10-Q 1 edmc0331201210-q.htm EDMC 03.31.2012 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________ 
FORM 10-Q
___________________________________________ 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From                     to
Commission File Number: 001-34466
___________________________________________ 
EDUCATION MANAGEMENT CORPORATION
(Exact name of registrant as specified in its charter)
 ___________________________________________ 
Pennsylvania
 
25-1119571
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
210 Sixth Avenue, 33rd Floor
Pittsburgh, PA, 15222
(412) 562-0900
(Address, including zip code and telephone number, of principal executive offices)
___________________________________________ 
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes   x     No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
  
Accelerated filer
 
x
 
 
 
 
 
 
 
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
  
Smaller reporting company  
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):
Yes   ¨     No x
As of May 8, 2012, there were 125,131,387 shares of the registrant’s common stock outstanding.




INDEX
 


1




EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
 
 
March 31,
2012
 
June 30,
2011
 
March 31,
2011
 
(Unaudited)
 
 
 
(Unaudited)
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
$
287,503

 
$
403,224

 
$
613,155

Restricted cash
284,053

 
47,513

 
52,907

Total cash, cash equivalents and restricted cash
571,556

 
450,737

 
666,062

Student receivables, net of allowances of $219,070, $187,102 and $180,667
139,565

 
157,793

 
110,158

Notes, advances and other receivables
20,768

 
15,164

 
15,143

Inventories
10,035

 
9,594

 
11,785

Deferred income taxes
76,674

 
76,804

 
65,761

Prepaid income taxes
7,406

 
13,277

 

Other current assets
40,009

 
46,166

 
42,391

Total current assets
866,013

 
769,535

 
911,300

Property and equipment, net (Note 4)
658,665

 
697,377

 
695,761

Other long-term assets (Note 6)
52,106

 
46,613

 
89,915

Intangible assets, net (Note 5)
458,844

 
462,387

 
463,545

Goodwill (Note 5)
2,083,751

 
2,579,131

 
2,579,131

Total assets
$
4,119,379

 
$
4,555,043

 
$
4,739,652

Liabilities and shareholders’ equity
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Current portion of long-term debt (Note 8)
$
12,076

 
$
12,076

 
$
12,076

Revolving credit facility

 
79,000

 

Accounts payable
31,735

 
58,494

 
43,420

Accrued liabilities (Note 7)
169,838

 
135,126

 
201,155

Accrued income taxes

 

 
24,400

Unearned tuition
80,046

 
140,150

 
104,610

Advance payments
261,260

 
112,095

 
293,368

Total current liabilities
554,955

 
536,941

 
679,029

Long-term debt, less current portion (Note 8)
1,456,352

 
1,466,774

 
1,517,480

Deferred income taxes
173,407

 
222,684

 
177,390

Deferred rent
195,494

 
188,803

 
190,548

Other long-term liabilities
45,766

 
35,897

 
16,947

Shareholders’ equity:
 
 
 
 
 
Common stock, at par
1,434

 
1,431

 
1,431

Additional paid-in capital
1,774,634

 
1,761,848

 
1,758,402

Treasury stock, at cost
(317,888
)
 
(226,926
)
 
(140,610
)
Retained earnings
252,746

 
579,781

 
544,982

Accumulated other comprehensive loss
(17,521
)
 
(12,190
)
 
(5,947
)
Total shareholders’ equity
1,693,405

 
2,103,944

 
2,158,258

Total liabilities and shareholders’ equity
$
4,119,379

 
$
4,555,043

 
$
4,739,652

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

2


EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except per share amounts)
 
 
For the Three Months
 
For the Nine Months
 
Ended March 31,
 
Ended March 31,
 
2012
 
2011
 
2012
 
2011
Net revenues
$
702,499

 
$
754,340

 
$
2,121,782

 
$
2,192,238

Costs and expenses:
 
 
 
 
 
 
 
Educational services
382,313

 
381,703

 
1,133,850

 
1,113,384

General and administrative
191,638

 
190,568

 
580,179

 
564,317

Depreciation and amortization
40,610

 
37,148

 
118,694

 
107,548

Goodwill impairment (Note 5)
495,380

 

 
495,380

 

Total costs and expenses
1,109,941

 
609,419

 
2,328,103

 
1,785,249

Income (loss) before interest, loss on extinguishment of debt and income taxes
(407,442
)
 
144,921

 
(206,321
)
 
406,989

Interest expense, net
25,424

 
31,464

 
79,139

 
87,516

Loss on extinguishment of debt
9,474

 

 
9,474

 
8,363

Income (loss) before income taxes
(442,340
)
 
113,457

 
(294,934
)
 
311,110

Provision for (benefit from) income taxes
(25,224
)
 
40,474

 
32,101

 
116,401

Net income (loss)
$
(417,116
)
 
$
72,983

 
$
(327,035
)
 
$
194,709

Earnings (loss) per share: (Note 2)
 
 
 
 
 
 
 
Basic
$
(3.31
)
 
$
0.54

 
$
(2.57
)
 
$
1.40

Diluted
$
(3.31
)
 
$
0.53

 
$
(2.57
)
 
$
1.39

Weighted average number of shares outstanding: (Note 2)
 
 
 
 
 
 
 
Basic
126,005

 
135,655

 
127,224

 
139,258

Diluted
126,005

 
136,759

 
127,224

 
140,003

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

3


EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
 
For the Nine Months
 
Ended March 31,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net income (loss)
$
(327,035
)
 
$
194,709

Adjustments to reconcile net income to net cash flows from operating activities:
 
 
 
Depreciation and amortization of property and equipment
112,936

 
101,515

Amortization of intangible assets
5,758

 
6,033

Bad debt expense
117,695

 
105,807

Goodwill impairment
495,380

 

Fair value adjustments to loans held for sale

 
21,366

Loss on extinguishment of debt
9,474

 
8,363

Share-based compensation
10,171

 
8,293

Non cash adjustments related to deferred rent
(9,300
)
 
(2,842
)
Changes in assets and liabilities:


 


Restricted cash
(236,540
)
 
(40,065
)
Receivables
(105,089
)
 
(37,915
)
Reimbursements for tenant improvements
14,248

 
18,354

Inventory
(447
)
 
(113
)
Other assets
(9,444
)
 
(16,676
)
Purchase of Education Finance Loan program loans

 
(23,888
)
Accounts payable
(20,922
)
 
(13,737
)
Accrued liabilities
6,632

 
16,017

Unearned tuition
(60,104
)
 
(51,136
)
Advance payments
149,263

 
219,729

Total adjustments
479,711

 
319,105

Net cash flows provided by operating activities
152,676

 
513,814

Cash flows from investing activities:
 
 
 
Expenditures for long-lived assets
(64,679
)
 
(106,324
)
Reimbursements for tenant improvements
(14,248
)
 
(18,354
)
Net cash flows used in investing activities
(78,927
)
 
(124,678
)
Cash flows from financing activities:
 
 
 
Payments under revolving credit facility
(79,000
)
 

Issuance of common stock
2,618

 
655

Common stock repurchased for treasury
(92,756
)
 
(135,660
)
Principal payments on long-term debt
(8,141
)
 
(9,182
)
Debt issuance costs
(11,928
)
 
(5,411
)
Net cash flows used in financing activities
(189,207
)
 
(149,598
)
Effect of exchange rate changes on cash and cash equivalents
(263
)
 
71

Net change in cash and cash equivalents
(115,721
)
 
239,609

Cash and cash equivalents, beginning of period
403,224

 
373,546

Cash and cash equivalents, end of period
$
287,503

 
$
613,155

Cash paid during the period for:
 
 
 
Interest (including swap settlement)
$
77,736

 
$
77,189

Income taxes, net of refunds
74,328

 
126,535

 
As of March 31,
 
2012
 
2011
Noncash investing activities:
 
 
 
Capital expenditures in current liabilities
$
7,580

 
$
10,812

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

4


EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Dollars in thousands)
 
 
Common
Stock at
Par Value (c)
 
Additional
Paid-in
Capital
 
Treasury
Stock, at
Cost (c)
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss (b)
 
Total
Shareholders’
Equity
Balance at June 30, 2010
$
1,429

 
$
1,749,456

 
$
(2,207
)
 
$
350,273

 
$
(22,256
)
 
$
2,076,695

Exercise of stock options
2

 
1,322

 

 

 

 
1,324

Share-based compensation

 
11,070

 

 

 

 
11,070

Common stock repurchased for
treasury

 

 
(224,719
)
 

 

 
(224,719
)
Comprehensive income: (a)

 

 

 

 

 

Net income

 

 

 
229,508

 

 
229,508

Foreign currency translation

 

 

 

 
1,165

 
1,165

Reclassification into earnings on interest rate swaps, net of tax of $13,994

 

 

 

 
23,802

 
23,802

Periodic revaluation of interest rate swaps, net of tax of $8,771

 

 

 

 
(14,901
)
 
(14,901
)
Net change in unrecognized loss on interest rate swaps, net of tax

 

 

 

 
8,901

 
8,901

Comprehensive income

 

 

 
229,508

 
10,066

 
239,574

Balance at June 30, 2011
$
1,431

 
$
1,761,848

 
$
(226,926
)
 
$
579,781

 
$
(12,190
)
 
$
2,103,944

(Unaudited)

 

 

 

 
 
 

       Exercise of stock options
3

 
2,615

 

 

 

 
2,618

Share-based compensation

 
10,171

 

 

 

 
10,171

Common stock repurchased for treasury

 

 
(90,962
)
 

 

 
(90,962
)
Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
Net loss

 

 

 
(327,035
)
 

 
(327,035
)
Foreign currency translation

 

 

 

 
(641
)
 
(641
)
Reclassification into earnings on interest rate swaps, net of tax of $3,950

 

 

 

 
6,699

 
6,699

Periodic revaluation of interest rate swaps, net of tax of $6,718

 

 

 

 
(11,389
)
 
(11,389
)
Net change in unrecognized loss on interest rate swaps, net of tax

 

 

 

 
(4,690
)
 
(4,690
)
Comprehensive loss

 

 

 
(327,035
)
 
(5,331
)
 
(332,366
)
Balance at March 31, 2012
$
1,434

 
$
1,774,634

 
$
(317,888
)
 
$
252,746

 
$
(17,521
)
 
$
1,693,405


(a)
During the nine months ended March 31, 2011, other comprehensive income consisted of a $15.3 million net change in unrecognized loss, net of tax, and a $1.0 million foreign currency translation gain.
(b)
The balance in accumulated other comprehensive loss at March 31, 2012June 30, 2011 and March 31, 2011 was comprised of $(17.2) million, $(12.5) million and $(6.0) million of cumulative unrecognized losses on interest rate swaps, net of tax, respectively, and $(0.3) million, $0.3 million and $0.1 million of a cumulative foreign currency translation gain/(loss), respectively.
(c)
There were 600,000,000 authorized shares of common stock, par value $0.01, at March 31, 2012June 30, 2011 and March 31, 2011. There were 133,806,843 outstanding shares of common stock, net of 9,284,672 shares in treasury, at March 31, 2011. Common stock and treasury stock balances and activity were as follows for the periods indicated.

 
Treasury
 
Outstanding
Balance at June 30, 2010
123,000

 
142,852,418

Repurchased
13,210,972

 
(13,210,972
)
Issued for stock-based compensation plans

 
170,303

Balance at June 30, 2011
13,333,972

 
129,811,749

Repurchased
4,497,572

 
(4,497,572
)
Issued for stock-based compensation plans

 
234,226

Balance at March 31, 2012
17,831,544

 
125,548,403


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

5


EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION
Basis of presentation
The accompanying unaudited consolidated financial statements of Education Management Corporation ("EDMC" and together with its subsidiaries, the "Company") have been prepared by the Company’s management in accordance with generally accepted accounting principles for interim financial information and applicable rules and regulations of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for annual financial statements. The unaudited consolidated financial statements included herein contain all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary to present fairly the financial position of the Company as of March 31, 2012 and 2011, and its statements of operations for the three and nine months ended March 31, 2012 and 2011 and of cash flows for the nine months ended March 31, 2012 and 2011. The statements of operations for the three and nine months ended March 31, 2012 and 2011 are not necessarily indicative of the results to be expected for future periods. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2011 (the “Annual Report on Form 10-K”) as filed with the Securities and Exchange Commission (“SEC”). The accompanying consolidated balance sheet at June 30, 2011 has been derived from the consolidated audited balance sheet included in the Annual Report on Form 10-K.
Nature of operations
The Company is among the largest providers of post-secondary education in North America, with approximately 151,200 enrolled students as of October 2011. The Company offers education through four different education systems (The Art Institutes, Argosy University, Brown Mackie Colleges and South University) and through online platforms at three of the four education systems. The Company offers academic programs to its students through campus-based and online instruction, or through a combination of both. The Company is committed to offering quality academic programs and strives to improve the learning experience for its students. The curriculum is designed with a strong emphasis on applied career-oriented content and is primarily taught by faculty members who possess practical and relevant professional experience in their respective fields.
Going Private Transaction
On June 1, 2006, EDMC was acquired by a consortium of private equity investment funds led by Providence Equity Partners, Goldman Sachs Capital Partners and Leeds Equity Partners (collectively, the “Sponsors”). The acquisition was accomplished through the merger of EM Acquisition Corporation into EDMC, with EDMC surviving the merger (the “Transaction”). The Sponsors, together with certain other investors, became the owners of EDMC.
The acquisition of EDMC was financed by equity invested in EM Acquisition Corporation by the Sponsors and other investors, cash on hand, borrowings by Education Management LLC (“EM LLC”) under a new senior secured credit facility and the issuance by EM LLC and Education Management Finance Corp. (a wholly-owned subsidiary of EM LLC) of senior notes due 2014 (the “Senior Notes”) and senior subordinated notes due 2016 (the “Senior Subordinated Notes”). See Note 8, “Short-Term and Long-Term Debt”.

Initial Public Offering
In October 2009, EDMC completed an initial public offering of 23.0 million shares of its common stock, $0.01 par value (the "common stock"), at a per share price of $18.00 (the “initial public offering”). Net proceeds to EDMC, after transaction costs, totaled approximately $387.3 million. The Sponsors did not sell any of their shares in connection with the initial public offering. Of the net proceeds from the initial public offering, $355.5 million was used to purchase $316.0 million of the $385 million Senior Subordinated Notes then outstanding in a tender offer and $29.6 million was used to pay a termination fee under a management agreement entered into with the Sponsors in connection with the Transaction.
Seasonality
The Company’s quarterly net revenues and income fluctuate primarily as a result of the pattern of student enrollments, and its first fiscal quarter is typically its lowest revenue recognition quarter of the fiscal year due to student vacations. However, the seasonality of the Company’s business has decreased over the last several years due to the percentage of students enrolling in online programs, which generally experience less seasonal fluctuations than campus-based programs.

6


Reclassifications
Certain reclassifications of March 31, 2011 and June 30, 2011 data have been made to conform to the March 31, 2012 presentation. These reclassifications did not materially change any of the previously reported amounts.
Recent Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, which requires that the total of comprehensive income, the components of net income, and the components of other comprehensive income be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company is required to comply with ASU 2011-05 beginning in the quarter ended September 30, 2012. ASU 2011-05 does not change the items reported in other comprehensive income or affect whether a component of other comprehensive income must be reclassified to net income. Therefore, the new standard is not expected to impact the Company’s financial condition, results of operations or cash flows.

2. EARNINGS PER SHARE
Basic earnings per share (“EPS”) is computed using the weighted average number of shares outstanding during the period. The Company uses the treasury stock method to compute diluted EPS, which assumes that restricted stock was converted into common stock and that outstanding stock options were exercised and the resulting proceeds were used to acquire shares of the Company's common stock at its average market price during the reporting period.

Basic and diluted EPS were calculated as follows (in thousands, except per share amounts):
 
 
For the Three Months Ended March 31,
 
For the Nine Months Ended March 31,
 
2012
 
2011
 
2012
 
2011
Net income (loss)
$
(417,116
)
 
$
72,983

 
$
(327,035
)
 
$
194,709

 
Weighted average number of shares outstanding:
 
 
 
 
 
 
 
Basic
126,005

 
135,655

 
127,224

 
139,258

Effect of stock-based awards

 
1,104

 

 
745

Diluted
126,005

 
136,759

 
127,224

 
140,003

 
Earnings (loss) per share:
 
 
 
 
 
 
 
Basic
$
(3.31
)
 
$
0.54

 
$
(2.57
)
 
$
1.40

Diluted
$
(3.31
)
 
$
0.53

 
$
(2.57
)
 
$
1.39


For the three-month and nine-month periods ended March 31, 2012, options to purchase 9.2 million shares of common stock, which comprised all of the Company's outstanding time-based options, were excluded from the computation of diluted EPS. Time-based options to purchase 4.0 million shares of common stock were also excluded from the computation of diluted EPS for the three-month and nine-month periods ended March 31, 2011. The aforementioned time-based options were not included in the computation of diluted EPS because the effect of applying the treasury stock method would have been antidilutive. In addition, and as further described in Note 3, “Share-Based Compensation and Stock Repurchase Program,” the Company has determined that its 3.2 million outstanding performance-based stock options are contingently issuable; therefore, they were not included in the diluted EPS calculation for any period presented.

3. SHARE-BASED COMPENSATION AND STOCK REPURCHASE PROGRAM
Omnibus Long-Term Incentive Plan and 2006 Stock Option Plan
In August 2006, the Company’s Board of Directors approved the 2006 Stock Option Plan (the “2006 Plan”) for executive management and key personnel. Under the 2006 Plan, certain of the Company’s employees were granted a combination of time-based and performance-based options to purchase the Company’s common stock. In April 2009, the Company’s Board of Directors adopted the Omnibus Long-Term Incentive Plan (the “Omnibus Plan”), which became effective upon the completion of the initial public offering. Including forfeitures of options under the 2006 Plan, which can be used to issue new awards under the Omnibus Plan, approximately 1.6 million shares of common stock are available for issuance under the Omnibus Plan at March 31, 2012. The Omnibus Plan may be used to issue stock options, stock-option appreciation rights,

7


restricted stock, restricted stock units and other forms of long-term incentive compensation.
The Company recognized $3.6 million and $2.9 million of share-based compensation expense during the quarters ended March 31, 2012 and 2011, respectively, and $10.2 million and $8.3 million of share-based compensation expense during the nine months ended March 31, 2012 and 2011, respectively. None of the share-based compensation expense related to the Company’s performance-based stock options, all of which were granted under the 2006 Plan. Because the relevant performance conditions are not probable of being met at March 31, 2012, the Company continues to defer the recognition of any expense on its outstanding performance-based stock options.
On November 3, 2011, the Company granted 2.3 million time-based stock options that vest over a four year period and have an exercise price of $20.93 per share. Using key assumptions of 45% for stock price volatility and 6.25 years for expected option term, the Company estimated a fair value of $9.49 per option using the Black-Scholes-Merton pricing model.
Employees exercised 0.2 million stock options during the nine month period ended March 31, 2012. Prior to fiscal 2012, stock option exercises were not significant. Net of estimated forfeitures, the Company had $32.4 million of unrecognized compensation cost relating to time-based stock options and $29.3 million of unrecognized compensation cost related to performance-based stock options at March 31, 2012.
Long Term Incentive Compensation Plan
In fiscal 2007, EDMC adopted the Long-Term Incentive Compensation Plan (the “LTIC Plan”). The LTIC Plan consists of a bonus pool that is valued based on returns to Providence Equity Partners and Goldman Sachs Capital Partners (together, the “Principal Shareholders”) in connection with a change in control of EDMC. Out of a total of 1,000,000 units authorized, approximately 555,000 units were outstanding under the LTIC Plan at March 31, 2012. Each unit represents the right to receive a payment based on the value of the bonus pool. Because the contingent future events that would result in value to the unit-holders are less than probable, the Company has not recognized any compensation expense related to the LTIC Plan in any of the periods following the Transaction. The LTIC Plan is being accounted for as an equity-based plan because the units may be settled in stock or cash at the Company’s discretion, and it is the Company’s intent to settle any future payment out of the LTIC Plan by issuing common stock. The total amount of unrecognized compensation cost over the vesting periods of all units, net of estimated forfeitures, is approximately $2.1 million at March 31, 2012.
Stock Repurchase Program
In June 2010, EDMC’s Board of Directors (the “Board”) approved a stock repurchase program that permits EDMC to purchase shares of its common stock. On October 28, 2011, the Board extended the expiration of the period during which purchases could be made under the program from December 31, 2011 to June 30, 2012, and on December 15, 2011, the Board increased the size of the stock repurchase program from $325.0 million to $375.0 million and extended the expiration of the period during which purchases can be made under the program from June 30, 2012 to December 31, 2012. Under the terms of the stock repurchase program, EDMC may make repurchases in the open market, in privately negotiated transactions, through accelerated repurchase programs or in structured share repurchase programs. The program does not obligate EDMC to acquire any particular amount of common stock, and the program may be modified or suspended at any time at EDMC’s discretion. From the inception of the stock repurchase program through March 31, 2012, EDMC has repurchased 17.8 million shares of its common stock under the program at a total cost of $317.9 million.

4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following amounts (in thousands):  


8


Asset Class
March 31, 2012
 
June 30, 2011
 
March 31, 2011
Land
$
17,663

 
$
17,648

 
$
17,649

Buildings and improvements
76,105

 
75,835

 
75,315

Leasehold improvements
540,319

 
515,254

 
505,157

Furniture and equipment
153,565

 
148,191

 
141,916

Technology and other equipment
301,067

 
274,015

 
260,373

Software
79,848

 
69,665

 
65,130

Library books
42,073

 
39,395

 
37,941

Construction in progress
17,135

 
21,023

 
24,779

Total
1,227,775

 
1,161,026

 
1,128,260

Accumulated depreciation
(569,110
)
 
(463,649
)
 
(432,499
)
Property and equipment, net
$
658,665

 
$
697,377

 
$
695,761


Depreciation and amortization of property and equipment was $38.7 million and $35.1 million, respectively, for the quarters ended March 31, 2012 and 2011, and $112.9 million and $101.5 million, respectively, for the nine months ended March 31, 2012 and 2011.
In connection with the interim goodwill impairment analysis described in Note 5, "Goodwill and Intangible Assets," the Company also concluded that a triggering event occurred requiring management to evaluate whether the carrying values of net property, plant and equipment could have been impaired. However, based on reviews of future undiscounted cash flow projections for all schools, no impairments were recorded to property, plant and equipment at any individual institution or reporting unit.

5. GOODWILL AND INTANGIBLE ASSETS
Goodwill
The Company recorded approximately $2.6 billion of goodwill in connection with the Transaction. Goodwill is recognized as an asset in the financial statements and is initially measured as the excess of the purchase price of an acquired company over the amounts assigned to net assets acquired. In connection with the Transaction, property, equipment, intangible assets other than goodwill and other assets and liabilities were recorded at fair value. The excess of the amount paid to acquire the Company over the fair values of these net assets represented the intrinsic value of the Company beyond its tangible and identifiable intangible net assets at the time of the Transaction and was assigned to goodwill.
On April 1 of each fiscal year, the Company formally evaluates the carrying amount of goodwill for each of its four education systems, each of which represents a reporting unit of the Company. In addition, the Company also performs an evaluation on an interim basis if it determines that recent events or prevailing conditions indicate a potential impairment of goodwill. A significant amount of judgment is involved in determining whether an indicator of impairment has occurred between annual impairment tests. These indicators include, but are not limited to, adverse changes in recent forecasts of operating results, market capitalization, updated business plans and regulatory and legal developments. During the quarter ended March 31, 2012, the Company determined that its four reporting units had indicators of impairment, due primarily to current and projected future enrollment trends, as well as a decline in market capitalization. The Company believes that recent enrollment declines are principally due to economic conditions, student concern with the cost of education, the impact of new regulations on the for-profit post-secondary education industry and negative publicity regarding the industry. The enrollment declines resulting from these factors have negatively impacted each of the Company's reporting units to varying degrees and are expected to have an ongoing effect on the Company's future results. Based on these factors, the Company revised its future cash flow projections for all reporting units and undertook an interim evaluation of the carrying amount of goodwill at each reporting unit.
A two step process is used to determine the amount to be recorded for an impairment. In the first step, the Company determines the fair value of each reporting unit and compares that value to the reporting unit's carrying value. During the quarter ended March 31, 2012, the Company estimated the fair value of its reporting units using a combination of the traditional discounted cash flow approach and the guideline public company method, which takes into account the relative price and associated earnings multiples of publicly-traded peer companies. These approaches utilized a significant number of unobservable "Level Three" inputs. See Note 10, "Fair Value of Financial Instruments."

9


The valuation of the Company's reporting units requires the use of internal business plans that are based on judgments and estimates, which account for expected future economic conditions, demand and pricing for the Company's educational services, costs, inflation and discount rates, and other factors. The use of judgments and estimates involves inherent uncertainties. The Company's measurement of the fair values of its reporting units is dependent on the accuracy of the assumptions used and how the Company's estimates compare to future operating performance. The key assumptions used in impairment evaluations include, but are not limited to, the following:
Future cash flow assumptions — The Company's projections are based on organic growth and are derived from historical experience and assumptions regarding future growth and profitability trends. These projections also take into account the current economic climate and the extent to which the regulatory environment is expected to impact future growth opportunities. The Company's analysis incorporated an assumed period of cash flows of ten years with a terminal value determined using the Gordon Growth Model.
Discount rate — The discount rate is based on each reporting unit’s estimated weighted average cost of capital ("WACC"). The three components of WACC are the cost of equity, cost of debt and capital structure, each of which requires judgment by management to estimate. The Company developed its cost of equity estimate using the Capital Asset Pricing Model based on perceived risks and predictability of each reporting unit’s future cash flows. The cost of debt component represents a market participant’s estimated cost of borrowing, which the Company estimated using the average return on corporate bonds as of the valuation date, adjusted for taxes.
The WACC used to estimate the fair value of the Company's reporting units was within a range of 12.0% to 15.5% at March 31, 2012. Any difference in the WACC between reporting units is primarily due to the precision with which management expects to be able to predict its future cash flows.The results of the first step of the impairment analysis indicated that The Art Institutes reporting unit had an estimated fair value approximately 10% above its carrying value. However, the Argosy University, Brown Mackie Colleges, and South University reporting units each had carrying values higher than their respective estimated fair values. Therefore, the Company performed the second step of impairment testing for these three reporting units, which required the Company to determine the implied fair value of goodwill in the same manner as if it had acquired the reporting units in an arm’s length transaction as of the testing date of March 31, 2012. The Company performed this analysis by deducting the estimated fair value of all tangible and identifiable intangible net assets of the reporting unit from the estimated fair value of the reporting unit. Because the recorded amount of goodwill exceeded the amount of goodwill that would have been recorded under the second step as of the impairment testing date, the Company recorded goodwill impairment charges of $155.9 million, $254.6 million and $84.9 million at Argosy University, Brown Mackie Colleges and South University, respectively. Of the $495.4 million total impairment charge that the Company recorded, $379.0 million is not deductible for income tax purposes.
At March 31, 2012, the composition of the Company's goodwill balance is as follows:
 
Balance at June 30, 2011
 
Impairment Charge
 
Balance at March 31, 2012
The Art Institutes
$
1,981,820

 
$

 
$
1,981,820

Argosy University
219,350

 
(155,905
)
 
63,445

Brown Mackie Colleges
254,561

 
(254,561
)
 

South University
123,400

 
(84,914
)
 
38,486

Total goodwill
$
2,579,131

 
$
(495,380
)
 
$
2,083,751


Intangible Assets
Intangible assets consisted of the following amounts (in thousands):
 

10


 
March 31, 2012
 
June 30, 2011
 
March 31, 2011
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Gross
Carrying
Amount
 
Accumulated
Amortization
Tradename-Art Institute
$
330,000

 
$

 
$
330,000

 
$

 
$
330,000

 
$

Licensing, accreditation and Title IV program participation
112,179

 

 
112,179

 

 
112,179

 

Curriculum and programs
37,364

 
(27,350
)
 
35,221

 
(23,664
)
 
34,327

 
(22,303
)
Student contracts, applications and relationships
39,511

 
(35,992
)
 
39,511

 
(35,159
)
 
39,511

 
(34,881
)
Favorable leases and other
19,434

 
(16,302
)
 
19,451

 
(15,152
)
 
19,448

 
(14,736
)
Total intangible assets
$
538,488

 
$
(79,644
)
 
$
536,362

 
$
(73,975
)
 
$
535,465

 
$
(71,920
)

Tradenames are often considered to have useful lives similar to that of the overall business, which generally means that tradenames are assigned an indefinite life for accounting purposes. State licenses and accreditations of the Company’s schools, as well as their eligibility for Title IV program participation, are periodically renewed in cycles ranging from every year to up to every ten years depending upon government and accreditation regulations. Because the Company considers these renewal processes to be a routine aspect of the overall business, these assets are generally assigned indefinite lives.
In addition to performing an interim goodwill impairment analysis during the quarter ended March 31, 2012, management also performed an interim impairment analysis with respect to indefinite-lived intangible assets. As a result of this testing, the value of The Art Institute tradename was estimated to have a fair value more than 20% above its carrying value. In addition, the licensing, accreditation and Title IV program participation assets were estimated to have a fair value more than 40% above their carrying values.
Amortization of intangible assets was $1.9 million and $2.0 million, respectively, for the quarters ended March 31, 2012 and 2011, and $5.8 million and $6.0 million, respectively, for the nine months ended March 31, 2012 and 2011.
Total estimated amortization of the Company’s existing intangible assets at March 31, 2012 for each of the years ending June 30, 2012 through 2016 and thereafter is as follows (in thousands):

Fiscal years
Amortization
Expense
2012 (remainder)
$
2,556

2013
6,366

2014
4,598

2015
2,365

2016
451

Thereafter
329


6. OTHER LONG-TERM ASSETS
Other long-term assets consisted of the following (in thousands):
 

 
March 31, 2012
 
June 30, 2011
 
March 31, 2011
EFL program loans
$

 
$

 
$
44,403

Student receivables, net of allowance
14,602

 
11,425

 
7,493

Deferred financing fees
15,896

 
15,511

 
17,407

Deferred compensation
12,661

 
10,819

 
10,629

Other
8,947

 
8,858

 
9,983

Total other long-term assets
$
52,106

 
$
46,613

 
$
89,915



11


Student receivables, net of allowance, relates to payments due from students more than twelve months after the balance sheet date. The Company extends credit to students through payment plans for up to 36 months beyond graduation. This extension of credit helps fund the difference between total tuition and fees and the amount covered by other sources, including amounts awarded under Title IV programs, private loans and cash payments by students.
In August 2008, the Company introduced the Education Finance Loan (“EFL”) program, under which the Company purchased loans originated by a private lender. The EFL program enabled students who had exhausted all available government-sponsored or other aid and had been denied a private loan to borrow funds to finance a portion of their tuition and other educational expenses. In April 2011, the Company sold its wholly-owned subsidiary that held the EFL program loans to an unrelated third party for net proceeds of $42.8 million. The Company has no future obligations to purchase additional loans under the EFL program.


12


7. ACCRUED LIABILITIES
Accrued liabilities consisted of the following amounts (in thousands):
 
 
March 31,
2012
 
June 30,
2011
 
March 31,
2011
Payroll and related taxes
$
70,352

 
$
30,637

 
$
67,526

Advertising
23,425

 
28,279

 
34,767

Interest
11,390

 
12,340

 
21,727

Benefits
11,146

 
11,440

 
11,748

Capital expenditures
3,826

 
4,801

 
7,275

Interest rate swap liability

 

 
9,561

Other current liabilities
49,699

 
47,629

 
48,551

Total accrued liabilities
$
169,838

 
$
135,126

 
$
201,155


8. SHORT-TERM AND LONG-TERM DEBT
Senior Secured Credit Facility and Letter of Credit Facility
On March 30, 2012, EM LLC completed a refinancing of the $348.6 million portion of the $1.1 billion term loan under its senior secured credit facility that was due to expire in June 2013 by replacing it with $350.0 million of new term debt under the same credit agreement. The maturity date for the $348.6 million portion of the term loan that was repaid in connection with the March 2012 refinancing had not been extended as part of the December 7, 2010 transaction described below. The new $350.0 million term loan, which was issued with an original issue discount at 97.0% and will mature in March 2018, accrues interest at a rate equal to the greater of LIBOR or 1.25%, plus a margin of 7.0%. The new term loan is prepayable at any time; however, there are substantial penalties if it is prepaid prior to March 30, 2014. There were no changes to the $442.5 million revolving credit facility or the remaining $746.6 million of other term loan debt due in June 2016 as a result of the refinancing. The Company capitalized $5.8 million of third party costs as a result of the refinancing, of which $0.7 million was paid to one of the Sponsors.
On December 7, 2010, EM LLC entered into an agreement to amend and extend its senior secured credit facility. Holders of an aggregate of $758.7 million of then-outstanding amounts under the term loan agreed to extend the maturity date of their respective portions of the term loan from June 1, 2013 to June 1, 2016. The interest rate payable on these borrowings increased to LIBOR + 4.0%. In addition to the extension of the maturity date of the term loan borrowing, lenders providing $328.3 million of the $442.5 million in total commitments under the revolving credit facility extended their commitments from June 1, 2012 to June 1, 2015. The LIBOR based interest rate payable to lenders that agreed to extend the maturity of their revolving commitments increased by a margin of 2.5%, from LIBOR plus 1.5% to LIBOR plus 4.0%. The prime based interest rate payable to lenders that agreed to extend the maturity of their revolving commitments increased by a margin of 2.5%, from the prime rate plus a margin of 0.5% to the prime rate plus a margin of 3.0%. Lenders with revolving commitments totaling $114.2 million elected not to extend those commitments, which mature on the original maturity date of June 1, 2012 and bear interest at the lower rate. The Company capitalized $2.1 million of third party costs as a result of the refinancing.
Both refinancing transactions described above were accounted for as extinguishments of the old debt and the issuance of new debt. The Company recorded a loss on extinguishment of debt of $9.5 million in the period ended March 31, 2012, which consisted of $2.0 million of previously deferred financing fees that were being amortized through June 2013 and $7.5 million paid to lenders in connection with the refinancing. In the nine month period ended March 31, 2011, the Company recorded a loss on extinguishment of debt of $8.4 million, which included $5.1 million of previously deferred financing fees that were being amortized through June 2013 and $3.3 million paid to lenders in connection with the amendment.

At March 31, 2012, the Company had outstanding letters of credit for $416.8 million, the largest of which are issued to the U.S. Department of Education, which requires that the Company maintain a letter of credit due to the Company's failure to satisfy certain regulatory financial ratios after giving effect to the Transaction. The amount of this letter of credit requirement was $414.5 million at March 31, 2012, which equals 15% of the total financial aid under Title IV programs received by students attending the Company's institutions during fiscal 2011. During fiscal 2012, the Company entered into two cash secured letter of credit facilities pursuant to which the lenders agreed to issue letters of credit to the U.S. Department of Education in an aggregate face amount at any time outstanding of up to $200.0 million in the aggregate. The Company's obligations with respect to such letters of credit are secured by liens in favor of the lenders on certain of the Company's cash deposits, which must total at least 105% of the aggregate face amount of any outstanding letters of credit. The two facilities mature on November 30, 2013 and March 9, 2014, respectively, or earlier if the existing revolving credit facility is terminated.

13


On March 31, 2012, in order to fund its current letter of credit obligation to the Department of Education, the Company obtained a $214.5 million letter of credit under its revolving credit facility and used all $200.0 million of capacity under the cash secured letter of credit facilities, in connection with which the Company transferred $210.0 million to restricted cash to satisfy the 105% collateralization requirement.

At March 31, 2012, after giving effect to the letters of credit issued to the U.S. Department of Education, the Company had $225.7 million of remaining borrowing capacity under its revolving credit facility. On June 1, 2012, total borrowing capacity available under the Company’s revolving credit facility, including for the issuance of letters of credit, will decrease from $442.5 million to $328.3 million.
  

Short-Term Debt
As noted above, the Company had outstanding letters of credit for $416.8 million at March 31, 2012. The Company had no borrowings outstanding under the revolving credit facility at March 31, 2012 and 2011. At June 30, 2011, the Company borrowed $79.0 million under the revolving credit facility in order to satisfy year-end regulatory financial ratios, which the Company repaid on July 1, 2011 from available cash on hand.
At June 30, 2011, the interest rate on amounts outstanding under the revolving credit facility due in June 2012 was 3.75%, which equaled the prime rate plus a margin of 0.50%, and the interest rate on amounts outstanding under the revolving credit facility due in June 2015 was 6.25%, which equaled the prime rate plus a margin of 3.00%. The applicable margin for borrowings under the revolving credit facility may change based on certain leverage ratios and the Company’s credit ratings. EM LLC is also obligated to pay a per annum commitment fee on undrawn amounts under the revolving credit facility, which is currently 0.375% and varies based on certain leverage ratios. The revolving credit facility is secured by certain of EM LLC’s assets and is subject to EM LLC’s satisfaction of certain covenants and financial ratios, which are described in Part I, Item 2 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Covenant Compliance.”
Long-Term Debt

The Company’s long-term debt consisted of the following amounts (in thousands):
 
March 31, 2012
 
June 30, 2011
 
March 31, 2011
Senior secured term loan facility, due in June 2013
$

 
$
350,503

 
$
351,445

Senior secured term loan facility, due in June 2016
746,560

 
752,624

 
754,645

Senior secured term loan facility, due in March 2018, net of $3,660 discount
346,340

 

 

Senior notes due in June 2014, interest payable at 8.75%
375,000

 
375,000

 
375,000

Senior subordinated notes

 

 
47,680

Other debt
528

 
723

 
786

Total long-term debt
1,468,428

 
1,478,850

 
1,529,556

Current portion
(12,076
)
 
(12,076
)
 
(12,076
)
Total long term debt, less current portion
$
1,456,352

 
$
1,466,774

 
$
1,517,480


The interest rate on the senior secured term loan facility due in June 2013, which equaled three-month LIBOR plus a margin of 1.75%, was 2.00% and 2.06% at June 30, 2011 and March 31, 2011, respectively. The interest rate on the senior secured term loan facility due in June 2016, which equals three-month LIBOR plus a margin spread of 4.00%, was 4.50%, 4.25% and 4.31% at March 31, 2012, June 30, 2011 and March 31, 2011, respectively.

9. DERIVATIVE INSTRUMENTS
EM LLC has historically utilized interest rate swap agreements, which are contractual agreements to exchange payments based on underlying interest rates, to manage the floating interest rate risk on its long-term debt. Two such interest rate swaps, each with a notional amount of $375.0 million, expired on July 1, 2011.

In April 2011, EM LLC entered into three new interest rate swap agreements in the aggregate notional amount of $950.0 million, which became effective on July 1, 2011. One swap agreement is for a notional amount of $325.0 million and

14


effectively fixes future interest payments at a rate of 2.935% through June 1, 2013. The other two swap agreements, one of which was entered into with an affiliate of one of the Sponsors, are for notional amounts of $312.5 million each and effectively fix future interest payments at a rate of 6.26% through June 1, 2015.
The fair values of the interest rate swap liabilities were $29.8 million, $19.8 million and $18.6 million at March 31, 2012, June 30, 2011 and March 31, 2011, respectively. The March 31, 2012 and June 30, 2011 fair values were recorded in other long-term liabilities, and the March 31, 2011 fair values were recorded in accrued liabilities on the Company’s accompanying consolidated balance sheets.
On March 30, 2012, the Company replaced $348.6 million of its term loan with a new $350.0 million term loan, as further described in Note 8. Because the interest payable on the new term loan is based on the higher of LIBOR or 1.25% (rather than strictly the prevailing LIBOR) plus a margin of 7.0%, the $325.0 million interest rate swap described above no longer qualifies for cash flow hedge accounting treatment. As a result, the Company recorded the fair value loss of $2.5 million, which would previously have been recorded in other comprehensive loss, as interest expense in the accompanying March 31, 2012 consolidated statement of operations. Future changes in the fair value of this interest rate swap will be recorded as interest expense in the period incurred.
The refinancing of the term loan did not impact the Company's other two swap agreements for notional amounts of $312.5 million. At March 31, 2012, there was a cumulative unrealized loss of $17.2 million, net of tax, related to these interest rate swaps included in accumulated other comprehensive loss on the Company’s accompanying consolidated balance sheet. This loss would be immediately recognized in the consolidated statement of operations if these instruments fail to meet certain cash flow hedge requirements.
The net change in unrecognized loss on interest rate swaps, net of tax, recorded in other comprehensive loss was as follows (in thousands):
 
 
For the Three Months Ended March 31,
 
For the Nine Months Ended March 31,
 
2012
 
2011
 
2012
 
2011
Reclassification into earnings
$
1,963

 
$
6,018

 
$
6,699

 
$
17,796

Periodic revaluation
(3,062
)
 
(328
)
 
(13,927
)
 
(2,459
)
Fair value loss of interest rate swap that no longer qualifies for hedge accounting
2,538

 

 
2,538

 

Net change in unrecognized loss on interest rate swaps, net of tax
$
1,439

 
$
5,690

 
$
(4,690
)
 
$
15,337


Over the next twelve months, the Company estimates approximately $7.0 million will be reclassified from accumulated other comprehensive loss to the consolidated statement of operations based on current interest rates and underlying debt obligations at March 31, 2012.
The Company used “Level Two” inputs, which are defined in Note 10, "Fair Value of Financial Instruments" to value its interest rate swaps. The application of level two inputs includes obtaining quotes from counterparties, which are based on LIBOR forward curves, and assessing non-performance risk based upon published market data.

10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and fair values of financial instruments (in thousands):
 
 
March 31, 2012
 
June 30, 2011
 
March 31, 2011
 
Carrying
Value
 
Fair Value
 
Carrying
Value
 
Fair Value
 
Carrying
Value
 
Fair Value
Variable rate debt
$
1,092,900

 
$
1,037,768

 
$
1,103,127

 
$
1,085,768

 
$
1,106,090

 
$
1,082,146

Fixed rate debt
375,528

 
371,778

 
375,723

 
383,223

 
423,466

 
431,936

Total long-term debt
$
1,468,428

 
$
1,409,546

 
$
1,478,850

 
$
1,468,991

 
$
1,529,556

 
$
1,514,082


The Company determines the fair value of assets and liabilities based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an

15


orderly transaction between market participants and based on assumptions that market participants would use when pricing an asset or liability, including assumptions about risk and the risks inherent in valuation techniques and the inputs to valuations. The Company uses a fair value hierarchy based on whether the inputs to valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's own assumptions about the assumptions that market participants would use. The fair value hierarchy includes three levels of inputs that may be used to measure fair value as described below.
Level One - Quoted prices for identical instruments in active markets.
Level Two - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations for which all significant inputs are observable market data.
Level Three - Unobservable inputs significant to the fair value measurement supported by little or no market activity.
In some cases, the inputs used to measure fair value may meet the definition of more than one level of fair value hierarchy. The lowest level input that is significant to the fair value measurement in its totality determines the applicable level in the fair value hierarchy.
The fair values of cash and cash equivalents, restricted cash, accounts receivable, the revolving credit facility, accounts payable and accrued expenses approximate carrying values due to the short-term nature of these instruments. Derivative financial instruments are carried at fair value, which is based on the framework discussed in Note 9, “Derivative Instruments.” The fair value of the Company’s fixed rate debt was determined using "Level One" inputs. The fair value of the Company's variable rate debt was determined using "Level Two" inputs. These fair values are based on each instrument’s trading value at the dates presented.

11. INCOME TAXES
The Company uses the asset and liability method to account for income taxes. Under this method, deferred tax assets and liabilities result from (i) temporary differences in the recognition of income and expense for financial and federal income tax reporting requirements, and (ii) differences between the recorded value of assets acquired in business combinations accounted for as purchases for financial reporting purposes and their corresponding tax bases. The Company regularly evaluates deferred income tax assets for recoverability and records a valuation allowance if it is more-likely-than-not that some portion of the deferred income tax asset will not be realized.

The Company's effective tax rate was 5.7% and 35.7%, respectively, for the quarters ended March 31, 2012 and 2011. The Company's effective tax rate was (10.9)% and 37.4%, respectively, for the nine months ended March 31, 2012 and 2011. The effective tax rates in the current periods were significantly impacted by a $495.4 million goodwill impairment recorded during the quarter ended March 31, 2012, of which $379.0 million was not deductible for tax purposes. Excluding the income statement impact of the goodwill impairment, the effective tax rate would have been 38.0% and 38.7% in the three and nine months ended March 31, 2012, respectively. The effective tax rate differed from the combined federal and state statutory rates due to valuation allowances, expenses that are non-deductible for tax purposes, and the accounting related to uncertain tax positions.
As a result of the expiration of certain statutes of limitation with respect to the 2008 and 2007 fiscal years, the Company's liability for uncertain tax positions, excluding interest and the indirect benefits associated with state income taxes, decreased by $0.9 million and $4.3 million during the three month periods ended March 31, 2012 and 2011, respectively. The Company's effective tax rate was impacted by $0.7 million and $3.5 million during the three month periods ended March 31, 2012 and 2011, respectively, related to these statutes of limitation expirations.
As of March 31, 2012, the Company's accrual for uncertain tax positions was $4.5 million, excluding interest and the indirect benefits associated with state income taxes. It is reasonably possible that the total amount of unrecognized tax benefits, excluding interest and the indirect benefits associated with state income taxes, will decrease by $0.7 million within the next twelve months due to the expiration of certain statutes of limitation with respect to the 2009 fiscal year. The tax benefit of such decrease, if recognized, will be a discrete item in the third quarter of fiscal year 2013.
The statutes of limitation for the Company's U.S. income tax return are closed for years through fiscal 2008. The statutes of limitation for the Company's state and local income tax returns for prior periods vary by jurisdiction. However, the statutes of limitation with respect to the major jurisdictions in which the Company files state and local income tax returns are generally closed for years through fiscal 2007.



16


12. CONTINGENCIES
Securities Class Action
On August 11, 2010, a securities class action complaint captioned Gaer v. Education Management Corp., et. al was filed against the Company, certain of its executive officers and directors, and certain underwriters of the Company's initial public offering. The complaint alleges violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Exchange Act of 1934 due to allegedly false and misleading statements in connection with the Company's initial public offering and the Company's subsequent press releases and filings with the Securities and Exchange Commission. On September 29, 2011, the District Court granted the Company's motion to dismiss the case with prejudice. The plaintiffs appealed the District Court's dismissal of the lawsuit to the Third Circuit Court of Appeals, but on April 17, 2012, voluntarily withdrew their appeal. As a result, the Third Circuit Court of Appeals entered an Order dismissing the appeal with prejudice on April 18, 2012.
Qui Tam Matters
On May 3, 2011, a qui tam action captioned United States of America, and the States of California, Florida, Illinois, Indiana, Massachusetts, Minnesota, Montana, New Jersey, New Mexico, New York and Tennessee, and the District of Columbia, each ex rel., Lynntoya Washington and Michael T. Mahoney v. Education Management Corporation, et. al (“Washington”) filed under the federal False Claims Act in April 2007 was unsealed due to the U.S. Department of Justice’s decision to intervene in the case. Five of the states listed on the case caption and the District of Columbia have joined the case based on qui tam actions filed under their respective False Claims Acts. The State of Kentucky, which does not have a False Claims Act, filed a motion to intervene in the case under its consumer protection laws, which was denied by the Court. The case, which is pending in the Western District of Pennsylvania, relates to whether the defendants’ compensation plans for admission representatives violated the Higher Education Act, as amended (“HEA”), and U.S. Department of Education regulations prohibiting an institution participating in Title IV programs from providing any commission, bonus or other incentive payment based directly or indirectly on success in securing enrollments to any person or entity engaged in any student recruitment or admissions activity during the period of July 1, 2003 through June 30, 2011. The complaint was initially filed by a former admissions representative at The Art Institute of Pittsburgh Online Division and a former director of training at EDMC Online Higher Education and asserts the relators are entitled to recover treble the amount of actual damages allegedly sustained by the federal government as a result of the alleged activity, plus civil monetary penalties. The complaint does not specify the amount of damages sought but claims that the Company and/or students attending the Company’s schools received over $11 billion in funds from participation in Title IV programs and state financial aid programs during the period of alleged wrongdoing. On October 5, 2011, the Company filed a motion to dismiss the case with prejudice for failure to state a claim upon which relief can be granted. The Company believes the claims to be without merit and intends to vigorously defend itself.
In March 2012, a qui tam action captioned United States of America, ex rel. Jason Sobek v. Education Management Corporation, et al. filed under the federal False Claims Act in January 2010 was unsealed after the U.S. Department of Justice declined to intervene in the case. The case, which is pending in the Western District of Pennsylvania, alleges that the defendants violated the U.S. Department of Education's regulation prohibiting institutions from making substantial misrepresentations to prospective students, did not adequately track student academic progress and violated the U.S. Department of Education's prohibition on the payment of incentive compensation to admissions representatives. The complaint was filed by a former project associate director of admissions at EDMC Online Higher Education who worked for South University and asserts the relator is entitled to recover treble the amount of actual damages allegedly sustained by the federal government as a result of the alleged activity, plus civil monetary penalties. The complaint does not specify the amount of damages sought but claims that the Company's institutions were ineligible to participate in Title IV programs during the period of alleged wrongdoing. The Company believes the claims to be without merit and intends to vigorously defend itself.
OIG Subpoena
On March 22, 2011, the Company received a subpoena from the Office of Inspector General of the U.S. Department of Education requesting documents related to satisfactory academic progress standards and state licensing of online programs offered by South University and The Art Institute of Pittsburgh for the time period beginning January 1, 2006 through the date of the subpoena. The Company intends to cooperate with the subpoena and investigation. However, the Company cannot predict the eventual scope, duration or outcome of the investigation at this time.
Buirkle APA Program Accreditation Lawsuit
In August 2009, a petition was filed in the District Court for Dallas County, Texas in the case of Capalbo et al. v. Argosy Education Group, Inc. University, Education Management LLC, Education Management Corporation and Marilyn Powell-Kissinger by 15 former students in the Clinical Psychology program offered by the Dallas campus of Argosy University. In

17


September 2009, the defendants removed the case to the United States District Court for the Northern District of Texas, Dallas division. The case was remanded back to state court in November 2009 by agreement after the plaintiffs amended their pleadings to specify their allegations and agreed to dismiss Ms. Powell-Kissinger as a defendant. The plaintiffs filed an amended petition in state court in January 2010 under the name of Buirkle et al. v. Argosy Education Group, Inc., Education Management LLC and Education Management Corporation and included three new plaintiffs. The petition alleges that, prior to the plaintiffs’ enrollment and/or while the plaintiffs were enrolled in the program, the defendants violated the Texas Deceptive Trade Practices and Consumer Protection Act and made material misrepresentations regarding the importance of accreditation of the program by the Commission on Accreditation of the American Psychological Association, the status of the application of the Dallas campus for such accreditation, the availability of loan repayment options for the plaintiffs, and the quantity and quality of the plaintiffs’ career options. Plaintiffs seek unspecified monetary compensatory and punitive damages. In March 2010, claims filed by three of the plaintiffs who signed arbitration agreements with Argosy University were compelled to binding arbitration. The remaining lawsuits in the case were stayed pending the resolution of the three arbitrations.
In May 2010, those three plaintiffs and a fourth former student in the Clinical Psychology program offered by the Dallas campus of Argosy University filed a demand for arbitration. The first of four separate arbitrations is currently scheduled to be heard in 2012. Also in May 2010, three additional former students in the Clinical Psychology program offered by the Dallas campus of Argosy University filed a new action in the District Court for Dallas County, Texas in the case of Adibian et al. v. Argosy Education Group, Inc., Education Management LLC, and Education Management Corporation alleging the same claims made in the previous lawsuits. The defendants filed a motion to stay the new action pending the resolution of the arbitration proceedings. Prior to the hearing on the motion, plaintiffs filed a notice of non-suit without prejudice. The court signed the order of non-suit in August 2010, and the case was closed. In September 2010, the plaintiffs filed two amendments to the petition filed in the previously-stayed Buirkle lawsuit, adding four new plaintiffs to the lawsuit, including the plaintiffs from the non-suited Adibian lawsuit.
The Company believes the claims in the lawsuits and the arbitrations to be without merit and intends to vigorously defend itself.
State Attorney General Investigations
In August 2011, the Company received a subpoena from the Attorney General of the State of New York requesting documents and detailed information for the time period of January 1, 2000 through the present. The Art Institute of New York City is the Company’s only school located in New York though the subpoena also addresses fully online students who reside in the State. The subpoena is primarily related to the Company’s compensation of admissions representatives and recruiting activities. The relators in the Washington qui tam case filed the complaint under the State of New York’s False Claims Act though the state has not announced an intention to intervene in the matter. The Company intends to cooperate with the investigation. However, the Company cannot predict the eventual scope, duration or outcome of the investigation at this time.
In December 2010, the Company received a subpoena from the Office of Consumer Protection of the Attorney General of the Commonwealth of Kentucky requesting documents and detailed information for the time period of January 1, 2008 through December 31, 2010. The Company has three Brown Mackie College locations in Kentucky. The Kentucky Attorney General announced an investigation of the business practices of for-profit post-secondary schools and that subpoenas were issued to six proprietary colleges that do business in Kentucky in connection with the investigation. The Company intends to continue to cooperate with the investigation. However, the Company cannot predict the eventual scope, duration or outcome of the investigation at this time.
In October 2010, Argosy University received a subpoena from the Florida Attorney General’s office seeking a wide range of documents related to the Company’s institutions, including the nine institutions located in Florida, from January 2, 2006 to the present. The Florida Attorney General has announced that it is investigating potential misrepresentations in recruitment, financial aid and other areas. The Company is cooperating with the investigation, but has also filed a suit to quash or limit the subpoena and to protect information sought that constitutes proprietary or trade secret information. The Company cannot predict the eventual scope, duration or outcome of the investigation at this time.
In June 2007, The New England Institute of Art (“NEIA”) received a civil investigative demand letter from the Massachusetts State Attorney General requesting information in connection with the Attorney General’s review of alleged submissions of false claims by NEIA to the Commonwealth of Massachusetts and alleged unfair and deceptive student lending and marketing practices engaged in by the school. In February 2008, the Attorney General informed NEIA that it does not plan to further pursue its investigation of deceptive marketing practices. In June and August of 2011, the Company provided the Attorney General with additional information related to the false claims investigation. NEIA intends to fully cooperate with the Attorney General in connection with its continuing investigation.

18


City of San Francisco
In December 2011, the Company received a letter from the City Attorney of the City of San Francisco, California requesting information related to student recruitment and indebtedness, including recruiting practices and job placement reporting, among other issues, by The Art Institute of San Francisco and the seven other Art Institutes located in California. The Company intends to cooperate with the investigation. However, the Company cannot predict the eventual scope, duration or outcome of the investigation at this time.
Other Matters
The Company is a defendant in certain other legal proceedings arising out of the conduct of its business. In the opinion of management, based upon an investigation of these claims and discussion with legal counsel, the ultimate outcome of such other legal proceedings, individually and in the aggregate, is not expected to have a material adverse effect on the Company’s consolidated financial position, results of operations or liquidity.


13. GUARANTOR SUBSIDIARIES FINANCIAL INFORMATION
On June 1, 2006, in connection with the Transaction, EM LLC and Education Management Finance Corp. (a wholly owned subsidiary of EM LLC) issued the Senior Notes. The Senior Notes are fully and unconditionally guaranteed by all of EM LLC’s existing direct and indirect domestic restricted subsidiaries, other than any subsidiary that directly owns or operates a school, or has been formed for such purposes, and subsidiaries that have no material assets (collectively, the “Guarantor Subsidiaries”). None of EM LLC’s other direct or indirect subsidiaries guarantee the Senior Notes (collectively, the “Non-Guarantor Subsidiaries”). Additionally, EDMC has guaranteed the indebtedness of Education Management Finance Corp. and EM LLC under the Senior Notes.
The following tables present the condensed consolidated financial position of EM LLC, the Guarantor Subsidiaries, the Non-Guarantor Subsidiaries and EDMC as of March 31, 2012June 30, 2011 and March 31, 2011. The results of operations for the three and nine months ended March 31, 2012 and 2011 and of condensed cash flows for the nine months ended March 31, 2012 and 2011 are also presented for EM LLC, the Guarantor Subsidiaries, the Non-Guarantor Subsidiaries and EDMC.











19


CONDENSED CONSOLIDATED BALANCE SHEET
March 31, 2012 (In thousands)
 
 
EM LLC
Guarantor
Subsidiaries
Non-Guarantor
Subsidiaries
Eliminations
EM LLC
Consolidated
EDMC
Eliminations
EDMC
Consolidated
Assets
 
 
 
 
 
 
 
 
Current:
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
227,263

$
47

$
6,997

$

$
234,307

$
53,196

$

$
287,503

Restricted cash
48,243


235,810


284,053



284,053

Student and other receivables, net
3,841

174

156,319


160,334

(1
)

160,333

Inventories

117

9,918


10,035



10,035

Other current assets
26,653

218

97,218


124,089



124,089

Total current assets
306,000

556

506,262


812,818

53,195


866,013

Property and equipment, net
69,445

7,657

581,563


658,665



658,665

Intercompany balances
665,834

(29,550
)
(742,409
)

(106,125
)
106,125



Other long-term assets
53,451


(1,345
)

52,106



52,106

Investment in subsidiaries
1,989,615



(1,989,615
)

1,533,959

(1,533,959
)

Intangible assets, net
1,950

42

456,852


458,844



458,844

Goodwill
7,328


2,076,423


2,083,751



2,083,751

Total assets
$
3,093,623

$
(21,295
)
$
2,877,346

$
(1,989,615
)
$
3,960,059

$
1,693,279

$
(1,533,959
)
$
4,119,379

Liabilities and shareholders' equity (deficit)
 
 
 
 
 
 
 
 
Current:
 
 
 
 
 
 
 
 
Current portion of long-term debt
$
11,850

$

$
226

$

$
12,076

$

$

$
12,076

Other current liabilities
37,679

4,880

500,324


542,883

(4
)

542,879

Total current liabilities
49,529

4,880

500,550


554,959

(4
)

554,955

Long-term debt, less current portion
1,456,050


302


1,456,352



1,456,352

Other long-term liabilities
52,839

376

188,043


241,258

2


241,260

Deferred income taxes
1,246

265

172,020


173,531

(124
)

173,407

Total liabilities
1,559,664

5,521

860,915


2,426,100

(126
)

2,425,974

Total shareholders' equity (deficit)
1,533,959

(26,816
)
2,016,431

(1,989,615
)
1,533,959

1,693,405

(1,533,959
)
1,693,405

Total liabilities and shareholders’ equity  (deficit)
$
3,093,623

$
(21,295
)
$
2,877,346

$
(1,989,615
)
$
3,960,059

$
1,693,279

$
(1,533,959
)
$
4,119,379





20


CONDENSED CONSOLIDATED BALANCE SHEET
June 30, 2011 (In thousands)
 
 
EM LLC
Guarantor
Subsidiaries
Non-Guarantor
Subsidiaries
Eliminations
EM LLC
Consolidated
EDMC
Eliminations
EDMC
Consolidated
Assets
 
 
 
 
 
 
 
 
Current:
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
(16,816
)
$
270

$
369,637

$

$
353,091

$
50,133

$

$
403,224

Restricted cash
30,685


16,828


47,513



47,513

Student and other receivables, net
3,758

78

169,121


172,957



172,957

Inventories
(296
)
172

9,718


9,594



9,594

Other current assets
25,229

586

110,432


136,247



136,247

Total current assets
42,560

1,106

675,736


719,402

50,133


769,535

Property and equipment, net
71,417

7,552

618,408


697,377



697,377

Intangible assets, net
2,300

51

460,036


462,387



462,387

Goodwill
7,328


2,571,803


2,579,131



2,579,131

Intercompany balances
1,206,483

(29,516
)
(1,364,493
)

(187,526
)
187,526



Other long-term assets
30,229


16,384


46,613



46,613

Investment in subsidiaries
2,189,422



(2,189,422
)

1,866,158

(1,866,158
)

Total assets
$
3,549,739

$
(20,807
)
$
2,977,874

$
(2,189,422
)
$
4,317,384

$
2,103,817

$
(1,866,158
)
$
4,555,043

Liabilities and shareholders' equity (deficit)
 
 
 
 
 
 
 
 
Current:
 
 
 
 
 
 
 
 
Current portion of long-term debt and revolving credit facility
$
90,850

$

$
226

$

$
91,076

$

$

$
91,076

Other current liabilities
94,837

3,517

347,514


445,868

(3
)

445,865

Total current liabilities
185,687

3,517

347,740


536,944

(3
)

536,941

Long-term debt, less current portion
1,466,277


497


1,466,774



1,466,774

Other long-term liabilities
42,841

433

181,426


224,700



224,700

Deferred income taxes
(11,224
)
265

233,767


222,808

(124
)

222,684

Total liabilities
1,683,581

4,215

763,430


2,451,226

(127
)

2,451,099

Total shareholders' equity (deficit)
1,866,158

(25,022
)
2,214,444

(2,189,422
)
1,866,158

2,103,944

(1,866,158
)
2,103,944

Total liabilities and shareholders’ equity  (deficit)
$
3,549,739

$
(20,807
)
$
2,977,874

$
(2,189,422
)
$
4,317,384

$
2,103,817

$
(1,866,158
)
$
4,555,043





21


CONDENSED CONSOLIDATED BALANCE SHEET
March 31, 2011 (In thousands)
 
 
EM LLC
Guarantor
Subsidiaries
Non-Guarantor
Subsidiaries
Eliminations
EM LLC
Consolidated
EDMC
Eliminations
EDMC
Consolidated
Assets
 
 
 
 
 
 
 
 
Current:
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
543,502

$
10,636

$
9,919

$

$
564,057

$
49,098

$

$
613,155

Restricted cash
21,571


31,336


52,907



52,907

Student and other receivables, net
(77
)
101

125,273


125,297

4


125,301

Inventories
(254
)
117

11,922


11,785



11,785

Other current assets
31,085

418

76,649


108,152



108,152

Total current assets
595,827

11,272

255,099


862,198

49,102


911,300

Property and equipment, net
70,212

7,172

618,377


695,761



695,761

Intangible assets, net
2,445

53

461,047


463,545



463,545

Goodwill
7,328


2,571,803


2,579,131



2,579,131

Intercompany balances
692,994

(106,974
)
(857,282
)

(271,262
)
271,262



Other long-term assets
33,247

44,196

12,473


89,916

(1
)

89,915

Investment in subsidiaries
2,138,249



(2,138,249
)

1,837,633

(1,837,633
)

Total assets
$
3,540,302

$
(44,281
)
$
3,061,517

$
(2,138,249
)
$
4,419,289

$
2,157,996

$
(1,837,633
)
$
4,739,652

Liabilities and shareholders' equity (deficit)
 
 
 
 
 
 
 
 
Current:
 
 
 
 
 
 
 
 
Current portion of long-term debt
$
11,850

$

$
226

$

$
12,076

$

$

$
12,076

Other current liabilities
149,582

3,881

513,492


666,955

(2
)

666,953

Total current liabilities
161,432

3,881

513,718


679,031

(2
)

679,029

Long-term debt, less current portion
1,516,920


560


1,517,480



1,517,480

Other long-term liabilities
32,726

1,325

173,444


207,495



207,495

Deferred income taxes
(8,409
)
(23,987
)
210,046


177,650

(260
)

177,390

Total liabilities
1,702,669

(18,781
)
897,768


2,581,656

(262
)

2,581,394

Total shareholders' equity (deficit)
1,837,633

(25,500
)
2,163,749

(2,138,249
)
1,837,633

2,158,258

(1,837,633
)
2,158,258

Total liabilities and shareholders’ equity (deficit)
$
3,540,302

$
(44,281
)
$
3,061,517

$
(2,138,249
)
$
4,419,289

$
2,157,996

$
(1,837,633
)
$
4,739,652



22


CONSOLIDATED STATEMENT OF OPERATIONS
For the Three Months Ended March 31, 2012 (In thousands)
 
 
EM LLC
Guarantor
Subsidiaries
Non-Guarantor
Subsidiaries
Eliminations
EM LLC
Consolidated
EDMC
Eliminations
EDMC
Consolidated
Net revenues
$

$
1,430

$
701,069

$

$
702,499

$

$

$
702,499

Costs and expenses:
 
 
 
 
 
 
 
 
Educational services
26,948

2,518

354,818


384,284

(1,971
)

382,313

General and administrative
(21,211
)
85

210,736


189,610

2,028


191,638

Depreciation and amortization
6,626

142

33,842


40,610



40,610

Goodwill impairment


495,380


495,380



495,380

Total costs and expenses
12,363

2,745

1,094,776


1,109,884

57


1,109,941

Income (loss) before loss on extinguishment of debt, interest and income taxes
(12,363
)
(1,315
)
(393,707
)

(407,385
)
(57
)

(407,442
)
Interest (income) expense, net
24,826


599


25,425

(1
)

25,424

Loss on extinguishment of debt
9,474




9,474



9,474

Equity in earnings of subsidiaries
331,525



(331,525
)

417,060

(417,060
)

Income (loss) before income taxes
(378,188
)
(1,315
)
(394,306
)
331,525

(442,284
)
(417,116
)
417,060

(442,340
)
Provision for (benefit from) income taxes
38,872

294

(64,390
)

(25,224
)


(25,224
)
Net income (loss)
$
(417,060
)
$
(1,609
)
$
(329,916
)
$
331,525

$
(417,060
)
$
(417,116
)
$
417,060

$
(417,116
)

CONSOLIDATED STATEMENT OF OPERATIONS
For the Three Months Ended March 31, 2011 (In thousands)

 
EM LLC
Guarantor
Subsidiaries
Non-Guarantor
Subsidiaries
Eliminations
EM LLC
Consolidated
EDMC
Eliminations
EDMC
Consolidated
Net revenues
$

$
1,699

$
752,641

$

$
754,340

$

$

$
754,340

Costs and expenses:
 
 
 
 
 
 
 
 
Educational services
20,567

15,923

345,213


381,703



381,703

General and administrative
(26,170
)
(651
)
217,332


190,511

57


190,568