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Published in Print: May 22, 2002, as Edison Reels Amid Flurry Of Bad News

Edison Reels Amid Flurry Of Bad News

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The news just seemed to go from bad to worse last week for Edison Schools Inc.

Just minutes before the nation's largest for-profit manager of public schools was to begin a much-anticipated financial announcement on May 14—which among other things was meant to soothe investors after weeks of sharp declines in its stock price—the federal Securities and Exchange Commission released a bit of a bombshell.

The commission announced the settlement of a three-month inquiry into Edison's financial practices, concluding that the company had failed to disclose that money it reported as revenue had never actually passed through its hands.

The investigation was not a surprise to Edison executives, who had been spending much of their time cooperating with the SEC over the matter. But neither Edison nor the commission had publicly announced the investigation while it was going on, so it came as one more unpleasant revelation to the company's constituencies on Wall Street and in education.

Besides the SEC news, there was also the matter of Edison's report of another quarterly loss. For the three months ending March 31, the company lost $16.9 million on revenues of $121.9 million. The loss per share was 31 cents, compared with 13 cents for the same quarter last year.

And in the days that followed, more bad news surfaced. Three shareholder lawsuits were filed in U.S. District Court in New York City on May 15. The class actions, based largely on the information stemming from the SEC investigation, alleged that Edison and its officers had made misrepresentations and omissions regarding the company's financial information.

Then on May 16, Edison disclosed that its relationship with one of its first charter schools, located in Boston, was coming to an early end. The Boston Renaissance Charter School, with 1,300 students in grades K-8, is terminating a contract with Edison that was supposed to run until 2005. The company maintained that the decision was mutual.

By late last week, Edison's stock had sunk even lower, closing at $1.75 on May 16. It was down from around $20 a share this past January and far from its historic high of $36 a share in early 2001.

Philadelphia Support

Still, Edison executives declared that they remained upbeat. They said they had been constrained from mounting a strong public defense of the company in recent weeks because of the SEC investigation.

"The time has come to begin the process of correcting the record," Christopher D. Cerf, Edison's chief operating officer, said during the conference call with analysts on May 14. "Our business model remains sound. Our revenue growth is unquestioned. The undeniable fact is that we are producing academic improvements in our schools at a rate that is higher than any other large school system in the country."

Edison also got a qualified vote of confidence from the School Reform Commission in Philadelphia, which has tapped the company for a contract as its lead adviser for the revamped system and plans to give it 20 schools to operate. ("Phila. Panel Taps Temple University, Others to Run Troubled Schools," April 17, 2002.)

"I still remain optimistic in going forward with all of our vendors, including Edison," James E. Nevels, the chairman of the reform commission, said at a news conference on May 15.

Carey Dearnley, a spokeswoman for the Philadelphia panel, said that lawyers were still negotiating the final contracts for Edison's dual roles in the school system.

"I think the SRC is prepared to move forward if Edison can show it has the financial wherewithal to operate these 20 schools," she said. "They have indicated they can secure additional financing."

The sharp decline in Edison's stock price does not affect the company itself in the short term, because it has revenue coming in from contracts and money from its stock offerings. But a school management company such as Edison typically needs a significant amount of capital in the fall to open new schools.

Edison's president and chief executive officer, Christopher Whittle, said last week that the company currently had $45 million in cash and $15 million in credit at its disposal.

"To help open new schools, we will need to add to our existing capital," he said during the conference call. "As we speak, we are in discussions with an investor for $30 million to $50 million" in new investment.

The potential investor could not be identified, Mr. Whittle said, but the company was confident it would come up with the capital it needed to take control of schools in Philadelphia and other new contracts in the coming fall. Edison has never posted a profit in its 10 years of existence.

"We have a highly successful, 10-year track record of attracting capital when we need it," Mr. Whittle said.

Mr. Whittle also announced that Edison would slow its level of growth, beginning next year, from about 60 percent annually to 30 percent, in an effort to achieve profitability.

The company this year educates 74,000 students in 133 charter schools and traditional public schools. While it is still nailing down final contracts for next school year, it is currently looking to add 14,000 students in Philadelphia and 6,000 new students elsewhere, Mr. Whittle said. That does not take into account the loss of an undetermined number of students where Edison is losing contracts.

In the Vanguard

The SEC inquiry has taken up the time of the company's top executives over the past three months, and no capital could be pursued during that time, Mr. Whittle said.

The federal regulatory agency's investigation stemmed from a report on the Bloomberg News financial-wire service in February that raised questions about how Edison recorded some of its revenues. It specifically questioned whether the company should record as revenue portions of its contracts with school districts related to teacher salaries when the teachers in Edison schools remain employees of the district. ("Still in the Red, Edison Now Hit With Case of 'Enron-itis'," Feb. 20, 2002.)

Edison insisted, and some analysts and accounting experts agreed, that because the company is ultimately responsible for paying the teachers under such contracts, it was proper to record that part of a contract as revenue.

But the SEC concluded otherwise. "Edison has not disclosed that a portion of its reported revenues included payments that did not reach Edison and were made by school districts to teachers and other providers of services in Edison's schools," the commission said in its cease-and-desist order.

The order requires the company to restate certain financial information over the past few years and establish an internal auditor. Edison was not fined in the case.

Mr. Whittle said the company has instituted the changes called for by the commission.

"We are the most scrutinized school system in America, whether it be on our financial or academic results," he said. "Much of the scrutiny comes from the fact that we are in the vanguard of an important movement."

The three law firms that filed class actions against the company last week all invited Edison shareholders who suffered losses during specified periods to contact them to qualify for the class. The firms are Spector, Roseman & Kodroff of Philadelphia and two New York City firms, Kirby McInerney & Squire and Shalov Stone & Bonner.

Adam Tucker, a spokesman for Edison, said the shareholder suits were without merit.

"We firmly believe that our actions in terms of disclosure of information were correct," he said.

Wall Street Story

Wall Street analysts, several of whom had downgraded Edison's stock recently, said the company gave observers a lot to digest last week.

"One could argue it was too much information," said Lauren Rich Fine, a first vice president at Merrill Lynch in New York City. "We would take the other side of that debate and note that Edison needs to re-establish investor confidence, and that providing a lot of information is better than not."

Despite all the bad news, Ms. Fine actually had some good things to say about the company in a research note to investors. The company is still the leading private manager of public schools, she wrote, and is "making a difference with improved academic performance in the schools that it runs."

Despite the company's continuing losses and its restatement of financial information stemming from the SEC inquiry, it has not been knocked completely off track, she said.

"Edison had never expected to be profitable until [fiscal 2005], and we believe they are now in a position to accelerate that, potentially into [fiscal 2004]," Ms. Fine said.

Nancy Van Meter, the director of the center on privatization at the American Federation of Teachers, a critic of private management of public schools, said some on Wall Street are finally losing interest in Edison's story.

"Edison's story, as told by Chris Whittle, has been extremely appealing to Wall Street and to others," Ms. Van Meter said. "But the recent problems are really putting holes in that story."

Vol. 21, Issue 37, Pages 1,16

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