relating to articles of amendment), the undersigned business corporation, desiring to amend its Articles, hereby states that: 1. The name of the corporation is: Education Management Corporation 2. The address of this corporation's current (a) registered office in this Commonwealth or (b) commercial registered office provider and the county of venue is (the Department is hereby authorized to correct the following address to conform to the records of the Department): (a) 300 6th Avenue Building Pittsburgh PA 15222 Allegheny --------------------------------------------------------------- Number and Street City State Zip County (b)_______________________________________________________________ Name of Commercial Registered Office Provider For a corporation represented by a commercial registered office provider, the county in (b) shall be deemed the county in which the corporation is located for venue and official publication purposes. 3. The statute by or under which it was incorporated is: Pennsylvania Business Corporation Law, Act of May 5, 1933, as amended. 4. The date of its incorporation is: 5/16/62 5. (Check, and if appropriate complete, one of the following): _X_ The amendment shall be effective upon filing these Articles of Amendment in the Department of State. ___ The amendment shall be effective on: 6. (Check one of the following): ___ The amendment was adopted by the shareholders pursuant to 15 Pa.C.S. Section 1914(a) and (b). 2 _X The amendment was adopted by the board of directors pursuant to 15 Pa.C.S. Section 1914(c). 7. (Check and if appropriate complete, one of the following): ___ The amendment adopted by the corporation, set forth in full, is as follows: _X_ The amendment adopted by the corporation as set forth in full in Exhibit A, attached hereto and made a part hereof. 8. (Check if the amendment restates the articles) ___ The restated articles of incorporation supersede the original articles and all amendments thereto. IN TESTIMONY WHEREOF, the undersigned corporation has caused these articles of amendment to be signed by a duly authorized officer thereof this 31st day of January, 1997. EDUCATION MANAGEMENT CORPORATION (Name of Corporation) By: /s/ William M. Webster, IV -------------------------- (Signature) Name: William M. Webster, IV Title: Executive Vice-President 3 Exhibit A CERTIFICATE OF DESIGNATIONS of SERIES A JUNIOR PARTICIPATING PREFERRED STOCK of EDUCATION MANAGEMENT CORPORATION (Pursuant to Section 1522 of the Pennsylvania Business Corporation Law of 1988) - - - - - - - - - - - - - - - - - - - - - - Education Management Corporation, a corporation organized and existing under the Business Corporation Law of the Commonwealth of Pennsylvania (hereinafter called the "Corporation"), hereby certifies that the following resolution was adopted by the Board of Directors of the Corporation as required by Section 1522 of the Pennsylvania Business Corporation Law of 1988 at a meeting duly called and held on August 15, 1996 RESOLVED, that pursuant to the authority granted to and vested in the Board of Directors of this Corporation (hereinafter called the "Board of Directors" or the "Board") in accordance with the provisions of the Restated Articles of Incorporation, the Board of Directors hereby creates a series of Preferred Stock, par value one cent ($0.01) per share, of the Corporation (the "Preferred Stock") and hereby states the designation and number of shares, and fixes the relative rights, preferences, and limitations thereof as follows: SERIES A JUNIOR PARTICIPATING PREFERRED STOCK Section 1. Designation and Amount. The shares of such series shall be designated as "Series A Junior Participating Preferred Stock" (the "Series A Preferred Stock") and the number of shares constituting the Series A Preferred Stock shall be 250,000. Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, that no decrease shall reduce the number of shares of Series A Preferred Stock to a number less than the number of shares then outstanding plus the number of shares reserved for issuance upon the exercise of outstanding options, rights or warrants or upon the conversion of any outstanding securities issued by the Corporation convertible into Series A Preferred Stock. Section 2. Dividends and Distributions. 4 (A) Subject to the rights of the holders of any shares of any series of Preferred Stock (or any similar stock) ranking prior and superior to the Series A Preferred Stock with respect to dividends, the holders of shares of Series A Preferred Stock, in preference to the holders of Common Stock, par value $.01 per share (the "Common Stock"), of the Corporation, and of any other junior stock, shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for the purpose, quarterly dividends payable in cash on the first day of March, June, September and December in each year (each such date being referred to herein as a "Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of Series A Preferred Stock, in an amount per share (rounded to the nearest cent) equal to the greater of (a) $1 or (b) subject to the provision for adjustment hereinafter set forth, 100 times the aggregate per share amount of all cash dividends, and 100 times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions, other than a dividend payable in shares of Common Stock or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock since the immediately preceding Quarterly Dividend Payment Date or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of Series A Preferred Stock. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the amount to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event under clause (b) of the preceding sentence shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (B) The Corporation shall declare a dividend or distribution on the Series A Preferred Stock as provided in paragraph (A) of this Section immediately after it declares a dividend or distribution on the Common Stock (other than a dividend payable in shares of Common Stock); provided that, in the event no dividend or distribution shall have been declared on the Common Stock during the period between any Quarterly Dividend Payment Date and the next subsequent Quarterly Dividend Payment Date, a dividend of $1 per share on the Series A Preferred Stock shall nevertheless be payable on such subsequent Quarterly Dividend Payment Date. (C) Dividends shall begin to accrue and be cumulative on outstanding shares of Series A Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such shares, unless the date of issue of such shares is prior to the record date for the first Quarterly Dividend Payment Date, in which case dividends on such shares shall begin to accrue from the date of issue of such shares, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares of Series A Preferred Stock entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date, in either of which events such dividends shall begin to accrue and be cumulative from such Quarterly Dividend Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends paid on the shares 5 of Series A Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of Series A Preferred Stock entitled to receive payment of a dividend or distribution declared thereon, which record date shall be not more than 60 days prior to the date fixed for the payment thereof. Section 3. Voting Rights. The holders of shares of Series A Preferred Stock shall have the following voting rights: (A) Subject to the provision for adjustment hereinafter set forth, each share of Series A Preferred Stock shall entitle the holder thereof to 100 votes on all matters submitted to a vote of the shareholders of the Corporation. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the number of votes per share to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event shall be adjusted by multiplying such number by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (B) Except as otherwise provided herein, in any other Certificate of Designations creating a series of Preferred Stock or any similar stock, or by law, the holders of shares of Series A Preferred Stock and the holders of shares of Common Stock and any other capital stock of the Corporation having general voting rights shall vote together as one class on all matters submitted to a vote of shareholders of the Corporation. (C) Except as set forth herein, or as otherwise provided by law, holders of Series A Preferred Stock shall have no special voting rights and their consent shall not be required (except to the extent they are entitled to vote with holders of Common Stock as set forth herein) for taking any corporate action. Section 4. Certain Restrictions. (A) Whenever quarterly dividends or other dividends or distributions payable on the Series A Preferred Stock as provided in Section 2 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series A Preferred Stock outstanding shall have been paid in full, the Corporation shall not: (i) declare or pay dividends, or make any other distributions, on any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock; 6 (ii) declare or pay dividends, or make any other distributions, on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except dividends paid ratably on the Series A Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; (iii) redeem or purchase or otherwise acquire for consideration shares of any stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock, provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such junior stock in exchange for shares of any stock of the Corporation ranking junior (either as to dividends or upon dissolution, liquidation or winding up) to the Series A Preferred Stock; or (iv) redeem or purchase or otherwise acquire for consideration any shares of Series A Preferred Stock, or any shares of stock ranking on a parity with the Series A Preferred Stock, except in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of such shares upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes. (B) The Corporation shall not permit any subsidiary of the Corporation to purchase or otherwise acquire for consideration any shares of stock of the Corporation unless the Corporation could, under paragraph (A) of this Section 4, purchase or otherwise acquire such shares at such time and in such manner. Section 5. Reacquired Shares. Any shares of Series A Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and cancelled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of Preferred Stock and may be reissued as part of a new series of Preferred Stock subject to the conditions and restrictions on issuance set forth herein, in the Certificate of Incorporation, or in any other Certificate of Designations creating a series of Preferred Stock or any similar stock or as otherwise required by law. Section 6. Liquidation, Dissolution or Winding Up. Upon any liquidation, dissolution or winding up of the Corporation, no distribution shall be made (1) to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock unless, prior thereto, the holders of shares of Series A Preferred Stock shall have received $100 per share, plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment, provided that the holders of shares of Series A Preferred Stock shall be entitled to receive an aggregate amount per share, subject to the provision for adjustment hereinafter set forth, equal to 100 times the aggregate amount to be distributed per share to holders of shares of Common Stock, or (2) to the holders of shares of stock ranking on a parity (either as to dividends or upon 7 liquidation, dissolution or winding up) with the Series A Preferred Stock, except distributions made ratably on the Series A Preferred Stock and all such parity stock in proportion to the total amounts to which the holders of all such shares are entitled upon such liquidation, dissolution or winding up. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the aggregate amount to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event under the proviso in clause (1) of the preceding sentence shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. Section 7. Consolidation, Merger, etc. In case the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or securities, cash and/or any other property, then in any such case each share of Series A Preferred Stock shall at the same time be similarly exchanged or changed into an amount per share, subject to the provision for adjustment hereinafter set forth, equal to 100 times the aggregate amount of stock, securities, cash and/or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the amount set forth in the preceding sentence with respect to the exchange or change of shares of Series A Preferred Stock shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. Section 8. No Redemption. The shares of Series A Preferred Stock shall not be redeemable. Section 9. Rank. The Series A Preferred Stock shall rank, with respect to the payment of dividends and the distribution of assets, junior to all series of any other class of the Corporation's Preferred Stock. Section 10. Amendment. The Certificate of Incorporation of the Corporation shall not be amended in any manner which would materially alter or change the powers, preferences or special rights of the Series A Preferred Stock so as to affect them adversely without the affirmative vote of the holders of at least two-thirds of the outstanding shares of Series A Preferred Stock, voting together as a single class. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 8 IN WITNESS WHEREOF, this Certificate of Designations is executed on behalf of the Corporation by its Executive Vice-President and attested by its Secretary this 31st day of January, 1997. Attest: EDUCATION MANAGEMENT CORPORATION /s/ Frederick W. Steinberg By: /s/ William M. Webster, IV - -------------------------- -------------------------------- Frederick W. Steinberg William M. Webster, IV Title: Executive Vice-President EX-3.02 4 EDUCATIONAL MANAGEMENT CORP. 1 EXHIBIT 3.03 RESTATED BYLAWS OF EDUCATION MANAGEMENT CORPORATION Adopted: August 15, 1996 - 1 - 2 RESTATED BY-LAWS OF EDUCATION MANAGEMENT CORPORATION TABLE OF CONTENTS PAGE ARTICLE I MEETING OF SHAREHOLDERS Section 1.1 Annual Meeting 1 Section 1.2 Special Meetings 1 Section 1.3 Place of Meetings 1 Section 1.4 Notice of Meetings 1 Section 1.5 Quorum; Adjournments 1 Section 1.6 Advance Notice of Shareholder Proposals 2 Section 1.7 Advance Notice of Shareholder Nominations 3 Section 1.8 Voting 4 Section 1.10 Informal Action 4 Section 1.11 Presence at Meetings 5 ARTICLE II DIRECTORS Section 2.1 Number, Qualifications, Election and Term of Office 5 Section 2.2 Vacancies 6 Section 2.3 Removal of Directors 6 Section 2.4 Annual Meeting; Other Regular Meetings 6 Section 2.5 Special Meetings 7 Section 2.6 Quorum 7 Section 2.7 Powers of Directors 7 Section 2.8 Informal Action 7 Section 2.9 Telephone Participation in Meetings 7 Section 2.10 Compensation of Directors 7 ARTICLE III COMMITTEES OF DIRECTORS Section 3.1 Appointment and Powers 8 Section 3.2 Appointment by Committees of Substitute Members 8 Section 3.3 Procedure 8 Section 3.4 Telephone Participation in Meetings 9 Section 3.5 Informal Action 9 - 2 - 3 ARTICLE IV OFFICERS PAGE Section 4.1 Enumeration 9 Section 4.2 Chairman 9 Section 4.3 Chief Executive Officer 9 Section 4.4 President 10 Section 4.5 Vice President 10 Section 4.6 Secretary 10 Section 4.7 Treasurer 10 Section 4.8 Other Officers 11 Section 4.9 Compensation 11 Section 4.10 Additional Duties of Officers 11 ARTICLE V STOCK Section 5.1 Issuance of Stock 11 Section 5.2 Certificate of Stock 11 Section 5.3 Transfer of Stock 12 Section 5.4 Lost, Stolen, Destroyed or Mutilated Certificates 12 Section 5.5 Regulations 12 Section 5.6 Holders of Record 12 Section 5.7 Record Date 12 Section 5.8 Restriction on Transfer Rights 13 ARTICLE VI LIABILITY OF DIRECTORS Section 6.1 Directors' Personal Liability 13 Section 6.2 Preservation of Rights 13 ARTICLE VII INDEMNIFICATION OF DIRECTORS AND OFFICERS Section 7.1 Mandatory Indemnification of Directors and Officers 14 Section 7.2 Mandatory Advancement of Expenses to Directors and Officers 15 Section 7.3 Permissive Indemnification and Advancement of Expenses 16 Section 7.4 Enforcement 16 Section 7.5 General 17 Section 7.6 Definition of Corporation 17 Section 7.7 Definition of Authorized Representative 17 - 3 - 4 PAGE Section 7.8 Savings Clause 18 Section 7.9 Insurance 18 Section 7.10 Funding to Meet Indemnification Obligations 18 ARTICLE VIII GENERAL PROVISIONS Section 8.1 Corporate Seal 18 Section 8.2 Fiscal Year 18 Section 8.3 Authorization 19 Section 8.4 Inapplicability of Subchapter 25E 19 Section 8.5 Inapplicability of Subchapter 25F 19 Section 8.6 Inapplicability of Subchapter 25G 19 Section 8.7 Inapplicability of Subchapter 25H 19 ARTICLE IX AMENDMENTS 19 - 4 - 5 RESTATED BYLAWS OF EDUCATION MANAGEMENT CORPORATION ARTICLE I MEETING OF SHAREHOLDERS Section 1.1 Annual Meeting. An annual meeting of the shareholders for the election of directors and the transaction of such other business as may properly come before the same shall be held on the ____ day of November of each year, at 10:00 a.m., prevailing time, or at such other date and time as shall be designated by the Board of Directors. If the day fixed for the meeting falls on a Saturday or Sunday, or is a legal holiday, the meeting shall be held at the same hour on the next succeeding full business day or as soon thereafter as practicable. Section 1.2 Special Meetings. Special meetings may be called only by the Chairman, the Chief Executive Officer, the President, or a majority of the directors in office. The only business to be transacted at a special meeting of shareholders shall be the business stated in the notice provided pursuant to Section 1.4 of these Bylaws. Section 1.3 Place of Meetings. Meetings of the shareholders shall be held at the registered office of the Corporation, or at such other place within or without the Commonwealth of Pennsylvania as shall be fixed by the Board of Directors or the person or persons calling the meeting. Section 1.4 Notice of Meetings. A written notice stating the place, day and hour of any meeting and, in the case of a special meeting, the purpose or purposes for which the meeting is called shall be given by, or at the direction of, the Secretary, to each shareholder of record entitled to vote at such meeting, at such address as appears upon the records of the Corporation, at least twenty (20) days before the day named for the meeting if written notice is given by bulk mail or five (5) days before the day named for the meeting if written notice is given by first class or express mail, postage prepaid, or by telegram, telex or TWX (with answerback received), unless a greater period of time is required by law in a particular case. Section 1.5 Quorum; Adjournments. The presence, in person or by proxy, of the majority of the outstanding shares entitled to vote shall constitute a quorum. The shareholders present at a duly authorized meeting can continue to do business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum. If a meeting cannot be organized because a quorum has not attended, those present may, except as otherwise provided by statute, adjourn the meeting to such time and place as they may determine, but in the - 5 - 6 case of any meeting called for the election of directors, those who attend the second of such adjourned meetings, although less than a quorum, shall nevertheless constitute a quorum for the purpose of electing the directors. When a meeting is adjourned, it shall not be necessary to give any notice of the adjourned meeting or of the business to be transacted at an adjourned meeting other than the announcement at the meeting at which such adjournment is taken. If after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each shareholder of record entitled to vote at the meeting. Section 1.6 Advance Notice of Shareholder Proposals. At any annual meeting of shareholders, only such business shall be conducted as shall have been brought before the meeting (i) by or at the direction of the Board of Directors or (ii) by any shareholder of the Corporation who complies with the notice procedure set forth in this Section 1.6. For business to be properly brought before any annual meeting of the shareholders by a shareholder, the shareholder must be entitled by Pennsylvania law to present such business and such shareholder must have given timely notice of such shareholder's intent to make such presentation. To be timely, a shareholder's notice must have been received by the Secretary of the Corporation not less than 60 nor more than 90 days in advance of the first anniversary of the previous year's annual meeting; provided, however, that in the event that the date of the annual meeting is changed by more than 30 days from such anniversary date, notice by the shareholder to be timely must have been received no later than the close of business on the 5th day following the day on which public announcement of the date of such meeting is first made. Each such notice shall set forth: (i) a brief description of each item of business desired to be brought before the meeting and the reasons for conducting such business at the meeting; (ii) the name and address, as they appear on the Corporation's books, of the shareholder proposing such business; (iii) a representation by the shareholder proposing such business that such shareholder will be a holder of record of shares of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting; (iv) the class and number of shares of the Corporation that are beneficially owned by the shareholder; and (v) as to each item of business the shareholder proposes to bring before the meeting, any material interest of the shareholder in such business. In addition, the shareholder making such proposal shall promptly provide any other information reasonably requested by the Corporation. Only such business shall be conducted at any annual meeting of shareholders as shall have been brought before such meeting in accordance with the requirements set forth in these Bylaws. Notwithstanding the foregoing provisions of this Section 1.6, a shareholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder with respect to the matters set forth in these Bylaws. Nothing in these Bylaws shall be deemed to affect any rights of any shareholder to request inclusion of a proposal in the Corporation's proxy statement pursuant to Rule 14a-8 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Except as otherwise required by law, the chairman of any annual meeting of shareholders shall have the power and duty (x) to determine whether any business proposed to be brought before the meeting was brought in accordance with the requirements set forth in these Bylaws and (y) if any proposed - 6 - 7 business was not brought in compliance with these Bylaws to declare that such defective proposal shall be disregarded. For purposes of Sections 1.6 and 1.7 of these Bylaws, "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Service, the Associated Press or any comparable national news service or in a document publicly filed by the Corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of the Exchange Act. Section 1.7 Advance Notice of Shareholder Nominations. Nominations for the election of directors may be made by the Board of Directors or by any shareholder entitled to vote generally in the election of directors; provided, however, that a shareholder may nominate a person for election as a director at a meeting only if timely notice of such shareholder's intent to make such nomination has been given to the Secretary of the Corporation. To be timely, a shareholder's notice must have been received by the Secretary of the Corporation (a) in the case of an annual meeting, not less than 60 nor more than 90 days in advance of the first anniversary of the previous year's annual meeting; provided, however, that in the event that the date of the annual meeting is changed by more than 30 days from such anniversary date, notice by the shareholder to be timely must have been received no later than the close of business on the fifth day following the date on which public announcement of the date of such meeting is first made; and (b) in the case of a special meeting at which directors are to be elected, not later than the close of business on the fifth day following such public announcement. Each such notice shall set forth: (i) the name and address, as they appear on the Corporation's books, of the shareholder who intends to make the nomination and the name(s) and address list of the person or persons to be nominated; (ii) a representation that the holder will be a holder of record of shares of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting and nominate the person or persons specified in the notice; (iii) the class and number of shares of the Corporation that are beneficially owned by the shareholder; (iv) a description of all arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder; (v) such other information regarding each nominee proposed by such shareholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission had the nominee been nominated, or intended to be nominated, by the Board of Directors; and (vi) the consent of each nominee to serve as a director of the Corporation, if so elected. In addition, the shareholder making such nomination shall promptly provide any other information reasonably requested by the Corporation. Notwithstanding anything in these Bylaws to the contrary, no person shall be eligible for election as a director of the Corporation unless nominated in accordance with the procedures set forth in this Section 1.7. Notwithstanding the foregoing provisions of these Bylaws, a shareholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder with respect to the matters set forth in these Bylaws. - 7 - 8 Except as otherwise required by law, the chairman of any meeting of shareholders shall have the power and duty (x) to determine whether a nomination was made in accordance with the requirements set forth in these Bylaws and (y) if any proposed nomination was not made in compliance with these Bylaws, to declare that such defective nomination shall be disregarded. Section 1.8 Voting. Except as otherwise provided by law or the Articles of Incorporation, every shareholder of record shall have the right at every shareholders' meeting to one (1) vote for every share standing in his or her name on the books of the Corporation. A majority of the votes cast shall decide every question or matter submitted to the shareholders unless otherwise provided by law or the Articles of Incorporation. The vote upon any matter submitted to the shareholders may be taken viva voce; provided, however, that the vote upon any question shall be by ballot if demand for the same is made by any shareholder or is directed by the chairman of the meeting. Section 1.9 Informal Action. Whenever the vote of the shareholders at a meeting thereof is required or permitted to be taken in connection with any corporate action by any provision of law or of the Articles of Incorporation, the meeting, notice and vote of shareholders may be dispensed with, if a consent in writing, setting forth the action so taken, shall be signed by the holders of all the outstanding shares, prior or subsequent to such corporate action, and filed with the Secretary of the Corporation. Section 1.10 Presence at Meetings. A shareholder may participate in a meeting of the shareholders only if the shareholder or the shareholder's duly authorized proxy is physically present in person at the meeting. A shareholder or a proxy may not participate in a meeting of the shareholders by means of conference telephone or similar communications equipment. ARTICLE II DIRECTORS Section 2.1 Number, Qualifications, Election and Term of Office. The number of directors to manage and control the affairs of the Corporation shall be as determined by the Board of Directors from time to time, but shall not be less than three (3). Directors need not be shareholders of the Corporation or residents of the Commonwealth of Pennsylvania. Directors shall be elected by the shareholders at the annual meeting or any special meeting called for such purpose. Each director shall be elected to serve until the next annual meeting of the shareholders and until his or her successor is duly elected and qualified. The directors of the Corporation shall be divided into three classes: Class I, Class II and Class III. Each class shall consist, as nearly as may be possible, of one-third of the whole number of the Board of Directors. The initial Class I, II and III directors shall be those elected - 8 - 9 and designated to serve as such directors at the meeting of shareholders held to approve the Articles of Amendment dated as of October 24, 1996 (the "Shareholders Meeting"), such Class I directors shall hold office for a term to expire at the first annual meeting of the shareholders after the Shareholders Meeting; such Class II directors shall hold office for a term to expire at the second annual meeting of the shareholders after the Shareholders Meeting; and such Class III directors shall hold office for a term to expire at the third annual meeting of the shareholders after the Shareholders Meeting, and in the case of each class, until their respective successors are duly elected and qualified. At each annual election the directors elected to succeed those whose terms expire shall be identified as being of the same class as the directors they succeed and shall be elected to hold office for a term to expire at the third annual meeting of the shareholders after their election, and until their respective successors are duly elected and qualified. If the number of directors is changed, any increase or decrease in directors shall be apportioned among the classes so as to maintain all classes as equal in number as possible, and any additional director elected to any class shall hold office for a term which shall coincide with the terms of the other directors in such class and until his or her successor is duly elected and qualified. Subject to the rights of holders of any series of Preferred Stock then outstanding, in the case of any increase in the number of directors of the Corporation the additional director or directors shall be elected by the Board of Directors. No decrease in the number of directors of the Corporation shall shorten the term of any incumbent director. Section 2.2 Vacancies. Vacancies in the Board of Directors caused by death, resignation, increase in the number of directors or otherwise shall be filled by a majority vote of the remaining member or members of the Board; and each director so elected shall hold office until the next selection of the class for which such director has been chosen and until his or her successor is duly elected and qualified. Section 2.3 Removal of Directors. The entire Board of Directors, or any class of the Board, or any individual director may be removed from office by vote of the shareholders entitled to vote thereon only for cause. In case the Board or a class of the Board or any one or more directors are so removed, new directors may be elected at the same meeting. The repeal of a provision of the Articles of Incorporation or these Bylaws prohibiting, or the addition of a provision to the Articles of Incorporation or these Bylaws permitting, the removal by the shareholders of the Board, a class of the Board or a director without assigning any cause shall not apply to any incumbent director during the balance of the term for which he was elected. Section 2.4 Annual Meeting; Other Regular Meetings. An annual meeting of the Board of Directors shall be held each year as soon as practicable after the annual meeting of shareholders, at the place where such meeting of shareholders was held or at such other place as the Board of Directors may determine, for the purposes of organization, election or appointment of officers and the transaction of such other business as shall come before the annual meeting. No - 9 - 10 notice of the annual meeting need be given. Other regular meetings of the Board of Directors shall be held at such times and places as the Board of Directors may from time to time by resolution appoint; and no notice shall be required to be given of any such regular meeting. No minimum number of regular meetings and no more than one annual meeting of the Board of Directors need be called in any year. Section 2.5 Special Meetings. Special meetings of the Board of Directors may be called by the Chairman, the Chief Executive Officer, the President or a majority of the directors in office, to be held at such time (as will permit the giving of notice as provided in this Section) and at such place in the Commonwealth of Pennsylvania or elsewhere as may be designated by the person or persons calling the meeting. Notice of the place, day and hour of such special meeting shall be given to each director by the Secretary (i) by written notice deposited in the United States mail not later than during the third full business day immediately preceding the day for such meeting, or (ii) by telephone, telex, facsimile transmission or other oral, written or electronic means received not later than 24 hours before the meeting. The notice need not refer to the business to be transacted at the meeting except action under Article VII of the Bylaws. No minimum number of special meetings of the Board of Directors need be called in any year. Section 2.6 Quorum. A majority of the directors in office shall constitute a quorum for the transaction of business, and actions may be taken by a majority of the members present at any meeting at which a quorum is present. Section 2.7 Powers of Directors. Except as otherwise provided by statute or the Articles of Incorporation, all powers vested by law in the Corporation shall be exercised by or under the authority of, and the business and affairs of the Corporation shall be managed under the direction of, the Board of Directors. Section 2.8 Informal Action. Any action which may be taken at a meeting of the directors may be taken without a meeting, if a consent or consents in writing setting forth the action so taken shall be signed by all of the directors in office and filed with the Secretary of the Corporation. Section 2.9 Telephone Participation in Meetings. Any one or more directors may participate in a meeting of the Board of Directors by means of a conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other. Section 2.10 Compensation of Directors. Each director of the Corporation who is not a salaried officer or employee of the Corporation or of a subsidiary of the Corporation, shall receive such compensation (whether in cash or otherwise) and reimbursement of expenses for serving as a director and for attendance at meetings of the Board of Directors or any committee appointed by the Board of Directors as the Board of Directors may from time to time determine. - 10 - 11 ARTICLE III COMMITTEES OF DIRECTORS Section 3.1 Appointment and Powers. The Board of Directors may, by resolution adopted by a majority of the directors in office, establish one or more committees, each of which shall consist of one or more of the directors of the Corporation. To the extent provided in the resolution establishing any committee, such committee shall have and may exercise all of the powers and authority of the Board of Directors; provided, however, that no such committee shall have any power or authority as to the following: (i) the submission to the shareholders of the Corporation of any action requiring approval of the shareholders under the Pennsylvania Business Corporation Law of 1988, as amended; (ii) the creation or filling of vacancies in the Board of Directors; (iii) the adoption, amendment or repeal of the By-laws; (iv) the amendment or repeal of any resolution of the Board that by its terms is amendable or repealable only by the Board; or (v) action on matters committed by the By-laws or resolution of the Board of Directors to another committee of the Board. Section 3.2 Appointment by Committees of Substitute Members. In the absence or disqualification of any member of any such committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may by unanimous action appoint another director to act at the meeting in the place of any such absent or disqualify member. Section 3.3 Procedure. The Board of Directors may establish reasonable rules and regulations for the conduct of the proceedings of any such committee and may appoint a chairman of the committee who shall be a member thereof and a secretary of the committee who need not be a member thereof. To the extent that the Board of Directors shall not exercise such powers, they may be exercised by the Committee. Section 3.4 Telephone Participation in Meetings. Any one or more committee members may participate in a meeting of a committee of the Board of Directors by means of a - 11 - 12 conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other. Section 3.5 Informal Action. Any action which may be taken at a meeting of any such committee may be taken without a meeting, if a consent or consents in writing setting forth the action so taken shall be signed by all the members of any such committee and filed with the Secretary of the Corporation. ARTICLE IV OFFICERS Section 4.1 Enumeration. The officers of the Corporation shall be elected by the Board of Directors and shall consist of a Chairman, a Chief Executive Officer, a President, one or more Vice-Presidents, a Secretary, a Chief Financial Officer, a Treasurer and, in the discretion of the Board of Directors, such other officers as shall from time to time be chosen and appointed by the Board of Directors. Any two (2) or more offices may be held by one (1) person. Every officer of the Corporation shall hold his or her position at the will of the Board of Directors. Section 4.2 Chairman. The Chairman shall preside at meetings of the Board of Directors and meetings of the shareholders, and he shall perform such other duties and exercise such other powers as the Board of Directors may from time to time prescribe. Section 4.3. Chief Executive Officer. The Chief Executive Officer shall have general charge and control over the affairs of the Corporation, subject to the Board of Directors. The Chief Executive Officer shall sign certificates for shares of capital stock of the Corporation and may, together with the Secretary, execute on behalf of the Corporation any contract which has been authorized by the Board of Directors. In the absence of the Chairman, the Chief Executive Officer shall preside at meetings of the shareholders. In the absence of the President or if the Board of Directors has not appointed a person holding the title of "President," the Chief Executive Officer shall also perform the duties and exercise the powers of president within the meaning of the Business Corporation Law of 1988. Section 4.4 President. In the absence of the Chief Executive Officer or if the Board of Directors has not appointed a person holding the title of "Chief Executive Officer," the President shall perform the duties and exercise the powers of chief executive officer, and shall report to the Board of Directors. The President shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe. - 12 - 13 Section 4.5 Vice President. The Vice President, or, if there shall be more than one, the Vice Presidents, in the order determined by the Board of Directors, shall, in the absence or disability of the President, perform the duties and exercise the powers of the President and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe. Section 4.6 Secretary. The Secretary shall keep a record of the minutes of the proceedings of meetings of shareholders and directors and shall give notice as required by statute or these Bylaws of all such meetings. The Secretary shall have custody of the seal of the Corporation and of all the books, records and papers of the Corporation, except such as shall be in the charge of the Treasurer or of some other person authorized to have custody and be in possession thereof by resolution of the Board of Directors. The Secretary shall sign certificates for shares of the capital stock of the Corporation. The Secretary may, together with the Chief Executive Officer, execute on behalf of the Corporation any contract which has been authorized by the Board of Directors. Section 4.7 Treasurer. The Treasurer shall keep accounts of all moneys of the Corporation received and disbursed, and shall deposit all moneys and valuables of this Corporation in its name and to its credit in such banks and depositories as the Board of Directors shall designate. In the absence of the Treasurer or if the Board of Directors has not appointed a person holding the title of "Treasurer," the chief financial officer of the Corporation shall perform the duties and exercise the powers of treasurer within the meaning of the Business Corporation Law of 1988. The Treasurer shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe. Section 4.8 Other Officers. The duties and powers of other officers who may from time to time be chosen by the Board of Directors shall be as specified by the Board of Directors at the time of the appointment of such other officers. Section 4.9 Compensation. The salaries and other compensation (whether cash or otherwise) of all officers listed in Sections 4.2 through 4.8 of this Article shall be fixed by, or pursuant to authority delegated by, the Board of Directors. Section 4.10 Additional Duties of Officers. The Board of Directors may from time to time by resolution increase or decrease the duties and powers of the Chairman, the Chief Executive Officer, the President, one or more Vice-Presidents, the Secretary, the Chief Financial Officer, the Treasurer, or any other officer. ARTICLE V STOCK - 13 - 14 Section 5.1 Issuance of Stock. Shares of capital stock of any class now or hereafter authorized, securities convertible into such shares or options or other rights to purchase such shares or securities may be issued or granted only in accordance with the authority granted by the Board of Directors. Section 5.2 Certificate of Stock. Certificates for shares of the capital stock of the Corporation shall be in the form adopted by the Board of Directors, shall be signed by the Chief Executive Officer or the President and the Secretary or an Assistant Secretary, and shall be sealed with the seal of the Corporation. Where any such certificate is signed by a registrar other than the Corporation or its employee, the signatures thereon of any officer of the Corporation and, where authorized by the Board of Directors, any transfer agent, may be facsimiles. All such certificates shall be numbered consecutively; and the name of the person owning the shares and the date of issue shall be stated on each certificate and entered on the books of the Corporation. In case any officer, transfer agent or registrar who has executed, by facsimile or otherwise, any share certificate shall have ceased to be such officer, transfer agent or registrar by reason of death, resignation or otherwise, before the certificate is issued, it may be issued by the Corporation with the same effect as if the officer, transfer agent or registrar had not ceased to be such at the date of its issue. Section 5.3 Transfer of Stock. Shares of capital stock of the Corporation shall be transferred only on the books of the Corporation by the holder thereof in person or by his or her duly authorized attorney. All stock certificates transferred by endorsement thereon shall be surrendered for cancellation and new certificates issued to the transferee. Section 5.4 Lost, Stolen, Destroyed or Mutilated Certificates. New certificates of stock may be issued to replace certificates of stock lost, stolen, destroyed or mutilated, upon such terms and conditions, including proof of loss or destruction, and, if appropriate, the giving of a satisfactory bond of indemnity, as the Board of Directors or as one or more of the officers of the Corporation, as delegated to by the Board of Directors, may determine from time to time. Section 5.5 Regulations. The Board of Directors shall have power and authority to make all such rules and regulations not inconsistent with these Bylaws as it may deem expedient concerning the issue, transfer and registration of certificates of stock of the Corporation. The Board of Directors may appoint one or more transfer agents or assistant transfer agents and one or more registrars of transfers, and may require all stock certificates to bear the signature of a transfer agent or assistant transfer agent and a registrar of transfers. The Board of Directors may at any time terminate the appointment of any transfer agent or any assistant transfer agent or any registrar of transfers. Section 5.6 Holders of Record. The Corporation shall be entitled to treat the holder of record of any stock of the Corporation as the holder and owner in fact thereof for all purposes and shall not be bound to recognize any equitable or other claim to, or right, title or - 14 - 15 interest in, such stock on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by law. Section 5.7 Record Date. The Board of Directors may fix a time prior to the date of any meeting of shareholders as a record date for the determination of the shareholders entitled to notice of, or to vote at, the meeting, which time, except in the case of an adjourned meeting, shall be not more than 90 days prior to the date of the meeting of shareholders. Only shareholders of record on the date fixed shall be so entitled notwithstanding any transfer of shares on the books of the Company after any record date fixed as provided herein. The Board of Directors may similarly fix a record date for the determination of shareholders of record for any other purpose. When a determination of shareholders of record has been made as provided herein for purposes of a meeting, the determination shall apply to any adjournment thereof unless the Board fixes a new record date for the adjourned meeting. If a record date is not fixed by the Board of Directors: (i) the record date for determining shareholders entitled to notice of or to vote at a meeting of the shareholders shall be at the close of business on the day next preceding the day on which notice is given or, if notice is waived, at the close of business on the day immediately preceding the day on which the meeting is held; and (ii) the record date for determining shareholders entitled to express consent or dissent to corporate action in writing without a meeting, when prior action by the Board of Directors is not necessary, shall be the close of business on the day on which the first written consent or dissent is filed with the Secretary of the Corporation. Section 5.8 Restriction on Transfer Rights. Rights issued pursuant to the Rights Agreement, dated October 1, 1996, between the Corporation and the [Rights Agent], as the same may be amended from time to time (the "Rights Agreement") may be transferred by an Acquiring Person or an Associate or Affiliate of any such Person (as such terms are defined in the Rights Agreement) only in accordance with the terms of, and subject to the restrictions contained in, the Rights Agreement. ARTICLE VI LIABILITY OF DIRECTORS Section 6.1 Directors' Personal Liability. A director of the Corporation shall not be personally liable for monetary damages for any action taken, or any failure to take any action; provided, however, that this provision shall not eliminate or limit the liability of a director to the extent that such elimination or limitation of liability is expressly prohibited by the Business Corporation Law of 1988 or any successor statute as in effect at the time of the alleged action or failure to take action by such director. Section 6.2 Preservation of Rights. Any repeal or modification of this Article shall not adversely affect any right or protection existing at the time of such repeal or - 15 - 16 modification to which any director or former director may be entitled under this Article. The rights conferred by this Article shall continue as to any person who has ceased to be a director of the Corporation and shall inure to the benefit of the heirs, executors and administrators of such person. ARTICLE VII INDEMNIFICATION OF DIRECTORS AND OFFICERS Section 7.1 Mandatory Indemnification of Directors and Officers. (A) The Corporation shall promptly indemnify, to the fullest extent now or hereafter permitted by law and by Section 7.1(B) hereof, each director or officer (including each former director or officer) (an "indemnitee") of the Corporation who was or is made a party to or a witness in or is threatened to be made a party to or a witness in, any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative and whether external or internal to the Corporation (a "proceeding"), by reason of the fact that the indemnitee is or was an authorized representative of the Corporation, against all expenses (including attorneys' fees, disbursements and other charges), judgments, fines (including excise taxes and penalties) and amounts paid in settlement actually and reasonably incurred by the indemnitee in connection with such proceeding. (B) Indemnification pursuant to this Section 7.1 shall include but shall not be limited to cases in which indemnification is permitted pursuant to the provisions of Chapter 17, Subchapter D, of the Business Corporation Law of 1988. Indemnification pursuant to this Section 7.1 shall be made in every case described in Section 7.1(A) hereof except: (i) in connection with a proceeding (or any claim, issue or matter therein or any part thereof) initiated by the indemnitee, unless such initiation was authorized by the Board of Directors of the Corporation; or (ii) with respect to any act that is established, by a final, unappealable adjudication adverse to the indemnitee, as having been material to the cause of action so adjudicated and as having constituted either willful misconduct or recklessness; or (iii) with respect to any benefit or advantage gained by the indemnitee to which the indemnitee was not legally entitled; or (iv) in connection with a proceeding by or for the benefit of the Corporation to recover any profit pursuant to the provisions of section 16(b) of the Securities Exchange - 16 - 17 Act of 1934 and regulations thereunder or similar provisions of any applicable state law; or (v) to the extent that the indemnitee actually receives payment under any policy of insurance or is otherwise reimbursed. (C) Notwithstanding the foregoing provisions of this Section 7.1, to the extent that an indemnitee is successful on the merits or otherwise in defense of any proceeding or any part thereof or in defense of any claim, issue or matter therein, including but not limited to obtaining a dismissal without prejudice or a settlement without admission of liability, the indemnitee shall be promptly indemnified by the Corporation against expenses (including attorneys' fees, disbursements and other charges) actually and reasonably incurred by the indemnitee in connection therewith. (D) The right of indemnification pursuant to this Section 7.1 is conferred in order to attract and retain the services of highly qualified directors and officers and to encourage them to make corporate decisions without fear of strike suits and legal harassment. Indemnification pursuant to this Section 7.1 is therefore declared to be consistent with the fiduciary duty of the Corporation's Board of Directors. Except as specifically provided in this Section 7.1, such indemnification shall be made by the Corporation without any requirement that any determination be made or any action be taken by the Board of Directors, shareholders, or legal counsel. A failure of the Board of Directors, shareholders, or legal counsel to make a determination or take action favorable to the claim of an indemnitee for indemnification pursuant to this Section 7.1, or the making of a determination or taking of action adverse to such a claim, shall not preclude indemnification under this Article or create any presumption that the indemnitee is not entitled to such indemnification. Section 7.2 Mandatory Advancement of Expenses to Directors and Officers. The Corporation shall promptly pay all expenses (including attorneys' fees, disbursements and other charges) actually and reasonably incurred by an indemnitee in defending or appearing in any proceeding described in Section 7.1(A) hereof in advance of the final disposition of such proceeding upon receipt of (i) an undertaking by or on behalf of the indemnitee to repay all amounts advanced if it is ultimately specifically determined by a final, unappealable adjudication that the indemnitee is not entitled to be indemnified by the Corporation and (ii) an irrevocable assignment to the Corporation of all payments to which the indemnitee may be or become entitled, under any policy of insurance or otherwise, in reimbursement of any such expenses paid by the Corporation pursuant to this Section 7.2. Notwithstanding the foregoing, no advance payment shall be made by the Corporation pursuant to this Section 7.2 if the Board of Directors reasonably and promptly determines by a majority vote of the directors who are not parties to the proceeding that, based upon the facts known to the Board at the time the determination is made, the matter is of the kind described in Section 7.1(B)(i) or (iv) hereof or the indemnitee's actions were of the kind described in Section 7.1(B)(ii) or (iii) hereof. - 17 - 18 Section 7.3 Permissive Indemnification and Advancement of Expenses. The Corporation may, as determined by the Board of Directors from time to time: (A) indemnify, to the fullest extent permitted by Section 7.1 hereof, any other person who was or is made a party to or required to appear in, or is threatened to be made a party to or required to appear in, or was or is otherwise involved in, any threatened, pending or completed proceeding by reason of the fact that such person is or was an authorized representative of the Corporation, both as to action in such person's official capacity and as to action in another capacity while holding such office or position, against all expenses (including attorneys' fees, disbursements and other charges), judgments, fines (including excise taxes and penalties), and amounts paid in settlement actually and reasonably incurred by such person in connection with such action or proceeding, with the same effect as though such person were an "indemnitee" as defined in Section 7.1 hereof; and (B) pay expenses incurred by any such other person by reason of his or her participation in any such proceeding in advance of the final disposition of such proceeding upon receipt of an undertaking by or on behalf of such person to repay such amount if it shall ultimately be determined that he or she is not entitled to be indemnified by the Corporation and to repay all amounts advanced for which he or she is reimbursed under any policy of insurance or otherwise, with the same effect as though such person were an "indemnitee" as defined in Section 7.1 hereof. Section 7.4 Enforcement. If the Corporation refuses or fails to make any payment to an indemnitee required by this Article, the indemnitee shall be promptly indemnified by the Corporation against expenses (including attorneys' fees, disbursements and other charges) actually and reasonably incurred by the indemnitee in connection with the successful establishment of his or her right to indemnification or advancement of expenses, in whole or in part, in an action in a court of competent jurisdiction. Section 7.5 General. Each director or officer of the Corporation shall be deemed to act in such capacity in reliance upon such rights of indemnification and advancement of expenses as are provided in this Article. The rights of indemnification and advancement of expenses provided by this Article shall not be deemed exclusive of any other rights to which any person seeking indemnification or advancement of expenses may be entitled under any agreement, vote of shareholders or disinterested directors, statute or otherwise, both as to action in such person's official capacity and as to action in another capacity while holding such office or position, and shall continue as to a person who has ceased to be an authorized representative of the Corporation and shall inure to the benefit of the heirs and personal representatives of such person. Indemnification and advancement of expenses under this Article shall be provided whether or not the indemnified liability arises or arose from any threatened, pending or completed action by or in the right of the Corporation. Any repeal or modification of this Article shall not adversely affect - 18 - 19 any right or protection existing at the time of such repeal or modification to which any person may be entitled under this Article. Section 7.6 Definition of Corporation. For the purposes of this Article, references to "the Corporation" shall include all constituent corporations absorbed in a consolidation, merger or division, as well as the surviving or new corporations surviving or resulting therefrom, so that (i) any person who is or was an authorized representative of a constituent, surviving or new corporation shall stand in the same position under the provisions of this Article with respect to the surviving or new corporation as such person would if he or she had served the surviving or new corporation in the same capacity and (ii) any person who is or was an authorized representative of the Corporation shall stand in the same position under the provisions of this Article with respect to the surviving or new corporation as such person would with respect to the Corporation if its separate existence had continued. Section 7.7 Definition of Authorized Representative. For the purposes of this Article, the term "authorized representative" shall mean a director, officer, employee or agent of the Corporation or of any subsidiary of the Corporation, or a trustee, custodian, administrator, committeeman or fiduciary of any employee benefit plan established and maintained by the Corporation or by any direct or indirect subsidiary of the Corporation, or a person serving another corporation, partnership, joint venture, trust or other enterprise in any of the foregoing capacities at the request of the Corporation. Section 7.8 Savings Clause. If a court of competent jurisdiction determines that any provision of this Article requires the Corporation to take an action that would violate applicable law, such provision shall be limited or modified in its application to such action to the minimum extent necessary to avoid such violation of law, and, as so limited or modified, such provision and the balance of this Article shall be enforceable in accordance with their terms to the fullest extent permitted by applicable law, including but not limited to the Business Corporation Law of 1988. Section 7.9 Insurance. The Corporation may purchase and maintain insurance on behalf of any person who is or was a director or officer of the Corporation, or is or was an authorized representative of the Corporation, against any liability asserted against or incurred by such person in any such capacity, or arising out of the status of such person as such, whether or not the Corporation would have the power to indemnify such person against such liability under the provisions of this Article. Section 7.10 Funding to Meet Indemnification Obligations. The Board of Directors, without approval of the shareholders, shall have the power to borrow money on behalf of the Corporation, including the power to pledge the assets of the Corporation, from time to time to discharge the Corporation's obligations with respect to indemnification, the advancement and reimbursement of expenses, and the purchase and maintenance of insurance referred to in this Article. The Corporation may, in lieu of or in addition to the purchase and maintenance of - 19 - 20 insurance referred to in Section 7.9 hereof, establish and maintain a fund of any nature or otherwise secure or insure in any manner its indemnification obligations, whether arising under or pursuant to this Article or otherwise. ARTICLE VIII GENERAL PROVISIONS Section 8.1 Corporate Seal. The Corporate seal of the Corporation shall be a circular seal with the name of the Corporation and state of incorporation around the border or a seal in such form as the Board of Directors shall from time to time determine. Section 8.2 Fiscal Year. The fiscal year of the Corporation shall be as designated by the Board of Directors. Section 8.3 Authorization. All checks, notes, vouchers, warrants, drafts, acceptances and other orders for the payment of moneys of the Corporation shall be signed by such officer or officers or such other person or persons as the Board of Directors may from time to time designate. Section 8.4 Inapplicability of Subchapter 25E. Subchapter E of Chapter 25 of the Pennsylvania Business Corporation Law of 1988, as amended (former Section 910 of the Pennsylvania Business Corporation Law of 1933, as amended), shall not be applicable to the Corporation. Section 8.5 Inapplicability of Subchapter 25F. Subchapter F of Chapter 25 of the Pennsylvania Business Corporation Law of 1988, as amended (former Section 911 of the Pennsylvania Business Corporation Law of 1933, as amended), shall not be applicable to the Corporation. Section 8.6 Inapplicability of Subchapter 25G. Subchapter G of Chapter 25 of the Pennsylvania Business Corporation Law of 1988, as amended, shall not be applicable to the Corporation. Section 8.7 Inapplicability of Subchapter 25H. Subchapter H of Chapter 25 of the Pennsylvania Business Corporation Law of 1988, as amended, shall not be applicable to the Corporation. ARTICLE IX AMENDMENTS - 20 - 21 The authority to adopt, amend or repeal the Bylaws of the Corporation is expressly conferred upon the Board of Directors, which may take such action by the affirmative vote of a majority of the whole Board of Directors at any annual, regular or special meeting duly convened after notice of that purpose, subject always to the power of the shareholders to adopt, amend or repeal the Bylaws of the Corporation by the affirmative vote of the holders of two-thirds of the outstanding shares of common stock of the Corporation. Any change in the Bylaws shall take effect when adopted unless otherwise provided in the resolution effecting the change. - 21 - EX-4.02 5 EDUCATIONAL MANAGEMENT CORP. 1 EXHIBIT 4.02 RIGHTS AGREEMENT Dated as of October 1, 1996 Between EDUCATION MANAGEMENT CORPORATION AND MELLON BANK, N.A. Rights Agent - A1 - 2 TABLE OF CONTENTS Page Section 1. Certain Definitions .................................... 1 Section 2. Appointment of Rights Agent..............................6 Section 3. Issue of Right Certificates..............................6 Section 4. Form of Right Certificates...............................8 Section 5. Countersignature and Registration........................8 Section 6 Transfer, Split Up, Combination and Exchange of Right Certificates; Mutilated, Destroyed, Lost or Stolen Right Certificates.............................................9 Section 7. Exercise of Rights; Purchase Price; Expiration Date of Rights..................................................10 Section 8. Cancellation and Destruction of Right Certificates............................................11 Section 9. Availability of Preferred Shares........................12 Section 10. Preferred Shares Record Date............................13 Section 11. Adjustment of Purchase Price, Number of Shares or Number of Rights..............................13 Section 12. Certificate of Adjusted Purchase Price or Number of Shares..................................................21 Section 13. Consolidation, Merger or Sale or Transfer of Assets or Earning Power...........................................21 - A2 - 3 Section 14. Fractional Rights and Fractional Shares.................22 Section 15. Rights of Action........................................23 Section 16. Agreement of Right Holders..............................24 Section 17.. Right Certificate Holder Not Deemed a Stockholder.............................................25 Section 18. Concerning the Rights Agent.............................25 Section 19.. Merger or Consolidation or Change of Name of Rights Agent...................................................25 Section 20. Duties of Rights Agent..................................26 Section 21. Change of Rights Agent..................................28 Section 22. Issuance of New Right Certificates......................29 Section 23. Redemption..............................................30 Section 24. Exchange................................................30 Section 25. Notice of Certain Events................................32 Section 26. Notices.................................................33 Section 27. Supplements and Amendments..............................33 Section 28. Successors..............................................34 Section 29. Benefits of This Agreement..............................34 Section 30. Severability............................................34 Section 31. Governing Law...........................................34 Section 32. Counterparts............................................34 - A3 - 4 Section 33. Descriptive Headings....................................35 Section 34. Effective Date of This Agreement........................35 Exhibit A - Form of Certificate of Designations Exhibit B - Form of Right Certificate Exhibit C - Summary of Rights to Purchase Preferred Shares - A4 - 5 This Rights Agreement (the "Agreement"), dated as of October 1, 1996, between Education Management Corporation, a Pennsylvania corporation (the "Company"), and Mellon Bank, N.A., a national banking association as Rights Agent (the "Rights Agent"). The board of directors of the Company (the "Board of Directors") has authorized and declared a dividend of one preferred share purchase right (a "Right") for each Common Share (as hereinafter defined) of the Company outstanding at the Close of Business (as defined hereinafter) on the date of the consummation of the offering (the "Record Date"), each Right representing the right to purchase one one-hundredth of a Preferred Share (as hereinafter defined), upon the terms and subject to the conditions herein set forth, and has further authorized and directed the issuance of one Right with respect to each Common Share that shall become outstanding between the Record Date and the earliest of the Distribution Date, the Redemption Date and the Final Expiration Date (as such terms are hereinafter defined), including any Common Shares issued in connection with the initial public offering of the Common Shares. Accordingly, in consideration of the premises and the mutual agreements herein set forth, and intending to be legally bound, the parties hereby agree as follows: Section 1. Certain Definitions. For purposes of this Agreement, the following terms have the meanings indicated: (a) "Acquiring Person" shall mean any Person (as hereinafter defined) who or which, together with all Affiliates and Associates (as such terms are hereinafter defined) of such Person, shall be the Beneficial Owner (as hereinafter defined) of 17.5% or more of the Common Shares of the Company then outstanding, but shall not include (i) the Company, (ii) any Subsidiary (as hereinafter defined) of the Company, (iii) any employee benefit plan of the Company or of any Subsidiary of the Company, or any entity holding Common Shares for or pursuant to the terms of any such plan, or (iv) a Person who or which shall become the Beneficial Owner of 17.5% or more of the Common Shares then outstanding, if the transaction in which such Person became the Beneficial Owner of 17.5% or more of the Common Shares then outstanding had received prior approval of a majority of the Board of Directors. Notwithstanding anything in this definition of Acquiring Person to the contrary, no Person shall become an Acquiring Person as the result of an acquisition of Common Shares by the Company which, by reducing the number of shares outstanding, increases the proportionate number of shares beneficially owned by such Person to 17.5% or more of the Common Shares of the Company then outstanding; provided, however, that if a Person shall become the Beneficial Owner of 17.5% or more of the Common Shares of the Company then outstanding by reason of share purchases by the Company and shall, after such share purchases by the Company, become the Beneficial Owner of any additional Common Shares of the Company (other than through the acquisition of - A5 - 6 Employee Stock (as hereinafter defined)), then such Person shall be deemed to be an Acquiring Person. Notwithstanding anything in this definition of Acquiring Person to the contrary, no Person shall become an Acquiring Person as the result of his acquisition of Employee Stock that increases the number of shares beneficially owned by such Person to 17.5% or more of the Common Shares of the Company then outstanding; provided, however, that if a Person shall become the Beneficial Owner of 17.5% or more of the Common Shares of the Company then outstanding by reason of the acquisition of Employee Stock and shall, after such acquisition of Employee Stock, become the Beneficial Owner of any additional Common Shares of the Company by reason other than the acquisition of Employee Stock, then such Person shall be deemed to be an Acquiring Person. Notwithstanding anything in this definition of Acquiring Person to the contrary, if the Board of Directors determines in good faith that a Person who would otherwise be an Acquiring Person, as defined pursuant to the foregoing provisions of this paragraph (a), has become such inadvertently, and such Person divests as promptly as practicable a sufficient number of Common Shares so that such Person would no longer be an Acquiring Person, as defined pursuant to the foregoing provisions of this paragraph (a), then such Person shall not be deemed to be an Acquiring Person for any purposes of this Agreement. (b) "Affiliate" shall have the meaning ascribed to such term in Rule 12b-2 of the General Rules and Regulations under the Exchange Act (as hereinafter defined) as in effect on the date of this Agreement. (c) "Associate" shall have the meaning ascribed to such term in Rule 12b-2 of the General Rules and Regulations under the Exchange Act as in effect on the date of this Agreement. (d) A Person shall be deemed the "Beneficial Owner" of and shall be deemed to "beneficially own" any securities: (i) which such Person or any of such Person's Affiliates or Associates beneficially owns, directly or indirectly; (ii) which such Person or any of such Person's Affiliates or Associates has (A) the right to acquire (whether such right is exercisable immediately or only after the passage of time) pursuant to any agreement, arrangement or understanding (other than customary agreements with and between underwriters and selling group members with respect to a bona fide public offering of securities), whether or not in writing, or upon the exercise of conversion rights, exchange rights, rights (other than the Rights), warrants or options, or otherwise; provided, however, that a Person shall not be deemed the Beneficial Owner of, or to beneficially own, securities tendered pursuant to a tender or exchange offer made by or on behalf of such Person or any of such Person's Affiliates or Associates until such tendered securities are accepted for purchase or exchange; and provided, further, that a Person shall not be deemed to be the - A6 - 7 Beneficial Owner of, or to beneficially own, securities which such Person has the right to acquire (whether such right is exercisable immediately or only after the passage of time) upon the exercise of conversion rights conferred in any class or series of Preference Stock of the Company issued prior to the Distribution Date (as hereinafter defined) if the resolutions of the Board providing for the issuance of such class or series of Preference Stock shall specifically refer to this Rights Agreement and provide that the right to acquire securities upon the exercise of conversion rights so conferred shall not be deemed to constitute beneficial ownership of such securities; or (B) the right to vote, or the right to direct the vote, or dispose of, or has "beneficial ownership" (as determined pursuant to Rule 13d-3 of the General Rules and Regulations under the Exchange Act, as in effect on the Record Date) of, (including pursuant to any agreement, arrangement or understanding, whether or not in writing); provided, further, that a Person shall not be deemed the Beneficial Owner of, or to beneficially own, any security, if the agreement, arrangement or understanding to vote, or direct the vote of, such security (1) arises solely from a revocable proxy or consent given to such Person in response to a public proxy or consent solicitation made pursuant to, and in accordance with, the applicable rules and regulations promulgated under the Exchange Act and (2) is not also then reportable on Schedule 13D under the Exchange Act (or any comparable or successor report); or (iii) which are beneficially owned, directly or indirectly, by any other Person with which such Person or any of such Person's Affiliates or Associates has any agreement, arrangement or understanding, whether or not in writing, (other than customary agreements with and between underwriters and selling group members with respect to a bona fide public offering of securities) for the purpose of acquiring, holding, voting (except to the extent contemplated by the proviso to Section 1(c)(ii)(B)) or disposing of any securities of the Company. Notwithstanding anything in this definition of Beneficial Ownership to the contrary, no Person (and no Affiliate or Associate of any Person) shall at any time prior to the commencement of the Company's initial public offering be deemed to be the "Beneficial Owner" of or to "beneficially own" any securities if such Person is the Beneficial Owner of or "beneficially owns" such securities as a result of one or more agreements, arrangements or understandings with any Person described in Sections 1(a)(iv) and (v) (whether or not the Company or any other Person is a party thereto) and if such Person would not be the Beneficial Owner of or "beneficially own" such securities if such agreements, arrangements or understandings were not then in effect. Notwithstanding anything in this definition of Beneficial Ownership to the contrary, the phrase "then outstanding", when used with reference to a Person's Beneficial Ownership of securities of the Company, shall mean the number of such securities then issued and outstanding together with the number of such securities not then actually issued and outstanding which such Person would be deemed to own beneficially hereunder. (e) "Board of Directors" shall have the meaning set forth in the preamble hereof. - A7 - 8 (f) "Business Day" shall mean any day other than a Saturday, a Sunday, or a day on which banking institutions in Pittsburgh, Pennsylvania are authorized or obligated by law or executive order to close. (g) "Close of Business" on any given date shall mean 5:00 P.M., Pittsburgh, Pennsylvania time, on such date; provided, however, that, if such date is not a Business Day, it shall mean 5:00 P.M., Pittsburgh, Pennsylvania time, on the next succeeding Business Day. (h) "Common Shares" when used with reference to the Company shall mean the shares of common stock, par value $.01 per share, of the Company. "Common Shares," when used with reference to any Person other than the Company, shall mean the capital stock (or equity interest) with the greatest voting power of such Person or, if such Person is a Subsidiary of another Person, the Person or Persons which ultimately control such first-mentioned Person. (i) "Company" shall have the meaning set forth in the preamble hereof. (j) "Current Per Share Market Price" shall have the meaning set forth in Section 11(d)(i) hereof. (k) "Distribution Date" shall have the meaning set forth in Section 3 hereof. (l) "equivalent preferred shares" shall have the meaning set forth in Section 11(b) hereof. (m) "Employee Stock" shall mean, with respect to any Person who is a current or former officer or director of the Company, any Common Shares acquired after the effective date of this Agreement, as set forth in Section 34 hereof, by that Person pursuant to any employee benefit plan, employee stock purchase plan, stock incentive plan or any other similar right, plan or arrangement of the Company that provided or provides one or more officers or directors of the Company with the right to acquire Common Shares. (n) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. (o) "Exchange Ratio" shall have the meaning set forth in Section 24(a) hereof. (p) "Final Expiration Date" shall have the meaning set forth in Section 7(a) hereof. - A8 - 9 (q) "Person" shall mean any individual, firm, corporation, partnership or other entity, and shall include any successor (by merger or otherwise) of such entity. (r) "Preferred Shares" shall mean shares of Series A Junior Participating Preferred Stock, par value $.01 per share, of the Company having the rights and preferences set forth in the Form of Certificate of Designations attached to this Agreement as Exhibit A. (s) "Purchase Price" shall have the meaning set forth in Section 4 hereof. (t) "Record Date" shall have the meaning set forth in the preamble hereof. (u) "Redemption Date" shall have the meaning set forth in Section 7(a) hereof. (v) "Redemption Price" shall have the meaning set forth in Section 23(a) hereof. (w) "Right" shall have the meaning set forth in the preamble hereof. (x) "Right Certificate" shall have the meaning set forth in Section 3(a) hereof. (y) "Rights Agent" shall have the meaning set forth in the preamble hereof. (z) "Securities Act" shall have the meaning set forth in Section 9(d) hereof. (aa) "Security" shall have the meaning set forth in Section 11(d) hereof. (bb) "Shares Acquisition Date" shall mean the first date of public announcement by the Company or an Acquiring Person that an Acquiring Person has become such. (cc) "Subsidiary" of any Person shall mean any corporation or other entity of which a majority of the voting power of the voting equity securities or equity interest is owned, directly or indirectly, by such Person or otherwise controlled by such Person. (dd) "Summary of Rights" shall have the meaning set forth in Section 3(b) hereof. (ee) "Trading Day" shall have the meaning set forth in Section 11(d) hereof. Section 2. Appointment of Rights Agent. The Company hereby appoints the Rights Agent to act as agent for the Company and the holders of the Rights (who, in accordance - A9 - 10 with Section 3 hereof, shall prior to the Distribution Date also be the holders of the Common Shares) in accordance with the terms and conditions hereof, and the Rights Agent hereby accepts such appointment and agrees to act as Rights Agent under this Agreement. The Company may from time to time appoint such co-Rights Agents as it may deem necessary or desirable. Section 3. Issue of Right Certificates. (a) Until the earlier of (i) the Close of Business on the tenth Business Day after the Shares Acquisition Date or (ii) the Close of Business on the tenth Business Day (or such later date as may be determined by action of the Board of Directors prior to such time as any Person becomes an Acquiring Person) after the date of the commencement by any Person (other than the Company, any Subsidiary of the Company, any employee benefit plan of the Company or of any Subsidiary of the Company, or any entity holding Common Shares for or pursuant to the terms of any such plan of, or of the first public announcement of the intention of any Person (other than the Company, any Subsidiary of the Company, any employee benefit plan of the Company or of any Subsidiary of the Company, any entity holding Common Shares for or pursuant to the terms of any such plan to commence, a tender or exchange offer the consummation of which would result in any Person becoming the Beneficial Owner of Common Shares aggregating to 17.5% or more of the then outstanding Common Shares (the earlier of such dates being herein referred to as the "Distribution Date"), (x) the Rights will be evidenced (subject to the provisions of Section 3(b) hereof) by the certificates for Common Shares registered in the names of the holders thereof (which certificates shall also be deemed to be Right Certificates) and not by separate Right Certificates, and (y) the right to receive Right Certificates will be transferable only in connection with the transfer of Common Shares. As soon as practicable after the Distribution Date, the Company will prepare and execute, the Rights Agent will countersign, and the Company will send or cause to be sent (and the Rights Agent will, if requested, send) by first-class, insured, postage-prepaid mail, to each record holder of Common Shares as of the Close of Business on the Distribution Date, at the address of such holder shown on the records of the Company, a Right Certificate, in substantially the form of Exhibit B hereto (a "Right Certificate"), evidencing one Right for each Common Share so held. From and after the Distribution Date, the Rights will be evidenced solely by such Right Certificates. (b) On the Record Date, or as soon as practicable thereafter, the Company will send a copy of a Summary of Rights to Purchase Preferred Shares, in substantially the form of Exhibit C hereto (the "Summary of Rights"), by first-class, postage-prepaid mail, to each record holder of Common Shares as of the Close of Business on the Record Date, at the address of such holder shown on the records of the Company. With respect to certificates for Common Shares outstanding as of the Record Date, until the Distribution Date, the Rights will be evidenced by such certificates registered in the names of the holders thereof together with a copy of the Summary of Rights attached thereto. Until the Distribution Date (or the earlier of the - A10 - 11 Redemption Date or the Final Expiration Date), the surrender for transfer of any certificate for Common Shares outstanding on the Record Date, with or without a copy of the Summary of Rights attached thereto, shall also constitute the transfer of the Rights associated with the Common Shares represented thereby. (c) Certificates for Common Shares which become outstanding (including, without limitation, reacquired Common Shares referred to in the last sentence of this paragraph (c)) after the Record Date but prior to the earliest of the Distribution Date, the Redemption Date or the Final Expiration Date, shall have impressed on, printed on, written on or otherwise affixed to them the following legend: This certificate also evidences and entitles the holder hereof to certain Rights as set forth in a Rights Agreement between Education Management Corporation and Mellon Bank, dated as of October __, 1996 (the "Rights Agreement"), the terms of which are hereby incorporated herein by reference and a copy of which is on file at the principal executive offices of Education Management Corporation. Under certain circumstances, as set forth in the Rights Agreement, such Rights will be evidenced by separate certificates and will no longer be evidenced by this certificate. Education Management Corporation will mail to the holder of this certificate a copy of the Rights Agreement without charge after receipt of a written request therefor. Under certain circumstances, as set forth in the Rights Agreement, Rights issued to any Person who becomes an Acquiring Person or any Affiliate or Associate thereof (as such terms are defined in the Rights Agreement), whether currently held by or on behalf of such Person or by any subsequent holder, may become null and void. With respect to such certificates containing the foregoing legend, until the Distribution Date, the Rights associated with the Common Shares represented by such certificates shall be evidenced by such certificates alone, and the surrender for transfer of any such certificate shall also constitute the transfer of the Rights associated with the Common Shares represented thereby. In the event that the Company purchases or acquires any Common Shares after the Record Date but prior to the Distribution Date, any Rights associated with such Common Shares shall be deemed cancelled and retired so that the Company shall not be entitled to exercise any Rights associated with the Common Shares which are no longer outstanding. Section 4. Form of Right Certificates. - A11 - 12 (a) The Right Certificates (and the forms of election to purchase Preferred Shares and of assignment to be printed on the reverse thereof) shall be substantially the same as Exhibit B hereto and may have such marks of identification or designation and such legends, summaries or endorsements printed thereon as the Company may deem appropriate and as are not inconsistent with the provisions of this Agreement, or as may be required to comply with any applicable law or with any rule or regulation made pursuant thereto or with any rule or regulation of any stock exchange or automated quotation system on which the Rights may from time to time be listed, or to conform to usage. Subject to the provisions of Section 22 hereof, the Right Certificates shall entitle the holders thereof to purchase such number of one one-hundredths of a Preferred Share as shall be set forth therein at the price per one one-hundredth of a Preferred Share set forth therein (the "Purchase Price"), but the number of such one one-hundredths of a Preferred Share and the Purchase Price shall be subject to adjustment as provided herein. Section 5. Countersignature and Registration. The Right Certificates shall be executed on behalf of the Company by its Chairman of the Board, its President, any of its Vice Presidents, or its Treasurer, either manually or by facsimile signature, shall have affixed thereto the Company's seal or a facsimile thereof, and shall be attested by the Secretary or an Assistant Secretary of the Company, either manually or by facsimile signature. The Right Certificates shall be manually countersigned by the Rights Agent and shall not be valid for any purpose unless countersigned. In case any officer of the Company who shall have signed any of the Right Certificates shall cease to be such officer of the Company before countersignature by the Rights Agent and issuance and delivery by the Company, such Right Certificates, nevertheless, may be countersigned by the Rights Agent and issued and delivered by the Company with the same force and effect as though the individual who signed such Right Certificates had not ceased to be such officer of the Company; and any Right Certificate may be signed on behalf of the Company by any individual who, at the actual date of the execution of such Right Certificate, shall be a proper officer of the Company to sign such Right Certificate although at the date of the execution of this Agreement any such individual was not such an officer. Following the Distribution Date, the Rights Agent will keep or cause to be kept, at its principal office, books for registration and transfer of the Right Certificates issued hereunder. Such books shall show the names and addresses of the respective holders of the Right Certificates, the number of Rights evidenced on its face by each of the Right Certificates and the date of each of the Right Certificates. Section 6. Transfer, Split Up, Combination and Exchange of Right Certificates; Mutilated, Destroyed, Lost or Stolen Right Certificates. Subject to the provisions of Section 14 hereof, at any time after the Close of Business on the Distribution Date, and at or prior to the Close of Business on the earlier of the Redemption Date or the Final Expiration Date, any Right - A12 - 13 Certificate or Right Certificates (other than Right Certificates representing Rights that have become void pursuant to Section 11(a)(ii) hereof or that have been exchanged pursuant to Section 24 hereof) may be transferred, split up, combined, or exchanged for another Right Certificate or other Right Certificates entitling the registered holder to purchase a like number of one one-hundredths of a Preferred Share as the Right Certificate or Right Certificates surrendered then entitled such holder to purchase. Any registered holder desiring to transfer, split up, combine or exchange any Right Certificate or Right Certificates shall make such request in writing delivered to the Rights Agent, and shall surrender the Right Certificate or Right Certificates to be transferred, split up, combined or exchanged at the principal office of the Rights Agent. Neither the Rights Agent nor the Company shall be obligated to take any action whatsoever with respect to the transfer of any such surrendered Right Certificate until the registered holder shall have provided such additional evidence of the identity of this Beneficial Owner (or former Beneficial Owner) Affiliates or Associates thereof as the Company shall reasonably request. Thereupon the Rights Agent shall countersign and deliver to the Person entitled thereto a Right Certificate or Right Certificates, as the case may be, as so requested. The Company may require payment of a sum sufficient to cover any tax or governmental charge that may be imposed in connection with any transfer, split up, combination or exchange of Right Certificates. Upon receipt by the Company and the Rights Agent of evidence reasonably satisfactory to them of the loss, theft, destruction or mutilation of a Right Certificate, and, in case of loss, theft or destruction, of indemnity or security reasonably satisfactory to them, and, at the Company's request, reimbursement to the Company and the Rights Agent of all reasonable expenses incidental thereto, and upon surrender to the Rights Agent and cancellation of the Right Certificate if mutilated, the Company will make and deliver a new Right Certificate of like tenor to the Rights Agent for delivery to the registered holder in lieu of the Right Certificate so lost, stolen, destroyed or mutilated. Section 7. Exercise of Rights; Purchase Price; Expiration Date of Rights. (a) The registered holder of any Right Certificate may exercise the Rights evidenced thereby (except as otherwise provided herein), in whole or in part, at any time after the Distribution Date, upon surrender of the Right Certificate, with the form of election to purchase on the reverse side thereof duly executed, to the Rights Agent at the principal office of the Rights Agent, together with payment of the Purchase Price for each one one-hundredth of a Preferred Share as to which the Rights are exercised, at or prior to the earliest of (i) the Close of Business on the tenth anniversary of the date of the consummation of the offering (the "Final Expiration Date"), (ii) the time at which the Rights are redeemed as provided in Section 23 hereof (the "Redemption Date"), or (iii) the time at which such Rights are exchanged as provided in Section 24 hereof. - A13 - 14 (b) The Purchase Price for each one one-hundredth of a Preferred Share purchasable pursuant to the exercise of a Right shall initially be $50.00, and shall be subject to adjustment from time to time as provided in Section 11 or 13 hereof and shall be payable in lawful money of the United States of America in accordance with paragraph (c) below. (c) Upon receipt of a Right Certificate representing exercisable Rights, with the form of election to purchase duly executed, accompanied by payment of the Purchase Price for the shares to be purchased and an amount equal to any applicable transfer tax required to be paid by the holder of such Right Certificate in accordance with Section 9 hereof by certified check, cashier's check or money order payable to the order of the Company, the Rights Agent shall thereupon promptly (i) (A) requisition from any transfer agent of the Preferred Shares certificates for the number of Preferred Shares to be purchased and the Company hereby irrevocably authorizes any such transfer agent to comply with all such requests, or (B) requisition from the depositary agent depositary receipts representing such number of one one-hundredths of a Preferred Share as are to be purchased (in which case certificates for the Preferred Shares represented by such receipts shall be deposited by the transfer agent of the Preferred Shares with such depositary agent) and the Company hereby directs such depositary agent to comply with such request; (ii) when appropriate, requisition from the Company the amount of cash to be paid in lieu of issuance of fractional shares in accordance with Section 14 hereof; (iii) promptly after receipt of such certificates or depositary receipts, cause the same to be delivered to or upon the order of the registered holder of such Right Certificate, registered in such name or names as may be designated by such holder; and (iv) when appropriate, after receipt, promptly deliver such cash to or upon the order of the registered holder of such Right Certificate. (d) In case the registered holder of any Right Certificate shall exercise less than all the Rights evidenced thereby, a new Right Certificate evidencing Rights equivalent to the Rights remaining unexercised shall be issued by the Rights Agent to the registered holder of such Right Certificate or to his duly authorized assigns, subject to the provisions of Section 14 hereof. Section 8. Cancellation and Destruction of Right Certificates. All Right Certificates surrendered for the purpose of exercise, transfer, split up, combination or exchange shall, if surrendered to the Company or to any of its agents, be delivered to the Rights Agent for cancellation or in canceled form, or, if surrendered to the Rights Agent, shall be canceled by it, and no Right Certificates shall be issued in lieu thereof except as expressly permitted by any of the provisions of this Agreement. The Company shall deliver to the Rights Agent for cancellation and retirement, and the Rights Agent shall so cancel and retire, any other Right Certificate purchased or acquired by the Company otherwise than upon the exercise thereof. The Rights Agent shall deliver all canceled Right Certificates to the Company, or shall, at the written request of the Company, destroy such canceled Right Certificates, and, in such case, shall deliver a certificate of destruction thereof to the Company. - A14 - 15 Section 9. Availability of Preferred Shares; Registration. (a) The Company covenants and agrees that it will cause to be reserved and kept available out of its authorized and unissued Preferred Shares or any Preferred Shares held in its treasury, the number of Preferred Shares that will be sufficient to permit the exercise in full of all outstanding Rights in accordance with Section 7. The Company covenants and agrees that it will take all such action as may be necessary to ensure that all Preferred Shares delivered upon exercise of Rights shall, at the time of delivery of the certificates for such Preferred Shares (subject to payment of the Purchase Price), be duly and validly authorized and issued and fully paid and nonassessable shares. (b) The Company further covenants and agrees that it will pay when due and payable any and all federal and state transfer taxes and charges which may be payable in respect of the issuance or delivery of the Right Certificates or of any Preferred Shares upon the exercise of Rights. The Company shall not, however, be required to pay any transfer tax which may be payable in respect of any transfer or delivery of Right Certificates to a Person other than, or the issuance or delivery of certificates or depositary receipts for the Preferred Shares in a name other than that of, the registered holder of the Right Certificate evidencing Rights surrendered for exercise or to issue or to deliver any certificates or depositary receipts for Preferred Shares upon the exercise of any Rights until any such tax shall have been paid (any such tax being payable by the holder of such Right Certificate at the time of surrender) or until it has been established to the Company's reasonable satisfaction that no such tax is due. (c) The Company shall use all reasonable efforts to cause, from and after such time as the Rights become exercisable, all Preferred Shares, Common Shares and/or other securities issued or reserved for issuance in accordance with this Rights Agreement to be listed, upon official notice of issuance, upon a national securities exchange, or to be eligible for quotation in the National Association of Securities Dealers, Inc. Automated Quotation System ("NASDAQ") or any successor thereto or other comparable quotation system. (d) The Company shall use its best efforts to (i) file, as soon as practicable following the earliest date after the occurrence of an event under Section 11(a)(ii) hereof in which the consideration to be delivered by the Company upon exercise of the Rights has been determined in accordance with Section 11(a)(iii) hereof, or as soon as it is required by law following the Distribution Date, as the case may be, a registration statement under the Securities Act of 1933, as amended (the "Securities Act"), with respect to the securities purchasable upon exercise of the Rights of an appropriate form, (ii) cause such registration statement to become effective as soon as practicable after such filing, and (iii) cause such registration statement to remain effective (with a prospectus at all times meeting the requirements of the Securities Act) - A15 - 16 until the earlier of (A) the date as of which the Rights are no longer exercisable for such securities, and (B) the date of the expiration of the Rights. The company will also take such action as may be appropriate under, or to ensure compliance with, the securities or "blue sky" laws of the various states in connection with the exercisability of the Rights. The Company may temporarily suspend, for a period of time not to exceed 90 days after the date set forth in clause (i) of the first sentence of this Section 9(c), the exercisability of the Rights in order to prepare and file such registration statement. Upon any such suspension, the Company shall issue a public announcement stating, and notify the Rights Agent, that the exercisability of the Rights has been temporarily suspended, as well as a public announcement at such time as the suspension is no longer in effect. Notwithstanding any provisions of this Agreement to the contrary, the Rights shall not be exercisable in any jurisdiction unless the requisite qualification in such jurisdiction shall have been obtained. Section 10. Preferred Shares Record Date. Each Person in whose name any certificate for Preferred Shares is issued upon the exercise of Rights shall for all purposes be deemed to have become the holder of record of the Preferred Shares represented thereby on, and such certificate shall be dated, the date upon which the Right Certificate evidencing such Rights was duly surrendered and payment of the Purchase Price (and any applicable transfer taxes) was made; provided, however, that if the date of such surrender and payment is a date upon which the Preferred Shares transfer books of the Company are closed, such Person shall be deemed to have become the record holder of such shares on, and such certificate shall be dated, the next succeeding Business Day on which the Preferred Shares transfer books of the Company are open. Prior to the exercise of the Rights evidenced thereby, the holder of a Right Certificate shall not be entitled to any rights of a holder of Preferred Shares for which the Rights shall be exercisable, including, without limitation, the right to vote, to receive dividends or other distributions or to exercise any preemptive rights, and shall not be entitled to receive any notice of any proceedings of the Company, except as provided herein. Section 11. Adjustment of Purchase Price, Number of Shares or Number of Rights. The Purchase Price, the number of Preferred Shares covered by each Right and the number of Rights outstanding are subject to adjustment from time to time as provided in this Section 11. (a) (i) In the event the Company shall at any time after the date of this Agreement (A) declare a dividend on the Preferred Shares payable in Preferred Shares, (B) subdivide the outstanding Preferred Shares, (C) combine the outstanding Preferred Shares into a smaller number of Preferred Shares or (D) issue any shares of its capital stock in a reclassification of the Preferred Shares (including any such reclassification in connection with a consolidation or merger in which the Company is the continuing or surviving corporation), except as otherwise - A16 - 17 provided in this Section 11(a), the Purchase Price in effect at the time of the record date for such dividend or of the effective date of such subdivision, combination or reclassification, and the number and kind of shares of capital stock issuable on such date, shall be proportionately adjusted so that the holder of any Right exercised after such time shall be entitled to receive the aggregate number and kind of shares of capital stock which, if such Right had been exercised immediately prior to such date and at a time when the Preferred Shares transfer books of the Company were open, he would have owned upon such exercise and been entitled to receive by virtue of such dividend, subdivision, combination or reclassification; provided, however, that in no event shall the consideration to be paid upon the exercise of one Right be less than the aggregate par value of the shares of capital stock of the Company issuable upon exercise of one Right. (ii) Subject to Section 24 of this Agreement, in the event any Person becomes an Acquiring Person, each holder of a Right shall thereafter have a right to receive, upon exercise thereof at a price equal to the then current Purchase Price multiplied by the number of one one-hundredths of a Preferred Share for which a Right is then exercisable, in accordance with the terms of this Agreement and in lieu of Preferred Shares, such number of Common Shares of the Company as shall equal the result obtained by (A) multiplying the then current Purchase Price by the number of one one-hundredths of a Preferred Share for which a Right is then exercisable and dividing that product by (B) 50% of the then Current Per Share Market Price of the Company's Common Shares (determined pursuant to Section 11(d)(i) hereof) on the date of the occurrence of such event. In the event that any Person shall become an Acquiring Person and the Rights shall then be outstanding, the Company shall not take any action which would eliminate or diminish the benefits intended to be afforded by the Rights. From and after the occurrence of such event, any Rights that are or were acquired or beneficially owned by any Acquiring Person (or any Associate or Affiliate of such Acquiring Person) shall be void and any holder of such Rights shall thereafter have no right to exercise such Rights under any provision of this Agreement. No Right Certificate shall be issued pursuant to Section 3 that represents Rights beneficially owned by an Acquiring Person whose Rights would be void pursuant to the preceding sentence, or any Associate or Affiliate thereof; no Right Certificate shall be issued at any time upon the transfer of any Rights to an Acquiring Person whose Rights would be void pursuant to the preceding sentence or any Associate or Affiliate thereof or to any nominee of such Acquiring Person, Associate or Affiliate; and any Right Certificate delivered to the Rights Agent for transfer to an Acquiring Person whose Rights would be void pursuant to the preceding sentence shall be canceled. (iii) In the event that there shall not be sufficient Common Shares issued but not outstanding or authorized but unissued to permit the exercise in full of the Rights in accordance with the foregoing subparagraph (ii), the Company shall take all such action as may be necessary to authorize additional Common Shares for issuance upon exercise of the Rights. In the event the Company shall, after good faith effort, be unable to take all such action as may be - A17 - 18 necessary to authorize such additional Common Shares, the Company shall substitute, for each Common Share that would otherwise be issuable upon exercise of a Right, a number of Preferred Shares or fraction thereof such that the Current Per Share Market Price of one Preferred Share multiplied by such number or fraction is equal to the Current Per Share Market Price of one Common Share as of the date of issuance of such Preferred Shares or fraction thereof. (b) In case the Company shall fix a record date for the issuance of rights, options or warrants to all holders of Preferred Shares entitling them (for a period expiring within 45 calendar days after such record date) to subscribe for or purchase Preferred Shares (or shares having the same rights, privileges and preferences as the Preferred Shares ("equivalent preferred shares")) or securities convertible into Preferred Shares or equivalent preferred shares at a price per Preferred Share or equivalent preferred share (or having a conversion price per share, if a security convertible into Preferred Shares or equivalent preferred shares) less than the then Current Per Share Market Price of the Preferred Shares) on such record date, the Purchase Price to be in effect after such record date shall be determined by multiplying the Purchase Price in effect immediately prior to such record date by a fraction, the numerator of which shall be the number of Preferred Shares outstanding on such record date plus the number of Preferred Shares which the aggregate offering price of the total number of Preferred Shares and/or equivalent preferred shares so to be offered (and/or the aggregate initial conversion price of the convertible securities so to be offered) would purchase at such current market price and the denominator of which shall be the number of Preferred Shares outstanding on such record date plus the number of additional Preferred Shares and/or equivalent preferred shares to be offered for subscription or purchase (or into which the convertible securities so to be offered are initially convertible); provided, however, that in no event shall the consideration to be paid upon the exercise of one Right be less than the aggregate par value of the shares of capital stock of the Company issuable upon exercise of one Right. In case such subscription price may be paid in a consideration part or all of which shall be in a form other than cash, the value of such consideration shall be as determined in good faith by the Board of Directors, whose determination shall be described in a statement filed with the Rights Agent and shall be binding on the Rights Agent and holders of the Rights. Preferred Shares owned by or held for the account of the Company shall not be deemed outstanding for the purpose of any such computation. Such adjustment shall be made successively whenever such a record date is fixed; and in the event that such rights, options or warrants are not so issued, the Purchase Price shall be adjusted to be the Purchase Price which would then be in effect if such record date had not been fixed. (c) In case the Company shall fix a record date for the making of a distribution to all holders of the Preferred Shares (including any such distribution made in connection with a consolidation or merger in which the Company is the continuing or surviving corporation) of evidences of indebtedness or assets (other than a regular quarterly cash dividend or a dividend payable in Preferred Shares) or subscription rights or warrants (excluding those referred to in Section 11(b) hereof), the Purchase Price to be in effect after such record date shall be determined - A18 - 19 by multiplying the Purchase Price in effect immediately prior to such record date by a fraction, the numerator of which shall be the then Current Per Share Market Price of the Preferred Shares on such record date, less the fair market value (as determined in good faith by the Board of Directors, whose determination shall be described in a statement filed with the Rights Agent and shall be binding on the Rights Agent and holders of the Rights) of the portion of the assets or evidences of indebtedness so to be distributed or of such subscription rights or warrants applicable to one Preferred Share and the denominator of which shall be such Current Per Share Market Price of the Preferred Shares; provided, however, that in no event shall the consideration to be paid upon the exercise of one Right be less than the aggregate par value of the shares of capital stock of the Company to be issued upon exercise of one Right. Such adjustments shall be made successively whenever such a record date is fixed; and in the event that such distribution is not so made, the Purchase Price shall again be adjusted to be the Purchase Price which would then be in effect if such record date had not been fixed. (d) (i) For the purpose of any computation hereunder, the "Current Per Share Market Price" of any security (a "Security" for the purpose of this Section 11(d)(i)) on any date shall be deemed to be the average of the daily closing prices per share of such Security for the 30 consecutive Trading Days immediately prior to such date; provided, however, that in the event that the Current Per Share Market Price of the Security is determined during a period following the announcement by the issuer of such Security of (A) a dividend or distribution on such Security payable in shares of such Security or securities convertible into such shares, or (B) any subdivision, combination or reclassification of such Security and prior to the expiration of [30] Trading Days after the ex-dividend date for such dividend or distribution, or the record date for such subdivision, combination or reclassification, then, and in each such case, the Current Per Share Market Price shall be appropriately adjusted to reflect the current market price per share equivalent of such Security. The closing price for each day shall be the last sale price, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, in either case, as reported in the principal consolidated transaction reporting system with respect to securities listed or admitted to trading on the New York Stock Exchange or, if the Security is not listed or admitted to trading on the New York Stock Exchange, as reported in the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which the Security is listed or admitted to trading or, if the Security is not listed or admitted to trading on any national securities exchange, the last quoted price or, if not so quoted, the average of the high bid and low asked prices in the over-the-counter market, as reported on the Nasdaq National Market or such other system then in use, or, if on any such date the Security is not quoted by any such organization, the average of the closing bid and asked prices as furnished by a professional market maker making a market in the Security selected by the Board of Directors. The term "Trading Day" shall mean a day on which the principal national securities exchange on which the Security is listed or admitted to trading is open for the transaction of business or, if the Security is not listed or admitted to trading on any national securities exchange, a Business Day. - A19 - 20 (ii) For the purpose of any computation hereunder, the "Current Per Share Market Price" of the Preferred Shares shall be determined in accordance with the method set forth in Section 11(d)(i). If the Preferred Shares are not publicly traded, the "Current Per Share Market Price" of the Preferred Shares shall be conclusively deemed to be the Current Per Share Market Price of the Common Shares as determined pursuant to Section 11(d)(i) (appropriately adjusted to reflect any stock split, stock dividend or similar transaction occurring after the date hereof), multiplied by one hundred. If neither the Common Shares nor the Preferred Shares are publicly held or so listed or traded, "Current Per Share Market Price" shall mean the fair value per share as determined in good faith by the Board of Directors, whose determination shall be described in a statement filed with the Rights Agent and shall be binding on the Rights Agent and the holders of the Rights. (e) No adjustment in the Purchase Price shall be required unless such adjustment would require an increase or decrease of at least 1% in the Purchase Price; provided, however, that any adjustments which by reason of this Section 11(e) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section 11 shall be made to the nearest cent or to the nearest one one-millionth of a Preferred Share or one ten-thousandth of any other share or security as the case may be. Notwithstanding the first sentence of this Section 11(e), any adjustment required by this Section 11 shall be made no later than the earlier of (i) three years from the date of the transaction which requires such adjustment or (ii) the date of the expiration of the right to exercise any Rights. (f) If as a result of an adjustment made pursuant to Section 11(a) hereof, the holder of any Right thereafter exercised shall become entitled to receive any shares of capital stock of the Company other than Preferred Shares, thereafter the number of such other shares so receivable upon exercise of any Right shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the Preferred Shares contained in Section 11(a) through (c), inclusive, and the provisions of Sections 7, 9, 10 and 13 with respect to the Preferred Shares shall apply on like terms to any such other shares. (g) All Rights originally issued by the Company subsequent to any adjustment made to the Purchase Price hereunder shall evidence the right to purchase, at the adjusted Purchase Price, the number of one one-hundredths of a Preferred Share purchasable from time to time hereunder upon exercise of the Rights, all subject to further adjustment as provided herein. (h) Unless the Company shall have exercised its election as provided in Section 11(i), upon each adjustment of the Purchase Price as a result of the calculations made in Sections 11(b) and (c), each Right outstanding immediately prior to the making of such adjustment shall thereafter evidence the right to purchase, at the adjusted Purchase Price, that number of one one-hundredths of a Preferred Share (calculated to the nearest one one-millionth of a Preferred - A20 - 21 Share) obtained by (A) multiplying (x) the number of one one-hundredths of a share covered by a Right immediately prior to this adjustment by (y) the Purchase Price in effect immediately prior to such adjustment of the Purchase Price and (B) dividing the product so obtained by the Purchase Price in effect immediately after such adjustment of the Purchase Price. (i) The Company may elect on or after the date of any adjustment of the Purchase Price to adjust the number of Rights in substitution for any adjustment in the number of one one-hundredths of a Preferred Share purchasable upon the exercise of a Right. Each of the Rights outstanding after such adjustment of the number of Rights shall be exercisable for the number of one one-hundredths of a Preferred Share for which a Right was exercisable immediately prior to such adjustment. Each Right held of record prior to such adjustment of the number of Rights shall become that number of Rights (calculated to the nearest one ten-thousandth) obtained by dividing the Purchase Price in effect immediately prior to adjustment of the Purchase Price by the Purchase Price in effect immediately after adjustment of the Purchase Price. The Company shall make a public announcement of its election to adjust the number of Rights, indicating the record date for the adjustment, and, if known at the time, the amount of the adjustment to be made. This record date may be the date on which the Purchase Price is adjusted or any day thereafter, but, if the Right Certificates have been issued, shall be at least 10 days later than the date of the public announcement. If Right Certificates have been issued, upon each adjustment of the number of Rights pursuant to this Section 11(i), the Company shall, as promptly as practicable, cause to be distributed to holders of record of Right Certificates on such record date Right Certificates evidencing, subject to Section 14 hereof, the additional Rights to which such holders shall be entitled as a result of such adjustment, or, at the option of the Company, shall cause to be distributed to such holders of record in substitution and replacement for the Right Certificates held by such holders prior to the date of adjustment, and upon surrender thereof, if required by the Company, new Right Certificates evidencing all the Rights to which such holders shall be entitled after such adjustment. Right Certificates so to be distributed shall be issued, executed and countersigned in the manner provided for herein and shall be registered in the names of the holders of record of Right Certificates on the record date specified in the public announcement. (j) Irrespective of any adjustment or change in the Purchase Price or the number of one one-hundredths of a Preferred Share issuable upon the exercise of the Rights, the Right Certificates theretofore and thereafter issued may continue to express the Purchase Price and the number of one one-hundredths of a Preferred Share which were expressed in the initial Right Certificates issued hereunder. (k) Before taking any action that would cause an adjustment reducing the Purchase Price below one one-hundredth of the then par value, if any, of the Preferred Shares issuable upon exercise of the Rights, the Company shall take any corporate action which may, in - A21 - 22 the opinion of its counsel, be necessary in order that the Company may validly and legally issue fully paid and nonassessable Preferred Shares at such adjusted Purchase Price. (l) In any case in which this Section 11 shall require that an adjustment in the Purchase Price be made effective as of a record date for a specified event, the Company may elect to defer until the occurrence of such event the issuing to the holder of any Right exercised after such record date of the Preferred Shares and other capital stock or securities of the Company, if any, issuable upon such exercise over and above the Preferred Shares and other capital stock or securities of the Company, if any, issuable upon such exercise on the basis of the Purchase Price in effect prior to such adjustment; provided, however, that the Company shall deliver to such holder a due bill or other appropriate instrument evidencing such holder's right to receive such additional shares upon the occurrence of the event requiring such adjustment. (m) Anything in this Section 11 to the contrary notwithstanding, the Company shall be entitled to make such reductions in the Purchase Price, in addition to those adjustments expressly required by this Section 11, as and to the extent that it, in its sole discretion, shall determine to be advisable in order that (i) any consolidation or subdivision of the Preferred Shares, (ii) issuance wholly for cash of any Preferred Shares at less than the current market price, (iii) issuance wholly for cash of Preferred Shares or securities which by their terms are convertible into or exchangeable for Preferred Shares, (iv) dividends on Preferred Shares payable in Preferred Shares or (v) issuance of rights, options or warrants referred to hereinabove in Section 11(b), hereafter made by the Company to holders of its Preferred Shares shall not be taxable to such shareholders. (n) In the event that at any time after the date of this Agreement and prior to the Distribution Date, the Company shall (i) declare or pay any dividend on the Common Shares payable in Common Shares, or (ii) effect a subdivision, combination or consolidation of the Common Shares (by reclassification or otherwise than by payment of dividends in Common Shares) into a greater or lesser number of Common Shares, then in any such case (A) the number of one one-hundredths of a Preferred Share purchasable after such event upon proper exercise of each Right shall be determined by multiplying the number of one one-hundredths of a Preferred Share so purchasable immediately prior to such event by a fraction, the numerator of which is the number of Common Shares outstanding immediately before such event and the denominator of which is the number of Common Shares outstanding immediately after such event, and (B) each Common Share outstanding immediately after such event shall have issued with respect to it that number of Rights which each Common Share outstanding immediately prior to such event had issued with respect to it. The adjustments provided for in this Section 11(n) shall be made successively whenever such a dividend is declared or paid or such a subdivision, combination or consolidation is effected. - A22 - 23 Section 12. Certificate of Adjusted Purchase Price or Number of Shares. Whenever an adjustment is made as provided in Section 11 or 13 hereof, the Company shall promptly (a) prepare a certificate setting forth such adjustment, and a brief statement of the facts accounting for such adjustment, (b) file with the Rights Agent and with each transfer agent for the Common Shares or the Preferred Shares a copy of such certificate and (c) mail a brief summary thereof to each holder of a Right Certificate in accordance with Section 25 hereof. The Rights Agent shall be fully protected in relying on any such certificate and on any adjustment therein contained. Section 13. Consolidation, Merger or Sale or Transfer of Assets or Earning Power. In the event, directly or indirectly, at any time after a Person has become an Acquiring Person, (a) the Company shall consolidate with, or merge with and into, any other Person, and the Company shall not be the continuing or surviving corporation of such consolidation or merger, (b) any Person shall consolidate with the Company, or merge with and into the Company and the Company shall be the continuing or surviving corporation of such merger and, in connection with such merger, all or part of the Common Shares shall be changed into or exchanged for stock or other securities of any other Person (or the Company) or cash or any other property, or (c) the Company shall sell or otherwise transfer (or one or more of its Subsidiaries shall sell or otherwise transfer), in one or more transactions, assets or earning power aggregating 50% or more of the assets or earning power of the Company and its Subsidiaries (taken as a whole) to any other Person, or group of related Persons, other than the Company or one or more of its wholly owned Subsidiaries, then, and in each such case, proper provision shall be made so that (i) each holder of a Right (except as otherwise provided herein) shall thereafter have the right to receive, upon the exercise thereof at a price equal to the then current Purchase Price multiplied by the number of one one-hundredths of a Preferred Share for which a Right is then exercisable, in accordance with the terms of this Agreement and in lieu of Preferred Shares, such number of Common Shares of such other Person (including the Company as successor thereto or as the surviving corporation) as shall equal the result obtained by (A) multiplying the then current Purchase Price by the number of one one-hundredths of a Preferred Share for which a Right is then exercisable and dividing that product by (B) 50% of the then Current Per Share Market Price of the Common Shares of such other Person (determined pursuant to Section 11(d) hereof) on the date of consummation of such consolidation, merger, sale or transfer; (ii) the issuer of such Common Shares shall thereafter be liable for, and shall assume, by virtue of such consolidation, merger, sale or transfer, all the obligations and duties of the Company pursuant to this Agreement; (iii) the term "Company" shall thereafter be deemed to refer to such issuer; and (iv) such issuer shall take such steps (including, but not limited to, the reservation of a sufficient number of its Common Shares in accordance with Section 9 hereof) in connection with such consummation as may be necessary to assure that the provisions hereof shall thereafter be applicable, as nearly as reasonably may be, in relation to the Common Shares thereafter deliverable upon the exercise of the Rights. The Company shall not consummate any such consolidation, merger, sale or transfer unless prior thereto the Company - A23 - 24 and such issuer shall have executed and delivered to the Rights Agent a supplemental agreement so providing. The Company shall not enter into any transaction of the kind referred to in this Section 13 if at the time of such transaction there are any rights, warrants, instruments or securities outstanding or any agreements or arrangements which, as a result of the consummation of such transaction, would eliminate or substantially diminish the benefits intended to be afforded by the Rights. The provisions of this Section 13 shall similarly apply to successive mergers or consolidations or sales or other transfers. Section 14. Fractional Rights and Fractional Shares. (a) The Company shall not be required to issue fractions of Rights or to distribute Right Certificates which evidence fractional Rights. In lieu of such fractional Rights, there shall be paid to the registered holders of the Right Certificates with regard to which such fractional Rights would otherwise be issuable, an amount in cash equal to the same fraction of the current market value of a whole Right. For the purposes of this Section 14(a), the current market value of a whole Right shall be the closing price of the Rights for the Trading Day immediately prior to the date on which such fractional Rights would have been otherwise issuable. The closing price for any day shall be the last sale price, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, in either case, as reported in the principal consolidated transaction reporting system with respect to securities listed on the principal national securities exchange on which the Rights are listed or admitted to trading or, if the Rights are not listed or admitted to trading on any national securities exchange, the last quoted price or, if not so quoted, the average of the high bid and low asked prices in the over-the-counter market, as reported on the Nasdaq National Market or such other system then in use or, if on any such date the Rights are not quoted by any such organization, the average of the closing bid and asked prices as furnished by a professional market maker making a market in the Rights selected by the Board of Directors. If on any such date no such market maker is making a market in the Rights, the fair value of the Rights on such date as determined in good faith by the Board of Directors shall be used. (b) The Company shall not be required to issue fractions of Preferred Shares (other than fractions which are integral multiples of one one-hundredth of a Preferred Share) upon exercise of the Rights or to distribute certificates which evidence fractional Preferred Shares (other than fractions which are integral multiples of one one-hundredth of a Preferred Share). Fractions of Preferred Shares in integral multiples of one one-hundredth of a Preferred Share may, at the election of the Company, be evidenced by depositary receipts, pursuant to an appropriate agreement between the Company and a depositary selected by it; provided that such agreement shall provide that the holders of such depositary receipts shall have all the rights, privileges and preferences to which they are entitled as beneficial owners of the Preferred Shares represented by such depositary receipts. In lieu of fractional Preferred Shares that are not integral multiples of - A24 - 25 one one-hundredth of a Preferred Share, the Company shall pay to the registered holders of Right Certificates at the time such Rights are exercised as herein provided an amount in cash equal to the same fraction of the current market value of one Preferred Share. For the purposes of this Section 14(b), the current market value of a Preferred Share shall be the closing price of a Preferred Share (as determined pursuant to the second sentence of Section 11(d)(i) hereof) for the Trading Day immediately prior to the date of such exercise. (c) The holder of a Right by the acceptance of the Right expressly waives his right to receive any fractional Rights or any fractional shares upon exercise of a Right (except as provided above). Section 15. Rights of Action. All rights of action in respect of this Agreement, excepting the rights of action given to the Rights Agent under Section 18 hereof, are vested in the respective registered holders of the Right Certificates (and, prior to the Distribution Date, the registered holders of the Common Shares) and any registered holder of any Right Certificate (or, prior to the Distribution Date, of the Common Shares), without the consent of the Rights Agent or of the holder of any other Right Certificate (or, prior to the Distribution Date, of the Common Shares), may, in his own behalf and for his own benefit, enforce, and may institute and maintain any suit, action or proceeding against the Company to enforce, or otherwise act in respect of, his right to exercise the Rights evidenced by such Right Certificate in the manner provided in such Right Certificate and in this Agreement. Without limiting the foregoing or any remedies available to the holders of Rights, it is specifically acknowledged that the holders of Rights would not have an adequate remedy at law for any breach of this Agreement and will be entitled to specific performance of the obligations under, and injunctive relief against actual or threatened violations of the obligations of any Person subject to, this Agreement. Section 16. Agreement of Right Holders. Every holder of a Right, by accepting the same, consents and agrees with the Company and the Rights Agent and with every other holder of a Right that: (a) prior to the Distribution Date, the Rights will be transferable only in connection with the transfer of the Common Shares; (b) after the Distribution Date, the Right Certificates are transferable only on the registry books of the Rights Agent if surrendered at the principal office of the Rights Agent, duly endorsed or accompanied by a proper instrument of transfer deed with appropriate forms and certificates fully executed; - A25 - 26 (c) the Company and the Rights Agent may deem and treat the person in whose name the Right Certificate (or, prior to the Distribution Date, the associated Common Shares certificate) is registered as the absolute owner thereof and of the Rights evidenced thereby (notwithstanding any notations of ownership or writing on the Right Certificate or the associated Common Shares certificate made by anyone other than the Company or the Rights Agent) for all purposes whatsoever, and neither the Company nor the Rights Agent shall be affected by any notice to the contrary; and (d) notwithstanding anything in this Agreement to the contrary, neither the Company nor the Rights Agent shall have any liability to any holder of a Right or other Person as a result of its inability to perform any of its obligations under this Agreement by reason of any preliminary or permanent injunction or other order, decree or ruling issued by a court of competent jurisdiction or by a governmental, regulatory or administrative agency or commission, or any statute, rule, regulation or executive order promulgated or enacted by any governmental authority prohibiting or otherwise restraining performance of such obligation. Section 17. Right Certificate Holder Not Deemed a Stockholder. No holder, as such, of any Right Certificate shall be entitled to vote, receive dividends or be deemed for any purpose the holder of the Preferred Shares or any other securities of the Company which may at any time be issuable on the exercise of the Rights represented thereby, nor shall anything contained herein or in any Right Certificate be construed to confer upon the holder of any Right Certificate, as such, any of the rights of a stockholder of the Company or any right to vote for the election of directors or upon any matter submitted to shareholders at any meeting thereof, or to give or withhold consent to any corporate action, or to receive notice of meetings or other actions affecting shareholders (except as provided in Section 25 hereof), or to receive dividends or subscription rights, or otherwise, until the Right or Rights evidenced by such Right Certificate shall have been exercised in accordance with the provisions hereof. Section 18. Concerning the Rights Agent. The Company agrees to pay to the Rights Agent reasonable compensation for all services rendered by it hereunder and, from time to time, on demand of the Rights Agent, its reasonable expenses and counsel fees and other disbursements incurred in the administration and execution of this Agreement and the exercise and performance of its duties hereunder. The Company also agrees to indemnify the Rights Agent for, and to hold it harmless against, any loss, liability, or expense incurred without negligence, bad faith or willful misconduct on the part of the Rights Agent, for anything done or omitted by the Rights Agent in connection with the acceptance and administration of this Agreement, including the costs and expenses of defending against any claim of liability in the premises. - A26 - 27 The Rights Agent shall be protected and shall incur no liability for, or in respect of any action taken, suffered or omitted by it in connection with, its administration of this Agreement in reliance upon any Right Certificate or certificate for the Preferred Shares or Common Shares or for other securities of the Company, instrument of assignment or transfer, power of attorney, endorsement, affidavit, letter, notice, direction, consent, certificate, statement, or other paper or document believed by it to be genuine and to be signed, executed and, where necessary, verified or acknowledged, by the proper person or persons, or otherwise upon the advice of counsel as set forth in Section 20 hereof. Section 19. Merger or Consolidation or Change of Name of Rights Agent. Any corporation into which the Rights Agent or any successor Rights Agent may be merged or with which it may be consolidated, or any corporation resulting from any merger or consolidation to which the Rights Agent or any successor Rights Agent shall be a party, or any corporation succeeding to the stock transfer or corporate trust powers of the Rights Agent or any successor Rights Agent, shall be the successor to the Rights Agent under this Agreement without the execution or filing of any paper or any further act on the part of any of the parties hereto; provided, however, that such corporation would be eligible for appointment as a successor Rights Agent under the provisions of Section 21 hereof. In case at the time such successor Rights Agent shall succeed to the agency created by this Agreement, any of the Right Certificates shall have been countersigned but not delivered, any such successor Rights Agent may adopt the countersignature of the predecessor Rights Agent and deliver such Right Certificates so countersigned; and, in case at that time any of the Right Certificates shall not have been countersigned, any successor Rights Agent may countersign such Right Certificates either in the name of the predecessor Rights Agent or in the name of the successor Rights Agent; and in all such cases such Right Certificates shall have the full force provided in the Right Certificates and in this Agreement. In case at any time the name of the Rights Agent shall be changed and at such time any of the Right Certificates shall have been countersigned but not delivered, the Rights Agent may adopt the countersignature under its prior name and deliver Right Certificates so countersigned; and in case at that time any of the Right Certificates shall not have been countersigned, the Rights Agent may countersign such Right Certificates either in its prior name or in its changed name; and in all such cases such Right Certificates shall have the full force provided in the Right Certificates and in this Agreement. Section 20. Duties of Rights Agent. The Rights Agent undertakes the duties and obligations imposed by this Agreement upon the following terms and conditions, by all of which the Company and the holders of Right Certificates, by their acceptance thereof, shall be bound: - A27 - 28 (a) The Rights Agent may consult with legal counsel (who may be legal counsel for the Company), and the opinion of such counsel shall be full and complete authorization and protection to the Rights Agent as to any action taken or omitted by it in good faith and in accordance with such opinion. (b) Whenever in the performance of its duties under this Agreement the Rights Agent shall deem it necessary or desirable that any fact or matter be proved or established by the Company prior to taking or suffering any action hereunder, such fact or matter (unless other evidence in respect thereof be herein specifically prescribed) may be deemed to be conclusively proved and established by a certificate signed by any one of the Chairman, the Chief Executive Officer, the President, any Vice President, the Treasurer or the Secretary of the Company and delivered to the Rights Agent; and such certificate shall be full authorization to the Rights Agent for any action taken or suffered in good faith by it under the provisions of this Agreement in reliance upon such certificate. (c) The Rights Agent shall be liable hereunder to the Company and any other Person only for its own negligence, bad faith or willful misconduct. (d) The Rights Agent shall not be liable for or by reason of any of the statements of fact or recitals contained in this Agreement or in the Right Certificates (except its countersignature thereof) or be required to verify the same, but all such statements and recitals are and shall be deemed to have been made by the Company only. (e) The Rights Agent shall not be under any responsibility in respect of the validity of this Agreement or the execution and delivery hereof (except the due execution hereof by the Rights Agent) or in respect of the validity or execution of any Right Certificate (except its countersignature thereof); nor shall it be responsible for any breach by the Company of any covenant or condition contained in this Agreement or in any Right Certificate; nor shall it be responsible for any change in the exercisability of the Rights (including the Rights becoming void pursuant to Section 11(a)(ii) hereof) or any adjustment in the terms of the Rights (including the manner, method or amount thereof) provided for in Section 3, 11, 13, 23 or 24, or the ascertaining of the existence of facts that would require any such change or adjustment (except with respect to the exercise of Rights evidenced by Right Certificates after actual notice that such change or adjustment is required); nor shall it by any act hereunder be deemed to make any representation or warranty as to the authorization or reservation of any Preferred Shares to be issued pursuant to this Agreement or any Right Certificate or as to whether any Preferred Shares will, when issued, be validly authorized and issued, fully paid and nonassessable. (f) The Company agrees that it will perform, execute, acknowledge and deliver or cause to be performed, executed, acknowledged and delivered all such further and other - A28 - 29 acts, instruments and assurances as may reasonably be required by the Rights Agent for the carrying out or performing by the Rights Agent of the provisions of this Agreement. (g) The Rights Agent is hereby authorized and directed to accept instructions with respect to the performance of its duties hereunder from any one of the Chairman, the Chief Executive Officer the President, any Vice President, the Secretary or the Treasurer of the Company, and to apply to such officers for advice or instructions in connection with its duties, and it shall not be liable for any action taken or suffered by it in good faith in accordance with instructions of any such officer or for any delay in acting while waiting for those instructions. (h) The Rights Agent and any shareholder, director, officer or employee of the Rights Agent may buy, sell or deal in any of the Rights or other securities of the Company or become pecuniarily interested in any transaction in which the Company may be interested, or contract with or lend money to the Company or otherwise act as fully and freely as though it were not Rights Agent under this Agreement. Nothing herein shall preclude the Rights Agent from acting in any other capacity for the Company or for any other legal entity. (i) The Rights Agent may execute and exercise any of the rights or powers hereby vested in it or perform any duty hereunder either itself or by or through its attorneys or agents, and the Rights Agent shall not be answerable or accountable for any act, default, neglect or misconduct of any such attorneys or agents or for any loss to the Company resulting from any such act, default, neglect or misconduct, provided reasonable care was exercised in the selection and continued employment thereof. (j) No provision of this Agreement shall require the Rights Agent to expend or risk its own funds or otherwise incur any financial liability in the performance of any of its duties hereunder or in the exercise of its rights if there shall be reasonable grounds for believing that repayment of such funds or adequate indemnification against such risk or liability is not reasonably assured to it. (k) If, with respect to any Right Certificate surrendered to the Rights Agent for exercise or transfer, the certificate attached to the form of assignment or form of election to purchase, as the case may be, has either not been completed or indicates an affirmative response to clause 1 and/or 2 on such certificate attached to the form of assignment or form of election to purchase, the Rights Agent shall not take any further action with respect to such requested exercise or transfer without first consulting with the Company. Section 21. Change of Rights Agent. The Rights Agent or any successor Rights Agent may resign and be discharged from its duties under this Agreement upon 30 days' notice in writing mailed to the Company and to each transfer agent of the Common Shares or Preferred - A29 - 30 Shares by registered or certified mail, and to the holders of the Right Certificates by first-class mail. The Company may remove the Rights Agent or any successor Rights Agent upon 30 days' notice in writing, mailed to the Rights Agent or successor Rights Agent, as the case may be, and to each transfer agent of the Common Shares or Preferred Shares by registered or certified mail, and to the holders of the Right Certificates by first-class mail. If the Rights Agent shall resign or be removed or shall otherwise become incapable of acting, the Company shall appoint a successor to the Rights Agent. If the Company shall fail to make such appointment within a period of 30 days after giving notice of such removal or after it has been notified in writing of such resignation or incapacity by the resigning or incapacitated Rights Agent or by the holder of a Right Certificate (who shall, with such notice, submit his Right Certificate for inspection by the Company), then the registered holder of any Right Certificate may apply to any court of competent jurisdiction for the appointment of a new Rights Agent. Any successor Rights Agent, whether appointed by the Company or by such a court, shall be a corporation or an affiliate of such corporation organized and doing business under the laws of the United States or of the Commonwealth of Pennsylvania (or of any other state of the United States so long as such corporation is authorized to do business as a banking institution in the Commonwealth of Pennsylvania), in good standing, having an office in the Commonwealth of Pennsylvania, which is authorized under such laws to exercise corporate trust or stock transfer powers and is subject to supervision or examination by federal or state authority and which has at the time of its appointment as Rights Agent a combined capital and surplus of at least $50 million. After appointment, the successor Rights Agent shall be vested with the same powers, rights, duties and responsibilities as if it had been originally named as Rights Agent without further act or deed; but the predecessor Rights Agent shall deliver and transfer to the successor Rights Agent any property at the time held by it hereunder, and execute and deliver any further assurance, conveyance, act or deed necessary for the purpose. Not later than the effective date of any such appointment, the Company shall file notice thereof in writing with the predecessor Rights Agent and each transfer agent of the Common Shares or Preferred Shares, and mail a notice thereof in writing to the registered holders of the Right Certificates. Failure to give any notice provided for in this Section 21, however, or any defect therein, shall not affect the legality or validity of the resignation or removal of the Rights Agent or the appointment of the successor Rights Agent, as the case may be. Section 22. Issuance of New Right Certificates. Notwithstanding any of the provisions of this Agreement or of the Rights to the contrary, the Company may, at its option, issue new Right Certificates evidencing Rights in such form as may be approved by the Board of Directors to reflect any adjustment or change in the Purchase Price and the number or kind or class of shares or other securities or property purchasable under the Right Certificates made in accordance with the provisions of this Agreement. Section 23. Redemption. - A30 - 31 (a) The Board of Directors may, at its option, at any time prior to such time as any Person becomes an Acquiring Person, redeem all but not less than all the then outstanding Rights at a redemption price of $.01 per Right, appropriately adjusted to reflect any stock split, stock dividend or similar transaction occurring after the date hereof (such redemption price being hereinafter referred to as the "Redemption Price"). The redemption of the Rights by the Board of Directors may be made effective at such time, on such basis and with such conditions as the Board of Directors, in its sole discretion, may establish. (b) Immediately upon the action of the Board of Directors ordering the redemption of the Rights pursuant to paragraph (a) of this Section 23, and without any further action and without any notice, the right to exercise the Rights will terminate and the only right thereafter of the holders of Rights shall be to receive the Redemption Price. The Company shall promptly give public notice of any such redemption; provided, however, that the failure to give, or any defect in, any such notice shall not affect the validity of such redemption. Within 10 days after such action of the Board of Directors ordering the redemption of the Rights, the Company shall mail a notice of redemption to all the holders of the then outstanding Rights at their last addresses as they appear upon the registry books of the Rights Agent or, prior to the Distribution Date, on the registry books of the transfer agent for the Common Shares. Any notice which is mailed in the manner herein provided shall be deemed given, whether or not the holder receives the notice. Each such notice of redemption will state the method by which the payment of the Redemption Price will be made. Neither the Company nor any of its Affiliates or Associates may redeem, acquire or purchase for value any Rights at any time in any manner other than that specifically set forth in this Section 23 or in Section 24 hereof, and other than in connection with the purchase of Common Shares prior to the Distribution Date. Section 24. Exchange. (a) The Board of Directors may, at its option (but subject to the provisions of Chapter 15 of the Pennsylvania Business Corporation Law of 1988, or any successor provision thereto, relating to the consideration to be paid for shares with a par value), at any time after any Person becomes an Acquiring Person, exchange all or part of the then outstanding and exercisable Rights (which shall not include Rights that have become void pursuant to the provisions of Section 11(a)(ii) hereof) for Common Shares at an exchange ratio of one Common Share per Right, appropriately adjusted to reflect any stock split, stock dividend or similar transaction occurring after the date hereof (such exchange ratio being hereinafter referred to as the "Exchange Ratio"). Notwithstanding the foregoing, the Board of Directors shall not be empowered to effect such exchange at any time after any Person (other than the Company, any Subsidiary of the Company, any employee benefit plan of the Company or of any Subsidiary of the Company or any entity holding Common Shares for or pursuant to the terms of any such plan, - A31 - 32 together with all Affiliates and Associates of such Person, becomes the Beneficial Owner of 50% or more of the Common Shares then outstanding. (b) Immediately upon the action of the Board of Directors ordering the exchange of any Rights pursuant to paragraph (a) of this Section 24 and without any further action and without any notice, the right to exercise such Rights shall terminate and the only right thereafter of a holder of such Rights shall be to receive that number of Common Shares equal to the number of such Rights held by such holder multiplied by the Exchange Ratio. The Company shall promptly give public notice of any such exchange; provided, however, that the failure to give, or any defect in, such notice shall not affect the validity of such exchange. The Company promptly shall mail a notice of any such exchange to all of the holders of such Rights at their last addresses as they appear upon the registry books of the Rights Agent. Any notice which is mailed in the manner herein provided shall be deemed given, whether or not the holder receives the notice. Each such notice of exchange will state the method by which the exchange of the Common Shares for Rights will be effected and, in the event of any partial exchange, the number of Rights which will be exchanged. Any partial exchange shall be effected pro rata based on the number of Rights (other than Rights which have become void pursuant to the provisions of Section 11(a)(ii) hereof) held by each holder of Rights. (c) In the event that there shall not be sufficient Common Shares issued but not outstanding or authorized but unissued to permit any exchange of Rights as contemplated in accordance with this Section 24, the Company shall take all such action as may be necessary to authorize additional Common Shares for issuance upon exchange of the Rights. In the event the Company shall, after good faith effort, be unable to take all such action as may be necessary to authorize such additional Common Shares, the Company shall substitute, for each Common Share that would otherwise be issuable upon exchange of a Right, a number of Preferred Shares or fraction thereof such that the Current Per Share Market Price of one Preferred Share multiplied by such number or fraction is equal to the Current Per Share Market Price of one Common Share as of the date of issuance of such Preferred Shares or fraction thereof. (d) The Company shall not be required to issue fractions of Common Shares or to distribute certificates which evidence fractional Common Shares. In lieu of such fractional Common Shares, the Company shall pay to the registered holders of the Right Certificates with regard to which such fractional Common Shares would otherwise be issuable an amount in cash equal to the same fraction of the current market value of a whole Common Share. For the purposes of this paragraph (d), the current market value of a whole Common Share shall be the closing price of a Common Share (as determined pursuant to the second sentence of Section 11(d)(i) hereof) for the Trading Day immediately prior to the date of exchange pursuant to this Section 24. - A32 - 33 Section 25. Notice of Certain Events. (a) In case the Company shall propose, at any time after the Distribution Date, (i) to pay any dividend payable in stock of any class to the holders of its Preferred Shares or to make any other distribution to the holders of its Preferred Shares (other than a regular quarterly cash dividend), (ii) to offer to the holders of its Preferred Shares rights or warrants to subscribe for or to purchase any additional Preferred Shares or shares of stock of any class or any other securities, rights or options, (iii) to effect any reclassification of its Preferred Shares (other than a reclassification involving only the subdivision of outstanding Preferred Shares), (iv) to effect any consolidation or merger into or with, or to effect any sale or other transfer (or to permit one or more of its Subsidiaries to effect any sale or other transfer), in one or more transactions, of 50% or more of the assets or earning power of the Company and its Subsidiaries (taken as a whole) to, any other Person, (v) to effect the liquidation, dissolution or winding up of the Company, or (vi) to declare or pay any dividend on the Common Shares payable in Common Shares or to effect a subdivision, combination or consolidation of the Common Shares (by reclassification or otherwise than by payment of dividends in Common Shares), then, in each such case, the Company shall give to each holder of a Right Certificate, in accordance with Section 26 hereof, a notice of such proposed action, which shall specify the record date for the purposes of such stock dividend, or distribution of rights or warrants, or the date on which such reclassification, consolidation, merger, sale, transfer, liquidation, dissolution, or winding up is to take place and the date of participation therein by the holders of the Common Shares and/or Preferred Shares, if any such date is to be fixed, and such notice shall be so given in the case of any action covered by clause (i) or (ii) above at least 10 days prior to the record date for determining holders of the Preferred Shares for purposes of such action, and in the case of any such other action, at least 10 days prior to the date of the taking of such proposed action or the date of participation therein by the holders of the Common Shares and/or Preferred Shares, whichever shall be the earlier. (b) In case any event set forth in Section 11(a)(ii) hereof shall occur, then the Company shall as soon as practicable thereafter give to each holder of a Right Certificate, in accordance with Section 26 hereof, a notice of the occurrence of such event, which notice shall describe such event and the consequences of such event to holders of Rights under Section 11(a)(ii) hereof. Section 26. Notices. Notices or demands authorized by this Agreement to be given or made by the Rights Agent or by the holder of any Right Certificate to or on the Company shall be sufficiently given or made if sent by first-class mail, postage prepaid, addressed (until another address is filed in writing with the Rights Agent) as follows: Education Management Corporation 300 Sixth Avenue - A33 - 34 Pittsburgh, Pennsylvania 15222 Attention: Corporate Secretary Subject to the provisions of Section 21 hereof, any notice or demand authorized by this Agreement to be given or made by the Company or by the holder of any Right Certificate to or on the Rights Agent shall be sufficiently given or made if sent by first-class mail, postage prepaid, addressed (until another address is filed in writing with the Company) as follows: Jack Livingston, Vice-President ChaseMellon Shareholder Services, L.L.C. Four Station Square Third Floor Pittsburgh, PA 15219 Notices or demands authorized by this Agreement to be given or made by the Company or the Rights Agent to the holder of any Right Certificate shall be sufficiently given or made if sent by first-class mail, postage prepaid, addressed to such holder at the address of such holder as shown on the registry books of the Rights Agent. Section 27. Supplements and Amendments. The Company may from time to time supplement or amend this Agreement without the approval of any holders of Right Certificates in order to cure any ambiguity, to correct or supplement any provision contained herein which may be defective or inconsistent with any other provisions herein, or to make any other provisions with respect to the Rights which the Company may deem necessary or desirable, any such supplement or amendment to be evidenced by a writing signed by the Company and the Rights Agent; provided, however, that from and after such time as any Person becomes an Acquiring Person, this Agreement shall not be amended in any manner which would adversely affect the interests of the holders of Rights. Upon the delivery of a certificate from an appropriate officer of the Company, which states that the proposed supplement or amendment is in compliance with the terms of this Section 27, the Rights Agent shall execute such supplement or amendment. Section 28. Successors. All the covenants and provisions of this Agreement by or for the benefit of the Company or the Rights Agent shall bind and inure to the benefit of their respective successors and assigns hereunder. Section 29. Benefits of This Agreement. Nothing in this Agreement shall be construed to give to any Person other than the Company, the Rights Agent and the registered holders of the Right Certificates (and, prior to the Distribution Date, the Common Shares) any - A34 - 35 legal or equitable right, remedy or claim under this Agreement; but this Agreement shall be for the sole and exclusive benefit of the Company, the Rights Agent and the registered holders of the Right Certificates (and, prior to the Distribution Date, the Common Shares). Section 30. Severability. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction or other authority to be invalid, void or unenforceable, the remainder of the terms, provisions, covenants and restrictions of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. Section 31. Governing Law. This Agreement and each Right Certificate issued hereunder shall be deemed to be a contract made under the laws of the Commonwealth of Pennsylvania and for all purposes shall be governed by and construed in accordance with the laws of such Commonwealth applicable to contracts to be made and performed entirely within such Commonwealth. Section 32. Counterparts. This Agreement may be executed in any number of counterparts and each of such counterparts shall for all purposes be deemed to be an original, and all such counterparts shall together constitute but one and the same instrument. Section 33. Descriptive Headings. Descriptive headings of the several Sections of this Agreement are inserted for convenience only and shall not control or affect the meaning or construction of any of the provisions hereof. Section 34. Effective Date of This Agreement. This Agreement shall be effective upon and subject to the consummation of the Company's initial public offering. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] - A35 - 36 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and attested, all as of the day and year first above written. Attest: EDUCATION MANAGEMENT CORPORATION By /s/ DANIEL K. O'DAY By /s/ FREDRICK W. STEINBERG ---------------------------- ------------------------------- Name: Daniel K. O'Day Name: Fredrick W. Steinberg Title: Assistant Treasurer Title: Vice President General Counsel and Secretary MELLON BANK, N.A. Attest: By /s/ J. D. CURTIN By /s/ J. A. LIVINGSTON ---------------------------- ------------------------------- Name: J. D. Curtin Name: J. A. Livingston Title: Authorized Officer Title: Authorized Officer - A36 - 37 Exhibit A FORM of CERTIFICATE OF DESIGNATIONS of SERIES A JUNIOR PARTICIPATING PREFERRED STOCK of EDUCATION MANAGEMENT CORPORATION (Pursuant to Section 1522 of the Pennsylvania Business Corporation Law of 1988) - - - - - - - - - - - - - - - - - - - - - - Education Management Corporation, a corporation organized and existing under the Business Corporation Law of the Commonwealth of Pennsylvania (hereinafter called the "Corporation"), hereby certifies that the following resolution was adopted by the Board of Directors of the Corporation as required by Section 1522 of the Pennsylvania Business Corporation Law of 1988 at a meeting duly called and held on August 15, 1996 RESOLVED, that pursuant to the authority granted to and vested in the Board of Directors of this Corporation (hereinafter called the "Board of Directors" or the "Board") in accordance with the provisions of the Restated Articles of Incorporation, the Board of Directors hereby creates a series of Preferred Stock, par value one cent ($0.01) per share, of the Corporation (the "Preferred Stock") and hereby states the designation and number of shares, and fixes the relative rights, preferences, and limitations thereof as follows: SERIES A JUNIOR PARTICIPATING PREFERRED STOCK Section 1. Designation and Amount. The shares of such series shall be designated as "Series A Junior Participating Preferred Stock" (the "Series A Preferred Stock") and the number of shares constituting the Series A Preferred Stock shall be 600,000. Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, that no - A37 - 38 decrease shall reduce the number of shares of Series A Preferred Stock to a number less than the number of shares then outstanding plus the number of shares reserved for issuance upon the exercise of outstanding options, rights or warrants or upon the conversion of any outstanding securities issued by the Corporation convertible into Series A Preferred Stock. Section 2. Dividends and Distributions. (A) Subject to the rights of the holders of any shares of any series of Preferred Stock (or any similar stock) ranking prior and superior to the Series A Preferred Stock with respect to dividends, the holders of shares of Series A Preferred Stock, in preference to the holders of Common Stock, par value $.01 per share (the "Common Stock"), of the Corporation, and of any other junior stock, shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for the purpose, quarterly dividends payable in cash on the first day of March, June, September and December in each year (each such date being referred to herein as a "Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of Series A Preferred Stock, in an amount per share (rounded to the nearest cent) equal to the greater of (a) $1 or (b) subject to the provision for adjustment hereinafter set forth, 100 times the aggregate per share amount of all cash dividends, and 100 times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions, other than a dividend payable in shares of Common Stock or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock since the immediately preceding Quarterly Dividend Payment Date or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of Series A Preferred Stock. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the amount to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event under clause (b) of the preceding sentence shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (B) The Corporation shall declare a dividend or distribution on the Series A Preferred Stock as provided in paragraph (A) of this Section immediately after it declares a dividend or distribution on the Common Stock (other than a dividend payable in shares of Common Stock); provided that, in the event no dividend or distribution shall have been - A38 - 39 declared on the Common Stock during the period between any Quarterly Dividend Payment Date and the next subsequent Quarterly Dividend Payment Date, a dividend of $1 per share on the Series A Preferred Stock shall nevertheless be payable on such subsequent Quarterly Dividend Payment Date. (C) Dividends shall begin to accrue and be cumulative on outstanding shares of Series A Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such shares, unless the date of issue of such shares is prior to the record date for the first Quarterly Dividend Payment Date, in which case dividends on such shares shall begin to accrue from the date of issue of such shares, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares of Series A Preferred Stock entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date, in either of which events such dividends shall begin to accrue and be cumulative from such Quarterly Dividend Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends paid on the shares of Series A Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of Series A Preferred Stock entitled to receive payment of a dividend or distribution declared thereon, which record date shall be not more than 60 days prior to the date fixed for the payment thereof. Section 3. Voting Rights. The holders of shares of Series A Preferred Stock shall have the following voting rights: (A) Subject to the provision for adjustment hereinafter set forth, each share of Series A Preferred Stock shall entitle the holder thereof to 100 votes on all matters submitted to a vote of the shareholders of the Corporation. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the number of votes per share to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event shall be adjusted by multiplying such number by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. - A39 - 40 (B) Except as otherwise provided herein, in any other Certificate of Designations creating a series of Preferred Stock or any similar stock, or by law, the holders of shares of Series A Preferred Stock and the holders of shares of Common Stock and any other capital stock of the Corporation having general voting rights shall vote together as one class on all matters submitted to a vote of shareholders of the Corporation. (C) Except as set forth herein, or as otherwise provided by law, holders of Series A Preferred Stock shall have no special voting rights and their consent shall not be required (except to the extent they are entitled to vote with holders of Common Stock as set forth herein) for taking any corporate action. Section 4. Certain Restrictions. (A) Whenever quarterly dividends or other dividends or distributions payable on the Series A Preferred Stock as provided in Section 2 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series A Preferred Stock outstanding shall have been paid in full, the Corporation shall not: (i) declare or pay dividends, or make any other distributions, on any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock; (ii) declare or pay dividends, or make any other distributions, on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except dividends paid ratably on the Series A Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; (iii) redeem or purchase or otherwise acquire for consideration shares of any stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock, provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such junior stock in exchange for shares of any stock of the Corporation ranking junior (either as to dividends or upon dissolution, liquidation or winding up) to the Series A Preferred Stock; or - A40 - 41 (iv) redeem or purchase or otherwise acquire for consideration any shares of Series A Preferred Stock, or any shares of stock ranking on a parity with the Series A Preferred Stock, except in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of such shares upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes. (B) The Corporation shall not permit any subsidiary of the Corporation to purchase or otherwise acquire for consideration any shares of stock of the Corporation unless the Corporation could, under paragraph (A) of this Section 4, purchase or otherwise acquire such shares at such time and in such manner. Section 5. Reacquired Shares. Any shares of Series A Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and cancelled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of Preferred Stock and may be reissued as part of a new series of Preferred Stock subject to the conditions and restrictions on issuance set forth herein, in the Certificate of Incorporation, or in any other Certificate of Designations creating a series of Preferred Stock or any similar stock or as otherwise required by law. Section 6. Liquidation, Dissolution or Winding Up. Upon any liquidation, dissolution or winding up of the Corporation, no distribution shall be made (1) to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock unless, prior thereto, the holders of shares of Series A Preferred Stock shall have received $100 per share, plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment, provided that the holders of shares of Series A Preferred Stock shall be entitled to receive an aggregate amount per share, subject to the provision for adjustment hereinafter set forth, equal to 100 times the aggregate amount to be distributed per share to holders of shares of Common Stock, or (2) to the holders of shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except distributions made ratably on the Series A Preferred Stock and all such parity stock in proportion to the total amounts to which the holders of all such shares are entitled upon such liquidation, dissolution or winding up. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of - A41 - 42 Common Stock, then in each such case the aggregate amount to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event under the proviso in clause (1) of the preceding sentence shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. Section 7. Consolidation, Merger, etc. In case the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or securities, cash and/or any other property, then in any such case each share of Series A Preferred Stock shall at the same time be similarly exchanged or changed into an amount per share, subject to the provision for adjustment hereinafter set forth, equal to 100 times the aggregate amount of stock, securities, cash and/or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the amount set forth in the preceding sentence with respect to the exchange or change of shares of Series A Preferred Stock shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. Section 8. No Redemption. The shares of Series A Preferred Stock shall not be redeemable. Section 9. Rank. The Series A Preferred Stock shall rank, with respect to the payment of dividends and the distribution of assets, junior to all series of any other class of the Corporation's Preferred Stock. Section 10. Amendment. The Certificate of Incorporation of the Corporation shall not be amended in any manner which would materially alter or change the powers, preferences or special rights of the Series A Preferred Stock so as to affect them adversely without the affirmative vote of the holders of at least two-thirds of the outstanding shares of Series A Preferred Stock, voting together as a single class. - A42 - 43 IN WITNESS WHEREOF, this Certificate of Designations is executed on behalf of the Corporation by its _______________________ and attested by its ___________________ this ______ day of _________________, 1996. _______________________________ Attest: __________________________________ - A43 - 44 Exhibit B FORM OF RIGHT CERTIFICATE Certificate No. R- ___________ Rights NOT EXERCISABLE AFTER _______ __, 2006 OR EARLIER IF REDEMPTION OR EXCHANGE OCCURS. THE RIGHTS ARE SUBJECT TO REDEMPTION AT $.01 PER RIGHT AND TO EXCHANGE ON THE TERMS SET FORTH IN THE RIGHTS AGREEMENT. Right Certificate EDUCATION MANAGEMENT CORPORATION This certifies that ______________, or registered assigns, is the registered owner of the number of Rights set forth above, each of which entitles the owner thereof, subject to the terms, provisions and conditions of the Rights Agreement, dated as of October 1, 1996 (the "Rights Agreement"), between Education Management Corporation, a Pennsylvania corporation (the "Company"), and Mellon Bank, N.A., a national banking association (the "Rights Agent"), to purchase from the Company at any time after the Distribution Date (as such term is defined in the Rights Agreement) and prior to 5:00 P.M., Pittsburgh, Pennsylvania time, on the tenth anniversary of the date of the consummation of the offering at the principal office of the Rights Agent, or at the office of its successor as Rights Agent, one one-hundredth of a fully paid non-assessable share of Series A Junior Participating Preferred Stock, par value one cent ($0.01) per share, of the Company (the "Preferred Shares"), at a purchase price of $__ per one one-hundredth of a Preferred Share (the "Purchase Price"), upon presentation and surrender of this Right Certificate with the Form of Election to Purchase duly executed. The number of Rights evidenced by this Right Certificate (and the number of one one-hundredths of a Preferred Share which may be purchased upon exercise hereof) set forth above, and the Purchase Price set forth above, are the number and Purchase Price as of ________ ___, 1996, based on the Preferred Shares as constituted at such date. As provided in the Rights Agreement, the Purchase Price and the number of one one-hundredths of a Preferred Share which may be purchased upon the exercise of the Rights evidenced by this Right Certificate are subject to modification and adjustment upon the happening of certain events. This Right Certificate is subject to all of the terms, provisions and conditions of the Rights Agreement, which terms, provisions and conditions are hereby incorporated herein by reference and made a part hereof and to which Rights Agreement reference is hereby made for a - B1 - 45 full description of the rights, limitations of rights, obligations, duties and immunities hereunder of the Rights Agent, the Company and the holders of the Right Certificates. Copies of the Rights Agreement are on file at the principal executive offices of the Company and the offices of the Rights Agent. This Right Certificate, with or without other Right Certificates, upon surrender at the principal office of the Rights Agent, may be exchanged for another Right Certificate or Right Certificates of like tenor and date evidencing Rights entitling the holder to purchase a like aggregate number of Preferred Shares as the Rights evidenced by the Right Certificate or Right Certificates surrendered shall have entitled such holder to purchase. If this Right Certificate shall be exercised in part, the holder shall be entitled to receive upon surrender hereof another Right Certificate or Right Certificates for the number of whole Rights not exercised. Subject to the provisions of the Rights Agreement, the Rights evidenced by this Right Certificate (i) may be redeemed by the Company at a redemption price of $.01 per Right or (ii) may be exchanged in whole or in part for Preferred Shares or shares of the Company's Common Stock, par value $.01 per share. No fractional Preferred Shares will be issued upon the exercise of any Right or Rights evidenced hereby (other than fractions which are integral multiples of one one-hundredth of a Preferred Share, which may, at the election of the Company, be evidenced by depositary receipts), but, in lieu thereof, a cash payment will be made, as provided in the Rights Agreement. No holder of this Right Certificate shall be entitled to vote or receive dividends or be deemed for any purpose the holder of the Preferred Shares or of any other securities of the Company which may at any time be issuable on the exercise hereof, nor shall anything contained in the Rights Agreement or herein be construed to confer upon the holder hereof, as such, any of the rights of a stockholder of the Company or any right to vote for the election of directors or upon any matter submitted to shareholder at any meeting thereof, or to give or withhold consent to any corporate action, or to receive notice of meetings or other actions affecting shareholders (except as provided in the Rights Agreement), or to receive dividends or subscription rights, or otherwise, until the Right or Rights evidenced by this Right Certificate shall have been exercised as provided in the Rights Agreement. This Right Certificate shall not be valid or obligatory for any purpose until it shall have been countersigned by the Rights Agent. WITNESS the facsimile signature of the proper officers of the Company and its corporate seal. Dated as of _____________________. - B2 - 46 ATTEST: EDUCATION MANAGEMENT CORPORATION _____________________________ By________________________________ Name: Name: Title: Title: Countersigned: [TRUST COMPANY] By_____________________________ Name: Title: - B3 - 47 Form of Reverse Side of Right Certificate FORM OF ASSIGNMENT (To be executed by the registered holder if such holder desires to transfer the Right Certificate.) FOR VALUE RECEIVED ____________________ hereby sells, assigns and transfers unto ___________________________________________________________ (Please print name and address of transferee) ______________________________________________________________________________ this Right Certificate, together with all right, title and interest therein, and does hereby irrevocably constitute and appoint ___________ Attorney, to transfer the within Right Certificate on the books of the within-named Company, with full power of substitution. Dated: _______________, ____ _________________________________ Signature Signature Guaranteed: Signatures must be guaranteed by a member firm of a registered national securities exchange, a member of the National Association of Securities Dealers, Inc., or a commercial bank or trust company having an office or correspondent in the United States or by another eligible guarantor institution, as defined in Rule 17Ad-15 under the Securities Exchange Act of 1934. - - - - - - - - - - - - - - - - - - - - - - - - - - - - - The undersigned hereby certifies that the Rights evidenced by this Right Certificate are not beneficially owned by an Acquiring Person or an Affiliate or Associate thereof (as defined in the Rights Agreement). _________________________________ Signature - B4 - 48 Form of Reverse Side of Right Certificate -- continued FORM OF ELECTION TO PURCHASE (To be executed if holder desires to exercise Rights represented by the RightCertificate.) To: EDUCATION MANAGEMENT CORPORATION The undersigned hereby irrevocably elects to exercise __________ Rights represented by this Right Certificate to purchase the Preferred Shares issuable upon the exercise of such Rights and requests that certificates for such Preferred Shares be issued in the name of: Please insert social security or other identifying number ______________________________________________________________________________ (Please print name and address) ______________________________________________________________________________ If such number of Rights shall not be all the Rights evidenced by this Right Certificate, a new Right Certificate for the balance remaining of such Rights shall be registered in the name of and delivered to: Please insert social security or other identifying number ______________________________________________________________________________ (Please print name and address) ______________________________________________________________________________ Dated: ________________, ____ _________________________________ Signature Signature Guaranteed: - B5 - 49 Signatures must be guaranteed by a member firm of a registered national securities exchange, a member of the National Association of Securities Dealers, Inc., or a commercial bank or trust company having an office or correspondent in the United States or by another eligible guarantor institution, as defined in Rule 17Ad-15 under the Securities Exchange Act of 1934. Form of Reverse Side of Right Certificate -- continued - - - - - - - - - - - - - - - - - - - - - - - - - - - - - The undersigned hereby certifies that the Rights evidenced by this Right Certificate are not beneficially owned by an Acquiring Person or an Affiliate or Associate thereof (as defined in the Rights Agreement). _________________________________ Signature - - - - - - - - - - - - - - - - - - - - - - - - - - - - - NOTICE The signature in the Form of Assignment or Form of Election to Purchase, as the case may be, must conform to the name as written upon the face of this Right Certificate in every particular, without alteration or enlargement or any change whatsoever. In the event the certification set forth above in the Form of Assignment or the Form of Election to Purchase, as the case may be, is not completed, the Company and the Rights Agent will deem the beneficial owner of the Rights evidenced by this Right Certificate to be an Acquiring Person or an Affiliate or Associate thereof (as defined in the Rights Agreement) and such Assignment or Election to Purchase will not be honored. - B6 - 50 Exhibit C SUMMARY OF RIGHTS TO PURCHASE PREFERRED SHARES On _______ __, 1996, the Board of Directors of Education Management Corporation (the "Company") declared a dividend of one preferred share purchase right (a "Right") for each outstanding share of common stock, par value $.01 per share, of the Company (the "Common Shares"). The dividend is payable on on the date of the consummation of the offering (the "Record Date") to the shareholders of record on that date. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value one cent ($0.01) per share, of the Company (the "Preferred Shares") at a price of $____ per one one-hundredth of a Preferred Share (the "Purchase Price"), subject to adjustment. The description and terms of the Rights are set forth in a Rights Agreement dated as of October 1, 1996 (the "Rights Agreement") between the Company and Mellon Bank, N.A., as Rights Agent (the "Rights Agent"). Until the earlier to occur of (i) 10 days following a public announcement that a person or group of affiliated or associated persons (an "Acquiring Person") have acquired beneficial ownership of 17.5% or more of the outstanding Common Shares or (ii) 10 business days (or such later date as may be determined by action of the Board of Directors of the Company prior to such time as any person or group of affiliated persons becomes an Acquiring Person) following the commencement of, or announcement of an intention to make, a tender offer or exchange offer the consummation of which would result in the beneficial ownership by a person or group of 17.5% or more of the outstanding Common Shares (the earlier of such dates being the "Distribution Date"), the Rights will be evidenced, with respect to any of the Common Share certificates outstanding as of the Record Date, by such Common Share certificate with a copy of this Summary of Rights attached thereto. The Rights Agreement contains exceptions from its operating provision for a person who or which shall become the Beneficial Owner of 17.5% or more of the Common Shares then outstanding upon receipt of the prior approval of a majority of the Board of Directors. The Rights Agreement provides that, until the Distribution Date (or earlier redemption or expiration of the Rights), the Rights will be transferred with and only with the Common Shares. Until the Distribution Date (or earlier redemption or expiration of the Rights), new Common Share certificates issued after the Record Date upon transfer or new issuance of Common Shares will contain a notation incorporating the Rights Agreement by reference. Until the Distribution Date (or earlier redemption or expiration of the Rights), the surrender for transfer of any certificates for Common Shares outstanding as of the Record Date, even without such notation or a copy of this Summary of Rights being attached thereto, will also constitute the transfer of the Rights associated with the Common Shares represented by such certificate. As - C1 - 51 soon as practicable following the Distribution Date, separate certificates evidencing the Rights ("Right Certificates") will be mailed to holders of record of the Common Shares as of the close of business on the Distribution Date and such separate Right Certificates alone will evidence the Rights. The Rights are not exercisable until the Distribution Date. The Rights will expire on the tenth anniversary of the date of the consummation of the offering (the "Final Expiration Date"), unless the Final Expiration Date is extended or unless the Rights are earlier redeemed or exchanged by the Company, in each case, as described below. The Purchase Price payable, and the number of Preferred Shares or other securities or property issuable, upon exercise of the Rights are subject to adjustment from time to time to prevent dilution (i) in the event of a stock dividend on, or a subdivision, combination or reclassification of, the Preferred Shares; (ii) upon the grant to holders of the Preferred Shares of certain rights or warrants to subscribe for or purchase Preferred Shares at a price, or securities convertible into Preferred Shares with a conversion price; less than the then-current market price of the Preferred Shares or (iii) upon the distribution to holders of the Preferred Shares of evidences of indebtedness or assets (excluding regular periodic cash dividends paid out of earnings or retained earnings or dividends payable in Preferred Shares) or of subscription rights or warrants (other than those referred to above). The number of outstanding Rights and the number of one one-hundredths of a Preferred Share issuable upon exercise of each Right are also subject to adjustment in the event of a stock split of the Common Shares or a stock dividend on the Common Shares payable in Common Shares or subdivisions, consolidations or combinations of the Common Shares occurring, in any such case, prior to the Distribution Date. Preferred Shares purchasable upon exercise of the Rights will not be redeemable. Each Preferred Share will be entitled to a minimum preferential quarterly dividend payment of $1 per share but will be entitled to an aggregate dividend of 100 times the dividend declared per Common Share. In the event of liquidation, the holders of the Preferred Shares will be entitled to a minimum preferential liquidation payment of $100 per share but will be entitled to an aggregate payment of 100 times the payment made per Common Share. Each Preferred Share will have 100 votes, voting together with the Common Shares. Finally, in the event of any merger, consolidation or other transaction in which Common Shares are exchanged, each Preferred Share will be entitled to receive 100 times the amount received per Common Share. These rights are protected by customary antidilution provisions. Because of the nature of the Preferred Shares' dividend, liquidation and voting rights, the value of the one one-hundredth interest in a Preferred Share purchasable upon exercise of each Right should approximate the value of one Common Share. - C2 - 52 In the event that the Company is acquired in a merger or other business combination transaction or 50% or more of its consolidated assets or earning power are sold after a person or group has become an Acquiring Person, proper provision will be made so that each holder of a Right will thereafter have the right to receive, upon the exercise thereof at the then current exercise price of the Right, that number of shares of common stock of the acquiring company which at the time of such transaction will have a market value of two times the exercise price of the Right. In the event that any person or group of affiliated or associated persons becomes an Acquiring Person, proper provision shall be made so that each holder of a Right, other than Rights beneficially owned by the Acquiring Person (which will thereafter be void), will thereafter have the right to receive upon exercise that number of Common Shares having a market value of two times the exercise price of the Right. At any time after any person or group becomes an Acquiring Person and prior to the acquisition by such person or group of 50% or more of the outstanding Common Shares, the Board of Directors of the Company may exchange the Rights (other than Rights owned by such person or group which will have become void), in whole or in part, at an exchange ratio of one Common Share, or one one-hundredth of a Preferred Share, per Right (subject to adjustment). With certain exceptions, no adjustment in the Purchase Price will be required until cumulative adjustments require an adjustment of at least 1% in such Purchase Price. No fractional Preferred Shares will be issued (other than fractions which are integral multiples of one one-hundredth of a Preferred Share, which may, at the election of the Company, be evidenced by depositary receipts) and, in lieu thereof, an adjustment in cash will be made based on the market price of the Preferred Shares on the last trading day prior to the date of exercise. At any time prior to the acquisition by a person or group of affiliated or associated persons of beneficial ownership of 17.5% or more of the then outstanding Common Shares, the Board of Directors of the Company may redeem the Rights in whole, but not in part, at a price of $.01 per Right (the "Redemption Price"). The redemption of the Rights may be made effective at such time on such basis with such conditions as the Board of Directors in its sole discretion may establish. Immediately upon any redemption of the Rights, the right to exercise the Rights will terminate and the only right of the holders of Rights will be to receive the Redemption Price. The terms of the Rights may be amended by the Board of Directors of the Company without the consent of the holders of the Rights, except that from and after such time as any person or group of affiliated or associated persons becomes an Acquiring Person no such amendment may adversely affect the interests of the holders of the Rights. - C3 - 53 Until a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of the Company, including, without limitation, the right to vote or to receive dividends. A copy of the Rights Agreement has been filed with the Securities and Exchange Commission as an Exhibit to a Registration Statement on Form S-1 (Registration No.333-10385). A copy of the Rights Agreement is available free of charge from the Company. This summary description of the Rights does not purport to be complete and is qualified in its entirety by reference to the Rights Agreement, which is hereby incorporated herein by reference. - C4 - EX-10.19 6 EDUCATIONAL MANAGEMENT CORP. 1 EXHIBIT 10.19 COMMON STOCK REGISTRATION RIGHTS AGREEMENT as of August 15, 1996 The parties to this Common Stock Registration Rights Agreement ("Agreement") are Education Management Corporation, a Pennsylvania corporation (the "Company"); Marine Midland Bank, not in its corporate capacity, but solely as trustee (the "ESOP Trustee") of the Education Management Corporation Employee Stock Ownership Trust; The Northwestern Mutual Life Insurance Company ("Northwestern Mutual"); National Union Fire Insurance Company of Pittsburgh, PA ("National Union"); ML Employees LBO Partnership No. I, L.P., ML IBK Positions, Inc., Merrill Lynch KECALP L.P. 1986, ML Offshore LBO Partnership No. IV, Merrill Lynch Capital Corporation and Merrill Lynch Capital Appreciation Partnership IV, L.P. (collectively, the "ML Holders"); Robert B. Knutson, as trustee ("Knutson"); and those other persons who are signatories to this Agreement. This Agreement shall become effective when duly executed and delivered by the Company, the ESOP Trustee, Northwestern Mutual, National Union, the ML Holders and Robert B. Knutson and subject to and automatically upon the occurrence of the date (the "Effective Date") on which the Company first becomes subject to the periodic reporting requirements of Section 13 of the Exchange Act by virtue of its registration under Section 12 of the Exchange Act of Common Stock. The parties to this Agreement, intending to be legally bound hereby, agree as follows: I. Definitions. As used in this Agreement, the following terms shall have the following meanings: "affiliate" has the meaning ascribed to that term in Rule 1-02 of Regulation S-X promulgated under the Securities Act. "Common Stock" means the Common Stock, par value $.01 per share, of the Company. "Demand" has the meaning ascribed to that term in Section 3.1. "Effective Date" has the meaning ascribed to that term in the recitals to this Agreement. 1 2 "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time. "Incidental Registration" has the meaning ascribed to that term in Section 3.2. "Initiating Holder" means any of (i) the ESOP Trustee, (ii) Northwestern Mutual, (iii) National Union, (iv) any of the ML Holders, and (v) Knutson. "person" means an individual, partnership, corporation, trust or unincorporated organization, or a government or agency or political subdivision thereof. "Prospectus" means the prospectus included in any Registration Statement, as amended or supplemented by any prospectus supplement and by all other amendments, and supplements to such prospectus, including post-effective amendments, and all information incorporated by reference in such prospectus. "Registrable Securities" means any shares of Common Stock (i) owned as of the Effective Date by a party to this Agreement (other than any shares that are sold by any parties hereto in the initial public offering by the Company), (ii) underlying the option held on the Effective Date by one such party identified as an "Option Holder" in the signature page to this Agreement, or (iii) acquired after the Effective Date by a party to this Agreement by virtue of any stock split or combination, stock dividend or similar event in respect of any of the shares referred to in clause (i) or clause (ii) of this definition; provided, however, that shares of Common Stock that are Registrable Securities shall cease to be Registrable Securities upon the sale thereof pursuant to an effective Registration Statement or pursuant to Rule 144 (or successor rule) under the Securities Act or upon, in the case of any holder thereof, shares of Common Stock that have become saleable pursuant to Rule 144 without volume or other restrictions; and provided further that shares of Common Stock that are Registrable Securities shall continue to be Registrable Securities upon their transfer in a private transaction exempt from the registration requirements of the Securities Act to a person who is already a party to this Agreement (or an affiliate of any party to this Agreement) or who becomes a party to this Agreement by agreeing in writing to be bound by the terms of this Agreement, such agreement to be in form and substance reasonably satisfactory to the Company. "Registration Expenses" means all registration and filing fees, fees with respect to filings required to be made with the National Association of Securities Dealers, Inc. (the "NASD"), the fees and expenses of any "qualified independent underwriter" (and its counsel), if any, that is required to be retained by any holder of Registrable Securities in accordance with the rules and regulations of the NASD, fees and expenses of compliance with securities or blue sky laws (including reasonable fees and disbursements of one counsel for the underwriters or sellers of Registrable Securities in connection with blue sky qualifications of the Registrable Securities and determination of their eligibility for investment under the laws of such jurisdictions as the managing underwriters or holders of a majority of the Registrable Securities being sold may designate), printing expenses, messenger, telephone and distribution expenses associated with the preparation and distribution of any Registration Statement, any Prospectus, and amendments or 2 3 supplements thereto, any underwriting agreements, securities sales agreements and other documents relating to the performance of and compliance with this Agreement, all fees and expenses associated with the listing of any Registrable Securities on any securities exchange or exchanges, and fees and disbursements of counsel for the Company and its independent certified public accountants, any fees and expenses of underwriters customarily paid by issuers (but specifically excluding any Selling Expenses), the fees and expenses of other persons retained by the Company, and the reasonable fees and disbursements of one counsel to the holders of the Registrable Securities that are being sold, which counsel shall be reasonably satisfactory to the Company. "Registration Statement" means any registration statement of the Company filed under the Securities Act, including the Prospectus forming a part thereof, amendments and supplements to such Registration Statement, including post-effective amendments, and all exhibits to and all information incorporated by reference in such Registration Statement. "SEC" means the Securities and Exchange Commission. "Securities Act" means the Securities Act of 1933, as amended from time to time. "Selling Expenses" means, with respect to any holder of Registrable Securities, all underwriting discounts, selling commissions and stock transfer or documentary stamp taxes, if any, applicable to any Registrable Securities registered and sold by such holder, and all fees and disbursements of any counsel for such holder (other than any counsel fees expressly constituting a Registration Expense as defined in this Agreement). "Selling Holders" has the meaning ascribed to that term in Section 3.1. "underwritten offering" means an offering registered under the Securities Act in which securities are sold to an underwriter, whether on a "firm commitment", "best efforts" or other basis, for reoffering to the public. 2. Securities Subject to this Agreement. The only securities entitled to the benefits of this Agreement are the Registrable Securities. 3. Registration of Registrable Securities. 3.1 Demand Registration. (a) Demand. At any time after the first anniversary of the Effective Date and subject to the other provisions of this Agreement, any Initiating Holder or Holders shall have the right, exercisable by making a written request to the Company (with each such request being referred to hereinafter as a "Demand"), to require that the Company effect the registration in accordance with the provisions of the Securities Act of the offering and sale of any of the Registrable Securities held by such Initiating Holder or Holders, but in no event fewer than 500,000 shares per Initiating Holder (with such number to be adjusted, as appropriate, by the 3 4 Company to reflect any stock splits, reverse stock splits, stock combinations or the like occurring after the Effective Date). Upon receipt of one or more Demands, the Company shall promptly give written notice of the Demand to all other holders of Registrable Securities, and the Company shall use all reasonable efforts to effect, at the earliest practicable date, the registration under the Securities Act on Form S-3 (or a successor form thereto), including by means of a shelf registration on Form S-3 (or a successor form thereto) pursuant to Rule 415 under the Securities Act if so requested in such Demand (in any case only if Form S-3 (or such successor form) is then available to the Company and only if the Company is then eligible to use such a shelf registration), of (i) the offering and sale of the Registrable Securities that the Company has been so required to register by such Initiating Holder or Holders, and (ii) the offering and sale of all other Registrable Securities that the Company has been requested to register by the holders thereof (such holders together with the Initiating Holders being hereinafter referred to as the "Selling Holders") by written request given to the Company within 20 days after the giving of such written notice by the Company. (b) Effective Registration Statement. A registration requested pursuant to this Section 3.1 shall not be deemed to have been effected (i) unless a Registration Statement with respect thereto has become effective and remained effective in compliance with the provisions of the Securities Act with respect to the disposition of all Registrable Securities covered by such Registration Statement until such time as all of such Registrable Securities have been disposed of in accordance with the intended methods of disposition by the Selling Holders thereof set forth in such registration statement, unless the failure to so dispose of such Registrable Securities shall be caused solely by reason of a failure on the part of the Selling Holders); provided, that with respect to any registration statement filed pursuant to Rule 415 under the Securities Act, such period need not exceed 180 days, and that with respect to any other such registration statement, such period need not exceed 135 days, (ii) if, after it has become effective, such registration is interfered with by any stop order, injunction or other order or requirement of the SEC or other governmental agency or court for any reason not attributable to the Selling Holders and has not thereafter become effective, or (iii) if the conditions to closing specified in the underwriting agreement, if any, entered into in connection with such registration are not satisfied or waived, other than by reason of a failure on the part of the Selling Holders. (c) Selection of Underwriters. The underwriter or underwriters of each underwritten offering of the Registrable Securities so to be registered shall be selected by the Selling Holders of more than 50% of the Registrable Securities to be included in such registration and shall be reasonably acceptable to the Company. (d) Priority in Requested Registration. If the managing underwriter of any underwritten offering of Registrable Securities shall advise the Company in writing (and the Company shall so advise each Selling Holder of Registrable Securities requesting registration of such advice) that, in its opinion, the number of Registrable Securities requested to be included in such registration exceeds the number which can be sold in such offering within a price range acceptable to the Selling Holders of 66_% of the Registrable Securities requested to be included in such registration, the Company, except as provided in the following sentence, shall include in such registration, to the extent of the number which the Company is so advised can be sold in 4 5 such offering, Registrable Securities requested to be included in such registration allocated first to the Registrable Securities requested to be included in such registration by the Initiating Holder or the Initiating Holders exercising one or more Demands, and then, to the extent of the remainder of the number which the Company is so advised can be sold in the offering, pro rata among the other Selling Holders requesting such registration on the basis of the estimated gross proceeds from the sale thereof. If the total number of Registrable Securities requested by a Selling Holder to be included in such registration cannot be included as provided in the preceding sentence, a Selling Holder shall have the right to withdraw such Selling Holder's request for registration by giving written notice to the Company within 10 days after receipt of such notice by the Company and, in the event of such withdrawal, such request shall not be counted for purposes of the number of Demands an Initiating Holder is entitled pursuant to Section 3.1(e). (e) Limitations on Demand Registrations. No Initiating Holder may exercise more than two Demands during the term of this Agreement; provided, however, that for purposes of this sentence only the ML Holders shall be considered as a single group and accordingly the ML Holders may not exercise more than two Demands in the aggregate regardless of which ML Holder exercises a Demand. Following a registration pursuant to this Section 3.1, the Company shall not be required to effect another registration pursuant to this Section 3.1 for the six-month period immediately subsequent to the effectiveness (within the meaning of Section 3.1(b)) of the Registration Statement filed with respect to such first registration. In addition, the Company may delay the filing of any Registration Statement pursuant to this Section 3.1 for a reasonable period of time if, in the good faith judgment of the Board of Directors of the Company, the Company would be required to include in such registration statement material information which at that time could not be publicly disclosed without materially interfering with any financing, acquisition, corporate reorganization or other material development or transaction then pending or in progress and without other material adverse consequences; provided, however, that the duration of any such delay shall not exceed 90 days from the date the Company's Board of Directors actually becomes aware of such material development or transaction; and, provided, further, that the Company shall make such filing no later than the earlier of (i) the date on which the conditions that permitted it to delay such filing no longer pertain and (ii) the end of such 90-day period. In the event of any such delay, any Selling Holder shall have the right to withdraw his or its request for registration, and any such withdrawn request that would otherwise have been considered a Demand shall not be considered for purposes of the determining the maximum number of Demands provided for in the first sentence of this Section 3.1(e). 5 6 3.2 Incidental Registration. (a) Right to Include Registrable Securities. If the Company at any time proposes to register the offering and sale of shares of Common Stock under the Securities Act by registration on any form other than forms S-4 or S-8 (or any successors thereto) whether or not for sale for its own account, it shall each such time give prompt written notice to all holders of Registrable Securities of its intention to do so and of such holders' rights under this Section 3.2. Upon the written request of any such holder (a "Requesting Holder") made as promptly as practicable and in any event within 20 days after the receipt of any such notice (which request shall specify the Registrable Securities intended to be disposed of by such Requesting Holder and the intended methods of such disposition), the Company shall use all reasonable efforts to effect the registration under the Securities Act of all Registrable Securities which the Company has been so requested to register by the Requesting Holders thereof to the extent requisite to permit the disposition (in accordance with such intended methods thereof) of the Registrable Securities so to be registered; provided that (i) if such registration involves an underwritten public offering, all holders of Registrable Securities requesting to be included in the Company's registration must sell their Registrable Securities to the underwriters selected by the Company on the same terms and conditions as apply to the Company; and (ii) if, at any time after giving notice of its intention to register any securities pursuant to this Section 3.2(a) and prior to the effective date of the registration statement filed in connection with such registration, the Company shall determine for any reason not to register such securities, the Company shall give written notice to all holders of Registrable Securities and, thereupon, shall be relieved of its obligation to register any Registrable Securities in connection with such registration (but not from any obligation of the Company to pay the Registration Expenses in connection therewith), without prejudice, however, to the rights of holders under Section 3.1. If a registration pursuant to this Section 3.2(a) involves an underwritten public offering, any holder of Registrable Securities requesting to be included in such registration may elect, in writing prior to the effective date of the registration statement filed in connection with such registration, not to register such securities in connection with such registration. No registration effected under this Section 3.2 shall relieve the Company of its obligations to effect registrations upon request under Section 3.1. (b) Priority in Incidental Registrations. If the managing underwriter of the underwritten offering shall inform the Company by letter of its opinion that the number of Registrable Securities requested to be included in such registration would, in its opinion, materially adversely affect such offering, including the price at which such securities can be sold, and the Company has so advised the Requesting Holders in writing, then the Company shall include in such registration, to the extent of the number which the Company is so advised can be sold in (or during the time of) such offering, first, all securities proposed by the Company as so advised can be sold for its own account, second, to the extent that the number of shares of Common Stock which the Company proposes to sell for its own account pursuant to Section 3.2(a) is less than the number of shares of Common Stock which the Company has been advised can be sold in such offering without having the material adverse effect referred to above, such Registrable Securities requested to be included in such registration pursuant to this Section 3.2, allocated pro rata among such Requesting Holders on the basis of the estimated gross proceeds from the sale thereof. 6 7 4. Hold-Back Agreements. Each holder of Registrable Securities whose Registrable Securities are covered by a Registration Statement filed pursuant to Section 3 shall, if requested by the managing underwriter or underwriters in an underwritten offering, agree not to effect any public sale or distribution of securities of the Company of the same class as the securities included in such Registration Statement, including a sale pursuant to Rule 144 under the Securities Act, except as part of such underwritten registration, during the 15-day period prior to, and during a period of up to 120 days beginning on, the closing date of each underwritten offering made pursuant to such Registration Statement, to the extent timely notified in writing by the Company or the managing underwriter or underwriters. 5. Registration Procedures. In connection with the Company's obligations under Section 3, the Company shall use all reasonable efforts to effect such registration to permit the sale of such Registrable Securities in accordance with the intended method or methods of distribution thereof, and pursuant thereto the Company shall as expeditiously as practicable: (a) prepare and file with the SEC, as soon as practicable, a Registration Statement on an appropriate registration form, which Registration Statement shall comply as to form in all material respects with the requirements of the applicable form and include or incorporate by reference all financial statements required by the SEC to be filed therewith or incorporated by reference therein, and in either case use all reasonable efforts to cause such Registration Statement to become effective and remain effective in accordance with Section 3.1(b); provided, however, that before filing a Registration Statement or Prospectus or any amendment or supplement thereto, including information incorporated by reference after the initial filing of the Registration Statement, the Company shall furnish to the holders of the Registrable Securities covered by such Registration Statement and the managing underwriter or underwriters, if any, copies of all such documents proposed to be filed (including, upon request, any and all exhibits thereto), which documents shall be subject to the reasonable and prompt review of such holders and underwriters, and the Company shall not file any Registration Statement or amendment thereto or any Prospectus or any supplement thereto to which the holders of at least 50% of the Registrable Securities covered by such Registration Statement, or the managing underwriter or underwriters, if any, shall reasonably object; (b) prepare and file with the SEC such amendments and post-effective amendments to such Registration Statement as may be necessary to keep the Registration Statement effective for the applicable period, or such shorter period which shall terminate when all Registrable Securities covered by such Registration Statement have been sold; cause the Prospectus to be supplemented by any required Prospectus supplement, and to be filed pursuant to Rule 424 under the Securities Act; and comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such Registration Statement during the applicable period in accordance with the intended method or methods of distribution by the Selling Holders set forth in such Registration Statement or supplement to the Prospectus; 7 8 (c) notify the Selling Holders of Registrable Securities and the managing underwriter or underwriters, if any, promptly, and (if requested by any such person) confirm such advice in writing promptly, (1) when the Prospectus or any Prospectus supplement or post-effective amendment to the Registration Statement has been filed, and, with respect to such Registration Statement or any post-effective amendment thereto, when the same has become effective, (2) of any comments of the SEC or any state securities authority with regard to the Registration Statement and of any request by the SEC or any state securities authority for amendments or supplements to the Registration Statement or the Prospectus or for additional information, (3) of the issuance by the SEC or any state securities authority of any stop order suspending the effectiveness of the Registration Statement or the initiation of any proceedings for that purpose, (4) of the receipt by the Company of any notification with respect to the suspension of the qualification of the Registrable Securities for sale in any jurisdiction or the initiation or threatening of any proceeding for such purpose, (5) in the case of any shelf Registration Statement, if between the effective date of a Registration Statement and the closing of any sale of Registrable Securities covered thereby, the representations and warranties of the Company contained in any underwriting agreement, securities sale agreement or other similar agreement, relating to the offering cease to be true and correct in all material respects and (6) of the happening of any event or the discovery of any facts that makes any statement made in the Registration Statement, the Prospectus or any document incorporated therein by reference untrue in any material respect or which requires the making of any changes in the Registration Statement, the Prospectus or any document incorporated therein by reference in order to make the statements therein not contain an untrue statement of a material fact or omit to state any material fact necessary to make the statements therein not misleading; (d) make every reasonable effort to obtain the withdrawal of any order suspending the effectiveness of the Registration Statement at the earliest possible time; (e) if requested by the managing underwriter or underwriters or a Holder of Registrable Securities being offered for sale in connection with an underwritten offering, promptly incorporate in a Prospectus supplement or post-effective amendment such information as the managing underwriter or underwriters or such holder of Registrable Securities being offered for sale consider should be included therein relating to the plan of distribution with respect to such Registrable Securities, including, without limitation, information with respect to the number of Registrable Securities being offered for sale, the purchase price being paid therefor and with respect to any other terms of the offering of the Registrable Securities to be sold in such offering; and make all required filings of such Prospectus supplement or post-effective amendment as soon as practicable after being notified of the matters to be incorporated in such Prospectus supplement or post-effective amendment; (f) furnish to each selling holder of Registrable Securities and each managing underwriter, without charge, at least one signed copy of the Registration Statement, any amendment (including any post-effective amendment) thereto, including financial statements and schedules, all documents incorporated therein by reference and all exhibits (including those incorporated by reference); 8 9 (g) deliver to each selling holder of Registrable Securities and the underwriters, if any, without charge, as many copies of the Prospectus (including each preliminary prospectus) and any amendment or supplement thereto as such persons may reasonably request; (h) prior to any public offering of Registrable Securities, register or qualify or cooperate with the selling holders of Registrable Securities, the underwriters, if any, and their respective counsel in connection with the registration or qualification of such Registrable Securities for offer and sale under the state securities or blue sky laws of such jurisdictions as any seller or underwriter reasonably requests in writing and do any and all other acts or things necessary or advisable to enable the disposition in such jurisdictions of the Registrable Securities covered by the Registration Statement; provided that the Company shall not be required to qualify generally to do business in any jurisdiction where it is not then so qualified or to take any action which would subject it to general service of process in any such jurisdiction where it is not then so subject; (i) cooperate with the selling holders of Registrable Securities and the managing underwriter or underwriters, if any, to facilitate the timely preparation and delivery of certificates representing Registrable Securities to be sold without any restrictive legends; and enable such Registrable Securities to be in such denominations and registered in such names as the managing underwriter or underwriters may request at least two business days prior to any sale of Registrable Securities to underwriters; (j) upon the occurrence of any event contemplated by clause (6) of paragraph (c) above, prepare a supplement or post-effective amendment to the Registration Statement or the related Prospectus or any document incorporated therein by reference or file any other required document so that, as thereafter delivered to purchasers of the Registrable Securities, the Prospectus shall not contain an untrue statement of a material fact or omit to state any material fact necessary to make the statements therein not misleading; (k) use all reasonable efforts to cause all Registrable Securities covered by the Registration Statement to be listed on each securities exchange or on the Nasdaq National Market, if any, on which the Common Stock is then listed; (l) enter into such agreements (including an underwriting agreement) and take all such other actions in connection therewith in order to expedite or facilitate the disposition of Registrable Securities covered by a Registration Statement and in such connection, whether or not an underwriting agreement is entered into and whether or not the registration is an underwritten registration (1) make such representations and warranties to the holders of such Registrable Securities and the underwriters, if any, in form, substance and scope as are customarily made by issuers to underwriters in primary underwritten offerings; (2) obtain opinions of counsel to the Company and updates thereof (which counsel and opinions (in form, scope and substance) shall be reasonably satisfactory to the managing underwriter or underwriters, if any, and the holders of at least 50% of the Registrable Securities being sold, addressed to each selling holder and the underwriters, if any, covering the matters customarily covered in opinions requested in underwritten offerings and such other matters as may be reasonably requested by such holders and 9 10 underwriters; and (3) obtain "comfort" letters and updates thereof from the Company's independent certified public accountants addressed to the selling holders of Registrable Securities and the underwriters, if any, such letters to be in customary form and covering matters of the type customarily covered in "comfort" letters by underwriters in connection with primary underwritten offerings; (m) make available for inspection by a representative of the holders of at least a majority of the Registrable Securities, any underwriter participating in any disposition pursuant to Registration Statement and any attorney or accountant retained by any selling holder or holders of Registrable Securities or any underwriter, all financial and other records and all pertinent corporate documents and properties of the Company, and cause the Company's officers, directors and employees to be available for discussions with and to supply all information reasonably requested by any such representative, underwriter, attorney or accountant in connection with such Registration Statement; provided, that any records, information or documents that are designated by the Company in writing as confidential shall be kept confidential by such persons unless disclosure of such records, information or documents is required by court or administrative order or becomes publicly available; (n) use all reasonable best efforts to comply with all applicable rules and regulations of the SEC and make generally available to its security holders, as provided in Rule 158 or otherwise, earnings statements satisfying the provisions of Section 11(a) of the Securities Act; (o) promptly prior to the filing of any document which is to be incorporated by reference into Registration Statement or Prospectus (after initial filing of the Registration Statement), provide copies of such document to counsel to the selling holders of Registrable Securities and to the managing underwriter or underwriters, if any, make the Company's representatives available for discussion of such document and make such changes in such document prior to the filing thereof as counsel for such selling holders or underwriters may reasonably request; and (p) otherwise reasonably cooperate with the Selling Holders to carry out the intent of this Agreement. The Company may require each seller of Registrable Securities as to which any registration is being effected to furnish to the Company such information regarding the distribution of such securities as the Company may from time to time reasonably request in writing; provided, however, that such information shall be used by the Company only to the extent necessary for and in connection with, such registration. Each holder of Registrable Securities agrees that, upon receipt of any notice from the Company of the happening of any event of the kind described in Section 5(c)(6) hereof, such holder shall forthwith discontinue disposition of such Registrable Securities until such holder's receipt of the copies of the supplemented or amended Prospectus contemplated by Section 5(j), or until it is advised in writing (the "Advice") by the Company that the use of the Prospectus may be 10 11 resumed, and has received copies of any additional or supplemental filings which are incorporated by reference in the Prospectus, and, if so directed by the Company, such holder shall deliver to the Company (at the Company's expense) all copies, other than permanent file copies then in such holder's possession, of the Prospectus covering such Registrable Securities current at the time of receipt of such notice. In the event the Company shall give any such notice, the time periods regarding the maintenance of the Registration Statement in Section 3 shall be extended by the number of days during the period from and including the date of the giving of such notice pursuant to Section 5(c)(6) to and including the date when each seller of Registrable Securities covered by such Registration Statement shall have received the copies of the supplemented or amended prospectus contemplated by Section 5(j) or the Advice. 6. Expenses of Registration. All Registration Expenses incurred in connection with any registration commenced in accordance with Section 3 or 4 (even if subsequently terminated or withdrawn) shall be borne by the Company. All Selling Expenses relating to Registrable Shares registered on behalf of any person shall be borne by such person. 7. Indemnification. (a) Indemnification by Company. The Company shall indemnify and hold harmless, to the full extent permitted by law, each holder of Registrable Securities, its officers, directors and employees and each person who controls such holder (within the meaning of the Securities Act) against all losses, claims, damages, liabilities and expenses arising out of any untrue or alleged untrue statement of a material fact contained in any Registration Statement (or amendment (including any post-effective amendment) or supplement thereto), Prospectus or preliminary Prospectus) or any amendment or supplement thereto, including all documents incorporated therein by reference, or any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, except insofar as the same are caused by or contained in any information furnished in writing to the Company by such holder expressly for use therein or by such holder's failure to deliver a copy of the Registration Statement or Prospectus after the Company has furnished such holder with a sufficient number of copies of the same; provided, however, that in the event of an underwritten offering, no holder shall be deemed to have failed to make any such delivery. The Company shall also indemnify underwriters, selling brokers, dealer managers and similar securities industry professionals participating in the distribution, their officers and directors and each person who controls such persons (within the meaning of the Securities Act) to the same extent as provided above with respect to the indemnification of the holders of Registrable Securities, if requested. (b) Indemnification by Holder of Registrable Securities. In connection with a Registration Statement, each holder of Registrable Securities covered thereby shall furnish to the Company in writing such information as the Company reasonably requests for use in connection with any Registration Statement (or amendment (including any post-effective amendment) or supplement thereto) or Prospectus (or any amendment or supplement thereto) and shall indemnify and hold harmless, to the full extent permitted by law, the Company, its directors and officers and each person who controls the Company (within the meaning of the Securities Act) against any 11 12 losses, claims, damages, liabilities and expenses arising out of any untrue or alleged untrue statement of a material fact or any omission or alleged omission of a material fact required to be stated in the Registration Statement (or amendment (including any post-effective amendment) or supplement thereto) or Prospectus or preliminary Prospectus (or any amendment or supplement thereto), including all documents incorporated therein by reference or necessary to make the statements therein not misleading, to the extent, but only to the extent, that such untrue statement is contained or omission is required to be in any information so furnished in writing by such holder to the Company specifically for inclusion in such Registration Statement (or amendment (including any post-effective amendment) or supplement thereto) or Prospectus (or any amendment or supplement thereto). The liability of any selling holder of Registrable Securities hereunder shall not exceed the dollar amount of the proceeds received by such holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. The Company shall be entitled to receive indemnities from underwriters, selling brokers, dealer managers and similar securities industry professionals participating in the distribution, to the same extent as provided above with respect to information so furnished in writing by such persons specifically for inclusion in any Prospectus or Registration Statement (or amendment (including any post-effective amendment) or supplement thereto). (c) Conduct of Indemnification Proceedings. Any person entitled to indemnification hereunder shall (i) give prompt notice to the indemnifying party of any claim with respect to which it seeks indemnification and (ii) permit such indemnifying party to assume the defense of such claim with counsel reasonably satisfactory to the indemnified party, provided, however, that any person entitled to indemnification hereunder shall have the right to employ separate counsel and to participate in the defense of such claim, but the fees and expenses of such counsel shall be at the expense of such person unless (a) the indemnifying party has agreed to pay such fees or expenses, or (b) the indemnifying party shall have failed to assume the defense of such claim and employ counsel reasonably satisfactory to such person, or (c) in the reasonable judgment of any such person, based upon advice of its counsel, a conflict of interest may exist between such person and the indemnifying party with respect to such claims or there may exist legal defenses for such person that are materially different from or in addition to those available to the indemnifying party (in which case, if the person notifies the indemnifying party in writing that such person elects to employ separate counsel at the expense of the indemnifying party, the indemnifying party shall not have the right to assume the defense of such claim on behalf of such person). If such defense is not assumed by the indemnifying party, the indemnifying party shall not be subject to any liability for any settlement or consent to judgment made without its consent (but if such consent is requested, such consent shall not be unreasonably withheld). No indemnifying party shall be required to consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such indemnified party of a release from all liability in respect to such claim or litigation. An indemnifying party who is not entitled to, or elects not to, assume the defense of a claim shall not be obligated to pay the fees and expenses of more than one counsel for all parties indemnified by such indemnifying party with respect to such claim, unless in the reasonable judgment of any indemnified party, after consultation with counsel, a conflict of interest may exist between such indemnified party and any other of such indemnified parties or there may exist legal defenses for such indemnified party that are materially different from or in addition to those 12 13 available to the other indemnified parties with respect to such claim, in which event the indemnifying party shall be obligated to pay the fees and expenses of such additional counsel or counsels. (d) Contribution. If for any reason the indemnification provided for in the preceding clauses (a) and (b) is unavailable to an indemnified party or insufficient to hold it harmless as contemplated by the preceding clauses (a) and (b), then the indemnifying party shall contribute to the amount paid or payable by the indemnified party as a result of such loss, claim, damage or liability (i) in such proportion as is appropriate to reflect the relative fault of the indemnified party and the indemnifying party, or (ii) if the allocation provided by clause (i) is not permitted by applicable law, in such proportion as is appropriate to reflect the relative benefits received by the indemnified party and the indemnifying party as well as their relative fault, as well as any other relevant equitable considerations. The relative fault of the indemnified party and the indemnifying party shall be determined by reference to, among other things, whether any such untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact relates to information supplied by the indemnified party or the indemnifying party and each party's relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission, provided that no holder of Registrable Securities shall be required to contribute in an amount greater than the dollar amount of the proceeds received by such holder with respect to the sale of any Registrable Securities. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. 8. Current Public Information. For so long as the Company is subject to the reporting requirements of Section 13 or 15 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Company covenants that it will file the reports required to be filed by it under the Securities Act and Section 13(a) or 15 (d) of the Exchange Act and the rules and regulations adopted by the SEC thereunder, that if it ceases to be so required to file such reports, it will upon the request of any holder of Registrable Securities (a) make publicly available such information as is necessary to permit sales pursuant to Rule 144 under the Securities Act, (b) deliver such information to a prospective purchaser as is necessary to permit sales pursuant to Rule 144A under the Securities Act and it will take such further action as any holder of Registrable Securities may reasonably request, and (c) take such further action that is reasonable in the circumstances, in each case, to the extent required from time to time to enable such holder to sell its Registrable Securities without registration under the Securities Act within the limitation of the exemptions provided by (i) Rule 144 under the Securities Act, as such Rule may be amended from time to time, (ii) Rule 144A under the Securities Act, as such Rule may be amended from time to time, or (iii) any similar rules or regulations hereafter adopted by the SEC. Upon the request of any holder of Registrable Securities, the Company will deliver to such holder a written statement as to whether it has complied with such requirements. 9. Miscellaneous. (a) Amendments and Waivers. The provisions of this Agreement, including the provisions of this sentence, may not be amended, modified or supplemented, and waivers or 13 14 consents to departures from the provisions hereof may not be given unless the Company has obtained the written consent of holders of at least 80% of the Registrable Securities; provided, however, that with respect to a particular Registration Statement filed pursuant to Section 3, a waiver or consent to departure from the provisions of this Agreement regarding only such Registration Statement and the offering covered thereby may be given by the holders of not less than 66-2/3% of the Registrable Securities covered by such Registration Statement, except that no such waiver or consent shall operate to affect adversely the rights hereunder of any other holder of Registrable Securities. (b) Notices. All notices and other communications provided for or permitted hereunder shall be made in writing by hand-delivery, registered first-class mail, telex, telecopier, or courier guaranteeing overnight delivery: (i) if to a holder of Registrable Securities, at the most current address given by such holder to the Company in accordance with the provisions of this Section 9(b); and (ii) if to the Company, initially at 300 Sixth Avenue, Pittsburgh, PA 15222, Telecopy: (412) 562-0934, Attention: Chief Executive Officer and General Counsel, and thereafter at such other address, notice of which is given in accordance with the provisions of this Section 9(b). All such notices and communications shall be deemed to have been duly given: at the time delivered by hand, if personally delivered; three days after being deposited in the mail, postage prepaid, if mailed; when answered back, if telexed; when receipt acknowledged, if telecopied; and on the next business day if timely delivered to a courier guaranteeing overnight delivery. (c) Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the successors and assigns of each of the parties. (d) Counterparts. This Agreement may be executed in any number of counterparts and by the parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. (e) Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Pennsylvania applicable to agreements made and to be performed in Pennsylvania without regard to principles of conflicts of laws. (f) Severability. Each provision of this Agreement shall be considered severable, and if for any reason any provision that is not essential to the effectuation of the basic purposes of the Agreement is determined by a court of competent jurisdiction to be invalid or unenforceable under existing or future applicable law, such invalidity shall not impair the operation of or affect those provisions of this Agreement that are valid. In that case, this Agreement shall be construed so as to limit any term or provision so as to make it enforceable or 14 15 valid within the requirements of any applicable law, and in the event such term or provision cannot be so limited, this Agreement shall be construed to omit such invalid or unenforceable provisions. (g) Entire Agreement. This Agreement is intended by the parties as a final expression of their agreement and intended to be a complete and exclusive statement of the agreement and understanding of the parties hereto in respect of the subject matter contained herein. There are no representations, promises, warranties or undertakings, other than those set forth or referred to herein with respect to the registration rights granted by the Company hereby. Upon the Effective Date, this Agreement supersedes all prior agreements and understandings between the parties with respect to such subject matter, and cannot be changed or terminated orally; provided, however, that nothing contained in this Agreement shall be deemed to modify the provisions a letter agreement dated as of August 9, 1996, between the Company and the ESOP Trustee, with respect to the disposition of shares of the Company's capital stock held by the ESOP Trustee. (h) Term. This Agreement shall terminate and cease to be of any further force or effect on the earlier of (i) the tenth anniversary of the Effective Date and (i) the first date on which both (A) the total number of shares of Registrable Securities subject to this Agreement is less than 1,750,000 and (B) no Initiating Holder (with the ML Holders being treated as a single Initiating Holder) holds 500,000 or more shares (such numbers in clause (A) and (B) to be adjusted, as appropriate, by the Company to reflect any stock splits, reverse stock split, stock combinations or the like occurring after the Effective Date); provided, however, that with respect to any particular party to this Agreement, this Agreement shall terminate and cease to be of any further force or effect on the first date which that party ceases to hold any Registrable Securities. (i) Construction. As used in this Agreement, unless the context otherwise requires (i) references to "Sections" are to sections of this Agreement, (ii) "hereof", "herein", "hereunder" and comparable terms refer to this Agreement in its entirety and not to any particular part of this Agreement, (iii) the singular includes the plural and the masculine, feminine and neutral gender includes the other, (iv) "including" or "includes" shall be deemed to be followed by the phrase "without limitation", and (v) headings of the various Sections and subsections are for convenience of reference only and shall not be given any effect for purposes of interpreting this Agreement. (j) Termination of Stockholders Agreement. Subject to and automatically upon the effectiveness of this Agreement, the Stockholders Agreement dated as of October 26, 1989, as amended, among the Company, the Initiating Holders and the other parties named therein shall terminate and be of no further force or effect, except that the provisions of section 6.1.3 thereof [Demand Registration Expenses], insofar as they relate to the registration of shares of Common Stock in the Company's initial public offering, shall survive such termination. 15 16 Witness the due execution hereof, as of this date first above written, on behalf of the undersigned thereunto duly authorized. EDUCATION MANAGEMENT MERRILL LYNCH CAPITAL CORPORATION APPRECIATION PARTNERSHIP IV, L.P. By: /s/ FREDERICK W. STEINBERG By: Merrill Lynch LBO Partners, -------------------------- No. I, L.P., General Partner Title: Vice President, General Counsel & Secretary By: Merrill Lynch Capital Partners, Inc., General Partner By: /s/ JAMES V. CARUSO ------------------------ Title: Vice President -------------------- THE NORTHWESTERN MUTUAL ML EMPLOYEES LIFE INSURANCE COMPANY LBO PARTNERSHIP NO. I, L.P. By: ML Employees LBO Managers, Inc., General Partner By: /s/ J. THOMAS CHRISTOFFERSON By: /s/ JAMES V. CARUSO ---------------------------- ----------------------- Title: Vice President Title: Vice President ------------------------- -------------------- NATIONAL UNION FIRE INSURANCE ML IBK POSITIONS, INC. COMPANY OF PITTSBURGH, PA By: /s/ DAVID B. PINKERTON By: /s/ JAMES V. CARUSO ---------------------------- ----------------------- Title: Vice President Title: Vice President ------------------------- -------------------- MERRILL LYNCH CAPITAL MERRILL LYNCH KECALP L.P. 1986 CORPORATION By: KECALP Inc., General Partner By: /s/ JAMES V. CARUSO By: /s/ JAMES V. CARUSO ---------------------------- ----------------------- 16 17 Title: Senior Vice President Title: Vice President ------------------------- ---------------------- ML OFFSHORE LBO PARTNERSHIP NO. IV By: Merrill Lynch LBO Partners, No. I, L.P. Investment, General Partner By: Merrill Lynch Capital Partners, Inc. General Partners By: /s/ JAMES V. CARUSO ---------------------------- Title: Vice President -------------------------- MARINE MIDLAND BANK, not in its corporate capacity, but solely in its capacity as trustee, and on behalf, of the Education Management Corporation Employee Stock Ownership Trust By: /s/ STEPHEN HARTMAN --------------------------- Title: Senior Vice President -------------------------- ROBERT B. KNUTSON, not in his individual capacity, but solely in his capacity as trustee of the Revocable Trust Agreement of Robert B. Knutson dated 3/4/93 By: /s/ ROBERT B. KNUTSON ---------------------------- Title: Vice President -------------------------- 17 18 /s/ R. MARGARET BARBER /s/ C. THOMAS BURKETT - ----------------------------- ---------------------------- R. Margaret Barber C. Thomas Burkett /s/ GARY C. GRYSIAK /s/ PATRICK T. DECOURSEY - ----------------------------- ---------------------------- Gary C. Grysiak Patrick T. DeCoursey /s/ RONALD G. GUIDA /s/ MIRYAM L. DRUCKER - ----------------------------- ----------------------------- Ronald G. Guida Miryam L. Drucker 18 19 /s/ DENNIS R. HARKINS /s/ ALAN R. FREEDMAN - ----------------------------- ----------------------------- Dennis R. Harkins Alan R. Freedman /s/ MARK C. HODGES /s/ JAMES R. GRAFT - ----------------------------- ---------------------------- Mark C. Hodges James R. Graft /s/ ALBERT GREENSTONE /s/ STEVE R. GREGG, JR. - ----------------------------- ----------------------------- Albert Greenstone Steve R. Gregg, Jr. /s/ DANIEL J. LAFFERTY /s/ ROBERT S. PETERSON - ----------------------------- ---------------------------- Daniel J. Lafferty Robert S. Peterson /S/ ELLIS MATHEWS /s/ LESLIE E. PRITCHARD, III - ----------------------------- ---------------------------- Ellis Mathews Leslie E. Pritchard, III /s/ WILLIAM J. MAZUR /s/ GEORGE L. PRY - ---------------------------- ---------------------------- William J. Mazur George L. Pry /s/ ROBERT T. MCDOWELL /s/ SAUNDRA M. VANDYKE - ---------------------------- ---------------------------- Robert T. McDowell Saundra M. VanDyke /s/ HARVEY SANFORD - ---------------------------- Harvey Sanford [Option Holder] 19 EX-10.23 7 EDUCATIONAL MANAGEMENT CORP. 1 Exhibit 10.23 THIRD AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT THIS THIRD AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT is made as of the 14th day of March, 1997 (the "Third Amendment") to that certain Amended and Restated Credit Agreement dated as of March 16, 1995, as previously amended by the First Amendment to Amended and Restated Credit Agreement dated as of October 13, 1995 and the Second Amendment to Amended and Restated Credit Agreement (the Amended and Restated Credit Agreement as previously amended, together with all exhibits and schedules thereto, the "Original Agreement") (the Original Agreement as amended by the Third Amendment, together with all extensions, substitutions, replacements, restatements and other amendments or modifications thereof or thereto, the "Credit Agreement") by and among EDUCATION MANAGEMENT CORPORATION, a corporation organized and existing under the laws of the Commonwealth of Pennsylvania (the "Borrower"), the FINANCIAL INSTITUTIONS listed on the signature pages to this Third Amendment (individually a "Bank" and collectively the "Banks"), PNC BANK, NATIONAL ASSOCIATION as the issuer of letters of credit under the Credit Agreement (in such capacity the "Issuing Bank") and PNC BANK, NATIONAL ASSOCIATION, a national banking association as the agent for the Banks (in such capacity the "Agent"). WITNESSETH: WHEREAS, the Borrower and the Banks, the Issuing Bank and the Agent desire to amend the Original Agreement as set forth herein. NOW, THEREFORE, in consideration of the terms and conditions contained herein, and other good and valuable consideration, the parties hereto, intending to be legally bound, hereby agree as follows: ARTICLE I AMENDMENTS TO ORIGINAL AGREEMENT FIRST: Section 1.1 of the Original Agreement is hereby amended in the following particulars: 1. A definition of "Moody's" is added which shall read: "Moody's" means Moody's Investors Services, Inc. or any successor thereto. 2. A definition of "S&P" is added which shall read: 2 "S&P" means Standard & Poor's Rating Group, a division of McGraw-Hill, Inc. and any successor thereto. 3. A definition of "Third Amendment" is added which shall read: "Third Amendment" means the Third Amendment to Amended and Restated Credit Agreement dated as of March 14, 1997. SECOND: Section 5.15 of the Original Agreement as added by the First Amendment and captioned "Interest Rate Protection", is hereby deleted in its entirety. THIRD: Section 5.15 of the Original Agreement as added by the Second Amendment and captioned "Performance under the Preferred Stock Redemption Plan", is hereby confirmed as Section 5.15 of the Agreement. FOURTH: Section 6.11b of the Original Agreement is amended and restated in its entirety to read as follows: 6.11b Investments. The Borrower will not, nor will it permit any Subsidiary to make any capital contribution to purchase any stock, bonds, notes, debentures or other securities of, or make any other investment in any other Person, except: a) existing Subsidiaries; b) acquisitions permitted by Section 6.18 hereof; c) direct obligations of the United States of America or any agency or instrumentality thereof or obligations backed by the full faith and credit of the United States of America maturing in twelve months or less from the date of acquisition; d) commercial paper maturing in 180 days or less rated not lower than A-1 by S&P or P-1 by Moody's on the date of acquisition; e) demand deposits, time deposits or certificates of deposit maturing within one year in commercial banks whose obligations are rated A-1, A or the equivalent or better by S&P or Moody's on the date of acquisition; f) publicly traded debt securities, privately placed debt securities as to which there is an existence a remarketing arrangement creating liquidity for such privately placed debt securities or preferred stocks, in each case rated at least A or the equivalent or better by S&P or Moody's; and g) money market funds rated AA or AAm-G or higher (or an equivalent rating) by S&P or Moody's whose net asset value remains a constant $1.00 per share. - 2 - 3 ARTICLE II CONDITIONS PRECEDENT This Third Amendment shall become operative as of the date hereof when each of the following conditions precedent are satisfied in the judgment of the Agent or have been waived in writing by the Agent: (a) Third Amendment. Receipt by the Agent on behalf of the Banks and the Issuing Bank of duly executed counterparts of this Third Amendment from the Borrower and the Banks and the Issuing Bank. (b) Closing Certificate. Receipt by the Agent on behalf of the Banks of a certificate signed by an Authorized Officer of the Borrower dated as of even date herewith certifying that the representations and warranties set forth in the Original Agreement are true and correct in all material respects on and as of the date of this Third Amendment as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date (in which case, such representations and warranties shall have been true and correct on and as of such earlier date). (c) Corporate Documents of the Borrower. Receipt by the Agent on behalf of the Banks of an incumbency certificate of the Borrower dated as of the date hereof. (d) Proceedings Satisfactory. Receipt by the Agent on behalf of the Banks of evidence that all proceedings taken in connection with this Third Amendment and the consummation of the transactions contemplated hereby and all documents and papers relating hereto have been completed or duly executed, and receipt by the Agent on behalf of the Banks of such documents and papers, all in form and substance reasonably satisfactory to the Agent and Agent's special counsel, as the Agent or its special counsel may reasonably request in connection therewith. ARTICLE III MISCELLANEOUS FIRST: Except as expressly amended by this Third Amendment, the Original Agreement and each and every representation, warranty, covenant, term and condition contained therein is specifically ratified and confirmed. SECOND: Except for proper nouns and as otherwise defined or amended herein, capitalized terms used herein which are not defined herein, but which are defined in the Original Agreement, shall have the meaning given them in the Original Agreement. THIRD: This Third Amendment has been duly authorized, executed and delivered by the Borrower. - 3 - 4 FOURTH: This Third Amendment shall be binding upon and inure to the benefit of the Borrower, the Banks, the Issuing Bank, the Agent and their respective successors and assigns. FIFTH: Nothing in this Third Amendment shall be deemed or construed to be a waiver, release or limitation upon the Agent's or any Bank's exercise of any of their respective rights and remedies under the Original Agreement or the other Loan Documents, whether arising as a consequence of any Events of Default which may now exist, hereafter arise or otherwise, and all such rights and remedies are hereby expressly reserved. SIXTH: This Third Amendment may be executed in as many different counterparts as shall be convenient and by the different parties hereto on separate counterparts, each of which when executed by the Borrower, a Bank, the Issuing Bank and the Agent shall be regarded as an original. All such counterparts shall constitute but one and the same instrument. SEVENTH: This Third Amendment shall be a contract made under and governed by the laws of the Commonwealth of Pennsylvania without regard to the principles thereof regarding conflict of laws. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] - 4 - 5 Executed as of the day and year first above written. EDUCATION MANAGEMENT CORPORATION By /s/ ROBERT T. McDOWELL ------------------------------------ Name Robert T. McDowell ---------------------------------- Title Senior Vice President and --------------------------------- Chief Financial Officer --------------------------------- PNC BANK, NATIONAL ASSOCIATION, in its capacity as the Agent, a Bank and the Issuing Bank By /s/ JONATHAN RITZ ------------------------------------ Name Jonathan Ritz ---------------------------------- Title Vice President --------------------------------- KEYBANK NATIONAL ASSOCIATION By /s/ LAWRENCE A. MACK ------------------------------------ Name Lawrence A. Mack ---------------------------------- Title Vice President --------------------------------- NATIONAL CITY BANK OF PENNSYLVANIA By /s/ VINCENT J. DELIE, JR. ------------------------------------ Name Vincent J. Delie, Jr. ---------------------------------- Title Vice President --------------------------------- - 5 - EX-11.01 8 EDUCATIONAL MANAGEMENT CORP. 1 EXHIBIT 11.01 EDUCATION MANAGEMENT CORPORATION CALCULATION OF OUTSTANDING SHARES FOR EARNINGS PER SHARE CALCULATION
FOR THE YEARS ENDED JUNE 30, 1995 1996 1997 ---- ---- ---- Weighted average primary common shares outstanding during the year 6,876 9,872 12,923 Dilutive effect of shares assumed issued upon exercise of stock options (less shares assumed purchased by the Company) 14 298 312 -- --- --- Outstanding common shares for primary earnings per share calculation 6,890 10,170 13,235 ===== ====== ====== Weighted average fully diluted common shares outstanding during the year 6,876 11,576 13,352 Dilutive effect of shares assumed issued upon exercise of stock options (less shares assumed purchased by the Company) 14 298 335 -- --- --- Outstanding common shares for fully diluted earnings per share calculation 6,890 11,874 13,687 ===== ====== ======
EX-21.01 9 EDUCATIONAL MANAGEMENT CORP. 1 EXHIBIT 21.01 MATERIAL SUBSIDIARIES
Name of Subsidiary Jurisdiction of Incorporation Art Institutes International, Inc. Pennsylvania Art Institute of Atlanta, Inc. Georgia Art Institute of Dallas, Inc. Texas Art Institute of Fort Lauderdale, Inc. Florida Art Institute of Houston, Inc. Texas Illinois Institute of Art, Inc. Illinois Illinois Institute of Art at Schaumburg, Inc. Illinois Art Institute of Philadelphia, Inc. Pennsylvania Art Institute of Phoenix, Inc. Arizona Art Institute of Seattle, Inc. Washington Colorado Institute of Art, Inc. Colorado The National Center for Professional Development, Inc. Georgia NCPT, Inc. Georgia Art-Photo Supply Corp. Florida Eisenhower Boulevard Associates, Inc. Florida EMC Management Services, Inc. Pennsylvania EMC Marketing & Advertising, Inc. Georgia Ocean World, Inc. Florida The National Center for Educational Testing, Inc. New York The National Center for Financial Services Training, Inc. Georgia The National Center for Paralegal Training Delaware The National Center for Paralegal Training Illinois The National Center for Paralegal Training New York NCPT, Inc. Georgia NCPT, Inc. California NCPT-AZ, Inc. Arizona New York Restaurant School, Inc. New York Art Institute of Los Angeles, Inc. California Art Institute of Minnesota, Inc. Minnesota
2 Art Institutes International - Twin Cities, Inc. Minnesota Art Institute of Charleston, Inc. South Carolina Art Institute of Honolulu, Inc. Hawaii Art Institute of Indianapolis, Inc. Indiana Art Institute of Las Vegas, Inc. Nevada Art Institute of New Orleans, Inc. Louisiana Art Institute of Orlando, Inc. Florida Art Institute of Washington, Inc. District of Columbia AII Placement Services, Inc. New York Chicago Institute of Art and Design, Inc. Illinois Education Management Corporation New York Music Business Institute, Inc. Tennessee New York Institute of Art, Inc. New York San Francisco Institute of Design, Inc. California The Design Schools Pennsylvania The National Center for Credit Training, Inc. New York The National Center for Financial Services Training, Inc. Illinois The National Center for Legal Training, Inc. Georgia The National Center for Professional Fund Raising Training, Inc. New York The National Center for Professional Placement, Inc. New York Education Housing Services, Inc. Pennsylvania Art Institute of Minneapolis, Inc. Minnesota
-2- EX-23.01 10 EDUCATIONAL MANAGEMENT CORP. 1 Exhibit 23.01 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report dated August 4, 1997 included in this Form 10-K into the Company's previously filed Registration Statements on Form S-8, File Nos. 333-20057 and 333-20073. /s/ ARTHUR ANDERSEN LLP Pittsburgh, Pennsylvania August 4, 1997 EX-27 11 EDUCATIONAL MANAGEMENT CORP.
5 1,000 YEAR JUN-30-1997 JUL-01-1996 JUN-30-1997 33,227 0 16,099 (7,393) 1,356 48,886 99,820 (47,249) 126,292 36,178 34,031 0 0 144 57,612 126,292 182,849 182,849 120,918 164,030 0 0 1,603 17,216 7,231 9,985 0 0 0 9,985 .72 .72
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