Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
---
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: December 31, 2002
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
For the transition period from ___________ to ____________
Commission File Number 1-10031
NOBEL LEARNING COMMUNITIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 22-2465204
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
1615 West Chester Pike, West Chester, PA 19382
(Address of principal executive offices) (Zip Code)
(484) 947-2000
(Registrant's telephone number, including area code)
Indicate by check whether the registrant (1) has filed all report(s) 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_______
-----------
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 6,554,966 shares of Common
Stock outstanding at February 24, 2002.
INDEX TO FORM 10-Q
Nobel Learning Communities, Inc.
Page
PART I. FINANCIAL INFORMATION Number
------
Item 1. Financial Statements
Consolidated Balance Sheets,
December 31, 2002 (unaudited) and June 30, 2002 ............... 3
Consolidated Statements of Operations for the
six months ended December 31, 2002 (unaudited)
and 2001 (unaudited) .......................................... 4
Consolidated Statements of Operations for the
three months ended December 31, 2002 (unaudited)
and 2001 (unaudited) .......................................... 5
Consolidated Statements of Cash Flows for the
six months ended December 31, 2002 (unaudited)
and 2001 (unaudited) .......................................... 6
Consolidated Statements of Stockholders' Equity and
Comprehensive Income for the six months Ended December 31,
2002 (unaudited) .............................................. 7
Notes to Consolidated Interim Financial Statements ............ 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ................. 13
Item 3 Quantitative and Qualitative Disclosures About Market Risk .... 22
Item 4 Controls and Procedures ....................................... 23
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K .............................. 24
ii
PART I
Financial Information
Recent Developments
Nobel Learning Communities, Inc. ("NLCI" or "the Company") entered into an
Agreement and Plan of Merger, dated as of August 5, 2002, with Socrates
Acquisition Corporation ("Socrates"), a corporation formed by Gryphon Partners
II, L.P. and Cadigan Investment Partners, Inc. The Agreement and Plan of Merger
(as amended by a First Amendment thereto, dated as of October 2, 2002, the
"Merger Agreement") contemplated that Socrates would be merged into NLCI, with
NLCI as the surviving corporation (the "Merger").
Under the Merger Agreement, Socrates' obligation to consummate the Merger was
subject to its ability to obtain financing. Although at the time the Merger
Agreement was signed, Socrates had received signed commitment letters providing
for the necessary debt and equity financing, subject to certain conditions,
Socrates did not receive the financing necessary to consummate the Merger.
Accordingly, the Company terminated the Merger Agreement, in accordance with its
terms, on February 3, 2003.
"Safe Harbor" Statement under Private Securities Litigation Reform Act of 1995
Certain statements set forth in this 10-Q constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements include, without limitation, whether and when the
Merger will be consummated, the Company's outlook for the fiscal year ended June
30, 2003 ("Fiscal 2003"), other statements in this report other than historical
facts relating to the financial conditions, results of operations, plans,
objectives, future performance and business of the Company. In addition, words
such as "believes," "anticipates," "expects," "intends," "estimates," and
similar expressions are intended to identify forward-looking statements, but are
not the exclusive means of identifying such statements. Such statements are
based on management's currently available operating budgets and forecasts, which
are based upon detailed assumptions about many important factors such as market
demand, market conditions and competitive activities. While the Company believes
that its assumptions are reasonable, readers are cautioned that there are
inherent difficulties in predicting the impact of certain factors, especially
those affecting the acceptance of the Company's newly developed schools and
businesses and performance of recently acquired businesses, which could cause
actual results to differ materially from predicted results. Readers are
cautioned that the forward-looking statements reflect management's analysis only
as of the date hereof, and the Company assumes no obligation to update these
statements. Actual future results, events and trends may differ materially from
those expressed in or implied by such statements depending on a variety of
factors set forth throughout this 10-Q. With respect to any forward-looking
statements regarding the Merger, these factors include, but are not limited to,
the risks that stockholder approval, financing and regulatory and other
governmental and third-party clearances and consents may not be obtained in a
timely manner or at all and that other conditions to the Merger may not be
satisfied.
2
Nobel Learning Communities, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands)
(unaudited)
Current Assets December 31, 2002 June 30, 2002
- -------------- ----------------- -------------
Cash and cash equivalents $ 1,218 $ 1,787
Accounts receivable, less allowance for doubtful accounts
of $575 and $468 at December 2002 and June 2002, respectively 2,873 2,685
Notes receivable 275 251
Prepaid rents 2,245 2,408
Other prepaid expenses 1,807 2,543
Assets held for sale 3,850 -
----------------- -------------
Total Current Assets 12,268 9,674
----------------- -------------
Property, & equipment at cost 62,865 66,047
Accumulated depreciation (29,014) (26,458)
----------------- -------------
Total property and equipment 33,851 39,589
Goodwill 46,176 48,376
Intangible assets, net 955 1,145
Investment 2,600 2,600
Deposits and other assets 1,386 1,596
----------------- -------------
Total Assets $ 97,236 $ 102,980
================= =============
Liabilities and Stockholders' Equity
- ------------------------------------
Current portion of long-term obligations $ 31,552 $ 4,488
Current portion of swap contract 94 63
Cash overdraft liability 3,249 3,564
Accounts payable and other current liabilities 3,947 7,528
Unearned income 9,346 7,356
----------------- -------------
Total Current Liabilities 48,188 22,999
----------------- -------------
Long-term obligations - 25,411
Long-term subordinated debt 10,229 10,318
Swap contract 468 313
Deferrred gain on sale/leaseback 15 28
Deferred taxes 1,192 1,192
Minority interest in consolidated subsidiary 84 232
----------------- -------------
Total Liabilities 60,176 60,493
Stockholders' Equity:
Preferred Stock, $.001 par value; 10,000,000 shares authorized, issued
and outstanding 4,587,464 at December 31, 2002, and June 30, 2002;
$5,524 aggregate liquidation preference at December 31, 2002
and June 30, 2002. 5 5
Common Stock, $.001 par value, 20,000,000 shares authorized, issued and
outstanding 6,554,966 at December 31, 2002 and 6,544,953 at June 30, 2002. 6 6
Treasury Stock, cost; 230,510 shares (1,375) (1,375)
Additional paid in capital 41,415 41,389
Retained earnings (2,429) 2,838
Accumulated other comprehensive loss (562) (376)
----------------- -------------
Total Stockholders' Equity 37,060 42,487
----------------- -------------
Total Liabilities & Stockholders' Equity $ 97,236 $ 102,980
================= =============
The accompanying notes and the notes in the financial statement included in the
Registrant's Annual Report on the Form 10-K are an integral part of these
financial statements.
3
Nobel Learning Communities Inc. and Subsidiaries
Consolidated Statements Of Operations
for the six months ended December 31, 2002 and 2001
(Dollars in thousands except per share amounts)
(unaudited)
2002 2001
-------- --------
Revenues $ 75,018 $ 73,472
Total operating expenses 68,767 64,712
-------- --------
School operating profit 6,251 8,760
Goodwill impairment 2,200 -
Transaction related costs 1,018 -
General and administrative expenses 5,716 5,886
-------- --------
Operating (loss) income (2,683) 2,874
Interest expense 1,689 1,872
Other expense (income) 14 (84)
Minority interest in earnings 11 17
-------- --------
(Loss) income before taxes (4,397) 1,069
Income tax (benefit) expense (902) 437
-------- --------
Net (loss) income from continuing operations (3,495) 632
Loss from discontinued operations, net of income
tax benefits of $1,203 and $157 in 2002 and 2001, respectively (1,731) (226)
-------- --------
Net (loss) income $ (5,226) $ 406
-------- --------
Preferred stock dividends 41 41
-------- --------
Net (loss) income available to common stockholders $ (5,267) $ 365
======== ========
Basic (loss) income per share:
- ------------------------------
Continuing operations (0.56) 0.10
Discontinued operations (0.27) (0.04)
-------- --------
(Loss) income per share $ (0.83) $ 0.06
======== ========
Dilutive income per share:
- ---------------------------------
Continuing operations -- 0.08
Discontinued operations -- (0.03)
-------- --------
Income per share $ -- $ 0.05
======== ========
The accompanying notes and the notes in the financial statements included in the
Registrant's Annual Report on Form 10-K are an integral part of these financial
statements.
4
Nobel Learning Communities Inc. and Subsidiaries
Consolidated Statements Of Operations
for the three months ended December 31, 2002 and 2001
(Dollars in thousands except per share amounts)
(unaudited)
2002 2001
------------- -------------
Revenues $ 40,476 $ 39,300
Total operating expenses 35,745 33,540
------------- -------------
School operating profit 4,731 5,760
Goodwill impairment 2,200 -
Transaction related costs 600 -
General and administrative expenses 3,005 3,115
------------- -------------
Operating (loss) income (1,074) 2,645
Interest expense 817 922
Other income (4) (2)
Minority interest in earnings 6 7
------------- -------------
(Loss) income before taxes (1,893) 1,718
Income tax expense 126 704
------------- -------------
Net (loss) income from continuing operations (2,019) 1,014
Loss from discontinued operations, net of income tax
benefit of $939 and $47 in 2002 and 2001, respectively (1,352) (68)
------------- -------------
Net (loss) income $ (3,371) $ 946
============= =============
Preferred stock dividends 21 21
------------- -------------
Net (loss) income available to common stockholders $ (3,392) $ 925
============= =============
Basic (loss) income per share:
- -----------------------
Continuing operations (0.32) 0.16
Discontinued operations (0.21) (0.01)
------------- -------------
(Loss) income per share $ (0.53) $ 0.15
============= =============
Dilutive income per share:
- --------------------------
Continuing operations - 0.14
Discontinued operations - (0.01)
------------- -------------
Income per share $ - $ 0.13
============= =============
The accompanying notes and the notes in the financial statements included in the
Registrant's Annual Report on Form 10-K are an integral part of these financial
statements.
5
Nobel Learning Communities, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
for the six months ended December 31, 2002 and 2001
(Dollars in thousands)
(unaudited)
2002 2001
------- -------
Net Cash Provided By Operating Activities $ 2,093 $ 4,830
Cash Flows From Investing Activities:
Proceeds from sale of real estate - 532
Capital expenditures (3,589) (5,127)
Cash payments on note receivable - 1,736
Advance on note receivable (85) (314)
------- -------
Net Cash Used In Investing Activities: (3,674) (3,173)
------- -------
Cash Flows From Financing Activities:
Proceeds from long term debt 3,681 3,454
Repayment of long term debt (1,071) (1,288)
Repayment of subordinated debt (1,036) (2,151)
Repayment of capital lease obligation (74) -
Proceeds from exercise of stock options and warrants 26 568
Cash distribution of minority interest (158) (63)
Payments of dividends on preferred stock (41) (41)
Cash overdraft (315) (2,588)
------- -------
Net Cash (Used in) Provided by Financing Activities: 1,012 (2,109)
------- -------
Net increase (decrease) in cash and cash equivalents (569) (452)
Cash and cash equivalents at the beginning of the period 1,787 1,321
------- -------
Cash and cash equivalents at the end of the period $ 1,218 $ 869
======= =======
The accompanying notes and the notes in the financial statements included
in the Registrant's Annual Report on Form 10-K are an integral part of
these consolidated financial statements.
6
Nobel Learning Communities, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity and Comprehensive Loss
For the Six Months Ended December 31, 2002
(Dollars in thousands except share data)
(Unaudited)
Retained Accumulated
Preferred Stock Common Stock Additional Earnings Other
------------------- ------------------- Paid-In Treasury /Accumulated Comprehensive
Shares Amount Shares Amount Capital Stock Deficit Loss Total
--------- --------- --------- -------- ---------- ----------- -------------- -------------- ---------
June 30, 2002 4,587,464 $ 5 6,544,953 $ 6 $ 41,389 $ (1,375) $ 2,838 $ (376) $ 42,487
Comprehensive income:
Net loss (5,226) $ (5,226)
Swap contract (186) (186)
---------
Total comprehensive loss $ (5,412)
Stock options exercised - - 10,013 - 26 - - $ 26
Preferred dividends - - - - - - (41) - (41)
--------- -------- --------- ------- --------- --------- ---------- ----------- ---------
December 31, 2002 4,587,464 $ 5 6,554,966 $ 6 $ 41,415 $ (1,375) $ (2,429) $ (562) $ 37,060
========= ======== ========= ======= ========= ========= ========== =========== =========
The accompanying notes and the notes to the financial statements
included in the Registrant's Annual Report on Form 10-K are an
integral part of these financial statements
7
NOBEL LEARNING COMMUNITIES, INC. AND SUBSIDIARIES
Notes to Consolidated Interim Financial Statements
for the three months ended December 31, 2002 and 2002
(unaudited)
Note 1 - Basis of Presentation
The consolidated financial statements have been prepared by the Company
pursuant to the rules and regulations of the Securities and Exchange Commission
("SEC") and, in the opinion of management, include all adjustments, consisting
of normal recurring adjustments, necessary to present fairly the Company's
financial position and results of operations. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such SEC rules and regulations. It is suggested that these financial
statements be read in conjunction with the consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for the year
ended June 30, 2002.
Due to the inherent seasonal nature of the education and child care
businesses, annualization of amounts in these interim financial statements may
not be indicative of the actual operating results for the full year.
Future results of operations of the Company involve a number of risks and
uncertainties. Factors that could affect future operating results and cause
actual results to vary materially from historical results include, but are not
limited to, consumer acceptance of the Company's business strategy with respect
to expansion into new and existing markets, the Company's debt and related
financial covenants, difficulties in managing the Company's growth including
attracting and retaining qualified personnel, a large portion of the Company's
assets represent goodwill, increased competition, changes in government policy
and regulation, ability to obtain additional capital required to fully implement
the Company's business plan, and the Company's investment in Total Education
Solutions, Inc.
Note 2 - Liquidity
The Company terminated the Merger Agreement with Socrates on February 3,
2003. For the six months ending on December 31, 2002 the Company expensed
$1,018,000 of fees and expenses associated with this transaction. These charges,
coupled with the cost of closing the Company's school in Sarasota, Florida and
the overall impact of general economic conditions on the Company's revenue have
placed the Company in noncompliance with certain of its senior debt facility
financial covenants as of the quarter ended December 31, 2002. Further, in the
absence of restructuring these covenants, it is probable that the Company will
be in noncompliance of one or more financial covenants for the quarters ending
March 31, 2003 and June 30, 2003. As a result, the Company has classified all of
its senior debt as a current liability at December 31, 2002. The Company is in
discussions with its senior lenders and has requested a waiver for the covenant
noncompliance through December 31, 2002 and is actively engaged in discussions
with its senior lenders with respect to amending the financial covenants for
future quarters. However, management has not received a waiver and is unable to
assure that its efforts in this regard will be successful. As a result of the
event of default, the senior bank debt can be deemed to be immediately due and
payable at the lender's discretion.
The Company has $10,955,000 outstanding under subordinated debt
agreements at December 31, 2002. The Company is in compliance with the financial
ratios of these agreements as they are less restrictive than the senior debt
facility. The Company's subordinated debt obligations due over one year remain
as long term debt.
8
Note 3 - Merger Agreement
On May 16, 2000, the Company entered into a rights agreement (the
"Stockholder Rights Agreement") with Stocktrans, Inc., as rights agent, under
which preferred stock purchase rights were distributed to NLCI's stockholders.
The Stockholder Rights Agreement was amended, on August 4, 2002, by Amendment
No.1, to permit discussions among the buying group and management in connection
with the Merger Agreement without raising a concern about triggering the rights.
In addition, the Stockholder Rights Agreement was amended, on August 5, 2002, by
Amendment No.2, to amend the definition of "Acquiring Person," so that the
dilutive effect of the rights was not triggered by the announcement of a public
bid.
The Company's Board of Directors, acting upon the unanimous
recommendation of the Special Committee of the Board comprised of three
disinterested directors, approved the Merger. In reaching its decision, the
Special Committee and the Board received a fairness opinion from the Company's
financial advisor, Legg Mason Wood Walker, Incorporated.
Under the Merger Agreement, Socrates' obligation to consummate the Merger was
subject to its ability to obtain financing, and at the time the Merger Agreement
was signed, Socrates had received signed commitment letters providing for the
necessary debt and equity financing, subject to certain conditions.
However, in November, 2002, Socrates advised the special committee of the
Company's board of directors formed in connection with the Merger that Socrates
did not believe the contemplated merger consideration would be financeable at
$7.75 per share. Subsequently, on February 3, 2003, the Company terminated the
Merger Agreement, and abandoned the merger and the other transactions
contemplated thereby, due to the fact that the Merger had not occurred by
January 31, 2003.
During the first six months ended December 31, 2002, the Company expensed
approximately $1,018,000 of legal, professional and other registration fees
incurred in connection with the Merger.
On August 7, 2002, a civil action was commenced in the Court of Chancery
in the State of Delaware in New Castle County. The plaintiff in that action
sought to represent a putative class consisting of the public stockholders of
the Company. Named as defendants in the complaint were the Company, members of
the Company Board of Directors and one former member of the Company's Board of
Directors. The plaintiff alleged, among other things, that the Merger was unfair
and that the Company's directors breached their fiduciary duties by failing to
fully disclose material non-public information related to the value of the
Company and by engaging in self-dealing. The complaint sought an injunction,
damages and other relief. The Company was served with the complaint on August
22, 2002. A stipulation and dismissal of that case was ordered by the court on
February 27, 2003 due to the fact that the Merger Agreement was terminated.
9
Note 4 - Goodwill
The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets,
effective July 1, 2001. Under SFAS No. 142, goodwill is no longer amortized but
will be assessed for impairment at least annually or upon an adverse change in
operations. The annual impairment testing required by SFAS No. 142 will require
judgments and estimates and could require us to write down the carrying value of
our goodwill and other intangible assets in future periods.
The net carrying value of goodwill was $48,376,000 as of July 1, 2002. Due
to the termination of the Merger Agreement and the decline in the stock price,
the Company is required by SFAS 142 to evaluate the Company's goodwill for
recovery based on the facts and circumstances at December 31, 2002. An
independent valuation consultant engaged by the Company estimated fair values
for each reporting unit using discounted cash flow projections in evaluating and
measuring a potential impairment charge. The level one impairment test as
required under SFAS 142 as of December 31, 2002 indicated that two of the
Company's ten reporting units were impaired (Washington/Oregon and
Pennsylvania/New Jersey). The Company is in the process of evaluating the
consultant's report and completing the level two analysis. Based on the
consultant's independent valuation, the Company currently estimates that the
impairment loss related to these two reporting units is approximately
$2,200,000, which is recorded as a component of income from operations. This
estimated goodwill impairment loss represents a preliminary estimate and may
require adjustment based on work still to be completed. Any change to this
estimate based on the Company's final assumptions and analysis could be
different than this estimate and will be adjusted in the third quarter results
of operations.
Note 5 - Earnings Per Share
Earnings per share are based on the weighted average number of shares
outstanding and common stock equivalents during the period. In the calculation
of dilutive earnings per share, shares outstanding are adjusted to assume
conversion of the Company's non-interest bearing convertible preferred stock if
they are dilutive. In the calculation of basic earnings per share, weighted
average number of shares outstanding are used as the denominator. The Company
was in a loss position for the three months and the six months ended December
31, 2002, resulting in the calculation of dilutive earnings per share being
antidilutive. Earnings per share are computed as follows (dollars and average
common stock outstanding in thousands):
10
For the Three Months December 31, For the Six Months December 31,
----------------------------------- ---------------------------------
2002 2001 2002 2001
----------------------------------- ---------------------------------
Basic earnings per share
- ------------------------
Net income (loss) $ (3,371) $ 946 $ (5,226) $ 406
Less preferred dividends 21 21 41 41
------------ ------------- --------------- ------------
Net income available for common stock (3,392) 925 (5,267) 365
------------ ------------- --------------- ------------
Average common stock outstanding 6,332 6,172 6,328 6,082
Basic earnings (loss) per share $ (0.53) $ 0.15 $ (0.83) $ 0.06
============ ============= =============== ============
Dilutive earnings per share
- ---------------------------
Net income available for
common stock and dilutive securities $ 946 $ 406
------------- ------------
Average common stock outstanding 6,172 6,082
Options, warrants
and convertible securities 1,256 1,343
------------- ------------
Average common stock and
dilutive securities outstanding 7,428 7,425
Dilutive earnings per share $ 0.13 $ 0.05
============= ============
Note 6. New Accounting Pronouncements
In April 2002, the FASB issued SFAS 146, "Accounting for cost associated
with exit or disposal activities". SFAS 146 establishes guidelines for the
recognition and measurement of these cost and is effective as of January 1,
2003. The Company will evaluate the impact of SFAS 146 in connection with its
school closure plan.
Note 7. Discontinued Operations
During the first quarter of Fiscal 2003, the Company discontinued the
operations of a school in Sarasota, Florida. As a result, the Company is
accounting for the closure as a discontinued operation in accordance with SFAS
144, "Accounting for the Impairment of Long-Lived Assets", as the Company does
not have any other schools in the Sarasota area. During the three months ended
September 2002, the Company recorded $301,000, net of tax for current year
operating losses and the write-off of certain fixed assets. In addition, the
Company has approximately $657,000 of leasehold improvements remaining which are
reflected in the balance sheet as of December 31, 2002. In January 2003, the
Company entered into a sub-lease agreement for the remaining term of the lease
in excess of the future lease payment obligations.
In December 2002, the Company entered into an agreement to sell certain
property and reduced the carrying value of the property to its approximate net
realizable value. Accordingly, the Company recorded $1,430,000, net of tax for
current year operating losses and the write-off of certain assets in the quarter
ended December 31, 2002. The transaction is expected to be consummated in the
next six months.
The total loss of $1,731,000 is recorded as a loss from discontinued
operations as of December 31, 2002.
11
Note 8 - Segment Information
The Company manages its schools based on 3 geographical regions within the
United States. In FY 2000 the Company acquired Houston Learning Academy and The
Activities Club and began managing charter schools. These operations have
different characteristics and are managed separately from the school operations.
These operations do not currently meet the quantification criteria and therefore
are not deemed reportable under Statement of Financial Accounting Standards 131,
"Disclosures about Segments of an Enterprise and Related Information" and are
reflected in the "other" category.
The table below presents information about the reported operating income of
the Company for the six months and the three months ended December 31, 2002 and
2001. (dollars in thousands):
Schools Other Corporate Total
-------------- -------------- ------------- ----------
Six months ended December 31,
- ------------------------------
2002
- -----
Revenues $ 71,087 3,931 75,018
School operating profit $ 6,052 199 6,251
Depreciation and amortization $ 2,409 326 215 2,950
Goodwill $ 44,228 1,948 46,176
Segment assets $ 79,491 12,048 5,697 97,236
2001
- -----
Revenues $ 69,861 3,611 73,472
School operating profit $ 8,583 177 8,760
Depreciation and amortization $ 2,348 351 213 2,912
Goodwill $ 46,428 1,948 48,376
Segment assets $ 82,607 14,505 5,761 102,873
Three months ended December 31,
- ---------------------------------
2002
- -----
Revenues $ 38,562 1,914 40,476
School operating profit $ 4,763 (32) 4,731
Depreciation and amortization $ 1,221 156 118 1,495
2001
- -----
Revenues $ 37,414 1,886 39,300
School operating profit $ 5,720 40 5,760
Depreciation and amortization $ 1,209 179 112 1,500
Note 9 - Intangible Assets
12
Intangible assets include non-compete agreements, trademarks and other
identifiable intangibles acquired in acquisitions. Such intangibles are being
amortized over the life of the intangibles ranging from 3 - 20 years.
At December 31, 2002 and June 30, 2002 the Company's intangibles assets were as
follows (dollars in thousands):
December 31, 2002 June 30, 2002
----------------- -------------
Intangible assets
Non-compete $ 2,493 $ 2,493
Other 901 901
---------- ---------
3,394 3,394
Accumulated amortization (2,439) (2,249)
---------- ---------
$ 955 $ 1,145
========== =========
Amortization of intangible assets are as follows: $309,000 in 2003, $96,000 in
2004, $74,000 in 2005, $48,000 in 2006, and $428,000 in 2007 and thereafter.
Note 10 - Commitments and Contingencies
The Company is engaged in legal actions arising in the ordinary course of
its business. The Company believes that the ultimate outcome of all such matters
will not have a material adverse effect on the Company's consolidated financial
position. The significance of these matters on the Company's future operating
results and cash flows depends on the level of future results of operations and
cash flows as well as on the timing and amounts, if any, of the ultimate
outcome.
The Company carries fire and other casualty insurance on its schools and
liability insurance in amounts which management believes are adequate for its
operations. As is the case with other entities in the education and preschool
industry, the Company cannot effectively insure itself against certain risks
inherent in its operations. Some forms of child abuse have sublimits per claim
in the general liability coverage.
Note 11 - Interest Rate Swap Agreement
In connection with the May 2001 amendment to the Company's Amended and
Restated Loan and Security Agreement, the Company entered an interest rate swap
agreement in June 2002 on the $15,000,000 Term Loan Facility. The Company uses
this derivative financial instrument to manage its exposure to fluctuations in
interest rates. The instrument involves, to varying degrees, market risk, as the
instrument is subject to rate and price fluctuations, and elements of credit
risk in the event the counterparty should default. The Company does not enter
into derivative transactions for trading purposes. At December 31, 2002 the
Company's interest rate swap contract outstanding had a total notional amount of
$11,786,000. Under the interest rate swap contract, the Company agrees to pay a
fixed rate of 5.48% and the counterparty agrees to make payments based on
3-month LIBOR. The market value of the interest rate swap agreement at December
31, 2002 was a liability of $562,000, net of taxes and is included as a
component of Accumulated Other Comprehensive Loss, of which a portion is
expected to be reclassified to the consolidated statement of income within one
year.
Note 12 - Subsequent Event
In February 2003, the Company identified and is creating a plan to close or
sell schools that are under performing or are in locations that do not fit into
the Company's school cluster concept. Accordingly, the Company expects to record
a charge in the third quarter ending March 31, 2003 related to lease
discontinuance, recoverability of certain assets below carrying value and other
cost associated with a school closure plan following additional review,
evaluation and approval of management and the board of directors.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
13
The Company entered into the Merger Agreement with Socrates on August 5,
2002, and entered into the First Amendment thereto on October 2, 2002. The
Company's Board of Directors, acting upon the unanimous recommendation of the
Special Committee of the Board comprised of three disinterested directors,
approved the Merger. In reaching its decision, the Special Committee and the
Board received a fairness opinion from the Company's financial advisor, Legg
Mason Wood Walker, Incorporated.
Under the Merger Agreement, Socrates' obligation to consummate the
Merger was subject to its ability to obtain financing. Although at the time that
the Merger Agreement was signed, Socrates had received signed commitment letters
providing for the necessary debt and equity financing, subject to certain
conditions, Socrates did not receive the financing necessary to consummate the
Merger. Accordingly, the Company terminated the Merger Agreement, in accordance
with its terms, on February 3, 2003.
During the first six months ended December 31, 2002, the Company expensed
approximately $1,018,000 of legal, professional and other registration fees
incurred in connection with the Merger.
On August 7, 2002, a civil action was commenced in the Court of Chancery in
the State of Delaware in New Castle County. The plaintiff in that action sought
to represent a putative class consisting of the public stockholders of the
Company. Named as defendants in the complaint were the Company, members of the
Company Board of Directors and one former member of the Company's Board of
Directors. The plaintiff alleged, among other things, that the Merger was unfair
and that the Company's directors breached their fiduciary duties by failing to
fully disclose material non-public information related to the value of the
Company and by engaging in self-dealing. The complaint sought an injunction,
damages and other relief. The Company was served with the complaint on August
22, 2002. A stipulation and dismissal of that case was ordered by the court on
February 27, 2003 due to the fact that the Merger Agreement was terminated.
Results of Operations
For the Six Months ended December 31, 2002 vs. the Six Months ended December 31,
2001
At December 31, 2002, the Company operated 178 schools. Since December 31,
2001, the Company has opened eight new schools: two elementary schools, five
preschools, and one specialty high school. The Company has also closed two
schools during this period. Since June 2002, seven new schools were opened.
Revenues for the six months ended December 31, 2002 increased $1,546,000 or
2.1% to $75,018,000 from $73,472,000 for the six months ended December 31, 2001.
The increase in revenues is primarily attributable to the increase in revenue
from new schools.
Same school revenue (schools that were opened in both periods) decreased
$323,000 or 0.4% in the six months ended December 31, 2002 as compared to the
prior year. This decrease is primarily due to current economic conditions that
are forcing parents to consider preschool and elementary school alternatives
such as fewer days in attendance in the Company's preschools and public school
alternatives for elementary schools. The increase in revenues related to the
eight schools opened totaled $2,301,000. In addition, the decrease in revenues
related to school closings was $432,000.
School operating profit for the six months ended December 31, 2002
decreased $2,509,000 or 28.6% to $6,251,000 from $8,760,000 for the six months
ended December 31, 2001. Total school operating profit margin decreased from
11.9% for the six months ended December 31, 2001 to 8.3% for the six months
ended December 31, 2002.
14
Same school operating profit decreased $1,731,000 or 19.0%. Same school
operating profit margin decreased from 12.2% for the six months ended December
31, 2001 to 10.2% for the six months ended December 31, 2002. This decrease is
primarily due to decreases in revenue and increases in insurance cost for health
care benefits and property and casualty insurance. For the six months ended
December 31, 2002, new schools incurred start up losses of $1,000,000. School
closings positively affected the change in school operating profit by $222,000.
Due to the termination of the Merger Agreement and the decline in the stock
price, the Company is required by SFAS 142 to evaluate the Company's goodwill
for recovery based on the facts and circumstances at December 31, 2002. An
independent valuation consultant engaged by the Company estimated fair values
for each reporting unit using discounted cash flow projections in evaluating and
measuring a potential impairment charge. The level one impairment test as
required under SFAS 142 as of December 31, 2002 indicated that two of the
Company's ten reporting units were impaired (Washington/Oregon and
Pennsylvania/New Jersey). The Company is in the process of evaluating the
consultant's report and completing the level two analysis. Based on the
consultant's independent valuation, the Company currently estimates that the
impairment loss related to these two reporting units is approximately
$2,200,000, which is recorded as a component of income from operations. This
estimated goodwill impairment loss represents a preliminary estimate and may
require adjustment based on work still to be completed. Any change to this
estimate based on the Company's final analysis could be different than this
estimate and will be adjusted in the third quarter results of operations.
During the six months ending December 31, 2002, the Company expensed
$1,018,000 associated with the Merger.
General and administrative expenses decreased $170,000 or 2.9% from
$5,886,000 for the six months ended December 31, 2001 to $5,716,000 for the six
months ended December 31, 2002. As a percentage of revenue, general and
administrative expense was 7.6% for the six months ended December 31, 2002 and
8.0% for the six months ended December 31, 2001. This decrease in general and
administrative expenses was primarily related to decreases in corporate
personnel cost caused by attrition and reimbursement related to an insurance
claim. These decreases were offset by an increase in corporate rent expense
related to the relocation of the corporate office.
As a result of the factors mentioned above, operating income decreased
$5,557,000 from $2,874,000 for the six months ended December 31, 2001 to an
operating loss of $2,683,000 for the six months ended December 31, 2002.
Interest expense decreased $183,000 or 9.8% from $1,872,000 for the six
months ended December 31, 2001 to $1,689,000 for the six months ended December
31, 2002. The decrease is due to decreased interest rates on the Company's
credit facility.
Income tax for the six months ended December 31, 2002 was a benefit of
$902,000 as compared to income tax expense of $437,000 for the same period in
the prior year. The income tax benefit for the six months ended December 31,
2002 is lower than the statutory amount due to the non-deductible goodwill
impairment charge of $2,200,000. The income tax benefit of $902,000 for the six
months ended December 31, 2002 represents 41% of the adjusted pretax loss of
$2,197,000 (pretax loss before the goodwill impairment charge). The Company's
effective tax rate for both periods was 41%.
During the first quarter of Fiscal 2003, the Company discontinued the
operations of a school in Sarasota, Florida. As a result, the Company is
accounting for the closure as a discontinued operation in accordance with SFAS
144, "Accounting for the Impairment of Long-Lived Assets", as the Company does
not have any other schools in the Sarasota area. During the three months ended
September 2002, the Company recorded $301,000, net of tax for current year
operating losses and the write-off of certain fixed assets. In addition, the
Company has approximately $657,000 of leasehold improvements remaining which are
reflected in the balance sheet as of December 31, 2002. In January 2003, the
Company entered into a sub-lease agreement for the remaining term of the lease
in excess of the future lease payment obligations.
In December 2002, the Company entered into an agreement to sell certain
property and reduced the carrying value of the property to its approximate net
realizable value. In accordance with SFAS 144, the Company recorded $1,430,000,
net of tax for current year operating losses and the write-off of certain assets
in the quarter ended December 31, 2002. The transaction is expected to be
consummated in the next six months.
The total loss of $1,731,000 is recorded as a loss from discontinued
operations as of December 31, 2002.
Effect of Goodwill and Transaction Costs
For the six months ended December 31, 2002, the Company had a pretax loss
of $4,397,000. Of this loss, $3,218,000 is related to a non-cash goodwill
impairment charge of $2,200,000 and a charge for transactional expenses
$1,018,000 for the cancelled merger.
These non-GAAP results are not comparable to the information included above
and are presented as an alternative as management believes this information
appropriately reflects our performance for the related periods.
15
For the Second Quarter ended December 31, 2002 vs. the Second Quarter ended
December 31, 2001
Revenues for the second quarter ended December 31, 2002 increased
$1,176,000 or 3.0% to $40,476,000 from $39,300,000 for the second quarter ended
December 31, 2001. The increase in revenues is primarily attributable to the
increase in revenue from new schools.
Same school revenue (schools that were opened in both periods) decreased
$102,000 or 0.3% in the second quarter ended December 31, 2002 as compared to
the prior year. This decrease is primarily due to current economic conditions
that are forcing parents to consider preschool and elementary school
alternatives such as fewer days in attendance in the Company's preschools and
public school alternatives for elementary schools. The increase in revenues
related to the eight schools opened totaled $1,499,000. In addition, the
decrease in revenues related to school closings was $221,000.
School operating profit for the second quarter ended December 31, 2002
decreased $1,029,000 or 17.9% to $4,731,000 from $5,760,000 for the second
quarter ended December 31, 2001. Total school operating profit margin decreased
from 14.7% for the quarter ended December 31, 2001 to 11.7% for the quarter
ended December 31, 2002.
Same school operating profit decreased $783,000 or 13.1%. Same school
operating profit margin decreased from 15.3% for the second quarter ended
December 31, 2001 to 13.3% for the second quarter ended December 31, 2002. This
decrease is primarily due to decreases in revenue and increases in insurance
cost for health care benefits and property and casualty insurance. For the
second quarter ended December 31, 2002, new schools incurred start up losses of
$337,000. School closings positively affected the change in school operating
profit by $91,000.
Due to the termination of the Merger Agreement and the decline in the stock
price, the Company is required by SFAS 142 to evaluate the Company's goodwill
for recovery based on the facts and circumstances at December 31, 2002. An
independent valuation consultant engaged by the Company estimated fair values
for each reporting unit using discounted cash flow projections in evaluating and
measuring a potential impairment charge. The level one impairment test as
required under SFAS 142 as of December 31, 2002 indicated that two of the
Company's ten reporting units were impaired (Washington/Oregon and
Pennsylvania/New Jersey). The Company is in the process of evaluating the
consultant's report and completing the level two analysis. Based on the
consultant's independent valuation, the Company currently estimates that the
impairment loss related to these two reporting units is approximately
$2,200,000, which is recorded as a component of income from operations. This
estimated goodwill impairment loss represents a preliminary estimate and may
require adjustment based on work still to be completed. Any change to this
estimate based on the Company's final analysis could be different than this
estimate and will be adjusted in the third quarter results of operations.
During the second quarter ending December 31, 2002, the Company expensed
$600,000 associated with the Merger.
General and administrative expenses decreased $110,000 or 3.5% from
$3,115,000 for the second quarter ended December 31, 2001 to $3,005,000 for the
second quarter ended December 31, 2002. As a percentage of revenue, general and
administrative expense was 7.3% for the quarter ended December 31, 2002 and 7.8%
for the quarter ended December 31, 2001. This decrease in general and
administrative expenses was primarily related to decreases in corporate
personnel cost caused by attrition. This decrease was offset by an increase in
corporate rent expense related to the relocation of the corporate office.
As a result of the factors mentioned above, operating income decreased
$3,719,000 from $2,645,000
16
for the second quarter ended December 31, 2001 to an operating loss of
$1,074,000 for the second quarter ended December 31, 2002.
Interest expense decreased $105,000 or 11.4% from $922,000 for the second
quarter ended December 31, 2001 to $817,000 for the second quarter ended
December 31, 2002. The decrease is due to decreased interest rates on the
Company's credit facility.
Income tax expense for the three months ended December 31, 2002 was
$126,000 as compared to income tax expense of $704,000 for the same period in
the prior year. The income tax expense for the three months ended December 31,
2002 is due to the non-deductible goodwill impairment charge of $2,200,000. The
income tax expense of $126,000 for the three months ended December 31, 2002
represents 41% of the adjusted pretax income of $307,000 (pretax income before
the goodwill impairment charge). The Company's effective tax rate for both
periods was 41%.
In December 2002, the Company entered into an agreement to sell certain
property and reduced the carrying value of the property to its approximate net
realizable value. In accordance with SFAS 144, the Company recorded $1,352,000,
net of tax for current year operating losses and the write-off of certain assets
in the quarter ended December 31, 2002. The transaction is expected to be
consummated in the next six months.
Effect of Goodwill and Transaction Costs
For the second quarter ended December 31, 2002, the Company had a pretax
loss of $1,893,000. Of this loss, $2,800,000 is related to a non-cash goodwill
impairment charge of $2,200,000 and a charge for transactional expenses $600,000
for the cancelled merger.
These non-GAAP results are not comparable to the information included above
and are presented as an alternative as management believes this information
appropriately reflects our performance for the related periods.
Liquidity and Capital Resources
The Company terminated the Merger Agreement with Socrates on February 3,
2003. For the six months ending on December 31, 2002 the Company expensed
$1,018,000 of fees and expenses associated with this transaction. These charges,
coupled with the cost of closing the Company's school in Sarasota, Florida and
the overall impact of general economic conditions on the Company's revenue have
placed the Company in noncompliance with certain of its senior debt facility
financial covenants as of the quarter ended December 31, 2002. Further, in the
absence of restructuring these covenants, it is probable that the Company will
be in noncompliance of one or more financial covenants for the quarters ending
March 31, 2003 and June 30, 2003. As a result, the Company has classified all of
its senior debt as a current liability at December 31, 2002. The Company is in
discussions with its senior lenders and has requested a waiver for the covenant
noncompliance through December 31, 2002 and is actively engaged in discussions
with its senior lenders with respect to amending the financial covenants for
future quarters. However, management has not received a waiver and is unable to
assure that its efforts in this regard will be successful. As a result of the
event of default, the senior bank debt can be deemed to be immediately due and
payable at the lenders discretion.
The Company has $10,955,000 outstanding under subordinated debt agreements
at December 31, 2002. The Company is in compliance with the financial ratios of
these agreements as they are less restrictive than the senior debt facility. The
Company's subordinated debt obligations due over one year remain as long term
debt.
In order for the Company to pursue a growth strategy, the Company will
continue to seek additional funds through debt or equity financing and possibly
amend or refinance its senior debt facility. Management's growth strategy for
the Company includes (1) internal growth of existing schools through the
expansion of certain facilities, (2) new school development in both existing and
new markets, (3) strategic acquisitions, and (4) development of new education
businesses. The Company's principal sources of liquidity are (a) cash flow
generated from operations, (b) future borrowings under the Company's $40.0
million Amended and Restated Loan and Security Agreement, (c) the use of site
developers to build schools and lease them to the Company, and (d) issuance of
subordinated indebtedness or shares of common stock. The Company identifies
growth markets through both extensive demographic studies and an analysis of the
existing educational systems in the area. The Company seeks to grow through a
cluster approach whereby several preschools feed into an elementary school.
17
Fiscal 2003 Cash Flows
Total cash and cash equivalents decreased $569,000 from $1,787,000 at June
30, 2002 to $1,218,000 at December 31, 2002. The net decrease was primarily
related to $3,589,000 in capital expenditures, scheduled repayments of long term
debt of $1,071,000, scheduled repayments of subordinated debt of $1,036,000, a
decrease in cash overdraft liability of $315,000 and a cash distribution related
to minority interest of $158,000. These decrease were offset by cash flow from
operations of $2,093,000 and an increase in borrowings under the Company's
working capital facility of $3,681,000.
The working capital deficit increased $22,595,000 from $13,325,000 at June
30, 2002 to $35,920,000 at December 31, 2002. The increase is primarily the
result of an increase of $27,064,000 in current maturities of long-term debt, an
increase in unearned income totaling $1,990,000 and a decrease in prepaid
expenses of $736,000. This increase was offset by an decrease in accounts
payable and other accrued expenses of $3,581,000 and assets held for sale of
$3,850,000. The increase in current maturities is related to $26,194,000 of long
term senior bank debt that has been reclassified as current debt. The debt was
reclassified as current because it is not currently anticipated that the Company
will be in compliance with certain of its bank covenants in the third quarter of
fiscal year 2003. The Company is in the process of negotiating an amendment to
modify the bank covenants with its senior bank creditors, but there can be no
assurance that the Company will be successful in doing so. The increase in
unearned income is related to the prepayment of annual and semi-annual tuition
by parents and by registration fees collected at the beginning of the school
year.
The Company anticipates that in the current economic conditions its
existing available principal credit facilities, cash generated from operations,
and continued support of site developers to build and lease schools will be
sufficient to satisfy working capital needs, capital expenditures, and
renovations and the building of new schools during Fiscal 2003. In addition, the
Company is actively marketing real estate for a potential sale of approximately
$6,000,000.
EBITDA (defined as earnings before interest expense, income taxes, depreciation
and amortization) is a key financial measurement defined in the Company's senor
bank credit facility and is used in determining compliance with its financial
debt covenant ratios. EBITDA for the six months ended December 31, 2002
decreased $3,411,000 from the same period in the prior year to $2,442,000.
EBITDA for the three months ended December 31, 2002 decreased $1,520,000 from
the same period in the prior year to $2,620,000. The decrease is related to
$1,018,000 in cost associated with the Merger, of which $600,000 was expensed
in the second quarter, a decrease in same school operating income and new school
start up losses. EBITDA is not intended to indicate that cash flow is sufficient
to fund all of the Company's cash needs or represent cash flow from operations
as defined by accounting principles generally accepted in the United States of
America.
Long-Term Obligations and Commitments
In May 2001, the Company entered into its current Amended and Restated Loan and
Security Agreement which increased the Company's borrowing capacity to
$40,000,000. Three separate facilities were established under the Amended and
Restated Loan and Security Agreement: (1) $10,000,000 Working Capital Credit
Facility (2) $15,000,000 Acquisition Credit Facility and (3) $15,000,000 Term
Loan. The Term Loan Facility will mature on April 1, 2006 and provides for
$2,143,000 annual interim amortization with the balance paid at maturity. Under
the Acquisition Credit Facility, no principal payments are required until April
2003. At that time, the outstanding principal under the Acquisition Credit
Facility will be converted into a term loan which will require principal
18
payments in 16 quarterly installments. The Working Capital Credit Facility is
scheduled to terminate on April 1, 2004. In addition, the credit facilities
provide that the Company must meet or exceed defined interest coverage ratios
and must not exceed leverage ratios.
In connection with the May 2001 amendment to the Company's Amended and
Restated Loan and Security Agreement, the Company entered an interest rate swap
agreement in June 2002 on the $15,000,000 Term Loan Facility. The Company uses
this derivative financial instrument to manage its exposure to fluctuations in
interest rates. The instrument involves, to varying degrees, market risk, as the
instrument is subject to rate and price fluctuations, and elements of credit
risk in the event the counterparty should default. The Company does not enter
into derivative transactions for trading purposes. At December 31, 2002 the
Company's interest rate swap contract outstanding had a total notional amount of
$11,786,000. Under the interest rate swap contract, the Company agrees to pay a
fixed rate of 5.48% and the counterparty agrees to make payments based on
3-month LIBOR. The market value of the interest rate swap agreement at December
31, 2002 was a liability of $562,000, net of taxes and is included as a
component of Accumulated Other Comprehensive Loss, of which a portion is
expected to be reclassified to the consolidated statement of income within one
year.
At December 31, 2002, a total of $30,826,000 was outstanding under the
Amended and Restated Loan Agreement. This debt was reclassified as current
because it is not currently anticipated that the Company will be in compliance
with certain of is bank covenants for the quarters ended March 31, 2003 and June
30, 2003. The Company is in discussions with its senior lenders and has
requested a waiver for the covenant noncompliance through December 31, 2002 and
is actively engaged in discussions with its senior lenders with respect to
amending the financial covenants for future quarters. However, management has
not received a waiver and is unable to assure that its efforts in this regard
will be successful. As a result of the event of default, the senior bank debt
can be deemed to be immediately due and payable at the lender's discretion. The
Company's loan covenants under its Amended and Restated Loan Agreement limit the
amount of senior debt borrowings. At December 31, 2002, there was $5,765,000
outstanding under the Working Capital Credit Facility, $13,275,000 was
outstanding under the Acquisition Credit Facility and $11,786,000 was
outstanding under the Term Loan. In addition, the Company has $10,955,000
outstanding under subordinated debt agreement as well as significant commitments
under operating lease agreements. The following is a summary of these
obligations (dollars in thousands):
Contractual Obligations Less than 2-4 Year 5 and
Total 1 year years after
Long-Term Obligations
41,781 31,552 5,229 5,000
Interest Rate Swap 562 94 468
Operating Leases * 228,682 25,127 69,890 133,665
* - Based on amounts presented in Footnote 14 of our June 30, 2002 financial
statements. These amounts have been updated for new leases entered into in
fiscal year 2003.
The Company also has significant commitments with certain of its executives that
would be triggered
19
upon a change in control or certain termination events.
Critical Accounting Policies
The preparation of financial statements in conformity with generally
accepted accounting principles 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 judgment. Actual results may vary from estimates
in amounts that may be material to the financial statements.
The Company's significant accounting policies are described in note 1 to
the consolidated financial statements included in the Company's Annual Report on
Form 10-K for the fiscal year ended June 30, 2002. The following accounting
policies are considered critical to the preparation of the Company's financial
statements due to the estimation processes and business judgment involved in
their application.
Revenue Recognition
Tuition revenues, net of discounts and other revenues are recognized as
services are performed. Any tuition payments received in advance of the time
period for which service is to be performed is recorded as unearned revenue.
Charter school management fees are recognized based on a contractual
relationship with the charter school and do not include any tuition revenue
received by the charter school. Certain fees may be received in advance of
services being rendered, in which case the fee revenue is deferred and
recognized over the appropriate period of service. The Company's net revenues
meet the criteria of SAB No. 101, including the existence of an arrangement, the
rendering of services, a determinable fee and probable collection.
Accounts Receivable
The Company's accounts receivable are comprised primarily of tuition due
from governmental agencies and parents. Accounts receivable are presented at
estimated net realizable value. The Company uses estimates in determining the
collectibility of its accounts receivable and must rely on its evaluation of
historical trends, governmental funding processes, 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.
The Company provides its services to the parents and guardians of the
children attending the schools. The Company does not extend credit for an
extended period of time, nor does it require collateral. Exposure to losses on
receivables is principally dependent on each person's financial condition. The
Company also has investments in other entities. The collectibility of such
investments is dependent upon the financial performance of these entities. The
Company monitors its exposure for credit losses and maintains allowances for
anticipated losses.
Long-lived and Intangible Assets
During the first quarter of Fiscal 2003, the Company adopted SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. Under the
requirements of SFAS No. 141, the Company assesses the potential impairment of
property and equipment and identifiable intangibles whenever events or changes
in circumstances indicate that the carrying value may not be recoverable. An
asset's value is impaired if management's estimate of the aggregate future cash
flows, undiscounted and
20
without interest charges, to be generated by the asset are 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 the fair value
of the asset. 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.
Goodwill
The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets,
effective July 1, 2001. Under SFAS No. 142, goodwill is no longer amortized but
will be assessed for impairment at least annually or upon an adverse change in
operations. The annual impairment testing required by SFAS No. 142 will require
judgments and estimates and could require us to write down the carrying value of
our goodwill and other intangible assets in future periods.
The net carrying value of goodwill was $48,376,000 as of July 1, 2002. Due
to the termination of the Merger Agreement and the decline in the stock price,
the Company is required by SFAS 142 to evaluate the Company's goodwill for
recovery based on the facts and circumstances at December 31, 2002.
An independent valuation consultant engaged by the Company estimated fair
values for each reporting unit using discounted cash flow projections in
evaluating and measuring a potential impairment charge. The level one impairment
test as required under SFAS 142 as of December 31, 2002 indicated that two of
the Company's ten reporting units were impaired (Washington/Oregon and
Pennsylvania/New Jersey). The Company is in the process of evaluating the
consultant's report and completing the level two analysis. Based on the
consultant's independent valuation, the Company currently estimates that the
impairment loss related to these two reporting units is approximately
$2,200,000, which is recorded as a component of income from operations. This
estimated goodwill impairment loss represents a preliminary estimate and may
require adjustment based on work still to be completed. Any change to this
estimate based on the Company's final assumptions and analysis could be
different than this estimate and will be adjusted in the third quarter results
of operations.
Long Term Note Receivable
At December 31, 2002, the Company had a $2,600,000 note receivable pursuant
to a Credit Agreement with Total Education Solutions ("TES") due May 2005, of
which $2,250,000 is convertible into 30.0% ownership of TES. During January
2003, $100,000 of the note receivable was repaid by TES. TES, established in
1997, provides special education services to charter schools and public schools
which, because of lack of internal capabilities or other reasons, wish to
out-source their provision of special education programs (which, under federal
law, they are required to provide to select students). The proceeds received by
TES have been used for the expansion of its product throughout California, and
TES plans to enter other states. Although TES's revenues have grown since the
origination of the credit agreement, TES has also incurred losses as a result of
building the infrastructure to service other regions.
As part of the Company's evaluation of the carrying value of TES, the
Company considered a number of positive and negative factors affecting TES
including:
. Operating results and outlook for TES;
. Expected future cash flows;
. Current conditions and trends in the industry;
. Other industry comparables; and
. The Company's plans and ability to continue to hold this investment.
In evaluating the investment in TES, a discounted cash flow analyses was
prepared for TES based on a recent financing discussion memorandum. The cash
flow analyses indicated that the investment in
21
TES has a value greater than the Company's current carrying value. In addition,
the Company reviewed other objective evidence including recent comparable
transactions similar to TES, industry publications supporting the market and
growth rates and TES's ongoing discussions with third parties regarding
additional financing.
Income Taxes
The Company accounts for income taxes using the asset and liability method,
in accordance with FAS 109, Accounting for Income Taxes. Under the asset and
liability method, deferred income taxes are recognized for the tax consequences
of "temporary differences" by applying enacted statutory tax rates applicable to
future years to differences between the financial statement carrying amounts and
the tax basis of existing assets and liabilities. The effect on deferred taxes
of a change in tax rate is recognized as income in the period of enactment. A
valuation allowance is recorded based on the uncertainty regarding the ultimate
realizability of deferred tax assets.
The Company files a U.S. federal income tax return and various state income
tax returns, which are subject to examination by tax authorities. This process
involves estimating the actual current tax exposure together with assessing
temporary differences resulting from differing treatment of items for tax and
accounting purposes. The Company's estimated tax liability is subject to change
as examinations of specific tax years are completed in the respective
jurisdictions including possible adjustments related to the nature and timing of
deductions and the local attribution of income.
Item 3 Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of loss that may impact the consolidated
financial position, results of operations or cash flows of the Company. The
Company is exposed to market risk in the areas of interest rates and interest
rate swaps agreements.
Interest Rates
The Company's exposure to market risk for changes in interest rates relate
primarily to debt obligations. The Company has no cash flow exposure due to rate
changes on its 12.0%, $10,000,000 senior subordinated debt at December 31, 2002
and June 30, 2002. The Company also has no cash flow exposure on certain
mortgages, notes payable and subordinate debt agreements aggregating $955,000
and $2,386,000 at December 31, 2002 and June 30, 2002, respectively. However,
the Company does have cash flow exposure on two of its credit facilities under
the Amended and Restated Loan and Security Agreement. The Working Capital and
the Acquisition Credit Facility are subject to variable LIBOR or prime base rate
pricing. Accordingly, a 1.0% change in the LIBOR rate and the prime rate would
have resulted in interest expense changing by approximately $37,000 for the
three months ended December 31, 2002 and 2001.
Interest Rate Swap Agreement
In connection with the May 2001 amendment to the Company's Amended and
Restated Loan and Security Agreement, it entered an interest rate swap agreement
on the $15,000,000 Term Loan Facility. The Company uses this derivative
financial instrument to manage its exposure to fluctuations in interest rates.
The instrument involves, to varying degrees, market risk, as the instrument is
subject to rate and price fluctuations and elements of credit risk in the event
the counterparty should default. The Company does not enter into derivative
transactions for trading purposes. At December 31, 2002 the Company's interest
rate swap contract outstanding had a total notional amount of $11,786,000. Under
22
the interest rate swap contract, the Company agrees to pay a fixed rate of 5.48%
and the counterparty agrees to make payments based on 3-month LIBOR. The market
value of the interest rate swap agreement at December 31, 2002 was a liability
of $562,000, net of taxes and is included as a component of Accumulated Other
Comprehensive Loss, of which a portion is expected to be reclassified to the
consolidated statement of income within one year.
Item 4 Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer have
concluded, based on an evaluation conducted within 90 days prior to the filing
date of this Quarterly Report on Form 10-Q, that the Company's disclosure
controls and procedures have functioned effectively so as to provide those
officers the information necessary to evaluate whether:
(i) this Quarterly Report on Form 10-Q contains any untrue statement of a
material fact or omits to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this Quarterly Report on Form
10-Q, and
(ii) the financial statements, and other financial information included in this
Quarterly Report on Form 10-Q, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of,
and for, the periods presented in this Quarterly Report on Form 10-Q.
There have been no significant changes in the Company's internal controls or in
other factors since the date of the Chief Executive Officer's and Chief
Financial Officer's evaluation that could significantly affect these internal
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
23
Part II
Other Information
Item 6. Exhibits and Reports on Form 8-K
None
24
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.
NOBEL LEARNING COMMUNITIES, INC.
Dated: March 6, 2003 By: /s/ Robert E. Zobel
------------------------------------
Robert E. Zobel
Vice Chairman - Corporate Affairs and
Chief Financial Officer
(duly authorized officer and
principal financial officer)
25
CERTIFICATION
I, A.J. Clegg, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Nobel Learning
Communities, Inc. (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons fulfilling the equivalent
function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: March 6, 2003
/s/ A. J. Clegg
---------------------------
A. J. Clegg
Chief Executive Officer
26
CERTIFICATION
I, Robert E. Zobel, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Nobel Learning
Communities, Inc. (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons fulfilling the equivalent
function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: March 6, 2003
/s/ Robert E. Zobel
---------------------------
Robert E. Zobel
Chief Financial Officer
27
Exhibits
Exhibit
Number Description of Exhibit
10.37 Employment Agreement dated as of March 1, 2002 between the
Registrant and Scott Clegg.
Item 6. Exhibits and Reports on Form 8-K
None
28