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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 19, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 333-42137
KINDERCARE LEARNING CENTERS, INC.
(Exact name of registrant as specified in its charter)
Delaware 63-0941966
(State or other (I.R.S. Employer
jurisdiction of incorporation) Identification No.)
650 NE Holladay Street, Suite 1400
Portland, OR 97232
(Address of principal executive offices)
(503) 872-1300
(Registrant's telephone number, including area code)
(Former name, address and fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares of the registrant's common stock, $.01 par value per
share, outstanding at October 31, 2003 was 19,696,797.
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KinderCare Learning Centers, Inc. and Subsidiaries
Index
Part I. Financial Information................................................ 2
Item 1. Unaudited financial statements:
Consolidated balance sheets at September 19, 2003
and May 30, 2003 (unaudited).............................. 2
Consolidated statements of operations for the sixteen
weeks ended September 19, 2003 and September 20,
2002 (unaudited).......................................... 3
Consolidated statements of stockholders' equity and
comprehensive income (loss) for the sixteen weeks
ended September 19, 2003 and the fiscal year ended
May 30, 2003 (unaudited).................................. 4
Consolidated statements of cash flows for the sixteen
weeks ended September 19, 2003 and September 20,
2002 (unaudited).......................................... 5
Notes to unaudited consolidated financial statements........ 6
Item 2. Management's discussion and analysis of financial
condition and results of operations.........................13
Item 3. Quantitative and qualitative disclosures about market risk..25
Item 4. Controls and procedures.....................................26
Part II. Other Information....................................................27
Item 4. Submission of matters to a vote of security holders.........27
Item 6. Exhibits and reports on Form 8-K............................27
Signatures....................................................................28
1
PART I.
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)
(Unaudited)
September 19, May 30,
2003 2003
------------ ------------
Assets
Current assets:
Cash and cash equivalents............................ $ 18,861 $ 18,066
Receivables, net..................................... 35,201 31,493
Prepaid expenses and supplies........................ 10,077 9,423
Deferred income taxes................................ 11,154 14,500
Assets held for sale................................. 1,002 1,126
------------ ------------
Total current assets............................. 76,295 74,608
Property and equipment, net............................ 751,115 665,372
Deferred income taxes.................................. 5,380 1,868
Goodwill............................................... 42,565 42,565
Deferred financing costs............................... 22,290 9,445
Other assets........................................... 22,484 17,235
------------ ------------
$ 920,129 $ 811,093
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Bank overdrafts...................................... $ 8,738 $ 9,304
Accounts payable..................................... 9,114 8,888
Current portion of long-term debt.................... 4,026 13,744
Accrued expenses and other liabilities............... 97,659 109,671
------------ ------------
Total current liabilities........................ 119,537 141,607
Long-term debt......................................... 564,373 441,336
Long-term self-insurance liabilities................... 25,722 22,771
Deferred income taxes.................................. 5,711 3,696
Other noncurrent liabilities........................... 72,647 66,524
------------ ------------
Total liabilities................................ 787,990 675,934
------------ ------------
Commitments and contingencies.......................... -- --
Stockholders' equity:
Preferred stock, $.01 par value; authorized
10,000,000 shares; none outstanding.............. -- --
Common stock, $.01 par value; authorized 100,000,000
shares; issued and outstanding 19,696,797 and
19,661,216, respectively......................... 197 197
Additional paid-in capital........................... 26,425 25,909
Notes receivable from stockholders................... (1,578) (1,085)
Retained earnings.................................... 107,284 110,297
Accumulated other comprehensive loss................. (189) (159)
------------ ------------
Total stockholders' equity....................... 132,139 135,159
------------ ------------
$ 920,129 $ 811,093
============ ============
See accompanying notes to unaudited consolidated financial statements.
2
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands, except per share amounts)
(Unaudited)
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
Revenues, net........................................... $ 260,849 $ 253,607
------------ ------------
Operating expenses:
Salaries, wages and benefits......................... 147,014 144,692
Depreciation and amortization........................ 18,623 17,101
Rent................................................. 16,998 15,043
Provision for doubtful accounts...................... 1,883 1,688
Other................................................ 64,100 61,095
------------ ------------
Total operating expenses......................... 248,618 239,619
------------ ------------
Operating income................................... 12,231 13,988
Investment income....................................... 72 108
Interest expense........................................ (12,963) (12,839)
Loss on the early extinguishment of debt............. (3,669) --
------------ ------------
Income (loss) before income taxes and
discontinued operations............................ (4,329) 1,257
Income tax benefit (expense)............................ 1,713 (498)
------------ ------------
Income (loss) before discontinued operations....... (2,616) 759
Discontinued operations, net of income tax
benefit of $260 and $198, respectively............... (397) (302)
------------ ------------
Net income (loss).................................. $ (3,013) $ 457
============ ============
Basic and diluted net income (loss) per share:
Income (loss) before discontinued operations......... $ (0.13) $ 0.04
Discontinued operations, net......................... (0.02) (0.02)
------------ ------------
Net income (loss).................................. $ (0.15) $ 0.02
============ ============
Weighted average common shares outstanding:
Basic................................................. 19,684,402 19,771,203
Diluted............................................... 19,684,402 19,973,777
See accompanying notes to unaudited consolidated financial statements.
3
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
(Dollars in thousands)
(Unaudited)
Notes Accumulated
Common Stock Additional Receivable Other
-------------------- Paid-in from Retained Comprehensive
Shares Amount Capital Stockholders Earnings Loss Total
---------- -------- --------- ------------ ---------- ------------- ----------
Balance at May 31, 2002.............. 19,819,352 $ 198 $ 28,107 $ (1,426) $ 96,882 $ (492) $ 123,269
Comprehensive income:
Net income......................... -- -- -- -- 13,415 -- 13,415
Cumulative translation
adjustment....................... -- -- -- -- -- 333 333
----------
Total comprehensive income....... 13,748
Retirement of common stock........... (119,838) (1) (1,645) -- -- -- (1,646)
Repurchase of common stock........... (38,298) -- (553) -- -- -- (553)
Proceeds from collection of
stockholders' notes receivable..... -- -- -- 341 -- -- 341
---------- -------- --------- ------------ ---------- ------------- ----------
Balance at May 30, 2003.......... 19,661,216 $ 197 $ 25,909 $ (1,085) $ 110,297 $ (159) $ 135,159
Comprehensive loss:
Net loss........................... -- -- -- -- (3,013) -- (3,013)
Cumulative translation adjustment.. -- -- -- -- -- (30) (30)
----------
Total comprehensive loss......... (3,043)
Issuance of common stock............. 48,739 -- 714 -- -- -- 714
Repurchase of common stock........... (13,158) -- (198) -- -- -- (198)
Issuance of stockholders' notes
receivable......................... -- -- -- (638) -- -- (638)
Proceeds from collection of
stockholders' notes receivable..... -- -- -- 145 -- -- 145
---------- -------- --------- ------------ ---------- ------------- ----------
Balance at September 19, 2003.... 19,696,797 $ 197 $ 26,425 $ (1,578) $ 107,284 $ (189) $ 132,139
========== ======== ========= ============ ========== ============= ==========
See accompanying notes to unaudited consolidated financial statements.
4
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
Cash flows from operations:
Net income (loss)..................................... $ (3,013) $ 457
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation...................................... 18,890 17,180
Amortization of deferred financing costs and
deferred gain on sale-leasebacks................ 3,167 1,034
Provision for doubtful accounts................... 1,901 1,749
Gain on sales and disposals of property and
equipment....................................... (50) (74)
Deferred tax expense.............................. 1,848 3,273
Changes in operating assets and liabilities:
Increase in receivables......................... (5,609) (5,698)
Increase in prepaid expenses and supplies....... (654) (1,724)
(Increase) decrease in other assets........... (4,483) 115
Decrease in accounts payable, accrued
expenses and other current and noncurrent
liabilities................................... (8,019) (10,565)
Other, net........................................ (30) 209
------------ ------------
Net cash provided by operating activities........... 3,948 5,956
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment................... (16,478) (34,739)
Purchases of property and equipment previously in
the synthetic lease facility........................ (97,851) --
Proceeds from sales of property and equipment......... 16,290 14,612
Proceeds from (issuance of) notes receivable.......... (759) 52
------------ ------------
Net cash used by investing activities.............. (98,798) (20,075)
------------ ------------
Cash flows from financing activities:
Proceeds from long-term borrowings................... 327,000 36,000
Payments on long-term borrowings..................... (213,681) (20,612)
Deferred financing costs related to refinanced debt.. (16,890) --
Payments on capital leases........................... (241) (433)
Proceeds from issuance of common stock............... 714 --
Proceeds from collection of stockholders' notes
receivable......................................... 145 101
Issuance of notes receivable to stockholders......... (638) --
Repurchase of common stock........................... (198) --
Bank overdrafts...................................... (566) (258)
------------ ------------
Net cash provided by financing activities.......... 95,645 14,798
------------ ------------
Increase in cash and cash equivalents............ 795 679
Cash and cash equivalents at the beginning of
the period......................................... 18,066 8,619
------------ ------------
Cash and cash equivalents at the end of the
period............................................. $ 18,861 $ 9,298
Supplemental cash flow information:
Interest paid.................................... $ 16,612 $ 16,717
Income taxes paid, net........................... 1,927 1,141
See accompanying notes to unaudited consolidated financial statements.
5
KinderCare Learning Centers, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
1. Nature of Business
KinderCare Learning Centers, Inc., referred to as KinderCare, is the
leading for-profit provider of early childhood education and care in the United
States. At September 19, 2003, we served approximately 118,000 children and
their families at 1,260 child care centers. At our child care centers, we
provide educational and care services to infants and children up to twelve years
of age. However, the majority of the children we serve are from six weeks to
five years old. The total licensed capacity at our centers was approximately
167,000 at September 19, 2003.
We operate early childhood education and care centers under two brands as
follows:
o KinderCare - At September 19, 2003, we operated 1,190 KinderCare
centers. The brand was established in 1969 and operates centers in 39
states, as well as two centers located in the United Kingdom.
o Mulberry - We operated 70 Mulberry centers at September 19, 2003,
which are located primarily in the northeast region of the United
States and southern California. In addition we had eight service
contracts to operate before-and-after-school programs.
We also partner with companies to provide on- or near-site care to help
employers attract and retain employees. Included in the 1,260 centers at
September 19, 2003, are 45 employer-sponsored centers. In addition to our
center-based child care operations, we own and operate a distance learning
company serving teenagers and young adults. Our subsidiary, KC Distance
Learning, Inc., offers an accredited high school program delivered in either
online or correspondence format. We have made minority investments in Voyager
Expanded Learning, Inc., a developer of educational curricula for elementary and
middle schools and a provider of a public school teacher retraining program, and
Chancellor Beacon Academies, Inc., an education management company.
This report will be available on our website, kindercare.com, as soon as
practicable after filing with the Securities and Exchange Commission. The
information on our website is not incorporated by reference in this report.
Fiscal Year. References to fiscal 2004 and fiscal 2003 are to the 52 weeks
ended May 29, 2004 and May 30, 2003, respectively. Our fiscal year ends on the
Friday closest to May 31. The first quarter is comprised of 16 weeks and ended
on September 19, 2003 in fiscal 2004 and September 20, 2002 in fiscal 2003. The
second, third and fourth quarters are each comprised of 12 weeks.
2. Summary of Significant Accounting Policies
Basis of Presentation. The unaudited consolidated financial statements
include the financial statements of KinderCare and our subsidiaries, all of
which are wholly owned. All significant intercompany balances and transactions
have been eliminated in consolidation.
In the opinion of management, the unaudited consolidated financial
statements reflect the adjustments, all of which are of a normal recurring
nature, necessary to present fairly our financial position at September 19,
2003, and our results of operations and cash flows for the sixteen weeks ended
September 19, 2003 and September 20, 2002. Interim results are not
6
necessarily indicative of results to be expected for a full fiscal year because
of seasonal and short-term variances and other factors such as the timing of new
center openings and center closures. The unaudited consolidated financial
statements should be read in conjunction with the annual consolidated financial
statements and notes thereto included in our Annual Report on Form 10-K for the
fiscal year ended May 30, 2003.
Revenue Recognition. We recognize revenue for child care services as earned
in accordance with Securities and Exchange Commission ("SEC") Staff Accounting
Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements. Net
revenues include tuition, fees and non-tuition income, reduced by discounts. We
receive fees for reservation, registration, education and other services.
Non-tuition income is primarily comprised of field trip revenue. Registration
and education fees are amortized over the estimated average enrollment period,
not to exceed twelve months. Tuition, other fees and non-tuition income are
recognized as the related services are provided.
Restricted Cash. Restricted cash includes cash held in connection with our
$300.0 million mortgage loan, see "Note 3. Long-Term Debt." At September 19,
2003, restricted cash of $2.9 million was included in other assets in our
unaudited consolidated balance sheet. The restricted cash relates primarily to
capital expenditure requirements for our collateralized centers under the
mortgage loan.
Property and Equipment, net. In connection with our debt refinancing in
July 2003, our $300.0 million mortgage loan is secured by first mortgages or
deeds of trust on 475 of our owned centers. In addition, we mortgaged another
119 of our owned centers for our new revolving credit facility. At September 19,
2003, the net book value of $401.0 million for these 594 centers was included in
property and equipment, net in our unaudited consolidated balance sheet.
Deferred Financing Costs. Deferred financing costs are amortized on a
straight-line basis over the lives of related debt facilities. Such method
approximates the effective yield method. At September 19, 2003 and May 30, 2003,
deferred financing costs were $22.3 million and $8.2 million, respectively. The
increase in deferred financing costs for the sixteen weeks ended September 19,
2003 was due to our debt refinancing in July 2003, see "Note 3. Long-Term Debt."
A summary of the increase was as follows, with dollars in thousands:
Balance at May 30, 2003.............................. $ 9,445
Deferred financing cost additions.................... 16,890
Deferred financing costs written-off in connection
with refinancing................................... (2,870)
Amortization of deferred financing costs for the
sixteen weeks ended September 19, 2003............. (1,175)
---------
Balance at September 19, 2003...................... $ 22,290
=========
7
Comprehensive Income (Loss). Comprehensive income (loss) is comprised of
the following, for the periods indicated, with dollars in thousands:
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
Net income (loss)..................... $ (3,013) $ 457
Cumulative translation adjustment..... (30) 209
------------ ------------
$ (3,043) $ 666
============ ============
Stock-Based Compensation. We measure compensation expense for our
stock-based employee compensation plans using the method prescribed by
Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued
to Employees, and provide, if material, pro forma disclosures of net income and
earnings per share as if the method prescribed by Statement of Financial
Accounting Standards ("SFAS") No. 148, Accounting for Stock-Based Compensation -
Transition and Disclosure, had been applied in measuring compensation expense.
Had compensation expense for our stock option plans been determined based
on the estimated weighted average fair value of the options at the date of grant
in accordance with SFAS No. 148, our net income and basic and diluted net income
(loss) per share would have been as follows, with dollars in thousands, except
per share data:
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
Reported net income (loss).................. $ (3,013) $ 457
Compensation cost for stock option
plan, net of taxes........................ (290) (200)
------------ ------------
Pro forma net income (loss)................. $ (3,303) $ 257
============ ============
Pro forma net income (loss) per share:
Basic and diluted net income (loss)
per share before discontinued
operations, net......................... $ (0.15) $ 0.03
Discontinued operations, net of taxes..... (0.02) (0.02)
------------ ------------
Adjusted net income (loss) per share.. $ (0.17) $ 0.01
============ ============
A summary of the weighted average fair values was as follows:
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
Weighted average fair value of options
granted during the period, using the
Black-Scholes option pricing model........ $ 7.04 $ 4.57
Assumptions used to estimate the present
value of options at the grant date:
Volatility.............................. 48.2% 38.7%
Risk-free rate of return................ 3.7% 4.3%
Dividend yield.......................... 0.0% 0.0%
Number of years to exercise options..... 7 7
8
Discontinued Operations. Discontinued operations included the operating
results for the twelve centers closed during the sixteen weeks ended September
19, 2003 and the 28 centers closed in fiscal year 2003 for all periods
presented. A summary of discontinued operations was as follows with dollars in
thousands:
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
Revenues, net............................... $ 454 $ 3,854
Operating expenses.......................... 1,111 4,534
------------ ------------
Operating loss............................ (657) (500)
Income tax benefit.......................... 260 198
------------ ------------
Discontinued operations, net of tax....... $ (397) $ (302)
Of the center closures, four were held for sale at September 19, 2003. As a
result, $1.0 million and $1.1 million of property and equipment was classified
as current in the unaudited consolidated balance sheet at September 19, 2003 and
September 20, 2002, respectively.
Net Income (Loss) per Share. The difference between basic and diluted net
income (loss) per share was a result of the dilutive effect of options, which
are considered potential common shares. A summary of the weighted average common
shares was as follows:
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
Basic weighted average common shares
outstanding............................. 19,684,402 19,771,203
Dilutive effect of options................ -- 202,574
------------ ------------
Diluted weighted average common shares
outstanding............................. 19,684,402 19,973,777
============ ============
Shares excluded from potential shares due
to their anti-dilutive effect........... 2,671,089 1,022,910
============ ============
Recently Issued Accounting Pronouncements. Financial Accounting Standards
Board Interpretation ("FIN") 46, Consolidation of Variable Interest Entities,
requires consolidation where there is a controlling financial interest in a
variable interest entity, previously referred to as a special-purpose entity.
The implementation of FIN 46 has been delayed and will be effective during the
third quarter of our fiscal year 2004. We do not anticipate an impact to our
financial position or results of operations.
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity, establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The statement requires that an
issuer classify a financial instrument that is within its scope as a liability,
or an asset in some circumstances. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective in our second quarter of our fiscal year 2004. This statement is not
expected to have a material impact to our financial position or results of
operations.
Use of Estimates. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts
9
of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates under different conditions or if our assumptions change.
Reclassifications. Certain prior period amounts have been reclassified to
conform to the current period's presentation.
3. Long-Term Debt
Long-term debt consisted of the following, with dollars in thousands:
September 19, May 30,
2003 2003
------------ ------------
Secured:
Mortgage loan payable in monthly installments
through July 2008, interest at adjusted LIBOR
plus 2.25%, of 3.36% to 3.37%........................... $ 299,456 $ --
Borrowings under revolving credit facility, interest at:
o September 19, 2003 - adjusted LIBOR plus
3.25% of 4.37%
o May 30, 2003 - adjusted LIBOR plus 1.25% of
2.57% and ABR of 4.25% 17,000 104,000
Term loan facility, interest at adjusted LIBOR
plus 2.50% of 3.82%..................................... -- 47,000
Industrial refunding revenue bonds at variable rates
of interest of 1.25% to 1.70% and 1.60% to 2.50%,
respectively, supported by letters of credit,
maturing calendar 2009.................................. 8,500 8,500
Industrial revenue bonds secured by real property with
maturities to calendar 2005 at interest rates of 2.80%
to 4.55% and 2.98% to 4.55%, respectively............... 3,733 3,739
Real and personal property mortgages payable in monthly
installments through calendar 2005, interest rates of
7.00%................................................... 31 34
Unsecured:
Senior subordinated notes due calendar 2009,
interest at 9.5%, payable semi-annually................ 238,000 290,000
Notes payable in monthly installments through
calendar 2008, interest rate at 8.00%.................. 1,679 1,807
------------ ------------
568,399 455,080
Less current portion of long-term debt................... 4,026 13,744
------------ ------------
$ 564,373 $ 441,336
Refinancing. In July 2003 we refinanced a portion of our debt. We obtained
a new $125.0 million revolving credit facility, and, as described below in
greater detail, one of our subsidiaries obtained a $300.0 million mortgage loan.
Proceeds from the mortgage loan were used to pay off the balance on the then
existing revolving credit facility, the term loan facility and the synthetic
lease facility. We also used a portion of the remaining proceeds to purchase
$37.0 million aggregate principal amount of our 9.5% senior subordinated notes.
In accordance with SFAS No. 6, "Classification of Short-Term Obligations
Expected to Be Refinanced, an Amendment of ARB No. 43, Chapter 3A," the $104.0
million balance on our previous revolving credit facility and our annual $0.5
million installment on our term loan were classified as long-
10
term debt at May 30, 2003, since they were refinanced on a long-term basis
during our first quarter.
Mortgage Loan. The $300.0 million mortgage loan is secured by first
mortgages or deeds of trust on 475 of our owned centers located in 33 states. We
refer to the mortgage loan as the CMBS Loan and the 475 mortgaged centers as the
CMBS Centers. In connection with the CMBS Loan, the CMBS Centers were
transferred to a newly formed wholly owned subsidiary of ours, which is the
borrower under the CMBS Loan and is referred to as the CMBS Borrower. Because
the CMBS Centers are owned by the CMBS Borrower and subject to the CMBS Loan,
recourse to the CMBS Centers by our creditors will be effectively subordinated
to recourse by holders of the CMBS Loan.
The CMBS Loan is nonrecourse to the CMBS Borrower and us, subject to
customary recourse provisions, and has a maturity date of July 9, 2008, which
may be extended to July 9, 2009, subject to certain conditions. The CMBS Loan
bears interest at a per annum rate equal to LIBOR plus 2.25% and requires
monthly payments of principal and interest. Principal payments are based on a
30-year amortization (based on an assumed rate of 6.50%). We have purchased an
interest rate cap agreement to protect us from significant changes in LIBOR
during the initial three years of the CMBS Loan. Under the cap agreement, which
terminates July 9, 2006, LIBOR is capped at 6.50%. We are required to purchase
additional interest rate cap agreements capping LIBOR at a rate no higher than
7.00% for the period from July 9, 2006 to the maturity date of the CMBS Loan.
Each of the centers included in the CMBS Centers is being ground leased by
the CMBS Borrower to another wholly owned subsidiary formed in connection with
the CMBS Loan, which is referred to as the CMBS Operator, and is being managed
by us pursuant to a management agreement with the CMBS Operator. Transactions
between the CMBS Borrower and the CMBS Operator are eliminated in consolidation
since both the CMBS Borrower and the CMBS Operator are wholly owned
subsidiaries.
Prepayment of the CMBS Loan is prohibited through July 8, 2005, after which
prepayment is permitted in whole, subject to a prepayment premium of 3.0% from
July 8, 2005 through July 8, 2006, 2.0% from July 9, 2006 through July 8, 2007
and 1.0% from July 9, 2007 through January 8, 2008, with no prepayment penalty
thereafter. In addition, after July 9, 2005, the loan may be partially prepaid
as follows:
o up to $15.0 million each loan year in connection with releases of
mortgaged centers with no prepayment premium, and
o up to $5.0 million each loan year subject to payment of the applicable
prepayment premium.
The CMBS Loan contains a provision that requires the loan servicer to
escrow 50% of excess cash flow generated from the CMBS Centers (determined after
payment of debt service on the CMBS Loan, certain fees and required reserve
amounts) if the net operating income, as defined in the CMBS Loan agreement, of
the CMBS Centers declines to $60.0 million, as adjusted to account for released
properties. The amount of excess cash flow to be escrowed increases to 100% if
the net operating income of the CMBS Centers declines to $50.0 million, as
adjusted. The net operating income of the CMBS Centers for the trailing 13
periods ended July 1, 2003 was approximately $83.0 million. The maximum amount
of excess cash flow that can be escrowed is limited to one year of debt service
on the CMBS Loan and one year of the rent due under the ground lease with the
CMBS Operator during the term of the CMBS Loan. The escrowed amounts are
released if the CMBS Centers generate the necessary minimum net operating income
for two consecutive quarters. The annual debt service on the CMBS Loan is
approximately $22.8 million (assuming a 6.50% interest rate). The annual rent
under the ground
11
lease is $34.0 million for the term of the CMBS Loan. These excess cash flow
provisions could limit the amount of cash made available to us.
Credit Facility. Our new $125.0 million credit facility is secured by first
mortgages or deeds of trusts on 119 of our owned centers and certain other
collateral and has a maturity date of July 9, 2008. The revolving credit
facility includes borrowing capacity of up to $75.0 million for letters of
credit and up to $10.0 million for selected short-term borrowings.
The credit facility bears interest, at our option, at either of the
following rates, which are adjusted in quarterly increments based on the
achievement of performance goals:
o an adjusted LIBOR rate plus, a rate ranging from 2.00% to 3.25%
dependent upon the ratio of total consolidated debt to total
consolidated EBITDA. At September 19, 2003 our rate was adjusted LIBOR
plus 3.25%, or an all-in rate of 4.37%.
o an alternative base rate plus, a rate ranging from 0.75% to 2.00%
dependent upon the ratio of total consolidated debt to total
consolidated EBITDA. At September 19, 2003 our rate was the
alternative base rate plus 2.00%, or an all-in rate of 6.00%.
----------
EBITDA is defined in the credit facility as net income before interest
expense, income taxes, depreciation, amortization, non-recurring charges,
non-cash charges, gains and losses on asset sales, restructuring charges or
reserves and non-cash gains.
The credit facility contains customary covenants and provisions that
restrict our ability to:
o make certain fundamental changes to our business,
o consummate asset sales,
o declare dividends,
o grant liens,
o incur additional indebtedness, amend the terms of or repay certain
indebtedness, and
o make capital expenditures.
In addition, the credit facility requires us to meet or exceed certain
leverage and interest and lease expense coverage ratios.
Under the new revolving credit facility we are required to pay a commitment
fee at a rate ranging from 0.40% to 0.50% on the available commitment. The fee
is payable quarterly in arrears. In addition, we are required to pay a letter of
credit fee at a rate ranging from 2.00% to 3.25% minus 0.125% plus, a fronting
fee of 0.125%. These fees are also payable quarterly in arrears. At September
19, 2003 our commitment and letter of credit fees were 0.50% and 3.25%,
respectively.
4. Commitments and Contingencies
We are presently, and are from time to time, subject to claims and
litigation arising in the ordinary course of business. We believe that none of
the claims or litigation of which we are aware will materially affect our
financial position, operating results or cash flows, although assurance cannot
be given with respect to the ultimate outcome of any such actions.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Introduction
The following discussion should be read in conjunction with the unaudited
consolidated financial statements and the related notes included elsewhere in
this report. Our fiscal year ends on the Friday closest to May 31. The
information presented refers to the sixteen weeks ended September 19, 2003 as
"the first quarter of fiscal 2004" and the sixteen weeks ended September 20,
2002 as "the first quarter of fiscal 2003." Our first fiscal quarter includes 16
weeks and the remaining quarters each include twelve weeks.
We calculate the average weekly tuition rate as net revenues, exclusive of
fees and non-tuition income, divided by FTE attendance for the related time
period. The average weekly tuition rate represents the approximate weighted
average weekly tuition rate at all of the centers paid by parents for children
to attend the centers five full days during a week. However, the occupancy mix
between full- and part-time children at each center can significantly affect
these averages with respect to any specific center. FTE attendance is not a
strict head count. Rather, the methodology determines an approximate number of
full-time children based on weighted averages. For example, an enrolled
full-time child equates to one FTE, while a part-time child enrolled for five
half-days equates to 0.5 FTE. The FTE measurement of center capacity utilization
does not necessarily reflect the actual number of full- and part-time children
enrolled. Occupancy is a measure of the utilization of center capacity. We
calculate occupancy as the full-time equivalent, or FTE, attendance at all of
the centers divided by the sum of the centers' licensed capacity.
A center is included in comparable center net revenues when it has been
open and operated by us at least one year and it has not been rebuilt or
permanently relocated within that year. Therefore, a center is considered
comparable during the first four-week period it has prior year net revenues.
Non-comparable centers include those that have been closed during the past year.
13
First Quarter of Fiscal 2004 compared to First Quarter of Fiscal 2003
The following table shows the comparative operating results of KinderCare,
with dollars in thousands, except the average weekly tuition rate:
Sixteen Sixteen Change
Weeks Ended Percent Weeks Ended Percent Amount
September 19, of September 20, of Increase/
2003 Revenues 2002 Revenues (Decrease)
------------ ---------- ------------ ------------ ----------
Revenues, net............................. $ 260,849 100.0% $ 253,607 100.0% $ 7,242
------------ ---------- ------------ ------------ ----------
Operating expenses:
Salaries, wages and benefits:
Center expense........................ 136,461 52.3 134,719 53.1 1,742
Region and corporate expense.......... 10,553 4.1 9,973 4.0 580
------------ ---------- ------------ ------------ ----------
Total salaries, wages and benefits.. 147,014 56.4 144,692 57.1 2,322
Depreciation and amortization........... 18,623 7.1 17,101 6.7 1,522
Rent.................................... 16,998 6.5 15,043 5.9 1,955
Other................................... 65,983 25.3 62,783 24.8 3,200
------------ ---------- ------------ ------------ ----------
Total operating expenses.............. 248,618 95.3 239,619 94.5 8,999
------------ ---------- ------------ ------------ ----------
Operating income.................... $ 12,231 4.7% $ 13,988 5.5% $ (1,757)
============ ========== ============ ============ ==========
Average weekly tuition rate............... $ 150.88 $ 143.06 $ 7.82
Occupancy................................. 59.5% 62.4% (2.9)
Revenues, net. Net revenues increased $7.2 million, or 2.9%, from the same
period last year to $260.8 million in the first quarter of fiscal 2004. The
increase was due to higher average weekly tuition rates as well as additional
net revenues generated by the newly opened centers. Comparable center net
revenues increased $0.8 million, or 0.3%. During the first quarter of fiscal
2004 and 2003, we opened and closed centers as follows:
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
Number of centers at the beginning of the period.. 1,264 1,264
Openings.......................................... 8 12
Closures.......................................... (12) (12)
------------ ------------
Number of centers at the end of the period........ 1,260 1,264
============ ============
Total center licensed capacity at the end
of the period................................... 167,000 166,000
The average weekly tuition rate increased $7.82, or 5.5%, to $150.88 in the
first quarter of fiscal 2004 due primarily to tuition increases. Occupancy
declined to 59.5% from 62.4% for the same period last year due primarily to
reduced full-time equivalent attendance within the older center population. Our
fall enrollment period, which typically extends into our second quarter, has not
met our expectations largely due to a larger than expected decline in our
customer base that receives government subsidies. Enrollments from our
non-subsidized customer base have also declined, to a degree that was expected,
based on our most recent quarterly trends. The negative impact from the lower
than expected government subsidy fall enrollments has been offset, in part, by
an overall average weekly tuition rate that exceeded our expectations, due to
the reduction in discounts associated with government subsidized enrollments.
14
Salaries, wages and benefits. Expenses for salaries, wages and benefits
increased $2.3 million, or 1.6%, from the same period last year to $147.0
million. Total salaries, wages and benefits expense as a percentage of net
revenues was 56.4% for the first quarter of fiscal 2004 compared to 57.1% for
the first quarter of fiscal 2003.
Expenses for salaries, wages and benefits directly associated with the
centers was $136.5 million, an increase of $1.7 million from the same period
last year. The increase was primarily due to costs from newly opened centers,
overall higher wage rates and higher medical insurance costs, offset by control
over labor hours. See "Wage Increases." At the center level, salaries, wages and
benefits expense as a percentage of net revenues declined to 52.3% from 53.1%
for the same period last year due primarily to improved labor productivity.
Depreciation and amortization. Depreciation and amortization expense
increased $1.5 million from the same period last year to $18.6 million.
Depreciation increased $1.0 million due to newly opened centers and $0.9 million
as a result of purchasing the centers previously held under the synthetic lease
facility. Impairment charges of $0.6 million were recognized in the first
quarter of fiscal 2004, an increase of $0.5 million over the same period last
year. These charges related to under-performing centers and certain undeveloped
properties. In connection with our sale-leaseback program, whereby centers are
classified as operating leases when they are sold and leased back, depreciation
expense decreased $0.8 million.
Rent. Rent expense increased $2.0 million from the same period last year to
$17.0 million primarily due to our sale-leaseback program. See "Liquidity and
Capital Resources." In addition, the rental rates experienced on new and renewed
center leases are higher than those experienced in previous fiscal periods. The
rent expense associated with the centers in the synthetic lease facility was
eliminated effective July 1, 2003 in connection with our debt refinancing, which
was $0.4 million and $1.3 million during the first quarter of fiscal 2004 and
2003, respectively.
Other operating expenses. Other operating expenses increased $3.2 million,
or 5.1%, from the same period last year to $66.0 million. The increase was due
primarily to $2.0 million of increased insurance costs and additional center
level costs for newly opened centers. Other operating expenses as a percentage
of net revenues increased to 25.3% from 24.8% for the same period last year
primarily as a result of higher insurance costs.
Other operating expenses include costs directly associated with the
centers, such as food, insurance, transportation, janitorial, maintenance,
utilities and marketing costs, and expenses related to field management and
corporate administration.
Operating income. Operating income was $12.2 million, a decrease of $1.8
million, or 12.6%, from the same period last year. Operating income decreased
due to higher insurance costs and increased rent expense from sale-leasebacks,
offset by higher tuition rates. Operating income as a percentage of net revenues
was 4.7% compared to 5.5% for the same period last year.
Interest expense. Interest expense was $13.0 million compared to $12.8
million for the same period last year. Our weighted average interest rate on our
long-term debt, including amortization of deferred financing costs, but
excluding the write-off discussed below, was 6.5% and 7.4% for the first quarter
of fiscal 2004 and fiscal 2003, respectively.
Loss on early extinguishment of debt. As a result of out debt refinancing
in July 2003, we recognized a loss on early extinguishment of debt of $3.7
million in the first quarter of fiscal 2004. These costs included the write-off
of deferred financing costs of $2.9 million associated with the debt that was
repaid and the incurrence of premium costs of $0.8 million in connection
15
with the acquisition of a portion of our 9.5% senior subordinated notes. In the
first quarter of fiscal 2004, we purchased $41.0 million aggregate principal
amount of our 9.5% senior subordinated notes, primarily using a portion of the
proceeds from our debt refinancing, see "Liquidity and Capital Resources."
Income tax benefit (expense). The income tax benefit was $1.7 million, or
39.6% of pretax income, in the first quarter of fiscal 2004. In the first
quarter of fiscal 2003, income tax expense was $0.5 million, or 39.6% of pretax
income. The income tax benefit (expense) was computed by applying estimated
effective income tax rates to the income or loss before income taxes. Income tax
benefit (expense) varies from the statutory federal income tax rate, due
primarily to state income taxes and non-tax deductible expenses, offset by tax
credits.
Discontinued operations. Losses on discontinued operations were $0.4
million and $0.3 million in the first quarters of fiscal 2004 and 2003,
respectively, which represents the operating results, net of tax, for all
periods presented of the 12 centers closed during the first quarter of fiscal
2004 and the 28 centers closed in fiscal 2003. Discontinued operations included
the following, with dollars in the thousands:
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
Revenues, net..................................... $ 454 $ 3,854
------------ ------------
Operating expenses:
Salaries, wages and benefits.................... 390 2,535
Depreciation.................................... 271 204
Rent............................................ 82 503
Provision for doubtful accounts................. 18 61
Other........................................... 350 1,051
------------ ------------
Total operating expenses...................... 1,111 4,354
Operating loss.................................. (657) (500)
Income tax benefit................................ 260 198
------------ ------------
Discontinued operations, net of tax............. $ (397) $ (302)
============ ============
Net income (loss). We recorded a net loss of $3.0 million in the first
quarter of fiscal 2004, compared to net income of $0.5 million in the same
period last year. The most significant reason for the decrease was $3.7 million
($2.2 million after tax) of charges for the loss on the early extinguishment of
debt, as discussed above. Rising insurance costs and increased rent expense also
contributed to the decrease in net income in the first quarter of fiscal 2004.
Basic and diluted net loss per share were both $0.15 for the first quarter of
fiscal 2004. For the first quarter of fiscal 2003, basic and diluted net income
per share were both $0.02.
Liquidity and Capital Resources
In July 2003 we refinanced a portion of our debt. We obtained a new $125.0
million revolving credit facility, and, as described below in greater detail,
one of our subsidiaries obtained a $300.0 million mortgage loan. Proceeds from
the mortgage loan were used to pay off the $98.0 million balance of the then
existing revolving credit facility, $47.0 million of term loan facility and
$97.9 million under the synthetic lease facility. We also used a portion of the
remaining proceeds to purchase $37.0 million aggregate principal amount of our
9.5% senior subordinated notes.
The $300.0 million mortgage loan is secured by first mortgages or deeds of
trust on 475 of our owned centers located in 33 states. We refer to the mortgage
loan as the CMBS Loan and
16
the 475 mortgaged centers as the CMBS Centers. In connection with the CMBS Loan,
the CMBS Centers were transferred to a newly formed wholly owned subsidiary of
ours, which is the borrower under the CMBS Loan and is referred to as the CMBS
Borrower. Because the CMBS Centers are owned by the CMBS Borrower and subject to
the CMBS Loan, recourse to the CMBS Centers by our creditors will be effectively
subordinated to recourse by holders of the CMBS Loan.
The CMBS Loan is nonrecourse to the CMBS Borrower and us, subject to
customary recourse provisions, and has a maturity date of July 9, 2008, which
may be extended to July 9, 2009, subject to certain conditions. The CMBS Loan
bears interest at a per annum rate equal to LIBOR plus 2.25% and requires
monthly payments of principal and interest. Principal payments are based on a
30-year amortization (based on an assumed rate of 6.50%). We have purchased an
interest rate cap agreement to protect us from significant changes in LIBOR
during the initial three years of the CMBS Loan. Under the cap agreement, which
terminates July 9, 2006, LIBOR is capped at 6.50%. We are required to purchase
additional interest rate cap agreements capping LIBOR at a rate no higher than
7.00% for the period from July 9, 2006 to the maturity date of the CMBS Loan.
Each of the centers included in the CMBS Centers is being ground leased by
the CMBS Borrower to another wholly owned subsidiary formed in connection with
the CMBS Loan, which is referred to as the CMBS Operator, and is being managed
by us pursuant to a management agreement with the CMBS Operator. Transactions
between the CMBS Borrower and the CMBS Operator are eliminated in consolidation
since both the CMBS Borrower and the CMBS Operator are wholly owned
subsidiaries.
Prepayment of the CMBS Loan is prohibited through July 8, 2005, after which
prepayment is permitted in whole, subject to a prepayment premium of 3.0% from
July 8, 2005 through July 8, 2006, 2.0% from July 9, 2006 through July 8, 2007
and 1.0% from July 9, 2007 through January 8, 2008, with no prepayment penalty
thereafter. In addition, after July 9, 2005, the loan may be partially prepaid
as follows:
o up to $15.0 million each loan year in connection with releases of
mortgaged centers with no prepayment premium, and
o up to $5.0 million each loan year subject to payment of the applicable
prepayment premium.
The CMBS Loan contains a provision that requires the loan servicer to
escrow 50% of excess cash flow generated from the CMBS Centers (determined after
payment of debt service on the CMBS Loan, certain fees and required reserve
amounts) if the net operating income, as defined in the CMBS Loan Agreement of
the CMBS Centers declines to $60.0 million, as adjusted to account for released
properties. The amount of excess cash flow to be escrowed increases to 100% if
the net operating income of the CMBS Centers declines to $50.0 million, as
adjusted. The net operating income of the CMBS Centers for the trailing 13
periods ended July 1, 2003 was approximately $83.0 million. The maximum amount
of excess cash flow that can be escrowed is limited to one year of debt service
on the CMBS Loan and one year of rent due under the ground lease with the CMBS
Operator during the term of the CMBS Loan. The escrowed amounts are released if
the CMBS centers generate the necessary minimum net operating income for two
consecutive quarters. The annual debt service on the CMBS Loan is approximately
$22.8 million (assuming a 6.50% interest rate). The annual rent due under the
ground lease is $34.0 million during the term of the CMBS Loan. These excess
cash flow provisions could limit the amount of cash made available to us.
Our new $125.0 million credit facility is secured by first mortgages or
deeds of trusts on 119 of our owned centers and certain other collateral and has
a maturity date of July 9, 2008. The
17
revolving credit facility includes borrowing capacity of up to $75.0 million for
letters of credit and up to $10.0 million for selected short-term borrowings.
During the first quarter of fiscal 2004, we acquired $41.0 million
aggregate principal amount of our 9.5% senior subordinated notes at an aggregate
price of $41.8 million, which included a loss of $0.8 million. In addition,
these transactions resulted in the write-off of deferred financing costs of $0.8
million. These $1.6 million of costs were included in interest expense in the
first quarter of fiscal 2004. We also acquired $11.0 million aggregate principal
amount of our 9.5% senior subordinate notes at an aggregate price of $11.1
million in the first quarter of fiscal 2004. This acquisition was committed to
at the end of fiscal 2003, at which time the related write-off of deferred
financing costs and premium costs were recognized.
Our principal sources of liquidity are cash flow generated from operations,
proceeds received from our sale-leaseback program and borrowings under our
revolving credit facility. At September 19, 2003, we had drawn $17.0 million
under our new revolving credit facility and had outstanding letters of credit
totaling $65.0 million. Our availability under our new credit facility was $43.0
million. Our principal uses of liquidity are new center development and debt
service.
Our consolidated net cash provided by operating activities for the first
quarter of fiscal 2004 was $3.9 million compared to $6.0 million in the same
period last year. The decrease in net cash flow was due to a change in working
capital. Cash and cash equivalents totaled $18.9 million at September 19, 2003,
compared to $18.1 million at May 30, 2003.
EBITDA, which is a non-GAAP financial measure, is defined as earnings
before interest, taxes, depreciation, amortization and the related components of
discontinued operations. EBITDA reflects a non-GAAP financial measure of our
liquidity. A non-GAAP financial measure is a numerical measure of historical or
future financial performance, financial position or cash flow that excludes or
includes amounts, or is subject to adjustments that have the effect of excluding
or including amounts, from the most directly comparable measure calculated and
presented in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). We believe EBITDA is a useful tool for
certain investors and creditors for measuring our ability to meet debt service
requirements. Additionally, management uses EBITDA for purposes of reviewing our
results of operations on a more comparable basis. We have provided EBITDA in
previous filings and continue to provide this measure for comparability between
periods. EBITDA was restated from amounts reported in previous filings to
include the impact of discontinued operations. EBITDA does not represent cash
flow from operations as defined by GAAP, is not necessarily indicative of cash
available to fund all cash flow needs and should not be considered an
alternative to net income under GAAP for purposes of evaluating our results of
operations.
EBITDA was calculated as follows, with dollars in thousands:
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
Net income (loss)..................... $ (3,013) $ 457
Interest expense, net................. 16,560 12,731
Income tax expense (benefit).......... (1,713) 498
Depreciation and amortization......... 18,623 17,101
Discontinued operations:
Interest expense.................... -- 1
Income tax benefit.................. (260) (198)
Depreciation........................ 271 204
------------ ------------
EBITDA............................ $ 30,468 $ 30,794
============ ============
EBITDA - percentage of net revenues... 11.7% 12.1%
18
A reconciliation of EBITDA to cash provided by operating activities was as
follows, with dollars in thousands:
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
Net cash provided by operating activities... $ 3,948 $ 5,956
Income tax (benefit) expense................ (1,713) 498
Deferred income taxes....................... (1,848) (3,273)
Interest expense, net....................... 16,560 12,731
Effect of discontinued operations on
interest and taxes........................ (260) (198)
Change in operating assets and liabilities.. 13,599 15,644
Other non-cash items........................ 182 (564)
------------ ------------
EBITDA.................................... $ 30,468 $ 30,794
============ ============
During the first quarter of fiscal 2004, EBITDA decreased $0.3 million, or
1.1%, from the same period last year. Despite higher tuition rates and
controlled labor productivity, we have experienced higher insurance costs and
increased rent expense due primarily to our sale-leaseback program that has
resulted in the decline in EBITDA. EBITDA is not intended to indicate that cash
flow is sufficient to fund all of our cash needs or represent cash flow from
operations as defined by accounting principles generally accepted in the United
States of America. In addition, EBITDA should not be used as a tool for
comparison as the computation may not be the same for all companies.
In fiscal year 2000, we entered into a $100.0 million synthetic lease
facility under which a syndicate of lenders financed the construction of new
centers for lease to us for a three to five year period. A total of 44 centers
were constructed at a cost of $97.9 million. The synthetic lease facility was
terminated in July 2003 as part of our refinancing. The 44 centers are now owned
by us and the assets are reflected in our fiscal year 2004 consolidated
financial statements.
During the fourth quarter of fiscal year 2002, we began selling centers to
individual real estate investors and then leasing them back. The resulting
leases have been classified as operating leases. We will continue to manage the
operations of any centers that are sold in such transactions. The sales were
summarized as follows, with dollars in thousands:
Sixteen Weeks
Ended Fiscal Year Ended
------------- ---------------------
September 19, May 30, May 31,
2003 2003 2002
------------- --------- ---------
Number of centers................... 11 41 5
Net proceeds from completed sales... $ 17,993 $ 88,703 $ 9,180
Deferred gains...................... 6,869 32,507 2,600
The deferred gains are amortized on a straight-line basis, typically over a
period of 15 years. Subsequent to September 19, 2003, we closed $6.8 million in
sales, which included four centers, and are currently in the process of
negotiating another $49.4 million of sales related to 19 centers. It is possible
that we will be unable to complete these transactions in process. We expect our
sale-leaseback efforts to continue throughout fiscal year 2004, assuming the
market for such transactions remains favorable.
19
We expect to fund future new center development through the new $125.0
million revolving credit facility and sale-leaseback proceeds, although
alternative forms of funding continue to be evaluated and new arrangements may
be entered into in the future.
We believe that cash flow generated from operations, proceeds from our
sale-leaseback program and borrowings under the new revolving credit facility
will adequately provide for our working capital and debt service needs and will
be sufficient to fund our expected capital expenditures for the foreseeable
future. Any future acquisitions, joint ventures or similar transactions may
require additional capital, and such capital may not be available to us on
acceptable terms or at all. Although no assurance can be given that such sources
of capital will be sufficient, the capital expenditure program has substantial
flexibility and is subject to revision based on various factors, including but
not limited to, business conditions, cash flow requirements, debt covenants,
competitive factors and seasonality of openings. If we experience a lack of
working capital, it may reduce our future capital expenditures. If these
expenditures were substantially reduced, in management's opinion, our operations
and cash flow would be adversely impacted.
We may experience decreased liquidity during the summer months and the
calendar year-end holidays due to decreased attendance during these periods. New
enrollments are generally highest during the traditional fall "back to school"
period and after the calendar year-end holidays. Enrollment generally decreases
5% to 10% during the summer months and calendar year-end holidays.
We have certain contractual obligations and commercial commitments.
Contractual obligations are those that will require cash payments in accordance
with the terms of a contract, such as a loan agreement or lease agreement.
Commercial commitments represent potential obligations for performance in the
event of demands by third parties or other contingent events, such as lines of
credit.
Our contractual obligations and commercial commitments at September 19,
2003 were as follows, with dollars in thousands:
Remainder
of Fiscal Year
Fiscal --------------------------------------------------------------
Total 2004 2005 2006 2007 2008 Thereafter
---------- ---------- ---------- ---------- ---------- ---------- ----------
Long-term debt................. $ 551,399 $ 2,877 $ 7,570 $ 4,136 $ 4,314 $ 4,447 $ 528,055
Capital lease obligations...... 29,133 1,736 2,240 2,291 2,400 2,400 18,066
Operating leases............... 382,567 29,314 39,771 35,765 32,770 29,109 215,838
Line of credit................. 17,000 -- -- -- -- -- 17,000
Standby letters of credit...... 64,538 51,390 -- -- -- -- 13,148
Other commitments............... 8,429 8,429 -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ---------- ----------
$1,053,066 $ 93,746 $ 49,581 $ 42,192 $ 39,484 $ 35,956 $ 792,107
========== ========== ========== ========== ========== ========== ==========
Other commitments include center development commitments, obligations to
purchase vehicles and other purchase order commitments.
Capital Expenditures
During the first quarter of fiscal 2004 and 2003, we opened eight and
twelve new centers, respectively. We expect to open approximately 25 new centers
in fiscal 2004 and to continue our practice of closing centers that are
identified as not meeting performance expectations. In addition, we may acquire
existing centers from local or regional early childhood education and care
providers. We may not be able to successfully negotiate and acquire sites and/or
previously constructed centers, meet our targets for new center additions or
meet targeted deadlines for development of new centers.
20
New centers are located based upon detailed site analyses that include
feasibility and demographic studies and financial modeling. The length of time
from site selection to construction and, finally, the opening of a community
center ranges from 16 to 24 months. Frequently, new site negotiations are
delayed or canceled or construction is delayed for a variety of reasons, many of
which are outside our control. The average total cost per community center
typically ranges from $1.9 million to $2.8 million depending on the size and
location of the center. However, the actual costs of a particular center may
vary from such range.
Our new centers typically have a licensed capacity ranging from 145 to 180,
while the centers constructed during fiscal 1997 and earlier have an average
licensed capacity of 125. When mature, these larger centers are designed to
generate higher revenues, operating income and margins than our older centers.
These new centers also have higher average costs of construction and typically
take three to four years to reach maturity. On average, our new centers should
begin to produce positive EBITDA during the first year of operation and begin to
produce positive net income by the end of the second year of operation.
Accordingly, as more new centers are developed and opened, profitability will be
negatively impacted in the short-term but is expected to be enhanced in the
long-term once these new centers achieve anticipated levels of occupancy.
Capital expenditures included the following, with dollars in thousands:
Sixteen Weeks Ended
-----------------------------
September 19, September 20,
2003 2002
------------ ------------
New center development.................. $ 9,035 $ 25,304
Renovation of existing facilities....... 3,898 5,387
Equipment purchases..................... 2,913 3,378
Information systems purchases........... 632 670
------------ ------------
$ 16,478 $ 34,739
============ ============
Capital expenditures do not include $97.9 million spent to purchase the 44
centers previously included in the synthetic lease facility.
Capital expenditure limits under our credit facility for fiscal year 2004
are $110.0 million. We have some ability to incur additional indebtedness,
including through mortgages or sale-leaseback transactions, subject to the
limitations imposed by the indenture under which our senior subordinated notes
were issued and the new credit facility.
Application of Critical Accounting Policies
Critical Accounting Estimates. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America requires that management make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes. Predicting
future events is inherently an imprecise activity and as such requires the use
of judgment. Actual results may vary from estimates in amounts that may be
material to the financial statements.
For a description of our significant accounting policies, see "Note 2.
Summary of Significant Accounting Policies" to the unaudited consolidated
financial statements. For a more complete description, please refer to our
Annual Report on Form 10-K for the fiscal year ended May 30, 2003. The following
accounting estimates and related policies are considered critical to the
preparation of our financial statements due to the business judgment and
estimation processes
21
involved in their application. Management has reviewed the development and
selection of these estimates and their related disclosure with the Audit
Committee of the Board of Directors.
Revenue recognition. Tuition revenues, net of discounts, and other revenues
are recognized as services are performed. Payments may be received in advance of
services being rendered, in which case the revenue is deferred and recognized
during the appropriate time period, typically a week. Our non-refundable
registration and education fees are amortized over the average enrollment
period, not to exceed one year. The recognition of our net revenues meets the
criteria of the Securities and Exchange Commission Staff Accounting Bulletin No.
101, Revenue Recognition in Financial Statements, including the existence of an
arrangement, the rendering of services, a determinable fee and probable
collection.
Accounts receivable. Our accounts receivable are comprised primarily of
tuition due from governmental agencies, parents and employers. Accounts
receivable are presented at estimated net realizable value. We use estimates in
determining the collectibility of our accounts receivable and must rely on our
evaluation of historical experience, governmental funding levels, specific
customer issues and current economic trends to arrive at appropriate reserves.
Material differences may result in the amount and timing of bad debt expense if
actual experience differs significantly from management estimates.
Long-lived and intangible assets. We assess the potential impairment of
property and equipment and finite-lived intangibles whenever events or changes
in circumstances indicate that the carrying value may not be recoverable, in
accordance with SFAS No. 144 Accounting for the Impairment or Disposal of
Long-Lived Assets. An asset's value is impaired if our estimate of the aggregate
future cash flows, undiscounted and without interest charges, to be generated by
the asset is less than the carrying value of the asset. Such cash flows consider
factors such as expected future operating income and historical trends, as well
as the effects of demand and competition. To the extent impairment has occurred,
the loss will be measured as the excess of the carrying amount of the asset over
its fair value. Such estimates require the use of judgment and numerous
subjective assumptions, which, if actual experience varies, could result in
material differences in the requirements for impairment charges. Impairment
charges were $0.6 million and $0.1 million in the first quarter of fiscal 2004
and 2003, respectively, and were included as a component of depreciation
expense.
Investments. Investments, wherein we do not exert significant influence or
own over 20% of the investee's stock, are accounted for under the cost method.
We measure the fair values of these investments annually using multiples of
comparable companies and discounted cash flow analysis.
Self-insurance obligations. We self-insure a portion of our general
liability, workers' compensation, auto, property and employee medical insurance
programs. We purchase stop loss coverage at varying levels in order to mitigate
our potential future losses. The nature of these liabilities, which may not
fully manifest themselves for several years, requires significant judgment. We
estimate the obligations for liabilities incurred but not yet reported or paid
based on available claims data and historical trends and experience, as well as
future projections of ultimate losses, expenses, premiums and administrative
costs. The accrued obligations for these self-insurance programs were $49.8
million and $45.1 million at September 19, 2003 and May 30, 2003, respectively.
Our internal estimates are reviewed quarterly by a third party actuary. While we
believe that the amounts accrued for these obligations are sufficient, any
significant increase in the number of claims and costs associated with claims
made under these programs could have a material adverse effect on our financial
position, cash flows or results of operations.
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Income taxes. Accounting for income taxes requires us to estimate our
future tax liabilities. Due to timing differences in the recognition of items
included in income for accounting and tax purposes, deferred tax assets or
liabilities are recorded to reflect the impact arising from these differences on
future tax payments. With respect to recorded tax assets, we assess the
likelihood that the asset will be realized. If realization is in doubt because
of uncertainty regarding future profitability or enacted tax rates, we provide a
valuation allowance related to the asset. Should any significant changes in the
tax law or our estimate of the necessary valuation allowance occur, we would be
required to record the impact of the change. This could have a material effect
on our financial position or results of operations.
Initial Adoption of Accounting Policies. SFAS No. 149, Amendments of
Statement 133 on Derivative Instruments and Hedging Activities, amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No.
149 was adopted for contracts entered into or modified and for hedging
relationships designated after June 30, 2003. SFAS No. 149 was adopted in our
first quarter of our fiscal year 2004. This adoption did not have a material
impact on our financial position or results of operations.
Recently Issued Accounting Pronouncements
FIN 46, Consolidation of Variable Interest Entities, requires consolidation
where there is a controlling financial interest in a variable interest entity,
previously referred to as a special-purpose entity. The implementation of FIN 46
has been delayed and will be effective during the third quarter of our fiscal
year 2004. We do not anticipate an impact to our financial position or results
of operations.
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity, establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The statement requires that an
issuer classify a financial instrument that is within its scope as a liability,
or an asset in some circumstances. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective in the second quarter of our fiscal year 2004. This statement is not
expected to have a material impact to our financial position or results of
operations.
Wage Increases
Expenses for salaries, wages and benefits represented approximately 56.4%
of net revenues for the first quarter of fiscal 2004. We believe that, through
increases in our tuition rates, we can recover any future increase in expenses
caused by adjustments to the federal or state minimum wage rates or other market
adjustments. However, we may not be able to increase our rates sufficiently to
offset such increased costs. We continually evaluate our wage structure and may
implement changes at targeted local levels.
Forward-Looking Statements
We have made statements in this report that constitute forward-looking
statements as that term is defined in the federal securities laws. These
forward-looking statements concern our operations, economic performance and
financial condition and include statements regarding: opportunities for growth;
the number of early childhood education and care centers expected to be added in
future years; the profitability of newly opened centers; capital expenditure
levels; the ability to refinance or incur additional indebtedness; strategic
acquisitions, investments, alliances and other transactions; changes in
operating systems and policies and their intended results; our
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expectations and goals for increasing center revenue and improving our
operational efficiencies; changes in the regulatory environment; the potential
benefit of tax incentives for child care programs; our projected cash flow; and
our marketing efforts to sell and lease back centers. The forward-looking
statements are subject to various known and unknown risks, uncertainties and
other factors. When we use words such as "believes," "expects," "anticipates,"
"plans," "estimates" or similar expressions we are making forward-looking
statements.
Although we believe that our forward-looking statements are based on
reasonable assumptions, our expected results may not be achieved. Actual results
may differ materially from our expectations. Important factors that could cause
actual results to differ from expectations include, among others:
o the effects of general economic conditions;
o competitive conditions in the child care and early education
industries;
o various factors affecting occupancy levels, including, but not limited
to, the reduction in or changes to the general labor force that would
reduce the need for child care services;
o the availability of a qualified labor pool, the impact of labor
organization efforts and the impact of government regulations
concerning labor and employment issues;
o federal and state regulations regarding changes in child care
assistance programs, welfare reform, transportation safety, minimum
wage increases and licensing standards;
o the loss of government funding for child care assistance programs;
o our inability to successfully execute our growth strategy;
o the availability of financing or additional capital;
o our difficulty in meeting or inability to meet our obligations to
repay our indebtedness;
o the availability of sites and/or licensing or zoning requirements that
may make us unable to open new centers;
o our ability to integrate acquisitions;
o our inability to successfully defend against or counter negative
publicity associated with claims involving alleged incidents at our
centers;
o our inability to obtain insurance at the same levels, or at costs
comparable to those incurred historically;
o the effects of potential environmental contamination existing on any
real property owned or leased by us; and
o other risk factors that are discussed in this report and, from time to
time, in our other Securities and Exchange Commission reports and
filings.
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We caution you that these risks may not be exhaustive. We operate in a
continually changing business environment and new risks emerge from time to
time.
You should not rely upon forward-looking statements except as statements of
our present intentions and of our present expectations that may or may not
occur. You should read these cautionary statements as being applicable to all
forward-looking statements wherever they appear. We assume no obligation to
update or revise the forward-looking statements or to update the reasons why
actual results could differ from those projected in the forward-looking
statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our consolidated
financial position, results of operations or cash flows. We are exposed to
market risk in the areas of interest rates and foreign currency exchange rates.
Interest Rates
Our exposure to market risk for changes in interest rates relates primarily
to debt obligations. We have no cash flow exposure due to rate changes on our
9.5% senior subordinated notes aggregating $238.0 million at September 19, 2003.
We also have no cash flow exposure on certain industrial revenue bonds,
mortgages and notes payable aggregating $5.4 million at September 19, 2003.
However, we have cash flow exposure on our new revolving credit facility entered
into on July 1, 2003 and certain industrial revenue bonds subject to variable
LIBOR or adjusted base rate pricing. We had $17.0 million outstanding on our
revolving credit facility at September 19, 2003. Accordingly, a 1% (100 basis
points) change in the LIBOR rate would have resulted in interest expense
changing by less than $0.1 million in the first quarter of fiscal 2004. The new
credit facility currently bears interest at a rate equal to LIBOR plus 3.25%,
which may be reduced based on the achievement of certain performance measures. A
1% (100 basis points) change in the variable LIBOR or adjusted base rate pricing
on our industrial revenue bonds, aggregating $8.5 million at September 19, 2003,
would have resulted in interest expense changing by $0.1 million in the first
quarters of fiscal 2004 and 2003.
We have cash flow exposure on the CMBS Loan entered into in July 2003,
which bears interest at a rate equal to LIBOR plus 2.25%. A 1% (100 basis
points) change in the LIBOR rate would have resulted in interest expense
changing by approximately $0.7 million in the first quarter of fiscal 2004. We
have purchased an interest rate cap agreement to protect us from significant
movements in LIBOR during the initial three years of the CMBS Loan. The LIBOR
strike price is 6.50% under the interest rate cap agreement, which terminates
July 9, 2006, at which time we are required to purchase an additional interest
rate cap agreement.
In addition, we have cash flow exposure on our vehicle leases with variable
interest rates. A 1% (100 basis points) change in the interest rate defined in
our vehicle lease agreement would have resulted in rent expense changing by
approximately $0.2 million in both of the first quarters of fiscal 2004 and
2003.
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Foreign Exchange Risk
We are exposed to foreign exchange risk to the extent of fluctuations in
the United Kingdom pound sterling. Based upon the relative size of our
operations in the United Kingdom, we do not believe that the reasonably possible
near-term change in the related exchange rate would have a material effect on
our financial position, results of operations and cash flows.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. Our management has evaluated, under the
supervision and with the participation of our Chief Executive Officer ("CEO")
and Chief Financial Officer ("CFO"), the effectiveness of our disclosure
controls and procedures at the end of the period covered by this report,
pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934 (the
"Exchange Act"). Based on that evaluation, our CEO and CFO have concluded that,
at the end of the period covered by this report, our disclosure controls and
procedures are effective in ensuring that information required to be disclosed
in our Exchange Act reports is:
o recorded, processed, summarized and reported in a timely manner, and
o accumulated and communicated to our management, including our CEO and
CFO, as appropriate to allow timely decisions regarding required
disclosure.
Internal Control Over Financial Reporting. There has been no change in our
internal controls over financial reporting that occurred during our first
quarter ended September 19, 2003 that has materially affected, or is reasonably
likely to materially affect, our internal controls over financial reporting.
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PART II.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The following exhibits are filed with this report or incorporated
herein by reference:
3(a) Amended and Restated Certificate of Incorporation of KinderCare
(incorporated by reference from Exhibit 3(a) to our Annual Report on
Form 10-K for the fiscal year ended May 31, 2002).
3(b) Restated Bylaws of KinderCare effective September 1, 2001
(incorporated by reference from Exhibit 3(a) to our Quarterly Report
on Form 10-Q for the quarterly period ended September 21, 2001).
4(a) Indenture dated February 13, 1997 between KinderCare and Marine
Midland Bank, as Trustee (incorporated by reference from Exhibit 4.1
of our Registration Statement on Form S-4, filed March 11, 1997,
File No. 333-23127).
4(b) First Supplemental Indenture dated September 1, 1999 to the
Indenture dated as of February 13, 1997 between KinderCare and HSBC
Bank USA (formerly known as Marine Midland Bank), as Trustee
(incorporated by reference from Exhibit 4(a) to our Quarterly Report
on Form 10-Q for the quarterly period ended September 17, 1999).
4(c) Form of 9.5% Series B Senior Subordinated Note due 2009
(incorporated by reference from Exhibit 4.3 of our Registration
Statement on Form S-4, filed March 11, 1997, File No. 333-23127).
31(a) Certification of Chief Executive Officer of registrant pursuant to
SEC Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31(b) Certification of Chief Financial Officer of registrant pursuant to
SEC Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32(a) Certification of Chief Executive Officer of registrant pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32(b) Certification of Chief Financial Officer of registrant pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K: Filed August 28, 2003 for fiscal 2003 earnings
released on August 28, 2003.
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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, on November 3, 2003.
KINDERCARE LEARNING CENTERS, INC.
By: DAVID J. JOHNSON
----------------------------------
David J. Johnson
Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
By: DAN R. JACKSON
----------------------------------
Dan R. Jackson
Executive Vice President,
Chief Financial Officer
(Principal Financial and
Accounting Officer)
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