SYLVANLEARNING SYSTEMS, INC.

1998 Annual Report

All men by nature

desire knowledge.ARISTOTLE

EDUCATION is the bridge between the past and thefuture. It drives the soul, buoys the spirit and feeds the mind.It takes people into new worlds and gives them the power to fulfill their dreams. Whatever those dreams may be.

At Sylvan Learning Systems, we recognize that the quest for knowledge is universal, that education empowers andthat learning knows no boundaries.

Sylvan Learning Centers®

delivereducational programs to students of all agesand skill levels through 739 neighborhoodlocations throughout the United States andCanada. In 1998, the Sylvan Learning Centersserved more than 129,000 students.

Canter develops training,staff development and grad-uate course materials for K-12 educators. Canter pro-grams are delivered primarilythrough distance learning.

Sylvan At SchoolSM

programs provide tutoring tostudents and a range of support services to teachers andadministrators of public and non-public schools. Cur-rently, these programs are being delivered under contractto more than 900 schools across the United States.

Wall Street Institute® delivers English languageinstruction primarily to working professionals on a part-time basis in their home countries. There are 263 Wall Street Institute centers in Europe, LatinAmerica, Asia and the Middle East.

ASPECT offers English languageimmersion programs primarily to college-aged students in English speaking coun-tries. ASPECT programs currently areoffered at 28 schools in five countries.

PACE delivers corporate trainingand consulting services to morethan 300 corporate clients. PACE’sservices help clients to identify individual, team and organizationalperformance issues and to developlong-term solutions.

Sylvan Prometric® delivers computer-based testing services at more than 2,500 locations throughoutthe world. Computer-based testsoffered through Sylvan Prometricinclude university admissions tests suchas the Graduate Record Examination®,Graduate Management AdmissionTest® and Test of English as a ForeignLanguage™, and exams used to licenseand certify professionals such as physi-cians, nurses, teachers, stock brokers,architects, computer technicians andmany more. Through sites serving 150 countries, Sylvan Prometric delivers testing programs on behalf of more than 100 organizations.

Sylvan Learning CentersInternational offer tutoring andhomework help services to school-agedstudents. There are approximately 900 centers across Germany, Austriaand Italy under the Schülerhilfe® brandname and 12 Sylvan tutoring centers in Madrid and Barcelona, a networkthat is expected to expand to 50 centersthroughout Spain by the end of 1999.

adult education

K-12 services

SYLVAN AT A GLANCE

OUR MISSION is to be the world’s leading provider of educational services to families, schools and industry.

services

The Universidad Europea de Madrid (UEM) is the first private for-profit university in a new international networkof universities that Sylvan plans to establish inselect markets, initially spanning Europe andLatin America. Sylvan is launching this initia-tive to address an exploding demand for highereducation in these markets. Sylvan expects tocomplete the purchase of a controlling interestin UEM in the second or third quarter of 1999.

SITES WORLDWIDEStudents

Number Servedof Sites in 1998

K-12 EDUCATION SERVICES

Sylvan Learning Centers North America 739 129,000

Sylvan Learning Centers International 912 50,000

Sylvan At School 900 65,000

Canter (degree and credit programs for teachers) * 35,000

ADULT EDUCATION SERVICES

Sylvan Technology Centers 571

Authorized Prometric Testing Centers 2,002

English Language (Wall Street Institute, ASPECT) 291 100,000

*Programs delivered through distance learning

3.5 million tests delivered}

At Sylvan, we know that success is learnedSM.

REVENUE BY DIVISION

In millions

Sylvan Learning CentersSylvan Contract Education ServicesSylvan Prometric

1994 1995 1996 1997 1998

FINANCIAL HIGHLIGHTS1

In thousands 1994 1995 1996 1997 1998

Total Revenues $94,205 $139,286 $219,973 $301,011 $440,330

Operating Income $ 4,170 $ 5,619 $ 24,105 $ 13,7952 $ 56,4573

Net Income $ 3,947 $ 4,042 $ 15,754 $ 27,904 $ 35,709

1 Restated for various poolings of interests consummated by the Company as discussed in Note 3 to the Consolidated Financial Statements.

2 The 1997 Operating Income was negatively impacted by $25.5 million of non-recurring pre-tax charges, discussed in Notes 13 and 15 to the

Consolidated Financial Statements.

3 The 1998 Operating Income was negatively impacted by $9.9 million of non-recurring pre-tax charges, discussed in Management’s Discussion and Analysis of

Financial Condition and Results of Operations to the Consolidated Financial Statements.

$275

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Knowledge is power.FRANCIS BACON

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TO OUR SHAREHOLDERS

IN 1998 Sylvan posted an outstanding financial per-formance for the fifth consecutive year since goingpublic. Overall our revenues reached $440.3 million,an increase of 46 percent over 1997. Net incomeincreased to $35.7 million, and earnings per shareincreased to $0.70 on diluted shares outstanding of 51.3 million, compared to net income of$27.9 million, or $0.62 per share, on dilutedshares outstanding of 44.9 million in 1997.

Costs associated with the acquisition of ASPECT,an English language business acquired in May 1998,impacted the year ended December 31, 1998 byreducing net income by $8.9 million. Sylvan’s netincome for the year excluding these costs would havebeen approximately $44.6 million, or $0.87 per shareon diluted shares of 51.3 million. The net incomefor the year ended December 31, 1997, adjusted for$1.9 million in non-recurring net income resultingfrom the NEC acquisition termination and $4.7 mil-lion in net non-recurring costs associated with theASPECT acquisition, would have been approximately$30.7 million, or $0.68 per share, on diluted sharesoutstanding of 44.9 million.

Each of Sylvan’s business areas made significantstrides this past year. Our Sylvan Learning Centersdivision, which celebrates its 20th Anniversary in1999, continued to attain high growth in same center revenues—hitting 18 percent for franchisedcenters and 16 percent for company-owned centers.Although we are by far the leader in the tutoringfield, we foresee excellent prospects for growth, as we currently serve less than one percent of childrenfrom families who can afford our services. Overall,Sylvan Learning Centers increased total revenues by 39 percent over 1997 to $65 million, as a result of growth in all the components that comprise itsrevenues: royalties from franchised learning centerlocations (8 percent on average), sales of new franchiseterritories and tuition fees from company-ownedcenters. With 61 new franchised centers added tothe network during 1998, the current total numberof franchised centers is 676. In addition, we pur-chased 13 franchised centers in 1998, bringing thetotal number of company-owned centers to 63.

Our network of tutoring centers also expandedinternationally during 1998 with the acquisition of Schülerhilfe, a tutoring business with more than

900 centers across Germany, Austria and Italy. Andin Spain, Sylvan tutoring centers are now open inMadrid and Barcelona, and as many as 50 centersare expected to be operating across that country during 1999.

Sylvan’s Contract Education Services divisionincreased total revenues by 51 percent over 1997 to $101 million. This increase resulted from newcontract relationships with districts across theUnited States, most notably in California, and theacquisition of Canter in January 1998. In January 1998, Sylvan entered into an agreement to provide services to 19 Compton public schools. In April,Sylvan was chosen to provide educational serviceswithin 32 public schools in the Los Angeles UnifiedSchool District, and we also began new relationshipswith the districts of Hawthorne and Long Beach.Elsewhere, we entered into agreements with theschool districts of Hartford, Conn., Portland, Ore., St. Louis, Mo., and Minneapolis, Minn. Also, this division’s development efforts were bolsteredthrough the addition to our executive team of Dr. Curman Gaines, former superintendent of St. Paul Public Schools.

Sylvan Prometric, the company’s computer-basedtesting division, posted strong gains in 1998 due, inpart, to large volume increases in academic testingprograms, such as the Graduate ManagementAdmission Test (GMAT) and the Test of English as a Foreign Language (TOEFL®), which converted to computer-based delivery worldwide in late 1997and mid-1998, respectively. In addition, we sawstrong growth in our Information Technology testingprograms for such vendors as Microsoft®, Oracle®,Novell®, Cisco Systems® and others. Also, we addedto our roster of testing programs the United StatesMedical Licensing Examination® (USMLE®), theexam used in the licensure of most physicians in the United States. Each year, more than 125,000USMLE exams are given in a paper-and-pencil for-mat. Revenues for the Sylvan Prometric division,which also includes our English language businesses,increased 46 percent over 1997, to $275 million.

Along with increasing our market share domestically,Sylvan took major steps in our steady climb towardleadership of the international testing market in1998. Leveraging our strong international distribu-tion system for computer-based testing services, we won a five-year, $125 million contract to deliverall drivers’ license theory tests throughout England,Scotland and Wales, with testing set to begin in

There is only one good, knowledge, and one evil, ignorance.

SOCRATES

3

programs. Also, we announced that Dr. JosephDuffey, former director of the United StatesInformation Agency (USIA) and former presi-dent of American University and Chancellor of the University of Massachusetts, will managethis venture. With such a respected leader in theworlds of higher education and internationalrelations as Dr. Duffey, and such an exceptionaluniversity as UEM, we believe we are getting off to the strongest possible start to this new ven-ture, and we are truly excited about the prospectsof this new area of business.

Through its growing network of tutoring, test-ing and training sites, Sylvan is establishing aubiquitous distribution channel for educationalservices around the globe. Much as the SylvanLearning Centers have served as the base ofSylvan’s distribution network across NorthAmerica, our growing international presencecan serve as the base upon which existing andfuture service offerings can be added.

In summary, we are gratified with our achievementsover the past year, both in increased shareholdervalue and in progress toward our goal to becomethe world’s leading provider of educational servicesto families, schools and industry. We thank ouremployees for their dedication, our board ofdirectors for their counsel and our investors fortheir support. We are grateful that they share ourconfidence and enthusiasm that Sylvan is poisedto fully exploit the enormous opportunities thatlie ahead in the global education marketplace.

Sincerely,

Christopher Hoehn-SaricChairman and Co-Chief Executive Officer

Douglas L. BeckerPresident and Co-Chief Executive Officer

2000. Shortly afterward, we won the contract todeliver all drivers’ license theory tests throughoutNorthern Ireland. While to date Sylvan’s testingprograms abroad are delivered primarily on behalfof U.S.-based organizations serving internationalconstituencies, we intend to build on our presencewithin more than 150 countries to deliver moreindigenous testing programs. These contracts in Great Britain and Northern Ireland serve asthe first important milestones in fulfilling thisobjective. And, as the first and largest imple-mentations of computer-based testing in Europe,these programs will provide excellent examplesfor other domestic testing authorities to follow.

Internationally beyond testing, our Wall StreetInstitute (WSI) network of English languageinstruction centers expanded to 263 centers serving 15 countries. WSI provides instruction pri-marily to adult students on a part-time basis in theirhome countries. WSI’s business complements thatof ASPECT, a provider of English language immer-sion programs through schools in five Englishspeaking countries, which we acquired in 1998.Through the combined offerings of WSI andASPECT, Sylvan offers a complete spectrum of services that can be cross-marketed to students seeking English language instruction either in theirhome countries or abroad.

In other international business, we announced a significant new initiative early in 1999: ourintention to own and operate an internationalnetwork of for-profit universities, starting inEurope and Latin America and later expandingto Asia. As the launching point for this new venture, we have an agreement to acquire a controlling interest in the Universidad Europeade Madrid (UEM), a for-profit university inSpain. With Spain as our first international uni-versity market, we are taking advantage of thecountry’s unique position as a bridge betweenEurope and Latin America. We have identifiedcertain markets within these regions that havelimited access to university education due to limited government funding, yet have exhibitedan exploding demand for higher education by an increasingly wealthy and aspiring middleclass. This trend already has spurred the devel-opment of private and for-profit universities in many countries. Sylvan plans to create oracquire a unique network of for-profit universi-ties that would share courses and faculty througha new generation of technology-driven exchange

RECURRING DILUTED

EARNINGS PER SHARE

0

$0.40

$0.20

$0.60

$0.80

$1.00

1994 1995 1996 19971 19982

SYLVANLEARNING CENTERS®

1 Adjusted for non-recurring net income from the NEC acquisi-tion termination and net non-recurring costs associated with theASPECT acquisition.

2 Adjusted for non-recurring net costs associated with theASPECT acquisition.

Q: How is Sylvan’s senior managementteam structured?

HOEHN-SARIC: As Co-Chief Executive Officers,Doug and I concentrate on Sylvan’s long-termgrowth strategy. Having worked together in seniormanagement positions in education-related com-panies for nearly 15 years, we combine our broadmanagement experience with an entrepreneurialspirit to chart Sylvan’s course into the next millen-nium and beyond.

Eight divisional presidents manage the operationsand growth of each of our business units. Giventhat the education industry has only 20 or 30 com-panies of any scale, and each of these is, for the mostpart, focused on a single line of business, Sylvanclearly has the deepest and broadest managementteam in the industry. We back these divisional leaderswith a corporate support staff in Finance, MIS, Legal,Human Resources and Real Estate.

Q: The company started with tutoring forchildren. How did you choose the otherservices that Sylvan offers now? And look-ing ahead, what criteria do you employ incharting Sylvan’s future business areas?

HOEHN-SARIC: Several years ago, Doug and Iidentified the business of education as having enor-mous potential, and in recent years several educationindustry analysts have predicted that this market-place will produce multi-billion dollar companies inthe next five years. Our strategy is to choose segmentsof the industry that will ensure that Sylvan is firstamong those multi-billion dollar companies.

In choosing business areas to enter, we select marketniches for which there is huge and growing demand,in which high margins are attainable and in whichSylvan has an inherent edge that will allow thecompany to attain a leadership position. Delivery

4

of services such as tutoring in North America andabroad, teacher training in the U.S., English languageinstruction overseas and computer-based testing areexcellent examples of these niches.

We have chosen the services sector rather than theproduct sector of this industry because we believethat Sylvan has tremendous strength as a worldwidedistribution network for high quality services. Under-standing that the key to success is the coupling ofunmatched service with best-in-class content, Sylvanestablishes partnerships with leading providers ofeducational and training content. In fact, partner-ship with the education establishment is central toour long-term strategy, and is a major element thatsets us apart from our competitors.

Recognizing the vast array of choices in this industry—with worldwide spending estimated at more than$3 trillion annually—we carefully evaluate a num-ber of diverse prospects before determining our nextventure. By holding to the criteria noted above, westrive to chart the course that will lead our companyto the forefront of this industry.

Q: Why have you chosen to enter theprivate university market outside of theUnited States?

BECKER: We have identified tremendous need forhigher education in many parts of the world. Inthese areas, governments have restricted access tohigher education due to limited funding, yetfamilies are realizing that the correlation betweeneducation and earnings is higher than ever before.These families have both rising aspirations andgrowing income levels, and are demanding morehigher education alternatives for their children.Many are sending their children overseas to pursuethis education—currently, more than 1.3 millionstudents are pursuing university and advanceddegrees outside of their home countries. And in1995, more than 400,000 foreign students spent$7 billion on higher education-related activities inthe United States. We believe that many more fami-lies, for a number of reasons including cost andconvenience, would prefer to have their childrenpursue their education in their home countries.Already, we are seeing a proliferation of privateand for-profit universities across Europe and LatinAmerica. We see a tremendous opportunity to createa first-of-its-kind network which would maximizethe benefits of these universities to their home com-munities and supplement their offerings with best-in-class technology and business education programs.

An Interview with Sylvan’s Co-Chief Executive Officers

Douglas L. BeckerPresident and Co-Chief Executive Officer

5

Q: Do you think the world of higher educationwill accept Sylvan as one of its own?

BECKER: Partnership with the education estab-lishment is one of the fundamental tenets ofSylvan’s strategy. We are proud of our track recordof being a good partner with American publicschools, with the Educational Testing Service (theworld’s leading provider of admissions testing forhigher education) and with the many universitieswith which we collaborate.

Dr. Joseph Duffey, formerly the president ofAmerican University and the Chancellor of theUniversity of Massachusetts, who recently joinedSylvan to lead our university venture, tells us that he has received a great deal of encouragement fromuniversities in the U.S. and abroad that have inter-est in working with Sylvan on this project. We fullyexpect this to be the case as we pursue our strategyof partnership on the university initiative.

Q: What kind of opportunities do you see inSylvan’s immediate future?

HOEHN-SARIC: The first is continued growth inour existing areas of business. We believe that, com-bined, our existing business areas have the potential togenerate well upwards of $2 billion in annual revenue.

In our computer-based testing business, we expectcontinued volume increases in academic tests, suchas the Graduate Management Admission Test andthe Test of English as a Foreign Language, whichhave just completed conversion to the computer-based format worldwide. Also, we have enormoustesting programs still under development, such asthe United States Medical Licensing Exam, ofwhich more than 125,000 paper-and-pencil testsper year have traditionally been delivered. We’llbegin delivering these tests in mid-1999.

Another area of opportunity lies in the delivery ofindigenous testing programs in countries all over theworld, evidenced by our new contracts to deliverdrivers’ license testing in Great Britain andNorthern Ireland. Programs such as these allowSylvan to expand its presence within a country bybuilding an expansive infrastructure of testing cen-ters. Once established, this network of sites can beused to deliver any number of testing programs costeffectively, and potentially can serve as a base for thedistribution of other services. In this way, Sylvan isable to deeply penetrate a large number of countrieswith a ubiquitous network of sites for the delivery ofservices. Moreover, these programs represent the firsttesting organizations to allow Sylvan to market otherservices to testing clients within the site. We believe

this holds tremendous promise, as the ability to pre-sent important, relevant offerings to everyone whotakes a drivers’ license test in Great Britain, forexample, is an important opportunity for Sylvanand a valuable service to test takers. As other testingprograms seek ways of reducing costs, we believethey will encourage us to help them in generatingnew sources of revenue from marketing programs.

BECKER: Not only do we expect the significantgrowth to continue in existing businesses, but our newest initiative—an international universitynetwork—has huge growth potential. We expect to add another university to this network within the year, and afterward to add at least one universityper year over the next 10 years to build our globaluniversity presence.

Q: Has Sylvan grown primarily throughacquisitions?

BECKER: Actually, that is not the case. Over one-half of Sylvan’s revenues and profits come fromorganic growth. We have substantial experience inbuilding—as well as buying businesses.

For example, after more than 20 years in business,our Sylvan Learning Centers division has producedgrowth in same center revenues of 15 to 20 percentper year for the past five years. We believe that thisdivision has the potential to produce a 30 percent-plus growth rate for the foreseeable future. Currently,this business is about seven times the size of its nearest competitor, yet we are opening 50 to 60 newcenters per year and we are buying back profitablefranchised centers in key markets across the UnitedStates. Also, we are expanding internationally withSchülerhilfe and Sylvan tutoring centers in Spain.Growth and expansion of this kind prove that this is not yet a mature business.

About one-half of our Contract Education Servicesdivision’s revenues also have come from organicgrowth. We started this business in 1993 serving oneschool district. We’ve been expanding to more districtsat a steady pace, just this year adding seven more.

HOEHN-SARIC: Our testing business is anotherexample. We started the testing business in 1994and today, one-half of its $275 million in revenuehas come from organic growth. Although it’s theundisputed market leader worldwide, tremendousgrowth still lies ahead for this division. Today only about five percent of standardized testing is computerized. As more organizations make

Education is the transmission of civilization.

WILL DURANT

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the businesses we have acquired, such as Wall StreetInstitute, ASPECT, Canter, PACE, Drake Prometricand Schülerhilfe, had all been in business for decadesprior to joining with Sylvan. So, in each of our areasof business there is a long history upon which to basedecisions about our future.

With that in mind, however, we understand theimportance of combining these businesses into a strong single corporation. We have invested inbuilding a solid and flexible management team andinfrastructure that can support the company’s rapidexpansion. In each area of Sylvan’s business we haveappointed divisional presidents to manage the per-formance of their divisions. This way, we have asenior management team focused on the operationsof each business, while Chris and I concentrate onthe company’s future direction. We are confidentthat we have built an organization with very broadshoulders that is poised for even more dramaticgrowth in the years ahead.

Q: Some for-profit companies in the educa-tion sector have come up against strongopposition by educator groups. Is Sylvanbeing accepted by the public educationestablishment?

BECKER: Sylvan has been well received by the education establishment because we have made itclear that our role is to supplement, rather than tosupplant public schools. Sylvan strives to maintainan open and cooperative relationship with teachers’unions and has publicly stated its opposition tovouchers for school choice and private managementof public schools. In our primary model for deliveryof tutoring services to public schools, the districts’teachers serve as Sylvan instructors. The teachers,who volunteer for assignment to the Sylvan program,remain as employees of the district and work underthe supervision of Sylvan’s school-based managers.Our considerable experience with this model, in St. Paul, Minneapolis and Los Angeles, has shownthat it allows teachers to experience intensive training and an optimal teaching environment—a professional development opportunity benefitingboth the teachers and the district. This model is beneficial for Sylvan, too, in that it increases marginswhile decreasing overhead associated with staffingissues. As our services to public schools and teachersevolve, Sylvan is committed to maintaining its excellent rapport with the public education community.

the inevitable change from paper-and-pencil to computer-based testing, Sylvan will continue toincrease its capacity to deliver testing programs all over the world.

And we continue to demonstrate our ability to grow businesses. Revenues for Wall Street Institutehave more than doubled since we acquired it in1996, and by employing many of the same tech-niques and strategies we’ve proven over the past five years, we’re already seeing increases in ASPECT and Schülerhilfe, as well.

Q: Why has Sylvan expanded to Englishlanguage instruction?

BECKER: In today’s global knowledge economy, it is clear that English is rapidly becoming the WorldStandard Language—the international medium ofcommerce and exchange. Students of all ages aroundthe world need English language instruction, eitherto supplement what is provided by the public school,or to advance their professional careers. This needhas created an industry whose value has been esti-mated in excess of $5 billion worldwide. With ourglobal presence in education and testing and ourexpertise in the delivery of instructional services,Sylvan is uniquely qualified to command a leader-ship position in this marketplace.

Q: What effect does instability in the worldeconomy have on Sylvan’s business?

HOEHN-SARIC: Today, our international business is derived primarily from countries whoseeconomies are strong and stable. For example, ourEnglish language and tutoring businesses are experi-encing strong growth throughout Western Europe. In choosing new areas to do business, we take intoaccount the region’s economic strength and invest our resources accordingly.

Q: Sylvan is known as one of the fastestgrowing companies in its industry. Canmanagement maintain stability with thisrapid growth?

BECKER: Sylvan certainly has come into the spot-light in recent years, but the company is not an“overnight success.” Underlying the growth over thepast five years are many years of preparation. OurSylvan Learning Centers division is 20 years old and our testing business got its start when, prior toacquiring Sylvan, Chris and I headed a companyinvolved in computer-based training. In addition,

To be able to becaught up into the world ofthought—that is being educated.

EDITH HAMILTON

7

Q: Why is Sylvan now in the business ofteacher training?

BECKER: Over the next several years, the UnitedStates will experience a dire shortage of teachers inelementary and secondary schools. The NationalCommission on Teaching and America’s Futureestimates that more than two million additionalteachers will be needed over the next decade toaccount for a record number of students enrollingin schools, to relieve overcrowded classrooms and to replace retiring teachers. More than $20 billionwill be spent to recruit and train these new teachers.Clearly, this is a large business opportunity.

With 15,000 teachers in its Sylvan Learning Centersnetwork, Sylvan is the nation’s largest privateemployer of teachers. Our work with the nation’spublic schools over the past 20 years, and our deliv-ery of such tests as The Praxis Series®: ProfessionalAssessments for Beginning Teachers and the test for the National Board for Professional TeachingStandards give us experience with and appreciationfor the work of public school teachers. Our Cantersubsidiary, a leading developer of teacher trainingand professional development materials servingmore than one million teachers over 20 years, isalready the nation’s largest teacher training compa-ny. We intend to build this rewarding businesswhile helping the nation to address this potentiallydevastating teacher crisis.

Q: You say that Sylvan’s areas of businessare synergistic with each other. How?

BECKER: When we talk about synergy withinSylvan, we are referring to the concept that eacharea of business adds value to another, and thematrix of businesses that comprise the companysupplement each other to maximize benefit toSylvan’s clients and profitability to Sylvan. Here are some examples, to name but a few:

The majority of Sylvan’s computer-based testingcenters in the United States are co-located withSylvan Learning Centers. This saves on overheadcosts associated with real estate and staffing, andalso exposes testing candidates—often of the samedemographic group as tutoring customers—to the Sylvan Learning Centers’ offerings.

Our Sylvan Learning Centers provide tutoring ser-vices to families who can afford to pay for them,and the Sylvan at School programs of our ContractEducation Services division, provide, in essence, the same kind of tutoring services to families whocannot. The Sylvan Learning Centers curriculum

and operating models serve as the basis for tutoringservices provided by our Contract EducationServices division. In turn, publicity of Sylvan’s workas an educational service provider to public schoolsenhances the company’s credibility among SylvanLearning Centers’ consumers. Canter, another areawithin our Contract Education Services division,ensures a steady flow of qualified teachers will beavailable, not only to the nation’s schools, but alsoto our Sylvan Learning Centers and Sylvan atSchool programs.

Our two English language businesses, Wall StreetInstitute (WSI) and ASPECT, complement eachother. WSI offers English language training primar-ily to adult professionals in their home countries.Students attend WSI centers for as few or as manyhours as they prefer to reach their objectives. Incontrast, ASPECT’s programs provide students—typically individuals of college age—with full-timeEnglish language training and cultural immersion.WSI students often find that spending two or threeweeks in an ASPECT immersion program is anexcellent way to “jump-start” their instruction. And ASPECT students find WSI instruction pro-vides a good refresher and maintenance programafter their return to their home countries. Wealready are seeing the benefits of the synergybetween these businesses.

Q: What is the relationship between Sylvanand Caliber Learning Network?

HOEHN-SARIC: Founded as a joint initiativebetween Sylvan Learning Systems, Inc., and MCICommunications Corp. in 1996, Caliber LearningNetwork became a publicly held company in 1998.Now as an affiliate company of Sylvan, Caliberdelivers professional education and training througha network of high-tech adult learning centers acrossthe United States. Caliber works in collaborationwith Sylvan to bring educational and training con-tent to learners through a range of programs.

Christopher Hoehn-SaricChairman and Co-Chief Executive Officer

K-12

9services

SYLVAN LEARNING CENTERS

Sylvan Learning Centers was founded in 1979 toprovide personalized instructional services to stu-dents of all ages and skill levels. Today, there are 739 Sylvan Learning Centers in North America and Asia (Hong Kong and Guam) and the companyis building an international network of tutoringcenters. More than 90 percent of Sylvan LearningCenters are franchised and Sylvan has been con-sistently cited as one of the best franchise oppor-tunities in the country.

In North America, Sylvan offers programs for stu-dents of all ages and skill levels who want to catchup, keep up or get ahead. Sylvan’s range of programsincludes beginning, academic and accelerated reading;basic math, algebra 1-2 and geometry; writing andcomposition; study skills; and SAT® preparation. In addition, certified high school courses for creditin geometry, algebra 1-2, trigonometry, precalculusand English 9, 10, 11 are offered. In 1998, approxi-mately 129,000 children received Sylvan services.More than one million students have attendedSylvan to date.

Sylvan instruction begins with a series of diagnosticassessments that pinpoint each child’s learningchallenges. Based on the results of these assessments,a program of instruction is tailored to meet theneeds of each individual. The pace of instruction is based on the educational concept of “masterylearning,” which requires that a student achieve proficiency in each skill before moving on to thenext. Instruction is delivered in a highly motivationalatmosphere, with Sylvan teachers working withstudents individually or in small groups, typicallyof three or fewer students for most courses. During

a student’s Sylvan program, center directors meetfrequently with parents and schoolteachers to keepthem abreast of the student’s progress.

Most Sylvan centers guarantee that each student willadvance one grade equivalent in either reading ormath within 36 hours of instruction (roughly fivemonths) or the center offers 12 hours of additionalinstruction at no charge.

Although not required to be accredited, Sylvan is the first private educational services provider tohave achieved accreditation status from the regionalschool accrediting bodies, including the Commis-sions of the Middle States, Southern, Northwest,North Central and Western Associations. Theseassociations are responsible for accrediting morethan 27,000 schools and colleges in the UnitedStates and internationally. Accreditation statusmeans that Sylvan centers have met similar stan-dards and protocols required of all fully accreditedschools. Sylvan has worked with these associationsto develop accredited status specifically focused on

Education is helping the child realize hispotentialities.

ERICH FROMM

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the ability to offer transferable credit in support ofthe students’ core academic requirements at theirregular schools.

In Europe, Sylvan has 900 company-owned and fran-chised tutoring centers throughout Germany, Austriaand Italy known as Schülerhilfe. Schülerhilfe, whichmeans “student help,” offers tutoring in small groupsto primary and secondary school students. RecentGerman news reports indicate that 35 percent of the country’s students receive supplemental tutoringof some kind. To capitalize on this large demand,Sylvan is developing its first television advertisingcampaign in Germany. Based on the success of its TV advertising in North America for SylvanLearning Centers and across Europe and LatinAmerica for Wall Street Institute, Sylvan believesthat this medium will generate a significant increasein enrollments to Schülerhilfe centers.

The network of Sylvan tutoring centers is growingacross Spain. Currently 12 centers are operating inBarcelona and Madrid, and 50 franchised centersare expected to be in operation by the end of 1999.These Sylvan centers provide small group tutoringand English language instruction to school-aged students. In addition, Sylvan is pioneering a programcalled Informatica, which allows students to learnbasic computer skills after school.

SYLVAN CONTRACT

EDUCATION SERVICES

In 1993, through a first-of-its-kind partnership witha public school district, Sylvan Learning Systemsbegan providing educational services within six ofBaltimore City’s lowest performing public elemen-tary schools. Within these schools, Sylvan providedintensive instruction to address the needs of theschools’ most academically and economically disad-vantaged students. After Sylvan consistently exceededthe school district’s expectations for increasing stu-dent academic performance, Sylvan expanded bothwithin Baltimore and across the country.

Currently, Sylvan serves approximately 65,000 students within 900 elementary, middle and highschools in urban districts including Los Angeles,Detroit, Chicago, Newark, Philadelphia,Minneapolis, St. Paul, New Orleans and many others. Sylvan’s services include remedial math andreading instruction, special education assessments,speech therapy and a range of other specialized services. These services, provided free-of-charge tostudents and their families, are funded by federalTitle I grants, state grants and other funding sources earmarked for children of poverty and those with special needs.

Sylvan also provides services in support of schooldistricts’ comprehensive school reform efforts.Designed to help schools develop the capacity toserve their growing numbers of students and toincrease the quality of their teaching, Sylvan ser-vices include data analysis and consulting servicesfocusing on state testing, parent outreach programs, and professional development through practicalexperience in Sylvan Learning Centers and inser-vice training programs.

Whoso neglects learning in his youth, loses the past and is dead for the future.

EURIPEDES

The network of Sylvan tutoring centers is growingacross Spain.

11

CANTER

Canter, a subsidiary of Sylvan, is a leading developerof training, staff development and graduate coursematerials for educators. The company’s educationalmaterials have been used by more than a millionteachers since 1976.

Canter has developed the materials for a distance-learning Master’s degree program for teachers. Withmore than 5,000 students currently enrolled, theMaster’s program is offered through five accreditedcolleges and universities. This collaboration betweenCanter and its partner colleges and universities is setting a new standard for excellence in distancelearning. As a result, this Master’s degree program is the country’s largest distance learning degreeprogram for teachers. Additionally, Canter has13 college and university partners that offer Canter-produced distance learning video courses, for which

teachers receive graduate level credit. In 1998,more than 30,000 teachers enrolled in Canter-produced courses through these collaborating educational institutions.

Canter also develops and distributes staff developmentmaterials and programs utilized by elementary andsecondary schools nationwide. Assertive Discipline,Canter’s first program for teachers, was originallydeveloped in 1976, and focused on behavior man-agement. Since that time, it has been continuouslyrevised and updated and has been taught to morethan a million teachers nationwide.

Canter’s educational materials, courses and pro-grams are based on extensive research on the needsof today’s teachers in the classroom. Utilizingnationally recognized experts in various fields ofteacher education, Canter’s product developmentmethodologies represent the state of the art inteacher training. Canter’s courses and materialscover a comprehensive array of topics, includingtechnology, instructional strategies, teacher motiva-

tion, parent involvement, behavior management,student learning styles, inclusion of the specially-abled, conflict resolution and school safety. Canteris currently developing new course materials in thecurriculum areas of reading, math and science.

While consistentlyexceeding school districtexpectations, Sylvan At School is expandingacross the United States.

adult education

13services

SYLVAN PROMETRIC

Currently the largest division of Sylvan LearningSystems, Inc., Sylvan Prometric is a global distribu-tion network for computer-based testing services.Sylvan Prometric delivers a wide range of computer-based standardized tests for academic admissionsand professional licensure/certification throughmore than 2,500 sites serving 150 countries.

Since 1991, Sylvan has served as the exclusive com-mercial distribution partner to Educational TestingService® (ETS®), the nation’s leading educationaltesting firm. Currently, Sylvan offers ETS’s computer-based tests including the Graduate ManagementAdmission Test (GMAT), the Graduate RecordExamination (GRE) and the Test of English as aForeign Language (TOEFL).

Sylvan is especially well known for delivering computer-based tests for professional licensure andcertification in many important professions. Examplesof such professions include financial services, nurs-ing, medicine, architecture and many others.

In addition, Sylvan delivers computer-based tests for virtually all major IT industry certification pro-grams, including Microsoft, Compaq®, ComputerAssociates®, Novell, CompTIA®, Lotus®, IBM®,Oracle, Corel®, PictureTel®, Sybase®, Sun Micro-systems®, AutoDesk® and many others.

In 1998, Sylvan Prometric delivered more than3.5 million computer-based tests in 25 languagesthrough its network of Sylvan Technology Centers(STCs) and Authorized Prometric Testing Centers(APTCs). STCs are closely monitored testing facili-ties that provide the high level of security that is

essential in delivering sensitive testing programs.APTCs, located within facilities such as third partycomputer training centers and on campuses of colleges and universities, provide secure testing facilities that are convenient to where testing can-didates live and work.

Sylvan Prometric clients realize significant benefitsfrom computerizing their testing programs, includ-ing time and cost savings in program administration,the ability to use simulations, multimedia and othertechnology to assess candidates more comprehensively,and increased security. Also, testing candidates expe-rience benefits including increased convenience intesting times and locations, immediate availabilityof test results and the ability to transfer scores elec-tronically to organizations of their choice.

Education is not a preparation for life; education is life itself.

JOHN DEWEY

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All ASPECT language schools are accredited by therelevant government agencies and organizations intheir respective countries of operation. In the U.S.,ASPECT programs are accredited by the Accredi-ting Council for Continuing Education & Trainingand the Council for Private Postsecondary andVocational Education. In Canada, Australia and theUnited Kingdom, ASPECT schools are accreditedand/or recognized by the relevant agencies. In1997, ASPECT became the first language schoolchain to receive the ISO 9002 quality certificationupon application by its U.K. language schools.ISO 9002 is an internationally recognized qualitystandard that certifies the quality and consistencyof operations.

WALL STREET INSTITUTE

Wall Street Institute (WSI), a subsidiary of Sylvan,is a leading provider of English language instruc-tional services to professionals. WSI currently hasmore than 260 learning centers in 15 countries inEurope, Latin America, Asia and the Middle East.WSI uses an exclusive Multimethod® teaching sys-tem composed of multimedia interactive video onCD-ROM, live, personalized instruction and smallgroup classes. This flexible approach allows clientsto choose their own schedules of attendance, workingWSI instruction around their work and travel sched-ules. WSI allows clients to attend, at no extra cost, as

ASPECT

Founded in 1982, ASPECT delivers intensiveEnglish language programs at 28 schools in fivecountries. Currently, 18 of these English languageschools are in the United States, six in the UnitedKingdom, two in Canada and one each in Australiaand Ireland. The schools are located on collegecampuses and in independent, leased facilities.ASPECT’s programs are sold to students through12 international sales offices and a network of morethan 800 independent agents in 75 countries.

ASPECT students, typically pre-college and college-aged students, come from more than 90 countriesaround the world. They attend ASPECT programs,which include intensive English language instructionand immersion in an English language culture, foran average of 10 weeks. ASPECT takes a distinctly

different approach to English language instructionthan Sylvan’s Wall Street Institute (WSI) Englishlanguage centers, which provide instruction on apart-time basis primarily to working professionals in their own countries.

Through Wall StreetInstitute and ASPECT,Sylvan offers a com-plete spectrum ofEnglish languageinstruction services.

15

many hours as they need to accomplish their objectives.Also, WSI offers clients membership to a social clubwith activities that provide additional English languageexposure and cultural experiences.

Founded in 1972, WSI started franchising in 1991.The company currently is expanding its worldwidepresence by selling Master Licensing agreements,where areas are developed through a combination ofcompany-owned and franchised centers. Short-termgrowth plans include continued expansion throughoutEurope and Latin America, while regions targetedfor longer-term expansion include Asia, the MiddleEast and Africa.

PACE

PACE works in partnership with more than 300 corporate clients to help them solve their busi-ness problems. PACE provides performance-based

consulting services, skills and knowledge develop-ment initiatives and contracted training services.

PACE’s performance-based consulting services help

clients to identify individual, team and organizational

performance issues and to develop long-term strate-

gic solutions. PACE’s consultants work closely in

collaboration with the client’s internal resources to

find the right measures to achieve maximum

performance for the client organization. These

measures often involve the integration of PACE

knowledge development initiatives with other

remedial actions to address specific organizational

challenges. Also, many clients employ PACE’s

contracted training services to manage all or part

of their training needs.

PACE applies the Human Performance Technology

process to provide clients with enterprise-wide

business solutions that maximize human perfor-

mance to help them achieve organizational goals.

The company’s aim is to enable clients to develop

their own ability to identify exemplary perfor-

mance and processes, and to maintain these

improvements over time.

Only the educated are free.

EPICTETUS

PACE helps corporateclients maximize humanperformance.

16

Board of Directors and Officers

Board of Directors

R. Christopher Hoehn-SaricChairman of the Board and Co-Chief Executive Officer,Sylvan Learning Systems, Inc.

Douglas L. BeckerPresident, Co-Chief ExecutiveOfficer and Secretary,Sylvan Learning Systems, Inc.

R. William PollockChairman, Drake Holdings Limited

James H. McGuireChairman of the Audit Committee Member of the Compensation Committee President, NJK Holding Corporation

J. Phillip SamperMember of the Compensation and Audit CommitteesFounder and General Partner, Gabriel Venture Partners Chairman, Placeware Inc.

Donald V. BerlantiChairman of the Compensation Committee Member of the Audit Committee General Partner, Quince Associates Limited Partnership

Rick InatomeChairman of the Board, Inacom Corp.

(left to right)

Tom O. Ericsson President, ASPECT

Paula R. Singer President,

Sylvan Contract Education Services

John K. Hoey Senior Vice President,

Corporate Services

Robert W. Zentz Vice President,

General Counsel

(left to right)

Joseph Duffey Senior Vice President,

International University Initiative

Thomas B. McCord Senior Vice President,

Corporate Finance

Ricardo Arévalo President,

Wall Street Institute

Constance M. Bentley President,

PACE

Stephen A. Hoffman President,

Sylvan Prometric

(left to right)

Peter J. Cohen President,

Sylvan Learning Centers

Marlene Canter Co-Chief Executive Officer and

President, Canter

Toby D. BernsteinCo-Chief Executive Officer

and Chief Financial Officer, Canter

B. Lee McGee Executive Vice President

and Chief Financial Officer

CORPORATE INFORMATION

Shareholder communication regarding change ofaddress, transfer of share ownership or lost certificatesshould be directed to:

State Street Bank and TrustInvestor RelationsP.O. Box 8200Boston, MA 02266-8200

A copy of the fiscal 1998 Form 10-K filed with theSecurities and Exchange Commission may be obtainedby shareholders without charge by written request to:

Sylvan Learning Systems, Inc.Investor Relations1000 Lancaster StreetBaltimore, MD 21202

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For Additional InformationTo contact the Sylvan Learning Center near you,call 1-800-EDUCATE.

To learn more about Sylvan Learning Systems,Inc., visit our site on the World Wide Web atwww.educate.com.

Sylvan Learning Systems, Inc. common stock hasbeen publicly traded since December 1993. It islisted on the NASDAQ National Market Systemunder the symbol SLVN.

TrademarksEducational Testing Service, ETS, the ETS logo, GRE, The PraxisSeries: Professional Assessments for Beginning Teachers, Test ofEnglish as a Foreign Language and TOEFL are registered trademarksor trademarks of Educational Testing Service.

GMAT is a registered trademark of the Graduate ManagementAdmission Council.

The United States Medical Licensing Examination and USMLE areregistered trademarks of The National Board of Medical Examiners.

SAT is a registered trademark of the College Board.

Sylvan Learning Center, Sylvan Technology Center, Sylvan at Work, are registered trademarks of Sylvan Learning Systems, Inc.

Prometric Testing Center, Sylvan Prometric, Caliber Learning Networkand Caliber Learning Center are trademarks of Sylvan Learning Systems, Inc.

1-800-EDUCATE and Sylvan At School are service marks of Sylvan Learning Systems, Inc.

Success is Learned is a registered service mark of Sylvan LearningSystems, Inc.

All other trademarks contained in this report are the property of theirrespective owners.

Transfer AgencyState Street Bank and Trustc/o Boston EquiServeInvestor RelationsP.O. Box 8200Boston, MA 02266-8200

CounselPiper & MarburyBaltimore, MD

Independent AuditorsErnst & Young LLPBaltimore, MD

Annual MeetingMay 20, 1999 at 10:00 amHarbor Inn Pier 5711 Eastern Ave.Baltimore, MD 21202

Sylvan Learning Systems, Inc.

1000 Lancaster Street

Baltimore, Maryland 21202

(410) 843-8000

www.educate.com

The selected financial data for the years ended December 31, 1994, 1995, 1996, 1997 and 1998 have been derivedfrom Sylvan’s financial statements which have been audited by Ernst & Young LLP. The financial data should be read in conjunction with the historical Consolidated Financial Statements and Notes thereto.

The Company consummated significant purchase business combinations in each of the four years in the periodended December 31, 1998. These business combinations affect the comparability of the amounts presented, and the following data should be read in conjunction with Note 3 to the Consolidated Financial Statements.

Year Ended December 31,(in thousands, except per share data) 1994 1995(1) 1996(2) 1997(3) 1998(4)(5)

Statements of Operations Data:Revenues $94,205 $139,286 $219,973 $301,011 $440,330Cost and expenses:

Direct costs (6) 85,037 124,146 187,819 263,523 359,613General and administrative expense (6) 4,998 6,205 8,049 19,693 15,530Transaction costs related to pooling-of-interests — — — — 5,000Restructuring and asset impairment charges — 3,316 — 4,000 3,730

Total costs and expenses 90,035 133,667 195,868 287,216 383,873Operating income 4,170 5,619 24,105 13,795 56,457Non-operating income 277 1,402 2,108 31,330 1,777Interest income, net (313) (2,623) (1,320) (801) (943)Income before income taxes 4,134 4,398 24,893 44,324 57,291Income taxes (187) (356) (9,139) (16,420) (21,582)

Net income $ 3,947 $ 4,042 $ 15,754 $ 27,904 $ 35,709

Earnings per common share, diluted (7): $ 0.15 $ 0.15 $ 0.40 $ 0.62 $ 0.70

Diluted shares (7) 26,512 27,701 38,963 44,890 51,286

Balance Sheet Data (at period end):Cash and cash equivalents $ 7,118 $ 6,652 $ 18,720 $ 29,818 $ 33,170Available-for-sale securities 2,357 30,735 16,474 82,951 6,166Net working capital 12,999 39,044 28,836 112,874 15,100Intangible assets and deferred contract costs 8,104 83,289 123,461 193,192 293,710Total assets 62,679 19,238 278,078 496,779 659,796Long-term debt, including current portion 12,093 12,272 39,621 74,744 67,611Stockholders’ equity 34,294 139,131 182,768 340,460 488,833

(1) Effective September 30, 1995, Sylvan acquired Drake Prometric, L.P. (“Drake”), a leading provider of computer-based certification, licensure and assessment testing. Thetransaction was accounted for using the purchase method of accounting, and Sylvan’s results of operations from October 1, 1995 include the operations of Drake.

(2) Effective December 1, 1996, Sylvan acquired Wall Street International, B.V., and its commonly controlled affiliates (collectively “Wall Street”), a European-based franchisorand operator of learning centers that teach the English language. This transaction was accounted for using the purchase method of accounting and Sylvan’s results of operationsfrom December 1, 1996 include the operations of Wall Street.

(3) Effective December 1, 1997, the Company purchased the assets and liabilities of Block Testing Services L.P. and Block State Testing Services L.P. and also acquired all of theoutstanding common stock of National Assessment Institute, Inc., (collectively, “NAI/Block”), commonly controlled companies engaged in the business of designing, marketing,selling, distributing and administering paper and pencil tests for the licensing of individuals. The acquisition, which was paid for by issuing 642,901 shares of common stockvalued at $24.6 million in January 1998, was accounted for using the purchase method of accounting, and Sylvan’s results of operations from December 1, 1997 include theoperations of NAI/Block.

(4) On January 1, 1998, the Company acquired all of the outstanding capital stock of Canter for $25 million plus additional consideration if Canter achieves certain EBITDAtargets. The acquisition was accounted for as a purchase, and Sylvan’s results of operations from January 1, 1998 include the operations of Canter.

Effective October 28, 1998, the Company acquired all the operating assets and liabilities of ZGS Zentrale Gelsenkirchener SCHÜLERHILFE J. Gratze + M. Mohr GbR mbH(“Schülerhilfe Partnership”) and all of the outstanding common stock of SCHÜLERHILFE Gesellschaft für Nachhilfeunterricht mbH (“Schülerhilfe Corporation,” and collectivelywith Schülerhilfe Partnership, “Schülerhilfe”), in exchange for an initial purchase price of $16.5 million in cash and 123,973 shares of restricted common stock valued at $2.5 mil-lion. The results of operations of Schülerhilfe for the period from October 28, 1998 through December 31, 1998 are included in Sylvan’s 1998 results of operations.

(5) Includes certain non-recurring expenses related to the merger with Aspect. These expenses include $5.0 million of transaction-related costs, such as legal, accounting and advisory fees, $1.2 million of compensation to former shareholders of Aspect, who are no longer with the Company and were not replaced and $3.7 million of costs, classifiedin the financial statements as restructuring costs that relate to the integration of Aspect with Sylvan. The net effect of the above items was a decrease in pre-tax income of $9.9 million and net income of $8.9 million, or $0.17 per diluted share.

(6) The Company has reclassified certain operating expenses previously included in general and administrative expense to direct costs. This change has been reflected for all periods presented.

(7) All share and per share data have been restated to reflect a 3-for-2 stock dividend paid on November 7, 1996 and a 3-for-2 stock dividend paid on May 22, 1998.

Selected Consolidated Financial Data

SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

17

18

All statements contained herein that are not historical facts, includingbut not limited to, statements regarding the anticipated impact ofuncollectible accounts receivable on future liquidity, expenditures todevelop licensing and certification tests under existing contracts, theCompany’s contingent payment obligations relating to the Schülerhilfeand Canter acquisitions, future capital requirements, potential acqui-sitions, the failure to remediate or the cost of remediating Year 2000Issues and the Company’s future development plans are based on cur-rent expectations. These statements are forward looking in nature andinvolve a number of risks and uncertainties. Actual results may differmaterially. Among the factors that could cause actual results to differmaterially are the following: Changes in the financial resources of theCompany’s clients; timing and extent of testing clients conversions tocomputer-based testing; amount of revenues earned by the Company’stutorial and teacher training operations; the availability of sufficientcapital to finance the Company’s business plan on terms satisfactory tothe Company; the failure to remediate or the cost of remediating Year2000 Issues; general business and economic conditions; and other riskfactors described in the Company’s reports filed from time to time withthe Commission. The Company wishes to caution readers not to placeundue reliance on any such forward looking statements, which state-ments are made pursuant to the Private Securities Litigation ReformAct of 1995 and, as such, speak only as of the date made.

Overview The Company generates revenues from three businesssegments: Sylvan Learning Centers, which primarily consist of franchise royalties, franchise sales fees andCompany-owned Learning Center revenues; SylvanContract Educational Services, which consists of revenuesattributable to providing supplemental remedial educationservices to public and non-public schools and major corporations as well as providing teacher training services;and Sylvan Prometric, which consists of computer-basedtesting fees paid to the Company and the operations of WSI and Aspect. The following selected segment datais derived from the Company’s audited consolidatedfinancial statements.

Year Year YearEnded Ended Ended

December 31, December 31, December 31,(in thousands) 1996 1997 1998Operating revenue:Sylvan Learning Centers $ 38,898 $ 46,629 $ 64,754Sylvan Contract Educational Services 58,186 66,582 100,519

Sylvan Prometric 122,889 187,800 275,057Total revenue $219,973 $301,011 $440,330

Direct costs: Sylvan Learning Centers $ 27,442 $ 39,186 $ 45,415Sylvan Contract Educational Services 53,459 56,352 85,870

Sylvan Prometric 106,918 167,985 228,328Total direct costs $187,819 $263,523 $359,613

SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations Comparison of results for the year ended December 31,1998 to the year ended December 31, 1997. Revenues. Total revenues increased by $139.3 million, or46%, to $440.3 million for the year ended December 31,1998, compared to the same period in 1997. Thisincrease resulted from higher revenues in all business segments—Sylvan Learning Centers, Sylvan ContractEducational Services and Sylvan Prometric.

Sylvan Learning Centers revenue consists primarily ofLearning Services royalties, franchise sales fees and revenuefrom Company-owned Centers. Learning Centers revenueincreased by $18.1 million, or 39%, for the year endedDecember 31, 1998, compared to the same period in1997. Overall, franchise royalties increased by $2.5 millionor 19% for the year ended December 31, 1998, despite the acquisition of 13 franchised Centers during 1998.Excluding the effect of the Center acquisitions, franchiseroyalties increased 24% in 1998. The increase in royaltieswas due to a net increase of 60 new Centers opened during1998, combined with same center revenue increases of18% for the year ended December 31, 1998.

Franchise sales fees increased by $1.2 million, or27%, to $5.8 million for the year ended December 31,1998, compared to the same period in 1997. Theincrease in sales is principally due to international sales increasing by $0.5 million compared to 1997.Domestic territory and area development sales increased by $0.7 million in 1998.

Revenues from Company-owned Learning Centersincreased by $9.3 million, or 37%, to $34.4 million dur-ing 1998. The acquisition of 13 centers in 1998 resultedin $8.2 million of additional revenue in 1998. On a fullyear basis, same center revenues increased by $3.5 million,or 16%, in 1998 compared to revenues in 1997.

On October 28, 1998, the Company acquired amajor German tutoring company known as Schülerhilfe.The business has over 700 franchised centers and 178 Company-owned locations. This purchase resulted in an additional $2.4 million in revenue in 1998. Theremaining revenue increase in 1998 of $2.7 million is principally due to increased product sales.

Sylvan Contract Educational Services revenueincreased by $33.9 million, or 51%, to $100.5 million for the year ended December 31, 1998. Canter, acquired

19

in January 1998, contributed $24.8 million of theincrease. Public and non-public school contracts con-tributed $11.1 million of the increase, while PACE services revenue decreased by $2.0 million.

The $11.1 million increase in revenue from publicand non-public schools for the year ended December 31,1998 is the result of $17.4 million in revenue from newcontracts, offset by a decrease of $3.7 million in revenuefrom contracts in existing districts lost or reduced due tolocal district budget constraints. This segment’s revenuealso declined by $2.6 million as a result of the dispositionin late 1997 of an unrelated business assumed upon theacquisition of Educational Inroads.

Sylvan Prometric revenue increased by $87.3 mil-lion, or 46%, to $275.1 million during the year endedDecember 31, 1998, compared to the same period in1997. The increase in testing services revenues resultedmainly from volume increases in Information Technology(IT) ($26.8 million), Academic admissions ($6.0 million)and Professional certification testing ($3.6 million), the full year impact of the December 1997 NAI/Blockacquisition ($11.6 million), and increased revenue fromEnglish language instruction businesses ($23.4 million).Increases in testing volumes resulted primarily fromincreased testing volumes with Microsoft and certainother IT clients, and increased services under EducationalTesting Service (ETS) contracts, which included the cost-plus international contract for delivery of the GRE,GMAT and TOEFL examinations ($15.9 million).

Cost and Expenses. Total direct costs increased 36%,from $263.5 million in 1997 to $359.6 million in 1998,but decreased as a percentage of total revenues from 88%in 1997 to 82% in 1998. However, both periods presentedcontain certain non-recurring costs, as further discussedbelow. Excluding these non-recurring costs, total directcosts decreased as a percentage of total revenues from 82%in 1997 to 81% in 1998.

Sylvan Learning Centers expenses increased $6.2 million to $45.4 million or 70% of LearningCenters revenue in 1998 compared to $39.2 million, or 84% of Learning Centers revenue in 1997. Included in Sylvan Learning Centers expenses for the 1997 periodis a non-recurring $5.0 million contribution of theCompany’s Common Stock to a corporation whose solepurpose is to develop and fund advertising programs forSylvan Learning Centers. Excluding this contribution,Sylvan Learning Centers expenses as a percentage of revenue would have been 73% in 1997. Approximately$9.8 million of the increase in recurring expenses wasdue to direct costs associated with higher revenues atexisting centers and the acquisition of 13 franchised

learning centers in 1998. As a percentage of revenues,expenses for Company-owned centers decreased from85% in 1997 to 84% in 1998. The Company’s fourthquarter 1998 acquisition of Schülerhilfe accounted for$2.0 million of increased expenses.

Sylvan Contract Educational Services expensesincreased by $29.5 million to $85.9 million, or 85% ofSylvan Contract Educational Services revenue during theyear ended December 31, 1998, compared to $56.4 mil-lion or 85% of Sylvan Contract Educational Services revenue during the year ended December 31, 1997.

Sylvan Prometric expenses for the year endedDecember 31, 1998 increased by $60.3 million to$228.3 million, or 83% of total Sylvan Prometric reve-nue, compared to $168.0 million, or 89% of total SylvanPrometric revenue for the year ended December 31, 1997.The 1998 period included $1.2 million of compensationto the former owners of Aspect, who are no longer withthe Company and have not been replaced. During thesecond quarter of 1997, Sylvan Prometric expensesincluded contributions of $10.0 million to a nonprofitcorporation whose sole purpose is to fund promotionaland channel support programs for the Sylvan Prometricdistribution channel. The 1997 period included $2.2 mil-lion in non-recurring charges related to the Aspect merger.Excluding these non-recurring expenditures, expenses asa percentage of total Sylvan Prometric revenue remainedconstant at 83% in both years. Lower delivery costs percomputer-based test as a result of increased volumes andefficiencies in the 1998 period were offset by certainfavorable volume-based pricing adjustments in 1997 andhigher expenses as a percentage of revenue in the Englishlanguage business in 1998 as a result of the 1997 periodcontaining a higher level of franchise sales.

General and administrative expenses decreased by $4.2 million to $15.5 million during 1998, anddecreased as a percentage of revenues from 7% to 4%.Included in 1997 general and administrative expenseswere non-recurring expenses related to a contribution ofthe Company’s common stock valued at $6.5 million toSylvan Learning Foundation, Inc., a nonprofit founda-tion formed to promote various educational pursuits, and a $3.2 million contribution to InternationalEducation Forum, Inc., a not-for-profit foundationformed to provide exchange programs for internationalstudents in the United States. Excluding these non-recurring expenses, general and administrative expensesincreased from 3.3% of total revenues for 1997 to 3.5%of total revenues for 1998.

During the year ended December 31, 1998, Sylvanincurred $5.0 million of non-recurring transaction-relatedcosts relating to the pooling-of-interests with Aspect. Thetransaction costs consist principally of legal, accountingand advisory fees.

In connection with the acquisition of Aspect in 1998,the Company recorded a $3.7 million restructuring chargeassociated with the merger and integration of the com-bined operations. These charges consist primarily of contract cancellation costs of $2.6 million, severance andother employee related costs of $0.4 million, and liabilitiesof $0.7 million incurred to discontinue certain foreignexchange programs of Aspect. The contract cancellationcosts are payments made to repurchase master franchiserights under which Sylvan is in default of contractual non-competition provisions as a result of the acquisition ofAspect. Through December 31, 1998, $1.1 million of contract cancellation costs and $0.7 million of otherrestructuring charges have been paid, with the remainderexpected to be paid during 1999. The net effect of the$3.7 million restructuring charge, the $1.2 million in com-pensation paid to former owners and the $5.0 million oftransaction-related costs was a decrease in pre-tax incomeof $9.9 million and net income of $8.9 million, or $0.17per diluted share for the year ended December 31, 1998.

Non-Operating Income. Non-operating income, con-sisting of investment and other income and equity in netlosses of investees accounted for under the equity method,decreased from $31.3 million in 1997 to $1.8 million in 1998. The decrease is principally attributable to a $28.5 million net termination fee from the breakup of the NEC acquisition recorded in 1997 and an increase in the allocable losses of Caliber of $1.5 million in 1998.

The Company’s effective tax rate has increased from37% in 1997 to 38% in 1998 due primarily to $5.0 mil-lion of transaction costs related to the acquisition of Aspectfor which there is no allowable income tax deduction.

Comparison of results for the year ended December 31,1997 to the year ended December 31, 1996.Revenues. Total revenues increased by $81.0 million, or37%, to $301.0 million for the year ended December 31,1997, compared to the same period in 1996. Thisincrease resulted from higher revenues in all business segments—Sylvan Learning Centers, Sylvan ContractEducational Services and Sylvan Prometric.

Sylvan Learning Centers revenues increased by $7.7 million, or 20%, to $46.6 million for 1997.Franchise royalties increased $1.9 million or 20%, for

20

1997. This increase in franchise royalties was due to anoverall 10% increase in revenues at existing LearningCenters open for more than one year combined with a net increase of 60 new Learning Centers opened in 1997.

Franchise sales fees increased by $1.3 million, or41%, to $4.5 million for the year ended December 31,1997, compared to the same period in 1996. During1997, there were six area development agreements sold for $2.9 million and 42 franchise Learning Centerlicenses sold, compared to four area development agree-ments sold for $1.7 million and 38 franchise Centerlicenses sold during 1996. Product sales decreased by$190,000, or 5%, to $3.7 million for 1997.

Revenues from Company-owned Learning Centersincreased by $4.4 million, or 21%, to $25.0 million during 1997, primarily as a result of student enrollmentincreases for Centers operating over 12 months as ofDecember 31, 1997 and, to a lesser extent, the Company’sacquisition in 1997 of thirteen Learning Centers from five franchisees.

Contract Educational Services revenue increased by $8.4 million, or 14%, to $66.6 million for the yearended December 31, 1997. Revenue from public andnon-public contracts increased by $2.2 million for theyear ended December 31, 1997, primarily the result ofcontracts with new school districts. Revenue from PACEcontracts accounted for $6.2 million of the increase for1997. The PACE increase resulted primarily from con-tracts with new customers.

Revenue from new public and non-public contractsobtained after December 31, 1996 contributed $5.3 mil-lion to revenue for 1997. Revenue from existing publicand non-public contracts obtained before December 31,1996 decreased by $3.1 million in 1997, primarilyrelated to reduced funding in certain school districts andcertain contracts expiring in 1997.

Sylvan Prometric revenue increased by $64.9 mil-lion, or 53%, to $187.8 million during the year endedDecember 31, 1997, compared to the year endedDecember 31, 1996. The increase in testing services revenues resulted mainly from increased services underEducational Testing Service (ETS) contracts, whichincluded the cost-plus international contract, GRE,GMAT and TOEFL, and certain volume-based pricingadjustments, testing in the information technology and professional licensure businesses. WSI, acquired in December 1996, contributed $19.0 million of the revenue increase. Revenues for Aspect increased by $16.5 million, or 46%, as a result of volume growth.

Cost and Expenses. Total direct costs increased 40%,from $187.8 million in 1996 to $263.5 million in 1997and increased as a percentage of total revenues from 85%in 1996 to 88% in 1997 primarily as a result of non-recurring expenses of $15.0 million being included indirect costs in 1997, as discussed below. Total direct costs in 1997 also include $2.2 million of non-recurringexpenses related to Aspect. Excluding the non-recurringexpenses, total direct costs as a percentage of total revenueswould be 82% for the year ended December 31, 1997.

Sylvan Learning Centers expense increased 43% from $27.4 million in 1996 to $39.2 million in 1997 andincreased as a percentage of revenue from 71% in 1996 to84% in 1997. Included in Sylvan Learning Centers expensefor the 1997 period is advertising expense related to a non-recurring $5.0 million contribution of the Company’scommon stock to a non-profit corporation whose sole pur-pose is to develop and fund advertising programs for theSylvan Learning Centers. Excluding the non-recurring con-tribution, 1997 expense was 73% of revenues. Franchiseservices expense increased by $8.4 million, to $18.0 millionor 83% of franchise related revenues for the year endedDecember 31, 1997, compared to $9.6 million, or 53% offranchise related revenues for the year ended December 31,1996. The lower margin in franchise services was primarilydue to the non-recurring expense discussed above, as well as to costs incurred for development of new financing andafter-school programs and additional management staff for the Sylvan Learning Centers division.

Company-owned Learning Center expense increasedby $3.4 million, to $21.2 million or 85% of Company-owned Learning Center services revenues for the yearended December 31, 1997, compared to $17.8 million,or 86% of Company-owned Learning Center servicesrevenues for the year ended December 31, 1996. Theincrease resulted from $1.1 million of expenses associatedwith 13 acquired Learning Centers, and increases inadvertising, labor and general overhead associated withincreased Center enrollment. Expenses for Centers operating over 12 months as of December 31, 1997accounted for $2.3 million of the increase for 1997.

Sylvan Contract Educational Services expenseincreased by $2.9 million to $56.4 million, or 85% ofSylvan Contract Educational Services revenues during1997, compared to $53.5 million, or 92% of contract edu-cational services revenues during 1996. Operating expensesfor public and non-public schools decreased $1.1 million,while operating expenses for PACE increased by $3.5 mil-lion for the year ended December 31, 1997. The decreasein Sylvan Contract Educational Services expense as a percentage of revenue for 1997 versus 1996 is the result

21

of increased profit margins for PACE and public and non-public services in 1997, as well a higher mix of revenuefrom PACE contracts which generate a higher profit mar-gin than public and non-public services. In March 1998,the additional contingent consideration payable to the for-mer shareholders of PACE resulting from the purchase ofPACE in 1995 was determined to be $25.8 million, whichwas recorded as additional goodwill and is being amortizedover the estimated remaining useful life of 22 years. Thisamount increased the amount of amortization associatedwith the contract educational services segment by $1.2 mil-lion in 1998.

Sylvan Prometric expenses for the year endedDecember 31, 1997 increased by $61.1 million to $168.0 million, or 89% of total Sylvan Prometric revenue,compared to $106.9 million, or 87% of total SylvanPrometric revenue for the year ended December 31, 1996.The increase in Sylvan Prometric expense as a percentageof Sylvan Prometric revenues was predominantly a resultof a non-recurring marketing expense of $10.0 millionrelated to a contribution to IT Training MarketingCompany, a nonprofit corporation whose sole purpose isto fund promotional and channel support programs forthe Sylvan Prometric distribution channel. The 1996expense includes $2.4 million of non-recurring chargesrelated to the Drake acquisition, incurred during the firstand second quarter of 1996. Excluding these effects,expenses as a percentage of total testing revenue for 1996and 1997 were 85% and 84%, respectively. This decreasein recurring expenses as a percentage of Sylvan Prometricrevenue was primarily due to the fixed expenses of thedivision being spread over a higher revenue base as well as the effects of a full year of results of WSI, at higherincremental margins, being included in 1997 compared to only one month for the 1996 period.

General and administrative expenses increased by $11.6 million to $19.7 million during 1997 andincreased as a percentage of revenues from 4% to 7%.Included in general and administrative expenses is a non-recurring expense of $9.7 million related to a contribution of the Company’s common stock valued at$6.5 million to Sylvan Learning Foundation, Inc., a non-profit foundation formed to promote various educationalpursuits and a $3.2 million contribution to InternationalForum, Inc., a not-for-profit foundation formed to pro-vide exchange programs for international students in theUnited States. Excluding these non-recurring expenses,general and administrative expenses were 3.7% of totalrevenues for 1996 and 3.3% of total revenues for 1997.

22

In March 1997, the Company and National EducationCorporation (“NEC”) executed a definitive agreement pur-suant to which the Company was to acquire NEC. In May1997, NEC accepted a competing offer which resulted in thetermination of NEC’s agreement with the Company. As aresult, NEC paid the Company a $30.0 million terminationfee, which has been recorded, net of $1.5 million of transac-tion costs, as a separate component of non-operating income.

In May 1997, the Company determined that certainassets of Sylvan Prometric were impaired as a result ofcertain strategic changes that were made as a result ofpursuing the NEC acquisition. During and after theacquisition negotiations with NEC, the Company devel-oped certain plans that resulted in required changes inboth software systems and hardware currently utilized in Sylvan Prometric’s network of centers. The plans con-tinued to be valid for the Company even after the NECacquisition was terminated. The impaired assets, consist-ing of computer equipment and software, were impairedas a result of changes in the technical requirements andspecifications of certain computer hardware and software.The amount of the impairment loss was determined by evaluating the likely sales proceeds from the disposi-tion of the assets compared to their book value. TheCompany determined that it was unlikely that the netcash proceeds from the sale of any assets would be significant, and therefore recorded an impairment lossequal to the net book value of the assets of $4.0 million.During 1998, these assets were disposed of for no signif-icant consideration.

Investment and other income increased by $3.1 million to $4.8 million during 1997, primarily due to the $2.0 million non-cash dividend incomereceived from the Company’s investment in JLCHoldings, Inc. and the higher cash and investment balances resulting from the NEC termination fee andthe proceeds received from the sale of the Company’scommon stock during 1997. The Company’s interestexpense decreased by $0.5 million due to the repaymentof all outstanding Educational Inroads debt in the second quarter of 1997.

The Company reported losses of $2.0 million in1997 from its investment in affiliates, consisting primar-ily of $1.4 million attributable to Caliber LearningNetwork, Inc., in which the Company has an equityinvestment. The Company and MCI CommunicationsCorp. organized Caliber in November of 1996.

The Company’s effective tax rate remained constantat 37% in 1996 and 1997.

Future Assessment of Recoverability andImpairment of Goodwill In connection with its various acquisitions, the Companyrecorded goodwill, which is being amortized on astraight-line basis over periods of 10 to 25 years, its esti-mated periods that the Company will be benefited bysuch goodwill. At December 31, 1998, the unamortizedgoodwill was $275.8 million (which represented 42% oftotal assets and 56% of stockholders’ equity). Goodwillarises when an acquirer pays more for a business than the fair value of the tangible and separately measurableintangible net assets. For financial reporting purposes,goodwill and all other intangible assets are amortized overthe estimated period benefited. The Company has deter-mined the life for amortizing goodwill based upon severalfactors, the most significant of which are the relative size, historical financial viability and growth trends of the acquired companies and the relative lengths of timesuch companies have been in existence.

Management of the Company periodically reviewsthe Company’s carrying value and recoverability ofunamortized goodwill. If the facts and circumstances sug-gest that the goodwill may be impaired, the carrying valueof such goodwill will be adjusted which will result in animmediate charge against income during the period of the adjustment and/or the length of the remaining amor-tization period may be shortened, which will result in anincrease in the amount of goodwill amortization duringthe period of adjustment and each period thereafter untilfully amortized. Once adjusted, there can be no assurancethat there will not be further adjustments for impairmentand recoverability in future periods. Of the various factorsto be considered by management of the Company indetermining whether goodwill is impaired, the most significant will be (i) losses from operations, (ii) loss ofcustomers, and (iii) industry developments, including the Company’s inability to maintain its market share,development of competitive products or services, andimposition of additional regulatory requirements.

Liquidity and Capital Resources The Company in 1998 generated $58.1 million of cashflow from operations, a decrease of $1.1 million as com-pared to 1997. The decrease is attributable to an increasein net income, excluding non-cash charges (principallydepreciation and amortization) of $9.5 million, offset bya net additional investment in operating assets (princi-pally accounts and notes receivable) of $10.6 million.

The Company’s investment in working capital continues to reduce net cash flow from operations, particularly as a result of the growth in accounts and

notes receivable. The $18.5 million increase in accountsand notes receivable is principally the result of a 47%increase in revenue during 1998. Of the $18.5 millioncash flow reduction attributable to an increase inaccounts and notes receivable, approximately $8.4 mil-lion relates to Sylvan’s expanding testing contracts, withthe remainder of the increase related to the Company’sother operating segments. The increase in amounts duefrom expanding testing contracts resulted from higherdomestic testing volumes and a significant increase inbillings under the international contract with ETS toestablish overseas testing capacity. ETS typically makesmonthly payments for domestic activity and quarterlypayments for international services. Notes receivable for new area development agreements accounted for $5.0 million of the increase in 1998. Notes receivablefrom tuition financing activities increased by $5.4 mil-lion. Sylvan believes that uncollectible accounts receiv-able will not have a significant effect on future liquidity,as a significant portion of its accounts receivable are duefrom enterprises with substantial financial resources,such as ETS and governmental units.

The Company’s investing activities include the netsale of $77.1 million in available-for-sale securities. Theproceeds were used in part to fund the acquisitions ofCanter and Schülerhilfe and to settle a portion of the contingent consideration that was payable to the formershareholders of PACE. The remaining securities are readilymarketable and available for use in current operations.The Company also made $11.6 million of additionalinvestments in or loans to affiliates accounted for usingthe equity method, consisting primarily of additionalinvestments in Caliber Learning Network, Inc.

Effective January 1, 1998, the Company acquired all of the outstanding stock of Canter & Associates, Inc. andCanter Educational Productions, Inc. (collectively, “Canter”),commonly controlled companies engaged in the business of providing materials and training programs for educators,for an initial purchase price of $25.0 million in cash.

Effective October 28, 1998, the Company acquiredall the operating assets and liabilities of ZGS ZentraleGelsenkirchener SCHÜLERHILFE J. Gratze + M. Mohr GbR mbH (“Schülerhilfe Partnership”) and all ofthe outstanding common stock of SCHÜLERHILFEGesellschaft für Nachhilfeunterricht mbH (“SchülerhilfeCorporation,” and collectively with SchülerhilfePartnership, “Schülerhilfe”), in exchange for an initialpurchase price of $16.5 million in cash and 123,973 sharesof restricted common stock valued at $2.5 million.

23

Sylvan continues to incur expenditures for additionsto property and equipment, which totaled $58.3 million in 1998. These additions consist primarily of furniture and equipment for general business expansion, includingexpenditures for the headquarters facility, new publicschool-based programs’ classrooms, and equipment neededfor overseas testing centers operated by Sylvan. Under theinternational testing contract with ETS, Sylvan is reim-bursed for overseas equipment expenditures as the equip-ment is depreciated. This reimbursement includes afinancing charge over the reimbursement period.

The Company has entered into a long-term revolv-ing credit facility with a group of banks, (hereinafter the“credit facility”) that provides an unsecured revolving lineof credit. The credit facility allows the Company to bor-row a maximum of $100.0 million through the expira-tion date of December 31, 2003. The credit facility bearsinterest at either the prime rate, the federal funds rateplus 0.5%, or rates based on the Eurodollar rate plus acontractual margin. The credit facility had outstandingprime rate borrowings of $8.0 million at December 31,1998, bearing interest at 7.75%. Effective January 7,1999, the borrowings began to bear interest at 6.06%,based on the Eurodollar rate.

During 1998, the Company received $6.4 million of cash as a result of the exercise of stock options andwarrants to purchase 653,652 shares of common stock.

Sylvan believes that its capital resources will be suffi-cient over the next 12 to 24 months to fund expectedexpansion of its existing business, including working capitalneeds and expected investments in property and equipment.

Sylvan continues to review other companies in theeducation or computer-based testing industries for poten-tial acquisitions. Additional capital resources may be neces-sary to acquire and thereafter operate additional businesses.

The Company has entered into an agreement pro-viding an exclusive option to acquire 54 percent of theshares of Universidad Europea de Madrid (UEM) forapproximately $51 million. The purchase price wouldinclude payment of approximately $28.5 million in cash and the assumption of approximately $22.5 million in existing debt. Total revenues for the year endedDecember 31, 1998 for UEM are estimated to be $49 million and recurring earnings before interest, taxesand depreciation are estimated to be $15.5 million. All required regulatory approvals have been received and this transaction is expected to close during the sec-ond or third quarter of 1999.

24

Year 2000 Compliance The Year 2000 Issue is the result of computer programswritten using two digits (rather than four) to define theapplicable year. Absent corrective actions, programs withdate-sensitive logic may recognize “00” as 1900 ratherthan 2000. This could result in a system failure or miscal-culations causing disruptions of operations, including,among other things, production difficulties, a temporaryinability to process transactions, send invoices, or engagein similar normal business activities.

The Company has established a corporate-wide Year2000 task force with representatives from all divisions. Thetask force has conducted a comprehensive review of theCompany’s information technology and non-informationtechnology systems affected by the Year 2000 issue and hasdeveloped an implementation plan to resolve them. TheCompany measures its progress towards completion basedon the level of efforts completed to date compared to thetotal expected. The process involves five phases:

Phase I—Inventory and Data Collection. This phaseinvolves conducting a comprehensive inventory of theCompany’s information systems which includes but is notlimited to telecommunications systems, computer hard-ware, software and networks as well as building infrastruc-ture such as HVAC, elevators and security systems. Theidentification of key third party vendors is also involved.During this phase, all new systems are required to havepassed Year 2000 compliance tests before being purchasedand implemented. The Company commenced this phasein the first quarter of 1998 and the phase is complete.

Phase II—Assessment/Date Impact. In this phase, systems identified during Phase I are reviewed to deter-mine what impact, if any, the Year 2000 Issue has on the operation of these systems. This phase also identifiesthe effects of Year 2000 being a leap year. This phase is95% complete.

Phase III—Remediation. This phase involves modify-ing, replacing or upgrading the systems that have failedduring Phase II. The remediation phase is 55% completeand is expected to be completed by the middle of the second quarter of 1999.

Phase IV—Testing. This phase involves review of systems for compliance and re-testing as necessary. Thetesting phase is 55% complete and is expected to be completed by the end of the second quarter of 1999.

Phase V—Implementation. This phase involves imple-menting the systems after they have been successfullyremediated and tested. This is the final step in assuringthat the systems are Year 2000 complaint. The phase is55% complete and is expected to be completed by theend of the third quarter of 1999.

The Company believes the cost to remedy all Year2000 Issues to be $4.5 million and has expended $1.0 mil-lion through December 31, 1998. The Company is notaware of any material non-compliance that would have amaterial effect on its financial position. As part of the Year2000 Issue process, formal communication with theCompany’s suppliers, customers and other support serviceshas been initiated and efforts will continue until positivestatements of readiness have been received from all thirdparties. To date, the Company is not aware of any non-compliance by its customers or suppliers that would havematerial impact on the Company’s business. Nevertheless,there can be no assurance that unanticipated non-compli-ance will not occur, and such non-compliance couldrequire material costs to repair or could cause material dis-ruptions if not repaired. The Company is in the process of developing a strategy to address these potential conse-quences that may result from unresolved Year 2000 Issues,which will include the development of one or more contin-gency plans by mid-1999.

Euro ConversionOn January 1, 1999, certain countries of the EuropeanUnion established fixed conversion rates between theirexisting currencies and one common currency, the euro.The euro is now traded on currency exchanges and maybe used in business transactions. Beginning in January2002, new euro-denominated currencies will be issuedand the existing currencies will be withdrawn from circu-lation. The Company is currently evaluating the systemsand business issues raised by the euro conversion. Theseissues include the need to adapt computer and otherbusiness systems and equipment and the competitiveimpact of cross-border transparency. The Company hasnot yet completed its estimate of the potential impactlikely to be caused by the euro conversion; however, atpresent the Company has no reason to believe the euroconversion will have a material impact on the Company’sfinancial condition or results of operations.

Contingent Matters In connection with the Company’s acquisition of Canterand based on Canter’s earnings in 1998, additional con-sideration of $28.5 million is payable to the seller in cash of $16.3 million and the remainder in shares of restrictedcommon stock which has been valued at $12.2 million. As of December 31, 1998, the Company has recorded this additional consideration as a liability and additional goodwill which will be amortized over the remaining

amortization period of 24 years. Additional variable amountsof contingent consideration are also payable to the seller if specified levels of earnings are achieved in 1999 and 2000,payable in equal amounts of cash and stock. The Companywill record the contingent consideration when the contingen-cies are resolved and the additional consideration is payable.

In connection with the Company’s acquisition ofSchülerhilfe, the Company may be obligated to pay thesellers up to an additional $13.3 million of considerationin February 2000 (payable in either cash or commonstock at the discretion of the Company) based on theamount of 1999 franchise fees which have been collectedby Schülerhilfe on or before January 31, 2000. TheCompany will record this contingent consideration when the contingencies are resolved and the additionalconsideration is payable.

Effects of Inflation Inflation has not had a material effect on Sylvan’s revenuesand income from continuing operations in the past three years. Inflation is not expected to have a materialfuture effect.

Quarterly Fluctuations Sylvan’s revenues and operating results have varied substan-tially from quarter to quarter and may continue to vary,depending upon the timing of implementation of new com-puter-based testing contracts and contracts funded underTitle I or similar programs. Based on Sylvan’s experience, rev-enues generated by computer-based testing services may varybased on the frequency or timing of delivery of individualtests and the speed of test administrators conversion of teststo computer-based format. In addition, franchise license feesearned by the Company in its Sylvan Learning Centers andtesting services segments may vary significantly from quarterto quarter. Revenues or profits in any period will not necessarily be indicative of results in subsequent periods.

Quantitative and Qualitative DisclosuresAbout Market RiskThe Company is exposed to market risk from changes ininterest rates and foreign currency exchange rates, whichcould affect its future results of operations and financialcondition. The Company manages its exposure to theserisks through its regular operating and financing activities.

Foreign Currency RiskThe Company derives approximately 29% of its revenuesfrom customers outside of the United States. This busi-ness is transacted through a network of international sub-sidiaries, generally in the local currency that is consideredthe functional currency of that foreign subsidiary. TheCompany generally views its investment in the majority

25

of its foreign subsidiaries as long-term. The functionalcurrencies of these foreign subsidiaries are principallydenominated in the Spanish peseta, the British poundsterling, and the Australian dollar. The effects of a changein foreign currency exchange rates on the Company’s netinvestment in foreign subsidiaries are reflected in othercomprehensive income. A 10% depreciation in year-end1998 functional currencies relative to the U.S. dollarwould result in a $300,000 decrease in consolidatedstockholders’ equity.

The Company’s investment in certain foreign sub-sidiaries providing information technology testing servicesis considered temporary. These subsidiaries regularly remitcollected testing fees, generally paid in advance of the testand denominated in foreign currencies, to the U.S. par-ent, which upon test delivery, pays the test sponsor’s feeand retains the residual. The principal currencies of thesesubsidiaries are the British pound sterling, the Germandeutsche mark and the Japanese yen. The Company isgenerally not exposed to foreign exchange rate fluctuationsrelated to collected fees on undelivered tests as a result of contractual provisions with test sponsors. Foreignexchange gains and losses during the period from the date of test delivery through the date of payment of thetest sponsor have not been material, and the Company’sexposure to such exchange losses at December 31, 1998,assuming a 10% deterioration in foreign exchange rates,would not be material.

The Company’s foreign operations providing inter-national academic testing services under a cost-plus con-tract with ETS are not exposed to foreign currency risk.Under the contract, foreign exchange rate gains and lossesare a component of the reimbursable contract costs.

Interest Rate RiskThe fair value of the Company’s cash and cash equivalentswould not be significantly impacted by either a 100 basispoint increase or decrease in interest rates due to the short-term nature of the Company’s portfolio. At December 31,1998, the Company’s investment in available-for-sale,interest-bearing securities is not material.

The Company’s long-term revolving credit facilitybears interest at variable rates, and the fair value of thisinstrument is not significantly affected by changes in mar-ket interest rates. A hypothetical 100 basis points increasein interest rates under the credit facility for one year wouldincrease interest expense by an immaterial amount.

SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

26

December 31, December 31,(Amounts in thousands, except per share data) 1997 1998

(Restated - Note 1)

AssetsCurrent assets:

Cash and cash equivalents $ 29,818 $ 33,170Available-for-sale securities 82,951 6,166Receivables:

Accounts receivable 59,721 71,248Costs and estimated earnings in excess of billings

on uncompleted contracts 3,900 7,806Notes receivable from tuition financing 978 2,977Other notes receivable 2,943 8,922Other receivables 8,752 2,404

76,294 93,357Allowance for doubtful accounts (2,509) (2,963)

73,785 90,394Inventory 4,999 9,841Deferred income taxes 3,755 1,831Prepaid expenses 6,303 10,093Other current assets 265 1,843

Total current assets 201,876 153,338Notes receivable from tuition financing, less current portion — 3,415Other notes receivable, less current portion 6,232 9,882Costs and estimated earnings in excess of billings on

uncompleted contracts, less current portion 352 637Property and equipment:

Land and buildings 5,710 9,917Furniture and equipment 59,201 111,490Leasehold improvements 7,988 13,156

72,899 134,563Accumulated depreciation (21,532) (36,682)

51,367 97,881Intangible assets:

Goodwill 183,172 292,693Contract rights 13,973 13,973Other 2,522 3,111

199,667 309,777Accumulated amortization (16,799) (26,322)

182,868 283,455Deferred contract costs, net of accumulated amortization of $6,205 as

of December 31, 1997 and $11,740 as of December 31, 1998 10,324 10,255Investments in and advances to affiliates 12,464 18,532Other investments 28,017 44,230Net assets to be transferred to joint venture — 31,575Other assets 3,279 6,596Total assets $496,779 $659,796

Consolidated Balance Sheets

December 31, December 31,(Amounts in thousands, except per share data) 1997 1998

(Restated - Note 1)

Liabilities and stockholders’ equity

Current liabilities:

Accounts payable and accrued expenses $ 40,754 $ 57,177

Income taxes payable 5,590 11,784

Current portion of long-term debt 1,253 1,128

Current portion of due to shareholders of acquired companies 13,794 40,719

Deferred revenue 26,323 27,411

Other current liabilities 1,288 19

Total current liabilities 89,002 138,238

Long-term debt, less current portion 2,428 12,504

Deferred income taxes 7,620 6,961

Due to shareholders of acquired companies, less current portion 56,366 12,239

Other long-term liabilities 903 1,021

Total liabilities 156,319 170,963

Stockholders’ equity:

Preferred stock, par value $.01 per share—authorized 10,000 shares, no shares

issued and outstanding as of December 31, 1997 and 1998 — —

Common stock, par value $.01 per share—authorized 90,000 shares,

issued and outstanding shares of 45,450 as of December 31, 1997 and 50,952

as of December 31, 1998 455 510

Additional paid-in capital 302,022 410,694

Retained earnings 39,144 75,852

Accumulated other comprehensive income (loss) (1,161) 1,777

Total stockholders’ equity 340,460 488,833

Total liabilities and stockholders’ equity $496,779 $659,796

See accompanying notes.

Consolidated Balance Sheets (Cont.)

27

Year Ended December 31,(Amounts in thousands, except per share data) 1996 1997 1998

(Restated - Note 1) (Restated - Note 1)

Revenues $219,973 $301,011 $440,330

Cost and expensesDirect costs 187,819 263,523 359,613General and administrative expense 8,049 19,693 15,530Transaction costs related to pooling-of-interests — — 5,000Restructuring and asset impairment charges — 4,000 3,730Total expenses 195,868 287,216 383,873Operating income 24,105 13,795 56,457

Other income (expense)Termination fee, net of direct costs — 28,500 —Investment and other income 1,747 4,836 5,281Interest expense (1,320) (801) (943)Equity in net income (loss) of affiliates 361 (2,006) (3,504)Income before income taxes 24,893 44,324 57,291Income taxes (9,139) (16,420) (21,582)

Net income $ 15,754 $ 27,904 $ 35,709

Earnings per common share, basic $ 0.43 $ 0.66 $ 0.73

Earnings per common share, diluted $ 0.40 $ 0.62 $ 0.70

See accompanying notes.

SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

28

Consolidated Statements of Income

Retained AccumulatedAdditional Earnings Other Total

Common Paid-In (Accumulated Comprehensive Stockholders’(Amounts in thousands) Stock Capital Deficit) Income Equity

Balance at January 1, 1996—as restated (Note 1) $ 356 $140,450 $ (1,768) $ 93 $139,131Options and warrants exercised for purchase of 993 shares of

common stock, including income tax benefit of $1,887 10 6,988 6,998Issuance of 1,236 shares of common stock in connection

with the investment in JLC Learning Corporation 12 21,206 21,218Issuance of 175 shares of common stock in connection with other acquisitions 2 27 (320) (291)Exercise of underwriter’s overallotment option to purchase 51 shares

of common stock in connection with 1995 public stock offering 533 533Comprehensive income:

Net income for 1996 15,754 15,754Other comprehensive income:

Foreign currency translation adjustment (269) (269)Unrealized loss on available-for-sale securities (6) (6)

Total comprehensive income 15,479Distributions to former shareholders (300) (300)

Balance at December 31, 1996—as restated (Note 1) 380 169,204 13,366 (182) 182,768Options and warrants exercised for purchase of 1,706 shares of common

stock, including income tax benefit of $8,156 17 13,102 13,119Issuance of 536 shares of common stock in connection with contingent

consideration related to the acquisition of Drake 5 8,137 8,142Issuance of 1,072 shares of common stock in connection with the

acquisition of WSI 11 15,309 15,320Issuance of 404 shares of common stock to Sylvan Learning Foundation

as charitable contribution 4 6,537 6,541Issuance of 309 shares of common stock to IT Training Marketing

Company as marketing expense 3 6,997 7,000Issuance of 265 shares of common stock to SLC National Advertising

Fund, Inc. as advertising expense 3 4,997 5,000Issuance of 3,098 shares of common stock for cash—net of offering costs of $3,645 31 73,660 73,691Capital contribution by former shareholders of Educational Inroads 2,811 2,811Issuance of 94 shares of common stock in connection with other acquisitions 1 718 719Stock options to purchase 317 shares of common stock granted to non-employees 550 550Comprehensive income:

Net income for 1997 27,904 27,904Other comprehensive income:

Foreign currency translation adjustment (990) (990)Unrealized loss on available-for-sale securities 11 11

Total comprehensive income 26,925Distributions to former shareholders (2,126) (2,126)

Balance at December 31, 1997—as restated (Note 1) 455 302,022 39,144 (1,161) 340,460Options and warrants exercised for purchase of 654 shares

of common stock, including income tax benefit of $5,176 7 11,531 11,538Stock options granted to non-employees 539 539Issuance of 27 shares of common stock in connection

with the Employee Stock Purchase Plan 527 527Issuance of 2,570 shares of common stock in connection with

contingent consideration related to the acquisition of Drake 26 39,179 39,205Issuance of 964 shares of common stock in connection with

the acquisition of NAI / Block 10 24,990 25,000Issuance of 345 shares of common stock in connection with

contingent consideration related to the acquisition of PACE 3 11,305 11,308Issuance of 277 shares of common stock in connection with other investments 3 7,997 8,000Issuance of 258 shares of common stock in connection with the purchase of assets 3 7,454 7,457Issuance of 124 shares of common stock in connection with

the acquisition of Schülerhilfe 1 2,527 2,528Issuance of 205 shares of common stock in connection with other acquisitions 2 1,477 681 2,160Capital contribution by former shareholders of Aspect 1,300 1,300Comprehensive income:

Net income for 1998 35,709 35,709Other comprehensive income:

Foreign currency translation adjustment 2,938 2,938Total comprehensive income 38,647

Other (154) 318 164Balance at December 31, 1998 $ 510 $410,694 $75,852 $ 1,777 $488,833

See accompanying notes.

SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

29

Consolidated Statements of Stockholders’ Equity

SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

30

Year Ended December 31,(Amounts in thousands) 1996 1997 1998

(Restated - Note 1) (Restated - Note 1)

Operating activitiesNet income $ 15,754 $ 27,904 $ 35,709

Adjustments to reconcile net income to net cash provided by (used in) operating activities:Depreciation 6,462 8,790 15,599Amortization 7,494 10,071 16,724Non-cash marketing and advertising expense — 11,500 —Non-cash compensation expense — — 1,300Non-cash issuance of options to non-employees — 550 539Non-cash dividend income — (2,000) (1,167)Loss on impairment of assets — 4,000 —Gain on sale of property and equipment — (651) —Equity in net (income) loss of affiliates (361) 2,006 3,504Deferred income taxes 2,073 1,834 1,265Changes in operating assets and liabilities:

Accounts and notes receivable (10,269) (27,304) (18,543)Cost and estimated earnings in excess of billings on uncompleted contracts (413) (137) (4,191)Inventory (183) (398) (4,202)Prepaid expenses and other current assets (299) (1,892) (4,451)Accounts payable and accrued expenses 3,428 4,831 8,475Income taxes payable 2,197 13,437 11,346Deferred revenue and other current liabilities 4,458 6,684 (3,781)

Net cash provided by operating activities 30,341 59,225 58,126

Investing activitiesPurchase of available-for-sale securities (31,286) (92,522) (2,502)Proceeds from sale of available-for-sale securities 45,542 26,045 79,611Investment in and advances to affiliates (3,445) (9,653) (11,572)Increase in other investments (2,330) (4,136) (5,046)Purchase of property and equipment (14,866) (30,964) (58,294)Proceeds from sale of property and equipment 11 1,916 —Purchase of contract rights (4,891) — —Purchase of Canter, including direct costs of acquisition, net of cash acquired — — (24,086)Purchase of Schülerhilfe, including direct costs of acquisition, net of cash acquired — — (16,649)Payment of contingent consideration for PACE acquisition — — (13,532)Purchase of Wall Street Institute, including direct costs of acquisition,

net of cash acquired 2,013 (4,671) —Cash paid for other businesses, net of cash acquired 570 (1,851) (13,777)Expenditures for deferred contract costs (6,942) (1,443) (2,771)Increase in other assets (999) (731) (5,895)Net cash used in investing activities (16,623) (118,010) (74,513)

Financing activitiesPayments on loans to stockholders of acquired companies (38) (493) —Proceeds from exercise of options and warrants 5,111 4,964 6,362Proceeds from issuance of common stock 533 73,691 527Proceeds from issuance of long-term debt 364 452 22,039Payments on long-term debt and capital lease obligations (2,793) (5,675) (11,985)Distributions (301) (793) —Proceeds from bank lines of credit 200 13,575 114,396Payments on bank lines of credit (3,812) (14,575) (114,107)Net cash provided by (used in) financing activities (736) 71,146 17,232Effects of exchange rate changes on cash (914) (1,263) 2,507Net increase in cash and cash equivalents 12,068 11,098 3,352Cash and cash equivalents at beginning of period 6,652 18,720 29,818Cash and cash equivalents at end of period $ 18,720 $ 29,818 $ 33,170

See accompanying notes.

Consolidated Statements of Cash Flows

1. Basis of Presentation and Description of Business

Sylvan Learning Systems, Inc. and subsidiaries (“theCompany” or “Sylvan”) is an international provider ofeducational and testing services. The Company conductsoperations in three separate business segments—SylvanLearning Centers, Sylvan Prometric, and Sylvan ContractEducational Services. The Sylvan Learning Centers segment designs and delivers individualized tutorial pro-grams to school-age children and adults through a net-work of 727 franchised and Company-owned SylvanLearning Centers in operation in 49 states, six Canadianprovinces, Hong Kong and Guam. The Sylvan Prometricsegment administers computer-based tests for major cor-porations, professional associations and governmentalagencies through a network of certification centers whichare located throughout the world. This segment alsoincludes the operations of Wall Street Institute, B.V., aEuropean-based franchisor and operator of learning cen-ters that teach the English language through a combina-tion of computer-based and live instruction, as well asAspect International Language Schools, B.V. (“Aspect”).Aspect focuses principally on intensive English languageinstruction to students and professionals worldwidethrough its 27 language schools in five countries. TheSylvan Contract Educational Services segment principallyprovides educational programs to employees of large cor-porations and to public and non-public school districtsthrough contracts funded by federal Title I and state-based programs.

The consolidated financial statements include theaccounts of Sylvan Learning Systems, Inc. and its wholly-owned subsidiaries. All intercompany accounts and trans-actions have been eliminated in consolidation. Investmentsin affiliates owned more than 20%, but not in excess of50%, and corporate joint ventures are reported using theequity method.

The preparation of the financial statements in con-formity with generally accepted accounting principlesrequires management to make estimates and assumptionsthat affect reported amounts and related disclosures.Actual results could differ from those estimates.

As discussed in Note 3, during fiscal year 1998, theCompany consummated mergers with three franchiseesof Sylvan Learning Centers and with Aspect. These mergers were each consummated by the exchange of allof the outstanding shares of voting common stock of the acquired company for shares of common stock of theCompany and were accounted for as poolings-of-interest.

SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES

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Notes to Consolidated Financial Statements(Dollar and share amounts in thousands, except per share data)

The accompanying consolidated financial statements havebeen restated to retroactively combine the financial state-ments of the combining companies as if the mergers hadoccurred on January 1, 1996, the beginning of the earli-est period presented.

The Company’s fiscal year ends on December 31.The accounts of its wholly-owned subsidiary, Aspect,have been consolidated on the basis of a year ending on September 30. Such fiscal period corresponds withAspect’s natural business year.

2. Accounting Policies Cash EquivalentsThe Company considers all highly-liquid investmentswith a maturity of three months or less when purchasedto be cash equivalents.

InvestmentsAvailable-for-sale securities are carried at fair value, withany unrealized gains and losses, net of tax, reported inother comprehensive income. The amortized cost of debtsecurities in this category is adjusted for amortization ofpremiums and accretion of discounts to maturity. Suchamortization is included in investment income. Realizedgains and losses and declines in value judged to be other than temporary on available-for-sale securities areincluded in investment income. The cost of securitiessold is based on the specific identification method.Interest and dividends on securities classified as available-for-sale are included in investment income.

InventoryInventory, consisting primarily of computer software andeducational, instructional, and marketing materials andsupplies, is stated at the lower of cost (first-in, first-out)or market value.

Property and EquipmentProperty and equipment is stated at cost. Depreciation is determined using the straight-line method over theestimated useful lives of the assets.

Included in property and equipment are the directcosts of developing or obtaining software for internal use.In March 1998, the AICPA issued Statement of Position98-1 (“SOP 98-1”) Accounting for the Costs of ComputerSoftware Developed or Obtained For Internal Use. SOP 98-1 is effective beginning January 1, 1999 and requiresthe capitalization of direct costs incurred in connectionwith developing or obtaining software for internal use. The adoption of SOP 98-1 in 1999 will not have anyeffect on the Company’s current accounting policies.

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Intangible AssetsGoodwill consists of the cost in excess of fair value of the identifiable net assets of entities acquired in purchasetransactions, and is amortized on a straight-line basis,over the estimated future periods to be benefited, whichrange from 10 to 25 years. At December 31, 1997 and1998, accumulated amortization of goodwill was $8,873and $16,886, respectively.

Contract rights consist of the allocated cost of acquiringcomputer-based testing contracts in business combinationsaccounted for as purchases. Contract rights are being amor-tized on a straight-line basis, over the term of the relatedcontract, which range from nine months to 10 years. AtDecember 31, 1997 and 1998, accumulated amortization of contract rights was $6,899 and $8,068, respectively.

Deferred Contract CostsDeferred contract costs include direct costs incurred todevelop computer-based tests under contractual arrange-ments with customers. Under these arrangements, theCompany incurs certain costs related to the developmentof new computer-based tests on behalf of the customer inreturn for the right to deliver the computer-based tests andcollect a testing fee from either the candidate or the spon-soring organization. These costs are capitalized and amor-tized over the shorter of the estimated utility period of thetest or the contractual period for delivery of the test.

Deferred contract costs also include payments ofapproximately $10,400 made in 1996 to non-affiliatedcomputer-based testing centers that have entered intothree-year contracts with the Company to deliver infor-mation technology computer-based certification tests. Inaccordance with the terms of these contracts, the indepen-dent testing centers have received an advance paymentand will receive no additional fees upon delivery of thecomputer-based certification tests. These costs are beingamortized over the contractual term of three years.

Impairment of Long-Lived AssetsLong-lived assets, including intangible assets, are reviewedfor impairment whenever events or changes in circum-stances indicate that the carrying amount of an asset maynot be fully recoverable. If an impairment indicator ispresent, the Company evaluates whether an impairmentexists on the basis of undiscounted expected future cashflows from operations for the remaining amortizationperiod. If an impairment exists, the asset is reduced bythe estimated shortfall of discounted cash flows.

Revenue RecognitionRevenue related to single-center and area franchise sales isrecognized when all material services or conditions relat-ing to the sales have been substantially performed or satis-fied by the Company. For single-center franchise sales, the

criteria for substantial performance include: (1) receipt ofan executed franchise license agreement, (2) receipt of fullpayment of the franchise fee, (3) completion of requisitetraining by the franchisee or center director, and (4) com-pletion of site selection assistance and site approval. Areafranchise sales generally transfer to the licensee the right to develop and operate centers in a specified territory, primarily in a foreign country, and the Company’s futureobligations are insignificant. Area franchise fees are recog-nized upon the signing of the license agreement and thedetermination that (1) all material services or conditionsrelating to the sale have been satisfied and the fee is non-refundable, (2) a minimum payment of 50% of the fee is required within 90 days of the date of the agreement, and (3) the Company has the ability to estimate the collectibility of any unpaid amounts. Franchise sales feesnot meeting the recognition criteria are recorded asdeferred revenue if not refundable, or deposits from franchisees if refundable.

Fixed price contracts with school districts receivingfunds under the federal Title I program and state-basedprograms are accounted for using the percentage-of-completion method. Income is recognized based on the per-centage of contract completion determined by the totalexpenses incurred to date as a percentage of total esti-mated expenses at the completion of the contract. Totalcontract income is estimated as contract revenue less total estimated costs considering the most recent costinformation. Revenues from cost-plus-fee contracts arerecognized on the basis of costs incurred during theperiod plus the fee earned.

Franchise royalties are reported as revenue as the royalties are earned and become receivable, unless collec-tion is not reasonably assured. Revenues from educationalservices, including English language instruction, are recognized in the period the services are provided.

Revenue from the sale of products to franchisees isrecognized when shipped. Testing revenues are recognizedupon the completion of tests.

AdvertisingThe Company expenses advertising costs as incurred,except for direct-response advertising, which is capitalizedand amortized over its expected period of future benefit.

Capitalized direct-response advertising consists primar-ily of the costs to produce direct-mail order catalogues andbrochures that are used to solicit students of educationalprograms who have responded directly to the advertising.The capitalized production costs are amortized over theperiod of the respective programs, ranging from one tothree years.

At December 31, 1997 and 1998, advertising coststotaling approximately $1,800 and $5,000, respectively,

were reported as assets. The acquisition of Canter in 1998contributed to the majority of this increase. Advertisingexpense for the year ended December 31, 1996, 1997 and1998 was $5,952, $8,514 and $13,950, respectively.

Stock Options Granted to Employees and Non-EmployeesThe Company records compensation expense for all stock-based compensation plans using the intrinsic value methodprescribed by APB Opinion 25, Accounting for StockIssued to Employees (“APB 25”). Under APB 25, if theexercise price of the Company’s employee stock optionsequals the estimated fair value of the underlying stock onthe date of grant, no compensation expense is generally recognized. Statement of Financial Accounting StandardsNo. 123, Accounting for Stock-Based Compensation(“Statement 123”) encourages companies to recognizeexpense for stock-based awards based on their estimated fairvalue on the date of grant. Statement 123 requires disclo-sure of pro forma income and earnings per share data in thenotes to the financial statements if the fair value method is not elected. The Company supplementally discloses in Note 12 to these financial statements the pro forma infor-mation as if the fair value method had been adopted.

The Company records compensation expense for all stock options granted to non-employees in an amountequal to the estimated fair value at the date of grant,determined using the Black-Scholes option valuationmodel. The compensation expense is recognized ratablyover the vesting period.

Foreign Currency TranslationThe financial statements of certain foreign subsidiariesthat are measured in local functional currencies are trans-lated into U.S. dollars using the current rate method. All balance sheet accounts are translated using theexchange rates at the balance sheet date. Income state-ment amounts have been translated using the averageexchange rates for the year. Translation gains or lossesresulting from the changes in exchange rates from year to year, are reported in other comprehensive income.

The financial statements of other foreign subsidiaries,primarily those subsidiaries providing services overseas toEducational Testing Services, Inc. (“ETS”) (see Note 19),prepare financial statements using the U.S. dollar as thefunctional currency. The transactions of these subsidiariesthat are denominated in foreign currencies have beenremeasured into U.S. dollars. Any resulting gain or loss is recorded as an adjustment of the amount due from ETS as the contract with ETS requires ETS to bear therisk of foreign currency gains or losses.

Comprehensive IncomeAs of January 1, 1998, the Company adopted Statementof Financial Accounting Standards No. 130, Reporting

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Comprehensive Income (“Statement 130”). Statement 130establishes new rules for the reporting and display ofcomprehensive income and its components. The adop-tion of Statement 130 had no impact on the Company’snet income or stockholders’ equity. Statement 130requires non-owner changes in stockholders’ equity,including unrealized gains or losses on the Company’savailable-for-sale securities and foreign currency transla-tion adjustments, which prior to adoption were reportedseparately in stockholders’ equity, to be included in othercomprehensive income. Statement 130 requires the dis-closure of comprehensive income in a financial statement.The Company has elected to report comprehensiveincome in the statement of stockholders’ equity. Prioryear financial statements have been reclassified to con-form to the requirements of Statement 130.

Impact of Recently Issued Accounting StandardIn 1998, the AICPA issued SOP 98-5, Reporting theCosts of Start-up Activities (“SOP 98-5”). SOP 98-5 iseffective beginning on January 1, 1999, and requires thatstart-up costs capitalized prior to January 1, 1999 bewritten-off and any future start-up costs to be expensedas incurred. The Company previously capitalized pre-contract costs directly associated with specific anticipatedcontracts as well as development costs for new educa-tional programs that were estimated to be recoverable.SOP 98-5 defines start-up costs to include pre-contractcosts and costs to introduce a new product, and accord-ingly, previously capitalizable costs are required to bewritten-off upon adoption of SOP 98-5. The unamor-tized balance of pre-contract and new product develop-ment costs (approximately $2,000 as of December 31,1998) will be written-off as a cumulative effect of anaccounting change as of January 1, 1999.

ReclassificationsCertain amounts in the 1996 and 1997 consolidatedfinancial statements have been reclassified to conform tothe 1998 presentation.

3. Acquisitions Canter & Associates, Inc. and Canter EducationalProductions, Inc.Effective January 1, 1998, the Company acquired all of the outstanding stock of Canter & Associates, Inc. and Canter Educational Productions, Inc. (collectively,“Canter”), commonly controlled companies engaged inthe business of providing materials and training programsfor educators, for an initial purchase price of $25,000 incash. The acquisition was accounted for using the pur-chase method of accounting and goodwill of $24,559 was recorded and is being amortized over a period of 25 years. The results of operations of Canter for the period

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from January 1, 1998 through December 31, 1998 areincluded in the accompanying 1998 consolidated state-ment of income.

In connection with the Company’s acquisition ofCanter and based on Canter’s earnings in 1998, addi-tional consideration of $28,558 is payable to the seller incash of $16,319 and the remainder in shares of restrictedcommon stock which has been valued at $12,239. As of December 31, 1998, the Company has recorded thisadditional consideration as a liability and additionalgoodwill which will be amortized over the remainingamortization period of 24 years. Additional variableamounts of contingent consideration are also payable tothe seller if specified levels of earnings are achieved in1999 and 2000, payable in equal amounts of cash andstock. The Company will record the contingent consider-ation when the contingencies are resolved and the addi-tional consideration is payable.

Schülerhilfe Effective October 28, 1998, the Company acquired all the operating assets and liabilities of ZGS ZentraleGelsenkirchener SCHÜLERHILFE J. Gratze + M. MohrGbR mbH (“Schülerhilfe Partnership”) and all of the outstanding common stock of SCHÜLERHILFEGesellschaft für Nachhilfeunterricht mbH (“SchülerhilfeCorporation,” and collectively with SchülerhilfePartnership, “Schülerhilfe”), in exchange for an initial purchase price of $16,554 in cash and 124 shares of restricted common stock valued at $2,528. TheSchülerhilfe Partnership designs and delivers individu-alized tutorial services to school-age children and adults through a network of 700 franchised learning centersthroughout Germany and Austria. The SchülerhilfeCorporation designs and delivers individualized tutorialprograms to school-age children and adults through a network of 177 company-owned learning centersthroughout Germany.

The acquisition was accounted for using the pur-chase method of accounting and goodwill of $19,749 was recorded and is being amortized over a period of 25 years. The results of operations of Schülerhilfe for theperiod from October 28, 1998 through December 31,1998 are included in the accompanying 1998 consoli-dated statement of income.

In addition to the initial purchase price, the sellersmay receive up to an additional $13,300 in February2000 (payable in either cash or common stock at the dis-cretion of the Company) based on the amount of 1999franchise fees which have been collected by Schülerhilfeon or before January 31, 2000. The Company will recordthis contingent consideration when the contingencies areresolved and the additional consideration is payable.

The following combined unaudited pro forma resultsof operations of the Company give effect to the Canterand Schülerhilfe acquisitions as though they had occurredon January 1, 1997.

Year ended December 31,1997 1998

Revenues $336,208 $452,087Net income 30,581 37,352Earnings per share—diluted 0.67 0.73

Sylvan Learning Center FranchisesDuring March 1998, the Company consummated acqui-sitions of all of the outstanding common stock of threeSylvan Learning Center franchise businesses in exchangefor a total of 79 shares of Sylvan common stock. Theacquisitions were accounted for as poolings-of-interest,and accordingly, the Company’s consolidated financialstatements for periods prior to the mergers have beenrestated to include the results of operations, financialposition and cash flows of these businesses.

Aspect On May 6, 1998 the Company acquired all of the out-standing common stock of Aspect International LanguageSchools, B.V. and subsidiaries (“Aspect”) in exchange for2,004 shares of Sylvan common stock. The acquisitionwas accounted for as a pooling-of-interests, and accord-ingly, the Company’s consolidated financial statementsfor periods prior to the merger have been restated toinclude the results of operations, financial position andcash flows of Aspect.

Aspect is a leading provider of English languagetraining programs for college students from non-Englishspeaking companies. Founded in 1992, Aspect deliversintensive English language programs at 27 schools in five countries.

Combined and separate results of operations ofSylvan, Aspect and the Sylvan Learning Center Franchisesduring the years prior to the mergers are as follows:

Company Sylvan Prior to Learning

Restatement Aspect Centers Combined

Year ended December 31, 1997

Revenues $246,212 $52,460 $2,339 $301,011Net income (loss) 29,434 (1,810) 280 27,904Earnings per

share—diluted 0.69 0.62

Year ended December 31, 1996

Revenues $181,936 $35,938 $2,099 $219,973Net income 14,796 641 317 15,754Earnings per

share—diluted 0.40 0.40

The following table presents the combined and sepa-rate results of operations of the companies from January 1,1998 through the date of merger. The table excludes theSylvan Learning Centers which were acquired on March 1,1998 (unaudited):

Sylvan Aspect Combined

Three months ended March 31, 1998

Revenues $75,356 $10,967 $86,323Net income (loss) 5,647 (1,380) 4,267Earnings per

share—diluted 0.12 0.09

In connection with the acquisition of Aspect, theCompany recorded a $3,730 restructuring charge associ-ated with the merger and integration of the combinedoperations. These charges consist primarily of contract cancellation costs of $2,600, severance and other employeerelated costs of $390, and liabilities of $590 incurred todiscontinue certain foreign exchange programs of Aspect.The contract cancellation costs are payments made torepurchase master franchise rights under which Sylvan is in default of contractual non-competition provisions as a result of the acquisition of Aspect.

Details of the restructuring charge are as follows:

Paid Through Balance at Original December 31, December 31, Accrual 1998 1998

Contract cancellation costs $2,600 $1,100 $1,500Severance and other

employee costs 390 87 303Costs to exit foreign

exchange program 590 590 —Other 150 — 150

$3,730 $1,777 $1,953

It is expected that the remaining unpaid amountswill be paid in 1999.

NAI/Block Effective December 1, 1997, the Company purchased the assets and liabilities of Block Testing Services L.P. andBlock State Testing Services L.P. and also acquired all ofthe outstanding stock of National Assessment Institute,Inc., (collectively “NAI/Block”), commonly controlledcompanies engaged in the business of designing, market-ing, selling, distributing and administering paper andpencil tests and the licensing of individuals. The consid-eration for the acquisition was 964 shares of commonstock having an aggregate market value of $25,000. Theacquisition was accounted for using the purchase methodof accounting and goodwill of $27,113 was recorded andis being amortized over a period of 25 years.

I-R, Inc. and Independent Child Study Teams, Inc.On May 30, 1997, the Company acquired by merger all of the outstanding stock of I-R, Inc. and Independent

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Child Study Teams, Inc. (collectively, “EducationalInroads”) in exchange for 2,121 shares of common stock. I-R, Inc. and Independent Child Study Teams, Inc.were commonly owned by two shareholders that provideremedial and special educational services to public andnon-public school systems.

The acquisition was accounted for as a pooling-of-interests and accordingly, the Company’s consolidatedfinancial statements for periods prior to the merger havebeen restated to include the combined results of operations,financial position and cash flows of Educational Inroads.

Wall Street Institute International, B.V. and AffiliatesEffective December 1, 1996, the Company acquired sub-stantially all of the operating net assets of Wall StreetInstitute International, B.V. and its commonly controlledaffiliates (collectively, “WSI”). The Company recordedthe acquisition using the purchase method of accounting.WSI is a European-based franchisor and operator oflearning centers that teach the English language througha combination of computer-based and live instruction.WSI has a network of franchised centers in operationthroughout Europe and Latin America.

The total purchase price of WSI of $21,071 consistedof cash of $4,921; 758 shares of restricted common stockvalued at $9,250; 314 shares of unrestricted commonstock valued at $5,900 and $1,000 of direct acquisitioncosts. The sellers may not transfer the restricted stock for a period of three years from the date of issuance, unlessthe Company, in its sole discretion, removes the restric-tion. Of the 758 shares of restricted common stock issuedto the sellers, 186 shares are held in escrow to indemnifythe Company against any subsequent losses resulting fromany misrepresentation or breach of certain covenants. Theunrestricted common stock held in escrow will be releasedin varying amounts to the sellers through 2001. Goodwillof $21,163 is being amortized over its estimated useful lifeof 25 years.

The Company on the closing date of the acquisitionentered into option agreements to purchase two fran-chisees of WSI, and granted the owners of these samefranchisees put rights that require, in certain circum-stances and at the election by the right holders, theCompany to purchase the franchisees. At the Company’soption it may purchase the two franchisees at any timeduring the period from September 1, 2001 throughSeptember 1, 2005 for an amount equal to seven timesthe previous fiscal year’s earnings before interest andtaxes, adjusted for certain defined items. The franchiseesmay require the Company to purchase substantially all of their net assets during the same four-year period ifdefined levels of operating results are met or exceeded atthe end of the most recently completed fiscal year. The

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purchase price is payable 10% in cash and 90% in com-mon stock, or at the Company’s option, entirely in cash.

The PACE GroupEffective February 28, 1995, the Company purchased theassets and liabilities of The PACE Group (“PACE”), aprovider of educational services to corporations. Underthe purchase agreement, additional contingent considera-tion was payable in an amount equal to 6.5 times PACE’searnings before interest and income taxes (EBIT) in 1997as elected by the sellers, determined in accordance withgenerally accepted accounting principles. EBIT in 1997was $3,966, resulting in additional consideration of$25,777 of which $14,469 was paid in cash and theremainder in 345 shares of common stock (see Note 8).The Company has recorded this additional considerationas additional goodwill, and is amortizing that amountover the remaining amortization period of 22 years.

Drake Prometric, L.P.Effective September 30, 1995, the Company acquiredDrake Prometric, L.P. (“Drake”), a provider of computer-based certification, licensure and assessment testing programs. The Company acquired Drake for an initialpurchase price of $70,600, consisting of $20,000 in cashand 8,571 shares of restricted common stock. The pur-chase agreement further provided for the payment ofcontingent consideration to the extent that certain rev-enue targets relating to portions of the combined com-puter-based testing business were achieved from 1996through 1998. In addition, the sellers could receive up to an additional $40,000 of consideration to the extentother revenue targets were achieved in 1998 or 1999,with the measuring year selected by the sellers. As ofDecember 31, 1998, all contingencies surrounding thepayment of additional consideration to the sellers wereresolved and total contingent consideration of $71,748was recorded in 1996, 1997 and 1998, consisting ofrestricted common stock valued at $47,348 and amountsto be paid in cash of $24,400 (see Note 8).

4. Available-For-Sale Securities The following is a summary of available-for-sale securities(cost approximates fair value):

December 31, 1997 1998

Municipal securities funds $ 8,200 $ —Cash reserve fund 38,246 3,366Municipal bonds 36,505 2,800

$82,951 $6,166

The Company has not had any significant realized or unrealized gains or losses on its investments during the periods presented. As of December 31, 1998, the

Company has approximately $3,400 of investments thatmature within one year, $1,800 of investments that maturebetween one and five years, and $1,000 of investments thatmature beyond five years. These investments are classifiedas current as the Company views its available-for-sale securities as available for use in its current operations.

5. InvestmentsInvestments in AffiliatesAt December 31, 1998 and 1997, the Company’s invest-ments in and advances to affiliates consists primarily of its 10% voting interest in Caliber Learning Network,Inc. (“Caliber”), including related loans. Caliber is a publicly-traded company formed for the purpose of provid-ing adults throughout the United States with university-quality continuing education using multimedia technology.

The Company’s investment in and advances toCaliber consisted of the following at December 31:

1997 1998Invested capital $ 3,936 $14,300Loans and related interest 3,362 —Amounts due for

management fee 2,880 51710,178 14,817

Allocable share of losses from inception (1,501) (4,403)

$ 8,677 $10,414

From its inception in 1996 through December 31,1997, Caliber relied almost entirely on the Company’sresources, systems and personnel for administrative, man-agement, accounting and financial functions. In consider-ation for these services, the Company charged Caliber amanagement fee of $2,880 which was paid in May 1998upon the consummation of Caliber’s initial public offering. Although Caliber has developed its own infra-structure, the Company continues to provide to Calibercertain accounting and administrative services. Caliber has agreed to pay an annual management fee of $2,000 in 1998 and 1999 for these services.

During 1997, the Company assigned the leases for 32 testing centers to Caliber for the use by Caliber in its operations. Upon assignment of the centers, Caliberassumed the revenue stream from the ongoing testingoperations and paid the Company a fee of $4,000 tomanage the continuing testing operations in 1997.During 1997 and 1998, the Company paid Caliber$1,200 and $2,042, respectively, for the administration of computer-based tests at these testing centers.

The Company also maintains investments in andadvances to other affiliates totaling $3,787 and $8,118 at December 31, 1997 and 1998, respectively. TheCompany’s allocable share of losses related to these invest-ments for the years ended December 31, 1997 and 1998was $(647) and $(602), respectively.

Other InvestmentsOther investments consist of non-marketable investmentsin common and preferred stocks of private companies inwhich the Company does not exercise significant influ-ence. These investments are carried at the lower of cost or estimated net realizable value.

At December 31, 1997 and 1998, other investmentsconsist primarily of an investment in non-voting convertiblepreferred stock and junior subordinated debentures ofJLC Learning Corporation (“JLC”), a company thatdevelops educational software products. At December 31,1997 and 1998, the Company’s investment in JLC was$24,038 and $25,700, respectively. During 1996, 1997and 1998, the Company recorded dividend income fromthis investment in the amount of $333, $2,000 and$1,167, respectively.

In November 1998, the Company purchased 53 sharesof 6% redeemable convertible preferred stock of TheChauncey Group International, Ltd. (“Chauncey”), asubsidiary of Educational Testing Services (“ETS”), forconsideration of $8,000. Chauncey designs, develops andadministers occupational, certification and professionalassessment programs.

The Company also maintains other investments not readily marketable totaling $3,979 and $10,530 at December 31, 1997 and 1998, respectively.

6. Net Assets to be Transferred to Joint Venture

On January 1, 1999, the Company entered into an agreement with Chauncey to form Experior AssessmentsLLC (“Experior”), a joint venture to be engaged in thebusiness of developing and administering state andmunicipal sponsored licensing and certification programsand other related services. In exchange for a 50% interestin Experior, Sylvan will contribute the net assets ofNAI/Block (see Note 3), excluding certain working capital balances. These net assets will be transferred athistorical cost with no gain or loss recorded on the transfer. As of December 31, 1998, the Company hasclassified the net assets to be contributed to Experior of $31,575 as net assets to be transferred to joint venturein the accompanying consolidated balance sheet.

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7. Long-term DebtLong-term debt consists of the following:

December 31,1997 1998

Long-term revolving credit facility with banks $ — $ 8,000

Various notes payable bearing interest at rates ranging from 8% to 10.75%. 3,681 5,632

3,681 13,632Less: current portion of

long-term debt 1,253 1,128Total long-term debt $2,428 $12,504

The revolving credit facility with a group of six banksallows the Company to borrow up to an aggregate of$100,000. Additionally, the Company has been pre-approvedto increase the aggregate borrowings by $50,000 in incre-ments of $10,000. Outstanding borrowings under thisfacility are unconditionally guaranteed by a pledge of the capital stock of the Company’s subsidiaries, and aredue on December 31, 2003. Outstanding borrowings bearinterest at either the prime rate, the federal funds rate plus0.5%, or rates based on the Eurodollar rate plus a contrac-tual margin. As of December 31, 1998, $8,000 of primerate borrowings bearing interest at 7.75% were outstanding.Effective January 7, 1999, the borrowings began to bearinterest at 6.06%, based on the Eurodollar rate.

8. Due to Shareholders of Acquired CompaniesDue to shareholders of acquired companies consists ofthe following (see also Note 3):

December 31,1997 1998

Amounts payable to former owners of NAI/Block, paid in 964 shares of common stock in January 1998 $ 25,000 $ —

Amounts payable to former shareholder of Canter in cash — 16,319

Amounts payable to former shareholder of Canter in 535 shares of common stock — 12,239

Amounts payable to former shareholders of WSI in cash 262 —

Amounts payable to former shareholders of PACE in cash 13,532 —

Amounts payable to former shareholders of PACE, paid in 345 shares of common stock in April 1998 11,309 —

Amounts payable to former shareholders of Drake, paid in 1,071 shares of common stock in April 1998 20,057 —

Amounts payable to former shareholders of Drake in cash — 24,400

70,160 52,958Less: current portion (13,794) (40,719)

$ 56,366 $ 12,239

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9. LeasesThe Company conducts all of its operations from leasedfacilities. These facilities include the Company’s corporateheadquarters and other office locations, warehouse space,certain testing sites, and Company-owned learning cen-ters. The terms of substantially all of these leases are fiveyears or less, with the exception of the Company’s corpo-rate headquarters, which has a lease term of ten years,and generally contain renewal options. The Companyalso leases certain equipment under operating leases of 36 months or less. Future minimum lease payments atDecember 31, 1998 by year and in the aggregate, underall non-cancelable operating leases are as follows:

Years ending December 31:1999 $16,2982000 14,6202001 11,3572002 9,7622003 8,452Thereafter 23,333

$83,822

Rent expense under all cancelable and non-cancelable leases was approximately $7,500, $9,500 and $13,600 for the year ended December 31, 1996, 1997 and 1998, respectively.

10. ContingenciesOn November 18, 1996, ACT, Inc. filed suit against theCompany alleging that the Company violated federalantitrust laws and committed various state law torts inconnection with the operations of its computer-basedtesting operations and in obtaining a testing services contract from the NASD. The Company believes thegrounds of the lawsuit are without merit and intends todefend the lawsuit vigorously. Management is unable topredict the ultimate outcome of the lawsuit, but believesthat the ultimate resolution of the matter will not have a material effect on consolidated financial position.

The Company is subject to other legal actions arisingin the ordinary course of its business. In management’sopinion, the Company has adequate legal defenses and/orinsurance coverage with respect to the eventuality of suchactions and does not believe any settlement would mate-rially affect the Company’s financial position.

11. Fair Value of Financial InstrumentsThe fair value of the Company’s financial instruments,which consist primarily of cash and cash equivalents,accounts and notes receivable, available-for-sale invest-ments, accounts payable, due to shareholders of acquiredcompanies (cash portion), and short and long-term debt,approximate their carrying amounts reported in the consolidated balance sheets.

It was not practical to estimate the fair value of theCompany’s other investments because of the lack ofquoted market prices of the underlying equity securitiesand the inability to determine fair value without incur-ring excessive costs. Management does not believe thatthe value of these investments has been impaired.

12. Stock OptionsThe Company has five stock options plans that providefor the granting of stock options to employees, officersand directors. The 1998 Stock Incentive Plan (“1998Plan”) is the only plan with significant stock optionawards available for grant. Prior plans have outstandingstock options at December 31, 1998. The 1998 Planallows for the grant of up to 3,750 shares of commonstock in the form of incentive and non-qualified stockoptions, stock appreciation rights, stock awards, phantomstock awards, convertible securities and performanceawards that expire six years after the date of grant.During 1998, non-qualified options to purchase 1,095 shares of common stock were granted under the 1998 Plan. Options outstanding under all of theCompany’s stock option plans have been granted atprices which are equal to the market value of the stock on the date of grant and vest ratably over periods notexceeding six years.

During 1997, the Company established the SylvanTechnology Center Stock Option Plan (“the STC Plan”)for the franchisee owners of Sylvan Technology Centers.The STC Plan provides for the granting of stock optionsto purchase up to 450 shares of common stock. During1997, 317 options were granted that vest ratably over athree-year period and expire 10 years after the date of grantor on the date of cessation of operations of the center. Thefair value of these options, determined using the Black-Scholes option valuation model, was $1,386, of which$550 and $539 of expense was recognized in 1997 and1998, respectively, with the remainder to be recognized in expense over the next two years as the options vest.

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The following table summarizes the stock option activity of the Company.

1996 1997 1998Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise

Options Price Options Price Options PriceOutstanding at beginning of year 4,853 $ 5.13 6,921 $ 8.71 6,935 $13.75Granted 2,772 14.61 1,714 23.73 2,989 26.77Exercised (577) 7.25 (1,621) 2.92 (659) 9.92Forfeited (127) 7.47 (79) 11.83 (198) 17.03Outstanding at end of year 6,921 $ 8.71 6,935 $13.75 9,067 $17.86

Exercisable at end of year 2,688 $ 4.45 2,691 $ 8.51 3,584 $10.80

Weighted-average fair value of options granted during the year $ 5.55 $ 7.15 $11.26

Exercise prices for options outstanding as of December 31, 1998 ranged from $3.48 to $31.25 as follows:

Weighted Average Weighted Average Weighted AverageExercise Prices of Remaining Exercise Prices of

Range of Outstanding Outstanding Contractual Life of Exercisable ExercisableExercise Prices Options Options Outstanding Options Options Options

$ 3.48-$ 6.08 1,245 $ 4.48 0.9 years 1,223 $ 4.45

$ 6.78-$11.62 850 9.17 2.7 years 605 9.02

$13.55-$19.77 2,948 15.30 5.9 years 1,563 14.58

$21.50-$31.25 4,024 25.71 6.1 years 193 26.02

For the years ended December 31, 1996, 1997 and1998, pro forma net income and earnings per shareinformation required by Statement 123 has been deter-mined as if the Company had accounted for its stockoptions using the fair value method. The fair value of these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for 1996, 1997and 1998: risk-free interest rate of 6.00%, dividend yield of 0%, volatility factors of the expected market price of the Company’s common stock of .399, .280 and .360,respectively, and an expected life of granted optionswhich varies from four to six years depending upon thevesting period.

The Black-Scholes option pricing model was devel-oped for use in estimating the fair value of traded optionswhich have no vesting restrictions and are fully transfer-able. In addition, option valuation models require theinput of highly subjective assumptions including theexpected stock price volatility. Because the Company’sstock options have characteristics significantly differentfrom those of traded options and because changes in thesubjective input assumptions can materially affect the fairvalue estimate, in management’s opinion, the existingmodels do not necessarily provide a reliable single mea-sure of the fair value of its stock options.

For purposes of pro forma disclosures, the estimatedfair value of the options is amortized to expense over theoptions’ vesting periods. The Company’s pro forma infor-mation follows:

1996 1997 1998Pro forma net income $12,896 $24,477 $25,446Pro forma earnings per share:

Basic 0.35 0.58 0.52Diluted 0.33 0.55 0.50

13. Impairment LossIn May 1997, the Company determined that certain assetsof Sylvan Prometric were impaired as a result of certainstrategic changes that were made as a result of pursuingthe National Education Corporation (“NEC”) acquisition(see Note 14). During and after the acquisition negotia-tions with NEC, the Company developed certain plansthat resulted in required changes in both software systemsand hardware currently utilized in Sylvan Prometric’s net-work of centers. The plans continued to be valid for theCompany even after the NEC acquisition was terminated.The impaired assets, consisting of computer equipmentand software, were impaired as a result of changes in thetechnical requirements and specifications of certain com-puter hardware and software. The amount of the impair-ment loss was determined by evaluating the likely sales

proceeds from the disposition of the assets compared totheir book value. The Company determined that it wasunlikely that the net cash proceeds from the sale of anyassets would be significant, and therefore recorded animpairment loss equal to the net book value of the assetsof $4,000. During 1998, these assets were disposed of forno significant consideration.

14. Termination FeeIn March 1997, the Company and NEC executed adefinitive agreement pursuant to which the Companywas to acquire NEC. In May 1997, NEC accepted theoffer of Harcourt General, Inc. to acquire all of the stockof NEC which resulted in the termination of NEC’sagreement with the Company and NEC’s payment to theCompany of the $30,000 termination fee required bythat agreement. The Company also incurred $1,500 ofexpenses in connection with the NEC transaction, andreported the net termination fee of $28,500 in 1997.

15. ContributionsDuring 1997, the Company made certain cash expendi-tures and common stock contributions resulting in anaggregate expense to the Company of approximately$21,500. The $21,500, recorded as operating expenses,was attributable to contributions of (i) $3,000 in cash andcommon stock valued at $7,000 to IT Training MarketingCompany, a nonprofit corporation whose sole purpose isto fund promotional and channel support programs for theSylvan Prometric distribution channel, (ii) common stockvalued at $5,000 to SLC National Advertising Fund, Inc.,a nonprofit corporation whose sole purpose is to developand fund advertising programs for the Sylvan LearningCenters and (iii) common stock valued at $6,500 to SylvanLearning Foundation, a nonprofit foundation formed topromote various educational pursuits.

16. Income TaxesSignificant components of the provision for income taxesare as follows:

Year ended December 31, 1996 1997 1998

Current:Federal $5,078 $ 8,956 $12,367Foreign 550 1,292 1,521State 1,403 1,618 2,865

Total current 7,031 11,866 16,753Deferred:

Federal 1,773 3,396 1,083Foreign — 306 3,097State 335 852 649

Total deferred 2,108 4,554 4,829Total provision $9,139 $16,420 $21,582

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For the year ended December 31, 1996, 1997 and1998, foreign income before income taxes was $3,800,$12,900 and $16,470, respectively.

The Company uses the liability method to accountfor income taxes. Deferred income taxes reflect the nettax effects of temporary differences between the carryingamount of assets and liabilities for financial reportingpurposes and the amounts used for income tax purposes.

Significant components of the Company’s deferredtax assets and liabilities are as follows:

Year ended December 31, 1997 1998

Deferred tax assets:Net operating loss carryforwards $ 765 $ 252Loss on impairment of assets 779 483Deferred revenue 630 1,018Allowance for doubtful accounts 548 853Advertising costs 5,305 2,360Amortization of intangible assets 643 204Equity share of losses from affiliates 827 2,115Charitable contribution carryforward 2,425 1,535Tax credit carryforwards 926 1,154Other 538 1,329

Total deferred tax assets 13,386 11,303Deferred tax liabilities:

Deferred contract costs 2,066 917Contract rights 170 79Depreciation 1,755 1,521Deferred income 11,388 11,670Accrued receivables 559 1,136Other 565 720

Total deferred tax liabilities 16,503 16,043Net future income tax liabilities (3,117) (4,740)Valuation allowance for deferred

tax assets (765) (252)Net deferred tax liabilities $ (3,882) $ (4,992)

The net operating loss carryforwards at December 31,1998 are related to a subsidiary of the Company, and areavailable only to offset future taxable income of the sub-sidiary. These net operating loss carryforwards will begin to expire in 2007.

The reconciliation of the reported income taxexpense to the amount that would result by applying theU.S. federal statutory tax rates (34% in 1996 and 1997,35% in 1998) to income before income taxes is as follows:

Year ended December 31, 1996 1997 1998

Tax expense at U.S. statutory rate $8,464 $15,070 $20,052

Permanent differences 813 2,662 1,237State income tax expense,

net of federal tax benefit 1,130 1,555 2,284Tax effect of foreign income

taxed at lower rate (734) (3,244) (1,852)Utilized tax credits (254) — —Other (280) 377 (139)

$9,139 $16,420 $21,582

17. Earnings Per ShareThe following table summarizes the computations ofbasic and diluted earnings per share:

Year ended December 31, 1996 1997 1998

Numerator used in basic and diluted earnings per common share:Net income $15,754 $27,904 $35,709

Denominator:Denominator for basic

earnings per common share—weighted average shares 36,626 42,412 48,962

Effect of dilutive securities:Employee stock options 2,069 1,850 2,151Common stock

contingently issuable 268 628 173Total dilutive potential

common shares 2,337 2,478 2,324Denominator for diluted

earnings per common share—weighted average shares and assumed conversions 38,963 44,890 51,286

Earnings per common share, basic $0.43 $0.66 $0.73

Earnings per common share, diluted $0.40 $0.62 $0.70

18. Shares Reserved For Future IssuanceThe Company as of December 31, 1998 has reserved9,602 shares of common stock for future issuance uponthe exercise of all outstanding stock options and theissuance of shares of common stock in connection withpurchase business combinations.

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19. Major Customers and Concentration of Credit Risk

The Company has an agreement with ETS to be theexclusive commercial provider of ETS domestic computer-based tests through the year 2005. The contract to provideinternational computer-based tests runs through the year2003. The international testing contract with ETS stipu-lates that the Company will be compensated for its servicesfor a fee equal to approved costs plus 10 percent, and theCompany recognizes revenues accordingly. Operatingcosts under the contract are paid at cost plus 10 percenton a monthly basis by ETS. Total revenues from ETS represented approximately 8.9%, 11.3% and 12.4% ofconsolidated revenues for the years ended December 31,1996, 1997 and 1998, respectively.

The Company’s information technology testing business is highly concentrated with two customers.These customers contributed approximately 25.7%,13.1% and 12.0% to consolidated revenues for the yearended December 31, 1996, 1997 and 1998, respectively.The Company expects the contracts with these two customers to be renewed at the expiration date of thecurrent contracts. The failure of these contracts to berenewed under similar terms would have a detrimentaleffect on future operating results and significantly impairthe Company’s ability to recover the remaining goodwillrelated to this business of approximately $130,886.

Financial instruments which potentially subject the Company to credit risk are investments in available-for-sale securities, accounts receivable and notes receivable.The Company maintains an allowance for losses on receiv-ables based on the collectibility of all amounts owed. TheCompany generally does not require collateral for tradereceivables. Notes receivable are generally collateralized byassets of the debtors. At December 31, 1998, the Companydoes not have any significant concentrations of credit risk.

20. Defined Contribution Retirement PlanThe Company sponsors a defined contribution retirementplan under section 401(k) of the Internal Revenue Code.The provisions of this plan allow for voluntary employeecontributions, subject to certain annual limitations, anddiscretionary Company contributions which are allocatedto eligible participants based upon compensation. Allemployees are eligible after meeting certain service require-ments. The Company made discretionary contributions to this plan of $248 in 1997 and $315 in 1998.

21. Business and Geographic Segment Information

Description of Services From Which Each ReportableSegment Derives its RevenuesThe Company provides lifelong educational servicesthrough three distinct operating segments. The SylvanLearning Centers division provides personalized instruc-tional services to students of all ages and skill levels,through its network of franchised and Company-ownedlearning centers located in 49 states, five Canadianprovinces, Hong Kong and Guam. The Sylvan ContractEducational Services division provides educational servicesand professional development to children and adultsthrough contracts with school systems and other organi-zations. These services to children are delivered at over 700 schools and in the case of its professional development services for adults, at the contracting parties’ facilities. TheSylvan Prometric division delivers computer-based testingfor academic admissions and professional certification programs through a network of computer testing centerslocated throughout the world, and includes the operationsof Wall Street Institute and Aspect. Wall Street Institute is aEuropean-based franchisor and operator of learning centersfor English language instruction that will administer certaincomputer-based testing programs throughout Europe andLatin America. Aspect is an international provider of inten-sive English language instruction to professionals worldwidethrough its 27 language schools in five countries.

Measurement of Segment Profit or Loss and Segment AssetsThe Company evaluates performance and allocatesresources based on operating income before corporategeneral and administrative expenses and income taxes.The accounting policies used by the reportable segmentsare the same as those used by the Company as describedin Note 2 to the consolidated financial statements. Thereare no significant intercompany sales or transfers.

Factors Management Uses to Identify the Company’sReportable SegmentsThe Company’s reportable segments are business unitsthat offer distinct services. The segments are managedseparately as they have different customer bases and delivery channels.

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The following table sets forth information on theCompany’s reportable segments:

Year Ended December 31, 1996Sylvan Sylvan Contract

Learning Educational Sylvan Centers Services Prometric

Revenues $38,898 $58,186 $122,889Depreciation and

amortization 998 1,940 9,729Segment profit 11,456 4,727 15,971Segment assets 14,432 27,496 171,683Expenditures for

long-lived assets 914 2,690 7,197

Year Ended December 31, 1997Sylvan Sylvan Contract

Learning Educational Sylvan Centers Services Prometric

Revenues $46,629 $66,582 $187,800Depreciation and amortization 756 1,614 14,002

Loss on impairment of assets — — 4,000Unusual item—contribution to marketing fund — — 10,000

Significant non-cash charges (advertising) 5,000 — —

Segment profit 7,443 10,230 15,815Segment assets 22,309 57,064 275,522Expenditures for long-lived assets 1,688 4,661 19,861

Year Ended December 31, 1998Sylvan Sylvan Contract

Learning Educational Sylvan Centers Services Prometric

Revenues $64,754 $100,519 $275,057Depreciation and amortization 1,565 5,762 23,016

Unusual item—transaction costs — — 5,000

Restructuring charges — — 3,730Segment profit 19,339 14,649 37,999Segment assets 56,841 127,276 391,434Expenditures for

long-lived assets 2,274 8,607 42,732

The following tables reconcile the reported informa-tion on segment profit and assets to income before incometaxes and total assets reported in the statements of incomeand balance sheets for the years ended December 31,1996, 1997 and 1998:

1996 1997 1998Total profit for

reportable segments $32,154 $ 33,488 $ 71,987Corporate general and

administrative expense (8,049) (19,693) (15,530)Other income (expense),

net of direct costs 788 30,529 834Income before

income taxes $24,893 $ 44,324 $ 57,291

1996 1997 1998Segment assets $213,611 $354,895 $575,551Cash and available for sale

securities—Corporate 27,381 86,631 5,967Deferred income taxes 620 3,755 1,832Property, plant and

equipment—Corporate 5,249 6,810 9,746Investments in and

advances to affiliates 5,896 12,464 13,919Other investments 22,220 28,017 40,372Other non-segment assets 3,102 4,207 12,409Total assets $278,079 $496,779 $659,796

Included in corporate general and administrativeexpense for the year ended December 31, 1997 was a contri-bution of the Company’s common stock valued at $6,500as discussed in Note 15 to these financial statements.

Depreciation and amortization expense in the amountsof $1,289, $2,489 and $1,980 were charged to corporatedepartments during the year ended December 31, 1996,1997 and 1998, respectively. Expenditures for corporatelong-lived assets were $4,065, $4,754 and $4,681 during theyear ended December 31, 1996, 1997 and 1998, respectively.

Enterprise-Wide Disclosures—Information on Geographic Areas

Year Ended December 31, 1996Revenues Long-lived Assets

United States $165,539 $25,679Foreign countries—total 54,434 7,502Consolidated total $219,973 $33,181

Year Ended December 31, 1997Revenues Long-lived Assets

United States $212,336 $40,182Foreign countries—total 88,675 11,185Consolidated total $301,011 $51,367

Year Ended December 31, 1998Revenues Long-lived Assets

United States $313,043 $73,128Foreign countries—total 127,287 24,753Consolidated total $440,330 $97,881

Revenues are attributed to countries based on thelocation of the customer. Revenues from individual for-eign countries did not exceed 10% of consolidated rev-enues in any of the years presented. Long-lived assetsdomiciled in individual foreign countries did not exceed10% of consolidated long-lived assets in any of the yearspresented. Note 19 to the financial statements containsinformation about major customers of the Company.

43

22. Supplemental Cash Flow InformationInterest payments were approximately $1,300, $800 and$900 for the year ended December 31, 1996, 1997 and1998, respectively. Income tax payments were $4,200,$2,700 and $8,600 for the year ended December 31,1996, 1997, and 1998, respectively.

In connection with the 1998 acquisitions of Canterand Schülerhilfe for combined consideration of $44,082,the Company acquired assets with a fair value of $50,465and assumed liabilities of $6,383.

In connection with the 1997 acquisition of NAI/Blockfor total consideration of $25,000, the Company acquiredassets with a fair value of $29,616 and assumed liabilities of $4,616.

In connection with the 1996 acquisition of WSI fortotal consideration of $21,071, the Company acquiredassets with a fair value of $24,101 and assumed liabilitiesof $3,030.

23. Quarterly Financial Data (Unaudited)Quarter ended

March 31, June 30, Sept. 30, Dec. 31,1997 1997 1997 1997

Operating revenues $61,406 $ 69,510 $71,960 $98,135Operating expenses 57,061 83,810 61,302 81,043Loss on impairment

of assets — 4,000 — —Operating income (loss) 4,345 (18,300) 10,658 17,092Non-operating items, net 333 28,933 805 458Income before

income taxes 4,678 10,633 11,463 17,550Income taxes (1,953) (3,916) (3,993) (6,558)Net income $ 2,725 $ 6,717 $ 7,470 $10,992Net income per

common share:Basic $ 0.07 $ 0.17 $ 0.17 $ 0.24Diluted $ 0.06 $ 0.16 $ 0.16 $ 0.22

Shares used in computation:Basic 40,152 40,332 43,702 45,517Diluted 42,960 42,747 45,966 49,101

During the second quarter of 1997, the Companyrecognized an impairment loss of $4,000, income from atermination fee of $28,500 and recorded expense relatedto contributions which totaled $21,500. These transac-tions are described in Notes 13, 14 and 15, respectively.

The net effect of the above non-recurring items wasan increase in pre-tax income of $3,000 and net incomeof $1,900, or $.04 per diluted share.

Diluted earnings per common share for the yearended December 31, 1997 is $0.62. The total dilutedearnings per common share derived from the addition ofthe quarterly amounts in 1997 is $0.60. This difference

is caused by differences in the estimated effect of contin-gently issuable shares related to the acquisition of PACE inthe quarterly periods as compared to the annual period.

Quarter endedMarch 31, June 30, Sept. 30, Dec. 31,

1998 1998 1998 1998Operating revenues $86,323 $99,328 $109,701 $144,978Operating expenses 80,108 89,384 89,386 116,265Transaction costs — 5,000 — —Restructuring costs — 3,730 — —Operating income 6,215 1,214 20,315 28,713Non-operating items, net 367 147 (690) 1,010Income before

income taxes 6,582 1,361 19,625 29,723Income taxes (2,315) (2,839) (6,323) (10,105)Net income (loss) $ 4,267 $ (1,478) $ 13,302 $ 19,618Net income (loss) per

common share:Basic $ 0.09 $ (0.03) $ 0.27 $ 0.39Diluted $ 0.09 $ (0.03) $ 0.26 $ 0.37

Shares used in computation:Basic 47,760 48,185 48,535 50,592Diluted 49,926 48,185 50,596 53,334

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During the year ended December 31, 1998, theCompany recognized certain non-recurring expensesrelated to the merger with Aspect. These expensesinclude $5,000 of transaction-related costs, such as legal, accounting and advisory fees, and $3,730 of costs,classified in the financial statements as restructuring coststhat relate to the integration of Aspect with Sylvan.

The net effect of the above non-recurring items wasa decrease in pre-tax income of $8,730 and net income of $7,857, or $0.15 per diluted share.

Diluted earnings per common share for the year endedDecember 31, 1998 is $0.70. The total diluted earnings percommon share derived from the addition of the quarterlyamounts in 1998 is $0.69. This difference is caused by theeffect of in-the-money options and warrants and contingentlyissuable shares which were excluded from the second quartercomputation because the effect was anti-dilutive, but includedin the annual computation because the effect was dilutive.

The Board of Directors and StockholdersSylvan Learning Systems, Inc.

We have audited the consolidated balance sheets ofSylvan Learning Systems, Inc. as of December 31, 1998and 1997, and the related consolidated statements ofincome, stockholders’ equity, and cash flows for each ofthe three years in the period ended December 31, 1998.These financial statements are the responsibility of themanagement of Sylvan Learning Systems, Inc. Ourresponsibility is to express an opinion on these financialstatements based on our audits. We did not audit the1996 combined financial statements of I-R, Inc. andIndependent Child Study Teams, Inc., or the 1997 and1996 financial statements of Aspect, Inc. and AngloWorld Education Limited and subsidiaries, each wholly-owned subsidiaries. Those statements reflect total assets of $17,198,487 as of December 31, 1997, and total rev-enues of $35,613,484, and $48,152,198 for the yearsended December 31, 1997 and 1996, respectively. Thosestatements were audited by other auditors whose reportshave been furnished to us, and our opinion, insofar as itrelates to data included for these subsidiaries, is basedsolely on the reports of the other auditors.

Report of Independent Auditors

We conducted our audits in accordance with gener-ally accepted auditing standards. Those standards requirethat we plan and perform the audit to obtain reasonableassurance about whether the financial statements are freeof material misstatement. An audit includes examining,on a test basis, evidence supporting the amounts and dis-closures in financial statements. An audit also includesassessing the accounting principles used and significantestimates made by management, as well as evaluating theoverall financial statement presentation. We believe thatour audits and the reports of other auditors provide a rea-sonable basis for our opinion.

In our opinion, based on our audits and the reportsof other auditors, the financial statements referred toabove present fairly, in all material respects, the consoli-dated financial position of Sylvan Learning Systems, Inc.at December 31, 1998 and 1997, and the consolidatedresults of its operations and its cash flows for each of thethree years in the period ended December 31, 1998, inconformity with generally accepted accounting principles.

Baltimore, MarylandFebruary 25, 1999