10-K 1 d10k.txt ESYLVAN, INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 ---------------------------------------------- or [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 --------------------- --------------------- Commission file number: 333-42530 ------------------------------------------------------ eSylvan, Inc. ------------------------------------------------------------ (Exact name of registrant as specified in its charter) Maryland 52-2257470 ------------------------------------------------------------------------------- (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

506 South Central Avenue, Baltimore, Maryland 21202 -------------------------------------------------------- (Address of principal executive offices) (ZIP Code) (410) 843-2622 ------------------------------------------------------------ (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name Of Each Exchange Title Of Each Class On Which Registered ------------------- ------------------- None None Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] On March 25, 2002, the aggregate value of the voting stock held by non-affiliates of the Registrant, based upon the price at which the Common Stock was sold, was none (affiliates being, for these purposes only, directors, executive officers and holders of more than 5% of the Registrant's Common Stock.) As of March 25, 2002, the registrant had 14,000,000 outstanding shares of Common Stock and 2,452,484 outstanding shares of Class A Convertible Common Stock. ESYLVAN, INC. 2001 ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS

PART I. ITEM 1: BUSINESS Overview eSylvan, Inc., (the Company") was incorporated by Sylvan Learning Systems, Inc. ("Sylvan") on February 3, 2000 under the laws of the state of Maryland for the purpose of delivering high quality supplemental education programs to students through internet-based applications. Prior to incorporation and upon inception on October 1, 1999, the Company operated as an unincorporated division of Sylvan. On June 30, 2000, Sylvan contributed substantially all of its ownership in the Company to a newly formed majority-owned subsidiary of Sylvan, Sylvan Ventures, LLC ("Sylvan Ventures"). We are a development stage company that delivers individualized supplemental education to families and children via applications on the Internet. Through our fee-based services, we deliver diagnostic and prescriptive instruction in real time. Our services are comparable to services that Sylvan provides in its traditional bricks and mortar learning center environment. Since our inception, we have focused on leveraging our licensed right to use Sylvan intellectual property, including the Sylvan instructional methodology, the Sylvan brand, and our marketing partnership with Sylvan to create various referral opportunities between eSylvan and Sylvan Learning Centers. Using these assets as a foundation, we have made substantial investments in technology and education resources and have developed the capability to provide these services over the internet. In addition to delivering our tutoring services to individual students, we are also conducting a pilot offering of these services to school districts. We have launched our website, commenced delivering services to the public and started recognizing revenue in October 2000. Until October 2000, our operations consisted primarily of organizational and capital raising activities, research and analysis with respect to Internet education industry opportunities, and the development of our technical and operational infrastructure. We maintain our corporate offices at 506 South Central Avenue, Baltimore, Maryland 21202. Our telephone number is (410) 843-2622. Our Internet Web Site address is http://www.esylvan.com K through 12 Distance Learning Through the Internet We believe that the broad accessibility of the Internet and its real-time interactive nature make it an ideal platform for K through12 distance learning. Learning online encourages students to participate in classes and activities at times that are convenient for them from a variety of geographic locations, particularly their own homes. Online learning allows both students and parents additional flexibility by eliminating transportation requirements. According to a Nielsen/Net Ratings report issued in January 2002, consumers now spend 2.3 billion hours online each month. We believe that growth in internet usage provides a rapidly expanding market for distance learning. In order to meet this demand, we believe that education providers face several challenges in delivering education over the Internet. We believe that effective online learning requires that students receive: . Comparable experience and results to in-person learning . Access to content . Access to qualified teachers and tutors . The ability to track results The eSylvan solution We offer two- or three-to-one, diagnostic and prescriptive instruction over the Internet for students who are seeking a highly individualized and convenient program of supplemental academic help. By providing instructional services at home, eSylvan makes the tutoring process more convenient for both the student and the parent, because instructional sessions are conducted without the need to drive. Modeled after Sylvan's center-based program, our Internet-based program requires from four to six months to complete and generally comprises 40 to 60 hours of instruction. We provide instruction on average twice a week in one-hour sessions, and our Academic Directors schedule parent conferences periodically during the program. Throughout a student's course of study, we test 3 students using specially designed mastery tests, and we share the results with parents on an ongoing basis. We offer our online tutoring programs at prices that are comparable to the prices of similar programs offered by most private tutors and learning centers. Each of our teachers is a certified teacher who completes a formalized training program prior to teaching their initial student session. This ensures that the quality of our services are consistent from teacher to teacher and allows us to offer our parents a guarantee. eSylvan guarantees that each math and reading student will progress one full grade-level equivalent in 36 hours of instruction, or we will provide 12 additional hours of instruction at no additional charge. Content We use tutoring content for our core reading and math programs based upon Sylvan's Individual Learning Objectives (ILO) tutoring curricula. The ILO tutoring curricula provide a measurable academic outcome from a series of activities or curriculum based programs and has been tested and proven to be effective through 22 years in the market covering more than one million students. We have spent a significant portion of our efforts to date in converting the ILO curricula into an internet-deliverable format. Given the breadth of the offerings available from Sylvan and the expansion of these offerings that we have done to date we are not dependent upon other third parties for educational content. Marketing Our customer acquisition and retention strategy includes the following marketing activities: . Direct Response Marketing. The majority of our students currently come to us through our on-line marketing campaigns. Utilizing knowledge gained through our efforts to date and through Sylvan's experiences, we have established a network of providers of web based advertising and are constantly working to refine this network to ensure that we are obtaining the highest quality audience at the lowest possible cost. We may expand our sources of students in the future through efforts in other media areas that may include radio, television and print as well as direct mail. We also believe that as we expand our student population that we will see significant numbers of referrals from our current and former students. . Sylvan Referrals and Cross Marketing. We intend to capitalize upon the distribution strengths of Sylvan to pursue referrals from Sylvan's system of products and services. We intend to pursue cross-promotion opportunities with existing and former Sylvan customers in cross-referral relationships developed with Sylvan's franchised learning centers. . Marketing Relationships. We believe that we have an opportunity to establish ourselves as the educational services provider of choice for other websites that also target the K through 12th grade market, our selected demographic. We can work with potential partners to provide a revenue sharing or referral fee based payment for students referred to us from the partners' web sites. We believe this will result in a mutually beneficial relationship as our partners can expand the nature of services provided to their visitors and receive a fee for referrals while we gain highly desirable leads for potential customers. Technology Our service offerings are supported by a technical infrastructure developed to provide effective interaction over the Internet for students and instructors and an operational support environment for effective business operation. Our technical infrastructure includes commercial technologies that have been integrated by our technology staff with some outsourcing to consulting firms. The primary interface to our learning environment is a personal computer equipped with a 56K modem connection to the Internet. We supply each student and instructor with an audio headset, a microphone and a special pen-shaped mouse. All these components are commonly available retail products. Students gain access to our online program by entering our website where information on learning programs is presented. When registered for a learning program, students interact with instructors in real time through an audio/visual session, where existing 4 technologies permit simultaneous voice and data transmission over the Internet connection. This learning environment permits the instructor to control a tutoring session for up to three students per session. Instructors can present curriculum associated content on a whiteboard on the student's computer, which both parties can simultaneously reference and markup or annotate. The whiteboard may also be used without content so that either party in the session can use freeform drawing tools for illustration purposes. In addition to our technical infrastructure, we also have licensed access to technology based solutions developed by Sylvan. Included in this licensed technology are the following key items: . Teach 2000. The Teach 2000 software delivers content on demand in the learning center environment and tracks the instructional delivery process as teachers and students work through a personalized instruction plan. Based on this software, we have developed an application to provide a complete learning environment for students and instructors that can be accessed through the Internet. . Shortcut to Success/Sylvan Automated Assessment System. STS/SAAS delivers and scores a variety of tests for students that enroll at Sylvan. These software systems are seamlessly integrated to deliver diagnostic and prescriptive tests that pinpoint a student's skill gaps, analyze a student's test results to prepare a personalized instruction profile and create initial and on-going parent conference reports to monitor progress. We have licensed this program from Sylvan and adopted it for use on the Internet. Together, these two pieces of software allow us to create unique programs for each student and to track student progress as the programs are delivered to students. U.S. patents are pending for these proprietary software programs. Sylvan will hold the patents and the software will be used under license from Sylvan. We have also developed and continue to develop several administrative applications to support our learning environment. Our customer relationship management system permits us to retrieve student-specific data including specific tutoring session schedules. Competition We believe that the key competitive factors in our market are: . Technology, expertise and capabilities . Brand recognition . Content and instructional methodology . Access to capital We compete in the tutoring market against both traditional bricks and mortar providers of educational services and companies that are implementing an online business plan. . Individual Tutors. We compete with individual home tutors who serve high-income families. In most geographic areas, individual tutors form the largest share of the tutoring market. We may also compete with state and local education agencies that fund individual tutoring. Our experience to date indicates we do not substantially compete with traditional Sylvan Learning Centers who serve a segment of the market highly desirous of face-to-face services. . Online Providers. We compete with several companies that currently participate in the online tutoring market. Further, we expect that many existing bricks and mortar tutoring companies, and others, will begin to distribute their services over the Internet in the near future. We believe that our services differ significantly from those currently offered by these companies. Other online providers currently provide a portion of our services, but we are not aware of any other companies that provide the full range of services that we provide. Current competitors generally provide either a chat-only homework help service, or provide only a whiteboard for instruction with no available assessment, content or measurable results. Others may provide a synchronous access to content, but no live instruction. A variety of models like these, though they differ from ours, will compete with us for market share. 5 . New Entrants. As Internet and broadband services become more widely deployed in the K through 12 market, we believe new and as yet unidentified companies will enter the market. Traditional media companies and rapidly expanding Internet companies represent potential new competition. Many of our current and potential competitors have longer operating histories and greater customer or user bases, brand recognition and greater financial, marketing and other resources than we do. In addition, many of these competitors can devote substantially greater resources to product development, marketing and promotional campaigns and website and systems development than we can. Relationship with Sylvan and Sylvan Ventures Sylvan has created eSylvan as a stand-alone corporation to separate its online educational services business plan from Sylvan's other businesses and to facilitate capital raising. Although we have hired a seasoned management team and built a staff, we will continue to be dependent for the foreseeable future upon the resources provided by Sylvan and Sylvan Ventures for the execution of our business plan. Currently, 100% of our funding requirements are derived from commitments from Sylvan Ventures. Sylvan Learning Centers Sylvan seeks to provide educational services with consistent, quantifiable results, and has delivered its core educational services to more than 1.2 million students primarily in grades three through eight over the past 22 years. In 2001, Sylvan provided services to over 140,000 students through its nearly 900 centers in North America. Sylvan offers programs for students of all ages and skill-levels who want to catch up, keep up or get ahead. Sylvan's range of programs includes beginning, academic and accelerated reading; basic math, algebra I and II and geometry; writing and composition; study skills; and SAT/ACT preparation. In addition, Sylvan offers certified high school courses for credit in geometry, algebra I and II, trigonometry, pre-calculus and English 9, 10 and 11. Services provided to us by Sylvan Professional Services Agreement Student Referrals. We may elect to participate in a cross referral program whereby we and Sylvan receive payments for each student referred to each other. Under the referral program, we will receive or pay amounts equal to five percent, up to a maximum of $100, of all revenues received by Sylvan or us, respectively, for the programs to which each referred student initially subscribes, including testing and registration fees. For each student enrollment a Sylvan franchisee generates for us, we will pay Sylvan a sales commission of five percent, up to a maximum of $100, of the revenues we receive for the first programs to which such student initially subscribes through the franchisee's center. Professional Services. Prior to assigning a diagnostic and prescriptive instructor to a referred student, we must request Sylvan to provide an instructor for a committed period. In the event Sylvan does not provide an instructor, we may use instructors that are not provided by Sylvan. In the event Sylvan makes personnel available for committed periods, we shall reimburse Sylvan for the salary of such instructors or other personnel at an hourly rate based on the base compensation such person receives from Sylvan. In addition to salary reimbursement, Sylvan shall receive a 30% management fee for each hour of direct instruction or test administration, including some specified preparation time, or parent conferences (calculated as a salary reimbursement multiplied by 30%). Additional services to be provided to us by center personnel and corresponding fees may be arranged subsequently. If Sylvan refers instructors to us on an independent contractor basis, we will pay Sylvan a referral fee of $100. Co-Marketing. We have agreed with Sylvan that we will provide a link to Sylvan's website on our website and Sylvan will provide a link to our website on its website. Sylvan has agreed to adhere to our reasonable directives concerning promotion of our business including displaying posters or other promotional materials in Sylvan-owned centers and requesting its franchisees to display posters or other promotional materials in their centers. License Agreement We have entered into a license agreement with Sylvan under which we have licensed certain of the materials that we believe are necessary to implement our business plan as follows: 6 . "eSYLVAN," "eSYLVAN.COM", and the associated Internet domain name, "1-800-eSylvan", "SYLVAN", "SYLVAN LEARNING CENTER," "SYLVAN LEARNING CENTERS," "SYLVAN LEARNING SYSTEMS" and such other trade names, trademarks, service marks, associated logos and symbols as may be designated by Sylvan in writing. . The Sylvan system, which includes, but is not limited to, Sylvan's proprietary programs, systems and techniques and certain copyrighted materials, all software and computer programs necessary to offer the online educational services and such other content as may be designated by Sylvan in writing. . New materials, modifications, enhancements and improvements related to the above (subject to an additional license fee). The licenses of Sylvan's trademarks and content as described in the bullets above are limited to use in connection with our Internet business in the United States and Canada. For the duration of this agreement and for one year thereafter, we have agreed not, directly or indirectly, to engage in or compete with any of Sylvan's site based businesses or centers offering certain educational services. For the duration of this agreement and for one year thereafter, Sylvan has agreed not, directly or indirectly, to engage in or compete with any of our fee-based educational services that are provided online to students, other than those services provided online to students at any of Sylvan's site based businesses or centers. Under this agreement, we have agreed to co-develop with Sylvan a confidential operations manual, which may be revised by Sylvan from time to time, to govern the use of Sylvan's intellectual property in our business. We have agreed that in order to promote Sylvan's intellectual property in connection with our business, we will expend quarterly at least six percent of our prior quarter's gross revenues on advertising approved by Sylvan. Under this agreement, we have the right to modify Sylvan's intellectual property or create derivative works and Sylvan has the right to modify any software or materials that we create or develop for our business or create derivative works from our software and materials. We will own any copyright in the derivative works created by us and we have agreed to license to Sylvan these derivative works for no additional consideration. We have agreed that Sylvan will own any copyright in the derivative works created by it from our intellectual property and that Sylvan will license to us these derivative works for no additional consideration. With respect to certain other intellectual property that we develop for our business, including software and other materials, Sylvan will have 30 days from the date it receives notice that we have developed this material to notify us of its desire to license it. Any license will be for a reasonable fee designed to permit us to recoup our development costs on a proportional basis across all the products or services in which we will commercialize the material. We will have 30 days from the date we receive notice that Sylvan has developed or created any new intellectual property, including software or other materials, related to its learning center business to notify Sylvan if we desire to obtain a license of that content. Any license will be for a fee based on financial terms offered to all of its franchise licensees. We have paid Sylvan an initial license fee of $1 million and we have agreed to pay Sylvan a periodic, running royalty equal to four percent of our net revenues (gross revenues less discounts and refunds) and an additional amount equal to any sales, gross receipts or similar tax imposed on Sylvan. The initial license fee of $1 million was agreed to be an initial capital contribution by Sylvan, and no cash was paid for the initial license fee. During 2001 there will be no guaranteed minimum royalty, but for each calendar year thereafter, there will be a guaranteed minimum royalty equal to 120% of the prior year's minimum royalty, with the guaranteed minimum royalty for calendar year 2002 of $400,000. As part of our arrangement with Sylvan, Sylvan has agreed to reduce future royalty payments due under the terms of the license agreement by the amounts that we paid to Sylvan franchisees who received shares of our Class A Convertible Common Stock. We have accounted for the payments to Sylvan franchises as prepaid royalties under our agreement with Sylvan. This agreement has an initial term of five years and it will terminate on the fifth anniversary of the effective date; provided, however, that the license with respect to content is for the duration of the applicable copyrights and will not otherwise terminate. We have the option to serially renew the agreement for unlimited consecutive five-year terms and no initial license fee will be owned for such renewal terms. We have agreed to cooperate with Sylvan for the protection of the intellectual property licensed to us. Sylvan has agreed, at its expense, to defend and indemnify us from certain claims brought against us in the United States based upon any infringement of United States intellectual property rights with respect to only the licensed 7 trademarks and service marks and not the licensed content; provided, however, that Sylvan's liability is limited to the amount of royalties paid by us within the one year preceding the date upon which we make a demand for indemnification. We have agreed to defend any action, suit or proceeding brought against Sylvan based upon or arising out of our operation of our business. Services Agreement Sylvan has agreed to provide management services, MIS support services, corporate accounting services, PeopleSoft (database management) services, human resources/payroll services and legal services to us on an independent contractor basis at fees that are fair and reasonable, as jointly determined by us and Sylvan for the services provided based on our utilization of such services. Fees that have been billed but that have not been paid within 30 days shall accrue simple interest at the prime rate plus one percent per annum. This agreement, which had an initial term of one-year, has been extended through June 30, 2002 and can be terminated at any time on 60 days notice. Facility Use Agreement Sylvan has agreed to provide us with the use of its facilities for a monthly use fee based upon Sylvan's good faith estimate of our use of such facilities. In the event Sylvan owns a facility, the use fee is based on market rent. In the event Sylvan leases a facility, the use fee is based on Sylvan's lease payments. We currently occupy office space pursuant to this agreement. This agreement, which had an initial term of one-year, has been extended through June 30, 2002 and can be terminated at any time on 60 days notice. Sylvan Ventures, LLC Founded in February 2000, Sylvan Ventures develops and invests in educational technology companies, providing them with access to brands, content and resources of its parent company Sylvan. Funding provided to us by Sylvan Ventures includes: . A revolving line of credit in the amount of $10 million, which originally terminated on December 31, 2001, and has been extended through December 31, 2002. Sylvan Ventures and the Company have agreed that the balance outstanding under the line of credit on December 31, 2001 will be repaid from the proceeds of the sale of Series A preferred stock discussed below. . An investment of $20 million in return for 10,526,316 shares of our Series A preferred stock as of December 31, 2001. In February 2002, Sylvan Ventures purchased an additional 4,947,368 shares of our Series A preferred stock for $9.4 million. Sylvan Learning Center Franchisees During December 2000, we filed a Registration Statement on form S-1 for the registration of up to 3,000,000 shares of our Class A Convertible Common Stock to be issued to Sylvan Learning Center franchisees participating in the offering. On March 30, 2001, we issued 2,452,484 shares of Class A Common Stock pursuant to the receipt of executed participation agreements from certain Sylvan Learning Center franchisees that provide for support of the delivery of our services to students living in the relevant franchisees territory. In connection with this offering, we were obligated to pay an amount in cash to each Class A Convertible Common Stock shareholder equal to $0.35 multiplied by the number of shares received. In April 2001, we paid an aggregate amount of $858,385 to the shareholders. These payments have been recorded as prepaid royalties to Sylvan as the license agreement with Sylvan provides for the offset of this payment against any future royalties due Sylvan. We are not able to deliver our services to students in territories for which the relevant franchisee has elected not to participate. Government Regulation And Legal Uncertainties There are an increasing number of laws and regulations pertaining to the Internet. In addition, a number of legislative and regulatory proposals are under consideration by federal, state and local governments and agencies. Recently, the United States Congress enacted Internet legislation regarding children's privacy, copyrights and taxation. Other laws or regulations may be adopted with respect to online content regulation, user privacy, pricing, 8 taxation and quality of products and services. Any new legislation or regulation, or the application or interpretation of existing laws, may decrease the growth in the use of the Internet, which could in turn decrease the demand for our service, increase our cost of doing business or otherwise have a material adverse effect on our prospects and revenues. Liability for information retrieved from our website and other websites Content may be accessed on our website or on other Internet sites that are linked to our website. This content may be downloaded by users and subsequently transmitted to others over the Internet. By providing those links, we may be exposed to claims that we are liable for wrongful actions by the owners of these sites. Claims of this nature have been brought, sometimes successfully, against providers of Internet services. We could also be exposed to liability with respect to third-party content that may be posted by users in chat rooms or bulletin boards, which may be offered on our website. We also may be subject to claims, alleging that we, by directly or indirectly providing links to other websites, are liable for copyright or trademark infringement or the wrongful actions of third parties through their respective websites. The Digital Millennium Copyright Act of 1998 established limited liability for online copyright infringement by online service providers for listing or linking to third party websites that include copyright-infringing materials. Although we hold general liability insurance, that insurance may not cover all potential claims to which we are exposed and may not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of insurance coverage could result in significant expense and cash demands, which would adversely affect operating results and financial condition. Even to the extent that these claims do not result in liability, we could incur significant costs in investigating and defending against these claims, which would also adversely affect our operating results and financial condition. Privacy Concerns The Children's Online Privacy Protection Act of 1998 makes it unlawful for an operator of a website or online service directed to children under 13 to collect, use or distribute personal information from a child under 13 in a manner which violates regulations to be proscribed by the Federal Trade Commission (FTC). The FTC has issued final regulations, which concern the scope of this Act's parental consent requirements. The FTC is also considering adopting regulations regarding the collection and use of personal identifying information obtained from individuals when accessing websites. Further, the FTC has conducted investigations into the privacy practices of companies that collect information on the Internet. The Children's Online Privacy Protection Act may apply to our business if we collect personal information on persons under the age of 13. Accordingly, we may be required to obtain verifiable parental consent for such collection activities and provide parental access to personal information we maintain about their children. While we believe we will be able to comply with the regulations that have been promulgated by the FTC to implement that Act, the present regulations are subject to clarification through administrative implementation and amendment and the specific means for complying remain to be developed. The costs of compliance could be a significant element of our costs of doing business. Internet Taxation A number of legislative proposals have been made at the federal, state and local level that would impose additional taxes on the sale of goods and services over the Internet and some states have taken measures to tax Internet-related activities. Although Congress recently placed a three-year moratorium on state and local taxes on Internet access or on discriminatory taxes on electronic commerce, existing state or local laws were expressly excepted from this moratorium. Further, once this moratorium is lifted, some type of federal and/or state taxes may be imposed upon Internet commerce. This legislation, or other attempts at regulating commerce over the Internet, may substantially impede the growth of commerce on the Internet and, as a result, adversely affect our opportunity to derive financial benefit from those activities. Jurisdictions It is possible that, although our transmissions over the Internet will originate primarily in Maryland, the governments of other states might attempt to regulate our transmissions or prosecute us for violations of their laws. These laws may be modified, or new laws enacted, in the future. Any of these developments could have a material adverse effect on our prospects, operating results and financial condition. In addition, as we expect to offer our services in multiple states and Canada, these jurisdictions may claim that we are required to qualify to do business as 9 a foreign corporation in each of these states or Cananda. As of the date of this filing, we are not qualified to do business in any state other than Maryland and California, and our failure to qualify as a foreign corporation in a jurisdiction where we are required to do so could subject us to taxes and penalties and could result in our inability to enforce contracts in these jurisdictions. Any new legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or the application of existing laws and regulations to the Internet and other online services could have a material adverse effect on our prospects, operating results and financial condition. Employees We have approximately 45 full-time and 120 part-time employees. We expect to hire additional full-time employees as we grow our business. Although the competition for skilled employees in the Internet and education industries is intense, we do not now foresee problems in hiring qualified employees to meet our needs. None of our employees is represented by a union. We consider our relations with our employees to be good. FACTORS THAT MAY AFFECT FUTURE RESULTS Risks and factors described below are not the only ones we face. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations. Risks Related to Our Business Our technology for the online delivery of tutoring services is new. Our online program includes live, voice-based, interactive, three student to one teacher instruction with tutoring curriculum individualized to the student based upon a needs assessment supplemented by rewards for student participation. Although some other companies delivering tutoring services over the Internet have programs that rely on chat or message board homework help, these companies generally do not have programs that include one or more of the key features of our online program. This is primarily because the companies' existing technology is not sufficiently developed to support our program. The key features of our technology are new and have been internally developed. This new technology includes our voice-based interactive instruction, our diagnostic and assessment software and our content search engine. If we fail to integrate such technology to provide reliable service to our customers, if our technology remains incompatible with some of our customer's technology, or if the reliability of our technology decreases as the number of customers in our program increases, we may fail to become profitable. We have only recently commenced recognizing revenues, our accumulated operating loss since inception is $24.8 million as of December 31, 2001, and we expect to generate significant operating losses and continue to experience negative cash flow for the foreseeable future. We launched our website, commenced delivering services to the public and started recognizing revenue in October 2000. As of December 31, 2001, we have generated approximately $476,000 in revenues, and we have incurred expenses and an accumulated net loss of approximately $24.8 million from inception, consisting primarily of research and development, sales and marketing, legal, accounting, consulting, personnel and facilities costs. Our ability to generate revenue will depend on our ability to attract customers to our online educational services and improve our content and technology. We believe that our expenditures for marketing and advertising and personnel will substantially increase over the next year as we shift from organizational activities, the development of our technology and initial market testing to the broad based sale of tutoring services to the public. We also expect to incur substantial expenses in software and computer hardware, tutoring content and professional fees and other areas. Because we are a new entrant to the Internet market, these expenditures may be significantly higher than we anticipate. These expenses are substantially dependent upon the success of our business plan and marketing and advertising efforts and factors outside of our control such as lawsuits, unexpected technical difficulties with our on-line tutoring infrastructure, our need for additional financing and other factors discussed in this section. Our expenses generally will precede revenues. If these expenses are not followed by sufficient revenues, our business 10 may not become profitable. If online tutoring fails to gain acceptance, it is unlikely that eSylvan will become a viable business. We have operated as a separate entity for less than two years, and for the foreseeable future we will remain dependent upon our majority stockholder for operational support and financing. From inception on October 1, 1999 through February 2, 2000, we operated as an unincorporated division of Sylvan, from February 3, 2000 to June 29, 2000, we operated as a subsidiary of Sylvan. Since June 30, 2000, we have operated as a majority-owned subsidiary of Sylvan Ventures. Pursuant to separate agreements, Sylvan provides us with facilities, management services, intellectual property, including the eSylvan name, marketing referrals and a website link to the Sylvan website. Our facilities agreement with Sylvan had an initial term of one-year, has been extended through June 30, 2002 and can be terminated at any time with 60 days notice. Our services agreement with Sylvan had an initial term of one-year, has been extended through June 30, 2002 and can be terminated at any time with 60 days notice. Our license agreement with Sylvan has an initial term of five years; provided, however, that the license with respect to content is for the duration of the applicable copyrights. We have the option to serially renew the license agreement for unlimited additional five-year terms. Our professional services agreement with Sylvan terminates upon the termination or expiration of the license agreement. Sylvan Ventures has met our financing needs through December 31, 2001, with a $10 million line of credit, which has been extended through December 31, 2002, and the purchase of 10,526,316 shares of our Series A preferred stock for $20 million. In addition, Sylvan Ventures purchased an additional 4,947,368 shares of our Series A preferred stock in February 2002 for $9.4 million. We believe that we cannot replace the services and intellectual property that Sylvan provides to us on reasonable terms, if at all. Accordingly, if Sylvan or Sylvan Ventures terminates its support of our business plan, we may not be able to continue operations, or if we continue operations, we may not become profitable. The terms and conditions of these agreements were not negotiated on an arms-length basis with Sylvan or Sylvan Ventures and, accordingly, we expect that these terms and conditions may be less favorable to us than the terms and conditions that might have been negotiated on an arms-length basis with an unaffiliated third party. We currently have one independent member of our board of directors. Fees for diagnostic and prescriptive tutoring services provided to us by Sylvan may be higher than the cost of such services otherwise available. Prior to assigning a diagnostic and prescriptive instructor to a student, we must request Sylvan to provide an instructor for a committed period. In the event Sylvan does not provide an instructor, we may use instructors that are not provided by Sylvan. In the event Sylvan makes personnel available for committed periods, we shall reimburse Sylvan for the salary of such instructors or other personnel at an hourly rate based on the base compensation such person receives from Sylvan. In addition to salary reimbursement, Sylvan shall receive a 30% management fee for each hour of direct instruction or test administration, including some specified preparation time, or parent conferences. Additional services to be provided to us by center personnel and corresponding fees may be arranged subsequently. If Sylvan refers instructors to us on an independent contractor basis, we will pay Sylvan a referral fee of $100. The terms and conditions of this agreement were not negotiated on an arms-length basis with Sylvan and we believe that the terms and conditions are less favorable to us than the terms and conditions that might have been negotiated on an arms-length basis with an unaffiliated party. If the cost of tutoring services under our agreement with Sylvan is greater than can be obtained on the open market, our higher expenses could affect our ability to compete with other companies that can obtain tutoring services at lower costs. We will need additional financing. We expect to experience negative cash flow from operations for the foreseeable future. We expect that our available funds will be insufficient to meet our needs for working capital and capital expenditures prior to July 2002. Accordingly, we will need to raise additional funds prior to July 31, 2002. We are unable to predict the exact amount of additional financing we will need because such amount is substantially dependent upon the success of our business plan and marketing and advertising efforts and factors outside our control such as lawsuits, unexpected technical difficulties with our on-line tutoring infrastructure and other factors discussed under this section. We cannot be certain that additional financing will be available to us on favorable terms when required or at all. If we fail to secure the necessary financing, we may not be able to continue operations. 11 Our business strategy is new, evolving, unproven and subject to change and may not generate sufficient revenue opportunities. Our business objective is to become the premier provider of online tutoring services to the K through 12 market. Our business strategy is new, evolving and unproven. Due to the rapidly changing nature of the Internet, we are continuously modifying our business strategy and expect to continue to modify our strategy in the future. Our business model assumes that we will be able to attract students and their parents to our fee-based internet tutoring services. Our current business strategy may not be scalable and, if it is not scalable, we may not be able to modify it in a timely and successful manner. In addition, we may not be able to develop successful business strategies to capitalize on opportunities in new and unproven areas. Consumers may not accept an online source for tutoring services. Our success depends on attracting and retaining online consumers. Some factors that could prevent consumer acceptance of online tutoring services, and consequently our ability to generate our revenues, include: . student or parent preference for in-person tutoring relationships, . pricing that does not meet consumer expectations of finding "the lowest price on the Internet," and . lack of consumer awareness of our online presence. We may fail to retain and integrate key personnel. Our success depends upon the key members of our management team. Loss of the services of key members of our senior management team would harm our business. Our senior management may not perform effectively as individuals or work together as a team. If we were to lose members of our management team we may not be able to achieve profitability or raise sufficient capital to allow us to continue our operations. We may fail to attract qualified employees. Our success also depends on our ability to attract, retain and motivate skilled employees, including trained instructors and information technology specialists. Competition for these skilled employees is intense. We expect to experience difficulty in hiring and retaining skilled employees. We have no employment contracts with our employees. If we do not establish, maintain and strengthen our brand we may not attract customers for our services or generate revenue opportunities. We must expend resources to establish the eSylvan brand and promote our services. We are in competition with a number of Internet companies currently seeking to establish their names as dominant brands in the online tutoring market. As such, we face competition for placement of our advertising on web sites that attract the appropriate prospects for our services and will also face additional expenses should we decide to expand our marketing efforts to radio, television and print media. We will pursue an aggressive web based direct response marketing campaign to establish, maintain and grow our brand. Our other advertising efforts will also be designed to strengthen our brand. Although we commenced operations in October 2000, we have incurred $3.3 million in sales and marketing expenses to date through December 31, 2001. In addition, we expect substantial increases in such expenditures to support our business plan. We expect that the funds for these efforts will be provided through the sale of our Series A preferred stock to Sylvan Ventures. See "Management's Discussion and Analysis of Financial Condition and Plan of Operation-Liquidity and Capital Resources." If our promotional efforts are unsuccessful, we may fail to generate sufficient revenues to become profitable. We face intense competition. 12 We compete with numerous providers of tutoring services, including other online companies as well as traditional bricks and mortar tutoring providers. Sylvan Ventures, our majority stockholder, is controlled by Sylvan, a bricks and mortar provider of tutoring services through company-owned and franchised learning centers, and, to the extent that Sylvan's customers find online tutoring to be more convenient, we may compete with Sylvan. Some of our competitors have greater access to capital than we do and may use these resources to engage in aggressive advertising and promotion campaigns such as offering free services to attract new consumers. The current practice of such aggressive advertising and promotion may generate pricing pressures to which we must respond. We expect that competition will continue to increase because of the relative ease with which new websites may be developed. Individual tutors, for example, can easily and at low cost establish a rudimentary web presence and compete with us on the Internet in their local markets. Traditional media companies and existing bricks and mortar companies can also establish a web presence with relative ease. The nature of the Internet as an electronic delivery medium for services, which may, among other things, facilitate competitive entry and price comparisons, may also render it inherently more competitive than traditional formats of service delivery. Increased competition may reduce our gross margins, cause us to lose market share, decrease the value of the eSylvan brand and prevent us from generating revenues and becoming profitable. We may lose users if we do not adapt to rapid technological change and provide tools and features which meet the changing demands of our users. The Internet market is characterized by rapidly changing technology, evolving industry standards and frequent new service announcements. We must adopt to our rapidly changing market by continuing to improve the performance, features and reliability of our website and, in particular, its functionality with new versions of web browsers and other platforms. We also could incur substantial costs if we need to modify our services or infrastructure in order to adopt to these changes. If we fail to keep pace with technological advancements, our consumers may not use our services and instead may use competitive services. In addition, we must provide informational content, interactive tools and other features that consumers demand in order to continue to attract and retain our consumer audiences. We have allocated significant resources to improve our software and computer hardware and tutoring content. However, we must properly anticipate, identify and respond to changes in consumer demands. Notwithstanding these planned expenditures, if we fail to respond to changes in consumer demand, expand the scope of our content and services, introduce new services quickly and efficiently, or if our content and services fail to achieve market acceptance, our ability to retain customers and generate revenues could be materially and adversely affected. We may incur expenses for compensation paid to Sylvan for participating in our program. We may incur significant expenses for the consideration we are required to pay to Sylvan if Sylvan provides us with instructors, education developers and other professionals. Specifically, prior to assigning a tutor to a referred student for a diagnostic and prescriptive program, we must request Sylvan to provide a tutor for a committed period for which we reimburse Sylvan for the salary of such tutor at an hourly rate based on the base compensation such person receives, and pay Sylvan a 30% management fee per hour of service. If Sylvan refers instructors to us, we will pay Sylvan a $100 referral fee. The amount of these fees was not determined through arms-length negotiation and such fees may be in excess, perhaps substantially so, of the cost to retain such professionals on the open market from unaffiliated third parties. Our computer and communications systems may fail or experience delays. Our success, and in particular our ability to provide quality customer service, depends on the efficient and uninterrupted operation of our computer systems. Systems interruptions may result from fire, power loss, water damage, telecommunications failures, vandalism and other malicious acts and problems related to our software and equipment. Our website may also experience disruptions or interruptions in service due to failures by third-party communications providers. We will depend on communications providers and our website host to provide our consumers with access to our website. In addition, our consumers depend on their own Internet service providers for access to our website. Periodic systems interruptions will occur. These occurrences may cause consumers to 13 perceive our website as not functioning properly and therefore cause them to stop using our services. Systems interruptions that last more than a few hours would harm our business. We are substantially dependent upon Sylvan for our use of the eSylvan brand. Sylvan licensed us the right to use the eSylvan name and its other trademarks and various tutoring content for an initial license fee of $1 million and a periodic, running royalty equal to four percent of our net revenues and an additional amount equal to any sales, gross receipts or similar tax imposed on Sylvan. The initial license fee of $1 million was agreed to be an initial capital contribution by Sylvan, and no cash was paid for the initial license fee. During 2001, there was no guaranteed minimum royalty, but for each calendar year thereafter, there will be a guaranteed minimum royalty equal to 120% of the prior year's minimum royalty, with the guaranteed minimum royalty for calendar year 2002 of $400,000. Sylvan has agreed to reduce future royalty payments due under the terms of the license agreement by the amounts that we paid to Sylvan franchisees who received shares of our Class A Convertible Common Stock. This agreement has an initial term of five years and it will terminate on the fifth anniversary of the effective date; provided, however, that the license with respect to content is for the duration of the applicable copyrights and will not otherwise terminate. We have the option to renew the agreement for unlimited additional five-year terms and no initial license fee will be owed for such renewal terms. We believe that we cannot replace the intellectual property that Sylvan has licensed to us under this agreement on reasonable terms, if at all. Accordingly, if Sylvan terminates the license agreement, we may not become profitable. The terms and conditions of this agreement were not negotiated on an arms-length basis with Sylvan and, accordingly, we expect that these terms and conditions may be less favorable to us than the terms and conditions that might have been negotiated on an arms-length basis with an unaffiliated third party. Others may infringe upon or misappropriate our intellectual property rights. The intellectual property rights that we license from Sylvan for use on the Internet are critical to our success. These intellectual property rights include the use of the eSylvan name, the eSylvan.com website and the Sylvan tutoring content that we have adapted for the online delivery of tutoring services. We believe that our ability to leverage Sylvan's existing reputation with respect to the provision of tutoring services in bricks and mortar centers to generate brand recognition and loyalty for our online tutoring business is the key to our marketing plans. We will rely on trademark and copyright law, trade secret protection and confidentiality, license and other agreements with customers, other companies and others to protect our proprietary rights. The steps taken to protect this intellectual property may not be adequate, and third parties may infringe upon or misappropriate our intellectual property rights. Our efforts to protect our intellectual property rights may result in litigation. Intellectual property litigation is expensive and can divert management's attention from the operation of our business. The market data upon which we have based our business plan may not be accurate and has not been verified independently. Much of the market and related data upon which we have based our business plan including our estimates of future revenues, expenses and required financing, was obtained from industry publications and reports prepared by independent sources. We have not independently verified the accuracy of such information. We have not independently generated or verified this market data because we do not currently have the capacity to do so, nor do we currently have the resources to acquire the capacity to do so. The methodology typically used in compiling market and related data, including the fact that such data are usually based upon a selected sampling of the market or population rather than a survey of the market or population as a whole, means that the data are subject to uncertainties and estimations. If the market data upon which we have relied in developing our business plan is materially inaccurate our estimates with respect to future revenues, the expenses necessary to generate future revenues, need for and timing of future financing and profitability are likely to be inaccurate which, depending on the nature of such inaccuracies, could affect the viability of our business plan. Sylvan Ventures' ownership of over 70% of our outstanding voting stock on a fully diluted basis and the presence of interlocking directors and officers could prevent a change of control. Sylvan Ventures owns a substantial majority of our outstanding voting stock on a fully diluted basis. Sylvan Ventures is a majority-owned subsidiary of Sylvan. Christopher Hoehn-Saric, our chairman, chief executive 14 officer and director is a director and former co-chief executive officer and chairman of Sylvan and chairman, president and a manager of Sylvan Ventures. B. Lee McGee, our senior vice president, treasurer, assistant secretary and director is a managing director, chief financial officer and treasurer of Sylvan Ventures. Robert Zentz, our secretary, assistant treasurer and director is senior vice president and general counsel of Sylvan and secretary of Sylvan Ventures. Peter Cohen, our director and assistant secretary, is president of Sylvan. Susannah Bennett, our assistant secretary, is vice president of Sylvan. As a result, the directors and officers of Sylvan and Sylvan Ventures will be able to control our day-to-day operations and the outcome of substantially all matters submitted to our stockholders for approval, including the election of directors and any proposed merger, liquidation, transfer or encumbrance of a substantial portion of our assets, or amendment to our charter to change our authorized capitalization. This concentration of ownership may also have the effect of delaying or preventing a change in control of our company. Our control by Sylvan Ventures and Sylvan and the presence of interlocking directors and officers could create potential conflicts of interest. Christopher Hoehn-Saric, our chairman, chief executive officer and director is a director and former co-chief executive officer and chairman of Sylvan and chairman, president and a manager of Sylvan Ventures. B. Lee McGee, our senior vice president, treasurer, assistant secretary and director is a managing director, chief financial officer and treasurer of Sylvan Ventures. Robert Zentz, our secretary, assistant treasurer and director is vice president and general counsel of Sylvan and secretary of Sylvan Ventures. Peter Cohen, our director and assistant secretary, is president of Sylvan, Susannah Bennett, our assistant secretary, is vice president of Sylvan. Mr. Hoehn-Saric beneficially owns less than five percent and three percent of the outstanding equity securities of Sylvan and Sylvan Ventures, respectively. Each of Messrs. Graves, Offutt, McGee, Zentz and Cohen and Ms. Bennett beneficially owns less than one percent of the outstanding equity securities of Sylvan. Because of these relationships, equity interests and the fact that we currently have only one independent member on our board of directors, our directors and officers have conflicts of interest when making decisions related to transactions between us and Sylvan Ventures or Sylvan. These conflicts of interest include possible competition between Sylvan and us for tutoring customers, the demands for management attention placed upon our executive team by the other companies they serve, whether another company or we should be presented business or financing opportunities that present themselves to our management team and the extent of Sylvan resources that will be made available to us under our agreements with Sylvan for implementation of our business plan. The ability of Sylvan Ventures and Sylvan to control the outcome of matters submitted to stockholders together with the potential conflicts of interest of their affiliates who also serve as our executive officers could adversely affect the operation of our business. In addition, those persons serving as both our officers and key employees and those of Sylvan Ventures and Sylvan have not committed to devote any specific percentage of their business time to us. The competing claims upon each officer's time and energies could divert attention from our affairs, placing additional demands on our resources. The efforts of all or any of these individuals may not be sufficient to meet both our needs and those of Sylvan Ventures and/or Sylvan. If we were deprived of access to the members of our management team, or other personnel, or lost access to these services altogether, we may not be able to meet the objectives set forth in our business plan. Risks Related to the Internet We depend on continued growth in use of the Internet and online commerce. Our success depends upon the ability of the Internet infrastructure to support increased use. The performance and reliability of the Internet may decline as the number of online users grows or bandwidth requirements increase. The Internet has experienced a variety of outages due to equipment malfunctions, human error and physical damage to portions of its infrastructure. If outages or delays frequently occur in the future, Internet usage, including usage of our website, could grow slowly or decline. Concerns about inadequate Internet infrastructure, security, reliability, accessibility, privacy and the availability of cost-effective, high-speed service also may inhibit growth in Internet usage. Even if the necessary infrastructure or technologies develop, we may incur significant costs to adapt our operating strategy. We may be sued due to privacy or security concerns. 15 Consumer concerns over the security of transactions conducted on the Internet or the privacy of users may inhibit the growth of the Internet and online service delivery. To transmit confidential information securely, we will rely on encryption and authentication technology licensed to us by third parties. Events or developments may result in a compromise or breach of the encryption software that we use to protect consumer transaction data. Any penetration of our network security or misappropriation of our consumers' personal information could subject us to liability. Furthermore, our servers may be vulnerable to computer viruses, physical or electronic break-ins and similar disruptions. We may need to expend significant additional capital and other resources to protect against a security breach or to alleviate problems caused by any breaches. Our business may be harmed if our security measures do not prevent security breaches. Claims may be based on other misuses of personal information, such as for unauthorized marketing purposes. Websites typically place identifying data "cookies" on a user's computer hard drive without the user's express consent. We may use cookies for a variety of reasons, including the collection of data derived from the user's Internet activity. Any reduction or limitation in the use of cookies could limit the effectiveness of our sales and marketing efforts. Most currently available Internet browsers allow users to remove cookies at any time or to prevent cookies from being stored on their computer hard drives. In addition, some commentators, privacy advocates and governmental bodies have suggested that the use of cookies be limited or eliminated. The FTC and several states have investigated the use of personal information by online companies. We may incur expense if regulations regarding the use of personal information are introduced or if our privacy practices were investigated. Any claims that may be brought against us would be expensive to defend even if these claims are determined to be without merit. The Children's Online Privacy Protection Act may apply to our business if we collect personal information on persons under the age of 13. Accordingly, we may be required to obtain verifiable parental consent for such collection activities and provide parental access to personal information we maintain about their children. While we believe we will be able to comply with the regulations that have been promulgated by the FTC to implement that Act, the present regulations are subject to clarification through administrative implementation and amendment and the specific means for complying remain to be developed. The costs of compliance could be a significant element of our costs of doing business. Government regulation and legal uncertainties could add additional burdens to doing business on the Internet. Laws and regulations applicable to Internet communications, commerce and advertising are becoming more prevalent. Online commerce is new and rapidly changing, and federal, state and foreign regulations relating to the Internet and online commerce are evolving. Due to the increasing popularity of the Internet, it is probable that new laws and regulations will be enacted to address issues such as user privacy, pricing, content, copyrights, distribution, antitrust matters and the qualify of products and services. The adoption of these laws or regulations could reduce the rate of growth of the Internet, which could potentially decrease the usage of our website and could otherwise harm our business. In addition, many existing laws governing issues such as advertising, property ownership, copyrights and other intellectual property issues, libel, obscenity and personal privacy are now being applied to the Internet. Most of these laws were adopted prior to the advent of the Internet and do not necessarily apply easily to the unique issues of the Internet. New laws applicable to the Internet may impose substantial burdens on companies conducting business over the Internet. In addition, the growth and development of online commerce has already prompted calls for more stringent consumer protection laws in the United States and abroad. As one example, the European Union has adopted a privacy directive that may well have an effect on websites in the United States. Compliance with that directive, or other regulatory activities of foreign governments, could have a significant effect on our business. Several telecommunications carriers have asked the Federal Communications Commission (FCC) to regulate telecommunications over the Internet. Due to the increasing use of the Internet and the burden it has placed on the telecommunications infrastructure, telephone carriers have requested the FCC to regulate Internet and online service providers and to impose access fees on those providers. If the FCC imposes access fees, the costs of using the Internet could increase dramatically. In this event, our business could be negatively impacted. 16 The FTC has already promulgated a number of regulations and proposed regulations that are designed specifically to deal with e-commerce and has several on-going industry studies that might result in further regulation. The Children's Online Privacy Protection Act may apply to our business if we collect personal information on persons under the age of 13. Accordingly, we may be required to obtain verifiable parental consent for such collection activities and provide parental access to personal information we maintain about their children. While we believe we will be able to comply with the regulations that have been promulgated by the FTC to implement that Act, the present regulations are subject to clarification through administrative implementation and amendment and the specific means for complying remain to be developed. The costs of compliance could be a significant element of our costs of doing business. Historically the use of encryption on the Internet has provoked national security concerns among certain governments. While the current posture of the United States is to permit the use and export of strong encryption, law enforcement agencies here and abroad are pressing for changes that could have an adverse effect on our ability to protect customer privacy through encryption. We may be liable for information displayed on and communicated through our website. We may be subjected to claims for defamation, negligence, copyright or trademark infringement or other theories relating to the information that we publish on our website. These claims have been brought against online companies as well as print publications in the past. Based on hyperlinks that we provide to other websites, we may also be subjected to claims based upon online content that we do not control but that is accessible from our website. Any claims that may be brought against us would be expensive to defend even if these claims are determined to be without merit. Registration of similar domain names may result in a diversion of our potential customers to other websites. For the foreseeable future, we will substantially rely on the eSylvan.com domain name as a significant means of attracting potential customers to our website. Domain names are registered by a growing number of organizations around the world. Governing authorities could establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names. As a result, we may not be able to prevent others from adopting and using domain names that might result in a diversion of our potential customers to competing websites. While there is a growing number of cases in which "domain name piracy" has been redressed, the law in this area is evolving and not totally effective in preventing use of confusingly similar domain names. While it is possible that others might claim that our own domain name `eSylvan.com' infringes on their rights, we are not aware of any such claim and believe we have the right to maintain and use that domain name. However, if we were subsequently unable to continue using that domain name, we might experience a significant loss of business. FORWARD-LOOKING STATEMENTS Many statements made in this filing under the headings "Business," "Management's Discussion and Analysis of Financial Condition and Plan of Operation" and elsewhere are forward-looking statements that are not based on historical facts. Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including those discussed under "Factors that May Affect Future Results." ITEM 2: PROPERTIES Our headquarters is located in Baltimore, Maryland. We currently lease our facilities from Sylvan pursuant to a facilities use agreement. See "Business - Services Provided to us by Sylvan." We expect to expand our facilities as our operations grow. We believe that additional space will be available on commercially acceptable terms. 17 ITEM 3: LEGAL PROCEEDINGS We are not party to any material legal proceedings. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS No matters were submitted to be voted on by securities holders during the fourth quarter ended December 31, 2001. PART II. ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. There is no established public trading market for our common stock. 10,526,316 shares of our common stock are subject to outstanding options or warrants to purchase, or securities convertible into, our common stock. None of the shares of our common stock are available for sale under Rule 144. We have agreed to register 70,000,000 shares of our common stock under the Securities Act for sale by our stockholders. As of March 25, 2002, there were 14,000,000 shares of our common stock and 2,452,484 shares of Class A Convertible Common Stock outstanding, held by approximately 466 holders of record. We have never declared or paid any cash dividends on our common stock and presently intend to retain our future earnings, if any, to fund the development and growth of our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future. On June 30, 2000, 14,000,000 shares of common stock were sold to Sylvan for cash of $5 million. Subsequent to the purchase of the 14,000,000 shares of common stock, 13,714,286 of those shares were contributed to Sylvan Ventures. On June 30, 2000, 10,526,316 shares of Series A preferred stock was subscribed for purchase by Sylvan Ventures for aggregate proceeds of $20 million issuable and payable equally over the subsequent six quarters beginning September 30, 2000. As of December 31, 2001, all of the shares had been fully paid and were issued and outstanding. During February 2002, Sylvan Ventures purchased an additional 4,947,368 shares of Series A preferred stock for $9.4 million. A portion of the proceeds of this issuance was used to pay the balance outstanding under the line of credit agreement between Sylvan Ventures and the Company. Through December 31, 2001, we incurred approximately $880,000 in expenses in connection with the offering of our Class A Convertible common stock to holders of Sylvan franchise license agreements or area development agreements. Through the time of conclusion of this offering, 359 franchisees executed participation agreements, and we were obligated to issue 2,452,484 shares of Class A Convertible common stock and remit $858,385 in exchange for the franchisees' participation in this offering. We issued these shares and paid this amount on March 2, 2001. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." ITEM 6: SELECTED FINANCIAL DATA The following table presents the selected financial data of our business. The financial data for all periods presented have been derived from and are qualified by reference to, our audited financial statements included elsewhere in this report. 18

19 ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Financial Statements and related Notes thereto included elsewhere in this Annual Report on Form 10-K. Results of Operation We are a development stage business that delivers individualized supplemental education to families and children via applications on the Internet. We launched our website, commenced delivering services to the public and started recognizing revenue in October 2000. Our lack of operating history makes it difficult to evaluate our business and prospects. You must consider our prospects in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of development, particularly companies dependent upon the relatively new and rapidly evolving Internet environment. We have no assurance that we will be successful in addressing these or any other risks, and our failure to do so could have a material adverse effect on our business, financial condition and results of operations. From inception on October 1, 1999 through February 2, 2000, we operated as an unincorporated division of Sylvan, from February 3, 2000 to June 29, 2000, we operated as a subsidiary of Sylvan and since June 30, 2000, we have operated as a majority owned subsidiary of Sylvan Ventures. Until October 2000, our operations consisted of organizational activities, research and analysis with respect to the Internet educational services industry, development of our website and identifying and testing key technology. As of December 31, 2001, we have generated minimal revenues, our financial statements show a net loss, and we have incurred expenses and an accumulated operating loss of approximately $24.8 million from inception, consisting primarily of research and development, sales and marketing, legal, accounting, consulting, personnel and facilities costs. Since our inception, Sylvan has provided us with a significant portion of the administrative personnel and services that we have required. During 2002, the expenses we expect to incur in connection with the implementation of our business plan include: . Improvement of our website, . Improvement of technical infrastructure for online delivery of tutoring services, . Improvement of online tutoring content, . Direct marketing, advertising and promotion of the eSylvan brand, . Recruiting and retention of executive, marketing, technical and tutoring personnel, . Administration, and . Legal, accounting and investment related fees. As of March 25, 2002, we estimate that we will incur $12 to $15 million in expenditures for marketing and advertising, personnel, professional fees, software, computer hardware, tutoring content, costs of delivering services and other expenses during the year ending December 31, 2002. Because we are a development stage company that commenced operations in October 2000, this estimate is not based on our historical experience. Instead, it is based upon the experience of our management team in the tutoring services industry, our internally developed business plan and strategy and publicly available research concerning our proposed market. Because we have only recently commenced operations, we are updating our business plan, and our internal estimate of the expenses we may incur in the next year, on a weekly and even daily basis to reflect our operating experience. Since this estimate is based upon less than eighteen months of operating experience in a limited market, we believe that we are unable to predict the exact amount of any specific expense and the aggregate amount of such expenses may exceed our estimated range by $5 million or more. For example, though we believe that our expenditures for personnel, marketing and advertising will substantially increase over the next year as we shift from organizational activities and the development of our technology to the sale of tutoring services to the public, the actual level of expenditures will depend upon the success of our marketing and advertising efforts. If our marketing and advertising efforts were to raise a demand for our services that exceeded our capacity, our personnel and infrastructure expense would likely increase. 20 Alternatively, if our marketing and advertising are unsuccessful in generating demand for our services, these efforts would likely be increased beyond our current plans. Further, unforeseen legal issues, technical difficulties, problems with our tutoring content and other risks set forth under the heading "Factors That May Affect Future Results" could require a reallocation of our resources to cover more urgent items of expense and heavier reliance upon the funding commitment of Sylvan and Sylvan Ventures than we currently expect. Under our professional services agreement with Sylvan, we may elect to participate in a cross referral program whereby we and Sylvan receive payments for each student referred to each other. Under the referral program, we will receive or pay amounts equal to 5%, up to a maximum of $100, of all revenues received by Sylvan or us, respectively, for the programs to which each referred student initially subscribes, including testing and registration fees. For each student enrollment a Sylvan franchisee generates for us, we will pay Sylvan a sales commission of 5%, up to a maximum of $100, of the revenues we receive for the first programs to which such student initially subscribes through the franchisee's center. Also under this agreement, before we assign a diagnostic and prescriptive instructor to a student, we must request Sylvan to provide an instructor for a committed period. If Sylvan makes personnel available for committed periods, we shall reimburse Sylvan for the salary of such instructors or other personnel at an hourly rate based on the base compensation such person receives from Sylvan. In addition to salary reimbursement, Sylvan shall receive a 30% management fee for each hour of direct instruction or test administration, including some specific preparation time, or parent conferences. If Sylvan refers instructors to us on an independent contractor basis, we will pay Sylvan a referral fee of $100. We anticipate that, for the foreseeable future, we will incur substantial operating losses and negative cash flow as we execute our business plan and acquire and integrate the necessary technology, systems and supporting infrastructure, enroll students in our service, develop our brand name, hire employees and contract personnel and expand our business. The extent of these loses will depend, in part, on the amount and rates of growth in our revenue from enrolled students. Revenue is charged on an hourly basis for diagnostic/prescriptive instructional programs. Revenue from these services are recognized as hours of instruction are completed. To the extent that revenue does not grow at anticipated rates or that increases in our operating expenses precede or are not subsequently followed by commensurate increases in revenue, our business, results of operations and financial condition will be materially and adversely affected. There can be no assurance that our operating losses will not increase in the future or that we will ever achieve or sustain profitability. Comparison of results for the year ended December 31, 2001 to results for the year ended December 31, 2000 We incurred net losses of $13.1 and $11.3 million for the years ended December 31, 2001 and 2000, respectively. Revenues for the year ended December 31, 2001 were $460,000. We had revenues of $16,000 during the year ended December 31, 2000, as we did not commence delivering services until October 2000. During the years ended December 31, 2001 and 2000, we incurred $13.7 and $12.7 million, respectively, in operating and other expenses in implementing our business plan. Direct costs of services provided increased by $993,000 to $1.1 million for the year ended December 31, 2001 from $151,000 for the year ended December 31, 2000. These costs consist primarily of labor for instructional, technical and operations support related to providing instructional services to our students. The increase was a direct result of the increase in revenues. Sales and marketing expenses increased by $1.1 million to $2.2 million for the year ended December 31, 2001 from $1.1 million for the year ended December 31, 2000. Sales and marketing costs are incurred to establish and grow the "eSylvan" brand. The primary costs incurred were related to advertising on various third-party web sites and internet-based newsletters and labor costs related to converting the leads generated from the advertising 21 campaigns into enrollments. The increase in sales and marketing costs was a result of promoting our product for a the full year in 2001 versus a partial year in 2000. General and administrative expenses increased by $800,000 to $6.7 million for the year ended December 31, 2001 from $5.9 million for the year ended December 31, 2000. General and administrative expenses consist of personnel costs, professional fees, maintenance expenses, depreciation and other expenses. The increase in general and administrative expenses resulted from additional personnel and other costs incurred to develop and expand administrative and operations support systems and services. Research and development expenses decreased by $2.6 million to $2.3 million for the year ended December 31, 2001 from $4.9 million for the year ended December 31, 2000. The decrease in research and development expenses is attributable to the fact that the development of our online tutoring technical infrastructure was more intensive during the period prior to the initial launch of our tutoring services in late 2000. Management services and facility usage charges from Sylvan increased by $734,000 to $1.3 million for the year ended December 31, 2001 from $529,000 for the year ended December 31, 2000. Under a services agreement with Sylvan, which commenced in July 2000, Sylvan provides management services, information systems support services, corporate accounting services, database management services, human resources and payroll services, general liability insurance and legal services to us. During 2001, the agreements were in place for the full year, versus six months in the prior year. Additionally, as our business activities have expanded, we have increased our utilization of these services thereby resulting in an increase in the charges. Allocated indirect overhead costs from Sylvan decreased by $200,000 to none for the year ended December 31, 2001 from $200,000 for the year ended December 31, 2000. Beginning June 30, 2000, upon the transfer of ownership of the Company from Sylvan to Sylvan Ventures and the adoption of the management services agreement with Sylvan, indirect overhead costs were no longer allocated to us. During the period October 1, 1999 through June 30, 2000, the Company and Sylvan operated under a tax sharing agreement that provided for the allocation to us of any tax benefits realized by Sylvan as a result of including our operations in its consolidated income tax return. Commencing July 1, 2000, Sylvan could not realize income tax benefits attributable to our operations as a result of the transfer of Sylvan's ownership in us to Sylvan Ventures. For the year ended December 31, 2000, we recorded tax benefits of $1.5 million under this agreement, related to the period from January 1, 2000 to June 30, 2000. For the periods subsequent to June 30, 2000, we have not reported a tax benefit from operating losses because of an increase in the valuation allowance for deferred tax assets. This results primarily from the inability to determine the realization of the net operation loss carryforwards generated in those periods. Liquidity And Capital Resources Net cash used in operating activities was $12.6 million in 2001 compared to $9.1 million in 2000. The 2001 cash used in operating activities resulted primarily from the net loss of $13.1 million, the reduction in accounts payable and accrued expenses of $1.7 million and the payment of certain fees to Sylvan totaling $300,000. These items were partially offset by non-cash depreciation and amortization expense of $2.2 million. The 2000 cash used in operating activities resulted primarily from the net loss of $11.1 million partially offset by an increase in accounts payable and accrued expenses of $2.7 million. Capital expenditures during 2001 and 2000 were $900,000 and $4.3 million, respectively consisting primarily of increases in software and educational content during 2001. Expenditures during 2000 consisted primarily of increases in software and educational content of $2.4 million and computer equipment and furnishings of $1.7 million. Our operations and capital requirements were funded by Sylvan from inception to June 30, 2000 and by Sylvan Ventures from July 1, 2000 to December 31, 2001. 22 On June 30, 2000, we entered into a revolving credit note with Sylvan Ventures pursuant to which we may borrow up to $10 million. The revolving credit note expires on December 31, 2002. As of December 31, 2001, $4.5 million was due under this note. The note is non-interest bearing. On June 30, 2000, we also entered into an agreement with Sylvan Ventures under which we agreed to issue an aggregate of 10,526,316 shares of Series A preferred stock in six closings. These closings were held on the last day of each fiscal quarter through December 31, 2001, for an aggregate price of $20 million, which represents a price per share of $1.90. As of December 31, 2000, we had issued 3,508,772 shares of Series A preferred stock to Sylvan Ventures for aggregate proceeds of $6.7 million and as of December 31, 2001 we have issued 10,526,316 shares of Series A preferred stock to Sylvan Ventures for aggregate proceeds of $20 million. Subsequent to December 31, 2001, the Company and Sylvan Ventures entered into an additional agreement under which Sylvan Ventures would acquire an additional 4,947,368 shares of our Series A preferred stock for $9.4 million which also represents a price per share of $1.90. A portion of the proceeds from this sale will be used to repay the balance outstanding on the revolving credit note discussed above, with the balance available to fund operations. We lease certain equipment from Sylvan under an operating lease dated October 1, 2000. The lease expires on September 30, 2003. Future minimum payments under this arrangement are $270,127 for 2002 and $202,954 for 2003. We have authorized the issuance of 10,000,000 shares of $.001 par value Class A Convertible Common Stock. On December 14, 2000, we filed a Form S-1 Registration Statement with the Securities and Exchange Commission in connection with the offering of up to 3,000,000 shares of Class A Convertible Common Stock to certain holders of Sylvan franchise license agreements or area development agreements. On March 2, 2001 the offer to issue shares was finalized and on March 30, 2001 we issued 2,452,484 shares of Class A Convertible Common Stock to Sylvan franchisees and remitted $858,385 to the holders of the Class A shares. We received no cash consideration for the Class A Convertible Common Stock issued to franchisees, instead the investors received a cash payment of $0.35 per share in exchange for execution of the participation agreement, which requires that the franchisee support our business plan. On March 2, 2001, we closed on this offering upon receipt of participation agreements and requests to issue an aggregate of 2,452,484 shares of Class A Convertible Common Stock to franchisees and the related payment of $858,385. We expect to incur significant negative cash flow from operations for the foreseeable future. Although we believe that the closings on our sale of Series A preferred stock to Sylvan Ventures will satisfy the majority of our cash needs through July 31, 2002, we do not expect that our current resources will be sufficient to support our growth and operations until we are profitable. We expect that we will need to raise additional capital or other financing prior to July 31, 2002. We cannot guarantee that we will be able to raise additional funds, or, if we can, that we will be able to do so on terms that we deem acceptable. In particular, potential investors may be unwilling to invest in us due to Sylvan Venture's voting control over us. We are unable to predict the amount of additional financing we will need prior to July 31, 2002 because such amount is substantially dependent upon the success of our business plan and marketing and advertising efforts and factors outside our control such as lawsuits, unexpected technical difficulties with our on-line tutoring infrastructure and other factors discussed herein and under the heading "Factors That May Affect Future Results." Our failure to raise the funds necessary to establish and grow our business would have a material adverse effect on our business and our ability to generate and grow revenues. If we raise funds through the issuance of equity, equity-related or debt securities, these securities will likely have rights, preferences or privileges senior to those of the rights of our existing Common stock, and our current Common stockholders may experience dilution. Our current and projected operating losses and limited funding raises substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS 23 In August 2001, the Financial Standards Board issued Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. Statement No.144 Supercedes Statement No.121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and provides a single accounting model for long-lived assets to be disposed of. We will apply the new rules on accounting for the impairment or disposal of long-lived assets beginning in the first quarter of 2002. Statement No. 144 retains the requirements of Statement No. 121 to recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and to measure the impairment loss as the difference between the carrying amount and the fair value of the asset. We do not believe that the adoption of the new standard will have a material impact on its financial position or results of operations. CRITICAL ACCOUNTING POLICIES Our accounting policies are more fully described in Note 1 of the Notes to Financial Statements. As discussed in this note, the preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty; therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. Valuation of Participation Agreements The fair value of the participation agreements was determined based on the fair value of the underlying Class A Convertible Common Stock that we issued in exchange for the executed agreements. The assumptions used to calculate the fair value of these securities included estimates of future operating results and cash flows as well as discount rates based on specifically identified risks and assumptions about our weighted average cost of capital. The assigned useful life of the participation agreements of six years is based upon the estimated weighted-average useful five of the agreements, which was determined based on an analysis of the historical useful life of Sylvan franchise agreements. If we used different assumptions and estimates in the calculation of the fair value of the underlying securities and the estimation of the related useful life, the amounts allocated to this asset, as well as the related amortization expense, would have been significantly different than the amounts recorded. Impairment of Participation Agreements In assessing the recoverability of the participation agreements, we must make assumptions regarding estimated future cash flows and other factors to determine its current fair value. If these estimates or their related assumptions change in the future, we may be required to record an impairment charge for this asset not previously recorded. ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET AND INTEREST RATE RISK Market risk is the risk of loss to future earnings, to fair values or to future cash flows that may result from changes in the price of financial instruments. We are exposed to market risks primarily through changes in 24 interest rates. We do not utilize derivatives and therefore exposure to market risks is managed through our regular operating and financing activities. The Company's revolving credit facility with Sylvan Ventures represents its only significant financial instrument and does not bear interest. ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (a) 1. Financial Statements. The information required by this Item is set forth on pages F-1 to F-26. (b) 2. Supplementary Data. Not Applicable. ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III. ITEM 10: DIRECTORS AND OFFICERS OF THE REGISTRANT Our directors and executive officers are as follows:

R. Christopher Hoehn-Saric has served as our chairman since inception and as a director since June 30, 2000. He has been president, chief executive officer and director of Sylvan Ventures, LLC, our majority stockholder, since 2000, and a principal in Sterling Capital, Ltd. ("Sterling"), the investment partnership that led the 1986 acquisition of the predecessor to Sylvan Learning Systems, Inc. since prior to 1986. Mr. Hoehn-Saric was co-chief executive officer of Sylvan Learning Systems, Inc. from 1993 to June 2000 and was president of Sylvan from 1988 to 1992. Before becoming Sylvan's president, Mr. Hoehn-Saric was involved in Sterling's acquisition of several distribution, broadcasting and photography businesses. Mr. Hoehn-Saric also serves as a director of Sylvan Learning Systems, Inc. Mr. Hoehn-Saric serves as an officer and director at the request of Sylvan Ventures under our services agreement with Sylvan. 25 David S. Graves has been our president since inception. From 1997 to 2000, he was vice president of marketing for Sylvan. In that role, he served as president of the SLC National Advertising Fund, Inc., a cooperative advertising fund managed with the input and support of Sylvan franchisees. Until 2000, he also served as executive director of Book Adventure, launching this new interactive, online reading program (www.bookadventure.com) with his team in 1999. From 1996 to 1997, he was vice president/general manager for the Franklin Mint jewelry and collector plates divisions. From 1988 to 1996, he held positions of increasing responsibility in brand marketing for Colgate-Palmolive Company's Hill's Pet Foods division (Science Diet brand), including marketing manager for US marketing, director of marketing for Europe, and managing director/general manager of northern European subsidiaries (UK, Ireland, Belgium, Luxembourg, and Netherlands). He began his marketing career at the Quaker Oats Company, working on the Gatorade brand and Quaker frozen foods. Barry C. Offutt has been our vice president and chief financial officer since September 1, 2001. He also serves as chief financial officer of MindSurf Inc., a company partially owned by Sylvan Ventures, and has served in that role since May 2001. He previously served as chief financial officer of Nexus Communications from June 2000 until joining Mindsurf. From 1992 to 2000 he was chief financial officer of HCIA Inc., a publicly traded health care information provider. During his tenure as CFO at HCIA, the Company acquired ten companies and completed its Initial Public Offering and three follow-on offerings. B. Lee McGee has been our senior vice president, treasurer and assistant secretary since inception and a director since June 30, 2000. He served as our chief financial officer from inception through August 2001. He served as chief financial officer of Sylvan Learning Systems, Inc. or its predecessor entities from 1987 to 2000 and executive vice president from 1997 to 2000. Mr. McGee has been a managing director, chief financial officer and treasurer of Sylvan Ventures, LLC, our majority stockholder, since 2000. Mr. McGee serves as an officer and director at the request of Sylvan and Sylvan Ventures under our services agreement with Sylvan. Robert W. Zentz has been our secretary, assistant treasurer and director since inception. He has been secretary of Sylvan Ventures, LLC, our majority stockholder since 2000, and since 1998, has been vice president and general counsel to Sylvan Learning Systems, Inc. From 1997 to 1998, Mr. Zentz was a partner of the law firm of Frank & Kraft. From 1996 to 1997, Mr. Zentz served as campaign manager in the political campaign of Jack O'Malley. From 1990 to 1996, he was vice president and general counsel of A.C. Nielsen, Inc., a marketing research firm. Mr. Zentz serves as an officer and director at the request of Sylvan and Sylvan Ventures under our services agreement with Sylvan. Anna T. Parmer has been our vice president of technology since September 2001 and since April 2000 our Director of Information Technology. For the prior nine years, she held positions of increasing responsibility related to applications development, information systems architecture and management of information systems personnel with the Procter & Gamble Company. Catherine Killian has been our vice president of sales since February 2001. From 1994 through February 2001 she was employed by Sylvan, and since 1995 held the position of Western regional vice president for Sylvan. In this position, she was responsible for overseeing daily operations, developing local and regional management teams, planning local advertising and territory expansion for 50 locations in six corporate markets. Prior to 1994, she held a series of sales and operations positions of increasing responsibility at Nutri/Sytems, Inc. Stuart A. Finnigan has been our vice president of operations since August 2000. From 1998 to 2000, he was vice president of operations for Sylvan's ASPECT language schools, responsible for global operations of 26 immersion ESL (English as second language) schools in five countries. Prior to ASPECT, he held the positions of vice president - Europe and vice president of test center operations for Sylvan's Prometric division from 1993 to 1998. In this position, he oversaw testing center growth from 80 centers to over 2,000 centers in 130 countries, with direct responsibility for operations in Europe, the Middle East and Africa. Peter Cohen has been our assistant secretary and a director since inception. He has been president of Sylvan Learning Systems, Inc. since February 2000. From 1996 to February 2000, Mr. Cohen was president of the learning center division of Sylvan. Prior to joining Sylvan, he was the chief executive officer of The Pet Practice, an 85 hospital veterinary business. He also served as vice president of sales for National Media Corporation and senior 26 vice president of corporate operations for Nutri-System Weight Loss Centers. Mr. Cohen serves as a director at the request of Sylvan under our services agreement with Sylvan. Susannah Bennett has been our assistant secretary since June 30, 2000. Ms. Bennett has been vice president and assistant general counsel of Sylvan Learning Systems, Inc. since 1999 and 1995, respectively. Ms. Bennett serves as an officer at the request of Sylvan under our services agreement with Sylvan. Barry E. Miller has been a member of our board of directors since February 2001. Mr. Miller has served as president of NBM Management, a company which owns and operates Sylvan Learning Centers and Thomson Prometric, Computer Based Testing Centers in Northeast Ohio and Western Pennsylvania since 1985. Since 1991 Mr. Miller has served four terms as president of Sylvan Franchise Owners Association, Inc. (FOA) and was a founding director and officer of SLC National Advertising Fund, Inc. Mr. Miller is currently a director of Sylvan Franchise Owners Association, Inc., and has been elected to serve as president of the board in 2002. He also serves as a director of the Sylvan National Advertising Fund. Mr. Miller was designated by the FOA and approved by Sylvan as the FOA's representative to our board of directors under the program agreement between Sylvan and the FOA. Beth J. Kaplan has been a member of our board of directors since March 2001. In May 2001, she founded Axcel Partners, LLC, a venture capital fund focused on early state start-ups with a focus on retail and consumer good technology. From 1996 through 1999, she was senior executive vice president of Rite Aid Drugstores, a national chain of over 4,000 drugstores with $13 billion in revenue. She was responsible for marketing , merchandising, category management, store design and logistics. In 1998 she was named Drugstore Marketer of the Year and identified as "one of the top 20 women to watch" by Advertising ----------- Age. From 1981 through 1996 she held positions of increasing responsibility with --- Proctor & Gamble, including President of Noxell. ITEM 11: EXECUTIVE COMPENSATION Compensation of Executive Officers and Directors Compensation of Executive Officers. The following table sets forth information about the annual and long-term compensation of the four highest paid executive officers of the Company during the period August 16, 2000 through December 31, 2001 (collectively, the "Named Executive Officers").

27 ____________ (1) Mr. Graves became a full-time employee of the Company on August 16, 2000. (2) This amount represents automobile allowance for each officer. (3) This amount represents the Company match on employee 401(k) contributions. (4) All other compensation represents taxable expenses in connection with Ms. Killian's relocation. During 2001, our current directors and executive officers, except our president and chief operating officer, vice president of technology, vice president of sales and vice president of operations, were employees of Sylvan or Sylvan Ventures and were not separately compensated by us for services. Ms. Kaplan, one of our directors, is a consultant to the Company and received compensation of $135,000 in 2001. Mr. Offutt, our vice president and chief financial officer, who also serves as vice president and chief financial officer of another Sylvan Venture company, Mindsurf, Inc., was hired in September 2001. We pay a portion of his compensation and benefits and Mindsurf, Inc. pays the remainder. Our portion did not exceed $100,000 for 2001. No other officers' compensation exceeded $100,000 in 2001. Sylvan did not allocate any of its corporate overhead for salaries to us during 2001. During 2000, our current directors and executive officers, were employees of Sylvan or Sylvan Ventures and were not separately compensated for those services. For the period January 1, 2000 through August 15, 2000, David Graves, our President, was an employee of Sylvan and not separately compensated by us for his services. Sylvan allocated $205,196 of its corporate overhead for salaries to us during 2000. During 1999, we operated as an unincorporated division of Sylvan. Accordingly, during 1999, we did not have any directors or executive officers. Employees of Sylvan, including our current directors and executive officers, that provided services to us during 1999, were not separately compensated for those services. Sylvan allocated $219,622 of its corporate overhead for salaries to us during 1999. These allocations were intended to reflect an estimate of all services that Sylvan and Sylvan Ventures employees provided to us during 2000 and 1999; however, we believe that any attempt to determine the portion of these allocations that would have been attributable to our executive officers would be speculative. Option Grants In The Last Fiscal Year. The following table sets forth information about options to purchase shares of the Common Stock granted to the Named Executive Officers during the last fiscal year.

______________ (1) The exercise price equaled the fair market value of the Common Stock as determined by the Board of Directors on the date of grant. The exercise price is payable in cash or by delivery of shares of Common Stock having a fair market value equal to the exercise price of options exercised. (2) The 5% and 10% assumed annual rates of stock price appreciation used to calculate potential gains to optionees are mandated by the rules of the Securities and Exchange Commission. The potential realizable value does not represent the Company's prediction of its 28 stock price performance. There can be no assurance that the stock price will actually appreciate over the 10-year option term at the assumed 5 percent and 10 percent levels or at any other level. Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values of eSylvan options. The following table sets forth information concerning the number and exercise price of the options to purchase Common Stock of eSylvan exercised by the Named Executive Officers during the last fiscal year and the number and value of unexercised options to purchase Common Stock of eSylvan held at the end of the fiscal year by the Named Executive Officers. Value is considered to be, in the case of exercised options, the difference between exercise price and fair market value as determined by the board of directors on the date of exercise, and, in the case of unexercised eSylvan options and exercisable options, the difference between exercise price and the fair market value as determined by the board of directors on December 31, 2001.

_______________ (1) (E) = Exercisable; (U) = Unexercisable. Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values of Sylvan Options. Certain of the Named Executive Officers were formerly employees of Sylvan. In connection with their employment with Sylvan, they participated in stock option programs sponsored by Sylvan. The following table sets forth information concerning the number and exercise price of the options to purchase Common Stock of Sylvan exercised by the Named Executive Officers during the last fiscal year and the number and value of unexercised options to purchase Common Stock of Sylvan held at the end of the fiscal year by the Named Executive Officers. Value is considered to be, in the case of exercised options, the difference between exercise price and market price for Sylvan common stock on the date of exercise and, in the case of unexercised options and exercisable options, the difference between exercise price and market price for Sylvan common stock at December 31, 2001.

_______________ (1) (E) = Exercisable; (U) = Unexercisable. Other Compensation Arrangements Services Agreement. Under our services agreement with Sylvan, we have contracted with Sylvan to provide management services to us. These management services include the services of members of our management team and board of directors. Specifically, Messrs. Hoehn-Saric, McGee, Zentz and Cohen and Ms. Bennett provide services to us at the request of Sylvan and/or Sylvan Ventures pursuant to this agreement. See "Business-Services provided to us by Sylvan-Services Agreement." Indemnification by Sylvan and Sylvan Ventures Since Messrs. Hoehn-Saric and McGee serve as officers and directors at the request of Sylvan Ventures, each is entitled to indemnification from Sylvan Ventures for their activities in such capacities. Since Mr. Cohen serves as director and Mr. Zentz and Ms. Bennett serve as officers at the request of Sylvan, each is entitled to indemnification from Sylvan for their activities in such capacities. Director's Compensation Although the Company has not paid, and has no current plans to pay, compensation to its directors and executive officers that are employees of Sylvan or Sylvan Ventures, these individuals may be entitled to stock options grants under our 2000 Omnibus Stock Plan. During 2001, 120,000 and 15,000 shares were granted to Messrs. Cohen and Zentz, respectively, on the same terms as those shares granted to employees of the Company. 29 Committees of the Board of Directors During 2002, the Board of Directors established a Compensation Committee. The Compensation Committee will establish the compensation for executive officers of the Company and generally review benefits and compensation for all officers and employees. It will also administer the Company's stock option plans. Peter Cohen and Beth J. Kaplan are the initial members of the Compensation committee. Series A Preferred Stock Director Under our charter, holders of our Series A preferred stock have the right to elect one member of our board of directors. The Series A preferred stockholders nominated Barry Miller and he was elected to our board of directors on February 12, 2001. Program Agreement Sylvan has entered into a program agreement with the FOA, under which, during the term of our license agreement with Sylvan, Sylvan has agreed to: . cause us to elect a person designated by the FOA and approved by Sylvan to our board of directors, and . establish a committee, the eSylvan Committee, comprised of two officers of Sylvan and two representatives of the FOA to: . negotiate with us regarding service fees and other modifications to the franchise benefits under the participation agreement between Sylvan and participating Sylvan franchisees, . review with Sylvan the exploitation of technology and content developed by us and which we now or hereafter license to Sylvan, pursuant to the license agreement, and to review our schedule and priorities for Internet technology transfer to Sylvan franchisees, either through direct marketing by us (i.e., wholesaling) or through acquisition from us and distribution of technology products, . review and approve proposed modifications to the license agreement that may have a material effect on Sylvan franchisees, . review methodology for population analysis by territory for purposes of distributing our stock, or for payments of reverse royalties as contemplated in the form of participation agreement, . analyze Sylvan franchisee participation levels in our business and to develop strategies for increasing participation and benefits to Sylvan franchisees, . analyze efficacy data on our programs and determine areas where the SYLVAN brand may be negatively impacted, and to propose strategies to deal with any related areas of concern, . review audit data and verify proper payments have been made to Sylvan franchisees and other relevant financial matters, and . provide such other guidance to Sylvan as the eSylvan Committee deems appropriate. Deadlocks on the eSylvan Committee shall be resolved by the chief executive officer of Sylvan. Sylvan has agreed not to consent to certain material amendments to the license agreement without the affirmative vote of at least three-quarters of the members of the eSylvan Committee. See "Business-Relationship with Sylvan and Sylvan Ventures." 2000 eSylvan, Inc. Omnibus Stock Plan Our board of directors has established the 2000 eSylvan, Inc. Omnibus Stock Plan to enable us to grant equity compensation to our directors, officers, employees and consultants. Our stock plan is administered by our board of directors. There are currently 3,000,000 shares of our common stock reserved and authorized for issuance 30 under the plan. As of December 31, 2001, there were 1,215,500 options outstanding. The options were issued at their estimated fair market value on the date of grant, vest over a period of four years and expire ten years from the date of grant. 1,215,500 options had been granted under the plan as of December 31, 2001. ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information about the beneficial ownership of shares of our common stock and our Series A preferred stock as of December 31, 2001 by (i) each person known by us to own beneficially 5% or more of the outstanding shares prior to this offering, (ii) each of our directors and executive officers, (iii) our Chief Executive Officer and (iv) all of our directors and executive officers as a group. Except as otherwise indicated, we believe that the beneficial owners of stock listed below, based on information furnished by such owners, have sole voting and investment power with respect to such shares, subject to community property laws where applicable. The percentages of beneficial ownership of common stock are based on 14 million shares of common stock outstanding as of December 31, 2001. The percentages of beneficial ownership of Series A preferred stock are based on 10,526,316 shares of Series A preferred stock outstanding as of December 31, 2001. No shares of our Class A Convertible Common Stock were owned by the parties listed below as of such date.

_________________ *Represents beneficial ownership of not more than one percent of the outstanding common stock. (1) The address of each stockholder listed in this table is c/o eSylvan, Inc., 506 South Central Avenue, Baltimore, MD 21202. (2) Represents shares held by Sylvan Ventures, LLC. Sylvan Learning Systems, Inc. is a controlling security holder of Sylvan Ventures, LLC and certain officers and/or directors of Sylvan Learning Systems, Inc. also serve as officers and/or managers of Sylvan Ventures, LLC. ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Christopher Hoehn-Saric, our chairman, chief executive officer and director is a director and former co-chief executive officer and chairman of Sylvan Learning Systems, Inc. and chairman, president and a manager of 31 Sylvan Ventures, LLC. B. Lee McGee, our senior vice president, treasurer, assistant secretary and director is a managing director, chief financial officer and treasurer of Sylvan Ventures, LLC. Robert W. Zentz, our secretary, assistant treasurer and director is vice president and general counsel of Sylvan Learning Systems, Inc. and secretary of Sylvan Ventures, LLC. Peter Cohen, our director, is president of Sylvan Learning Systems, Inc. Sylvan Ventures, LLC is a majority owned subsidiary of Sylvan Learning Systems, Inc. Susannah Bennett, our assistant secretary, is vice president of Sylvan. Barry C. Offutt, our chief financial officer, is also chief financial officer of another Sylvan Venture company, Mindsurf, Inc. Mr. Hoehn-Saric beneficially owns less than five percent and three percent of the outstanding equity securities of Sylvan and Sylvan Ventures, respectively. Each of Messrs. Graves, Offutt, McGee, Zentz and Cohen and Ms. Bennett beneficially owns less than one percent of the outstanding equity securities of Sylvan. Our relationships with Sylvan and Sylvan Ventures are key elements of our business plan. These relationships are set forth in various contracts between us that require compensation to Sylvan or Sylvan Ventures in exchange for certain assets and services. The terms and conditions of these agreements were not negotiated on an arms-length basis with Sylvan or Sylvan Ventures, and, accordingly, we expect that these terms and conditions may be less favorable to us than the terms and conditions that might have been negotiated on an arms-length basis with an unaffiliated third party. We believe, however, that the agreements and financing described below would not be available to us from an unaffiliated third party. At the time these agreements were initiated we had no independent members of our board of directors; however, the transactions described below were unanimously approved by our stockholders. After issuing our Class A Convertible Common Stock on March 2, 2001, we have added one independent member to our board of directors. On June 30, 2000, we entered into a license agreement with Sylvan pursuant to which we have licensed the materials we deem necessary to implement our business plan. See "Business-Relationship with Sylvan and Sylvan Ventures." We have agreed to pay Sylvan an initial license fee of $1 million and we have agreed to pay Sylvan a periodic, running royalty equal to 4% of our net revenues (gross revenues less discounts and refunds) and an additional amount equal to any sales, gross receipts or similar tax imposed on Sylvan. The initial license fee of $1 million was agreed to be an initial capital contribution by Sylvan, and no cash was paid for the initial license fee. During the first year of this agreement, there will be no guaranteed minimum royalty, but for each calendar year thereafter, there will be a guaranteed minimum royalty equal to 120% of the prior year's minimum royalty, with the guaranteed minimum royalty for calendar year 2002 of $400,000. As part of our arrangement with Sylvan, Sylvan has agreed to reduce future royalty payments due under the terms of the license agreement by any amounts that we pay to franchisees who enter into a participation agreement with us. Accordingly, we will not accrue or pay royalties to Sylvan under this license agreement until the amount of royalties that would otherwise be payable under this agreement exceeds the amount paid to franchisees. On June 30, 2000, we entered into professional services agreement with Sylvan which sets forth the terms by which we will obtain referrals of students from Sylvan and its franchisees, make referrals to Sylvan and its franchisees, compensate Sylvan for providing tutors and other professionals to us and undertake certain co-marketing arrangements with Sylvan as follows: . Student Referrals. We may elect to participate in a cross referral program whereby we and Sylvan receive payments for each student referred to each other. Under the referral program, we will receive or pay amounts equal to 5%, up to a maximum of $100, of all revenues received by Sylvan or us, respectively, for the programs to which each referred student initially subscribes, including testing and registration fees. For each student enrollment a Sylvan franchisee generates for us, we will pay Sylvan a sales commission of 5%, up to a maximum of $100, of the revenues we receive for the first programs to which such student initially subscribes through the franchisee's center. . Professional Services. Prior to assigning a diagnostic and prescriptive instructor to a student, we must request Sylvan to provide an instructor for a committed period. In the event Sylvan does not provide an instructor, we may use instructors that are not provided by Sylvan. In the event Sylvan makes personnel available for committed periods, we shall reimburse Sylvan for the salary of such instructors or other personnel at an hourly rate based on the base compensation such person receives from Sylvan. In addition to salary reimbursement, Sylvan shall receive a 30% management fee for each hour of direct instruction or test administration, including some specified 32 preparation time, or parent conferences. Additional services to be provided to us by center personnel and corresponding fees may be arranged subsequently. If Sylvan refers instructors to us on an independent contractor basis, we will pay Sylvan a referral fee of $100. . Co-Marketing. We have agreed with Sylvan that we will provide a link to Sylvan's website on our website and Sylvan will provide a link to our website on its website. Sylvan has agreed to adhere to our reasonable directives concerning promotion of our business including displaying posters or other promotional materials in Sylvan-owned centers and requesting its franchisees to display posters or other promotional materials in their centers. No fees have been incurred or paid under this agreement as of December 31, 2001. On June 30, 2000, we entered into a services agreement with Sylvan pursuant to which Sylvan has agreed to provide management services, information support services, corporate accounting services, PeopleSoft (database management) services, human resources/payroll services, general liability insurance and legal services to us on an independent contractor basis at fees that are fair and reasonable, as jointly determined by us and Sylvan for the services provided based on our utilization of such services. Fees that have been billed but that have not been paid within 30 days shall accrue simple interest at the prime rate plus one percent per annum. This agreement, which had an initial term of one-year, has been extended through June 30, 2002 and can be terminated at any time on 60 days notice. Fees for services under this agreement were $715,098 and $286,918 for the year ended December 31, 2001 and the six-month period ended December 31, 2000, respectively. On June 30, 2000, we entered into a facility use agreement with Sylvan pursuant to which Sylvan has agreed to provide us with the use of its facilities for a quarterly use fee and separate overhead fee based upon Sylvan's good faith estimate of our use of such facilities. In the event Sylvan owns a facility, the use fee is based on market rent. In the event Sylvan leases a facility, the use fee is based on Sylvan's lease payments. We currently occupy office space pursuant to this agreement This agreement, which had an initial term of one-year, has been extended through June 30, 2002 and can be terminated at any time on 60 days notice. Fees for services under this agreement were $548,489 and $242,386 for the year ended December 31, 2001 and the six-month period ended December 31, 2000, respectively. On June 30, 2000, we entered into revolving credit note with Sylvan Ventures, LLC pursuant to which we may borrow up to $10 million. The note is non-interest bearing and expires on December 31, 2002. On June 30, 2000, we entered into a contribution agreement with Sylvan Learning Systems, Inc. under which we agreed to issue 14,000,000 shares of our common stock to Sylvan, of which 285,714 shares of our common stock were directed to Ivy West Educational Services, Inc., in exchange for (i) $5 million in cash, (ii) Sylvan's agreement to enter into the following contracts: eSylvan license agreement, facilities use agreement, services agreement and program agreement and (iii) Sylvan's contribution of the following trademarks: 24-7 TUTORS, 24-7TUTORS.COM, ANYTIMETUTORS.COM and ANYTIME TUTORS. On June 30, 2000, we entered into a stock purchase agreement with Sylvan Ventures, LLC under which we have agreed to issue an aggregate of 10,526,316 shares of Series A preferred stock in closings on the last day of each fiscal quarter through December 31, 2001 for an aggregate price of $20 million, which represents a price per share of $1.90. In connection with this transaction, we have also entered into a registration rights agreement under which we have agreed to register the shares of common stock to be issued on conversion of the Series A preferred stock under certain circumstances. As of December 31, 2001, all of the shares had been fully paid and were issued and outstanding. During February 2002, Sylvan Ventures purchased an additional 4,947,368 shares of Series A preferred stock for $9.4 million. A portion of these proceeds was used to pay the balance outstanding under the line of credit agreement between Sylvan Ventures and the Company. During the period from October 1, 1999 through June 30, 2000, we incurred a net operating loss that was used by Sylvan to reduce consolidated income taxes payable. We entered into a tax sharing agreement with Sylvan. This agreement provided that income tax benefits attributable to our operations, which were realized by Sylvan, would be treated as distributions to Sylvan. During the period from inception through June 30, 2000, we and Sylvan 33 estimated that the tax benefits realized by Sylvan arising from our operations equaled approximately $1.77 million, summarized as follows: Tax benefit at U.S. statutory rate of 35% $(1,588,295) Effect of permanent differences 1,508 State income taxes, net of federal benefit (181,667) ----------- Total $(1,768,454) Sylvan will not realize income tax benefits in future periods attributable to our operations as a result of the transfer of Sylvan's ownership in our company to Sylvan Ventures on June 30, 2000. Sylvan Ventures is organized as a limited liability company, and under applicable income tax regulations, is unable to utilize or pass through losses to its members resulting from its investment in our company. Barry E. Miller, who serves as one of our directors, was issued 16,664 shares of Class A Convertible Common Stock and received a cash payment in the amount of $5,832. Mr. Miller is the holder of a Sylvan franchise and participated in the offering of Class A Convertible Common Stock solely on that basis. Mr. Miller is also a director of Sylvan's FOA and the Sylvan National Advertising Fund. PART IV. ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements -------------------- The following financial statements of eSylvan, Inc., are filed as part of this Form 10-K on the pages indicated: Index to Financial Statements Page ----------------------------- ---- Report of Independent Auditors........ F-2 Balance Sheets ....................... F-3 Statements of Operations ............. F-5 Statements of Deficiency of Assets ... F-6 Statements of Cash Flows ............. F-8 Notes to Financial Statements ........ F-9 2. Financial Statement Schedules ----------------------------- None. (b) Reports on Form 8-K None. (c) Exhibits. The exhibits to the Form 10-K have been included only -------- with the copy of this Form 10-K filed with the Securities and Exchange Commission. Copies of individual exhibits will be furnished to stockholders upon requests to eSylvan and payment of a reasonable fee. Exhibit Number -------------- 3.1 Form of Articles of Amendment and Restatement of eSylvan, Inc.* 3.2 Form of Bylaws of eSylvan, Inc., as amended.* 34 4.1 Specimen certificate for shares of common stock.* 10.1 Form of Services Agreement dated June 30, 2000, by and between eSylvan, Inc. and Sylvan Learning Systems, Inc.* 10.2 Form of Facilities Use Agreement dated June 30, 2000, by and between eSylvan, Inc. and Sylvan Learning Systems, Inc.* 10.3 Form of License Agreement dated June 30, 2000 by and between eSylvan, Inc. and Sylvan Learning Systems, Inc.* 10.4 Form of Professional Services Agreement dated June 30, 2000, by and between eSylvan, Inc. and Sylvan Learning Systems, Inc.* 10.5 Form of Revolving Credit Facility dated June 30, 2000, by and between eSylvan, Inc. and Sylvan Ventures LLC.* 10.6 Stock Purchase Agreement dated as of June 30, 2000, by and between eSylvan, Inc. and Sylvan Ventures LLC.* 10.7 Form of eSylvan, Inc., 2000 Omnibus Stock Plan.* 10.8 Form of Subscription Agreement by and between eSylvan, Inc. and the Class A Convertible Redeemable Preferred Stockholders.* 10.9 Form of Participation Agreement by and between Sylvan Learning Systems, Inc. and the Class A Convertible Redeemable Preferred Stockholders.* 23.1 Consent of Ernst & Young LLP 24.1 Power of Attorney. * Indicates an exhibit previously filed with the Securities and Exchange Commission as an exhibit to our Registration Statement on Form S-1, (File No. 333-42530), such exhibit incorporated herein by reference. 35 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. eSYLVAN, INC. March 29, 2002 /s/ R. Christopher Hoehn-Saric __________________________________________ R. Christopher Hoehn-Saric Chairman of the Board, Chief Executive Officer and Director (Principal Executive Officer) March 29, 2002 /s/ Barry C. Offutt __________________________________________ Barry C. Offutt Vice President and Chief Financial Officer (Principal Financial Officer) 36 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Enterprise) Audited Financial Statements Years ended December 31, 2001 and 2000 and the period October 1, 1999 (date of inception) through December 31, 1999 Contents Report of Independent Auditors............................................ F-2 Audited Financial Statements Balance Sheets ........................................................... F-3 Statements of Operations ................................................. F-5 Statements of Deficiency of Assets ....................................... F-6 Statements of Cash Flows ................................................. F-8 Notes to Financial Statements ............................................ F-9 F-1 Report of Independent Auditors The Board of Directors and Stockholders eSylvan, Inc. We have audited the accompanying balance sheets of eSylvan, Inc. (a subsidiary of Sylvan Ventures, LLC), a development stage company, as of December 31, 2001 and 2000, and the related statements of operations, deficiency of assets and cash flows for the years ended December 31, 2001 and 2000, the period October 1, 1999 (date of inception) through December 31, 1999, and the period October 1, 1999 (date of inception) through December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of eSylvan, Inc. at December 31, 2001 and 2000, and the results of its operations and its cash flows for the years ended December 31, 2001 and 2000, the period October 1, 1999 (date of inception) through December 31, 1999, and the period October 1, 1999 (date of inception) through December 31, 2001, in conformity with accounting principles generally accepted in the United States. The accompanying financial statements have been prepared assuming that eSylvan, Inc. will continue as a going concern. As more fully described in Note 13, the Company's current and projected operating losses and limited committed funding raise substantial doubt about its ability to continue as a going concern. Management's plans to address this matter are also described in Note 13. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. Baltimore, Maryland /s/ Ernst & Young LLP February 15, 2002 F-2 eSylvan, Inc. (A Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Balance Sheets

F-3 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Balance Sheets (continued)

See accompanying notes. F-4 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Statements of Operations

See accompanying notes. F-5 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Statements of Deficiency of Assets

See accompanying notes. F-6 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Statements of Deficiency of Assets (continued)

See accompanying notes F-7 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Statements of Cash Flows

See accompanying notes. F-8 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements December 31, 2001 1. Summary of Significant Accounting Policies Organization and Operations eSylvan, Inc., (the "Company") was incorporated by Sylvan Learning Systems, Inc. ("Sylvan") on February 3, 2000 under the laws of the state of Maryland for the purpose of delivering through Internet-based applications high quality supplemental education programs to families. Prior to incorporation and upon inception on October 1, 1999, the Company operated as an unincorporated division of Sylvan. On June 30, 2000, Sylvan contributed substantially all of its ownership in the Company to its majority-owned subsidiary, Sylvan Ventures, LLC ("Sylvan Ventures"). Since inception, the Company's activities have consisted primarily of organizational and research and development activities for its planned principal operations. Accordingly, no significant revenues have been earned, and the Company is considered a development stage company at December 31, 2001. Basis of Financial Statement Presentation As more fully discussed in Note 2, the accompanying statements of operations include an allocation of Sylvan's corporate expenses for the period from inception through June 30, 2000. The allocated expenses and contributions of Sylvan prior to incorporation were accumulated into a single caption on the balance sheet entitled "owner's net investment." Subsequent to incorporation on February 3, 2000 through June 30, 2000, these allocations and contributions were accounted for as additional paid-in capital. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. All of the accounting judgments, estimates and allocations used in the preparation of the financial statements are based on assumptions that management believes are reasonable under the circumstances. However, these allocations and estimates are not necessarily indicative of the costs that would have resulted if the Company operated as a separate entity. F-9 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) Property and Equipment Property and equipment is stated at cost. Depreciation is computed using the straight-line method over estimated useful lives. Estimated useful lives of furniture and equipment, computer software, and educational content range from two to seven years. Leasehold improvements are depreciated over the lesser of the lease term or the useful life of the asset. Educational content consists of payments made to vendors to acquire and develop educational content to be delivered to the Company's customers through its Internet-based applications. Intangible Assets Intagible assets consists of the fair value of participation agreements executed with Sylvan Learning Center Franchisees in connection with the issuance of Class A Convertible Common Stock (see Note 6). Amortization is calculated on a straight-line basis over the estimated useful life of six years. Deferred Stock Issuance Costs Deferred costs at December 31, 2000 represent costs incurred in connection with the sale of 2,452,484 shares of Class A Convertible Common Stock (see Note 6). All costs were accounted for as a reduction of additional paid-in capital upon the completion of the offering. Impairment of Long-Lived Assets Long-lived assets, including intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. If an impairment indicator is present, the Company evaluates whether impairment exists on the basis of undiscounted expected future cash flows from operations for the remaining amortization period. If impairment exists, the asset is reduced by the estimated shortfall of discounted cash flows. F-10 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) Revenue Recognition Revenues from the delivery of Internet-based educational services are recognized in the period the services are provided. Research and Development and Capitalized Software Costs The Company accounts for web site and software development costs in accordance with Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Costs incurred in planning the development of the Company's web site have been expensed as research and development costs. In July 2000, after completion of the planning stage and the establishment of the plan's technological feasibility as evidenced by a detailed program design, the Company began capitalizing the costs of developing software to operate its web site. These costs are included in property and equipment in the accompanying balance sheets. Amortization commenced in March 2001 when the web site and software were substantially complete and in use by customers. Advertising Costs The Company expenses advertising costs as incurred. Advertising expense totaled $1,306,500 and $1,082,431, respectively, for the years ended December 31, 2001 and December 31, 2000. The Company did not incur any advertising expense during the period October 1, 1999 (date of inception) through December 31, 1999. Stock Options Granted to Employees and Non-Employees The Company records compensation expense for its stock-based compensation plan using the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees. Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation ("Statement No. 123") encourages companies to recognize expense for stock-based awards based on their estimated value on the date of grant. Statement No. 123 requires the disclosure of pro forma income and earnings per share data in the notes to the financial statements if the fair value method is not elected. The Company has supplementally disclosed in these financial statements the required pro forma information as if the fair value method had been elected. F-11 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 1. Summary of Significant Accounting Policies (continued) The Company has also granted stock options to employees of Sylvan and Sylvan Ventures ("non-employee options"). The Company measures the fair value of non-employee options at the grant date using the Black-Scholes option pricing model and recognizes that fair value as a dividend to Sylvan. Effect of New Accounting Pronouncements In August 2001, the Financial Standards Board issued Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. Statement No.144 Supercedes Statement No.121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, and provides a single accounting model for long-lived assets to be disposed of. The Company will apply the new rules on accounting for the impairment or disposal of long-lived assets beginning in the first quarter of 2002. Statement No. 144 retains the requirements of Statement No. 121 to recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and to measure the impairment loss as the difference between the carrying amount and the fair value of the asset. The Company does not believe that the adoption of the new standard will have a material impact on its financial position or results of operations. F-12 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 2. Related Party Transactions Allocated Indirect Overhead Costs- October 1, 1999 through June 30, 2000 All obligations of the Company during the period October 1, 1999 (date of inception) through June 30, 2000 were satisfied by Sylvan and accounted for as contributions to capital. These obligations included all expenditures for property and equipment and all expenses directly attributable to the Company's operations and paid through Sylvan's cash management systems. The Company did not maintain any cash accounts during the period. In addition, during the period October 1, 1999 (date of inception) through June 30, 2000, management has allocated corporate indirect overhead costs to the Company based on an analysis of the components of corporate general and administrative expenses and the estimated percentage of each component attributable to the Company. Corporate general and administrative expenses consisted principally of corporate payroll and were allocated considering the estimated efforts of individual employees. Management believes that the method used to allocate these expenses is reasonable. Allocated indirect overhead costs consisted principally of the following: . Corporate human resources, including labor relations, payroll and training . Executive, finance and accounting, legal and administration . Tax services, including tax return preparation . Information technology management services Services Agreement On June 30, 2000 the Company entered into a services agreement with Sylvan under which Sylvan provides certain management, financial, legal, management information and human resources services and other management or administrative services upon request. The Company pays a quarterly fee that is based on Sylvan's good faith estimate of the cost of such services. This agreement which originally had a one-year term, was renewed for an additional year, and is terminable by either party with 60 days notice. Sylvan charged the Company services fees of $715,098 for the year ended December 31, 2001 and $286,918 for the six-month period ended December 31, 2000. F-13 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 2. Related Party Transactions (continued) Facilities Use Agreement On June 30, 2000 the Company entered into a facilities use agreement with Sylvan that provides for the payment of fees to Sylvan for office space used by the Company located within premises leased or owned by Sylvan. The Company pays a monthly fee that is based on Sylvan's good faith estimate of square footage occupied by the Company and market rates for comparable facilities located nearby. The facilities use fee also includes an overhead charge determined based on a pro rata allocation of associated overhead costs incurred by Sylvan to maintain its facilities. This agreement which originally had a one-year term, was renewed for an additional year, and is terminable by either party with 60 days notice. Sylvan charged the Company $548,489 in facilities usage fees for the year ended December 31, 2001 and $242,368 for the six-month period ended December 31, 2000. License Agreement On June 30, 2000, the Company entered into a license agreement with Sylvan to license specified trademarks, service marks and educational content in connection with its business. In consideration for this license, the Company was obligated to pay an initial license fee of $1,000,000 and will pay quarterly royalties in an amount equal to 4% of net revenues of the Company derived from Internet service delivery. A minimum annual royalty of $400,000 will be payable commencing in 2002, and the minimum royalty will increase by 20% each year until the expiration of the agreement. The term of the agreement is 5 years, except for the content license, which is for the duration of the applicable copyrights. The Company, at its option, may renew the license for consecutive five-year terms. The initial license fee of $1,000,000 due to Sylvan was agreed to be an initial capital contribution by Sylvan, and no cash was paid for the initial license fee. Because this was a nonmonetary transaction between a parent and its subsidiary prior to an initial public offering, the Company was required by accounting regulations to record the license at its historical cost basis to Sylvan. Because Sylvan had no basis in the transferred assets, the Company recorded no amount as the value of the license. F-14 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 2. Related Party Transactions (continued) Professional Services Agreement On June 30, 2000, the Company entered into a professional services agreement with Sylvan. The agreement specifies how the parties to the agreement will compensate each other for student referrals and exchange instructor services. Under the student referral program, the Company will receive 5%, up to a maximum of $100, of all revenues received by Sylvan or a participating franchisee as a result of a student referral from the Company. The Company will pay an equal amount to Sylvan or its participating franchisees for a student referral it receives. In addition, if the Company is obligated to pay a referral fee to a participating franchisee, the Company will pay to Sylvan a commission of 5%, up to a maximum of $100, of the revenues that the Company receives for the first program to which a student initially enrolls. No referral fees have been incurred or earned by the Company to date. In accordance with the instructor services section of this agreement, prior to assigning a diagnostic and prescriptive instructor to a student the Company must request Sylvan to provide an instructor for a committed period. In the event that Sylvan does not provide an instructor, the Company will provide its own instructors. In the event that Sylvan provides instructors for committed periods, the Company will reimburse Sylvan for the salary of the instructors during the committed period, plus a 30% management fee. If Sylvan refers instructors classified as independent contractors to the Company, the Company will pay a $100 referral fee to Sylvan. No instructor fees have been incurred by the Company to date. Leasing Management Services Agreement Effective October 23, 2000, the Company entered into a leasing management services agreement with Sylvan under which the Company can lease certain equipment under Sylvan's master equipment lease. Under this agreement, the Company is obligated to pay all amounts due related to the equipment that it leases. In addition, the Company must pay a quarterly lease management service fee to Sylvan equal to 5% of all lease payments. For the years ended December 31, 2001 and 2000, the Company was charged lease management services fees totaling $5,652 and $5,067, respectively, which are included in general and administrative expenses. F-15 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 3. Line of Credit with Sylvan Ventures, LLC On June 30, 2000, the Company entered into a revolving credit facility with Sylvan Ventures, a related party, under which it may borrow up to $10,000,000. The revolving credit facility, which originally expired December 31, 2001, has been extended through December 31, 2002. As of December 31, 2001 and 2000, $4,469,673 and $3,078,699, respectively, were due under the facility. For the year ended December 31, 2001 and the six-month period ended December 31, 2000, interest expense calculated at the prime rate of interest and totaling $401,105 and $124,548, respectively, was accrued by the Company. Effective December 31, 2001, Sylvan Ventures agreed to forgive all past and future accrued interest and accordingly, the Company recognized income of $525,653 in the accompanying statement of operations as "Interest expense forgiven by Sylvan Ventures." 4. Income Taxes During the period from October 1, 1999 through June 30, 2000, the Company and Sylvan operated under a tax sharing agreement that provided for the allocation to the Company of any tax benefits realized by Sylvan as a result of including the Company's operations in its consolidated income tax return. Any allocated income tax benefits were treated as a distribution to Sylvan. The Company would not have recorded these income tax benefits if it recorded an income tax provision using the separate return method. During the period from October 1, 1999 through June 30, 2000, the Company incurred a net operating loss that was used by Sylvan to reduce consolidated income taxes payable. The Company and Sylvan estimated that the tax benefits realized by Sylvan arising from the Company's operations equaled approximately $252,337 and $1,516,117 for the period October 1, 1999 (date of inception) through December 31, 1999 and the period January 1, 2000 through June 30, 2000, respectively. The tax benefit is summarized as follows:

F-16 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 4. Income Taxes (continued) Had the Company not recorded an income tax benefit attributable to its operating losses, the recorded net loss and net loss per share would have been as follows: Period October 1, 1999 (date Year ended December of inception) through 31, 2000 December 31, 1999 ---------------------- ----------------------- Net loss $ (12,853,441) $ (647,516) Net loss per share $ (1.83) $ - Commencing July 1, 2000, Sylvan could not realize income tax benefits attributable to the Company's operations as a result of the transfer of Sylvan's ownership in the Company to Sylvan Ventures on June 30, 2000. Sylvan Ventures is organized as a limited liability company, and under applicable income tax regulations, is unable to utilize or pass through losses to its members resulting from its investment in the Company. Significant components of the Company's deferred tax assets and liabilities as of December 31 are as follows: ----------------------------- 2001 2000 ----------------------------- Deferred tax assets: Net operating loss carryforwards $ 8,429,799 $ 3,494,482 Allowance for doubtful accounts 12,840 98 Accrued expenses - 56,324 Depreciation 110,257 - Deferred revenue 153,107 - -------------- ------------- Total deferred tax assets 8,706,002 3,550,904 Deferred tax liability: Depreciation - 14,474 -------------- ------------- Net future income tax benefit 8,706,002 3,536,430 Valuation allowance for net deferred tax assets (8,706,002) (3,536,430) -------------- ------------- Net deferred tax asset $ - $ - ============== ============= F-17 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 5. Income Taxes (continued) In assessing the realization of deferred tax assets, management considers whether it is more likely than not that all or some portion of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences are deductible and net operating losses are utilized. Based on consideration of these factors, the Company has established a valuation allowance of $8,706,002 and $3,536,430 at December 31, 2001 and 2000, respectively. At December 31, 2001, the Company had net operating loss carryforwards for approximately $21,300,000, which expire in 2020 and 2021 and are available to offset future U. S. taxable income. The reconciliation of the reported income tax expense benefits to the amount that would result by applying the U.S. federal statutory rate to income before income taxes is as follows:

F-18 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 5. Preferred Stock On June 30, 2000, the Company entered into a stock purchase agreement with Sylvan Ventures under which Sylvan Ventures subscribed to purchase 10,526,316 shares of Series A Convertible Preferred Stock ("Preferred Stock") for aggregate proceeds of $20,000,000. The Preferred Stock has been issued with the following terms: Conversion Rights The Preferred Stock is convertible into common stock at the option of the holder at any time. In addition, the Preferred Stock will convert automatically into shares of common stock upon the closing of an underwritten public offering of at least $10,000,000 of gross proceeds to the Company with a price to the public of not less than $4.00 per share. Each share of Preferred Stock is initially convertible into one share of common stock. Additionally, prior to conversion, if the Company issues any shares of stock for less then the conversion price, the conversion ratio will be adjusted based upon a predetermined formula. Dividends The holders of the Preferred Stock are entitled to share ratably in any dividends declared by the Board of Directors, assuming the conversion of all outstanding convertible securities. Liquidation In the event of liquidation, the holders of Preferred Stock are entitled to share any remaining net assets ratably with holders of all common stock. Voting Rights Each holder of Preferred Stock is entitled to five votes for each share of common stock that the holder could obtain assuming the exercise of conversion rights. In addition, the holders of Preferred Stock are entitled to elect one director acting as a separate class. F-19 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 6. Class A Convertible Common Stock During 2000, the Company commenced an offering of up to 3,000,000 shares of Class A Convertible Common Stock ("Class A") to be issued to Sylvan Learning Center franchisees that execute participation agreements that provide for the franchisee's support of the Company's Internet-based delivery of educational services. Sylvan Learning Centers offer supplemental educational services to students at all skill levels and ages. The Company has authorized the issuance of 10,000,000 shares of $0.001 par value Class A. On March 30, 2001, the Company issued, for no monetary consideration, 2,452,484 shares of Class A pursuant to the receipt of executed participation agreements from Sylvan Learning Center franchisees. Upon issuance, $880,156 of direct costs incurred in connection with the stock issuance were removed from deferred stock issuance costs and recorded as a reduction to additional paid-in-capital. The Company also recorded an intangible asset entitled participation agreements of $2,145,923, which is equal to the estimated fair value of the Class A on the date of issuance. The Company is amortizing this asset over six years, the estimated average useful life of the participation agreements, using the straight-line method. At December 31, 2001, accumulated amortization totaled $268,240. In connection with this offering, the Company was obligated to pay an amount in cash to each Class A shareholder equal to $0.35 multiplied by the number of shares received. In April 2001, the Company paid an aggregate of $858,385 to the shareholders. These payments have been recorded as prepaid royalties to Sylvan as the license agreement with Sylvan provides for the offset of this payment against any future royalties due Sylvan (see Note 2). The Class A was issued with the following terms: Redemption Rights The Class A Convertible Common Stock is redeemable upon the occurrence of certain events or transactions solely at the discretion of the Company. The redemption amount is equal to the greater of $0.875 per share or the appraised value. F-20 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 6. Class A Convertible Common Stock (continued) Conversion Rights The Class A will automatically convert into shares of common stock upon the sale of the Company or upon the closing of an underwritten public offering of at least $10,000,000 of gross proceeds to the Company with a price to the public of not less than $4.00 per share. Each share of Class A is convertible into one share of common stock. Dividends The holders of the Class A are entitled to share ratably in any dividends declared by the Board of Directors, assuming the conversion of all outstanding convertible securities. Liquidation In the event of liquidation, the holders of Class A are entitled to share any remaining net assets ratably with all stockholders, assuming conversion of all convertible securities. Voting Rights Each share of the Class A has substantially the same voting rights as the number of shares of common stock into which it can be converted. Restrictions on Transfer The transfer of Class A, other than to the Company, is restricted until September 30, 2010. 7. Common Stock On June 30, 2000, 14,000,000 shares of common stock were sold to Sylvan in exchange for cash of $5,000,000. In connection with the sale, Sylvan also agreed to transfer or license specified intangible assets to the Company (see Note 2). In satisfying the purchase price, Sylvan was allowed to reduce the entire amount due by capital contributions in the form of expenses and expenditures paid on the Company's behalf. Subsequent to the purchase by Sylvan of 14,000,000 shares of common stock, 13,857,143 of those shares were contributed by Sylvan to its majority-owned subsidiary, Sylvan Ventures. F-21 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 8. Stock Option Plan On June 30, 2000, the Company adopted the eSylvan, Inc. 2000 Omnibus Stock Plan. The plan allows for the grant of up to 3,000,000 shares of common stock to employees, directors, and consultants in the form of incentive and non-qualified stock options, stock appreciation rights, stock awards, phantom stock awards, convertible securities and performance awards. During 2001, the Company issued options to purchase 616,500 shares of common stock to the Company's employees ("employee options") and options to purchase 599,000 shares of common stock to Sylvan employees ("non-employee options") for $0.975 per share, the estimated fair value of common stock on the date of grant. At December 31, 2001, 179,750 employee options were exercisable and 196,375 non-employee options were exercisable. The options vest over periods of up to four years and expire ten years from the date of grant. No options have been exercised or forfeited at December 31, 2001. The weighted average remaining contractual life at December 31, 2001 is 8.28 years for employee options and 8.35 years for non-employee options. No options had been granted under the plan as of December 31, 2000. To determine the pro forma data required by Statement No.123, the Company used the Black-Scholes option-pricing model to measure the fair value of options at the date of grant with the following weighted average assumptions: risk-free interest rate of 4.5%, dividend yield of 0%, volatility factor of the expected market price of the Company's common stock of 0.44 and an expected life of the granted options of five years. The weighted average estimated fair value of the Company's stock options granted utilizing the Black-Scholes option-pricing model was $0.45. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. For purposes of pro forma disclosures for employee options, the estimated fair value of the options is amortized to expense over the options' vesting period. The pro forma expense calculated using Black-Scholes for employee options was immaterial to the net loss for the year ended December 31, 2001, and would not change basic and diluted loss per common share. The aggregate fair value of the non-employee options granted during 2001 of $269,550 has been treated as a dividend to Sylvan by recording the value of the options as an increase to additional paid-in capital and the corresponding value of the dividend as a decrease to additional paid-in capital. F-22 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 9. Loss Per Share The following table sets forth the computation of basic and diluted loss per common share:

Since the Company was not incorporated until February 3, 2000, no computation has been presented for the period October 1, 1999 (date of inception) through December 31, 1999. The subscribed and unissued shares of Series A Convertible Preferred Stock have not been included in the weighted-average calculation as they are not eligible to share in dividends until the consideration is paid, and are therefore considered for purposes of computing loss per share the equivalent of warrants. The dilutive effect of these subscriptions is computed using the treasury stock method, whereby the unpaid balance is assumed to be proceeds used to purchase stock under the treasury stock method. At December 31, 2001 and 2000, no additional dilution from preferred stock resulted from the computation. F-23 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 10. Operating Leases The Company leases certain computer and other equipment under non-cancelable operating leases that are guaranteed by Sylvan. Future minimum lease payments under non-cancelable operating leases consisted of the following at December 31, 2001: 2002 $270,127 2003 202,954 -------- $473,081 ======== Rent expense under all operating leases for the years ended December 31, 2001 and 2000 was $276,686 and $101,298, respectively. 11. Defined Contribution Retirement Plan Sylvan sponsors a defined contribution retirement plan under section 401(k) of the Internal Revenue Code. The provisions of this plan allow for voluntary employee contributions, subject to certain annual limitations, and discretionary contributions that are allocated to eligible participants based upon compensation. All employees of the Company are eligible after meeting certain service requirements. No discretionary contributions have been made to this plan on behalf of the Company. 12. Quarterly Financial Data (Unaudited) The following financial information reflects all normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of the results of the interim periods. Summarized operating data is as follows: F-24 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued)

During the three months ended December 31, 2001, the Company recognized non- operating income of $525,653 related to the forgiveness of interest expense from Sylvan Ventures (see Note 3). F-25 eSylvan, Inc. (a Subsidiary of Sylvan Ventures, LLC and a Development Stage Company) Notes to Financial Statements (continued) 13. Going Concern The Company's financial statements have been prepared on a going concern basis, which contemplates the realization of assets and settlement of liabilities in the normal course of business. As of December 31, 2001, the Company had $250,880 in cash and a working capital deficiency of $4,735,359. The Company has incurred net losses of $24,832,539 and used $22,338,258 in its operations since inception. All of these factors raise substantial doubt about the Company's ability to continue as a going concern. The Company has a $10 million revolving line of credit with Sylvan Ventures expiring on December 31, 2002, of which $4,469,673 is outstanding at December 31, 2001. In addition, the Company executed a stock purchase agreement with Sylvan Ventures in February 2002, as discussed in Note 14. The Company believes that its cash will be sufficient to meet its obligations in the ordinary course of business through July 2002. Management believes sufficient capital can be obtained to support planned operations through December 31, 2002, however there can be no assurance that the Company will be able to obtain this financing on acceptable terms. 14. Subsequent Event In February 2002, the Company issued 4,947,368 additional shares of Series A Preferred Stock to Sylvan Ventures for a total aggregate purchase price of $9.4 million. The Company used $6,205,668 of the proceeds to repay the outstanding balance on the line of credit to Sylvan Ventures. F-26

ESYLVAN INC 10-K