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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
|- | -------------------------------------------------------------------------------------------



For the quarter ended September 30, 2003



OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



Commission file number: 333-42530



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eSylvan, Inc.

(Exact name of registrant as specified in its charter)



|Maryland                                                      |  | 52-2257470                         
|------------------------------------------------------------- |  | -----------------------------------
|(State or other jurisdiction ofincorporation or organization) |  | (I.R.S. EmployerIdentification 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)



---



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 a chek mark whether the registrant is an accelerated filer (as defined In Exhange Act Rule 12b-2).  Yes ̈No  x



As of November 12, 2003, the registrant had 14,000,000 outstanding shares of Common Stock and 2,517,984 outstanding shares of Class A Convertible Common Stock.



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##### Table of Contents



eSylvan, Inc.



INDEX



|         |  |                                                                                                                                                                                               |  | PAGE
|-------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|PART I.  |  |                                                                                                                                                                                               |  |     
|         |  |                                                                                                                                                                                              
|ITEM 1.  |  | Financial Statements (Unaudited):                                                                                                                                                             |  |     
|         |  |                                                                                                                                                                                              
|         |  | Balance Sheets  September 30, 2003 for eSylvan, Inc. and December 31, 2002 for predecessor eSylvan, Inc.                                                                                     |  | 2   
|         |  |                                                                                                                                                                                              
|         |  | Statements of Operations Three Months Ended September 30, 2003 for eSylvan Inc, and Three Months Ended September 30, 2002 for predecessor eSylvan, Inc.                                      |  | 4   
|         |  |                                                                                                                                                                                              
|         |  | Statements of Operations  Three Months Ended September 30, 2003 for eSylvan, Inc., and Six Months Ended June 30, 2003 and Nine Months Ended September 30, 2002 for predecessor eSylvan, Inc. |  | 5   
|         |  |                                                                                                                                                                                              
|         |  | Statements of Cash Flows  Three Month Ended September 30, 2003 for eSylvan Inc, and Six Months Ended June 30, 2003 and Nine Months Ended September 30, 2002 for predecessor eSylvan, Inc.    |  | 6   
|         |  |                                                                                                                                                                                              
|         |  | Notes to Financial Statements  September 30, 2003                                                                                                                                            |  | 7   
|         |  |                                                                                                                                                                                              
|ITEM 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                                                                         |  | 13  
|         |  |                                                                                                                                                                                              
|ITEM 3.  |  | Quantitative and Qualitative Disclosures about Market Risk                                                                                                                                    |  | 19  
|         |  |                                                                                                                                                                                              
|ITEM 4.  |  | Controls and Procedures                                                                                                                                                                       |  | 19  
|         |  |                                                                                                                                                                                              
|PART II. |  |                                                                                                                                                                                               |  |     
|         |  |                                                                                                                                                                                              
|ITEM 1.  |  | Legal Proceedings                                                                                                                                                                             |  | 20  
|         |  |                                                                                                                                                                                              
|ITEM 2.  |  | Changes in Securities and Use of Proceeds                                                                                                                                                     |  | 20  
|         |  |                                                                                                                                                                                              
|ITEM 3.  |  | Defaults upon Senior Securities                                                                                                                                                               |  | 20  
|         |  |                                                                                                                                                                                              
|ITEM 4.  |  | Submission of Matters to a Vote of Security Holders                                                                                                                                           |  | 20  
|         |  |                                                                                                                                                                                              
|ITEM 5.  |  | Other Information                                                                                                                                                                             |  | 20  
|         |  |                                                                                                                                                                                              
|ITEM 6.  |  | Exhibits and Reports on Form 8-K                                                                                                                                                              |  | 20  
|         |  |                                                                                                                                                                                              
|         |  | SIGNATURES                                                                                                                                                                                    |  | 21  





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##### Table of Contents

|ITEM 1. |  | FINANCIAL STATEMENTS
|------- |  | --------------------



eSylvan, Inc.

(a Subsidiary of Educate, Inc.)



Balance Sheets



|                                                                                                                       |  |                    |           |   | Predecessor      |  
|---------------------------------------------------------------------------------------------------------------------- |  | ------------------ | --------- | - | ---------------- | -
|                                                                                                                       |  | September 30, 2003 |           |   | December 31,2002 |  
|                                                                                                                       |  | (Unaudited)        |           |   | (Audited)        |  
|Assets                                                                                                                 |  |                    |           |   |                  |  
|Current assets:                                                                                                        |  |                    |           |   |                  |  
|Cash                                                                                                                   |  | $                  | 227,228   |   |                  | $
|Amounts due from prior investor                                                                                        |  |                    | 564,525   |   |                  |  
|Accounts receivable, net of allowance of $24,628 and $49,844 at September 30, 2003 and December 31, 2002,
respectively |  |                    | 75,941    |   |                  |  
|Accounts receivable from related party                                                                                 |  |                    | 45,826    |   |                  |  
|Prepaid expenses                                                                                                       |  |                    | 11,951    |   |                  |  
|Prepaid royalties to related party                                                                                     |  |                    | 79,153    |   |                  |  
|                                                                                                                       |  |                    |           |   |                  |  
|Total current assets                                                                                                   |  |                    | 1,004,624 |   |                  |  
|                                                                                                                       |  |                   
|Property and equipment:                                                                                                |  |                    |           |   |                  |  
|Furniture and equipment                                                                                                |  |                    | 336,222   |   |                  |  
|Software                                                                                                               |  |                    | 425,506   |   |                  |  
|Educational content                                                                                                    |  |                    |          |   |                  |  
|Leasehold improvements                                                                                                 |  |                    | 2,312     |   |                  |  
|                                                                                                                       |  |                    |           |   |                  |  
|                                                                                                                       |  |                    | 764,040   |   |                  |  
|Accumulated depreciation and amortization                                                                              |  |                    | (147,725  | ) |                  |  
|                                                                                                                       |  |                    |           |   |                  |  
|                                                                                                                       |  |                    | 616,315   |   |                  |  
|                                                                                                                       |  |                   
|Intangible assets:                                                                                                     |  |                    |           |   |                  |  
|Participation agreements, net of accumulated amortization of $625,894 at December 31, 2002                             |  |                    |          |   |                  |  
|                                                                                                                       |  |                    |           |   |                  |  
|Total assets                                                                                                           |  | $                  | 1,620,939 |   |                  | $
|                                                                                                                       |  |                    |           |   |                  |  



2



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##### Table of Contents

eSylvan, Inc.

(a Subsidiary of Educate, Inc.)



Balance Sheets (continued)



|                                                                                                                                                                                                                    |  |                    |            |   | Predecessor      |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ---------- | - | ---------------- | -
|                                                                                                                                                                                                                    |  | September 30, 2003 |            |   | December 31,2002 |  
|                                                                                                                                                                                                                    |  | (Unaudited)        |            |   | (Audited)        |  
|Liabilities and stockholders deficit                                                                                                                                                                               |  |                    |            |   |                  |  
|Current liabilities:                                                                                                                                                                                                |  |                    |            |   |                  |  
|Accounts payable and accrued expenses                                                                                                                                                                               |  | $                  | 702,420    |   |                  | $
|Accrued severance costs                                                                                                                                                                                             |  |                    | 18,883     |   |                  |  
|Fees payable to related party                                                                                                                                                                                       |  |                    |           |   |                  |  
|Borrowings from related party                                                                                                                                                                                       |  |                    | 1,534,692  |   |                  |  
|Borrowings from prior investor                                                                                                                                                                                      |  |                    |           |   |                  |  
|Deferred revenue                                                                                                                                                                                                    |  |                    | 292,296    |   |                  |  
|                                                                                                                                                                                                                    |  |                    |            |   |                  |  
|Total current liabilities                                                                                                                                                                                           |  |                    | 2,548,291  |   |                  |  
|                                                                                                                                                                                                                    |  |                   
|Commitments and contingent liabilities                                                                                                                                                                              |  |                    |           |   |                  |  
|                                                                                                                                                                                                                    |  |                   
|Stockholders (deficit):                                                                                                                                                                                            |  |                    |            |   |                  |  
|Series A Convertible Preferred Stock, par value $.001 per share 30,000,000 shares authorized, 20,629,633 and 15,473,684
shares issued and outstanding as of September 30, 2003 and December 31, 2002, respectively |  |                    | 20,630     |   |                  |  
|Class A Convertible Common Stock, par value $.001 per share 10,000,000 shares authorized, 2,517,984 shares issued and
outstanding as of September 30, 2003 and December 31, 2002                                   |  |                    | 2,518      |   |                  |  
|Common stock, par value $.001 per share  authorized 60,000,000 shares, 14,000,000 shares issued and outstanding as of
September 30, 2003 and December 31, 2002                                                     |  |                    | 14,000     |   |                  |  
|Additional paid-in capital                                                                                                                                                                                          |  |                    | 242,795    |   |                  |  
|Accumulated deficit                                                                                                                                                                                                 |  |                    | (1,207,295 | ) |                  |  
|                                                                                                                                                                                                                    |  |                    |            |   |                  |  
|Total stockholders deficit                                                                                                                                                                                         |  |                    | (927,352   | ) |                  |  
|                                                                                                                                                                                                                    |  |                    |            |   |                  |  
|Total liabilities and stockholders deficit                                                                                                                                                                         |  | $                  | 1,620,939  |   |                  | $
|                                                                                                                                                                                                                    |  |                    |            |   |                  |  



See accompanying notes.



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##### Table of Contents

eSylvan, Inc.

(a Subsidiary of Educate, Inc.)



Statements of Operations (Unaudited)



|                                                 |  |                                     |            |   | Predecessor                         |  
|------------------------------------------------ |  | ----------------------------------- | ---------- | - | ----------------------------------- | -
|                                                 |  | Three monthsendedSeptember 30, 2003 |            |   | Three monthsendedSeptember 30, 2002 |  
|Revenues                                         |  | $                                   | 472,744    |   |                                     | $
|                                                 |  |                                    
|Costs and expenses                               |  |                                     |            |   |                                     |  
|Direct costs of services provided                |  |                                     | 388,657    |   |                                     |  
|Sales and marketing                              |  |                                     | 164,807    |   |                                     |  
|General and administrative                       |  |                                     | 793,293    |   |                                     |  
|Research and development                         |  |                                     | 182,166    |   |                                     |  
|Management services and facilities usage charges |  |                                     | 151,116    |   |                                     |  
|                                                 |  |                                     |            |   |                                     |  
|Total operating costs and expenses               |  |                                     | 1,680,039  |   |                                     |  
|                                                 |  |                                     |            |   |                                     |  
|Net loss                                         |  | $                                   | (1,207,295 | ) |                                     | $
|                                                 |  |                                     |            |   |                                     |  
|Basic and diluted loss per common share          |  | $                                   | (0.07      | ) |                                     | $
|                                                 |  |                                     |            |   |                                     |  



See accompanying notes.



4



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##### Table of Contents

eSylvan, Inc.

(a Subsidiary of Educate, Inc.)



Statements of Operations (Unaudited)



|                                                 |  |                                    |            |   | Predecessor                 |  
|------------------------------------------------ |  | ---------------------------------- | ---------- | - | --------------------------- | -
|                                                 |  | Three monthsendedSeptember 30,2003 |            |   | Six monthsendedJune 30,2003 |  
|Revenues                                         |  | $                                  | 472,744    |   |                             | $
|                                                 |  |                                    |           
|Costs and expenses                               |  |                                    |            |   |                             |  
|Direct costs of services provided                |  |                                    | 388,657    |   |                             |  
|Sales and marketing                              |  |                                    | 164,807    |   |                             |  
|General and administrative                       |  |                                    | 793,293    |   |                             |  
|Research and development                         |  |                                    | 182,166    |   |                             |  
|Management services and facilities usage charges |  |                                    | 151,116    |   |                             |  
|                                                 |  |                                    |            |   |                             |  
|Total operating costs and expenses               |  |                                    | 1,680,039  |   |                             |  
|                                                 |  |                                    |            |   |                             |  
|Net loss                                         |  | $                                  | (1,207,295 | ) |                             | $
|                                                 |  |                                    |            |   |                             |  
|                                                 |  |                                    |           
|Basic and diluted loss per common share          |  | $                                  | (0.07      | ) |                             | $
|                                                 |  |                                    |            |   |                             |  



See accompanying notes.



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##### Table of Contents

eSylvan, Inc.

(a Subsidiary of Educate, Inc.)



Statements of Cash Flows (Unaudited)



|                                                                            |  |                                    |            |   | Predecessor                 |  
|--------------------------------------------------------------------------- |  | ---------------------------------- | ---------- | - | --------------------------- | -
|                                                                            |  | Three monthsendedSeptember 30,2003 |            |   | Six monthsendedJune 30,2003 |  
|Operating activities                                                        |  |                                    |            |   |                             |  
|Net loss                                                                    |  | $                                  | (1,207,295 | ) |                             | $
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                    |            |   |                             |  
|Depreciation and amortization                                               |  |                                    | 147,725    |   |                             |  
|Non-cash compensation expense                                               |  |                                    |           |   |                             |  
|Changes in operating assets and liabilities:                                |  |                                    |            |   |                             |  
|Accounts receivable, net                                                    |  |                                    | 48,474     |   |                             |  
|Accounts receivable from related party                                      |  |                                    | (45,826    | ) |                             |  
|Prepaid expenses                                                            |  |                                    | 72,365     |   |                             |  
|Prepaid royalties to related party                                          |  |                                    | 120,000    |   |                             |  
|Accounts payable and accrued expenses                                       |  |                                    | (176,073   | ) |                             |  
|Accrued severance costs                                                     |  |                                    | (135,196   | ) |                             |  
|Fees payable to related party                                               |  |                                    | 10,093     |   |                             |  
|Deferred revenue                                                            |  |                                    | (3,737     | ) |                             |  
|                                                                            |  |                                    |            |   |                             |  
|Net cash used in operating activities                                       |  |                                    | (1,169,470 | ) |                             |  
|                                                                            |  |                                    |            |   |                             |  
|                                                                            |  |                                    |           
|Investing activities                                                        |  |                                    |            |   |                             |  
|Purchase of property and equipment                                          |  |                                    | (145,688   | ) |                             |  
|Proceeds from sale of property and equipment                                |  |                                    |           |   |                             |  
|                                                                            |  |                                    |            |   |                             |  
|Net cash used in investing activities                                       |  |                                    | (145,688   | ) |                             |  
|                                                                            |  |                                    |            |   |                             |  
|                                                                            |  |                                    |           
|Financing activities                                                        |  |                                    |            |   |                             |  
|Proceeds from borrowings from related party                                 |  |                                    | 1,534,692  |   |                             |  
|Payments on line of credit with related party                               |  |                                    |           |   |                             |  
|Sale of Series A Convertible Preferred Stock to Sylvan Ventures             |  |                                    |           |   |                             |  
|                                                                            |  |                                    |            |   |                             |  
|Net cash provided by financing activities                                   |  |                                    | 1,534,692  |   |                             |  
|                                                                            |  |                                    |            |   |                             |  
|                                                                            |  |                                    |           
|Net change in cash                                                          |  |                                    | 219,534    |   |                             |  
|Cash at beginning of period                                                 |  |                                    | 7,694      |   |                             |  
|                                                                            |  |                                    |            |   |                             |  
|Cash at end of period                                                       |  | $                                  | 227,228    |   |                             | $
|                                                                            |  |                                    |            |   |                             |  



See accompanying notes.



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eSylvan, Inc.

(a Subsidiary of Educate, Inc.)



Notes to Financial Statements (Unaudited)



September 30, 2003



1. Basis of Presentation



The accompanying financial statements of eSylvan, Inc. (the Company) present the
financial position, results of operations and cash flows of the Company as of and for the three months ended September 30, 2003. As discussed more fully in Note 2, Educate, Inc. acquired the Company on June 30, 2003. The financial statements
included herein also include the financial position of the predecessor business as of December 31, 2002, and the results of its operations for the three months and for the nine months ended September 30, 2002 and for the six months ended June
30, 2003.



These financial statements have been prepared in accordance with
accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been
included. Certain reclassifications have been made to financial statements of the predecessor in order to conform them to the current period presentation. Operating results for the three month period ended September 30, 2003 are not necessarily
indicative of the results that may be expected for the year ended December 31, 2003. The predecessor balance sheet at December 31, 2002 has been derived from the audited financial statements at that date but does not include all of the information
and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the predecessor financial statements included in the eSylvan, Inc. annual report on Form
10-K for the year ended December 31, 2002.



2. Acquisition by Educate, Inc.



On June 30, 2003, Sylvan Learning Systems, Inc. (Sylvan)
completed the sale of its K-12 education operating units. Under the transaction, Sylvans ownership interest in the Company and other assets, were sold to Educate Operating Co., LLC (Educate), a wholly owned subsidiary of Educate,
Inc. To consummate the transaction, Educate purchased from Sylvan Ventures LLC (Sylvan Ventures), the prior investor a majority owned subsidiary of Sylvan, 13,857,143 shares of Common Stock of eSylvan, Inc. and 20,629,633 shares of
Series A Convertible Preferred Stock of eSylvan, Inc. Educate now owns 83.89% and 100% of the outstanding Common Stock and Series A Convertible Preferred Stock, respectively, of the Company. The transaction was accounted for as a business
combination, and purchase accounting was applied as of the acquisition date to establish a new basis of accounting for the acquired net assets of the Company.



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eSylvan, Inc.

(a Subsidiary of Educate, Inc.)



Notes to Financial Statements (Unaudited)



2. Acquisition by
Educate, Inc. (continued)



Educate is currently in the process of determining the estimated fair market value of the assets and liabilities it
acquired from Sylvan. An independent appraiser was engaged to complete a valuation of the net assets of the Company as of the acquisition date. As of November 12, 2003, a preliminary report by this appraiser indicated that the fair value of the net
assets acquired was approximately $280,000. Although the appraisers report has not been finalized, management believes that the estimated fair value of the acquired net assets will not vary significantly from this preliminary valuation. A
summary of the purchase price adjustments recorded in connection with the acquisition are presented below:



|                                           |  | Predecessor                       |             |   |                            |   |             |                                 
|------------------------------------------ |  | --------------------------------- | ----------- | - | -------------------------- | - | ----------- | --------------------------------
|                                           |  | June 30, 2003closingbalance sheet |             |   | Purchase price adjustments |   |             | July 1, 2003openingbalance sheet
|Assets:                                    |  |                                   |             |   |                            |   |             |                                 
|Total current assets                       |  | $                                 | 415,578     |   |                            | $ | 564,525     |                                 
|Property and equipment                     |  |                                   | 5,547,190   |   |                            |   | (4,928,838  | )                               
|Accumulated depreciation and amortization  |  |                                   | (4,584,470  | ) |                            |   | 4,584,470   |                                 
|                                           |  |                                   |             |   |                            |   |             |                                 
|Property and equipment, net                |  |                                   | 962,720     |   |                            |   | (344,368    | )                               
|Intangible assets:                         |  |                                   |             |   |                            |   |             |                                 
|Participation agreements, net              |  |                                   | 1,341,202   |   |                            |   | (1,341,202  | )                               
|                                           |  |                                   |             |   |                            |   |             |                                 
|Total assets                               |  | $                                 | 2,719,500   |   |                            | $ | (1,121,045  | )                               
|                                           |  |                                   |             |   |                            |   |             |                                 
|                                           |  |                                   |            
|Liabilities and stockholders equity:      |  |                                   |             |   |                            |   |             |                                 
|Total liabilities                          |  | $                                 | 1,328,605   |   |                            | $ | (10,093     | )                               
|Stockholders equity:                      |  |                                   |             |   |                            |   |             |                                 
|Series A Convertible Preferred Stock       |  |                                   | 20,333      |   |                            |   | 297         |                                 
|Class A Convertible Common Stock           |  |                                   | 2,518       |   |                            |   |             |                                 
|Common stock                               |  |                                   | 14,000      |   |                            |   |             |                                 
|Additional paid-in-capital                 |  |                                   | 42,673,314  |   |                            |   | (42,430,519 | )                               
|Accumulated deficit                        |  |                                   | (41,319,370 | ) |                            |   | 41,319,370  |                                 
|                                           |  |                                   |             |   |                            |   |             |                                 
|Total stockholders equity                 |  |                                   | 1,390,895   |   |                            |   |             |                                 
|                                           |  |                                   |             |   |                            |   |             |                                 
|Total liabilities and stockholders equity |  | $                                 | 2,719,500   |   |                            | $ | (1,121,045  | )                               
|                                           |  |                                   |             |   |                            |   |             |                                 



Significant adjustments were made to
record the final financing amounts due from Sylvan Ventures before the acquisition by Educate and to record all property and equipment at fair value.



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eSylvan, Inc.

(a Subsidiary of Educate, Inc.)



Notes to Financial Statements (Unaudited)



3. 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 performed the pro forma calculation as if the fair value method had been elected as required by statement No. 123 and determined there was
no change on pro forma net loss or net loss per share.



The Black-Scholes
option-pricing model was developed for use in estimating the fair value of traded options that 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.



9



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##### Table of Contents

eSylvan, Inc.

(a Subsidiary of Educate, Inc.)



Notes to Financial Statements (continued)



4. Restructuring Plan



In February 2003, the Company initiated, with board of directors
approval, a restructuring plan. Under the plan, which was completed in May 2003, the employee workforce was reduced by 14 full time employees, or 33% of the full time workforce. The terminated employees were engaged in providing direct services to
customers, sales and marketing, general and administrative and research and development activities. The Company paid $135,196 and $280,921 in severance benefits to terminated employees in the three month period ended September 30, 2003 and six month
period ended June 30, 2003, respectively. General and administrative expense for the three month period ended September 30, 2003 and six month period ended June 30, 2003 included $0 and $435,000, respectively, for severence benefits incurred and to
be paid in future periods.



5. Income Taxes



The Company as a member of a consolidated group uses the separate return method of
accounting for income taxes. Under the separate return method, income tax expense or benefit is determined assuming that the Company is a separate taxpayer. Deferred tax assets and liabilities are determined based upon differences between the
financial statement and income tax bases of the Companys assets and liabilities using the enacted marginal income tax rate. For all periods presented, the Company has not reported an income tax benefit arising from its deferred tax assets,
consisting principally of net operating loss carryforwards, because of significant uncertainties surrounding their ultimate realization.



10



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##### Table of Contents

eSylvan, Inc.

(a Subsidiary of Educate, Inc.)



Notes to Financial Statements (Unaudited)



6. Loss Per Share



The following table sets forth the computation of basic
and diluted loss per common share:



|                                                                                |  |                                    |            |   | Predecessor                 |  
|------------------------------------------------------------------------------- |  | ---------------------------------- | ---------- | - | --------------------------- | -
|                                                                                |  | Three monthsendedSeptember 30,2003 |            |   | Six monthsendedJune 30,2003 |  
|Net loss                                                                        |  | $                                  | (1,207,295 | ) |                             | $
|                                                                                |  |                                    |            |   |                             |  
|Weighted-average common and Class A common shares outstanding during the period |  |                                    | 16,517,984 |   |                             |  
|                                                                                |  |                                    |            |   |                             |  
|Shares used in computations                                                     |  |                                    | 16,517,984 |   |                             |  
|                                                                                |  |                                    |            |   |                             |  
|Basic and diluted loss per common share                                         |  | $                                  | (0.07      | ) |                             | $
|                                                                                |  |                                    |            |   |                             |  



Basic and diluted loss per common
share are equal because the assumed conversion of preferred stock and exercise of outstanding stock options would result in the computation being antidilutive as a result of the net loss in each period presented.



7. Financing Arrangements with Sylvan Ventures, Liquidity and Capital Resources



As described below, during 2003 the Company issued additional shares of
Series A Convertible Preferred Stock (Preferred Stock) for cash to fund its operations and meet its obligations under certain borrowings. These shares of Preferred Stock were issued with terms identical to the terms of the outstanding
Preferred Stock issued in prior periods as described more fully in the Companys 2002 annual financial statements.



Prior to June 30, 2003, the Company had a revolving credit facility with Sylvan Ventures under which it could borrow up to $10,000,000. At December 31, 2002, the Company
had $5,485,329 outstanding under the line of credit.



In February 2003, the
Company issued 3,578,947 shares of Preferred Stock to Sylvan Ventures for a total purchase price of $6,800,000. The Company used $6,637,630 of the proceeds to repay the line of credit with Sylvan Ventures and $162,370 to fund operations of the
Company.



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eSylvan, Inc.

(a Subsidiary of Educate, Inc.)



Notes to Financial Statements (Unaudited)



7. Financing
Arrangements, Liquidity and Capital Resources (continued)



In June 2003, the Company issued 1,279,884 additional shares of the Preferred Stock to Sylvan Ventures for a total
purchase price of $2,431,779. The Company used the proceeds to repay amounts advanced to the Company by Sylvan Ventures.



In September 2003, the Company issued 297,118 additional shares of the Preferred Stock to Sylvan Ventures for a total purchase price of $564,525. This financing was
required under the terms of the June 30, 2003 purchase agreement between Educate and Sylvan, and the shares issued were transferred by Sylvan Ventures to Educate in connection with the acquisition by Educate of the Common Stock and Preferred Stock
held by Sylvan Ventures. This amount was classified as due from prior investor at September 30, 2003, was paid in October 2003, and represents the final financing obligations of Sylvan Ventures.



The Companys operating losses, forecasted operating losses and limited funding sources
raise substantial doubt about the Companys ability to continue as a going concern. Management is actively pursuing the expansion of its online tutoring business and is also pursuing additional financing through its parent, Educate, Inc. While
the Company anticipates continued funding from Educate, Inc. at least through the end of 2003, there can be no assurance that the Company will be able to generate sufficient cash flow from operations or additional financing to meet its development
and operating needs, or that such financing would be available on terms acceptable to the Company.



8. Borrowings from Parent



As of
September 30, 2003 the Company has borrowed $1,534,692 which is due to its parent, Educate Inc. The borrowings represent cash advances received during the period and are repayable upon demand. For the three month period ended September 30, 2003 the
average outstanding balance on the borrowings was $665,500.



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|ITEM 2. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- |  | -------------------------------------------------------------------------------------



All statements contained herein that are not historical facts, including but not limited to the Companys future
development plans and future capital requirements, are based on current expectations. These statements are forward looking in nature and involve a number of risks and uncertainties. Actual results may differ materially. Factors that could cause
actual results to differ materially include the following: the reliability of our technology; our efforts to establish, maintain and strengthen the eSylvan brand; consumer acceptance of online tutoring; our ability to secure additional financing;
and other risk factors described in the Companys reports filed from time to time with the Securities and Exchange Commission. The Company wishes to caution readers not to place undue reliance on any such forward looking statements, which
statements are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such, speak only as of the date made.



The Company delivers supplemental education to families and children through a variety of applications on the Internet. From October 1, 1999 (date of
inception of predecessor Company) through December 31, 2001, the Company was a development stage business. The Companys lack of an operating history makes it difficult to evaluate its business and prospects. The Companys results of
operations and future prospects should be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stages of development, particularly companies dependent upon the relatively new and rapidly
evolving Internet environment.



On June 30, 2003, Sylvan
Learning Systems, Inc. (Sylvan) completed the sale of its K-12 education operating units. As part of the transaction, the Sylvan Learning Center and Sylvan Education Solutions divisions of Sylvan, the ownership interest in eSylvan and
other assets were sold to Educate Operating Co., LLC, a wholly owned subsidiary of Educate, Inc. (Educate). Under these transactions, Educate Operating Co., LLC purchased from Sylvan Ventures, a majority owned subsidiary of Sylvan,
13,857,143 shares of Common Stock of eSylvan, Inc. and 20,629,633 shares of Series A Convertible Preferred Stock of eSylvan, Inc. As a result, Educate Operating Co., LLC now owns 83.89% and 100% of the outstanding Common Stock and Series A
Convertible Preferred Stock of the Company, respectively. We cannot predict how this transaction will impact our business. However, we expect to have access to management resources we need and to the services previously provided to us by Sylvan
under various management services agreements. While we anticipate continued funding from Educate at least through the end of 2003, there can be no assurance that we will be able to obtain the capital we will need to continue to operate our business
on a longer term basis.



Comparison of
Financial Results



The transaction whereby Educate acquired a
controlling interest in the Company was accounted for as a business combination, and purchase accounting was applied as of the acquisition date to establish a new basis of accounting for the acquired net assets of the Company. Educate is currently
in the process of determining the estimated fair market value of the assets and liabilities it acquired to Sylvan. An independent appraiser was engaged to complete a valuable of the net assets of the Company as of the acquisition date. As of
November 12, 2003, a preliminary report by this appraiser indicated that the fair value of the net assets acquired was approximately $280,000. Although the appraisers report has not been finalized, management believes that the estimated fair
value of the acquired net assets will not vary significantly from this preliminary valuation. As a consequence of the revaluation of the Companys net assets at fair value upon the significant change in ownership on June 30, 2003, the financial
results for the three month period



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ended September 30, 2003 are not comparable in certain respects with the results of operations for periods prior to the acquisition. However, management
believes that the predecessors results of operations provide the most relevant basis for explaining significant trends in the results of operations of the business since its acquisition on June 30, 2003. Accordingly, the Company has
presented a comparison of the three-month period ended September 30, 2003 to the three-month period ended September 30, 2002 of the predecessor business. In addition, the Company has combined the operations of the six-month period ended
June 30, 2003 of the predecessor business with the three-month period ended September 30, 2003 for comparison to the nine-month period ended September 30, 2002 of the predecessor. These results are discussed below.



Results of Operations



Comparison of results for the three months ended September 30, 2003 to results for the three months ended September 30, 2002



The Company incurred net losses of $1.2 million and $3.2
million for the three months ended September 30, 2003 and 2002, respectively. The reduction in the Companys quarterly net loss reflects the benefits of the restructuring plan we implemented in February 2003. Under the plan, we reduced the size
of our operating losses and cash requirements by enrolling and servicing fewer students in 2003 than we did in 2002, by enrolling and servicing those students on a more economical basis and by reducing our personnel and other overhead costs. By
reducing our enrollments and the number of students enrolled and served in 2003, we believe we can develop the software applications and operational processes that will enable us to operate more efficiently as we increase enrollments in the future.



Revenues for the three months ended September 30, 2003
declined 45% to $0.5 million from $0.9 million for the three months ended September 30, 2002. This decline was the result of a 57% decline in enrollments and related assessment and registration fees and a 43% decline in tutoring revenue.



During the three months ended September 30, 2003, total operating costs
and other expenses decreased by $2.4 million, or 58%, to $1.7 million from $4.1 million for the three months ended September 30, 2002.



Direct costs of services provided for the three months ended September 30, 2003 decreased 49% to $0.4 million from $0.8 million for the three months ended
September 30, 2002. In both periods, direct costs of services provided consisted primarily of labor for instructional, technical and operations support. The decline was attributable to a 46% decline in the number of tutoring sessions delivered as
well as an increase in efficiency in delivering sessions.



Sales and marketing expenses decreased by $0.7 million, or 82%, to $0.2 million for the three months ended September 30, 2003, from $0.9 million for the three months ended September 30, 2002. The decrease in sales and marketing expenses was
due to our



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increased focus on utilizing customer acquisition channels that were more efficient than those utilized in the prior year and an overall reduction in the
number of students we sought to enroll in the three month period ended September 30, 2003. We incur sales and marketing costs for media and marketing campaigns and for establishing and growing the eSylvan brand.



General and administrative expenses decreased by $0.8 million, or 49%, to
$0.8 million for the three months ended September 30, 2003, from $1.6 million for the three months ended September 30, 2002. This decrease reflects lower depreciation and amortization expense of $0.3 million, $0.1 of which is a direct result of the
revaluation of the Companys fixed and intangible assets on June 30, 2003. The remainder of the decrease was a result of lower costs resulting from implementation of our restructuring plan earlier in 2003. We terminated 14 full-time personnel,
or 33% of our total full-time personnel, in February 2003. General and administrative expenses consist of personnel costs, professional fees, maintenance expenses, depreciation and other expenses.



Research and development expenses decreased by 63%, to $0.2 million for the
three months ended September 30, 2003, from $0.5 million for the three months ended September 30, 2002. The decrease in research and development expenses resulted from our need for less intensive development of our on-line tutoring technical
infrastructure in the 2003 period compared to the 2002 period.



Management services and facilities usage charges from our parent decreased by 56%, to $0.2 million for the three months ended September 30, 2003, from $0.3 million for the three months ended September 30, 2002. Under our current services
agreement with Educate, Educate provides us with management services, information systems support services, corporate accounting services, database management services, human resources and payroll services, general liability insurance and legal
services.



We incurred no interest expense for the three months
ended September 30, 2003 or for the three months ended September 30, 2002 because neither Educate nor Sylvan Ventures charged interest on amounts they advanced to us.



Comparison of results for the nine months ended September 30, 2003 to results for the nine months ended September 30, 2002



The results for the nine month period ended September 30,
2003 are presented for comparative purposes and comprise the results for eSylvan for the three months ended September 30, 2003 and for the predecessor business for the six months ended June 30, 2003. The results are not directly comparable to
results for the nine months ended September 30, 2002 given that the three month period ended September 30, 2003 does not include amortization of participation agreements, whereas other periods presented and discussed do include amortization of
participation agreements. In addition, our fixed asset base was larger and subject to higher depreciation charges prior to the June 30, 2003 acquisition.



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The Company incurred net losses of $5.5 million and $9.7 million for the nine months ended September 30,
2003 and 2002, respectively. The net loss for the nine months ended September 30, 2003 includes $0.4 million of accrued severance costs related to a restructuring plan implemented in February 2003. Participant Agreement amortization expense of $0.2
million was recorded during the six months ended June 30, 2003 and $0.3 million during the nine months ended September 30, 2002.



Revenues for the nine months ended September 30, 2003 declined 31% to $1.4 million from $2.1 million for the nine months ended September 30, 2002 as a
result of a 63% decline in enrollments and related assessment and registration revenue and an 8% decline in tutoring revenue.



During the nine months ended September 30, 2003, total operating costs and other expenses decreased by $4.8 million, or 41%, to $7.0 million from $11.8
million for the nine months ended September 30, 2002.



Direct
costs of services provided for the nine months ended September 30, 2003 decreased 34% to $1.3 million from $1.9 million for the nine months ended September 30, 2002. The decline was attributable to a 10% decline in the number of tutoring sessions
delivered as well as an increase in efficiency in delivering sessions.



Sales and marketing expenses decreased by $1.9 million, or 70%, to $0.8 million for the nine months ended September 30, 2003, from $2.6 million for the nine months ended September 30, 2002. The decrease in sales and marketing expenses was
due to the Companys increased focus on utilizing customer acquisition channels that were more efficient than those utilized in the prior year along with an overall reduction in the number of students we sought to enroll.



General and administrative expenses decreased by $1.4 million, or 21%, to
$3.5 million for the nine months ended September 30, 2003, from $4.8 million for the nine months ended September 30, 2002. A decrease in depreciation and amortization expense of $0.8 million was partially offset by $0.4 million of severance costs
recognized in the nine months ended September 30, 2003 in conjunction with Companys restructuring plan. The remainder of the decline in general and administrative expenses was a result of lower costs after implementing our restructuring plan.



Research and development expenses decreased by 47%, to $0.7
million for the nine months ended September 30, 2003, from $1.3 million for the nine months ended September 30, 2002. The decrease in research and development expenses resulted from the need for less intensive development of our on-line tutoring
technical infrastructure in the 2003 period versus the 2002 period.



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Management services and facilities usage charges decreased by $0.3 million, or 31%, to $0.7 million for
the nine months ended September 30, 2003, from $1.1 million for the nine months ended September 30, 2002.



The Company incurred no interest expense for the nine months ended September 30, 2003 or for the nine months ended September 30, 2002 because
our investors did not charge interest on amounts advanced.



Liquidity and
Capital Resources



We used net cash in our operating
activities for the nine months ended September 30, 2003 of $4.6 million, primarily to fund our $4.8 million loss before depreciation and amortization, compared to net cash used of $7.8 million for the nine months ended September 30, 2002. During the
nine months ended September 30, 2003, we purchased and capitalized $0.3 million of software development costs and $0.1 million of networking equipment which had previously been leased. Capital expenditures, primarily for computer software, for the
nine months ended September 30, 2002 were $0.2 million.



In
February 2003, we issued 3,578,947 shares of our Preferred Stock to Sylvan Ventures for an aggregate purchase price of $6.8 million. We used $6.6 million of the proceeds to repay the then outstanding balance under the line of credit with Sylvan
Ventures.



In June 2003, we issued 1,279,884 shares of our
Preferred Stock to Sylvan Ventures for an aggregate purchase price of $2.4 million. We used the proceeds to repay amounts advanced to us by Sylvan Ventures.



In September 2003, we issued 297,118 additional shares of our Preferred Stock for a total purchase price of $564,525. This financing was required under
the terms of the June 30, 2003 purchase agreement between Educate and Sylvan, and the shares issued were transferred by Sylvan Ventures to Educate in connection with the acquisition by Educate of the Common Stock and Preferred Stock held by Sylvan
Ventures. This amount was classified as due from prior investor at September 30, 2003, was paid in October 2003, and represents the final financing obligations of Sylvan Ventures.



We expect to incur significant negative cash flow from operations for the foreseeable future and do not expect that our
current resources will be sufficient to support our growth and operations until we become profitable. Since our founding, we have relied upon our investors for the capital necessary to operate our business. While we expect Educate to fund our
operations at least through the end of 2003, we cannot predict whether Educate will continue to provide the necessary capital to us on a longer term basis. Therefore, we cannot be certain that we will be able to raise additional funds as needed, or,
if we can, that we will be able to do so on terms that we deem acceptable. In particular, potential third party investors may be unwilling to invest in us due to Educates voting control. We are unable to predict the amount of additional



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financing we will need because the amount is substantially dependent upon our success in implementing our business plan, including our marketing and
advertising efforts and a variety of factors outside of our control, such as unexpected technical difficulties with the on-line tutoring infrastructure and other factors discussed in our most recent Form 10-K filed with the Securities and Exchange
Commission. Our failure to obtain the funds necessary to establish and grow our business would have a material adverse effect on the business and our ability to generate and grow revenues. If we raise funds through the issuance of equity or
equity-related securities, these securities will likely have rights, preferences or privileges senior to those of the rights of the Companys Common Stock, and current holders of the Common Stock will experience dilution, which may be
substantial.



Our current and projected operating losses and
limited committed funding raise substantial doubt about our ability to continue as a going concern. Our financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or
the amount and classification of liabilities that may result from the outcome of this uncertainty.



Effects of Inflation



Inflation has not had a material effect on our revenues and expenses since inception on October 1, 1999. Inflation is not expected to have a material
future effect for the foreseeable future.



Seasonality in Results of Operations



We experience
seasonality in our results of operations primarily as a result of quarterly fluctuations in the level of student enrollments. The strongest operating results are achieved in the third quarter of the year when we expect to deliver our highest
tutoring session volume, while our marketing and student acquisition expenses are lowest given that the third quarter has been our weakest enrollment quarter. The aforementioned seasonality trend is based upon our very limited operating experience
and may not be indicative of actual operating results, particularly as student enrollments increase or decrease dramatically. Revenues and profits in any period will not necessarily be indicative of results in subsequent periods.



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|ITEM 3. |  | QUANTITATATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- |  | ------------------------------------------------------------



Market risk is the risk of loss to future earnings, to fair values or to future cash flows that may result from the changes in the price of financial
instruments. Our operations are exclusively in the United States and have been funded without an interest charge. Therefore, we currently have no direct exposure to financial market risks, as we have no exposure to fluctuations in foreign currency
exchange rates, interest rates, equity prices or investment values.



|ITEM 4. |  | CONTROLS AND PROCEDURES
|------- |  | -----------------------



As of November 4, 2003 (the Evaluation Date), an evaluation was performed under the supervision and with the participation of the
Companys management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures. Based on that evaluation, the Companys
management, including its Chief Executive Officer and Chief Financial Officer, concluded that the Companys disclosure controls and procedures were effective as of the Evaluation Date to ensure that information required to be disclosed in the
reports that the Company files and submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported as and when required. There have been no significant changes in the our internal controls or in other factors that
could significantly affect internal controls subsequent to the Evaluation Date and no corrective actions with regard to significant deficiencies and material weaknesses.



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PART II  OTHER INFORMATION



|ITEM 1. |  | LEGAL PROCEEDINGS
|------- |  | -----------------



None.



|ITEM 2. |  | CHANGES IN SECURITIES AND USE OF PROCEEDS
|------- |  | -----------------------------------------



See Note 7 to Notes to Financial Statements (unaudited) filed with this Form 10-Q, which is incorporated herein by reference.



|ITEM 3. |  | DEFAULTS UPON SENIOR SECURITIES
|------- |  | -------------------------------



None.



|ITEM 4. |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- |  | ---------------------------------------------------



None.



|ITEM 5. |  | OTHER INFORMATION
|------- |  | -----------------



The Company has filed with the Securities and Exchange Commission the certifications of its principal executive officer and principal financial officer
required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 (the Act) as exhibits to this Quarterly Report on Form 10-Q.



|ITEM 6. |  | EXHIBITS AND REPORTS ON FORM 8-K
|------- |  | --------------------------------



| | (a) | Exhibits
| | --- | --------



31.1 - Certification of principal executive officer under Section 302 of Sarbanes-Oxley Act of 2002.

31.2 -
Certification of principal financial officer under Section 302 of Sarbanes-Oxley Act of 2002.

32.1 - Certification of principal executive
officer under Section 906 of Sarbanes-Oxley Act of 2002.

32.2 - Certification of principal financial officer under Section 906 of
Sarbanes-Oxley Act of 2002.



| | (b) | Reports on Form 8-K
| | --- | -------------------



The Company filed a Form 8-K on July 15, 2003 regarding the sale of Sylvans K-12 businesses to Educate Inc.



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SIGNATURES



Pursuant to the requirements of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on behalf by the undersigned thereunto duly authorized.



|                        |  |  |  | eSylvan, Inc.                                                                                
|----------------------- |  |  |  | ---------------------------------------------------------------------------------------------
|                        |  | 
|Date: November 13, 2003 |  |  |  | /s/ R. Christopher Hoehn-Saric                                                               
|                        |  |  |  | R. Christopher Hoehn-Saric Chairman and Chief Executive Officer (principal executive officer)
|                        |  | 
|Date: November 13, 2003 |  |  |  | /s/ Kevin E. Shaffer                                                                         
|                        |  |  |  | Kevin E. Shaffer Chief Financial Officer (principal financial officer)                       
|                        |  | 
|Date: November 13, 2003 |  |  |  | /s/ Glenn F. McAvoy                                                                          
|                        |  |  |  | Glenn F. McAvoy Vice President -Finance (principal accounting officer)                       



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