Educate to sell part of its business

No Child Left Behind would be affected


Educate Inc., the Baltimore company best known for its Sylvan tutoring centers, said yesterday that it plans to sell the main piece of its No Child Left Behind business, which caters to troubled schools trying to improve student performance.

It's a surprising move for a company so closely associated with the federal program. Market watchers thought the nearly four-year-old act would be a windfall for Educate. But analysts said the time seems ripe to get out.

"My sense is, they've been finding that the competition in the big, urban districts where a lot of the NCLB dollars are focused remains intense," said Trace Urdan, a senior analyst at investment banker Robert W. Baird & Co. "Although they had a decent chance of being one of the last men standing in that fight, I think it's going to take a period of years ... and they thought, `This is the moment at which someone else will probably pay us a big price for this business.'"

The announcement came on a day when the company reported disappointing earnings, mostly because of higher expenses.

Educate, which says it is the largest No Child Left Behind tutoring contractor, provides services in 80 school districts nationwide. In the last school year, it tutored 30,000 students through Education Station, the unit it intends to sell within the next year.

"We were at a crossroads," said R. Christopher Hoehn-Saric, chairman and chief executive officer of Educate. "We made a decision that said, `This is a good business ... for somebody else.'"

Education Station - with a full-time management staff of about 500 - will probably be bought by an investment group and spun off, Hoehn-Saric said.

The organization's headquarters probably will remain in Baltimore, he said.

That's precisely how Educate came to be: Until 2003, its businesses were part of a larger city-based company that also owned for-profit universities.

Also yesterday, Educate said that its operating income dropped 18 percent in the three months that ended Sept. 30, to $6.2 million from $7.6 million in the third quarter of 2004. The company saw decreased revenue from No Child Left Behind services - in part because Hurricanes Katrina and Rita forced school closures - but the larger dent was a $16.1 million increase in expenses for the Sylvan tutoring centers.

The company, which has been buying back franchised tutoring-center territories to reap increased income down the road, blamed the 46 percent jump in expenses on the larger-than-normal purchase of 19 territories in July, August and September.

Revenue rose 27 percent to $78.9 million in the traditionally weak third quarter, up from $62.4 million in the third quarter last year. No Child Left Behind services produced just $485,000 of that, down 4 percent from the corresponding period last year.

The bulk of the No Child Left Behind earnings comes earlier in the year; revenue totaled $28 million for the first nine months of the year, up 28 percent.

Educate's net income tripled in the third quarter, to $2.7 million from $903,000 in the third quarter last year. Earnings per share were 6 cents in the quarter, compared to 2 cents in the third quarter last year. Analysts expected to see 11 cents.

The company's stock price dropped $1.81 to close at $12.39 per share yesterday. That's about the same level as when Educate went public a year ago, a significant decrease from its end-of-day high of about $16.70 a share last month.

Hoehn-Saric said Educate decided to sell Education Station because the unit would need more service offerings and sales staff to capitalize on growth potential but would still not see margins as high as in the tutoring center business.

Educate will keep its other, much smaller units that offer No Child Left Behind tutoring, Catapult Online and Ace It!, because both can be offered through the Sylvan franchisee system.

Urdan, the analyst, said those services should allow the company to focus cost-effectively on smaller, rural school districts.

There's lots of competition for the more than $500 million in No Child Left Behind tutoring dollars that will likely be spent this school year, according to the Education Industry Association, a Potomac-based trade group. States have approved about 2,000 providers, nearly half of them for-profit companies.

Jack Jennings, president of the nonprofit Center on Education Policy in Washington, said companies that try to make money in public education often find the profits aren't what they expected. At the same time, companies are likely to face increased demands for accountability.

"I think that Sylvan sees the handwriting on the wall: not enough money to be made, and too much pressure to raise scores," he said.

The Gulf Coast hurricanes have caused problems for Educate's No Child Left Behind services and its Sylvan tutoring centers, Hoehn-Saric said. Schools they serve in Louisiana and Alabama are only beginning to reopen, and four Sylvan centers in the New Orleans area remain closed.

He estimated the third-quarter cost of the hurricanes as about $700,000 and said the impact will probably be $1.5 million in the final three months of the year.

Hoehn-Saric says the spike in fuel costs after the storms had an additional effect, dampening parents' desire to pay for Sylvan tutoring.

"We saw an immediate drop off in inquiry levels," he said. "While it's still early, we did see a shift back the other direction in October."

Urdan was surprised that Sylvan, with its higher-income clientele, would feel an oil shock.

"There may be something changing in the marketplace - say, saturation or incremental demand," he said. "You always wonder, how much of this is really related to the hurricanes and the gas prices, and how much of this might we have seen even if everything were great."

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