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The following is an excerpt from a S-1/A SEC Filing, filed by LINCOLN EDUCATIONAL SERVICES CORP on 5/6/2005.
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LINCOLN EDUCATIONAL SERVICES CORP - S-1/A - 20050506 - CERTAIN_TRANSACTIONS

Related Party Transactions

        In 2003, we entered into a multi-year management service agreement with our majority stockholder, Stonington. In accordance with this agreement we pay Stonington Partners a management fee of $0.75 million in the first month of each year for management consulting and financial and business advisory services. Such services include valuing acquisitions and structuring their financing and assisting with new loan agreements. This agreement will terminate upon completion of this offering.

        We had a consulting agreement with Hart Capital to advise us in identifying acquisition and merger targets and to assist with the due diligence reviews and negotiations with these targets. This agreement terminated by its terms in June 2004. Hart Capital is the managing member of Five Mile River Capital Partners, which is our second largest stockholder and Steven Hart, who is the owner and President of Hart Capital, sits on our board of directors. We paid Hart Capital a monthly retainer, reimbursement of expenses and an advisory fee for its work on successful acquisitions or mergers. In accordance with the agreement, we paid Hart Capital approximately $0.7 million, $0.6 million and $0.4 million for the years ended December 31, 2002, 2003 and 2004, respectively. Pursuant to the agreement, we may have future obligations to make certain payments to Hart Capital with respect to acquisition opportunities identified for us by Hart Capital prior to the termination of the agreement if we consummate any such acquisition opportunities within the twelve months following the termination of the agreement. We paid Hart Capital $0.3 million for its services in connection with the NETI acquisition, which closed on January 11, 2005.

Seasonality and Trends

        Our net revenues and operating results normally fluctuate as a result of seasonal variations in our business, principally due to changes in total student population. Student population varies as a result of new student enrollments, graduations and student attrition. Historically, our schools have had lower student populations in our first and second quarters and we have experienced large class starts in the third and fourth quarters and student attrition in the first half of the year. Our expenses, however, do not vary significantly with changes in our student population and net revenues. During the first half the year, we make significant investments in marketing, staff, programs and facilities to ensure that we meet our second half of the year targets and, as a result, such expenses do not fluctuate significantly on a quarterly basis. We expect quarterly fluctuation in operating results to continue as a result of seasonal enrollment patterns. Such patterns may change however, as a result of new school openings, new program introductions, increased enrollments of adult students or acquisitions.

        Operating income is negatively impacted during the initial start-up phase of new campus expansions. We incur sales and marketing costs as well as campus personnel costs in advance of the campus facility opening. Typically we begin to incur such costs approximately 15 months in advance of the campus opening with the majority of such costs being incurred in the nine-month time period prior to a campus opening. During the current year, we initiated expansion efforts for one new campus, located in Queens, New York, which is scheduled to open in the third quarter of 2005.

Quantitative and Qualitative Disclosures About Market Risk

        Our principal exposure to market risk relates to changes in interest rates. At April 30, 2005, we had $31.0 million of loans outstanding under our new credit agreement and $4.3 million in outstanding letters of credit, loans outstanding under our credit agreement accrue interest at a rate of 4.07%. Each 1% increase in this interest rate would add $0.3 million per year to our interest expense. We intend to use a portion of the proceeds from this offering to repay all outstanding amounts under our new credit agreement. See "Use of Proceeds."

Effect of Inflation

        Inflation has not had a significant effect on our operations.

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Recent Accounting Pronouncements

        In November 2002, the FASB issued Interpretation No. ("FIN") 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including indirect Guarantees of Indebtedness of Others . FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, we must recognize an initial liability for the fair value of the obligations we assume under the guarantee and must disclose that information in our financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor's obligations does not apply to product warranties or to guarantees accounted for as derivatives. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. We had no guarantees which require disclosure under FIN 45 as of December 31, 2004.

        In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 00-21 " Accounting for Revenue Arrangements with Multiple Deliverables " ("EITF 00-21"). Under EITF 00-21, in order to separate the accounting for multiple deliverables (products or services) provided to a customer by a vendor, the deliverables must have separable value to the customer. EITF 00-21 is effective for us for revenue arrangements entered into after January 1, 2004. The adoption of EITF 00-21 did not have a material effect on the consolidated financial statements.

        In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities , as amended in December 2003 by FIN 46 (Revised) ("FIN 46-R"), which deferred the effective date until the first interim or annual reporting period ending after March 15, 2004. FIN 46-R requires the consolidation of an entity by an enterprise known as a "primary beneficiary," (i) if that enterprise has a variable interest that will absorb a majority of the entity's expected losses, if they occur, receive a majority of the entity's expected residual returns, if they occur, or both and (ii) if the entity is a variable interest entity ("VIE"), as defined. An entity qualifies as a variable interest entity if (i) the total equity investment at risk in the entity is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) the equity investors do not have the characteristics of a controlling financial interest in the entity. The initial determination of whether an entity is a variable interest entity shall be made as of the date at which an enterprise becomes involved with the entity and re-evaluated as of the date of triggering events, as defined. The adoption of FIN 46-R did not have a material effect on the consolidated financial statements.

        In May 2003, the FASB issued SFAS No. 150, " Accounting for Certain Financial Instruments with Characteristics of Liabilities, Equity, or Both ," which establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. On November 7, 2003, the FASB deferred, indefinitely, the application of paragraphs 9 and 10 of SFAS No. 150 as it relates to mandatory redeemable non-controlling interests in consolidated subsidiaries in order to address a number of interpretation and implementation issues. The adoption of SFAS 150 did not have a material effect on the consolidated financial statements.

        In December 2004, the FASB issued SFAS No. 123R, " Share Based Payment ," which eliminated the alternative to measure stock-based compensation awards using the intrinsic value approach permitted by APB Opinion No. 25, " Accounting for Stock-Based Compensation " and by SFAS No. 123. We have not yet determined what impact, if any, the adoption of SFAS No. 123R will have on the consolidated financial statements; however, as discussed in Note 2 to the financial statements included elsewhere in this prospectus, we adopted the fair value method of accounting for stock-based compensation provisions of SFAS No. 123 and the retroactive transitional provisions of SFAS No. 148, " Accounting for Stock-Based Compensation—Transition and Disclosure. " As a result, we have been recording stock-based compensation expense for all employee stock awards that were granted or modified.

        In December 2004, the FASB issued SFAS No. 153, " Exchanges of Nonmonetary Assets , an Amendment of APB Opinion No. 29 , Accounting for Nonmonetary Transactions ." SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and requires that such exchanges be measured at fair value, with limited exceptions. SFAS No. 153 amends APB Opinion No. 29 by eliminating the exception that required nonmonetary exchanges of similar productive assets be recorded on a carryover basis. The provisions of SFAS No. 153 are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We will adopt the provisions of SFAS No. 153, as required.

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BUSINESS

Overview

        We are a leading and diversified for-profit provider of career-oriented post-secondary education as measured by total enrollment and number of graduates. We offer recent high school graduates and working adults degree and diploma programs in four principal areas of study: automotive technology, allied health, skilled trades and business and information technology. We believe that our diverse program offerings across a number of growing markets enable us to target a broad range of prospective students. We had 16,664 students enrolled as of December 31, 2004 and our average enrollment for the year ended December 31, 2004 was 16,266 students, an increase of 30.3% from average enrollment of 12,487 for the year ended December 31, 2003. For the year ended December 31, 2004 our revenues were $261.3 million, which represents a 31.4% increase from the year ended December 31, 2003. Excluding our acquisition of Southwestern College in January 2004, our revenues and average enrollments for the year ended December 31, 2004 would have increased by 27.5% and 22.4%, respectively, compared to the year ended December 31, 2003.

        As of December 31, 2004 we operated 28 campuses under six well-established brands with long operating histories: Lincoln Technical Institute, or LTI, (58 years of operation), Nashville Auto-Diesel College, or NADC (85 years), Denver Automotive & Diesel College, or DADC (41 years), The Cittone Institute, or Cittone (36 years), Career Education Institute, or CEI (21 years), and Southwestern College, or Southwestern (26 years). On January 11, 2005, we acquired NETI, which has been in operation for 65 years and has four campuses. Our campuses, the majority of which serve major metropolitan markets, are located in various areas throughout the United States. Four of our campuses are destination schools, which attract students from across the United States and, in some cases, from abroad. Our other campuses primarily attract students from their local communities and surrounding areas. All of our schools are nationally accredited and eligible to participate in federal financial aid programs. Southwestern received an executed provisional program participation agreement from the DOE. NETI has received an executed temporary provisional program participation agreement from the DOE.

        On January 11, 2005, we acquired the rights, title and interest in the assets used in the conduct and operation of NETI for a purchase price of approximately $20.0 million. NETI operates four schools in New Britain, Hamden, Shelton and Cromwell, Connecticut and provides programs in automotive technology, allied health, business and information technology and skilled trades, including culinary arts and nursing. This acquisition expands our presence in the northeastern U.S. and increased the number of campuses we operate from 28 to 32.

        We believe that we provide our students with the highest quality career-oriented training available for our areas of study in our markets. We offer programs in areas of study that we believe are typically underserved by traditional providers of post-secondary education and for which we believe there exists significant demand among students and employers. Furthermore, we believe our convenient class scheduling, career focused curricula and emphasis on job placement offer our students valuable advantages that have been neglected by the traditional academic sector. By combining substantial hands-on training with traditional classroom-based training led by experienced instructors, we believe we offer our students a unique opportunity to develop practical job skills in key areas of expected job demand. We believe these job skills enable our students to compete effectively for employment opportunities and to pursue on-going salary and career advancement.

History

        We were founded in 1946 as Lincoln Technical Institute, Inc. Our programs were initially focused on automotive technical education and were subsequently expanded into adjacent fields including skilled trades, business and information technology and, most recently, allied health, in order to capitalize on our expertise in creating and delivering technical education programs. In June 1999,

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Stonington and Hart Capital acquired a controlling interest in us. Following the close of that transaction, David Carney was named our Chairman and Chief Executive Officer, and has worked with our senior management to refocus our business on growing our campuses and student population, expanding our areas of study and improving our operational performance. From 1999 through December 31, 2004, we have added nine schools through our acquisitions of DADC in 2000 (one campus), CEI in 2001 (two campuses), NADC in 2003 (one campus) and Southwestern in 2004 (five campuses). In that same time, we have also started eight new campuses and introduced more than 50 new programs of study across our campuses. In January 2005, we acquired NETI, which increased the number of our campuses by four. As a result of these initiatives, we have significantly grown and diversified our program offerings and student population.

Market Opportunity

        The market for post-secondary education is large and growing. Expenditures on post-secondary education in the United States totaled over $350.8 billion in the 2003-2004 academic year. The number of students in the United States obtaining some form of post-secondary education totaled 16.1 million in fall of 2002, and The National Center for Education Statistics estimates enrollments will grow to approximately 18.2 million by 2013.

        Although expenditures on and enrollment in post-secondary education as a whole do not necessarily reflect a market opportunity for the career oriented, post-secondary education sector that we serve, we believe that this sector will grow due to, among other factors, a variety of demographic and economic factors, including an increasing demand for skilled workers, an increasing wage premium for skilled workers, a growing number of high school graduates and working adults seeking post-secondary education, and market share gains from traditional academic institutions. We believe that for-profit providers will continue to increase the percentage of students served as for-profit providers are able to offer students advantages relative to traditional academic colleges and universities, including convenient course scheduling, career-oriented curricula and strong job placement opportunities. According to the DOE, over the last 25 years, enrollments at for-profit post-secondary institutions, which comprised 3.3% of total student enrollments in post-secondary institutions in 2001, have experienced a compounded annual growth rate of approximately 10% versus enrollments at traditional colleges and universities that have had a compounded annual growth rate of approximately 1% over the same time period.

        Government spending in support of post-secondary education is another significant factor supporting the growth in student enrollment. According to the DOE, total government aid to support this sector is estimated to have grown from $45 billion in the 2000-2001 academic year to over $80 billion for the fiscal 2006 budget. The federal government provides the majority of this assistance in the form of aid or loans to qualified students. The remainder of government aid comes from state and local government sources. Private third-party lenders also provide student financial aid.

        We believe there is significant and growing demand by employers for individuals possessing skills in each of our areas of study. The U.S. Department of Labor estimates that there will be approximately 4.5 million job openings due to growth and net replacements from 2002 to 2012 in careers related to the areas of study we offer. Furthermore, we believe that each of our four areas of study have strong entry-level employment opportunities and ongoing career and salary advancement potential.

        Automotive Technology.     The U.S. Department of Labor estimates that there were approximately 1,038,000 working automotive servicers and repairers in the United States in 2002, and that this number is expected to increase by 12.5% from 2002 to 2012 due to aggregate growth and net replacements of 392,000 job openings during this period. In fact, the National Auto Dealers Association cites a current shortage of approximately 60,000 automotive technicians. In addition, the U.S. Department of Labor estimates that there were approximately 267,000 bus and truck mechanics and diesel engine specialists in the United States in 2002 and that their number is expected to increase by 14.2% by 2012 due to

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aggregate growth and net replacements of 107,000 jobs. Replacements are being driven by the rising average age of automotive technicians in the United States, which results in the creation of "replacement" job openings when a retiring technician exits the workforce. Growth is being driven by an increase in the number of automobiles and trucks, as well as rapid technological advancement that has raised hiring standards and increased the need for continuous training. Furthermore, the recurring need for, and expense of, training has led many automotive manufacturers to outsource training previously conducted in-house or in partnership with their local dealerships.

        Allied Health.     According to the U.S. Department of Labor, allied health represents one of the fastest growing segments of the domestic economy. Of the 30 fastest growing jobs from 2002-2012, the U.S. Department of Labor anticipates that 13 will be health-related. This growing demand for allied health professionals is being driven by technological advancements in healthcare, the aging population in the United States and an increasing awareness of health-related issues, all trends which we expect to continue for the foreseeable future. The U.S. Department of Labor estimates that there were over 5.6 million allied health positions (defined to include healthcare technicians and related support occupations) in 2002 and projects that this number will increase to 7.4 million in 2012. Similar to the growth projected in the total allied health sector, we expect strong demand within our specific program areas, which include medical administrative assistant, medical assistant and pharmacy technician. According to the U.S. Department of Labor, the number of medical assistants and pharmacy technicians is expected to increase from 576,000 in 2002 to 850,000 in 2012.

        Skilled Trades.     The skilled trades industry covers a wide variety of fields, including construction, equipment installation and repair and drafting occupations. Job growth is being driven by technological advancement, as well as a shift away from traditional training sources. Many public vocational schools, which have historically trained skilled trades professionals, are suffering from reduced funding, creating increased opportunities for non-traditional providers of skilled trades programs, such as for-profit post-secondary institutions. Specifically, our program offerings include: skilled electronic systems technicians, mechanical and architectural drafting specialists and heating, ventilation and air conditioning, or HVAC, technicians. For example, the U.S. Department of Labor estimates that there were 216,000 drafters and 249,000 HVAC installers in 2002 and employment is expected to grow to 222,000 and 328,000, respectively, in these areas in 2012. In addition to the skilled trades fields that our programs cover, there is also demand for skilled trades professionals in construction, plumbing and electrical wiring. We continually evaluate opportunities to develop or acquire the curriculum to offer programs designed to prepare our graduates to enter these and other attractive skilled trade professions.

        Business and Information Technology.     Despite recent weakness in the business and information technology sector, we believe demand still exists for business and information technology professionals. According to the U.S. Department of Labor, of the top 30 fastest growing jobs, seven are IT-related. Furthermore, we believe that the industry will be positively impacted by an economic recovery and accompanying business investment that will drive the demand for IT technicians to upgrade computer hardware and install, integrate and operate new software applications. We have focused our business and information technology program offerings to the skills that we believe will be most marketable in the business and information technology job market in the coming years. Our business and information technology programs include: computer programming, software applications technology, network and PC systems technology, network systems administration, business administration and graphic design. According to the U.S. Department of Labor, there was an aggregate of 1.1 million computer programmers, software application engineers and network and computer systems administrators in 2002 and this number is expected to grow to 1.5 million in 2012.

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Business Strengths

        We believe that the following strengths differentiate us from our competitors:

        Program Diversification.     We believe the breadth of our areas of study and the diversity of our offerings increase our addressable market and enhance our overall revenue stability and operational flexibility. The breadth of our areas of study improves our potential for program expansion by providing us with a broader range of areas upon which to add or expand. The diversity of our program and degree offerings broadens our addressable market by attracting a varied student population, including recent high school graduates and working adults, both men and women. Additionally, our program offerings enable us to capitalize on positive trends in certain segments of the economy while reducing our dependence on other segments, as we have recently demonstrated by expanding our allied health programs to take advantage of job growth in these areas.

        Operational Flexibility.     Our operational infrastructure is highly flexible and enables us to adapt quickly to changing market trends. Our management team is experienced in the development of new programs and curricula that we can rapidly roll out to our schools. For example, we developed several allied health programs, including Medical Assisting which was piloted in one school and then replicated across our system to an additional 13 schools. We also developed the Electronic System Technology program at our Melrose Park campus and to date have replicated it to five additional campuses. This program is designed to train students in cable systems, audio/visual circuits, computer networks, fiber optics, telecommunications and satellite systems, and other related specialized programs. We recently launched online associate degree programs and we expect to introduce other degree programs. We expect our online program offerings to broaden our market and further enhance our program flexibility. We also have substantial experience with the complex regulatory environment in which we operate and we believe this enables us to efficiently obtain the required approvals for new programs, expansion and acquisitions. We are also focused on the continual evaluation of our portfolio of schools and programs to maximize our facility utilization and can rapidly reallocate classroom space and other resources as necessary to exploit market opportunities. Finally, once we enter a new market through expansion or acquisition, our marketing and recruiting programs are designed to quickly populate the new program or school. For example, in 2002, we rapidly developed our allied health program curriculum, obtained the requisite regulatory approval, redesigned some of our classrooms and began to successfully market this new program offering. While allied health accounted for only 7% of our total enrollments as of December 31, 2002, it accounted for 24% of our total enrollments as of December 31, 2003 and 31.9% of our total enrollments as of December 31, 2004.

        Strong Brands and Geographic Presence.     We believe that our schools have established a strong competitive position in their respective local markets and significant brand recognition with prospective students and employers. The majority of our 32 campuses serve major metropolitan markets in the United States. Our LTI, DADC, NADC, Cittone, CEI, Southwestern and NETI brands provide us with local market representation in 15 states, while our destination schools—DADC, NADC, our Columbia, Maryland LTI School and our Indianapolis, Indiana LTI school—attract students from across the United States and, in some cases, from abroad. Unlike competitors with single or regional campus models, we are able to recruit effectively from a national pool of potential students while also securing job placement for our graduates on a broader basis.

        Strong Marketing and Student Recruitment.     We use a variety of marketing and recruiting methods to attract students and increase enrollments. Our program combines various methods of media advertising such as television, the Internet and print media with a team of field- and campus-based recruiting representatives. Our media advertising is directed primarily at attracting high school students and working adults to our local campuses. Our field-based recruiting representatives make presentations at high schools to attract students to our local and destination campuses while our campus-based recruiting representatives field calls from our toll-free number that is included in our advertising and follow-up with potential students on an individual basis. We continuously monitor and

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adjust the focus of our marketing and recruiting efforts to maximize efficiency and minimize our student acquisition costs. In addition, our administrators actively work with our current students, graduates and others to encourage referrals, which have historically represented over 20% of our new enrollments.

        Experienced Management Team.     Our senior management team has over 200 years of combined experience and an average of approximately 20 years of experience in the for-profit, post-secondary education industry. Mr. David Carney, our Chief Executive Officer, has 27 years of experience with for-profit education companies, including serving as Vice President, Chief Financial Officer and Vice President of Development for the chain of technical schools owned by British Oxygen Group Limited which he grew from four schools when he started to 25 schools ten years later. Mr. Lawrence Brown, our President and Chief Operating Officer, has over 32 years of experience in the industry. He has been with us for more than 27 years, and has performed various roles such as admissions officer/director, school director, regional Vice President and executive Vice President. Mr. Thomas McHugh, our Vice President of Compliance, has 30 years of experience with for-profit education companies, including serving as Director of Review and Analysis for Computer Learning Centers, Inc. We believe that our management team's deep understanding of the for-profit, post-secondary education industry enables us to successfully manage our operations and facilitate our growth.

Growth Strategy

        Our goal is to strengthen our role as a leading and diversified provider of career-oriented post-secondary education by continuing to pursue the following growth strategies:

        Expand Existing Areas of Study and Existing Facilities.     We believe we can leverage our existing operations to capitalize on the growing demand from students and employers in our local markets. We are adding new programs and degree offerings in our current areas of study and are expanding several of our campus facilities.

    Expand Existing Areas of Study . We are expanding our program offerings in our existing areas of study by replicating existing programs, developing new, but related, programs and increasing our degree offerings.

    We replicate programs by taking the curriculum for an existing program at one school and introducing it to other schools across our campus base. The replication of our Electronic System Technician, or EST, program, which we introduced at one school in September 2001, three schools in 2003 and two schools in 2004, is an example of the success of our program replication. We plan to further replicate our EST program at additional locations in the future.

    The development of new, but related, programs in existing areas of study allows us to expand our program offerings and increase enrollments at a relatively low cost. For example, our recently developed pharmacy technician program leverages our existing allied health expertise and infrastructure while attracting a new base of students and satisfying employers' evolving needs. We are currently developing three new allied health programs and one new skilled trades program.

    We believe expanding our associate degree offerings will increase our average enrollments and the average length of stay of our students, broaden our addressable market and diversify our student demographics. We currently offer associate degrees in selected programs at thirteen of our campuses and are seeking to offer associate degrees at nine additional campuses.

    Expand Existing Facilities . We are expanding our existing facilities by renovating certain schools and relocating other schools to expand capacity. This will enable us to roll out new programs and attract more students. For example, we moved to a new facility in June 2004 in Indianapolis,

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      Indiana which accommodates 2,200 students, nearly doubling the capacity of our two other facilities in that city. This additional space will allow us to grow our student population and further diversify our product offering. We moved into a new 40,000 square foot facility in October 2004 in Lincoln, Rhode Island which allowed us to consolidate facilities into one location and more than double our classroom space. Operationally, we believe these new facilities will be more efficient to manage and will accommodate increased enrollments and programs.

        Enter New Geographic Markets and New Areas of Study.     We believe we can increase our student enrollments by entering selected new geographic markets and new areas of study. We target new markets and areas of study that we believe have significant growth potential and where we can leverage our reputation and operating expertise. We expect that our entrance into new geographic markets and areas of study will increase our diversification and potential for future program expansion.

    Enter New Geographic Markets . We continuously evaluate entry into markets where we can start new schools. In the summer of 2001, we acquired eight schools that we consider start-ups because they did not have any students or staff. In starting these schools, we obtained the necessary government approvals for financial aid, hired teaching professionals and administrative staff, implemented our programs, marketed the schools under new brands and successfully populated the schools with students. Our reputation, experienced regulatory personnel and management expertise enabled us to begin accepting students in all of these schools within six months of acquisition. Today, these schools enroll more than 2,500 students. Our most recent start-up is in partnership with the Greater New York Area Automobile Dealers Association (GNYADA), and is expected to offer programs in automotive technology starting in 2005. Construction has begun on our facility in Queens, New York and this location will allow us to capitalize on the significant employer and student demand in an attractive market that we believe is currently underserved.

    Enter New Areas of Study . We continuously evaluate new, high-growth areas of study that are in demand by students and employers. For example, in 2002, we targeted allied health and successfully developed and launched a suite of programs in that area of study. We typically require six to 18 months to develop new programs and to obtain necessary regulatory approvals. On January 11, 2005, we acquired NETI, which offers programs in the culinary arts and nursing, which are new programs for us. In addition, in 2005 we intend to roll-out a new program for dental assistants.

        Opportunistically Pursue Strategic Acquisitions.     In evaluating potential acquisitions, we seek to identify schools with the potential for program replication at our existing campuses, new areas of study, new markets with attractive growth opportunities and advanced degree programs. We also look for schools whose operations we can improve by leveraging our sales and marketing expertise, business management systems and our experienced management team. In 2003, we acquired NADC, which provided us entry into the attractive Nashville, Tennessee market. We were able to successfully leverage our expertise and improve the operating income margins at NADC from 3.9% to 18.0% in the twelve months following the acquisition. In January 2004, we completed our acquisition of Southwestern and on January 11, 2005, we completed the acquisition of NETI. We continue to evaluate attractive acquisition candidates and believe that we will be successful in locating such candidates.

        Introduce Online Education Alternatives.     We recently launched our online initiative to capitalize on the rapidly growing demand for, and flexibility provided by, online education alternatives. Initially, we are offering our diploma graduates the opportunity to earn their associate degree online and we expect to expand our offering to include other degree programs. We began offering on-line courses in mid-2004. This should broaden our addressable market and be an attractive option for students without the geographic or financial flexibility to enroll in campus-based programs. We believe that we will be able to leverage our existing programs and campuses, as well as our relationship with eCollege.com, a

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provider of technology and services for online learning programs, in developing our online offerings. We initially plan to use our online offerings to enable certificate and diploma automotive students and graduates to obtain an associate degree. These students or graduates must complete a series of general education courses, which are conducive to being offered online, to obtain an associate degree. We do not anticipate that these online offerings will contribute meaningfully to our 2005 revenues.

        We have a two year contract with eCollege that expires June 12, 2005, and we are currently negotiating a new contract. Under the terms of the existing contract, eCollege provides us with a website housed on eCollege servers which serves as a portal for students to access our on-line curriculum. The eCollege platform tracks all interaction between the student and the instructor. In addition, we purchased $75,000 of prepaid professional services of which approximately $25,000 remains to be used. The professional services were for customization of the eCollege portal and course design and development.

Programs and Areas of Study

        We structure our program offerings to provide our students with practical, career-oriented education and position our students for attractive entry-level job opportunities in their chosen fields. Our programs are designed to be completed in 24 to 100 weeks. Tuition ranges from $8,000 to $26,000, depending on the length of the program and the area of study. All of our schools offer diploma and certificate programs and currently twelve of our schools also offer associate degree programs. In order to accommodate the schedules of our students and maximize classroom utilization, we typically offer courses five days a week in three shifts a day and start new classes every month. We update and expand our programs frequently to reflect the latest technological advances in the field, providing our students with the specific skills and knowledge required in the current marketplace. Classroom instruction combines lectures and demonstrations by our experienced faculty with comprehensive hands-on laboratory exercises in simulated workplace environments.

        The following table lists the programs offered and the number of students enrolled in each area of study as of December 31, 2004.

Programs Offered

 
Area of Study

  Associate
  Diploma and Certificate(1)
  Enrollment
  Percent of
Total
Enrollment

 
Automotive Technology   Auto Service Management, Collision Repair, Diesel Technology, Diesel & Truck Service Management   Automotive Mechanics, Automotive Technology, Collision Repair, Diesel Truck Mechanics, Diesel Technology, Diesel & Truck Technology, Master Automotive Technology   7,917   47.5 %

Allied Health

 


 

Medical Administrative Assisting, Medical Assisting, Pharmacy Technology, Therapeutic Massage & Body Technology

 

5,311

 

31.9

%

Skilled Trades

 

Mechanical/Architectural Drafting, Electronics Engineering Technology

 

Electronic Servicing, Electronics Engineering Technology, Electronics System Technology, HVAC, Mechanical/Architectural Drafting

 

1,710

 

10.2

%

Business and Information Technology

 

PC Systems & Networking Technology

 

Business Administration, Computer Programming with Web Technology, Graphic Web Design, Network Systems Administrating, PC Support Technology

 

1,726

 

10.4

%

 

 

 

 

 

 



 



 

 

 

Total:

 

 

 

16,664

 

100.0

%

(1)
Additional programs in development: Dental Assisting, Billing and Coding, Health Information Technology, and Electrician. Upon our acquisition of NETI in January 2005, we added programs in nursing, electrical and culinary arts.

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        Automotive Technology.     Automotive technology represents our largest area of study, with 47.5% of our enrollments as of December 31, 2004. Our automotive technology programs are 24 to 100 weeks in length, with tuition rates of $8,000 to $24,000. We believe we are a leading provider of automotive technology education in each of our local markets. Graduates of our programs are qualified to obtain entry level employment ranging from positions as technicians and mechanics to various apprentice level positions. Our graduates are employed by a wide variety of employers, ranging from automotive and diesel dealers, independent auto body paint and repair shops, to trucking and construction companies.

        In 2002, we signed a lease on a new 48,000 square-foot facility in Queens, New York that we expect to open in the third quarter of 2005. This school will offer courses in automotive technology and will operate under the LTI brand name in partnership with GNYADA. GNYADA represents over 500 dealers in New York and Connecticut that comprise a large source of potential employers for our graduates, both at Queens and at our other automotive schools. We expect that we will be able to leverage our current advertising in the New York city television market to not only offer potential students who could not travel to one of our New Jersey schools a closer-to-home opportunity, but also to gain access to the entire eastern Long Island and southern Connecticut markets.

        We have a partnership with BMW that offers our automotive technology students the opportunity to work for BMW through the Service Technician Education Program (STEP). The STEP program is a "graduate" school program for individuals who have successfully earned an automotive certification either at one of our schools or any of our competitor's schools. Students who are admitted to the STEP program have their tuition paid for by BMW and upon successfully completing the program are typically employed as BMW mechanics. The BMW STEP program commenced at our Columbia, Maryland facility in the second quarter of 2004. Our partnership with BMW signifies our high quality education capabilities and is an attractive marketing program.

        All of our LTI schools, with the exception of our Allentown campus, offer programs in automotive technology, in most cases in addition to other technical programs. DADC and NADC, which we acquired in 2000 and 2003, respectively, currently offer programs exclusively in automotive technology. DADC, NADC, our Columbia, Maryland LTI school and our Indianapolis, Indiana LTI schools are destination schools, attracting students from throughout the United States and, in some cases, from abroad.

        Allied Health.     As of December 31, 2004, allied health represented our second largest area of study, with 31.9% of our total enrollments up from 7.0% in 2002. Our allied health programs are 30 to 65 weeks in length, with tuition rates of $8,000 to $12,000. Graduates of our programs are qualified to obtain positions such as medical administrative assistant, EKG technician, claims examiner and pharmacy technician. Our graduates are employed by a wide variety of employers, including hospitals, laboratories, insurance companies, doctors' offices and pharmacies.

        Our medical assistant and medical administrative assistant programs are our largest allied health programs. We recently received the necessary regulatory approvals for our therapeutic massage & body technology program, which we have introduced in eleven campuses and we offer our pharmacy technician program which we offer in nine of our campuses. We expect to augment these existing allied health programs with a new program in dental assisting and we are considering adding billing and coding and health information technology to our program offerings.

        We offer allied health programs at all of our Cittone and CEI schools, Southwestern College, and our Allentown, Pennsylvania and Melrose, Illinois LTI schools.

        Skilled Trades.     As of December 31, 2004, 10.2% of our students were enrolled in our skilled trades programs. Our skilled trades programs are 24 to 88 weeks in length, with tuition rates of $8,000 to $24,000. Our skilled trades programs include heating, ventilation and air conditioning repair, drafting and computer-aided design and EST. Graduates of our programs are qualified to obtain entry level

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employment positions such as cable, wiring and HVAC installers and servicers and drafting technicians. Our graduates are employed by a wide variety of employers, including residential and commercial telecommunications companies and architectural firms.

        We created our own in-house EST program in 2001 by partnering with two industry groups, Electronic Systems Technician Consortium and the National Center for Construction Education and Research. We have introduced our EST program to six of our campuses and plan to expand it to additional campuses. Students in these programs are trained to install and service equipment such as alarm systems, cable infrastructure, home entertainment systems, fiber-optic wiring in homes and offices, and satellite and telecommunication systems.

        We offer skilled trades programs at seven of our eight LTI schools (all but the Philadelphia, Pennsylvania campus).

        Business and Information Technology.     As of December 31, 2004, 10.4% of our students were enrolled in our business and information technology programs. Our business and information technology programs are 30 to 64 weeks in length, with tuition rates of $11,000 to $26,000. We experienced a decline in our business and information technology programs between the years 2000 and 2003 due to weakness in the economy and reduced demand for IT professionals. We therefore reduced our exposure to this area by developing our in-house allied health and EST programs in 2001 and 2002. However, we remain committed to the IT industry and expect this to be an important area of growth, especially as the economy recovers, business investment in hardware and software increases and the rapid technological advancement of computer applications continues. We have focused our current program offerings on those that are most in demand, such as our PC systems technician, network systems administrator and business administration specialist programs.

        We offer business and information technology programs at all of our Cittone and CEI schools, in addition to two of our LTI schools (Columbia, Maryland and Allentown, Pennsylvania campuses) and all of our Southwestern schools.

Marketing and Student Recruitment

        We utilize a variety of marketing and recruiting methods to attract students and increase enrollments. Our marketing and recruiting efforts are targeted at potential students who are entering the workforce, or who are underemployed or unemployed and require additional training to enter or re-enter the workforce.

        Marketing.     Our marketing program utilizes media advertising such as television, the Internet, and various print media and is enhanced by referrals. We continuously monitor and adjust the focus of our marketing efforts to maximize efficiency and minimize our student acquisition costs.

    Media .    Our media advertising is directed primarily at attracting students from the local areas in which our schools operate. Television advertising, which is coordinated by a national buyer, is our most successful medium, generating approximately one third of our new enrollments in 2004. Systems we have developed enable us to closely monitor and track the effectiveness of each advertisement on a daily or weekly basis and make adjustments accordingly. The Internet is our second most successful medium and its effectiveness is rapidly increasing. We also advertise via direct mail, in telephone directories and in newspapers.

    Referrals .    Referrals from current students, high school counselors and satisfied graduates and their employers have historically represented over 20% of our new enrollments. Our school administrators actively work with our current students to encourage them to recommend our programs to potential students. We continue to build strong relationships with high school guidance counselors and instructors by offering annual seminars at our training facilities to further educate these individuals on the strengths of our programs. Graduates who have gone on

54


      to enjoy success in the workforce frequently recommend our programs, as do local business owners who are pleased with the performance of our graduates whom they have hired.

        Recruiting.     Our recruiting efforts are conducted by a group of field- and campus-based representatives who meet directly with potential students during presentations conducted at high schools, in the potential student's home or during a visit to one of our campuses.

    Field-Based Recruiting .    Our field-based recruiting representatives make presentations at high schools to attract students to both our local and destination campuses. Our field-based representatives also visit directly with potential students in their homes. We estimate that in the year ended December 31, 2004, our 178 field-based representatives made approximately 7,492 visits (excluding representatives from NADC) to high schools and student homes, a 22% increase from the prior year. Over the last three years, we have recruited approximately 25% of our students directly out of high school.

    Campus-Based Recruiting .    When a potential student is identified through our marketing and recruiting efforts, one of our 170 campus-based representatives is paired with the potential student to follow up on an individual basis. Our media advertisements contain a unique toll-free number and our telephone system automatically directs the call to the campus nearest the caller. One of our campus-based recruiting representatives responds, typically within 24 hours, to these inquiries and other inquiries generated by our marketing efforts to explain the opportunities available within each program, schedule an appointment for the potential student to visit the school and arrange a tour of the school's facilities.

Student Admissions, Enrollment and Retention

        Admissions.     In order to attend our schools, students must complete an application and pass an entry examination. While each of our programs has different admissions criteria, we screen all applications and counsel the students on the most appropriate program to increase the likelihood that our students complete the requisite coursework and obtain and sustain employment following graduation.

        Enrollment.     We enroll students continuously throughout the year, with our largest classes enrolling in late summer or early fall following high school graduation. We had 16,664 students enrolled as of December 31, 2004 and our average enrollment for the year ended December 31, 2004 was 16,226 students, an increase of 30.3% from December 31, 2003. Excluding our acquisition of Southwestern in January 2004, our average enrollments would have increased by 22.4%. For the year ended December 31, 2003, we had average enrollments of 12,487 students, a 36.4% increase over average enrollments of 9,155 in 2002. Excluding our acquisition of NADC in February 2003, our average enrollments were 11,227 students, a 22.6% increase over the prior year.

        Retention.     To maximize student retention, the staff at each school is trained to recognize the early warning signs of a potential drop and to assist and advise students on academic, financial, employment and personal matters. We monitor our retention rates by instructor, course, program and school. When we notice that a particular instructor or program is experiencing a higher than normal dropout rate, we quickly determine the cause of the problem and attempt to correct it. When we notice that a student is having trouble academically, we provide tutoring.

Job Placement

        We believe that securing employment for our graduates is critical to our ability to attract high quality students. In addition, high job placement rates result in low student loan default rates, an important requirement for continued participation in Title IV Programs. See "Regulatory Environment—Regulation of Federal Student Financial Aid Programs." Accordingly, we dedicate

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significant resources to maintaining an effective graduate placement program. Our non-destination schools work closely with local employers to ensure that we are training students with skills that employers want. Each school has an advisory council made up of local employers who provide us with direct and immediate feedback on how well we are preparing our students to succeed in the workplace. This enables us to tailor our programs to the market. For example, part of a student's grade is dependent upon attendance and appearance because employers want their employees to be punctual and to have a professional appearance. The placement staff in each of our destination schools maintains databases of potential employers throughout the country, allowing us to place students in the market of their choice upon graduation. We also have internship programs that provide our students with opportunities to work with employers prior to graduation. For example, some of the students in our automotive programs have the opportunity to complete a portion of their hands-on training while working with a potential employer. In addition, some of our allied health students are required to participate in an internship program during which they work in the field as part of their career training. Students that participate in these programs often go on to work for the same business upon graduation. We also assist students with resume writing, interviewing and other job search skills.

        Our placement rates in 2002, 2003 and 2004 were 83.3%, 84.6% and 86.7%, respectively, of our graduates obtaining employment in their field prior to March 1 of the year following the year of their graduation. Throughout this period, our placement rate for our automotive technology graduates has consistently exceeded 89.0%. Many of our automotive technology graduates are employed by dealership and repair centers. Many of our non-auto graduates are placed with local employers such as small businesses, national chains and doctors' offices.

Faculty and Employees

        We hire our faculty in accordance with established criteria, including relevant work experience, educational background and accreditation and state regulatory standards. We require meaningful industry experience of our teaching staff in order to maintain the quality of instruction in all of our programs and to address current and industry-specific issues in our course content. In addition, we provide intensive instructional training and continuing education, including quarterly instructional development seminars, annual reviews, technical upgrade training, faculty development plans and weekly staff meetings.

        The staff of each school typically includes a school director, a director of graduate placement, an education director, a director of student services, a financial-aid director, an accounting manager and a director of admissions, all of whom are industry professionals with experience in our areas of study.

        As of December 31, 2004, we had approximately 2,350 employees, including 818 full-time faculty and 275 part-time instructors, and 239 of our teaching professionals at four of our campuses are represented by unions. These employees are covered by collective bargaining agreements that expire in 2005 through 2006. Contract negotiations with regard to the two collective bargaining agreements expiring in 2005 are expected to begin in July and August of this year. We believe that we have good relationships with these unions.

        We have had no work stoppages at any of our campuses in the past 20 years.

Intellectual Property

        Lincoln Educational Services®, Lincoln Technical Institute®, Lincoln Tech®, LTI®, New England Technical Institute®, NETI®, New England Tech®, Center for Culinary Arts®, The Cittone Institute®, DOC® and DOC and design (a logo for our "Doctors Office Classroom" program) are our registered trademarks. CEI, Career Education Institute, is our registered mark in various states.

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Competition

        The for-profit post-secondary education industry is highly competitive and highly fragmented, with no one provider controlling significant market share. Direct competition between career-oriented schools and traditional four-year colleges or universities is limited. Thus, our main competitors are other for-profit, career-oriented schools, as well as public and private two-year junior and community colleges. Competition is generally based on location, the type of programs offered, the quality of instruction, placement rates, reputation, recruiting and tuition rates. Public institutions are generally able to charge lower tuition than our schools, due in part to government subsidies and other financial sources not available to for-profit schools. In addition, some of our private competitors have a more extended or dense network of schools and campuses than we do, which enables them to recruit students more efficiently from a wider geographic area. Nevertheless, we believe that we are able to compete effectively in our local markets because of the diversity of our program offerings, quality of instruction, the strength of our brands, our reputation and our success in placing students with employers.

        We compete with every institution that is eligible to receive Title IV funding. This includes four-year not-for-profit public and private colleges and universities, community colleges and all for-profit institutions whether they are four years, two years or less. Our competition differs in each market depending on the curriculum that we offer. For example, a school offering automotive, allied health and skilled trades programs will have a different group of competitors than a school offering allied health, business/IT and skilled trades. Also, because schools can add new programs within six to twelve months, new competitors can emerge relatively quickly. Moreover, with the introduction of online learning, the number of competitors in each market has increased because students can now stay local but learn from a non-local institution.

        Notwithstanding the above, today we mainly compete with community colleges and other career schools, both for-profit and not-for-profit. We focus on programs that are in high demand and are offered by as few competitors as possible. We compete against community colleges by seeking to offer more frequent start dates, more flexible hours, better instructional resources, more hands on training, shorter program length and greater assistance with job placement. We compete against the other career schools by seeking to offer a higher quality of education, higher quality instructional equipment and a better overall value. On average each of our schools has at least three direct competitors and at least a dozen indirect competitors. As we continue to add courses and degree programs, our addressable market increases and thus we face increased competition.

        While competition with four-year institutions is more limited, we do compete with two-year traditional private and public institutions.

Facilities

        We lease all of our facilities, except for our former Indianapolis, Indiana campus, our Nashville, Tennessee campus and our Cincinnati (Tri-County) campus, which we own. Four of our facilities (Union, New Jersey; Allentown, New Jersey; Philadelphia, Pennsylvania; and Grand Prairie, Texas) are also accounted for by us under a finance lease obligation as further described in Note 12 to the audited consolidated financial statements included elsewhere in this prospectus. We continue to re-evaluate our facilities to maximize our facility utilization and efficiency and to allow us to introduce new programs and attract more students. We entered into a 15-year lease for a 126,000 square foot facility in Indianapolis, which replaced our existing facility in that city. We also entered into a ten-year lease for a 40,000 square foot facility in Lincoln, Rhode Island, which replaced our existing facilities in that city. In addition, in July 2002, we signed a lease for a new 48,000 square-foot facility in Queens, New York, which we expect to open in the third quarter of 2005. During 2003, we moved all of our Boston, Massachusetts students into our Somerville, Massachusetts campus. All of our existing leases expire between October 2005 and November 2020, with the exception of one lease representing a total of

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10,000 square feet that we lease on a month-to-month basis. We have entered into a letter of intent to sell our former Indianapolis, Indiana campus which we own. These assets were classified as available for sale as of July 1, 2004.

        The following table provides information relating to our facilities as of December 31, 2004, including our corporate offices:

Location

  Brand
  Approximate Square
Footage

Union, New Jersey   Lincoln Technical Institute   60,000
Mahwah, New Jersey   Lincoln Technical Institute   79,000
Allentown, Pennsylvania   Lincoln Technical Institute   26,000
Philadelphia, Pennsylvania   Lincoln Technical Institute   33,000
Columbia, Maryland   Lincoln Technical Institute   91,000
Indianapolis, Indiana(1)   Lincoln Technical Institute   182,000
Melrose Park, Illinois   Lincoln Technical Institute   67,000
Grand Prairie, Texas   Lincoln Technical Institute   48,000
Denver, Colorado   Denver Automotive & Diesel College   78,000
Nashville, Tennessee   Nashville Auto Diesel College   278,000
Edison, New Jersey   Cittone Institute   64,000
Mt. Laurel, New Jersey   Cittone Institute   26,000
Philadelphia, Pennsylvania   Cittone Institute   37,000
Northeast Philadelphia, Pennsylvania   Cittone Institute   45,000
Plymouth Meeting, Pennsylvania   Cittone Institute   30,000
Paramus, New Jersey   Cittone Institute   27,000
Boston, Massachusetts   Career Education Institute   7,000
Brockton, Massachusetts   Career Education Institute   10,000
Lincoln, Rhode Island   Career Education Institute   40,000
Lowell, Massachusetts   Career Education Institute   20,000
Somerville, Massachusetts   Career Education Institute   33,000
Norcross, Georgia   Career Education Institute   27,000
Marietta, Georgia   Career Education Institute   16,000
Henderson, Nevada   Career Education Institute   27,000
Dayton, Ohio   Southwestern College   9,000
Franklin, Ohio   Southwestern College   14,000
Cincinnati, Ohio   Southwestern College   10,000
Cincinnati (Tri-County), Ohio   Southwestern College   15,000
Florence, Kentucky   Southwestern College   9,000
West Orange, New Jersey   Corporate Offices   41,000

(1)
Our Indianapolis, Indiana school is currently comprised of two facilities: a 55,900 square foot facility that we own and a 126,000 square foot facility that we lease. We have entered into a letter of intent to sell the owned facility and have classified these assets as available for sale on July 1, 2004.

Legal Proceedings

        In the ordinary conduct of our business, we are subject to periodic lawsuits, investigations and claims, including, but not limited to, claims involving students or graduates and routine employment matters. Although we cannot predict with certainty the ultimate resolution of lawsuits, investigations and claims asserted against us, we do not believe that any currently pending legal proceeding to which we are a party will have a material adverse effect on our business or financial condition.

        Since May 2002, we have been involved in litigation brought by two former employees acting as "relators" under the qui tam provisions of the federal False Claims Act, 31 U.S.C. §§ 3729-33, or FCA. The relators have alleged that we violated Title IV Program requirements that prohibit the payment of

58



commissions, bonuses or other incentive payments to admissions and recruitment personnel based upon their success in securing enrollments, and that our participation in the federal student aid programs under these circumstances constituted actionable "false claims" within the meaning of federal law. The "relators" are seeking to recover, on behalf of themselves and the United States government, treble damages and a civil penalty of $5,000-$10,000 for each action that violated the FCA as well as their costs and reasonable attorney fees. The relators are pursuing the litigation against us on their own, without the involvement or support of the U.S. Department of Justice, which had given notice, after investigation, of its intention not to participate in the case. On September 3, 2003, after full briefing of the issues by the parties, the district court granted our motion and dismissed the entire action, with prejudice. The relators appealed the ruling to the United States Court of Appeals for the Fifth Circuit, which affirmed the District Court's dismissal of the case on October 15, 2004. The relators subsequently served upon us a petition for a Writ of Certiorari with the Supreme Court of the United States and the petition was docketed in the Supreme Court on March 10, 2005. We would vigorously defend the rulings of the District Court and the Fifth Circuit if the Supreme Court granted the writ.

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REGULATORY ENVIRONMENT

        Students attending our schools finance their education through a combination of family contributions, individual resources and federal financial aid programs. Each of our schools participates in the federal programs of student financial aid authorized under Title IV Programs, which are administered by the DOE. For the year ended December 31, 2004, approximately 81% (calculated on a cash basis of accounting) of our revenues were derived from the Title IV Programs. Students obtain access to federal student financial aid through a DOE prescribed application and eligibility certification process. Student financial aid funds are generally made available to students at prescribed intervals throughout their predetermined expected length of study. Students typically use the funds received from the federal financial aid programs to pay their tuition and fees. The transfer of funds from the financial aid programs are to the student, who then applies those funds to the cost of their education.

        In connection with the students' receipt of federal financial aid, our schools are subject to extensive regulation by governmental agencies and licensing and accrediting bodies. In particular, the Title IV Programs, and the regulations issued thereunder by the DOE, subject us to significant regulatory scrutiny in the form of numerous standards that each of our schools must satisfy in order to participate in the various federal student financial aid programs. To participate in the Title IV Programs, a school must be authorized to offer its programs of instruction by the applicable state education agencies in the states in which it is physically located, be accredited by an accrediting commission recognized by the DOE and be certified as an eligible institution by the DOE. The DOE defines an eligible institution to consist of both a main campus and its additional locations, if any. Each of our schools is either a main campus or an additional location of a main campus. Each of our schools is subject to extensive regulatory requirements imposed by state education agencies, accrediting commissions, and the DOE. Our schools also participate in other federal and state financial aid programs that assist students in paying the cost of their education.

State Authorization

        Each of our schools must be authorized by the applicable education agencies in the states in which the school is physically located and, in some cases other states, in order to operate and to grant degrees, diplomas or certificates to its students. State agency authorization is also required in each state in which a school is physically located in order for the school to become and remain eligible to participate in Title IV Programs. Currently, each of our schools is authorized by the applicable state education agencies in the states in which the school is physically located and in which it recruits students.

        Our schools are subject to extensive, ongoing regulation by each of these states. State laws typically establish standards for instruction, qualifications of faculty, location and nature of facilities and equipment, administrative procedures, marketing, recruiting, financial operations and other operational matters. State laws and regulations may limit our ability to offer educational programs and to award degrees, diplomas or certificates. Some states prescribe standards of financial responsibility that are different from, and in certain cases more stringent than, those prescribed by the DOE. Some states require schools to post a surety bond. Currently, we have posted surety bonds on behalf of our schools and education representatives with multiple states in a total amount of approximately $8.6 million. These bonds are backed by $2.4 million of letters of credit.

        If any of our schools fail to comply with state licensing requirements, they are subject to the loss of state licensure or accreditation. If any one of our schools lost its authorization from the education agency of the state in which the school is located, that school and its related main campus and/or additional locations would lose its eligibility to participate in Title IV Programs, be unable to offer its programs and we could be forced to close that school. If one of our schools lost its state authorization from a state other than the state in which the school is located, the school would not be able to recruit

60



students in that state. We believe that each of our schools is in substantial compliance with the applicable education agency requirements in each state in which it is physically located.

        Due to state budget constraints in other states in which we operate, it is possible that those states may reduce the number of employees in, or curtail the operations of, the state education agencies that authorize our schools. A delay or refusal by any state education agency in approving any changes in our operations that require state approval could prevent us from making such changes or could delay our ability to make such changes.

Accreditation

        Accreditation is a non-governmental process through which a school submits to ongoing qualitative review by an organization of peer institutions. Accrediting commissions primarily examine the academic quality of the school's instructional programs, and a grant of accreditation is generally viewed as confirmation that the school's programs meet generally accepted academic standards. Accrediting commissions also review the administrative and financial operations of the schools they accredit to ensure that each school has the resources necessary to perform its educational mission.

        Accreditation by an accrediting commission recognized by the DOE is required for an institution to be certified to participate in Title IV Programs. In order to be recognized by the DOE, accrediting commissions must adopt specific standards for their review of educational institutions. Ten of our campuses, plus the additional four campuses we acquired as a result of our acquisition of NETI, are accredited by the Accrediting Commission of Career Schools and Colleges of Technology, or ACCSCT, and 18 of our campuses are accredited by the Accrediting Council for Independent Colleges and Schools, or ACICS. ACCSCT and ACICS are accrediting commissions recognized by the DOE. The following is a list of the dates in which each campus was accredited by its accrediting commission and the date by which its accreditation must be renewed.

    ACCSCT Reaccreditation Dates

School

  Last Accreditation Letter
  Next Accreditation
Philadelphia, PA   May 2003   May 2008
Union, NJ   June 2004   February 2009
Mahwah, NJ*   August 1999   August 2009
Melrose Park, IL   March 2005   November 2009
Denver, CO   February 2001   February 2006
Columbia, MD   March 2002   March 2007
Grand Prairie, TX   June 2002   June 2007
Allentown, PA   January 2002   January 2007
Nashville, TN   May 2002   May 2007
Indianapolis, IN   November 2002   November 2007
New Britain, CT   January 2003   January 2008
Shelton, CT**   September 2003   September 2005
Cromwell, CT**   November 2004   November 2006
Hamden, CT**   July 2002   July 2007

*
Branch campus of main campus in Union, NJ

**
Branch campus of main campus in New Britain, CT

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    ACICS Reaccreditation Dates

School

  Last Accreditation Letter
  Next Accreditation
 
Brockton, MA****   April 14, 2005   December 31, 2008  
Henderson, NV****   April 14, 2005   December 31, 2008  
Lincoln, RI   April 14, 2005   December 31, 2008  
Lowell, MA**   December 19, 2002   December 31, 2004 (1)
Somerville, MA   May 1, 2002   December 31, 2004 (1)
Center City, PA*   April 30, 2003   December 31, 2006  
Edison, NJ   April 30, 2003   December 31, 2006  
Marietta, GA****   April 14, 2005   December 31, 2008  
Mt. Laurel, NJ*   April 30, 2003   December 31, 2006  
Norcross, GA****   April 14, 2005   December 31, 2008  
Paramus, NJ*   April 30, 2003   December 31, 2006  
Philadelphia, PA*   April 30, 2003   December 31, 2006  
Plymouth Meeting, PA*   April 30, 2003   December 31, 2006  
Dayton, OH   August 23, 2004(2)   December 31, 2005  
Vine Street, OH***   August 23, 2004(2)   December 31, 2005  
Northland Blvd., OH***   August 23, 2004(2)   December 31, 2005  
Franklin, OH***   August 23, 2004(2)   December 31, 2005  
Florence, KY***   August 23, 2004(2)   December 31, 2005  

*
Branch campus of main campus in Edison, NJ

**
Branch campus of main campus in Somerville, MA

***
Branch campus of main campus in Dayton, OH

****
Branch campus of main campus in Lincoln, NJ

(1)
We are in the process of obtaining a new accreditation letter.

(2)
Date of letter reconfirming accreditation upon acquisition. The last accreditation letter was dated May 1, 2002.

        If one of our schools fails to comply with accrediting commission requirements, the institution and its main and/or branch campuses are subject to the loss of accreditation. If any one of our schools lost its accreditation, students attending that school would no longer be eligible to receive Title IV Program funding, and we could be forced to close that school. Our Edison school (including its branch campuses in Mt. Laurel, Paramus, Philadelphia, Northeast Philadelphia and Plymouth Meeting) and our Somerville school (including its branch campus in Lowell) are presently under financial review with ACICS. Under financial review, the schools are required to submit to ACICS financial reports on a quarterly basis. While under financial review, an institution must obtain approval from ACICS before applying to add a new non-main location and may be required to request permission to submit a new program application. We believe that each of our schools is in substantial compliance with its respective accrediting commission's standards.

Nature of Federal and State Support for Post-Secondary Education

        The federal government provides a substantial part of its support for post-secondary education through Title IV Programs, in the form of grants and loans to students who can use those funds at any institution that has been certified as eligible by the DOE. Most aid under Title IV Programs is awarded on the basis of financial need, generally defined as the difference between the cost of attending the institution and the expected amount a student and his or her family can reasonably contribute to that

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cost. All recipients of Title IV Program funds must maintain a satisfactory grade point average and progress in a timely manner toward completion of their program of study. In addition, each school must ensure that Title IV Program funds are properly accounted for and disbursed in the correct amounts to eligible students.

        Students at our schools receive grants and loans to fund their education under the following Title IV Programs: (1) the Federal Family Education Loan, or FFEL, program, (2) the Federal Pell Grant, or Pell, program, (3) the Federal Supplemental Educational Opportunity Grant, or FSEOG, program, and (4) the Federal Perkins Loan, or Perkins, program.

        FFEL.     Under the FFEL program, banks and other lending institutions make loans to students or their parents. If a student or parent defaults on a loan, payment is guaranteed by a federally recognized guaranty agency, which is then reimbursed by the DOE. Students with financial need qualify for interest subsidies while in school and during grace periods. For the year ended December 31, 2004, we derived approximately 60% respectively of our Title IV revenues (calculated on the cash basis of accounting) from the FFEL program.

        Pell.     Under the Pell program, the DOE makes grants to students who demonstrate the greatest financial need. For the year ended December 31, 2004, we derived less than 20% of our revenues (calculated on the cash basis of accounting) from the Pell program.

        FSEOG.     FSEOG grants are designed to supplement Pell grants for students with the greatest financial needs. An institution is required to make a 25% matching contribution for all funds received from the DOE under this program. For the year ended December 31, 2004, we received less than 1% of our revenues (calculated on the cash basis of accounting) from the FSEOG program.

        Perkins.     Perkins loans are made from a revolving institutional account, 75% of which is capitalized by the DOE and the remainder by the institution. Each institution is responsible for collecting payments on Perkins loans from its former students and lending those funds to currently enrolled students. Defaults by students on their Perkins loans reduce the amount of funds available in the applicable school's revolving account to make loans to additional students, but the school does not have any obligation to guarantee the loans or repay the defaulted amounts. For the year ended December 31, 2004, we derived less than 1% of our revenues (calculated on the cash basis of accounting) from the Perkins program.

Other Financial Assistance Programs

        Some of our students receive financial aid from federal sources other than Title IV Programs, such as the programs administered by the U.S. Department of Veterans Affairs and under the Workforce Investment Act. In addition, many states also provide financial aid to our students in the form of grants, loans or scholarships. The eligibility requirements for state financial aid and these other federal aid programs vary among the funding agencies and by program. Several states that provide financial aid to our students are facing significant budgetary constraints. We believe that the overall level of state financial aid for our students is likely to decrease in the near term, but we cannot predict how significant any such reductions will be or how long they will last.

        In addition to Title IV and other government-administered programs, all of our schools are eligible to participate in alternative loan programs for their students. Alternative loans fill the gap between what the student receives from all financial aid sources and what the student may need to cover the full cost of their education. Students or their parents can apply to a number of different lenders for this funding at current market interest rates.

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Reorganization

        We were founded in 1946 as Lincoln Technical Institute, Inc. In February 2003, we reorganized our corporate structure to create a holding company, Lincoln Educational Services Corporation. The ownership of Lincoln Education Services Corporation was identical to that of Lincoln Technical Institute, Inc. immediately prior to this reorganization. We subsequently began operating our entire organization under the Lincoln Educational Services Corporation name; however, before this reorganization, all of our interaction with the DOE, state and federal regulators and accrediting agencies was conducted by Lincoln Technical Institute, Inc.

Regulation of Federal Student Financial Aid Programs

        To participate in Title IV Programs, an institution must be authorized to offer its programs by the relevant state education agencies, be accredited by an accrediting commission recognized by the DOE and be certified as eligible by the DOE. The DOE will certify an institution to participate in Title IV Programs only after the institution has demonstrated compliance with the HEA and the DOE's extensive regulations regarding institutional eligibility. The DOE defines an institution to consist of both a main campus and its additional locations, if any. Under this definition, for DOE purposes, we have the following 14 institutions, collectively consisting of 14 main campuses and 18 additional locations:

Brand

  Main Campus(es)
  Additional Location(s)
Lincoln Technical Institute   Indianapolis, IN
Philadelphia, PA
Columbia, MD
Grand Prairie, TX
Melrose Park, IL
Union, NJ
Allentown, PA
  Mahwah, NJ (additional location of Union)

Denver Automobile & Diesel College

 

Denver, CO

 


Nashville Auto Diesel College

 

Nashville, TN

 


Cittone Institute

 

Edison, NJ

 

Mount Laurel, NJ
Paramus, NJ
Philadelphia, PA
Plymouth Meeting, PA
Northeast Philadelphia, PA

Career Education Institute

 

Lincoln, RI
Somerville, MA

 

Brockton, MA (Lincoln)
Norcross, GA (Lincoln)
Marietta, GA (Lincoln)
Henderson, NV (Lincoln)
Lowell, MA (Somerville)

Southwestern College

 

Dayton, OH

 

Cincinnati, OH
Franklin, OH
Tri-County, Cincinnati, OH
Florence, KY

New England Technical Institute

 

New Britain, CT

 

Shelton, CT
Cromwell, CT
Hamden, CT

        All of our main campuses, including their additional locations, are currently certified by the DOE to participate in Title IV Programs. NETI received an executed temporary provisional program participation agreement, or a TPPPA, from the DOE after its change in ownership. Southwestern has

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received an executed provisional program participation agreement from the DOE. The DOE agreed that the addition of the holding company to our ownership structure in 2003 would not constitute a change in ownership of our institutions resulting in a change of control provided that certain conditions were met, including that the holding company execute the program participation agreement for each institution. See "Regulatory Environment—Reorganization" for a description of our reorganization in 2003. The holding company has executed a program participation agreement for each of our institutions except for NETI which has executed a TPPPA. In addition, the DOE requested that the institutions submit audited financial statements of both the holding company and the subsidiary companies as consolidating statements. We expect to submit to the DOE consolidating information for the 2004 fiscal year for LTI and Southwestern.

        The DOE, accrediting commissions and state education agencies have responsibilities for overseeing compliance of schools with Title IV Program requirements. As a result, each of our schools is subject to detailed oversight and review, and must comply with a complex framework of laws and regulations. Because the DOE periodically revises its regulations and changes its interpretation of existing laws and regulations, we cannot predict with certainty how the Title IV Program requirements will be applied in all circumstances.

        Significant factors relating to Title IV Programs that could adversely affect us include the following:

        Congressional Action.     Political and budgetary concerns significantly affect Title IV Programs. Congress must reauthorize the Higher Education Act approximately every five years. The last reauthorization took place in 1998. Consequently, Congress recently began the process of reviewing and reauthorizing the HEA again, a process that is expected to be concluded in 2005. We believe that this reauthorization will likely result in numerous changes to the HEA. At this time, we cannot predict with certainty what changes Congress will make.

        In addition, Congress reviews and determines federal appropriations for Title IV Programs on an annual basis. Congress can also make changes in the laws affecting Title IV Programs in the annual appropriations bills and in other laws it enacts between the HEA reauthorizations. Because a significant percentage of our revenues are derived from Title IV Programs, any action by Congress that significantly reduces Title IV Program funding or the ability of our schools or students to participate in Title IV Programs could reduce our student enrollment and our revenues. Congressional action may also increase our administrative costs and require us to modify our practices in order for our schools to comply fully with Title IV Program requirements.

        The "90/10 Rule."     A proprietary institution, such as each of our institutions, loses its eligibility to participate in Title IV Programs if, on a cash accounting basis, it derives more than 90% of its revenues for any fiscal year from Title IV Programs. Any institution that violates this rule becomes ineligible to participate in Title IV Programs as of the first day of the fiscal year following the fiscal year in which it exceeds 90%, and is unable to apply to regain its eligibility until the next fiscal year. If one of our institutions violated the 90/10 Rule and became ineligible to participate in Title IV Programs but continued to disburse Title IV Program funds, the DOE would require the institution to repay all Title IV Program funds received by the institution after the effective date of the loss of eligibility.

        We have calculated that, for each of our 2002, 2003 and 2004 fiscal years, none of our institutions derived more than 86.6% of its revenues from Title IV Programs. For our 2004 fiscal year, our institutions' 90/10 Rule percentages ranged from 73.3% to 86.6%. We regularly monitor compliance with this requirement to minimize the risk that any of our institutions would derive more than the maximum percentage of its revenues from Title IV Programs for any fiscal year.

        Student Loan Defaults.     An institution may lose its eligibility to participate in some or all Title IV Programs if the rates at which the institution's current and former students default on their federal student loans exceed specified percentages. The DOE calculates these rates based on the number of

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students who have defaulted, not the dollar amount of such defaults. The DOE calculates an institution's cohort default rate on an annual basis as the rate at which borrowers scheduled to begin repayment on their loans in one year default on those loans by the end of the next year. An institution whose FFEL cohort default rate is 25% or greater for three consecutive federal fiscal years (which correspond to our fiscal years) loses eligibility to participate in the FFEL and Pell programs for the remainder of the federal fiscal year in which the DOE determines that such institution has lost its eligibility and for the two subsequent federal fiscal years. An institution whose FFEL cohort default rate for any single federal fiscal year exceeds 40% may have its eligibility to participate in all Title IV Programs limited, suspended or terminated by the DOE.

        None of our institutions has had an FFEL cohort default rate of 25% or greater for any of the federal fiscal years 2000, 2001 and 2002, the three most recent years for which the DOE has published such rates. Nine of our 14 institutions (which include 23 of 32 campuses) had default rates less than 10% for these years. The following table sets forth the FFEL cohort default rates for each of our 14 DOE numbers for those fiscal years.

Institution

  2000
  2001
  2002
 
Union, NJ   4.4 % 4.2 % 5.9 %
Indianapolis, IN   9.1 % 5.8 % 8.41 %
Philadelphia, PA   9.5 % 15.2 % 13.7 %
Columbia, MD   4.4 % 5.7 % 7.1 %
Allentown, PA   4.1 % 2.7 % 7.1 %
Melrose Park, IL   5.9 % 5.6 % 11.9 %
Grand Prairie, TX   11.7 % 10.7 % 14.3 %
Edison, NJ   4.4 % 2.9 % 4.1 %
Denver, CO   9.0 % 10.4 % 8.4 %
Nashville, TN   7.4 % 5.5 % 5.0 %
Lincoln, RI   3.7 % 5.1 % 6.2 %
Somerville, MA   1.2 % 2.5 % 6.2 %
Dayton, OH   16.6 % 0.0 % 0.0 %
New Britain, CT   2.8 % 2.8 % 3.9 %

        An institution whose cohort default rate under the FFEL program is 25% or greater for any one of the three most recent federal fiscal years, or whose cohort default rate under the Perkins program exceeds 15% for any federal award year (the twelve-month period from July 1 through June 30), may be placed on provisional certification status by the DOE. None of our institutions have a FFEL cohort default rate above 25% for any of the three most recent fiscal years for which the DOE has published rates.

        An institution whose Perkins cohort default rate is 50% or greater for three consecutive federal award years loses eligibility to participate in the Perkins program for the remainder of the federal award year in which DOE determines that the institution has lost its eligibility and for the two subsequent federal award years. None of our institutions has had a Perkins cohort default rate of 50% or greater for any of the last three federal award years. The DOE also will not provide any additional federal funds to an institution for Perkins loans in any federal award year in which the institution's Perkins cohort default rate is 25% or greater. DADC and NETI are our only institutions participating in the Perkins program. DADC's cohort default rate was 22.86% for students scheduled to begin repayment in the 2002-2003 federal award year. The DOE has not provided any federal funds for Perkins loans to DADC. DADC continues to make loans out of its existing Perkins loan fund. NETI is provisionally certified by the DOE based on its change in ownership and on a finding by the DOE prior to the change in ownership that NETI had not transmitted certain data related to the Perkins program to the National Student Loan Data System during periods prior to the acquisition. NETI's

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cohort default rate was 4.35% for students scheduled to begin repayment in the 2002-2003 federal award year.

        Financial Responsibility Standards.     All institutions participating in Title IV Programs must satisfy specific standards of financial responsibility. The DOE evaluates institutions for compliance with these standards each year, based on the institution's annual audited financial statements, as well as following a change in ownership resulting in a change of control of the institution.

        The most significant financial responsibility measurement is the institution's composite score, which is calculated by the DOE based on three ratios:

    the equity ratio, which measures the institution's capital resources, ability to borrow and financial viability;

    the primary reserve ratio, which measures the institution's ability to support current operations from expendable resources; and

    the net income ratio, which measures the institution's ability to operate at a profit.

        The DOE assigns a strength factor to the results of each of these ratios on a scale from negative 1.0 to positive 3.0, with negative 1.0 reflecting financial weakness and positive 3.0 reflecting financial strength. The DOE then assigns a weighting percentage to each ratio and adds the weighted scores for the three ratios together to produce a composite score for the institution. The composite score must be at least 1.5 for the institution to be deemed financially responsible without the need for further oversight. If an institution's composite score is below 1.5, but is at least 1.0, it is in a category denominated by the DOE as "the zone." Under the DOE regulations, institutions that are in the zone are deemed to be financially responsible for a period of up to three years but are required to accept payment of Title IV Program funds under the cash monitoring or reimbursement method of payment, to be provisionally certified and to provide to the DOE timely information regarding various oversight and financial events.

        If an institution's composite score is below 1.0, the institution is considered by the DOE to lack financial responsibility. If the DOE determines that an institution does not satisfy the DOE's financial responsibility standards, depending on its composite score and other factors, that institution may establish its financial responsibility on an alternative basis by, among other things:

    posting a letter of credit in an amount equal to at least 50% of the total Title IV Program funds received by the institution during the institution's most recently completed fiscal year;

    posting a letter of credit in an amount equal to at least 10% of such prior year's Title IV Program funds, accepting provisional certification, complying with additional DOE monitoring requirements and agreeing to receive Title IV Program funds under an arrangement other than the DOE's standard advance funding arrangement; and/or

    complying with additional DOE monitoring requirements and agreeing to receive Title IV Program funds under an arrangement other than the DOE's standard advance funding arrangement.

        The DOE has evaluated the financial condition of our institutions on a consolidated basis. DOE regulations permit the DOE to examine our financial statements, including the financial statements of each institution and the financial statements of any related party. Based on our calculations, our audited financial statements for the 2003 and 2004 fiscal years reflect a composite score of 2.1 and 1.8, respectively. However, as a result of the corrections of certain errors in our prior financial statements, including accounting for advertising costs, a sale leaseback transaction, rent and other individually insignificant adjustments, the DOE recomputed our previously submitted consolidated composite scores for the years ended December 31, 2001 and 2002 and concluded that the recomputed consolidated composite scores for those two years were below 1.0. In addition, we identified certain additional errors

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in our financial statements for the year ended December 31, 2003 relating to our accounting for stock-based compensation and accrued bonuses that did not result in a recomputation of our 2003 composite score. The DOE has informed us that as a result, for a period of three years effective December 30, 2004, all of our current and future schools have been placed on "Heightened Cash Monitoring, Type 1 status" and are required to timely notify the DOE with respect to certain enumerated oversight and financial events. The DOE also informed us that these corrections will be taken into consideration when each of our institutions applies for recertification of its eligibility to participate in Title IV Programs. When each of our institutions is next required to apply for recertification to participate in Title IV Programs, we expect that the DOE will also consider our audited financial statements and composite scores for our most recent fiscal year as well as for other fiscal years after 2001 and 2002. Additionally, since the DOE concluded that the previously computed composite scores for 2001 and 2002 were overstated, we have agreed to pay $165,000 to the DOE, pursuant to a settlement agreement, with respect to compliance issues related to this matter. We paid this amount on March 3, 2005. Although no assurance can be given, we do not believe that actions of the DOE specified above will have a material effect on our financial position or results of operations.

        Return of Title IV Funds.     An institution participating in Title IV Programs must calculate the amount of unearned Title IV Program funds that have been disbursed to students who withdraw from their educational programs before completing them, and must return those unearned funds to the DOE or the applicable lending institution in a timely manner, which is generally within 30 days from the date the institution determines that the student has withdrawn.

        If an institution is cited in an audit or program review for returning Title IV Program funds late for 5% or more of the students in the audit or program review sample, the institution must post a letter of credit in favor of the DOE in an amount equal to 25% of the total amount of Title IV Program funds that should have been returned for students who withdrew in the institution's previous fiscal year. Southwestern made late returns of Title IV Program funds in excess of the DOE's prescribed threshold, most of which predated our acquisition of Southwestern. As a result, in accordance with DOE regulations, we have submitted a letter of credit to the DOE in the amount of $28,400. NADC made late returns of Title IV Program funds in excess of the DOE's prescribed threshold during periods that predated our acquisition of NADC. As a result, in accordance with DOE regulations, we submitted a letter of credit to the DOE in the amount of $327,000. Based on the absence of late returns of Title IV Program funds in excess of the DOE's prescribed thresholds in NADC's compliance audits for the 2002 fiscal year after our acquisition and for the 2003 fiscal year, we were allowed to have this letter of credit expire in accordance with its terms in March 2004. Our other institutions were not required to submit a letter of credit based on the results of their 2002 and 2003 compliance audits.

        School Acquisitions.     When a company acquires a school that is eligible to participate in Title IV Programs, that school undergoes a change of ownership resulting in a change of control as defined by the DOE. Upon such a change of control, a school's eligibility to participate in Title IV Programs is generally suspended until it has applied for recertification by the DOE as an eligible school under its new ownership, which requires that the school also re-establish its state authorization and accreditation. The DOE may temporarily and provisionally certify an institution seeking approval of a change of control under certain circumstances while the DOE reviews the institution's application. The time required for the DOE to act on such an application may vary substantially. DOE recertification of an institution following a change of control will be on a provisional basis. Our expansion plans are based, in part, on our ability to acquire additional schools and have them certified by the DOE to participate in Title IV Programs. Our expansion plans take into account the approval requirements of the DOE and the relevant state education agencies and accrediting commissions. Southwestern received an executed provisional program participation agreement from the DOE. In connection with our acquisition of NETI, we have received an executed TPPPA from the DOE and are in the process of

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obtaining a final approval of the NETI acquisition from the DOE. We expect the DOE approval issued to NETI at the conclusion of the pending change in ownership approval process to be provisional although we can provide no assurance as to the timing and content of the DOE's response to the pending change in ownership application.

        Change of Control.     In addition to school acquisitions, other types of transactions can also cause a change of control. DOE, most state education agencies and our accrediting commissions have standards pertaining to the change of control of schools, but these standards are not uniform. DOE regulations describe some transactions that constitute a change of control, including the transfer of a controlling interest in the voting stock of an institution or the institution's parent corporation. For a company that is privately held, but not closely held, which is the status of our company prior to the offering, DOE regulations provide that a change of ownership resulting in a change of control occurs if any person either acquires or ceases to hold at least 25% of the company's total outstanding voting stock and that person gains or loses actual control of the corporation. With respect to a publicly traded corporation, which will be the status of our company after the offering, DOE regulations provide that a change of control occurs in one of two ways: (a) if there is an event that would obligate the corporation to file a Current Report on Form 8-K with the Securities and Exchange Commission disclosing a change of control or (b) if the corporation has a shareholder that owns at least 25% of the total outstanding voting stock of the corporation and is the largest shareholder of the corporation, and that shareholder ceases to own at least 25% of such stock or ceases to be the largest shareholder. These standards are subject to interpretation by the DOE.

        A significant purchase or disposition of our common stock could be determined by the DOE to be a change of control under this standard. Most of the states and our accrediting commissions include the sale of a controlling interest of common stock in the definition of a change of control. A change of control under the definition of one of these agencies would require the affected school to reaffirm its state authorization or accreditation. The requirements to obtain such reaffirmation from the states and our accrediting commissions vary widely.

        We have not received confirmation from the DOE or from our state licensing agencies that this offering will not be a change of control under its standards. We have submitted requests for such confirmation from the DOE and educational agencies in states in which our schools are physically located, which we expect to receive prior to completion of this offering. ACCSCT and ACICS have previously confirmed that this offering will not be a change of control under its standards.

        A change of control could occur as a result of future transactions in which our company or schools are involved. Some corporate reorganizations and some changes in the board of directors are examples of such transactions. Moreover, once we become a publicly traded company, the potential adverse effects of a change of control could influence future decisions by us and our stockholders regarding the sale, purchase, transfer, issuance or redemption of our stock. In addition, the adverse regulatory effect of a change of control also could discourage bids for your shares of common stock and could have an adverse effect on the market price of your shares.

        Opening Additional Schools and Adding Educational Programs.     For-profit educational institutions must be authorized by their state education agencies and fully operational for two years before applying to the DOE to participate in Title IV Programs. However, an institution that is certified to participate in Title IV Programs may establish an additional location and apply to participate in Title IV Programs at that location without reference to the two-year requirement, if such additional location satisfies all other applicable DOE eligibility requirements. Our expansion plans are based, in part, on our ability to open new schools as additional locations of our existing institutions and take into account the DOE's approval requirements.

        A student may use Title IV Program funds only to pay the costs associated with enrollment in an eligible educational program offered by an institution participating in Title IV Programs. Generally, an

69



institution that is eligible to participate in Title IV Programs may add a new educational program without DOE approval if that new program leads to an associate level or higher degree and the institution already offers programs at that level, or if that program prepares students for gainful employment in the same or a related occupation as an educational program that has previously been designated as an eligible program at that institution and meets minimum length requirements. If an institution erroneously determines that an educational program is eligible for purposes of Title IV Programs, the institution would likely be liable for repayment of Title IV Program funds provided to students in that educational program. Our expansion plans are based, in part, on our ability to add new educational programs at our existing schools. We do not believe that current DOE regulations will create significant obstacles to our plans to add new programs.

        Some of the state education agencies and our accrediting commission also have requirements that may affect our schools' ability to open a new campus, establish an additional location of an existing institution or begin offering a new educational program. Our Edison school (including its branch campuses in Mt. Laurel, Paramus, Philadelphia, Center City and Plymouth Meeting) and our Somerville school (including its Lowell branch campus) are presently under financial review with ACICS. Under financial review, the school is required to submit financial reports to ACICS on a quarterly basis. While on financial review, an institution must obtain approval from ACICS before applying to add a new non-main location and may be required to request permission to submit a new program application. We do not believe that these standards will create significant obstacles to our expansion plans.

        Administrative Capability.     The DOE assesses the administrative capability of each institution that participates in Title IV Programs under a series of separate standards. Failure to satisfy any of the standards may lead the DOE to find the institution ineligible to participate in Title IV Programs or to place the institution on provisional certification as a condition of its participation. These criteria require, among other things, that the institution:

    complies with all applicable federal student financial aid regulations;

    has capable and sufficient personnel to administer the federal student financial aid programs;

    has acceptable methods of defining and measuring the satisfactory academic progress of its students;

    refers to the Office of the Inspector General any credible information indicating that any applicant, student, employee or agent of the school has been engaged in any fraud or other illegal conduct involving Title IV Programs;

    provides financial aid counseling to its students; and

    submits in a timely manner all reports and financial statements required by the regulations.

Failure by an institution to satisfy any of these or other administrative capability criteria could cause the institution to lose its eligibility to participate in Title IV Programs, which would have a material adverse effect on our business and results of operations.

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        Other standards provide that an institution may be found to lack administrative capability and be placed on provisional certification if its student loan default rate under the FFEL program is 25% or greater for any of the three most recent federal fiscal years, or if its Perkins cohort default rate exceeds 15% for any federal award year. None of our institutions have a FFEL cohort default rate above 25% for any of the three most recent fiscal years for which the DOE has published rates. DADC and NETI are our only institutions participating in the Perkins program. DADC's cohort default rate was 22.86% for students scheduled to begin repayment in the 2002-2003 federal award year. The DOE has not provided any federal funds for Perkins loans to DADC. DADC continues to make loans out of its existing Perkins loan fund. As it was prior to when we acquired it, NETI is provisionally certified by the DOE based on its change in ownership and on a finding by the DOE prior to the change in ownership that NETI had not transmitted certain data related to the Perkins program to the National Student Loan Data System during periods prior to the acquisition. NETI's cohort default rate was 4.35% for students schedule to begin repayment in the 2002-2003 federal award year.

        Ability to Benefit Regulations.     Under certain circumstances, an institution may elect to admit non-high school graduates, or "ability to benefit," or ATB, students, into certain of its programs of study. In order for ATB students to be eligible for Title IV Program participation, the institution must comply with the ATB requirements set forth in the Title IV Program requirements. The basic evaluation method to determine that a student has the ability to benefit from the program is the student's achievement of a minimum score on a test approved by the DOE and independently administered in accordance with DOE regulations. In addition to the testing requirements, the DOE regulations also prohibit ATB student enrollments from constituting 50% or more of the total enrollment of the institution. We changed our policy and stopped admitting ATB students in 2003. We subsequently acquired Southwestern in 2004 and NETI in 2005, both of which currently enroll ATB students. With the exception of Southwestern and NETI, we expect to continue this policy and our other schools do not expect to admit ATB students in the future.

        On or about May 10, 2002, the DOE Office of Inspector General, or OIG, issued a final audit report to the Philadelphia, Pennsylvania LTI school concerning an OIG audit of the Philadelphia LTI school's administration of ATB testing. The report was issued under OIG audit control number A03-B0013 and covered the administration of ATB testing requirements at the Philadelphia LTI school from July 1, 1997 through November 7, 2000. The findings presented in the OIG report cited alleged deficiencies with respect to aspects of ATB test administration. We disagreed with the OIG findings and recommendations and submitted detailed comments to the DOE's Philadelphia Case Management Team explaining our position. On October 31, 2003, we entered into a Settlement Agreement with the DOE constituting a complete accord and satisfaction and final resolution of the findings in the OIG final audit report.

        Restrictions on Payment of Commissions, Bonuses and Other Incentive Payments.     An institution participating in Title IV Programs may not provide any commission, bonus or other incentive payment based directly or indirectly on success in securing enrollments or financial aid to any person or entity engaged in any student recruiting or admission activities or in making decisions regarding the awarding of Title IV Program funds. In November 2002, the DOE published new regulations which attempt to clarify this so-called "incentive compensation rule." Failure to comply with the incentive compensation rule could result in loss of ability to participate in Title IV Programs or in fines or liabilities. We believe that our current compensation plans are in compliance with the HEA and the DOE's new regulations, although we cannot assure you that DOE will not find deficiencies in our compensation plans.

        Eligibility and Certification Procedures.     Each institution must periodically apply to the DOE for continued certification to participate in Title IV Programs. The institution must also apply for recertification when it undergoes a change in ownership resulting in a change of control. The institution also may come under DOE review when it undergoes a substantive change that requires the submission

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of an application, such as opening an additional location or raising the highest academic credential it offers. The DOE agreed that the addition of the holding company to our ownership structure in 2003 would not constitute a change in ownership of our schools resulting in a change of control provided that certain conditions were met, including that the holding company execute the program participation agreement for each institution. See "Regulatory Environment—Reorganization" for a description of our reorganization in 2003. The holding company has executed a program participation agreement for each of our institutions, except for NETI, which has executed a TPPPA. In addition, the DOE requested that the institutions submit audited financial statements of both the holding company and the subsidiary companies as consolidating statements. We expect to submit consolidating information for the 2004 fiscal year for LTI and Southwestern.

        The DOE may place an institution on provisional certification status if it determines that the institution does not fully satisfy certain administrative and financial standards or if the institution undergoes a change in ownership resulting in a change of control. The DOE may withdraw an institution's provisional certification with the institution having fewer due process protections than if it were fully certified. In addition, the DOE may more closely review an institution that is provisionally certified if it applies for approval to open a new location, add an educational program, acquire another school or make any other significant change. Provisional certification does not otherwise limit an institution's access to Title IV Program funds. Southwestern received an executed provisional program participation agreement from the DOE. In connection with our acquisition of NETI, we have received an executed TPPPA from the DOE and are in the process of obtaining final approval of the NETI acquisition from the DOE. We expect the DOE approval issued to NETI at the conclusion of the pending change in ownership approval process to be provisional although we can provide no assurance as to the timing and content of the DOE's response to the pending change in ownership application.

        All institutions are recertified on various dates for various amounts of time. The following table sets forth the expiration dates for each of our institutions' current program participation agreement:

Institution

  Expiration Date of Current Program
Participation Agreement

 
Allentown, PA   September 30, 2007  
Columbia, MD   September 30, 2007  
Philadelphia, PA   September 30, 2007  
Denver, CO   December 31, 2009  
Lincoln, RI   March 31, 2008  
Nashville, TN   June 30, 2008  
Somerville, MA   March 31, 2008  
Edison, NJ   September 30, 2007  
Union, NJ   September 30, 2007  
Grand Prairie, TX   March 31, 2009  
Indianapolis, IN   March 31, 2009  
Melrose Park, IL   March 31, 2009  
Dayton, OH   March 31, 2008 *
New Britain, CT   March 31, 2005 **

*
Provisionally certified.

**
The temporary provisional program participation agreement continues on a month-to-month basis until the DOE makes a determination on the institution's application for approval of the change in ownership. The institution is waiting for final DOE approval of the change in ownership.

        Compliance with Regulatory Standards and Effect of Regulatory Violations.     Our schools are subject to audits, program reviews, and site visits by various regulatory agencies, including the DOE, the DOE's Office of Inspector General, state education agencies, student loan guaranty agencies, the U.S. Department of Veterans Affairs and our accrediting commissions. In addition, each of our institutions must retain an independent certified public accountant to conduct an annual audit of the institution's

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administration of Title IV Program funds. The institution must submit the resulting audit report to the DOE for review.

        The DOE conducted a program review at Southwestern and issued an initial program review report in which it identified potential instances of non-compliance with DOE requirements. The report contained nine findings in which the DOE contended that Southwestern did not identify the specific date each Title IV transaction was posted to a student's account, did not provide adequate financial aid counseling to its eligible students applying for Title IV assistance, did not have certain internal control procedures, did not make refunds timely to certain students, did not have satisfactory academic progress that met regulatory requirements, did not have a system between the financial aid and fiscal offices to regularly reconcile student financial aid awards and disbursements, did not maintain adequate records to support expenditures in the Federal Pell Grant and Federal Supplemental Educational Opportunity Grant programs, and awarded Federal Supplemental Educational Opportunity Grant program funds in amounts below the minimum award amount for an academic year. The report also included a finding that the overall findings reflected a lack of administrative capability on the part of the institution. That finding also stated that the DOE was aware of the change in ownership of Southwestern and that DOE reviewers discussed with school personnel the expectation that Southwestern would correct the deficiencies. Southwestern has submitted an initial response to the report, has provided additional information requested by the DOE, and is waiting for a response or determination from the DOE.

        The DOE also conducted a program review at NADC and issued a final program review determination stating that NADC had taken the required corrective actions to resolve four of five findings of noncompliance with DOE requirements and requiring that NADC pay the DOE $14,499 based on the fifth finding. The first four findings contended that NADC had failed to properly prorate the Federal Pell Grant award for one student, had underawarded Federal Pell Grants to seven students, had improperly awarded a Federal Pell Grant award to one student, and had made an unequal Federal Supplemental Educational Opportunity Grant program award to one student. The fifth finding related to NADC granting Federal Supplemental Educational Opportunity Grant matching funds to ineligible students. NADC expects to pay the $14,499 amount to the DOE in the second quarter of 2005.

        If one of our schools failed to comply with accrediting or state licensing requirements, such school and its main and/or branch campuses could be subject to the loss of state licensure or accreditation, which in turn could result in a loss of eligibility to participate in Title IV Programs. If the DOE determined that one of our institutions improperly disbursed Title IV Program funds or violated a provision of the Higher Education Act or DOE regulations, the institution could be required to repay such funds and related costs to the DOE and lenders, and could be assessed an administrative fine. The DOE could also place the institution on provisional certification and/or transfer the institution to the reimbursement or cash monitoring system of receiving Title IV Program funds, under which an institution must disburse its own funds to students and document the students' eligibility for Title IV Program funds before receiving such funds from the DOE. The DOE has informed us that as a result of our recomputed composite scores for the 2001 and 2002 fiscal years, all of our current and future institutions have been placed on "Heightened Cash Monitoring, Type 1 status" for a period of three years effective December 30, 2004 and are required to timely notify the DOE with respect to certain enumerated oversight and financial events. The DOE has also informed us that these accounting charges will be taken into consideration when each of our institutions applies for recertification of its eligibility to participate in Title IV Programs.

        An institution that is operating under "Heightened Cash Monitoring, Type 1 status," is required to credit student accounts before drawing down funds under Title IV Programs and to draw down funds in an amount no greater than the previous disbursement to students and parents. Additionally, the institution's compliance audit will be required to contain verification that this did occur throughout the year. In addition to the above, the DOE has required us to comply with certain requirements prescribed for institutions operating in "the zone," which is indicative of a composite score between 1.0

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and 1.4. Those requirements include providing timely information regarding any of the following oversight and financial events:

    any adverse action, including a probation or similar action, taken against the institution by its accrediting agency;

    any event that causes the institution, or related entity to realize any liability that was noted as a contingent liability in the institution's or related entity's most recent audit financial statement;

    any violation by the institution of any loan agreement;

    any failure of the institution to make a payment in accordance with its debt obligations that results in a creditor filing suit to recover funds under those obligations;

    any withdrawal of owner's equity from institution by any means, including declaring a dividend; or

    any extraordinary losses, as defined in accordance with Accounting Principles Board Opinion No. 30.

        Operating under the zone requirements may also require the institution to submit its financial statement and compliance audits earlier than the date previously required and require the institution to provide information about its current operations and future plans. An institution that continues to fail to meet the financial responsibility standards set by the DOE or does not comply with the zone requirements may lose its eligibility to continue to participate in Title IV funding or it may be required to post irrevocable letters of credit, for an amount determined by the DOE that is not less than 50% of the Title IV Program funds received by the institution during its most recently completed fiscal year.

        Significant violations of Title IV Program requirements by us or any of our institutions could be the basis for a proceeding by the DOE to limit, suspend or terminate the participation of the affected institution in Title IV Programs or to civil or criminal penalties. Generally, such a termination extends for 18 months before the institution may apply for reinstatement of its participation. There is no DOE proceeding pending to fine any of our institutions or to limit, suspend or terminate any of our institutions' participation in Title IV Programs.

        We and our schools are also subject to complaints and lawsuits relating to regulatory compliance brought not only by our regulatory agencies, but also by third parties, such as present or former students or employees and other members of the public. If we are unable to successfully resolve or defend against any such complaint or lawsuit, we may be required to pay money damages or be subject to fines, limitations, loss of federal funding, injunctions or other penalties. Moreover, even if we successfully resolve or defend against any such complaint or lawsuit, we may have to devote significant financial and management resources in order to reach such a result.

        Lenders and Guaranty Agencies.     In 2004, six lenders provided funding to more than 91% of the students at the schools we owned during that year: Bank One, N.A., SLMA Wilmington Trust, Citibank Student Loan Corporation, SunTrust Bank, JPMorgan Chase Bank, Educaid (Wachovia), and ASAP Union Bank & Trust. While we believe that other lenders would be willing to make federally guaranteed student loans to our students if loans were no longer available from our current lenders, there can be no assurances in this regard. In addition, the HEA requires the establishment of lenders of last resort in every state to ensure that loans are available to students at any school that cannot otherwise identify lenders willing to make federally guaranteed loans to its students.

        Our primary guarantors for Title IV loans are USA Group, a subsidiary of Sallie Mae, and New Jersey Higher Education Assistance Authority, an independent agency of the State of New Jersey. These two agencies currently guarantee 91% of all federally guaranteed student loans made to students enrolled at our schools. There are six other guaranty agencies that guarantee student loans made to students enrolled at our schools. We believe that other guaranty agencies would be willing to guarantee loans to our students if any of the guarantee agencies ceased guaranteeing those loans or reduced the volume of loans they guarantee, although there can be no assurances in this regard.

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