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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 March 5, 2004
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 April 9, 2004 was 19,721,646.
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KinderCare Learning Centers, Inc. and Subsidiaries
Index
Part I. Financial Information................................................ 2
Item 1. Financial statements and supplementary data:
Consolidated balance sheets at March 5, 2004
and May 30, 2003 (unaudited).............................. 2
Consolidated statements of operations for the
twelve and forty weeks ended March 5, 2004
and March 7, 2003 (unaudited)............................. 3
Consolidated statements of stockholders' equity and
comprehensive income for the forty weeks
ended March 5, 2004 and the fiscal year ended
May 30, 2003 (unaudited).................................. 4
Consolidated statements of cash flows for the forty
weeks ended March 5, 2004 and March 7, 2003 (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..31
Item 4. Controls and procedures.....................................32
Part II. Other Information....................................................33
Item 4. Submission of matters to a vote of security holders.........33
Item 6. Exhibits and reports on Form 8-K............................33
Signatures....................................................................34
1
PART I.
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except per share amounts)
(Unaudited)
March 5, 2004 May 30, 2003
------------- -------------
Assets
Current assets:
Cash and cash equivalents........................... $ 34,557 $ 18,066
Receivables, net.................................... 30,091 31,493
Prepaid expenses and supplies....................... 8,175 9,423
Deferred income taxes............................... 11,063 14,500
Assets held for sale................................ 4,238 5,560
------------- -------------
Total current assets............................ 88,124 79,042
Property and equipment, net........................... 716,887 660,939
Deferred income taxes................................. 15,771 1,868
Goodwill.............................................. 42,565 42,565
Deferred financing costs.............................. 19,982 9,445
Other assets.......................................... 22,261 17,234
------------- -------------
$ 905,590 $ 811,093
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Bank overdrafts..................................... $ 6,644 $ 9,304
Accounts payable.................................... 7,496 8,888
Current portion of long-term debt................... 7,580 13,744
Accrued expenses and other liabilities.............. 109,441 109,671
------------- -------------
Total current liabilities....................... 131,161 141,607
Long-term debt........................................ 509,490 441,336
Noncurrent self-insurance liabilities................. 32,417 22,771
Deferred income taxes................................. 5,059 3,696
Other noncurrent liabilities.......................... 85,284 66,524
------------- -------------
Total liabilities............................... 763,411 675,934
------------- -------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; authorized 10,000
shares; none outstanding........................ -- --
Common stock, $.01 par value; authorized 100,000
shares; issued and outstanding 19,722 and
19,661, respectively............................ 197 197
Additional paid-in capital.......................... 26,800 25,909
Notes receivable from stockholders.................. (1,933) (1,085)
Retained earnings................................... 116,686 110,297
Accumulated other comprehensive income (loss)....... 429 (159)
------------- -------------
Total stockholders' equity...................... 142,179 135,159
------------- -------------
$ 905,590 $ 811,093
============= =============
See accompanying notes to unaudited consolidated financial statements.
2
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
Twelve Weeks Ended Forty Weeks Ended
----------------------------- -----------------------------
March 5, 2004 March 7, 2003 March 5, 2004 March 7, 2003
------------- ------------- ------------- -------------
Revenues, net..................... $ 194,387 $ 190,192 $ 649,105 $ 635,097
------------- ------------- ------------- -------------
Operating expenses:
Salaries, wages and benefits.... 106,660 104,078 358,880 355,346
Depreciation and amortization... 13,345 12,543 46,153 42,997
Rent............................ 12,842 12,596 41,709 39,514
Provision for doubtful
accounts...................... 1,463 1,365 4,639 4,631
Other........................... 40,507 40,649 148,532 142,811
------------- ------------- ------------- -------------
Total operating expenses.... 174,817 171,231 599,913 585,299
------------- ------------- ------------- -------------
Operating income.............. 19,570 18,961 49,192 49,798
Investment income................. 577 35 712 215
Interest expense.................. (9,054) (9,338) (31,563) (31,791)
Loss on the early extinguishment
of debt......................... (1,363) -- (5,209) --
------------- ------------- ------------- -------------
Income before income taxes
and discontinued operations. 9,730 9,658 13,132 18,222
Income tax expense................ (4,233) (3,825) (5,605) (7,215)
------------- ------------- ------------- -------------
Income before discontinued
operations................. 5,497 5,833 7,527 11,007
Discontinued operations, net of
income tax benefit of $333,
$351, $848 and $623,
respectively.................... (432) (535) (1,138) (952)
------------- ------------- ------------- -------------
Net income................... $ 5,065 $ 5,298 $ 6,389 $ 10,055
============= ============= ============= =============
Basic and diluted net income
per share:
Income before discontinued
operations.................. $ 0.28 $ 0.30 $ 0.38 $ 0.56
Discontinued operations, net.. (0.02) (0.03) (0.06) (0.05)
------------- ------------- ------------- -------------
Net income................ $ 0.26 $ 0.27 $ 0.32 $ 0.51
============= ============= ============= =============
Weighted average common shares
outstanding:
Basic.................... 19,704 19,664 19,694 19,713
Diluted.................. 19,801 19,836 20,005 19,901
See accompanying notes to unaudited consolidated financial statements.
3
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity and Comprehensive Income
(In thousands)
(Unaudited)
Notes Accumulated
Common Stock Additional Receivable Other
----------------- Paid-In from Retained Comprehensive
Shares Amount Capital Stockholders Earnings Income (Loss) Total
-------- ------- ---------- ------------ ---------- ------------- ---------
Balance at May 31, 2002........... 19,819 $ 198 $ 28,107 $ (1,426) $ 96,882 $ (492) $ 123,269
Comprehensive income:
Net income...................... -- -- -- -- 13,415 -- 13,415
Cumulative translation
adjustment.................... -- -- -- -- -- 333 333
---------
Total comprehensive income.... 13,748
Retirement of common stock........ (120) (1) (1,645) -- -- -- (1,646)
Repurchase of common stock........ (38) -- (553) -- -- -- (553)
Proceeds from collection
of stockholders' notes
receivable...................... -- -- -- 341 -- -- 341
-------- ------- ---------- ------------ ---------- ------------- ---------
Balance at May 30, 2003..... 19,661 197 25,909 (1,085) 110,297 (159) 135,159
Comprehensive income:
Net income...................... -- -- -- -- 6,389 -- 6,389
Cumulative translation
adjustment.................... -- -- -- -- -- 588 588
---------
Total comprehensive income.... 6,977
Issuance of common stock.......... 74 -- 1,089 -- -- -- 1,089
Repurchase of common stock........ (13) -- (198) -- -- -- (198)
Issuance of stockholders'
notes receivable................ -- -- -- (1,004) -- -- (1,004)
Proceeds from collection
of stockholders' notes
receivable...................... -- -- -- 156 -- -- 156
-------- ------- ---------- ------------ ---------- ------------- ---------
Balance at March 5, 2004...... 19,722 $ 197 $ 26,800 $ (1,933) $ 116,686 $ 429 $ 142,179
======== ======= ========== ============ ========== ============= =========
See accompanying notes to unaudited consolidated financial statements.
4
KinderCare Learning Centers, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Forty Weeks Ended
-----------------------------
March 5, 2004 March 7, 2003
------------- -------------
Cash flows from operations:
Net income....................................... $ 6,389 $ 10,055
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation................................. 47,423 44,686
Amortization of deferred financing costs and
deferred gain on sale-leasebacks........... 4,237 1,669
Provision for doubtful accounts.............. 4,757 4,910
Gain on sales and disposals of property and
equipment.................................. (672) (1,881)
Deferred tax expense (benefit)............... (9,103) 5,624
Changes in operating assets and liabilities:
Increase in receivables.................... (3,356) (5,555)
Decrease in prepaid expenses and supplies.. 1,248 518
Increase in other assets................... (1,756) (249)
Increase (decrease) in accounts payable,
accrued expenses and other current and
noncurrent liabilities................... 9,466 (11,636)
Other, net................................... 587 320
------------- -------------
Net cash provided by operating activities...... 59,220 48,461
------------- -------------
Cash flows from investing activities:
Purchases of property and equipment.............. (41,345) (69,731)
Purchases of property and equipment previously
included in the synthetic lease facility....... (97,851) --
Acquisition of previously constructed center..... (872) --
Proceeds from sales of property and equipment.... 59,117 72,516
Increase in restricted cash...................... (3,621) --
Return of investment accounted for under the
cost method..................................... 171 --
Proceeds from notes receivable................... 183 68
------------- -------------
Net cash (used) provided by
investing activities......................... (84,218) 2,853
------------- -------------
Cash flows from financing activities:
Proceeds from long-term borrowings............... 343,300 48,000
Payments on long-term borrowings................. (281,310) (94,104)
Deferred financing costs related to refinanced
debt........................................... (17,323) --
Payments on capital leases....................... (562) (743)
Proceeds from issuance of common stock........... 86 --
Proceeds from stockholders' notes receivable..... 156 341
Repurchase of common stock....................... (198) (553)
Bank overdrafts.................................. (2,660) 691
------------- -------------
Net cash provided by (used in) financing
activities................................... 41,489 (46,368)
------------- -------------
Increase in cash and cash equivalents........ 16,491 4,946
Cash and cash equivalents at the beginning
of the period.................................. 18,066 8,619
------------- -------------
Cash and cash equivalents at the end of the
period......................................... $ 34,557 $ 13,565
============= =============
Supplemental cash flow information:
Interest paid................................ $ 34,175 $ 35,980
Income taxes paid, net....................... 8,877 6,257
Non-cash financial activities:
Issuance of notes receivable to
stockholders............................. $ 1,004 $ --
Retirement of common stock................... -- 1,646
See accompanying notes to unaudited consolidated financial statements.
5
KinderCare Learning Centers, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
1. Nature of Business
KinderCare Learning Centers, Inc., referred to as KinderCare, is the
leading for-profit provider of early childhood education and care in the United
States. At March 5, 2004, we served approximately 126,000 children and their
families at 1,245 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 166,000 at
March 5, 2004.
We operate early childhood education and care centers under two brands as
follows:
o KinderCare - At March 5, 2004, we operated 1,176 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 69 Mulberry centers at March 5, 2004, 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 1,245 centers at March
5, 2004 are 43 KinderCare at Work 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., operates in three business units as follows: Keystone
National High School, Learning & Education Center and iQ Academies.
We have made minority investments in Voyager Expanded Learning, Inc., a
developer of educational curricula for elementary and middle schools and a
provider of a public school teacher retraining program, and Chancellor Beacon
Academies, Inc., an education management company.
Fiscal Year. References to fiscal 2004 and fiscal 2003 are to the 52 weeks
ended May 28, 2004 and May 30, 2003, respectively. Our fiscal year ends on the
Friday closest to May 31. The third quarter is comprised of 12 weeks and ended
on March 5, 2004 in fiscal 2004 and March 7, 2003 in fiscal 2003. The first
quarter is comprised of 16 weeks, while the second, third and fourth quarters
are each comprised of 12 weeks.
2. Summary of Significant Accounting Policies
Basis of Presentation. The unaudited consolidated financial statements
include the financial statements of KinderCare and our subsidiaries, all of
which are wholly owned. All significant intercompany balances and transactions
have been eliminated in consolidation.
In the opinion of management, the unaudited consolidated financial
statements reflect the adjustments, all of which are of a normal recurring
nature, necessary to present fairly our financial position at March 5, 2004, our
results of operations for the twelve and forty weeks ended March 5, 2004 and
March 7, 2003, and cash flows for the forty weeks ended March 5, 2004 and March
7, 2003. Interim results are not necessarily indicative of results to be
expected for a full fiscal year because of seasonal and short-term variances and
other factors such as the timing of new center openings and center closures. The
unaudited consolidated financial statements should be read in conjunction with
6
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. The recognition of our net revenues meets the
following criteria: the existence of an arrangement, the rendering of services,
a determinable fee and probable collection. Net revenues include tuition, fees
and other income, reduced by discounts. We receive fees for reservation,
registration, education and other services. Other income is primarily comprised
of supplemental fees from tutoring programs and field trips. Tuition, other fees
and other income are recognized as the related services are provided. Payments
for these types of services 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 estimated average enrollment period, not
to exceed twelve months.
Comprehensive Income. Comprehensive income is comprised of the following,
for the periods indicated, in thousands:
Twelve Weeks Ended Forty Weeks Ended
---------------------------- ----------------------------
March 5, 2004 March 7, 2003 March 5, 2004 March 7, 2003
------------- ------------- ------------- -------------
Net income......................... $ 5,065 $ 5,298 $ 6,389 $ 10,055
Cumulative translation adjustment.. 381 29 588 320
------------- ------------- ------------- -------------
Comprehensive income.......... $ 5,446 $ 5,327 $ 6,977 $ 10,375
============= ============= ============= =============
Stock-Based Compensation. We measure compensation expense for our
stock-based employee compensation plans using the method prescribed by
Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued
to Employees, and provide pro forma disclosures of net income and earnings per
share as if the method prescribed by Statement of Financial Accounting Standards
("SFAS") No. 123, Accounting for Stock-Based Compensation, had been applied in
measuring compensation expense.
In accordance with SFAS No. 148, Accounting for Stock-Based Compensation -
Transition and Disclosure, we have provided the required disclosures below. Had
compensation expense for our stock option plans been determined based on the
estimated weighted average fair value of the options at the date of grant in
accordance with SFAS No. 123, our net income and basic and diluted net income
per share would have been as follows, in thousands, except per share data:
Twelve Weeks Ended Forty Weeks Ended
---------------------------- ----------------------------
March 5, 2004 March 7, 2003 March 5, 2004 March 7, 2003
------------- ------------- ------------- -------------
Reported net income................. $ 5,065 $ 5,298 $ 6,389 $ 10,055
Compensation costs for stock option
plans, net of taxes............... (237) (132) (789) (441)
------------- ------------- ------------- -------------
Pro forma net income............ $ 4,828 $ 5,166 $ 5,600 $ 9,614
============= ============= ============= =============
Pro forma net income per share:
Basic and diluted net income
per share before
discontinued operations,
net............................. $ 0.26 $ 0.27 $ 0.32 $ 0.51
Discontinued operations, net
of taxes........................ (0.01) (0.01) (0.04) (0.02)
------------- ------------- ------------- -------------
Adjusted net income per
share...................... $ 0.25 $ 0.26 $ 0.28 $ 0.49
============= ============= ============= =============
7
A summary of the weighted average fair values was as follows:
Twelve Weeks Ended Forty Weeks Ended
---------------------------- ----------------------------
March 5, 2004 March 7, 2003 March 5, 2004 March 7, 2003
------------- ------------- ------------- -------------
Weighted average fair value
of options granted during
the period, using the
Black-Scholes option
pricing model.................... $ 3.64 $ -- $ 7.58 $ 4.27
Assumptions used to estimate
the present value of
options at the grant date:
Volatility..................... 48.1% -- 48.1% 42.9%
Risk-free rate of return....... 3.6% -- 3.7% 3.9%
Dividend yield................. 0.0% -- 0.0% 0.0%
Number of years to exercise
options...................... 7 -- 7 7
There were no options granted during the third quarter of fiscal 2003.
Discontinued Operations. Discontinued operations included the operating
results of the 60 centers closed during fiscal 2003 and the forty weeks ended
March 5, 2004. A summary of discontinued operations was as follows, in
thousands:
Twelve Weeks Ended Forty Weeks Ended
---------------------------- ----------------------------
March 5, 2004 March 7, 2003 March 5, 2004 March 7, 2003
------------- ------------- ------------- -------------
Revenues, net....................... $ 263 $ 3,144 $ 3,684 $ 13,010
Operating expenses.................. 1,028 4,030 5,670 14,584
------------- ------------- ------------- -------------
Operating loss.................... (765) (886) (1,986) (1,574)
Interest expense.................... -- -- -- (1)
------------- ------------- ------------- -------------
Loss before income taxes.......... (765) (886) (1,986) (1,575)
Income tax benefit.................. 333 351 848 623
------------- ------------- ------------- -------------
Discontinued operations, net
of tax.......................... $ (432) $ (535) $ (1,138) $ (952)
============= ============= ============= =============
Operating expense related to discontinued operations included the
following, in thousands:
Twelve Weeks Ended Forty Weeks Ended
---------------------------- ----------------------------
March 5, 2004 March 7, 2003 March 5, 2004 March 7, 2003
------------- ------------- ------------- -------------
Impairment charges.................. $ 5 $ 336 $ 145 $ 999
Gains on closed center sales........ -- -- 563 1,202
Of the center closures, 14 were held for sale at March 5, 2004. As a
result, $4.2 million and $5.6 million of property and equipment was classified
as current in the unaudited consolidated balance sheets at March 5, 2004 and May
30, 2003, respectively.
8
Net Income per Share. The difference between basic and diluted net income
per share was a result of the dilutive effect of options, which are considered
potential common shares. A summary of the weighted average common shares was as
follows, in thousands:
Twelve Weeks Ended Forty Weeks Ended
---------------------------- ----------------------------
March 5, 2004 March 7, 2003 March 5, 2004 March 7, 2003
------------- ------------- ------------- -------------
Basic weighted average common
shares outstanding................ 19,704 19,664 19,694 19,713
Dilutive effect of options.......... 97 172 311 188
------------- ------------- ------------- -------------
Diluted weighted average common
shares outstanding.............. 19,801 19,836 20,005 19,901
============= ============= ============= =============
Shares excluded from potential
shares due to their anti-dilutive
effect............................ 1,544 2,272 1,206 2,256
============= ============= ============= =============
Restricted Cash. Restricted cash includes cash held in connection with our
$300.0 million mortgage loan, see "Note 4. Long-Term Debt." At March 5, 2004,
restricted cash of $3.6 million was included in other assets in our unaudited
consolidated balance sheet. The restricted cash relates primarily to capital
expenditure and debt service requirements under the mortgage loan.
Property and Equipment, net. In connection with our debt refinancing in
July 2003, our $300.0 million mortgage loan was secured by first mortgages or
deeds of trust on 475 of our owned centers. In addition, we mortgaged another
119 of our owned centers to secure the debt under our revolving credit facility.
At March 5, 2004, the net book value of $395.6 million for these 594 centers was
included in property and equipment in our unaudited consolidated balance sheet.
Deferred Financing Costs. Deferred financing costs are amortized on a
straight-line basis over the lives of related debt facilities, such method
approximates the effective yield method. At March 5, 2004 and May 30, 2003,
deferred financing costs were $20.0 million and $9.4 million, respectively. The
increase in deferred financing costs for the forty weeks ended March 5, 2004 was
due to our debt refinancing in July 2003, see "Note 4. Long-Term Debt." A
summary of the changes were as follows, in thousands:
Balance at May 30, 2003......................... $ 9,445
Additions....................................... 17,323
Costs written-off in connection with the
refinancing................................... (3,089)
Amortization for the forty weeks ended
March 5, 2004................................. (3,697)
---------
Balance at March 5, 2004.................... $ 19,982
=========
Recently Issued Accounting Pronouncements. Financial Accounting Standards
Board Interpretation ("FIN") 46, Consolidation of Variable Interest Entities, as
amended by FIN 46R, requires consolidation where there is a controlling
financial interest in a variable interest entity, previously referred to as a
special-purpose entity, and certain other entities. The implementation of FIN
46R has been delayed and will be effective during the fourth quarter of our
fiscal year 2004. We do not anticipate an impact to our consolidated financial
statements.
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity, establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The statement requires that an
issuer classify a financial instrument that is within its scope as a liability,
or an asset in some circumstances. SFAS No. 150 was effective for financial
instruments entered into or modified after May 31, 2003 and otherwise was
9
effective in the second quarter of our fiscal 2004. This statement did not have
a material impact to our consolidated financial statements.
Use of Estimates. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates under different conditions or if our assumptions change.
The most significant estimates underlying the consolidated financial statements
include the timing of revenue recognition, the allowance for doubtful accounts,
long-lived and intangible asset valuations and any resulting impairment, the
valuation of our investments, the adequacy of our self insurance obligations and
future tax liabilities.
Reclassifications. As a result of the 60 center closures during fiscal 2003
and the forty weeks ended March 5, 2004, we have restated amounts previously
reported in our Report on Form 10-Q for the quarterly period ended March 7, 2003
to reflect the results of operations for these centers as discontinued
operations. Certain other prior period amounts have also been reclassified to
conform to the current period's presentation.
3. Property and Equipment
Property and equipment consisted of the following, with dollars in
thousands:
March 5, 2004 May 30, 2003
------------- ------------
Land......................................... $ 165,530 $ 155,855
Buildings and leasehold improvements......... 651,046 582,434
Equipment.................................... 194,489 182,462
Construction in progress..................... 16,691 22,708
------------- ------------
1,027,756 943,459
Accumulated depreciation and amortization.... (310,869) (282,520)
------------- ------------
$ 716,887 $ 660,939
============= ============
10
4. Long-Term Debt
Long-term debt consisted of the following, in thousands:
March 5, 2004 May 30, 2003
------------- ------------
Secured:
Mortgage loan payable in monthly installments
through July 2008, interest rate of 3.35% at
March 5, 2004................................... $ 298,071 $ --
Borrowings under revolving credit facilities,
interest rates of:
o 4.34% at March 5, 2004.......................
o 2.57% and 4.25% at May 30, 2003.............. 11,000 104,000
Term loan facility, interest rate of 3.82% at
May 30, 2003.................................... -- 47,000
Industrial refunding revenue bonds at variable
rates of interest of 1.20% and 1.70%
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.................................... 3,639 3,739
Real and personal property mortgages payable in
monthly installments maturing calendar 2005,
interest rate of 7.00%.......................... 21 34
Unsecured:
Senior subordinated notes due calendar 2009,
interest rate of 9.5%, payable semi-annually.... 194,423 290,000
Notes payable in monthly installments through
calendar 2008, interest rate of 8.00%........... 1,416 1,807
------------- ------------
517,070 455,080
Less current portion of long-term debt.......... 7,580 13,744
------------- ------------
$ 509,490 $ 441,336
============= ============
We redeemed an additional $15.0 million aggregate principal amount of our
9.5% senior subordinated notes on March 29, 2004 at an aggregate price of $15.4
million. The redemption was funded by cash flows from operations and proceeds
from sale-leaseback transactions.
Refinancing. In July 2003, we refinanced a portion of our debt. We obtained
a $125.0 million revolving credit facility, and, as described below in greater
detail, one of our subsidiaries obtained a $300.0 million mortgage loan.
Proceeds from the mortgage loan were used to pay off the balance on the then
existing revolving credit facility, the term loan facility and the synthetic
lease facility. We also used a portion of the remaining proceeds to purchase
$37.0 million aggregate principal amount of our 9.5% senior subordinated notes.
In accordance with SFAS No. 6, Classification of Short-Term Obligations Expected
to Be Refinanced, an Amendment of ARB No. 43, Chapter 3A, the $104.0 million
balance on our previous revolving credit facility and our annual $0.5 million
installment on our term loan were classified as long-term debt at May 30, 2003,
since they were refinanced on a long-term basis during our first quarter of
fiscal 2004.
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
11
the CMBS Centers are owned by the CMBS Borrower and subject to the CMBS Loan,
recourse to the CMBS Centers by our creditors will be effectively subordinated
to recourse by holders of the CMBS Loan.
The CMBS Loan is nonrecourse to the CMBS Borrower and us, subject to
customary recourse provisions, and has a maturity date of July 9, 2008, which
may be extended to July 9, 2009, subject to certain conditions. The CMBS Loan
bears interest at a per annum rate equal to LIBOR plus 2.25% and requires
monthly payments of principal and interest. Principal payments are based on a
thirty-year amortization (based on an assumed rate of 6.50%). We have purchased
an interest rate cap agreement to protect us from significant changes in LIBOR
during the initial three years of the CMBS Loan. Under the cap agreement, which
terminates July 9, 2006, LIBOR is capped at 6.50%. We are required to purchase
additional interest rate cap agreements capping LIBOR at a rate no higher than
7.00% for the period from July 9, 2006 to the maturity date of the CMBS Loan.
Each of the centers included in the CMBS Centers is being ground leased by
the CMBS Borrower to another wholly owned subsidiary formed in connection with
the CMBS Loan, which is referred to as the CMBS Operator, and is being managed
by us pursuant to a management agreement with the CMBS Operator. Transactions
between the CMBS Borrower and the CMBS Operator are eliminated in consolidation
since both the CMBS Borrower and the CMBS Operator are wholly owned
subsidiaries. If the CMBS Loan is accelerated for any reason, the terms of such
loan will prevent us from allowing our centers that are not mortgaged under the
CMBS Loan to compete with CMBS Centers for a period of time after such
acceleration, as specified in the CMBS Loan agreement.
Prepayment of the CMBS Loan is prohibited through July 8, 2005, after which
prepayment is permitted in whole, subject to a prepayment premium of 3.0% from
July 8, 2005 through July 8, 2006, 2.0% from July 9, 2006 through July 8, 2007
and 1.0% from July 9, 2007 through January 8, 2008, with no prepayment penalty
thereafter. In addition, after July 8, 2005, the loan may be partially prepaid
as follows:
o up to $15.0 million each loan year in connection with releases of
mortgaged centers with no prepayment premium, and
o up to $5.0 million each loan year subject to payment of the applicable
prepayment premium.
The CMBS Loan contains a provision that requires the loan servicer to
escrow 50% of excess cash flow generated from the CMBS Centers (determined after
payment of debt service on the CMBS Loan, certain fees and required reserve
amounts) if the net operating income, as defined in the CMBS Loan agreement, of
the CMBS Centers declines to $60.0 million, as adjusted to account for released
properties. The amount of excess cash flow to be escrowed increases to 100% if
the net operating income of the CMBS Centers, declines to $50.0 million, as
adjusted. The net operating income of the CMBS Centers for the trailing 52 weeks
ended March 5, 2004 was approximately $80.2 million. The maximum amount of
excess cash flow that can be escrowed is limited to one year of debt service on
the CMBS Loan and one year of rent due under the ground lease with the CMBS
Operator during the term of the CMBS Loan. The escrowed amounts are released if
the CMBS Centers generate the necessary minimum net operating income for two
consecutive fiscal quarters. The annual debt service on the CMBS Loan is
approximately $22.8 million (assuming a 6.50% interest rate). The annual rent
under the ground lease is $34.0 million for the term of the CMBS Loan. These
excess cash flow provisions could limit the amount of cash made available to us.
Our restricted cash balance in connection with the CMBS Loan was $3.6 million at
March 5, 2004. The restricted cash balance will fluctuate periodically due
primarily to the timing of debt service payments compared to our period end
date.
Revolving Credit Facility. Our $125.0 million revolving 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
12
of credit and up to $10.0 million for selected short-term borrowings. At March
5, 2004, there were $11.0 million of borrowings outstanding under our credit
facility.
The credit facility bears interest, at our option, at either of the
following rates, which are adjusted in quarterly increments based on our ratio
of total consolidated debt to total consolidated EBITDA (EBITDA is defined in
the credit facility as net income before interest expense, income taxes,
depreciation, amortization, non-recurring charges, non-cash charges, gains and
losses on asset sales, restructuring charges or reserves and non-cash gains):
o An adjusted LIBOR rate plus 2.00% to 3.25%. At March 5, 2004, this
rate was adjusted LIBOR plus 3.25%, or an all-in rate of 4.34%. There
were $11.0 million of borrowings outstanding at this rate at March 5,
2004.
o An alternative base rate (ABR) plus 0.75% to 2.00%. At March 5, 2004,
this rate would have been ABR plus 2.00%, or an all-in rate of 6.00%.
There were no borrowings outstanding at this rate at March 5, 2004.
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. We were in compliance
with our covenants at March 5, 2004.
Under the 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%, in each case on the average daily stated amount of each letter of
credit. These fees are also payable quarterly in arrears. At March 5, 2004 the
rates for our commitment and letter of credit fees were 0.50% and 3.125%,
respectively.
5. Commitments and Contingencies
We are presently, and are from time to time, subject to claims and
litigation arising in the ordinary course of business. We believe that none of
the claims or litigation of which we are aware will materially affect our
consolidated financial statements, although assurance cannot be given with
respect to the ultimate outcome of any such actions.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the unaudited
consolidated financial statements and the related notes presented elsewhere in
this report. We utilize a financial reporting schedule comprised of 13 four-week
periods and our fiscal year ends on the Friday closest to May 31. The
information presented refers to the 12 weeks ended March 5, 2004 as "the third
quarter of fiscal 2004" and the 12 weeks ended March 7, 2003 as "the third
quarter of fiscal 2003." Our first fiscal quarter is comprised of 16 weeks,
while the remaining quarters are each comprised of 12 weeks.
13
Overview
We are the nation's leading for-profit provider of early childhood
education and care. We provide services to infants and children up to 12 years
of age, with a majority of the children from the ages of six weeks to five years
old. We are the largest for-profit provider in the United States in terms of the
number of centers and licensed capacity. At March 5, 2004, licensed capacity at
our centers was approximately 166,000 and we served approximately 126,000
children and their families at 1,245 child care centers. We distinguish
ourselves by providing high quality educational programs, a professional,
well-trained staff and attractive and safe facilities. We focus on the
development of the whole child: physically, socially, emotionally, cognitively
and linguistically. In addition to our primary business of center-based child
care, we also own and operate a distance learning company serving teenagers and
young adults through our subsidiary, KC Distance Learning, Inc.
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.
Net Revenues
We derive our net revenues from:
o Tuition charges. We collect tuition on a weekly basis in advance. The
majority of our tuition is paid by individual families. Approximately
20% is paid at varying levels of subsidy by government agencies. In
our employer-sponsored centers, tuition may be partly subsidized by
the employers. We provide certain discounts to families, government
agencies and employees. These include discounts with respect to
government agency reimbursed rates, staff discounts, family discounts
for multiple enrollments, marketing discounts for referrals or trial
periods and employer-based discounts.
o Fees. We charge a reservation fee, typically at half of the normal
tuition charge, for any full week that an enrolled child is absent
from our centers. We also collect registration fees and fees to cover
educational supplies at the time of enrollment and annually
thereafter.
o Other income. We offer tutoring programs, on a supplemental fee basis,
in the majority of our centers in the areas of literacy and reading,
foreign language and mathematics. We also offer field trips,
predominantly during the summer months, for an additional charge. We
earn other income from various sources, including management fees
related to certain employer-sponsored contracts.
o Distance learning services. Our subsidiary, KC Distance Learning,
primarily sells high school courses and the related instruction
services directly to private students, as well as to schools and
school districts.
Tuition charges represent the majority of our net revenues. We determine
tuition rates based upon a number of factors, including the age of the child,
full- or part-time attendance, enrollment levels, location and competition.
Tuition rates are typically adjusted company-wide each year to coincide with the
back-to-school periods. However, we may adjust individual room rates within a
specific center at any time based on competitive position, occupancy levels and
demand. In order to maximize enrollment, center directors may also adjust the
rates at their center or offer discounts at their discretion, within limits.
These rate discounts and adjustments are closely monitored by our field
management and corporate headquarters. Our focus on pricing at the classroom
level within our centers has enabled us to improve same-center sales growth
throughout the year without losing occupancy in centers where the quality of our
services, demand and other market conditions support such increases.
We calculate and monitor average weekly tuition rates and occupancy for
each center as measurements of performance. The average weekly tuition rate is
14
calculated as the actual tuition charged, net of discounts, for a specified time
period, divided by "full-time equivalent," or FTE, attendance for the related
time period. 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 FTE
attendance divided by the sum of the center's licensed capacity.
The average weekly tuition rate and occupancy for all of our centers
combined were as follows:
Average
weekly
tuition rate Occupancy
------------ ---------
Forty weeks ended March 5, 2004... $ 152.04 59.3%
Fiscal 2003....................... 144.45 63.3
Fiscal 2002....................... 137.72 65.6
Fiscal 2001....................... 129.34 68.3
The average weekly tuition rate has risen primarily due to the annual
tuition rate increases we have instituted as well as the room specific tiered
rates we have implemented. Although we have increased rates, in most cases our
families experience lower tuition charges over time. This is due to the fact
that within a specific center the highest pricing levels exist in the infant
program and the lowest pricing is charged in our school age offerings, as a
result of the higher care requirements of younger children. The average weekly
tuition rate is also impacted by shifts in enrollment within various geographic
markets, enrollment mix between age segments, enrollment mix between full- and
part-time attendance and the opening of new centers in markets that support
rates at levels higher than our company average.
We have experienced declines in our occupancy levels. We believe the
factors contributing to these declines include reduced or flat government
funding for child care assistance programs, increased unemployment rates and job
losses and the general economic downturn.
Net revenue growth has primarily resulted from the addition of new centers
through organic growth and acquisitions, and to a lesser extent due to increased
tuition and expanded programs at existing centers. Our comparable center net
revenue growth has remained relatively flat in each period from 2001 to the
forty weeks ended March 5, 2004. 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 net revenues include those generated from centers that
have been closed and our revenues from distance learning services.
Over the past several years our management has pursued a strategy of
increasing our net revenues through an increase in tuition rates offset by a
gradual decline in occupancy levels and the expansion of service offerings. We
believe that our reputation, brand awareness, educational offerings and focus on
developing centers in growing and comparatively more affluent regions of the
United States are some of the primary reasons we have been able to charge
premium tuition rates. We have also successfully executed on our growth strategy
to open new centers and to pursue strategic acquisitions.
Seasonality
New enrollments are generally highest during the traditional fall "back to
school" period and after the calendar year-end holidays. Therefore, we attempt
to focus our marketing efforts to support these periods of high re-enrollments.
Enrollment generally decreases 5% to 10% during the summer months and calendar
year-end holidays.
15
New Center Openings, Acquisitions and Center Closures
We intend to continue to open 15 to 30 new centers each year. In addition,
we will make selective acquisitions of existing high quality centers. We also
continually evaluate our centers and close those, typically older, centers that
are not generating positive cash flow. During the periods indicated we opened,
acquired and closed centers as follows:
Fiscal Year Ended
Forty Weeks ------------------------------------------
Ended March 5, 2004 May 30, 2003 May 31, 2002 June 1, 2001
------------------- ------------ ------------ ------------
Number of centers at the
beginning of the period..... 1,264 1,264 1,242 1,169
Openings........................ 12 28 35 44
Acquisitions.................... 1 -- -- 75
Closures........................ (32) (28) (13) (46)
------------------- ------------ ------------ ------------
Number of centers at the
end of the period........... 1,245 1,264 1,264 1,242
=================== ============ ============ ============
Total center license capacity
at the end of the period...... 166,000 167,000 166,000 162,000
=================== ============ ============ ============
Operating Expenses
Our operating expenses include the direct costs related to the operations
of our centers, as well as the costs associated with the field and corporate
oversight of such centers. Our large, nationwide customer base gives us the
ability to spread the costs of programs and services, such as curriculum
development, training programs and other management processes, over a large
number of centers.
Labor related costs are the largest component of operating expenses. We
have been successful in managing our labor productivity without impacting the
quality of services within our centers. Other costs incurred at the center level
include insurance, janitorial, maintenance, utilities, transportation, provision
for doubtful accounts, food and marketing. While we generally have seen gradual
rises in our expenses, our largest increase in expense has come from the recent
renewals of our insurance policies due to the higher premiums that resulted from
the terrorist attacks on September 11, 2001. We anticipate that these costs will
remain at their current levels or may increase further.
Other significant components of our cost structure include depreciation and
rent. We have experienced increases in our rent expense primarily due to an
active sale-leaseback program in which we sell our centers to unaffiliated third
parties and lease them back. We then redeploy the proceeds to buy and develop
additional sites for our child care centers, or to reduce debt levels. We have
an active inventory of our properties available for sale, and plan to continue
our sale-leaseback program for as long as there is investor interest.
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 involved in their application. Management has reviewed the
16
development and selection of these estimates and their related disclosure with
the Audit Committee of the Board of Directors.
Revenue recognition. The recognition of our net revenues meets the
following criteria: the existence of an arrangement, the rendering of services,
a determinable fee and probable collection. 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.
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. An
asset's value is impaired if our estimate of the aggregate future cash flows,
undiscounted and without interest charges, to be generated by the asset is less
than the carrying value of the asset. Such cash flows consider factors such as
expected future operating income and historical trends, as well as the effects
of demand and competition. To the extent impairment has occurred, the loss will
be measured as the excess of the carrying amount of the asset over its fair
value. Such estimates require the use of judgment and numerous subjective
assumptions, which, if actual experience varies, could result in material
differences in the requirements for impairment charges. Impairment charges,
which were included as a component of depreciation expense, were as follows, in
thousands:
Twelve Weeks Ended Forty Weeks Ended
---------------------------- ----------------------------
March 5, 2004 March 7, 2003 March 5, 2004 March 7, 2003
------------- ------------- ------------- -------------
Impairment charges included in
depreciation expense............. $ 331 $ 88 $ 1,137 $ 280
Impairment charges included in
discontinued operations.......... 5 336 145 999
------------- ------------- ------------- -------------
Total impairment charges........... $ 336 $ 424 $ 1,282 $ 1,279
============= ============= ============= =============
Investments. Investments, wherein we do not exert significant influence or
own over 20% of the investee's stock, are accounted for under the cost method.
We measure the fair values of these investments annually, or more frequently if
there is an indication of impairment, using multiples of comparable companies
and discounted cash flow analysis. During the third quarter of fiscal 2004 we
received a $0.7 million dividend payment from a minority investment accounted
for under the cost method. We recognized investment income of $0.5 million for
our proportionate share of accumulated earnings since the date of the initial
investment and $0.2 million was recorded as a return of investment in the
subject company.
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 $53.7
million and $45.1 million at March 5, 2004 and May 30, 2003, respectively. Our
internal estimates are reviewed throughout the fiscal year by a third party
actuary. While we believe that the amounts accrued for these obligations are
17
sufficient, any significant increase in the number of claims and/or costs
associated with claims made under these programs could have a material adverse
effect on our consolidated financial statements.
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. In the third quarter of
fiscal 2004 our effective tax rate increased to 43.5% compared to 39.6% for the
same period last year due, in part, to the expiration of the Work Opportunity
Tax Credit as of December 31, 2003.
Initial Adoption of Accounting Policies
Statement of Financial Accounting Standards ("SFAS") No. 149, Amendments of
Statement 133 on Derivative Instruments and Hedging Activities, amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No.
149 was adopted for contracts entered into or modified and for hedging
relationships designated after June 30, 2003. This adoption did not have a
material impact on our consolidated financial statements.
SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity, establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. The statement requires that an
issuer classify a financial instrument that is within its scope as a liability,
or an asset in some circumstances. SFAS No. 150 was effective for financial
instruments entered into or modified after May 31, 2003, and otherwise was
effective in the second quarter of our fiscal year 2004. This statement did not
have a material impact to our consolidated financial statements.
Recently Issued Accounting Pronouncements
Financial Accounting Standards Board Interpretation ("FIN") 46,
Consolidation of Variable Interest Entities, as amended by FIN 46R, requires
consolidation where there is a controlling financial interest in a variable
interest entity, previously referred to as a special-purpose entity, and certain
other entities. The implementation of FIN 46R has been delayed and will be
effective during the fourth quarter of our fiscal year 2004. We do not
anticipate an impact to our consolidated financial statements.
18
Third Quarter of Fiscal 2004 compared to Third Quarter of Fiscal 2003
The following table shows the comparative operating results of KinderCare,
in thousands, except the average weekly tuition rate:
Change
Twelve Weeks Percent Twelve Weeks Percent Amount
Ended of Ended of Increase/
March 5, 2004 Revenues March 7, 2003 Revenues (Decrease)
------------- -------- ------------- -------- ----------
Revenues, net.................... $ 194,387 100.0% $ 190,192 100.0% $ 4,195
------------- -------- ------------- -------- ----------
Operating expenses:
Salaries, wages and benefits:
Center expense............... 97,095 49.9 96,221 50.6 874
Field and corporate expense.. 9,565 4.9 7,857 4.1 1,708
------------- -------- ------------- -------- ----------
Total salaries, wages and
benefits................. 106,660 54.8 104,078 54.7 2,582
Depreciation and amortization.. 13,345 6.9 12,543 6.6 802
Rent........................... 12,842 6.6 12,596 6.6 246
Other.......................... 41,970 21.6 42,014 22.1 (44)
------------- -------- ------------- -------- ----------
Total operating expenses..... 174,817 89.9 171,231 90.0 3,586
------------- -------- ------------- -------- ----------
Operating income........... $ 19,570 10.1% $ 18,961 10.0% $ 609
============= ======== ============= ======== ==========
Average weekly tuition rate...... $ 152.47 $ 144.69 $ 7.78
Occupancy........................ 58.4% 61.2% (2.8)
Revenues, net. Net revenues increased $4.2 million, or 2.2%, from the same
period last year to $194.4 million in the third quarter of fiscal 2004. The
increase was due to higher average weekly tuition rates, offset by reduced
occupancy, as well as additional net revenues generated by the newly opened
centers. Comparable center net revenues increased $0.3 million, or 0.1%.
The average weekly tuition rate increased $7.78, or 5.4%, to $152.47 in the
third quarter of fiscal 2004 due primarily to tuition increases. Occupancy
declined to 58.4% from 61.2% for the same period last year due primarily to
reduced full-time equivalent attendance within the population of older centers.
We believe the factors contributing to this decline include reduced or flat
government funding for child care assistance programs, increased unemployment
rates and job losses and the general economic downturn.
During the third quarters of fiscal 2004 and 2003, we opened and closed
centers as follows:
Twelve Weeks Ended
-----------------------------
March 5, 2004 March 7, 2003
------------- -------------
Number of centers at the beginning
of the period......................... 1,253 1,266
Openings................................ 2 6
Acquisition............................. 1 --
Closures................................ (11) (8)
------------- -------------
Number of centers at the end of the
period............................. 1,245 1,264
============= =============
Total center licensed capacity at the
end of the period..................... 166,000 167,000
Salaries, wages and benefits. Expenses for salaries, wages and benefits
increased $2.6 million, or 2.5%, from the same period last year to $106.7
19
million. Total salaries, wages and benefits expense as a percentage of net
revenues was 54.8% for the third quarter of fiscal 2004 compared to 54.7% for
the third quarter of fiscal 2003.
Expenses for salaries, wages and benefits directly associated with the
centers was $97.1 million, an increase of $0.9 million from the same period last
year. The increase was primarily due to overall higher wage rates, offset by
control over labor hours and a reduction in medical insurance costs. See "Wage
Increases." At the center level, salaries, wages and benefits expense as a
percentage of net revenues declined to 49.9% from 50.6% for the same period last
year due primarily to improved labor productivity and a reduction in medical
insurance costs. Expenses for salaries, wages and benefits associated with field
and corporate employees increased $1.7 million due primarily to a $1.5 million
increase in the management bonus accrual, which was the result of recognizing
the expense earlier this fiscal year compared to the prior year. This earlier
recognition was due to the timing of our financial performance to date compared
to the same period last year. Our annual management bonus expense is not
expected to be materially higher than prior year.
Depreciation and amortization. Depreciation and amortization expense
increased $0.8 million from the same period last year to $13.3 million.
Significant changes in depreciation expense included the impact of purchasing
centers previously included in our synthetic lease facility, our sale-leaseback
program, whereby centers are classified as operating leases when they are sold
and leased back, and impairment charges. These changes were as follows, in
thousands:
Depreciation for centers previously included
in the synthetic lease facility..................... $ 778
Impairment charges.................................... 243
Impact of centers sold in the sale-leaseback program.. (411)
Other................................................. 192
-----------
Increase in depreciation and amortization expense.. $ 802
===========
Impairment charges of $0.3 million and $0.1 million in the third quarter of
fiscal 2004 and 2003, respectively, related to under-performing centers and
certain undeveloped properties.
Rent. Rent expense increased $0.2 million in the third quarter of 2004
compared to the same period last year. Significant changes in rent expense
included the impact of the sale-leaseback program, whereby centers are sold and
leased back, and centers previously included in our synthetic lease facility.
See "Liquidity and Capital Resources." The changes were as follows, in
thousands:
Impact of centers leased under the sale-leaseback
program........................................... $ 1,259
Amortization of deferred gains on sale-leaseback
transactions...................................... (453)
Rent expense for centers previously included in the
synthetic lease facility.......................... (745)
Other............................................... 185
-----------
Increase in rent expense......................... $ 246
===========
Other operating expenses. Other operating expenses include costs directly
associated with the centers, such as food, insurance, transportation,
janitorial, maintenance, utilities, property taxes and licenses and marketing
costs, and expenses related to field management and corporate administration.
Other operating expenses remained flat at $42.0 million in the third quarter of
fiscal 2004 compared to the same period last year. Other operating expenses as a
percentage of net revenues decreased to 21.6% from 22.1% for the same period
last year primarily as a result of cost controls.
Operating income. Operating income was $19.6 million in the third quarter
of fiscal 2004, an increase of $0.6 million compared to the same period last
20
year. During the third quarter of fiscal 2004 operating income, as a percentage
of net revenues, was 10.1% compared to 10.0% for the same period last year. The
slight improvement in margin was due primarily to control over costs.
Investment income. During the third quarter of fiscal 2004 we received a
dividend payment of $0.7 million from a minority investment accounted for under
the cost method. Investment income of $0.5 million was recognized to the extent
of our proportionate share of accumulated earnings since the date of the initial
investment. In accordance with APB No. 18, The Equity Method of Accounting for
Investments in Common Stock, the remaining $0.2 million was recorded as a return
of investment in the subject company.
Interest expense. Interest expense was $9.1 million compared to $9.3
million for the same period last year. Our weighted average interest rate on our
long-term debt, including amortization of deferred financing costs, but
excluding the write-off discussed below, was 7.0% and 7.6% for the third quarter
of fiscal 2004 and fiscal 2003, respectively.
Loss on the early extinguishment of debt. As a result of redeeming $39.3
million of our 9.5% senior subordinated notes in the third quarter of fiscal
2004, we recognized a loss on the early extinguishment of debt of $1.4 million.
These costs included the write-off of deferred financing costs of $0.8 million
associated with the debt that was repaid and the incurrence of premium costs of
$0.6 million.
Income tax expense. Income tax expense was $4.2 million, or 43.5% of pretax
income, in the third quarter of fiscal 2004. In the third quarter of fiscal
2003, income tax expense was $3.8 million, or 39.6% of pretax income. Income tax
expense was computed by applying estimated effective income tax rates to the
income or loss before income taxes. Income tax expense varies from the statutory
federal income tax rate due primarily to state income taxes and non-tax
deductible expenses, offset by tax credits. The increase in the effective rate
in the third quarter of fiscal 2004 was due, in part, to the expiration of the
Work Opportunity Tax Credit as of December 31, 2003.
Discontinued operations. We recognized losses of $0.4 million and $0.5
million on discontinued operations in the third quarters of fiscal 2004 and
2003, respectively, which represents the operating results, net of tax, for all
periods presented of the 60 centers closed during fiscal 2003 and the forty
weeks ended March 5, 2004. Discontinued operations included the following, in
thousands:
Twelve Weeks Ended
-----------------------------
March 5, 2004 March 7, 2003
------------- -------------
Revenues, net.................................. $ 263 $ 3,144
------------- -------------
Operating expenses:
Salaries, wages and benefits................ 298 2,103
Depreciation................................ 395 598
Rent........................................ 42 307
Provision for doubtful accounts............. 38 72
Other....................................... 255 950
------------- -------------
Total operating expenses.................. 1,028 4,030
Operating loss.............................. (765) (886)
Income tax benefit............................. 333 351
------------- -------------
Discontinued operations, net of tax.......... $ (432) $ (535)
============= =============
Depreciation expense for the twelve weeks ended March 7, 2003 included $0.3
million of impairment charges.
Net income. Net income was $5.1 million in the third quarter of fiscal 2004
compared to $5.3 million in the third quarter of fiscal 2003. The decrease was
due primarily to the $1.4 million ($0.8 million after tax) of costs associated
with the loss on the early extinguishment of debt discussed above. As a
21
percentage of net revenue, net income was 2.6% and 2.8% in the third quarter of
fiscal 2004 and fiscal 2003, respectively. Basic and diluted net income per
share were both $0.26 for the third quarter of fiscal 2004 and $0.27 for the
third quarter of 2003.
Forty Weeks ended March 5, 2004 compared to Forty Weeks ended March 7, 2003.
The following table shows the comparative operating results of KinderCare,
in thousands, except the average weekly tuition rate:
Change
Forty Percent Forty Percent Amount
Weeks Ended of Weeks Ended of Increase/
March 5, 2004 Revenues March 7, 2003 Revenues (Decrease)
------------- -------- ------------- -------- ----------
Revenues, net.................... $ 649,105 100.0% $ 635,097 100.0% $ 14,008
------------- -------- ------------- -------- ----------
Operating expenses:
Salaries, wages and benefits:
Center expense............... 330,893 51.0 329,232 51.9 1,661
Field and corporate expense.. 27,987 4.3 26,114 4.1 1,873
------------- -------- ------------- -------- ----------
Total salaries, wages and
benefits................. 358,880 55.3 355,346 56.0 3,534
Depreciation and amortization.. 46,153 7.1 42,997 6.8 3,156
Rent........................... 41,709 6.4 39,514 6.2 2,195
Other.......................... 153,171 23.6 147,442 23.2 5,729
------------- -------- ------------- -------- ----------
Total operating expenses..... 599,913 92.4 585,299 92.2 14,614
------------- -------- ------------- -------- ----------
Operating income........... $ 49,192 7.6% $ 49,798 7.8% $ (606)
============= ======== ============= ======== ==========
Average weekly tuition rate...... $ 152.04 $ 143.85 $ 8.19
Occupancy........................ 59.3% 62.5% (3.2)
Revenues, net. Net revenues increased $14.0 million, or 2.2%, from the same
period last year to $649.1 million in the forty weeks ended March 5, 2004. The
increase was due to higher average weekly tuition rates, offset by reduced
occupancy, as well as additional net revenues generated by the newly opened
centers. Comparable center net revenues decreased $0.2 million.
The average weekly tuition rate increased $8.19, or 5.7%, to $152.04 in the
forty weeks ended March 5, 2004 due primarily to tuition increases. Occupancy
declined to 59.3% from 62.5% for the same period last year due primarily to
reduced full-time equivalent attendance within the population of older centers.
We believe the factors contributing to this decline include reduced or flat
government funding for child care assistance programs, increased unemployment
rates and job losses and the general economic downturn.
During the periods indicated, we opened and closed centers as follows:
Forty Weeks Ended
----------------------------
March 5, 2004 March 7, 2003
------------- -------------
Number of centers at the beginning of
the period.................................... 1,264 1,264
Openings........................................ 12 24
Acquisitions.................................... 1 --
Closures........................................ (32) (24)
------------- -------------
Number of centers at the end of the
period..................................... 1,245 1,264
============= =============
Total center licensed capacity at the end
of the period................................. 166,000 167,000
Salaries, wages and benefits. Expenses for salaries, wages and benefits
increased $3.5 million, from the same period last year to $358.9 million. Total
22
salaries, wages and benefits expense as a percentage of net revenues was 55.3%
and 56.0% for the forty weeks ended March 5, 2004 and March 7, 2003,
respectively.
Expenses for salaries, wages and benefits directly associated with the
centers was $330.9 million, an increase of $1.7 million from the same period
last year. The increase was primarily due to costs from newly opened centers and
overall higher wage rates, offset by control over labor hours and a reduction in
medical insurance costs. See "Wage Increases." At the center level, salaries,
wages and benefits expense as a percentage of net revenues declined to 51.0%
from 51.9% for the same period last year due primarily to improved labor
productivity and a reduction in medical insurance costs. Expense for salaries,
wages and benefits associated with field and corporate and employees increased
$1.9 million due primarily to $1.5 million additional management bonus expense,
which was the result of recognizing the expense earlier this fiscal year
compared to the prior year. This earlier recognition was due to the timing of
our financial performance to date compared to the same period last year. Our
annual management bonus expense is not expected to be materially higher than the
prior year.
Depreciation and amortization. Depreciation and amortization expense
increased $3.2 million from the same period last year to $46.2 million.
Significant changes in depreciation expense included the impact of purchasing
centers previously included in our synthetic lease facility, our sale-leaseback
program, whereby centers are classified as operating leases when they are sold
and leased back, and impairment charges. These changes were as follows, in
thousands:
Depreciation for centers previously included
in the synthetic lease facility..................... $ 2,929
Impairment charges.................................... 857
Impact of centers sold in the sale-leaseback program.. (1,585)
Other................................................. 955
-----------
Increase in depreciation and amortization expense.. $ 3,156
===========
Impairment charges of $1.1 million and $0.2 million in the forty weeks
ended March 5, 2004 and March 7, 2003, respectively, related to under-performing
centers and certain undeveloped properties.
Rent. Rent expense increased $2.2 million from the same period last year to
$41.7 million. The most significant changes in the rent expense included the
impact of our sale-leaseback program and the impact of centers previously
included in our synthetic lease facility. In addition, the rental rates
experienced on new and renewed center leases are higher than those experienced
in previous fiscal periods. The changes were as follows, in thousands:
Impact of centers leased under the sale-leaseback
program.......................................... $ 5,095
Amortization of deferred gains on sale-leaseback
transactions..................................... (1,638)
Rent expense for centers previously included in the
synthetic lease facility......................... (2,449)
Other.............................................. 1,187
-----------
Increase in rent expense........................ $ 2,195
===========
Other operating expenses. Other operating expenses include costs directly
associated with the centers, such as food, insurance, transportation,
janitorial, maintenance, utilities, property taxes and licenses and marketing
costs, and expenses related to field management and corporate administration.
Other operating expenses increased $5.7 million, or 3.9%, from the same period
last year to $153.2 million. The increase was due primarily to $4.4 million of
increased insurance costs and additional center level costs for newly opened
23
centers. Other operating expenses as a percentage of net revenues increased to
23.6% from 23.2% for the same period last year primarily as a result of the
higher insurance costs.
Operating income. Operating income was $49.2 million, a decrease of $0.6
million, or 1.2%, from the same period last year. Operating income decreased due
to $1.6 million of higher insurance costs and $3.5 million of increased rent
expense from sale-leasebacks, offset by higher tuition rates and control over
labor productivity. Operating income as a percentage of net revenues was 7.6%
compared to 7.8% for the same period last year.
Investment income. During the third quarter of fiscal 2004 we received a
dividend payment of $0.7 million from a minority investment accounted for under
the cost method. Investment income of $0.5 million was recognized to the extent
of our proportionate share of accumulated earnings since the date of the initial
investment. In accordance with APB No. 18, The Equity Method of Accounting for
Investments in Common Stock, the remaining $0.2 million was recorded as a return
of investment in the subject company.
Interest expense. Interest expense was $31.6 million for the forty weeks
ended March 5, 2004, a decrease of $0.2 million from the same period last year.
Our weighted average interest rate on our long-term debt, including amortization
of deferred financing costs, but excluding the write-off discussed below, was
7.0% and 7.8% for the forty weeks ended March 5, 2004 and March 7, 2003,
respectively.
Loss on the early extinguishment of debt. As a result of our debt
refinancing in July 2003 and the acquisition and redemption of a portion of our
9.5% senior subordinated notes, we recognized a loss on the early extinguishment
of debt of $5.2 million in the forty weeks ended March 5, 2004. These costs
included the write-off of deferred financing costs of $3.6 million associated
with the debt that was repaid and the incurrence of premium costs of $1.6
million in connection with the acquisition and redemption of a portion of our
9.5% senior subordinated notes. In the forty weeks ended March 5, 2004, we
purchased $56.3 million and redeemed $39.3 million aggregate principal amount of
our 9.5% senior subordinated notes.
Income tax expense. Income tax expense was $5.6 million, or 42.7% of pretax
income, and $7.2 million, or 39.6% of pretax income, in the forty weeks ended
March 5, 2004 and March 7, 2003, respectively. Income tax expense was computed
by applying estimated effective income tax rates to the income or loss before
income taxes. Income tax expense varies from the statutory federal income tax
rate due primarily to state income taxes and non-tax deductible expenses, offset
by tax credits. The increase in the effective tax rate for the forty weeks ended
March 5, 2004 was due, in part, to the expiration of the Work Opportunity Tax
Credit as of December 31, 2003.
24
Discontinued operations. We recognized losses of $1.1 million and $1.0
million on discontinued operations in the forty weeks ended March 5, 2004 and
March 7, 2003, respectively, which represents the operating results, net of tax,
for all periods presented of the 60 centers closed during fiscal 2003 and the
forty weeks ended March 5, 2004. Discontinued operations included the following,
in thousands:
Forty Weeks Ended
----------------------------
March 5, 2004 March 7, 2003
------------- -------------
Revenues, net................................... $ 3,684 $ 13,010
------------- -------------
Operating expenses:
Salaries, wages and benefits.................. 2,853 8,506
Depreciation.................................. 1,275 1,991
Rent.......................................... 322 1,323
Provision for doubtful accounts............... 118 280
Other......................................... 1,102 2,484
------------- -------------
Total operating expenses................... 5,670 14,584
Operating loss................................ (1,986) (1,574)
Interest expense................................ -- (1)
Income tax benefit.............................. 848 623
------------- -------------
Discontinued operations, net of tax.......... $ (1,138) $ (952)
============= =============
Depreciation expense for the forty weeks ended March 5, 2004 and March 7,
2003 included $0.1 million and $1.0 million of impairment charges, respectively.
Other operating expenses included gains on closed center sales of $0.6 million
and $1.2 million in the forty weeks ended March 5, 2004 and March 7, 2003,
respectively.
Net income. Net income was $6.4 million and $10.1 million in the forty
weeks ended March 5, 2004 and March 7, 2003, respectively. The most significant
reason for the decrease was $5.2 million ($3.0 million after tax) of charges
from the early extinguishment of debt, as discussed above. Increased rent
expense from our sale-lease back program and rising insurance costs also
contributed to the decrease in net income in the forty weeks ended March 5,
2004. Basic and diluted net income per share were both $0.32 for the forty weeks
ended March 5, 2004. For the forty weeks ended March 7, 2003, basic and diluted
net income per share were both $0.51.
Liquidity and Capital Resources
Financing Activities
In July 2003 we refinanced $279.9 million of our debt. We obtained a $125.0
million revolving credit facility, and, as described below in greater detail,
one of our subsidiaries obtained a $300.0 million mortgage loan. Proceeds from
the mortgage loan were used to pay off the $98.0 million balance of the then
existing revolving credit facility, $47.0 million of term loan facility and
$97.9 million under the synthetic lease facility. We also used a portion of the
remaining proceeds to purchase $37.0 million aggregate principal amount of our
9.5% senior subordinated notes.
The $300.0 million mortgage loan is secured by first mortgages or deeds of
trust on 475 of our owned centers located in 33 states. We refer to the mortgage
loan as the CMBS Loan and the 475 mortgaged centers as the CMBS Centers. In
connection with the CMBS Loan, the CMBS Centers were transferred to a newly
formed wholly owned subsidiary of ours, which is the borrower under the CMBS
Loan and is referred to as the CMBS Borrower. Because the CMBS Centers are owned
by the CMBS Borrower and subject to the CMBS Loan, recourse to the CMBS Centers
by our creditors will be effectively subordinated to recourse by holders of the
CMBS Loan.
25
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. For more information on the CMBS
Loan, see "Note 4. Long Term Debt" to the unaudtied consolidated financial
statements.
Our $125.0 million revolving 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.
During the forty weeks ended March 5, 2004 we repurchased and redeemed our
9.5% senior subordinated notes as follows, in thousands:
Write-off of
Deferred
Aggregate Premium Financing
Principal Price Costs Costs Total Loss
--------- --------- --------- ------------ ------------
Notes repurchased........ $ 56,300 $ 59,424 $ 925 $ 949 $ 1,874
Notes redeemed........... 39,277 39,931 622 741 1,363
--------- --------- --------- ------------ ------------
Total................. $ 95,577 $ 99,355 $ 1,547 $ 1,690 $ 3,237
========= ========= ========= ============ ============
We repurchased $11.0 million aggregate principal amount of our 9.5% senior
subordinated notes at an aggregate price of $11.4 million in the first quarter
of fiscal 2004, which is included above. The premium costs and associated
write-off of deferred financing costs related to this repurchase were recognized
in the fourth quarter of fiscal 2003 and were excluded from the costs above. We
redeemed an additional $15.0 million aggregate principal amount of our 9.5%
senior subordinated notes on March 29, 2004 at an aggregate price of $15.4
million. The redemption was funded by cash flow from operations and proceeds
received from sale-leaseback transactions.
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.
Cash Flows and Liquidity Sources
Our principal liquidity requirements are for debt service and new center
development. We will fund our liquidity needs primarily with cash flow generated
from operations, proceeds received from our sale-leaseback program and, to the
extent necessary, through borrowings under our revolving credit facility,
although alternative forms of funding continue to be evaluated and new
arrangements may be entered into in the future. At March 5, 2004 we had $11.0
million of borrowings outstanding under our revolving credit facility and had
outstanding letters of revolving credit totaling $55.1 million. Our availability
under our revolving credit facility was $58.9 million.
Our consolidated net cash provided by operating activities for the forty
weeks ended March 5, 2004 increased $10.7 million to $59.2 million compared to
$48.5 million in the same period last year. The increase was due primarily to a
change in working capital. Cash and cash equivalents totaled $34.6 million at
March 5, 2004, 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
26
presented in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). We believe EBITDA is a useful tool for
certain investors and creditors for measuring our ability to meet debt service
requirements. Additionally, management uses EBITDA for purposes of reviewing our
results of operations on a more comparable basis. EBITDA does not represent cash
flow from operations as defined by GAAP, is not necessarily indicative of cash
available to fund all cash flow needs and should not be considered an
alternative to net income under GAAP for purposes of evaluating our results of
operations. EBITDA was calculated as follows, in thousands:
Twelve Weeks Ended Forty Weeks Ended
---------------------------- ----------------------------
March 5, 2004 March 7, 2003 March 5, 2004 March 7, 2003
------------- ------------- ------------- -------------
Net income......................... $ 5,065 $ 5,298 $ 6,389 $ 10,055
Interest expense, net.............. 9,840 9,303 36,060 31,576
Income tax expense................. 4,233 3,825 5,605 7,215
Depreciation and amortization...... 13,345 12,543 46,153 42,997
Discontinued operations:
Interest expense................. -- -- -- 1
Income tax benefit............... (333) (351) (848) (623)
Depreciation..................... 395 598 1,275 1,991
------------- ------------- ------------- -------------
EBITDA......................... $ 32,545 $ 31,216 $ 94,634 $ 93,212
============= ============= ============= =============
EBITDA - percentage of net
revenues......................... 16.8% 16.4% 14.6% 14.7%
A reconciliation of EBITDA to cash provided by operating activities was as
follows, in thousands:
Twelve Weeks Ended Forty Weeks Ended
---------------------------- ----------------------------
March 5, 2004 March 7, 2003 March 5, 2004 March 7, 2003
------------- ------------- ------------- -------------
Net cash provided by operating
activities........................ $ 17,487 $ 12,594 $ 59,220 $ 48,461
Income tax expense.................. 4,233 3,825 5,605 7,215
Deferred income tax (expense)
benefit........................... 5,626 (54) 9,103 (5,624)
Interest expense, net............... 9,840 9,303 36,060 31,576
Effect of discontinued operations
on interest and taxes............. (333) (351) (848) (622)
Change in operating assets
and liabilities................... (6,616) 5,281 (16,937) 12,052
Other non-cash items................ 2,308 618 2,431 154
------------- ------------- ------------- -------------
EBITDA............................ $ 32,545 $ 31,216 $ 94,634 $ 93,212
============= ============= ============= =============
During the twelve and forty week periods ended March 5, 2004, EBITDA
increased $1.3 million, or 4.3%, and $1.4 million or 1.5%, respectively, from
the same period last year. The increase was due primarily to higher tuition
rates and cost controls, offset by higher insurance costs and increased rent
expense due primarily to our sale-leaseback program. EBITDA is not intended to
indicate that cash flow is sufficient to fund all of our cash needs or represent
cash flow from operations as defined by accounting principles generally accepted
in the United States of America. In addition, EBITDA should not be used as a
tool for comparison as the computation may not be the same for all companies.
Our current sale-leaseback program began during the fourth quarter of
fiscal year 2002. Under this initiative, we began selling centers to individual
real estate investors and then leasing them back. The resulting leases have been
classified as operating leases with an average lease term of 15 years and three
to four five-year renewal options. We continue to manage the operations of
27
any centers that are sold in such transactions. The sales were summarized as
follows, in thousands:
Fiscal Year Ended
Forty Weeks Ended ---------------------------
March 5, 2004 May 30, 2003 May 31, 2002
------------------ ------------ ------------
Number of centers.................. 29 41 5
Net proceeds from completed sales.. $ 58,099 $ 88,704 $ 9,177
Deferred gains..................... 19,786 32,507 2,599
Our sale-leaseback program has the effect of increasing rent expense, while
typically reducing the depreciation and interest expense incurred to support the
previously owned centers. In addition, deferred gains have generally been
recognized on our sale-leaseback transactions. The deferred gains are amortized
on a straight-line basis, typically over a period of 15 years, and are offset
against the related rent expense. At March 5, 2004 and May 30, 2003, other
noncurrent liabilities on the consolidated balance sheet included deferred gains
on sale-leaseback transactions of $56.5 million and $38.6 million, respectively.
Subsequent to March 5, 2004, we closed $13.0 million in sales, which included
five centers, and are currently in the process of negotiating another $71.7
million of sales related to 28 centers. We expect our sale-leaseback efforts to
continue, assuming the market for such transactions remains favorable.
We believe that cash flow generated from operations, proceeds from our
sale-leaseback program and borrowings under our revolving credit facility will
be sufficient to fund our interest and principal payment obligations, expected
capital expenditures and working capital requirements for the foreseeable
future. Any future acquisitions, joint ventures or similar transactions may
require additional capital, which may be financed through borrowings under our
revolving credit facility, net cash provided by operating activities or our
sale-leaseback program, other third party financing or a combination of these
alternatives, 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.
Contractual Commitments
We have certain contractual obligations and commercial commitments.
Contractual obligations are those that will require cash payments in accordance
with the terms of a contract, such as a loan or lease agreement. Commercial
commitments represent potential obligations for performance in the event of
demands by third parties or other contingent events, such as lines of credit.
Our contractual obligations and commercial commitments at March 5, 2004 were as
follows, in thousands:
Remainder Fiscal Year
of Fiscal ------------------------------------------------------
Total 2004 2005 2006 2007 2008 Thereafter
----------- --------- --------- --------- --------- --------- ----------
Long-term debt.................. $ 517,070 $ 1,116 $ 7,572 $ 4,136 $ 4,314 $ 4,447 $ 495,485
Capital lease obligations....... 27,958 407 2,240 2,279 2,396 2,415 18,221
Operating lease................. 457,948 8,391 48,263 45,056 41,180 37,824 277,234
Standby letters of credit....... 55,139 -- 55,139 -- -- -- --
Other commitments............... 4,892 4,892 -- -- -- -- --
----------- --------- --------- --------- --------- --------- ----------
$ 1,063,007 $ 14,806 $ 113,214 $ 51,471 $ 47,890 $ 44,686 $ 790,940
=========== ========= ========= ========= ========= ========= ==========
Other commitments include center development commitments and purchase order
commitments.
Capital Expenditures
During the forty weeks ended March 5, 2004 and March 7, 2003, we opened 12
and 24 new centers, respectively. In addition, we completed the acquisition of
28
one center in the third quarter of fiscal 2004. We expect to open 17 new centers
in fiscal 2004 and to continue our practice of closing centers that are
identified as not meeting performance expectations. In addition, we may acquire
existing centers from local or regional early childhood education and care
providers. We may not be able to successfully negotiate and acquire sites and/or
previously constructed centers, meet our targets for new center additions or
meet targeted deadlines for development of new centers.
New centers are located based upon detailed site analyses that include
feasibility and demographic studies and financial modeling. The length of time
from site selection to construction and, finally, the opening of a community
center ranges from 16 to 24 months. Frequently, new site negotiations are
delayed or canceled or construction is delayed for a variety of reasons, many of
which are outside our control. The average total cost per community center
typically ranges from $1.9 million to $2.8 million depending on the size and
location of the center. However, the actual costs of a particular center may
vary from such range.
Our new centers typically have a licensed capacity ranging from 145 to 180,
while the centers constructed during fiscal 1997 and earlier have an average
licensed capacity of 125. When mature, these new, 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, in thousands:
Twelve Weeks Ended Forty Weeks Ended
---------------------------- ----------------------------
March 5, 2004 March 7, 2003 March 5, 2004 March 7, 2003
------------- ------------- ------------- -------------
New center development............. $ 5,479 $ 9,706 $ 21,379 $ 44,274
Renovation of existing facilities.. 3,537 3,425 12,610 14,648
Equipment purchases................ 1,681 2,092 6,652 9,516
Information systems purchases...... 67 317 704 1,293
------------- ------------- ------------- -------------
$ 10,764 $ 15,540 $ 41,345 $ 69,731
============= ============= ============= =============
Capital expenditures for the forty weeks ended March 5, 2004 do not include
$97.9 million spent to purchase the 44 centers previously included in the
synthetic lease facility. Capital expenditures for the twelve and forty weeks
ended March 5, 2004 do not include $0.9 million for the acquisition of a
previously constructed center.
Capital expenditure limits under our credit facility for fiscal year 2004
are $110.0 million. We have some ability to incur additional indebtedness,
including through mortgages or sale-leaseback transactions, subject to the
limitations imposed by the indenture under which our senior subordinated notes
were issued and our revolving credit facility.
Wage Increases
Expenses for salaries, wages and benefits represented approximately 55.3%
of net revenues for the forty weeks ended March 5, 2004. We believe that,
through increases in our tuition rates, we can mitigate any future increase in
expenses caused by adjustments to the federal or state minimum wage rates or
other market adjustments. However, we may not be able to increase our rates
sufficiently to offset such increased costs. We continually evaluate our wage
structure and may implement changes at targeted local levels.
29
Forward-Looking Statements
We have made statements in this report that constitute forward-looking
statements as that term is defined in the federal securities laws. These
forward-looking statements concern our operations, economic performance and
financial condition and include statements regarding: opportunities for growth;
the number of early childhood education and care centers expected to be added in
future periods; the profitability of newly opened centers; capital expenditure
levels; the ability to refinance or incur additional indebtedness; strategic
acquisitions, investments, alliances and other transactions; changes in
operating systems and policies and their intended results; our expectations and
goals for increasing center revenue and improving our operational efficiencies;
changes in the regulatory environment; the potential benefit of tax incentives
for child care programs; our projected cash flow; and our marketing efforts to
sell and leaseback centers. The forward-looking statements are subject to
various known and unknown risks, uncertainties and other factors. When we use
words such as "believes," "expects," "anticipates," "plans," "estimates,"
"projects," "may," "intends," "seeks" or similar expressions, we are making
forward-looking statements.
All forward-looking statements address matters that involve risks and
uncertainties. Accordingly, there are or will be important factors that could
cause actual results to differ materially from those indicated in these
statements. We believe that these factors include the following:
o the effects of general economic conditions, including changes in the
rate of inflation, tuition price sensitivity and interest rates;
o competitive conditions in the early childhood education and care
industry;
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, tax rates,
minimum wage increases and licensing standards;
o the loss or reduction of government funding for child care assistance
programs or the establishment of a governmentally mandated universal
child care benefit;
o our inability to successfully execute our growth strategy or plans
designed to improve the operating results, cash flow or our financial
position, or to improve our disclosure controls and procedures;
o the availability of financing, additional capital or access to the
sale-leaseback market;
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 hinder our ability 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;
30
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.
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 undertake no obligation to
publicly update or revise any forward-looking statement or to update the reasons
why actual results could differ from those projected in the forward-looking
statement, whether as a result of new information, future developments or
otherwise.
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 $194.4 million at March 5, 2004. We
also have no cash flow exposure on certain industrial revenue bonds, mortgages
and notes payable aggregating $5.1 million at March 5, 2004. However, we have
cash flow exposure on our revolving credit facility and certain industrial
revenue bonds subject to variable LIBOR or adjusted base rate pricing. We had
borrowings of $11.0 million outstanding under our credit facility at March 5,
2004. 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 both the
twelve and forty weeks ended March 5, 2004. 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 March 5, 2004, would have resulted in
interest expense changing by less than $0.1 million in the third quarters of
fiscal 2004 and 2003, and $0.1 million in the forty weeks ended March 5, 2004
and March 7, 2003, respectively.
We have cash flow exposure on the CMBS Loan entered into in July 2003,
which bears interest at a rate equal to LIBOR plus 2.25%. A 1% (100 basis
points) change in the LIBOR rate would have resulted in interest expense
changing by approximately $0.7 million and $2.1 million in the twelve and forty
weeks ended March 5, 2004, respectively. We have purchased an interest rate cap
agreement to protect us from significant movements in LIBOR during the initial
three years of the CMBS Loan. The LIBOR strike price is 6.50% under the interest
rate cap agreement, which terminates July 9, 2006, at which time we are required
to purchase an additional interest rate cap agreement for the duration of the
loan term.
We also have cash flow exposure on our vehicle leases with variable
interest rates. A 1% (100 basis points) change in the interest rate defined in
our vehicle lease agreement would have resulted in rent expense changing by
approximately $0.1 million in both of the third quarters of fiscal 2004 and 2003
and $0.4 million and $0.3 million in the forty weeks ended March 5, 2004 and
March 7, 2003, respectively.
Foreign Exchange Risk
We are exposed to foreign exchange risk to the extent of fluctuations in
the United Kingdom pound sterling. Based upon the relative size of our
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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 were effective in ensuring that information required to be disclosed
in our Exchange Act reports was:
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 third
quarter ended March 5, 2004 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: Furnished January 23, 2004 for second quarter fiscal
2004 earnings released on January 22, 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 April 15, 2004.
KINDERCARE LEARNING CENTERS, INC.
By: /s/ DAVID J. JOHNSON
-------------------------------------
David J. Johnson
Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)
By: /s/ DAN R. JACKSON
-------------------------------------
Dan R. Jackson
Executive Vice President,
Chief Financial Officer
(Principal Financial and Accounting Officer)
34