SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

(MARK ONE)

LEARNING CARE GROUP, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

For the Quarterly Period Ended January 7, 2005

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PART I – FINANCIAL INFORMATION

ITEM 1. Condensed Consolidated Financial Statements

LEARNING CARE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

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LEARNING CARE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

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LEARNING CARE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

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LEARNING CARE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1 – DESCRIPTION OF BUSINESS

Learning Care Group, Inc. conducts business through its wholly-owned subsidiary Childtime Childcare, Inc. and its other wholly-owned subsidiaries (collectively, the “Company”). The Company and its predecessors began operations in 1967. The Company operates in three business segments: Childtime Learning Centers, Tutor Time Learning Centers and Franchise Operations. The Company provides center-based educational services and child care to children between the ages of six weeks and 12 years under two distinct brand identities: Childtime Learning Centers (“Childtime”) and Tutor Time Childcare Learning Centers (“Tutor Time”). As of January 7, 2005, the Company operated or franchised a total of 462 centers system-wide under three major lines of business and had system-wide licensed capacity capable of serving over 70,000 children. The Company’s three lines of business are:

Childtime and Tutor Time corporate centers are located throughout the United States (in 26 states) and Canada (one location). The vast majority of these centers are operated on leased premises, with typical lease terms ranging from 1 to 25 years. Thirty-eight of the Childtime centers are operated on Company-owned premises.

The Company operates six Childtime centers under management contracts. These centers serve hospitals, corporations and the federal government. Under these contracts, the Company receives an annual operating fee and, in some cases, is eligible to receive incentives for improving revenues and/or managing costs. These contracts are typically up for renewal on an annual basis.

Tutor Time franchise centers are also predominantly located in the U.S., with 118 centers operating in 17 states. An additional 12 centers are operated in Canada, Hong Kong, Indonesia, and the Philippines, mostly under master franchise agreements. The Company is currently the primary obligor or guarantor on leases for 50 of its franchise centers.

An amendment to the Company’s Restated Articles of Incorporation was approved by shareholders on August 17, 2004, which resulted in a change in the Company’s name from Childtime Learning Centers, Inc. to Learning Care Group, Inc.

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

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

The accompanying financial statements have been prepared by the Company in accordance with the accounting policies described in the Company’s audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended April 2, 2004, and should be read in conjunction with the notes thereto.

In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements contain all adjustments which are necessary to present fairly its financial position as of January 7, 2005, and the results of its operations and cash flows for the periods ended January 7, 2005 and January 2, 2004, respectively, and are of a normal and recurring nature. The results of operations for interim periods are not necessarily indicative of the operating results to be expected for the full year.

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Use of Estimates

The preparation of condensed 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 condensed consolidated financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.

Fiscal Year

The Company utilizes a 52-53 week fiscal year ending on the Friday closest to March 31. For fiscal year 2005, the third quarter contained 12 weeks, and the fiscal year contains 52 weeks. For fiscal year 2004, the third quarter contained 12 weeks, and the fiscal year contained 53 weeks.

Stock-Based Compensation

The Company has adopted the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation, and continues to measure compensation cost using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Had stock option compensation cost for these plans been determined based on the fair value at the grant dates for awards under those plans consistent with the methodology of SFAS No. 123, the Company’s net income (loss) and net income (loss) per share would have been reduced or increased, as applicable, to the pro forma amounts indicated below (in thousands except per share data):

The fair value of the options used to compute pro forma net income (loss) and net income (loss) per share is the estimated present value at grant date using the “Black-Scholes” option-pricing model with the following weighted average assumptions for the 12 and 40 weeks ended January 7, 2005 and January 2, 2004, respectively: no dividend yield; expected volatility of 76.0 and 37.3 percent; risk free interest rate of 3.6 and 2.0 percent; and expected holding periods of 5.0 and 5.0 years.

Franchise Lease Liabilities

A subsidiary of the Company is primarily or contingently liable for many of the leases of Tutor Time’s franchisees (see Note 5 below). 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 does not record any liabilities for any known default if the value of the existing franchise operation is greater than the potential liability or if the known net worth of the franchisee (or the owner of the franchisee, who personally guarantees the related franchise liabilities) is greater than the potential liability.

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NOTE 3 – ACCOUNTS RECEIVABLE

Accounts receivable is presented net of an allowance for doubtful accounts. At January 7, 2005 and April 2, 2004, the allowance for doubtful accounts was $1.0 million and $2.0 million, respectively.

NOTE 4 – 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 7, 2005 and April 2, 2004, the aggregate drafts payable were $3.9 million and $4.5 million, respectively.

NOTE 5 – COMMITMENTS AND CONTINGENCIES

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 payments the Company could be required to pay related to leases and guarantees aggregate $73.4 million and $13.2 million, respectively, in 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 does not anticipate 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.

Various legal actions and other claims are pending or could be asserted against the Company including pending claims relating to exposure to mold and other contaminants resulting from the condition of one of the Company’s centers. In addition, the Company has and will continue to vigorously protect its rights against parties that violate franchise agreements or infringe on its intellectual property rights. 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 beyond amounts already accrued.

NOTE 6 – 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. Total consulting fees incurred for Jacobson Partners were $187,500 and $342,500 for the 40 weeks ended January 7, 2005 and January 2, 2004, respectively, and are included in General and administrative expenses in the accompanying Condensed Consolidated Statements of Operations.

NOTE 7 – INCOME TAXES

During the 40 weeks ended January 7, 2005, an income tax provision of $0.1 million (all related to state income taxes) was recorded on income before income taxes and discontinued operations of $0.8 million, compared to an income tax provision of $0.0 million on loss before discontinued operations of ($2.1 million) for the same period last year. During the 12 weeks ended January 7, 2005, an income tax provision of $0.0 million was recorded on income before income taxes and discontinued operations of $0.7 million, compared to an income tax provision of $0.0 million on loss before discontinued operations of ($0.5 million) for the same period last year. Income tax expense for the 12 and 40 weeks ended January 7, 2005 varied from the U.S. statutory rate of 34% due primarily to the utilization of net operating loss carryforwards for which a valuation allowance has been recorded.

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NOTE 8 – NET INCOME (LOSS) PER SHARE

For the 12 and 40 weeks ended January 7, 2005 and January 2, 2004, basic income (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 calculation of basic and diluted shares is as follows (in thousands):

(1) For the 12 and 40 weeks ended January 7, 2005, the above calculation does not include 994,053 and 970,124 shares, respectively, issuable from stock options that have the potential to dilute earnings per share in the future. For the 12 and 40 weeks ended January 2, 2004, the above calculation does not include 1,995,819 and 1,625,963 shares, respectively, issuable from stock options that have the potential to dilute earnings per share in the future. These shares were not included in the above calculation of diluted shares because to do so would have been antidilutive.

NOTE 9 – EXIT AND CLOSURE EXPENSES AND DISCONTINUED OPERATIONS

The Company has made provisions for closed center lease obligations and discontinued operations in connection with the closing of under-performing centers. During the 12 and 40 weeks ended January 7, 2005, the Company incurred charges of $0.1 million and $0.2 million, respectively, to increase the reserves and to provide for other closed centers. The Company made payments related to its restructuring reserve of $0.2 million and $0.6 million for the 12 and 40 weeks ended January 7, 2005. A summary of the accrual is as follows (in thousands):

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NOTE 10 – INTANGIBLE ASSETS AND GOODWILL

The changes in the carrying amounts of goodwill and other intangible assets for the 40 weeks ended January 7, 2005 were as follows (in thousands):

On July 30, 2004, the Company acquired eight Tutor Time centers from a franchisee for $1.3 million, adjusted for certain assets and liabilities, which resulted in an addition to goodwill. Estimated amortization of intangible assets is expected to be $0.7 million for fiscal 2005 and approximately $0.7 million annually for the next four years.

NOTE 11 – 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 franchisees 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.

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NOTE 12 – FINANCIAL INSTRUMENT

The Company has entered into interest rate swap contracts to manage its exposure to fluctuations in interest rates relating to the revolving line of credit. Swap contracts fix the interest payments of floating rate debt instruments. As of January 7, 2005 and January 2, 2004, contracts representing $5.0 million of notional amount were outstanding with maturity dates of November 2005 and January 2006. These contracts provide for the Company to pay interest at an average fixed rate of 2.98% in return for receiving interest at a floating rate of three month LIBOR, which is reset in three month intervals. The fair value of interest rate swap agreements is subject to changes in value due to changes in interest rates, and the fair value of $0.0 million and less than $0.1 million is included in other current liabilities as of January 7, 2005 and January 2, 2004, respectively.

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NOTE 13 – CONSOLIDATION OF VARIABLE INTEREST ENTITIES

During the fourth quarter of 2004, the Company implemented FIN 46R. The Company has concluded that some of its franchise arrangements represent variable interest entities (“VIEs”) which are subject to the provisions of FIN 46R. The Company’s variable interest in these entities include royalty fees and in some cases lease guarantees and debt due to the Company from the franchisee. The Company has analyzed these franchise agreements and has determined that two franchises are entities in which the Company is the primary beneficiary. As a result, these entities were consolidated as of April 2, 2004. During the quarter ended October 15, 2004, the Company acquired the two franchise entities that had previously been consolidated as VIEs. As a result, these entities are not considered VIEs as of January 7, 2005. The following is a summary of the effect of consolidating these entities for the period up to the acquisition date (in thousands).

The Company has not restated prior periods for the above consolidation and there was no cumulative effect on the prior years related to the consolidation during first quarter 2005.

NOTE 14 – ACQUISITION OF FRANCHISE CENTERS

On July 30, 2004, the Company acquired the entire equity interests of eight entities that each owned a Tutor Time franchise center in the Minneapolis, Minnesota area. These entities were delinquent in the payment of amounts due to the Company and, in certain instances, under leases guaranteed by the Company. The Company decided to purchase these entities in order to cure these delinquencies and to allow the Company to take advantage of operating and expansion opportunities in the Minnesota market. The Company made a cash payment of $0.3 million and assumed liabilities in excess of assets of $1.1 million, resulting in recorded goodwill of $1.2 million. Included in the liability of the purchased entities was a payable to the Company of $0.8 million, for which the Company had established an allowance for doubtful accounts of $0.2 million. The Company is in the process of gathering information to finalize the purchase price allocation. The results of operations have been included in the Company’s operating results since the date of acquisition.

NOTE 15 – CREDIT AGREEMENT

On November 22, 2004, the Company entered into a Second Amended and Restated Credit Agreement, which increased the revolving line of credit from $13.7 million to $17.5 million and extended the maturity date to July 31, 2006.

ITEM 2. Management’s Discussion and Analysis

GENERAL

The information presented herein refers to the 12 weeks (third quarter 2005) and the 40 weeks (year to date 2005) ended January 7, 2005, compared to the 12 weeks (third quarter 2004) and 40 weeks (year to date 2004) ended January 2, 2004.

The results of Learning Centers opened, acquired or disposed of are included in the Company’s condensed consolidated financial statements from the date of opening or acquisition and through the date of disposition, except for those centers treated as discontinued operations in accordance with SFAS 144. The timing of such new openings, acquisitions or dispositions could influence comparisons of year over year results.

During third quarter 2005, a franchisee opened one franchise center and another franchisee closed one franchise center, and the Company closed four Learning Centers. During the third quarter 2004, the Company opened one Learning Center.

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During year to date 2005, the Company acquired eight Learning Centers from a franchisee, opened two franchise centers, closed one franchise center, closed six Learning Centers and sold two additional Learning Centers to franchisees. During year to date 2004, the Company closed four Learning Centers, franchised one center previously operated as a corporate center and opened two corporate centers.

The Company is subject to certain risks common to the providers of child care and early education, including dependence on key personnel, dependence on client relationships, competition from alternate sources or providers of the Company’s services, market acceptance of work and family services, the ability to hire and retain qualified personnel, the Company’s ability to manage its overall cost structure and general economic conditions.

The Company’s enrollments change over the course of a year, with the highest enrollments occurring during the traditional fall “back to school”, and after calendar period year-end holidays. Enrollments generally decrease during summer months and calendar year-end holidays. As a result, operating results change during the quarters and individual quarterly results are not indicative of annual operating results.

RESULTS OF OPERATIONS

Third Quarter 2005 Compared to Third Quarter 2004

Revenue, net. Net revenue for third quarter 2005 increased $4.0 million, or 9.0%, from the same period last year to $47.9 million. Learning Center revenues increased $3.8 million. Revenue increases were achieved through a combination of increased tuition rates and enrollments as well as through center acquisitions. Childtime Learning Centers revenues increased $1.9 million, with comparable Childtime center revenues (centers opened 18 months or longer) increasing 6.3%. Tutor Time Learning Centers revenues increased $1.9 million, with comparable Tutor Time center revenues increasing 5.4%. Franchise Operations revenues, which consisted primarily of royalties, increased $0.1 million, or 9.9%, from the same period last year to $1.6 million.

Operating expenses of Learning Centers. Operating expenses for third quarter 2005 increased $3.4 million, or 9.0%, from the same period last year to $41.3 million. The increase was a result of an increase in personnel expense ($1.5 million), which increased with higher enrollments and general wage increases; an increase in center controllable expenses ($1.2 million), which increased with higher enrollments and increased costs from center maintenance improvements, food, transportation and utility expenses; and an increase in occupancy expense ($0.7 million), which was primarily a result of rent on new center openings and acquired centers, and increased insurance and other occupancy costs for existing centers. Operating expenses as a percentage of net revenue remained unchanged at 86.2% for third quarter 2005, with an increase in center controllable expenses being offset by a reduction in personnel expenses.

Gross profit. Gross profit for third quarter 2005 increased $0.6 million, or 9.2%, from the same period last year to $6.6 million. This increase consisted of a $0.4 million increase in Learning Center Operations gross profit and a $0.1 million increase in Franchise Operations gross profit. Gross profit percentages for third quarter 2005 by segment were 13.0% for Childtime centers (as compared to 14.0% for 2004), 6.1% for Tutor Time centers (as compared to 3.2% for 2004) and 100% for Franchise Operations. The third quarter gross profit and gross profit percentage changes were a result of the revenue increases and changes in operating expenses described above.

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General and administrative expenses. General and administrative expenses for third quarter 2005 decreased $0.2 million, or 3.9%, from the same period last year to $4.2 million. The decrease was a result of a decrease in consulting and temporary help, partially offset by increases in wages and incentives based on operating improvements. General and administrative expenses as a percentage of net revenue decreased to 8.8% for third quarter 2005 from 10.0% in the same period last year. The decrease was a result of revenues increasing while general and administrative expenses decreased.

Depreciation and amortization expense. Depreciation and amortization expense for third quarter 2005 remained unchanged from last year. Depreciation and amortization expense as a percentage of net revenue decreased to 2.0% for third quarter 2005 from 2.2% in the same period last year. The decrease was a result of revenues increasing while depreciation and amortization expense remained the same.

Provision for doubtful accounts. Provision for doubtful accounts for third quarter 2005 decreased $0.3 million, or 48.8%, from the same period last year to $0.3 million. This decrease was a result of improved collection experience during the quarter.

Interest expense. Interest expense for third quarter 2005 was $0.5 million, compared to $0.4 million for the same period last year. This increase was a result of sale leaseback transactions completed in fourth quarter 2004.

Income tax provision. An income tax provision for third quarter of $0.0 million was recorded on income before income taxes and discontinued operations of $0.7 million, compared to an income tax provision of $0.0 million on loss before discontinued operations of ($0.5 million) for the same period last year. Income tax expense for the first quarter 2005 varied from the U.S. statutory rate of 34% due primarily to the utilization of net operating loss carryforwards for which a valuation allowance had been recorded.

Discontinued operations, net of taxes. Discontinued operations, net of taxes, for third quarter 2005 was $0.2 million compared to a loss of ($0.1 million) for the same period last year. This income includes gain on the disposal of assets in one closed center of $0.6 million, offset by operating and lease termination costs associated with closed centers.

Net income (loss). As a result of the foregoing changes, net income for third quarter 2005 was $0.9 million compared to a net loss of ($0.6 million) for the same period last year.

Year to Date 2005 Compared to Year to Date 2004

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Revenue, net.  Net revenue for year to date 2005 increased $11.5 million, or 7.7%, from the same period last year to $161.0 million. Learning Center revenues increased $10.7 million. Revenue increases were achieved through a combination of increased tuition rates and enrollments. Childtime Learning Centers revenues increased $5.3 million, with comparable Childtime center revenues (centers opened 18 months or longer) increasing 5.4%. Tutor Time Learning Centers revenues increased $5.0 million, with comparable Tutor Time center revenues increasing 6.3%. Revenue attributable to the consolidation of two franchise arrangements considered variable interest entities (VIEs as discussed in Note 13 of the Notes to Condensed Consolidated Financial Statements (unaudited) included in this Report under Item 1) accounted for $0.4 million of the year to date 2005 Tutor Time Learning Centers increase. Franchise Operations revenues, which consisted primarily of royalties, increased $0.8 million, or 16.7%, from the same period last year to $5.4 million.

Operating expenses of Learning Centers. Operating expenses year to date 2005 increased $8.6 million, or 6.6%, from the same period last year to $140.0 million. The increase was a result of an increase in personnel expense ($3.7 million), which increased with higher enrollments and general wage increases; an increase in occupancy expense ($2.4 million), which was primarily a result of rent on new center openings and acquired centers, and increased insurance and other occupancy costs for existing centers; an increase in center controllable expenses ($2.1 million), which increased with higher enrollments and increased costs from center maintenance improvements, food, transportation and utility expenses; and operating expenses associated with the VIEs ($0.4 million). Operating expenses as a percentage of net revenue decreased to 87.0% for year to date 2005, from 87.9% in the same period last year. This decrease is a result of a decrease in personnel expenses as a percentage of net revenues, resulting from improved labor efficiencies, and the increased portion of revenues derived from Franchise Operations, which have no associated costs in Operating expenses of Learning Centers.

Gross profit. Gross profit for year to date 2005 increased $2.9 million, or 16.0%, from the same period last year to $21.0 million. This increase consisted of a $2.1 million increase in Learning Center Operations gross profit and a $0.8 million increase in Franchise Operations gross profit. Gross profit percentages for year to date 2005 by segment were 11.5% for Childtime centers (as compared to 11.6% for 2004), 6.3% for Tutor Time centers (as compared to 3.3% for 2004) and 100% for Franchise Operations. The third quarter gross profit and gross profit percentage changes were a result of the revenue increases and changes in operating expenses described above.

General and administrative expenses. General and administrative expenses for year to date 2005 increased $0.5 million, or 3.7%, from the same period last year to $14.8 million. The increase was a result of increased center staff training expenses, general wage increases and increased employee bonuses due to operating improvements. General and administrative expenses as a percentage of net revenue decreased to 9.2% for year to date 2005 as compared to 9.6% for year to date 2004, due to the greater rate of increase in net revenue for the current period.

Depreciation and amortization expense. Depreciation and amortization expense for year to date 2005 increased $0.2 million, or 6.1%, from the same period last year to $3.2 million. The increase was primarily a result of depreciation expense attributable to capital expenditures. Depreciation and amortization expense as a percentage of net revenue remained unchanged from last year.

Gain on sale of center and vacant lands. Gain on sale of centers was a result of the sale under a franchise agreement of two Tutor Time centers to an existing franchisee in first quarter 2005 and the sale of vacant land in second quarter 2005. There were no similar transactions in the same period last year.

Provision for doubtful accounts. Provision for doubtful accounts for year to date 2005 remained unchanged from the same period last year at $1.1 million.

Interest expense. Interest expense for year to date 2005 was $1.6 million, compared to $1.5 million for the same period last year. This increase was a result of interest on sale leaseback transactions completed in fourth quarter 2004.

Income tax provision. Income tax provision for year to date 2005 of $0.1 million (all related to state income taxes) was recorded on income before income taxes and discontinued operations of $0.8 million, compared to an income tax provision of $0.0 million on a loss before discontinued operations of ($2.1 million) for the same period last year. Income tax expense for year to date 2005 varied from the U.S. statutory rate of 34% due primarily to the utilization of net operating loss carryforwards for which a valuation allowance had been recorded.

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Discontinued operations, net of taxes. Discontinued operations, net of taxes, for year to date 2005 was $0.2 million, compared to a loss of ($0.3 million) for the same period last year. This income includes gain on the disposal of assets in one closed center of $0.6 million, offset by operating and lease termination costs associated with closed centers.

Net income (loss). As a result of the foregoing changes, net income increased to $0.9 million for year to date 2005, compared to a net loss of ($2.4 million) for the same period last year.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s primary cash requirements currently consist of payment of operating expenses, repayment of debt and capital expenditures. The Company expects to fund cash needs through the revolving credit facility, described below, and cash generated from operations. The Company has also funded cash needs through sale leaseback transactions. The Company may evaluate alternative forms of funding and new arrangements may be entered into in the future. The Company experiences decreased liquidity during the calendar year-end holidays due to decreased attendance. While new enrollments are generally highest during the traditional fall “back to school” period and after the calendar year-end holidays, enrollment generally decreases during the summer months and calendar year-end holidays. Should cash flow generated from operations and borrowings available under the revolving credit facility not be adequate to provide for its working capital and debt service needs, the Company will attempt to make other arrangements to provide needed liquidity. No assurance can be given that such sources of capital will be sufficient.

On November 22, 2004, the Company entered into a Second Amended and Restated Credit Agreement. This agreement provides a $17.5 million revolving line of credit that will mature on July 31, 2006. It is collateralized 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 $10.0 million at January 7, 2005, and $5.4 million at April 2, 2004. Outstanding letters of credit reduced the availability under the line of credit in the amount of $4.0 million at January 7, 2005 and $2.1 million at April 2, 2004. As of January 7, 2005 and April 2, 2004, unused amounts available for borrowing under this line of credit were $3.5 million and $6.2 million, respectively.

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. The Company was in compliance with the agreement as of January 7, 2005.

Net cash provided (used) by operating activities was $2.8 million for year to date 2005, compared to ($1.5 million) for the same period last year. During year to date 2005, financing activities totaled ($0.3 million) and consisted primarily of repayments under long-term debt and changes in drafts payable offset by net borrowings on the line of credit. During year to date 2004, financing activities totaled $3.5 million and consisted primarily of the issuance of shares net of issuance costs of $12.1 million, the issuance of subordinated notes of $3.5 million, and net borrowings on the revolving line of credit of $2.3 million, offset by repayments of long-term debt of $15.1 million. Investing activities were ($3.3 million) for the year to date 2005. Of this, $4.6 million was used for capital spending and $0.3 was used to acquire centers from a franchisee. This was partially offset by $1.5 million of proceeds from asset disposals. Investing activities were ($3.1 million) for year to date 2004, of which $3.3 million was used for capital spending which was partially offset by $0.2 million of proceeds from asset sales.

On May 16, 2003, the Company completed a rights offering. Total proceeds from the offering were $15.9 million, of which $12.4 million ($11.6 million net of expenses) was for the issuance of 14.1 million shares of common stock and $3.5 million was Subordinated Debt. The proceeds of the offering were used to pay off the balance, which included accrued interest, on the Subordinated Debt issued to a group of lenders organized by Jacobson Partners (see Related Party Transactions below).

The Company has entered into interest rate swap contracts to manage its exposure to fluctuations in interest rates relating to the revolving line of credit. Swap contracts fix the interest payments of floating rate debt instruments. As of January 7, 2005, contracts representing $5.0 million of notional amount were outstanding with maturity dates of November 2005 and January 2006. These contracts provide for the Company to pay interest at an average fixed rate of 2.98% in return for receiving interest at a floating rate of three month LIBOR, which is reset in three month intervals. The fair value of interest rate swap agreements is subject to changes in value due to changes in interest rates. During year to date 2005, the market value of the outstanding interest rate contracts increased $0.1 million.

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Contractual Obligations and Commitments

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 payments the Company could be required to pay related to leases and guarantees aggregate $73.4 million and $13.2 million, respectively, in 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 does not anticipate 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.

At January 7, 2005, aggregate potential payments on leases and guarantees over the next five fiscal years and thereafter are as follows:

Related Party Transactions

For information regarding related party transactions, see the Company’s Annual Report on Form 10-K for the fiscal year ended April 2, 2004 (see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Related Party Transactions”).

Contingencies

Various legal actions and other claims are pending or could be asserted against the Company including pending claims relating to exposure to mold and other contaminants resulting from the condition of one of the Company’s centers. In addition, the Company has and will continue to vigorously protect its rights against parties that violate franchise agreements or infringe on its intellectual property rights. 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 beyond amounts already accrued.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires that management make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Predicting future events is inherently an imprecise activity and as such requires the use of judgment. Actual results may vary from estimates in amounts that may be material to the financial statements.

For a description of the Company’s significant accounting policies, see Note 3, “Summary of Significant Accounting Policies”, of the Notes to Condensed Consolidated Financial Statements (unaudited) included in this Report under Item 1. For a more complete description, please refer to the Company’s Annual Report on Form 10-K for the fiscal year ended April 2, 2004.

Wage and Benefit Increases

Expenses for center-level salaries, wages and benefits represented approximately 48.1% of net revenue for third quarter 2005, as compared to approximately 51.4% of net revenue in third quarter 2004. Management believes that, through increases in tuition rates, the Company can offset any future center-level wage increases caused by

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adjustments to the federal, state or county minimum wage rates or other market adjustments. However, no assurance can be given that rates can be increased sufficiently to cover such increased costs. The Company continually evaluates its wage structure and may implement changes at targeted local levels.

“SAFE HARBOR” STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Form 10-Q Report contains certain forward-looking statements regarding, among other things, the anticipated financial and operating results of the Company. Investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly release any modifications or revisions to these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions investors that future financial and operating results may differ materially from those projected in forward-looking statements made by, or on behalf of, the Company. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause the actual results, performance, or achievements of the Company to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Forward-looking statements involve a number of risks and uncertainties, including, but not limited to, ability to hire, train and retain qualified personnel, continuation of federal and state assistance programs, projected exit and closure expenses, pricing, competition, insurability, demand for childcare and general economic conditions. Accordingly, actual results could differ materially from those projected in such forward-looking statements.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risks

Market risk represents the risk of loss that may impact the Company’s consolidated financial position, results of operations or cash flow. The Company is exposed to market risk due to changes in interest rates and foreign currency exchange rates.

Interest Rates. The Company has exposure to market risk for changes in interest rates related to its debt obligations. The Company does not have cash flow exposure due to rate changes on its 15% Subordinated Notes in the amount of $3.5 million as of January 7, 2005. The Company has cash flow exposure on the revolving line of credit, with an outstanding balance of $10.0 million, and its notes payable, with an outstanding balance of $0.1 million, each as of January 7, 2005. These exposures have been partially offset by the Company entering into $5.0 million notional amount of interest rate swap contracts. Accordingly, a 2% (200 basis points) change in the LIBOR rate or the prime rate would have resulted in interest expense changing by approximately $0.1 million for fiscal year 2005.

Foreign Currency Exchange Rates. The Company’s exposure to foreign currency exchange rates is limited to revenues for one company-owned center and royalties for 12 international franchised centers. Based upon the relative size of its foreign operations, the Company does not believe that the reasonably possible near-term change in the related exchange rate would have a material effect on its financial position, results of operations and cash flows.

ITEM 4. Controls and Procedures

Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report, and, based on their evaluation, our chief executive officer and chief financial officer have concluded that these controls and procedures are effective. There were no significant changes in our internal control over financial reporting during the fiscal quarter ended January 7, 2005, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the

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Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

PART II – OTHER INFORMATION

ITEM 1. Legal Proceedings

Information regarding this Item is set forth in Note 5 to the Notes of Condensed Consolidated Financial Statements (unaudited) included in Part I, Item 1 of this Report.

ITEMS 2 through 4 are not applicable.

ITEM 5. OTHER INFORMATION

On February 22, 2005, the Company issued the press release attached hereto as Exhibit 99.1, announcing its results for the fiscal quarter and 40 weeks ended January 7, 2005, which press release is incorporated in this Item 5 by reference. The information in this Item 5 and the attached Exhibit 99.1 shall not be deemed filed for purposed of Section 18 of the Securities Act of 1934, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, except as shall be expressly stated by specific reference in such filing.

ITEM 6. Exhibits and Reports on Form 8-K

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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.

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