EAI's promising future begins to look bleak

THE BALTIMORE SUN

NEW YORK -- For 18 months, Wall Street was Education Alternatives Inc.'s best friend.

Starting in mid-1992, investors showered the company with millions of dollars, helping to replenish EAI's war chest and to make its high-profile expansion into public education possible. Even when EAI used unorthodox accounting practices and failed to sell its product outside Baltimore, Wall Street stood by and ponied up a small fortune in financial support.

But now that friendship is over.

The failure to win new contracts and growing skepticism about company officers -- who liberally cashed in on EAI's temporary stock market success last year -- have convinced investors to jump ship, helping to slice EAI's stock price in half. This has closed the company's spigot of easy money from the stock market -- money that has helped EAI renovate the 11 schools that it manages in Baltimore.

"The whole thing is coming crashing down on them," said Howard Schilit, a business professor at the American University and author of an independent study commissioned by large investors of EAI. "The stock is heading down and shows no signs of recovering."

This dissatisfaction came to a head 10 days ago when two shareholders filed a class action lawsuit against EAI, charging the company with unethical accounting practices and unfounded predictions of new business to boost its stock. Company officers, the suit charges, used the high stock price to sell stock and make six- to seven-figure profits.

Although most on Wall Street are not so harsh, interviews with analysts and former stockholders describe a company that has lost much of its credibility. The company, they say, has been more concerned with hyping its Baltimore contracts than with buckling down to daily business. Instead of getting in on the ground floor of the next blue chip stock, many investors feel they were caught in one of Wall Street's fad stocks.

One of the main complaints heard on Wall Street is that EAI has so consistently oversold its prospects that investors feel misled. Since signing the contract to manage nine schools in Baltimore two years ago, EAI has added just two more schools in Baltimore, and those have been under terms that give the company only a fraction of the revenues they receive for the first nine.

Most recently, the company disappointed investors by failing to land contracts in Milwaukee and Washington. When the news hit the market Thursday, the company's stock fell 23 percent, or $5 a share. The stock closed Friday at $13.25, down $3.50 a share.

"Had they been able to sign new contracts, I would have had a higher degree of confidence. After a while, it seemed the stock was trading on air," said Jay Tracey, a manager of Oppenheimer's Discovery Fund, which once owned EAI's stock.

Like many on Wall Street, Mr. Tracey said he was attracted to the company that promised to revolutionize public education -- much like Federal Express had changed mail delivery. Besides helping to improve the country's educational level, EAI could become a multibillion-dollar company if it could get just a small slice of the $250 billion spent each year on public education, Mr. Tracey figured.

"It was a very appealing idea. It was a concept stock, but it became a bit too concepty for me," said Mr. Tracey, who sold his fund's 90,000 shares of EAI in December, when the stock was still trading at about $35 a share.

Mr. Tracey said he lost confidence in EAI because the company seemed able to generate headlines better than profits.

Questions have also been raised about EAI's accounting methods. EAI records the full $27 million that Baltimore gives it each year as revenue.

Much of that money, however, is immediately returned to the city to pay for teachers' salaries and administrative costs, leading some critics to say that EAI deliberately uses this accounting method to inflate revenues and mislead investors into thinking it is a much bigger company.

EAI officials have strongly denied that their accounting practices are flawed. Company accountants, Arthur Andersen & Co., have also reaffirmed their approval of the method in use. Besides, company officials say, the accounting issue does not affect EAI's bottom line, which has been in the black after years of heavy losses.

But even the bottom line has not satisfied investors. Last year, the company recorded an operating profit of $735,000 -- representing just 3 percent of the $27 million contract, though investors had been told that the company was sure to earn 10 percent profit margins.

This year has been worse, with EAI making no operating profit. It has been in the black only because it has earned interest on money the company raised from the stock market.

Unfulfilled promises

rTC Some of the company's unfulfilled promises go back to its roots: EAI was founded in 1986 to run private schools using an educational method called "Tesseract." But it failed to make money running private schools, so moved into public schools as a consultant and then manager.

The company landed a consulting contract in Miami three years ago on which it earns a fee based on the amount of funds it raises for the Miami public school. EAI was supposed to raise $2.5 million for the school, but in another letdown has not yet managed to meet this goal, causing consulting revenues to lag.

The contract with Baltimore calls for the company to manage eight elementary schools and one middle school for $27 million a year. Besides implementing its "Tesseract" curriculum, its partners, Johnson Controls, a grounds keeping company, and accounting firm KPMG Peat Marwick, maintain the schools and handle bookkeeping.

Soon after that contract was signed, EAI and its representatives on Wall Street -- brokerages Dain Bosworth Inc. and Piper Jaffray Inc. -- said EAI was in promising negotiations with other cities' school boards.

In September 1992, EAI indicated to analysts that it was close to signing up 14 schools in Palm Beach County, Fla. In research reports, analysts painted EAI's worst-case scenario as one in which it would keep the nine Baltimore schools and add the 14 schools in Palm Beach, helping revenues jump to $60 million from $30 million -- all from a company with just $3 million in revenues in 1992.

Not only did the Palm Beach County contract not materialize, but half a dozen highly touted prospects also came to nought. For example, EAI failed to sign up three school districts in Arkansas, despite adding a powerful new member to its board of directors, Wal-Mart heir and Arkansas resident John Walton.

The company's revenues this year have changed little from last year, failing to even match the worst-case scenario described by its Wall Street boosters. These failures led some on Wall Street to question the company's management, especially its dynamic chief executive officer, John Golle.

"It was always the same with Golle. He was always on the verge of something great. Always telling us that this or that was imminent, but nothing ever happened," said the manager of a mutual fund who recently sold more than 50,000 shares.

Mr. Golle refused to comment on Wall Street's view of the company. EAI spokeswoman Lori Sutton said the company had a "new policy" not to talk about its stock price or Wall Street's perceptions of the company.

Source of unease

According to Dain Bosworth analyst Mike Moe, a bull on EAI who has helped organize EAI stock offerings, Mr. Golle may be a tad too optimistic, but he does possess "the energy, vision and drive to fight the battles. I wouldn't recommend EAI if it didn't have someone like John Golle.

Another source of investor unease was the propensity of top EAI personnel to sell stock last fall when EAI's stock was making its charge upward. Between June and November, EAI's stock more than doubled to $48 a share from $20 a share, though the company's operations had not changed fundamentally.

Mr. Golle sold 50,000 shares in October, a year after he startled the markets by selling 100,000 shares. Mr. Golle, who has not bought EAI stock on the public markets since the company went public in 1991, according to SEC filings, paid only $1 or less for 45,000 of the shares he sold. This guaranteed him a profit of more than $1.5 million on the sale, 10 times his annual salary.

Tesseract Development Corp., created by Mr. Golle to manage one of the money-losing Tesseract private schools, also filed to sell 50,000 shares. EAI gave this company 100,000 shares of EAI stock that it could exercise for a price of $1 a share. The sale was worth $1.5 million to Tesseract Development.

Another big beneficiary of the stock's upward run was EAI President David Bennett, who sold 21,000 shares between September and January. Based on company filings with the Securities and Exchange Commission, Mr. Bennett stood to make more than $500,000 on the sale -- five times his annual salary.

Mr. Moe agreed that the stock sales last fall "weren't the greatest message, given that no new business had come through." While defending EAI's management as "committed" to the company, he said managers of a small, untested company are expected to hold their shares as a sign of confidence in the company, even when the stock price spikes temptingly upward.

No profit

What finally convinced many investors to give up on EAI's stock was the simple fact that EAI has not made a profit this year managing Baltimore's schools.

The two most-recent financial filings with the Securities and Exchange Commission show that EAI has relied on money it raised from the stock market to make a profit. EAI raised $30 million when it sold stock last spring and has invested that money in securities that provide EAI with a steady stream of interest and dividends.

During the three-month period of July to September, EAI lost $383,000, but interest from the securities gave the company a $330,000 profit.

During the October-December period, EAI lost another $298,000. again showed a profit, this time of $549,000. The apparent increase in profits (from $330,000 in the first quarter) came, however, because the company sold $256,000 of the securities -- a move that will cut into future profits because EAI will have fewer securities from which it can earn interest and dividends.

With few new contracts in sight, many on Wall Street have apparently run out of patience.

"This year was really disappointing. . . . If it isn't making a profit managing schools, then what's behind EAI's concept?" Mr. Tracey said.

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