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Published in Print: February 9, 2000, as For-Profit School Management Company Hits Hard Times

For-Profit School Management Company Hits Hard Times

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Tesseract Group Inc., a pioneer in the growing business of managing public schools for profit, is facing a mounting barrage of bad news.

In recent months, the Scottsdale, Ariz.-based company—formerly known as Education Alternatives Inc.—replaced its founding chief executive officer, laid off one-fourth of its central administrative workforce, and closed three of its schools.

Then last week, Tesseract's interim CEO and its chief financial officer resigned, and the company said it was running out of money. The spate of troubles leaves the company's 37 preschools, private schools, and public charter schools, which serve some 8,000 students, facing an uncertain future.

Its stock, which reached a high of $48.50 per share in 1993, was trading last week for less than $1 per share. The Nasdaq stock market recently informed Tesseract that the stock would be "de-listed" because the company's assets have fallen below the market's minimum criteria.

The company issued a statement last week saying it expects its stock to be taken off the Nasdaq market on Feb. 10 unless "it is able to secure additional financing."

"The company's cash position is extremely tight," Tesseract said in the Feb. 1 press release.

Calls to the company's offices went unanswered late last week. An unidentified employee reached at the headquarters late last month said: "We're in a quiet period. We've hired an investment banker. That's all I can say right now."

History of Problems

As EAI, the company helped usher in the trend of private management of public schools, paving the way for larger companies such as Edison Schools Inc. and Advantage Schools Inc.

Starting in 1991 with a contract to run one elementary school in Miami Beach, EAI was soon hired to run a dozen schools in Baltimore and the entire school system in Hartford, Conn.

But teachers' unions in Baltimore and Hartford battled the company fiercely over its program, which included among other things the replacement of unionized teachers' aides with its own lower-paid staff members. Amid heated disputes over test scores and the company's overall performance, both Baltimore and Hartford ended their contracts with EAI.

Hoping for a fresh start, the company moved its headquarters from Minneapolis to Scottsdale and changed its name in 1998 to Tesseract. It began to focus on running charter schools, and was particularly successful in the charter hotbed of Arizona. Tesseract runs 13 charters in the state, along with a handful of tuition-based private schools in Arizona and Minnesota, and two other charter schools in Texas and the District of Columbia.

Tesseract also acquired Sunrise Preschools, an Arizona- based chain, and the Academy of Business Inc., a postsecondary business school in that state.

"But it has been struggling after Baltimore," said John M. McLaughlin, the editor of The Education Industry Report, a newsletter that tracks for-profit education providers. "It became hard for the company to reinvent itself."

Besides last week's executive resignations, the company has had other recent misfortunes.

In November, Tesseract's board replaced John T. Golle, the company's founder and longtime chief executive officer, with an interim CEO, Martha Taylor Thomas. Ms. Thomas, a Phoenix-area lawyer who has served on Tesseract's board since 1997, resigned last week along with Richard Yonker, the chief financial officer. Neither could be reached for comment, but Tesseract said in its release that they resigned over differences about "the direction of the company."

The company laid off 10 employees in its headquarters in December and closed some unprofitable schools in the past year, two in New Jersey and one in Colorado.

The company also said it was in dispute with the board of the Southeast Academy of Scholastic Excellence charter school in Washington and is likely to withdraw from managing the school.

In December, company officials said Tesseract would forgo national expansion in favor of growth in the Southwest. But it also hired an investment bank, First Security Van Kamper of Scottsdale, "to explore strategic alternatives."

In the Red

Even in Arizona, Tesseract has faced challenges. The company has benefited from a loophole in the state's charter school law that has allowed it and other charter operators to pocket hefty transportation fees. Charter schools that are sponsored by districts, such as Tesseract's, get reimbursed as much as $1.95 per mile for transporting students and can pocket any savings from actual transportation costs.

Tesseract says in a quarterly report that it collected $760,000 in such fees just in the three months that ended Sept. 30. But lawmakers closed the loophole in a revision to the charter law that takes effect July 1. Tesseract also has troubles related to the construction of charter school facilities. It said in November that it was unable to prepay rent or property tax of $2.8 million at the start of the school year for four school sites. And it faces a foreclosure lawsuit over other properties.

Tesseract's cash flow problems were so severe that it borrowed $5 million from one of its directors and major investors, Benjamin Nazarian of the Pioneer Venture Fund. Under an agreement with the company, Mr. Nazarian was to be allowed to convert the unpaid principal of the loan into 3.5 million shares of Tesseract stock. But the company's shareholders rejected the proposal in December. As a result of the rejection, the loan agreement calls for the interest rate on the loan to increase from 12 percent annually to 18 percent.

An associate of Mr. Nazarian's said he did not want to comment on Tesseract.

In its fiscal year that ended June 30, Tesseract had revenues of $37 million, a 144 percent jump over fiscal 1998 resulting mostly from the acquisitions of Sunrise Preschools and the business college. But it had a net loss for the year of $10.7 million.

In its most recent quarterly report, filed in November for the three months ending on Sept. 30, the company had a net loss of $3.4 million and said its accumulated deficit was $39.1 million.

"These factors, among other things, may indicate that the company will be unable to continue as a going concern for a reasonable period of time," the report said.

As for Tesseract's stock, the company said it was being de-listed for noncompliance with Nasdaq's requirement for net tangible assets. According to Nasdaq's rules, a listed company must maintain net tangible assets of $4 million. Another requirement is for a minimum bid price of $1 per share. Tesseract's share price fell below $1 after the Jan. 3 announcement of the de-listing.

A company that falls below the stock market's minimum criteria must persuade a hearing panel that it has a viable plan to get back into compliance or else it will be de- listed, according to a Nasdaq spokesman.

If Tesseract's stock is indeed de-listed, it could still be traded on smaller, less prestigious markets.

Vol. 19, Issue 22, Page 5

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