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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 12, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 333-42137
KINDERCARE LEARNING CENTERS, INC.
(Exact name of registrant as specified in its charter)
Delaware 63-0941966
(State or other (I.R.S. Employer
jurisdiction of incorporation) Identification No.)
650 NE Holladay Street, Suite 1400
Portland, OR 97232
(Address of principal executive offices)
(503) 872-1300
(Registrant's telephone number, including area code)
(Former name, address and fiscal year, if changed since last report)
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares of the registrant's common stock, $.01 par value per
share, outstanding at January 16, 2004 was 19,696,797.
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KinderCare Learning Centers, Inc. and Subsidiaries
Index
Part I. Financial Information................................................ 2
Item 1. Financial Statements and Supplementary Data:
Consolidated balance sheets at December 12, 2003
and May 30, 2003 (unaudited)............................. 2
Consolidated statements of operations for the twelve
and twenty-eight weeks ended December 12, 2003
and December 13, 2002 (unaudited)........................ 3
Consolidated statements of stockholders' equity and
comprehensive income for the twenty-eight weeks
ended December 12, 2003 and the fiscal year ended
May 30, 2003 (unaudited)................................. 4
Consolidated statements of cash flows for the
twenty-eight weeks ended December 12, 2003
and December 13, 2002 (unaudited)........................ 5
Notes to unaudited consolidated financial statements........ 6
Item 2. Management's discussion and analysis of financial
condition and results of operations.........................13
Item 3. Quantitative and qualitative disclosures about market risk..28
Item 4. Controls and procedures.....................................29
Part II. Other Information....................................................30
Item 4. Submission of matters to a vote of security holders.........30
Item 6. Exhibits and reports on Form 8-K............................30
Signatures....................................................................32
1
PART I.
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)
(Unaudited)
December 12, May 30,
2003 2003
----------- -----------
Assets
Current assets:
Cash and cash equivalents........................... $ 28,152 $ 18,066
Receivables, net.................................... 32,321 31,493
Prepaid expenses and supplies....................... 8,568 9,423
Deferred income taxes............................... 12,852 14,500
Assets held for sale................................ 2,436 3,260
----------- -----------
Total current assets............................ 84,329 76,742
Property and equipment, net........................... 739,074 663,239
Deferred income taxes................................. 8,356 1,868
Goodwill.............................................. 42,565 42,565
Deferred financing costs.............................. 21,447 9,445
Other assets.......................................... 26,028 17,234
----------- -----------
$ 921,799 $ 811,093
=========== ===========
Liabilities and Stockholders' Equity
Current liabilities:
Bank overdrafts..................................... $ 7,468 $ 9,304
Accounts payable.................................... 7,489 8,888
Current portion of long-term debt................... 4,307 13,744
Accrued expenses and other liabilities.............. 112,393 109,671
----------- -----------
Total current liabilities....................... 131,657 141,607
Long-term debt........................................ 542,076 441,336
Long-term self-insurance liabilities.................. 28,676 22,771
Deferred income taxes................................. 5,059 3,696
Other noncurrent liabilities.......................... 77,619 66,524
----------- -----------
Total liabilities............................... 785,087 675,934
----------- -----------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; authorized
10,000,000 shares; none outstanding............. -- --
Common stock, $.01 par value; authorized 100,000,000
shares; issued and outstanding 19,696,797 and
19,661,216, respectively........................ 197 197
Additional paid-in capital.......................... 26,425 25,909
Notes receivable from stockholders.................. (1,578) (1,085)
Retained earnings................................... 111,621 110,297
Accumulated other comprehensive income (loss)....... 47 (159)
----------- -----------
Total stockholders' equity...................... 136,712 135,159
----------- -----------
$ 921,799 $ 811,093
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
2
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Operations
(Dollars and number of shares outstanding in thousands,
except per share amounts)
(Unaudited)
Twelve Weeks Ended Twenty-Eight Weeks Ended
------------------------- -------------------------
December 12, December 13, December 12, December 13,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Revenues, net...................... $ 196,607 $ 194,388 $ 456,638 $ 447,087
----------- ----------- ----------- -----------
Operating expenses:
Salaries, wages and benefits..... 107,113 108,588 253,584 252,700
Depreciation and amortization.... 14,503 14,168 33,070 31,181
Rent............................. 12,034 12,048 28,982 27,041
Provision for doubtful accounts.. 1,331 1,626 3,201 3,297
Other............................ 44,736 41,884 108,588 102,702
----------- ----------- ----------- -----------
Total operating expenses.... 179,717 178,314 427,425 416,921
----------- ----------- ----------- -----------
Operating income............... 16,890 16,074 29,213 30,166
Investment income.................. 63 73 135 181
Interest expense................... (9,546) (9,615) (22,508) (22,454)
Loss on the early extinguishment
of debt ......................... (177) -- (3,846) --
----------- ----------- ----------- -----------
Income before income taxes
and discontinued operations.. 7,230 6,532 2,994 7,893
Income tax expense................. (2,855) (2,586) (1,177) (3,125)
----------- ----------- ----------- -----------
Income before discontinued
operations................... 4,375 3,946 1,817 4,768
Discontinued operations, net of
income tax benefit (expense) of
$25, ($232), $319 and $7,
respectively..................... (37) 354 (493) (11)
----------- ----------- ----------- -----------
Net income.................. $ 4,338 $ 4,300 $ 1,324 $ 4,757
=========== =========== =========== ===========
Basic and diluted net income
per share:
Income before discontinued
operations................... $ 0.22 $ 0.20 $ 0.09 $ 0.24
Discontinued operations, net... -- 0.02 (0.02) --
----------- ----------- ----------- -----------
Net income.................. $ 0.22 $ 0.22 $ 0.07 $ 0.24
=========== =========== =========== ===========
Weighted average common shares
outstanding:
Basic.......................... 19,697 19,983 19,690 19,734
Diluted........................ 19,951 19,877 20,085 19,932
See accompanying notes to unaudited consolidated financial statements.
3
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity and Comprehensive Income
(Dollars and number of shares in thousands)
(Unaudited)
Notes Accumulated
Common Stock Additional Receivable Other
------------------- Paid-In from Retained Comprehensive
Shares Amount Capital Stockholders Earnings Income (Loss) Total
--------- -------- ---------- ------------ ---------- ------------- ----------
Balance at May 31, 2002............... 19,819 $ 198 $ 28,107 $ (1,426) $ 96,882 $ (492) $ 123,269
Comprehensive income:
Net income.......................... -- -- -- -- 13,415 -- 13,415
Cumulative translation adjustment... -- -- -- -- -- 333 333
----------
Total comprehensive income........ 13,748
Retirement of common stock............ (120) (1) (1,645) -- -- -- (1,646)
Repurchase of common stock............ (38) -- (553) -- -- -- (553)
Proceeds from collection of
stockholders' notes receivable...... -- -- -- 341 -- -- 341
--------- -------- ---------- ------------ ---------- ------------- ----------
Balance at May 30, 2003........... 19,661 197 25,909 (1,085) 110,297 (159) 135,159
Comprehensive income:
Net income.......................... -- -- -- -- 1,324 -- 1,324
Cumulative translation adjustment... -- -- -- -- -- 206 206
----------
Total comprehensive income........ 1,530
Issuance of common stock.............. 49 -- 714 -- -- -- 714
Repurchase of common stock............ (13) -- (198) -- -- -- (198)
Issuance of stockholders' notes
receivable.......................... -- -- -- (638) -- -- (638)
Proceeds from collection of
stockholders' notes receivable...... -- -- -- 145 -- -- 145
--------- -------- ---------- ------------ ---------- ------------- ----------
Balance at December 12, 2003...... 19,697 $ 197 $ 26,425 $ (1,578) $ 111,621 $ 47 $ 136,712
========= ======== ========== ============ ========== ============= ==========
See accompanying notes to unaudited consolidated financial statements.
4
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
Twenty-Eight Weeks Ended
------------------------------
December 12, December 13,
2003 2002
------------- -------------
Cash flows from operations:
Net income........................................ $ 1,324 $ 4,757
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation.................................. 33,683 31,617
Amortization of deferred financing costs and
deferred gain on sale-leasebacks............ 3,421 1,345
Provision for doubtful accounts............... 3,256 3,474
Gain on sales and disposals of property and
equipment................................... (672) (1,507)
Deferred tax expense (benefit)................ (3,477) 5,570
Changes in operating assets and liabilities:
Increase in receivables..................... (4,084) (4,587)
Decrease (increase) in prepaid expenses
and supplies.............................. 855 (33)
Increase in other assets.................... (1,117) (1)
Increase (decrease) in accounts payable,
accrued expenses and other current and
noncurrent liabilities.................... 8,338 (5,059)
Other, net.................................... 206 291
------------- -------------
Net cash provided by operating activities....... 41,733 35,867
------------- -------------
Cash flows from investing activities:
Purchases of property and equipment............... (30,581) (54,191)
Purchases of property and equipment previously in
the synthetic lease facility.................... (97,851) --
Proceeds from sales of property and equipment..... 32,421 34,853
Increase in restricted cash....................... (6,017) --
Proceeds from (issuance of) notes receivable...... (1,656) 56
------------- -------------
Net cash used by investing activities........... (103,684) (19,282)
------------- -------------
Cash flows from financing activities:
Proceeds from long-term borrowings................ 327,800 36,000
Payments on long-term borrowings.................. (236,497) (48,158)
Deferred financing costs related to refinanced
debt............................................ (17,092) --
Payments on capital leases........................ (361) (573)
Proceeds from issuance of common stock............ 714 --
Proceeds from collection of stockholders' notes
receivable...................................... 145 267
Issuance of notes receivable to stockholders...... (638) --
Repurchase of common stock........................ (198) (402)
Bank overdrafts................................... (1,836) (480)
------------- -------------
Net cash provided by (used in) financing
activities.................................... 72,037 (13,346)
------------- -------------
Increase in cash and cash equivalents......... 10,086 3,239
Cash and cash equivalents at the beginning of
the period...................................... 18,066 8,619
------------- -------------
Cash and cash equivalents at the end of the
period.......................................... $ 28,152 $ 11,858
============= =============
Supplemental cash flow information:
Interest paid................................... $ 19,342 $ 19,719
Income taxes paid, net.......................... 3,172 1,823
Non-cash financial activities:
Retirement of common stock.................... $ -- $ 1,646
See accompanying notes to unaudited consolidated financial statements.
5
KinderCare Learning Centers, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
1. Nature of Business
KinderCare Learning Centers, Inc., referred to as KinderCare, is the
leading for-profit provider of early childhood education and care in the United
States. At December 12, 2003 we served approximately 120,000 children and their
families at 1,253 child care centers. At our child care centers, we provide
educational and care services to infants and children up to twelve years of age.
However, the majority of the children we serve are from six weeks to five years
old. The total licensed capacity at our centers was approximately 167,000 at
December 12, 2003.
We operate early childhood education and care centers under two brands as
follows:
o KinderCare - At December 12, 2003, we operated 1,183 KinderCare
centers. The brand was established in 1969 and operates centers in 39
states, as well as two centers located in the United Kingdom.
o Mulberry - We operated 70 Mulberry centers at December 12, 2003, which
are located primarily in the northeast region of the United States and
southern California. In addition we had eight service contracts to
operate before-and-after-school programs.
We also partner with companies to provide on- or near-site care to help
employers attract and retain employees. Included in the 1,253 centers at
December 12, 2003 are 45 employer-sponsored centers. In addition to our
center-based child care operations, we own and operate a distance learning
company serving teenagers and young adults. Our subsidiary, KC Distance
Learning, Inc., offers an accredited high school program delivered in either
online or correspondence format. We have made minority investments in Voyager
Expanded Learning, Inc., a developer of educational curricula for elementary and
middle schools and a provider of a public school teacher retraining program, and
Chancellor Beacon Academies, Inc., an education management company.
Fiscal Year. References to fiscal 2004 and fiscal 2003 are to the 52 weeks
ended May 28, 2004 and May 30, 2003, respectively. Our fiscal year ends on the
Friday closest to May 31. The second quarter is comprised of 12 weeks and ended
on December 12, 2003 in fiscal 2004 and December 13, 2002 in fiscal 2003. The
first quarter is comprised of 16 weeks, while the second, third and fourth
quarters are each comprised of 12 weeks.
2. Summary of Significant Accounting Policies
Basis of Presentation. The unaudited consolidated financial statements
include the financial statements of KinderCare and our subsidiaries, all of
which are wholly owned. All significant intercompany balances and transactions
have been eliminated in consolidation.
In the opinion of management, the unaudited consolidated financial
statements reflect the adjustments, all of which are of a normal recurring
nature, necessary to present fairly our financial position at December 12, 2003,
our results of operations for the twelve and twenty-eight weeks ended December
12, 2003 and December 13, 2002 and cash flows for the twenty-eight weeks ended
December 12, 2003 and December 13, 2002. Interim results are not necessarily
indicative of results to be expected for a full fiscal year because of seasonal
and short-term variances and other factors such as the timing of new center
openings and center closures. The unaudited consolidated financial statements
should be read in conjunction with the annual consolidated financial statements
and notes thereto included in our Annual Report on Form 10-K for the fiscal year
ended May 30, 2003.
Revenue Recognition. We recognize revenue for child care services as earned
in accordance with Securities and Exchange Commission ("SEC") Staff Accounting
6
Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements, as
amended. Net revenues include tuition, fees and non-tuition income, reduced by
discounts. We receive fees for reservation, registration, education and other
services. Non-tuition income is primarily comprised of field trip revenue.
Registration and education fees are amortized over the estimated average
enrollment period, not to exceed twelve months. Tuition, other fees and
non-tuition income are recognized as the related services are provided.
Comprehensive Income. Comprehensive income is comprised of the following,
for the periods indicated, with dollars in thousands:
Twelve Weeks Ended Twenty-Eight Weeks Ended
------------------------ ------------------------
December 12, December 13, December 12, December 13,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net income.......................... $ 4,338 $ 4,300 $ 1,324 $ 4,757
Cumulative translation adjustment... 236 82 206 291
----------- ----------- ----------- -----------
$ 4,574 $ 4,382 $ 1,530 $ 5,048
=========== =========== =========== ===========
Stock-Based Compensation. We measure compensation expense for our
stock-based employee compensation plans using the method prescribed by
Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued
to Employees, and provide pro forma disclosures of net income and earnings per
share as if the method prescribed by Statement of Financial Accounting Standards
("SFAS") No. 123, Accounting for Stock-Based Compensation, had been applied in
measuring compensation expense.
In accordance with SFAS No. 148, Accounting for Stock-Based Compensation -
Transition and Disclosure, we have provided the required disclosures below. Had
compensation expense for our stock option plans been determined based on the
estimated weighted average fair value of the options at the date of grant in
accordance with SFAS No. 123, our net income and basic and diluted net income
per share would have been as follows, with dollars in thousands, except per
share data:
Twelve Weeks Ended Twenty-Eight Weeks Ended
------------------------ ------------------------
December 12, December 13, December 12, December 13,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Reported net income................... $ 4,338 $ 4,300 $ 1,324 $ 4,757
Compensation costs for stock
option plan, net of taxes........... (222) (132) (520) (309)
----------- ----------- ----------- -----------
Pro forma net income.............. $ 4,116 $ 4,168 $ 804 $ 4,448
=========== =========== =========== ===========
Pro forma net income per share:
Basic and diluted net income per
share before discontinued
operations, net................... $ 0.21 $ 0.19 $ 0.06 $ 0.22
Discontinued operations, net
of taxes.......................... -- 0.02 (0.02) --
----------- ----------- ----------- -----------
Adjusted net income per share.. $ 0.21 $ 0.21 $ 0.04 $ 0.22
=========== =========== =========== ===========
7
A summary of the weighted average fair values was as follows:
Twelve Weeks Ended Twenty-Eight Weeks Ended
------------------------ ------------------------
December 12, December 13, December 12, December 13,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Weighted average fair value of options
granted during the period, using the
Black-Scholes option pricing model..... $ 4.91 $ 4.01 $ 7.34 $ 4.27
Assumptions used to estimate the
present value of options at the
grant date:
Volatility........................... 39.2% 36.2% 39.2% 36.2%
Risk-free rate of return............. 3.8% 3.6% 3.7% 3.9%
Dividend yield....................... 0.0% 0.0% 0.0% 0.0%
Number of years to exercise options.. 7 7 7 7
Discontinued Operations. Discontinued operations included the operating
results for the 21 centers closed during the twenty-eight weeks ended December
12, 2003 and the 28 centers closed in fiscal year 2003 for all periods
presented. A summary of discontinued operations was as follows with dollars in
thousands:
Twelve Weeks Ended Twenty-Eight Weeks Ended
------------------------ ------------------------
December 12, December 13, December 12, December 13,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Revenues, net........................... $ 239 $ 2,923 $ 1,501 $ 7,684
Operating expenses...................... 301 2,337 2,313 7,701
----------- ----------- ----------- -----------
Operating income (loss)............... (62) 586 (812) (17)
Interest expense........................ -- -- -- (1)
Income tax benefit (expense)............ 25 (232) 319 7
----------- ----------- ----------- -----------
Discontinued operations, net of tax... $ (37) $ 354 $ (493) $ (11)
=========== =========== =========== ===========
Operating expenses for the twelve and twenty-eight weeks ended December 12,
2003 included gains on closed center sales of $0.6 million. Operating expenses
for the twelve and twenty-eight weeks ended December 13, 2002 included gains on
closed center sales in the amount of $1.1 million and $1.2 million,
respectively, and an impairment charge of $0.1 million.
Of the center closures, ten were held for sale at December 12, 2003. As a
result, $2.4 million and $3.3 million of property and equipment was classified
as current in the unaudited consolidated balance sheets at December 12, 2003 and
May 30, 2003, respectively.
8
Net Income per Share. The difference between basic and diluted net income
per share was a result of the dilutive effect of options, which are considered
potential common shares. A summary of the weighted average common shares was as
follows, in thousands:
Twelve Weeks Ended Twenty-Eight Weeks Ended
------------------------ ------------------------
December 12, December 13, December 12, December 13,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Basic weighted average common
shares outstanding................... 19,697 19,683 19,690 19,734
Dilutive effect of options............. 254 194 395 198
----------- ----------- ----------- -----------
Diluted weighted average
common shares outstanding........ 19,951 19,877 20,085 19,932
=========== =========== =========== ===========
Shares excluded from potential shares
due to their anti-dilutive effect.... 1,277 2,168 1,115 2,163
=========== =========== =========== ===========
Restricted Cash. Restricted cash includes cash held in connection with our
$300.0 million mortgage loan, see "Note 4. Long-Term Debt." At December 12,
2003, restricted cash of $6.0 million was included in other assets in our
unaudited consolidated balance sheet. The restricted cash relates primarily to
capital expenditure and debt service requirements under the mortgage loan.
Property and Equipment, net. In connection with our debt refinancing in
July 2003, our $300.0 million mortgage loan was secured by first mortgages or
deeds of trust on 475 of our owned centers. In addition, we mortgaged another
119 of our owned centers for our revolving credit facility. At December 12,
2003, the net book value of $399.1 million for these 594 centers was included in
property and equipment in our unaudited consolidated balance sheet.
Deferred Financing Costs. Deferred financing costs are amortized on a
straight-line basis over the lives of related debt facilities, such method
approximates the effective yield method. At December 12, 2003 and May 30, 2003,
deferred financing costs were $21.4 million and $9.4 million, respectively. The
increase in deferred financing costs for the twenty-eight weeks ended December
12, 2003 was due to our debt refinancing in July 2003, see "Note 4. Long-Term
Debt." A summary of the increase was as follows, with dollars in thousands:
Balance at May 30, 2003..................... $ 9,445
Deferred financing cost additions........... 17,092
Deferred financing costs written-off in
connection with refinancing............... (2,957)
Amortization of deferred financing costs
for the twenty-eight weeks ended
December 12, 2003......................... (2,133)
----------
Balance at December 12, 2003............ $ 21,447
==========
Recently Issued Accounting Pronouncements. Financial Accounting Standards
Board Interpretation ("FIN") 46, Consolidation of Variable Interest Entities,
requires consolidation where there is a controlling financial interest in a
variable interest entity, previously referred to as a special-purpose entity,
and certain other entities. The implementation of FIN 46 has been delayed and
will be effective during the fourth quarter of our fiscal year 2004. We do not
anticipate an impact to our consolidated financial statements.
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity, establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The statement requires that an
issuer classify a financial instrument that is within its scope as a liability,
or an asset in some circumstances.
9
SFAS No. 150 was effective for financial instruments entered into or modified
after May 31, 2003, and otherwise was effective in the second quarter of our
fiscal 2004. This statement did not have a material impact to our consolidated
financial statements.
Use of Estimates. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates under different conditions or if our assumptions change.
Reclassifications. Certain prior period amounts have been reclassified to
conform to the current period's presentation.
3. Property and Equipment
Property and equipment consisted of the following, with dollars in
thousands:
December 12, May 30,
2003 2003
------------ ------------
Land....................................... $ 171,146 $ 156,656
Buildings and leasehold improvements....... 661,953 584,606
Equipment.................................. 193,884 182,954
Construction in progress................... 17,101 22,708
------------ ------------
1,044,084 946,924
Accumulated depreciation and amortization... (305,010) (283,685)
------------ ------------
$ 739,074 $ 663,239
============ ============
10
4. Long-Term Debt
Long-term debt consisted of the following, with dollars in thousands:
December 12, May 30,
2003 2003
------------ ------------
Secured:
Mortgage loan payable in monthly installments
through July 2008, interest rate at adjusted
LIBOR plus 2.25% of 3.37% at December 12, 2003.. $ 298,906 $ --
Borrowings under revolving credit facilities,
interest rate at:
o December 12, 2003 - adjusted LIBOR plus
3.25%
o May 30, 2003 - adjusted LIBOR plus 1.25%
of 2.57% and ABR of 4.25%.................... -- 104,000
Term loan facility, interest rate at adjusted
LIBOR plus 2.50% of 3.82% at May 30, 2003....... -- 47,000
Industrial refunding revenue bonds at variable
rates of interest of 1.25% to 1.70% and 1.60%
to 2.50%, respectively, supported by letters
of credit, maturing calendar 2009............... 8,500 8,500
Industrial revenue bonds secured by real property
with maturities to calendar 2005 at interest
rates of 2.80% to 4.55% and 2.98% to 4.55%,
respectively.................................... 3,702 3,739
Real and personal property mortgages payable in
monthly installments maturing calendar 2005,
interest rate of 7.00%.......................... 26 34
Unsecured:
Senior subordinated notes due calendar 2009,
interest rate of 9.5%, payable semi-annually.... 233,700 290,000
Notes payable in monthly installments through
calendar 2008, interest rate of 8.00%........... 1,549 1,807
------------ ------------
546,383 455,080
Less current portion of long-term debt.......... 4,307 13,744
------------ ------------
$ 542,076 $ 441,336
============ ============
Refinancing. In July 2003 we refinanced a portion of our debt. We obtained
a $125.0 million revolving credit facility, and, as described below in greater
detail, one of our subsidiaries obtained a $300.0 million mortgage loan.
Proceeds from the mortgage loan were used to pay off the balance on the then
existing revolving credit facility, the term loan facility and the synthetic
lease facility. We also used a portion of the remaining proceeds to purchase
$37.0 million aggregate principal amount of our 9.5% senior subordinated notes.
In accordance with SFAS No. 6, Classification of Short-Term Obligations
Expected to Be Refinanced, an Amendment of ARB No. 43, Chapter 3A, the $104.0
million balance on our previous revolving credit facility and our annual $0.5
million installment on our term loan were classified as long-term debt at May
30, 2003, since they were refinanced on a long-term basis during our first
quarter.
Mortgage Loan. The $300.0 million mortgage loan is secured by first
mortgages or deeds of trust on 475 of our owned centers located in 33 states. We
11
refer to the mortgage loan as the CMBS Loan and the 475 mortgaged centers as the
CMBS Centers. In connection with the CMBS Loan, the CMBS Centers were
transferred to a newly formed wholly owned subsidiary of ours, which is the
borrower under the CMBS Loan and is referred to as the CMBS Borrower. Because
the CMBS Centers are owned by the CMBS Borrower and subject to the CMBS Loan,
recourse to the CMBS Centers by our creditors will be effectively subordinated
to recourse by holders of the CMBS Loan.
The CMBS Loan is nonrecourse to the CMBS Borrower and us, subject to
customary recourse provisions, and has a maturity date of July 9, 2008, which
may be extended to July 9, 2009, subject to certain conditions. The CMBS Loan
bears interest at a per annum rate equal to LIBOR plus 2.25% and requires
monthly payments of principal and interest. Principal payments are based on a
thirty-year amortization (based on an assumed rate of 6.50%). We have purchased
an interest rate cap agreement to protect us from significant changes in LIBOR
during the initial three years of the CMBS Loan. Under the cap agreement, which
terminates July 9, 2006, LIBOR is capped at 6.50%. We are required to purchase
additional interest rate cap agreements capping LIBOR at a rate no higher than
7.00% for the period from July 9, 2006 to the maturity date of the CMBS Loan.
Each of the centers included in the CMBS Centers is being ground leased by
the CMBS Borrower to another wholly owned subsidiary formed in connection with
the CMBS Loan, which is referred to as the CMBS Operator, and is being managed
by us pursuant to a management agreement with the CMBS Operator. Transactions
between the CMBS Borrower and the CMBS Operator are eliminated in consolidation
since both the CMBS Borrower and the CMBS Operator are wholly owned
subsidiaries.
Prepayment of the CMBS Loan is prohibited through July 8, 2005, after which
prepayment is permitted in whole, subject to a prepayment premium of 3.0% from
July 8, 2005 through July 8, 2006, 2.0% from July 9, 2006 through July 8, 2007
and 1.0% from July 9, 2007 through January 8, 2008, with no prepayment penalty
thereafter. In addition, after July 8, 2005, the loan may be partially prepaid
as follows:
o up to $15.0 million each loan year in connection with releases of
mortgaged centers with no prepayment premium, and
o up to $5.0 million each loan year subject to payment of the applicable
prepayment premium.
The CMBS Loan contains a provision that requires the loan servicer to
escrow 50% of excess cash flow generated from the CMBS Centers (determined after
payment of debt service on the CMBS Loan, certain fees and required reserve
amounts) if the net operating income, as defined in the CMBS Loan agreement, of
the CMBS Centers declines to $60.0 million, as adjusted to account for released
properties. The amount of excess cash flow to be escrowed increases to 100% if
the net operating income of the CMBS Centers declines to $50.0 million, as
adjusted. The net operating income of the CMBS Centers for the trailing twelve
months ended December 12, 2003 was approximately $81.1 million. The maximum
amount of excess cash flow that can be escrowed is limited to one year of debt
service on the CMBS Loan and one year of rent due under the ground lease with
the CMBS Operator during the term of the CMBS Loan. The escrowed amounts are
released if the CMBS Centers generate the necessary minimum net operating income
for two consecutive fiscal quarters. The annual debt service on the CMBS Loan is
approximately $22.8 million (assuming a 6.50% interest rate). The annual rent
under the ground lease is $34.0 million for the term of the CMBS Loan. These
excess cash flow provisions could limit the amount of cash made available to us.
Our restricted cash balance in connection with the CMBS Loan was $6.0 million at
December 12, 2003. The restricted cash balance will fluctuate periodically due
primarily to the timing of debt service payments compared to our period end
date.
Credit Facility. Our $125.0 million credit facility is secured by first
mortgages or deeds of trusts on 119 of our owned centers and certain other
collateral and has a maturity date of July 9, 2008. The revolving credit
facility includes borrowing capacity of up to $75.0 million for letters of
credit and up to $10.0 million for selected short-term borrowings. At December
12, 2003 there were no borrowings outstanding under our credit facility.
12
The credit facility bears interest, at our option, at either of the
following rates, which are adjusted in quarterly increments based on our ratio
of total consolidated debt to total consolidated EBITDA (EBITDA is defined in
the credit facility as net income before interest expense, income taxes,
depreciation, amortization, non-recurring charges, non-cash charges, gains and
losses on asset sales, restructuring charges or reserves and non-cash gains):
o An adjusted LIBOR rate plus 2.00% to 3.25%. At December 12, 2003 this
rate would have been adjusted LIBOR plus 3.25%, or an all-in rate of
4.37%.
o An alternative base rate plus 0.75% to 2.00%. At December 12, 2003
this rate would have been the alternative base rate plus 2.00%, or an
all-in rate of 6.00%.
The credit facility contains customary covenants and provisions that
restrict our ability to:
o make certain fundamental changes to our business,
o consummate asset sales,
o declare dividends,
o grant liens,
o incur additional indebtedness, amend the terms of or repay certain
indebtedness, and
o make capital expenditures.
In addition, the credit facility requires us to meet or exceed certain
leverage and interest and lease expense coverage ratios.
The credit facility requires us to pay a commitment fee at a rate ranging
from 0.40% to 0.50% on the available commitment. The fee is payable quarterly in
arrears. In addition, we are required to pay a letter of credit fee at a rate
ranging from 2.00% to 3.25%, minus 0.125%, as well as a fronting fee of 0.125%,
in each case on the average daily stated amount of each letter of credit. These
fees are also payable quarterly in arrears. At December 12, 2003 the rates for
our commitment and letter of credit fees were 0.50% and 3.125%, respectively.
5. Commitments and Contingencies
We are presently, and are from time to time, subject to claims and
litigation arising in the ordinary course of business. We believe that none of
the claims or litigation of which we are aware will materially affect our
financial position, operating results or cash flows, although assurance cannot
be given with respect to the ultimate outcome of any such actions.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Introduction
The following discussion should be read in conjunction with the unaudited
consolidated financial statements and the related notes included elsewhere in
this report. Our fiscal year ends on the Friday closest to May 31. The
information presented refers to the twelve weeks ended December 12, 2003 as "the
second quarter of fiscal 2004" and the twelve weeks ended December 13, 2002 as
"the second quarter of fiscal 2003." Our first fiscal quarter includes 16 weeks
and the remaining quarters each include twelve weeks.
We calculate the average weekly tuition rate as net revenues, exclusive of
fees and non-tuition income, divided by FTE attendance for the related time
period. The average weekly tuition rate represents
13
the approximate weighted average weekly tuition rate at all of the centers paid
by parents for children to attend the centers five full days during a week.
However, the occupancy mix between full- and part-time children at each center
can significantly affect these averages with respect to any specific center. FTE
attendance is not a strict head count. Rather, the methodology determines an
approximate number of full-time children based on weighted averages. For
example, an enrolled full-time child equates to one FTE, while a part-time child
enrolled for five half-days equates to 0.5 FTE. The FTE measurement of center
capacity utilization does not necessarily reflect the actual number of full- and
part-time children enrolled. Occupancy is a measure of the utilization of center
capacity. We calculate occupancy as the full-time equivalent, or FTE, attendance
at all of the centers divided by the sum of the centers' licensed capacity.
A center is included in comparable center net revenues when it has been
open and operated by us at least one year and it has not been rebuilt or
permanently relocated within that year. Therefore, a center is considered
comparable during the first four-week period it has prior year net revenues.
Non-comparable centers include those that have been closed during the past year.
This report will be available on our website, kindercare.com, as soon as
practicable after filing with the Securities and Exchange Commission. The
information on our website is not incorporated by reference in this report.
Second Quarter of Fiscal 2004 compared to Second Quarter of Fiscal 2003
The following table shows the comparative operating results of KinderCare,
with dollars in thousands, except the average weekly tuition rate:
Twelve Weeks Twelve Weeks Change
Ended Percent Ended Percent Amount
December 12, of December 13, of Increase/
2003 Revenues 2002 Revenues (Decrease)
------------ ----------- ------------ ----------- ------------
Revenues, net................... $ 196,607 100.0% $ 194,388 100.0% $ 2,219
------------ ----------- ------------ ----------- ------------
Operating expenses:
Salaries, wages and benefits:
Center expense.............. 99,244 50.5 100,304 51.6 (1,060)
Field and corporate expense. 7,869 4.0 8,284 4.3 (415)
------------ ----------- ------------ ----------- ------------
Total salaries, wages and
benefits................ 107,113 54.5 108,588 55.9 (1,475)
Depreciation and amortization. 14,503 7.4 14,168 7.2 335
Rent.......................... 12,034 6.1 12,048 6.2 (14)
Other......................... 46,067 23.4 43,510 22.4 2,557
------------ ----------- ------------ ----------- ------------
Total operating expenses.... 179,717 91.4 178,314 91.7 1,403
------------ ----------- ------------ ----------- ------------
Operating income.......... $ 16,890 8.6% $ 16,074 8.3% $ 816
============ =========== ============ =========== ============
Average weekly tuition rate..... $ 153.17 $ 144.06 $ 9.11
Occupancy....................... 59.9% 64.0% (4.1)
Revenues, net. Net revenues increased $2.2 million, or 1.1%, from the same
period last year to $196.6 million in the second quarter of fiscal 2004. The
increase was due to higher average weekly tuition rates, offset by reduced
occupancy, as well as additional net revenues generated by the newly opened
centers. Comparable center net revenues decreased $1.6 million, or 0.8%.
The average weekly tuition rate increased $9.11, or 6.3%, to $153.17 in the
second quarter of fiscal 2004 due primarily to tuition increases. Occupancy
declined to 59.9% from 64.0% for the same period last year due primarily to
reduced full-time equivalent attendance within the population of older centers.
A factor that has contributed to this decline includes reduced or flat
government funding for child care assistance programs.
14
During the second quarters of fiscal 2004 and 2003, we opened and closed
centers as follows:
Twelve Weeks Ended
-------------------------
December 12, December 13,
2003 2002
----------- -----------
Number of centers at the beginning of the period.... 1,260 1,264
Openings............................................ 2 6
Closures............................................ (9) (4)
----------- -----------
Number of centers at the end of the period.......... 1,253 1,266
=========== ===========
Total center licensed capacity at the end of the
period............................................ 167,000 167,000
Salaries, wages and benefits. Expenses for salaries, wages and benefits
decreased $1.5 million, or 1.4%, from the same period last year to $107.1
million. Total salaries, wages and benefits expense as a percentage of net
revenues was 54.5% for the second quarter of fiscal 2004 compared to 55.9% for
the second quarter of fiscal 2003.
Expenses for salaries, wages and benefits directly associated with the
centers was $99.2 million, a decrease of $1.1 million from the same period last
year. The decrease was primarily due to control over labor hours and a reduction
in medical insurance costs, offset by costs from newly opened centers and
overall higher wage rates. See "Wage Increases." At the center level, salaries,
wages and benefits expense as a percentage of net revenues declined to 50.5%
from 51.6% for the same period last year due primarily to improved labor
productivity. Expenses for salaries, wages and benefits associated with field
and corporate employees decreased $0.4 million due primarily to the absence of
one-time termination benefits related to our field management reorganization,
which had been recognized in the second quarter of fiscal 2003.
Depreciation and amortization. Depreciation and amortization expense
increased $0.3 million from the same period last year to $14.5 million.
Significant changes in depreciation included the impact of centers previously
included in our synthetic lease facility, our sale-leaseback program and
impairment charges. Additional depreciation expense of $1.3 million was incurred
as a result of purchasing the centers previously held under the synthetic lease
facility. In connection with our sale-leaseback program, whereby centers are
classified as operating leases when they are sold and leased back, depreciation
expense decreased $0.4 million. Impairment charges of $0.4 million were
recognized in the second quarter of fiscal 2004, a decrease of $0.3 million from
the same period last year. These charges related to under-performing centers and
certain undeveloped properties.
Rent. Rent expense remained relatively flat at $12.0 million in the second
quarter of 2004 compared to the same period last year. During the second quarter
of fiscal 2004, the rent expense associated with the centers previously included
in the synthetic lease facility was eliminated as a result of our July 1, 2003
debt refinancing, which resulted in decreased rent expense of $0.8 million
compared to the second quarter of fiscal 2003. Our sale-leaseback program,
whereby centers are sold and leased back, resulted in additional rent expense of
$1.3 million. See "Liquidity and Capital Resources." All gains on these
transactions were included as an offset within rent expense. The net impact was
an increase in rent expense from the sale-leaseback program of $0.8 million in
the second quarter of fiscal 2004 compared to the same period last year.
Other operating expenses. Other operating expenses increased $2.6 million,
or 5.9%, from the same period last year to $46.1 million. The increase was due
primarily to $2.4 million of increased insurance costs and additional center
level costs for newly opened centers. Other operating expenses as a percentage
of net revenues increased to 23.4% from 22.4% for the same period last year
primarily as a result of the higher insurance costs.
15
Other operating expenses include costs directly associated with the
centers, such as food, insurance, transportation, janitorial, maintenance,
utilities and marketing costs, and expenses related to field management and
corporate administration.
Operating income. Operating income was $16.9 million, an increase of $0.8
million, or 5.1%, from the same period last year. Operating income increased due
to higher tuition rates. During the second quarter of fiscal 2004 operating
income, as a percentage of net revenues, was 8.6% compared to 8.3% for the same
period last year.
Interest expense. Interest expense was $9.5 million compared to $9.6
million for the same period last year. Our weighted average interest rate on our
long-term debt, including amortization of deferred financing costs, but
excluding the write-off discussed below, was 7.2% and 7.5% for the second
quarter of fiscal 2004 and fiscal 2003, respectively.
Loss on the early extinguishment of debt. As a result of acquiring $4.3
million of our 9.5% senior subordinated notes in the second quarter of fiscal
2004, we recognized a loss on the early extinguishment of debt of $0.2 million.
These costs included the write-off of deferred financing costs of $0.1 million
associated with the debt that was repaid and the incurrence of premium costs of
$0.1 million.
Income tax expense. Income tax expense was $2.9 million, or 39.5% of pretax
income, in the second quarter of fiscal 2004. In the second quarter of fiscal
2003, income tax expense was $2.6 million, or 39.6% of pretax income. Income tax
expense was computed by applying estimated effective income tax rates to the
income or loss before income taxes. Income tax expense varies from the statutory
federal income tax rate due primarily to state income taxes and non-tax
deductible expenses, offset by tax credits.
Discontinued operations. We recorded a loss of less than $0.1 million and
income of $0.4 million on discontinued operations in the second quarters of
fiscal 2004 and 2003, respectively, which represents the operating results, net
of tax, for all periods presented of the 21 centers closed during the
twenty-eight weeks ended December 12, 2003 and the 28 centers closed in fiscal
2003. Discontinued operations included the following, with dollars in the
thousands:
Twelve Weeks Ended
-------------------------
December 12, December 13,
2003 2002
----------- -----------
Revenues, net.................................... $ 239 $ 2,923
----------- -----------
Operating expenses (income):
Salaries, wages and benefits.................. 258 1,857
Depreciation.................................. 290 374
Rent.......................................... 33 339
Provision for doubtful accounts............... 24 99
Other......................................... (304) (332)
----------- -----------
Total operating expenses................... 301 2,337
Operating (loss) income....................... (62) 586
Income tax benefit (expense)..................... 25 (232)
----------- -----------
Discontinued operations, net of tax........... $ (37) $ 354
=========== ===========
Depreciation expense for the twelve weeks ended December 13, 2002 included
$0.1 million of impairment charges. Other operating expense included $0.6
million and $1.1 million for gains on closed center sales in the second quarter
of fiscal 2004 and 2003, respectively.
Net income. Net income was $4.3 million in both the second quarters of
fiscal 2004 and 2003. Basic and diluted net income per share were both $0.22 for
the second quarters of fiscal 2004 and 2003.
16
Twenty-Eight Weeks ended December 12, 2003 compared to Twenty-Eight Weeks ended
December 13, 2002.
The following table shows the comparative operating results of KinderCare,
with dollars in thousands, except the average weekly tuition rate:
Twenty-Eight Twenty-Eight Change
Weeks Ended Percent Weeks Ended Percent Amount
December 12, of December 13, of Increase/
2003 Revenues 2002 Revenues (Decrease)
------------ ----------- ------------ ----------- ------------
Revenues, net.................... $ 456,638 100.0% $ 447,087 100.0% $ 9,551
------------ ----------- ------------ ----------- ------------
Operating expenses:
Salaries, wages and benefits:
Center expense............... 235,162 51.5 234,444 52.4 718
Field and corporate expense.. 18,422 4.0 18,256 4.1 166
------------ ----------- ------------ ----------- ------------
Total salaries, wages and
benefits................. 253,584 55.5 252,700 56.5 884
Depreciation and amortization.. 33,070 7.2 31,181 7.0 1,889
Rent........................... 28,982 6.4 27,041 6.1 1,941
Other.......................... 111,789 24.5 105,999 23.7 5,790
------------ ----------- ------------ ----------- ------------
Total operating expenses..... 427,425 93.6 416,921 93.3 10,504
------------ ----------- ------------ ----------- ------------
Operating income........... $ 29,213 6.4% $ 30,166 6.7% $ (953)
============ =========== ============ =========== ============
Average weekly tuition rate...... $ 151.86 $ 143.50 $ 8.36
Occupancy........................ 59.7% 63.1% (3.4)
Revenues, net. Net revenues increased $9.6 million, or 2.1%, from the same
period last year to $456.6 million in the twenty-eight weeks ended December 12,
2003. The increase was due to higher average weekly tuition rates, offset by
reduced occupancy, as well as additional net revenues generated by the newly
opened centers. Comparable center net revenues decreased $0.7 million, or 0.2%.
The average weekly tuition rate increased $8.36, or 5.8%, to $151.86 in the
twenty-eight weeks ended December 12, 2003 due primarily to tuition increases.
Occupancy declined to 59.7% from 63.1% for the same period last year due
primarily to reduced full-time equivalent attendance within the population of
older centers. A factor that has contributed to this decline includes reduced or
flat government funding for child care assistance programs.
During the periods indicated, we opened and closed centers as follows:
Twenty-Eight Weeks Ended
------------------------
December 12, December 13,
2003 2002
----------- -----------
Number of centers at the beginning of the period.. 1,264 1,264
Openings.......................................... 10 18
Closures.......................................... (21) (16)
----------- -----------
Number of centers at the end of the period...... 1,253 1,266
=========== ===========
Total center licensed capacity at the end of
the period...................................... 167,000 167,000
17
Salaries, wages and benefits. Expenses for salaries, wages and benefits
increased $0.9 million, from the same period last year to $253.6 million. Total
salaries, wages and benefits expense as a percentage of net revenues was 55.5%
and 56.5% for the twenty-eight weeks ended December 12, 2003 and December 13,
2002, respectively.
Expenses for salaries, wages and benefits directly associated with the
centers was $235.2 million, an increase of $0.7 million from the same period
last year. The increase was primarily due to costs from newly opened centers and
overall higher wage rates, offset by control over labor hours and a reduction in
medical insurance costs. See "Wage Increases." At the center level, salaries,
wages and benefits expense as a percentage of net revenues declined to 51.5%
from 52.4% for the same period last year due primarily to improved labor
productivity.
Depreciation and amortization. Depreciation and amortization expense
increased $1.9 million from the same period last year to $33.1 million.
Significant changes in depreciation included the impact of centers previously
included in our synthetic lease facility, our sale-leaseback program and
impairment charges. Additional depreciation expense of $2.2 million was incurred
as a result of purchasing the centers previously held under the synthetic lease
facility. In connection with our sale-leaseback program, whereby centers are
classified as operating leases when they are sold and leased back, depreciation
expense decreased $1.2 million. Impairment charges of $0.9 million were
recognized in the twenty-eight weeks ended December 12, 2003, an increase of
$0.2 million over the same period last year. These charges related to
under-performing centers and certain undeveloped properties.
Rent. Rent expense increased $1.9 million from the same period last year to
$29.0 million. The rent expense related to our sale-leaseback program increased
$3.9 million from the same period last year. Deferred gains related to this
program were included as an offset within rent expense. During the twenty-eight
weeks ended December 12, 2003, the net impact was an increase in rent expense
from the sale-leaseback program of $2.7 million from the same period last year.
See "Liquidity and Capital Resources." In addition, the rental rates experienced
on new and renewed center leases are higher than those experienced in previous
fiscal periods. During the twenty-eight weeks ended December 12, 2003, the rent
expense associated with the centers previously included in the synthetic lease
facility was eliminated as a result of our July 1, 2003 debt refinancing, which
resulted in a $1.7 million decrease in rent expense, compared to the same period
last year.
Other operating expenses. Other operating expenses increased $5.8 million,
or 5.5%, from the same period last year to $111.8 million. The increase was due
primarily to $4.4 million of increased insurance costs and additional center
level costs for newly opened centers. Other operating expenses as a percentage
of net revenues increased to 24.5% from 23.7% for the same period last year
primarily as a result of the higher insurance costs.
Other operating expenses include costs directly associated with the
centers, such as food, insurance, transportation, janitorial, maintenance,
utilities and marketing costs, and expenses related to field management and
corporate administration.
Operating income. Operating income was $29.2 million, a decrease of $1.0
million, or 3.2%, from the same period last year. Operating income decreased due
to $3.2 million of higher insurance costs and $2.7 million of increased rent
expense from sale-leasebacks, offset by higher tuition rates and control over
labor productivity. Operating income as a percentage of net revenues was 6.4%
compared to 6.7% for the same period last year.
Interest expense. Interest expense was $22.5 million for both of the
twenty-eight week periods ended December 12, 2003 and December 13, 2002. Our
weighted average interest rate on our long-term debt, including amortization of
deferred financing costs, but excluding the write-off discussed below, was 6.8%
and 7.6% for the twenty-eight weeks ended December 12, 2003 and December 13,
2002, respectively.
18
Loss on the early extinguishment of debt. As a result of our debt
refinancing in July 2003 and the acquisition of a portion of our 9.5% senior
subordinated notes, we recognized a loss on the early extinguishment of debt of
$3.8 million in the twenty-eight weeks ended December 12, 2003. These costs
included the write-off of deferred financing costs of $2.9 million associated
with the debt that was repaid and the incurrence of premium costs of $0.9
million in connection with the acquisition of a portion of our 9.5% senior
subordinated notes. In the twenty-eight weeks ended December 12, 2003, we
purchased $45.3 million aggregate principal amount of our 9.5% senior
subordinated notes. These purchases excluded our $11.0 million aggregate
principal amount acquired in the first quarter of fiscal 2004, which was
committed to at the end of fiscal 2003. See "Liquidity and Capital Resources."
Income tax expense. Income tax expense was $1.2 million, or 39.3% of pretax
income, and $3.1 million, or 39.6% of pretax income, in the twenty-eight weeks
ended December 12, 2003 and December 13, 2002, respectively. Income tax expense
was computed by applying estimated effective income tax rates to the income or
loss before income taxes. Income tax expense varies from the statutory federal
income tax rate due primarily to state income taxes and non-tax deductible
expenses, offset by tax credits.
Discontinued operations. We recorded a loss on discontinued operations in
the twenty-eight weeks ended December 12, 2003 and December 13, 2002, which
represents the operating results, net of tax, for all periods presented of the
21 centers closed during the twenty-eight weeks ended December 12, 2003 and the
28 centers closed in fiscal 2003. Discontinued operations included the
following, with dollars in the thousands:
Twenty-Eight Weeks Ended
------------------------
December 12, December 13,
2003 2002
----------- -----------
Revenues, net................................... $ 1,501 $ 7,684
----------- -----------
Operating expenses:
Salaries, wages and benefits................. 1,192 4,971
Depreciation................................. 617 666
Rent......................................... 165 893
Provision for doubtful accounts.............. 55 177
Other........................................ 284 994
----------- -----------
Total operating expenses.................. 2,313 7,701
Operating loss............................... (812) (17)
Interest expense............................. -- (1)
Income tax benefit.............................. 319 7
----------- -----------
Discontinued operations, net of tax.......... $ (493) $ (11)
=========== ===========
Depreciation expense for the twenty-eight weeks ended December 13, 2002
included $0.1 million of impairment charges. Other operating expenses included
gains on closed center sales of $0.6 million and $1.2 million in the
twenty-eight weeks ended December 12, 2003 and December 13, 2002, respectively.
Net income. Net income was $1.3 million and $4.8 million in the
twenty-eight weeks ended December 12, 2003 and December 13, 2002, respectively.
The most significant reason for the decrease was $3.8 million ($2.4 million
after tax) of charges from the early extinguishment of debt, as discussed above.
Rising insurance costs and increased rent expense also contributed to the
decrease in net income in the twenty-eight weeks ended December 12, 2003. Basic
and diluted net income per share were both $0.07 for the twenty-eight weeks
ended December 12, 2003. For the twenty-eight weeks ended December 13, 2002,
basic and diluted net income per share were both $0.24.
19
Liquidity and Capital Resources
In July 2003 we refinanced a portion of our debt. We obtained a $125.0
million revolving credit facility, and, as described below in greater detail,
one of our subsidiaries obtained a $300.0 million mortgage loan. Proceeds from
the mortgage loan were used to pay off the $98.0 million balance of the then
existing revolving credit facility, $47.0 million of term loan facility and
$97.9 million under the synthetic lease facility. We also used a portion of the
remaining proceeds to purchase $37.0 million aggregate principal amount of our
9.5% senior subordinated notes.
The $300.0 million mortgage loan is secured by first mortgages or deeds of
trust on 475 of our owned centers located in 33 states. We refer to the mortgage
loan as the CMBS Loan and the 475 mortgaged centers as the CMBS Centers. In
connection with the CMBS Loan, the CMBS Centers were transferred to a newly
formed wholly owned subsidiary of ours, which is the borrower under the CMBS
Loan and is referred to as the CMBS Borrower. Because the CMBS Centers are owned
by the CMBS Borrower and subject to the CMBS Loan, recourse to the CMBS Centers
by our creditors will be effectively subordinated to recourse by holders of the
CMBS Loan.
The CMBS Loan is nonrecourse to the CMBS Borrower and us, subject to
customary recourse provisions, and has a maturity date of July 9, 2008, which
may be extended to July 9, 2009, subject to certain conditions. The CMBS Loan
bears interest at a per annum rate equal to LIBOR plus 2.25% and requires
monthly payments of principal and interest. Principal payments are based on a
thirty-year amortization (based on an assumed rate of 6.50%). We have purchased
an interest rate cap agreement to protect us from significant changes in LIBOR
during the initial three years of the CMBS Loan. Under the cap agreement, which
terminates July 9, 2006, LIBOR is capped at 6.50%. We are required to purchase
additional interest rate cap agreements capping LIBOR at a rate no higher than
7.00% for the period from July 9, 2006 to the maturity date of the CMBS Loan.
Each of the centers included in the CMBS Centers is being ground leased by
the CMBS Borrower to another wholly owned subsidiary formed in connection with
the CMBS Loan, which is referred to as the CMBS Operator, and is being managed
by us pursuant to a management agreement with the CMBS Operator. Transactions
between the CMBS Borrower and the CMBS Operator are eliminated in consolidation
since both the CMBS Borrower and the CMBS Operator are wholly owned
subsidiaries.
Prepayment of the CMBS Loan is prohibited through July 8, 2005, after which
prepayment is permitted in whole, subject to a prepayment premium of 3.0% from
July 8, 2005 through July 8, 2006, 2.0% from July 9, 2006 through July 8, 2007
and 1.0% from July 9, 2007 through January 8, 2008, with no prepayment penalty
thereafter. In addition, after July 8, 2005, the loan may be partially prepaid
as follows:
o up to $15.0 million each loan year in connection with releases of
mortgaged centers with no prepayment premium, and
o up to $5.0 million each loan year subject to payment of the applicable
prepayment premium.
The CMBS Loan contains a provision that requires the loan servicer to
escrow 50% of excess cash flow generated from the CMBS Centers (determined after
payment of debt service on the CMBS Loan, certain fees and required reserve
amounts) if the net operating income, as defined in the CMBS Loan Agreement, of
the CMBS Centers declines to $60.0 million, as adjusted to account for released
properties. The amount of excess cash flow to be escrowed increases to 100% if
the net operating income of the CMBS Centers declines to $50.0 million, as
adjusted. The net operating income of the CMBS Centers for the trailing twelve
months ended December 12, 2003 was approximately $81.1 million. The maximum
amount of excess cash flow that can be escrowed is limited to one year of debt
service on the CMBS Loan and one year of rent due under the ground lease with
the CMBS Operator during the term of the CMBS Loan. The escrowed amounts are
released if the CMBS centers generate the necessary minimum net operating income
for two consecutive fiscal quarters. The annual debt service on the
20
CMBS Loan is approximately $22.8 million (assuming a 6.50% interest rate). The
annual rent due under the ground lease is $34.0 million during the term of the
CMBS Loan. These excess cash flow provisions could limit the amount of cash made
available to us.
Our $125.0 million credit facility is secured by first mortgages or deeds
of trusts on 119 of our owned centers and certain other collateral and has a
maturity date of July 9, 2008. The revolving credit facility includes borrowing
capacity of up to $75.0 million for letters of credit and up to $10.0 million
for selected short-term borrowings. At December 12, 2003 there were no
borrowings outstanding under our credit facility.
During the twenty-eight week period ended December 12, 2003, we acquired
$45.3 million aggregate principal amount of our 9.5% senior subordinated notes
at an aggregate price of $45.4 million, which included a loss of $0.9 million.
In addition, these transactions resulted in the write-off of deferred financing
costs of $0.9 million. The $1.8 million of costs were included in interest
expense in the twenty-eight weeks ended December 12, 2003. We also acquired
$11.0 million aggregate principal amount of our 9.5% senior subordinated notes
at an aggregate price of $11.1 million in the first quarter of fiscal 2004. We
have provided notice to the trustee that we intend to redeem $40.0 million
aggregate principal amount of our 9.5% senior subordinated notes. The redemption
will occur on February 18, 2004, subject to deposit of the redemption funds. The
redemption will be funded primarily by cash flow from operations, proceeds
received from sale-leaseback transactions and borrowings under our credit
facility, to the extent necessary.
Our principal sources of liquidity are cash flow generated from operations,
proceeds received from our sale-leaseback program and borrowings under our
revolving credit facility. At December 12, 2003, we had no outstanding
borrowings under our revolving credit facility and had outstanding letters of
credit totaling $55.3 million. Our availability under our new credit facility
was $69.7 million. Our principal uses of liquidity are new center development
and debt service.
Our consolidated net cash provided by operating activities for the
twenty-eight weeks ended December 12, 2003 was $41.7 million compared to $35.9
million in the same period last year. The increase of $5.8 million was due
primarily to a change in working capital. Cash and cash equivalents totaled
$28.2 million at December 12, 2003, compared to $18.1 million at May 30, 2003.
EBITDA, which is a non-GAAP financial measure, is defined as earnings
before interest, taxes, depreciation, amortization and the related components of
discontinued operations. EBITDA reflects a non-GAAP financial measure of our
liquidity. A non-GAAP financial measure is a numerical measure of historical or
future financial performance, financial position or cash flow that excludes or
includes amounts, or is subject to adjustments that have the effect of excluding
or including amounts, from the most directly comparable measure calculated and
presented in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). We believe EBITDA is a useful tool for
certain investors and creditors for measuring our ability to meet debt service
requirements. Additionally, management uses EBITDA for purposes of reviewing our
results of operations on a more comparable basis. EBITDA does not represent cash
flow from operations as defined by GAAP, is not necessarily indicative of cash
available to fund all cash flow needs and should not be considered an
alternative to net income under GAAP for purposes of evaluating our results of
operations. EBITDA was calculated as follows, with dollars in thousands:
21
Twelve Weeks Ended Twenty-Eight Weeks Ended
------------------------- -------------------------
December 12, December 13, December 12, December 13,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net income..................... $ 4,338 $ 4,300 $ 1,324 $ 4,757
Interest expense, net.......... 9,660 9,542 26,219 22,273
Income tax expense............. 2,855 2,586 1,177 3,125
Depreciation and amortization.. 14,503 14,168 33,070 31,181
Discontinued operations:
Interest expense............. -- -- -- 1
Income tax (benefit) expense. (25) 232 (319) (7)
Depreciation................. 290 374 617 666
----------- ----------- ----------- -----------
EBITDA..................... $ 31,621 $ 31,202 $ 62,088 $ 61,996
=========== =========== =========== ===========
EBITDA - percentage of net
revenues................... 16.1% 16.1% 13.6% 13.9%
A reconciliation of EBITDA to cash provided by operating activities was as
follows, with dollars in thousands:
Twelve Weeks Ended Twenty-Eight Weeks Ended
------------------------- -------------------------
December 12, December 13, December 12, December 13,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net cash provided by operating activities... $ 34,888 $ 29,911 $ 41,733 $ 35,867
Income tax expense.......................... 2,855 2,586 1,177 3,125
Deferred income tax (expense) benefit....... 5,325 (2,297) 3,477 (5,570)
Interest expense, net....................... 9,660 9,542 26,219 22,273
Effect of discontinued operations on
interest and taxes........................ (25) 232 (319) (6)
Change in operating assets and liabilities.. (21,023) (8,871) (10,321) 6,688
Other non-cash items........................ 59 (99) 122 (381)
----------- ----------- ----------- -----------
EBITDA.................................... 31,621 $ 31,202 $ 62,088 $ 61,996
=========== =========== =========== ===========
During the twelve and twenty-eight week periods ended December 12, 2003,
EBITDA increased $0.4 million, or 1.3%, and $0.1 million or 0.1%, respectively,
from the same period last year. Despite higher tuition rates and improved labor
productivity, we have experienced higher insurance costs and increased rent
expense due primarily to our sale-leaseback program. EBITDA is not intended to
indicate that cash flow is sufficient to fund all of our cash needs or represent
cash flow from operations as defined by accounting principles generally accepted
in the United States of America. In addition, EBITDA should not be used as a
tool for comparison as the computation may not be the same for all companies.
In fiscal year 2000, we entered into a $100.0 million synthetic lease
facility under which a syndicate of lenders financed the construction of new
centers for lease to us for a three to five year period. A total of 44 centers
were constructed at a cost of $97.9 million. The synthetic lease facility was
terminated in July 2003 as part of our refinancing. The 44 centers are now owned
by us and the assets are reflected in our fiscal year 2004 consolidated
financial statements.
During the fourth quarter of fiscal year 2002, we began selling centers to
individual real estate investors and then leasing them back. The resulting
leases have been classified as operating leases. We will continue to manage the
operations of any centers that are sold in such transactions. The sales were
summarized as follows, with dollars in thousands:
22
Twenty-Eight
Weeks Ended Fiscal Year Ended
------------ -------------------------
December 12, May 30, May 31,
2003 2003 2002
------------ ----------- -----------
Number of centers...................... 18 41 5
Net proceeds from completed sales...... $ 31,312 $ 88,703 $ 9,180
Deferred gains......................... 11,606 32,507 2,600
The deferred gains are amortized on a straight-line basis, typically over a
period of 15 years. Subsequent to December 12, 2003, we closed $12.3 million in
sales, which included five centers, and are currently in the process of
negotiating another $62.9 million of sales related to 24 centers. It is possible
that we will be unable to complete these transactions in process. We expect our
sale-leaseback efforts to continue throughout fiscal year 2004, assuming the
market for such transactions remains favorable.
We expect to fund future new center development through our $125.0 million
revolving credit facility and sale-leaseback proceeds, although alternative
forms of funding continue to be evaluated and new arrangements may be entered
into in the future.
We believe that cash flow generated from operations, proceeds from our
sale-leaseback program and borrowings under our revolving credit facility will
adequately provide for our working capital and debt service needs and will be
sufficient to fund our expected capital expenditures for the foreseeable future.
Any future acquisitions, joint ventures or similar transactions may require
additional capital, and such capital may not be available to us on acceptable
terms or at all. Although no assurance can be given that such sources of capital
will be sufficient, the capital expenditure program has substantial flexibility
and is subject to revision based on various factors, including but not limited
to, business conditions, cash flow requirements, debt covenants, competitive
factors and seasonality of openings. If we experience a lack of working capital,
it may reduce our future capital expenditures. If these expenditures were
substantially reduced, in management's opinion, our operations and cash flow
would be adversely impacted.
We may experience decreased liquidity during the summer months and the
calendar year-end holidays due to decreased attendance during these periods. New
enrollments are generally highest during the traditional fall "back to school"
period and after the calendar year-end holidays. Enrollment generally decreases
5% to 10% during the summer months and calendar year-end holidays.
We have certain contractual obligations and commercial commitments.
Contractual obligations are those that will require cash payments in accordance
with the terms of a contract, such as a loan or lease agreement. Commercial
commitments represent potential obligations for performance in the event of
demands by third parties or other contingent events, such as lines of credit.
Our contractual obligations and commercial commitments at December 12, 2003 were
as follows, with dollars in thousands:
Remainder Fiscal Year
of Fiscal ---------------------------------------------------
Total 2004 2005 2006 2007 2008 Thereafter
---------- ---------- -------- -------- -------- -------- -----------
Long-term debt............... $ 546,383 $ 2,163 $ 7,570 $ 4,136 $ 4,314 $ 4,447 $ 523,753
Capital lease obligations.... 28,593 1,042 2,240 2,279 2,396 2,415 18,221
Operating lease.............. 431,738 19,652 45,192 41,935 38,178 35,034 251,747
---------- ---------- -------- -------- -------- -------- -----------
$1,006,714 $ 22,857 $ 55,002 $ 48,350 $ 44,888 $ 41,896 $ 793,721
========== ========== ======== ======== ======== ======== ===========
23
Capital Expenditures
During the twenty-eight weeks ended December 12, 2003 and December 13,
2002, we opened ten and 18 new centers, respectively. We expect to open
approximately 20 new centers in fiscal 2004 and to continue our practice of
closing centers that are identified as not meeting performance expectations. In
addition, we may acquire existing centers from local or regional early childhood
education and care providers. We may not be able to successfully negotiate and
acquire sites and/or previously constructed centers, meet our targets for new
center additions or meet targeted deadlines for development of new centers.
New centers are located based upon detailed site analyses that include
feasibility and demographic studies and financial modeling. The length of time
from site selection to construction and, finally, the opening of a community
center ranges from 16 to 24 months. Frequently, new site negotiations are
delayed or canceled or construction is delayed for a variety of reasons, many of
which are outside our control. The average total cost per community center
typically ranges from $1.9 million to $2.8 million depending on the size and
location of the center. However, the actual costs of a particular center may
vary from such range.
Our new centers typically have a licensed capacity ranging from 145 to 180,
while the centers constructed during fiscal 1997 and earlier have an average
licensed capacity of 125. When mature, these larger centers are designed to
generate higher revenues, operating income and margins than our older centers.
These new centers also have higher average costs of construction and typically
take three to four years to reach maturity. On average, our new centers should
begin to produce positive EBITDA during the first year of operation and begin to
produce positive net income by the end of the second year of operation.
Accordingly, as more new centers are developed and opened, profitability will be
negatively impacted in the short-term but is expected to be enhanced in the
long-term once these new centers achieve anticipated levels of occupancy.
Capital expenditures included the following, with dollars in thousands:
Twenty-Eight Weeks Ended
---------------------------
December 12, December 13,
2003 2002
------------ ------------
New center development.................. $ 15,900 $ 34,568
Renovation of existing facilities....... 9,073 11,223
Equipment purchases..................... 4,971 7,424
Information systems purchases........... 637 976
------------ ------------
$ 30,581 $ 54,191
============ ============
Capital expenditures for the twenty-eight weeks ended December 12, 2003 do
not include $97.9 million spent to purchase the 44 centers previously included
in the synthetic lease facility.
Capital expenditure limits under our credit facility for fiscal year 2004
are $110.0 million. We have some ability to incur additional indebtedness,
including through mortgages or sale-leaseback transactions, subject to the
limitations imposed by the indenture under which our senior subordinated notes
were issued and our revolving credit facility.
Application of Critical Accounting Policies
Critical Accounting Estimates. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America requires that management make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes. Predicting
future events is inherently an imprecise activity and as such requires the use
of
24
judgment. Actual results may vary from estimates in amounts that may be material
to the financial statements.
For a description of our significant accounting policies, see "Note 2.
Summary of Significant Accounting Policies" to the unaudited consolidated
financial statements. For a more complete description, please refer to our
Annual Report on Form 10-K for the fiscal year ended May 30, 2003. The following
accounting estimates and related policies are considered critical to the
preparation of our financial statements due to the business judgment and
estimation processes involved in their application. Management has reviewed the
development and selection of these estimates and their related disclosure with
the Audit Committee of the Board of Directors.
Revenue recognition. Tuition revenues, net of discounts, and other revenues
are recognized as services are performed. Payments may be received in advance of
services being rendered, in which case the revenue is deferred and recognized
during the appropriate time period, typically a week. Our non-refundable
registration and education fees are amortized over the average enrollment
period, not to exceed one year. The recognition of our net revenues meets the
criteria of the Securities and Exchange Commission Staff Accounting Bulletin No.
101, Revenue Recognition in Financial Statements, as amended, including the
existence of an arrangement, the rendering of services, a determinable fee and
probable collection.
Accounts receivable. Our accounts receivable are comprised primarily of
tuition due from governmental agencies, parents and employers. Accounts
receivable are presented at estimated net realizable value. We use estimates in
determining the collectibility of our accounts receivable and must rely on our
evaluation of historical experience, governmental funding levels, specific
customer issues and current economic trends to arrive at appropriate reserves.
Material differences may result in the amount and timing of bad debt expense if
actual experience differs significantly from management estimates.
Long-lived and intangible assets. We assess the potential impairment of
property and equipment and finite-lived intangibles whenever events or changes
in circumstances indicate that the carrying value may not be recoverable, in
accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. An asset's value is impaired if our estimate of the aggregate
future cash flows, undiscounted and without interest charges, to be generated by
the asset is less than the carrying value of the asset. Such cash flows consider
factors such as expected future operating income and historical trends, as well
as the effects of demand and competition. To the extent impairment has occurred,
the loss will be measured as the excess of the carrying amount of the asset over
its fair value. Such estimates require the use of judgment and numerous
subjective assumptions, which, if actual experience varies, could result in
material differences in the requirements for impairment charges. Impairment
charges, which were included as a component of depreciation expense, were as
follows with dollars in thousands:
Twelve Weeks Ended Twenty-Eight Weeks Ended
------------------------- -------------------------
December 12, December 13, December 12, December 13,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Impairment charges included in
depreciation expense............. $ 369 $ 669 $ 945 $ 749
Impairment charges included in
discontinued operations.......... -- 106 -- 106
----------- ----------- ----------- -----------
Total impairment charges........... $ 369 $ 775 $ 945 $ 855
=========== =========== =========== ===========
Investments. Investments, wherein we do not exert significant influence or
own over 20% of the investee's stock, are accounted for under the cost method.
We measure the fair values of these investments annually, or more frequently if
there is an indication of impairment, using multiples of comparable companies
and discounted cash flow analysis.
25
Self-insurance obligations. We self-insure a portion of our general
liability, workers' compensation, auto, property and employee medical insurance
programs. We purchase stop loss coverage at varying levels in order to mitigate
our potential future losses. The nature of these liabilities, which may not
fully manifest themselves for several years, requires significant judgment. We
estimate the obligations for liabilities incurred but not yet reported or paid
based on available claims data and historical trends and experience, as well as
future projections of ultimate losses, expenses, premiums and administrative
costs. The accrued obligations for these self-insurance programs were $52.3
million and $45.1 million at December 12, 2003 and May 30, 2003, respectively.
Our internal estimates are reviewed throughout the fiscal year by a third party
actuary. While we believe that the amounts accrued for these obligations are
sufficient, any significant increase in the number of claims and/or costs
associated with claims made under these programs could have a material adverse
effect on our financial position, cash flows or results of operations.
Income taxes. Accounting for income taxes requires us to estimate our
future tax liabilities. Due to timing differences in the recognition of items
included in income for accounting and tax purposes, deferred tax assets or
liabilities are recorded to reflect the impact arising from these differences on
future tax payments. With respect to recorded tax assets, we assess the
likelihood that the asset will be realized. If realization is in doubt because
of uncertainty regarding future profitability or enacted tax rates, we provide a
valuation allowance related to the asset. Should any significant changes in the
tax law or our estimate of the necessary valuation allowance occur, we would be
required to record the impact of the change. This could have a material effect
on our financial position or results of operations.
Initial Adoption of Accounting Policies
SFAS No. 149, Amendments of Statement 133 on Derivative Instruments and
Hedging Activities, amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives) and for hedging
activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. SFAS No. 149 was adopted for contracts entered into or modified and
for hedging relationships designated after June 30, 2003. This adoption did not
have a material impact on our consolidated financial statements.
Recently Issued Accounting Pronouncements
FIN 46, Consolidation of Variable Interest Entities, requires consolidation
where there is a controlling financial interest in a variable interest entity,
previously referred to as a special-purpose entity, and certain other entities.
The implementation of FIN 46 has been delayed and will be effective during the
fourth quarter of our fiscal year 2004. We do not anticipate an impact to our
consolidated financial statements.
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity, establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The statement requires that an
issuer classify a financial instrument that is within its scope as a liability,
or an asset in some circumstances. SFAS No. 150 was effective for financial
instruments entered into or modified after May 31, 2003, and otherwise was
effective in the second quarter of our fiscal year 2004. This statement did not
have a material impact to our consolidated financial statements.
Wage Increases
Expenses for salaries, wages and benefits represented approximately 55.5%
of net revenues for the twenty-eight weeks ended December 12, 2003. We believe
that, through increases in our tuition rates, we can mitigate any future
increase in expenses caused by adjustments to the federal or state minimum wage
rates or other market adjustments. However, we may not be able to increase our
rates sufficiently to
26
offset such increased costs. We continually evaluate our wage structure and may
implement changes at targeted local levels.
Forward-Looking Statements
We have made statements in this report that constitute forward-looking
statements as that term is defined in the federal securities laws. These
forward-looking statements concern our operations, economic performance and
financial condition and include statements regarding: opportunities for growth;
the number of early childhood education and care centers expected to be added in
future periods; the profitability of newly opened centers; capital expenditure
levels; the ability to refinance or incur additional indebtedness; strategic
acquisitions, investments, alliances and other transactions; changes in
operating systems and policies and their intended results; our expectations and
goals for increasing center revenue and improving our operational efficiencies;
changes in the regulatory environment; the potential benefit of tax incentives
for child care programs; our projected cash flow; and our marketing efforts to
sell and leaseback centers. The forward-looking statements are subject to
various known and unknown risks, uncertainties and other factors. When we use
words such as "believes," "expects," "anticipates," "plans," "estimates" or
similar expressions we are making forward-looking statements.
Although we believe that our forward-looking statements are based on
reasonable assumptions, our expected results may not be achieved. Actual results
may differ materially from our expectations. Important factors that could cause
actual results to differ from expectations include, among others:
o the effects of general economic conditions;
o competitive conditions in the child care and early education
industries;
o various factors affecting occupancy levels, including, but not limited
to, the reduction in or changes to the general labor force that would
reduce the need for child care services;
o the availability of a qualified labor pool, the impact of labor
organization efforts and the impact of government regulations
concerning labor and employment issues;
o federal and state regulations regarding changes in child care
assistance programs, welfare reform, transportation safety, minimum
wage increases and licensing standards;
o the loss of government funding for child care assistance programs;
o our inability to successfully execute our growth strategy;
o the availability of financing or additional capital;
o our difficulty in meeting or inability to meet our obligations to
repay our indebtedness;
o the availability of sites and/or licensing or zoning requirements that
may make us unable to open new centers;
o our ability to integrate acquisitions;
o our inability to successfully defend against or counter negative
publicity associated with claims involving alleged incidents at our
centers;
o our inability to obtain insurance at the same levels, or at costs
comparable to those incurred historically;
o the effects of potential environmental contamination existing on any
real property owned or leased by us; and
27
o other risk factors that are discussed in this report and, from time to
time, in our other Securities and Exchange Commission reports and
filings.
We caution you that these risks may not be exhaustive. We operate in a
continually changing business environment and new risks emerge from time to
time.
You should not rely upon forward-looking statements except as statements of
our present intentions and of our present expectations that may or may not
occur. You should read these cautionary statements as being applicable to all
forward-looking statements wherever they appear. We assume no obligation to
update or revise the forward-looking statements or to update the reasons why
actual results could differ from those projected in the forward-looking
statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our consolidated
financial position, results of operations or cash flows. We are exposed to
market risk in the areas of interest rates and foreign currency exchange rates.
Interest Rates
Our exposure to market risk for changes in interest rates relates primarily
to debt obligations. We have no cash flow exposure due to rate changes on our
9.5% senior subordinated notes aggregating $233.7 million at December 12, 2003.
We also have no cash flow exposure on certain industrial revenue bonds,
mortgages and notes payable aggregating $5.3 million at December 12, 2003.
However, we have cash flow exposure on our revolving credit facility entered
into on July 1, 2003 and certain industrial revenue bonds subject to variable
LIBOR or adjusted base rate pricing. While there were no borrowings outstanding
under our revolving credit facility at December 12, 2003, we had borrowings up
to $27.0 million for the twenty-eight weeks ended December 12, 2003.
Accordingly, a 1% (100 basis points) change in the LIBOR rate would have
resulted in interest expense changing by less than $0.1 million in the twelve
and twenty-eight weeks ended December 12, 2003, respectively. A 1% (100 basis
points) change in the variable LIBOR or adjusted base rate pricing on our
industrial revenue bonds, aggregating $8.5 million at December 12, 2003, would
have resulted in interest expense changing by less than $0.1 million in the
second quarters of fiscal 2004 and 2003, and in the twenty-eight weeks ended
December 12, 2003 and December 13, 2002, respectively.
We have cash flow exposure on the CMBS Loan entered into in July 2003,
which bears interest at a rate equal to LIBOR plus 2.25%. A 1% (100 basis
points) change in the LIBOR rate would have resulted in interest expense
changing by approximately $0.7 million and $1.4 million in the twelve and
twenty-eight weeks ended December 12, 2003, respectively. We have purchased an
interest rate cap agreement to protect us from significant movements in LIBOR
during the initial three years of the CMBS Loan. The LIBOR strike price is 6.50%
under the interest rate cap agreement, which terminates July 9, 2006, at which
time we are required to purchase an additional interest rate cap agreement for
the duration of the loan term.
In addition, we have cash flow exposure on our vehicle leases with variable
interest rates. A 1% (100 basis points) change in the interest rate defined in
our vehicle lease agreement would have resulted in rent expense changing by
approximately $0.1 million in both of the second quarters of fiscal 2004 and
2003, and $0.3 million in the twenty-eight weeks ended December 12, 2003 and
December 13, 2002, respectively.
Foreign Exchange Risk
We are exposed to foreign exchange risk to the extent of fluctuations in
the United Kingdom pound sterling. Based upon the relative size of our
operations in the United Kingdom, we do not believe
28
that the reasonably possible near-term change in the related exchange rate would
have a material effect on our financial position, results of operations and cash
flows.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. Our management has evaluated, under the
supervision and with the participation of our Chief Executive Officer ("CEO")
and Chief Financial Officer ("CFO"), the effectiveness of our disclosure
controls and procedures at the end of the period covered by this report,
pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the
"Exchange Act"). Based on that evaluation, our CEO and CFO have concluded that,
at the end of the period covered by this report, our disclosure controls and
procedures are effective in ensuring that information required to be disclosed
in our Exchange Act reports is:
o recorded, processed, summarized and reported in a timely manner, and
o accumulated and communicated to our management, including our CEO and
CFO, as appropriate to allow timely decisions regarding required
disclosure.
Internal Control Over Financial Reporting. There has been no change in our
internal controls over financial reporting that occurred during our second
quarter ended December 12, 2003 that has materially affected, or is reasonably
likely to materially affect, our internal controls over financial reporting.
29
PART II.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On November 5, 2003 at our annual meeting of stockholders the following
matters were submitted to a vote of security holders:
Election of Directors. Six directors were re-elected to serve until the
next annual meeting of stockholders or until their successors are elected and
qualified:
Number of Shares
-------------------------
Name For Withheld
-------------------- ---------- --------
David J. Johnson 18,987,658 155,130
Henry R. Kravis 18,987,658 155,130
George R. Roberts 18,987,658 155,130
Micheal W. Michelson 18,987,658 155,130
Scott C. Nutall 18,987,658 155,130
Richard J. Goldstein 19,142,440 348
There were no abstentions.
Appointment of Auditors. The appointment of Deloitte and Touche, LLP to
serve as our independent auditors for the fiscal year ending May 28, 2004 was
ratified with 19,130,630 shares voting for, 16,794 shares voting against and 364
shares abstaining.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The following exhibits are filed with this report or incorporated
herein by reference:
3(a) Amended and Restated Certificate of Incorporation of KinderCare
(incorporated by reference from Exhibit 3(a) to our Annual Report on
Form 10-K for the fiscal year ended May 31, 2002).
3(b) Restated Bylaws of KinderCare effective September 1, 2001
(incorporated by reference from Exhibit 3(a) to our Quarterly Report
on Form 10-Q for the quarterly period ended September 21, 2001).
4(a) Indenture dated February 13, 1997 between KinderCare and Marine
Midland Bank, as Trustee (incorporated by reference from Exhibit 4.1
of our Registration Statement on Form S-4, filed March 11, 1997, File
No. 333-23127).
4(b) First Supplemental Indenture dated September 1, 1999 to the Indenture
dated as of February 13, 1997 between KinderCare and HSBC Bank USA
(formerly known as Marine Midland Bank), as Trustee (incorporated by
reference from Exhibit 4(a) to our Quarterly Report on Form 10-Q for
the quarterly period ended September 17, 1999).
4(c) Form of 9.5% Series B Senior Subordinated Note due 2009 (incorporated
by reference from Exhibit 4.3 of our Registration Statement on Form
S-4, filed March 11, 1997, File No. 333-23127).
10(a) Amendment No. 2 to Nonqualified Deferred Compensation Plan, effective
January 1, 2004.
31(a) Certification of Chief Executive Officer of registrant pursuant to
SEC Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31(b) Certification of Chief Financial Officer of registrant pursuant to
SEC Rule 13a- 14(a)/15d-14(a), as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32(a) Certification of Chief Executive Officer of registrant pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
30
32(b) Certification of Chief Financial Officer of registrant pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K: Furnished November 4, 2003 for first quarter fiscal
2004 earnings released on November 3, 2003.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on January 23, 2004.
KINDERCARE LEARNING CENTERS, INC.
By: /s/ DAVID J. JOHNSON
-------------------------------------
David J. Johnson
Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
By: /s/ DAN R. JACKSON
-------------------------------------
Dan R. Jackson
Executive Vice President,
Chief Financial Officer
(Principal Financial and Accounting Officer)
32