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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 JANUARY 3, 2003

OR

o 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: 0-27656

CHILDTIME LEARNING CENTERS, INC.

(Exact Name Of Registrant As Specified In Its Charter)

38345 West Ten Mile Road, Suite 100
Farmington Hills, Michigan 48335-2883
(Address of principal executive offices)

(248) 476-3200
(Registrant’s telephone number, including area code)

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 required for the past 90 days. Yes x No o

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

The number of shares of Registrant’s Common Stock, no par value per share, outstanding at February 14, 2003, was 5,416,210.

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CHILDTIME LEARNING CENTERS, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

For the Quarterly Period Ended January 3, 2003

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PART I: FINANCIAL INFORMATION

ITEM 1. Consolidated Financial Statements

CHILDTIME LEARNING CENTERS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(In thousands)

The accompanying footnotes are an integral part of the consolidated financial statements.

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CHILDTIME LEARNING CENTERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

(In thousands, except per share data)

The accompanying footnotes are an integral part of the consolidated financial statements.

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CHILDTIME LEARNING CENTERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

(In thousands)

The accompanying footnotes are an integral part of the consolidated financial statements.

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CHILDTIME LEARNING CENTERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1 — DESCRIPTION OF BUSINESS

Childtime Learning Centers, Inc. and subsidiaries (“Childtime” or the “Company”) began operations in 1967, and operates for-profit childcare centers in 27 states, the District of Columbia and Canada. On July 19, 2002, the Company acquired the assets of Tutor Time Learning Systems, Inc., a Florida corporation (“Tutor Time”), for an aggregate purchase price of approximately $22.8 million, including acquisition costs, plus the assumption of certain liabilities. The acquisition was consummated pursuant to an asset purchase agreement dated June 28, 2002, approved by the U.S. Bankruptcy Court, Southern District of Florida and closed on July 19, 2002. The Company purchased substantially all of the operating assets and contract rights used by Tutor Time in its child care operations, which were comprised of 198 company-owned and franchised child care centers operating in 23 states and internationally, and were purchased to improve the range of the Company’s product offering and to enter the child care franchise business. The Tutor Time centers are on average newer and larger than Childtime’s centers, and Tutor Time is one of the largest franchisors in the child care industry. Additionally, the Company gained access to approximately 34 sites that were under development, which have opened or are expected to open as either franchise or corporate centers over the next 18 months. As of January 3, 2003, Childtime operated 336 Company owned centers and franchised an additional 131 centers with an aggregate licensed capacity for over 50,000 children.

NOTE 2 — ACQUISITION AND PRO FORMA INFORMATION

As previously mentioned, on July 19, 2002, the Company acquired substantially all of the assets of Tutor Time Learning Systems, Inc., a Florida corporation (“Tutor Time”), for an aggregate purchase price of approximately $22.8 million, including acquisition costs, plus the assumption of certain liabilities. In consideration for providing investment advisory services with respect to the acquisition, Jacobson Partners was paid an advisory fee consisting of a cash payment of $333,336 and the issuance of 175,438 shares of common stock. These costs have been capitalized as part of the acquisition costs. Jacobson Partners is the management and financial consultant to the Company of which Benjamin R. Jacobson, the Company’s Chairman of the Board is the managing general partner, James J. Morgan, the Company’s former Chairman of the Board and interim Chief Executive Officer, is a partner, and George A. Kellner, the Company’s Vice Chairman of the Board, is a special advisor.

The Tutor Time acquisition was financed, in part, by Bank One, NA through its secured credit facility with Childtime Childcare, Inc., a wholly-owned subsidiary of the Company, as amended by the Second Amendment to Amended and Restated Credit Agreement (“Second Amendment”) dated as of July 19, 2002.

Subordinated loans (the “Subordinated Notes”) in the aggregate amount of $14 million were provided by a group of lenders organized by Jacobson Partners to fund the balance of the Tutor Time acquisition purchase price and to provide related working capital. The Subordinated Notes are subject to a Subordination Agreement in favor of Bank One, NA, mature December 31, 2004 and bear interest at 15% of which 7% is payable in cash, with the balance payable in kind by the issuance of additional subordinated notes (the “Additional Subordinated Notes”) with interest and principal payable on the earlier of December 31, 2004 or such date on which the Company has consummated the Rights Offering (defined below), provided that interest on the Subordinated Notes (including the Additional Subordinated Notes and interest thereon) may be paid only to the extent the aggregate proceeds of the Rights Offering exceeds $14 million. If the Rights Offering is not consummated, and the Company has not received net cash proceeds (and/or cancelled Subordinated Notes) of at least $7.5 million from the issuance of common stock in such Rights Offering (the “Minimum Equity Amount”), on or before July 19, 2003, then until the earlier of December 31, 2004 or the date on which the Company consummates the Rights Offering and receives the Minimum Equity Amount, all interest on the Subordinated Notes will be payable by the issuance of Additional Subordinated Notes. Although Jacobson Partners received no consideration for arranging this financing, lenders included JP Acquisition Fund II, L.P. and JP Acquisition Fund III, L.P., entities controlled and managed by affiliates of Jacobson Partners (for an aggregate of $10,497,154), and three directors of the Company (Mr. Jacobson, Mr. Morgan and Mr. Kellner) and trusts for the benefit of their children (for an aggregate of $545,132).

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NOTE 2 — ACQUISITION AND PRO FORMA INFORMATION (CONTINUED)

In connection with the Tutor Time acquisition, JP Acquisition Fund II, L.P., JP Acquisition Fund III, L.P., and certain of their co-investors (collectively, the “Optionees”), including Messrs. Jacobson, Morgan and Kellner, agreed to arrange for the Company to obtain a standby purchase commitment in connection with the Company’s proposed rights offering contemplated for the purpose of refinancing the subordinated debt incurred by the Company in connection with the Tutor Time acquisition (the “Rights Offering”). As consideration for obtaining such commitment, a Special Committee of the Board of Directors approved the grant to the Optionees of options to purchase, in the aggregate, up to 400,000 shares of common stock, until July 19, 2006, at an exercise price of $5.00 per share. All shares acquired by the Optionees upon the exercise of their options would be subject to registration rights, pursuant to which, until July 6, 2007, the Optionees would have the right to cause the Company to register, at the Company’s expense, their shares of common stock, whenever the Company is otherwise registering shares (except in certain circumstances). The option grant has been approved by the Company’s shareholders.

The Rights Offering is expected to take place during the first half of calendar 2003 and will refinance the subordinated debt incurred by the Company in connection with the Tutor Time acquisition. As currently contemplated, 100,000 Rights Offering units (“Units”) will be offered, consisting in the aggregate of $3.5 million in principal amount of subordinated debentures and a number of shares of common stock that, based on the formula described below, with the issuance of the new subordinated debentures, would allow payment in full of the Subordinated Notes (including the Additional Subordinated Notes) and all accrued and unpaid interest thereon. The offering price per share of the common stock under the Rights Offering would be the four-week volume-weighted average price of the common stock on The Nasdaq SmallCap Market, prior to the commencement date of the offering; provided, however, that if the one-week volume-weighted average price of the common stock, calculated during the one-week period immediately prior to the commencement date of the offering, was more than 10% less than such four-week volume-weighted average price, the offering price related to the common stock portion of the Rights Offering will equal 110% of such one-week volume-weighted average price. Subject to certain shareholder ownership requirements, all common shareholders as of the Rights Offering record date will be able to participate in the offering and will be allowed to acquire Units on a pro rata basis. The subordinated debentures will bear interest at 15%, have a five-year maturity, and be redeemable by the Company at any time at par, subject to restrictions under its senior lending agreements. As indicated above, JP Acquisition Fund II, L.P., JP Acquisition Fund III, L.P., and certain of their co-investors, including Messrs. Jacobson, Morgan and Kellner, have provided a commitment to purchase all Units not subscribed for in the Rights Offering up to an aggregate amount equal to the aggregate principal amount of the Subordinated Notes (including the Additional Subordinated Notes) plus all accrued and unpaid interest thereon.

The acquisition of Tutor Time is reflected in the consolidated balance sheet of the Company as of January 3, 2003 and has been accounted for in accordance with Statement of Financial Accounting Standards (“SFAS”) No 141, Business Combinations. The results of operations of Tutor Time since July 19, 2002 are included in the Company’s results of operations. The purchase price (in thousands) has been tentatively allocated as follows and is subject to further change upon audit.

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NOTE 2 — ACQUISITION AND PRO FORMA INFORMATION (CONTINUED)

Pro forma information for the Company and Tutor Time follows (in thousands, except per share data):

Since Tutor Time was acquired at the end of the first quarter, the 12 weeks ended January 3, 2003, includes a full 12 weeks of Tutor Time operations.

In connection with the Tutor Time Learning Systems, Inc. bankruptcy proceedings, Tutor Time, at the request of the Company was able to reject numerous leases and franchise agreements. The accompanying pro forma information includes only the revenues and costs from those Tutor Time centers and franchises that were not rejected as part of the bankruptcy proceedings. No pro forma adjustments were made to the historical Tutor Time corporate overhead expenses ($2.3 million for the 12 weeks ended January 4, 2002 and $2.0 million and $8.1 million for the 40 weeks ended January 3, 2003 and January 4, 2002, respectively). Additional interest expense was included in the pro forma results based upon the additional debt incurred to finance the Tutor Time acquisition.

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NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of Childtime Learning Centers, Inc. and its wholly owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.

The accompanying consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles and, accordingly, include all normal and recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the periods represented to fairly state the Company’s financial condition, results of operations and its cash flows, for the interim periods presented.

These statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the 52 weeks ended March 29, 2002. The results for the 12 weeks and the 40 weeks ended January 3, 2003, are not necessarily indicative of results for the entire year.

Use of Estimates

The preparation of consolidated financial statements in accordance with generally accepted accounting principles requires management to render estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.

Franchise Fees and Royalty Income

Franchise fees are recognized as revenue at the time the franchise center receives a certificate of occupancy. Royalty income related to franchise operations is recognized as revenue is earned by franchisees.

Fiscal Year

The Company utilizes a 52-53 week fiscal year ending on the Friday closest to March 31. For fiscal years 2002 and 2003, the first quarter contained 16 weeks, and the fiscal year contained 52 weeks.

NOTE 4 — ACCOUNTS RECEIVABLE

Accounts receivable is presented net of an allowance for doubtful accounts. At January 3, 2003 and March 29, 2002, the allowance for doubtful accounts was $1.1 million and $0.7 million, respectively.

NOTE 5 — REIMBURSABLE CONSTRUCTION COSTS

In connection with certain build-to-suit centers to be leased, the Company enters into arrangements, whereby the Company accumulates costs during the construction process and is then reimbursed by the developer. The Company has various legal remedies available pursuant to the construction agreements to minimize the risk of nonreimbursement. For the 40 weeks ended January 3, 2003, and the year ended March 29, 2002, the Company financed construction costs of $0.0 million and $0.9 million, respectively, while related repayments received under reimbursement agreements were $0.0 million and $2.0 million, respectively.

NOTE 6 — DRAFTS PAYABLE

Drafts payable represent unfunded checks drawn on zero balance accounts that have not been presented for funding to the Company’s banks. The drafts are funded, without finance charges, as soon as they are presented. At January 3, 2003 and March 29, 2002, the aggregate drafts payable were $5.4 million and $4.0 million, respectively.

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NOTE 7 — FINANCING ARRANGEMENTS

On January 31, 2002, the Company amended and restated its revolving line of credit agreement by entering into a new $17.5 million revolving line of credit agreement with its existing lender. This credit agreement, as amended, will mature on July 31, 2003, and is secured by the Company’s receivables, equipment and real estate, with interest payable at a variable rate, at the Company’s option, based on either the prime rate or the Eurodollar rate. There were outstanding borrowings of $12.6 million at January 3, 2003, and outstanding borrowings of $2.5 million at March 29, 2002. Outstanding letters of credit reduced the availability under the line of credit in the amount of $2.6 million at January 3, 2003 and $1.8 million at March 29, 2002.

Under this agreement, the Company is required to maintain certain financial ratios and other financial conditions. In addition, there are restrictions on the incurrence of additional indebtedness, disposition of assets and transactions with affiliates. At July 19, 2002 and at October 11, 2002, the Company had not maintained minimum consolidated EBITDA levels and had not provided timely reporting as required by the Amended and Restated Credit Agreement. The Company’s lender approved waivers to the Amended and Restated Credit Agreement for financial results for the quarter ended October 11, 2002. The Company’s noncompliance with the required consolidated EBITDA levels continued as of January 3, 2003. In February 2003, the Amended and Restated Credit Agreement was further amended, among other things, to revise the financial covenants (including measuring them on a monthly basis) and to shorten the maturity of the line of credit to July 31, 2003. The Company is in compliance with the agreement, as amended. The Company intends to extend and further amend this agreement prior to its maturity date, but no assurance can be given that the Company will be successful in doing so.

As previously discussed, subordinated loans in the aggregate amount of $14 million were provided by a group of lenders organized by Jacobson Partners to fund the balance of the Tutor Time acquisition purchase price and to provide related working capital. The Subordinated Notes are subject to a Subordination Agreement in favor of Bank One, NA, mature December 31, 2004 and bear interest at 15% of which 7% is payable in cash, with the balance payable in kind by the issuance of Additional Subordinated Notes ($0.5 million accrued and included in Subordinated Notes), with interest and principal payable on the earlier of December 31, 2004 or such date on which the Company consummated the Rights Offering (see Note 2), provided that interest on the Subordinated Notes (including the Additional Subordinated Notes and interest thereon) may be paid only to the extent the aggregate proceeds of the Rights Offering exceeds $14 million. If the Rights Offering is not consummated, and the Company has not received net cash proceeds (and/or cancelled Subordinated Notes) of at least $7.5 million from the issuance of common stock in such Rights Offering (the “Minimum Equity Amount”), on or before July 19, 2003, then until the earlier of December 31, 2004 or the date on which the Company consummates the Rights Offering and receives the Minimum Equity Amount, all interest on the Subordinated Notes will be payable by the issuance of Additional Subordinated Notes. Although Jacobson Partners received no consideration for arranging this financing, lenders included JP Acquisition Fund II, L.P. and JP Acquisition Fund III, L.P., entities controlled and managed by affiliates of Jacobson Partners (for an aggregate of $10,479,154), and three directors of the Company (Mr. Jacobson, Mr. Morgan and Mr. Kellner) and trusts for the benefit of their children (for an aggregate of $545,132).

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NOTE 8 — CONTINGENCIES

During fiscal 2002, the Company decided not to pursue opening three new build-to-suit centers after leases for these centers had been signed with the developer of the centers. The Company was subsequently sued by the developer for breach of contract. This case was settled at the end of fiscal 2002, and a current liability was recorded on the balance sheet as of March 29, 2002 in the amount of $0.8 million, which was paid during first quarter 2003.

The Company is primarily liable on approximately $1.0 million for lease assignments already negotiated in connection with certain lease terminations resulting from the fiscal 2001 restructuring program (see Note 12). The Company has recorded a liability for estimates of future liabilities under these leases. A subsidiary of the Company is primarily or contingently liable for many of the leases of Tutor Time’s franchisees. In an effort to build its franchisee network, Tutor Time either leased the prospective site for a franchisee, with a subsequent sublease of the site to the franchisee, or provided a lease guarantee to the landlord for the benefit of the franchisee in exchange for a monthly lease guarantee fee payable by the franchisee that is based upon the monthly rent expense of the guaranteed lease. The liability is approximately $99.0 million related to leases and $15.7 million related to guarantees. The leases have durations from 1-20 years. The Company would be required to pay the related lease obligations in the case of default by the franchisee. Should the Company be required to make payments under these leases, it may assume obligations for operating the center. Should the center not be economically viable, the Company will make provision for the lease termination at that time. The Company has taken over operations for a center previously operated by a franchisee as a result of a default under the franchisee’s lease and intends to continue to operate this center. Other than with respect to the foregoing center, the Company has not been notified that it will be required to make payments under any of these leases or guarantees, does not believe that any payments are likely and has not recorded any related liability.

In addition, various legal actions and other claims are pending or could be asserted against the Company. Litigation is subject to many uncertainties; the outcome of individual litigated matters is not predictable with assurance, and it is reasonably possible that some of these matters may be decided unfavorably to the Company. It is the opinion of management that the ultimate liability, if any, with respect to these matters will not materially affect the financial position, results of operations or cash flows of the Company.

NOTE 9 — OPTION GRANTS AND PAYMENTS FOR CONSULTING SERVICES

In July 2000, the Company retained Jacobson Partners, of which Benjamin R. Jacobson, the Company’s Chairman of the Board, is the managing general partner, to provide management and financial consulting services. As part of the consideration to be paid to, and to add further incentive for such services, Jacobson Partners was granted stock options to purchase 557,275 shares. Jacobson Partners has exercised options totaling 294,117 shares at a cost of $2,500,000. The remaining 263,158 shares expired in July 2002. Additionally, Jacobson Partners receives an annual consulting fee in the amount of $250,000, plus reimbursement of reasonable out-of-pocket expenses. In connection with the Tutor Time acquisition, Jacobson Partners was paid an advisory fee consisting of $333,336 and the issuance of 175,438 shares, and options were granted to certain related parties to acquire up to 400,000 shares of the Company’s common stock (see Note 2 “Acquisition and Pro Forma Information”). Total expenses incurred for Jacobson Partners (exclusive of the Tutor Time fee) were $192,500 and $192,500 for the 40 weeks ended January 3, 2003 and January 4, 2002, respectively, and are included in General and administrative expense in the accompanying Consolidated Statement of Operations.

The Company’s former Chairman of the Board and Interim Chief Executive Officer was granted 60,000 options in January 2001. As initially granted, the options have a $7.00 exercise price, vest at the rate of 10,000 per month and expire January 2003. After the executive was appointed Chairman of the Board in August 2001, these options were extended to expire in September 2006. At that time, he was also granted an additional 50,000 options. These additional options have an $11.00 exercise price, vest after one year and expire in September 2006.

The former interim Chief Financial Officer was granted 10,000 options in March 2001. The options have a $7.97 exercise price, vest evenly over 3 years and expire in March 2007. In September 2001, the executive was granted an additional 20,000 options. These additional options have an $11.00 exercise price, vest after one year and expire in September 2006. As a result of these stock option grants, the Company recorded additional compensation expense of $18,004 at fiscal year end 2002.

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NOTE 10 — INCOME TAXES

The Company provides for income taxes in accordance SFAS No. 109, Accounting for Income Taxes, which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.

Due to continued losses and uncertainties, the Company has determined that it is more likely than not that the deferred tax assets will not be recovered through future taxable income. As a result, a valuation reserve has been provided reducing deferred tax assets to an amount recoverable through the reversal of deferred tax liabilities or through carryback to prior tax years. Deferred taxes are as follows (in thousands):

NOTE 11 — LOSS PER SHARE

For the 12 and 40 weeks ended January 3, 2003 and January 4, 2002, basic loss per share has been calculated by dividing earnings available to common shareholders by the weighted average number of common shares outstanding for the period. The potential effect of stock options has been excluded in computing the loss per share as the effect would be antidilutive. The calculation of basic and diluted shares is as follows (in thousands):

NOTE 12 — EXIT AND CLOSURE EXPENSES AND DISCONTINUED OPERATIONS

The Company instituted a restructuring program in fiscal 2001 and incurred a charge of $4,000,000 in March 2001. In this regard, the Company closed all 10 of its Oxford Learning Centers of America and identified 19 under-performing centers to be closed in fiscal 2002. During the 40 weeks ended January 3, 2003, 8 centers were closed, of which 2 related to centers classified as discontinued operations. As of January 3, 2003, all but one of the under-performing centers have been closed.

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A summary of the accrual is as follows (in thousands):

The lease liability for the centers closed during the 40 weeks ended January 3, 2003 has been recorded at management’s estimate of fair value.

A summary of discontinued operations was as follows, with dollars in thousands:

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NOTE 13 — INTANGIBLE ASSETS AND LONG LIVED ASSET IMPAIRMENT

During the second quarter of 2003, the Company completed the implementation of SFAS 142, Goodwill and Other Intangible Assets. Under SFAS 142, goodwill is no longer amortized. Instead, goodwill and indefinite-lived intangible assets are tested for impairment in accordance with the provisions of SFAS 142. In accordance with its impairment policy, the Company employed a discounted cash flow analysis in conducting its impairment tests as of the beginning of fiscal 2003. The Company completed its impairment test and recorded an impairment loss of $5.0 million (net of a tax benefit of $0.9 million) as a cumulative effect of a change in accounting principle. In addition, as a result of continuing weakening economic conditions, the Company tested for goodwill impairment as of October 11, 2002, and recorded an impairment loss during the second quarter of $4.2 million.

In accordance with the provisions of SFAS 142, the Company did not amortize goodwill for the quarter and 40 weeks ended January 3, 2003. If goodwill amortization had not been recorded for the quarter and 40 weeks ended January 4, 2002, net loss would have decreased $0.4 and $1.4 million to an adjusted net loss of ($0.1) and ($0.2) million, respectively.

The changes in the carrying amounts of goodwill and other intangible assets for the 40 weeks ended January 3, 2003 were as follows (in thousands):

(1)  Additions relate to the July 19, 2002 acquisition of Tutor Time Learning Systems, Inc.

Estimated amortization of intangible assets is expected to be $0.5 million for fiscal 2003 and approximately $0.7 million for each of the next four years.

Due to the continuing weakening economic conditions, the Company tested for long-lived asset impairment, which consists primarily of equipment, leasehold improvements and other assets, as of October 11, 2002, in accordance with the provisions of SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The Company employed a cash flow analysis in conducting its impairment test. The Company completed its impairment test and recorded an impairment loss of $3.5 million, which impacted the Childtime reporting segment.

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Note 14 — SEGMENT INFORMATION

The Company has three reportable segments: Childtime, Tutor Time and Franchise Operations. Childtime operates childcare centers primarily under the Childtime Learning Centers brand name, Tutor Time operates childcare centers under the Tutor Time brand name and Franchise Operations licenses and provides developmental and administrative support to franchises operating under the Tutor Time brand name. The accounting polices of the segments are the same as those described in the summary of significant accounting policies. The Company’s reportable segments are reported separately because the Company’s chief operating decision maker uses the segment information in determining the allocation of resources among segments and appraising the performance of the segments.

Information about the Company’s operating segments are presented below in thousands: