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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934



|                                         |  |                                  
|---------------------------------------- |  | ---------------------------------
|For the fiscal year ended: June 30, 2004 |  | Commission File Number: 000-21363



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EDUCATION MANAGEMENT CORPORATION

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Pennsylvania                                                   |  | 25-1119571                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|210 Sixth Avenue, Pittsburgh, PA                               |  | 15222                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



Registrants
telephone number, including area code:(412) 562-0900



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Securities registered pursuant to Section 12 (g) of the Act:



Common Stock, $0.01 par value

(Title of class)



Preferred Share Purchase Rights

(Title of class)



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Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 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 the definitive proxy statement incorporated by reference into Part III of this Form 10-K or any amendment to this Form 10-K. ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).    Yes  x    No ̈



The aggregate market value of the voting common stock held by non-affiliates of the registrant as of December 31, 2003 was approximately $1,941,538,746. The number of shares of Common Stock outstanding on August 31,
2004 was 73,653,909 shares.



Documents incorporated by
reference: Portions of the definitive Proxy Statement of the registrant for the annual meeting of shareholders to be held on November 23, 2004 (Proxy Statement), which will be filed with the Securities and Exchange Commission within 120
days after the end of the Registrants fiscal year ended June 30, 2004, are incorporated by reference into Part III of this Form 10-K. The incorporation by reference herein of portions of the Proxy Statement shall not be deemed to
incorporate by reference the information referred to in Items 306 or 402(a)(8) of Regulation S-K.



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PART I



Forward-Looking Statements: This Annual Report on Form 10-K contains statements that may be forward-looking statements within the meaning of the U.S.
Private Securities Litigation Reform Act of 1995. We have tried to use terms such as believes, estimates, anticipates, continues, contemplates, expects, may,
will, could, should or would and similar expressions to identify these forward-looking statements. These statements, which are based on information currently available to us, are not guarantees of
future performance and may involve risks and uncertainties, including those factors described at the end of the response to Item 7 under the heading Risks Related to Our Business, that could cause our actual growth, results of
operations, performance and business prospects, and opportunities to materially differ from those expressed in, or implied by, these statements. We expressly disclaim any obligation or understanding to release publicly any updates or revisions to
any forward-looking statement included in this Annual Report. The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto filed in response to Item 8 of this Annual Report.



ITEM 1BUSINESS



Business Overview



We are among the largest providers of private post-secondary education in North America, based on student enrollment and revenue, and have provided
career-oriented education for over 40 years. We deliver education to our students through traditional classroom settings as well as through online instruction. As of June 30, 2004, we had 67 primary campus locations in 24 states and two Canadian
provinces. Our total student enrollment as of the fall of 2003 was approximately 59,000 students. We were organized as a Pennsylvania corporation in 1962 and completed our initial public offering in 1996.



Our educational systems offer a broad range of academic programs concentrated
in the media arts, design, fashion, culinary arts, behavioral sciences, health sciences, education, information technology, legal studies and business fields, culminating in the award of associates through doctoral degrees. We primarily offer
academic programs through the following educational institutions:



| |  |  | The Art Institutes.    The Art Institutes offer programs in the media arts, design, fashion and culinary arts. As of June 30, 2004, The Art Institutes
consisted of 31 schools in cities throughout North America. In addition to our physical campuses, The Art Institute Online offers a broad suite of bachelors, associates and diploma degree programs in the creative fields. Art Institute
programs are designed to provide the knowledge and skills necessary for employment in various fields, including graphic design, media arts and animation, multimedia and web design, game art and design, animation, video and digital media production,
interior design, industrial design, culinary arts, photography and fashion. These programs typically are completed in 18 to 48 months and culminate in a bachelors or associates degree. In the summer quarter beginning July 2004, 24 Art
Institutes offered bachelors degree programs, and we expect to continue to introduce bachelors degree programs in states that permit proprietary post-secondary institutions to offer these programs.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Argosy University.    Argosy University offers doctoral and masters programs in clinical psychology, counseling and education. Argosy also offers
doctoral, masters and bachelors degree programs in business administration, bachelors degrees in psychology and associates degree programs in various health sciences fields. As of June 30, 2004, there were 13 Argosy
University campuses and six extension sites in ten states.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We also acquired Western State University College of Law in California and Argosy Professional Services in connection with our acquisition of Argosy University. Argosy Professional Services provides courses and
materials for post-graduate licensure examinations in human services fields and provides continuing education courses for K-12 educators.



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| |  |  | South University.    South University offers undergraduate and graduate degree programs in business, legal studies, information technology and health
sciences fields. As of June 30, 2004 there were four South University campuses in four states in the southeastern United States. In July 2004, South University introduced fully online bachelors degree level programs in business administration
and information technology. We acquired all the issued and outstanding shares of common stock of South University in July 2003 for approximately $51 million.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | American Education Centers.    American Education Centers (AEC) offers bachelors and associates degree programs in health
sciences, business, information technology, legal studies and design technologies. As of June 30, 2004, there were 18 AEC education institutions in eight states primarily in the Midwest. We acquired all the issued and outstanding shares of common
stock of AEC in September 2003 for approximately $103.5 million in cash, $11.0 million in notes which were paid in September 2004 and the assumption of $3.5 million in debt.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Prior to fiscal 2004, The Art Institutes and Argosy University were managed as separate operating segments. During the first
quarter of fiscal 2004 we shifted from an educational system approach to a centralized corporate structure utilizing divisions which have been aggregated into one operating segment. We currently have three distinct operating divisions organized by
geographic location within North America: The Eastern Division; Central Division; and Western Division.



Operating Strategy



We
have managed our growth and improved our operating results through the successful implementation of our operating strategy. Key elements of our operating strategy include the following components:



Emphasize Graduate Outcomes and Student Career
Advancement.    Our primary mission is to promote student success by providing students with the education necessary to begin or advance in their chosen career. Accordingly, we have developed a wide variety of programs
designed to meet employers current and anticipated needs. Additionally, we focus on marketing to a broad range of potential students, admitting students who possess the relevant interests, having many faculty members with both practical
experience in their fields as well as the required academic credentials, providing students with appropriate facilities, classroom technology and equipment, and offering students various career services. To ensure academic programs meet the needs of
employers, over 1,200 industry professionals and employers sit on curricula advisory teams. We maintain dedicated career services personnel at our schools who provide significant assistance to our students seeking jobs, including contacting and
recruiting potential employers, establishing internship programs, helping students prepare for interviews and helping students prepare resumes. We also evaluate the placement of our students from each of our programs to assist us in determining how
to allocate our resources in the future. Our focus on student outcomes also helps us to maintain a strong student retention rate and manage our cohort loan default rates.



Develop New School Locations.    During fiscal 2004 we opened two new start-up campuses.
We expect to open approximately five new start-up campuses during fiscal 2005. Our new start-up campuses are typically opened as branch campuses of an existing main campus location. Prior to opening a new campus, we perform a detailed analysis of
the geographic areas, including the attractiveness of a metropolitan statistical area based on population size and growth, the percentage of the total population likely to pursue education in a particular program area and the level of competition
from other post-secondary educational institutions. In addition, opening new campuses allows us to effectively leverage our existing infrastructure and our curricula from our other schools.



While historically we have grown our student base primarily by the expansion
of existing schools and programs, we have also grown through the acquisition of educational systems and schools. During fiscal 2004 we acquired AEC and South University, along with two other smaller schools. We will continue to analyze and evaluate
potential acquisition candidates and, where appropriate, engage in discussions which may lead to acquisitions of additional schools. When evaluating potential acquisitions, we consider a schools potential for future growth, past regulatory
compliance, demographic trends, our projected internal rate of return and return on invested capital, compatibility with our existing programs, level of competition, availability and quality of existing faculty, among other factors.



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Use of Shared Services Locations.    During fiscal 2004 we started
combining the facilities and administrative functions of some of our schools which are located in the same geographic regions. We refer to these schools as shared services locations. The administrative services which are combined for two
schools located within a single facility typically include career services, facilities management, finance, human resources, marketing and admissions, public relations, registration, student affairs, student financial services, student accounting
and information technology. While these non-academic services are shared by the separate schools, shared services locations also strive to maintain a separate identity for each school within the facility by maintaining separate signage for each
school along with separate faculty areas. Additionally, primary classroom space is designated for each educational institution. We anticipate establishing ten shared services locations during fiscal 2005.



Create New and Revise Existing Academic
Programs.    We continually strive to identify emerging industry trends in order to understand the evolving educational needs of our students and the employment market. When we identify a need that we do not believe is
being addressed by the market or our schools, we develop and introduce a new program designed to address the new market opportunity. Additionally, we evaluate our existing program offerings and revise existing courses to meet changing market needs.



Rollout Existing Programs to New
Schools.    Our broad base of 67 schools enables us to leverage programs that have been successful at one school to other schools within our system. During fiscal 2004, we successfully rolled out 105 existing educational
programs to new schools and we anticipate rolling out more than 100 existing educational programs to new schools during fiscal 2005. The introduction of existing programs at additional campuses allows us to minimize costs associated with the
development of new academic programs and quickly capitalize on identified market needs.



Expand the Number of Online Students.    Online learning, which provides students with flexibility to take courses at times most convenient to them, is a fast growing method of
program delivery for many working adults. We continue to invest in our rapidly growing online course delivery models. Currently, The Art Institute Online offers a broad suite of programs in the creative fields and South University offers
bachelors degree programs in business administration and information technology. During the summer term of 2004, 1,940 students took all of their courses online compared to 888 students during the summer term of 2003. During fiscal 2005 we
plan to continue to roll out new programs at The Art Institutes and South University to satisfy the needs of students taking all their courses online.



In addition to our programs for fully online students, we also offer blended programs that permit students to take some of their courses online. For
example, approximately 25% of students at Argosy University take at least one of their courses online while working towards their degree. Blended programs provide flexibility for students while also permitting our schools to more effectively
leverage their facilities. We plan to continue to develop new online courses for our existing schools during fiscal 2005.



Student Recruitment and Marketing



The general reputation of our schools and referrals from current students, alumni and employers are the largest sources of new students. We also use
marketing tools such as the Internet, radio, local newspaper, television and print media advertising, telephone campaigns, and direct mail campaigns. In addition, we employ approximately 135 representatives who make presentations at high schools to
promote The Art Institutes. These representatives also participate in college fairs and other inquiry-generating activities. In fiscal 2004, representatives conducted over 18,000 high school visits and attended approximately 2,500 career events. We
estimate that in fiscal 2004 our students at The Art Institutes and South University decided to attend our schools based on the following percentages:



|                                            |  |    |  
|------------------------------------------- |  | -- | -
|Referrals from other students and graduates |  | 30 | %
|Internet advertising and our websites       |  | 29 | %
|High school recruitment programs            |  | 16 | %
|Broadcast advertising                       |  | 13 | %
|Print media                                 |  | 4  | %
|Direct mail campaigns                       |  | 2  | %
|Other recruiting efforts                    |  | 6  | %



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In fiscal 2004, our marketing efforts generated inquiries from approximately 740,000 qualified
prospective students. Our inquiry-to-application conversion ratio for these students increased from 8.4% in fiscal 2003 to 9.5% in fiscal 2004, and the applicant-to-new-student ratio for our students decreased from 59.3% for fiscal 2003 to 56.8% for
fiscal 2004. If our AEC and South University schools were not included in these percentages, our inquiry-to-application conversion ratio for students would have increased from 8.4% in fiscal 2003 to 8.6% in fiscal 2004, and the
applicant-to-new-student ratio for our students would have decreased from 59.3% for fiscal 2003 to 57.4% for fiscal 2004.



Our internal advertising agency creates publications, television and radio commercials, videos and other promotional materials for our schools. The agency
is also responsible for inquiry generation, media planning and placement, online marketing, website development and branding.



Student Admissions and Retention



The admissions and entrance standards of each school are designed to identify those students who are best equipped to meet the requirements of their
chosen fields of study and successfully complete their programs. In evaluating prospective students, we seek individuals with, among other things, a strong desire to learn, passion for their area of interest, and initiative. We believe that a
success-oriented student body results in higher retention and placement rates, increased student and employer satisfaction, and lower student default rates on government loans. To be qualified for admission to one of our schools, each applicant must
have received a high school diploma or a General Education Development certificate. Our graduate and doctoral programs require an undergraduate degree. Most of our schools interview prospective students to assess their qualifications, their interest
in the programs offered by the school and their commitment to their education. In addition, the curricula, student services, education costs, available financial resources and student housing options, if applicable, are reviewed during interviews.



Due to our broad program offerings, our students come from a
wide variety of backgrounds. The average age for new students at each of our schools during fiscal 2004 was as follows:



| |  |  | The Art InstitutesAverage age of 23
| | - |  | ------------------------------------



| |  |  | ArgosyAverage age of 35
| | - |  | ------------------------



| |  |  | AECAverage age of 29
| | - |  | ---------------------



| |  |  | South UniversityAverage age of 27
| | - |  | ----------------------------------



Overall, the average age of a new student at all of our schools during fiscal 2004 was 25 years old.



Our students may fail to finish their programs for a variety of personal, academic or financial reasons. To reduce the risk
of student withdrawals, each of our schools devotes staff resources to advising students regarding academic and financial matters, part-time employment and, if applicable, housing. Remedial courses are mandated for our undergraduate and graduate
students with lower academic skill levels and tutoring is encouraged for students experiencing academic difficulties. Our net annual persistence rate, which measures the number of students who are enrolled during a fiscal year and either graduate or
advance to the next fiscal year, for all of our students was approximately 70.2% in fiscal 2003 and approximately 68.0% in fiscal 2004. The decrease in the persistence rate from fiscal 2003 to fiscal 2004 was primarily due to the acquisitions of AEC
and South University during fiscal 2004 which historically have experienced lower persistence rates than The Art Institutes and Argosy University. If AEC and South University were not included in the fiscal 2004 percentage, the persistence rate for
fiscal 2004 would have been approximately 70.2%.



Education Programs



We believe that curriculum is a critical component of our
operations because students choose, and employers recruit from, career-oriented schools based on the type and quality of education provided. The curriculum development efforts of our schools are a product of their operating partnership with students
and the business and industrial communities.



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The relationship of each of our schools with potential employers for our students plays a significant
role in the development and adaptation of school curriculum. Most of our schools have one or more program advisory boards composed of members of the local and regional communities. These boards provide valuable input to the schools education
department, which allows the school to keep programs current and provide students with the training and skills that employers seek.



Our wide range of academic programs culminate in the awarding of diploma certificates through doctoral degrees. In the fall of 2003, the enrollment by
degree for all our schools was as follows:



| |  |  | Associates degrees40%
| | - |  | -----------------------



| |  |  | Bachelors degrees39%
| | - |  | ----------------------



| |  |  | Doctoral degrees9%
| | - |  | -------------------



| |  |  | Diploma/certificates8%
| | - |  | -----------------------



| |  |  | Masters4%
| | - |  | ----------



The type of degrees and programs we offer vary by each of our schools. The following summarizes the programs offered at each of our educational systems.
Not all programs are offered at each school location within an educational system.



The Art Institutes.    The Art Institutes offer the following degree programs. For internal purposes, we classify the degree programs at The Art Institutes according to four
schools or areas of study.



|                               |  |                                  
|------------------------------ |  | ---------------------------------
|The School of Design           |  | The School of Media Arts         
|Associates Degree Programs    |  | Associates Degree Programs      
|Graphic Design                 |  | Animation Art & Design           
|Industrial Design Technology   |  | Audio Production                 
|Interior Design                |  | Broadcasting                     
|                               |  | Interactive Media Design         
|Bachelors Degree Programs     |  | Photography                      
|Advertising                    |  | Video Production                 
|Graphic Design                 |  |                                  
|Illustration                   |  | Bachelors Degree Programs       
|Industrial Design              |  | Audio Production                 
|Interior Design                |  | Digital Media Production         
|Painting                       |  | Film                             
|Visual Communications          |  | Game Art & Design                
|Yacht & Marine Design          |  | Interactive Media Design         
|                               |  | Media Arts & Animation           
|Masters Degree Program        |  | Photography                      
|Graphic Design                 |  | Simulation & Virtual Environments
|Painting                       |  | Visual Effects & Motion Graphics 
|                               |  | Visual & Game Programming        
|The School of Fashion          |  |                                  
|Associates Degree Programs    |  | Masters Degree Programs         
|Accessory Design               |  | Computer Animation               
|Apparel Design                 |  | Film                             
|Fashion Design                 |  |                                  
|Fashion Marketing              |  | The School of Culinary Arts      
|Visual Merchandising           |  | Associates Degree Programs      
|                               |  | Culinary Arts                    
|Bachelors Degree Programs     |  | Restaurant & Catering Management 
|Apparel Design                 |  |                                  
|Fashion Design                 |  | Bachelors Degree Program        
|Fashion Marketing & Management |  | Culinary Management              



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Argosy University.    The following degree programs are offered by
Argosy University, organized by discipline.



|                                                                       |  |                                  
|---------------------------------------------------------------------- |  | ---------------------------------
|Psychology and Behavioral Sciences                                     |  | Business                         
|                                                                       | 
|Doctor of Psychology                                                   |  | Doctor of Business Administration
|Clinical Psychology                                                    |  | Accounting                       
|                                                                       |  | Information Systems              
|Doctor of Education                                                    |  | International Business           
|Counseling Psychology                                                  |  | Leadership                       
|Organizational Leadership                                              |  | Management                       
|Pastoral Community Counseling                                          |  | Marketing                        
|                                                                       |  |                                  
|Master of Arts                                                         |  | Master of Business Administration
|Clinical Psychology                                                    |  |                                  
|Clinical Psychology/Marriage and Family Therapy                        |  | Bachelor of Science              
|Counseling Psychology                                                  |  | Business Administration          
|Counseling Psychology/Marriage and Family Therapy                      |  | e-Business                       
|Forensic Psychology                                                    |  | Organizational Management        
|Guidance Counseling                                                    |  |                                  
|Marriage and Family Therapy                                            |  | Health Sciences                  
|Mental Health Counseling                                               |  |                                  
|Professional Counseling                                                |  | Associate of Applied Science     
|Sport-Exercise Psychology                                              |  | Diagnostic Medical Sonography    
|                                                                       |  | Histotechnology                  
|Education Specialist Degree                                            |  | Medical Assisting                
|School Counseling                                                      |  | Veterinary Technology            
|                                                                       |  | Radiologic Technology            
|Bachelor of Arts                                                       |  |                                  
|Psychology                                                             |  | Associate of Science             
|                                                                       |  | Dental Hygiene                   
|Law                                                                    |  | Medical Laboratory Technician    
|                                                                       |  | Radiation Therapy                
|Juris Doctor                                                           |  |                                  
|                                                                       | 
|Education                                                              |  |                                  
|                                                                       | 
|Doctor of Education, Education Specialist, Master of Arts in Education |  |                                  
|Curriculum & Instruction                                               |  |                                  
|Educational Leadership                                                 |  |                                  



AEC.    American Education Centers offer the following primary degree programs.



|                                     |  |                                      
|------------------------------------ |  | -------------------------------------
|Health Sciences                      |  | Business                             
|Associate of Applied Science Degree  |  | Associate of Applied Business Degree 
|Medical Assistant                    |  | Accounting Technology                
|Occupation Therapy Assistant         |  | Business Management                  
|Optical Science                      |  |                                      
|Physical Therapy Assistant           |  | Information Technology               
|                                     |  | Associate of Applied Science Degree  
|Legal Studies                        |  | Electronics Engineering              
|Associate of Applied Business        |  |                                      
|Criminal Justice                     |  | Associate of Applied Business Degree 
|Paralegal                            |  | Computer Networking and Application  
|                                     |  | Computer Programming and Applications
|Design Technologies                  |  | Computer Software Technology         
|Associate of Applied Science Degrees |  |                                      
|Audio/Video Production               |  |                                      
|Computer Aided Design and Drafting   |  |                                      



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South University.    South University offers the following degree
programs.



|                                                 |  |                        
|------------------------------------------------ |  | -----------------------
|School of Pharmacy                               |  | School of Business     
|Doctoral Degrees                                 |  | Baccalaureate Degrees  
|Doctor of Pharmacy (only at the Savannah campus) |  | Business Administration
|                                                 |  | Healthcare Management  
|School of Health Professions                     |  | Paralegal Studies      
|Masters Degrees                                 |  | Information Technology 
|Physician Assistant                              |  |                        
|Anesthesiologist Assistant                       |  | Certificates           
|                                                 |  | Paralegal Studies      
|Baccalaureate Degrees                            |  |                        
|Physician Assistant                              |  |                        
|Nursing                                          |  |                        
|                                                 | 
|Associates Degrees                              |  |                        
|Allied Health Science                            |  |                        
|Medical Assisting                                |  |                        
|Physical Therapist Assisting                     |  |                        



Graduate Employment



We measure our success as an educator of students to a significant extent
by the ability of our students to find jobs in their chosen field of employment upon graduation from our schools. Each of our schools provide career development instruction to our students in order to assist the students in developing essential
job-search skills. In addition to individualized training in interviewing, networking techniques and resume-writing, most of our schools require students to take a career development course. Additionally, we provide ongoing placement resources to
our students and recent graduates. Career services departments also assist current students in finding part-time employment while attending school. Students in certain of our doctoral programs spend up to a year in a paid internship in their chosen
field.



Each schools career services department plays a
role in marketing the schools curriculum to the community in order to produce job leads for graduates. Career services advisors educate employers about the caliber of our graduates. These advisors participate in professional organizations,
trade shows and community events to keep apprised of industry trends and maintain relationships with key employers. Career services staff visit employer sites to learn more about their operations and better understand their employment needs. As of
June 30, 2004, the career services departments of our schools had approximately 320 employees. We estimate that our career services departments maintain contact with over 50,000 employers nationwide.



Based on information collected by us from graduating students and employers,
we believe that of the 6,453 undergraduate students who graduated from The Art Institutes during the calendar year ended December 31, 2003, 88.9% of the available graduates obtained employment in their fields of study, or in related fields of study,
within six months of graduation. This excludes students who are pursuing further education, deceased, in active military service, who have medical conditions that prevent them from working, who are continuing in a career unrelated to their program
of study, or who are international students no longer residing in the United States. The average salary paid to our available graduating undergraduate students from The Art Institutes for calendar year 2003 who obtained employment in their fields of
study, or in related fields of study, was approximately $28,500 as compared to $27,600 for calendar year 2002.



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Accreditation



In the United States, accreditation is a process through which an institution submits itself to qualitative review by an organization of peer
institutions. Accrediting agencies primarily examine the academic quality of the instructional programs of an institution, and a grant of accreditation is generally viewed as certification that an institutions programs meet generally accepted
academic standards. Accrediting agencies also review the administrative and financial operations of the institutions they accredit to ensure that each institution has the resources to perform its educational mission.



Pursuant to provisions of the Higher Education Act of 1965, as amended
(HEA), the U.S. Department of Education relies on accrediting agencies to determine whether institutions educational programs qualify the institutes to participate in federal financial aid programs under Title IV of the HEA
(Title IV Programs). The HEA specifies certain standards that all recognized accrediting agencies must adopt in connection with their review of post-secondary institutions. All of our U.S. schools are accredited by an accrediting agency
recognized by the U.S. Department of Education.



In addition to
the institutional accreditations described above, three Art Institutes offer interior design programs that have programmatic accreditation by the Foundation for Interior Design Education Research (FIDER) and eight Art Institutes offer culinary
programs accredited by the American Culinary Federation. Ten Argosy University locations have received accreditation by the American Psychological Association for their Doctor of Psychology programs.



The following table shows the location of each of our schools at June 30,
2004, the name under which it operates, the year of its establishment, the date we opened or acquired it, and the institutional accrediting agency (for schools accredited by more than one recognized accrediting agency, the primary accrediting agency
is listed first). No accreditation is shown for The Art Institute of Toronto as the Province of Ontario has no accreditation process for post-secondary schools.



|                                              |  |                   |  |                         |  |                                |  |                                                                                    
|--------------------------------------------- |  | ----------------- |  | ----------------------- |  | ------------------------------ |  | -----------------------------------------------------------------------------------
|School                                        |  | Location          |  | CalendarYearEstablished |  | Fiscal YearEDMCAcquired/Opened |  | Accrediting Agency                                                                 
|The Art Institutes                            |  |                   |  |                         |  |                                |  |                                                                                    
|The Art Institute of Atlanta                  |  | Atlanta, GA       |  | 1949                    |  | 1971                           |  | Commission on Colleges of the Southern Association of Colleges and Schools (SACS)
|The Art Institute of CaliforniaLos Angeles   |  | Los Angeles, CA   |  | 1997                    |  | 1998                           |  | Accrediting Council of Independent Colleges and Schools
(ACICS)                  
|The Art Institute of CaliforniaOrange County |  | Orange County, CA |  | 2000                    |  | 2001                           |  | ACICS (as a branch of The Art Institute of
CaliforniaLos Angeles)                 
|The Art Institute of CaliforniaSan Diego     |  | San Diego, CA     |  | 1981                    |  | 2001                           |  | Accrediting Commission of Career Schools and Colleges of Technology
(ACCSCT)     
|The Art Institute of CaliforniaSan Francisco |  | San Francisco, CA |  | 1939                    |  | 1998                           |  | ACICS (as a branch of The Art Institute of
CaliforniaLos Angeles)                 



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|                                                                       |  |                     |  |                         |  |                                |  |                                                                                                            
|---------------------------------------------------------------------- |  | ------------------- |  | ----------------------- |  | ------------------------------ |  | -----------------------------------------------------------------------------------------------------------
|School                                                                 |  | Location            |  | CalendarYearEstablished |  | Fiscal YearEDMCAcquired/Opened |  | Accrediting Agency                                                                                         
|The Art Institute of Charlotte                                         |  | Charlotte, NC       |  | 1973                    |  | 2000                           |  | ACICS                                                                                                      
|The Art Institute of Colorado                                          |  | Denver, CO          |  | 1952                    |  | 1976                           |  | ACICS                                                                                                      
|The Art Institute of Dallas                                            |  | Dallas, TX          |  | 1964                    |  | 1985                           |  | SACS                                                                                                       
|The Art Institute of Fort Lauderdale                                   |  | Fort Lauderdale, FL |  | 1968                    |  | 1974                           |  | ACICS                                                                                                      
|The Art Institute of Houston                                           |  | Houston, TX         |  | 1974                    |  | 1979                           |  | SACS                                                                                                       
|The Art Institute of Las Vegas                                         |  | Las Vegas, NV       |  | 1983                    |  | 2001                           |  | ACCSCT                                                                                                     
|The Art Institute of New York City                                     |  | New York, NY        |  | 1980                    |  | 1997                           |  | ACICS; New York State Board of Regents                                                                     
|The Art Institute of OhioCincinnati                                   |  | Cincinnati, OH      |  | 2004                    |  | 2005                           |  | ACICS (as a branch of AEC Southern Ohio College in Findlay,
OH)                                            
|The Art Institute Online                                               |  | Pittsburgh, PA      |  | 1999                    |  | 2000                           |  | Approved by ACICS to offer programs as a division of The Art Institute of Pittsburgh                       
|The Art Institute of Philadelphia                                      |  | Philadelphia, PA    |  | 1971                    |  | 1980                           |  | ACICS                                                                                                      
|The Art Institute of Phoenix                                           |  | Phoenix, AZ         |  | 1995                    |  | 1996                           |  | ACICS (as a branch of The Art Institute of Colorado)                                                       
|The Art Institute of Pittsburgh                                        |  | Pittsburgh, PA      |  | 1921                    |  | 1970                           |  | ACICS; candidate with Middle States Association of Colleges & Schools of the Commission on Higher Education
|The Art Institute of Portland                                          |  | Portland, OR        |  | 1963                    |  | 1998                           |  | Northwest Commission on Colleges and Universities (NWCCU)                                                
|The Art Institute of Seattle                                           |  | Seattle, WA         |  | 1946                    |  | 1982                           |  | NWCCU                                                                                                      
|The Art Institute of Tampa                                             |  | Tampa, FL           |  | 2004                    |  | 2004                           |  | SACS (as a branch of the Miami International University of Art & Design)                                   
|The Art Institute of Toronto                                           |  | Toronto, Ontario    |  | 1997                    |  | 2002                           |  | Not Applicable                                                                                             
|The Art Institute of Vancouver                                         |  | Vancouver, BC       |  | 1998                    |  | 2003                           |  | Private Post-Secondary Education Commission of British Columbia (PPSEC)                                  
|The Art Institute of VancouverBurnaby                                 |  | Burnaby, BC         |  | 1979                    |  | 2003                           |  | PPSEC                                                                                                      
|The Art Institute of VancouverDubrulle International Culinary Academy |  | Vancouver, BC       |  | 1998                    |  | 2004                           |  | PPSEC                                                                                                      



10



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|                                                   |  |                    |  |                         |  |                                |  |                                                                                                  
|-------------------------------------------------- |  | ------------------ |  | ----------------------- |  | ------------------------------ |  | -------------------------------------------------------------------------------------------------
|School                                             |  | Location           |  | CalendarYearEstablished |  | Fiscal YearEDMCAcquired/Opened |  | Accrediting Agency                                                                               
|The Art Institute of Washington                    |  | Arlington, VA      |  | 2000                    |  | 2001                           |  | SACS (as a branch of The Art Institute of Atlanta)                                               
|The Art Institutes International Minnesota         |  | Minneapolis, MN    |  | 1964                    |  | 1997                           |  | ACICS                                                                                            
|Bradley Academy for the Visual Arts                |  | York, PA           |  | 1952                    |  | 2004                           |  | ACCSCT                                                                                           
|California Design College                          |  | Los Angeles, CA    |  | 1991                    |  | 2003                           |  | ACICS                                                                                            
|The Illinois Institute of ArtChicago              |  | Chicago, IL        |  | 1916                    |  | 1996                           |  | ACCSCT; Higher Learning Commission (HLC) of the North Central
Association (Chicago location only)
|The Illinois Institute of ArtSchaumburg           |  | Schaumburg, IL     |  | 1983                    |  | 1996                           |  | ACCSCT (as a branch of The Illinois Institute of
ArtChicago)                                    
|The Miami International University of Art & Design |  | Miami, FL          |  | 1965                    |  | 2002                           |  | SACS                                                                                             
|The New England Institute of Art                   |  | Boston, MA         |  | 1988                    |  | 2000                           |  | New England Association of Schools and Colleges                                                  
|                                                   |  |                    |  |                        
|Argosy University                                  |  |                    |  |                         |  |                                |  | HLC (all locations)                                                                              
|Argosy University/Atlanta                          |  | Atlanta, GA        |  | 1990                    |  | 2002                           |  |                                                                                                  
|Argosy University/Chicago                          |  | Chicago, IL        |  | 1976                    |  | 2002                           |  |                                                                                                  
|Argosy University/Dallas                           |  | Dallas, TX         |  | 2002                    |  | 2002                           |  |                                                                                                  
|Argosy University/Honolulu                         |  | Honolulu, HI       |  | 1979                    |  | 2002                           |  |                                                                                                  
|Argosy University/Orange County                    |  | Orange, CA         |  | 1999                    |  | 2002                           |  |                                                                                                  
|Argosy University/Phoenix                          |  | Phoenix, AZ        |  | 1997                    |  | 2002                           |  |                                                                                                  
|Argosy University/San Francisco                    |  | Point Richmond, CA |  | 1998                    |  | 2002                           |  |                                                                                                  
|Argosy University/Sarasota                         |  | Sarasota, FL       |  | 1969                    |  | 2002                           |  |                                                                                                  
|Argosy University/Schaumburg                       |  | Schaumburg, IL     |  | 1979                    |  | 2002                           |  |                                                                                                  
|Argosy University/Seattle                          |  | Seattle, WA        |  | 1997                    |  | 2002                           |  |                                                                                                  
|Argosy University/Tampa                            |  | Tampa, FL          |  | 1997                    |  | 2002                           |  |                                                                                                  
|Argosy University/Twin Cities                      |  | Eagan, MN          |  | 1961                    |  | 2002                           |  |                                                                                                  
|Argosy University/Washington D.C.                  |  | Arlington, VA      |  | 1994                    |  | 2002                           |  |                                                                                                  



11



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|                                        |  |                     |  |                         |  |                                |  |                                                                                                                                   
|--------------------------------------- |  | ------------------- |  | ----------------------- |  | ------------------------------ |  | ----------------------------------------------------------------------------------------------------------------------------------
|School                                  |  | Location            |  | CalendarYearEstablished |  | Fiscal YearEDMCAcquired/Opened |  | Accrediting Agency                                                                                                                
|Western State University College of Law |  | Fullerton, CA       |  | 1966                    |  | 2002                           |  | Commission on Colleges of the Western Association of Schools and
Colleges; provisionally accredited by American Bar Association(1)
|South University                        |  |                     |  |                         |  |                                |  | SACS (all locations)                                                                                                              
|South University/Savannah               |  | Savannah, GA        |  | 1899                    |  | 2004                           |  |                                                                                                                                   
|South University/Montgomery             |  | Montgomery, AL      |  | 1997                    |  | 2004                           |  |                                                                                                                                   
|South University/West Palm Beach        |  | West Palm Beach, FL |  | 1974                    |  | 2004                           |  |                                                                                                                                   
|South University/Columbia               |  | Columbia, SC        |  | 1935                    |  | 2004                           |  |                                                                                                                                   
|American Education Centers              |  |                     |  |                         |  |                                |  |                                                                                                                                   
|AEC Southern Ohio College               |  | Akron, OH           |  | 1980                    |  | 2004                           |  | ACICS (as a branch of AEC Southern Ohio College in Cincinnati, OH)                                                                
|AEC Southern Ohio College               |  | Cincinnati, OH      |  | 1927                    |  | 2004                           |  | ACICS                                                                                                                             
|AEC Southern Ohio College               |  | Findlay, OH         |  | 1986                    |  | 2004                           |  | ACICS                                                                                                                             
|AEC Southern Ohio College               |  | Ft. Mitchell, KY    |  | 1927                    |  | 2004                           |  | ACICS (as a branch of AEC Southern Ohio College in Cincinnati, OH)                                                                
|AEC Southern Ohio College               |  | North Canton, OH    |  | 1984                    |  | 2004                           |  | ACICS                                                                                                                             
|AEC Texas Institute                     |  | Garland, TX         |  | 2001                    |  | 2004                           |  | ACICS (as a branch of AEC Southern Ohio College in Cincinnati, OH)                                                                
|AEC Texas Institute                     |  | Hurst, TX           |  | 2001                    |  | 2004                           |  | ACICS (as a branch of AEC Southern Ohio College in Cincinnati, OH)                                                                
|Asher School of Business                |  | Norcross, GA        |  | 1969                    |  | 2004                           |  | ACICS(2)                                                                                                                          
|The Brown Mackie College                |  | Lenexa, KS          |  | 1984                    |  | 2004                           |  | HLC (as a branch of The Brown Mackie College Salina)                                                                              
|The Brown Mackie College                |  | Salina, KS          |  | 1892                    |  | 2004                           |  | HLC                                                                                                                               
|Commonwealth Business College           |  | Merrillville, IN    |  | 1984                    |  | 2004                           |  | ACICS                                                                                                                             
|Commonwealth Business College           |  | Michigan City, IN   |  | 1890                    |  | 2004                           |  | ACICS (as a branch of Commonwealth Business College in Merrillville,
IN)                                                          
|Commonwealth Business College           |  | Moline, IL          |  | 1985                    |  | 2004                           |  | ACICS (as a branch of Commonwealth Business College in Merrillville,
IN)                                                          



12



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|                                    |  |                  |  |                         |  |                                |  |                                                                         
|----------------------------------- |  | ---------------- |  | ----------------------- |  | ------------------------------ |  | ------------------------------------------------------------------------
|School                              |  | Location         |  | CalendarYearEstablished |  | Fiscal YearEDMCAcquired/Opened |  | Accrediting Agency                                                      
|Michiana College                    |  | Fort Wayne, IN   |  | 1991                    |  | 2004                           |  | ACICS (as a branch of Michiana College in South Bend, IN)               
|Michiana College                    |  | South Bend, IN   |  | 1882                    |  | 2004                           |  | ACICS                                                                   
|RETS Institute of Technology        |  | Louisville, KY   |  | 1935                    |  | 2004                           |  | ACICS                                                                   
|RETS Institute of Technology        |  | Pittsburgh, PA   |  | 2001                    |  | 2004                           |  | ACICS (as a branch of RETS Institute of Technology in Louisville, KY)(3)
|RETS Medical and Business Institute |  | Hopkinsville, KY |  | 1995                    |  | 2004                           |  | ACICS (as a branch of RETS Institute of Technology in Louisville,
KY)   

---

|(1) |  | Western State University College of Law, which is instructionally accredited by Commission on Colleges of the Western Association of Schools and Colleges, reached an agreement with
the American Bar Association pursuant to which WSU voluntarily relinquished ABA conditional accreditation as of August 8, 2004. In accordance with the terms of the settlement agreement, WSU filed a new application for provisional approval by the ABA
on August 23, 2004. Under the terms of the settlement agreement, the ABA will perform a site inspection in the fall of 2004. Following the site visit, the inspection team will issue an inspection report which will be most likely be acted upon by the
Accreditation Committee of the Section on Legal Education and Admission to the Bar in January 2005 and by the Council and the House of Delegates in February 2005.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Asher School of Business in Norcross, GA maintained accreditation as a stand-alone campus with ACICS accreditation until May 27, 2004 at which time it became a branch of The Art
Institute of Charlotte, NC under ACICS accreditation.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | The RETS Institute of Technology in Pittsburgh, PA discontinued accepting new enrollments, effective April 5, 2004 and the complete teach-out of all students is expected to be
completed in January 2005. Upon completion of the teach-out, the school will close.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Accrediting agencies monitor each educational institutions performance in specific areas. In the
event that the information provided by a school to an accrediting agency indicates that such schools performance in one or more areas falls below certain parameters, the accrediting agency may require the school to supply it with supplemental
reports on the accrediting agencys specific areas of concern until that school meets the accrediting agencys performance guideline or standard. As of June 30, 2004, six of our schools were required to provide such supplemental reports.
Three of these schools must seek the prior approval of their accrediting agency in order to open or commence teaching at new locations. The accrediting agencies do not consider requesting that a school provide supplemental reports to be a negative
action.



Student Financial Assistance



Many students at our U.S. schools rely, at least in part, on financial
assistance to pay for the cost of their education. In the United States, the largest sources of such support are the federal student aid programs under the HEA (Title IV Programs). Additional sources of funds include other federal grant
programs, state grant and loan programs, private loan programs and institutional grants and scholarships. To provide students access to financial assistance resources available through Title IV Programs, a school must be (i) authorized to offer its
programs of instruction by the relevant agency of the states in which it is located, (ii) accredited by an agency recognized by the U.S. Department of Education, and (iii) certified as an eligible institution by the U.S. Department of Education. In
addition, the school must ensure that Title IV Program funds are properly accounted for and disbursed in the correct amounts to eligible students and remain in compliance generally with the Title IV Program regulations. During fiscal 2004,
approximately 73% of our net revenues were indirectly derived from Title IV Programs.



As in the U.S., there are certain risks operating postsecondary institutions in Canada, including but not limited to: failure of our schools to understand or comply with extensive regulations could result in financial
penalties, restrictions on our operations, or loss of external financial aid funding for our students. The provinces or national government may change the law or reduce funding for student financial aid programs, which could harm our student
population and revenue. If our schools do not maintain their approvals, they may not operate or participate in federal student financial aid programs. Government and regulatory agencies may conduct compliance reviews, bring claims or initiate
litigation against us. During fiscal 2004, approximately 1% of our net revenues were from our schools located in Canada.



Nature of Federal Support for Post-secondary Education



While the states support public colleges and universities primarily through direct state subsidies, the federal government
provides a substantial part of its support for post-secondary education in the form of grants and loans to students who can use this support at any institution that has been certified as eligible by the U.S. Department of Education. Students at our
U.S. schools receive loans, grants and work-study funding to fund their education under several Title IV Programs, of which the two largest are the Federal Family Education Loan (FFEL) program and the Federal Pell Grant
(Pell) program. Our U.S. schools also participate in the Federal Supplemental Educational Opportunity Grant (FSEOG) program, the Federal Perkins Loan (Perkins) program, and the Federal Work-Study (FWS)
program.



FFEL.    The FFEL program
consists of two types of loans: Stafford loans, which are made available to students regardless of financial need, and PLUS loans, which are made available to parents of students classified as dependents. Under the Stafford loan program, a student
may borrow up to $2,625 for the first academic year, $3,500 for the second academic year and, in certain educational programs, $5,500 for each of the third and fourth academic years. Students who are classified as independent can obtain up to an
additional $4,000 for each of the first and second academic years and, depending upon the educational program, an additional $5,000 for each of the third and fourth academic years. Students enrolled in programs higher than a bachelor-level program
can borrow up to $18,500 per academic year. Students enrolled in certain graduate-level health professions can receive an additional $12,500 per academic year. Amounts received by students in our U.S. schools under the Stafford loan program in
fiscal 2004 equaled approximately 47% of our net revenues. PLUS loans may be obtained by the parent(s) of a dependent student in an amount not to exceed the difference



14



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between the total cost of that students education (including allowable educational expenses) and other aid to which that student is entitled. Amounts
received by parents of students in our U.S. schools under the PLUS loan program in fiscal 2004 equaled approximately 15% of our net revenues.



Pell.    Pell grants are the primary component of the Title IV Programs under which the U.S. Department of Education makes
grants to students who demonstrate financial need. Every eligible student is entitled to receive a Pell grant; there is no institutional allocation or limit. During fiscal 2004, Pell grants ranged up to $4,050 per year, depending on student need and
other factors. Amounts received by students enrolled in our U.S. schools in fiscal 2004 under the Pell program represented approximately 9% of our net revenues.



FSEOG.    FSEOG awards are designed to supplement Pell grants for the neediest students. FSEOG grants at our schools
generally range in amount from $300 to $1,200 per year. However, the availability of FSEOG awards is limited by the amount of those funds allocated to an institution under a formula that takes into account the size of the institution, its costs and
the income levels of its students. We are required to make a 25% matching contribution for all FSEOG program funds disbursed. Resources for this institutional contribution may include institutional grants and scholarships and, in certain states,
portions of state grants and scholarships. Amounts received by students in our U.S. schools under the FSEOG program in fiscal 2004 represented approximately 1% of our net revenues.



Perkins.    Eligible undergraduate students may borrow up to $4,000 under the Perkins program
during each academic year, with an aggregate maximum of $20,000. Eligible graduate students may borrow up to $6,000 in Perkins loans each academic year, with an aggregate maximum of $40,000. Perkins loans have a 5% interest rate and repayment is
delayed until nine months after a student ceases enrollment as at least a half-time student. Perkins loans are made available to those students who demonstrate the greatest financial need. Perkins loans are made from a revolving account, with 75% of
new funding contributed by the U.S. Department of Education and the remainder by the applicable school. Subsequent federal capital contributions, which must be matched by school funds, may be received if an institution meets certain requirements.
Each school collects payments on Perkins loans from its former students and re-lends those funds to currently enrolled students. Collection and disbursement of Perkins loans is the responsibility of each participating institution. During fiscal
2004, we collected approximately $5.9 million from our former students. In fiscal 2004, our required matching contributions were approximately $0.3 million. The Perkins loans disbursed to students in our U.S. schools in fiscal 2004 represented less
than 1% of our net revenues.



Federal
Work-Study.    Under the Federal Work-Study program, federal funds are made available to pay up to 75% of the cost of part-time employment of eligible students, based on their financial need, to perform work for the
institution or for off-campus public or non-profit organizations. Most of our schools participate in the Federal Work-Study program. In order to participate in the program, each year a school must have at least 7% of the schools Federal
Work-Study program allocation paid to students performing community service work. One of our schools owned longer than one year and most of the schools we acquired during fiscal 2004 did not meet this requirement in fiscal 2004. To our knowledge,
there have not been any penalties assessed to schools who have not met this requirement, but we cannot be assured that a penalty will not be assessed in the future. In fiscal 2004, Federal Work-Study funds represented less than 1% of our net
revenues.



Legislative
Action.    Political and budgetary concerns can significantly affect the Title IV Programs. The U.S. Congress must reauthorize the HEA approximately every six years. The next reauthorization of the HEA is expected to take
place in 2005 or 2006. In addition, the U.S. Congress reviews and determines federal appropriations for Title IV Programs on an annual basis. The U.S. Congress can also make changes in the laws affecting Title IV Programs in those annual
appropriations bills and in other laws it enacts between HEA reauthorizations. Since a significant percentage of our revenue is derived from Title IV Programs, any action by the U.S. Congress that significantly reduced Title IV Program funding or
the ability of our schools or students to participate in the Title IV Programs would have a material adverse effect on our business, results of operations or financial condition. Legislative action also could increase our administrative costs
and require us to adjust our practices in order for our schools to comply fully with Title IV Program requirements.



15



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Other Financial Assistance Sources



Students at several of our U.S. schools participate in state grant programs.
In fiscal 2004, approximately 3% of our net revenues were indirectly derived from state grant programs. In addition, certain students at some of our U.S. schools receive financial aid provided by the U.S. Department of Veterans Affairs, the U.S.
Department of the Interior (Bureau of Indian Affairs) and the Rehabilitative Services Administration of the U.S. Department of Education (vocational rehabilitation funding). In fiscal 2004, financial assistance from such federal programs equaled
less than our 1% of net revenues. Our schools also provide institutional scholarships to qualified students. In fiscal 2004, institutional scholarships had a value equal to approximately 2% of our net revenues.



We have also arranged alternative supplemental loan programs that allow
students to repay a portion of their loans after graduation and allow students with lower than average credit ratings to obtain loans. The primary objective of these loan programs is to lower the monthly payments required of students. Such loans are
without recourse to us or our schools. In fiscal 2004, alternative loans represented approximately 11% of our net revenues.



Availability of Lenders



During fiscal 2004, eight lending institutions provided over 94% of all federally guaranteed loans to students attending our U.S. schools. While we
believe that other lenders or the Federal Direct Loan program would be willing to make federally guaranteed student loans to our students if loans were no longer available from our current lenders, there can be no assurances in this regard. In
addition, the HEA requires the establishment of lenders of last resort in every state to ensure that loans are available to students at any school that cannot otherwise identify lenders willing to make federally guaranteed loans to its students.



Three student loan guaranty agencies currently guarantee at
least 90% of all federally guaranteed student loans made to students enrolled at our U.S. schools. We believe that other guaranty agencies would be willing to guarantee loans to our students if any of the four current agencies ceased guaranteeing
those loans or reduced the volume of loans they guarantee, although there can be no assurances in this regard.



Federal Oversight of Title IV Programs.    Our U.S. schools are subject to audits or program compliance reviews by various
external agencies, including the U. S. Department of Education, its Office of Inspector General, and state, guaranty and accrediting agencies. The HEA and its implementing regulations also require that an institutions administration of Title
IV Program funds be audited annually by an independent accounting firm. If the U. S. Department of Education or another regulatory agency determines that an institution has improperly disbursed Title IV Program funds or violated a provision of the
HEA or its implementing regulations, the affected institution may be required to repay such funds to the U.S. Department of Education or the appropriate state agency or lender and may be assessed an administrative fine. Although we endeavor to
comply with the HEA and implementing regulations, we cannot guarantee that our interpretation of the relevant rules will be upheld by the U. S. Department of Education or in all court cases.



If the U. S. Department of Education views a violation as significant, it can
also transfer the institution from the advance system of receiving Title IV Program funds to the cash monitoring or reimbursement method of payment, under which a school may have to disburse its own funds to students and document students
eligibility for Title IV Program funds, prior to receiving reimbursement from the Title IV Programs.



Violations or alleged violations of Title IV Program requirements also could subject us to other civil and criminal sanctions, including a proceeding to
impose a fine, place restrictions on an institutions participation in Title IV Programs or terminate its eligibility to participate in Title IV Programs. Potential restrictions may include a suspension of an institutions ability to
participate in Title IV Programs for up to 60 days and/or a limitation of an institutions participation in Title IV programs, either by limiting the number or percentage of students enrolled who may participate in Title IV Programs or by
limiting the percentage of an institutions total receipts derived from Title IV Programs. The U. S. Department of Education also may initiate an emergency



16



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action to temporarily suspend an institutions participation in Title IV Programs without advance notice if it determines that a regulatory violation
creates an imminent risk of material loss of public funds.



The
HEA requires each accrediting agency recognized by the U.S. Department of Education to undergo comprehensive periodic review by the U.S. Department of Education to ascertain whether such accrediting agency is adhering to required standards. We are
not aware of any reason that any of the agencies that accredit our institutions would not be approved as a result of such review. In any event, if an accreditation agency is not approved by the U.S. Department of Education, the institutions that are
affected are given time to apply for accreditation from a different agency.



Cohort Default Rates.    Each institution that participates in the FFEL program must maintain a student loan cohort default rate equal to or less than 25% for three consecutive years or it
will no longer be eligible to participate in the Title IV programs for the remainder of the federal fiscal year in which the U.S. Department of Education determines that such institution has lost its eligibility and for the two subsequent federal
fiscal years. Each institution that participates in the Perkins program must maintain a student loan cohort default rate equal to or less than 50% for three consecutive years or it will no longer be eligible to participate in the Perkins programs
for the remainder of the federal fiscal year in which the U.S. Department of Education determines that such institution has lost its eligibility and for the two subsequent federal fiscal years.



None of our schools has had an FFEL cohort default rate of 25% or greater for
any of the last three consecutive federal fiscal years. For federal fiscal year 2001, the most recent year for which such rates have been published, the average FFEL cohort default rate for borrowers at all proprietary institutions was 9.0%. For
that year, the combined FFEL cohort default rate for all borrowers at our schools was 6.7%, and our individual schools rates ranged from 1.6% to 22.9%. For federal fiscal year 2002, the combined FFEL cohort default rate for borrowers at our
schools was 6.2%, and our individual schools rates ranged from 2.0% to 18.8%.



If an institutions FFEL cohort default rate equals or exceeds 25% in any of the three most recent federal fiscal years, or if its cohort default rate for loans under the Perkins program exceeds 15% for the most
recent federal award year (July 1 through June 30), that institution may be placed on provisional certification status for up to three years. Provisional certification does not by itself limit an institutions access to Title IV Program funds,
but does subject that institution to closer review by the U.S. Department of Education and possible summary adverse action if that institution commits a material violation of Title IV Program requirements.



To our knowledge, the U.S. Department of Education reviews an
institutions compliance with the cohort default rate thresholds described in the previous paragraph only when that institution is otherwise subject to a U.S. Department of Education renewal of certification review. As of June 30, 2004, seven
of our schools had Perkins cohort default rates in excess of 15% for students who were to begin repayment during the federal award year ending June 30, 2003, the most recent year for which such rates have been calculated. In aggregate, funds from
the Perkins program equaled less than 2% of these schools net revenues in fiscal 2004. None of these schools has been placed on provisional certification solely for this reason. None of our Perkins cohort default rates exceeded 50% during the
federal award year ending June 30, 2004.



Each of our schools
whose students participate in the FFEL program and/or the Perkins program maintains a student loan default management plan if their default rates equal or exceed five percent. Those plans provide for extensive loan counseling, methods to increase
student persistence and completion rates and graduate employment rates, strategies to increase graduate salaries and, for most schools, the use of external agencies to assist the school with loan counseling and loan servicing after a student ceases
to attend that school. These activities are in addition to the loan servicing and collection activities of FFEL lenders and guaranty agencies. Argosys historical default rates have been quite low, and therefore Argosy has engaged in
significantly fewer default management activities.



Regulatory Oversight.    The U.S. Department of Education is required to conduct periodic reviews to determine whether to renew the eligibility and certification of every institution participating in Title IV
Programs. Generally such reviews occur every six years. A denial of renewal of certification precludes a school from continuing to participate in Title IV Programs. All our schools that submitted renewal of certification



17



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applications during fiscal 2004 either received renewed certification or have not yet heard back from the U.S. Department of Education. During fiscal 2005,
four schools are scheduled to apply for recertification.



As of
June 30, 2004, twenty-six of our schools were provisionally certified by the U.S. Department of Education due to our recent acquisition of these schools. A letter of credit was required to be posted during the change of ownership of California
Design College.



Financial Responsibility
Standards.    All institutions participating in Title IV Programs must satisfy certain standards of financial responsibility. Institutions are evaluated for compliance with these requirements as part of the U.S. Department of
Educations renewal of certification process, and also annually as each institution submits its audited financial statements to the U.S. Department of Education. For the year ended June 30, 2004, we believes that, on an individual institution
basis, each of our schools then participating in Title IV Programs satisfied the financial responsibility standards. For purposes of financial responsibility standards, the main campus and each of its branches and other locations are consolidated.



Return of Title IV
Funds.    Institutions that receive Title IV funds must follow requirements that ensure the return to the federal student financial aid programs of all unearned funds of a student who withdraws from a program. If refunds are
not properly calculated and timely paid, institutions are subject to adverse actions by the U.S. Department of Education. We have posted letters of credit for twenty-eight of our schools because independent audits indicated that they had been late
in the payment of 5% or more of their refunds during at least one of their two most recent fiscal years. Of these schools for which we posted letters of credit, twenty-four were schools we acquired in the last fiscal year. We have instituted
practices and procedures to expedite refunds of FFEL program funds, including payment of refunds by electronic fund transfers.



Administrative Capability Requirements.    Regulations of the U.S. Department of Education specify extensive criteria an
institution must satisfy to establish that it has the requisite administrative capability to participate in Title IV Programs. These criteria require, among other things, that the institution comply with all applicable federal student
financial aid regulations; have capable and sufficient personnel to administer the Title IV Programs; have acceptable methods of defining and measuring the satisfactory academic progress of its students; provide financial aid counseling to its
students; and submit all reports and financial statements required by the regulations. If an institution fails to satisfy any of these criteria, the U.S. Department of Education may require the repayment of federal student financial aid funds;
transfer the institution from the advance system of payment of Title IV Program funds to the cash monitoring or reimbursement method of payment; place the institution on provisional certification status; or commence a proceeding to impose a fine or
to limit, suspend or terminate the participation of the institution in Title IV Programs.



Restrictions on Operating Additional Schools.    The HEA generally requires that certain educational institutions be in full operation for two years before applying to participate in Title
IV Programs. However, under the HEA and applicable regulations, an institution that is certified to participate in Title IV Programs may establish an additional location and apply to participate in Title IV Programs at that location without
reference to the two-year requirement if such additional location satisfies all other applicable requirements. In addition, a school that undergoes a change of ownership resulting in a change in control (as defined under the HEA) must be reviewed
and recertified for participation in Title IV Programs under its new ownership. A schools change of ownership application can be reviewed prior to the change of ownership. If the Department finds the application to be materially complete, the
Department may generate a Temporary Program Participation Agreement allowing the schools students to continue to receive federal funding, subject to the Departments continued review of the transaction and certain other conditions.
Subsequent to the Departments review of the complete application filed as a result of the transaction, the Department will either deny recertification to the school under the new ownership or recertify the school on a provisional basis. During
the time a school is provisionally certified, it may be subject to summary adverse action for a material violation of Title IV Program requirements and may not establish additional locations without prior approval from the U.S. Department of
Education. However, provisional certification does not otherwise limit an institutions access to Title IV Program funds. Our expansion plans are based, in part, on our ability to add additional locations and acquire schools that can be
recertified.



18



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The 90/10 Rule.    Under a provision of the HEA commonly referred
to as the 90/10 Rule, institution will cease to be eligible to participate in Title IV Programs if, on a cash accounting basis, more than 90% of its revenues for the prior fiscal year was derived from Title IV Programs. Any school that
violates the 90/10 Rule immediately becomes ineligible to participate in Title IV Programs and is unable to apply to regain eligibility until the following fiscal year. For our schools that disbursed federal financial aid during fiscal 2004, the
percentage of revenues derived from Title IV Programs ranged from approximately 40.8% to 86.2%, with a weighted average of approximately 68.2%.



Restrictions on Payment of Bonuses, Commissions or Other Incentives.    An institution participating in the Title IV Programs
may not provide any commission, bonus, or other incentive payment based directly or indirectly on success in securing enrollments or financial aid to any person or entity engaged in any student recruiting or admission activities or in making
decisions regarding the awarding of Title IV Program funds. Effective July 2003, the U.S. Department Of Education published new regulations to attempt to clarify this so-called incentive compensation law. The new regulations identify
twelve compensation arrangements that the U.S. Department Of Education has determined are not in violation of the incentive compensation law, including the payment and adjustment of salaries, bonuses and commissions in certain circumstances. The new
regulations do not establish clear criteria for compliance in all circumstances, and the department has announced that it will no longer review and approve individual schools compensation plans. Although we can not provide any assurances that
the U.S. Department of Education will not find deficiencies in our compensation plans, we believe that our current compensation plans are in compliance with the HEA and the new regulations promulgated by the Department of Education.



State Authorization and Accreditation Agencies



Each of our U.S. schools is authorized to offer education programs and grant
degrees or diplomas by the state in which such school is located. The level of regulatory oversight varies substantially from state to state. In some states, the schools are subject to licensure by the state education agency and also by a separate
higher education agency. State laws may establish standards for instruction, qualifications of faculty, location and nature of facilities, financial policies and responsibility and other operational matters. State laws and regulations may limit our
ability to obtain authorization to operate in certain states or to award degrees or diplomas or offer new degree programs. Certain states prescribe standards of financial responsibility that are different from those prescribed by the U.S. Department
of Education.



Each of our U.S. schools is accredited by a
national or regional accreditation agency recognized by the U.S. Department of Education, and some educational programs are also programmatically accredited. The level of regulatory oversight and standards can vary based on the agency. Certain
accreditation agencies prescribe standards that are different from those prescribed by the U. S. Department of Education.



If a school does not meet its accreditation or state requirements, its accreditation and/or state licensing could be limited, modified, suspended or
terminated. Failure to maintain licensure or accreditation makes a school ineligible to participate in Title IV Programs.



Certain of the state authorizing agencies and accrediting agencies with jurisdiction over our schools also have requirements that may, in certain
instances, limit our ability to open a new school, acquire an existing school, establish an additional location of an existing school, or add new educational programs.



Canadian Regulation and Financial Aid



Our Canadian schools are subject to regulation in the provinces in which they operate and in the provinces in which they recruit students. Depending on
their province of residence, our Canadian students may receive loans under the Canada Student Loans Program and/or provincial funding from their province of residence. Canadian schools must meet eligibility standards to administer these programs and
must comply with extensive statutes, rules, regulations, and requirements. We believe our Canadian schools currently hold all necessary registrations, approvals, and permits and meet all eligibility requirements to administer these governmental



19



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financial aid programs. If our Canadian schools cannot meet these and other eligibility standards or fail to comply with applicable requirements, it could
have a material adverse effect on our business, results of operations or cash flows, or financial condition.



The British Columbia government, through its Ministry of Advanced Education, regulates private career colleges through an arms length accreditation and
registration body called the Private Post Secondary Education Commission of British Columbia (PPSEC) and provides financial assistance to eligible students through the British Columbia Student Assistance Program (BCSAP). In
Ontario, the government regulates private career colleges through the Ministry of Training Colleges and Universities and provides student assistance through the Ontario Student Assistance Program (OSAP). In both provinces, the student
aid programs are substantially the same and include two main components, the Canada Student Loans Program integrated into the OSAP or the BCSAP. In order to maintain the right to administer student assistance, our schools must abide by the rules,
regulations, and administrative manuals and Memorandum of Agreements with the Canada Student Loan Program and the respective OSAP/BCSAP Student Loans Plans. In order to attain eligibility, an institution has to establish that it has been in
operation for at least two years with at least 15 students enrolled in each year, provide audited financial statements for each year of operation, and in the case of British Columbia schools, be accredited by PPSEC.



A school may submit applications for loans only to students enrolled in
educational programs that have been approved by the provincial government authority filed with BCSAP or OSAP as the case may be. To be eligible, among other things, a program must be registered with the responsible provincial authority, be of a
minimum length, and must lead to a diploma or certificate.



Ontario has the additional requirement that private career colleges are also required to derive no more than 90% of their cash basis revenue from OSAP. Failure to satisfy this 90/10 requirement results in the revocation of an
institutions designation until it submits a viable revenue/enrollment plan.



Institutions cannot automatically acquire student aid designation through the acquisition of other student aid eligible institutions. In the event of a change of ownership, including a change in controlling interest,
the respective ministries as well OSAP or BCSAP, as applicable, require evidence of the institutions continued capacity and a formal undertaking to comply with registration and student aid eligibility requirements. Given that the provincial
governments and PPSEC (in the case of British Columbia) periodically revises their respective regulations and other requirements and change their respective interpretations of existing laws and regulations, we cannot assure you that the provincial
governments and/or PPSEC will agree with our interpretation of each requirement.



Canadian schools are required to audit their administration of student aid programs annually or as otherwise directed by OSAP or BCSAP, as the case may be. We believe we have complied with these requirements.



Default Rates.    Similar to the
U.S. Department of Education, the Ontario Ministry calculates student loan default rates for each school and expresses the default rates as a percentage of the total number of loans issued to students attending that school. Additionally, schools are
required to share a cost of student defaults. To our knowledge, no school has been assessed a penalty due to student default rates. In the award years of 2001-2002 through 2004-2005, this cost sharing applied or will apply to institutions with a
default rate during the respective award year equal to or greater than 25.0%. The first report of default rates relating to our Ontario locations is not expected until August of 2005.



The Ontario Ministry anticipates implementing a default management plan designed to reduce the overall default rate for
Ontario postsecondary institutions to 10.0%. Institutions with default rates in excess of 10.0% will potentially be responsible for sharing the cost of defaults if the institution does not reduce student default rates.



20



---

The Ontario Government Efficiency Act of 2002, which became effective on November 26, 2002, clarified
that Memorandum of Agreements between the Ministry and a school may impose performance or other requirements on a private career college that must be met in order for students of the institution to be eligible to apply for awards, grants, or student
loans. These requirements may include, among other things, a performance bond and a loan default sharing arrangement. If one of our schools ceases to meet any condition of any such agreement, the Ontario Ministry may withdraw the schools OSAP
eligibility.



The British Columbia government has completed
consultations with the private career college industry and other interested parties with respect to establishing new guideline for the tracking and reporting of student loan default rates. The British Columbia government and BCSAP have not come to a
final decision on implementing a new student loan default tracking or compliance system.



Other Significant Requirements.    In Ontario, schools must achieve overall graduation and graduate employment rates of not less than 33.0% below the average graduation and graduate
employment rates for public colleges in at least one out of every two years. The most recent published OSAP report on graduation and employment rates affirmed our compliance with this requirement. There can be no assurances that we will continue to
meet this requirement in the future.



While our schools in
British Columbia also must report on these rates, no minimum thresholds have been established.



Employees



As of June
30, 2004, we employed approximately 5,500 full time and approximately 1,900 part-time employees, of whom approximately 1,700 were full-time faculty members and approximately 1,650 were part-time faculty members.



Competition



The post-secondary education market is highly fragmented and competitive. Our undergraduate programs compete for students
with traditional public and private two-year and four-year colleges and universities and other proprietary schools; our graduate programs also compete with other post-graduate institutions. Many public and private colleges and universities offer
programs similar to those we offer. Public institutions often receive government subsidies, government and foundation grants, tax-deductible contributions and other financial resources generally not available to proprietary schools. Accordingly,
public institutions may have facilities and equipment superior to those in the private sector, and can offer lower tuition prices. However, tuition at private non-profit institutions is, on average, higher than that at our institutions.



Seasonality in Results of Operations



We have experienced seasonality in our results of operations primarily due
to the pattern of student enrollment. Historically, our lowest quarterly revenues and income have been in the first quarter (July to September) of our fiscal year due to fewer students being enrolled during the summer months and the expenses
incurred in preparation for the peak enrollment in the fall quarter (October to December). We expect that this seasonal trend will continue.



Availability of Reports



We make available financial information, news releases and other information on our Web site at www.edmc.com. Information contained on our web site
is not part of this Annual Report on Form 10-K or our other filings with the Securities and Exchange Commission. There is a direct link from the Web site to our Securities and Exchange Commission filings, where our annual report on Form 10-K,
quarterly reports on



21



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Form 10-Q, current reports on Form 8-K and any amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 are available free of charge as soon as reasonably practicable after we file such reports and amendments with, or furnish them to, the Securities and Exchange Commission. Stockholders may also contact Investor Relations at 210
Sixth Avenue, 33rdFloor, Pittsburgh, Pennsylvania 15222 or call 412-995-7684 to obtain a hard copy of these reports
without charge.



ITEM 2PROPERTIES



Our corporate headquarters are located in Pittsburgh, Pennsylvania. As of
June 30, 2004, our schools were located in major metropolitan areas in 24 states and two Canadian provinces. Typically, an Art Institute occupies an entire building or several floors or portions of floors in a building. Argosy, AEC and South schools
are smaller and typically located in office or commercial buildings.



We currently lease the majority of our facilities. We own a student housing facility in Fort Lauderdale, Florida; buildings occupied by The Art Institutes of Pittsburgh, Colorado and Seattle, by Western State University College of Law in
Fullerton, California, by Argosy University in Egan, Minnesota and Sarasota, Florida, and by AEC in Salina and Lenexa, Kansas and Akron, Ohio. As of June 30, 2004, we owned approximately 0.7 million square feet and leased approximately 2.6 million
square feet. The leases have remaining terms ranging from less than one year to 18 years. We have secured alternative space for those lease agreements that are nearing expiration.



ITEM 3LEGAL PROCEEDINGS



We are a defendant in certain legal proceedings arising out of the conduct of our business. In the opinion of management, based upon an investigation of
these claims and discussion with legal counsel, the ultimate outcome of such legal proceedings, individually and in the aggregate, will not have a material adverse effect on our consolidated financial position, results of operations or liquidity.



ITEM 4SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



We did not submit any matters to a vote of security
holders during the fourth quarter of the fiscal year covered by this report.



22



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PART II



ITEM 5MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS



Our common stock is traded on the Nasdaq National Market System under the
symbol EDMC. As of August 31, 2004, there were 73,354,654 shares of Common Stock outstanding held by approximately 840 holders of record. The prices set forth below reflect the high and low sales prices for our common stock, as reported
in the consolidated transaction reporting system of the Nasdaq National Market System:



|                   |  |      |       |      |   |       |  |     |       |  |   |      
|------------------ |  | ---- | ----- | ---- | - | ----- |  | --- | ----- |  | - | -----
|                   |  | 2004 |       | 2003
|Three Months Ended |  | High |       | Low  |   | High  |  | Low
|September 30       |  | $    | 32.12 |      | $ | 26.38 |  | $   | 22.75 |  | $ | 15.64
|December 31        |  |      | 34.99 |      |   | 29.58 |  |     | 23.33 |  |   | 16.38
|March 31           |  |      | 35.00 |      |   | 28.43 |  |     | 21.31 |  |   | 16.60
|June 30            |  |      | 36.62 |      |   | 30.02 |  |     | 26.74 |  |   | 19.86



Our Board of Directors
declared a stock split effected in the form of a stock dividend, payable at the rate of one share of common stock for each share owned at the close of business on December 1, 2003. The shares issued for the stock split were distributed on December
22, 2003. The stock price information for all periods presented has been adjusted to reflect the stock split.



We have not declared or paid any cash dividends on our capital stock during the past two years. We currently intend to retain future earnings, if any, to
fund the development and growth of our business and we do not anticipate paying any cash dividends in the foreseeable future.



Information concerning securities authorized for issuance under our equity compensation plans will be contained in the Proxy Statement under the caption
Equity Compensation Plan Information and is incorporated herein by reference.



23



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ITEM 6SELECTED FINANCIAL DATA



The following selected consolidated financial and other data should be read in conjunction with our Consolidated Financial
Statements and Notes filed in response to Item 8 below and the information included in response to Item 7 below. Most of the summary data presented below is derived from our consolidated financial statements audited by independent auditors, whose
reports are filed in response to Item 8 below. The consolidated financial statements as of and for the years ended June 30, 2004, 2003 and 2002 were audited by Ernst & Young LLP. The financial statements as of and for the years ended June 30,
2001 and 2000 were audited by Arthur Andersen LLP. The results presented include results of operations for the acquisitions completed during the fiscal year as of their respective acquisition dates.



|                                                               |  |                                                  |         |         |   |         |  |      |         |      |   |         |  |   |        
|-------------------------------------------------------------- |  | ------------------------------------------------ | ------- | ------- | - | ------- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|                                                               |  | Year ended June 30,                             
|                                                               |  | 2004(1)                                          |         | 2003(2) |   | 2002    |  | 2001 |         | 2000
|                                                               |  | (dollars in thousands, except per share amounts)
|Income Statement Data:                                         |  |                                                  |         |         |   |         |  |      |         |      |   |         |  |   |        
|Net revenues                                                   |  | $                                                | 853,019 |         | $ | 640,027 |  | $    | 500,576 |      | $ | 370,681 |  | $ | 307,249
|Net income                                                     |  |                                                  | 77,014  |         |   | 56,277  |  |      | 42,314  |      |   | 28,978  |  |   | 22,530 
|                                                               |  |                                                  |         |         |  
|Per Share Data(6):                                             |  |                                                  |         |         |   |         |  |      |         |      |   |         |  |   |        
|Basic:                                                         |  |                                                  |         |         |   |         |  |      |         |      |   |         |  |   |        
|Earnings per share                                             |  | $                                                | 1.06    |         | $ | 0.79    |  | $    | 0.64    |      | $ | 0.48    |  | $ | 0.39   
|Weighted average number of shares outstanding, in thousands(3) |  |                                                  | 72,786  |         |   | 70,956  |  |      | 66,052  |      |   | 59,484  |  |   | 57,928 
|Diluted:                                                       |  |                                                  |         |         |   |         |  |      |         |      |   |         |  |   |        
|Earnings per share                                             |  | $                                                | 1.03    |         | $ | 0.77    |  | $    | 0.61    |      | $ | 0.46    |  | $ | 0.38   
|Weighted average number of shares outstanding, in thousands(3) |  |                                                  | 74,870  |         |   | 73,018  |  |      | 68,958  |      |   | 62,032  |  |   | 59,842 
|                                                               |  |                                                  |         |         |  
|Other Data:                                                    |  |                                                  |         |         |   |         |  |      |         |      |   |         |  |   |        
|Capital expenditures(4)                                        |  | $                                                | 80,793  |         | $ | 76,983  |  | $    | 50,371  |      | $ | 38,822  |  | $ | 58,149 
|Enrollment at beginning of fall quarter(5)                     |  |                                                  | 58,828  |         |   | 43,784  |  |      | 32,180  |      |   | 27,718  |  |   | 24,152 
|                                                               | 
|                                                               |  | As of June 30,                                  
|                                                               |  | 2004                                             |         | 2003    |   | 2002    |  | 2001 |         | 2000
|                                                               |  | (in thousands)                                  
|Balance Sheet Data:                                            |  |                                                  |         |         |   |         |  |      |         |      |   |         |  |   |        
|Total cash (including restricted cash)                         |  | $                                                | 123,142 |         | $ | 89,552  |  | $    | 92,123  |      | $ | 47,290  |  | $ | 39,538 
|Receivables, net                                               |  |                                                  | 52,196  |         |   | 40,641  |  |      | 30,378  |      |   | 22,539  |  |   | 14,931 
|Current assets                                                 |  |                                                  | 205,054 |         |   | 161,022 |  |      | 140,042 |      |   | 83,175  |  |   | 66,713 
|Total assets                                                   |  |                                                  | 827,999 |         |   | 577,595 |  |      | 492,655 |      |   | 287,540 |  |   | 240,675
|Current liabilities                                            |  |                                                  | 281,508 |         |   | 140,201 |  |      | 139,672 |      |   | 73,897  |  |   | 62,891 
|Long-term debt (including current portion)                     |  |                                                  | 128,560 |         |   | 38,500  |  |      | 28,576  |      |   | 53,660  |  |   | 64,283 
|Shareholders investment                                       |  |                                                  | 528,687 |         |   | 427,779 |  |      | 346,577 |      |   | 159,949 |  |   | 112,950

---

|(1) |  | South University and AEC are included as of the acquisition dates during fiscal 2004. Note 1 to the consolidated financial statements provides pro forma results as if the
acquisitions had been acquired and consolidated as of July 1, 2002. Fiscal 2004 includes an adjustment recognized in the fourth quarter reducing employee benefit expense for lower than expected heath insurance claims for fiscal 2004. Net income and
basic and diluted earnings per share increased by $0.9 million and $0.01, respectively due to this change in employee benefit expense. Additionally, a charge of $2.2 million was recognized in the fiscal 2004 fourth quarter to increase the valuation
allowance related to our Canadian net deferred tax assets.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Fiscal 2003 results reflect a change in accounting estimate as we evaluated the useful lives for our property and equipment and adjusted the lives of certain classes of assets to
more closely reflect actual usage. The useful life adjustment in the fourth quarter decreased income before interest and taxes by $3.2 million. Net income and basic and diluted earnings per share were reduced by $1.9 million and $0.05, respectively.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



24



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|(3) |  | The weighted average shares outstanding used to calculate basic income per share does not include potentially dilutive securities (such as stock options). Diluted weighted average
shares outstanding includes, where dilutive, the equivalent shares of common stock calculated under the treasury stock method for the assumed exercise of options.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Capital expenditures for fiscal 2004, 2003, 2002 and 2001 reflect approximately $5.7 million, $5.7 million, $9.5 million and $4.5 million included in accounts payable at year-end,
respectively.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Excludes students enrolled at NCPT: The National Center for Paralegal Training (NCPT), which has taught out all programs. NCPT had 45, 195, 281 and 350 students enrolled
at the beginning of the fall quarters of fiscal 2003, 2002, 2001, and 2000, respectively
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) |  | The share information for all periods presented has been adjusted to reflect the stock split that occurred on December 22, 2003. See Note 1 of the Notes to the Consolidated
Financial Statements.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



25



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ITEM 7MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS



The following discussion of our
results of operations and financial condition should also be read in conjunction with the information filed in response to Item 6 above and Item 8 below. Unless otherwise specified, any reference to a year is to a fiscal year ended June
30.



Background



We are among the largest providers of private post-secondary education in
North America, based on student enrollment and revenue, and have provided career-oriented education for over 40 years. We deliver education to our students through traditional classroom settings as well as through online instruction. Our educational
institutions offer a broad range of academic programs concentrated in the following areas:



|                                         |  |                             
|---------------------------------------- |  | ----------------------------
|     Media arts                         |  |      Education             
|     Design                             |  |      Information technology
|     Fashion                            |  |      Law and legal studies 
|     Culinary arts                      |  |      Business              
|     Psychology and behavioral sciences |  |      Health sciences       



We primarily offer
academic programs through four educational systems: The Art Institutes; Argosy University; American Education Centers; and South University. We acquired AEC and South University during fiscal 2004. As of June 30, 2004, we had 67 primary campus
locations in 24 states and two Canadian provinces. Our program offerings culminate with the award of degrees ranging from associates to doctoral degrees. We also offer non-degreed programs, some of which result in the issuance of diplomas upon
successful completion.



Prior to fiscal 2004, The Art
Institutes and Argosy University were managed as separate operating segments. During the first quarter of fiscal 2004 we shifted from an educational system approach to a centralized corporate structure utilizing divisions which have been aggregated
into one operating segment. We currently have three distinct operating divisions organized by geographic location within North America: the Eastern Division; Central Division; and Western Division.



Recent Acquisitions



On October 1, 2003, we acquired Dubrulle International Culinary & Hotel Institute of Canada (Dubrulle),
located in Vancouver, British Columbia. On October 8, 2003, we acquired Bradley Academy for the Visual Arts (Bradley), located in York, Pennsylvania. The aggregate purchase price for these two entities was approximately $10.6 million.
Dubrulle will allow us to expand on our current base of students in the Vancouver area, while the purchase of Bradley complemented our existing presence in Pennsylvania. Bradley also allowed us to reach students interested in a suburban setting and
also reach the more populous centers of Baltimore, MD and Harrisburg, PA. The pro forma information presented below does not include these two acquisitions.



On September 2, 2003, we acquired 100 percent of the outstanding stock of American Education Centers, Inc. and related companies. We paid approximately
$103.5 million in cash, an additional $11.0 million in notes which were paid on September 2, 2004, and assumed $3.5 million in debt. The purchase of AEC broadened our range of academic programs for working adults.



On July 14, 2003, we acquired 100 percent of the outstanding stock of South
University. We paid approximately $51.0 million in cash for South, which includes $4.0 million held in escrow. Funds from this escrow account will be transferred to the previous owner if certain conditions are met. These conditions primarily relate
to the development and performance of certain health profession programs. The purchase of South University broadened our program offerings in the health sciences.



26



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The following table reports pro forma information as if the acquisitions of South University and AEC had
been completed at July 1, 2002. Pro forma results for the year ended June 30, 2004 include $15.9 million in expenses for AEC pertaining to stock compensation payouts and costs incurred related to the acquisition by us. These stock plans at AEC are
no longer in place and we do not expect to incur charges of this nature in future periods.



|                           |  |                     |                                                   |      |   |        
|-------------------------- |  | ------------------- | ------------------------------------------------- | ---- | - | -------
|                           |  | Year Ended June 30,
|                           |  | 2004                |                                                   | 2003
|                           |  |                     | (unaudited, inthousands, except pershare amounts)
|Net revenues               |  |                     |                                                   |      |   |        
|As reported                |  | $                   | 853,019                                           |      | $ | 640,027
|Pro forma                  |  |                     | 863,349                                           |      |   | 712,304
|                           |  |                    
|Net income                 |  |                     |                                                   |      |   |        
|As reported                |  | $                   | 77,014                                            |      | $ | 56,277 
|Pro forma                  |  |                     | 67,852                                            |      |   | 64,910 
|                           |  |                    
|Diluted earnings per share |  |                     |                                                   |      |   |        
|As reported                |  | $                   | 1.03                                              |      | $ | 0.77   
|Pro forma                  |  |                     | 0.91                                              |      |   | 0.89   



The following table
summarizes the estimated fair values of the assets we acquired and liabilities we assumed in connection with our acquisition of AEC (in thousands):



|                       |  |   |        
|---------------------- |  | - | -------
|Current assets         |  | $ | 6,667  
|Property and equipment |  |   | 11,355 
|Intangible assets      |  |   | 4,502  
|Goodwill               |  |   | 102,574
|                       |  |   |        
|Total assets acquired  |  |   | 125,098
|Current liabilities    |  |   | 7,078  
|                       |  |   |        
|Net assets acquired    |  | $ | 118,020
|                       |  |   |        



The following table
summarizes the estimated fair values of the assets we acquired and liabilities we assumed in connection with our acquisition of South University (in thousands):



|                       |  |   |       
|---------------------- |  | - | ------
|Current assets         |  | $ | 9,004 
|Property and equipment |  |   | 3,340 
|Intangible assets      |  |   | 2,820 
|Goodwill               |  |   | 40,010
|                       |  |   |       
|Total assets acquired  |  |   | 55,174
|Current liabilities    |  |   | 8,155 
|                       |  |   |       
|Net assets acquired    |  | $ | 47,019
|                       |  |   |       



27



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The following table presents the intangible assets with finite lives we acquired with the purchase of AEC
(dollars in thousands):



|                                   |  |        |       |                            |  
|---------------------------------- |  | ------ | ----- | -------------------------- | -
|                                   |  | Amount |       | AmortizationPeriod (years)
|Curriculum                         |  | $      | 410   |                            | 6
|Accreditation                      |  |        | 332   |                            | 6
|Title IV                           |  |        | 160   |                            | 6
|Student contracts and applications |  |        | 3,600 |                            | 2
|                                   |  |        |       |                            |  
|Total                              |  | $      | 4,502 |                            |  
|                                   |  |        |       |                            |  



The following table
presents the intangible assets with finite lives we acquired with the purchase of South (dollars in thousands):



|                                   |  |        |       |                            |   
|---------------------------------- |  | ------ | ----- | -------------------------- | --
|                                   |  | Amount |       | AmortizationPeriod (years)
|Curriculum                         |  | $      | 1,700 |                            | 16
|Accreditation                      |  |        | 190   |                            | 16
|Title IV                           |  |        | 160   |                            | 16
|Student contracts and applications |  |        | 770   |                            | 3 
|                                   |  |        |       |                            |   
|Total                              |  | $      | 2,820 |                            |   
|                                   |  |        |       |                            |   



On November 8, 2002,
we acquired all of the outstanding stock of Infocast Digital Arts Inc., which operated IDA Institute of Digital Arts in Richmond, British Columbia, Canada, for approximately $1.0 million in cash. This school was renamed The Art Institute of
Vancouver.



On October 15, 2002, we purchased assets and
assumed certain liabilities of California Design College, located in Los Angeles, California, for approximately $15.0 million in cash.



On October 3, 2002, we acquired all of the outstanding stock of the Center for Digital Imaging and Sound (CDIS) in Burnaby, British Columbia,
Canada for approximately $9.9 million in cash. This school was renamed The Art Institute of Vancouver-Burnaby.



We acquired Infocast Digital Arts, California Design College and CDIS as part of our strategy to enter new geographic areas we believe are attractive
based on a number of factors and to solidify our presence in growing markets.



These acquisitions were accounted for as purchases in accordance with Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations. The results of operations for each of
the acquired entities have been consolidated as of the respective closing date. The fair value for the material acquisitions described above has been determined by an independent appraisal by a third party. Any excess purchase price over the fair
market value of the net assets acquired is recorded as goodwill and other intangible assets included in assets acquired. Note 1 to the consolidated financial statements provides additional information related to our acquisitions.



Start-up schools and smaller acquisitions are expected to incur operating
losses during the first two to three years following their opening or purchase. The combined operating losses of these newer schools were approximately $11.8 million and $5.2 million in fiscal 2004 and 2003, respectively. We expect to open up to
five new start-up campuses during fiscal 2005.



28



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Results of Operations



Net revenues increased 33.3% to $853.0 million in fiscal 2004 from $640.0 million in fiscal 2003. Income before interest and
taxes increased 43.4% to $133.0 million in fiscal 2004 from $92.7 million in fiscal 2003. Net income increased by 36.8% to $77.0 million in fiscal 2004 from $56.3 million in fiscal 2003. Acquisitions contributed approximately $91.0 million and $27.3
million, respectively, to our revenue growth and pre-tax income during 2004.



Other than the acquisitions, the increase in average quarterly enrollment was primarily due to new education programs and additional school locations, along with expanded bachelors degree offerings and online
educational programs.



Our largest source of revenue is tuition
collected from our students which is presented after deducting refunds, scholarships and other adjustments. We recognize revenue on a pro rata basis over the term of instruction or occupancy. Net revenues consist of tuition and fees, student housing
fees, bookstore sales, restaurant sales in connection with culinary programs, workshop fees and sales of related study materials. Tuition revenue generally varies based on the average tuition charge per credit hour, type of program, specific
curriculum and the average student population. Bookstore and housing revenue is largely a function of the average student population at our Art Institutes. The average student population is influenced by the number of continuing students attending
school at the beginning of a period and by the number of new students entering school during such period. We believe that the size of our student population at our campuses is influenced by the number of graduating high school students, the
attractiveness of our program offerings, the effectiveness of our marketing efforts, changes in technology, the persistence of our students, the length of the education programs, our overall educational reputation and general economic conditions.
The introduction of additional program offerings at existing schools and the establishment of new schools (through acquisition or start-up) are important factors influencing our average student population.



Tuition increases have been implemented in varying amounts in each of the
past several years. Historically, we have been able to pass along cost increases through increases in tuition. Average tuition rates for schools owned for more than one year increased by approximately 6% during both fiscal 2004 and fiscal 2003.
Tuition rates vary by geographic region, but are generally consistent from program to program at the respective schools.



The majority of our students rely on funds received under various government-sponsored student financial aid programs, especially Title IV Programs, to
pay a substantial portion of their tuition and other education-related expenses. For the years ended June 30, 2004, 2003 and 2002 approximately 73%, 68% and 65%, respectively, of our net revenues were indirectly derived from Title IV
Programs.



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Educational services expense consists primarily of costs related to the development, delivery and
administration of our education programs. Major cost components are faculty compensation, administrative salaries, costs of educational materials, facility occupancy costs, information systems costs, bad debt expense and depreciation and
amortization of property and equipment.



General and
administrative expense consists of marketing and student admissions expenses and certain central staff departmental costs such as executive management, finance and accounting, legal, corporate development and other departments that do not provide
direct services to our students. We have centralized many of these services to gain consistency in management reporting, efficiency in administrative effort and cost control.



Depreciation is recognized using the straight-line method over the useful lives or lease terms of the related assets for
financial reporting purposes and accelerated methods for income tax reporting purposes. Amortization of intangibles relates to the values assigned to identifiable intangible assets and write-offs and impairment of goodwill and other intangible
assets. These intangible assets arose principally from the acquisitions of schools.



The following table sets forth for the periods indicated the percentage relationship of certain statements of income items to net revenues.



|                                  |  |                     |   |  |       |   |  |       |  
|--------------------------------- |  | ------------------- | - |  | ----- | - |  | ----- | -
|                                  |  | Year ended June 30, |  
|                                  |  | 2004                |   |  | 2003  |   |  | 2002  |  
|Net revenues                      |  | 100.0               | % |  | 100.0 | % |  | 100.0 | %
|Costs and expenses:               |  |                     |   |  |       |   |  |       |  
|Educational services              |  | 64.0                |   |  | 65.2  |   |  | 64.9  |  
|General and administrative        |  | 19.6                |   |  | 19.6  |   |  | 20.5  |  
|Amortization of intangible assets |  | 0.8                 |   |  | 0.7   |   |  | 0.8   |  
|                                  |  |                     |   |  |       |   |  |       |  
|                                  |  | 84.4                |   |  | 85.5  |   |  | 86.2  |  
|                                  |  |                     |   |  |       |   |  |       |  
|                                  |  |                     |  
|Income before interest and taxes  |  | 15.6                |   |  | 14.5  |   |  | 13.8  |  
|Interest expense, net             |  | 0.3                 |   |  | 0.2   |   |  | 0.3   |  
|                                  |  |                     |   |  |       |   |  |       |  
|Income before income taxes        |  | 15.3                |   |  | 14.3  |   |  | 13.5  |  
|Provision for income taxes        |  | 6.3                 |   |  | 5.5   |   |  | 5.0   |  
|                                  |  |                     |   |  |       |   |  |       |  
|Net income                        |  | 9.0                 | % |  | 8.8   | % |  | 8.5   | %
|                                  |  |                     |   |  |       |   |  |       |  



30



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Year Ended June 30, 2004 Compared with Year Ended June 30, 2003



Net Revenues



Average quarterly student enrollment was 53,724 in fiscal 2004 compared to
40,457 in fiscal 2003, an increase of 32.8%. The previously mentioned acquisitions contributed 15.6% of this growth in student population. Our net revenues increased by 33.3% to $853.0 million in fiscal 2004 from $640.0 million in fiscal 2003
primarily due to increases in student enrollment and tuition rates, as well as recent acquisitions. In addition, our tuition increased by approximately 6% over the prior year. Revenue from schools acquired during fiscal 2004 totaled $91.0 million.



Net housing revenues increased by 19.0% to $38.0 million in
fiscal 2004 compared to $31.8 million in fiscal 2003 and revenues from bookstore sales in fiscal 2004 grew by 55.1% to $32.1 million. Both increased primarily as a result of higher average student enrollment. Housing and bookstore revenue is
generated primarily through The Art Institutes.



Educational Services



Our educational
services expense increased by $128.6 million, or 30.8%, to $546.1 million in fiscal 2004 from $417.6 million in fiscal 2003, due primarily to the incremental costs incurred to support higher student enrollment. These costs include employee
compensation, rent and other facility operating costs, cost of sales, bad debt, and depreciation and amortization. Educational services expense from schools acquired during fiscal 2004 totaled $48.5 million. Overall, educational services expense as
a percentage of revenue decreased approximately 120 basis points to 64.0% in fiscal 2004 from 65.2% in fiscal 2003. This decrease is attributable primarily to leverage on our facilities and staff personnel expenses on higher enrollment levels. These
favorable items were offset, in part, by an approximately 60 basis point increase in bad debt expense as a percentage of revenue. The increase in bad debt expense as a percentage of revenue was due in part to the addition of AEC, which historically
experienced higher bad debt expense as a percentage of revenue than our other schools.



General and Administrative



General and administrative expense was $167.0 million in fiscal 2004, an increase of 33.3% from $125.3 million in fiscal 2003. The increase over the prior fiscal year primarily reflects increases in marketing and
admissions expenses, and salaries and benefits expenses including $20.0 million related to newly-acquired entities. As a percentage of net revenues, general and administrative expense was flat compared to fiscal 2003. During fiscal 2004, we
experienced favorable results due to leverage of our facilities and telecommunications expenses which was offset by higher compensation expense for general and administrative employees as compared to the prior year and increased outside accounting,
auditing and legal fees due primarily to Sarbanes-Oxley implementation and a dispute with the ABA over the provisional accreditation of Western State University Law School.



Amortization of Intangible Assets



Amortization of intangibles increased by $2.5 million, to $6.9 million, in fiscal 2004 as compared to $4.4 million in
fiscal 2003. This increase primarily resulted from $2.2 million of amortization of intangible assets with schools acquired during fiscal 2004.



Interest Expense, Net



Net interest expense was $2.5 million in fiscal 2004, as compared to $1.3 million in fiscal 2003. The increase of $1.2 million or 93.1% as compared to the
prior year is primarily a result of borrowings incurred to fund acquisitions during fiscal 2004. The average outstanding borrowings under our revolving credit facility were approximately $26.1 million in fiscal 2004 compared to $0.1 million in
fiscal 2003. The increase in average



31



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borrowings under the revolving credit facility was offset, in part, by a decrease in the average interest rate on the revolving credit facility from 2.51% in
fiscal 2003 to 2.25% in fiscal 2004. In addition, we had borrowings under a mortgage obligation of approximately $3.4 million and $3.5 million at June 30, 2004 and June 30, 2003, respectively. Net interest expense includes, among other items, the
amortization of $0.5 million in fees paid in connection with the amendment of our revised credit agreement during fiscal 2004, offset by $0.1 million in interest and dividend income.



Provision for Income Taxes



Our effective tax rate was 41.0% for fiscal 2004, as compared to 38.5% in
fiscal 2003. The change in the rate as compared to the prior year is due to an increase in the valuation allowance related to Canadian deferred tax assets and the distribution of taxable income to states with higher tax rates. In addition, no tax
benefit was recorded on losses incurred by our Canadian entities and the charge of $2.2 million was recognized in the fiscal 2004 fourth quarter to increase the valuation allowance attributable to slower than expect growth at our Canadian
schools. This reserve does not affect our ability to utilize and realize the deferred tax assets in the future.



Net Income



Net income increased by $20.7 million to $77.0 million in fiscal 2004 from $56.3 million in fiscal 2003. The increase is attributable to improved results
from operations as well as recent acquisitions, partially offset by increased amortization of intangibles expense and a higher tax provision in fiscal 2004.



Year Ended June 30, 2003 Compared with Year Ended June 30, 2002



Net Revenues



Net revenues increased by 27.9% to $640.0 million in 2003 from $500.6 million in 2002 primarily due to an increase of 24.3% in student enrollment to
40,457 from 32,545 in the prior year accompanied by tuition increases. Increases in total enrollment were influenced by the higher number of potential students, including increasing numbers of high school graduates; new locations through start-up or
acquisition; and expansion of education programs.



The average
academic year tuition increased approximately 6% in fiscal 2003 compared to fiscal 2002. Average enrollment at locations operated by us for two years or more increased 10.8% in 2003 to 31,369 compared to 28,315 in 2002. In addition to the growth at
more established locations, acquisitions during fiscal 2003 have contributed approximately $16.6 million or 3.6% to the growth in net revenues. Fiscal 2003 includes a full year of revenue for Miami International University of Art & Design and
ITI Information Technology Institute, neither of which we owned for the entire comparable prior year. Additionally, The Art Institute of Vancouver-Burnaby and California Design College were purchased in October 2002 and The Art Institute of
Vancouver was purchased in November 2002.



Net housing revenues
increased by 18.1% to $31.8 million in 2003 from $26.9 million in 2002 and revenues from bookstore sales in 2003 grew by 12.4% to $20.6 million. Both increased primarily as a result of higher average student enrollment.



We acquired Argosy on December 21, 2001 and have incorporated their results
from that date forward. Argosy does not have student housing revenue.



Overall refunds increased to $15.0 million in 2003 from $11.5 million in 2002.



Educational Services



Educational services expense increased by $92.5 million, or 28.5%, to $417.6 million in 2003 from $325.0 million in 2002. The increase was primarily due to additional costs required to service higher student



32



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enrollment, accompanied by normal cost increases for wages and other services. Additionally, on April 1, 2003, we revised the estimated useful lives of
several classes of fixed assets to more accurately reflect the current estimates on actual usage. This change in accounting estimate increased 2003 educational services expense by $3.2 million and included the write-off of the net book value of
certain fixed assets as of the start of fiscal 2003 fourth quarter. The charge related solely to changing the estimated useful lives of certain fixed asset categories. While the estimated useful lives of three classes of assets were extended, the
shortening of the lives assigned to personal computers from five years to three years more than offset the impact of the extended lives.



Educational services expenses increased by $92.5 million, or 28.5%, to $417.6 million in fiscal 2003, from $325 million in fiscal 2002. Approximately
$41.6 million of the increase in educational services expenses was attributable to schools owned by us prior to 2002 and $15.1 million was attributable to schools added in fiscal 2003 and fiscal 2002. Overall, the primary components of the increase
included salaries, rent and operating expenses as well as increased depreciation associated with recent capital expenditures and the change in useful lives.



As a percentage of net revenues, educational services expense increased approximately 31 basis points to 65.2% as compared to 64.9% in fiscal 2002. This
increase reflects the increased investment in schools, including expenses such as deprecation, facility costs and instructional salaries, offset by improvement in bad debt expense.



General and Administrative



General and administrative expense increased by $22.8 million or 22.3%, to $125.3 million in 2003 from $102.5 million in
2002 primarily due to incremental marketing and student admissions expenses incurred to generate higher student enrollment at the schools. As a percentage of revenue, general and administrative expense improved as a result of increased leverage on
certain fixed costs as well as marketing and admissions expense and corporate costs increasing at a lesser rate than net revenue.



Amortization of Intangible Assets



Amortization of intangibles increased by approximately $0.3 million to $4.4 million in 2003 due to the incremental amortization associated with
intangibles purchased, along with amortization of ongoing curriculum. This increase was partially offset by several intangible assets that had been amortized in 2002 becoming fully amortized in 2003. Additionally, during fiscal 2002 a goodwill
impairment charge of approximately $1.2 million was included with the amortization of intangible assets in connection with the planned closures of NCPT and of the Halifax, Nova Scotia location of ITI Information Technology Institute.



Interest Expense, Net



We had net interest expense of $1.3 million in 2003 as compared to $1.6
million in 2002. Our outstanding borrowings were reduced significantly at the end of the second quarter of fiscal 2002 due to proceeds received in a public offering of our Common Stock (the Offering). The average outstanding borrowings
under the revolving credit facility were approximately $0.1 million in fiscal 2003, down from $10.0 million in fiscal 2002. The average borrowing rate decreased approximately 200 basis points, from 4.45% in fiscal 2002 to 2.51% in fiscal 2003. In
addition, we had borrowings under a mortgage obligation. Net interest expense includes, among other items, the amortization of fees paid in connection with amendment of our credit agreement (the Credit Agreement) during fiscal 2002.



Provision for Income Taxes



Our effective tax rate was 38.5% in 2003, compared to 37.2% in 2002. The
income tax provision for 2002 was reduced by approximately $0.8 million resulting from a one-time tax credit for the rehabilitation of the building occupied by The Art Institute of Pittsburgh. The effective rates differed from the combined federal
and state statutory rates due to the net impact of goodwill and non-deductible expenses. At June 30, 2003, we had



33



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state and foreign net operating loss carryforwards of $45.9 million and $11.2 million, respectively. A valuation allowance has been applied against $8.5
million of the foreign net operating loss carryforward. These expire at various dates beginning in fiscal 2007 through 2023.



Net Income



Net income increased by $14.0 million or 33.0% to $56.3 million in 2003, from $42.3 million in 2002. The increase resulted from improved operations at our
schools, especially improved profitability at newer schools, the full-year impact of the Argosy acquisition, and reduced interest expense, all of which were partially offset by a higher effective tax rate.



Quarterly Financial Results (unaudited)



We have experienced seasonality in our results of operations primarily due
to the pattern of student enrollment. Historically, our lowest quarterly revenues and income have been in the first quarter (July to September) of our fiscal year due to fewer students being enrolled during the summer months and expenses incurred in
preparation for the peak enrollment in the fall quarter (October to December). We expect that this seasonal trend will continue.



The following table sets forth our quarterly results for fiscal 2004 and 2003:



|                                        |  |                                               |         |                |   |                  |  |                  |         |  |   |        
|--------------------------------------- |  | --------------------------------------------- | ------- | -------------- | - | ---------------- |  | ---------------- | ------- |  | - | -------
|                                        |  | Quarter ended                                
|                                        |  | Sept. 30 (Summer)                             |         | Dec. 31 (Fall) |   | Mar. 31 (Winter) |  | June 30 (Spring)
|                                        |  | (dollars in thousands, except per share data)
|Fiscal 2004                             |  |                                               |         |                |   |                  |  |                  |         |  |   |        
|Net revenues                            |  | $                                             | 168,976 |                | $ | 232,980          |  | $                | 235,150 |  | $ | 215,913
|Income before interest and income taxes |  |                                               | 8,069   |                |   | 54,468           |  |                  | 44,668  |  |   | 25,781 
|Income before income taxes              |  |                                               | 7,379   |                |   | 53,648           |  |                  | 44,085  |  |   | 25,399 
|Net income                              |  |                                               | 4,501   |                |   | 32,157           |  |                  | 25,447  |  |   | 14,909 
|Earnings per share                      |  |                                               |         |                |   |                  |  |                  |         |  |   |        
|Basic                                  |  |                                               | 0.06    |                |   | 0.44             |  |                  | 0.35    |  |   | 0.21   
|Diluted                                |  |                                               | 0.06    |                |   | 0.43             |  |                  | 0.34    |  |   | 0.20   
|Fiscal 2003                             |  |                                               |         |                |   |                  |  |                  |         |  |   |        
|Net revenues                            |  | $                                             | 128,143 |                | $ | 175,136          |  | $                | 173,691 |  | $ | 163,057
|Income before interest and income taxes |  |                                               | 4,888   |                |   | 41,966           |  |                  | 30,214  |  |   | 15,665 
|Income before income taxes              |  |                                               | 4,578   |                |   | 41,634           |  |                  | 29,875  |  |   | 15,364 
|Net income                              |  |                                               | 2,838   |                |   | 25,811           |  |                  | 18,521  |  |   | 9,107  
|Earnings per share                      |  |                                               |         |                |   |                  |  |                  |         |  |   |        
|Basic                                  |  |                                               | 0.04    |                |   | 0.37             |  |                  | 0.26    |  |   | 0.13   
|Diluted                                |  |                                               | 0.04    |                |   | 0.35             |  |                  | 0.25    |  |   | 0.12   



Our Board of Directors
declared a stock split effected in the form of a stock dividend, payable at the rate of one share of Common Stock for each outstanding share as of the close of business on December 1, 2003. The shares issued for the stock split were distributed on
December 22, 2003. The share information for all periods presented have been adjusted to reflect the stock split.



During the fourth quarter of fiscal 2004 we recorded a $1.6 million adjustment to employee benefit expense for lower than expected heath insurance claims
for fiscal 2004 and a reserve of $2.2 million to increase the valuation allowance related to our Canadian net deferred tax assets. The estimated of the incurred but not reported claims used during prior fiscal quarters was found to be higher than
the amounts determined at the end of fiscal 2004, leading to adjustment.



34



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On April 1, 2003, we revised the estimated useful lives of several classes of fixed assets to more
accurately reflect the current estimates on actual usage. This change in accounting estimate increased 2003 educational services expense by $3.2 million. This charge related solely to changing the estimated useful lives of certain fixed asset
categories. While the estimated useful lives of three classes of assets were extended, the shortening of the lives assigned to personal computers from five to three years more than offset the impact of the extended lives.



Earnings per share amounts for each quarter are required to be calculated
independently and therefore may not total to the amount calculated for the year.



Liquidity and Capital Resources



In fiscal
2004, cash generated from operations of $163.3 million, proceeds from both the net increase in debt of $90.1 million and the issuance of common stock of $12.0 million were used primarily to fund the cash component of acquisitions of $157.8 million
and to invest $80.7 million in property and equipment.



We had
$116.7 million of cash (unrestricted) on hand at June 30, 2004. The increase of $27.8 million over the prior years cash balance primarily represents the impact of acquisitions described above and the timing of income tax installment payments.



Our current liabilities exceeded current assets by $76.5
million at June 30, 2004, as compared to working capital of $20.8 million and $0.4 million at June 30, 2003 and June 30, 2002 respectively. This change was primarily a result of the increase in borrowings under both the revolving credit facility and
note payable issued in connection with the acquisition of AEC. Net trade receivables increased by $11.7 million from $33.8 million at June 30, 2003 to $45.5 million at June 30, 2004. The increase in net trade receivables relates primarily to higher
student enrollment and the corresponding revenue increases. The days sales outstanding in accounts receivable (DSO) and other receivables decreased approximately 1 day to 21 days at June 30, 2004 as compared to last year. We calculate DSO by
dividing net receivables by average revenue for the preceding quarter. Quarterly average revenue is determined by taking the total revenue for a quarter and dividing by the daily number of days in a quarter.



Cash flow from operations was $163.3 million, $79.4 million and $100.4
million in fiscal 2004, 2003 and 2002, respectively. The increase in cash flow from operations over the prior year was due to the increase in net income and the timing of receipt of student loan proceeds in fiscal 2003. Federal regulations provide
for transfer of student loan proceeds only within 10 days before the start of classes. The timing of the start of the summer academic quarter for the Art Institutes in fiscal 2002 allowed for receipt of the loan proceeds for the summer quarter in
June of fiscal 2002. For the comparable academic quarter for 2003 and 2004, the funds were received in July of the respective fiscal year.



The accompanying Consolidated Balance Sheet and Consolidated Statement of Cash Flows include two changes from amounts presented in our August 3, 2004
earnings release. Cash flows from operations are approximately $2.7 million higher and shareholders investment (accumulated other comprehensive income) is approximately $1.9 million lower than reported in our earnings release. These changes do
not impact our Consolidated Statement of Income. The change to the Balance Sheet reflects an adjustment between accumulated other comprehensive income and deferred income tax liability related to the additional valuation allowance recorded to fully
reserve the foreign operating loss carryforwards for our Canadian schools. The Cash Flow Statement revision is a result of the reclassification referred to above and the presentation of stock-based compensation as a non-cash adjustment to net income
within operating activities. This amount was included with cash flow from financing activities when calculating the cash flow from operating activities disclosed in the earnings release.



Capital expenditures were $80.7 million, or 9.5% of revenue for fiscal 2004, compared to $80.8 million, or 12.6% of revenue,
in fiscal 2003. The reduction in capital expenditures as a percentage of revenue is due in part to our focus on improving our capital efficiency and the effect of our acquisitions of AEC, which has less intensive capital requirements than our other
educational systems.



The 2004 expenditures relate to the
investment in schools acquired or started during the previous several years and schools to be added in 2005, continued expansion and improvements to current facilities, additional or



35



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replacement school and housing facilities, and classroom and administrative technology. We expect fiscal 2005 capital expenditures to be approximately $95
million.



We amended and restated our revolving credit facility
(Credit Agreement) effective August 18, 2003 to increase allowable borrowings from $150 million to $250 million. The Credit Agreement, which now expires August 18, 2008, contains customary covenants that, among other matters, require us
to meet specified financial ratios, restrict the repurchase of Common Stock and limit the incurrence of additional indebtedness. Outstanding letters of credit reduce the availability of borrowings under the revolving credit facility. At June 30,
2004, we had borrowings of $125.1 million under this facility and were in compliance with all covenants under the agreement. We repaid all borrowings outstanding at June 30, 2004 in July 2004.



Borrowings under the Credit Agreement are available to us to finance
acquisitions and fund seasonal working capital needs resulting from the seasonal pattern of cash receipts throughout the year. The level of accounts receivable reaches a peak immediately after the billing of tuition and fees at the beginning of each
academic quarter. Collection of these receivables is heaviest at the start of each academic quarter. Additionally, federal financial aid proceeds for continuing students can be received up to ten days prior to the start of an academic quarter.



Our primary source of cash is tuition collected from our
students. We finance our operating activities primarily from cash generated from operations; acquisitions are primarily financed through cash generated from operations as well as credit facility borrowings. We believe that cash flow from operations,
supplemented from time to time by borrowings under the Credit Agreement, will provide adequate funds for ongoing operations, planned expansion to new locations, planned capital expenditures and debt service during the next twelve months. Borrowings
under the Credit Agreement may be used by us primarily to fund acquisitions and working capital needs resulting from the seasonal pattern of cash receipts throughout the year.



We lease the majority of our facilities. We anticipate that future commitments on existing leases will be paid from cash
provided from operating activities.



We guarantee a significant
portion of real estate lease obligations for our subsidiaries, including a mortgage on the building that the Western State University College of Law occupies, which had an outstanding balance of $3.4 million at June 30, 2004. We would be required to
perform under these guarantees if the subsidiary could not satisfy the obligations.



The following table describes our commitments at June 30, 2004 under various contracts and agreements (in thousands):



|                             |  |                       |         |                        |           |        |           |   |                 |  |   |         |  |   |        
|---------------------------- |  | --------------------- | ------- | ---------------------- | --------- | ------ | --------- | - | --------------- |  | - | ------- |  | - | -------
|                             |  | Totalamountscommitted |         | Payments due by period
|                             |  |                       | 2005    |                        | 2006-2007 |        | 2008-2009 |   | 2010-Thereafter
|Line of credit borrowings(1) |  | $                     | 125,100 |                        | $         |       |           | $ |                |  | $ |        |  | $ |       
|Standby letters of credit(2) |  |                       | 3,928   |                        |           |       |           |   |                |  |   |        |  |   |       
|Mortgage obligation          |  |                       | 3,442   |                        |           | 20     |           |   | 3,422           |  |   |        |  |   |       
|Note payable(3)              |  |                       | 11,000  |                        |           | 11,000 |           |   |                |  |   |        |  |   |       
|Operating leases             |  |                       | 493,104 |                        |           | 78,264 |           |   | 126,983         |  |   | 107,408 |  |   | 180,449
|Other                        |  |                       | 40      |                        |           | 40     |           |   |                |  |   |        |  |   |       
|                             |  |                       |         |                        |           |        |           |   |                 |  |   |         |  |   |        
|Total commitments            |  | $                     | 636,614 |                        | $         | 89,324 |           | $ | 130,405         |  | $ | 107,408 |  | $ | 180,449

---

|(1) |  | These borrowings were repaid in early July 2004. Under the terms of our Credit Agreement, all outstanding borrowings become due at expiration of the facility in fiscal 2009.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | We do not anticipate these letters of credit will be drawn on.
|--- |  | --------------------------------------------------------------

|(3) |  | Amount paid on September 2, 2004.
|--- |  | ---------------------------------



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Contingencies



On December 11, 2003, the ABA Council of the Section of Legal Education and Admission to the Bar notified Western State
University (WSU) that the Council had adopted a motion to withdraw provisional approval and that the matter would be submitted to the ABA House of Delegates at its meeting in February 2004. On January 16, 2004, WSU and two WSU students
filed a lawsuit against the ABA in the United States District Court for the Central District of California seeking a preliminary injunction preventing the ABA from reviewing the Councils decision to withdraw provisional approval. WSU and the
ABA subsequently reached an agreement pursuant to which WSU voluntarily relinquished ABA approval as of August 8, 2004. In accordance with the terms of the settlement agreement, WSU filed a new application for provisional approval by the ABA on
August 23, 2004. Under the terms of the settlement agreement, the ABA will perform a site inspection in the fall of 2004. Following the site visit, the inspection team will issue an inspection report which will be most likely be acted upon by the
Accreditation Committee of the Section on Legal Education and Admission to the Bar in January 2005 and by the Council and the House of Delegates in February 2005. WSU continues to be eligible to participate in federal financial aid programs based on
a separate accreditation by the Senior Commission of the Western Association of Schools and Colleges. WSU is also accredited by the Committee of Bar Examiners of the State Bar of California.



Regulations



We indirectly derived approximately 73%, 68% and 65% of our net revenues from Title IV Programs in 2004, 2003 and 2002,
respectively. U.S. Department of Education regulations prescribe the timing of disbursements of funds under Title IV Programs. Students must apply for a new loan for each academic year. Lenders generally provide loan funds in multiple disbursements
each academic year. For first-time students in their first academic quarter, the initial loan disbursement is generally received at least 30 days after the commencement of that academic quarter. Otherwise, the first loan disbursement is received, at
the earliest, ten days before the commencement of the students academic quarter.



U.S. Department of Education regulations require Title IV Program funds received by our schools in excess of the tuition and fees owed by the relevant students at that time to be, with these students permission,
maintained and classified as restricted funds until they are billed for the portion of their education program related to those funds. Funds transferred through electronic funds transfer programs are held in a separate cash account and released when
certain conditions are satisfied. These restrictions have not significantly affected our ability to fund daily operations.



Education institutions participating in Title IV Programs must satisfy a series of specific standards of financial responsibility. The U.S. Department of
Education has adopted standards to determine an institutions financial responsibility to participate in Title IV Programs. The regulations establish three ratios: (i) the equity ratio, intended to measure an institutions capital
resources, ability to borrow and financial viability; (ii) the primary reserve ratio, intended to measure an institutions ability to support current operations from expendable resources; and (iii) the net income ratio, intended to measure an
institutions profitability. Each ratio is calculated separately, based on the figures in the institutions most recent annual audited financial statements, and then weighted and combined to arrive at a single composite score. Such
composite score must be at least 1.5 for the institution to be deemed financially responsible without conditions or additional oversight.



Regulations promulgated under the HEA also require all proprietary education institutions to comply with the 90/10 Rule, which prohibits participating
schools from deriving 90% or more of total revenue from Title IV Programs in any year.



If an institution fails to meet any of these requirements, it may be deemed to be not financially responsible by the U.S. Department of Education, or otherwise ineligible to participate in Title IV Programs. We
believe that all of our participating schools met these requirements as of June 30, 2004.



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Critical Accounting Policies



In preparing our financial statements in conformity with accounting principles generally accepted in the United States,
judgments and estimates are made about the amounts reflected in the consolidated financial statements. As part of the financial reporting process, our management collaborates to determine the necessary information on which to base judgments and
develop estimates used to prepare the consolidated financial statements. Historical experience and available information are used to make these judgments and estimates. However, different amounts could be reported using different assumptions and in
light of different facts and circumstances. Therefore, actual amounts could differ from the estimates reflected in the consolidated financial statements.



Our management makes judgments and estimates on an ongoing basis that include, but are not limited to, revenue recognition, allowance for doubtful
accounts, valuations of goodwill and indefinite-lived intangible assets, valuations of acquired finite-lived intangible assets and loss contingencies. Further description of how these estimates are developed is provided below.



We believe that the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of the consolidated financial statements:



Revenue Recognition and Receivables



Our net revenues consist of tuition and fees, student housing fees, bookstore sales, restaurant sales in connection with culinary programs, workshop fees
and sales of related study materials. Tuition revenue generally varies based on the average tuition charge per credit hour, type of program, specific curriculum and the average student population. Bookstore and housing revenue is largely a function
of the average student population at our Art Institutes. Advance payments represent that portion of payments received but not earned and are reflected as a current liability in the accompanying consolidated balance sheets. These payments are
typically related to future academic periods and are for the most part, refundable.



We bill tuition and housing revenues at the beginning of an academic term and recognize the revenue on a pro rata basis over the term of instruction or occupancy. For most of our programs, the academic and fiscal
quarters are the same; therefore, unearned revenue is not significant at the end of a fiscal quarter. However, Argosy University and South University have educational programs with programs starting and ending dates that differ from our fiscal
quarters. Therefore, at the end of the fiscal quarter, we have revenue from these programs that has not yet been earned in accordance with the Securities and Exchange Commissions Staff Accounting Bulletin No. 104, Revenue Recognition in
Financial Statements.



Refunds are calculated and paid in
accordance with federal, state and accrediting agency standards.



The trade receivable balances are comprised of individually insignificant amounts due primarily from students throughout the United States and Canada. We determine our allowance for doubtful accounts for most locations primarily by
categorizing gross receivables based upon the enrollment status (in-school student vs. out-of-school student) of the student and establishing a reserve based on the likelihood of collection, which is based upon historical experience. Student
accounts are monitored through an aging process whereby past due accounts are pursued. When certain criteria are met (primarily aging past the due date by approximately three or four months) and internal collection measures have been taken without
success, the account is placed with an outside collection agency. Student accounts in collection are fully reserved and evaluated on a case-by-case basis before being written off. If current collection trends differ significantly from historic
collections, an adjustment would be required to our allowance. Historically, however, the allowance has been within our estimate of uncollectible accounts.



Use of Estimates



Generally accepted accounting principles in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and



38



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liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could
differ from these estimates.



Long-Lived Assets



We evaluate the recoverability of property, plant and
equipment and intangible assets other than goodwill whenever events or changes in circumstances indicate the carrying amount of any such assets may not be fully recoverable in accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. Changes in circumstances include economic conditions or operating performance. If such a circumstance existed, we would perform additional analysis based upon assumptions about the estimated future undiscounted
cash flows associated with the asset. If the projected undiscounted future cash flows are less than the carrying value, we would determine the fair value of the asset based upon a discounted cash flow model. If the discounted cash flows are less
than the carrying value of the asset, an impairment loss is recognized. We continually apply our judgment when performing these evaluations to determine the timing of the testing, the undiscounted cash flows used to assess recoverability and the
fair value of the asset. Key to this process is the identification of indicators of impairment and accurately estimating cash flows. The failure to identify an indicator or inaccurate cash flow estimates could result in unrecognized impairments. To
date, we believe our processes of identifying and estimating have produced timely and accurate recognition of impairments.



We evaluate the recoverability of the goodwill attributable to each reporting unit as required under Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets (SFAS No. 142), by comparing the fair value of each reporting unit with its carrying value. Individual campus components have been aggregated to form three distinct operating
divisions by geographic location within North America. These divisions are the Eastern, Central and Western divisions and are considered reporting units. The evaluation is performed at least annually and when potential impairment indicators exist as
required by SFAS No. 142. We continually apply our judgment when performing these evaluations to determine the financial projections used to assess the fair value of each reporting unit. The fair market value of the reporting units is estimated by
applying multiples to earnings before interest, tax and depreciation. To validate the multiples used, management compares the multiples to recent identified transactions where business similar to ours were sold.



Income Taxes



We account for income taxes in accordance with Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109), which requires the use of the asset and liability method.



Under this method, deferred tax assets and liabilities result from (i) temporary differences in the recognition of income and expense for financial and
federal income tax reporting requirements, and (ii) differences between the recorded value of assets acquired in business combinations accounted for as purchases for financial reporting purposes and their corresponding tax basis.



At June 30, 2004, we had net state operating loss carryforwards of
approximately $45.1 million. These carryforwards expire at varying dates beginning in fiscal 2009 through 2024. We have recorded approximately $2.8 million in deferred tax assets related to these state carryforwards. No valuation allowance has been
established against the state deferred tax assets, as we believe that these tax benefits will be realizable through tax carryforward availability and our demonstrated ability to produce taxable income.



At June 30, 2004, we had Canadian net operating loss carryforwards of
approximately $18.2 million and we had $6.3 million in deferred tax assets related to our Canadian entities. We have established a valuation allowance equal to 100% of our Canadian deferred tax assets due to concerns related to the future use of the
assets. None of these foreign carryforwards have expired and we have approximately three years before they begin to expire. We evaluate on a quarterly basis whether, based on all available evidence, the deferred income



39



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tax assets are realizable. During the fiscal year ended June 30, 2004, we increased the valuation allowance by approximately $2.2 million through a non-cash
charge to the income tax provision. The recording of allowances against deferred tax assets does not affect our ability to utilize and realize the deferred tax assets in the future.



Recently Issued Accounting Standards



We adopted FASB Interpretation No. 46R (FIN 46), Consolidation of Variable Interest Entities, for
the quarter ended March 31, 2004. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, relating to consolidation of certain entities. FIN 46 requires identification of our
participation in variable interest entities (VIE), which are identified as entities with a level of invested equity that is not sufficient to fund future activities to permit them to operate on a standalone basis, or whose equity holders
lack certain characteristics of a controlling financial interest. For entities identified as VIE, FIN 46 sets forth a model to evaluate potential consolidation based on an assessment of which party to the VIE, if any, bears a majority of the
exposure to its expected losses, or stands to gain from a majority of its expected returns. FIN 46 also sets forth certain disclosures regarding interests in VIE that are deemed significant, even if consolidation is not required. The adoption of FIN
46 did not have any impact on our consolidated financial statements.



Effect
of Inflation



We do not believe our operations have been
materially affected by inflation.



Risks Related to Our Business



The following risks, uncertainties, and other factors
could have a material adverse affect on our business, financial condition, operating results, and growth prospects.



Failure to Comply with Extensive and Changing Regulations and Laws Could Have a Material Adverse Effect on our Business



Failure of our schools to comply with extensive regulations could
result in financial penalties, restrictions on our operations, or loss of external financial aid funding for our students.



Approximately 65% of our revenues are derived from federal student financial aid programs overseen by the U.S. Department of Education and various
agencies. For these programs to be available to our students, our schools must obtain and maintain approvals from state agencies, accrediting agencies recognized by the U.S. Department of Education, loan guarantee agencies and certification by the
U.S. Department of Education. As a result, our schools are subject to extensive regulation and review by these agencies which cover virtually all phases of our operations. These regulations also affect our ability to acquire or open additional
schools, add new educational programs, or change our corporate structure. The agencies that regulate our operations periodically revise their requirements and modify their interpretations of existing requirements.



If one of our schools were to violate any of these regulatory requirements,
we could suffer financial penalty, limitations on our operating activities or termination of the schools ability to grant degrees and certificates or the schools eligibility to receive federal student financial aid funds on behalf of its
students. A significant portion of our students rely on federal student financial aid funds to finance their education. We cannot predict with certainty how all of these requirements will be applied or interpreted by the regulatory body, or whether
each of our schools will be able to comply with all of the requirements in the future.



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Congress may change the law or reduce funding for federal student financial aid programs, which
could harm our student population and revenue.



Political and budgetary concerns can significantly affect the Title IV Programs and other laws governing the federal student financial aid programs. Congress must reauthorize the HEA, which provides for federal student financial aid
programs, approximately every six years and annually determines the funding level for each of these programs. The next reauthorization of the HEA is expected to take place in 2005 or 2006, which may result in numerous legislative changes. Any action
by Congress that significantly reduces funding for the federal student financial aid programs or the ability of our schools or students to participate in these programs would have a material adverse effect on our student population and revenue.
Legislative action may also increase our administrative costs and require us to modify our practices in order for our schools to comply fully with applicable requirements.



If we do not meet specific financial responsibility ratios and tests established by the DOE our schools may lose
eligibility to participate in federal student financial aid programs.



To participate in the federal student financial aid programs, an institution must either satisfy quantitative standards of financial responsibility, or post a letter of credit in favor of the U.S. Department of
Education and possibly accept other conditions on its participation in the federal student financial aid programs. Currently, none of our schools is required to post a letter of credit in favor of the U.S. Department of Education or accept other
conditions on its participation in the federal student financial aid programs due to failure to satisfy the numeric measures of financial responsibility. However, the U.S. Department of Education will periodically provide clarification of the
calculation, which could adversely effect our compliance with the required ratios. If we or our institutions fail to satisfy the numeric standards in the future, any required letter of credit, if obtainable, and any limitations on our participation
in the federal student financial aid programs could adversely affect our net income and student population. Our inability to obtain a required letter of credit could also adversely affect our net income and student population.



An institution may lose its eligibility to participate in some or all of the
federal student financial aid programs if defaults by its students on their federal student loans exceed specified rates. Additionally, a school is ineligible to participate in the federal student financial aid programs if it derives more than 90%
of its revenue from these programs in any fiscal year. Though we believe all our schools do not exceed the specified rates for student default as of June 30, 2004 or percentage of revenue limitation test, loss of eligibility to participate in the
federal student financial aid programs by one of our schools could have a material adverse effect on our student population and revenue.



If regulators do not approve transactions involving a change of control or change in our corporate structure, we may lose our ability to participate
in federal student financial aid programs.



If we
experience a change of control under the standards of applicable state agencies, accrediting agencies or the U.S. Department of Education, we or the schools governed by such agencies must seek the approval of the relevant agencies. The failure of
any of our schools to reestablish its state authorization, accreditation or U.S. Department of Education certification would result in a suspension or loss of federal student financial aid funding, which could have a material adverse effect on our
student population and revenue.



The U.S. Department of
Education, state agencies, or accrediting agencies may consider other transactions or events to constitute a change of control. If the U.S. Department of Education or any other regulatory agencies interpreted a particular sequence of events to
constitute a change of control, we would be required to seek all necessary approvals to continue our participation in the federal student financial aid programs, and could at least temporarily lose access to financial aid funding on that basis. Some
of these transactions or events, such as a significant acquisition of our common stock by someone not familiar with these rules, may be beyond our control.



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If our schools do not maintain their state authorizations and accreditations, they may not operate
or participate in federal student financial aid programs.



A school that grants degrees, diplomas, or certificates must be authorized by the relevant agencies of the state in which it is located and, in some cases, other states where the school is deemed to be operating. State authorization and
accreditation by an accrediting agency recognized by the DOE also are required for an institution to participate in the federal student financial aid programs. The failure by one or more of our schools to maintain their state authorizations and
accreditations could have a material adverse effect on our business.



Government and regulatory agencies may conduct compliance reviews, bring claims or initiate litigation against us.



The post-secondary education industry is highly regulated. From time to time we may be subject to investigations, claims of non-compliance, or lawsuits by
governmental agencies or third parties, which may allege statutory violations, regulatory infractions, or common law causes of action. If the results of the investigations are unfavorable to us or if we are unable to successfully defend against
third-party lawsuits, we may be required to pay material monetary damages or be subject to material fines, penalties, injunctions or other censure that could materially and adversely affect on business. Even if we adequately address the issues
raised by an agency investigation or successfully defend a third-party lawsuit, we may have to devote significant money and management resources to address these issues, which could harm our business.



Loss of State Grants could negatively impact our revenues from students



State grants received by our students represented
approximately 3% of our revenue from our U.S. schools in fiscal 2004. Certain states in which we are operating are experiencing budgetary constraints which may lead to the state eliminating or significantly decreasing the amount of state aid to
students at our schools. The loss of access to these state grants by our students could have a material adverse effect to our business due to enrollment losses at our schools.



Failure to comply with extensive Canadian regulations could affect the ability of our schools in Canada to participate
in Canadian financial aid programs.



Our schools
located in British Columbia and Ontario derive a significant percentage of their revenue from Canadian governmental financial programs. These schools must meet eligibility standards to administer these programs and must comply with extensive
statutes, rules, regulations and requirements. If our Canadian schools cannot meet these and other eligibility standards or fail to comply with applicable requirements, it could have a material adverse effect on our business and results of
operations.



Additionally, the Canadian and various provincial
governments continuously review the legislative, regulatory and other requirements relating to student financial assistance programs due to political and budgetary pressures. Although we do not currently anticipate a significant reduction in the
funding for these programs, any change that significantly reduces funding or the ability of our schools to participate in these programs could have a material adverse effect on our business and results of operation.



Risks Specific to our Business Could Have a Material Adverse Effect on Us



Failure to keep pace with changing market needs and
technology could harm our student population.



The
success of our schools depends to a large extent on the willingness of prospective employers to employ our students upon graduation. Our schools must keep current with changing technological needs and skills demanded by prospective employers. If we
fail to respond to changes in industry requirements by offering new programs to our students or investing in new technology, it could have a material adverse effect on our ability to attract students.



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Opening additional new schools and growing our online student programs could be difficult for us.



We anticipate continuing to open new schools during
fiscal 2005 and in future years. Establishing new schools poses unique challenges and requires us to make investments in management, capital expenditures, marketing expenses and other resources. When opening a new school, we may be required to
obtain appropriate state or provincial and accrediting agency approvals. In addition, to be eligible for federal student financial aid programs, such a school has to be certified by the U.S. Department of Education. Our failure to effectively manage
the operations of newly established schools or service areas, or any diversion of managements attention from our core career-oriented school operating activities, could harm our business.



We anticipate significant future growth from online course we offer to
students. Currently, The Art Institute Online offers a broad suite of programs in the creative fields and South University Online offers bachelors degree programs in business administration and information technology. During fiscal 2005 and in
future years we will continue to roll out new online programs at The Art Institutes and South University along with online classes at Argosy University and AEC schools. The success of our new online programs and classes depends in part on our
ability to expand the content of our programs, develop new programs in a cost-effective manner, and meet the needs of our students in a timely manner. The expansion of our existing online programs, the creation of new online classes and the
development of new online programs may not be accepted by students or the online education market.



Failure to effectively manage our growth could harm our business.



Our business has grown rapidly. Our continued rapid growth may place a strain on our management, operations, employees, or
resources. We may not be able to maintain or accelerate our current growth rate, effectively manage our expanding operations, or achieve planned growth on a timely or profitable basis. If we are unable to manage our growth effectively, we may
experience operating inefficiencies, and our net income may be materially adversely affected.



Failure to integrate acquired schools could harm our business.



From time to time, we engage in evaluations of, and discussions with, possible acquisition candidates. We may not continue to be able to identify suitable
acquisition opportunities or to acquire any such schools on favorable terms. Additionally, we may not be able to successfully integrate any acquired schools into our operations profitably. Continued growth through acquisition may also subject us to
unanticipated business or regulatory uncertainties or liabilities. Acquired schools may not enhance our business and, if we do not successfully address associated risks and uncertainties, may ultimately have a material adverse effect on our growth
and ability to compete.



In the event we decide to acquire an
institution, the U.S. Department of Education and most applicable state authorizing agencies and accrediting agencies consider that a change of ownership or control of the institution has occurred. A change of ownership or control of an institution
under the standards of the U.S. Department of Education may result in the temporary suspension of the institutions participation in the federal student financial aid programs until the U.S. Department of Education issues a temporary
certification document. If we were unable to promptly reestablish the state authorization, accreditation or U.S. Department of Education certification of an institution we acquired, depending on the size of that acquisition, that failure could have
a material adverse effect on our business.



Competitors
with greater resources could harm our business



The
post-secondary education market is highly competitive. Our schools compete with traditional public and private two-year and four-year colleges and universities and other proprietary schools, including those that offer distance learning programs.
Some public and private colleges and universities, as well as other private career-oriented schools, may offer programs similar to those of our schools. Although tuition at private non-profit



43



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institutions is, on average, higher than tuition at our schools, some public institutions are able to charge lower tuition than our schools, due in part to
government subsidies, government and foundation grants, tax-deductible contributions and other financial sources not available to proprietary schools. Some of our competitors in both the public and private sectors have substantially greater
financial and other resources than us.



Our success
depends upon our ability to recruit and retain key personnel



Our success also depends, in large part, upon our ability to attract and retain highly qualified faculty, school presidents and administrators and corporate management. We may have difficulty locating and hiring qualified personnel, and
retaining such personnel once hired. The loss of the services of any of our key personnel, or our failure to attract and retain other qualified and experienced personnel on acceptable terms, could cause our business to suffer.



Failure to obtain additional capital in the future could reduce our
ability to grow.



We believe that funds from
operations, cash, investments and borrowings under our $250 million revolving credit facility will be adequate to fund our current operation plans for the foreseeable future. However, we may need additional debt or equity financing in order to
finance our continued growth. The amount and timing of such additional financing will vary principally depending on the timing and size of acquisitions and new school openings, the sellers willingness to provide financing themselves for
acquisitions, and the amount of cash flow from our operations. To the extent that we require additional financing in the future and are unable to obtain such additional financing, we may not be able to fully implement our growth strategy.



Anti-takeover provisions in our charter documents and
our stockholders rights plan could make an acquisition of us, which may be beneficial to our stockholders, more difficult.



Provisions of our Articles of Incorporation and our by-laws contain provisions that may delay, defer, or inhibit a future acquisition of us not approved
by our board of directors. These provisions are intended to encourage any person interested in acquiring us to negotiate with and obtain the approval of our board of directors in connection with the transaction. For example, our Articles of
Incorporation authorizes our board of directors to issue up to 10,000,000 shares of preferred stock with such voting, conversion, and other rights, preferences, privileges, and restrictions as it determines, without any further vote or action by our
stockholders. The rights of the holders of our common stock will be subject to, and may be harmed by, the rights of the holders of our preferred stock that may be issued in the future. In addition, our Articles of Incorporation divides our board of
directors into three classes having staggered terms. We have also implemented a stockholders rights plan, also commonly called a poison pill, that would substantially reduce or eliminate the expected economic benefit to an acquiror
from acquiring us in a manner or on terms not approved by our board of directors. These and other impediments to a third-party acquisition or change of control could limit the price investors are willing to pay in the future for shares of our common
stock.



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ITEM 7AQUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



We are exposed to market risks in the ordinary course of business that
include foreign currency exchange rates. We do not currently utilize interest rate swaps, forward or option contracts on foreign currencies or commodities, or other types of derivative financial instruments. Due to our operation of subsidiaries in
Canada, we are subject to fluctuations in the value of the Canadian dollar relative to the U.S. dollar. However, we do not believe we are subject to material risks from near-term changes in exchange rates.



The fair values and carrying amounts of our financial instruments, primarily
accounts receivable and debt, are approximately equivalent. We had outstanding borrowings under the Credit Agreement and one fixed-rate debt instrument as of June 30, 2004, with an outstanding balance of $3.4 million and bearing interest at 7.13%.
This obligation provides for monthly installments of approximately $26,000 with a balloon payment of $3.3 million due March 2006. Borrowings under the Credit Agreement bear interest at floating rates based upon market rates. At June 30, 2004 and
2003, we had $128.6 million and $38.5 million of outstanding debt, respectively. In fiscal 2004, weighted average interest rates were 2.25% on variable-rate debt and 7.13% on fixed-rate debt. Interest rates were 2.15% and 7.13% for the variable-rate
debt and fixed-rate debt, respectively, at the end of fiscal 2003. A hypothetical change of 10% in interest rates from year-end 2004 levels would have increased or decreased interest expense by approximately $0.1 million for the variable-rate debt
in fiscal 2004 and 2003. All other financial instruments are classified as current and will be utilized within the next operating cycle.



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ITEM 8FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Shareholders of Education Management Corporation and
Subsidiaries



We have audited the accompanying
consolidated balance sheets of Education Management Corporation and subsidiaries as of June 30, 2004 and 2003, and the related consolidated statements of income, cash flows, and shareholders investment, for each of the three years in the
period ended June 30, 2004. Our audits also included the financial statement schedule listed in the Index at Item 15(2). These financial statements and schedule are the responsibility of the Companys management. Our responsibility is to
express an opinion on these financial statements and schedule based on our audits.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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 consolidated financial position of Education Management Corporation and subsidiaries at June 30, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the
period ended June 30, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present
fairly in all material respects the information set forth therein.



/s/ ERNST & YOUNG LLP



Pittsburgh, Pennsylvania

August 3, 2004



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



(Dollars in thousands, except share and per share data)



|                                                                                                                |  |                |         |   |      |   |         |  
|--------------------------------------------------------------------------------------------------------------- |  | -------------- | ------- | - | ---- | - | ------- | -
|                                                                                                                |  | As of June 30, |        
|                                                                                                                |  | 2004           |         |   | 2003 |  
|Assets                                                                                                          |  |                |         |   |      |   |         |  
|Current assets:                                                                                                 |  |                |         |   |      |   |         |  
|Cash and cash equivalents                                                                                       |  | $              | 116,728 |   |      | $ | 88,957  |  
|Restricted cash                                                                                                 |  |                | 6,414   |   |      |   | 595     |  
|                                                                                                                |  |                |         |   |      |   |         |  
|Total cash                                                                                                      |  |                | 123,142 |   |      |   | 89,552  |  
|Receivables:                                                                                                    |  |                |         |   |      |   |         |  
|Trade, net of allowances of $40,903 and $26,837                                                                 |  |                | 45,503  |   |      |   | 33,825  |  
|Notes, advances and other                                                                                       |  |                | 6,693   |   |      |   | 6,816   |  
|Inventories                                                                                                     |  |                | 5,002   |   |      |   | 4,371   |  
|Deferred income taxes                                                                                           |  |                | 17,203  |   |      |   | 11,739  |  
|Prepaid income taxes                                                                                            |  |                |        |   |      |   | 5,423   |  
|Other current assets                                                                                            |  |                | 7,511   |   |      |   | 9,296   |  
|                                                                                                                |  |                |         |   |      |   |         |  
|Total current assets                                                                                            |  |                | 205,054 |   |      |   | 161,022 |  
|                                                                                                                |  |                |         |   |      |   |         |  
|Property and equipment, net                                                                                     |  |                | 276,148 |   |      |   | 230,749 |  
|Other long-term assets                                                                                          |  |                | 14,676  |   |      |   | 12,231  |  
|Intangible assets, net                                                                                          |  |                | 20,596  |   |      |   | 16,892  |  
|Goodwill                                                                                                        |  |                | 311,525 |   |      |   | 156,701 |  
|                                                                                                                |  |                |         |   |      |   |         |  
|Total assets                                                                                                    |  | $              | 827,999 |   |      | $ | 577,595 |  
|                                                                                                                |  |                |         |   |      |   |         |  
|Liabilities and shareholders investment                                                                        |  |                |         |   |      |   |         |  
|Current liabilities:                                                                                            |  |                |         |   |      |   |         |  
|Current portion of long-term debt                                                                               |  | $              | 125,194 |   |      | $ | 35,074  |  
|Accounts payable                                                                                                |  |                | 30,079  |   |      |   | 25,362  |  
|Note payable                                                                                                    |  |                | 11,000  |   |      |   |        |  
|Accrued liabilities                                                                                             |  |                | 39,189  |   |      |   | 30,077  |  
|Accrued income taxes                                                                                            |  |                | 6,786   |   |      |   |        |  
|Unearned tuition                                                                                                |  |                | 22,909  |   |      |   | 13,429  |  
|Advance payments                                                                                                |  |                | 46,351  |   |      |   | 36,259  |  
|                                                                                                                |  |                |         |   |      |   |         |  
|Total current liabilities                                                                                       |  |                | 281,508 |   |      |   | 140,201 |  
|                                                                                                                |  |                |         |   |      |   |         |  
|Long-term debt, less current portion                                                                            |  |                | 3,366   |   |      |   | 3,426   |  
|Deferred income taxes                                                                                           |  |                | 5,892   |   |      |   | 3,608   |  
|Other long-term liabilities                                                                                     |  |                | 8,546   |   |      |   | 2,581   |  
|Shareholders investment:                                                                                       |  |                |         |   |      |   |         |  
|Common Stock, par value $0.01 per share; 120,000,000 shares authorized; 73,519,497 and 72,161,382 shares issued |  |                | 735     |   |      |   | 722     |  
|Additional paid-in capital                                                                                      |  |                | 296,038 |   |      |   | 272,702 |  
|Treasury stock, 180,364 shares at cost                                                                          |  |                | (1,495  | ) |      |   | (1,495  | )
|Retained earnings                                                                                               |  |                | 230,382 |   |      |   | 153,368 |  
|Accumulated other comprehensive income                                                                          |  |                | 3,027   |   |      |   | 2,482   |  
|                                                                                                                |  |                |         |   |      |   |         |  
|Total shareholders investment                                                                                  |  |                | 528,687 |   |      |   | 427,779 |  
|                                                                                                                |  |                |         |   |      |   |         |  
|Total liabilities and shareholders investment                                                                  |  | $              | 827,999 |   |      | $ | 577,595 |  
|                                                                                                                |  |                |         |   |      |   |         |  



The accompanying notes
to consolidated financial statements are an integral part of these statements.



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF INCOME



(Dollars and shares in thousands, except per share amounts)



|                                               |  |                              |         |      |   |         |  |   |        
|---------------------------------------------- |  | ---------------------------- | ------- | ---- | - | ------- |  | - | -------
|                                               |  | For the years ended June 30,
|                                               |  | 2004                         |         | 2003 |   | 2002   
|Net revenues                                   |  | $                            | 853,019 |      | $ | 640,027 |  | $ | 500,576
|                                               |  |                              |        
|Costs and expenses:                            |  |                              |         |      |   |         |  |   |        
|Educational services                           |  |                              | 546,132 |      |   | 417,557 |  |   | 325,027
|General and administrative                     |  |                              | 166,990 |      |   | 125,294 |  |   | 102,486
|Amortization of intangible assets              |  |                              | 6,911   |      |   | 4,443   |  |   | 4,096  
|                                               |  |                              |         |      |   |         |  |   |        
|                                               |  |                              | 720,033 |      |   | 547,294 |  |   | 431,609
|                                               |  |                              |         |      |   |         |  |   |        
|Income before interest and income taxes        |  |                              | 132,986 |      |   | 92,733  |  |   | 68,967 
|Interest expense, net                          |  |                              | 2,475   |      |   | 1,282   |  |   | 1,552  
|                                               |  |                              |         |      |   |         |  |   |        
|Income before income taxes                     |  |                              | 130,511 |      |   | 91,451  |  |   | 67,415 
|Provision for income taxes                     |  |                              | 53,497  |      |   | 35,174  |  |   | 25,101 
|                                               |  |                              |         |      |   |         |  |   |        
|Net income                                     |  | $                            | 77,014  |      | $ | 56,277  |  | $ | 42,314 
|                                               |  |                              |         |      |   |         |  |   |        
|Earnings per share:                            |  |                              |         |      |   |         |  |   |        
|Basic                                          |  | $                            | 1.06    |      | $ | 0.79    |  | $ | 0.64   
|Diluted                                        |  | $                            | 1.03    |      | $ | 0.77    |  | $ | 0.61   
|                                               |  |                              |        
|Weighted average number of shares outstanding: |  |                              |         |      |   |         |  |   |        
|Basic                                          |  |                              | 72,786  |      |   | 70,956  |  |   | 66,052 
|Diluted                                        |  |                              | 74,870  |      |   | 73,018  |  |   | 68,958 





The accompanying notes to consolidated financial statements are an integral part of these statements.



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS



(Dollars in thousands)



|                                                                                |  |                              |          |   |      |   |          |      |  |   |          |  
|------------------------------------------------------------------------------- |  | ---------------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                |  | For the years ended June 30, |         
|                                                                                |  | 2004                         |          |   | 2003 |   |          | 2002 | 
|Cash flows from operating activities:                                           |  |                              |          |   |      |   |          |      |  |   |          |  
|Net income                                                                      |  | $                            | 77,014   |   |      | $ | 56,277   |      |  | $ | 42,314   |  
|Adjustments to reconcile net income to net cash flows from operatingactivities: |  |                              |          |   |      |   |          |      |  |   |          |  
|Depreciation and amortization                                                   |  |                              | 55,287   |   |      |   | 44,920   |      |  |   | 34,064   |  
|Stock-based compensation expense                                                |  |                              | 871      |   |      |   |         |      |  |   |         |  
|Deferred credit for income taxes                                                |  |                              | (2,231   | ) |      |   | (97      | )    |  |   | (2,791   | )
|Changes in current assets and liabilities:                                      |  |                              |          |   |      |   |          |      |  |   |          |  
|Restricted cash                                                                 |  |                              | (5,819   | ) |      |   | 1,161    |      |  |   | (1,538   | )
|Receivables                                                                     |  |                              | (5,226   | ) |      |   | (9,179   | )    |  |   | (1,842   | )
|Inventories                                                                     |  |                              | (128     | ) |      |   | (398     | )    |  |   | (210     | )
|Other current assets                                                            |  |                              | 8,577    |   |      |   | (5,026   | )    |  |   | (860     | )
|Accounts payable                                                                |  |                              | 4,126    |   |      |   | 3,574    |      |  |   | 6,908    |  
|Accrued liabilities                                                             |  |                              | 22,360   |   |      |   | 10,356   |      |  |   | 13,169   |  
|Advance payments                                                                |  |                              | 8,465    |   |      |   | (22,202  | )    |  |   | 11,210   |  
|                                                                                |  |                              |          |   |      |   |          |      |  |   |          |  
|Total adjustments                                                               |  |                              | 86,285   |   |      |   | 23,109   |      |  |   | 58,110   |  
|                                                                                |  |                              |          |   |      |   |          |      |  |   |          |  
|Net cash flows from operating activities                                        |  |                              | 163,296  |   |      |   | 79,386   |      |  |   | 100,424  |  
|                                                                                |  |                              |          |   |      |   |          |      |  |   |          |  
|Cash flows used for investing activities:                                       |  |                              |          |   |      |   |          |      |  |   |          |  
|Acquisition of subsidiaries, net of cash acquired                               |  |                              | (157,777 | ) |      |   | (23,661  | )    |  |   | (104,396 | )
|Expenditures for property and equipment                                         |  |                              | (80,703  | ) |      |   | (80,809  | )    |  |   | (45,400  | )
|Other items, net                                                                |  |                              | 1,546    |   |      |   | (3,966   | )    |  |   | (4,441   | )
|                                                                                |  |                              |          |   |      |   |          |      |  |   |          |  
|Net cash flows used for investing activities                                    |  |                              | (236,934 | ) |      |   | (108,436 | )    |  |   | (154,237 | )
|                                                                                |  |                              |          |   |      |   |          |      |  |   |          |  
|Cash flows from financing activities:                                           |  |                              |          |   |      |   |          |      |  |   |          |  
|Net activity under revolving credit facility                                    |  |                              | 90,100   |   |      |   | 10,000   |      |  |   | (28,525  | )
|Principal payments on debt                                                      |  |                              | (78      | ) |      |   | (329     | )    |  |   | (8,756   | )
|Net proceeds from issuance of Common Stock                                      |  |                              | 12,018   |   |      |   | 14,581   |      |  |   | 135,808  |  
|                                                                                |  |                              |          |   |      |   |          |      |  |   |          |  
|Net cash flows from financing activities                                        |  |                              | 102,040  |   |      |   | 24,252   |      |  |   | 98,527   |  
|                                                                                |  |                              |          |   |      |   |          |      |  |   |          |  
|Effective exchange rate changes on cash and cash equivalents                    |  |                              | (631     | ) |      |   | 1,632    |      |  |   | 337      |  
|                                                                                |  |                              |          |   |      |   |          |      |  |   |          |  
|Net change in cash and cash equivalents                                         |  |                              | 27,771   |   |      |   | (3,166   | )    |  |   | 45,051   |  
|                                                                                |  |                              |         
|Cash and cash equivalents, beginning of year                                    |  |                              | 88,957   |   |      |   | 92,123   |      |  |   | 47,072   |  
|                                                                                |  |                              |          |   |      |   |          |      |  |   |          |  
|Cash and cash equivalents, end of year                                          |  | $                            | 116,728  |   |      | $ | 88,957   |      |  | $ | 92,123   |  
|                                                                                |  |                              |          |   |      |   |          |      |  |   |          |  



The accompanying notes
to consolidated financial statements are an integral part of these statements.



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF SHAREHOLDERS INVESTMENT



(Dollars in thousands)



|                                                                 |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|---------------------------------------------------------------- |  | ----------------------- | --- | ------------------------ | - | ------------- |  | - | ---------------- | - | ----------------------------------- | - | ------- |  | - | ----- |  | - | -------
|                                                                 |  | CommonStock atPar Value |     | AdditionalPaid-inCapital |   | TreasuryStock |  |   | RetainedEarnings |   | AccumulatedOtherComprehensiveIncome |   | Total  
|Balance, June 30, 2001                                           |  | $                       | 610 |                          | $ | 108,158       |  | $ | (3,596           | ) |                                     | $ | 54,777  |  | $ |      |  | $ | 159,949
|Comprehensive income:                                            |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|Net income                                                       |  |                         |    |                          |   |              |  |   |                 |   |                                     |   | 42,314  |  |   |      |  |   | 42,314 
|Foreign currency translation                                     |  |                         |    |                          |   |              |  |   |                 |   |                                     |   |        |  |   | 358   |  |   | 358    
|                                                                 |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|Comprehensive income                                             |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   | 42,672 
|Net proceeds from public offering of Common Stock                |  |                         | 84  |                          |   | 127,541       |  |   |                 |   |                                     |   |        |  |   |      |  |   | 127,625
|Options exchanged in connection with acquisition of a subsidiary |  |                         |    |                          |   | 2,279         |  |   |                 |   |                                     |   |        |  |   |      |  |   | 2,279  
|Exercise of stock options                                        |  |                         | 10  |                          |   | 11,246        |  |   | 1,838            |   |                                     |   |        |  |   |      |  |   | 13,094 
|Issuance of Common Stock under employee stock purchase plan      |  |                         |    |                          |   | 695           |  |   | 263              |   |                                     |   |        |  |   |      |  |   | 958    
|                                                                 |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|Balance, June 30, 2002                                           |  |                         | 704 |                          |   | 249,919       |  |   | (1,495           | ) |                                     |   | 97,091  |  |   | 358   |  |   | 346,577
|                                                                 |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|Comprehensive income:                                            |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|Net income                                                       |  |                         |    |                          |   |              |  |   |                 |   |                                     |   | 56,277  |  |   |      |  |   | 56,277 
|Foreign currency translation                                     |  |                         |    |                          |   |              |  |   |                 |   |                                     |   |        |  |   | 2,124 |  |   | 2,124  
|                                                                 |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|Comprehensive income                                             |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   | 58,401 
|Exercise of stock options                                        |  |                         | 18  |                          |   | 21,527        |  |   |                 |   |                                     |   |        |  |   |      |  |   | 21,545 
|Issuance of Common Stock under employee stock purchase plan      |  |                         |    |                          |   | 1,256         |  |   |                 |   |                                     |   |        |  |   |      |  |   | 1,256  
|                                                                 |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|Balance, June 30, 2003                                           |  |                         | 722 |                          |   | 272,702       |  |   | (1,495           | ) |                                     |   | 153,368 |  |   | 2,482 |  |   | 427,779
|                                                                 |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|Comprehensive income:                                            |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|Net income                                                       |  |                         |    |                          |   |              |  |   |                 |   |                                     |   | 77,014  |  |   |      |  |   | 77,014 
|Foreign currency translation                                     |  |                         |    |                          |   |              |  |   |                 |   |                                     |   |        |  |   | 545   |  |   | 545    
|                                                                 |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|Comprehensive income                                             |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   | 77,559 
|Issuance of restricted stock                                     |  |                         |    |                          |   | 871           |  |   |                 |   |                                     |   |        |  |   |      |  |   | 871    
|Exercise of stock options                                        |  |                         | 13  |                          |   | 20,561        |  |   |                 |   |                                     |   |        |  |   |      |  |   | 20,574 
|Issuance of Common Stock under employee stock purchase plan      |  |                         |    |                          |   | 1,904         |  |   |                 |   |                                     |   |        |  |   |      |  |   | 1,904  
|                                                                 |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        
|Balance, June 30, 2004                                           |  | $                       | 735 |                          | $ | 296,038       |  | $ | (1,495           | ) |                                     | $ | 230,382 |  | $ | 3,027 |  | $ | 528,687
|                                                                 |  |                         |     |                          |   |               |  |   |                  |   |                                     |   |         |  |   |       |  |   |        



The accompanying notes
to consolidated financial statements are an integral part of these statements.



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:



Basis of Consolidation and Presentation



The consolidated financial statements include the accounts of EDMC and its
wholly-owned subsidiaries. The results of operations of acquired entities are consolidated with those of the Company from the date of acquisition. All significant intercompany transactions and balances have been eliminated. Unless otherwise
specified, any reference to a year is to a fiscal year ended June 30.



Prior to fiscal 2004, The Art Institutes and Argosy University were managed as separate operating segments. During the first quarter of fiscal 2004, we switched from an educational system approach to a centralized
corporate structure utilizing divisions which have been aggregated into one operating segment. We currently have three distinct operating divisions organized by geographic locations within North America: The Eastern division; Central division; and
Western division. As a result of common economic business and market conditions, these operating segments have been aggregated to form one distinct reporting segment.



During the fourth quarter of fiscal 2004 we recorded a $1.6 million adjustment to employee benefit expense for lower than
expected health insurance claims for fiscal 2004. The estimate of the incurred but not reported claims used during prior fiscal quarters was found to be higher than the amounts determined at the end of fiscal 2004, leading to adjustment.



Stock Split



The Companys Board of Directors declared a stock split effected in the form of a stock dividend, payable at the rate
of one share of Common Stock for each outstanding share as of the close of business on December 1, 2003. The shares issued for the stock split were distributed on December 22, 2003. The share information for all periods presented has been adjusted
to reflect the stock split.



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 reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.



Government Regulations



The Companys U.S. schools participate in various federal student financial assistance programs (Title IV Programs) under Title IV of the
Higher Education Act of 1965, as amended (the HEA). Approximately 73%, 68% and 65% of the Companys net revenues in 2004, 2003 and 2002, respectively, were indirectly derived from funds distributed under these programs to students
at its participating schools. Participating schools are required to comply with certain federal regulations established by the U.S. Department of Education.



Participating schools are required to administer Title IV Program funds in accordance with the HEA and U.S. Department of Education regulations and must
use due diligence in approving and disbursing funds and servicing loans. In the event a participating school does not comply with federal requirements or if student loan default rates are at a level considered excessive by the federal government,
that school could lose its eligibility to participate in Title IV Programs or could be required to repay funds determined to have been improperly disbursed. If one or more of the Companys schools loses or suffers limited access to Title IV
Program funds, that loss could have a materially adverse effect on the results of operations. However, management believes that its participating schools are in substantial compliance with the federal requirements and that student loan default rates
are not at a level considered excessive.



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Certain schools make contributions to Federal Perkins Loan Programs (the Funds). Current
contributions to the Funds are made 75% by the federal government and 25% by the school. The Company carries its investments in the Funds at cost, net of an allowance for estimated future loan losses.



Cash and Cash Equivalents and Restricted Cash



The Company considers all highly liquid debt instruments purchased with a
maturity of three months or less to be cash equivalents. These investments are stated at cost, which, based upon the scheduled maturities, approximates market value.



U.S. Department of Education regulations require Title IV Program funds received by the Companys schools in excess of
the tuition and fees owed by the relevant students at that time to be, with these students permission, maintained and classified as restricted until the students are billed for the portion of their education program related to those funds.
Funds transferred through electronic funds transfer programs are held in a separate cash account and released when certain conditions are satisfied. These restrictions have not significantly affected the Companys ability to fund daily
operations.



Restricted cash balances include amounts held in
escrow related to certain acquisitions. Funds from this account will be transferred to the previous owner if certain conditions are met. These conditions primarily relate to the development and performance of certain health profession programs (See
recent acquisitions below).



Inventories



Inventories consist mainly of textbooks and supplies held for sale to
students enrolled in the Companys educational programs. Inventories are valued at the lower of cost (first-in, first-out) or market.



Recent Acquisitions



On October 1, 2003, the Company acquired Dubrulle International Culinary & Hotel Institute of Canada (Dubrulle), located in Vancouver,
British Columbia. On October 8, 2003, the Company acquired Bradley Academy for the Visual Arts (Bradley), located in York, Pennsylvania. The aggregate purchase price for these two entities was approximately $10.6 million. Dubrulle will
allow the Company to expand on its current base of students in the Vancouver area, while the purchase of Bradley will complement the Companys existing presence in Pennsylvania. Bradley will allow the Company to reach students interested in a
suburban setting and also reach the more populous centers of Baltimore, MD and Harrisburg, PA. The pro forma information presented above does not include these two acquisitions because the impact of these acquisitions on operations was not material.
The Company is in the process of finalizing the third-party valuation of certain tangible and intangible assets associated with the purchases; therefore, the allocation of the purchase price is subject to adjustment, which we do not believe will be
material.



On September 2, 2003, the Company acquired 100
percent of the outstanding stock of American Education Centers, Inc. and related companies (AEC). AEC operates 18 education institutions in eight states, mainly in the Midwest, offering programs in health sciences, business, information
technology, legal studies and design technologies. The Company paid approximately $103.5 million in cash; an additional $11.0 million in notes, payable on September 2, 2004; and assumed $3.5 million in debt. The purchase of AEC broadened the
Companys range of academic programs for working adults.



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



On July 14, 2003, the Company acquired 100 percent of the outstanding stock of South University, Inc.
(South). South has four campuses in the southeastern United States and offers undergraduate and graduate degree programs in business, legal studies, information technology and health sciences fields. The Company paid approximately $51.0
million for South, which includes $4.0 million held in escrow. Funds from this account will be transferred to the previous owner if certain conditions are met. These conditions primarily relate to the development and performance of certain health
profession programs. The purchase of South broadened the Companys program offerings in the health sciences.



The results of operations for AEC and South have been consolidated as of the respective closing dates. Approximately $145 million and $7.3 million were
assigned to goodwill and intangible assets, respectively. The Company is in the process of finalizing the third-party valuation of certain tangible and intangible assets associated with AEC and South; therefore, the allocation of the purchase price
is subject to adjustment, however the adjustments are not believed to be material to our financial position, operating results or cash flows.



The following table reports pro forma information as if the acquisitions of AEC and South had been completed at July 1, 2002 (unaudited, in thousands,
except per share amounts). Pro forma results for the fiscal year ended June 30, 2004 include $15.9 million in expenses for AEC pertaining to stock compensation payouts and costs incurred related to the acquisition by EDMC. These stock plans at AEC
are no longer in place, and the Company does not expect to incur charges of this nature in future periods.



|                           |  |                     |         |      |   |        
|-------------------------- |  | ------------------- | ------- | ---- | - | -------
|                           |  | Year Ended June 30,
|                           |  | 2004                |         | 2003
|Net revenues               |  |                     |         |      |   |        
|As reported                |  | $                   | 853,019 |      | $ | 640,027
|Pro forma                  |  |                     | 863,349 |      |   | 712,304
|                           |  |                    
|Net income                 |  |                     |         |      |   |        
|As reported                |  | $                   | 77,014  |      | $ | 56,277 
|Pro forma                  |  |                     | 67,852  |      |   | 64,910 
|                           |  |                    
|Diluted earnings per share |  |                     |         |      |   |        
|As reported                |  | $                   | 1.03    |      | $ | 0.77   
|Pro forma                  |  |                     | 0.91    |      |   | 0.89   



The following table
summarizes the estimated fair values of the assets we acquired and liabilities we assumed in connection with our acquisition of AEC (in thousands):



|                       |  |   |        
|---------------------- |  | - | -------
|Current assets         |  | $ | 6,667  
|Property and equipment |  |   | 11,355 
|Intangible assets      |  |   | 4,502  
|Goodwill               |  |   | 102,574
|                       |  |   |        
|Total assets acquired  |  |   | 125,098
|Current liabilities    |  |   | 7,078  
|                       |  |   |        
|Net assets acquired    |  | $ | 118,020
|                       |  |   |        



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The following table summarizes the estimated fair values of the assets we acquired and liabilities we
assumed in connection with our acquisition of South University (in thousands):



|                       |  |   |       
|---------------------- |  | - | ------
|Current assets         |  | $ | 9,004 
|Property and equipment |  |   | 3,340 
|Intangible assets      |  |   | 2,820 
|Goodwill               |  |   | 40,010
|                       |  |   |       
|Total assets acquired  |  |   | 55,174
|Current liabilities    |  |   | 8,155 
|                       |  |   |       
|Net assets acquired    |  | $ | 47,019
|                       |  |   |       



The following table
presents the finite-lived intangible assets acquired with the purchase of AEC (dollars in thousands):



|                                   |  |        |       |                            |  
|---------------------------------- |  | ------ | ----- | -------------------------- | -
|                                   |  | Amount |       | AmortizationPeriod (years)
|Curriculum                         |  | $      | 410   |                            | 6
|Accreditation                      |  |        | 332   |                            | 6
|Title IV                           |  |        | 160   |                            | 6
|Student contracts and applications |  |        | 3,600 |                            | 2
|                                   |  |        |       |                            |  
|Total                              |  | $      | 4,502 |                            |  
|                                   |  |        |       |                            |  



The following table
presents the finite-lived intangible assets acquired with the purchase of South (dollars in thousands):



|                                   |  |        |       |                            |   
|---------------------------------- |  | ------ | ----- | -------------------------- | --
|                                   |  | Amount |       | AmortizationPeriod (years)
|Curriculum                         |  | $      | 1,700 |                            | 16
|Accreditation                      |  |        | 190   |                            | 16
|Title IV                           |  |        | 160   |                            | 16
|Student contracts and applications |  |        | 770   |                            | 3 
|                                   |  |        |       |                            |   
|Total                              |  | $      | 2,820 |                            |   
|                                   |  |        |       |                            |   



On November 8, 2002,
the Company acquired all of the outstanding stock of Infocast Digital Arts Inc., which operated IDA Institute of Digital Arts in Richmond, British Columbia, Canada, for approximately $1.0 million in cash. This school was renamed The Art Institute of
Vancouver.



On October 15, 2002, the Company purchased assets
and assumed certain liabilities of California Design College, located in Los Angeles, California, for approximately $15.0 million in cash.



On October 3, 2002, the Company acquired all of the outstanding stock of the Center for Digital Imaging and Sound (CDIS) in Burnaby, British
Columbia, Canada for approximately $9.9 million in cash. This school was renamed The Art Institute of Vancouver-Burnaby.



We acquired Infocast Digital Arts, California Design College and CDIS as part of our strategy to enter new geographic areas we believe are attractive
based on a number of factors and to solidify our presence in growing markets.



These acquisitions were accounted for as purchases in accordance with Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations (SFAS 141). The results of
operations for each of the



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



acquired entities have been consolidated as of the respective closing date. Pro forma information is not presented because the impact of the acquisitions
other than AEC and South was not deemed to be material. The fair value for the material acquisitions described above has been determined by an independent appraisal by a third party. Any excess purchase price over the fair market value of the net
assets acquired is recorded as goodwill and other intangible assets.



Property and Equipment



Property and equipment
are stated at cost, net of accumulated depreciation. Expenditures for additions and major improvements are capitalized, while those for maintenance, repairs and minor renewals are expensed as incurred. The Company uses the straight-line method of
depreciation for financial reporting, while using different methods for tax purposes. Depreciation is based upon estimated useful lives, ranging from 3 to 30 years. On April 1, 2003, the Company revised the estimated useful lives of several classes
of fixed assets to more accurately reflect the current estimates on actual usage. See Note 4 for additional information regarding the change in estimates for useful lives. Leasehold improvements are amortized over the term of the lease, or over
their estimated useful lives, whichever is shorter.



The
Company reviews property and equipment for impairment when an impairment indicator exists as defined under SFAS No.144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144). No impairment was identified
in fiscal 2004, 2003 or 2002.



The Company conducts a major
part of its operations at leased facilities and recognizes rent expense on a straight-line basis over the term of the lease. Before entering into a lease, an analysis is performed to determine whether a lease should be classified as a capital or an
operating lease according to SFAS No. 13, Accounting for Leases (SFAS 13), as amended.



Goodwill and Intangible Assets



The Company accounts for goodwill according to Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. Intangible assets with finite useful lives are amortized generally on a
straight-line basis over the periods benefited.



The carrying
values of goodwill and other intangible assets with indefinite useful lives are tested for impairment at least annually during the first quarter. If the fair value of the reporting unit is higher than the book value of the reporting unit, no
impairment is recognized. If the fair value of the reporting unit is lower than the book value a hypothetical purchase price analysis would be prepared to determine a reduced book value of goodwill. The current value is then compared to the carrying
value of goodwill. To the extent that the current fair value is lower than the carrying value, an impairment must be recorded. The Company completed the annual impairment test for fiscal 2004, and no impairment was determined. Future impairment
tests will continue to be performed in the first fiscal quarter, annually or more frequently, if necessary. Any resulting impairment charge, if any, would be reflected as an operating expense. Individual campus components have been aggregated to
form three distinct operating groups by geographic locations within North America. These groups are the Eastern, Central and Western groups, each of which represent a reporting unit at which goodwill is analyzed for impairments.



Intangible assets are recorded at their fair market value as of the
acquisition date, as determined by an independent appraiser. The Company uses the straight-line method of amortization for those intangibles, including online curriculum with an identifiable useful life. The Company reviews intangible assets with an
identifiable useful life for impairment, when indicators of impairment exist, as defined by SFAS 144.



55



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Foreign Currency Translation



The financial position and results of operations of the Companys foreign subsidiaries are measured in the functional
currency, Canadian dollars. Accordingly, the assets and liabilities of the foreign subsidiaries are translated to U.S. dollars using the exchange rates in effect as of the balance sheet date, while revenues and expenses are translated into U.S.
dollars using the average monthly exchange rates. Translation adjustments resulting from this process are recorded as a separate component of shareholders investment designated as accumulated other comprehensive income in the accompanying
consolidated balance sheets. Transaction gains or losses during the years ended June 30, 2004 and 2003 were not material.



Financial Instruments



The fair values and carrying amounts of the Companys financial instruments, primarily accounts receivable and debt, are approximately equivalent.
The Company had outstanding borrowings under the revolving credit facility and one fixed-rate mortgage debt instrument as of June 30, 2004. The mortgage obligation had an outstanding balance of $3.4 million, bears interest at 7.13% and provides for
monthly installments of approximately $26,000, with a balloon payment of $3.3 million due March 2006. Borrowings under the revised revolving credit facility bear interest at floating rates based upon market rates. At June 30, 2004 and 2003 these
borrowings were classified as current as they were subsequently repaid in July. At June 30, 2004, we had a note payable of $11.0 million, which was paid on September 2, 2004. All other financial instruments are classified as current and will be
utilized within the next operating cycle.



Revenue Recognition and
Receivables



Our net revenues consist of tuition and fees,
student housing fees, bookstore sales, restaurant sales in connection with culinary programs, workshop fees and sales of related study materials. Tuition revenue generally varies based on the average tuition charge per credit hour, type of program,
specific curriculum and the average student population. Bookstore and housing revenue is largely a function of the average student population at our Art Institutes. The Company derived 90.8%, 90.8%, and 90.2% of its net revenues from tuition and
fees paid by, or on behalf of, its students in fiscal 2004, 2003 and 2002, respectively. Net revenues are reduced for student refunds and scholarships. Bookstore and restaurant revenue is recognized when the sale occurs. Advance payments represent
that portion of payments received but not earned and are reflected as a current liability in the accompanying consolidated balance sheets. These payments are typically related to future academic periods and are for the most part refundable.



The Company bills tuition and fees and housing revenues at the
beginning of an academic term and recognizes the revenue on a pro rata basis over the term of instruction or occupancy. For most Art Institute and AEC programs, the academic and fiscal quarters are the same; therefore, unearned revenue is not
significant at the end of a fiscal quarter. However, Argosy and South schools have programs starting and ending dates that differ from the Companys fiscal quarters. Therefore, at the end of the fiscal quarter, the Company has revenue from
these programs that has not yet been earned in accordance with the Securities and Exchange Commissions Staff Accounting Bulletin No. 101 and 104, Revenue Recognition in Financial Statements.



The trade receivable balances are comprised of individually insignificant
amounts due primarily from students throughout the United States and Canada. The Company generally determines its allowance for doubtful accounts by categorizing gross receivables based upon the enrollment status of the student and establishing a
reserve based on the likelihood of collection, which is primarily based upon historic experience. Student accounts are monitored through an aging process whereby past due accounts are pursued. When certain criteria are met and internal collection
measures have been taken, the account is placed with an outside collection agency. Student accounts in collection are fully reserved and are evaluated on a case-by-case basis before being written off.



56



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Costs and Expenses



Educational services expense consists primarily of costs related to the development, delivery and administration of the Companys education
programs. Major cost components are faculty compensation, administrative salaries, costs of educational materials, facility leases and school occupancy costs, information systems costs and bad debt expense, along with depreciation and amortization
of property and equipment.



General and administrative expense
consists of marketing and student admissions expenses and certain central staff departmental costs such as executive management, finance and accounting, legal, corporate development and other departments that do not provide direct services to the
Companys students.



Advertising costs are expensed in the
fiscal year incurred and classified as general and administrative expense in the accompanying consolidated statements of income. The Companys advertising expense was $46.2 million, $35.0 million, and $29.2 million for fiscal 2004, 2003 and
2002, respectively.



Amortization of intangibles relates
primarily to the values assigned to identifiable intangibles, which arose principally from the acquisitions discussed above (see also Note 5). These intangible assets are amortized over periods ranging from 1 to 17 years.



Stock Compensation



The Company maintains two Stock Incentive Plans for directors, executive management and key personnel, which provides for
the issuance of stock-based incentive awards. In addition, the Company also had two non-qualified management option plans under which options to purchase shares of Common Stock were granted to management employees prior to 1996.



The Company accounts for these plans under Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees. Had compensation expense for the stock option and stock purchase plans been determined consistent with SFAS No. 123, Accounting for Stock-Based Compensation
(SFAS 123), the Companys net income and earnings per share would have been reduced to the following pro forma amounts (dollars in thousands, except per share amounts):



|                                                                                             |  |                     |         |   |      |   |        |      |  |   |        |  
|-------------------------------------------------------------------------------------------- |  | ------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                             |  | Year ended June 30, |        
|                                                                                             |  | 2004                |         |   | 2003 |   |        | 2002 | 
|Net income:                                                                                  |  |                     |         |   |      |   |        |      |  |   |        |  
|As reported                                                                                  |  | $                   | 77,014  |   |      | $ | 56,277 |      |  | $ | 42,314 |  
|Stock-based employee compensation expense included in reported net income, net of tax        |  |                     | 542     |   |      |   |       |      |  |   |       |  
|Stock-based employee compensation expense determined under the fair value method, net of tax |  |                     | (16,003 | ) |      |   | (6,634 | )    |  |   | (6,111 | )
|                                                                                             |  |                     |         |   |      |   |        |      |  |   |        |  
|Pro forma net income                                                                         |  | $                   | 61,553  |   |      | $ | 49,643 |      |  | $ | 36,203 |  
|                                                                                             |  |                     |        
|Basic earnings per share:                                                                    |  |                     |         |   |      |   |        |      |  |   |        |  
|As reported                                                                                  |  | $                   | 1.06    |   |      | $ | 0.79   |      |  | $ | 0.64   |  
|Pro forma                                                                                    |  |                     | 0.84    |   |      |   | 0.70   |      |  |   | 0.55   |  
|                                                                                             |  |                     |        
|Diluted earnings per share:                                                                  |  |                     |         |   |      |   |        |      |  |   |        |  
|As reported                                                                                  |  | $                   | 1.03    |   |      | $ | 0.77   |      |  | $ | 0.61   |  
|Pro forma                                                                                    |  |                     | 0.82    |   |      |   | 0.69   |      |  |   | 0.53   |  
|Weighted average fair value of options granted*                                              |  | $                   | 16.58   |   |      | $ | 19.61  |      |  | $ | 14.10  |  



57



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



---

|* |  | The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for grants:
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                 |  |      |   |  |      |   |  |      |  
|-------------------------------- |  | ---- | - |  | ---- | - |  | ---- | -
|                                 |  | 2004 |   |  | 2003 |   |  | 2002 |  
|Risk-free interest rate          |  | 2.86 | % |  | 2.80 | % |  | 4.09 | %
|Expected dividend yield          |  |     |   |  |     |   |  |     |  
|Expected life of options (years) |  | 4.5  |   |  | 4.5  |   |  | 4.5  |  
|Expected volatility rate         |  | 53.8 | % |  | 59.0 | % |  | 60.0 | %



Recently Issued Accounting
Standards



The Company adopted FASB Interpretation No. 46R
(FIN 46), Consolidation of Variable Interest Entities, for the quarter ended March 31, 2004. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, relating to
consolidation of certain entities. FIN 46 requires identification of the Companys participation in variable interest entities (VIE), which are identified as entities with a level of invested equity that is not sufficient to fund
future activities to permit them to operate on a standalone basis, or whose equity holders lack certain characteristics of a controlling financial interest. For entities identified as VIE, FIN 46 sets forth a model to evaluate potential
consolidation based on an assessment of which party to the VIE, if any, bars a majority of the exposure to its expected losses, or stands to gain from a majority of its expected returns. FIN 46 also sets forth certain disclosures regarding interests
in VIE that are deemed significant, even if consolidation is not required. The adoption of FIN 46 did not have any impact on the consolidated financial statements of the Company.



Supplemental Disclosures of Cash Flow Information



|                                                                               |  |                     |         |   |      |   |        |      |  |   |         |  
|------------------------------------------------------------------------------ |  | ------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------- | -
|                                                                               |  | Year ended June 30, |        
|                                                                               |  | 2004                |         |   | 2003 |   |        | 2002 | 
|                                                                               |  | (in thousands)      |        
|Cash paid during the period for:                                               |  |                     |         |   |      |   |        |      |  |   |         |  
|Interest                                                                       |  | $                   | 1,779   |   |      | $ | 925    |      |  | $ | 771     |  
|Income taxes                                                                   |  |                     | 34,233  |   |      |   | 30,530 |      |  |   | 19,885  |  
|Noncash investing and financing activities:                                    |  |                     |         |   |      |   |        |      |  |   |         |  
|Expenditures for property and equipment included in accounts payable           |  |                     | 5,741   |   |      |   | 5,651  |      |  |   | 9,477   |  
|Tax benefit for options exercised                                              |  |                     | 10,460  |   |      |   | 8,220  |      |  |   | 5,869   |  
|Stock options exchanged in connection with acquisition of a subsidiary         |  |                     |        |   |      |   |       |      |  |   | 2,279   |  
|                                                                               |  |                     |        
|Cash paid for acquisitions:                                                    |  |                     |         |   |      |   |        |      |  |   |         |  
|Fair value of:                                                                 |  |                     |         |   |      |   |        |      |  |   |         |  
|Assets acquired                                                                |  | $                   | 190,210 |   |      | $ | 28,910 |      |  | $ | 152,875 |  
|Liabilities assumed                                                            |  |                     | (14,515 | ) |      |   | (3,376 | )    |  |   | (36,280 | )
|Less: cash acquired                                                            |  |                     | (6,918  | ) |      |   | (1,873 | )    |  |   | (9,920  | )
|Notes payable                                                                  |  |                     | (11,000 | ) |      |   |       |      |  |   |        |  
|Stock options exchanged in connection with acquisition of a subsidiary         |  |                     |        |   |      |   |       |      |  |   | (2,279  | )
|                                                                               |  |                     |         |   |      |   |        |      |  |   |         |  
|Net cash paid for acquisitions                                                 |  | $                   | 157,777 |   |      | $ | 23,661 |      |  | $ | 104,396 |  
|                                                                               |  |                     |         |   |      |   |        |      |  |   |         |  
|Net proceeds from issuance of Common Stock:                                    |  |                     |         |   |      |   |        |      |  |   |         |  
|Total proceeds received per Consolidated Statement of Shareholders Investment |  | $                   | 22,478  |   |      | $ | 22,801 |      |  | $ | 143,956 |  
|Tax benefit for option exercise                                                |  |                     | (10,460 | ) |      |   | (8,220 | )    |  |   | (5,869  | )
|Stock options exchanged in connection with acquisition of a subsidiary         |  |                     |        |   |      |   |       |      |  |   | (2,279  | )
|                                                                               |  |                     |         |   |      |   |        |      |  |   |         |  
|Net proceeds from issuance of Common Stock                                     |  | $                   | 12,018  |   |      | $ | 14,581 |      |  | $ | 135,808 |  
|                                                                               |  |                     |         |   |      |   |        |      |  |   |         |  



58



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Reclassifications



Certain prior-year balances have been reclassified to conform to the current-year presentation.



2.    SHAREHOLDERS INVESTMENT:



Pursuant to the Companys Preferred Share Purchase Rights Plan (the
Rights Plan), one Preferred Share Purchase Right (a Right) is associated with each outstanding share of Common Stock. Each Right entitles its holder to buy one two-hundredth of a share of Series A Junior Participating
Preferred Stock, $0.01 par value, at an exercise price of $50, subject to adjustment (the Purchase Price). The Rights Plan is not subject to shareholder approval.



The Rights will become exercisable under certain circumstances following a public announcement by a person or group of
persons (an Acquiring Person) that they acquired or commenced a tender offer for 17.5% or more of the outstanding shares of Common Stock. If an Acquiring Person acquires 17.5% or more of the Common Stock, each Right will entitle its
holder, except the Acquiring Person, to acquire upon exercise a number of shares of Common Stock having a market value of two times the Purchase Price. In the event that the Company is acquired in a merger or other business combination transaction
or 50% or more of its consolidated assets or earning power is sold after a person or group of persons becomes an Acquiring Person, each Right will entitle its holder to purchase, at the Purchase Price, that number of shares of the acquiring company
having a market value of two times the Purchase Price. The Rights will expire in fiscal 2007 and are subject to redemption by the Company at $0.01 per Right, subject to adjustment.



The Companys Common Capital Stock consists of 120,000,000 authorized shares of common stock, $0.01 par value.



|                                                  |  |            |  |                  |  |            
|------------------------------------------------- |  | ---------- |  | ---------------- |  | -----------
|                                                  |  | Issued     |  | Held in Treasury |  | Outstanding
|Balance, June 30, 2002                            |  | 70,364,406 |  | 180,364          |  | 70,184,042 
|                                                  |  |            | 
|Shares issued under Employee Stock Purchase Plans |  | 75,348     |  |                 |  | 75,348     
|Shares issued under Stock Option Plans            |  | 1,721,628  |  |                 |  | 1,721,628  
|                                                  |  |            |  |                  |  |            
|                                                  |  |            | 
|Balance, June 30, 2003                            |  | 72,161,382 |  | 180,364          |  | 71,981,018 
|                                                  |  |            | 
|Shares issued under Employee Stock Purchase Plans |  | 81,239     |  |                 |  | 81,239     
|Shares issued under Stock Option Plans            |  | 1,276,876  |  |                 |  | 1,276,876  
|                                                  |  |            |  |                  |  |            
|                                                  |  |            | 
|Balance, June 30, 2004                            |  | 73,519,497 |  | 180,364          |  | 73,339,133 
|                                                  |  |            |  |                  |  |            



3.    EARNINGS
PER SHARE:



Basic EPS is computed using the weighted
average number of shares outstanding during the period, while diluted EPS is calculated to reflect the potential dilution related to stock options, using the treasury stock method.



Reconciliation of Diluted Shares (prior periods adjusted for the stock split, see Note 1):



|                           |  |                     |  |        |  |       
|-------------------------- |  | ------------------- |  | ------ |  | ------
|                           |  | Year ended June 30,
|                           |  | 2004                |  | 2003   |  | 2002  
|                           |  | (in thousands)     
|Basic shares               |  | 72,786              |  | 70,956 |  | 66,052
|Dilution for stock options |  | 2,084               |  | 2,062  |  | 2,906 
|                           |  |                     |  |        |  |       
|Diluted shares             |  | 74,870              |  | 73,018 |  | 68,958
|                           |  |                     |  |        |  |       



Options to purchase
190,500, 194,192 and 177,472 shares were excluded from the dilutive earnings per share calculation because of their antidilutive effect (due to the exercise price of such options exceeding the average market price for the period) for fiscal years
2004, 2003, and 2002 respectively.



59



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



4.    PROPERTY AND EQUIPMENT:



Property and equipment consisted of the following at June 30:



|                                               |  |                |         |      |   |        
|---------------------------------------------- |  | -------------- | ------- | ---- | - | -------
|                                               |  | 2004           |         | 2003
|                                               |  | (in thousands)
|Assets (asset lives in years)                  |  |                |         |      |   |        
|Land                                           |  | $              | 10,213  |      | $ | 8,740  
|Buildings and improvements (15 to 30)          |  |                | 81,411  |      |   | 63,674 
|Furniture and equipment (3 to 10)              |  |                | 232,660 |      |   | 204,670
|Library books (10)                             |  |                | 13,543  |      |   | 9,018  
|Leasehold interests and improvements (1 to 20) |  |                | 137,357 |      |   | 110,494
|Aircraft (12)                                  |  |                | 2,240   |      |   |       
|Construction in progress                       |  |                |        |      |   | 7,598  
|                                               |  |                |         |      |   |        
|Total                                          |  |                | 477,424 |      |   | 404,194
|Less accumulated depreciation                  |  |                | 201,276 |      |   | 173,445
|                                               |  |                |         |      |   |        
|                                               |  | $              | 276,148 |      | $ | 230,749
|                                               |  |                |         |      |   |        



Depreciation expense
for the fiscal years ended June 30, 2004, 2003, and 2002 was approximately $48.4 million, $40.5 million and $30.0 million, respectively.



On April 1, 2003, the Company revised the estimated useful lives of several classes of fixed assets to more accurately reflect the current estimates of
actual usage. This change was a result of the reevaluating the estimated useful lives of certain fixed asset categories. While the estimated useful life of furniture and fixtures, culinary equipment and library book increased, the estimated useful
life of personal computers decreased. The change in the useful lives was as follows



|                       |  |                         |  |        
|---------------------- |  | ----------------------- |  | -------
|                       |  | Useful lives (in years)
|                       |  | Prior                   |  | Current
|Category of Asset      |  |                         |  |        
|Personal computers     |  | 5                       |  | 3      
|Furniture and fixtures |  | 5                       |  | 7      
|Culinary equipment     |  | 5                       |  | 7      
|Library books          |  | 3                       |  | 10     



60



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The Company accounted for this change in accounting estimate prospectively. The adjustment of useful
lives resulted in an additional depreciation charge of approximately $3.2 million in the fourth quarter of fiscal 2003 and $0.6 million in fiscal 2004.



5.    INTANGIBLE ASSETS:



The changes in the carrying amount of goodwill for the years ended June 30, 2004 and 2003, were as follows (in thousands):



|                                                                         |  |   |         |  
|------------------------------------------------------------------------ |  | - | ------- | -
|Balance as of June 30, 2002                                              |  | $ | 131,309 |  
|Goodwill related to acquisitions and earnout payments during fiscal 2003 |  |   | 24,391  |  
|Purchase price adjustments(1)                                            |  |   | (1,321  | )
|Goodwill variance due to foreign currency translation                    |  |   | 2,322   |  
|                                                                         |  |   |         |  
|Balance as of June 30, 2003                                              |  |   | 156,701 |  
|Goodwill related to acquisitions and earnout payments during fiscal 2004 |  |   | 154,685 |  
|Goodwill variance due to foreign currency translation                    |  |   | 139     |  
|                                                                         |  |   |         |  
|Balance as of June 30, 2004                                              |  | $ | 311,525 |  
|                                                                         |  |   |         |  



|(1) |  | The purchase price adjustment in fiscal 2003 for Argosy relates primarily to the refinement of the liability established for the straight-line effect of applicable leases.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Intangible assets consisted of the following
(dollars in thousands):



|                                   |  |                     |        |                         |   |         |                                          |  |                     |  |                         |        |  |   |        |  
|---------------------------------- |  | ------------------- | ------ | ----------------------- | - | ------- | ---------------------------------------- |  | ------------------- |  | ----------------------- | ------ |  | - | ------ | -
|                                   |  | At June 30, 2004    |        | At June 30, 2003        |  
|                                   |  | GrossCarryingAmount |        | AccumulatedAmortization |   |         | WeightedAverageAmortizationPeriod(years) |  | GrossCarryingAmount |  | AccumulatedAmortization |       
|Curriculum                         |  | $                   | 13,260 |                         | $ | (4,973  | )                                        |  | 7                   |  | $                       | 9,126  |  | $ | (3,080 | )
|Accreditation                      |  |                     | 4,023  |                         |   | (1,043  | )                                        |  | 11                  |  |                         | 3,534  |  |   | (732   | )
|Bachelors degree programs         |  |                     | 1,100  |                         |   | (270    | )                                        |  | 15                  |  |                         | 1,100  |  |   | (198   | )
|Student contracts and applications |  |                     | 12,502 |                         |   | (7,804  | )                                        |  | 3                   |  |                         | 7,854  |  |   | (3,589 | )
|Software                           |  |                     | 424    |                         |   | (299    | )                                        |  | 4                   |  |                         | 395    |  |   | (166   | )
|Title IV                           |  |                     | 1,130  |                         |   | (172    | )                                        |  | 12                  |  |                         | 785    |  |   | (82    | )
|Tradename                          |  |                     | 500    |                         |   |        |                                          |  | Indefinite          |  |                         | 500    |  |   |       |  
|Other                              |  |                     | 3,738  |                         |   | (1,520  | )                                        |  | 15                  |  |                         | 2,768  |  |   | (1,323 | )
|                                   |  |                     |        |                         |   |         |                                          |  |                     |  |                         |        |  |   |        |  
|Total                              |  | $                   | 36,677 |                         | $ | (16,081 | )                                        |  | 5                   |  | $                       | 26,062 |  | $ | (9,170 | )
|                                   |  |                     |        |                         |   |         |                                          |  |                     |  |                         |        |  |   |        |  



Amortization of
intangible assets for the years ended June 30, 2004, 2003, and 2002 was approximately $6.9 million, $4.4 million and $2.9 million, respectively. Additionally, approximately $1.2 million of goodwill was written off in 2002 in connection with the
closure of the National Center for Paralegal Training and the Halifax, Nova Scotia location of ITI. Estimated amortization expense for amortized intangible assets for the next five fiscal years is as follows:



|             |  |                |      
|------------ |  | -------------- | -----
|Fiscal years |  | (in thousands)
|2004         |  | $              | 6,171
|2005         |  |                | 3,169
|2006         |  |                | 1,684
|2007         |  |                | 1,296
|2008         |  |                | 1,016



61



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



6.    INDEBTEDNESS:



The Company and its subsidiaries were indebted under the following obligations as of June 30 (in thousands):



|                                                                                                           |  |      |         |      |   |       
|---------------------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | ------
|                                                                                                           |  | 2004 |         | 2003
|Revolving credit facilities                                                                                |  | $    | 125,100 |      | $ | 35,000
|Note payable                                                                                               |  |      | 11,000  |      |   |      
|Mortgage debt, fixed rate of 7.13% with monthly payments of $26, including interest, through March 1, 2006 |  |      | 3,422   |      |   | 3,500 
|Capital lease                                                                                              |  |      | 38      |      |   |      
|                                                                                                           |  |      |         |      |   |       
|                                                                                                           |  |      | 139,560 |      |   | 38,500
|Less current portion                                                                                       |  |      | 125,194 |      |   | 35,074
|                                                                                                           |  |      |         |      |   |       
|                                                                                                           |  | $    | 14,366  |      | $ | 3,426 
|                                                                                                           |  |      |         |      |   |       



On August 18, 2003,
the Company and its lenders amended and restated a Credit Agreement that increased allowable borrowings from $150 million to $250 million. The Credit Agreement, which expires on August 18, 2008, contains customary covenants that, among others
matters, require the Company to meet specified financial ratios, restrict the repurchase of Common Stock and limit the incurrence of additional indebtedness. At June 30, 2004, the Company had $125.1 million drawn against this facility and was in
compliance with covenants under the Credit Agreement. The Company repaid the entire amount under the revolver in July 2004. The Company pays commitment fees on the unused credit amount under the facility. At June 30, 2004 these fees were 20 basis
points of the available borrowings, based upon a measure of leverage as defined in the Credit Agreement. The Company had approximately $3.9 million of letters of credit outstanding at June 30, 2004, which reduced the available borrowings under the
facility. The $11.0 million note payable was paid on September 2, 2004.



Relevant information regarding borrowings under the revolving credit facilities under both the Credit Agreement and the prior credit agreement is reflected below:



|                                                              |  |                        |         |   |      |   |        |      |  |   |        |  
|------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                              |  | Year ended June 30,    |        
|                                                              |  | 2004                   |         |   | 2003 |   |        | 2002 | 
|                                                              |  | (dollars in thousands) |        
|Outstanding borrowings, end of period                         |  | $                      | 125,100 |   |      | $ | 35,000 |      |  | $ | 25,000 |  
|Approximate average outstanding balance throughout the period |  |                        | 26,121  |   |      |   | 83     |      |  |   | 9,957  |  
|Approximate maximum outstanding balance during the period     |  |                        | 125,100 |   |      |   | 35,000 |      |  |   | 53,750 |  
|Weighted average interest rate for the period                 |  |                        | 2.25    | % |      |   | 2.51   | %    |  |   | 4.45   | %



As of June 30, 2004,
future annual principal payments on debt related instruments are as follows:



|             |  |                |      
|------------ |  | -------------- | -----
|Fiscal years |  | (in thousands)
|2005         |  | $              | 94   
|2006         |  |                | 3,328



62



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



7.    COMMITMENTS AND CONTINGENCIES:



The Company and its subsidiaries lease certain classroom, dormitory and
office space as well as equipment and automobiles under operating leases that expire on various dates through September 2022. Rent expense under these leases was $80.5 million, $68.1 million, and $52.7 million respectively for 2004, 2003 and 2002.
Rent expense includes short-term commitments for student housing of $23.8 million, $19.8 million, and $18.5 million respectively for 2004, 2003 and 2002. Certain of the Companys operating leases contain provisions for escalating payments and
options for renewal. The approximate minimum future commitments under non-cancelable, long-term operating leases as of June 30, 2004 are reflected below:



|             |  |                |        
|------------ |  | -------------- | -------
|Fiscal Years |  | (in thousands)
|2005         |  | $              | 78,264 
|2006         |  |                | 67,525 
|2007         |  |                | 59,458 
|2008         |  |                | 54,893 
|2009         |  |                | 52,515 
|Thereafter   |  |                | 180,449
|             |  |                |        
|             |  | $              | 493,104
|             |  |                |        



In November 2002, the
Financial Accounting Standards Board (FASB) issued Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Indebtedness of Others. This interpretation elaborates on
the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it issued. The Company guarantees a significant portion of real estate lease obligations for its
subsidiaries, including a mortgage on the building that the Western State University College of Law occupies, which had an outstanding balance of $3.4 million at June 30, 2004. The Company would be required to perform under these guarantees if
the subsidiary could not satisfy the obligations. The Company has no guarantees for any unconsolidated entities. The minimum future commitments under non-cancelable, long-term operating leases at June 30, 2004 are reflected in the above table.



The Company has a management incentive compensation plan that
provides for the awarding of cash bonuses to management personnel using formalized guidelines based upon the operating results of individual schools and of the Company and other qualitative factors. These amounts are reflected in accrued liabilities
in the accompanying balance sheets.



The Company is a defendant
in certain legal proceedings arising out of the conduct of its businesses. In the opinion of management, based upon its investigation of these claims and discussion with legal counsel, the ultimate outcome of such legal proceedings, individually and
in the aggregate, will not have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company.



On December 11, 2003, the ABA Council of the Section of Legal Education and Admission to the Bar notified Western State University (WSU) that
the Council had adopted a motion to withdraw provisional approval and that the matter would be submitted to the ABA House of Delegates at its meeting in February 2004. On January 16, 2004, WSU and two WSU students filed a lawsuit against the ABA in
the United States District Court for the Central District of California seeking a preliminary injunction preventing the ABA from reviewing the Councils decision to withdraw provisional approval at the February meeting of the House of
Delegates. WSU and the ABA subsequently reached an agreement pursuant to which WSU voluntarily relinquished ABA approval as of August 8, 2004. In accordance with the terms of the settlement agreement, WSU filed a new application for provisional
approval by the ABA on August 23, 2004. Under the terms of the settlement agreement, the ABA will perform a site inspection in the fall of 2004. Following the site visit, the inspection team will issue an inspection report which will be most likely
be acted upon by the Accreditation Committee of the Section on Legal Education and Admission to the Bar in January 2005 and by the Council and the House of Delegates in



63



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



February 2005. WSU continues to be eligible to participate in federal financial aid programs, as it is separately accredited by the Senior Commission of the
Western Association of Schools and Colleges. WSU is also accredited by the Committee of Bar Examiners of the State Bar of California. The Company has concluded that, despite the actions described above, an impairment of WSUs assets is not
apparent.



8.    RELATED PARTY TRANSACTIONS:



The Art Institute of Philadelphia, a division of The Art
Institutes International, Inc (AII), which is a wholly-owned subsidiary of EDMC, leases one of the buildings it occupies from a partnership in which the subsidiary serves as a 1% general partner and an executive officer/director and a
director of EDMC are among the minority limited partners. The Art Institute of Fort Lauderdale, Inc., a wholly-owned subsidiary of AII, leases part of its facilities from a partnership in which an executive officer/director of EDMC is one of several
minority limited partner. Total rental payments, which are included in educational services on the consolidated income statements, under these arrangements were approximately $2.9 million, $2.4 million and $2.5 million for the fiscal years ended
June 30, 2004, 2003 and 2002, respectively.



South University,
which is a wholly-owned subsidiary of EDMC, leases two of the buildings it occupies from two separate entities owned by the President of South University, who became an employee of EDMC after the purchase of South. Total rental payments, which are
included in educational services on the consolidated statements of income, under these arrangements were approximately $0.8 million for the fiscal year ended June 30, 2004.



9.    EMPLOYEE BENEFIT PLANS:



The Company sponsors a retirement plan that covers substantially all employees. This plan provides for matching Company
contributions of 100% of employee 401(k) contributions up to 3% of compensation and 50% of contributions between 4% and 6% of compensation. Other contributions to the plan are at the discretion of the Board of Directors. The provisions of the plan
allow that forfeitures of unvested balances can be used to reduce the Companys matching contributions. The expense relating to these plans was approximately $4.3 million, $2.8 million and $1.8 million for the fiscal years ended June 30, 2004,
2003 and 2002, respectively. The increase in the expense results from an increased number of employees) and less forfeitures available to offset the Company match.



The Companys retirement plan includes an Employee Stock Ownership Plan (ESOP), which enabled eligible employees to
have stock ownership in the Company. The ESOP loan has been retired and no additional Company contributions are anticipated. Distribution of shares from the ESOP is made following the retirement, disability or death of an employee. For employees who
terminate for any other reason, the vested balance is distributed in accordance with the terms of the ESOP.



10.    OTHER LONG-TERM ASSETS:



Other long-term assets consist of the following at June 30 (in thousands):



|                                                                                                                   |  |      |        |      |   |       
|------------------------------------------------------------------------------------------------------------------ |  | ---- | ------ | ---- | - | ------
|                                                                                                                   |  | 2004 |        | 2003
|Investment in federal Perkins Loan Program, net of allowance for estimated future loan losses of $1,534 and $1,362 |  | $    | 3,579  |      | $ | 3,339 
|Cash value of life insurance, face value of $7,379 at June 30, 2004                                                |  |      | 4,579  |      |   | 4,322 
|Deferred compensation plan                                                                                         |  |      | 4,062  |      |   | 2,558 
|Other                                                                                                              |  |      | 2,456  |      |   | 2,012 
|                                                                                                                   |  |      |        |      |   |       
|                                                                                                                   |  | $    | 14,676 |      | $ | 12,231
|                                                                                                                   |  |      |        |      |   |       



64



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



11.    ACCRUED LIABILITIES:



Accrued liabilities consist of the following at June 30 (in thousands):



|                          |  |      |        |      |   |       
|------------------------- |  | ---- | ------ | ---- | - | ------
|                          |  | 2004 |        | 2003
|Payroll and related taxes |  | $    | 22,113 |      | $ | 14,679
|Income and other taxes    |  |      | 1,576  |      |   | 1,223 
|Professional fees         |  |      | 1,475  |      |   | 1,291 
|Other                     |  |      | 14,025 |      |   | 12,884
|                          |  |      |        |      |   |       
|                          |  | $    | 39,189 |      | $ | 30,077
|                          |  |      |        |      |   |       



12.    INCOME
TAXES:



The composition of income before taxes from
foreign and domestic locations for the year ended June 30 follows (in thousands):



|                    |  |      |         |   |      |   |        |      |  |   |        |  
|------------------- |  | ---- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                    |  | 2004 |         |   | 2003 |   |        | 2002 | 
|Income before taxes |  |      |         |   |      |   |        |      |  |   |        |  
|Domestic            |  | $    | 138,888 |   |      | $ | 94,499 |      |  | $ | 70,845 |  
|Foreign             |  |      | (8,377  | ) |      |   | (3,048 | )    |  |   | (3,430 | )
|                    |  |      |         |   |      |   |        |      |  |   |        |  
|                    |  | $    | 130,511 |   |      | $ | 91,451 |      |  | $ | 67,415 |  
|                    |  |      |         |   |      |   |        |      |  |   |        |  



The provision for
income taxes includes current and deferred taxes as reflected below (in thousands):



|                             |  |                     |         |   |      |   |        |      |  |   |        |  
|---------------------------- |  | ------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                             |  | Year ended June 30, |        
|                             |  | 2004                |         |   | 2003 |   |        | 2002 | 
|Current taxes:               |  |                     |         |   |      |   |        |      |  |   |        |  
|Federal                      |  | $                   | 42,744  |   |      | $ | 29,704 |      |  | $ | 23,671 |  
|State                        |  |                     | 12,985  |   |      |   | 5,567  |      |  |   | 4,221  |  
|Tax benefit on stock options |  |                     | (10,461 | ) |      |   | (8,220 | )    |  |   | (5,869 | )
|                             |  |                     |         |   |      |   |        |      |  |   |        |  
|Total current taxes          |  |                     | 45,268  |   |      |   | 27,051 |      |  |   | 22,023 |  
|Deferred taxes               |  |                     | (2,232  | ) |      |   | (97    | )    |  |   | (2,791 | )
|Tax benefit on stock options |  |                     | 10,461  |   |      |   | 8,220  |      |  |   | 5,869  |  
|                             |  |                     |         |   |      |   |        |      |  |   |        |  
|Total provision              |  | $                   | 53,497  |   |      | $ | 35,174 |      |  | $ | 25,101 |  
|                             |  |                     |         |   |      |   |        |      |  |   |        |  



The provision for
income taxes reflected in the accompanying consolidated statements of income varies from the amounts that would have been provided by applying the federal statutory income tax rate to earnings before income taxes as shown below:



|                                                                |  |                     |   |  |      |   |  |      |  
|--------------------------------------------------------------- |  | ------------------- | - |  | ---- | - |  | ---- | -
|                                                                |  | Year ended June 30, |  
|                                                                |  | 2004                |   |  | 2003 |   |  | 2002 |  
|Federal statutory income tax rate                               |  | 35.0                | % |  | 35.0 | % |  | 35.0 | %
|State and local income taxes, net of federal income tax benefit |  | 4.5                 |   |  | 3.5  |   |  | 2.7  |  
|Goodwill and intangible asset related charges                   |  |                    |   |  | 0.2  |   |  | 0.6  |  
|Nondeductible expenses                                          |  | 0.7                 |   |  | 0.3  |   |  | 0.3  |  
|Tax liability adjustment                                        |  | (1.0                | ) |  |     |   |  | (1.1 | )
|Tax credits                                                     |  |                    |   |  |     |   |  | (1.2 | )
|Increase in valuation allowance                                 |  | 3.1                 |   |  |     |   |  | 1.3  |  
|Other, net                                                      |  | (1.3                | ) |  | (0.5 | ) |  | (0.4 | )
|                                                                |  |                     |   |  |      |   |  |      |  
|Effective income tax rate                                       |  | 41.0                | % |  | 38.5 | % |  | 37.2 | %
|                                                                |  |                     |   |  |      |   |  |      |  



65



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Net deferred income tax assets (liabilities) consist of the following as of June 30 (in thousands):



|                                                                   |  |      |        |   |      |   |        |      |  |   |        |  
|------------------------------------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                   |  | 2004 |        |   | 2003 |   |        | 2002 | 
|Deferred income taxcurrent                                        |  | $    | 17,203 |   |      | $ | 11,739 |      |  | $ | 10,122 |  
|Deferred income taxlong term                                      |  |      | 1,751  |   |      |   | (30    | )    |  |   | 1,742  |  
|                                                                   |  |      |        |   |      |   |        |      |  |   |        |  
|Gross deferred tax asset                                           |  |      | 18,954 |   |      |   | 11,709 |      |  |   | 11,864 |  
|Valuation allowance                                                |  |      | (7,643 | ) |      |   | (3,578 | )    |  |   | (3,578 | )
|                                                                   |  |      |        |   |      |   |        |      |  |   |        |  
|Net deferred income tax asset                                      |  | $    | 11,311 |   |      | $ | 8,131  |      |  | $ | 8,286  |  
|                                                                   |  |      |        |   |      |   |        |      |  |   |        |  
|Consisting of:                                                     |  |      |        |   |      |   |        |      |  |   |        |  
|Allowance for doubtful accounts                                    |  | $    | 16,981 |   |      | $ | 10,858 |      |  | $ | 9,063  |  
|Assigned asset values for intangible assets in excess of tax basis |  |      | (8,035 | ) |      |   | (3,984 | )    |  |   | (3,337 | )
|Depreciation                                                       |  |      | (3,498 | ) |      |   | (4,451 | )    |  |   | (401   | )
|Foreign and state net operating loss carryforwards                 |  |      | 10,262 |   |      |   | 7,503  |      |  |   | 6,979  |  
|Financial reserves and other                                       |  |      | 3,244  |   |      |   | 1,783  |      |  |   | (440   | )
|Valuation allowance                                                |  |      | (7,643 | ) |      |   | (3,578 | )    |  |   | (3,578 | )
|                                                                   |  |      |        |   |      |   |        |      |  |   |        |  
|Net deferred income tax asset                                      |  | $    | 11,311 |   |      | $ | 8,131  |      |  | $ | 8,286  |  
|                                                                   |  |      |        |   |      |   |        |      |  |   |        |  



The Company has not
provided any U.S. tax on undistributed earnings or losses of foreign subsidiaries that are reinvested indefinitely outside the United States. As of June 30, 2004 and 2003, consolidated retained earnings of the Company included approximately $14.9
million and $6.5 million of undistributed losses from these investments, respectively.



At June 30, 2004, the Company had state net operating loss carryforwards of approximately $45.1 million and foreign net operating loss carryforwards of approximately $18.2 million (of which $5.1 million relate to
acquired net operating losses) that are available to offset certain state and foreign future taxable income. These net operating loss carryforwards expire at varying dates beginning in fiscal 2007 through 2023.



The valuation allowance for deferred tax assets for fiscal 2004 and 2003 was
$7.6 million and $3.6 million, respectively, related to the foreign net operating loss carryforward. The change in the valuation allowance was due to the Companys Canadian net deferred tax assets. The Company has deferred recognition of these
assets until such time that the Canadian operations become profitable. Management assesses the realizability of the deferred tax asset and considers whether it is more likely than not that some or all of the assets will be realized. The ultimate
realization of the deferred tax asset recorded for net operating losses is dependent upon the generation of future taxable income during the periods in which the assets can be utilized.



13.    STOCK-BASED COMPENSATION:



The Company maintains a 1996 Stock Incentive Plan and a 2003 Stock Incentive Plan for directors, executive management and
key personnel, which provide for the issuance of stock-based incentive awards. An aggregate of 12,000,000 and 5,400,000 shares of Common Stock are reserved for issuance under the 1996 Stock Incentive Plan and 2003 Stock Incentive Plan, respectively.
Prior to fiscal 2004, options issued to employees under the 1996 Incentive Plan provide for time-based vesting over three years. The majority of the grants made to employees in fiscal 2004 provide for time-based vesting over two years.



The Company also has two non-qualified management stock option plans under
which options to purchase shares of Common Stock were granted to management employees prior to 1996. All outstanding options under these non-qualified plans are fully vested. Under the terms of the three plans, the Board of Directors granted options
to purchase shares at prices representing the fair market value of the shares at the time of the grant.



66



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EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The Company made a restricted stock grant of 100,000 shares in the first quarter of 2004.
Compensation expense of approximately $0.9 million, is being recognized on a straight line basis over the vesting period.



The Company also has an employee stock purchase plan. The plan allows eligible employees of the Company to purchase at a specified discount, up to an
aggregate of 3,000,000 shares of Common Stock at quarterly intervals through periodic payroll deduction. The number of shares of Common Stock issued under this plan was 81,239, 75,348 and 37,560 in fiscal 2004, 2003 and 2002, respectively. In fiscal
2002 an additional 31,696 shares were issued from treasury under this plan. The Company had an ESOP feature as part of its retirement plan for its employees. Under the ESOP feature of the plan, the Company is under no further obligation to make ESOP
contributions to the Plan, but may do so at its discretion. No Company contributions were made in fiscal 2004 or 2003.



The Companys Board of Directors declared a stock split effected in the form of a stock dividend, payable at the rate of one share of Common Stock as
of the close of business on December 1, 2003 for each common share outstanding. The shares issued for the stock split were distributed on December 22, 2003. The share information for all periods presented have been adjusted to reflect the stock
split.



Summary of Stock Options



|                               |  |           |  |                                 |       |         |           |                                 |   |         |  |                                 |  |   |      
|------------------------------ |  | --------- |  | ------------------------------- | ----- | ------- | --------- | ------------------------------- | - | ------- |  | ------------------------------- |  | - | -----
|                               |  | 2004      |  | 2003                            |       | 2002   
|                               |  | Options   |  | Weighted Average Exercise Price |       | Options |           | Weighted Average Exercise Price |   | Options |  | Weighted Average Exercise Price
|Outstanding, beginning of year |  | 5,632,654 |  | $                               | 11.84 |         | 7,108,284 |                                 | $ | 10.28   |  | 5,135,948                       |  | $ | 6.65 
|Granted                        |  | 3,124,214 |  |                                 | 29.68 |         | 534,566   |                                 |   | 19.64   |  | 3,396,246                       |  |   | 13.99
|Exercised                      |  | 1,404,317 |  |                                 | 9.57  |         | 1,759,772 |                                 |   | 7.97    |  | 1,260,338                       |  |   | 5.86 
|Forfeited                      |  | 504,512   |  |                                 | 18.09 |         | 250,424   |                                 |   | 9.94    |  | 163,572                         |  |   | 7.43 
|                               |  |           |  |                                 |       |         |           |                                 |   |         |  |                                 |  |   |      
|Outstanding, end of year       |  | 6,848,039 |  | $                               | 7.70  |         | 5,632,654 |                                 | $ | 11.84   |  | 7,108,284                       |  | $ | 10.28
|                               |  |           |  |                                 |       |         |           |                                 |   |         |  |                                 |  |   |      
|Exercisable, end of year       |  | 2,513,866 |  |                                 |       |         | 2,728,256 |                                 |   |         |  | 2,329,770                       |  |   |      
|                               |  |           |  |                                 |       |         |           |                                 |   |         |  |                                 |  |   |      



|                         |  |                     |  |                                                     |  |                                  |       |         |           |                               |   |      
|------------------------ |  | ------------------- |  | --------------------------------------------------- |  | -------------------------------- | ----- | ------- | --------- | ----------------------------- | - | -----
|                         |  | Options Outstanding |  | Options Exercisable                                
|Range of Exercise Prices |  | Options             |  | Weighted-Average Remaining Contractual Life (years) |  | Weighted- Average Exercise Price |       | Options |           | Weighted-AverageExercisePrice
|$ 3.75$ 4.67            |  | 654,270             |  | 4.87                                                |  | $                                | 4.52  |         | 654,270   |                               | $ | 4.52 
|$ 6.19$9.25             |  | 547,172             |  | 2.79                                                |  |                                  | 7.94  |         | 547,172   |                               |   | 7.94 
|$9.40$14.00             |  | 1,432,936           |  | 7.25                                                |  |                                  | 12.20 |         | 720,500   |                               |   | 12.19
|$15.00$21.94            |  | 1,134,407           |  | 7.61                                                |  |                                  | 18.34 |         | 589,289   |                               |   | 18.00
|$23.03$32.92            |  | 3,065,254           |  | 9.41                                                |  |                                  | 30.18 |         | 2,635     |                               |   | 23.03
|$34.62                   |  | 14,000              |  | 9.92                                                |  |                                  | 34.62 |         |          |                               |   |     
|                         |  |                     |  |                                                     |  |                                  |       |         |           |                               |   |      
|                         |  | 6,848,039           |  | 7.70                                                |  | $                                | 20.23 |         | 2,513,866 |                               | $ | 10.64
|                         |  |                     |  |                                                     |  |                                  |       |         |           |                               |   |      



67



---

|ITEM  9. |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|-------- |  | ------------------------------------------------------------------------------------



None.



ITEM 9A. CONTROLS AND PROCEDURES



(a)    Evaluation of Disclosure Controls and Procedures



The Company maintains disclosure controls and procedures designed to ensure that it is able to collect the information it is
required to disclose in the reports it files with the Securities and Exchange Commission and to process, summarize and disclose this information within the time periods specified in the Securities and Exchange Commissions rules. The
Companys management, including the chief executive officer and chief financial officer, evaluated disclosure controls and procedures as of the end of the period covered by this report (the Evaluation Date). Based on that
evaluation, the Company concluded that, as of the Evaluation Date, the Companys disclosure controls and procedures are functioning effectively to alert management on a timely basis to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Companys periodic filings with the Securities and Exchange Commission.



(b)    Changes in Internal Controls over Financial Reporting



No significant change in the Companys internal controls over financial reporting occurred during the fourth fiscal
quarter that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.



68



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PART III



ITEM 10DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY



The information required by this Item will be contained in the Proxy Statement under the captions Nominees as Directors for Terms Expiring at the
2007 Annual Meeting of Shareholders, Directors Continuing in Office, Executive Officers of the Company, and Section 16(a) Beneficial Ownership Reporting Compliance, and is incorporated herein by reference.



ITEM 11EXECUTIVE COMPENSATION



The information required by this Item will be contained in the Proxy
Statement under the captions Compensation of Executive Officers, Directors Compensation, Compensation Committee Interlocks and Insider Participants and Employment Agreements, and is incorporated
herein by reference.



ITEM 12SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT



The information required by this
Item will be contained in the Proxy Statement under the captions Security Ownership and Equity Compensation Plan Information, and is incorporated herein by reference.



ITEM 13CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



The information required by this Item will be contained in the Proxy
Statement under the caption Certain Transactions, and is incorporated herein by reference.



ITEM 14PRINCIPAL ACCOUNTANT FEES AND SERVICES



The information required by this Item will be contained in the Proxy Statement under the caption Relationship With Independent Auditors, and is incorporated herein by reference.



PART IV



ITEM 15EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K



(1)    Financial Statements:



The following financial statements of the Company and its subsidiaries are
included in Part II, Item 8, on pages 43 through 63 of this Form 10-K.



Report of Independent Registered Public Accounting Firm



Consolidated Balance Sheets as of June 30, 2004 and 2003



Consolidated Statements of Income for years ended June 30, 2004, 2003 and 2002



Consolidated Statements of Cash Flows for years ended June 30, 2004, 2003 and 2002



Consolidated Statements of Shareholders Investment for years ended June 30, 2004, 2003 and 2002



Notes to Consolidated Financial Statements



(2)    Supplemental Financial Statement Schedules



Valuation and Qualifying Accounts, on page S-1 of this Form
10-K, is filed herewith.



All other schedules
for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.



69



---

(3)    The exhibits listed on the Exhibit Index on pages E-1 to E-4 of this Form 10-K
are filed herewith or are incorporated herein by reference.



70



---

SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) 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.



|                                
|--------------------------------
|EDUCATION MANAGEMENT CORPORATION
|                                
|By:    /s/ JOHN R. MCKERNAN,
JR.
|John R. McKernan, Jr.           
|Chief Executive Officer         



Date:
September 13, 2004



Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.



|                                                        |  |                                                      |  |                   
|------------------------------------------------------- |  | ---------------------------------------------------- |  | ------------------
|Signature                                               |  | Title                                                |  | Date              
|                                                        |  |                                                     
|/s/    ROBERT B.
KNUTSONRobert B.
Knutson               |  | Chairman and Director                                |  | September 13, 2004
|                                                        |  |                                                     
|/s/    JOHN R. MCKERNAN,
JR.John R. McKernan,
Jr.       |  | Chief Executive Officer and Director                 |  | September 13, 2004
|                                                        |  |                                                     
|/s/    ROBERT T.
MCDOWELLRobert T.
McDowell             |  | Executive Vice President and Chief Financial Officer |  | September 13, 2004
|                                                        |  |                                                     
|/s/    ROBERT H.
ATWELLRobert H.
Atwell                 |  | Director                                             |  | September 13, 2004
|                                                        |  |                                                     
|/s/    JAMES J. BURKE,
JR.James J. Burke,
Jr.           |  | Director                                             |  | September 13, 2004
|                                                        |  |                                                     
|/s/    WILLIAM M. CAMPBELL,
IIIWilliam M. Campbell, III |  | Director                                             |  | September 13, 2004
|                                                        |  |                                                     
|/s/    MARTIN L.
GARCIAMartin L.
Garcia                 |  | Director                                             |  | September 13, 2004
|                                                        |  |                                                     
|/s/    MIRYAM L.
KNUTSONMiryam L.
Knutson               |  | Director                                             |  | September 13, 2004
|                                                        |  |                                                     
|/s/    JAMES S. PASMAN,
JR.James S. Pasman,
Jr.         |  | Director                                             |  | September 13, 2004
|                                                        |  |                                                     
|/s/    FRIEDRICH
TEROERDEFriedrich
Teroerde             |  | Director                                             |  | September 13, 2004
|                                                        |  |                                                     
|/s/    DANIEL M.
FITZPATRICKDaniel M.
Fitzpatrick       |  | Senior Vice President and Controller                 |  | September 13, 2004



71



---

SCHEDULE II



EDUCATION MANAGEMENT CORPORATION AND SUBSIDIARIES



VALUATION AND QUALIFYING ACCOUNTS



(Dollars in thousands)



|                                       |  |                                |        |                               |   |            |  |          |        |                          |   |       |  |   |       
|-------------------------------------- |  | ------------------------------ | ------ | ----------------------------- | - | ---------- |  | -------- | ------ | ------------------------ | - | ----- |  | - | ------
|                                       |  | Balance at Beginning of Period |        | Additions Charged to Expenses |   | Deductions |  | Other(a) |        | Balance at End of Period
|Allowance accounts for:                |  |                                |        |                               |   |            |  |          |        |                          |   |       |  |   |       
|Year ended June 30, 2002               |  |                                |        |                               |   |            |  |          |        |                          |   |       |  |   |       
|Uncollectable accounts receivable      |  | $                              | 17,410 |                               | $ | 12,463     |  | $        | 7,575  |                          | $ | 1,645 |  | $ | 24,003
|Estimated future loan losses           |  |                                | 1,252  |                               |   | 48         |  |          |       |                          |   |      |  |   | 1,300 
|Deferred tax asset valuation allowance |  |                                |       |                               |   | 874        |  |          |       |                          |   | 2,704 |  |   | 3,578 
|                                       |  |                                |        |                               |  
|Year ended June 30, 2003               |  |                                |        |                               |   |            |  |          |        |                          |   |       |  |   |       
|Uncollectable accounts receivable      |  | $                              | 24,003 |                               | $ | 13,242     |  | $        | 10,984 |                          | $ | 576   |  | $ | 26,837
|Estimated future loan losses           |  |                                | 1,300  |                               |   | 62         |  |          |       |                          |   |      |  |   | 1,362 
|Deferred tax asset valuation allowance |  |                                | 3,578  |                               |   |           |  |          |       |                          |   |      |  |   | 3,578 
|                                       |  |                                |        |                               |  
|Year ended June 30, 2004               |  |                                |        |                               |   |            |  |          |        |                          |   |       |  |   |       
|Uncollectable accounts receivable      |  | $                              | 26,837 |                               | $ | 22,423     |  | $        | 8,357  |                          | $ |      |  | $ | 40,903
|Estimated future loan losses           |  |                                | 1,362  |                               |   | 172        |  |          |       |                          |   |      |  |   | 1,534 
|Deferred tax asset valuation allowance |  |                                | 3,578  |                               |   | 4,065      |  |          |       |                          |   |      |  |   | 7,643 

---

|(a) |  | Allowance for uncollectable accounts receivable and valuation allowance for deferred tax assets acquired in connection with acquisitions of subsidiaries.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



S-1



---

EXHIBIT INDEX



|              |  |                                                                                                                                                                                                                                 |  |                                                                                                                                                                                                                 
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit                                                                                                                                                                                                                         |  | Method of Filing                                                                                                                                                                                                
|              |  |                                                                                                                                                                                                                                
|3.01          |  | Amended and Restated Articles of Incorporation                                                                                                                                                                                  |  | Incorporated herein by reference to Exhibit 4.01 to the Companys Registration Statement on Form S-8 (File No. 333-110706) filed on November 24, 2003                                                           
|              |  |                                                                                                                                                                                                                                
|3.02          |  | Restated By-laws                                                                                                                                                                                                                |  | Incorporated herein by reference to Exhibit 3.01 to the Companys Quarterly Report on Form 10-Q for the quarter ended December 31, 2003                                                                         
|              |  |                                                                                                                                                                                                                                
|4.01          |  | Specimen Common Stock Certificate                                                                                                                                                                                               |  | Incorporated herein by reference to Exhibit 4.01 to Amendment No. 3 filed on October 28, 1996 to the Companys Registration Statement on Form S-1 (File No. 333-10385) filed on August 19,
1996 (the Form S-1)
|              |  |                                                                                                                                                                                                                                
|4.02          |  | Rights Agreement, dated as of October 1, 1996, between Education Management Corporation and Mellon Bank, N.A                                                                                                                    |  | Incorporated herein by reference to Exhibit 4.02 to the Companys Annual Report on Form 10-K for the year ended June 30, 1997 (the 1997 Form 10-K)                                                            
|              |  |                                                                                                                                                                                                                                
|4.03          |  | Amendment No. 1, dated November 9, 1999, to the Rights Agreement dated as of October 1, 1996 between the Company and ChaseMellon Shareholder Services, L.L.C., as Rights Agent                                                  |  | Incorporated herein by reference to Exhibit 4.01 to the Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 1999 (the September 30, 1999
10-Q)                                        
|              |  |                                                                                                                                                                                                                                
|4.04          |  | Letter Agreement dated November 9, 1999 by and among the Company, Baron Capital Group, Inc., BAMCO, Inc., Baron Capital Management Inc. and Ronald Baron                                                                        |  | Incorporated herein by reference to Exhibit 4.02 to the September 30, 1999 10-Q                                                                                                                                 
|              |  |                                                                                                                                                                                                                                
|4.05          |  | Amended and Restated Credit Agreement dated September 20, 2001 among the Company, National City Bank of Pennsylvania as the agent for the other lenders identified therein, and certain
banks                                   |  | Incorporated herein by reference to Exhibit 2 to Schedule 13D filed by Argosy Education Group, Inc. (Argosy) on October 9, 2001                                                                               
|              |  |                                                                                                                                                                                                                                
|4.06          |  | First Amendment to Amended and Restated Credit Agreement, dated February 15, 2002, among the Company, National City Bank of Pennsylvania as the agent for the other lenders identified therein,
and certain banks               |  | Incorporated herein by reference to Exhibit 4.06 to the Companys Annual Report on Form 10-K for the year ended June 30, 2002 (the 2002 Form 10-K                                                             
|              |  |                                                                                                                                                                                                                                
|4.07          |  | Second Amendment to Amended and Restated Credit Agreement, dated August 19, 2002, among the Company, National City Bank of Pennsylvania as the agent for the other lenders identified therein, and
certain banks                |  | Incorporated herein by reference to Exhibit 4.07 to the 2002 Form 10-K                                                                                                                                          
|              |  |                                                                                                                                                                                                                                
|4.08          |  | Waiver and Third Amendment to Amended and Restated Credit Agreement, dated as of April 30, 2003, among the Company, National City Bank of Pennsylvania as the agent for the other lenders
identified therein, and certain banks |  | Incorporated by reference to Exhibit 4.08 to the Companys Annual Report on Form 10-K for the year ended June 30, 2003 (the 2003 Form 10-K)                                                                   



E-1



---

|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |                                                                                                                                                       
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit                                                                                                                                                                                                                                                                                                                                                                                                                                                         |  | Method of Filing                                                                                                                                      
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|4.09          |  | Fourth Amendment to Amended and Restated Credit Agreement, dated as of June 27, 2003, among the Company, National City Bank of Pennsylvania as the agent for the other lenders identified therein,
and certain banks                                                                                                                                                                                                                                            |  | Incorporated by reference to Exhibit 4.09 to the 2003 Form 10-K                                                                                       
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|4.10          |  | Second Amended and Restated Credit Agreement dated as of August 18, 2003 by and among Education Management Corporation as the Borrower, The Banks Party Thereto as the Banks and National City
Bank of Pennsylvania as the Agent and Wachovia Bank, National Association, as Syndication Agent, Suntrust Bank, as Syndication Agent, Fleet National Bank, as Documentation Agent, and JPMorgan Chase Bank, as Documentation Agent                               |  | Incorporated herein by reference to Exhibit 4.1 to the Companys Current Report on Form 8-K filed on September 17, 2003 (the September 17, 2003 8-K)
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|10.01         |  | Stock Purchase Agreement dated as of June 24, 2003 by and among Education Management Corporation and Russell E. Palmer, Bradley C. Palmer, The Stephen R. Palmer Living Trust, The Russell E.
Palmer III Living Trust, The Karen J. Korfmann Living Trust, Michael Masin, Connie Walter, Technology Leaders L.P., Technology Leaders First Corp., J. William Brooks, Gerard Francois, Danny Finuf, The Companies Signatory Thereto and Sellers
Representative. |  | Incorporated herein by reference to Exhibit 2.1 to the September 17, 2003 8-K                                                                         
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|10.02         |  | Education Management Corporation Retirement Plan                                                                                                                                                                                                                                                                                                                                                                                                                |  | Incorporated by reference to Exhibit 10.02 to the 2003 Form 10-K*                                                                                     
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|10.03         |  | Education Management Corporation Management Incentive Stock Option Plan, effective November 11, 1993                                                                                                                                                                                                                                                                                                                                                            |  | Incorporated herein by reference to Exhibit 10.05 to the Form S-1*                                                                                    
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|10.04         |  | EMC Holdings, Inc. Management Incentive Stock Option Plan, effective July 1, 1990                                                                                                                                                                                                                                                                                                                                                                               |  | Incorporated herein by reference to Exhibit 10.06 to Amendment No. 1 to the Form S-1, filed on October 1, 1996 (Amendment No. 1)*                   
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|10.05         |  | Form of Management Incentive Stock Option Agreement, dated various dates, between EMC Holdings, Inc. and various management employees                                                                                                                                                                                                                                                                                                                           |  | Incorporated herein by reference to Exhibit 10.07 to Amendment No. 1*                                                                                 
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|10.06         |  | Form of Amendment to Management Incentive Stock Option Agreement, dated January 19, 1995, among Education Management Corporation and various management employees                                                                                                                                                                                                                                                                                               |  | Incorporated herein by reference to Exhibit 10.08 to Amendment No. 1*                                                                                 
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|10.07         |  | Education Management Corporation Deferred Compensation Plan                                                                                                                                                                                                                                                                                                                                                                                                     |  | Incorporated by reference to Exhibit 10.07 to the 2003 Form 10-K*                                                                                     
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|10.08         |  | Education Management Corporation Employee Stock Purchase Plan                                                                                                                                                                                                                                                                                                                                                                                                   |  | Incorporated by reference to Exhibit 10.08 to the 2003 Form 10-K*                                                                                     



E-2



---

|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  |                                                                                                            
|------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | Method of Filing                                                                                           
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.09         |  | 2001 Restatement of the Education Management Corporation 1996 Stock Incentive Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |  | Incorporated herein by reference to Exhibit A to the Proxy Statement for the Companys 2001 Annual Meeting*
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.10         |  | Education Management Corporation 2003 Incentive Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  | Incorporated by reference to Appendix B to the Proxy Statement for the Companys 2003 Annual Meeting*      
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.11         |  | Fourth Amended and Restated Employment Agreement, dated as of August 5, 2003, between Robert B. Knutson and Education Management Corporation                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Incorporated by reference to Exhibit 10.10 to the 2003 Form 10-K*                                          
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.12         |  | Amended and Restated Employment Agreement, dated as of August 5, 2003, between John R. McKernan, Jr. and Education Management Corporation                                                                                                                                                                                                                                                                                                                                                                                                                         |  | Incorporated by reference to Exhibit 10.11 to the 2003 Form 10-K*                                          
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.13         |  | Form of Employment Agreement, dated as of June 4 and September 8, 1999, between certain executives and Education Management Corporation                                                                                                                                                                                                                                                                                                                                                                                                                           |  | Incorporated herein by reference to Exhibit 10.10 to the 1999 Form 10-K*                                   
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.14         |  | Employment Agreement dated July 9, 2001 between Michael C. Markovitz and Education Management Corporation                                                                                                                                                                                                                                                                                                                                                                                                                                                         |  | Incorporated herein by reference to Exhibit 10.13 to the 2002 Form 10-K*                                   
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.15         |  | Employment Agreement dated June 12, 2003 between J. William Brooks and Education Management Corporation                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | Incorporated by reference to Exhibit 10.14 to the 2003 Form 10-K*                                          
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.16         |  | Restricted Stock Award Agreement dated September 2, 2003 between J. William Brooks and Education Management Corporation                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | Incorporated by reference to Exhibit 10.15 to the 2003 Form 10-K*                                          
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.17         |  | Form of EMC-Art Institutes International, Inc. Directors and/or Officers Indemnification Agreement                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  | Incorporated herein by reference to Exhibit 10.17 to the Form S-1*                                         
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.18         |  | Senior Management Team Incentive Compensation Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |  | Incorporated herein by reference to Exhibit 10.12 to the 1999 Form 10-K*                                   
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|10.29         |  | Common Stock Registration Rights Agreement, dated as of August 15, 1996, among Education Management Corporation and Marine Midland Bank, Northwestern Mutual Life Insurance Company, National
Union Fire Insurance Company of Pittsburgh, PA, Merrill Lynch Employees LBO Partnership No. I, L.P., Merrill Lynch IBK Positions, Inc., Merrill Lynch KECALP L.P., 1986, Merrill Lynch Offshore LBO Partnership No. IV, Merrill Lynch Capital
Corporation, Merrill Lynch Capital Appreciation Partnership IV, L.P., Robert B. Knutson and certain other individuals |  | Incorporated herein by reference to Exhibit 10.19 to the 1997 Form 10-K                                    
|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|16.01         |  | Letter from Arthur Andersen LLP to the Securities and Exchange Commission dated May 10, 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Incorporated by reference to Exhibit 16 to the Companys Current Report on Form 8-K dated May 14, 2002.    



E-3



---

|              |  |                                                                            |  |                 
|------------- |  | -------------------------------------------------------------------------- |  | ----------------
|ExhibitNumber |  | Exhibit                                                                    |  | Method of Filing
|              |  |                                                                           
|21.01         |  | Material subsidiaries of Education Management Corporation                  |  | Filed herewith  
|              |  |                                                                           
|23.01         |  | Consent of Ernst & Young LLP                                               |  | Filed herewith  
|              |  |                                                                           
|31.01         |  | Certification of CEO Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 |  | Filed herewith  
|              |  |                                                                           
|31.02         |  | Certification of CFO Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 |  | Filed herewith  
|              |  |                                                                           
|32.01         |  | Certification of CEO Pursuant to Section 906 of Sarbanes-Oxley Act of 2002 |  | Filed herewith  
|              |  |                                                                           
|32.02         |  | Certification of CFO Pursuant to Section 906 of Sarbanes-Oxley Act of 2002 |  | Filed herewith  

---

|* |  | Management contract or compensatory plan or arrangement.
|- |  | --------------------------------------------------------



E-4